26th Feb 2010 07:00
LANCASHIRE HOLDINGS LIMITED GROWTH IN FULLY CONVERTED BOOK VALUE PER SHARE, ADJUSTED FOR DIVIDENDS, OF 7.0% IN Q4, 26.5% IN 2009 COMBINED RATIO OF 25.7% IN Q4 2009, 44.6% FOR 2009 FINAL DIVIDEND OF 10.0 CENTS PER COMMON SHARE FULLY CONVERTED BOOK VALUE PER SHARE OF $7.41 AT 31 DECEMBER 2009 26 February 2010 Hamilton, Bermuda
Lancashire Holdings Limited ("Lancashire" or "the Group") today announces its preliminary financial results for the fourth quarter of 2009 and the twelve month period ended 31 December 2009.
Financial highlights for the fourth quarter of 2009:
* Fully converted book value per share of $7.41 at 31 December 2009 compared
to $6.89 at 31 December 2008. Return on equity, defined as growth in fully
converted book value per share adjusted for dividends, of 7.0% (Q4 2008:
8.3%); * Operating return on equity of 7.7% (Q4 2008: 8.1%); * Gross written premiums of $103.4 million (Q4 2008: $130.1 million). Net written premiums of $100.0 million (Q4 2008: $130.1 million);
* Reported loss ratio of negative 0.8% (Q4 2008: 11.5%) and combined ratio of
25.7% (Q4 2008: 35.4%). Accident year loss ratio of 24.0% (Q4 2008: 21.1%);
* Annualised total investment return of 2.1% (Q4 2008: 8.9%);
* Net operating profit of $122.4 million (Q4 2008: $98.3 million), or $0.65
(Q4 2008: $0.55) diluted operating earnings per share;
* Net profit after tax of $129.6 million (Q4 2008: $81.1 million), or $0.69
(Q4 2008: $0.46) diluted earnings per share; * Special dividend of $263.0 million (Q4 2008: $nil) or $1.25 per common share; and * Share repurchases of $16.9 million (Q4 2008: $nil).
Financial highlights for the twelve months to 31 December 2009:
* Return on equity, defined as growth in fully converted book value per share
adjusted for dividends, of 26.5% (2008: 7.8%); * Operating return on equity of 24.9% (2008: 9.6%); * Gross written premiums of $627.8 million (2008: $638.1 million). Net written premiums of $577.1 million (2008: 574.7 million); * Reported loss ratio of 16.6% (2008: 61.8%) and combined ratio of 44.6% (2008: 86.3%). Accident year loss ratio of 27.2% (2008: 66.5%); * Total investment return of 3.9% (2008: 3.1%); * Net operating profit of $364.7 million (2008: $119.4 million), or $1.94 (2008: $0.65) diluted operating earnings per share; * Net profit after tax of $385.4 million (2008: $97.5 million), or $2.05 (2008: $0.53) diluted earnings per share; * Interim dividend of $10.5 million (2008: $nil) or 5.0 cents per common share declared in July 2009, paid in October 2009;
* Special dividend of $263.0 million (2008: $nil) or $1.25 per common share
declared in November 2009, paid in January 2010; and
* Share repurchases of $16.9 million (2008: $58.0 million).
Richard Brindle, Group Chief Executive Officer, commented:
"Lancashire had an excellent 2009. Return on equity, defined as growth in fullyconverted book value per share adjusted for dividends, was 7.0% in the fourthquarter, and 26.5% for the year. Since inception, our compound annual return onequity is 19.8%.Our performance was largely driven by underwriting, evident in the combinedratios of 25.7% for the fourth quarter and 44.6% for the year. Our accidentyear loss ratios, removing the impact of favourable prior year reservedevelopment, were an excellent 24.0% for the fourth quarter and 27.2% for theyear. Since we started in business, our weighted average combined ratio is57.5%, a testament to our most important strategic cornerstone: UnderwritingComes First. Our investments also generated a significant contribution, with atotal return for the year of 3.9%. Our appetite for investment risk remainslow, and will continue to be so. We are very pleased to have achieved apositive total investment return for our shareholders in fifteen out of sixteenquarters. Capital management again played an important role in our overallperformance and we were delighted to return a substantial amount of capital toour shareholders during the year. Finally, we were very proud to list on theMain Market of the London Stock Exchange in 2009, joining the FTSE 250 in theprocess.The outlook for 2010 looks reasonable. The reinsurance market, while modestlyoff its all-time highs, remains fairly disciplined. As expected, the specialistinsurance classes are coming under some pressure, but remain relativelyattractive overall. In the past 12 months, industry capital has recovered well,faster than expected. We are encouraged to see increasing numbers of companiesreturning capital, but remain concerned that insufficient efforts will be madeacross the broader market. This increased supply of capital is placing pressureon pricing in certain areas, a trend we unfortunately expect to gather pace asthe year progresses. With that in mind, we actively sought to shift our renewalpattern forward for 2010, writing an increased level of well-priced propertycatastrophe reinsurance compared to 2009; thereby taking advantage of what webelieve may be the high point of rates in the year. Correspondingly, we expectto write less business in later months than we did last year.Most importantly, in 2010 the Lancashire approach will be business as usual:stay disciplined, don't be tempted to sacrifice profits for volume, and preparefor the unexpected - good or bad. All in all, we are positive about theprospects for Lancashire in the next 12 months, and believe our strategy willcontinue to produce an attractive return for shareholders."
Neil McConachie, President and Group Chief Financial Officer, commented:
"In 2009 we generated comprehensive income of $388.2 million. Between recentshare repurchases and dividends, including our final dividend of $20.8 millionannounced today, we are returning $314.8 million or fully 81% of 2009comprehensive income. More will be returned in the next weeks and months.At Lancashire, we strongly believe that prudent but active management ofcapital is fundamental to our business, and this will be at the forefront ofour minds in 2010. Currently, we have significant levels of capital above ourrequirements. At today's share price, our favoured method of returning capitalis to buy back shares. As of 25 February, we have $171.5 million remainingunder existing share repurchase authorisations and anticipate requestingshareholder approval for additional capacity at our forthcoming AGM. Shouldprices remain attractive, this is something that we expect to do in increasingamounts. At the same time, we will continually monitor alternative approachesto capital management. Should trading conditions remain the same or graduallydeteriorate, absent a change in our business plan, we would anticipatereturning more capital than we generate during 2010."
Lancashire Renewal Price Index for Major Classes
Lancashire's Renewal Price Index ("RPI") is an internal tool that itsmanagement uses to track trends in premium rates on a portfolio of insuranceand reinsurance contracts. The RPI is calculated on a per contract basis andreflects Lancashire's assessment of relative change in price, terms, conditionsand limits and is weighted by premium volume. See "Note Regarding RPI Tool" atthe end of this announcement.
The following RPIs are expressed as an approximate percentage of pricing achieved on similar contracts written in 2008:
Class Q1 2009 Q2 2009 Q3 2009 Q4 2009 Aviation (AV52) 100% 99% 100% 95% Gulf of Mexico Energy 250% 216% 172% 100% Energy Offshore 113% 113% 110% 103%Worldwide Marine 105% 99% 100% 101% Direct & Facultative 108% 110% 108% 100% Property Reinsurance 146% 118% 129% 98% Terrorism 93% 93% 95% 94% Combined 113%* 113%* 107%* 98%**
The overall RPI for the year to 31 December 2009 is 109% **
Notes
* Q1, Q2 and Q3 combined RPI have been updated for subsequent adjustments to bound premium.
** Q4 and overall RPI are taken at the end of the quarter.
Underwriting results
Gross written premiums decreased by 20.5% in the fourth quarter of 2009 and by 1.6% for the twelve months ended 31 December 2009 compared with the same periods in 2008.
The Group's four principal classes, and a discussion of the key market factors impacting them, are as follows:
Gross Written Premium Q4 Twelve months to 31 December 2009 2008 Change Change 2009 2008 Change Change $m $m $m % $m $m $m % Property 47.2 59.0 (11.8) (20.0) 317.3 302.7 14.6 4.8 Energy 14.7 16.1 (1.4) (8.7) 175.5 185.2 (9.7) (5.2) Marine 12.7 13.0 (0.3) (2.3) 73.7 78.6 (4.9) (6.2) Aviation 28.8 42.0 (13.2) (31.4) 61.3 71.6 (10.3) (14.4) Total 103.4 130.1 (26.7) (20.5) 627.8 638.1 (10.3) (1.6)Property gross written premiums decreased by 20.0% for the fourth quartercompared to the same period in 2008, and increased by 4.8% in the twelve monthsto 31 December 2009 compared to the twelve months to 31 December 2008. In 2009overall the Group wrote significantly more property catastrophe reinsurancerisks than in 2008. In the first quarter of 2009, a tactical decision was madeto reduce volumes in the retrocession and direct and facultative classes ascompared to the first quarter in 2008. This was done in anticipation ofimproving trading conditions in some classes, including property catastrophe,later in the year. Subsequently, the Group expanded into the propertycatastrophe excess of loss market. In the fourth quarter of 2009, as comparedto the same period of 2008, there was a reduction in property retrocessionpremiums due to a reduction in underlying exposures in addition to the impactof certain multi-year political risk contracts which are not yet due forrenewal.Energy gross written premiums decreased by 8.7% for the fourth quarter of 2009compared to the same period in 2008 and by 5.2% in the twelve months to 31December 2009 compared to the twelve months to 31 December 2008. Gulf of Mexicovolumes were lower in the first half 2009 compared to 2008 due to a reductionin demand. Some construction projects were also curtailed in the recessionaryenvironment. This reduction in volume was somewhat offset by increased volumein the worldwide offshore line later in the year despite a significant fourthquarter contract renewing in 2010.Marine gross written premiums decreased by 2.3% for the fourth quarter of 2009compared to the same period in 2008 and by 6.2% in the twelve months to 31December 2009 compared to the twelve months to 31 December 2008. The decline islargely due to recessionary driven reductions in shipbuilding projects and thetiming of certain multi-year contract renewals.Aviation gross written premiums decreased by 31.4% for the fourth quartercompared to the same period in 2008 and decreased by 14.4% in the twelve monthsto 31 December 2009 compared to the twelve months to 31 December 2008. Thesereductions were driven primarily by the non-renewal of a satellite riskprogramme in the first quarter of 2009. ******* Ceded premiums increased by $3.4 million in the fourth quarter compared to thesame period in 2008. For the twelve month period to 31 December 2009, cededpremiums reduced by 20.0% compared to the same period in 2008 due to areduction in the level of reinsurance purchased in respect of Gulf of Mexicoenergy catastrophe risks. This is directly related to the lower volumes ofpremium written in this class compared to the previous year. ******* Net earned premiums as a proportion of net written premiums were 155.6% in thefourth quarter of 2009 compared to 109.1% in the same period in 2008 and 103.0%in the twelve months to 31 December 2009 compared to 105.7% in the same periodin 2008. 2008 premium volumes were lower than 2007, which led to a reduction inthe deferral of earnings into 2009. The Group also reduced premiums written inthe first quarter of 2009 compared to 2008, resulting in a greater amount ofpremium being earned comparatively later in the year. The significant increasein the volume of property catastrophe business written in June and July 2009served to increase earned premiums in the second half of 2009, bringing theratio of earned premium for the year in line with 2008. ******* The net loss ratio for the fourth quarter was negative 0.8% compared to 11.5%for the same period in 2008. The net loss ratio for the twelve months to 31December 2009 was 16.6% compared to 61.8% for the twelve months to 31 December2008. The low loss ratios are mainly a reflection of an unusually low number ofreported losses during the year and some favourable development of prioraccident year reserves. The table below provides further detail of developmentby class excluding the impact of foreign exchange revaluations. Hurricane Ikenet reserves developed $17.1 million favourably in the fourth quarter and $17.1million adversely in 2009 overall.Loss Development by Class Twelve months to 31 December Q4 2009 Q4 2008 2009 2008 $m $m $m $m Property 7.5 2.8 44.4 22.3 Energy 29.6 8.3 9.3 5.5 Marine 2.2 1.3 6.1 - Aviation 0.2 0.1 3.7 0.8 Total 39.5 12.5 63.5 28.6
Note: Positive numbers denote favourable development and negative numbers denote adverse development.
Net prior accident year reserve releases were $39.5 million for the fourthquarter and $63.5 million for the twelve months to 31 December 2009 compared to$12.5 million and $28.6 million for the same periods in 2008. The increase inreserve releases in 2009 is a result of a lower number of attritional lossesreported on expiring years than expected, resulting in IBNR releases, plus thefavourable negotiation and settlement of a number of individually insignificantsmaller and medium sized reported losses. The accident year loss ratio for thefourth quarter of 2009 was 24.0% compared to 21.1% for the same period in 2008.For the twelve months to 31 December 2009, the accident year loss ratio was27.2% compared to 66.5% for the 2008 accident year. The higher ratio in 2008 islargely due to losses from Hurricane Ike. During 2009, previous accident yearsdeveloped as follows: * 2006 - favourable development of $4.4 million; * 2007 - favourable development of $25.2 million; and * 2008 - favourable development of $33.9 million.
Investments
Net investment income was $14.0 million for the fourth quarter, a smallincrease of 4.5% from the fourth quarter of 2008, due to a larger amount ofinvested assets compared to the same period in the prior year. Net investmentincome was $56.0 million for the twelve months to 31 December 2009, a decreaseof 5.9% over the same period in 2008, which is largely due to a reduction inthe overall portfolio yield.Total investment return, including net investment income, net realised gainsand losses, impairments and net change in unrealised gains and losses, was$11.1 million for the fourth quarter compared to $37.9 million for the sameperiod in 2008. The increase in treasury yields in December 2009 resulted innet unrealised losses for the Group in the fourth quarter of 2009 compared tonet unrealised gains in the same period of 2008, when treasury yields fell. Forthe twelve months to 31 December 2009 total investment return was $82.9 millionversus $54.7 million for the same period in 2008. Given the improved economicenvironment in 2009 compared to 2008, there were less impairments recognised.Impairment losses in 2009 were $0.4million versus $21.6 million in 2008. TheGroup also realised significant net gains as a result of a re-alignment of itsinvestment portfolio, as the Group's investment outlook evolved.The Group continues to hold a highly conservative portfolio, consistent withits long-held philosophy, with a strong emphasis on preserving capital. Thecorporate bond allocation, excluding Federal Deposit Insurance Corporationguaranteed bonds, has increased by 8.4% from 31 December 2008, bringing thetotal holding to 23.6% of managed invested assets. There was a small increasein the allocation to Treasury Inflation Protected Securities to hedge againstpotential future inflationary pressures, bringing the total holding of thesesecurities to 4.0% of managed invested assets. At 31 December 2009, the managedportfolio comprised 92.9% fixed income securities and 7.1% cash and cashequivalents versus the 2008 year end of 80.3% fixed income securities, 19.4%cash and cash equivalents and 0.3% equities. The Group is not currentlyinvested in equities, hedge funds or other alternative investments. Subsequentto the year end, the Group invested 3.9% of its portfolio in emerging marketdebt.
Key investment portfolio statistics as at 31 December are:
2009 2008 Duration 2.3 years 1.8 years Credit quality AA+ AA+ Book yield 2.8% 3.4% Market yield 2.2% 2.7%Other operating expenses
Other operating expenses, excluding employee remuneration, are broadly consistent compared to 2008 for the quarter and the year, reflecting the Group's stable operating platform. Fixed employee remuneration costs were 33.1% of other operating expenses in 2009 compared to 36.3% in 2008. Variable employee remuneration costs were 27.2% in 2009 compared to 16.0% in 2008, reflecting the strong performance of the Group in 2009.
Equity based compensation was $7.1 million in the fourth quarter of 2009compared to $8.9 million in the same period of 2008. For the twelve months to31 December 2009 and 2008 the charges were $16.4 million and $10.6 millionrespectively. Annual restricted stock awards typically vest over three years.The increased 2009 expense reflects two years worth of restricted stock awards.The restricted stock program began in 2008. This expense also includesmark-to-market adjustments on certain performance warrants plus chargesassociated with the revaluation of options due to amendments made to theirstrike price as a result of dividend declarations.
Capital
At 31 December 2009, total capital was $1.510 billion, comprising shareholders' equity of $1.379 billion and $131.4 million of long-term debt. Leverage was 8.7%. Total capital at 31 December 2008 was $1.404 billion and leverage was 9.3%.
Repurchase program
The Group continues to repurchase its own shares by way of on market purchasesutilising the approximately $21.5 million remaining to be repurchased under thefacility approved in 2008, and the $150.0 million facility approved by theBoard of Directors on 4 November 2009 and by shareholders at the SpecialGeneral Meeting held on 16 December 2009 (the "Repurchase Program"). $16.9million of shares were repurchased and held in Treasury during 2009 compared to$58.0 million during 2008.The Board will be proposing at the Annual General Meeting, to be held on 4 May2010, that the shareholders approve a renewal of the Repurchase Program withsuch authority to expire on the conclusion of the 2011 Annual General Meetingor, if earlier, 15 months from the date the resolution approving the RepurchaseProgram is passed.Dividends
During 2009 the Lancashire Board declared an interim and special dividend of 5.0 cents and $1.25 per common share respectively.
The Group also announces that its Board has declared a final dividend of 10.0cents per common share (approximately 6.4 pence per common share at the currentexchange rate), which results in an aggregate payment of approximately $17.0million. The dividend will be paid in GBP on 14 April 2010 (the "DividendPayment Date") to shareholders of record on 19 March 2010 using the GBP£/US$spot market exchange rate at the close of business in London on the recorddate.In addition to the dividend payment to shareholders, $3.8 million in aggregatewill be paid on the Dividend Payment Date to holders of warrants issued by theCompany pursuant to the terms of the warrants.
Lancashire will continue to review the appropriate level and composition of capital for the Group with the intention of managing capital to enhance risk-adjusted returns on equity.
Outlook
Lancashire aims to achieve a cross-cycle return of 13% above a risk free rate. This is unchanged from previous guidance.
Financial information and posting of accounts
The consolidated financial statements set out below are unaudited. The auditedAnnual Report and Accounts are expected to be posted to shareholders no laterthan 30 March 2010 and will also be available on the Company's website by thisdate.
Further details of our 2009 fourth quarter results can be obtained from our Financial Supplement. This can be accessed via our website www.lancashiregroup.com.
Analyst and Investor Earnings Conference Call
There will be an analyst and investor conference call on the results at 2:00pmUK time / 9:00 am EST on Friday 26 February 2010. The call will be hosted byRichard Brindle, Chief Executive Officer, Neil McConachie, President and ChiefFinancial Officer, Alex Maloney, Group Chief Underwriting Officer and SimonBurton, Deputy Chief Executive Officer.The call can be accessed by dialing +44 (0)20 7806 1953 / +1 718 354 1387 withthe passcode 2144649. The call can also be accessed via webcast, please go toour website (www.lancashiregroup.com) to access.A replay facility will be available for two weeks until Saturday 13 March 2010.The dial in number for the replay facility is +44 (0)20 7111 1244 / + 1 347 3669565 and the passcode is 2144649#. The replay facility can also be accessed atwww.lancashiregroup.com .
