UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2010
OR
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
Commission file number 001-31721
AXIS CAPITAL HOLDINGS LIMITED
(Exact name of registrant as specified in its charter)
BERMUDA
(State or other jurisdiction of incorporation or organization)
98-0395986
(I.R.S. Employer Identification No.)
92 Pitts Bay Road, Pembroke, Bermuda HM 08
(Address of principal executive offices and zip code)
(441) 496-2600
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of July 26, 2010 there were 119,982,422 Common Shares, $0.0125 par value per share, of the registrant outstanding.
INDEX TO FORM 10-Q
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Cautionary Statement Regarding Forward-looking Statements
This quarterly report contains forward-looking statements within the meaning of the U.S. federal securities laws. We intend these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in the United States securities laws. In some cases, these statements can be identified by the use of forward-looking words such as “may”, “should”, “could”, “anticipate”, “estimate”, “expect”, “plan”, “believe”, “predict”, “potential” and “intend”. Forward-looking statements contained in this report may include information regarding our estimates of losses related to catastrophes and other large losses, measurements of potential losses in the fair value of our investment portfolio and derivative contracts, our expectations regarding pricing and other market conditions, our growth prospects, and valuations of the potential impact of movements in interest rates, equity prices, credit spreads and foreign currency rates. Forward-looking statements only reflect our expectations and are not guarantees of performance.
These statements involve risks, uncertainties and assumptions. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements. We believe that these factors include, but are not limited to, the following:
the occurrence of natural and man-made disasters,
actual claims exceeding our loss reserves,
general economic, capital and credit market conditions and the persistence of the recent financial crisis,
the failure of any of the loss limitation methods we employ,
the effects of emerging claims and coverage issues,
the failure of our cedants to adequately evaluate risks,
inability to obtain additional capital on favorable terms, or at all,
the loss of one or more key executives,
a decline in our ratings with rating agencies,
loss of business provided to us by our major brokers,
changes in accounting policies or practices,
changes in governmental regulations,
increased competition,
changes in the political environment of certain countries in which we operate or underwrite business,
fluctuations in interest rates, credit spreads, equity prices and/or currency values, and
the other matters set forth under Item 1A, ‘Risk Factors’ and Item 7, ‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’ included in our Annual Report on Form 10-K for the year ended December 31, 2009.
We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
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Consolidated Balance Sheets as at June 30, 2010 (Unaudited) and December 31, 2009
Consolidated Statements of Operations for the three and six months ended June 30, 2010 and 2009 (Unaudited)
Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2010 and 2009 (Unaudited)
Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2010 and 2009 (Unaudited)
Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009 (Unaudited)
Notes to the Consolidated Financial Statements (Unaudited)
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CONSOLIDATED BALANCE SHEETS
JUNE 30, 2010 (UNAUDITED) AND DECEMBER 31, 2009
Assets
Investments:
Fixed maturities, available for sale, at fair value(Amortized cost 2010: $9,880,475; 2009: $9,628,287)
Equity securities, available for sale, at fair value(Cost 2010: $218,303; 2009: $195,011)
Other investments, at fair value
Short-term investments, at amortized cost
Total investments
Cash and cash equivalents
Restricted cash and cash equivalents
Accrued interest receivable
Insurance and reinsurance premium balances receivable
Reinsurance recoverable on unpaid and paid losses
Deferred acquisition costs
Prepaid reinsurance premiums
Securities lending collateral
Net receivable for investments sold
Goodwill and intangible assets
Other assets
Total assets
Liabilities
Reserve for losses and loss expenses
Unearned premiums
Insurance and reinsurance balances payable
Securities lending payable
Senior notes
Other liabilities
Net payable for investments purchased
Total liabilities
Commitments and Contingencies
Shareholders’ equity
Preferred shares - Series A and B
Common shares (2010: 154,549; 2009: 152,465 shares issued and 2010: 120,254; 2009: 132,140 shares outstanding)
Additional paid-in capital
Accumulated other comprehensive income
Retained earnings
Treasury shares, at cost (2010: 34,295; 2009: 20,325 shares)
Total shareholders’ equity
Total liabilities and shareholders’ equity
See accompanying notes to Consolidated Financial Statements.
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CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 AND 2009
Revenues
Net premiums earned
Net investment income
Other insurance related income (loss)
Net realized investment gains (losses):
Other-than-temporary impairment losses
Portion of impairment losses transferred to other comprehensive income
Other realized investment gains (losses)
Total net realized investment gains (losses)
Total revenues
Expenses
Net losses and loss expenses
Acquisition costs
General and administrative expenses
Foreign exchange losses (gains)
Interest expense and financing costs
Total expenses
Income before income taxes
Income tax expense
Net income
Preferred share dividends
Net income available to common shareholders
Weighted average common shares and common share equivalents:
Basic
Diluted
Earnings per common share:
Cash dividends declared per common share
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Other comprehensive income, net of tax:
Available for sale investments:
Unrealized gains arising during the period
Portion of other-than-temporary impairment losses recognized in other comprehensive income
Adjustment for re-classification of realized investment (gains) losses and net impairment losses recognized in net income
Foreign currency translation adjustment
Comprehensive income
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CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2010 AND 2009
Balance at beginning and end of period
Common shares (par value)
Balance at beginning of period
Shares issued
Balance at end of period
Stock options exercised
Share-based compensation expense
Accumulated other comprehensive income (loss)
Unrealized appreciation (depreciation) on available for sale investments, net of tax:
Cumulative effect of change in accounting principle (see Note 3(d))
Unrealized gains arising during the period, net of reclassification adjustment
Portion of other-than-temporary impairment losses
Cumulative foreign currency translation adjustments, net of tax:
Supplemental Executive Retirement Plans (SERPs):
Net actuarial gain (loss)
Cumulative effect of change in accounting principle, net of tax (see Note 3(d))
Series A and B preferred share dividends
Common share dividends
Treasury shares, at cost
Shares repurchased for treasury
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CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Net realized investment (gains) losses
Loss on insurance derivative contract
Net realized and unrealized gains of other investments
Amortization of fixed maturities
Other amortization and depreciation
Changes in:
Reinsurance recoverable balances
Reserve for loss and loss expenses
Insurance and reinsurance balances, net
Other items
Net cash provided by operating activities
Cash flows from investing activities:
Purchases of:
Fixed maturities
Equity securities
Other investments
Proceeds from the sale of:
Proceeds from redemption of fixed maturities
Net (purchases) sales of short-term investments
Purchase of other assets
Change in restricted cash and cash equivalents
Net cash used in investing activities
Cash flows from financing activities:
Net proceeds from issuance of senior notes
Repurchase of shares
Dividends paid - common shares
Dividends paid - preferred shares
Proceeds from issuance of common shares
Net cash (used in) provided by financing activities
Effect of exchange rate changes on foreign currency cash
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents - beginning of period
Cash and cash equivalents - end of period
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Basis of Presentation
The interim consolidated financial statements include the accounts of AXIS Capital Holdings Limited (“AXIS Capital”) and its subsidiaries (herein referred to as “we,” “us,” “our,” or the “Company”).
The consolidated balance sheet at June 30, 2010 and the consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for the periods ended June 30, 2010 and 2009 have not been audited. The balance sheet at December 31, 2009 is derived from our audited financial statements.
These statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“U.S. GAAP”) for interim financial information and with the Securities and Exchange Commission’s (“SEC”) instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these financial statements reflect all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of our financial position and results of operations for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for a full year. All inter-company accounts and transactions have been eliminated.
The following information should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2009. Tabular dollars and share amounts are in thousands, except per share amounts.
Significant Accounting Policies
There have been no changes to our significant accounting policies as described in our Annual Report on Form 10-K for the year ended December 31, 2009.
Adoption of New Accounting Standards
Fair Value Measurement and Disclosures
Effective January 1, 2010, we adopted new guidance issued by the FASB requiring additional disclosures about transfers into and out of Levels 1 and 2 of the fair value hierarchy and separate disclosures about purchases, sales, issuance, and settlements relating to Level 3 measurements. As these new requirements related solely to disclosures, the adoption did not impact our results of operations, financial condition or liquidity. The additional disclosures have been provided in Note 4 – Fair Value Measurements.
Consolidations
Effective January 1, 2010, we adopted amended FASB guidance related to the consolidation of variable interest entities (“VIEs”). This new guidance modifies the approach for determining the primary beneficiary of a VIE by eliminating the initial quantitative assessment and requiring ongoing qualitative reassessments. The adoption of this guidance did not impact our results of operations or financial condition.
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Recently Issued Accounting Standards Not Yet Adopted
Embedded Credit Derivatives
In March 2010, the FASB issued new guidance clarifying the scope exemption for embedded credit-derivative features. Embedded credit-derivative features related only to the transfer of credit risk in the form of subordination of one financial instrument to another are not subject to potential bifurcation and separate accounting. However, other embedded credit-derivative features are required to be analyzed to determine whether they must be accounted for separately. Additional guidance on whether embedded credit-derivative features in financial instruments issued by structures such as collateralized debt obligations (“CDOs”) and synthetic CDOs are subject to bifurcation and separate accounting. To simplify compliance with this new guidance, an entity may make a one-time election to apply the fair value option to any investment in a beneficial interest in securitized financial assets, regardless of whether such investments contain embedded derivative features. This new guidance is effective as of July 1, 2010, with early adoption being permitted at April 1, 2010. We do not anticipate the adoption of this guidance will significantly impact our results of operations, financial condition or liquidity.
Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses
In July 2010, the FASB issued new guidance requiring disclosures about the nature of credit risk in financing receivables and how that risk is analyzed in determining the related allowance for credit losses, as well as details on changes in the allowance for credit losses during the reporting period. Financing receivables are defined to include instruments such as certain trade receivables, notes receivable and lease receivables, in addition to instruments more traditionally associated with an allowance for credit losses, such as consumer and commercial lending agreements. The new disclosure requirements related to information at the end of a reporting period will become effective at October 1, 2010, while requirements related to activity that occurred during a reporting period will become effective at January 1, 2011. We are presently evaluating the disclosure impact of the adoption of this guidance.
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Our underwriting operations are organized around our two global underwriting platforms, AXIS Insurance and AXIS Reinsurance and therefore we have determined that we have two reportable segments, insurance and reinsurance. Except for goodwill and intangible assets, we do not allocate our assets by segment as we evaluate the underwriting results of each segment separately from the results of our investment portfolio.
The following tables summarize the underwriting results of our operating segments for the periods indicated and the carrying values of goodwill and intangible assets at June 30, 2010 and 2009:
Gross premiums written
Net premiums written
Underwriting income
Corporate expenses
Net realized investment gains (losses)
Foreign exchange (losses) gains
Net loss and loss expense ratio
Acquisition cost ratio
General and administrative expense ratio
Combined ratio
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Fixed Maturities and Equities
The amortized cost or cost and fair values of our fixed maturities and equities were as follows:
Fair
Value
At June 30, 2010
U.S. government and agency
Non-U.S. government
Corporate debt
Agency MBS(1)
Non-Agency CMBS
Non-Agency RMBS
ABS(2)
Municipals
Total fixed maturities
At December 31, 2009
In the normal course of investing activities, we make passive investments in structured securities (variable interests) issued by VIEs. These structured securities include RMBS, CMBS and ABS and are included in the above table. Additionally, within our other investments portfolio, we also invest in limited partnerships (hedge and credit funds) and CLO equity tranched securities, which are all variable interests issued by VIEs (see Note 3(b)). For these variable interests, we do not have the power to direct the activities that are most significant to the economic performance of the VIEs and accordingly we are not the primary beneficiary for any of these VIEs. Our maximum exposure to loss on these interests is limited to the amount of our investment. We have not provided financial or other support with respect to these structured securities other than our original investment.
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Gross Unrealized Loss
The following tables summarize fixed maturities and equities in an unrealized loss position and the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position:
Agency MBS
ABS
Fixed Maturities
At June 30, 2010, 583 fixed maturities (2009: 832) were in an unrealized loss position of $136 million (2009: $134 million) of which $17 million (2009: $20 million) of this balance was related to securities below investment grade or not rated.
