ASPEN INSURANCE HOLDINGS LTD - Annual Report: 2011 (Form 10-K)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

 

 

Commission file number 001-31909

 

 

 

 

ASPEN INSURANCE HOLDINGS LIMITED

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code:

(441) 295-8201

 

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

 

 

Securities registered pursuant to Section 12(g) of the Exchange Act: None.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

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

 

The aggregate market value of the ordinary shares held by non-affiliates of the registrant, as of June 30, 2011, was approximately $1.8 billion based on the closing price of the ordinary shares on the New York Stock Exchange on that date, assuming solely for the purpose of this calculation that all directors and employees of the registrant were “affiliates.” The determination of affiliate status is not necessarily a conclusive determination for other purposes and such status may have changed since June 30, 2011.

 

As of February 1, 2012, 70,751,322 ordinary shares were outstanding.

 

 

ASPEN INSURANCE HOLDINGS LIMITED
INDEX TO FORM 10-K

TABLE OF CONTENTS

 

 

Unless the context otherwise requires, references in this Annual Report to the “Company,” “we,” “us” or “our” refer to Aspen Insurance Holdings Limited (“Aspen Holdings”) or Aspen Holdings and its wholly-owned subsidiaries, Aspen Insurance UK Limited (“Aspen U.K.”), Aspen (UK) Holdings Limited (“Aspen U.K. Holdings”), Aspen Insurance UK Services Limited (“Aspen UK Services”), AIUK Trustees Limited (“AIUK Trustees”), Aspen Insurance Limited, renamed Aspen Bermuda Limited with effect January 1, 2012 (“Aspen Bermuda”), Aspen Underwriting Limited (“AUL”, corporate member of Lloyd’s Syndicate 4711, “Syndicate 4711”), Aspen Managing Agency Limited (“AMAL”), Aspen U.S. Holdings, Inc. (“Aspen U.S. Holdings”), Aspen Specialty Insurance Company (“Aspen Specialty”), Aspen Specialty Insurance Management Inc. (“Aspen Management”), Aspen Re America, Inc. (“Aspen Re America”), Aspen Insurance U.S. Services Inc. (“Aspen U.S. Services”), Aspen Re America California, LLC (“ARA — CA”), Aspen Specialty Insurance Solutions LLC (“ASIS”), Aspen Re America Risk Solutions LLC (“Aspen Solutions”), Acorn Limited (“Acorn”), APJ Continuation Ltd. (“APJ”), APJ Asset Protection Jersey Limited (“APJ Jersey”), Aspen UK Syndicate Services Limited (“AUSSL”, formerly APJ Services Limited), Aspen Risk Management Limited (“ARML”), Aspen American Insurance Company (“AAIC”) and any other direct or indirect subsidiary collectively, as the context requires. Aspen U.K., Aspen Bermuda, Aspen Specialty, AAIC, and AUL, as corporate member of Syndicate 4711, are each referred to herein as an “Operating Subsidiary,” and collectively referred to as the “Operating Subsidiaries.” References in this report to “U.S. Dollars,” “dollars,” “$” or “¢” are to the lawful currency of the United States of America, references to “British Pounds,” “pounds” or ‘‘£” are to the lawful currency of the United Kingdom, and references to “euros” or “€” are to the lawful currency adopted by certain member states of the European Union (the “E.U.”), unless the context otherwise requires.

 

This Form 10-K contains, and the Company may from time to time make other verbal or written, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that involve risks and uncertainties, including statements regarding our capital needs, business strategy, expectations and intentions. Statements that use the terms “believe,” “do not believe,” “anticipate,” “expect,” “plan,” “estimate,” “project,” “seek,” “will,” “may,” “aim,” “continue,” “intend,” “guidance” and similar expressions are intended to identify forward-looking statements. These statements reflect our current views with respect to future events and because our business is subject to numerous risks, uncertainties and other factors, our actual results could differ materially from those anticipated in the forward-looking statements, including those set forth below under Item 1, “Business,” Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report and the differences could be significant. The risks, uncertainties and other factors set forth below and under Item 1A, “Risk Factors” and other cautionary statements made in this report should be read and understood as being applicable to all related forward-looking statements wherever they appear in this report.

 

All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in these statements. We believe that these factors include, but are not limited to, those set forth under “Risk Factors” in Item 1A, and the following:

 

 

 

In addition, any estimates relating to loss events involve the exercise of considerable judgment in the setting of reserves and reflect a combination of ground-up evaluations, information available to date from brokers and cedants, market intelligence, initial tentative loss reports and other sources. The

actuarial range of reserves is based on our then current state of knowledge and explicit and implicit assumptions relating to the incurred pattern of claims, the expected ultimate settlement amount, inflation and dependencies between lines of business. Due to the complexity of factors contributing to losses and the preliminary nature of the information used to prepare estimates, there can be no assurance that our ultimate losses will remain within stated amounts.

 

The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this report. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise or disclose any difference between our actual results and those reflected in such statements.