For further information, please contact:
Lancashire Holdings + 44 (0)20 7264 4066 Jonny Creagh-Coen Haggie Financial +44 (0)20 7417 8989 Peter Rigby Henny Breakwell
Investor enquiries and questions can also be directed to [email protected] or by accessing the Company's website www.lancashiregroup.com.
About Lancashire
Lancashire, through its UK and Bermuda-based insurance subsidiaries, is aglobal provider of specialty insurance products. Its insurance subsidiariescarry the Lancashire group rating of A minus (Excellent) from A.M. Best with astable outlook. Lancashire has capital in excess of $1 billion and its CommonShares trade on the main market of the London Stock Exchange under the tickersymbol LRE. Lancashire is headquartered at Power House, 7 Par-la-Ville Road,Hamilton HM 11, Bermuda. The mailing address is Lancashire Holdings Limited,P.O. Box HM 2358, Hamilton HM HX, Bermuda. For more information on Lancashire,visit the Company's website at www.lancashiregroup.com
NOTE REGARDING RPI TOOL
LANCASHIRE'S RENEWAL PRICE INDEX ("RPI") IS AN INTERNAL TOOL THAT ITSMANAGEMENT USES TO TRACK TRENDS IN PREMIUM RATES OF A PORTFOLIO OF INSURANCEAND REINSURANCE CONTRACTS. THE RPI IS CALCULATED ON A PER CONTRACT BASIS ANDREFLECTS LANCASHIRE'S ASSESSMENT OF RELATIVE CHANGES IN PRICE, TERMS,CONDITIONS AND LIMITS AND IS WEIGHTED BY PREMIUM VOLUME. THE CALCULATIONINVOLVES A DEGREE OF JUDGMENT IN RELATION TO COMPARABILITY OF CONTRACTS AND THEASSESSMENT NOTED ABOVE. TO ENHANCE THE RPI TOOL, MANAGEMENT OF LANCASHIRE MAYREVISE THE METHODOLOGY AND ASSUMPTIONS UNDERLYING THE RPI, SO THE TRENDS INPREMIUM RATES REFLECTED IN THE RPI MAY NOT BE COMPARABLE OVER TIME.CONSIDERATION IS ONLY GIVEN TO RENEWALS OF A COMPARABLE NATURE SO IT DOES NOTREFLECT EVERY CONTRACT IN LANCASHIRE'S PORTFOLIO. THE FUTURE PROFITABILITY OFTHE PORTFOLIO OF CONTRACTS WITHIN THE RPI IS DEPENDENT UPON MANY FACTORSBESIDES THE TRENDS IN PREMIUM RATES.
NOTE REGARDING FORWARD-LOOKING STATEMENTS:
CERTAIN STATEMENTS AND INDICATIVE PROJECTIONS (WHICH MAY INCLUDE MODELED LOSSSCENARIOS) MADE THAT ARE NOT BASED ON CURRENT OR HISTORICAL FACTS AREFORWARD-LOOKING IN NATURE INCLUDING WITHOUT LIMITATION, STATEMENTS CONTAININGTHE WORDS 'BELIEVES', 'ANTICIPATES', 'PLANS', 'PROJECTS', 'FORECASTS','GUIDANCE', 'INTENDS', 'EXPECTS', 'ESTIMATES', 'PREDICTS', 'MAY', 'CAN','WILL', 'SEEKS', 'SHOULD', OR, IN EACH CASE, THEIR NEGATIVE OR COMPARABLETERMINOLOGY. ALL STATEMENTS OTHER THAN STATEMENTS OF HISTORICAL FACTSINCLUDING, WITHOUT LIMITATION, THOSE REGARDING THE GROUP'S FINANCIAL POSITION,RESULTS OF OPERATIONS, LIQUIDITY, PROSPECTS, GROWTH, CAPITAL MANAGEMENT PLANS,BUSINESS STRATEGY, PLANS AND OBJECTIVES OF MANAGEMENT FOR FUTURE OPERATIONS(INCLUDING DEVELOPMENT PLANS AND OBJECTIVES RELATING TO THE GROUP'S INSURANCEBUSINESS) ARE FORWARD-LOOKING STATEMENTS. SUCH FORWARD-LOOKING STATEMENTSINVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER IMPORTANT FACTORS THATCOULD CAUSE THE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE GROUP TO BEMATERIALLY DIFFERENT FROM FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS EXPRESSEDOR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS.THESE FACTORS INCLUDE, BUT ARE NOT LIMITED TO: THE NUMBER AND TYPE OF INSURANCEAND REINSURANCE CONTRACTS THAT WE WRITE; THE PREMIUM RATES AVAILABLE AT THETIME OF SUCH RENEWALS WITHIN OUR TARGETED BUSINESS LINES; THE LOW FREQUENCY OFLARGE EVENTS; UNUSUAL LOSS FREQUENCY; THE IMPACT THAT OUR FUTURE OPERATINGRESULTS, CAPITAL POSITION AND RATING AGENCY AND OTHER CONSIDERATIONS HAVE ONTHE EXECUTION OF ANY CAPITAL MANAGEMENT INITIATIVES; THE POSSIBILITY OF GREATERFREQUENCY OR SEVERITY OF CLAIMS AND LOSS ACTIVITY THAN OUR UNDERWRITING,RESERVING OR INVESTMENT PRACTICES HAVE ANTICIPATED; THE RELIABILITY OF, ANDCHANGES IN ASSUMPTIONS TO, CATASTROPHE PRICING, ACCUMULATION AND ESTIMATED LOSSMODELS; LOSS OF KEY PERSONNEL; A DECLINE IN OUR OPERATING SUBSIDIARIES' RATINGWITH A.M. BEST COMPANY AND/OR OTHER RATING AGENCIES; INCREASED COMPETITION ONTHE BASIS OF PRICING, CAPACITY, COVERAGE TERMS OR OTHER FACTORS; A CYCLICALDOWNTURN OF THE INDUSTRY; THE IMPACT OF A DETERIORATING CREDIT ENVIRONMENTCREATED BY THE FINANCIAL MARKETS AND CREDIT CRISIS; A RATING DOWNGRADE OF, OR AMARKET DECLINE IN, SECURITIES IN OUR INVESTMENT PORTFOLIO; CHANGES INGOVERNMENTAL REGULATIONS OR TAX LAWS IN JURISDICTIONS WHERE LANCASHIRE CONDUCTSBUSINESS; LANCASHIRE OR ITS BERMUDIAN SUBSIDIARY BECOMING SUBJECT TO INCOMETAXES IN THE UNITED STATES OR THE UNITED KINGDOM; AND THE EFFECTIVENESS OF OURLOSS LIMITATION METHODS. ANY ESTIMATES RELATING TO LOSS EVENTS INVOLVE THEEXERCISE OF CONSIDERABLE JUDGEMENT AND REFLECT A COMBINATION OF GROUND-UPEVALUATIONS, INFORMATION AVAILABLE TO DATE FROM BROKERS AND INSUREDS, MARKETINTELLIGENCE, INITIAL AND/OR TENTATIVE LOSS REPORTS AND OTHER SOURCES.JUDGEMENTS IN RELATION TO NATURAL CATASTROPHE AND MAN MADE EVENTS INVOLVECOMPLEX FACTORS POTENTIALLY CONTRIBUTING TO THESE TYPES OF LOSS, AND WE CAUTIONAS TO THE PRELIMINARY NATURE OF THE INFORMATION USED TO PREPARE ANY SUCHESTIMATES.THESE FORWARD-LOOKING STATEMENTS SPEAK ONLY AS AT THE DATE OF PUBLICATION.LANCASHIRE HOLDINGS LIMITED EXPRESSLY DISCLAIMS ANY OBLIGATION OR UNDERTAKING(SAVE AS REQUIRED TO COMPLY WITH ANY LEGAL OR REGULATORY OBLIGATIONS (INCLUDINGTHE RULES OF THE LONDON STOCK EXCHANGE)) TO DISSEMINATE ANY UPDATES ORREVISIONS TO ANY FORWARD-LOOKING STATEMENTS TO REFLECT ANY CHANGES IN THEGROUP'S EXPECTATIONS OR CIRCUMSTANCES ON WHICH ANY SUCH STATEMENT IS BASED.consolidated statement of comprehensive incomefor the year ended 31 december 2009 notes 2009 2008 $m $m gross premiums written 2 627.8 638.1 outwards reinsurance premiums 2 (50.7) (63.4) net premiums written 577.1 574.7
change in unearned premiums 2 22.0
42.2
change in unearned premiums on premiums ceded 2 (4.4) (9.6) net premiums earned 594.7 607.3 net investment income 3 56.0 59.5 net other investment income (losses) 3, 19 0.3
(0.7)
net realised gains (losses) and impairments 3, 19 23.8 (11.0)
net foreign exchange gains (losses) 3.4 (8.5) total net revenue 678.2 646.6
insurance losses and loss adjustment expenses 2 104.4 418.8
insurance losses and loss adjustment expenses 2 (5.7) (43.3)recoverable net insurance losses 98.7 375.5 insurance acquisition expenses 2, 4 112.6
106.9
insurance acquisition expenses ceded 2, 4 (6.6) (7.3) other operating expenses 5, 6, 7, 76.9 59.9 22 total expenses 281.6 535.0 results of operating activities 396.6 111.6 financing costs 18, 19 8.1 14.0 profit before tax 388.5 97.6 tax 8, 9 3.1 0.1
profit for the year attributable to equity 385.4
97.5shareholders
net change in unrealised gains (losses) on 3 2.7
7.1investments tax benefit (expense) on net change in 8 0.1
(0.2)
unrealised gains (losses) on investments
other comprehensive income 2.8 6.9 total comprehensive income attributable to 388.2 104.4equity shareholders earnings per share basic 23 $2.23 $0.55 diluted 23 $2.05 $0.53consolidated balance sheetas at 31 december 2009 notes 2009 2008 $m $m assets cash and cash equivalents 10, 18 440.0 413.6 accrued interest receivable 13, 18 12.0 10.1 investments - fixed income securities - available for sale 11, 18 1,892.5 1,595.4
- at fair value through profit and loss 11, 18 -
4.0
- equity securities - available for sale 11, 18 -
5.8 reinsurance assets - unearned premiums on premiums ceded 12 5.6 10.0 - reinsurance recoveries 12, 13 35.8 42.1 - other receivables 12, 13 4.3 3.2 deferred acquisition costs 14 52.9 60.9 other receivables 13 4.3 154.0 inwards premiums receivable from insureds and 13 178.2 187.3cedants deferred tax asset 9 3.3 1.2 property, plant and equipment 17 8.2 1.4 total assets 2,637.1 2,489.0 liabilities insurance contracts - losses and loss adjustment expenses 12 488.9 528.8 - unearned premiums 12 317.6 339.6 - other payables 12, 15 15.8 17.6 amounts payable to reinsurers 12, 15 4.2 2.0
deferred acquisition costs ceded 16 2.7
1.9 other payables 15 291.4 190.3 corporation tax payable 8 2.4 - interest rate swap 19 3.6 4.9 accrued interest payable 18 0.2 0.4 long-term debt 18 131.4 130.8 total liabilities 1,258.2 1,216.3 shareholders' equity share capital 20 91.2 91.1 own shares 20 (76.4) (58.0) share premium 2.4 2.4 contributed surplus 757.0 758.2 accumulated other comprehensive income 11 30.4 27.6 other reserves 21 65.3 54.3 retained earnings 509.0 397.1 total shareholders' equity attributable to equity 1,378.9 1,272.7shareholders total liabilities and shareholders' equity 2,637.1
2,489.0
The consolidated financial statements were approved by the Board of Directors on 25 February 2010
consolidated statement of changes in shareholders' equity
for the year ended 31 december 2009
notes share own share contributed accumulated
other retained total
capital shares surplus other reserves earnings premium comprehensive income $m $m $m $m $m $m $m $m balance as at 31 91.1 - 2.4 758.2 20.7 43.7 299.5 1,215.6december 2007 total comprehensive 3, 8 - - - - 6.9 - 97.5 104.4income for the year shares repurchased 20 - (58.0) - - - - - (58.0)and held in treasury dividends on common - - - - - - 0.1 0.1shares warrant issues - 6 - - - - - 2.4 - 2.4management and performance option issues 6 - - - - - 6.7 - 6.7 restricted stock 6 - - - - - 1.5 - 1.5issues - ordinary and exceptional balance as at 31 91.1 (58.0) 2.4 758.2 27.6 54.3 397.1 1,272.7december 2008 total comprehensive 3, 8 - - - - 2.8 - 385.4 388.2income for the year 20 - (16.9) - - - - - (16.9)shares repurchased and held in treasury shares repurchased 20 - (8.0) - - - - - (8.0)by trust shares distributed 20 - 6.5 - (6.5) - - - -by trust dividends on common 15, - - - - - - (225.0) (225.0)shares 20 dividends on 15, - - - - - - (48.5) (48.5)warrants 20 warrant exercises - 20 0.1 - - (0.1) - - - -founders option exercises - - - 5.4 - (5.4) - - warrant issues - 6 - - - - - 3.4 - 3.4performance option issues 6 - - - - - 5.7 - 5.7 restricted stock 6 - - - - - 7.3 - 7.3issues balance as at 31 91.2 (76.4) 2.4 757.0 30.4 65.3 509.0 1,378.9december 2009 statement of consolidated cash flows for the year ended 31 december 2009
notes 2009 2008 $m $m
cash flows from operating activities
profit before tax 388.5 97.6 tax paid (2.7) (0.9) depreciation 7 0.8 1.1 interest expense 18 6.4 9.8 interest and dividend income (64.7) (59.6)
accretion of fixed income securities 5.3
- equity based compensation 5, 6 16.4 10.6
foreign exchange (gains) losses (2.3)
9.4
net other investment (income) losses 3, 19 (0.3)
0.7
net realised (gains) losses and impairments 3 (23.8) 11.0
unrealised (gain) loss on interest rate swaps 19 (1.3) 2.7
changes in operational assets and liabilities - insurance and reinsurance contracts (32.6)
285.9
- other assets and liabilities (11.3)
(7.6)
net cash flows from operating activities 278.4
360.7
cash flows used in investing activities interest and dividends received 62.8
59.4
net purchase of property, plant and equipment (7.6)
(0.2)
dividends received from associate -
22.7
purchase of fixed income securities 25 (2,711.6) (3,882.4) purchase of equity securities - (31.9) proceeds on maturity and disposal of fixed 25 2,440.8 3,402.6income securities
proceeds on disposal of equity securities 4.8
66.7
net proceeds on other investments 0.1
4.5
net cash flows used in investing activities (210.7)
(358.6)
cash flows used in financing activities
interest paid 25 (6.4) (10.0) dividends paid 25 (10.5) (238.2) shares repurchased (24.9) (68.3) net cash flows used in financing activities (41.8)
(316.5)
net increase (decrease) in cash and cash 25.9 (314.4)equivalents 413.6 737.3
cash and cash equivalents at beginning of year effect of exchange rate fluctuations on cash 0.5 (9.3)and cash equivalents
cash and cash equivalents at end of year 10 440.0 413.6
summary of significant accounting policies
The basis of preparation, consolidation principles and significant accountingpolicies adopted in the preparation of Lancashire Holdings Limited ("LHL") andits subsidiaries' (collectively "the Group") consolidated financial statementsare set out below.basis of preparation
The Group's consolidated financial statements are prepared in accordance with accounting principles generally accepted under International Financial Reporting Standards ("IFRS") as adopted by the European Union.
Where IFRS is silent, as it is in respect of the measurement of insuranceproducts, the IFRS framework allows reference to another comprehensive body ofaccounting principles. In such instances, the Group determines appropriatemeasurement bases, to provide the most useful information to users of theconsolidated financial statements, using their judgement and considering theaccounting principles generally accepted in the United States ("U.S. GAAP").
All amounts, excluding share data or where otherwise stated, are in millions of United States ("U.S.") dollars.
While a number of new or amended IFRS and International Financial Reporting Interpretations Committee standards have been issued there are no standards that have had a material impact. The following standards have been adopted by the Group:
* IFRS 8, Operating Segments, which replaces IAS 14, Segment Reporting, has
been adopted with no significant impact on the Group's disclosures;
* IAS 1, Presentation of Financial Statements (Revised), has been adopted
resulting in minor changes to presentation in the primary statements, most
notably within the consolidated statement of changes in shareholders' equity; and * IFRS 7, Financial Instruments: Disclosures, has been adopted, with the additional disclosures required in respect of valuation categories for fixed income securities included in notes 11 and 19 to the Group's
consolidated financial statements. Under the standard's transitional rules
prior year comparative disclosure is not required in the year of adoption
and has not been presented.
IFRS 9, Financial Instruments: Classification and Measurement, which has beenissued but is not yet effective, has not been early adopted by the Group. TheGroup continues to apply IAS 39, Financial Instruments: Recognition andMeasurement and classifies most of it its fixed income securities as availablefor sale. The new standard is not expected to have a material impact on theresults and disclosures reported in the consolidated financial statements, butwould result in a re-classification of fixed income securities from availablefor sale to fair value through profit or loss and a re-classification of thenet change in unrealised gains and losses on investments from othercomprehensive income to income.
The consolidated balance sheet of the Group is presented in order of decreasing liquidity.
use of estimatesThe preparation of financial statements in conformity with IFRS requires theGroup to make estimates and assumptions that affect the reported and disclosedamounts at the balance sheet date and the reported and disclosed amounts ofrevenues and expenses during the reporting period. Actual results may differmaterially from the estimates made.The most significant estimate made by management is in relation to losses andloss adjustment expenses. This is discussed in the risk disclosures section.Estimates in relation to losses and loss adjustment expenses recoverable arediscussed in section iv. losses below.Estimates may also be made in determining the estimated fair value of certainfinancial instruments. These are discussed in note 11 and in section ii.investments below. Management judgement is applied in determining impairmentcharges.basis of consolidationi. subsidiariesThe Group's consolidated financial statements include the assets, liabilities,shareholders' equity, revenues, expenses and cash flows of LHL and itssubsidiaries. A subsidiary is an entity in which the Group owns, directly orindirectly, more than 50% of the voting power of the entity or otherwise hasthe power to govern its operating and financial policies. The results ofsubsidiaries acquired are included in the consolidated financial statementsfrom the date on which control is transferred to the Group. Intercompanybalances, profits and transactions are eliminated.
