FINANCIAL DATA
(Amounts in thousands, except per share data)
(Amounts in thousands, except per share data)
| Years ended December 31, | 2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||||||
| Net premiums written | $ | 4,033,899 | $ | 4,575,989 | $ | 4,818,993 | $ | 4,604,574 | $ | 4,266,361 | ||||||||||
| Net premiums earned | 4,289,580 | 4,663,701 | 4,692,622 | 4,460,935 | 4,061,092 | |||||||||||||||
| Net investment income | 537,033 | 634,386 | 549,030 | 385,417 | 274,389 | |||||||||||||||
| Income (loss) from investment funds | (3,553 | ) | 38,274 | 37,145 | 18,545 | 16,906 | ||||||||||||||
| Insurance service fees | 102,856 | 97,689 | 104,812 | 110,697 | 109,344 | |||||||||||||||
| Realized investment gains (losses) | (356,931 | ) | 49,696 | 9,648 | 17,209 | 48,268 | ||||||||||||||
| Revenues from wholly-owned investees | 137,280 | 102,846 | — | — | — | |||||||||||||||
| Total revenues | 4,708,808 | 5,588,397 | 5,394,831 | 4,996,839 | 4,512,235 | |||||||||||||||
| Interest expense | 84,623 | 88,996 | 92,522 | 85,926 | 66,423 | |||||||||||||||
| Income before income taxes | 326,322 | 1,092,392 | 988,645 | 770,537 | 638,513 | |||||||||||||||
| Income tax expense | (44,919 | ) | (323,070 | ) | (286,398 | ) | (222,521 | ) | (196,235 | ) | ||||||||||
| Minority interest | (262 | ) | (3,083 | ) | (2,729 | ) | (3,124 | ) | (3,446 | ) | ||||||||||
| Income before change in accounting | 281,141 | 766,239 | 699,518 | 544,892 | 438,832 | |||||||||||||||
| Cumulative effect of change in accounting | — | — | — | — | (727 | ) | ||||||||||||||
| Net income | 281,141 | 766,239 | 699,518 | 544,892 | 438,105 | |||||||||||||||
| Data per common share: | ||||||||||||||||||||
| Net income per basic share | 1.68 | 4.05 | 3.65 | 2.86 | 2.32 | |||||||||||||||
| Net income per diluted share | 1.62 | 3.90 | 3.46 | 2.72 | 2.21 | |||||||||||||||
| Stockholders’ equity | 18.87 | 19.92 | 17.30 | 13.42 | 11.13 | |||||||||||||||
| Cash dividends declared | .23 | .20 | .16 | .12 | .12 | |||||||||||||||
| Weighted average shares outstanding: | ||||||||||||||||||||
| Basic | 166,956 | 188,981 | 191,809 | 190,533 | 188,912 | |||||||||||||||
| Diluted | 173,454 | 196,698 | 201,961 | 200,426 | 198,408 | |||||||||||||||
| Balance sheet data as of year end: | ||||||||||||||||||||
| Investments | $ | 11,143,281 | $ | 11,956,717 | $ | 11,172,684 | $ | 9,866,389 | $ | 7,346,316 | ||||||||||
| Total assets | 16,121,158 | 16,820,005 | 15,656,489 | 13,896,287 | 11,451,033 | |||||||||||||||
| Reserves for losses and loss expenses | 8,999,596 | 8,678,034 | 7,784,269 | 6,711,760 | 5,449,611 | |||||||||||||||
| Junior subordinated debentures | 249,584 | 249,375 | 241,953 | 450,634 | 208,286 | |||||||||||||||
| Senior notes and other debt | 1,021,869 | 1,121,793 | 869,187 | 967,818 | 808,264 | |||||||||||||||
| Stockholders’ equity | 3,046,319 | 3,592,368 | 3,335,159 | 2,567,077 | 2,109,702 | |||||||||||||||
Certain amounts for 2007 and prior years have been restated to reflect a change in accounting in 2008 and to conform to the presentation of the 2008 financial statements.
PAST PRICES OF COMMON STOCK
The common stock of the Company is traded on the New York Stock Exchange under the symbol “WRB”.
The common stock of the Company is traded on the New York Stock Exchange under the symbol “WRB”.
| Price Range | Dividends | |||||||||||
| High | Low | Declared Per Share | ||||||||||
2008 | ||||||||||||
| Fourth Quarter | $ | 31.21 | $ | 16.62 | $ | .06 | ||||||
| Third Quarter | 29.34 | 20.39 | .06 | |||||||||
| Second Quarter | 29.02 | 24.01 | .06 | |||||||||
| First Quarter | 31.26 | 26.39 | .05 | |||||||||
2007 | ||||||||||||
| Fourth Quarter | $ | 32.21 | $ | 28.04 | $ | .05 | ||||||
| Third Quarter | 32.81 | 25.20 | .05 | |||||||||
| Second Quarter | 33.80 | 31.89 | .05 | |||||||||
| First Quarter | 35.10 | 31.30 | .05 | |||||||||
1
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
W. R. Berkley Corporation is an insurance holding company that is among the largest commercial lines writers in the United States and operates in five business segments: specialty insurance, regional property casualty insurance, alternative markets, reinsurance and international. The Company’s primary sources of revenues and earnings are insurance and investments.
The profitability of the Company’s insurance business is affected primarily by the adequacy of premium rates. The ultimate adequacy of premium rates is not known with certainty at the time a property casualty insurance policy is issued because premiums are determined before claims are reported. The ultimate adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural and other disasters, regulatory measures and court decisions that define and change the extent of coverage and the effects of economic inflation on the amount of compensation due for injuries or losses. General insurance prices are also influenced by available insurance capacity, i.e., the level of policyholders’ surplus employed in the industry, and the industry’s willingness to deploy that capital.
Available insurance capacity has increased in recent years, increasing competition in the industry and putting downward pressure on pricing and terms and conditions. In 2007, we saw increased competition and decreased prices across most of our business segments. This trend of increased competition and decreased prices continued in 2008 and, although there are signs of it beginning to ease for certain lines of business, we expect it to continue in the first half of 2009.
As a result of the current conditions in the financial markets, certain of the largest U.S. insurers have been significantly impacted by, among other things, investment losses, lower credit ratings and reduced policyholders’ surplus. This may lead to an increased emphasis on security and credit ratings of insurers, reduced insurance capacity and less competition in the industry, putting upward pressure on pricing and terms and conditions.
The Company’s profitability is also affected by its investment income. The Company’s invested assets, which are derived from its own capital and cash flow from its insurance business, are invested principally in fixed maturity securities. The return on fixed maturity securities is affected primarily by general interest rates and the credit quality and duration of the securities. The Company also invests in equity securities, including those of financial institutions, merger arbitrage, private equity investments and real estate securities.
Critical Accounting Estimates
The following presents a discussion of accounting policies and estimates relating to reserves for losses and loss expenses, assumed premiums and investments. Management believes these policies and estimates are the most critical to its operations and require the most difficult, subjective and complex judgments.
Reserves for Losses and Loss Expenses. To recognize liabilities for unpaid losses, either known or unknown, insurers establish reserves, which is a balance sheet account representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred. Estimates and assumptions relating to reserves for losses and loss expenses are based on complex and subjective judgments, often including the interplay of specific uncertainties with related accounting and actuarial measurements. Such estimates are also susceptible to change as significant periods of time may elapse between the occurrence of an insured loss, the report of the loss to the insurer, the ultimate determination of the cost of the loss and the insurer’s payment of that loss.