 

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we projected. Any forward-looking statements you read in this report reflect our current views with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us or individuals acting on our behalf are expressly qualified in their entirety by the points made above. You should specifically consider the factors identified in this report which could cause actual results to differ before making an investment decision.

 

 

General

 

We are a Bermudian holding company, incorporated on May 23, 2002, and conduct insurance and reinsurance business through our subsidiaries in three major jurisdictions: Aspen U.K. and AUL, corporate member of Syndicate 4711 at Lloyd’s of London (United Kingdom), Aspen Bermuda (Bermuda) and Aspen Specialty and AAIC (United States). Aspen U.K. also has branches in Paris (France), Zurich (Switzerland), Dublin (Ireland), Cologne (Germany), Singapore, Australia and Canada. We operate in the global markets for property and casualty insurance and reinsurance.

 

For the year ended December 31, 2011, we wrote $2,207.8 million in gross premiums and at December 31, 2011, we had total capital employed, including long-term debt, of $3,671.0 million.

 

Our corporate structure as at February 15, 2012 was as follows:

 

 

We manage our insurance and reinsurance businesses as two distinct underwriting segments, Aspen Insurance and Aspen Reinsurance (“Aspen Re”), to enhance and better serve our global customer base.

 

Our insurance segment is comprised of property, casualty, marine, energy and transportation insurance and financial and professional lines insurance. The insurance segment is led by Rupert Villers and Mario Vitale as Co-CEOs of Aspen Insurance. Our reinsurance segment is comprised of property reinsurance (catastrophe and other), casualty reinsurance and specialty reinsurance. The reinsurance segment is led by Brian Boornazian, CEO of Aspen Reinsurance and James Few, President of Aspen Reinsurance.

 

In our insurance segment, property, casualty and financial and professional lines insurance business is written primarily in the London Market through Aspen U.K. and in the U.S. through Aspen Specialty

and AAIC (both on an admitted and excess and surplus lines basis). Our marine, energy and transportation insurance business is written mainly through Aspen U.K. and AUL, which is the sole corporate member of Syndicate 4711 at Lloyd’s of London (“Lloyd’s”), managed by AMAL. We also write some casualty business through AUL.

 

In reinsurance, property reinsurance business is assumed by Aspen Bermuda and Aspen U.K. and written by teams located in Bermuda, London, Paris, Singapore, Cologne, the U.S. and Zurich. The property reinsurance business written in the U.S. is written exclusively by Aspen Re America and ARA-CA as reinsurance intermediaries with offices in Connecticut, Illinois, Florida, New York, Georgia and California.

 

Casualty reinsurance is mainly assumed by Aspen U.K. and written by teams located in London, Zurich, Singapore and the U.S. A small number of casualty reinsurance contracts is written by Aspen Bermuda. The business written in the U.S. is produced by Aspen Re America.

 

Specialty reinsurance is assumed by Aspen Bermuda and Aspen U.K. and written by teams located in London, Zurich and Bermuda.

 

Our Business Strategy

 

We are both an insurer and reinsurer of specialty and similar lines and our underwriting operations are organized and presented under two distinct brands — Aspen Re and Aspen Insurance.

 

We aim to grow the Company over time, but with the caution that growth opportunities are currently limited by weak conditions in many of our markets. Growth may be organic within existing lines, by recruitment of underwriters with complementary skills and experience or by acquisition. Our key evaluation criteria for any acquisition proposal will include strategic fit, financial attractiveness, manageable execution risks and consistency with our risk appetite.

 

Key strategies for Aspen Re.  Aspen Re’s primary strategy is to identify clients with sound underwriting processes, which are transparent in respect of their risks and exposures and which have a commitment to viewing trading relationships over the longer-term. We offer reinsurance for property, casualty and specialty risks as further described below. From time to time, the underwriting cycle allows us to deploy additional capacity on a more opportunistic basis and a key part of our strategy is to maintain the ability to identify special situations and take advantage of them however and whenever they arise.

 

Our largest market is the United States which at this time is not a market that offers significant growth opportunities. The markets in Latin America and Asia-Pacific have historically been less significant for us, but we believe they offer significant growth potential, especially in the medium and longer-term. We also believe that we have opportunity to increase our ultimate market share in Europe and we expect to see some growth in this region, conditional upon the currently challenging market environment.

 

We aim to maintain sufficient capital strength and access to capital markets to ensure that if market conditions harden significantly following a major loss (or for any other reason), we are able to rapidly expand capacity for existing reinsurance clients and provide opportunistic capacity to new clients.

 

Key strategies for Aspen Insurance.  Aspen Insurance from its London-market base is a significant global market for energy, marine, aviation, financial, professional, specie and political risks and for excess casualty. This requires specialized expertise, innovative underwriting and the financial strength to offer meaningful capacity in these lines.

 

Aspen Insurance will not generally seek to offer retail personal lines, including homeowners, private auto and health insurance.