Subsidiaries' accounting policies are consistent with the Group's accounting policies.
ii. associatesInvestments, in which the Group has significant influence over the operationaland financial policies of the investee, are initially recognised at cost andthereafter accounted for using the equity method. Under this method, the Grouprecords its proportionate share of income or loss from such investments in itsresults of operations for the period. Adjustments are made to associates'accounting policies, where necessary, in order to be consistent with theGroup's accounting policies.
foreign currency translation
The functional currency, which is the currency of the primary economicenvironment in which operations are conducted, for all Group entities is U.S.dollars. Items included in the financial statements of each of the Group'sentities are measured using the functional currency. The consolidated financialstatements are also presented in U.S. dollars.Foreign currency transactions are recorded in the functional currency for eachentity using the exchange rates prevailing at the dates of the transactions, orat the average rate for the period when this is a reasonable approximation.Monetary assets and liabilities denominated in foreign currencies aretranslated at period end exchange rates. The resulting exchange differences ontranslation are recorded in the consolidated statement of comprehensive income.Non-monetary assets and liabilities carried at historical cost denominated in aforeign currency are translated at historic rates. Non-monetary assets andliabilities carried at fair value denominated in a foreign currency aretranslated at the exchange rate at the date the fair value was determined, withresulting exchange differences recorded in accumulated other comprehensiveincome in shareholders' equity.
insurance contracts
i. classification
Insurance contracts are those contracts that transfer significant insurancerisk at the inception of the contract. Contracts that do not transfersignificant insurance risk are accounted for as investment contracts. Insurancerisk is transferred when an insurer agrees to compensate a policyholder if aspecified uncertain future event adversely affects the policyholder.
ii. premiums and acquisition costs
Premiums are first recognised as written at the date that the contract isbound. The Group writes both excess of loss and pro-rata (proportional)contracts. For the majority of excess of loss contracts, written premium isrecorded based on the minimum and deposit or flat premium, as defined in thecontract. Subsequent adjustments to the minimum and deposit premium arerecognised in the period in which they are determined. For pro-rata contractsand excess of loss contracts where no deposit is specified in the contract,written premium is recognised based on estimates of ultimate premiums providedby the insureds or ceding companies. Initial estimates of written premium arerecognised in the period in which the contract is bound. Subsequentadjustments, based on reports of actual premium by the insureds or cedingcompanies, or revisions in estimates, are recorded in the period in which theyare determined.Premiums are earned rateably over the term of the underlying risk period of theinsurance contract, except where the period of risk differs significantly fromthe contract period. In these circumstances, premiums are recognised over theperiod of risk in proportion to the amount of insurance protection provided.The portion of the premium related to the unexpired portion of the risk periodis reflected in unearned premiums.Where contract terms require the reinstatement of coverage after an insured'sor ceding company's loss, the estimated mandatory reinstatement premiums arerecorded as written premiums when a specific loss event occurs. Reinstatementpremiums are not recorded for losses included within the provision for lossesincurred but not reported ("IBNR") which do not relate to a specific lossevent.Inwards premiums receivable from insureds and cedants are recorded net ofcommissions, brokerage, premium taxes and other levies on premiums, unless thecontract specifies otherwise. These balances are reviewed for impairment, withany impairment loss recognised as an expense in the period in which it isdetermined.Acquisition costs represent commissions, brokerage, profit commissions andother variable costs that relate directly to the securing of new contracts andthe renewing of existing contracts. They are generally deferred over the periodin which the related premiums are earned to the extent they are recoverable outof expected future revenue margins. All other acquisition costs are recognisedas an expense when incurred.
iii. outwards reinsurance
Outwards reinsurance premiums comprise the cost of reinsurance contractsentered into. Outwards reinsurance premiums are accounted for in the period inwhich the contract is bound. The provision for reinsurers' share of unearnedpremiums represents that part of reinsurance premiums ceded which are estimatedto be earned in future financial periods. Unearned reinsurance commissions arerecognised as a liability using the same principles. Any amounts recoverablefrom reinsurers are estimated using the same methodology as the underlyinglosses.The Group monitors the credit-worthiness of its reinsurers on an ongoing basisand assesses any reinsurance assets for impairment, with any impairment lossrecognised as an expense in the period in which it is determined.
iv. losses
Losses comprise losses and loss adjustment expenses paid in the period andchanges in the provision for outstanding losses, including the provision forIBNR and related expenses. Losses and loss adjustment expenses are charged toincome as they are incurred.A significant portion of the Group's business is in classes with highattachment points of coverage, including property catastrophe. Reserving forlosses in such programs is inherently complicated in that losses in excess ofthe attachment level of the Group's policies are characterised by high severityand low frequency and other factors which could vary significantly as lossesare settled. This limits the volume of industry loss experience available fromwhich to reliably predict ultimate losses following a loss event. In addition,the Group has limited past loss experience, which increases the inherentuncertainty in estimating ultimate loss levels.Losses and loss adjustment expenses represent the estimated ultimate cost ofsettling all losses and loss adjustment expenses arising from events which haveoccurred up to the balance sheet date, including a provision for IBNR. TheGroup does not discount its liabilities for unpaid losses. Outstanding lossesare initially set on the basis of reports of losses received from thirdparties. Additional case reserves ("ACRs") are determined where the Group'sestimate of the reported loss is greater than that reported. Estimated IBNRreserves may also consist of a provision for additional development in excessof losses reported by insureds or ceding companies, as well as a provision forlosses which have occurred but which have not yet been reported by insureds orceding companies. IBNR reserves are estimated by management using variousactuarial methods as well as a combination of own loss experience, historicalinsurance industry loss experience, underwriters' experience, estimates ofpricing adequacy trends, and management's professional judgement.The estimation of the ultimate liability arising is a complex process whichincorporates a significant amount of judgement. It is reasonably possible thatuncertainties inherent in the reserving process, delays in insureds or cedingcompanies reporting losses to the Group, together with the potential forunforeseen adverse developments, could lead to a material change in losses
andloss adjustment expenses.v. liability adequacy testsAt each balance sheet date, the Group performs a liability adequacy test usingcurrent best estimates of future cash outflows generated by its insurancecontracts, plus any investment income thereon. If, as a result of these tests,the carrying amount of the Group's insurance liabilities is found to beinadequate, the deficiency is charged to income for the period, initially bywriting off deferred acquisition costs and subsequently by establishing aprovision.
financial instruments
i. cash and cash equivalents
Cash and cash equivalents are carried in the consolidated balance sheet atamortised cost and includes cash in hand, deposits held on call with banks andother short-term highly liquid investments with a maturity of three months orless at the date of purchase. Carrying amounts approximate fair value due tothe short-term nature and high liquidity of the instruments.
Interest income earned on cash and cash equivalents is recognised on the effective interest rate method. The carrying value of accrued interest income approximates fair value due to its short-term nature and high liquidity.
ii. investments
The Group's fixed income and equity securities are quoted investments that areclassified as available for sale or fair value through profit and loss and arecarried at estimated fair value. The classification is determined at the timeof initial purchase and depends on the category of investment. Investments withan embedded conversion option purchased since 1 January 2007 are designated asat fair value through profit and loss. Movements in estimated fair value relateprimarily to the option component.Regular way purchases and sales of investments are recognised at estimated fairvalue less transaction costs on the trade date and are subsequently carried atestimated fair value. Estimated fair value of quoted investments is determinedbased on bid prices from recognised exchanges, broker-dealers, recognisedindices or pricing vendors. Investments are derecognised when the Group hastransferred substantially all of the risks and rewards of ownership. Realisedgains and losses are included in income in the period in which they arise.Unrealised gains and losses from changes in estimated fair value of availablefor sale investments are included in accumulated other comprehensive income inshareholders' equity.On derecognition of an investment, previously recorded unrealised gains andlosses are removed from accumulated other comprehensive income in shareholders'equity and included in current period income. Changes in estimated fair valueof investments classified as at fair value through profit and loss arerecognised in current period income.Accretion and amortisation of premiums and discounts on available for salefixed income securities are calculated using the effective interest rate methodand are recognised in current period net investment income. Interest income isrecognised on the effective interest rate method. The carrying value of accruedinterest income approximates fair value due to its short-term nature and highliquidity. Dividends on equity securities are recorded as revenue on the datethe dividends become payable to the holders of record.The Group reviews the carrying value of its available for sale investments forevidence of impairment. An investment is impaired if its carrying value exceedsthe estimated fair value and there is objective evidence of impairment to theasset. Such evidence would include a prolonged decline in estimated fair valuebelow cost or amortised cost, where other factors, such as expected cash flows,do not support a recovery in value. If an impairment is deemed appropriate,the difference between cost or amortised cost and estimated fair value isremoved from accumulated other comprehensive income in shareholders' equity andcharged to current period income.
Impairment losses on equity securities are not subsequently reversed through income. Impairment losses on fixed income securities may be subsequently reversed through income.
iii. derivative financial instruments
Derivatives are recognised at estimated fair value on the date a contract isentered into, the trade date, and are subsequently carried at estimated fairvalue. Derivative instruments with a positive fair value are recorded asderivative financial assets and those with a negative fair value are recordedas derivative financial liabilities. Embedded derivatives that are not closelyrelated to their host contract are bifurcated and changes in estimated fairvalue are recorded through income.Derivative and embedded derivative financial instruments include option, swap,forward and future exchange-traded contracts. They derive their value from theunderlying instrument and are subject to the same risks as that underlyinginstrument, including liquidity, credit and market risk. Estimated fair valuesare based on exchange or broker-dealer quotations, where available, ordiscounted cash flow models, which incorporate the pricing of the underlyinginstrument, yield curves and other factors, with changes in the estimated fairvalue of instruments that do not qualify for hedge accounting recognised incurrent period income. For discounted cash flow techniques, estimated futurecash flows are based on management's best estimates and the discount rate usedis an appropriate market rate.Derivative financial assets and liabilities are offset and the net amount isreported in the consolidated balance sheet only to the extent there is alegally enforceable right of offset and there is an intention to settle on anet basis, or to realise the assets and liabilities simultaneously. Derivativefinancial assets and liabilities are derecognised when the Group hastransferred substantially all of the risks and rewards of ownership or theliability is discharged, cancelled or expired.
iv. long-term debt
Long-term debt is recognised initially at fair value, net of transaction costsincurred. Thereafter it is held at amortised cost, with the amortisationcalculated using the effective interest rate method. Derecognition occurs whenthe obligation has been extinguished.
property, plant and equipment
Property, plant and equipment is carried at historical cost, less accumulateddepreciation and any impairment in value. Depreciation is calculated towrite-off the cost over the estimated useful economic life on a straight-linebasis as follows:IT equipment 33% per annum
Office furniture and equipment 33% per annum
Leasehold improvements 20% per annum
The assets' residual values, useful lives and depreciation methods are reviewed, and adjusted if appropriate, at each balance sheet date.
An item of property, plant or equipment is derecognised on disposal or when nofuture economic benefits are expected to arise from the continued use of theasset.
Gains and losses on the disposal of property, plant and equipment are determined by comparing proceeds with the carrying amount of the asset, and are included in the consolidated statement of comprehensive income. Costs for repairs and maintenance are charged to income as incurred.
leases
Rentals payable under operating leases are charged to income on a straight-line basis over the lease term.
employee benefitsi. equity compensation plansThe Group operates a restricted share scheme. The Group has also operated amanagement warrant plan and an option plan in the past. The fair value of theequity instruments granted is estimated on the date of grant. The estimatedfair value is recognised as an expense pro-rata over the vesting period of theinstrument, adjusted for the impact of any non-market vesting conditions. Noadjustment to the estimated fair value is made in respect of market vestingconditions.At each balance sheet date, the Group revises its estimate of the number ofrestricted shares, warrants and options that are expected to becomeexercisable. It recognises the impact of the revision of original estimates, ifany, in the consolidated statement of comprehensive income, and a correspondingadjustment is made to other reserves in shareholders' equity over the remainingvesting period.
On exercise, the differences between the expense charged to the consolidated statement of comprehensive income and the actual cost to the Group is transferred to retained earnings. Where new shares are issued, the proceeds received are credited to share capital and share premium.
ii. pensions
The Group operates a defined contribution plan. On payment of contributions tothe plan there is no further obligation to the Group. Contributions arerecognised as employee benefits in the consolidated statement of comprehensiveincome in the period to which they relate.
tax
Income tax represents the sum of the tax currently payable and any deferred tax. The tax payable is calculated based on taxable profit for the period. Taxable profit for the period can differ from that reported in the consolidated statement of comprehensive income due to certain items which are not tax deductible or which are deferred to subsequent periods.
Deferred tax is recognised on temporary differences between the assets and liabilities in the consolidated balance sheet and their tax base. Deferred tax assets or liabilities are accounted for using the balance sheet liability method. Deferred tax assets are recognised to the extent that realising the related tax benefit through future taxable profits is likely.
Deferred tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets against current tax liabilities and when the deferred income taxes relate to the same fiscal authority.
own shares
Own shares include shares repurchased under share repurchase authorisations andheld in treasury plus shares repurchased and held in trust for the purposes ofemployee equity based compensation schemes. Own shares are deducted fromshareholders' equity. No gain or loss is recognised on the purchase, sale,cancellation or issue of own shares and any consideration paid or received isrecognised directly in equity.
risk disclosures: introduction
The Group is exposed to risks from several areas including insurance risk, market risk, liquidity risk, credit risk, operational risk and strategic risk. The primary risk to the Group is insurance risk.
The Group has a comprehensive Enterprise Risk Management ("ERM") program. ERMis co-ordinated by the Chief Risk Officer ("CRO") who reports to the Board ofDirectors on matters related to risk. The Board of Directors sets the overallrisk profile and risk appetite for the Group, while the Group's seniormanagement team is actively involved in all aspects of risk and capitalmanagement. Risk Committees are in place at the operating entity level. TheCommittees provide reports and updates to the operating entity and Group Boardsof Directors. The Risk Committees operate within the framework of agreed Termsof Reference and help to define and monitor risk tolerance levels over allcategories of risk for the operating entities. This includes the level ofcapital the operating entities are willing to expose to certain risks. TheCommittees meet formally at least quarterly to review, amongst other things,established tolerance levels, actual risk levels versus tolerances, emergingrisks and material risk failures or losses. The CRO is responsible formonitoring the adherence to the tolerance levels. Any risk tolerance breachesare reported to the Risk Committees, and thus to the Boards of Directors.Identification of emerging risks, and monitoring of already recognised risks,is the responsibility of individual risk owners but the process is facilitatedby the CRO. Risk owners periodically perform an exercise to identify theGroup's most significant risks. Risk reports are provided to the managementteam on a regular basis to assist in monitoring risk levels, threats andopportunities. The Group's risk register is a fundamental tool for integratingrisk and capital management into the day to day operations of the Group, and isa point of reference for decision making and change management. Risk registersalso assist in embedding ERM through the Group and strengthen the riskassessment, risk identification, risk monitoring and risk mitigation process.Risk registers are formally reviewed at least quarterly by each risk owner andthe CRO.
The Group's ERM framework has four primary drivers:
a. strategy; b. culture; c. process; and d. infrastructure. a. strategy
Strategy is the core of the Group's ERM framework and includes risk appetite and performance targets.
b. cultureThe risk management tone is set by the Group Board of Directors andcommunicated throughout the organisation by the management team. The managementteam ensures consistent communication of risks across the Group and hasestablished an environment that provides continuous training and development ofemployees, and a structured method of performance measurement and remuneration.
c. process
Process incorporates five elements:
* Risk identification; * Risk assessment; * Risk mitigation and management; * Risk measurement and reporting; and * Roles and responsibilities. An important component of the ERM process is the quarterly affirmationcertification where each risk owner is required to affirm their key risks andthe performance of control activities under their remit. Risk owners are alsorequired to comment on control failures or instances of fraud, if they occur,and the status of policies and procedures as part of their affirmations.
d. infrastructure
Setting and monitoring of risk tolerance limits and the design and monitoring of controls is supported by the Group's infrastructure, which includes IT systems and processes and regular management and executive meetings.
internal audit
Internal audit plays a key role by providing an independent opinion regardingthe accuracy and completeness of risks, in addition to verification of theeffectiveness of key and compensating controls. Internal audit's roles andresponsibilities are clearly defined through the Internal Audit Charter. Thehead of internal audit reports directly to the Group Audit Committee. The CROalso receives a copy of each audit report and considers the findings and agreedactions in the context of the risk policies and risk management strategy ofeach area.
The integration of internal audit and ERM into the business helps facilitate the Group's management in the protection of its assets and reputation.
economic capital model
The foundation of the Group's risk based capital approach to decision making isits economic capital model ("BLAST"), which is based on the widely acceptedeconomic capital modeling tool, ReMetrica. Management uses BLAST primarily formonitoring its insurance risks. However, BLAST is also used to monitor theentire spectrum of risks including market, credit and operational risks.BLAST produces data in the form of a stochastic distribution for all classes,including non-elemental classes. The distribution includes the mean outcome andthe result at various return periods, including very remote events. BLASTincludes the calculation of present and projected financial outcomes for eachinsurance class, and also recognises diversification credit. This arises asindividual risks are generally not strongly correlated and are unlikely to allproduce profits or losses at the same time. Diversification credit iscalculated within categories or across a range of risk categories, with themost significant impact resulting from insurance risks. BLAST also measures theGroup's aggregate insurance exposures. It therefore helps senior management andthe Board of Directors determine the level of capital required to meet thecombined risk from a wide range of categories. Assisted by BLAST, the Groupseeks to achieve an improved risk-adjusted return over time.BLAST is used in strategic underwriting decisions as part of the Group's annualplanning process. Management utilises BLAST in assessing the impact ofstrategic decisions on individual classes of business that the Group writes, oris considering writing, as well as the overall resulting financial impact tothe Group. BLAST output is reviewed, including the anticipated loss curves andcombined ratios, to determine profitability and risk tolerance headroom byclass. The output from BLAST assists in portfolio optimisation decisions.In addition, usually on a fortnightly basis, management reviews BLAST output tomonitor its expected losses against its risk tolerances for each class ofbusiness. Should a tolerance breach occur, action is taken to mitigate thebreach and the risk owner is required to produce a breach mitigation plan. Abreach form is required which is approved by the CRO and the operating entityCEO. Breaches may be reported to members of management, the Risk ManagementForum, the Risk Committee and the Board of Directors, depending on thecircumstances.
A. insurance risk
The Group underwrites worldwide short-tail insurance and reinsurance contractsthat transfer insurance risk, including risks exposed to both natural andman-made catastrophes. The Group's exposure in connection with insurancecontracts is, in the event of insured losses, whether premiums will besufficient to cover the loss payments and expenses. Insurance and reinsurancemarkets are cyclical and premium rates and terms and conditions vary by line ofbusiness depending on market conditions and the stage of the cycle. Marketconditions are impacted by capacity and recent loss events, amongst otherfactors. The Group's underwriters assess likely losses using their experienceand knowledge of past loss experience, industry trends and currentcircumstances. This allows them to estimate the premiums sufficient to meetlikely losses and expenses.The Group considers insurance risk at an individual contract level, at a sectorlevel, a geographic level, and at an aggregate portfolio level to ensurecareful risk selection, limits on concentration and appropriate portfoliodiversification are accomplished. The Group's four principal classes, or lines,are property, energy, marine and aviation. These classes are deemed to be theGroup's operating segments. The level of insurance risk tolerance per class peroccurrence and in aggregate is set by the Risk Committees and ultimatelyapproved by the Board of Directors.
A number of controls are deployed to control the amount of insurance exposure assumed:
* The Group has a rolling three year strategic plan that helps establish the
over-riding business goals that the Board of Directors aims to achieve; * A detailed business plan is produced annually which includes expected premiums and combined ratios by class and considers capital usage and requirements. The plan is approved by the Board of Directors and is monitored and reviewed on an on-going basis;
* BLAST is used to measure occurrence risks, aggregate risks and correlations
between classes;
* Each authorised class has a pre-determined normal maximum line structure;
* The Group has pre-determined tolerances on probabilistic and deterministic
losses of capital for certain single events and aggregate losses over a
period of time;
* Risk levels versus tolerances are communicated broadly on a regular basis;
* A daily underwriting meeting is held to peer review insurance proposals,
opportunities and emerging risks; * Sophisticated pricing models are utilised in certain areas of the underwriting process, and are updated frequently; * BLAST and other computer modeling tools are deployed to simulate catastrophes and resultant losses to the portfolio and the Group; and * Reinsurance may be purchased to mitigate both frequency and severity of losses.