In general, when a claim is reported, claims personnel establish a “case reserve” for the estimated amount of the ultimate payment. The estimate represents an informed judgment based on general reserving practices and reflects the experience and knowledge of the claims personnel regarding the nature and value of the specific type of claim. Reserves are also established on an aggregate basis to provide for losses incurred but not reported (“IBNR”) to the insurer, potential inadequacy of case reserves and the estimated expenses of settling claims, including legal and other fees and general expenses of administrating the claims adjustment process. Reserves are established based upon the then current legal interpretation of coverage provided.
In examining reserve adequacy, several factors are considered in addition to the economic value of losses. These factors include historical data, legal developments, changes in social attitudes and economic conditions, including the effects of inflation. The actuarial process relies on the basic assumption that past experience, adjusted judgmentally for the effects of current developments and anticipated trends, is an appropriate basis for predicting future outcomes. Reserve amounts are necessarily based on management’s informed estimates and judgments using currently available data. As additional experience and other data become available and are reviewed, these estimates and judgments may be revised. This may result in reserve increases or decreases that would be reflected in our results in periods in which such estimates and assumptions are changed.
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The risk and complexity of estimating loss reserves have increased under the current financial market conditions. It is especially difficult to estimate the impact of inflation on loss reserves given the current economic environment and related government actions. Whereas a slowing economy would generally lead to lower inflation or even deflation, increased government spending would generally lead to higher inflation. A change in our assumptions regarding inflation would result in reserve increases or decreases that would be reflected in our earnings in periods in which such assumptions are changed.
Reserves do not represent an exact calculation of liability. Rather, reserves represent an estimate of what management expects the ultimate settlement and claim administration will cost. While the methods for establishing the reserves are well tested over time, some of the major assumptions about anticipated loss emergence patterns are subject to unanticipated fluctuation. These estimates, which generally involve actuarial projections, are based on management’s assessment of facts and circumstances then known, as well as estimates of future trends in claims severity and frequency, judicial theories of liability and other factors, including the actions of third parties which are beyond the Company’s control. These variables are affected by external and internal events, such as inflation and economic volatility, judicial and litigation trends, reinsurance coverage, legislative changes and claim handling and reserving practices, which make it more difficult to accurately predict claim costs. The inherent uncertainties of estimating reserves are greater for certain types of liabilities where long periods of time elapse before a definitive determination of liability is made. Because setting reserves is inherently uncertain, the Company cannot assure that its current reserves will prove adequate in light of subsequent events.
Loss reserves included in the Company’s financial statements represent management’s best estimates based upon an actuarially derived point estimate and other considerations. The Company uses a variety of actuarial techniques and methods to derive an actuarial point estimate for each operating unit. These methods include paid loss development, incurred loss development, paid and incurred Bornhuetter-Ferguson methods and frequency and severity methods. In circumstances where one actuarial method is considered more credible than the others, that method is used to set the point estimate. For example, the paid loss and incurred loss development methods rely on historical paid and incurred loss data. For new lines of business, where there is insufficient history of paid and incurred claims data, or in circumstances where there have been significant changes in claim practices, the paid and incurred loss development methods would be less credible than other actuarial methods. The actuarial point estimate may also be based on a judgmental weighting of estimates produced from each of the methods considered. Industry loss experience is used to supplement the Company’s own data in selecting “tail factors” and in areas where the Company’s own data is limited. The actuarial data is analyzed by line of business, coverage and accident or policy year, as appropriate, for each operating unit.
The establishment of the actuarially derived loss reserve point estimate also includes consideration of qualitative factors that may affect the ultimate losses. These qualitative considerations include, among others, the impact of re-underwriting initiatives, changes in the mix of business, changes in distribution sources and changes in policy terms and conditions. Examples of changes in terms and conditions that can have a significant impact on reserve levels are the use of aggregate policy limits, the expansion of coverage exclusions, whether or not defense costs are within policy limits, and changes in deductibles and attachment points.
The key assumptions used to arrive at the best estimate of loss reserves are the expected loss ratios, rate of loss cost inflation, and reported and paid loss emergence patterns. Expected loss ratios represent management’s expectation of losses at the time the business is written, before any actual claims experience has emerged. This expectation is a significant determinant of the estimate of loss reserves for recently written business where there is little paid or incurred loss data to consider. Expected loss ratios are generally derived from historical loss ratios adjusted for the impact of rate changes, loss cost trends and known changes in the type of risks underwritten. Expected loss ratios are estimated for each key line of business within each operating unit. Expected loss cost inflation is particularly important for the long-tail lines, such as excess casualty, and claims with a high medical component, such as workers’ compensation. Reported and paid loss emergence patterns are used to project current reported or paid loss amounts to their ultimate settlement value. Loss development factors are based on the historical emergence patterns of paid and incurred losses, and are derived from the Company’s own experience and industry data. The paid loss emergence pattern is also significant to excess and assumed workers’ compensation reserves because those reserves are discounted to their estimated present value based upon such estimated payout patterns. Management believes the estimates and assumptions it makes in the reserving process provide the best estimate of the ultimate cost of settling claims and related expenses with respect to insured events which have occurred; however, different assumptions and variables could lead to significantly different reserve estimates.
Loss frequency and severity are measures of loss activity that are considered in determining the key assumptions described in our discussion of loss and loss expense reserves, including expected loss ratios, rate of loss cost inflation and reported and paid loss emergence patterns. Loss frequency is a measure of the number of claims per unit of insured exposure, and loss severity is a measure of the average size of claims. Factors affecting loss frequency include the effectiveness of loss controls and safety programs and changes in economic activity or weather patterns. Factors affecting loss severity include changes in policy limits, retentions, rate of inflation and judicial interpretations.
3
Another factor affecting estimates of loss frequency and severity is the loss reporting lag, which is the period of time between the occurrence of a loss and the date the loss is reported to the Company. The length of the loss reporting lag affects our ability to accurately predict loss frequency (loss frequencies are more predictable for lines with short reporting lags) as well as the amount of reserves needed for incurred but not reported losses (less IBNR is required for lines with short reporting lags). As a result, loss reserves for lines with short reporting lags are likely to have less variation from initial loss estimates. For lines with short reporting lags, which include commercial automobile, primary workers’ compensation, commercial multi-peril business, other liability (claims-made) and property business, the key assumption is the loss emergence pattern used to project ultimate loss estimates from known losses paid or reported to date. For lines of business with long reporting lags, which include other liability (occurrence), products liability, excess workers’ compensation and liability reinsurance, the key assumption is the expected loss ratio since there is often little paid or incurred loss data to consider.
Historically, the Company has experienced less variation from its initial loss estimates for lines of businesses with short reporting lags than for lines of business with long reporting lags. For example, as of December 31, 2008, initial loss estimates for accident years 1999 through 2007 were decreased by an average of 3% for lines with short reporting lags and by an average of 12% for lines with long reporting lags. For the latest accident year ended December 31, 2008, initial loss estimates were $1.7 billion for lines with short reporting lags and $1.1 billion for lines with long reporting lags.
The key assumptions used in calculating the most recent estimate of the loss reserves are reviewed each quarter and adjusted, to the extent necessary, to reflect historical changes, current trends and other factors observed. If the actual level of loss frequency and severity are higher or lower than expected, the ultimate losses will be different than management’s estimate. The following table reflects the impact of changes (which could be favorable or unfavorable) in frequency and severity on our loss estimate for claims occurring in 2008 (dollars in thousands):
| Frequency (+/-) | ||||||||||||
| Severity (+/-) | 1% | 5% | 10% | |||||||||
| 1% | 56,881 | 171,208 | 314,116 | |||||||||
| 5% | 171,208 | 290,062 | 438,631 | |||||||||
| 10% | 314,116 | 438,631 | 594,274 | |||||||||
Our net reserves for losses and loss expenses of $8.1 billion as of December 31, 2008 relate to multiple accident years. Therefore, the impact of changes in frequency or severity for more than one accident year could be higher or lower than the amounts reflected above.