 

A further part of Aspen Insurance’s strategy is to create a profitable specialty insurer in the U.S. domestic market headquartered in New York. Our approach is highly focused and in the past 18 months, we have hired teams with specialized focus on underwriting opportunities in specialty lines including inland marine and ocean risks, certain financial and professional lines and surety. These are underwritten in addition to our established lines of property, general casualty and environmental liability

on an excess and surplus lines basis. We have also invested significantly in terms of IT, actuarial resource, claims staff, legal, human resource and other functions in order to provide the right infrastructure on which to build our U.S. operations.

 

In addition to our U.S. and London-market insurance operations, we offer focused capacity from our Bermuda and Dublin operations for certain global casualty risks and management liability and from our Zurich branch we offer certain specialized risks within the Swiss market.

 

Targets and constraints.  We aim to generate returns on average common equity (“ROE”) which exceed the prevailing three-year risk free rate (yield from U.S. Treasury with 3-year duration) by an average of at least 8% measured on a time-weighted basis over the preceding 10 years, or from inception of the Company if a shorter period, and with a target of 10.5% measured on the same basis.

 

We aim to meet our return objective while limiting the risks we take so as to restrict the chance of an ROE which is 5 percentage points worse than plan, to a probability of less than 25% (i.e., 1 in 4 years).

 

We intend to maintain a level of qualifying equity capital at least equal to the highest of:

 

 

For a discussion of risks and uncertainties impacting our ability to achieve our targets and the related constraints, see Part I, Item 1A, “Risk Factors,” and “Forward-Looking Statements.”

 

Capital Management.  The level of capital that we hold is determined by our risk appetite as set out above, the opportunities that exist for the deployment of capital in our business and the objective of improving returns to our ordinary shareholders while maintaining the levels of financial strength expected by our customers, regulators and by the rating agencies.

 

Business Segments

 

We are organized into two business segments: reinsurance and insurance. We have considered similarities in economic characteristics, products, customers, distribution, the regulatory environment of our operating segments and quantitative thresholds to determine our reportable segments.

 

We have provided additional disclosures for corporate and other (non-underwriting) income and expenses. Corporate and other income includes net investment income, net realized and unrealized investment gains or losses, corporate expense, interest expense, net realized and unrealized foreign exchange gains or losses and income taxes, which are not allocated to the underwriting segments.

 

The gross written premiums are set forth below by business segment for the twelve months ended December 31, 2011, 2010 and 2009:

 

For a review of our results by segment, see Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 5 of our consolidated financial statements.

 

Reinsurance

 

Our reinsurance segment consists of property catastrophe reinsurance, other property reinsurance (risk excess, pro rata, risk solutions and facultative), casualty reinsurance (U.S. treaty, international treaty and global facultative) and specialty reinsurance (credit and surety, structured, agriculture and specialty).

 

The reinsurance business we write can be analyzed by geographic region, reflecting the location of the reinsured risks, as follows for the twelve months ended December 31, 2011, 2010 and 2009:

 

 

 

 

Our gross written premiums by our principal lines of business within our reinsurance segment for the twelve months ended December 31, 2011, 2010 and 2009 are as follows:

 

 

Property Catastrophe Reinsurance:  Property catastrophe reinsurance is generally written on a treaty excess of loss basis where we provide protection to an insurer for an agreed portion of the total losses from a single event in excess of a specified loss amount. In the event of a loss, most contracts provide for coverage of a second occurrence following the payment of a premium to reinstate the

coverage under the contract, which is referred to as a reinstatement premium. The coverage provided under excess of loss reinsurance contracts may be on a worldwide basis or limited in scope to selected regions or geographical areas.

 

Other Property Reinsurance:  Other property reinsurance includes risk excess of loss and proportional treaty reinsurance, facultative or single risk reinsurance and our risk solutions business. Risk excess of loss reinsurance provides coverage to a reinsured where it experiences a loss in excess of its retention level on a single “risk” basis. A “risk” in this context might mean the insurance coverage on one building or a group of buildings for fire or explosion or the insurance coverage under a single policy which the reinsured treats as a single risk. This line of business is generally less exposed to accumulations of exposures and losses but can still be impacted by natural catastrophes, such as earthquakes and hurricanes.

 

Proportional treaty reinsurance provides proportional coverage to the reinsured, meaning that, subject to event limits where applicable and ceding commissions, we pay the same share of the covered original losses as we receive in premiums charged for the covered risks. Proportional contracts typically involve close client relationships including regular audits of the cedants’ data. Our risk solutions business writes predominantly property insurance risks for a select group of U.S. program managers. Effective January 1, 2012, management responsibility for the risk solutions business was moved from reinsurance to insurance.

 

Casualty Reinsurance:  Casualty reinsurance is written on an excess of loss, proportional and facultative basis and consists of U.S. treaty, international treaty and casualty facultative. Our U.S. treaty business comprises exposures to workers’ compensation (including catastrophe), medical malpractice, general liability, auto liability, professional liability and excess liability including umbrella liability. Our international treaty business reinsures exposures mainly with respect to general liability, auto liability, professional liability, workers’ compensation and excess liability.