The Group also maintains targets for the maximum proportion of capital, including long-term debt, that can be lost in a single extreme event or a combination of events.
Some of the Group's business provides coverage for natural catastrophes (i.e.hurricanes, earthquakes and floods) and is subject to potential seasonalvariation. A proportion of the Group's business is exposed to large catastrophelosses in North America, Europe and Japan as a result of windstorms. The levelof windstorm activity, and landfall thereof, during the North American,European and Japanese wind seasons may materially impact the Group's lossexperience. The North American and Japanese wind seasons are typically June toNovember and the European wind season November to March. The Group also bearsexposure to large losses arising from other non-seasonal natural catastrophes,such as earthquakes, from risk losses throughout the year and from war,terrorism and political risk and other events.The Group's exposures to certain events, as a percentage of capital, includinglong-term debt, are shown below. Net loss estimates are before income tax andnet of reinstatement premiums and outward reinsurance.as at 31 december 2009 $m % of $m % of capital capital zones perils 100 year return period 250 year return estimated net loss period estimated net loss gulf of mexico(1) hurricane 278.5 18.4 391.2 25.9 california earthquake 190.1 12.6 292.6 19.4 pan-european windstorm 163.2 10.8 261.7 17.3 japan earthquake 138.2 9.2 236.1 15.6 japan typhoon 86.3 5.7 170.8 11.3
(1) landing hurricane from florida to texas
as at 31 december 2008 $m % of $m % of capital capital zones perils 100 year return period 250 year return estimated net loss period estimated net loss gulf of mexico(1) hurricane 250.2 17.8 357.1 25.4 california earthquake 177.1 12.6 255.6 18.2 pan-european windstorm 143.7 10.2 203.0 14.5 japan earthquake 213.3 15.2 244.2 17.4 japan typhoon 110.3 7.9 170.4 12.1
(1) landing hurricane from florida to texas
There can be no guarantee that the modeled assumptions and techniques deployedin calculating these figures are accurate. There could also be an unmodeledloss which exceeds these figures. In addition, any modeled loss scenario couldcause a larger loss to capital than the modeled expectation.Details of annual gross premiums written by line of business are providedbelow: 2009 2008 $m % $m % property 317.3 50.5 302.7 47.5 energy 175.5 28.0 185.2 29.0 marine 73.7 11.7 78.6 12.3 aviation 61.3 9.8 71.6 11.2 total 627.8 100.0 638.1 100.0Details of annual gross premiums written by geographic area of risks insuredare provided below: 2009 2008 $m % $m % worldwide offshore 227.3 36.2 232.6 36.5 U.S. and Canada 158.3 25.2 112.8 17.7 worldwide, including the U.S. and Canada 119.2 19.0 124.2 19.4(1) europe 36.2 5.8 42.0 6.6 worldwide, excluding the U.S. and Canada 35.6 5.7 48.5 7.6(2) far east 13.2 2.1 17.3 2.7 middle east 11.9 1.9 12.4 1.9 rest of world 26.1 4.1 48.3 7.6 total 627.8 100.0 638.1 100.0
(1) worldwide, including the U.S. and Canada, comprises insurance and reinsurance contracts that insure or reinsure risks in more than one geographic area
(2) worldwide, excluding the U.S. and Canada, comprises insurance and reinsurance contracts that insure or reinsure risks in more than one geographic area, but that specifically exclude the U.S. and Canada
Sections a to d below describe the risks in each of the four principal lines of business written by the Group.
a. property
Gross premiums written, for the year:
2009 2008 $m $m property direct and facultative 88.6
93.8
property catastrophe excess of loss 76.3 23.4 terrorism 69.1 75.5 property retrocession 61.2 76.4 property political risk 15.5 28.1 other property 6.6 5.5 total 317.3 302.7Property direct and facultative business is typically written on a first lossbasis, i.e. for a limit smaller than the total insured values, on an excess ofloss basis, where the exposure is excess of a deductible retained by theinsured, plus lower layers of coverage provided by other (re)insurers. Cover isgenerally provided to medium to large commercial and industrial enterpriseswith high value locations for non-elemental perils, including fire andexplosion, and elemental (natural catastrophe) perils including flood,windstorm, earthquake and tornado. Not all risks include both elemental andnon-elemental coverage. Coverage usually includes indemnification for bothproperty damage and business interruption.Property catastrophe excess of loss covers elemental risks and is written on anexcess of loss treaty basis. The property catastrophe excess of loss portfoliois written within the U.S. and also internationally. Cover is offered forspecific perils and regions or countries.Terrorism business is written on an excess of loss basis and can be writteneither ground up (i.e. the insured does not retain a deductible) or for primaryor high excess layers, with cover provided for U.S. and worldwide propertyrisks, but excluding nuclear, chemical and biological coverage in mostterritories. Cover is, as for direct and facultative business, generallyprovided to medium to large commercial and industrial enterprises. Policies aretypically written for scheduled locations and exposure is controlled by settinglimits on aggregate exposure within a "blast zone" radius. Some national poolsare also written, which may include nuclear, chemical and biological coverage.
Property retrocession is written on an excess of loss basis through treaty arrangements and covers elemental perils. Programs are often written on a pillared basis, with separate geographic zonal limits for risks in the U.S. and Canada and for risks outside the U.S. and Canada.
Political risk cover is generally written on a ground up excess of loss basis,on an individual case by case basis, and coverage can vary significantlybetween policies. Within its political risk class the Group also offers coverfor sovereign and quasi-sovereign credit risk. The Group does not currentlywrite private obligor trade credit.The Group is exposed to large natural catastrophic losses, such as windstormand earthquake loss, from assuming property catastrophe excess of loss andproperty retrocession portfolio risks and also from its property direct andfacultative portfolio. Exposure to such events is controlled and measured bysetting limits on aggregate exposures in certain classes per geographic zoneand through loss modeling. The accuracy of the latter exposure analysis islimited by the quality of data and effectiveness of the modeling. It ispossible that a catastrophic event significantly exceeds the expected modeledevent loss. The Group's appetite and exposure guidelines to large losses areset out in the preceding section, A. insurance risk.Reinsurance may be purchased to mitigate exposures to large natural catastrophelosses in the U.S. and Canada. Reinsurance may also be purchased to reduce theGroup's worldwide exposure to large risk losses.
b. energy
Gross premiums written, for the year:
2009 2008 $m $m worldwide offshore energy 100.5 76.3 gulf of mexico offshore energy 53.8 74.3 construction energy 10.7 21.5 onshore energy 7.8 10.0 other energy 2.7 3.1 total 175.5 185.2
Energy risks are written mostly on a direct excess of loss basis and may beground up or on primary or high excess of loss. Worldwide offshore energypolicies are typically "package" policies which may include physical damage,business interruption and third party liability sections. Coverage can includefire and explosion and occasionally elemental perils. Individual assets coveredcan be high value and are therefore mostly written on a subscription basis.Gulf of Mexico offshore energy programs cover elemental and non-elementalrisks. The largest exposure is from hurricanes in the Gulf of Mexico. Exposureto such events is controlled and measured through loss modeling. The accuracyof this exposure analysis is limited by the quality of data and effectivenessof the modeling. It is possible that a catastrophic event exceeds the expectedevent loss. The Group's appetite and exposure guidelines to large losses areset out in the preceding section, A. insurance risk. Most policies havesub-limits on coverage for elemental losses.
Construction energy contracts generally cover all risks of platform and drilling units under construction. Onshore energy risks can include onshore Gulf of Mexico and worldwide energy installations and are largely subject to the same loss events as described above.
Reinsurance protection may be purchased to protect a portion of loss from elemental and non-elemental energy claims, and from the accumulation of smaller, attritional losses.
c. marine
Gross premiums written, for the year:
2009 2008 $m $m marine hull and total loss 25.6 30.6 marine hull war 20.0 11.3 marine builders risk 16.7 26.3 marine P&I clubs 10.0 9.2 other marine 1.4 1.2 total 73.7 78.6Marine business is predominantly written on an excess of loss basis. With theexception of the marine P&I clubs where high excess layers are written, mostpolicies are written on a ground up basis. Marine hull and total loss isgenerally written on a direct basis and covers marine risks on a worldwidebasis, primarily for physical damage. Marine hull war is direct insurance ofloss of vessels from war, piracy or terrorist attack. Marine builders riskcovers the building of ocean going vessels in specialised yards worldwide.Marine P&I is mostly the reinsurance of The International Group of Protectionand Indemnity Clubs. Marine cargo programs are not normally written.
The largest expected exposure in the marine class is from physical loss rather than from elemental loss events.
Reinsurance may be purchased to reduce the Group's exposure to both large risk losses and an accumulation of smaller, attritional losses.
d. aviation
Gross premiums written, for the year:
2009 2008 $m $m AV52 52.9 51.2 aviation reinsurance - 13.7 other aviation 8.4 6.7 total 61.3 71.6AV52 is written on a risk attaching excess of loss basis and provides coveragefor third party liability, excluding own passenger liability, resulting fromacts of war or hijack of aircraft, excluding U.S. commercial airlines andcertain other countries whose governments provide a backstop coverage. Otheraviation business includes aviation hull war risks and contingent hull, whichthe Group writes from time to time. The Group does not presently write generalaviation business, including hull and liabilities.
Reinsurance may be purchased to mitigate exposures to an AV52 event loss.
reinsurance
The Group, in the normal course of business and in accordance with its riskmanagement practices, seeks to reduce certain types of loss that may arise fromevents that could cause unfavourable underwriting results by entering intoreinsurance arrangements. Reinsurance does not relieve the Group of itsobligations to policyholders. Under the Group's reinsurance security policy,reinsurers are assessed and approved as appropriate security based on theirfinancial strength ratings, amongst other factors. The Group ReinsuranceSecurity Committee ("GRSC") has defined limits by reinsurer by rating and anaggregate exposure to a rating band. The GRSC considers reinsurers that are notrated or do not fall within the pre-defined rating categories on a case by casebasis, and would usually require collateral to be posted to support suchobligations. The GRSC monitors the credit-worthiness of its reinsurers on anongoing basis and meets formally at least quarterly.Reinsurance protection is typically purchased on an excess of loss basis andoccasionally includes industry loss warranty covers. The mix of reinsurancecover is dependent on the specific loss mitigation requirements, marketconditions and available capacity. The structure varies between types of periland subclass. The Group regularly reviews its catastrophe exposures and maypurchase reinsurance in order to reduce the Group's net exposure to a largenatural catastrophe loss and/or to reduce net exposures to other large losses.There is no guarantee that reinsurance coverage will be available to meet allpotential loss circumstances, as it is possible that the cover purchased is notsufficient. Any loss amount which exceeds the program would be retained by theGroup. Some parts of the reinsurance program have limited reinstatementstherefore the number of claims which may be recovered from second or subsequentlosses in those particular circumstances is limited.
insurance liabilities
For most insurance and reinsurance companies, the most significant judgement made by management is the estimation of loss and loss adjustment expense reserves. The estimation of
the ultimate liability arising from claims made under insurance and reinsurance contracts is a critical estimate for the Group.
Under generally accepted accounting principles, loss reserves are not permitteduntil the occurrence of an event which may give rise to a claim. As a result,only loss reserves applicable to losses incurred up to the reporting date areestablished, with no allowance for the provision of a contingency reserve toaccount for expected future losses or for the emergence of new types of latentclaims. Claims arising from future events can be expected to require theestablishment of substantial reserves from time to time. All reserves arereported on an undiscounted basis.Loss and loss adjustment expense reserves are maintained to cover the Group'sestimated liability for both reported and unreported claims. Reservingmethodologies that calculate a point estimate for the ultimate losses areutilised, and then a range is developed around these point estimates. The pointestimate represents management's best estimate of ultimate loss and lossadjustment expenses. The Group's internal actuaries review the reservingassumptions and methodologies on a quarterly basis with loss estimates beingsubject to a quarterly corroborative review by independent actuaries, usingU.S. generally accepted actuarial principles. This independent review ispresented to the Group's Audit Committee. The Group has also established LargeLoss and Reserve Committees at the operating entity level, which haveresponsibility for the review of large claims, their development and anychanges in reserving methodology and assumptions on a quarterly basis.The extent of reliance on management's judgement in the reserving processdiffers as to whether the business is insurance or reinsurance, whether it isshort-tail or long-tail and whether the business is written on an excess ofloss or on a pro-rata basis. Over a typical annual period, the Group expects towrite the large majority of programs on a direct excess of loss basis. TheGroup does not currently write a significant amount of long-tail business.
a. insurance versus reinsurance
Loss reserve calculations for direct insurance business are not precise in thatthey deal with the inherent uncertainty of future contingent events. Estimatingloss reserves requires management to make assumptions regarding futurereporting and development patterns, frequency and severity trends, claimssettlement practices, potential changes in the legal environment and otherfactors, such as inflation. These estimates and judgements are based onnumerous factors, and may be revised as additional experience or other databecomes available or reviewed as new or improved methodologies are developed oras current laws change.Furthermore, as a broker market reinsurer, management must rely on lossinformation reported to brokers by other insurers who must estimate their ownlosses at the policy level, often based on incomplete and changing information.The information management receives varies by cedant and may include paidlosses, estimated case reserves, and an estimated provision for IBNR reserves.Additionally, reserving practices and the quality of data reporting may varyamong ceding companies which adds further uncertainty to the estimation of theultimate losses.
b. short-tail versus long-tail
In general, claims relating to short-tail property risks, such as the majorityof risks underwritten by the Group, are reported more promptly by third partiesthan those relating to long-tail risks, including the majority of casualtyrisks. However, the timeliness of reporting can be affected by such factors asthe nature of the event causing the loss, the location of the loss, and whetherthe losses are from policies in force with insureds, primary insurers or withreinsurers.
c. excess of loss versus proportional
For excess of loss business, management are aided by the fact that each policyhas a defined limit of liability arising from one event. Once that limit hasbeen reached, there is no further exposure to additional losses from thatpolicy for the same event. For proportional business, generally an initialestimated loss and loss expense ratio (the ratio of losses and loss adjustmentexpenses incurred to premiums earned) is used, based upon information providedby the insured or ceding company and/or their broker and management'shistorical experience of that treaty, if any, and the estimate is adjusted asactual experience becomes known.
d. time lags
There is a time lag inherent in reporting from the original claimant to theprimary insurer to the broker and then to the reinsurer. Also, the combinationof low claims frequency and high severity makes the available data morevolatile and less useful for predicting ultimate losses. In the case ofproportional contracts, reliance is placed on an analysis of a contract'shistorical experience, industry information, and the professional judgement ofunderwriters in estimating reserves for these contracts. In addition, ifavailable, reliance is placed partially on ultimate loss ratio forecasts asreported by insureds or cedants, which are normally subject to a quarterly
orsix month lag.e. uncertainty
As a result of the time lag described above, an estimation must be made of IBNRreserves, which consist of a provision for additional development in excess ofthe case reserves reported by insureds or ceding companies, as well as aprovision for claims which have occurred but which have not yet been reportedby insureds or ceding companies. Because of the degree of reliance that isnecessarily placed on insureds or ceding companies for claims reporting, theassociated time lag, the low frequency/high severity nature of much of thebusiness that the Group underwrites, and the varying reserving practices amongceding companies, reserve estimates are highly dependent on managementjudgement and therefore uncertain. During the loss settlement period, which maybe years in duration, additional facts regarding individual claims and trendsoften will become known, and current laws and case law may change, with aconsequent impact on reserving.The claims count on the types of insurance andreinsurance that the Group writes, which are low frequency and high severity innature, is generally low.For certain catastrophic events there is greater uncertainty underlying theassumptions and associated estimated reserves for losses and loss adjustmentexpenses. Complexity resulting from problems such as policy coverage issues,multiple events affecting one geographic area and the resulting impact onclaims adjusting (including the allocation of claims to the specific event andthe effect of demand surge on the cost of building materials and labour) by,and communications from, insureds or ceding companies, can cause delays to thetiming with which the Group is notified of changes to loss estimates.At 31 December 2009 management's estimates for IBNR represented 43.8% of totalnet loss reserves (2008 - 32.6%). The majority of the estimate relates topotential claims on non-elemental risks where timing delays in insured orcedant reporting may mean losses could have occurred which the Group were notmade aware of by the balance sheet date.
B. market risk
The Group is at risk of loss due to movements in market factors. These includeinvestment, insurance, debt and currency risks. These risks, and the managementthereof, are described below.a. investment riskMovements in investments resulting from changes in interest and inflationrates, amongst other factors, may lead to an adverse impact on the value of theGroup's investment portfolio. Investment guidelines are established by theInvestment Committee of the Board of Directors to manage this risk. Investmentguidelines set parameters within which the Group's external investment managersmust operate. Important parameters include guidelines on permissible assets,duration ranges, credit quality and maturity. Investment guidelines exist atthe individual portfolio level and for the Group's consolidated portfolio.Compliance with guidelines is monitored on a monthly basis. Any adjustments tothe investment guidelines are approved by the Investment Committee and theBoard of Directors.Within the Group guidelines is a sub-set of guidelines for the portion of fundsrequired to meet near term obligations and cash flow needs following an extremeevent. The funds to cover this potential liability are designated as the "core"portfolio and the portfolio duration is matched to the duration of theinsurance liabilities, within an agreed range. The core portfolio is investedin fixed income securities and cash and cash equivalents. The core portfoliomay, at times, contain assets significantly in excess of those required to meetinsurance liabilities or other defined funding needs. The sub-set of guidelinesadds a further degree of requirements, including fewer allowable asset classes,higher credit quality, shorter duration and higher liquidity. The primaryobjectives of this portion of assets are capital preservation and providingliquidity to meet insurance and other near term obligations.Assets in excess of those required to be held in the core portfolio, aretypically held in the "core plus" or "surplus" portfolios. The core plusportfolio is invested in fixed income securities and cash and cash equivalents.The surplus portfolio is invested in fixed income securities, cash and cashequivalents and can also be invested in equity securities and derivativeinstruments. The assets in the core plus and surplus portfolios are not matchedto specific insurance liabilities. In general, the duration of the surplusportfolio may be slightly longer than the core or core plus portfolio, whilemaintaining a focus on high quality assets. Currently, the Group does not holdany equity securities or any alternative investments, such as hedge funds.The Group reviews the composition, duration and asset allocation of itsinvestment portfolio on a regular basis in order to respond to changes ininterest rates and other market conditions. If certain asset classes areanticipated to produce a higher return within management's risk tolerance anadjustment in asset allocation may be made. Conversely, if the risk profile isexpected to move outside of tolerance levels, adjustments may be made to reducethe risks in the portfolio.The Group's fixed income portfolios are managed by three external investmentmanagers. The equity portfolio was managed by one investment manager and wasfully liquidated in the first half of 2009. The performance of the managers ismonitored on an on-going basis.