At June 30, 2010, 183 (2009: 312) securities have been in continuous unrealized loss position for 12 months or greater and have a fair value of $258 million (2009: $705 million). These securities were primarily corporate debt, non-agency CMBS, non-agency RMBS, and ABS with a weighted average S&P credit rating of BBB+, AA-, BBB+, and BB-, respectively. We concluded that these securities as well as the remaining securities in an unrealized loss position are temporarily depressed and are expected to recover in value as the securities approach maturity or as market spreads return to more normalized levels. Further, at June 30, 2010, we did not intend to sell these securities in an unrealized loss position and it is more likely than not that we will not be required to sell these securities before the anticipated recovery of their amortized costs.
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Equity Securities
At June 30, 2010, 138 securities (2009: 95) were in an unrealized loss position and 44 of these securities (2009: 56) have been in a continuous unrealized loss position for 12 months or greater. Based on our OTTI quarterly review process and our ability and intent to hold these securities for a reasonable period of time sufficient for a full recovery, we concluded that the above equities in an unrealized loss position were temporarily impaired at June 30, 2010 and December 31, 2009.
The table below shows our portfolio of other investments reported at fair value:
Hedge funds
Funds of hedge funds
Total hedge funds
Distressed securities
Long/short credit
Total credit funds
CLO - equity tranched securities
Short duration high yield fund
Total other investments
The major categories and related investment strategies for our investments in hedge and credit funds are as follows:
In aggregate, 94% of our hedge fund allocation is redeemable within one year and 100% is redeemable within two years, subject to prior written redemption notice varying from 45 to 95 days. This includes recognition of certain funds we hold which restrict new investor redemptions during a lock-up period. A lock-up period is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. Another common restriction is the suspension of redemptions (known as “gates”) which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the fund’s net assets or to prevent certain adverse regulatory, or any other reasons that may render the manager unable to promptly and accurately calculate the fund’s net asset value. During the six months ended June 30, 2010 and 2009, no gates were imposed on our redemption requests. At June 30, 2010, the only redemptions receivable relate to a December 31, 2009 redemption whereby $2 million is being held back until the completion of the fund’s annual audit.
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Additionally, certain hedge funds may be allowed to invest a portion of their assets in illiquid securities, such as private equity or convertible debt. In such cases, a common mechanism used is a side-pocket, whereby the illiquid security is assigned to a designated account. Generally, the investor loses its redemption rights in the designated account. Only when the illiquid security is sold, or otherwise deemed liquid by the fund, may investors redeem their interest. At June 30, 2010, the fair value of our hedge funds held in side-pockets was $4 million (2009: $4 million).
At June 30, 2010, we had $45 million of a long/short credit fund that we do not have the ability to liquidate at our own discretion as the fund is beyond its investment period and is currently distributing capital to its investors. Of the remaining credit fund holdings, 32% of the carrying value has annual or semi-annual liquidity and 68% has quarterly liquidity, subject to prior written redemption notice varying from 65 to 95 days. At June 30, 2010 and December 31, 2009, none of our credit funds had established side-pockets.
At June 30, 2010, we have no unfunded commitments relating to our investments in hedge and credit funds.
Net investment income was derived from the following sources:
Equities
Short-term investments
Gross investment income
Investment expenses
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The following table provides an analysis of net realized investment gains (losses):
Gross realized gains
Gross realized losses
Net OTTI recognized in earnings
Net realized gains (losses) on fixed maturities and equities
Change in fair value of investment derivatives(1)
Fair value hedges:(1)
Derivative instruments
Hedged investments
Refer to Note 6 – Derivative Instruments
The following table summarizes the OTTI recognized in earnings by asset class:
Fixed maturities:
Total OTTI recognized in earnings
On April 1, 2009, we adopted a new accounting standard which amended the previous OTTI recognition model for fixed maturities. For securities in an unrealized loss position that we intend to sell at the end of the reporting period, we recognized the entire unrealized loss position as a credit loss in earnings. For the remaining impaired fixed maturities, we have recorded only the estimated credit losses in earnings rather than the entire unrealized loss position. Because the new accounting standard does not allow for retrospective application, the OTTI amounts reported in the above table for the six months ended June 30, 2010, are not measured on the same basis as prior period amounts and accordingly these amounts are not comparable. The adoption of this new accounting standard on April 1, 2009 resulted in $38 million net after-tax increase to retained earnings with a corresponding decrease to accumulated other comprehensive income (loss), resulting in no change to our shareholders’ equity.
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The following table provides a roll forward of the credit losses, (“credit loss table”), before income taxes, for which a portion of the OTTI was recognized in AOCI:
Additions for:
Credit losses remaining in retained earnings related to adoption of accounting standard
Credit impairments recognized on securities not previously impaired
Additional credit impairments recognized on securities previously impaired
Increases due to changes in the timing of cash flows
Reductions for:
Decreases due to changes in the timing of cash flows
Securities previously impaired due to subsequent intent to sell
Securities sold/redeemed during the period
Credit losses are calculated based on the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to the impairment. The significant inputs and the methodology used to estimate the credit losses for which a portion of the OTTI was recognized in AOCI were as follows:
Corporate Debt:
Our projected cash flows for corporate debt securities, excluding medium-term notes (“MTNs”), are primarily driven by our assumptions regarding the probability of default and the severity associated with those defaults. Our default and loss severity rates are based on credit rating, credit analysis, industry analyst reports and forecasts, Moody’s historical default data and any other data relevant to the recoverability of the security. At December 31, 2009, the weighted average default rate and loss severity rate were 34% and 100%, respectively, for determining the credit losses on our impaired corporate debt securities. For the three and six months ended June 30, 2010, we have not impaired any corporate debt securities except for securities we intended to sell. Additionally, we have sold some previously impaired corporate debt, resulting in a decrease in credit loss impairments of $8 million and $8 million, respectively, in the above credit loss table.
For MTNs, our projected cash flows also include significant inputs such as future credit spreads and the use of leverage over the expected duration of each of the medium-term notes. At June 30, 2010, we have not modified our significant inputs since December 31, 2009, which were as follows:
Default rates, per annum
Loss severity rates, per annum
Collateral spreads, per annum
Leveraged duration
Agency MBS:
For agency MBS in an unrealized loss position, we do not impair these securities as they represent AAA-rated holdings backed by either the explicit or implicit guarantee of the U.S. government. We believe the risk of loss in this asset class is very remote and linked to the overall credit-worthiness of the U.S. government. At June 30, 2010, the fair value of our agency MBS was $1.7 billion (2009: $1.6 billion), which included $0.4 million (2009: $4.4 million) of gross unrealized losses.
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Non-agency CMBS:
Our investment in commercial MBS are diversified and rated highly with approximately 78% (2009: 79%) rated AAA by S&P, with a weighted average estimated subordination percentage of 28% at June 30, 2010 (2009: 27%). Based on discounted cash flows, the current level of subordination is sufficient to cover the estimated loan losses on the underlying collateral of the CMBS.
Non-agency RMBS:
For non-agency RMBS, we project expected cash flows to be collected by incorporating underlying data from widely accepted third-party data sources along with certain internal assumptions and judgments regarding the future performance of the security. At June 30, 2010, the fair value of our non-agency RMBS was $221 million (2009: $223 million), consisting primarily of $151 million (2009: $136 million) of Prime and $55 million (2009: $70 million) of Alt-A MBS.
We used the following weighted average significant inputs to estimate the credit loss for potentially impaired Prime and Alt-A MBS in an unrealized loss position at June 30, 2010:
Prime:
Pre-2004
2004
2005
2006
2007
Alt-A:
We used the following weighted average significant inputs to estimate the credit loss for potentially impaired Prime and Alt-A MBS in an unrealized loss position at December 31, 2009:
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These significant inputs require significant management judgment and vary for each structured security based on the underlying property type, vintage, loan to collateral value ratio, geographic concentration, and current level of subordination. We also corroborate our credit loss estimate with the independent investment manager’s credit loss estimate for each structured debt security with a significant unrealized loss position.
For the three and six months ended June 30, 2010, based on expected cash flows to be collected, we have recorded additional credit losses of $2 million and $4 million, respectively, on non-agency RMBS.
ABS:
The majority of the unrealized losses on ABS at June 30, 2010 were related to CLO debt tranched securities. We used the following weighted average significant inputs to estimate the credit loss for these securities at June 30, 2010:
Default rate, per annum
Loss severity rate, per annum
Our assumptions on default and loss severity rates are established based on an assessment of actual experience to date for each CLO debt tranche and review of recent credit rating agencies’ default and loss severity forecasts. Based on projected cash flows at June 30, 2010, we do not anticipate credit losses on the CLO debt tranched securities.
Fair Value Hierarchy
Fair value is defined as the price to sell an asset or transfer a liability (i.e. the “exit price”) in an orderly transaction between market participants. We use a fair value hierarchy that gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. The hierarchy is broken down into three levels as follows:
Level 1—Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access. Valuation adjustments and block discounts are not applied to Level 1 instruments.
Level 2—Valuations based on quoted prices in active markets for similar assets or liabilities, quoted prices for identical assets or liabilities in inactive markets, or for which significant inputs are observable (e.g. interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.
Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement. The unobservable inputs reflect our own assumptions about assumptions that market participants might use.
The availability of observable inputs can vary from financial instrument to financial instrument and is affected by a wide variety of factors including, for example, the type of financial instrument, whether the financial instrument is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment.
Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This may lead us to change the selection of our valuation technique (from market to cash flow approach) or may cause us to use multiple valuation techniques to estimate the fair value of a financial instrument. This circumstance could cause an instrument to be reclassified between levels.
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We used the following methods and assumptions in estimating the fair value of our financial instruments as well as the general classification of such financial instruments pursuant to the above fair value hierarchy.
At each valuation date, we use various valuation techniques to estimate the fair value of our fixed maturities portfolio. These techniques include, but are not limited to, prices obtained from third party pricing services for identical or comparable securities and the use of “pricing matrix models” using observable market inputs such as yield curves, credit risks and spreads, measures of volatility, and prepayment speeds. Pricing from third party pricing services are sourced from multiple vendors, and we maintain a vendor hierarchy by asset type based on historical pricing experience and vendor expertise. The following describes the techniques generally used to determine the fair value of our fixed maturities by asset class.
U.S. government and agency securities consist primarily of bonds issued by the U.S. Treasury and mortgage pass-through agencies such as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association. As the fair values of our U.S. Treasury securities are based on unadjusted market prices, they are classified within Level 1. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are classified within Level 2.
Non-U.S. government securities comprise bonds issued by non-U.S. governments and their agencies along with supranational organizations (also known as sovereign debt securities). The fair value of these securities is based on prices obtained from international indices or a valuation model that includes the following inputs: interest rate yield curves, cross-currency basis index spreads, and country credit spreads for structures similar to the sovereign bond in terms of issuer, maturity and seniority. As the significant inputs are observable market inputs, the fair value of non-U.S. government securities are classified within Level 2.
Corporate debt securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As these spreads and the yields for the risk-free yield curve are observable market inputs, the fair values of our corporate debt securities are classified within Level 2. Where pricing is unavailable from pricing services, we obtain unbinding quotes from broker-dealers. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, securities are classified within Level 3 and consisted primarily of private corporate debt securities at June 30, 2010.
MBS
Our portfolio of RMBS and CMBS are originated by both agencies and non-agencies. The fair values of these securities are determined through the use of a pricing model (including Option Adjusted Spread) which uses prepayment speeds and spreads to determine the appropriate average life of the MBS. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As the significant inputs used to price MBS are observable market inputs, the fair values of the MBS are classified within Level 2. Where pricing is unavailable from pricing services, we obtain unbinding quotes from broker-dealers to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. These securities are classified within Level 3 and consist primarily of certain non-agency RMBS and CMBS at June 30, 2010.