 

Specialty Reinsurance:  Specialty reinsurance is written on an excess of loss and proportional basis and consists of credit and surety reinsurance, structured risks, agriculture reinsurance and other specialty lines. Our credit and surety reinsurance business consists of trade credit reinsurance, international surety reinsurance (mainly European, Japanese and Latin American risks and excluding the U.S.) and a small political risks portfolio. Our agricultural reinsurance business is primarily written on a treaty basis covering crop and multi-peril business. Other specialty lines include reinsurance treaties and some insurance policies covering policyholders’ interests in marine, energy, liability aviation, space, contingency, terrorism, nuclear, personal accident and crop reinsurance.

 

A high percentage of the property reinsurance contracts we write exclude coverage for losses arising from the peril of terrorism. Within the U.S., our reinsurance contracts generally exclude or limit our liability to acts that are certified as “acts of terrorism” by the U.S. Treasury Department under the Terrorism Risk Insurance Act (“TRIA”), the Terrorism Risk Insurance Extension Act of 2005 (“TRIEA”) and now the Terrorism Risk Insurance Program Reauthorization Act of 2007 (“TRIPRA”), which is currently set to expire on December 31, 2014. With respect to personal lines risks, losses arising from the peril of terrorism that do not involve nuclear, biological or chemical attack are usually covered by our reinsurance contracts. Such losses relating to commercial lines risks are generally covered on a limited basis; for example, where the covered risks fall below a stated insured value or into classes or categories we deem less likely to be targets of terrorism than others. We have written a limited number of reinsurance contracts in this segment, both on a pro rata and risk excess basis, specifically covering the peril of terrorism. These contracts typically exclude coverage protecting against nuclear, biological or chemical attack.

Insurance

 

Our insurance segment consists of property insurance, casualty insurance, marine, energy and transportation insurance and financial and professional lines insurance.

 

The insurance business we write can be analyzed by geographic region, reflecting the location of the insured risk, as follows for the twelve months ended December 31, 2011, 2010 and 2009:

 

 

 

 

Our gross written premiums by our principal lines of business within our insurance segment for the twelve months ended December 31, 2011, 2010 and 2009 are as follows:

 

 

Property Insurance:  Our property insurance line comprises U.K. commercial property and construction business and U.S. property business. Property insurance provides physical damage and business interruption coverage for losses arising from weather, fire, theft and other causes.

 

 

 

Casualty Insurance:  Our casualty insurance line comprises commercial liability, global excess casualty, U.S. casualty insurance and environmental liability, written on a primary, quota share and facultative basis.

 

 

Marine, Energy and Transportation Insurance:  Our marine, energy and transportation insurance line comprises marine, energy and construction (“M.E.C.”) liability, energy physical damage, marine hull, specie, inland marine and ocean risks and aviation, written on a primary, quota share and facultative basis.

 

 

Financial and Professional Lines Insurance:  Our financial and professional lines comprise financial institutions, professional liability (including management & technology liability), financial and political risks and U.S. surety risks, written on a primary, quota share and facultative basis.

 

 

Underwriting and Reinsurance Purchasing

 

Our objective is to create a diversified portfolio with balanced non-correlated risks through a portfolio of insurance and reinsurance risks, diversified across lines of business, products, geographic areas of coverage, cedants and sources. The acceptance of appropriately priced risk is the core of our business. Underwriting requires judgment, based on important assumptions about matters that are inherently unpredictable and beyond our control, and for which historical experience and probability analysis may not provide sufficient guidance. We view underwriting quality and risk management as critical to our success.

 

Underwriting.  In 2011, our underwriting activities were managed in two product areas: reinsurance and insurance. Under our organizational structure, our insurance segment was led by Rupert Villers and John Cavoores as Co-CEOs of Aspen Insurance in 2011, and is led by Rupert Villers and Mario Vitale as Co-CEOs in 2012. Our reinsurance segment is led by Brian Boornazian, CEO of Aspen Reinsurance, and James Few, President of Aspen Reinsurance.

 

Our Chief Executive Officer is supported by our Director of Underwriting, Kate Vacher. Our Director of Underwriting assists in the management of the underwriting process by developing our underwriting strategy, monitoring our underwriting principles and acting as an independent reviewer of underwriting activity across our businesses.

We underwrite according to the following principles:

 

 

We also have an additional Reinsurance Underwriting Committee which reports into the Reinsurance Executive Committee.

 

Reinsurance Purchasing.  We purchase reinsurance and retrocession to limit and diversify our own risk exposure and to increase our own insurance and reinsurance underwriting capacity. These agreements provide for recovery of a portion of losses and loss expenses from reinsurers.