Approximately $1.8 billion, or 23%, of the Company’s net loss reserves as of December 31, 2008 relate to assumed reinsurance business. There is a higher degree of uncertainty and greater variability regarding estimates of assumed loss reserves because those estimates are based, in part, upon information received from ceding companies. If information received from ceding companies is not timely or correct, the Company’s estimate of ultimate losses may not be accurate. Furthermore, due to delayed reporting of claim information by ceding companies, the claim settlement tail for assumed reinsurance is extended. Management considers the impact of delayed reporting in its selection of assumed loss development factors.
Information received from ceding companies is used to set initial expected loss ratios, to establish case reserves and to estimate reserves for incurred but not reported losses on assumed reinsurance business. This information, which is generally provided through reinsurance intermediaries, is gathered through the underwriting process and from periodic claim reports and other correspondence with ceding companies. The Company performs underwriting and claim audits of selected ceding companies to determine the accuracy and completeness of information provided to the Company. The information received from the ceding companies is supplemented by the Company’s own loss development experience with similar lines of business as well as industry loss trends and loss development benchmarks.
Following is a summary of the Company’s reserves for losses and loss expenses by business segment as of December 31, 2008 and 2007 (dollars in thousands):
| 2008 | 2007 | |||||||
| Specialty | $ | 2,973,824 | $ | 2,853,479 | ||||
| Regional | 1,329,697 | 1,218,703 | ||||||
| Alternative Markets | 1,691,678 | 1,558,643 | ||||||
| Reinsurance | 1,842,848 | 1,884,051 | ||||||
| International | 284,539 | 308,021 | ||||||
| Net reserves for losses and loss expenses | 8,122,586 | 7,822,897 | ||||||
| Ceded reserves for losses and loss expenses | 877,010 | 855,137 | ||||||
| Gross reserves for losses and loss expenses | $ | 8,999,596 | $ | 8,678,034 | ||||
4
Following is a summary of the Company’s net reserves for losses and loss expenses by major line of business as of December 31, 2008 and 2007 (dollars in thousands):
| Reported Case | Incurred But Not | |||||||||||
| Reserves | Reported | Total | ||||||||||
| December 31, 2008 | ||||||||||||
| General liability | $ | 800,059 | $ | 2,227,257 | $ | 3,027,316 | ||||||
| Workers’ compensation | 988,714 | 1,014,524 | 2,003,238 | |||||||||
| Commercial automobile | 393,035 | 210,562 | 603,597 | |||||||||
| International | 129,351 | 155,188 | 284,539 | |||||||||
| Other | 145,010 | 216,038 | 361,048 | |||||||||
| Total primary | 2,456,169 | 3,823,569 | 6,279,738 | |||||||||
| Reinsurance | 770,247 | 1,072,601 | 1,842,848 | |||||||||
| Total | $ | 3,226,416 | $ | 4,896,170 | $ | 8,122,586 | ||||||
| December 31, 2007 | ||||||||||||
| General liability | $ | 756,121 | $ | 2,095,913 | $ | 2,852,034 | ||||||
| Workers’ compensation | 915,588 | 929,875 | 1,845,463 | |||||||||
| Commercial automobile | 377,922 | 223,767 | 601,689 | |||||||||
| International | 118,807 | 189,214 | 308,021 | |||||||||
| Other | 135,221 | 196,418 | 331,639 | |||||||||
| Total primary | 2,303,659 | 3,635,187 | 5,938,846 | |||||||||
| Reinsurance | 795,922 | 1,088,129 | 1,884,051 | |||||||||
| Total | $ | 3,099,581 | $ | 4,723,316 | $ | 7,822,897 | ||||||
For the year ended December 31, 2008, the Company reported losses and loss expenses of $2,689 million. Estimates for claims occurring in prior years decreased by $196 million. On an accident year basis, the change in prior year reserves is comprised of an increase in estimates for claims occurring in accident years 2002 and prior of $81 million and a decrease in estimates for claims occurring in accident years 2003 through 2007 of $277 million. The changes in prior year loss reserve estimates are generally the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as additional information becomes known regarding individual claims and aggregate claim trends.
By segment, prior year reserves decreased by $108 million for specialty, $40 million for alternative markets, $26 million for regional, $12 million for reinsurance and $10 million for international. For primary business lines, prior year reserves decreased by $125 million for general liability, $36 million for workers’ compensation, $16 million for commercial automobile and $7 million for property. The decrease in prior year reserves for general liability reflects the favorable loss reserve trends for excess and surplus lines for accident years 2003 through 2007.
Loss Reserve Discount. The Company discounts its liabilities for excess and assumed workers’ compensation business because of the long period of time over which losses are paid. Discounting is intended to appropriately match losses and loss expenses to income earned on investment securities supporting the liabilities. The expected losses and loss expense payout pattern subject to discounting was derived from the Company’s loss payout experience. For non-proportional business, reserves for losses and loss expenses have been discounted using risk-free discount rates determined by reference to the U.S. Treasury yield curve. These discount rates range from 3.1% to 6.5%, with a weighted average discount rate of 4.6%. For proportional business, reserves for losses and loss expenses have been discounted at the statutory rate permitted by the Department of Insurance of the State of Delaware of 2.5%. The aggregate net discount, after reflecting the effects of ceded reinsurance, was $847 million and $788 million as of December 31, 2008 and December 31, 2007, respectively.
5
Assumed Reinsurance Premiums. The Company estimates the amount of assumed reinsurance premiums that it will receive under treaty reinsurance agreements at the inception of the contracts. These premium estimates are revised as the actual amount of assumed premiums is reported to the Company by the ceding companies. As estimates of assumed premiums are made or revised, the related amount of earned premium, commissions and incurred losses associated with those premiums are recorded. Estimated assumed premiums receivable were approximately $49 million and $69 million at December 31, 2008 and December 31, 2007, respectively. The assumed premium estimates are based upon terms set forth in the reinsurance agreement, information received from ceding companies during the underwriting and negotiation of the agreement, reports received from ceding companies and discussions and correspondence with reinsurance intermediaries. The Company also considers its own view of market conditions, economic trends and experience with similar lines of business. These premium estimates represent management’s best estimate of the ultimate amount of premiums to be received under its assumed reinsurance agreements.
Other Than Temporary Declines in the Value of Investments. The cost of securities is adjusted where appropriate to include a provision for decline in value which is considered to be other than temporary. An other than temporary decline is considered to occur in investments where there has been a sustained reduction in market value and where the Company does not expect the fair value to recover prior to the time of sale or maturity. Since equity securities do not have a contractual cash flow at maturity, the Company considers whether the price of an equity security is expected to recover within a reasonable period of time. Management regularly reviews securities that have a fair value less than cost to determine whether an other than temporary impairment has occurred. If a decline in value is considered other than temporary, the Company reports a realized loss on its statement of income.
Write downs for other than temporary impairments were $433 million in 2008. These impairment charges included $263 million for Fannie Mae and Freddie Mac preferred stock, $90 million for a REIT common stock, $64 million for preferred stocks issued by banks, insurers and REITs and $16 million for private equity investments.