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ABS include mostly investment-grade bonds backed by pools of loans with a variety of underlying collateral, including automobile loan receivables, credit card receivables, and CLO debt tranched securities originated by a variety of financial institutions. Similarly to MBS, the fair values of ABS are priced through the use of a model which uses prepayment speeds and spreads sourced primarily from the new issue market. As the significant inputs used to price ABS are observable market inputs, the fair values of ABS are classified within Level 2. Where pricing is unavailable from pricing services, we obtain unbinding quotes from broker-dealers or use a discounted cash flow model to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. At June 30, 2010, the use of a discounted cash flow model was limited to our investment in CLO debt tranched securities and included the following significant inputs: default and loss severity rates, collateral spreads, and risk free yield curves (see Note 3(d) for quantitative inputs). As most of these inputs are unobservable, these securities are classified within Level 3.
Our municipal portfolio comprises bonds issued by U.S. domiciled state and municipality entities. The fair value of these securities is determined using spreads obtained from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the municipals are observable market inputs, municipals are classified within Level 2.
Equity securities include U.S. and foreign common stocks as well as a foreign bond mutual fund. For common stocks we classified these within Level 1 as their fair values are based on quoted market prices in active markets. Our investment in the foreign bond mutual fund has daily liquidity, with redemption based on the net asset value of the fund. Accordingly, we have classified this investment as Level 2.
Other Investments
The short-duration high yield fund is classified within Level 2 as its fair value is estimated using the net asset value reported by Bloomberg and it has daily liquidity.
The hedge and credit funds are classified within Level 3 as we estimate their respective fair values using net asset values as advised by external fund managers or third party administrators. Refer to Note 3 for further details on this asset class.
The CLO – equity tranched securities (“CLO – Equities”) are classified within Level 3 as we estimate the fair value for these securities based on an discounted cash flow model due to the lack of observable, relevant trade in the secondary markets. At June 30, 2010, our discounted cash flow model included the following significant unobservable inputs.
Default rates:
- for 2010
- thereafter per annum
Loss severity rate per annum
Collateral spreads per annum
Derivative Instruments
Our foreign currency forward contracts and options are customized to our hedging strategies and trade in the over-the-counter derivative market. We estimate the fair value for these derivatives using models based on significant observable market inputs from third party pricing vendors, non-binding broker-dealer quotes and/or recent trading activity. Accordingly, we classified these derivatives within Level 2.
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The table below presents the financial instruments measured at fair value on a recurring basis.
SignificantUnobservableInputs
(Level 3)
Other assets (see Note 6)
Total
During 2010 and 2009, we had no transfers between Levels 1 and 2.
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Level 3 financial instruments
The following tables present changes in Level 3 for financial instruments measured at fair value on a recurring basis for the periods indicated:
Three months ended June 30, 2010
Total net realized and unrealized gains included in net income(1)
Total net realized and unrealized losses included in net income(1)
Change in net unrealized gains included in other comprehensive income
Change in net unrealized losses included in other comprehensive income
Purchases
Sales
Settlements / distributions
Transfers into Level 3
Transfers out of Level 3
Level 3 gains / losses included in earnings attributable to the change in unrealized gains /losses relating to those assets held at the reporting date
Six months ended June 30, 2010
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Three months ended June 30, 2009
Level 3 gains / losses included in earnings attributable to the change in unrealized gains / losses relating to those assets and liabilities held at the reporting date
Six months ended June 30, 2009
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Following the adoption of the new Fair Value Measurements and Disclosures guidance on January 1, 2010, transfers into and out of Level 3 reflect the fair value of the securities at the end of the reporting period. This transition was applied prospectively and accordingly the transfers into and out of Level 3 from Level 2 for the three and six months ended June 30, 2010, are not comparable with prior periods as transfers into Level 3 were previously recorded at the fair value of the security at the beginning of the reporting period.
Transfers into Level 3 from Level 2
During the three months ended June 30, 2010, we had no transfers. For the same period in 2009, we transferred $14 million and $20 million of non-agency RMBS and ABS, respectively.
During the six months ended June 30, 2010, we transferred $1 million of non-agency RMBS. For the same period in 2009, we transferred $19 million, $65 million, and $70 million of corporate debt, non-agency RMBS and ABS, respectively.
The transfers to Level 3 from Level 2 were made due to a reduction in the volume of recently executed transactions or a lack of available quotes from pricing vendors and broker-dealers. None of the above transfers were as a result of changes in valuation methodology that we made.
Transfers out of Level 3 into Level 2
During the three months ended June 30, 2010, we transferred $17 million of corporate debt securities. The transfers were primarily related to a private corporate debt security as a result of entering into an agreement with the issuer to take delivery of a new corporate debt security, which its fair value measurement was based on observable market inputs at June 30, 2010. For the same period in 2009, we transferred $42 million and $26 million of non-agency RMBS and ABS, respectively.
During the six months ended June 30, 2010, we transferred $17 million, $2 million, and $4 million of corporate debt, non-agency CMBS and non-agency RMBS, respectively. For the same period in 2009, we transferred $1 million, $42 million, and $26 million of non-agency CMBS, non-agency RMBS, and ABS, respectively.
Except as noted above, the transfers out of Level 3 into Level 2 made in 2009 and 2010 were primarily due to the availability of multiple quotes from pricing vendors and broker-dealers as a result of the return of liquidity in the credit markets.
Fair Values of Financial Instruments
The carrying amount of financial assets and liabilities presented on the Consolidated Balance Sheets as at June 30, 2010, and December 31, 2009 approximated their fair values with the exception of senior notes. At June 30, 2010, the senior notes are recorded at amortized cost with a carrying value of $994 million (2009: $499 million) and a fair value of $997 million (2009: $510 million).
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The following table shows a reconciliation of our beginning and ending gross unpaid losses and loss expenses for the periods indicated:
Gross reserve for losses and loss expenses, beginning of period
Less reinsurance recoverable on unpaid losses, beginning of period
Net reserve for losses and loss expenses, beginning of period
Net incurred losses related to:
Current year
Prior years
Net paid losses related to:
Foreign exchange and other
Net reserve for losses and loss expenses, end of period
Reinsurance recoverable on unpaid losses, end of period
Gross reserve for losses and loss expenses, end of period
We write business with loss experience generally characterized as low frequency and high severity in nature, which results in volatility in our financial results. During the six months ended June 30, 2010, we recognized net loss and loss expenses of $133 million in relation to the February 2010 Chilean earthquake. Our estimate was derived from a ground-up assessment of our individual contracts and treaties in the affected regions and is consistent with our market share in the region. As part of our estimation process, we also considered current industry insured loss estimates, market share analysis, catastrophe modeling analysis and the information available to date from clients, brokers and loss adjusters. Industry-wide insured loss estimates and our own loss estimate for the Chilean earthquake are subject to change, as additional actual loss data becomes available. Actual losses in relation to this event may ultimately differ materially from current loss estimates.
Net losses and loss expenses incurred include net favorable prior period reserve development of $160 million and $181 million for the six months ended June 30, 2010 and 2009, respectively. Prior period reserve development arises from changes to loss estimates recognized in the current year that relate to losses incurred in previous calendar years.
The following table summarizes net favorable reserve development by segment:
Insurance
Reinsurance
Overall, a significant portion of the net favorable prior period reserve development in the second quarters of 2010 and 2009 was generated from the property, marine, terrorism (included in “other”) and aviation lines of our insurance segment and the property, catastrophe and crop (included in “other”) lines of our reinsurance segment. These lines of business, the majority of which have short
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tail exposures, contributed $38 million and $71 million of the total net favorable reserve development in the second quarters of 2010 and 2009, respectively. The favorable development on these lines of business primarily reflects the recognition of better than expected loss emergence, rather than explicit changes in our actuarial assumptions.
Approximately $36 million and $9 million of the net favorable reserve development in the second quarter of 2010 and 2009, respectively, was generated from professional lines insurance and reinsurance business. This favorable development was driven by increased incorporation of our own historical claims experience into our ultimate expected loss ratios for accident years 2006 and prior, with less weighting being given to information derived from industry benchmarks. We began to give weight to our own loss experience on 2005 and prior accident year professional lines business in 2008 because they had developed a reasonable level of credible loss data. However, the impact of this change was somewhat muted in the second quarter of 2009 due to the strengthening of reserves on the 2008 accident year in relation to the credit crisis.
During the second quarter of 2010, we recognized net favorable prior period reserve development of $13 million on our credit and bond reinsurance business, primarily on the 2009 accident year and, to a lesser extent, the 2007 and 2008 accident years, in recognition of better than expected loss experience. Partially offsetting the net favorable development recognized in the second quarter of 2010, we recognized $6 million in net adverse prior period development on our credit and political risk insurance business, primarily due to reduced recovery estimates on 2009 accident year credit business, after taking into consideration updated publicly available information and discussions with our insureds. The impact of the reduced recovery estimates was somewhat offset by favorable development on the 2008 and 2007 accident years, as a result of better than expected loss emergence on both traditional political risk (i.e. confiscation, expropriation, nationalization and deprivation, or “CEND”) and credit related business. During the second quarter of 2010, we concluded the settlement and policy cancellation on one peak credit insurance exposure, Blue City Investments 1 Limited; the net payment fell within the provision established in prior periods. During the second quarter of 2009, we recognized favorable reserve development of $13 million on our insurance liability lines of business, following incorporation of more of our own reinsurance recovery experience on our excess and surplus (“E&S”) umbrella lines.
For the six months ended June 30, 2010 and 2009, our net favorable development included $89 million and $149 million, respectively, in relation to the primarily short tail exposure lines outlined above. This favorable development primarily reflects the recognition of better than expected loss emergence, rather than explicit changes in our actuarial assumptions. Development on our professional lines business accounted for $72 million and $24 million for the six months ended June 30, 2010 and 2009, respectively, with the rationale being consistent with that outlined above.
The following table summarizes information on the location and amounts of derivative fair values on the consolidated balance sheet at June 30, 2010:
Derivatives designated as hedging instruments
Foreign exchange contracts
Derivatives not designated as hedging instruments
Relating to investment portfolio:
Relating to underwriting portfolio:
Total derivatives
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The following table summarizes information on the location and amounts of derivative fair values on the consolidated balance sheet at December 31, 2009:
For the fair value hierarchy level, refer to Note 4 – Fair Value Measurements.
The following table provides the total unrealized and realized gains (losses) on derivatives recorded in earnings:
Location of Gain (Loss) Recognized
in Income on Derivative
Derivatives in fair value hedging relationships
Longevity risk derivative
Currency collar options:
Put options - Long
Call options - Short
Catastrophe-related risk
Derivative Instruments Designated as a Fair Value Hedge
The hedging relationship foreign currency contracts were entered into to mitigate the foreign currency exposure of two available for sale fixed maturity portfolios denominated in Euros. The hedges were designated and qualified as a fair value hedge. The net impact of the hedges is recognized in net realized investment gains (losses).
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The following table provides the net earnings impact of the fair value hedges:
Hedged investment portfolio
Hedge ineffectiveness recognized in earnings
Derivative Instruments not Designated as Hedging Instruments
a) Relating to Investment Portfolio
Within our investment portfolio we are exposed to foreign currency risk. Accordingly, the fair values for our investment portfolio are partially influenced by the change in foreign exchange rates. We entered into foreign currency forward contracts to manage the effect of this foreign currency risk. These foreign currency hedging activities have not been designated as specific hedges for financial reporting purposes.
b) Relating to Underwriting Portfolio
Longevity Risk
In September 2007, we issued a policy which indemnifies a third party in the event of a non-payment of a $400 million asset-backed note. This security had a 10 year term with the full principal amount due at maturity and was collateralized by a portfolio of life settlement contracts and cash held by a special purpose entity. We concluded that the indemnity contract was a derivative instrument and accordingly recorded it at its fair value. For the three and six months ended June 30, 2009, the loss on this contract was $15 million and $25 million respectively. This contract was cancelled and settled during the fourth quarter of 2009.
Foreign Currency Risk
Our insurance and reinsurance subsidiaries and branches operate in various foreign countries and consequently our underwriting portfolio is exposed to significant foreign currency risk. We manage foreign currency risk by seeking to match our liabilities under insurance and reinsurance policies that are payable in foreign currencies with cash and investments that are denominated in such currencies. When necessary, we may also use derivatives to economically hedge un-matched foreign currency exposures, specifically forward contracts and currency options.