 

We have reinsurance covers in place for many of our insurance lines of business, the majority of which are on an excess of loss basis. In 2012, we anticipate renewing much of the reinsurance protecting our insurance business that we bought in 2011 which is comprised of specific excess of loss reinsurance on portfolios of property insurance, casualty insurance, financial and professional insurance, aviation insurance, marine, energy and liability insurance and programs. These covers provide protection in various layers and excess of varying attachment points according to the scope of cover provided. We have elected to take co-reinsurance participations within some of these programs. We also have a limited number of proportional treaty arrangements on specific lines of business and we anticipate continuing with these in most instances. Natural perils catastrophe coverage was included within excess of loss programs purchased for two portfolios. For our onshore U.S. insurance business, we bought protection of $110 million for natural catastrophe events in 2011. For 2012, we reduced the limit purchased to $52 million. For our offshore energy exposures, excluding Gulf of Mexico named hurricane losses, we bought catastrophe cover of $80 million excess of $20 million which expires on February 28, 2012.

 

We also buy whole account protections to cover certain lines within our insurance and reinsurance business. We expect to continue the philosophy first implemented in 2006 of limited and strategic retrocession purchasing to manage within our risk tolerances. We entered into various retrocession agreements to protect our property reinsurance lines through 2011. Of the total $255 million of available limit purchased against frequency and severity of natural peril events during 2011; $190 million was the maximum available protection for events against U.S. wind, $150 million against U.S. earthquake and $100 million against European wind, which attached in non-consecutive tranches of cover with the

lowest attaching at $250 million of loss; $140 million was the maximum available protection against European earthquake and flood, which attached in non-consecutive tranches of cover with the lowest attaching at $35 million of loss; and $115 million was the maximum available protection against natural perils losses in various territories outside the U.S., Europe and Japan, which attached at $35 million of loss.

 

For our 2012 program, as at February 15, 2012, we have $175 million of available limit for U.S. wind and earthquake and European wind attaching in non-consecutive tranches with the lowest attaching at $250 million of loss and $175 million of available limit for European flood attaching in non-consecutive tranches with the lowest attaching at $50 million of loss.

 

In addition, in 2011, we renewed twelve-month reciprocal arrangements with two major reinsurers accepting Japanese earthquake exposure and ceding our exposures to windstorms in parts of the U.S. The total aggregate event limit of these agreements is $127 million with both reinsurances responding on an index trigger basis.

 

During 2011, we purchased reinsurance excess of $50 million in respect of accumulation of losses arising from all classes of casualty and liability resulting from a common cause. The total limit of cover provided by this reinsurance is $11.7 million.

 

As is the case with most reinsurance treaties, we remain liable to the extent that reinsurers do not meet their obligations under these agreements, and therefore, in line with our risk management objectives, we evaluate the financial condition of our reinsurers and monitor concentrations of credit risk. Of our reinsurers who have been rated by A.M. Best, 100% of our uncollateralized reinsurance is provided by those who have been assigned a rating of “A−” (Excellent) (the fourth highest of fifteen rating levels) or better.

 

Risk Management

 

In this section we provide a summary of our Risk Governance arrangements and our current Risk Management Strategy. We also provide more detail on the management of core underwriting and market risks and on our Internal Model. The Internal Model is an economic capital model which has been developed internally for use in certain business decision making processes, the assessment of risk based capital requirements and for various regulatory purposes.

 

Risk Governance

 

Board of Directors.  The Board of Directors of the Company (the “Board”) considers effective identification, measurement, monitoring, management and reporting of the risks facing our business to be key elements of its responsibilities and those of the CEO and management. Matters relating to risk management reserved to the Board include approval of the internal controls and risk management framework and any changes to the Group’s risk appetite statement. The Board also receives reports at each scheduled meeting from the Group Chief Risk Officer and the Chairman of the Risk Committee and training in risk management processes including the design, operation, use and limitations of the Group’s Internal Model. The Board, assisted by management and its Committees, is able to exercise effective oversight of the operation of the risk management strategy described in “Risk Management Strategy” below.

 

Board Committees.  The Board delegates oversight of the management of certain key risks to its Risk, Audit and Investment Committees. Each of the Committees is chaired by an independent director of the Company who also reports to the Board on the Committees’ discussions and matters arising.

 

The membership of the Board Committees is set out under Item 10 “Directors, Executive Officers of the Registrant and Corporate Governance.”

Risk Committee:  The purpose of this committee is to assist the Board in its oversight duties in respect of the management of risk, including:

 

 

Audit Committee:  This committee is primarily responsible for assisting the Board in its oversight of the integrity of the financial statements. It is also responsible for reviewing the adequacy and effectiveness of the Company’s internal controls and receives regular reports from both internal and external audit in this regard.

 

Investment Committee:  This committee is responsible for, among other things, setting and monitoring the group’s investment risk and asset allocation policies and ensuring that the Chairman of the Risk Committee is kept informed of such matters.

 

Management Committees.  The group also has a number of executive management committees which have oversight of certain risk management processes.

 

Group Executive Committee:  This is the main executive committee responsible for making proposals to the Board relating to the strategy and conduct of the business of the Group. To assist in these duties, it receives regular reports from the Group Chief Risk Officer.

 

Capital Allocation Group:  This committee is primarily responsible for making recommendations on matters related to the capital requirements of the Group and its Operating Subsidiaries, the development and use of the Group’s Internal Model, capital allocation, the risk pricing governance arrangements, capital, risk appetite and risk limits and the management of insurance risks including catastrophe risk.