Fixed Maturity Securities Unrealized Losses- The following table provides a summary of all fixed maturity securities December 31, 2008 by the length of time those securities have been continuously in an unrealized loss position (dollars in thousands):
| Number of | Aggregate | Gross | ||||||||||
| Securities | Fair Value | Unrealized Losses (1) | ||||||||||
| Unrealized loss less than 20% of amortized cost | 298 | $ | 2,345,669 | $ | 172,695 | |||||||
| Unrealized loss 20% or greater: | ||||||||||||
| Less than six months | 22 | 57,017 | 57,589 | |||||||||
| Six months to less than nine months | 6 | 47,640 | 23,208 | |||||||||
| Nine months to less than twelve months | 11 | 100,697 | 30,479 | |||||||||
| Twelve months or greater | 23 | 212,463 | 103,830 | |||||||||
| Total | 360 | $ | 2,763,486 | $ | 387,801 | |||||||
| (1) | Fixed maturity securities classified as available for sale are carried at estimated fair value and unrealized losses, net of income taxes, are reported as a component of stockholders’ equity. |
In determining whether declines in fair values of fixed maturity securities are other than temporary, management assesses the issuer’s ability to continue to meet its contractual payment obligations as they become due and whether the Company has the ability and intent to hold the investment until it recovers or matures. The Company’s assessment of its intent to hold an investment until it recovers or matures is based on conditions at the time the assessment is made, including general market conditions, the Company’s overall investment strategy and management’s view of the underlying value of an investment relative to its current price. Additionally, for certain securitized financial assets with contractual cash flows (including asset-backed securities), the Company updates its best estimate of the present value of expected cash flows over the life of the security on a quarterly basis. If management determines that the fair value of the securitized financial asset and the present value of the asset’s cash flows estimated at the current financial reporting date are less than the present value of the estimated cash flows at the date of purchase, an other-than–temporary impairment is recognized and the securitized financial asset is written down to fair value.
On March 31, 2008, the Company purchased $58 million of senior subordinated secured notes (the “Notes”) from a residential mortgage lender (the “Borrower”) in connection with a recapitalization plan. At December 31, 2008, the Notes had an amortized cost of $58 million and an estimated market value of $15 million. The market value reflects uncertainty with respect to the Borrower’s ability to restructure or refinance certain bank debt that expires on March 16, 2009. The Company believes that the expected cash flow from the Borrower’s assets significantly exceeds its debt obligations, and accordingly the Company does not consider the Notes to be other than temporarily impaired.
Other than the Notes referred to above, there were 60 fixed maturity securities for which unrealized losses were 20% or greater than amortized cost at December 31, 2008. Those securities had an aggregate unrealized loss of $172 million. The Company has evaluated these securities and believes the unrealized losses are due primarily to temporary market and sector-related factors rather than to issuer-specific factors. The Company does not consider these securities to be other than temporarily impaired.
6
Perpetual Preferred Securities Unrealized Losses- The following table provides a summary of all perpetual preferred securities at December 31, 2008 by the length of time those securities have been continuously in an unrealized loss position (dollars in thousands):
| Gross | ||||||||||||
| Number of | Aggregate | Unrealized Losses | ||||||||||
| Securities | Fair Value | (1) | ||||||||||
| Unrealized loss less than 20% of amortized cost | 20 | $ | 65,703 | $ | 9,400 | |||||||
| Unrealized loss 20% or greater: | ||||||||||||
| Less than six months | 6 | 36,673 | 18,530 | |||||||||
| Six months to less than nine months | 5 | 16,778 | 6,227 | |||||||||
| Nine months to less than twelve months | 11 | 33,195 | 15,475 | |||||||||
| Twelve months or greater | 24 | 80,684 | 47,007 | |||||||||
| Total | 66 | $ | 233,033 | $ | 96,639 | |||||||
| (1) | Perpetual preferred securities classified as available for sale are carried at estimated fair value and unrealized losses, net of income taxes, are reported as a component of stockholders’ equity. |
In assessing other than temporary impairments of perpetual preferred securities, the Company applies an impairment model similar to those used for a fixed maturity security provided there has been no evidence of deterioration in credit of the issuer. Otherwise, impairment tests for perpetual preferred securities are similar to that used for common stock.
The Company owns perpetual preferred securities issued by two U.S. banks that were rated investment grade at December 31, 2008 and were downgraded to below investment grade subsequent to year end. These securities had a carrying value of $47 million and an unrealized loss of $21 million at December 31, 2008. The rating downgrades were generally due to current and expected financial performance, asset quality problems globally and the possibility that dividends would be deferred. As a result of these downgrades, we are required to evaluate the securities for other than temporary impairment using the equity security model rather than the debt security model. Based on the duration and severity of the decline, the Company does not consider the securities to be other than temporarily impaired as of December 31, 2008.
Other than the securities referred to above, there were 42 securities for which unrealized losses were 20% or greater than amortized cost at December 31, 2008. Those securities, which had an aggregate unrealized loss of $66 million, are primarily investment grade securities issued by banks, insurers and REITs. The Company has the ability and intent to hold these securities at least until the investment impairment is recovered. The Company believes these unrealized losses are due primarily to temporary market and sector-related factors rather than to issuer-specific factors and does not consider these securities to be other than temporarily impaired.
Common Stock Unrealized Losses- In determining whether declines in fair values of common stock are other than temporary, management assesses (1) the severity and duration of the impairment, (2) the historic and implied volatility of the security, (3) recoveries or additional declines in fair value subsequent to the balance sheet date, (4) the financial condition and near-term prospects of the issuer, (5) whether the market decline was affected by macroeconomic conditions or by specific information pertaining to an individual security and (6) the length of the forecasted recovery period.
At December 31, 2008, the Company owned a common stock of a monoline insurance company with a fair value of $6 million and an unrealized loss of $8 million. The insurer’s stock price was highly volatile in the fourth quarter of 2008, and the Company’s investment in the insurer had been in an unrealized loss position for less than two months at year-end. As of the most recent reporting date, the insurer’s book value was significantly above the average cost per share. The Company does not consider the stock to be other than temporarily impaired. There were no other common stocks in an unrealized loss position at December 31, 2008.
Because of changing economic and market conditions affecting issuers of debt and equity securities and the performance of the underlying collateral affecting certain classes of assets, it is reasonably possible that we will recognize other-than-temporary impairments in the future.
7
Fair Value Measurements
The Company’s fixed income securities and equity securities available for sale and its trading account securities are carried at fair value. Because many fixed income securities do not trade on a daily basis, the Company utilizes pricing models and processes which may include benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Market inputs used to evaluate securities include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. Quoted prices are often unavailable for recently issued securities, securities that are infrequently traded and securities that are only traded in private transactions. For publicly traded securities for which quoted prices are unavailable, the Company determines fair value based on independent broker quotations and other observable market data. For securities traded only in private negotiations, the Company determines fair value based primarily on the cost of such securities, which is adjusted to reflect prices of recent placements of securities of the same issuer, financial data, projections and business developments of the issuer and other relevant information.
8
Results for Operations for the Years Ended December 31, 2008 and 2007
Business Segment Results
The following is a summary of gross and net premiums written, premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of premiums earned), expense ratios (underwriting expenses expressed as a percentage of premiums earned) and combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the years ended December 31, 2008 and 2007. The combined ratio represents a measure of underwriting profitability, excluding investment income. A combined ratio in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit.