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Restricted Stock
The following table provides a reconciliation of the beginning and ending balance of nonvested restricted stock for the six months ended June 30, 2010:
Nonvested restricted stock - beginning of period
Granted
Vested
Forfeited
Nonvested restricted stock - end of period
At June 30, 2010, we had 4,060,203 nonvested restricted stock outstanding, including 291,125 restricted stock units. For the three months ended June 30, 2010, we incurred share-based compensation costs of $9 million (2009: $12 million) and recorded tax benefits thereon of $1 million (2009: $2 million). For the six months ended June 30, 2010, we incurred share-based compensation costs of $19 million (2009: $26 million) and recorded tax benefits thereon of $3 million (2009: $3 million). The total grant-date fair value of shares vested during the six months ended June 30, 2010 was $59 million (2009: $52 million). At June 30, 2010 there were $81 million (2009: $63 million) of unrecognized share-based compensation costs, which are expected to be recognized over the weighted average period of 2.8 years (2009: 2.4 years).
The following table sets forth the comparison of basic and diluted earnings per common share:
Basic earnings per common share
Weighted average common shares outstanding
Diluted earnings per common share
Share equivalents:
Warrants
Restricted stock
Options
Restricted stock units
Weighted average common shares outstanding - diluted
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For the six months ended June 30, 2010, there were 367,084 (2009: 1,504,230) restricted stock, nil (2009: 1,542,168) options and nil (2009: 82,000) restricted stock units, which would have resulted in the issuance of common shares that were excluded in the computation of diluted earnings per share because the effect would be anti-dilutive.
The following table presents our common shares issued and outstanding:
Shares issued, balance at beginning of period
Total shares issued at end of period
Treasury shares, balance at beginning of period
Shares repurchased
Total treasury shares at end of period
Total shares outstanding
The following table presents our share repurchases, which are held in treasury:
In the open market:
Total shares
Total cost
Average price per share(1)
From employees:
Calculated using whole figures.
Subsequent to June 30, 2010, through July 30, 2010, we repurchased a further 334,200 common shares at an average price of $29.56 per share, for a total cost of $10 million. At July 30, 2010, we have approximately $123 million of remaining authorization for common share repurchases under the 2009 plan, which will expire on December 31, 2011.
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On March 23, 2010, AXIS Specialty Finance LLC (“AXIS Specialty Finance”), an indirect wholly-owned subsidiary of AXIS Capital, issued $500 million aggregate principal amount of 5.875% senior unsecured debt (“5.875% Senior Notes”) at an issue price of 99.624%. The net proceeds of the issuance, after consideration of the offering discount and underwriting expenses and commissions, totaled approximately $495 million. AXIS Specialty Finance has the option to redeem the 5.875% Senior Notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price. Unless previously redeemed, the 5.875% Senior Notes will mature on June 1, 2020. Interest on the 5.875% Senior Notes is payable semi-annually in arrears on June 1 and December 1 of each year, beginning on June 1, 2010.
The 5.875% Senior Notes are ranked as unsecured senior obligations of AXIS Specialty Finance. AXIS Capital has fully and unconditionally guaranteed all obligations of AXIS Specialty Finance under the 5.875% Senior Notes. AXIS Capital’s obligations under this guarantee are unsecured and senior and rank equally with all other senior obligations of AXIS Capital.
The related indenture contains various covenants, including limitations on liens on the stock of restricted subsidiaries, restrictions as to the disposition of the stock of restricted subsidiaries and limitations on mergers and consolidations. We were in compliance with all covenants contained in the indenture at June 30, 2010.
Consistent with our Senior Notes issued in November 2004, interest expense recognized in relation to the 5.875% Senior Notes includes interest payable, amortization of the offering discount and amortization of debt offering expenses. The offering discount and debt offering expenses are amortized over the period of time during which the Senior Notes are outstanding.
On May 14, 2010, certain of AXIS Capital’s operating subsidiaries entered into a secured $750 million letter of credit facility (the “LOC Facility”) with Citibank Europe plc (“Citibank”) pursuant to a Master Reimbursement Agreement and other ancillary documents (together, the “Facility Documents”). The LOC Facility may be terminated by Citibank on December 31, 2013 upon thirty days prior notice. Under the terms of the LOC Facility, letters of credit to a maximum aggregate amount of $750 million are available for issuance on behalf of the operating subsidiaries. These letters of credit will principally be used to support the Company’s reinsurance obligations. The LOC Facility is subject to certain covenants, including the requirement to maintain sufficient collateral, as defined in the Facility Documents, to cover all of the Company’s obligations under the LOC Facility. Such obligations include contingent reimbursement obligations for outstanding letters of credit and fees payable to Citibank. In the event of default, Citibank may exercise certain remedies, including the exercise of control over pledged collateral and the termination of the availability of the LOC Facility to any or all of the operating subsidiaries party to the Facility Documents. At June 30, 2010 no letters of credit had been issued under the new LOC Facility.
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Except as noted below, we are not a party to any material legal proceedings. From time to time, we are subject to routine legal proceedings, including arbitrations, arising in the ordinary course of business. These legal proceedings generally relate to claims asserted by or against us in the ordinary course of insurance or reinsurance operations. In our opinion, the eventual outcome of these legal proceedings is not expected to have a material adverse effect on our financial condition or results of operations.
In 2005, a putative class action lawsuit was filed against our U.S. insurance subsidiaries. In re Insurance Brokerage Antitrust Litigation was filed on August 15, 2005 in the United States District Court for the District of New Jersey and includes as defendants numerous insurance brokers and insurance companies. The lawsuit alleges antitrust and Racketeer Influenced and Corrupt Organizations Act (“RICO”) violations in connection with the payment of contingent commissions and manipulation of insurance bids and seeks damages in an unspecified amount. On October 3, 2006, the District Court granted, in part, motions to dismiss filed by the defendants, and ordered plaintiffs to file supplemental pleadings setting forth sufficient facts to allege their antitrust and RICO claims. After plaintiffs filed their supplemental pleadings, defendants renewed their motions to dismiss. On April 15, 2007, the District Court dismissed without prejudice plaintiffs’ complaint, as amended, and granted plaintiffs thirty (30) days to file another amended complaint and/or revised RICO Statement and Statements of Particularity. In May 2007, plaintiffs filed (i) a Second Consolidated Amended Commercial Class Action complaint, (ii) a Revised Particularized Statement Describing the Horizontal Conspiracies Alleged in the Second Consolidated Amended Commercial Class Action Complaint, and (iii) a Third Amended Commercial Insurance Plaintiffs’ RICO Case Statement Pursuant to Local Rule 16.1(B)(4). On June 21, 2007, the defendants filed renewed motions to dismiss. On September 28, 2007, the District Court dismissed with prejudice plaintiffs’ antitrust and RICO claims and declined to exercise supplemental jurisdiction over plaintiffs’ remaining state law claims. On October 10, 2007, plaintiffs filed a notice of appeal of all adverse orders and decisions to the United States Court of Appeals for the Third Circuit, and a hearing was held in April 2009. We believe that the lawsuit is completely without merit and we continue to vigorously defend the filed action.
On May 6, 2010, our Board of Directors declared a dividend of $0.21 per common share to shareholders of record at the close of business on June 30, 2010 and payable on July 15, 2010. The Board of Directors also declared a dividend of $0.453125 per Series A 7.25% Preferred Share and a dividend of $1.875 per Series B 7.5% Preferred Share. The Series A Preferred Share dividend is payable on July 15, 2010, to shareholders of record at the close of business on June 30, 2010 and the Series B Preferred Share dividend is payable on September 1, 2010, to shareholders of record at the close of business on August 13, 2010.
During the second quarter of 2010, we purchased reinsurance coverage for our insurance lines of business. The minimum reinsurance premiums are contractually due on a quarterly basis in advance. Accordingly at June 30, 2010, we have an outstanding reinsurance purchase commitment of $90 million.
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The following is a discussion and analysis of our financial condition and results of operations. This should be read in conjunction with the consolidated financial statements and related notes included in Item 1 of this report and also our Management’s Discussion and Analysis of Results of Operations and Financial Condition contained in our Annual Report on Form 10-K for the year ended December 31, 2009. Tabular dollars are in thousands, except per share amounts. Amounts in tables may not reconcile due to rounding differences.
Second Quarter 2010 Financial Highlights
Executive Summary
Underwriting Results – Group
Results by Segment: For the three and six months ended June 30, 2010 and 2009
i) Insurance Segment
ii) Reinsurance Segment
Other Revenues and Expenses
Net Investment Income and Net Realized Investment Gains/Losses
Cash and Investments
Liquidity and Capital Resources
Critical Accounting Estimates
New Accounting Standards
Off-Balance Sheet and Special Purpose Entity Arrangements
Non-GAAP Financial Measures
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SECOND QUARTER 2010 FINANCIAL HIGHLIGHTS
Second Quarter 2010 Consolidated Results of Operations
Net income available to common shareholders of $205 million, or $1.68 per share basic and $1.51 diluted
Operating income of $180 million, or $1.33 per share diluted (1)
Gross premiums written of $940 million
Net premiums written of $789 million
Net premiums earned of $735 million
Net favorable prior year reserve development of $79 million, pre-tax
Underwriting income of $121 million and combined ratio of 86.2%
Net investment income of $83 million
Net realized investment gains of $25 million
Second Quarter 2010 Consolidated Financial Condition
Total investments of $10.9 billion; fixed maturities and short-term securities comprise 93% of total investments, with an average credit rating of AA
Total assets of $16.6 billion
Reserve for losses and loss expenses of $6.7 billion and reinsurance recoverable of $1.5 billion
Total debt of $994 million and a debt to total capitalization ratio of 15.3%
Common shareholders’ equity of $5.0 billion; diluted book value per common share of $36.57
Repurchased 4.0 million common shares in the open market for total cost of $121 million under share repurchase authorization; remaining authorization of $133 million at June 30, 2010
Strong liquidity in our cash and investments portfolio with $4.2 billion expected to be available within one to three business days
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EXECUTIVE SUMMARY
Business Overview
We are a Bermuda-based global provider of specialty lines insurance and treaty reinsurance products with operations in Bermuda, the United States, Europe, Singapore, Canada and Australia. Our underwriting operations are organized around our two global underwriting platforms, AXIS Insurance and AXIS Reinsurance. Our strategy is to leverage our expertise, experience and relationships to expand our business globally. We are focused on organic growth, which we have supplemented with small acquisitions, while managing a portfolio of diversified and attractively priced risks. Our execution on this strategy in the first half of 2010 included the launch of our Global Accident & Health platform, focused on specialty accident products rather than traditional medical coverages, locking in $500 million of capital for 10 years at 5.875% via issuance of senior notes in March 2010, restructuring certain of our ceded reinsurance programs and taking advantage of select opportunities for premium growth.
Results of Operations
Underwriting income:
Other revenues and expenses
Operating income
nm - not meaningful
Underwriting Results
Total underwriting income for the three and six months ended June 30, 2010 was $121 million and $149 million, respectively, compared to $141 million and $238 million in the respective periods of 2009.
In our insurance segment, underwriting results for the three and six month periods in 2010 benefited from a substantially reduced level of claim activity in our credit and political risk and aviation lines, as well as the continued consideration of our own loss experience in establishing our expected loss ratios, most notably for professional lines. The cancellation of our indemnity contract exposed to longevity risk in the fourth quarter of 2009 also benefited the current year’s results. These factors were partially offset by reductions in net favorable prior period reserve development and increases in acquisition costs and general and administrative expenses.
The reduction in underwriting income for our reinsurance segment the three months ended June 30, 2010 was primarily the result of an increase in our estimate of net losses related to the first quarter 2010 Chilean earthquake. An unusually high number of significant first quarter catastrophes, including the Chilean earthquake, Australian storms and European Windstorm Xynthia, drove the year to date reduction in underwriting income.
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Net Investment Income
Net investment income for the three and six months ended June 30, 2010 decreased $30 million and $24 million, respectively, compared to the same periods in 2009. Lower reinvestment yields on our fixed maturities and cash and cash equivalents and, to a lesser extent, negative foreign exchange movements, contributed to the quarter and year to date declines. Our alternative investment portfolio (“other investments”) also contributed to the decrease in the current quarter, generating a $2 million loss amidst broad market declines, compared with income of $12 million in the second quarter of 2009.