 

Reserve Committee:  This committee is responsible for managing reserving risk and making recommendations to executive management relating to the appropriate level of reserves to include in the Group’s financial statements.

 

Underwriting Committee:  The purpose of this committee is to assist the Group Chief Executive Officer in his oversight duties in respect of underwriting risk including oversight of the assurance activities of the Underwriting Quality Review team and the review of risks referred to it due to their unusual nature or because they are considered outside of normal underwriting guidelines, authorities or risk appetite.

 

Reinsurance Credit Committee:  The purpose of this committee is to seek to minimize credit risks arising from insurance and reinsurance counterparties by the assessment and monitoring of collateralized reinsurance arrangements, direct cedants, intermediaries and reinsurers.

 

Group Chief Risk Officer.  Our Group Chief Risk Officer, Julian Cusack, is a member of the Board and a member of the Risk Committee and the Investment Committee. His role includes providing the Board and the Risk Committee with reports and advice on risk management issues.

 

Risk Management Strategy

 

We operate an integrated risk management strategy designed to deliver shareholder value in a sustainable manner while providing a high level of policyholder protection. The use of the word ‘integrated’ emphasizes that risk management is not simply a support function but is a way of thinking

about and managing the business which is central to the formulation of strategy and annual business planning. The execution of our integrated risk management strategy is based on:

 

 

Risk Appetite.  Each year the Board approves a Group Risk Appetite Statement.

 

The Risk Appetite Statement is a central component of the Group’s overall risk management framework. It sets out, at a high level, how we think about risk in the context of our business model, group objectives and strategy. It sets out boundary conditions for the level of risk we assume, together with a statement of what reward we aim to receive for this level of risk.

 

It comprises the following components:

 

 

Risk Components.  The main types of risks that we face are:

 

Insurance risk:  The risk that claims occurring or reported in a period exceed the expected amounts (“underwriting risk”) or that reserves established in respect of prior periods are understated (“reserving risk”).

 

Credit risk:  The risk that a firm is exposed to if another party fails to perform its obligations. This principally comprises credit risks relating to premiums receivable and outward reinsurance. We include credit risks related to our investment portfolio under market risk.

 

Market risk:  The risk that arises from changes in the market value of our investment portfolio and related derivative contracts from fluctuations in interest rates, bond yields, credit spreads and foreign currency exchange rates. This includes the risk of issuer default or ratings downgrades.

 

Operational risk:  The risk of loss resulting from inadequate or failed internal processes including the failure to comply with procedures and regulations.

 

Liquidity risk:  The risks of failing to maintain sufficient liquid financial resources to meet liabilities as they fall due or to provide collateral as required for commercial or regulatory purposes.

We define insurance risk and market risk as core risks meaning that they are risks we intend to take on with a view to making a return for shareholders as a consequence. Other risks are designated as ‘non-core’ and our strategy for them is to seek to reduce exposures to the extent that is practicable and economic to do so.

 

Key Risk Limits.  We use the term risk limit to mean the upper limit of our tolerance for exposure to a given risk. In some cases we set annual risk targets which are lower than our risk limits. Key risk limits are a sub-set of risk limits and are subject to annual approval by the Board on the advice of the Risk Committee as part of the annual business planning process. If a risk exceeds key risk limits, the Chief Risk Officer is required to report the excess and management’s plans for dealing with it to the Risk Committee.

 

Business Distribution

 

Our business is produced principally through brokers and reinsurance intermediaries. The brokerage distribution channel provides us with access to an efficient, variable cost and global distribution system without the significant time and expense which would be incurred in creating wholly-owned distribution networks. The brokers and reinsurance intermediaries typically act in the interest of ceding clients or insurers; however, they are instrumental to our continued relationship with our clients.

 

The following tables show our gross written premiums by broker for each of our segments for the twelve months ended December 31, 2011, 2010 and 2009:

 

 

 

Claims Management

 

We have a staff of experienced claims professionals organized into insurance and reinsurance teams which are managed separately. We have developed processes and internal business controls for

identifying, tracking and settling claims, and authority levels have been established for all individuals involved in the reserving and settlement of claims.

 

The key responsibilities of our claims management departments are to:

 

 

On those accounts where it is applicable, a team of in-house claims professionals oversees and regularly audits claims handled under outsourcing agreements and manages those large claims and coverage issues on referral as required under the terms of those agreements.

 

Senior management receives a regular report on the status of our reserves and settlement of claims. We recognize that fair interpretation of our reinsurance agreements and insurance policies with our customers, and timely payment of valid claims, are a valuable service to our clients and enhance our reputation.