The investment mix of the fixed income portfolios is as follows:
as at 31 december 2009 $m % $m % $m % $m % available for sale - core core plus surplus total external - short-term investments 164.3 8.7 3.5 0.2 14.5 0.8 182.3 9.7 - U.S. treasuries 49.8 2.6 8.4 0.4 196.6 10.4 254.8 13.4
- other government bonds 14.0 0.7 - - 62.3 3.3 76.3 4.0
- U.S. government agency 35.1 1.9 10.7 0.6 69.2 3.7 115.0 6.2debt - U.S. government agency 64.0 3.4 16.4 0.9 404.0 21.3 484.4 25.6 mortgage backed securities - corporate bonds 151.0 8.0 11.8 0.6 317.0 16.8 479.8 25.4 - corporate bonds - FDIC 124.3 6.5 5.0 0.3 64.1 3.4 193.4 10.2 guaranteed(1) total available for sale 602.5 31.8 55.8 3.0 1,127.7 59.7 1,786.0 94.5- external available for sale - internal - short-term investments 106.5 5.5 - - - - 106.5 5.5 total fixed income 709.0 37.3 55.8 3.0 1,127.7 59.7 1,892.5 100.0securities
(1) FDIC guaranteed corporate bonds are protected by the Federal Deposit Insurance Corporation, an independent agency of the U.S. government
as at 31 december 2008 $m % $m % $m % $m % core core plus surplus total available for sale - external - short-term investments 101.5 6.4 9.9 0.6 52.2 3.3 163.6 10.3 - U.S. treasuries 148.3 9.3 15.8 1.0 27.6 1.7 191.7 12.0
- other government bonds 27.7 1.7 11.4 0.7 15.0 0.9 54.1 3.3
- U.S. government agency 39.5 2.5 15.5 1.0 59.5 3.7 114.5 7.2debt - U.S. government agency 180.9 11.3 82.2 5.1 351.3 22.0 614.4 38.4 mortgage backed securities - corporate bonds 138.3 8.6 52.0 3.2 113.2 7.1 303.5 18.9 - corporate bonds - FDIC 108.8 6.8 14.6 0.9 30.0 1.9 153.4 9.6 guaranteed(1) - convertible debt - - - - 0.2 - 0.2 -securities available for sale - 745.0 46.6 201.4 12.5 649.0 40.6 1,595.4 99.7external
at fair value through profit and loss - external
- convertible debt - - - - 4.0 0.3 4.0 0.3securities total fixed income 745.0 46.6 201.4 12.5 653.0 40.9 1,599.4 100.0securities
(1) FDIC guaranteed corporate bonds are protected by the Federal Deposit Insurance Corporation, an independent agency of the U.S. government
The sector allocation of the corporate bonds and convertible debt securities isas follows: 2009 2008 as at 31 december $m % $m % sector financial 344.1 51.1 254.6 55.2 industrial 262.9 39.1 172.7 37.5 utility 52.7 7.8 15.7 3.4 other 13.5 2.0 18.1 3.9 total 673.2 100.0 461.1 100.0
The financial sector allocation includes $193.4 million (2008 - $153.4 million) of FDIC guaranteed bonds.
The Group's net asset value is directly impacted by movements in the value ofinvestments held. Values can be impacted by movements in interest rates, creditratings, economic environment and outlook, and exchange rates.Following the liquidation of its equity portfolio in the first half of 2009,the Group has no exposure to valuation risk from equity securities. The impacton net unrealised gains and losses of a 10% fall in the value of the Group'sequity portfolio at 31 December 2008 would have been $0.6 million. Valuationrisk in the equity portfolio was mitigated by diversifying the portfolio acrosssectors.The Group's investment portfolio is comprised mainly of fixed incomesecurities. The fair value of the Group's fixed income portfolio is generallyinversely correlated to movements in market interest rates. If market interestrates fall, the fair value of the Group's fixed income securities would tend torise and vice versa.The sensitivity of the price of fixed income securities, and certainderivatives, to movements in interest rates is indicated by their duration(1).The greater a security's duration, the greater its price volatility tomovements in interest rates. The sensitivity of the Group's fixed income andderivative investment portfolio to interest rate movements is detailed below,assuming linear movements in interest rates: 2009 2008 as at 31 december $m % $m % immediate shift in yield (basis points) 100 (56.7) (3.0) (43.1) (2.7) 75 (42.5) (2.2) (32.3) (2.0) 50 (28.3) (1.5) (21.6) (1.4) 25 (14.2) (0.7) (10.8) (0.7) (25) 10.0 0.5 6.6 0.4 (50) 20.0 1.1 13.1 0.8 (75) 29.9 1.6 19.7 1.2 (100) 39.9 2.1 26.2 1.6
(1) duration is the weighted average maturity of a security's cash flows, where the present values of the cash flows serve as the weights. The effect of convexity on the portfolio's response to changes in interest rates has been factored into the data above.
The Group mitigates interest rate risk on the investment portfolio byestablishing and monitoring duration ranges in its investment guidelines. Theduration of the core portfolio is matched to the modeled duration of theinsurance reserves, within a permitted range. The permitted duration range forthe core plus portfolio is between one and four years and the surplus portfoliois between one and five years.The duration of the externally managed portfolios, expressed in years, is asfollows:as at 31 december 2009 2008 core portfolio 1.6 1.7 core plus portfolio 1.9 1.4 surplus portfolio 3.2 2.6
In addition to duration management, the Group uses Value at Risk ("VaR") on amonthly basis to measure potential losses in the estimated fair values of itscash and invested assets and to understand and monitor risk.The VaR calculation is performed using variance/covariance risk modeling tocapture the cash flows and embedded optionality of the portfolio. Securitiesare valued individually using market standard pricing models. These securityvaluations serve as the input to many risk analytics, including full valuationrisk analyses, as well as parametric methods that rely on option adjusted risksensitivities to approximate the risk and return profiles of the portfolio.The principal measure that is produced is a ninety day VaR at the 95thpercentile confidence level. Management also monitors the 99th percentileconfidence level. The ninety day VaR, at the 95th percentile confidence level,measures the minimum amount the assets should be expected to lose in a ninetyday time horizon, under normal conditions, 5% of the time. The current VaRtolerance is 4.0% of shareholders' equity, using the ninety day VaR at the 95thpercentile confidence level.
The Group's VaR calculations are as follows:
2009 2008 as at 31 december $m % $m %
95th percentile confidence level 40.4 2.9 43.1
3.4
99th percentile confidence level 57.0 4.1 60.9
4.8
derivative financial instruments
The Group may utilise derivative instruments for yield enhancement, duration management, interest rate and foreign currency exposure management, or to obtain an exposure to a specific financial market, currency or product. The Group currently invests in the following derivative financial instruments:
mortgage backed "to be announced" securities ("TBAs")
The TBA market is essentially a forward or delayed delivery market formortgage-backed securities issued by U.S. government agencies, where securitiesof a specific term and interest rate are bought or sold for future settlementon a "to be announced" basis. TBAs are generally physically settled andclassified as available for sale fixed income securities. Occasionally TBAs maybe traded for net settlement. Such instruments are deemed to be derivativeinstruments. All TBAs classified as derivatives are held on a non-leveragedbasis. The credit exposure is restricted to the differential between thesettlement value of the forward purchase and the forward sale. Thecredit-worthiness of the counter-party is monitored and collateral may berequired on open positions.
The estimated fair value of TBA positions is an asset and corresponding liability of $nil (2008 - $116.4 million).
futures
The Group's investment guidelines only permit the use of futures that areexchange-traded. Such futures provide the Group with participation in marketmovements, determined by the underlying instrument on which the futurescontract is based, without holding the instrument itself or the individualsecurities. This approach allows the Group more efficient and less costlyaccess to the exposure than would be available by the exclusive use ofindividual fixed income and money market securities. Exchange-traded futurescontracts may also be used as substitutes for ownership of the physicalsecurities.All futures contracts are held on a non-leveraged basis. An initial margin isprovided, which is a deposit of cash and/or securities in an amount equal to aprescribed percentage of the contract value. The fair value of futurescontracts is estimated daily and the margin is adjusted accordingly withunrealised gains and/or losses settled daily in cash and/or securities. Arealised gain or loss is recognised when the contract is closed.Futures contracts expose the Group to market risk to the extent that adversechanges occur in the estimated fair values of the underlying securities.Exchange-traded futures are, however, subject to a number of safeguards toensure that obligations are met, including: the use of clearing houses (thusreducing counter-party credit risk); the posting of margins; and the dailysettlement of unrealised gains and losses. The amount of credit risk istherefore considered low.The notional value of open futures contracts as at 31 December 2009 is asfollows: $m $m long short eurodollar futures 570.0 -contracts A Eurodollar futures contract is an exposure to 3 month LIBOR, based on acommitment to a $1.0 million deposit. The estimated fair value is based onexpectations of 3 month LIBOR, is determined using exchange-traded prices andis negligible as at 31 December 2009. The contracts currently held by the Groupexpire in December 2010. There were no Eurodollar futures contracts in placeduring 2008.
The sensitivity of the Group's Eurodollar futures position to interest rate movements as at 31 December 2009 is detailed below:
$m immediate shift in 3 month LIBOR (basis points) 100 (1.4) 75 (1.1) 50 (0.7) 25 (0.4) (25) 0.4 (50) 0.7 (75) 1.1 (100) 1.4 options
The Group's investment guidelines only permit the use of options which areexchange-traded. Options are held on a similar basis to futures and are subjectto similar safeguards. Options are contractual arrangements that give thepurchaser the right, but not the requirement, to either buy or sell aninstrument at a specific set price at a future date, which may or may not bepre-determined. There were no open option contracts in place as at 31 December2009 and there were no options contracts in place during 2008.The net gains or losses recognised in the consolidated statement ofcomprehensive income on exchange-traded derivatives in 2009 were as follows: $m eurodollar futures contracts 1.6 treasury futures contracts (1.7)
options on treasury futures contracts
0.2 total 0.1b. insurance risk
The Group is exposed to insurance market risk from several sources, including the following:
* The advent of a soft insurance market, which may result in a stabilisation
or decline in premium rates and/or terms and conditions for certain lines,
or across all lines;
* The actions and reactions of key competitors, which may directly result in
volatility in premium volumes and rates, fee levels and other input costs;
and * Market events which may cause a limit in the availability of cover, including unusual inflation in rates, causing political intervention or national remedies.
The most important method to mitigate insurance market risk is to maintain strict underwriting standards. The Group manages insurance market risk in numerous ways, including the following:
* Reviews and amends underwriting plans and budgets as necessary; * Reduces exposure to market sectors where conditions have reached unattractive levels; * Purchases appropriate, cost effective reinsurance cover to mitigate exposure; * Closely monitors changes in rates and terms and conditions; and
* Regularly reviews output from the Group's economic capital model, BLAST, to
assess up-to-date profitability of classes and sectors.
Insurance contract liabilities are not directly sensitive to the level of market interest rates, as they are undiscounted and contractually non-interest bearing.
c. debt riskThe Group has issued long-term debt as described in note 18. The loan notesbear interest at a floating rate that is re-set on a quarterly basis, plus afixed margin of 3.70%. The Group is subject to interest rate risk on the couponpayments of the long-term debt. The Group has mitigated the interest rate riskby entering into interest rate swap contracts as follows: maturity date prepayment date interest
hedged
subordinated loan notes $97.0 15 december 2035 15 march 2011
50%million 15 june 2035 15 march 2011 50%
subordinated loan notes €24.0 million
The swaps expire on 15 March 2011.
In certain circumstances the subordinated loan notes can be prepaid from 16 December 2005, with a sliding scale redemption price penalty which reduces to zero by 15 March 2011. Refer to note 18 for further details.
The current Euribor interest rate on 50% of the Euro subordinated loan noteshas been set at 0.71% (2008 - 3.33%). The current LIBOR interest rate on 50% ofthe U.S. dollar subordinated loan notes has been set at 0.25% (2008 - 2.00%).The Group has no interest rate risk on the remaining portion of the notes.
d. currency risk
The Group currently underwrites from two locations, Bermuda and London, although risks are assumed on a worldwide basis. Risks assumed are predominantly denominated in U.S. dollars.
The Group is exposed to currency risk to the extent its assets are denominated in different currencies to its liabilities. The Group is also exposed to non-retranslation risk on non-monetary assets such as unearned premiums and deferred acquisition costs. Exchange gains and losses can impact income.
The Group hedges non-U.S. dollar liabilities primarily with non-U.S. dollar assets. The Group's main foreign currency exposure relates to its insurance obligations, cash holdings, premiums receivable, dividends due and the €24.0 million subordinated loan notes long-term debt liability.
The Group's assets and liabilities, categorised by currency at their translated carrying amount were as follows:
assets $m $m $m $m $m U.S. $ sterling euro other total cash and cash equivalents 124.9 271.1 37.8 6.2 440.0 accrued interest receivable 12.0 - - - 12.0 fixed income securities - 1,892.5 - - - 1,892.5available for sale reinsurance assets 45.7 - - - 45.7 deferred acquisition costs 43.4 1.0 4.6 3.9 52.9 other receivables 4.0 0.3 - - 4.3 inwards premiums receivable from 143.6 4.8 19.1 10.7 178.2insureds and cedants deferred tax asset - 3.3 - - 3.3
property, plant and equipment 6.9 1.3 - - 8.2
total assets as at 31 december 2,273.0 281.8 61.5 20.8 2,637.12009 liabilities $m $m $m $m $m U.S. $ sterling euro other total losses and loss adjustment 445.0 3.6 21.4 18.9 488.9expenses unearned premiums 265.8 8.4 22.7 20.7 317.6 insurance contracts - other 12.4 0.2 2.1 1.1 15.8payables
amounts payable to reinsurers 4.2 - - - 4.2
deferred acquisition costs ceded 2.7 - - - 2.7 other payables 18.9 274.6 0.3 - 293.8 interest rate swap 3.0 - 0.6 - 3.6 accrued interest payable 0.1 - 0.1 - 0.2 long-term debt 97.0 - 34.4 - 131.4 total liabilities as at 31 849.1 286.8 81.6 40.7 1,258.2december 2009 assets $m $m $m $m $m U.S. $ sterling euro other total cash and cash equivalents 368.8 7.6 33.9 3.3 413.6 accrued interest receivable 10.1 - - - 10.1 investments - fixed income securities - available for sale 1,595.4 - - - 1,595.4 - at fair value through profit 4.0 - - - 4.0and loss - equity securities - available 5.8 - - - 5.8for sale reinsurance assets 55.3 - - - 55.3 deferred acquisition costs 48.8 1.7 5.5 4.9 60.9 other receivables 152.2 1.7 - 0.1 154.0 inwards premiums receivable from 143.9 7.8 25.0 10.6 187.3insureds and cedants deferred tax asset - 1.2 - - 1.2
property, plant and equipment 0.1 1.2 - 0.1 1.4
total assets as at 31 december 2,384.4 21.2 64.4 19.0 2,489.02008 liabilities $m $m $m $m $m U.S. $ sterling euro other total losses and loss adjustment 488.2 3.1 20.0 17.5 528.8expenses unearned premiums 274.2 14.0 26.6 24.8 339.6 insurance contracts - other 13.3 0.2 3.2 0.9 17.6payables
amounts payable to reinsurers 1.9 0.1 - - 2.0
deferred acquisition costs ceded 1.9 - - - 1.9 other payables 184.3 5.8 0.2 - 190.3 interest rate swap 4.4 - 0.5 - 4.9 accrued interest payable 0.2 - 0.2 - 0.4 long-term debt 97.0 - 33.8 - 130.8
total liabilities as at 31 1,065.4 23.2 84.5 43.2 1,216.3 december 2008
The impact on net income of a proportional foreign exchange movement of 10% up and 10% down against the U.S. dollar at the year end spot rates would be an increase or decrease of $0.7 million (2008 - $0.4 million).
C. liquidity risk
Liquidity risk is the risk that cash may not be available to pay obligations when they are due without incurring an unreasonable cost.
The Group's main exposures to liquidity risk are with respect to its insuranceand investment activities. The Group is exposed if proceeds from financialassets are not sufficient to fund obligations arising from its insurancecontracts. The Group can be exposed to daily calls on its available investmentassets, principally from insurance claims.
Exposures in relation to insurance activities are as follows:
* Large catastrophic events, or multiple medium-sized events in quick succession, resulting in a requirement to pay a large amount of claims within a relatively short time-frame;
* Failure of insureds or cedants to meet their contractual obligations with
respect to the payment of premiums in a timely manner; and
* Failure of reinsurers to meet their contractual obligations with respect to
the payment of claims in a timely manner.
Exposures in relation to investment activities are as follows:
* Adverse market movements and/or a duration mismatch to obligations,
resulting in investments being disposed of at a significant realised loss;
and
* An inability to liquidate investments due to market conditions.
The maturity dates of the Group's fixed income portfolio are as follows:
as at 31 december 2009 $m $m $m
$m
fixed income securities- external core core plus surplus total less than one year 180.4 4.8 29.1 214.3 between one and two years 120.1 3.5 131.2 254.8 between two and three years 156.2 15.3 152.0
323.5
between three and four years 39.8 14.3 70.1
124.2
between four and five years 38.6 1.5 193.0 233.1 over five years 3.4 - 148.3 151.7 mortgage backed securities 64.0 16.4 404.0
484.4
total fixed income securities - 602.5 55.8 1,127.7 1,786.0external fixed income securities - internal 106.5 - - 106.5 less than one year total 709.0 55.8 1,127.7 1,892.5 as at 31 december 2008 $m $m $m $m core core plus surplus total
fixed income securities- external
less than one year 184.4 22.2 69.8 276.4 between one and two years 128.8 30.8 39.9 199.5 between two and three years 157.7 48.7 63.7
270.1
between three and four years 61.7 8.9 20.8
91.4
between four and five years 18.4 6.8 27.0 52.2 over five years 13.1 1.8 80.5 95.4 mortgage backed securities 180.9 82.2 351.3
614.4
total fixed income securities - 745.0 201.4 653.0 1,599.4 external
The maturity profile of the financial liabilities of the Group is as follows:as at 31 december 2009 $m $m $m $m $m $m years until liability becomes due - undiscounted values balance less one to three over total three five sheet than to five one losses and loss adjustment 488.9 183.5 181.7 67.0 56.7 488.9expenses insurance contracts - other 15.8 12.7 2.4 0.7 - 15.8payables amounts payable to 4.2 4.2 - - - 4.2reinsurers other payables 291.4 291.4 - - - 291.4 corporation tax payable 2.4 2.4 - - - 2.4 interest rate swap 3.6 2.9 0.7 - - 3.6 accrued interest payable 0.2 0.2 - - - 0.2 long-term debt 131.4 5.2 10.7 10.7 243.1 269.7 total 937.9 502.5 195.5 78.4 299.8 1,076.2as at 31 december 2008 $m $m $m $m $m $m years until liability becomes due - undiscounted values balance less one to three over total three five sheet than to five one losses and loss adjustment 528.8 188.5 211.0 72.2 57.1 528.8expenses insurance contracts - other 17.6 14.0 3.2 0.4 - 17.6payables amounts payable to 2.0 2.0 - - - 2.0reinsurers other payables 190.3 190.3 - - - 190.3 interest rate swap 4.9 2.1 2.8 - - 4.9 accrued interest payable 0.4 0.4 - - - 0.4 long-term debt 130.8 7.9 15.8 15.8 303.4 342.9 total 874.8 405.2 232.8 88.4 360.5 1,086.9Actual maturities of the above may differ from contractual maturities becausecertain borrowers have the right to call or pre-pay certain obligations with orwithout call or prepayment penalties. The prepayment options for the Group'slong-term debt are discussed in note 18. While the estimation of the ultimateliability for losses and loss adjustment expenses is complex and incorporates asignificant amount of judgement, the timing of payment of losses and lossadjustment expenses is also uncertain and cannot be predicted as simply as forother financial liabilities. Actuarial and statistical techniques, pastexperience and management's judgement have been used to determine a likelysettlement pattern.The Group manages its liquidity risks via its investment strategy to hold highquality, highly liquid securities, sufficient to meet its insurance liabilitiesand other near term liquidity requirements. The creation of the core portfoliowith its subset of guidelines ensures funds are readily available to meetpotential insurance liabilities in an extreme event plus other near termliquidity requirements.In addition, the Group has established asset allocation and maturity parameterswithin the investment guidelines such that the majority of the investments arein high quality assets which could be converted into cash promptly and atminimal expense. The Group monitors market changes and outlooks andre-allocates assets as deemed necessary.