Net Realized Investment Gains (Losses)
Unprecedented volatility and turmoil in the global financial markets during 2008 and 2009 led to impairment charges on our available-for-sale investments in the prior year. In the three and six months ended June 30, 2009, net realized investment losses included OTTI charges of $21 million and $51 million respectively; the year to date amount also included a $15 million loss on the sale of preferred shares. Financial markets were comparatively stable in the three and six months ended June 30, 2010 and OTTI charges declined to $7 million and $13 million, respectively. The net realized gains for the three and six months ended June 30, 2010 were primarily driven by sales of U.S. corporate debt securities, as we rebalanced the sectors in our corporate debt portfolio.
The reductions in other revenues and expenses for the quarter and year to date were primarily due to foreign exchange gains on the translation of net liability balances denominated in the Euro and Sterling following the depreciation of these currencies against the U.S. dollar in the second quarter. In contrast, during the second quarter of 2009, the U.S. dollar equivalent of net liability balances denominated in foreign currencies increased, as a result of a weakening U.S. dollar.
Financial Measures
We believe the following financial indicators are important in evaluating our performance and measuring the overall growth in value generated for our common shareholders:
ROACE (annualized)(1)
Operating ROACE (annualized)(2)
DBV per common share(3)
Cash dividends per common share
Return on Equity
Annualized ROACE for the three months ended June 30, 2010 increased 1.4 percentage points compared to the same period in 2009. This increase was largely driven by the 29% increase in net income available to common shareholders quarter over quarter, which more than offset a higher average common equity balance. Average common equity has increased as the result of a global recovery in financial markets and net income available to common shareholders over the last 12 months, partially offset by common share repurchases executed in the most recent three quarters. On a year to date basis, annualized ROACE decreased 0.4 percentage points relative to the comparable 2009 period. The decline primarily reflects a higher average common equity balance.
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The 2.8 percentage point decline in annualized operating ROACE for the second quarter is a result of a higher average common equity balance, as noted for ROACE above. In addition to a higher average common equity balance, a 19% reduction in operating income also contributed to the 5.2 percentage point decline in annualized operating ROACE on a year to date basis. Operating income for the year to date was significantly impacted by the level of catastrophe activity in the first quarter of 2010. Although the impact of catastrophes on net income and ROACE was largely offset by a $105 million favorable variance in net realized gains/losses due to improved economic conditions, these are excluded from operating income and operating ROACE.
Diluted book value per common share
Our June 30, 2009, DBV per common share was depressed as a result of unprecedented turmoil in global credit and equity markets. By December 31, 2009, our DBV per common share had recovered to $33.65 due to: (1) a recovery in global financial markets resulting in improved valuations for our available-for-sale securities, (2) net income available to common shareholders in the last two quarters of 2009 and (3) the execution of share repurchases at a discount to diluted book value in the fourth quarter of 2009. A further 9% increase in our DBV per common share to $36.57 in the first half of 2010 was primarily driven by net income available to common shareholders of $317 million, the continued execution of share repurchases at a discount to diluted book value and further improvements in the valuations for our available-for-sale fixed maturity portfolio.
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UNDERWRITING RESULTS – GROUP
The following table provides our group underwriting results for the periods indicated. Underwriting income is a measure of underwriting profitability that takes into account net premiums earned and other insurance related income as revenues and net losses and loss expenses, acquisition costs and underwriting-related general and administrative costs as expenses.
Revenues:
Expenses:
Current year net losses and loss expenses
Prior period reserve development
Underwriting income(1)
UNDERWRITING REVENUES
Premiums Written: Gross and net premiums written, by segment, were as follows:
% ceded
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Our insurance segment drove the 3% increase in consolidated gross premiums written in the quarter. Growth opportunities in a number of lines of business, as well as rate increases on offshore energy business following the Deepwater Horizon event, contributed to the segment’s increased gross premiums written. To a lesser extent, shifting renewal dates also contributed to the increase in insurance segment premiums. Partially offsetting this growth, premiums in our reinsurance segment were lower this quarter, largely due to shifting renewal dates on certain treaties.
On a year to date basis, the 6% increase in consolidated gross premiums written was driven by select growth opportunities within several of our insurance and reinsurance lines of business.
The reduction in our ceded premium ratios in 2010 primarily reflects changes in reinsurance purchasing in our insurance segment, where we increased the attachment points on our excess of loss property program and reduced the cession rate on our quota share professional lines program on renewal during the second quarter.
Net Premiums Earned: Net premiums earned by segment were as follows:
Changes in net premiums earned reflect period to period changes in net premiums written and business mix, together with normal variability in premium earning patterns. The increase in total net premiums earned in the quarter and on a year-to-date basis reflects premium growth in our reinsurance segment, as discussed above.
In our insurance segment, net premiums earned were impacted by premium adjustments on our credit and political risk business (see insurance segment discussion). Exclusive of these adjustments, net premiums earned increased 9% and 3% for the three and six month periods, respectively. These increases were driven by changes in our ceded reinsurance programs, as previously discussed.
UNDERWRITING EXPENSES
The following table provides a breakdown of our combined ratio:
Current accident year loss ratio
General and administrative expense ratio(1)
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Current Accident Year Loss Ratio:
Our current accident year loss ratio for the three months ended June 30, 2010 was broadly comparable with that of the same period of 2009. However, there was some variance within our segments. Our insurance segment benefited from a lower level of claims activity in our credit and political risk line of business; loss activity was elevated in 2009 as a result of deteriorating global economic conditions. Claims activity in our aviation line of business also declined. The current accident year loss ratio for our reinsurance segment was higher in 2010, primarily due to the recognition of a $26 million increase in our estimate of pre-tax net losses (net of related reinstatement premiums) in relation to the first quarter Chilean earthquake, following receipt of updated information from cedants, intermediaries and other market sources.
For the year to date, our consolidated current accident year loss ratio was higher than 2009 primarily as a result of the significant level of catastrophe activity in the first quarter. During the six months ended June 30, 2010, we recognized estimated pre-tax net losses (net of related reinstatement premiums) of $124 million in relation to the February 27, 2010 Chilean earthquake. The earthquake and following tsunami and aftershocks caused significant destruction to areas in Chile. Our net estimated losses from the event before considering related reinstatement premiums are $133 million, with substantially all of this amount emanating from our reinsurance segment. Our estimate was derived from a ground-up assessment of our individual contracts and treaties in the affected regions and is consistent with our market share in the region. As part of our estimation process, we also considered current industry insured loss estimates, market share analysis, catastrophe modeling analysis and the information available to date from clients, brokers and loss adjusters. There are a number of potential complications involved with the investigation, adjustment and handling of insurance claims arising from the Chilean earthquake which may result in a longer development tail than that observed for other catastrophes of a similar magnitude. These include restrictions on who is permitted to adjust claims, the scope of the coverage on the original policies and the practical and logistical issues associated with adjusting business interruption losses in Chile. Industry-wide insured loss estimates, and our own estimate, remain subject to change as additional actual loss data becomes available. Actual losses in relation to this event may ultimately differ materially from current loss estimates.
In addition, during the first six months of 2010 we recognized pre-tax net losses (net of related reinstatement premiums) totaling $49 million for other notable first quarter events: Australian storms, European Windstorm Xynthia and U.S. storms. There was no material change in the estimate for these storms in the aggregate during the second quarter of 2010.
Natural catastrophe activity in the first quarter of 2010 was uncharacteristically high; in contrast, our 2009 catastrophe losses were notably lower and emanated principally from European Windstorm Klaus.
The following factors partially offset the impact of a higher level of catastrophe activity on the current accident year loss ratio:
A decrease in the expected loss ratio for our credit and political risk business in 2010, as loss activity was elevated in 2009 due to increased loss activity amidst the deteriorating global economic environment;
The continued incorporation of more of our own historical loss experience within short-tail lines of business, which had the impact of reducing our initial expected losses, given our loss experience has been generally better than we expected; and
For our medium to long-tail lines, and in particular our professional lines insurance and reinsurance business, our historical loss experience on prior accident years has generally been lower than our initial projected loss ratios. In recognition of the increasing maturity and credibility of our own historical loss experience, we placed increased weight on our own loss experience when establishing our projected loss ratios for the 2010 accident year, with a corresponding reduction in the weight assigned to industry data. We also took into account the recovery from the global financial crisis. This, therefore, led to lower initial projected loss ratios for the current accident year in 2010.
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Prior Period Reserve Development:
Our favorable prior period development was the net result of several underlying reserve developments on prior accident years, identified during our quarterly reserve review process. The following table provides a break down of prior period reserve development by segment:
Overview
Overall, a significant portion of the net favorable prior period reserve development in the second quarters of 2010 and 2009 was generated from the property, marine, terrorism (included in “other”) and aviation lines of our insurance segment and the property, catastrophe and crop (included in “other”) lines of our reinsurance segment. These lines of business, the majority of which have short tail exposures, contributed $38 million and $71 million of the total net favorable reserve development in the second quarters of 2010 and 2009, respectively. The favorable development on these lines of business primarily reflects the recognition of better than expected loss emergence, rather than explicit changes in our actuarial assumptions.
We caution that conditions and trends that impacted the development of our liabilities in the past may not necessarily occur in the future. The following sections provide further details on prior year reserve development by segment, line of business and accident year.
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Insurance Segment:
Property and other
Marine
Aviation
Credit and political risk
Professional lines
Liability
In the second quarter of 2010, we recognized $31 million of net favorable prior period reserve development, the principal components of which were:
$6 million of net favorable prior period reserve development on property business, the majority of which related to the 2009 accident year and related to better than expected loss emergence.
$6 million of net favorable prior period reserve development on marine business, driven by better than expected loss emergence.
$6 million of net adverse prior period reserve development on credit and political risk business. This amount included $22 million of adverse development on the 2009 accident year, as we reduced our recovery estimates on certain credit insurance claims after taking into consideration updated publicly available information and discussions with our insureds. This was partially offset by $16 million of net favorable development on 2008 and 2007 accident year CEND and credit business, as a result of better than expected loss emergence.
$22 million of net favorable prior period reserve development on professional lines business, principally related to the 2006 and 2005 accident years, as discussed in the overview.
In the second quarter of 2009, we recognized $47 million of net favorable prior period reserve development, the principal components of which were:
$20 million of net favorable prior period reserve development on property business, primarily related to accident year 2008 and driven by better than expected loss emergence. This included $6 million in favorable development on the 2008 accident year in relation to Hurricanes Ike and Gustav.
$14 million of net favorable prior period reserve development on marine business, largely related to the 2009 accident year and driven by better than expected loss emergence. This also included $3 million in favorable development on the 2008 accident year in relation to Hurricanes Ike and Gustav.
$3 million of net adverse prior period reserve development on professional lines business. This amount included $29 million of net adverse development on the 2008 accident year, primarily reflecting higher than expected loss activity on our financial institutions business as a result of the global economic downturn and credit crisis. This was partially offset by net favorable development, primarily related to the 2005 and 2004 accident years, for reasons discussed in the overview.
$13 million of net favorable prior period reserve development on liability business, across the 2004 through 2008 accident years and driven by the incorporation of more of our own actual experience with respect to reinsurance recoveries on our E&S umbrella lines.
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For the first six months of 2010, we recognized $56 million of net favorable prior period reserve development, the principal components of which were:
$20 million of net favorable prior period development on our property business, the majority of which related to the 2007 through 2009 accident years and related to better than expected loss emergence.
$8 million of net favorable prior period reserve development on marine business, largely related to the 2007 through 2009 accident years and driven by better than expected loss emergence. This included net favorable development on offshore energy business of $7 million.
$19 million of net adverse prior period reserve development on credit and political risk business. This balance consisted of net adverse development of $45 million on the 2009 accident year, as we finalize settlements for certain loss events and reduced our recovery estimates for the latest available information. Partially offsetting this amount was $26 million in net favorable prior period reserve development on the 2006 through 2008 accident years, in recognition of better than anticipated loss emergence on our CEND and credit business.
$44 million of net favorable prior period reserve development on professional lines business, primarily generated from the 2006 and 2005 accident years, as discussed in the overview.