 

Reserves

 

Loss & Loss Expense Reserves.  Under U.S. Generally Accepted Accounting Principles (“U.S. GAAP”), we are required to establish loss reserves for the estimated unpaid portion of the ultimate liability for losses and loss expenses under the terms of our policies and agreements with our insured and reinsured customers. These loss reserves consist of the following:

 

 

Case Reserves.  For reported claims, reserves are established on a case-by-case basis within the parameters of coverage provided in the insurance policy or reinsurance agreement. The method of establishing case reserves for reported claims differs among our operations. With respect to our insurance operations, we are advised of potential insured losses and our claims handlers record reserves for the estimated amount of the expected indemnity settlement, loss adjustment expenses and cost of defense where appropriate. The reserve estimate reflects the judgment of the claims personnel and is based on claim information obtained to date, general reserving practices, the experience and knowledge of the claims personnel regarding the nature of the specific claim and where appropriate and available, advice from legal counsel, loss adjusters and other claims experts.

With respect to our reinsurance claims operations, claims handlers set case reserves for reported claims generally based on the claims reports received from our ceding companies and take into consideration our cedants’ own reserve recommendations and prior loss experience with the cedant. Additional case reserves (“ACR”), in addition to the cedants’ own recommended reserves, may be established by us to reflect our estimated ultimate cost of a loss. ACRs are generally the result of either a claims handler’s own experience and knowledge of handling similar claims, general reserving practices or the result of reserve recommendations following an audit of cedants’ reserves.

 

Case reserves are based on a subjective judgment of facts and circumstances and are established for the purposes of internal reserving only. Accordingly, they do not represent a commitment to any course of conduct or admission of liability on our behalf in relation to any specific claim.

 

IBNR Reserves.  The need for IBNR reserves arises from time lags between when a loss occurs and when it is actually reported and settled. By definition on most occasions, we will not have specific information on IBNR claims; they need to be estimated by actuarial methodologies. IBNR reserves are therefore generally calculated at an aggregate level and cannot generally be identified as reserves for a particular loss or contract. We calculate IBNR reserves by line of business. IBNR reserves are calculated by projecting our ultimate losses on each class of business and subtracting paid losses and case reserves.

 

The main projection methodologies that are used by our actuaries are:

 

 

In addition to these methodologies, our actuaries may use other approaches depending upon the characteristics of the line of business and available data.

 

In general terms, the IELR method is most appropriate for lines of business and/or accident years where the actual paid or reported loss experience is not yet mature enough to override our initial expectations of the ultimate loss ratios. Typical examples would be recent accident years for lines of business in the casualty reinsurance segment. The BF method is generally appropriate where there are few reported claims and a relatively less stable pattern of reported losses. Typical examples would be our treaty risk excess line of business in our reinsurance segment and marine hull line of business in our insurance segment. The Chain Ladder method is appropriate when there is a relatively stable pattern of loss emergence and a relatively large number of reported claims. Typical examples are the U.K. commercial property and U.K. commercial liability lines of business in the insurance segment. There are no differences between our year end and our quarterly reserving procedures in the sense that our actuaries perform the basic projections and analyses described above for each line of business.

While our actuaries calculate the IELR, BF and Chain Ladder methods for each line of business and each accident year, they provide a range of ultimate losses (“ultimates”) within which management’s best estimate is most likely to fall. This range will usually reflect a blend of the various methodologies. These methodologies do involve significant subjective judgments reflecting many factors such as changes in legislative conditions, changes in judicial interpretation of legal liability policy coverages and inflation. Our actuaries collaborate with underwriting, claims, legal and finance in identifying factors which are incorporated in their range of ultimates in which management’s best estimate is most likely to fall. The actuarial ranges are not intended to include the minimum or maximum amount that the claims may ultimately settle at, but are designed to provide management with ranges from which it is reasonable to select a single best estimate for inclusion in our financial statements.

 

Management through its Reserve Committee then reviews the range of actuarial estimates and any other evidence before selecting its best estimate of reserves for each line of business and accident year. Management may select outside the range provided by the actuaries but to date gross reserves are within the range of actuarial estimates. This provides the basis for the recommendation made by management to the Audit Committee and the Board regarding the reserve amount to be recorded in the Company’s financial statements. The Reserve Committee is a management committee consisting of the Head of Risk (Chair of the Reserve Committee), the Group Chief Actuary, the Group Chief Financial Officer and senior members of our underwriting and claims staff. In the fourth quarter of 2011, we established two separate Reserve Committees for our reinsurance and insurance segments. There is a core membership of both committees consisting of the Group Head of Risk, the Group Chief Actuary, the Group Chief Financial Officer and the Underwriting Heads of insurance and reinsurance. Senior members of the insurance and reinsurance segments’ underwriting and claims staff comprise the remaining members of each committee.

 

Each line of business is reviewed in detail by management, through its Reserve Committee, at least once a year; the timing of such reviews varies throughout the year. Additionally, for all lines of business, we review the emergence of actual losses relative to expectations every fiscal quarter. If warranted from these loss emergence tests, we may accelerate the timing of our detailed actuarial reviews.