D. credit risk
Credit risk is the risk that a counter-party may fail to pay, or repay, a debt or obligation. The Group is exposed to credit risk on its fixed income investment portfolio and derivative instruments, its inwards premiums receivable from insureds and cedants, and on any amounts recoverable from reinsurers.
Credit risk on the fixed income portfolio is mitigated through the Group'spolicy to invest in instruments of high credit quality issuers and to limit theamounts of credit exposure with respect to particular ratings categories andany one issuer. Securities rated below BBB- / Baa3 may comprise no more than 5%of shareholders' equity, with the exception of U.S. government and agencysecurities. In addition, no one issuer, with the exception of U.S. governmentand agency securities, should exceed 5% of shareholders' equity. The Group istherefore not exposed to any significant credit concentration risk on itsinvestment portfolio, except for fixed income securities issued by the U.S.government and government agencies.
Credit risk on derivative instruments is mitigated by the use of exchange-traded instruments which use clearing houses to reduce counter-party credit risk, require the posting of margins and settle unrealised gains and losses daily.
Credit risk on inwards premiums receivable from insureds and cedants is managedby conducting business with reputable broking organisations, with whom theGroup has established relationships, and by rigorous cash collectionprocedures. The Group also has a broker approval process in place. Credit riskfrom reinsurance recoverables is primarily managed by review and approval ofreinsurer security by the GRSC as discussed in the insurance risk sectionabove.
The table below presents an analysis of the Group's major exposures to counter-party credit risk, based on their Standard & Poor's or equivalent rating. The table includes amounts due from policyholders and unsettled investment trades. The quality of these receivables is not graded, but based on management's historical experience there is limited default risk associated with these amounts.
as at 31 december $m $m $m $m2009 equity cash and inwards premiums reinsurance securities and recoveries other fixed income receivable and investments securities other receivables AAA - 1,830.6 - - AA+, AA, AA- - 110.8 - - A+, A, A- - 295.9 4.3 35.8 BBB+, BBB, BBB- - 95.0 - - other - 0.2 182.5 - total - 2,332.5 186.8 35.8 as at 31 december $m $m $m $m2008 equity cash and inwards premiums reinsurance securities and recoveries other fixed income receivable and investments securities other receivables AAA - 1,572.6 - - AA+, AA, AA- - 207.9 - - A+, A, A- - 190.8 3.2 42.1 BBB+, BBB, BBB- - 38.9 - - other 5.8 2.8 341.3 - total 5.8 2,013.0 344.5 42.1
The counter-party to the Group's interest rate swap is currently rated AA by Standard & Poor's.
The following table shows inwards premiums receivable that are past due but notimpaired: 2009 2008 as at 31 december $m $m less than 90 days past due 8.6 8.1
between 91 and 180 days past due 0.4
1.4 over 180 days past due 0.3 0.5 total 9.3 10.0Provisions of $1.4 million (2008 - $1.5 million) have been made for impaired orirrecoverable balances and $0.2 million (2008 - $1.4 million) was charged tothe consolidated statement of comprehensive income in respect of bad debts. Noprovisions have been made against balances recoverable from reinsurers.
E. operational risk
Operational risk is the risk of loss resulting from inadequate or failedinternal processes or systems including the risk of fraud, inadequate healthand safety for employees, damage to physical assets, business disruption,system failure and transaction processing failure. The Group's main operationalrisks are as follows: * Underwriters may operate outside of approved authority levels; * Employees may fail to comply with the Group's operating guidelines; * IT systems may fail to meet business needs; * Key processes may fail, leading to delays and/or inaccurate or untimely management information; * Effective and comprehensive enterprise risk management practices and philosophies may not be embedded throughout the Group; * Unintended insurance coverage may be provided or received due to the misinterpretation of insurance contract policy wording; * Management may fail to address or identify an unforeseen or unexpected risk; * Compliance and regulatory failures; and * Loss of key personnel. The Group has a robust self governance framework. Policies and procedures aredocumented, reviewed and updated when necessary and affirmed by management on aquarterly basis. The Group's internal audit function considers the accuracy andcompleteness of key risks and controls, and independently verifies theeffective operation of these through substantive testing. All higher risk areasare subject to annual audit, with all other areas audited, on a rotationalbasis, at least once every three years.Information technology risk tolerances have been defined and system performanceis monitored continuously. The Group's disaster recovery plan is re-assessedand updated on a regular basis.
F. strategic risk
The Group has identified several strategic risks. These include the risks thateither the poor execution of the business plan or poor business planning initself results in a strategy that fails to adequately reflect the tradingenvironment, resulting in an inability to optimise performance. The Group hasalso identified risks from the failure to maintain adequate capital, accessingcapital at an inflated cost or the inability to access capital. This includesunanticipated changes in regulatory and/or rating agency models that couldresult in an increase in capital requirements or a change in the type ofcapital required. Lastly, the Group has identified succession planning, staffretention and key man risk as strategic risks.
The Group addresses the risks associated with planning and execution of the business plan through a combination of the following:
* An iterative annual budget process with cross departmental involvement; * Approval of the annual budget by the Board of Directors; * Regular monitoring of actual versus budgeted results; and * Periodic review and re-forecasting as market conditions change.
Risks associated with the effectiveness of the Group's capital management are mitigated as follows:
* Regular monitoring of current regulatory and rating agency capital requirements; * Oversight of capital requirements by the Board of Directors; and
* Maintaining contact with regulators and rating agencies in order to stay
abreast of upcoming developments.
Risks associated with succession planning, staff retention and key man risks are mitigated through a combination of resource planning processes and controls, including:
* The identification of key personnel with appropriate succession plans; * Documented recruitment procedures, position descriptions and employment contracts; and * Resource monitoring and the provision of appropriate compensation and training schemes.
a. capital risk management
The total capital of the Group as at 31 December 2009 is determined as $1,510.3million (2008 - $1,403.5 million) comprising $1,378.9 million of shareholders'equity (2008 - $1,272.7 million) and $131.4 million of long-term debt (2008 -$130.8 million). The Group's capital requirements vary with the insurancecycle.
The Group reviews the level and composition of capital on an ongoing basis with a view to:
* Maintaining sufficient capital for underwriting opportunities and to meet
obligations to policyholders; * Maximising the return to shareholders within pre-determined risk tolerances; * Maintaining adequate financial strength ratings; and * Meeting internal and regulatory capital requirements.
Capital is increased or returned as appropriate. The retention of earnings generated leads to an increase in capital. Capital raising can include debt orequity and returns of capital may be made through dividends, share repurchases,a redemption of debt or any combination thereof. Other capital management toolsand products available to the Group may also be utilised. All capital actionsrequire approval by the Board of Directors.Internal methods have been developed to review the profitability of classes ofbusiness and their estimated capital requirements, and the capital requirementsof the combination of a wide range of other risk categories. Managementincreasingly uses these approaches in decision making. The operating entitiesalso conduct capital requirement assessments under internal measures and localregulatory requirements. Refer to note 26 for a discussion of the regulatorycapital requirements of the Group's operating entities.
b. risk adjusted return
The Group's aim is to provide its shareholders with a return on equity of 13%in excess of a risk free rate over the insurance cycle. The return is generatedwithin a broad framework of risk parameters. The return is measured bymanagement in terms of the internal rate of return ("IRR") of the increase infully converted book value per share ("FCBVS") in the period plus dividendsaccrued. This aim is a long-term goal, acknowledging that management expectboth higher and lower results in the shorter term. The cyclicality andvolatility of the insurance market is expected to be the largest driver of thispattern. Management monitors these peaks and troughs - adjusting the Group'sportfolio to make the most effective use of available capital and seeking tomaximise the risk adjusted return.IRR achieved is as follows: annual compound inception to return annual return date return 31 december 2005(1) (3.2%) n/a (3.2%) 31 december 2006 17.8% 14.0% 14.0% 31 december 2007 31.4% 22.4% 50.3% 31 december 2008 7.8% 17.9% 63.7% 31 december 2009 26.5% 19.8% 105.8%
(1) the returns shown are for the period from the date of incorporation, 12 October 2005 to 31 December 2005
IRR achieved in excess of the 3 month treasury yield is as follows:
annual compound inception to return annual return date return 31 december 2005(1) (3.4%) n/a (3.4%) 31 december 2006 13.0% 9.2% 9.2% 31 december 2007 26.9% 17.8% 40.8% 31 december 2008 6.4% 14.3% 52.7% 31 december 2009 26.4% 17.1% 94.6%
(1) the returns shown are for the period from the date of incorporation, 12 October 2005 to 31 December 2005
1. general information
The Group is a provider of global property insurance and reinsurance products.LHL was incorporated under the laws of Bermuda on 12 October 2005. On 16 March2009 LHL was listed on the main market of the London Stock Exchange ("LSE");previously LHL was listed on AIM, a subsidiary market of the LSE. A secondarylisting on the Bermuda Stock Exchange ("BSX") was approved on 21 May 2007. Theregistered office of LHL is Clarendon House, 2 Church Street, Hamilton HM 11,Bermuda. The registered office from 1 March 2010 will be Power House, 7Par-La-Ville Road, Hamilton HM 11, Bermuda.LHL has five subsidiaries, all wholly owned: Lancashire Insurance CompanyLimited ("LICL"), Lancashire Insurance Holdings (UK) Limited ("LIHL"),Lancashire Insurance Marketing Services Limited ("LIMSL"), Lancashire InsuranceServices Limited ("LISL") and Lancashire Marketing Services (Middle East)Limited ("LMEL"). LIHL is a holding company for a wholly owned operatingsubsidiary, Lancashire Insurance Company (UK) Limited ("LUK").
The subsidiaries were incorporated and licensed as insurance companies or intermediaries as follows:
LICL LIHL LUK LIMSL LISL LMEL date of 28 october 11 april 17 march 7 october 17 march 11 marchincorporation 2005 2006 2006 2005 2006 2007 licensing body BMA(1) none FSA(2) FSA(2) none DFSA(3) nature of business general holding general insurance support insurance insurance company insurance mediation services mediation business business activities activities
(1) Bermuda Monetary Authority ("BMA")
(2) United Kingdom, Financial Services Authority ("FSA")
(3) Dubai Financial Services Authority ("DFSA")
2. segmental reporting
Management and the Board of Directors review the Group's business primarily byits four principal classes: property, energy, marine and aviation. Theseclasses are therefore deemed to be the Group's operating segments for thepurposes of segment reporting. Further subclasses of business are underwrittenwithin each operating segment. The nature of these individual sub-classes isdiscussed further in the risk disclosures section. Operating segmentperformance is measured by the net underwriting profit or loss and the combinedratio.All amounts reported are transactions with external parties. There are nointer-segmental transactions and there are no insurance or reinsurancecontracts that insure or reinsure risks in Bermuda, the Group's country ofdomicile.gross premiums written $m $m $m $m $m property energy marine aviation total
analysed by geographical zone:
worldwide offshore 1.0 154.9 71.4 - 227.3 U.S. and Canada 156.0 2.2 0.1 - 158.3 worldwide, including the U.S. and 51.5 7.4 (0.6) 60.9 119.2Canada(1) europe 30.3 3.5 2.1 0.3 36.2 worldwide, excluding the U.S. and 35.1 - 0.4 0.1 35.6Canada(2) far east 10.9 2.1 0.2 - 13.2 middle east 8.6 3.3 - - 11.9 rest of world 23.9 2.1 0.1 - 26.1 total 317.3 175.5 73.7 61.3 627.8
outwards reinsurance premiums (17.2) (13.5) (9.3) (10.7) (50.7)
change in unearned premiums (14.8) 14.9 9.8 12.1
22.0
change in unearned premiums ceded (1.8) (4.3) 1.7 - (4.4) net premiums earned 283.5 172.6 75.9 62.7 594.7 insurance losses and loss 8.9 (82.6) (29.4) (1.3) (104.4)adjustment expenses insurance losses recoverable - 5.7 - - 5.7
insurance acquisition expenses (37.8) (37.8) (23.1) (13.9) (112.6)
insurance acquisition expenses 2.0 2.9 0.7 1.0
6.6ceded net underwriting profit 256.6 60.8 24.1 48.5 390.0 net unallocated income and (1.5)expenses profit before tax 388.5 loss ratio (3.1%) 44.6% 38.7% 2.1% 16.6% acquisition cost ratio 12.6% 20.2% 29.5% 20.6% 17.8% expense ratio - - - - 10.2% combined ratio 9.5% 64.8% 68.2% 22.7% 44.6%
revenue and expense by operating segment - for the year ended 31 december 2009
(1) worldwide, including the U.S. and Canada, comprises insurance and reinsurance contracts that insure or reinsure risks in more than one geographic area
(2) worldwide, excluding the U.S. and Canada, comprises insurance and reinsurance contracts that insure or reinsure risks in more than one geographic area, but that specifically exclude the U.S. and Canada
revenue and expense by operating segment - for the year ended 31 december 2008 gross premiums written $m $m $m $m $m property energy marine aviation total
analysed by geographical zone:
worldwide offshore 0.9 159.1 72.6 - 232.6 U.S. and Canada 108.5 4.2 0.1 - 112.8 worldwide, including the U.S. and 44.5 7.2 2.1 70.4 124.2Canada(1) europe 34.1 4.6 2.9 0.4 42.0 worldwide, excluding the U.S. and 47.5 0.5 0.2 0.3 48.5Canada(2) far east 14.1 2.1 0.7 0.4 17.3 middle east 8.9 3.5 - - 12.4 rest of world 44.2 4.0 - 0.1 48.3 total 302.7 185.2 78.6 71.6 638.1
outwards reinsurance premiums (23.1) (25.6) (7.6) (7.1) (63.4)
change in unearned premiums (2.3) 36.9 (0.5) 8.1
42.2
change in unearned premiums ceded (5.1) (5.3) 0.1 0.7 (9.6) net premiums earned 272.2 191.2 70.6 73.3 607.3 insurance losses and loss (100.9) (271.8) (38.1) (8.0) (418.8)adjustment expenses insurance losses recoverable - 43.3 - - 43.3
insurance acquisition expenses (35.3) (36.7) (19.8) (15.1) (106.9)
insurance acquisition expenses 1.2 5.4 0.4 0.3
7.3ceded net underwriting profit 137.2 (68.6) 13.1 50.5 132.2 net unallocated income and expenses (34.6) profit before tax 97.6 loss ratio 37.1% 119.5% 54.0% 10.9% 61.8% acquisition cost ratio 12.5% 16.4% 27.5% 20.2% 16.4% expense ratio - - - - 8.1% combined ratio 49.6% 135.9% 81.5% 31.1% 86.3%
(1) worldwide, including the U.S. and Canada, comprises insurance and reinsurance contracts that insure or reinsure risks in more than one geographic area
(2) worldwide, excluding the U.S. and Canada, comprises insurance and reinsurance contracts that insure or reinsure risks in more than one geographic area, but that specifically exclude the U.S. and Canada
3. investment return
The total investment return for the Group is as follows:
2009 2008 $m $m net investment income
- interest on fixed income securities 62.6
46.5
- net (accretion) amortisation (5.2)
3.5
- interest income on cash and cash equivalents 2.1
12.2
- dividends from equity securities -
0.9
- investment management and custodian fees (3.5) (3.6) net investment income 56.0 59.5 net other investment income (loss)(1) 0.3
(0.7)
net realised gains (losses) and impairments
- fixed income securities 24.7 10.6 - equity securities (1.0) (21.6)
- derivative financial instruments 0.1
-
net realised gains (losses) and impairments 23.8
(11.0)
net change in unrealised gains recognised in other
comprehensive income - fixed income securities 2.7 16.5 - equity securities - (9.4)
net change in unrealised gains (losses) 2.7
7.1 total investment return 82.8 54.9
(1) a share of loss of associate of $0.2 million is included in the year ended 31 December 2008
Net realised gains (losses) and impairments includes an impairment loss of $0.4million (2008 - $21.6 million) recognised on fixed income and equity securitiesheld by the Group.
Movements within unrealised gains and losses within accumulated other comprehensive income are as follows:
2009 2008 $m $m fixed income securities - net unrealised gains released (21.8)
(3.7)
- net unrealised gains recorded 24.1
17.6
- net unrealised losses released for impairments 0.4
2.6 equity securities - net unrealised losses (gains) released 1.1
(1.0)
- net unrealised losses recorded (1.1)
(20.6)
- net unrealised losses released for impairments -
12.2
net change in unrealised gains (losses) on 2.7
7.1investments
4. net insurance acquisition expenses
5. 2009 2008 $m $m insurance acquisition expenses 104.6
110.0
changes in deferred insurance acquisition expenses 8.0
(3.1)
insurance acquisition expenses ceded (5.2)
(6.1)
changes in deferred insurance acquisition expenses (1.4) (1.2)ceded total 106.0 99.6
5. other operating expenses
2009 2008 $m $m operating expenses unrelated to underwriting 60.5 49.3 equity based compensation 16.4 10.6 total 76.9 59.96. employee benefits 2009 2008 $m $m wages and salaries 15.7 14.2 pension costs 1.5 1.2 bonus and other benefits 18.4 9.6 equity based compensation 16.4 10.6 total 52.0 35.6equity based compensation
The Group's primary equity based compensation scheme is its restricted stock scheme ("RSS"). Previously the Group also administered a warrant plan and a long term incentive plan ("LTIP").