For the first six months of 2009, we recognized $83 million of net favorable prior period reserve development, the principal components of which were:
$35 million of net favorable prior period reserve development on our property business, primarily related to the 2008 accident year and reflecting better than expected loss emergence.
$24 million of net favorable prior period reserve development on our marine lines of business, primarily related to the 2008 accident year and, to a lesser extent, the 2006 and 2005 accident years. This development reflected better than expected loss emergence.
$3 million of net favorable prior period reserve development on our professional lines business, which included $40 million of net favorable prior period reserve development, primarily related to the 2005 and 2004 accident years as discussed in the overview, offset by net adverse prior period reserve development of $37 million on the 2008 accident year in relation to the global economic downturn and credit crisis.
$14 million net favorable prior period reserve development on our liability lines of business, as discussed in the second quarter section above.
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Reinsurance Segment:
Catastrophe, property and other
Credit and bond
Motor
In the second quarter of 2010, we recognized $48 million of net favorable prior period reserve development, the principal components of which were:
$24 million of net favorable prior period reserve development on catastrophe, property and other business largely consisting of:
$3 million of net adverse prior period reserve development on catastrophe business, driven by $12 million net adverse development on the 2008 accident year primarily as a result of updated information with respect to Hurricane Ike losses. This was partially offset by net favorable prior period reserve development on other accident years, most notably the 2009 accident year, primarily due to better than expected loss emergence.
$21 million of net favorable prior period reserve development on property business, emanating mainly from the 2009 and 2008 accident years and related to better than expected loss emergence.
$6 million of net favorable prior period reserve development on crop reserves (included in “other”), principally related to the 2009 accident year and largely as a result of the reduction in reserves for Canadian crop losses.
$13 million of net favorable prior period development on trade credit and bond reinsurance lines of business, largely related to the 2009 accident year and, to a lesser extent, the 2007 and 2008 accident years, in recognition of our better than expected actual experience to date and updated information from our cedants.
$15 million of net favorable prior period reserve development on professional lines reinsurance business, primarily on the 2006 accident year, as discussed in the overview above.
$4 million of net adverse prior period reserve development on liability business, approximately half of which was attributable to a relatively small increase in the reserve estimate for the 2004 accident year within one particular sub-class. The remainder was largely due to minor changes in our assumptions for loss adjustment expenses.
In the second quarter of 2009, we recognized $50 million of net favorable prior period reserve development, the principal components of which were:
$34 million of net favorable prior period reserve development on catastrophe, property and other business, consisting of:
$20 million of net favorable prior period reserve development on property business, primarily relating to the 2007 and 2008 accident years. The favorable development was driven by better than expected loss emergence.
$14 million of net favorable prior period reserve development on catastrophe business, primarily in relation to the 2008 accident year and driven by $12 million in net favorable development related to Hurricanes Ike and Gustav.
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$13 million of net favorable prior period reserve development on professional lines reinsurance business, primarily related to the 2005 and 2004 accident years as discussed in the overview above.
For the first six months of 2010, we recognized $104 million of net favorable prior period reserve development, the principal components of which were:
$59 million of net favorable prior period reserve development on catastrophe, property and other business largely consisting of:
$17 million of net favorable prior period reserve development on catastrophe business, primarily related to the 2009 and 2005 accident years. While the 2009 accident year development was primarily driven by better than expected loss emergence, the development on the 2005 accident year principally relates to a reduction in our reserve on one particular claim following receipt of updated information. Partially offsetting this was net adverse development of $9 million for the 2008 accident year, largely related to updated information provided by a cedant with respect to Hurricane Ike losses.
$27 million of net favorable prior period reserve development on property business, emanating mainly from the 2009 and 2008 accident years and related to better than expected loss emergence.
$14 million of net favorable development on crop reserves (included in “other”), principally related to the 2009 accident year and largely as a result of the reduction in reserves for Canadian crop losses following updated information from the cedant.
$18 million of net favorable prior period development on trade credit and bond reinsurance lines of business, largely related to the 2009 accident year and, to a lesser extent, the 2007 and 2008 accident years, in recognition of our better than expected actual experience to date.
$28 million of net favorable prior period reserve development on professional lines reinsurance business, primarily on the 2006 accident year and, to a lesser extent, the 2005 and 2007 accident years, as discussed in the overview above.
$2 million of net adverse prior period reserve development on liability reserves, attributable to a relatively small increase in the reserve estimate for the 2004 accident year within one particular sub-class and minor changes in our assumptions for loss adjustment expenses. This was partially offset by net favorable reserve development resulting from the commutation of two treaties.
For the first six months of 2009, we recognized $98 million of net favorable prior period reserve development, the principal components of which were:
$87 million of net favorable prior period reserve development on catastrophe, property and other business largely consisting of:
$45 million of net favorable prior period reserve development on catastrophe business, emanating primarily from the 2008 accident year, including $12 million in relation to Hurricanes Ike and Gustav, as well as the 2007 accident year to a lesser extent. This development was largely the result of better than expected loss emergence.
$36 million of net favorable prior period reserve development on property business, primarily relating to the 2009 and 2008 accident years and driven by better than expected loss emergence.
$15 million of net adverse prior period reserve development on our trade credit and bond reinsurance lines of business, driven by adverse development of $35 million on the 2008 accident year, reflecting updated loss information received from our cedants. This was partially offset by net favorable development on earlier accident years, in recognition of better than expected claims emergence.
$21 million of net favorable prior period reserve development on our professional lines reinsurance business, predominantly in relation to the 2005 and, to a lesser extent, 2004 accident years for the reasons discussed in the overview.
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RESULTS BY SEGMENT
INSURANCE SEGMENT
Results from our insurance segment were as follows:
Ratios:
Current year loss ratio
General and administrative ratio
Gross Premiums Written: The following table provides gross premiums written by line of business:
Property
Terrorism
Other(1)
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The 16% increase in gross premiums written in the quarter was primarily driven by our property and marine lines of business. The increase in property premiums was largely due to select new business opportunities in the onshore energy market, as well as in the U.S. property markets where we have written new, primarily non-catastrophe exposed, business. Rate increases on offshore energy business resulting from the Deepwater Horizon event, as well as increases in our share of certain policies and select new business opportunities, drove the increase in marine premiums. Although we ceased writing E&S primary casualty business this quarter due to sustained unfavorable market conditions, we have seen a greater number of opportunities in the E&S umbrella market and this resulted in an increase in liability premiums. While our aggregate terrorism exposures have declined, our gross premiums written in this line rose in the current quarter due to one multi-year policy and the restructuring of another significant policy. Aviation premiums written this quarter were higher as a result of a shift in renewal dates on certain policies from the first quarter to second quarter of 2010.
On a year to date basis, growth in our gross premiums written has been led by opportunities in the U.S. property market and, to a lesser extent, the recent rate increases on offshore energy business. Global lending and trade activity, which stagnated during the global financial crisis, is gradually resuming and we expect opportunities to write credit and political risk business will increase in the coming quarters.
Premiums Ceded: Premiums ceded in the current quarter were $146 million, or 24% of gross premiums written, compared with $214 million, or 41% in the comparable period in 2009. For the first six months of 2010, premiums ceded were $312 million, or 32% of gross premiums written, compared to $366 million, or 41%, in the same period of 2009. The reduction in the ceded premium ratio during the three and six months ended June 30, 2010 is primarily attributable to changes in our reinsurance purchasing, including higher attachment points on our property excess of loss program and reduced cession rates on our professional lines quota share reinsurance programs on renewal during the second quarter.
Net Premiums Earned: The following table provides net premiums earned by line of business:
Net premiums earned on our credit and political risk line for 2010 include a $12 million reduction in connection with the settlement of prior accident year claims in the first quarter, while the quarter and year to date amounts for 2009 include the accelerated recognition of $22 million of premium due to the exhaustion of exposure on certain loss impacted policies. Excluding the impacts of these adjustments in both periods, net premiums earned for the segment increased 9% and 3% for the three and six months ended June 30, 2010, respectively.
Net premiums written in the twelve months ended June 30, 2010 increased 15% compared to that of the twelve months ended June 30, 2009. The majority of this increase, however, relates to the significant increase in net premiums written during the second quarter of 2010 as a result of the previously discussed changes in reinsurance purchasing on our property and professional lines business. These changes will lead to increases in net earned premiums on these lines of business over the coming year, absent any significant reductions in net written premium.
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Loss Ratio: The table below shows the components of our loss ratio:
Current accident year
Loss ratio
Current Accident Year Loss Ratio
The decreases in our current accident year loss ratio for the quarter and year to date were primarily the result of a lower level of claims activity in our credit and political risk and aviation lines of business relative to the prior year. In addition, the lower current accident year loss ratio was driven by business mix changes and the previously discussed consideration of our own loss experience in establishing loss ratios for our medium to long-tail business in 2010, most notably for professional lines.
Our net losses and loss expenses for the three months ended June 30, 2010 include estimated pre-tax net losses of $9 million in relation to the April 21, 2010 Deepwater Horizon event in the Gulf of Mexico, which is contained within our annual loss expectations for the marine line of business.
Our insurance segment’s exposure to the Chilean earthquake was minimal.
Refer to the ‘Prior Period Reserve Development’ section for further details.
Acquisition Cost Ratio: The increase in our acquisition cost ratio this quarter reflects the impact of changes in our property and professional lines reinsurance purchasing, as well as prior year commission adjustments. A non-recurring premium tax adjustment also contributed to the year to date increase.
General and Administrative Expense Ratio: The increase in the general and administrative ratio for the quarter and year to date reflects additional headcount and IT costs over the period, associated with the build-out of the segment’s platform.
Other Insurance Related Income / Loss: During the three and six months ended June 30, 2009, we recorded increases in the fair value of the liability associated with our indemnity contract exposed to longevity risk of $15 million and $25 million, respectively. As we negotiated the cancellation of this contract during the fourth quarter of 2009 and this was the only contract of this kind in our portfolio, there are no corresponding amounts for 2010.
Insurance Segment Outlook
In the insurance marketplace, rates are falling modestly across most lines due to increased competition and we expect to see a continuation of this trend through the remainder of the year, absent a significant industry event. Single digit pricing declines are relatively consistent across our insurance portfolio.
One exception to this trend is the offshore energy class of business, where rates have been impacted by the Deepwater Horizon event. Renewal quotes in this class are currently averaging double-digit increases for drilling contractor and exploration and production accounts with minimal historical loss activity. We expect the market response to this loss to have two phases, with the first being increased pricing and scrutiny of coverage. The second phase will come with the renewal of marine and offshore reinsurance treaties, the majority of which will occur at the 1st of January.
While we exited the E&S primary casualty market this quarter as a result of weak market conditions, this will not have a significant impact on our gross premiums written or underwriting income, as this has been a relatively small class for us in recent periods. We have been pulling back from the line gradually since market conditions peaked for the class in 2004.
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REINSURANCE SEGMENT
Results from our reinsurance segment were as follows:
Gross Premiums Written: The following tables provide gross premiums written by line of business for the periods indicated:
%
Change
Catastrophe
Engineering
Other
The 16% decrease in gross premiums written this quarter was largely driven by shifting renewal dates. Premiums for our property line of business were impacted by the renewal of a significant second quarter 2009 treaty in the first quarter of 2010, as well as the extension of another significant second quarter 2009 treaty for renewal in the third quarter of 2010. Partially offsetting these decreases, our liability premiums increased this quarter due to the extension of a first quarter 2009 treaty for renewal this quarter. Our motor premiums were also impacted by shifting renewal dates, while a reduction in our share of a significant proportional treaty contributed to the lower professional lines premiums.
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Gross premiums written in the first six months of 2010 were favorably impacted by a weaker U.S. dollar at our major renewal date of January 1, most significantly against the Euro and Sterling. The impact of foreign exchange rate movements is highlighted in the table above. Gross premiums written otherwise increased 1%, driven by growth opportunities across several of our lines of business.
Our trade credit and bond line of business has grown primarily as a result of new Latin American surety business. Motor premiums benefited from significant new business in the first quarter of 2010, as we increased our participation in select European markets including the U.K. Partially offsetting these increases, was a reduction in professional lines business, largely as a result of a reduction of our share on one significant proportional treaty.