| (Dollars in thousands) | 2008 | 2007 | ||||||
| Specialty | ||||||||
| Gross premiums written | $ | 1,590,335 | $ | 1,816,727 | ||||
| Net premiums written | 1,453,778 | 1,704,880 | ||||||
| Premiums earned | 1,618,915 | 1,772,547 | ||||||
| Loss ratio | 60.1 | % | 57.3 | % | ||||
| Expense ratio | 28.4 | % | 26.7 | % | ||||
| Combined ratio | 88.5 | % | 84.0 | % | ||||
| Regional | ||||||||
| Gross premiums written | $ | 1,385,791 | $ | 1,441,077 | ||||
| Net premiums written | 1,211,096 | 1,267,451 | ||||||
| Premiums earned | 1,237,258 | 1,250,914 | ||||||
| Loss ratio | 65.4 | % | 59.1 | % | ||||
| Expense ratio | 32.3 | % | 31.4 | % | ||||
| Combined ratio | 97.7 | % | 90.5 | % | ||||
| Alternative Markets | ||||||||
| Gross premiums written | $ | 715,979 | $ | 758,285 | ||||
| Net premiums written | 622,185 | 656,369 | ||||||
| Premiums earned | 626,858 | 651,909 | ||||||
| Loss ratio | 62.7 | % | 59.2 | % | ||||
| Expense ratio | 24.2 | % | 23.1 | % | ||||
| Combined ratio | 86.9 | % | 82.3 | % | ||||
| Reinsurance | ||||||||
| Gross premiums written | $ | 458,668 | $ | 732,233 | ||||
| Net premiums written | 435,108 | 682,241 | ||||||
| Premiums earned | 519,717 | 740,439 | ||||||
| Loss ratio | 64.7 | % | 65.3 | % | ||||
| Expense ratio | 34.7 | % | 31.3 | % | ||||
| Combined ratio | 99.4 | % | 96.6 | % | ||||
| International | ||||||||
| Gross premiums written | $ | 369,353 | $ | 304,908 | ||||
| Net premiums written | 311,732 | 265,048 | ||||||
| Premiums earned | 286,832 | 247,892 | ||||||
| Loss ratio | 61.7 | % | 62.6 | % | ||||
| Expense ratio | 38.9 | % | 32.4 | % | ||||
| Combined ratio | 100.6 | % | 95.0 | % | ||||
| Consolidated | ||||||||
| Gross premiums written | $ | 4,520,126 | $ | 5,053,230 | ||||
| Net premiums written | 4,033,899 | 4,575,989 | ||||||
| Premiums earned | 4,289,580 | 4,663,701 | ||||||
| Loss ratio | 62.7 | % | 59.6 | % | ||||
| Expense ratio | 30.4 | % | 28.5 | % | ||||
| Combined ratio | 93.1 | % | 88.1 | % | ||||
9
Net Income. The following table presents the Company’s net income and net income per diluted share for the years ended December 31, 2008 and 2007 (amounts in thousands, except per share data):
| 2008 | 2007 | |||||||
| Net income | $ | 281,141 | $ | 766,239 | ||||
| Weighted average diluted shares | 173,454 | 196,698 | ||||||
| Net income per diluted share | $ | 1.62 | $ | 3.90 | ||||
Net income decreased to $281 million in 2008 from $766 million in 2007 primarily due to realized investment losses, net of tax of $232 million in 2008 as compared to realized investment gains, net of tax of $32 million in 2007. In addition, underwriting profits and investment income were lower in 2008. The decrease in weighted average diluted shares resulted from the Company’s repurchases of its common stock in 2007 and 2008.
Gross Premiums Written. Gross premiums written were $4.5 billion in 2008, down 11% from 2007. The Company has experienced increased competition and downward pressure on pricing since 2004. This trend continued in 2008, with overall price levels for renewal business declining approximately 5% as compared with the prior year period. New business volume was also lower in 2008. Gross premiums written for businesses that were started or acquired since 2006 were $298 million in 2008 and $171 million in 2007.
A summary of gross premiums written in 2008 compared with 2007 by business segment follows:
| • | Specialty gross premiums decreased by 12% to $1,590 million in 2008 from $1,817 million in 2007 due to lower premiums and less new business. The number of new and renewal policies issued in 2008, net of policy cancellations, was essentially unchanged. Gross premiums written decreased 26% for products liability, 24% for premises operations, 11% for commercial automobile and 8% for property lines. Gross premiums written increased 14% for professional liability. | ||
| • | Regional gross premiums decreased by 4% to $1,386 million in 2008 from $1,441 million in 2007 due primarily to lower prices. The number of new and renewal policies issued in 2008, net of policy cancellations, was essentially unchanged. Gross premiums written decreased 5% for commercial automobile, 5% for commercial multiple peril and 2% for workers’ compensation. Gross premiums include assigned risk premiums, which are fully reinsured, of $87 million in 2008 and $88 million in 2007. | ||
| • | Alternative markets gross premiums decreased by 6% to $716 million in 2008 from $758 million in 2007 due primarily to lower prices. The number of new and renewal policies issued (excluding personal accident business, a new line of business for the Company) decreased 28% in 2008, net of policy cancellations. Gross premiums written decreased 12% for excess workers’ compensation and 1% for primary workers’ compensation. Gross premiums include assigned risk premiums, which are fully reinsured, of $41 million in 2008 and $61 million in 2007. | ||
| • | Reinsurance gross premiums decreased by 37% to $459 million in 2008 from $732 million in 2007. The decline was due to non-renewals and lower new business volume as a result of business lost to competitors or retained by ceding companies. Casualty gross premiums written decreased 32% to $380 million, and property gross premiums written decreased 55% to $79 million. | ||
| • | International gross premiums increased by 21% to $369 million in 2008 from $305 million in 2007. Gross premiums in the U.K. and Continental Europe decreased 8% primarily as a result of the strengthening of the U.S. dollar against foreign currencies. Gross premiums in South America increased 34% as a result of higher price levels and new business. Gross premiums for the Australian branch, which began operating in 2008, were $25 million. |
Premiums Earned. Premiums earned decreased 8% to $4,290 million in 2008 from $4,664 million in 2007. Insurance premiums are earned ratably over the policy term, and therefore premiums earned in 2008 are related to business written during both 2008 and 2007. The 8% decrease for 2008 earned premiums reflects the underlying decline in net premiums written in 2007 and 2008.
Net Investment Income. Following is a summary of net investment income for the years ended December 31, 2008 and 2007 (dollars in thousands):
| Average Annualized | ||||||||||||||||
| Amount | Yield | |||||||||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||||||||
| Fixed maturity securities, including cash | $ | 497,549 | $ | 500,378 | 4.6 | % | 4.7 | % | ||||||||
| Arbitrage trading account and funds | 6,032 | 80,253 | 0.8 | % | 9.8 | % | ||||||||||
| Equity securities available for sale | 38,144 | 57,502 | 5.5 | % | 7.0 | % | ||||||||||
| Gross investment income | 541,725 | 638,133 | 4.4 | % | 5.3 | % | ||||||||||
| Investment expenses | (4,692 | ) | (3,747 | ) | ||||||||||||
| Total | $ | 537,033 | $ | 634,386 | 4.3 | % | 5.2 | % | ||||||||
10
Net investment income decreased 15% to $537 million in 2008 from $634 million in 2007 primarily as a result of lower income from the arbitrage trading account, which includes merger arbitrage and convertible arbitrage. Investment income from merger arbitrage investments decreased to $19 million from $65 million due primarily to a significant reduction in merger activity and related investment opportunities. Convertible arbitrage reported a loss of $13 million in 2008 compared with income of $16 million in 2007, as many of the financial institutions that were severely impacted by the credit crisis in 2008 were both issuers and holders of convertible preferred shares. Investment income from equity securities available for sale declined to $38 million from $58 million due to the deferral of dividends for Fannie Mae and Freddie Mac and to lower dividends for floating rate securities. Average invested assets, at cost (including cash and cash equivalents) increased 3% to $12.4 billion in 2008 from $12.1 billion in 2007 primarily as a result of cash flow from operations which was partially offset by cash used for repurchases of the Company’s common stock.