The following charges are included in other operating expenses in the consolidated statement of comprehensive income:
2009 2008 $m $m RSS - ordinary 6.8 1.1 RSS - exceptional 0.5 0.4 LTIP 5.7 6.7 warrants - ordinary - 3.3 warrants - performance 3.4 (0.9) total 16.4 10.6RSS - ordinaryOn 4 January 2008 the LTIP was closed and replaced with an RSS. RSS are subjectto time and, normally, performance conditions. The ordinary restricted shareawards vest after a three year period and are dependent on certain performancecriteria. A maximum of 50% of ordinary restricted share awards will vest onlyon the achievement of a total shareholder return in excess of the 75thpercentile of the total shareholder return of a pre-defined comparator group. Amaximum of 50% of ordinary restricted share awards will vest only on theachievement of a return on equity by LHL in excess of a required amount.ordinary restricted shares number weighted average fair value granted during the year 1,851,701 $5.75 forfeited during the year (18,914) $5.73 outstanding as at 31 december 2008 1,832,787 $5.75 granted during the year 2,480,125 $7.79 forfeited during the year (20,029) $5.73 outstanding as at 31 december 2009 4,292,883
$6.93
issuable as at 31 december 2009 -
-
The fair value of each restricted share granted pursuant to an ordinaryrestricted share award is equal to the share price of LHL on the date of grant.The fair value of ordinary restricted share awards granted ranges between $5.73and $8.58.RSS - exceptional
The exceptional restricted shares vest after a two year period and do not have associated performance criteria for vesting.
exceptional restricted shares number weighted average fair value granted during the year ending 31 166,904 $5.73december 2008 outstanding as at 31 december 2008 and 166,904 $5.732009
issuable as at 31 december 2009 -
-
The fair value of each restricted share granted pursuant to an exceptional restricted share award is equal to the share price of LHL on the date of grant.
LTIP
No further options have been granted since the close of the LTIP plan. All LTIPoptions issued will expire ten years from the date of issue. The exercise pricefor LTIP options issued prior to 2007 is equal to or greater than the averageclosing price of the shares on the twenty previous trading days prior to grant.The exercise price for options awarded in 2007 is equal to the closing price ofthe shares by reference to a single valuation date occurring five days afterthe end of the close period ("close period" as defined in the Glossary to theAIM Rules for Companies - February 2007) most recently concluded prior to grantor five days after the decision to make the award if such decision was madeoutside a close period. 25% of LTIP options vest on each of the first, second,third and fourth anniversary of the grant date. There are no associatedperformance criteria. Settlement is at the discretion of the Group and may
bein cash or shares.options number weighted average exercise price outstanding as at 31 december 2007 6,979,339 $6.42(1) forfeited during the year (86,039) $6.11(1) outstanding as at 31 december 2008 6,893,300 $5.38(1) exercised during the year (2,220,059) $4.39 forfeited during the year (56,489) $5.57 outstanding as at 31 december 2009 4,616,752
$4.34
exercisable as at 31 december 2009 1,798,832
$4.40
(1) adjusted for revaluation at the exchange rate as at 31 December 2009
On the dates listed below the Remuneration Committee exercised their discretionary power to adjust option exercise prices to neutralise the devaluing impact of dividend payments. The resulting charge to equity based compensation in the consolidated statement of comprehensive income is also shown. In all cases there is a net $nil impact to shareholders' equity.
adjustment to charge exercise price 2009 2008 date $ £ $m $m 14 february 2008 1.10 0.56 0.7 1.2 4 november 2009 1.30 0.79 2.0 - total 2.40 1.35 2.7 1.2
management team ordinary warrants ("ordinary warrants")
Ordinary warrants were all fully vested by 31 December 2008. The fair value of ordinary warrants granted for all periods was $2.62 per share. Ordinary warrants granted and outstanding are:
ordinary warrants number weighted average exercise price outstanding as at 31 december 2008 and 11,433,465 $4.712009 exercisable as at 31 december 2009 11,433,465
$4.71
management team performance warrants ("performance warrants")
Performance warrants were all fully vested by 31 December 2009. Vesting wasdependent on achieving certain performance criteria. The fair value of warrantsgranted for all periods was $2.62 per share. Performance warrants granted andoutstanding are:performance warrants number weighted average exercise price outstanding as at 31 december 2007 6,474,346 $5.00 lapsed during the year (2,782,659) $3.90 outstanding as at 31 december 2008 3,691,687 $4.10 lapsed during the year (1,931,377) $2.60 outstanding as at 31 december 2009 1,760,310
$3.62
exercisable as at 31 december 2009 1,760,310
$3.62
Refer to note 21 for further disclosure on the total management warrants outstanding.
7. results of operating activities
Results of operating activities are stated after charging the followingamounts: 2009 2008 $m $m depreciation on owned assets 0.8 1.1 operating lease charges 1.6 1.8 auditors remuneration - group audit fees 1.2 1.2 - other services 0.6 0.2 total 4.2 4.3
Fees paid to the Group's auditors for other services are approved by the Group's Audit Committee. Such fees comprise the following amounts:
2009 2008 $m $m tax advice 0.1 0.1 other 0.5 0.1 total 0.6 0.28. taxBermuda
LHL, LICL and LUK have received an undertaking from the Bermuda government exempting them from all Bermuda local income, withholding and capital gains taxes until 28 March 2016. At the present time no such taxes are levied in Bermuda.
United States
The Group does not consider itself to be engaged in trade or business in theU.S. and, accordingly, does not expect to be subject to U.S. taxation on itsincome or capital gains.United KingdomThe UK subsidiaries are subject to normal UK corporation tax on all theirprofits.tax charge 2009 2008 $m $m corporation tax charge (credit) for the year 4.8
(0.3)
adjustments in respect of prior year corporation tax 0.4
(0.4)
deferred tax (credit) charge for the year (1.5)
0.3
adjustments in respect of prior year deferred tax (0.6)
0.5 total 3.1 0.1tax reconciliation 2009 2008 $m $m profit before tax 388.5 97.6 less profit not subject to tax (372.9)
(101.9)
profits (losses) subject to tax 15.6 (4.3) UK corporation tax 4.4 (1.2)
adjustments in respect of prior period (0.2)
0.1
other expense temporary differences (1.2)
1.2
other expense permanent differences 0.1
- total 3.1 0.1On 1 April 2008 the standard rate of corporation tax in the UK decreased from30% to 28%. The standard rate of tax for 2009 is 28% (2008 - weighted averagerate of 28.5%). The current tax charge as a percentage of the Group's profitbefore tax is 0.8% (2008 - 0.1%) due to the different tax paying jurisdictionsthroughout the Group.
A current corporation tax expense of $0.1 million was credited to other comprehensive income during the year (2008 - $0.2 million charge), which relates to unrealised investment gains and losses included in accumulated other comprehensive income within shareholders' equity.
taxation 2009 2008 $m $m UK corporation tax payable 2.4 - 9. deferred tax 2009 2008 $m $m deferred tax assets 3.9 2.4 deferred tax liabilities (0.6) (1.2) net deferred tax asset 3.3 1.2
Deferred tax assets are recognised to the extent that realising the related taxbenefit through future taxable profits is likely. It is anticipated that theLancashire UK group of companies will be profitable in 2010, thus the entiredeferred tax asset is recognised.The deferred tax asset relates to the RSS, warrant and option employee benefitschemes. The deferred tax liability relates to claims equalisation reserves.All deferred tax assets and liabilities are classified as non-current.
The movement on the total net deferred tax asset is as follows:
2009 2008 $m $m as at 1 january 1.2 2.0 statement of comprehensive income credit (charge) 2.1 (0.8) as at 31 december 3.3 1.210. cash and cash equivalents 2009 2008 $m $m cash at bank and in hand 288.9 7.9 cash equivalents 151.1 405.7 total 440.0 413.6
Cash equivalents have an original maturity of three months or less. The carrying amount of these assets approximates their fair value.
Included in cash at bank and in hand is $232.5 million (2008 - $nil) of cashheld on deposit by LHL's share registrar to fund the special dividend paymentdisclosed in note 20.Refer to note 18 for the cash and cash equivalent balances on deposit ascollateral.11. investmentsas at 31 december 2009 $m $m $m $m cost or gross gross estimated amortised unrealised unrealised fair cost gain loss value fixed income securities - short-term investments 288.8 - - 288.8 - U.S. treasuries 251.9 4.1 (1.2) 254.8 - other government bonds 75.0 1.5 (0.2) 76.3 - U.S. government agency debt 114.1 1.0 (0.1)
115.0
- U.S. government agency mortgage 473.7 11.6 (0.9) 484.4backed securities - corporate bonds 467.1 13.3 (0.6) 479.8 - corporate bonds - FDIC guaranteed 191.0 2.6 (0.2) 193.4(1) total investments 1,861.6 34.1 (3.2) 1,892.5
(1) FDIC guaranteed corporate bonds are protected by the Federal Deposit Insurance Corporation, an independent agency of the U.S. government
as at 31 december 2008 $m $m $m $m cost or gross gross estimated amortised unrealised unrealised fair cost gain loss value fixed income securities - short-term investments 163.6 - - 163.6 - U.S. treasuries 186.8 6.5 (1.6) 191.7 - other government bonds 52.5 1.6 - 54.1 - U.S. government agency debt 109.1 5.4 - 114.5 - U.S. government agency mortgage 600.0 15.3 (0.9) 614.4backed securities - corporate bonds 306.6 3.8 (6.9) 303.5 - corporate bonds - FDIC guaranteed 148.4 5.0 - 153.4(1)
- convertible debt securities 0.2 - -
0.2
total fixed income securities - 1,567.2 37.6 (9.4) 1,595.4available for sale equity securities - available for 5.8 - - 5.8sale
total available for sale securities 1,573.0 37.6 (9.4) 1,601.2
fixed income securities - at fair 4.3 - (0.3) 4.0 value through profit and loss
total investments 1,577.3 37.6 (9.7) 1,605.2
(1) FDIC guaranteed corporate bonds are protected by the Federal Deposit Insurance Corporation, an independent agency of the U.S. government
Equity securities and other investments held as at 31 December 2008 are deemednon-current. Fixed income maturities are presented in the risk disclosuressection. Refer to note 18 for the investment balances in trusts in favour ofceding companies and on deposit as collateral.
The fair value of securities in the Group's investment portfolio is estimated using the following techniques:
i. Quoted prices in active markets for the same instrument; or
ii. Quoted prices on active markets for similar assets or liabilities or other
valuation techniques for which all significant inputs are based on
observable market data; or
iii. Valuation techniques for which any significant input is not based on
observable market data.
Securities that have quoted prices in active markets include publicly traded equity securities, U.S. treasuries and certain derivative financial instruments.
Securities that have their fair value estimated based on observable market data include:
* U.S. government agency debt;
* U.S. government agency mortgage backed securities;
* Non-agency mortgage backed securities;
* Corporate bonds;
* Convertible debt securities; and
* Certain derivative financial instruments.
A financial instrument is regarded as quoted in an active market, and includedin category (i), if quoted prices are readily and regularly available from anexchange, dealer, broker, industry group, pricing service or regulatory agencyand those prices represent actual and regularly occurring market transactionson an arms length basis. Instruments included in category (ii) are valued viaindependent external sources using modeled or other valuation methods. Suchmethods are typically industry accepted standard and consider the following:broker-dealer quotes; present value; future cash flows; yield curves; interestrates; prepayment speeds; default rates; and similar quoted instruments and/ormarket transactions.The fair value hierarchy of the Group's investment holdings is as follows:
as at 31 december 2009 $m $m $m fixed income securities (i) (ii) total - short-term investments 175.1 113.7 288.8 - U.S. treasuries 254.8 254.8 - other government bonds - 76.3 76.3 - U.S. government agency debt - 115.0 115.0 - U.S. government agency mortgage backed - 484.4 484.4securities - corporate bonds - 479.8 479.8 - corporate bonds - FDIC guaranteed (1) - 193.4
193.4
total fixed income securities - 429.9 1,462.6
1,892.5
available for sale
(1) FDIC guaranteed corporate bonds are protected by the Federal Deposit Insurance Corporation, an independent agency of the U.S. government
Prior year comparative disclosure is not required in the year of adoption andhas not been presented. There were no category (iii) investments as at 31December 2009 or 2008 therefore a reconciliation of movements within thatcategory has not been presented. There are no realised or unrealised gains orlosses recorded on category (iii) investments in the consolidated statement ofcomprehensive income or accumulated other comprehensive income. There have beenno transfers between categories (i) and (ii) during the year.Prices for the Group's investment portfolio are provided by a third partyinvestment accounting firm whose pricing processes, and the controls thereon,are subject to an annual audit on both the operation and the effectiveness ofthose controls - a "SAS 70" audit. SAS 70 audit reports are available toclients of the firm and the report is reviewed annually by management. Inaccordance with their pricing policy, various recognised reputable pricingsources are used including index providers, broker-dealers, and pricingvendors. The pricing sources use bid prices where available, otherwiseindicative prices are quoted based on observable market trade data. The pricesprovided are compared to the investment managers' and custodian's pricing.
12. insurance and reinsurance contracts
insurance liabilities $m $m $m unearned other total payables premiums as at 31 december 2007 381.8 16.5 398.3 net deferral for: prior years (317.5) - (317.5) current year 275.3 - 275.3 other - 1.1 1.1 as at 31 december 2008 339.6 17.6 357.2 net deferral for: prior years (274.8) - (274.8) current year 252.8 - 252.8 other - (1.8) (1.8) as at 31 december 2009 317.6 15.8 333.4
losses and loss adjustment expenses $m $m
$m losses reinsurance net losses recoveries and loss and loss adjustment adjustment expenses expenses as at 31 december 2007 179.6 (3.6) 176.0 net incurred losses for: prior years (26.0) (2.6) (28.6) current year 444.8 (40.7) 404.1 exchange adjustments (0.5) - (0.5) incurred losses and loss adjustment 418.3 (43.3) 375.0expenses net paid losses for: prior years 34.6 (0.4) 34.2 current year 34.5 (4.4) 30.1 paid losses and loss adjustment expenses 69.1 (4.8) 64.3 as at 31 december 2008 528.8 (42.1) 486.7 net incurred losses for: prior years (59.5) (4.0) (63.5) current year 163.9 (1.7) 162.2 exchange adjustments (0.4) (0.1) (0.5)
incurred losses and loss adjustment 104.0 (5.8)
98.2expenses net paid losses for: prior years 137.8 (12.1) 125.7 current year 6.1 - 6.1 paid losses and loss adjustment expenses 143.9 (12.1) 131.8 as at 31 december 2009 488.9 (35.8) 453.1reinsurance assets and $m $m $m $mliabilities unearned amounts other total payable to receivables premiums on reinsurers premiums ceded as at 31 december 2007 19.6 (5.7) 8.2 22.1 net deferral for: prior years (18.6) - - (18.6) current year 9.0 - - 9.0 other - 3.7 (5.0) (1.3) as at 31 december 2008 10.0 (2.0) 3.2 11.2 net deferral for: prior years (9.7) - - (9.7) current year 5.3 - - 5.3 other - (2.2) 1.1 (1.1) as at 31 december 2009 5.6 (4.2) 4.3 5.7
Further information on the calculation of loss reserves and the risks associated with them is provided in the risk disclosures section. The risks associated with general insurance contracts are complex and do not readily lend themselves to meaningful sensitivity analysis. The impact of an unreported event could lead to a significant increase in our loss reserves. The Group believes that the loss reserves established are adequate, however a 20% increase in estimated losses would lead to a $97.8 million (2008 - $105.8 million) increase in loss reserves. There was no change to the Group's reserving methodology during the year.
The split of losses and loss adjustment expenses between notified outstanding losses, ACRs assessed by management and IBNR is shown below:
2009 2008 $m % $m % outstanding losses 258.6 52.9 303.4 57.4 additional case reserves 22.9 4.7 63.8 12.1 losses incurred but not reported 207.4 42.4 161.6
30.5
losses and loss adjustment expenses 488.9 100.0 528.8 100.0
The Group's reserve for unpaid losses and loss adjustment expenses has an estimated duration of approximately two years.
claims development
The development of insurance liabilities is indicative of the Group's abilityto estimate the ultimate value of its insurance liabilities. The Group beganwriting insurance and reinsurance business in December 2005. Due to the minimalnumber of underlying risks and lack of known loss events occurring during theperiod to 31 December 2005, the Group does not expect to incur any losses fromcoverage provided in 2005. Accordingly, the loss development tables do not
include that year.accident year 2006 2007 2008 2009 total $m $m $m $m $m gross losses
estimate of ultimate liability(1)
at end of accident year 39.1 154.8 444.6 163.3 one year later 34.7 131.2 417.4 two years later 32.0 103.5 three years later 27.6 current estimate of cumulative 27.6 103.5 417.4 163.3 711.8liability payments made (20.5) (55.1) (141.2) (6.1) (222.9) total gross liability 7.1 48.4 276.2 157.2 488.9accident year 2006 2007 2008 2009 total $m $m $m $m $m reinsurance
estimate of ultimate recovery(1)
at end of accident year - 3.6 40.7 1.6 one year later - 6.2 47.1 two years later - 4.0 three years later - current estimate of cumulative - 4.0 47.1 1.6 52.7recovery payments received - (2.5) (14.4) - (16.9) total gross recovery - 1.5 32.7 1.6 35.8accident year 2006 2007 2008 2009 total $m $m $m $m $m net losses
estimate of net ultimate liability
(1) at end of accident year 39.1 151.2 403.9 161.7 one year later 34.7 125.0 370.3 two years later 32.0 99.5 three years later 27.6 current estimate of net cumulative 27.6 99.5 370.3 161.7 659.1liability payments made (20.5) (52.6) (126.8) (6.1) (206.0) total net liability 7.1 46.9 243.5 155.6 453.1
(1) adjusted for revaluation of foreign currencies at the exchange rate as at 31 December 2009
The inherent uncertainty in reserving gives rise to favourable or adverse development on the established reserves. The total favourable development on net losses and loss adjustment expenses, excluding the impact of foreign exchange revaluations, was as follows:
2009 2008 $m $m 2006 accident year 4.4 2.6 2007 accident year 25.2 26.0 2008 accident year 33.9 - total favourable development 63.5
28.6
During the year ending 31 December 2009 there were no major loss events thatimpacted the Group. In September 2008, Hurricane Ike passed through the Gulf ofMexico oil fields, making landfall in the U.S.. Hurricane Ike was a verydestructive storm, causing damage to and destruction of a significant number ofoil platforms. The net ultimate financial impact of Hurricane Ike is asfollows: $m insurance losses and loss adjustment expenses 204.1 insurance losses and loss adjustment expenses (33.5)recoverable reinstatement premium (8.9) other deductions (10.9)
net ultimate financial impact as at 31 december 2008 150.8
change in insurance losses and loss adjustment 21.0expenses change in insurance losses and loss adjustment (4.6)expenses recoverable change in reinstatement premium 0.7 change in other deductions (1.3)
net ultimate financial impact as at 31 december 2009 166.6
Estimation of the ultimate liability of offshore losses is complex. Lossassessments require skilled loss adjusters. The availability of loss adjusterswith the necessary expertise is scarce and large events put a further strain onthis resource. A substantial degree of judgement is involved in assessing theultimate cost of Hurricane Ike, and the final amount could be materiallydifferent from that currently reported. Management's best estimate of theultimate liability for Hurricane Ike is $178.7 million. The 90th percentile ofthe loss distribution for this estimate is $202.3 million with the 95thpercentile being $210.2 million.