The 6% and 9% increases in net premiums earned in the quarter and on a year to date basis, respectively, largely reflect an increase in gross premiums written of 5% in the twelve months ended June 30, 2010 compared to the same period ending June 30, 2009.
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The increase in our current accident year loss ratio during the second quarter of 2010 was largely driven by increases in our estimate of net losses related to first quarter 2010 catastrophes. During the three months ended June 30, 2010, we recognized a $26 million increase in our estimate of pre-tax net losses (net of related reinstatement premiums) for the Chilean earthquake.
The following factors partially offset the impact of the Chilean earthquake increase:
The continued incorporation of more of our own historical loss experience within short-tail lines of business, which has reduced our net loss ratio because our experience has generally been better than we expected.
The previously discussed increased consideration of our own loss experience in establishing loss ratios for our medium to long-tail business in 2010, most notably for professional lines.
Exposure to the Deepwater Horizon event is expected to be contained within our annual loss expectations.
The 13.2 percentage point increase in our current accident year loss ratio on a year-to-date basis was primarily driven by the increased natural catastrophe activity during the first quarter of 2010. We have recognized estimated pre-tax net losses (net of related reinstatement premiums) of $121 million for the Chilean earthquake. In addition, we have recognized pre-tax net losses (net of related reinstatement premiums) of $49 million for the first quarter Australian storms, European Windstorm Xynthia and U.S. storms, combined. In contrast, natural catastrophe activity in the first quarter of 2009 was notably less significant and our net catastrophe losses largely emanated from European Windstorm Klaus. Partially offsetting this catastrophe-related increase, however, are the factors outlined above and a decrease in the expected loss ratio for our trade credit and bond reinsurance business. The current accident year loss ratio on trade credit and bond business of 88% for the first six months of 2009 was elevated due to increased loss activity expected in the deteriorating global economic environment; the corresponding ratio for 2010 is 66%.
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Reinsurance Segment Outlook
We have concluded our July 1st renewals, with the majority of the business up for renewal being property business. In general, the reinsurance marketplace was more competitive; our markets remain stable, without material changes in pricing or loss trends. We estimate premiums at this renewal date were up 3% over the expiring amounts; on a currency-adjusted basis, we estimate premiums were up 5%. While there could be other activity in the third quarter that will impact our gross premiums written, we believe these estimates are a good indication of how we are faring in the marketplace.
Declines in our property catastrophe premium volume were offset by growth in our new Latin American surety reinsurance business, as well as select growth in our U.S. liability lines. The decline in property catastrophe business was driven by the removal of a significant aggregate excess treaty from the reinsurance market and a reduction in our exposure to lower layers in property per risk business, where competition was significant. At the July 1st renewal, property catastrophe reinsurance business saw a continued modest deterioration from the pricing level at the January 1st renewal. We do not anticipate this deterioration will have a material impact on margins. Greater rate deterioration was experienced in lower layers, which generally have more premium volume. Professional lines and other liability reinsurance lines are experiencing pricing pressure, as rates react to favorable trends and loss experience but do not seem to be reacting to reductions in investment income or early signs of inflation.
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OTHER REVENUES AND EXPENSES
The following table provides a breakdown of our other revenues and expenses:
Corporate Expenses: Our corporate expenses include holding company costs necessary to support our worldwide insurance and reinsurance operations and costs associated with operating as a publicly-traded company. As a percentage of net premiums earned, corporate expenses were 2.6% and 2.5% for the three and six months ended June 30, 2010, compared to 2.3% and 2.5% for the same periods in 2009.
Foreign Exchange Losses (Gains): Some of our business is written in currencies other than U.S. dollars. The foreign exchange gains in the three and six months ended June 30, 2010 were primarily due to the remeasurement of net liabilities denominated in Euro and Sterling, following their depreciation against the U.S. dollar.
The foreign exchange losses in the three and six months ended June 30, 2009 were principally due to the remeasurement of net liability balances denominated in Euro, Sterling and the Australian dollar, following an appreciation of these currencies against the U.S. dollar.
Interest Expense and Financing Costs: Interest expense primarily relates to interest due on our senior notes and has increased in 2010 following the issuance, on March 23, 2010, of $500 million aggregate principal amount of ten-year senior notes with a 5.875% coupon. See ‘Liquidity and Capital Resources’ for further details.
Income Tax Expense: Income tax expense is generated primarily through our foreign operations in the United States and Europe. Our effective tax rate, which is calculated as income tax expense divided by income before tax, was 2.9% and 5.0% for the three and six months ended June 30, 2010 compared to 6.7% and 5.7% in the same periods of 2009. During the three and six months ended June 30, 2010, we reduced our valuation allowance associated with deferred tax assets arising from realized U.S. capital losses. Net realized U.S. capital gains in 2010 will allow us to utilize a portion of those capital loss carryforwards. As a result, the effective tax rate for our U.S. operations declined, leading to an overall reduction in our consolidated effective tax rate.
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NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS/LOSSES
The following table provides a breakdown of income earned from our cash and investment portfolio by major asset class:
Investment expense
Pre-tax yield:(1)
Our pre-tax yield on fixed maturities was 3.6% and 3.7% for the three and six months ended June 30, 2010, respectively, compared with 4.4% and 4.3% for the three and six months ended June 30, 2009, respectively. The lower yields in the current year were caused by a downward shift in the U.S. Treasury yield curve, further tightening of credit spreads, and to a lesser extent, negative foreign exchange movements. The impact of lower reinvestment yields in 2010 was partially offset by larger average fixed maturities balances in the current year in comparison to 2009.
We record the change in fair value on our other investments in net investment income and consequently, the pre-tax return on other investments may vary materially period over period, in particular during volatile credit and equity markets.
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The following table provides a breakdown of net investment income (loss) from other investments:
Credit funds
Pre-tax return on other investments(1)
The decrease in investment income from other investments this quarter was driven primarily by declining hedge fund and credit fund valuations which are influenced by the direction of the broad equity and credit markets, respectively. The negative returns from these funds were offset partially by the continued valuation recovery of our CLO equity tranched securities (“CLO Equities”), which was driven primarily by much lower actual default rates, resulting in higher cash distributions from CLO Equities than previously expected. The weighted average actual default rate at May 31, 2010 for our CLO Equities was 1.4% compared to 3.4% at May 31, 2009. We continue to remain cautious on this positive development and as a result have not changed our default rate assumptions for the remaining lives of the CLO Equities in our valuation models (refer to Item 1, Note 4 to the Consolidated Financial Statements for further details).
For the six months ended June 30, 2010, the pre-tax return on other investments was 2.6%, compared to 3.8% for the same period in 2009. The decline in pre-tax return was primarily due to the strong recovery in the broad equity markets and loan valuations in the first half of 2009 compared to 2010. However, this decline was partially offset by an improvement in the valuation of our CLO Equities.
Cash and Cash Equivalents
The reduction in investment income from cash and cash equivalents was driven mainly by lower global short-term interest rates, lower average cash balances, and negative foreign exchange movements.
Net Realized Investment Gains/Losses
Our fixed maturities and equities are classified as available for sale and reported at fair value. The effect of market movements on our available for sale investment portfolio impacts net income (through net realized investment gains/losses) only when securities are sold, hedged, or impaired. Additionally, changes in the fair value of investment derivatives, mainly foreign exchange forward contracts, are recorded in net realized investment gains/losses.
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The following table provides a breakdown of net realized investment gains/losses:
On sale of:
Fixed maturities and short-term investments
OTTI charges recognized in earnings
Change in fair value of investment derivatives
Fair value hedges:
Change in fair value of derivative instruments
Change in fair value of hedged investments
On sale of investments
Generally, sales of individual securities occur when we conclude there are changes in the credit quality of a particular issuer or market value is likely to deteriorate. We may also sell to rebalance our investment portfolio in order to reduce a concentration in a particular issuer or asset class.
Fixed maturities and short-term investments:
The significant increase in net realized investment gains on the sale of fixed maturities and short-term investments in 2010, for both periods presented, relates primarily to gains on sales of U.S. corporate debt securities which were sold as a result of rebalancing the sector composition of our corporate debt portfolio.
Equities:
Net realized investment losses on the sale of equities in the first six months of 2009 were driven by the sale of preferred shares in the financial sector.
OTTI charges
We review our available-for-sale investment portfolio each quarter to determine if the unrealized loss position of a security is other-than-temporary. Refer to the ‘Critical Accounting Estimates – OTTI’ section for further details on our impairment review process.
In accordance with the new accounting guidance issued and effective April 1, 2009, the OTTI charge to earnings in 2010 reflects only credit impairments, where projected cash flows are less than the amortized cost of a security, or the full unrealized loss position if we intend to sell a fixed maturity security or it is more likely than not that we will need to sell it to meet our liabilities. This guidance does not allow for retrospective application, therefore the OTTI charge recorded in the first quarter of 2009 of $26 million for fixed maturities is based on previous OTTI accounting guidance (i.e. the difference between the fair value and amortized cost of a debt security in an unrealized loss position). Accordingly, the OTTI charge for the first six months of 2010 is not comparable with the OTTI charge for the same period in 2009.
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The following table summarizes our OTTI recognized in earnings by asset class:
The decline in OTTI charges for the second quarter of 2010 compared to 2009 was primarily due to the decline in securities we intended to sell. In 2009, we made decisions to sell securities mainly to take advantage of improved market conditions as well as to reduce our exposure to non-agency CMBS.
The OTTI charges in the first six months of 2010 were significantly lower when compared with the same period of 2009, primarily due to a change in accounting principle for OTTI charges recognized in earnings (as noted above) and the return of stability in the credit markets. During the first six months of 2009, the OTTI charges on corporate debt were related to the subordinated debt of certain U.S. and foreign banks while charges on non-agency RMBS and ABS were largely due to exposures to alternative-A and sub-prime collateral. Further, we made the decision to sell certain corporate debt securities, non-agency RMBS and non-agency CMBS.
The OTTI losses on equities in the three and six month periods ended June 30, 2010 and 2009 are primarily due to the severity and duration of the unrealized loss positions, for which we concluded the forecasted recovery period was too uncertain. The recognition of such losses does not necessarily indicate that sales will occur or that sales are imminent or planned.
Fair Value Hedges
Due to the significant volatility in the Euro vs. U.S. dollar currencies in 2008, we implemented a fair value hedging program to hedge un-matched foreign currency exposures. During the three and six months ended June 30, 2010 and 2009, our hedging program was effective, generating gains/losses of less than 2% of notional balances.
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Total Return
Our investment strategy is to take a long-term view by actively managing our investment portfolio to maximize total return within certain guidelines and constraints. In assessing returns under this approach, we include net investment income, net realized investment gains and losses and the change in unrealized gains and losses generated by our investment portfolio. The following table provides a breakdown of the total return on cash and investments for the period indicated:
Net realized investments gains (losses)
Change in net unrealized gains/losses, net of currency hedges
Average cash and investments(1)
Total return on average cash and investments, pre-tax(2)
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CASH AND INVESTMENTS
The table below provides a breakdown of our cash and investments:
Cash and cash equivalents(1)
The amortized cost/cost of our total investments increased by $244 million from December 31, 2009, primarily due to the investment of approximately $300 million of the $495 million net proceeds from our senior notes offering in March 2010, which was allocated to our fixed maturity portfolio.
The fair value of our total investments increased by $322 million from December 31, 2009, primarily due to net contributions and improved valuation for our fixed maturities. This increase was partially offset by net redemptions in our hedge fund investments, negative movement in foreign exchange rates, mostly the Euro against the U.S. dollar, and to a lesser extent negative returns in our global equity portfolios.
Cash and cash equivalents balances grew by $333 million during the first six months of 2010 primarily due to net cash provided by operations of $538 million and the remaining net proceeds from the above senior notes. This increase in cash and cash equivalents was offset partially by $409 million of share repurchases made in the open market during 2010.