Income (Loss) from Investment Funds. Following is a summary of income (loss) from investment funds for the years ended December 31, 2008 and 2007 (dollars in thousands):
| 2008 | 2007 | |||||||
| Real estate funds | $ | (42,490 | ) | $ | 25,007 | |||
| Kiln Ltd | 10,697 | 16,052 | ||||||
| Energy | 30,785 | 1,323 | ||||||
| Other | (2,545 | ) | (4,108 | ) | ||||
| Total | $ | (3,553 | ) | $ | 38,274 | |||
Losses from investment funds were $3.6 million in 2008 compared to income of $38.3 million in 2007, primarily as a result of losses from real estate funds. The real estate funds invest primarily in commercial loans and securities that are marked to market and were marked down as credit spreads widened significantly following the bankruptcy of Lehman Brothers, government intervention, heightened concern over the U.S. and global economies, deleveraging of capital markets, increased market illiquidity and a worsening credit outlook. Income from energy funds increased to $31 million from $1 million due to an increase in the fair value of energy related investments held by the funds. The decrease in income from Kiln Ltd is due to the sale of the Company’s interest in Kiln Ltd in March 2008.
The Company’s share of the earnings or losses of investment funds is generally reported on a one-quarter lag in order to facilitate the timely completion of the Company’s financial statements. Subsequent to December 31, 2008, the Company received 2008 financial statements for certain real estate and energy funds. The Company’s share of net losses reported by these funds for their 2008 fourth quarter was $111 million pre-tax, or $72 million after-tax. The Company will report this loss, together with the results for investment funds for which 2008 financial statements have not yet been received, in its income statement for the first quarter of 2009.
Insurance Service Fees. The alternative markets and specialty segments offer fee-based services to help clients develop and administer self-insurance programs, primarily for workers’ compensation coverage. Service fees increased to $103 million in 2008 from $98 million in 2007 primarily as a result of the acquisition of American Mining Insurance Company in October 2007.
Realized Investment Gains (Losses). Realized investment gains (losses) result primarily from sales of securities, as well as from provisions for other than temporary impairment in securities. The Company buys and sells securities on a regular basis in order to maximize its total return on investments. Decisions to sell securities are based on management’s view of the underlying fundamentals of specific securities as well as management’s expectations regarding interest rates, credit spreads, currency values and general economic conditions.
Realized investment losses were $357 million in 2008 compared with realized investment gains of $50 million in 2007. Write downs for other-than-temporary impairments were $433 million in 2008. These impairment charges included $263 million from the write down of preferred stocks issued by Fannie Mae and Freddie Mac, $90 million for a REIT common stock, $64 million for preferred stocks issued by banks, insurers and REITs and $16 million for private equity investments. Net realized investment gains (excluding investment impairments) in 2008 were $76 million, including a gain of $70 million from the sale of the Company’s interest in Kiln Ltd.
Revenues from Wholly-Owned Investees. Revenues from wholly-owned investees were $137 million in 2008 compared with $103 million in 2007. These revenues were derived from three fixed base operators that were separately purchased in 2007 and 2008. These companies provide services to the general aviation market, including fuel and line service, aircraft sales and maintenance, avionics and engineering services and parts fabrication. The 2008 and 2007 revenues are not comparative since the companies are not included for the same periods.
11
Losses and Loss Expenses. Losses and loss expenses decreased to $2,689 million in 2008 from $2,780 million in 2007. The consolidated loss ratio was 62.7% in 2008 compared with 59.6% in 2007. Estimated loss ratios for accident year 2008 were higher due to higher weather-related losses, a decline in price levels and the impact of anticipated loss cost trends and inflation. Weather-related losses (including reinstatement premiums) were $114 million in 2008 compared with $34 million in 2007. The 2008 weather-related losses included losses from Hurricanes Ike, Gustav and Dolly. The increase in the accident year 2008 loss ratio was partially offset by favorable prior year reserve development, which was $196 million in 2008 compared with $106 million in 2007. The favorable loss reserve development in 2008 and 2007 was primarily related to the specialty segment. A summary of loss ratios in 2008 compared with 2007 by business segment follows:
| • | Specialty’s loss ratio increased to 60.1% in 2008 from 57.3% in 2007. Estimated loss ratios for accident year 2008 were higher due to a decline in price levels and a more competitive market environment. The increase in the accident year 2008 loss ratio was partially offset by favorable reserve development. Net favorable prior year development was $108 million in 2008 compared with $97 million in 2007. | ||
| • | The regional loss ratio increased to 65.4% in 2008 from 59.1% in 2007. Estimated loss ratios for accident year 2008 were higher due to higher weather-related losses and to a decline in price levels. Weather-related losses were $86 million in 2008 compared with $34 million in 2007. Net favorable prior year development was $26 million in 2008 compared with $22 million in 2007. | ||
| • | Alternative markets’ loss ratio increased to 62.7% from 59.2% in 2007. Estimated loss ratios for accident year 2008 were higher due to a decline in price levels, a more competitive market environment and the impact of lower discount rates used to discount excess workers’ compensation reserves. Net favorable prior year development was $40 million in 2008 compared with $24 million in 2007. | ||
| • | The reinsurance loss ratio decreased to 64.7% in 2008 from 65.3% in 2007 due primarily to favorable reserve development. Favorable prior year development was $12 million in 2008 compared with unfavorable prior year development of $44 million in 2007. | ||
| • | The international loss ratio decreased to 61.7% in 2008 from 62.6% in 2007 due to favorable reserve development and a change in the mix of business. Favorable prior year development was $10 million in 2008 compared with $7 million in 2007. |
Other Operating Costs and Expenses.Following is a summary of other operating costs and expenses for the years ended December 31, 2008 and 2007 (dollars in thousands):
| 2008 | 2007 | |||||||
| Underwriting expenses | $ | 1,303,551 | $ | 1,330,519 | ||||
| Service expenses | 87,397 | 90,561 | ||||||
| Other costs and expenses | 84,217 | 109,907 | ||||||
| Total | $ | 1,475,165 | $ | 1,530,987 | ||||
Underwriting expenses are comprised of commissions paid to agents and brokers, premium taxes and other assessments and internal underwriting costs. The consolidated expense ratio (underwriting expenses expressed as a percentage of premiums earned) increased to 30.4% in 2008 from 28.5% in 2007 primarily due to the decline in earned premiums.
Service expenses, which represent the costs associated with the alternative markets and specialty segments’ fee-based businesses, decreased 3% to $87 million due to lower employment costs.
Other costs and expenses, which represent corporate expenses and foreign currency transaction gains and losses, decreased 23% to $84 million. The decrease was due to lower incentive compensation costs and to foreign currency transaction gains.
Expenses from Wholly-Owned Investees. Expenses from wholly-owned investees were $134 million in 2008 compared to $96 million in 2007. These expenses represent costs associated with three fixed base operators that were separately purchased in 2007 and 2008. These include cost of goods sold related to aircraft and other sales, labor and equipment costs related to repairs and other services and general and administrative expenses. The 2008 and 2007 expenses are not comparative since the companies are not included for the same periods.
Interest Expense. Interest expense decreased 5% to $85 million primarily due to the repayment of $89 million of 9.875% senior notes in May 2008.
Income Taxes. The effective income tax rate was 14% in 2008 and 29% in 2007. The effective tax rate differs from the federal income tax rate of 35% primarily because of tax-exempt investment income, which represented a greater portion of pre-tax income in 2008.