The Hurricane Ike ultimate financial impact developed adversely during 2009 by $15.8 million. This was offset by favourable development on other prior accident year reserves for attritional losses, plus reductions in a small number of reported losses based on new information received from loss adjusters. These developments are individually insignificant.
13. insurance, reinsurance and other receivables
2009 2008 $m $m accrued interest receivable 12.0 10.1 reinsurance assets - reinsurance recoveries 35.8 42.1 - other receivables 4.3 3.2 other receivables 4.3 154.0 inwards premiums receivable from insureds and cedants 178.2 187.3 total receivables 234.6 396.7All receivables are considered current other than $21.1 million (2008 - $24.0million) of inwards premiums receivable related to multi-year contracts. Thecarrying value approximates fair value due to the short-term nature of thereceivables. There are no significant concentrations of credit risk within theGroup's receivables.
14. deferred acquisition costs
The reconciliation between opening and closing deferred acquisition costs isshown below: $m as at 31 december 2007 57.8 net deferral during the year
110.0
expense incurred for the year (106.9) as at 31 december 2008 60.9 net deferral during the year
104.6
expense incurred for the year (112.6) as at 31 december 2009 52.9
15. insurance, reinsurance and other payables
2009 2008 $m $m dividends payable 263.0 - other payables 28.4 190.3 total other payables 291.4 190.3 insurance contracts - other payables 15.8 17.6 amounts payable to reinsurers 4.2 2.0 total payables 311.4 209.9Dividends payable are discussed in note 20. Other payables include unsettledinvestment trades, unsettled share repurchases and other accruals. Insurancepayables relate to amounts due to policyholders for profit commission, returnpremiums and claims payable. All payables are considered current. The carryingvalue approximates fair value due to the short-term nature of the payables.
16. deferred acquisition costs ceded
The reconciliation between opening and closing deferred acquisition costs cededis shown below: $m as at 31 december 2007 3.1 net deferral during the year 6.1 income recognised for the year (7.3) as at 31 december 2008 1.9 net deferral during the year 7.4 income recognised for the year (6.6) as at 31 december 2009 2.7
17. property, plant and equipment
2009 2008 $m $m cost 10.2 4.5 accumulated depreciation (2.0) (3.1) net book value 8.2 1.4
18. long-term debt and financing arrangements
as at 31 december 2009 2008 $m $m subordinated loan notes $97.0 million 97.0
97.0
subordinated loan notes €24.0 million 34.4
33.8 carrying value 131.4 130.8
On 15 December 2005 the Group issued, via a trust company, $97.0 million inaggregate principal amount of subordinated loan notes and €24.0 million inaggregate principal amount of subordinated loan notes ("long-term debt") at anissue price of $1,000 and €1,000 of their principal amounts respectively. Thefair value of the long-term debt is estimated as $121.4 million (2008 - $97.1million).The U.S. dollar subordinated loan notes are repayable on 15 December 2035 witha prepayment option available from 15 March 2011. Prior to 15 March 2011, uponthe occurrence and during the continuation of a "Special Event", LHL may, atits option, redeem the securities, in whole but not in part, at a sliding scaleredemption price. A Special Event is a change in the tax and/or investmentstatus of the issuing trust. Interest on the principal is based on a set margin(3.70%) above the variable LIBOR rate and is payable quarterly.The Euro subordinated loan notes are repayable on 15 June 2035 with aprepayment option available from 15 March 2011. Prior to this date prepaymentwould only be available in the event of a "Special Event". Interest on theprincipal is based on a set margin (3.70%) above the variable Euribor rate andis payable quarterly.
The Group is exposed to cash flow interest rate risk and currency risk on its long-term debt. Further information is provided in the risk disclosures section.
The interest accrued on the long-term debt was $0.2 million (2008 - $0.4 million) at the balance sheet date. The interest expense for the year was $6.4 million (2008 - $9.8 million) and is included in financing costs.
letters of credit
As both LICL and LUK are non-admitted insurers or reinsurers throughout theU.S., the terms of certain contracts require them to provide letters of creditto policyholders as collateral. LHL and LICL have a syndicated collateralisedcredit facility in the amount of $200.0 million which expires on 16 July 2012.The facility contains a $75.0 million loan sub-limit available for generalcorporate purposes.The facility is available for the issue of letters of credit ("LOCs") to cedingcompanies. The facility is also available for LICL to issue LOCs to LUK tocollateralise certain insurance balances. LOCs issued by LICL are as follows:as at 31 december 2009 2008 $m $m issued to affiliates - 61.9 issued to third parties 25.7 26.7
There was no outstanding debt under this facility at either reporting date. Letters of credit are required to be fully collateralised.
trusts
The Group has several trust arrangements in place in favour of policyholders and ceding companies in order to comply with the security requirements of certain reinsurance contracts and/or the regulatory requirements of certain jurisdictions.
The following cash and cash equivalents and investment balances were held in trust and other collateral accounts in favour of third parties:
2009 2008 as at 31 december $m $m $m $m cash and fixed cash and fixed income income cash securities cash securities equivalents equivalents
in various trust accounts for 14.1 100.9 11.3
-policyholders
in favour of letters of credit 1.9 37.0 37.7
80.0 in favour of interest rate 2.8 - 2.8 -swaps
in favour of futures contracts 0.6 - -
- total 19.4 137.9 51.8 80.0
As at and for the years ended 31 December 2009 and 2008 the Group was in compliance with all covenants under its trust facilities.
19. derivative financial instruments
Derivate instrument gains and losses recorded in the consolidated statement of comprehensive income are as follows:
2009 2008 $m $m
net realised gains (losses) and impairments 0.1
-
net other investment income -
0.1 financing costs (1.3) (3.6) total derivative net losses (1.2)
(3.5)
Refer to the risk disclosures section for the estimated fair value of the Group's derivative instruments. Realised gains and losses on futures and options contracts are included in net realised gains (losses) and impairments. The net impact of TBAs is $nil for all reporting periods.
In previous years the Group invested a small portion of its investmentportfolio in convertible debt securities. The option to convert was an embeddedderivative, which was required to be bifurcated from the host contract withchanges in estimated fair value recorded through income, unless the securitywas designated as at fair value through profit and loss. The Group'sinvestments in convertible debt securities were liquidated in the first half of2009. As at 31 December 2008 the derivative component of these instruments wasvalued at $nil. Changes in estimated fair value are included in net otherinvestment income.The Group hedges a portion of its floating rate borrowings using interest rateswaps to transfer floating to fixed rate. These instruments are held atestimated fair value through profit and loss. The net fair value position owedby the Group was $3.6 million (2008 - $4.9 million). The Group has the right tonet settle these instruments. The next cash settlement due on these instrumentsis $0.8 million (2008 - $0.5 million) and is due on 15 March 2010. Thecounter-party requires collateralisation of positions in excess of $2.0million. These instruments will expire on 15 March 2011. The net impact fromcash settlement and changes in estimated fair value is included in financingcosts.
The interest rate swaps are held at estimated fair value, priced using observable market inputs, and are therefore classified as category (ii) in the fair value hierarchy.
20. share capitalauthorised ordinary shares of $0.50 each number
$m
as at 31 december 2009 and 2008 3,000,000,000
1,500.0
allocated, called up and fully paid number
$m
as at 31 december 2008 and 2007 182,283,095
91.1
shares issued due to warrant exercises 219,968
0.1 as at 31 december 2009 182,503,063 91.2own shares number $m as at 31 december 2007 - -
shares repurchased and held in treasury 9,433,168
58.0 as at 31 december 2008 9,433,168 58.0
shares repurchased and held in treasury 2,406,674
16.9
shares repurchased by trust 1,078,403
8.0
shares distributed by trust (885,575) (6.5) as at 31 december 2009 12,032,670 76.4
The net shares outstanding as at 31 December 2009 were 170,470,393 (2008 - 172,849,927).
share repurchases
The Board of Directors have granted share repurchase authorisations as follows:date $m 29 october 2007 100.0 30 april 2008 100.0 4 november 2009 150.0 total 350.0
An amount of $175.1 million (2008 - $42.0 million) of approved repurchase remains in place under the current authorisations.
To date, shares have been repurchased by the Group under share repurchaseauthorisations as follows:date number weighted $m of shares average share price repurchased and cancelled 2007 (1) 13,640,916 £3.54 100.2
total repurchased and cancelled 13,640,916 £3.54
100.2
repurchased and transferred to treasury
shares 2008 9,433,168 £3.14 58.0 2009 2,406,674 £4.28 16.9 total repurchased and transferred to 11,839,842 £3.37 74.9treasury shares total repurchased 25,480,758 £3.46 175.1
(1) due to the movement of exchange rates between trade and settlement dates, the amount paid for the $100.0 million share repurchase program was $100.2 million versus the authorised program of $100.0 million. The variance was ratified by the Board of Directors on 14 February 2008.
At the balance sheet date $0.1 million (2008 - $0.2 million) remained to be settled.
In 2009 the trustees of the Lancashire Holdings Employee Benefit Trust (the "EBT") acquired 1,078,403 (2008 - nil) shares in accordance with the terms of the trust and distributed 885,575 (2008 - nil). There were no unsettled balances in relation to EBT purchases at either balance sheet date.
dividends
The Board of Directors have authorised the following dividends during the yearended 31 December 2009:dividends authorisation payment date $m date interim dividend of $0.05 (£0.0308) 28 july 2009 7 october 10.5 2009 special dividend of $1.25 (£0.75625) 4 november 2009 7 january 263.0 2010
There were no dividends declared during the year ended 31 December 2008.
21. warrants, options and restricted shares
Other reserves represents the Group's warrants, options and restricted shares.Changes in the number of options and restricted shares outstanding aredisclosed in note 6. The change in the total number of warrants outstanding
isas follows:warrants number number number number number founders' foundation management management management warrants ordinary performance performance warrants warrants warrants warrants granted unallocated outstanding as at 31 25,303,917 648,143 11,433,465 6,474,346 347,937december 2007 lapsed - - - (2,782,659) (149,542) outstanding as at 31 25,303,917 648,143 11,433,465 3,691,687 198,395december 2008 cancelled - - - - (198,395) exercised (833,200) - - - - lapsed - - - (1,931,377) - outstanding and 24,470,717 648,143 11,433,465 1,760,310 -exercisable as at 31 december 2009
The exercise price for all unvested warrants was automatically adjusted for dividends declared as follows:
authorisation payment date U.S.$ number number number numberdate founders' foundation ordinary performance warrants warrants warrants warrants 10 december 25 january 1.10 - 162,036 2,858,366 5,789,0652007 2008 28 july 2009 7 october 2009 0.05 - - - 2,894,532 4 november 7 january 2010 1.25 - - - 2,894,5322009
The weighted average exercise price for the warrants is:
$ $ $ $ founders' foundation ordinary performance warrants warrants warrants warrants as at 31 december 2008 5.00 4.73 4.71 4.85 as at 31 december 2009 5.00 4.73 4.71 3.62 22. lease commitmentsThe Group has payment obligations in respect of operating leases for certainitems of office equipment and office space. Operating lease expenses for theyear were $1.6 million (2008 - $1.8 million).Future minimum lease payments under non-cancellable operating leases are asfollows: 2009 2008 $m $m due in less than one year 2.1 1.7
due between one and five years 10.1
6.7 total 12.2 8.423. earnings per share
Basic earnings per share amounts are calculated by dividing net profit for the year attributable to shareholders by the weighted average number of common shares outstanding during the year.
Diluted earnings per share amounts are calculated by dividing the net profitattributable to shareholders by the weighted average number of common sharesoutstanding during the year plus the weighted average number of common sharesthat would be issued on the conversion of all potentially dilutive commonshares into common shares under the treasury stock method.
The following reflects the profit and share data used in the basic and diluted earnings per share computations:
2009 2008 $m $m
profit for the year attributable to equity 385.4
97.5shareholders number of number of shares shares thousands thousands basic weighted average number of shares 172,740 177,468 potentially dilutive shares 15,048 6,931 diluted weighted average number of shares 187,788
184,399
Share-based payments are only treated as dilutive when their conversion tocommon shares would decrease earnings per share or increase loss per share fromcontinuing operations. Unvested restricted shares without performance criteriaare therefore included in the number of potentially dilutive shares.Incremental shares from the assumed exercising of performance warrants andordinary restricted share awards, where relevant performance criteria have notbeen met, are not included in calculating dilutive shares. In addition, whereoptions are antidilutive, they are not included in the number of potentiallydilutive shares.
24. related party disclosures
The consolidated financial statements include LHL and the entities listedbelow:name domicile
Lancashire Insurance Company Limited Bermuda Lancashire Insurance Marketing Services Limited United Kingdom Lancashire Holdings Financing Trust I United States Lancashire Holdings Employee Benefit Trust Jersey Lancashire Insurance Holdings (UK) Limited United Kingdom Lancashire Insurance Company (UK) Limited United Kingdom Lancashire Insurance Services Limited United Kingdom
Lancashire Marketing Services (Middle East) Limited United Arab Emirates
All subsidiaries are wholly owned, either directly or indirectly.
The Group has issued subordinated loan notes via a trust vehicle - LancashireHoldings Financing Trust I (the "Trust") (see note 18). The Group effectivelyhas 100% of the voting rights in the Trust. These rights are subject to theproperty trustee's obligations to seek the approval of the holders of theTrust's preferred securities in case of default and other limited circumstanceswhere the property trustee would enforce its rights. While the ability of theGroup to influence the actions of the Trust is limited by the Trust Agreement,the Trust was set up by the Group with the sole purpose of issuing thesubordinated loan notes, is in essence controlled by the Group, and istherefore consolidated.
LICL holds $271.3 million of cash and cash equivalents and fixed income securities in trust for the benefit of LUK relating to intra-group reinsurance agreements.
On 14 February 2008 the Group established the EBT to assist in theadministration of the Group's employee equity based compensation schemes. Whilethe group does not have legal ownership of the EBT and the ability of the Groupto influence the actions of the EBT is limited by the Trust Deed, the EBT wasset up by the Group with the sole purpose of assisting in the administration ofthese schemes, is in essence controlled by the Group, and is thereforeconsolidated.During 2009 the Group made cash donations of $1.2 million to the EBT forfunding. The Group also entered into a Loan Facility Agreement (the "Facility")with RBC Cees Trustee Limited, the Trustees of the EBT. The Facility is aninterest free revolving credit facility under which the Trustee can requestadvances on demand, within the terms of the facility, up to a maximum aggregateof $10.0 million. The Facility may only be used by the Trustees for the purposeof achieving the objectives of the EBT. As at 31 December 2009 the Group hadmade advances of $7.0 million to the EBT under the terms of the Facility. Therewere no transactions with the EBT during 2008.
key management compensation
Remuneration for key management (the Group's executive and non-executive directors) for the years ending 31 December was as follows:
2009 2008 $m $m short-term compensation 6.6 5.3 equity based compensation 6.1 5.8 directors' fees and expenses 1.7 1.6 monitoring fees 0.1 0.2 total 14.5 12.9The directors' fees and expenses includes $0.7 million (2008 - $0.7 million)paid to significant founding shareholders. The monitoring fees are paid tosignificant founding shareholders. Non-executive directors do not receive anybenefits in addition to their agreed fees and expenses and do not participatein any of the Group's incentive, performance or pension plans.
transactions with Lancashire Foundation
Cash donations to the Foundation have been approved by the Board of Directorsas follows:30 april 2008 $1.0 million 14 may 2009 $1.1 million 25. non-cash transactions
Available for sale mortgage backed to be announced security purchases and sales of $229.3 million (2008 - $223.2 million) and $229.5 million (2008 - $228.4 million) respectively were net settled during the year through the use of derivative instruments.
The unsettled element of the share repurchase in 2009 of $0.1 million (2008 -$0.2 million) discussed in note 20 is not reflected in the 2009 cash flows. Ithas been recorded in the subsequent year when it was actually settled. The 2009special dividend declared of $263.0 million is not reflected in the 2009 cashflows. The settlement date was 7 January 2010 and the cash flow on thistransaction has been recorded in 2010.The unsettled element of the share repurchase in 2007 of $10.5 million was notreflected in the 2007 cash flows. It was recorded in 2008 when it was actuallysettled. The 2007 special dividend declared of $239.1 million was not reflectedin the 2007 cash flows. The settlement date was 25 January 2008 and the cashflow on this transaction was recorded in 2008.
26. statutory requirements and dividend restrictions
The primary source of capital used by the Group is equity shareholders' fundsand borrowings. As a holding company, LHL relies on dividends from itsoperating entities to provide the cash flow required for debt service anddividends to shareholders. The operating entities' ability to pay dividends andmake capital distributions is subject to the legal and regulatory restrictionsof the jurisdictions in which they operate. For the primary operating entitiesthese are based principally on the amount of premiums written and reserves forlosses and loss adjustment expenses, subject to overall minimum solvencyrequirements. Operating entity statutory capital and surplus is different fromshareholder's equity due to certain items that are capitalised under IFRS butexpensed or have a different valuation basis for regulatory reporting, or arenot admitted under insurance regulations.
Annual statutory capital and surplus reported to regulatory authorities by the primary operating entities is as follows:
as at 31 december 2009 $m £m LICL LUK statutory capital and surplus 1,215.4
120.0
minimum required statutory capital and surplus 257.1
22.6 as at 31 december 2008 $m £m LICL LUK statutory capital and surplus 1,080.1 125.1
minimum required statutory capital and surplus 256.8
22.7
For LUK, various capital calculations are performed and an individualassessment of LUK's capital needs (an "ICA") is presented to the FSA. The FSAthen considers the capital calculations and issues an individual capitalguidance ("ICG"), reflecting the FSA's own view as to the level of capitalrequired. The FSA considers that a decrease in an insurance company's capitalbelow the level of its ICG represents a regulatory intervention point.LICL is required to maintain a minimum liquidity ratio, whereby relevantassets, as defined in the regulations, must exceed 75% of relevant liabilities.As at 31 December 2009 and 2008 the liquidity ratio was met. LICL is alsorequired to perform various capital calculations under the BMA's regulatoryframework. An assessment is made of LICL's capital needs and a target capitalamount is determined. The BMA may require a further capital loading on thetarget capital amount in certain circumstances. The BMA considers that adecrease in capital below the target level represents a regulatory interventionpoint.
As at 31 December 2009 and 2008 the capital requirements of both regulatory jurisdictions were met.
27. subsequent event
On 25 February 2010 the Board of Directors authorised the payment of a finalordinary dividend of 10.0 cents per common share to shareholders of record on19 March 2010, with a settlement date of 14 April 2010. The total dividendpayable will be approximately $20.8 million. The Remuneration Committee has thediscretionary power to adjust the exercise price of options issued under theLTIP to neutralise the devaluing impact of dividend payments. The Committee hasnot yet approved any such adjustment. An amount equivalent to the dividendaccrues on all RSS awards and is paid at the time of vesting, pro-rataaccording to the number of RSS awards that vest.
28. presentation
Certain amounts in the 31 December 2008 consolidated financial statements havebeen re-presented to conform with the current year's presentation and format.These changes in presentation have no effect on the previously reported netprofit.
vendorRelated Shares:
Lancashire Holdings