The total change in net unrealized gains (losses) on our available-for-sale investment portfolio for the first six months of 2010 was as follows:
Net Unrealized
Gains (Losses) at
June 30, 2010
Common stock
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During the first six months of 2010, the downward shift in the U.S. Treasury yield curve as well as the additional tightening of credit spreads contributed to the improved valuation for most asset classes within our fixed income portfolio. The decline in the valuation for our non-U.S. government securities was primarily due to negative foreign exchange movements. The above table does not include the hedge benefit from our foreign exchange hedging program (refer to Part 1, Note 6 of the Consolidated Financial Statements).
The decline in the valuation for our equities was due to the decline in the global equity markets and negative foreign exchange movements.
The following provides a further analysis on our investment portfolio by asset classes.
The following provides a breakdown of our investment in fixed maturities:
U.S. government and agencies
Credit ratings:(1)
AAA(2)
AA
A
BBB
Below BBB(3)
For the six months ended June 30, 2010, we reduced our U.S. government and agencies holdings and allocated the proceeds, along with partial proceeds from our senior unsecured debt issued in March, primarily to corporate debt and ABS. New investments in corporate debt were made due to our positive outlook for further credit spread tightening while additional investments were made in ABS due to the availability of higher quality new issues with shorter durations. At June 30, 2010, fixed maturities had weighted average credit rating of AA (2009: AA) with an approximate average duration of 3.0 years (2009: 3.1 years). When incorporating cash and cash equivalents into this calculation, the average duration at June 30, 2010 was 2.7 years (2009: 2.8 years).
Of the $755 million (2009: $697 million) of non-U.S. government holdings held at June 30, 2010, we had no sovereign debt holdings issued by the governments of Portugal, Italy or Greece (2009: nil, $32 million and nil, respectively). Our sovereign exposure to Spain and Ireland was $38 million (2009: $20 million) and $7 million (2009: nil), respectively.
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The non-investment grade securities reported in the above table are predominantly the result of downgrades subsequent to our initial purchases. We continue to hold these non-investment grade securities as we believe their current valuations are attractive based on their respective fundamentals. The increase in non-investment grade holdings since December 31, 2009, was primarily due to downgrades and, to a lesser extent, improved valuations of several non-agency residential MBS issues and corporate debt issues along with a small number of municipals and ABS.
Gross Unrealized Losses:
At June 30, 2010, the gross unrealized losses on our fixed maturities portfolio were $136 million (2009: $134 million). The following table provides information on the severity of the unrealized loss position as a percentage of amortized cost for all investment grade fixed maturities in an unrealized loss position.
0-10%
10-20%
20-30%
30-40%
40-50%
> 50%
During the first six months of 2010, the gross unrealized losses that are in the 10-20% severity range for investment grade fixed maturities increased by $42 million. This increase was primarily due to the deterioration of the Euro against the U.S. dollar which has resulted in larger gross unrealized losses on certain of our non-U.S. government bonds and corporate debt. As previously noted, we hedged most of this foreign exchange exposure, which is not reflected in the above table. The gross unrealized losses for the other ranges of severity noted in the above table have shifted to lower severity bands in the current quarter primarily due to the recovery of the global financial markets.
The greater than 50% severity of unrealized loss at December 31, 2009, consisted primarily of non-agency RMBS, non-agency CMBS and ABS where we did not anticipate credit losses. These securities had a weighted average credit rating of AA- by S&P. The decrease in this balance since December 31, 2009 was primarily due to the significant improvement in the pricing of one AAA rated non-agency RMBS, the impairment of one BBB+ rated ABS and the sale of one AA+ rated non-agency CMBS during the first six months of 2010.
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The following table provides information on the severity of the unrealized loss position as a percentage of amortized cost for all below non-investment grade fixed maturities in an unrealized loss position at June 30, 2010 and December 31, 2009.
% of
Total GrossUnrealizedLosses
During the current quarter, we increased our allocation to global equities by $25 million and recorded an impairment charge of $4 million due to the severity and duration of the unrealized loss position for certain equity securities, for which we concluded the forecasted recovery period was too uncertain.
The composition of our other investment portfolio is summarized as follows:
June 30,
2010
December 31,
2009
CLO - Equities
The decrease in the fair value of our total hedge funds investment in 2010 reflects $35 million of redemptions, offset by $20 million of subscriptions. The performance of our hedge funds has been mostly flat year to date. Similarly, the decrease in fair value of our credit funds investment was due to $9 million of cash distributions, offset by $3 million of improved valuations due to positive performance of its underlying loan collateral. Certain hedge and credit fund investments may be subject to restrictions on redemptions which may limit our ability to liquidate these investments in the short term. Refer to Item 1, Note 3 (b) of our Consolidated Financial Statements for further details.
The decrease in the fair value of the CLO – Equities since December 31, 2009, was primarily due to $12 million of cash distributions collected in 2010, offset partially by an improved valuation of $9 million primarily due to lower default rates than previously expected.
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LIQUIDITY AND CAPITAL RESOURCES
Refer to the ‘Liquidity and Capital Resources’ section included under Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2009 for a general discussion of our liquidity and capital resources. During the first six months of 2010, we completed a senior note issuance, entered into a new secured letter of credit facility, and continued executions of common stock repurchases under the program authorized by our Board of Directors.
The following table summarizes our consolidated capitalization for the periods indicated:
Long-term debt
Preferred shares
Common equity
Total capitalization
Ratio of debt to total capitalization
Ratio of debt and preferred equity to total capital
Senior Note Issuance
On March, 23, 2010, AXIS Specialty Finance, an indirect wholly-owned subsidiary of AXIS Capital, issued ten-year senior notes with a $500 million aggregate principal amount, maturing on June 1, 2020. These notes bear interest at a rate of 5.875%, payable semi-annually in arrears. AXIS Capital has fully and unconditionally guaranteed all the obligations of AXIS Specialty Finance under these notes. AXIS Capital’s obligations under this guarantee are unsecured and senior and rank equally with all of its other senior obligations. The related indenture contains various covenants, including limitations on liens on the stock of restricted subsidiaries, restrictions as to the disposition of the stock of restricted subsidiaries and limitations on mergers and consolidations. We were in compliance with all covenants at June 30, 2010.
We used net proceeds from the senior notes offering for general corporate purposes. The issuance of this debt was the principal driver of the increase in our ratios of debt to total capitalization and debt and preferred equity to total capital to 15.3% and 23.0%, respectively, at June 30, 2010 from 8.3% and 16.7%, as of December 31, 2009.
Secured Letter of Credit Facility
On May 14, 2010, we entered into a secured $750 million letter of credit facility with Citibank Europe plc (“Citibank”). This facility may be terminated by Citibank on December 31, 2013 upon thirty days prior notice. Under the terms of the facility, letters of credit to a maximum aggregate amount of $750 million are available for issuance on behalf of AXIS Capital’s participating operating subsidiaries. The principal purpose of the facility is to issue, as required, standby letters of credit in favor of counterparties obtaining reinsurance protection from AXIS Capital’s subsidiaries to ensure that these counterparties are permitted to take credit, under U.S. insurance regulations, for the reinsurance obtained in U.S. jurisdictions where AXIS Capital’s subsidiaries are not licensed or otherwise admitted as an insurer. The facility is subject to certain covenants, including the requirement to maintain sufficient collateral to cover all of our obligations under the facility. Such obligations include contingent reimbursement obligations for outstanding letters of credit and fees payable to Citibank. In the event of default, Citibank may exercise certain remedies, including the exercise of control over pledged collateral and the termination of the availability of the facility to any or all of the participating operating subsidiaries. At June 30, 2010, no letters of credit had been issued under this new facility.
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At June 30, 2010, our common equity was $5.0 billion, comparable to the balance at December 31, 2009. The following table reconciles our opening and closing common equity position:
Common equity - opening
Change in unrealized appreciation on available for sale investments, net of tax
Share repurchases
Share-based compensation and other
Common equity - closing
During the first six months of 2010, we repurchased common shares in the open market for a total of $409 million (refer to Part II, Item 2 ‘Unregistered Sales of Equity Securities and Use of Proceeds’ for additional information). Subsequent to June 30, 2010, and through July 30, 2010, we repurchased additional common shares for $10 million. As of July 30, 2010, approximately $123 million remains available under our repurchase program.
We continue to anticipate that cash flows from operations will be sufficient to cover cash outflows under most loss scenarios, as well as our other contractual commitments, through the foreseeable future.
CRITICAL ACCOUNTING ESTIMATES
Our Consolidated Financial Statements have been prepared in conformity with U.S. GAAP and include certain accounting policies that we consider to be critical due to the amount of judgment and uncertainty inherent in the application of those policies. While we believe that the amounts included in our Consolidated Financial Statements reflect our best judgment, the use of different assumptions could produce materially different accounting estimates. As disclosed in our 2009 Annual Report on Form 10-K, we believe the following accounting estimates are critical to our operations and require the most subjective and complex judgment:
Premiums
Fair Value Measurements
Other-Than-Temporary Impairments (OTTI)
There have been no material changes to our critical accounting estimates since December 31, 2009. Refer to Item 7 included in our Annual Report on Form 10-K for the year ended December 31, 2009 for qualitative discussions on our Critical Accounting Estimates.
NEW ACCOUNTING STANDARDS
See Item 1, Note 1 to the Consolidated Financial Statements for a discussion of recently issued accounting pronouncements we have not yet adopted.
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OFF-BALANCE SHEET AND SPECIAL PURPOSE ENTITY ARRANGEMENTS
At June 30, 2010, we have not entered into any off-balance sheet arrangements, as defined by Item 303 (a) (4) of Regulation S-K.
NON-GAAP FINANCIAL MEASURES
In this report, we have presented operating income, which is a “non-GAAP financial measure” as defined in Regulation G. Operating income represents after-tax operational results without consideration of after-tax net realized investment gains (losses). In addition, we have presented diluted operating earnings per share and operating return on average common equity (“operating ROACE”), which are derived from the non-GAAP operating income measure. These measures can be reconciled to the nearest GAAP financial measures as follows:
Net realized investment gains, net of tax(1)
Operating income per share - diluted
Net realized investment gains, net of tax
Net income per share - diluted
Weighted average common shares and common share equivalents - diluted
Average common shareholders’ equity
ROACE (annualized)
Operating ROACE (annualized)
We present our results of operations in the way we believe will be most meaningful and useful to investors, analysts, rating agencies and others who use our financial information to evaluate our performance. This presentation includes the use of “operating income” and “annualized operating return on average common equity”, which is based on the “operating income” measure. Although the investment of premiums to generate income and realized investment gains (or losses) is an integral part of our operations, the determination to realize investment gains (or losses) is independent of the underwriting process and is heavily influenced by the availability of market opportunities. Furthermore, many users believe that the timing of the realization of investment gains (or losses) is somewhat opportunistic for many companies. In this regard, certain users of our financial statements evaluate earnings excluding after-tax net realized investment gains (losses) to understand the profitability of recurring sources of income.
We believe that showing net income available to common shareholders exclusive of net realized gains (losses) reflects the underlying fundamentals of our business. In addition, we believe that this presentation enables investors and other users of our financial information to analyze performance in a manner similar to how our management analyzes the underlying business performance. We also believe this measure follows industry practice and, therefore, facilitates comparison of our performance with our peer group. We believe that equity analysts and certain rating agencies that follow us, and the insurance industry as a whole, generally exclude realized gains (losses) from their analyses for the same reasons.
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Refer to Item 7A included in our 2009 Form 10-K. There have been no material changes to this item since December 31, 2009.
The Company’s management has performed an evaluation, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) as of June 30, 2010. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2010, our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and is accumulated and communicated to management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
The Company’s management has performed an evaluation, with the participation of the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of changes in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2010. Based upon that evaluation, there were no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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There were no material changes from the risk factors as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009.
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The following table sets forth information regarding the number of shares we repurchased during the three months ended June 30, 2010:
ISSUER PURCHASES OF EQUITY SECURITIES
Total Number
of Shares
Purchased as Part
of Publicly Announced
Plans or Programs(a)
Maximum Number (or Approximate(b) Dollar Value) of
Shares That May Yet Be
Purchased Under the Announced Plans
or Programs
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: August 4, 2010
/s/ JOHN R. CHARMAN
/s/ DAVID B. GREENFIELD
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