12
Results of Operations for the Years Ended December 31, 2007 and 2006
Business Segment Results
Following is a summary of gross and net premiums written, premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of premiums earned), expense ratios (underwriting expenses expressed as a percentage of premiums earned) and combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the years ended December 31, 2007 and 2006. The combined ratio represents a measure of underwriting profitability, excluding investment income. A combined ratio in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit.
| (Dollars in thousands) | 2007 | 2006 | ||||||
Specialty | ||||||||
| Gross premiums written | $ | 1,816,727 | $ | 1,918,521 | ||||
| Net premiums written | 1,704,880 | 1,814,479 | ||||||
| Premiums earned | 1,772,547 | 1,752,507 | ||||||
| Loss ratio | 57.3 | % | 59.1 | % | ||||
| Expense ratio | 26.7 | % | 25.0 | % | ||||
| Combined ratio | 84.0 | % | 84.1 | % | ||||
Regional | ||||||||
| Gross premiums written | $ | 1,441,077 | $ | 1,415,311 | ||||
| Net premiums written | 1,267,451 | 1,235,302 | ||||||
| Premiums earned | 1,250,914 | 1,205,912 | ||||||
| Loss ratio | 59.1 | % | 59.7 | % | ||||
| Expense ratio | 31.4 | % | 30.6 | % | ||||
| Combined ratio | 90.5 | % | 90.3 | % | ||||
Alternative Markets | ||||||||
| Gross premiums written | $ | 758,285 | $ | 747,680 | ||||
| Net premiums written | 656,369 | 651,255 | ||||||
| Premiums earned | 651,909 | 658,805 | ||||||
| Loss ratio | 59.2 | % | 53.5 | % | ||||
| Expense ratio | 23.1 | % | 22.1 | % | ||||
| Combined ratio | 82.3 | % | 75.6 | % | ||||
Reinsurance | ||||||||
| Gross premiums written | $ | 732,233 | $ | 940,797 | ||||
| Net premiums written | 682,241 | 892,769 | ||||||
| Premiums earned | 740,439 | 859,411 | ||||||
| Loss ratio | 65.3 | % | 72.0 | % | ||||
| Expense ratio | 31.3 | % | 27.8 | % | ||||
| Combined ratio | 96.6 | % | 99.8 | % | ||||
International | ||||||||
| Gross premiums written | $ | 304,908 | $ | 254,605 | ||||
| Net premiums written | 265,048 | 225,188 | ||||||
| Premiums earned | 247,892 | 215,987 | ||||||
| Loss ratio | 62.6 | % | 64.2 | % | ||||
| Expense ratio | 32.4 | % | 32.0 | % | ||||
| Combined ratio | 95.0 | % | 96.2 | % | ||||
Consolidated | ||||||||
| Gross premiums written | $ | 5,053,230 | $ | 5,276,914 | ||||
| Net premiums written | 4,575,989 | 4,818,993 | ||||||
| Premiums earned | 4,663,701 | 4,692,622 | ||||||
| Loss ratio | 59.6 | % | 61.0 | % | ||||
| Expense ratio | 28.5 | % | 27.0 | % | ||||
| Combined ratio | 88.1 | % | 88.0 | % | ||||
13
Net Income. The following table presents the Company’s net income and net income per share for the years ended December 31, 2007 and 2006 (amounts in thousands, except per share data):
| 2007 | 2006 | |||||||
| Net income | $ | 766,239 | $ | 699,518 | ||||
| Weighted average diluted shares | 196,698 | 201,961 | ||||||
| Net income per diluted share | $ | 3.90 | $ | 3.46 | ||||
The increase in net income in 2007 compared with 2006 reflects higher investment income as a result of operating cash flow. Underwriting profits were essentially unchanged as favorable prior year loss reserve development was offset by a higher expected loss ratio for accident year 2007 and by higher underwriting expenses.
Gross Premiums Written. Gross premiums written were $5.1 billion in 2007, down 4% from 2006. The Company has experienced increased competition and downward pressure on pricing since 2004. This trend continued in 2007, with price levels for renewal business declining approximately 5% as compared with the prior year period.
A summary of gross premiums written in 2007 compared with 2006 by business segment follows:
| • | Specialty gross premiums decreased by 5% to $1,817 million in 2007 from $1,919 million in 2006 due to primarily to lower prices. The number of new and renewal policies issued in 2007, net of policy cancellations, increased 3%. Gross premiums written decreased 15% for premises operations and 13% for products liability. Gross premiums written increased 11% for property lines and 5% for professional liability. Commercial automobile gross premiums written were essentially unchanged. | ||
| • | Regional gross premiums increased by 2% to $1,441 million in 2007 from $1,415 million in 2006 as new business was partially offset by lower prices. The number of new and renewal policies issued in 2007, net of policy cancellations, increased 1%. Gross premiums written increased 4% for commercial automobile and 1% for workers’ compensation. Commercial multiple peril was virtually unchanged. Gross premiums include assigned risk premiums, which are fully reinsured, of $88 million in 2007 and $102 million in 2006. | ||
| • | Alternative markets gross premiums increased by 1% to $758 million in 2007 from $748 million in 2006 as new business was partially offset by lower prices. The number of new and renewal policies issued, excluding personal accident business which is a new line of business, increased 3% in 2007 (net of policy cancellations). Gross premiums written decreased 3% for primary workers’ compensation and increased 3% for excess workers’ compensation. Gross premiums include assigned risk premiums, which are fully reinsured, of $61 million in 2007 and $67 million in 2006. | ||
| • | Reinsurance gross premiums decreased by 22% to $732 million in 2007 from $941 million in 2006. Casualty gross premiums written decreased 29% to $558 million, and property gross premiums written increased 10% to $174 million. The 2006 premiums include $131 million related to two medical malpractice reinsurance agreements that expired in 2007 and were not renewed. While these agreements contained limits on the potential amount of losses to be paid by the Company, they also contained limits on the potential profits that may be earned by the Company. | ||
| • | International gross premiums increased by 20% to $305 million in 2007 from $255 million in 2006. Gross premiums in the UK and Europe increased 19% as a result of expanded product offerings and from the impact of foreign exchange rates. Gross premiums in Argentina increased 32% as a result of higher price levels. |
Net Premiums Earned. Net premiums earned decreased 1% to $4,664 million from $4,693 million in 2006. Insurance premiums are earned ratably over the policy term, and therefore premiums earned in 2007 are related to business written during both 2007 and 2006. The 1% decrease for 2007 earned premiums reflects the underlying decline in net premiums written in 2007.
14
Net Investment Income. Following is a summary of net investment income for the years ended December 31, 2007 and 2006.
| Average Annualized | ||||||||||||||||
| Amount | Yield | |||||||||||||||
| (Dollars in thousands) | 2007 | 2006 | 2007 | 2006 | ||||||||||||
| Fixed maturity securities, including cash | $ | 500,378 | $ | 441,421 | 4.7 | % | 4.6 | % | ||||||||
| Arbitrage trading account | 80,253 | 74,551 | 9.8 | % | 10.4 | % | ||||||||||
| Equity securities available for sale | 57,502 | 35,662 | 7.0 | % | 6.8 | % | ||||||||||
| Gross investment income | 638,133 | 551,634 | 5.3 | % | 5.1 | % | ||||||||||
| Investment expenses | (3,747 | ) | (2,604 | ) | ||||||||||||
| Total | $ | 634,386 | $ | 549,030 | 5.2 | % | 5.1 | % | ||||||||
Net investment income increased 15% to $634 million in 2007 from $549 million in 2006. Average invested assets (including cash and cash equivalents) increased 13% to $12.1 billion in 2007 from $10.7 billion in 2006 as a result of cash flow from operations.
Income (Loss) from Investment Funds. Following is a summary of income from investment funds for the years ended December 31, 2007 and 2006 (dollars in thousands):
| 2007 | 2006 | |||||||
| Real estate | $ | 25,007 | $ | 23,421 | ||||
| Kiln Ltd | 16,052 | 15,883 | ||||||
| Energy | 1,323 | 2,014 | ||||||
| Other | (4,108 | ) | (4,173 | ) | ||||
| Total | $ | 38,274 | $ | 37,145 | ||||
Income from investment funds was $38.3 million in 2007 as compared to $37.1 million in 2006. Average invested assets increased to $474 million in 2007 from $391 million in 2006.