 

We take all reasonable steps to ensure that we utilize all appropriate information and actuarial techniques in establishing our IBNR reserves. However, given the uncertainty in establishing claims liabilities, it is likely that the final outcome will prove to be different from the original provision established at the balance sheet date. Changes to our previous estimates of prior period loss reserves impact the reported calendar year underwriting results by worsening our reported results if the prior year reserves prove to be deficient or improving our reported results if the prior year reserves prove to be redundant. A 5% change in our net loss reserves equates to $205.1 million and represents 6.5% of shareholders’ equity at December 31, 2011.

 

Reinsurance recoveries.  In determining net reserves, we estimate recoveries due under our proportional and excess of loss reinsurance programs. For proportional reinsurance we apply the appropriate cession percentages to estimate how much of the gross reserves will be collectable. For excess of loss recoveries, individual large losses are modeled through our reinsurance program. An assessment is also made of the collectability of reinsurance recoveries taking into account market data on the financial strength of each of the reinsurance companies.

The following tables show an analysis of consolidated loss and loss expense reserve development net and gross of reinsurance recoverables as at December 31, 2011, 2010, 2009, 2008, 2007, 2006, 2005, 2004, 2003 and 2002.

 

Analysis of Consolidated Loss and Loss Expense Reserve Development Net of Reinsurance Recoverables

 

 

 

 

Analysis of Consolidated Loss and Loss Expense Reserve Development Gross of Reinsurance Recoverables

 

All our reserves relate to reinsurance or insurance policies incepting on or after January 1, 2002, except for the following amounts assumed as a result of acquisitions:

 

 

For additional information concerning our reserves, see Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Part II, Item 8, “Financial Statements and Supplementary Data.”

 

Investments

 

The Investment Committee of the Board establishes investment guidelines and supervises our investment activity. The Investment Committee regularly monitors our overall investment results and reviews compliance with our investment objectives and guidelines. These guidelines specify minimum criteria on the overall credit quality and liquidity characteristics of the portfolio. They include limitations on the size of certain holdings as well as restrictions on purchasing certain types of securities. Management and the Investment Committee review our investment performance and assess credit and market risk concentrations and exposures to issuers.

 

We follow an investment strategy designed to emphasize the preservation of capital and provide sufficient liquidity for the prompt payment of claims. As of December 31, 2011, our investments consisted of a diversified portfolio of highly-rated, liquid, fixed income securities, global equities and money market funds. In March 2011, we invested $175.0 million into a global equity income strategy.

 

For 2011, we engaged BlackRock Financial Management, Alliance Capital Management L.P., Crédit Agricole Asset Management (Amundi), Deutsche Bank Asset Management, Pacific Investment Management Company and Goldman Sachs Asset Management to provide investment advisory and management services for our portfolio of fixed income and equity assets. We have agreed to pay investment management fees based on the average market values of total assets held under management at the end of each calendar quarter. These agreements may be terminated generally by either party on short notice without penalty.

 

The total return of our portfolio of fixed income investments, cash and cash equivalents for the twelve months ended December 31, 2011 was 4.7% (2010 — 4.8%). Total return is calculated based on total net investment return, including interest on cash equivalents and any change in unrealized gains/losses on our investments, divided by the average market value of our investments and cash balances during the twelve months ended December 31, 2011.

 

Fixed Income Portfolio.  We employ an active investment strategy that focuses on the outlook for interest rates, the yield curve and credit spreads. In addition, we manage the duration of our fixed income portfolio having regard to the average liability duration of our reinsurance and insurance risks. In 2011, we completed the balance ($500 million) of our $1 billion interest rate swaps program to mitigate the negative impact of rises in interest rates on the market value of our fixed income portfolio. The interest rate swaps reduce the fixed income portfolio duration by 0.67 years. At December 31, 2011, the fixed income portfolio duration was 2.21 years including the impact of swaps and 2.88 years excluding the impact of swaps. At December 31, 2010, the fixed income portfolio duration was 3.25 years excluding the impact of swaps and 2.90 years including the impact of swaps. As of December 31, 2011, the fixed income portfolio book yield was 3.4% compared to 3.7% as of December 31, 2010.

 

We employ several third-party investment managers to manage our fixed income assets. We agree separate investment guidelines with each investment manager. These investment guidelines cover, among

other things, counterparty limits, credit quality, and limits on investments in any one sector. We expect our investment managers to adhere to strict overall portfolio credit and duration limits and a minimum “AA–” portfolio credit rating for the portion of the assets they manage.

 

The following presents the cost or amortized cost, gross unrealized gains and losses and estimated fair value of available for sale fixed maturities as at December 31, 2011 and 2010:

 

 

 

Certain securities are denominated in currencies other than the U.S. Dollar. Currency fluctuations are reflected in the estimated fair value presented above.

The scheduled maturity distribution of available for sale fixed income maturity securities as at December 31, 2011 and December 31, 2010 is set forth below. Actual maturities may differ from contractual maturities because issuers of securities may have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

The following table summarizes the net realized and unrealized investment gains and losses, and the change in unrealized gains and losses on investments recorded in shareholders’ equity and in comprehensive income for the twelve months ended December 31, 2011, 2010 and 2009.