Insurance Service Fees. The alternative markets segment offers fee-based services to help clients develop and administer self-insurance programs, primarily for workers’ compensation coverage. Service fees were $98 million in 2007, down from $105 million in 2006, primarily as a result of a decline in fees for managing state-sponsored assigned risk plans.
Realized Investment Gains. Realized investment gains result primarily from sales of securities, as well as from provisions for other than temporary impairment in securities. Realized investment gains were $50 million in 2007 compared with $10 million in 2006. Charges for impairment of investments were $2.7 million in 2007 and $0.1 million in 2006. The Company buys and sells securities on a regular basis in order to maximize the total return on investments. Decisions to sell securities are based on management’s view of the underlying fundamentals of specific securities as well as management’s expectations regarding interest rates, credit spreads, currency values and general economic conditions.
Revenues from Wholly-Owned Investees. Revenues from wholly-owned investees were $103 million in 2007. These revenues were derived from two fixed base operators that the Company acquired in 2007. These companies provide services to the general aviation market, including fuel and line service, aircraft sales and maintenance, avionics and engineering services and parts fabrication.
Losses and Loss Expenses. Losses and loss expenses decreased 3% to $2,780 million in 2007 from $2,864 million in 2006. The consolidated loss ratio was 59.6% in 2007 compared with 61.0% in 2006. The 2007 loss ratio reflects favorable prior year loss reserve development of $106 million compared with $27 million of adverse development in 2006. The favorable loss reserve development was primarily related to the specialty segment. The Company also experienced favorable development for the regional, alternative markets and international segments that was partially offset by unfavorable reserve development for the reinsurance segment. The expected loss ratio for premiums earned in 2007 is higher than the expected loss ratio for the preceding year as a result of a decline in average prices. Weather-related losses were $34 million in 2007 compared with $39 million in 2006. A summary of loss ratios in 2007 compared with 2006 by business segment follows:
| • | Specialty’s loss ratio decreased to 57.3% in 2007 from 59.1% in 2006. The decrease reflects the impact of prior year loss reserve changes (favorable loss reserve changes were $97 million in 2007 compared with $6 million in 2006), partially offset by a higher expected loss ratio for accident year 2007 due to a decline in price levels. The favorable loss reserve development was primarily related to general liability business for accident years 2004 through 2006. |
| • | The regional loss ratio decreased to 59.1% in 2007 from 59.7% in 2006. The decrease reflects the impact of prior year loss reserve changes (favorable loss reserve changes were $22 million in 2007 compared with unfavorable loss reserve changes of $16 million in 2006), partially offset by a higher expected loss ratio for accident year 2007 as a result of a decline in price levels. Weather-related losses were $34 million in 2007 compared with $39 million in 2006. |
15
| • | Alternative market’s loss ratio increased to 59.2% from 53.5%. The increase reflects the impact of prior year reserve changes (favorable loss reserve changes were $24 million in 2007 compared to $48 million in 2006). In 2007, favorable loss reserve changes for primary workers’ compensation and medical excess business were offset by unfavorable loss reserve development for excess workers’ compensation business. The expected loss ratio for premiums earned in 2007 is higher than the expected loss ratio for the preceding year as a result of a decline in average prices. | ||
| • | The reinsurance loss ratio decreased to 65.3% in 2007 from 72.0% in 2006. The decrease reflects improved underwriting results from treaty reinsurance business and the Company’s participation in business underwritten at Lloyd’s. Prior year loss reserves increased by $44 million in 2007 compared with $69 million in 2006. | ||
| • | The international loss ratio decreased to 62.6% in 2007 from 64.2% in 2006. The decrease reflects the impact of prior year loss reserve changes (favorable loss reserve changes were $7 million in 2007 compared with $4 million in 2006). |
Other Operating Costs and Expenses. Following is a summary of other operating costs and expenses for the years ended December 31, 2007 and 2006 (dollars in thousands):
| 2007 | 2006 | |||||||
| Underwriting expenses | $ | 1,330,519 | $ | 1,267,217 | ||||
| Service expenses | 90,561 | 88,961 | ||||||
| Other costs and expenses | 109,907 | 92,988 | ||||||
| Total | $ | 1,530,987 | $ | 1,449,166 | ||||
Underwriting expenses are comprised of commissions paid to agents and brokers, premium taxes and other assessments and internal underwriting costs. Underwriting expenses increased 5% in 2007 primarily as a result of higher compensation costs and agent commissions, including contingent commissions. The consolidated expense ratio (underwriting expenses expressed as a percentage of premiums earned) was 28.5% in 2007 compared with 27.0% in 2006.
Service expenses, which represent the costs associated with the alternative markets and specialty segments’ fee-based business, increased 2% to $91 million.
Other costs and expenses, which represent corporate expenses and foreign currency transaction gains and losses, increased 18% to $110 million primarily as a result of higher costs for incentive compensation programs.
Expenses from Wholly-Owned Investees. Expenses from wholly-owned investees of $96 million in 2007 represent costs associated with revenues from wholly-owned investees described above. These include cost of goods sold related to aircraft and other sales, labor and equipment costs related to repairs and other services and general and administrative expenses.
Interest Expense. Interest expense decreased 4% to $89 million as a result of the redemption of $210 million of 8.197% junior subordinated debentures in December 2006, partially offset by the issuance of $250 million of 6.25% senior notes in February 2007.
Income Taxes. The effective income tax rate was 29% in 2007 and 2006. The effective tax rate differs from the federal income tax rate of 35% primarily because of tax-exempt investment income.
16
Investments
As part of its investment strategy, the Company establishes a level of cash and highly liquid short-term and intermediate-term securities that, combined with expected cash flow, it believes adequate to meet payment obligations. The Company also attempts to maintain an appropriate relationship between the average duration of the investment portfolio and the approximate duration of its liabilities, i.e., policy claims and debt obligations.
The Company’s investment portfolio and investment-related assets as of December 31, 2008 were as follows (dollars in thousands):
| Carrying | ||||||||
| Cost | Value | |||||||
| Fixed maturity securities | ||||||||
| United States government and government agencies | $ | 1,083,677 | $ | 1,126,684 | ||||
| State and municipal | 5,660,588 | 5,660,641 | ||||||
| Mortgage-backed securities | ||||||||
| Agency | 1,125,132 | 1,152,557 | ||||||
| Residential-Prime | 447,669 | 376,916 | ||||||
| Residential-Alt A | 110,192 | 100,125 | ||||||
| Commercial | 74,517 | 51,861 | ||||||
| Total mortgage-backed securities | 1,757,510 | 1,681,459 | ||||||
| Corporate | ||||||||
| Financial | 439,080 | 378,035 | ||||||
| Industrial | 244,232 | 225,090 | ||||||
| Asset-backed | 194,435 | 160,747 | ||||||
| Utilities | 127,640 | 120,998 | ||||||
| Other | 95,020 | 88,603 | ||||||
| Total corporate | 1,100,407 | 973,473 | ||||||
| Foreign government and foreign government agencies | 238,877 | 247,639 | ||||||
| Total fixed maturity securities | 9,841,059 | 9,689,896 | ||||||
| Equity securities available for sale | ||||||||
| Preferred stock Financial | 198,032 | 127,899 | ||||||
| Real estate | 145,001 | 125,517 | ||||||
| Utilities | 56,418 | 49,491 | ||||||
| Total preferred stock | 399,451 | 302,907 | ||||||
| Common stock | 39,343 | 80,843 | ||||||
| Total equity securities available for sale | 438,794 | 383,750 | ||||||
| Arbitrage trading account | 119,485 | 119,485 | ||||||
| Investment in arbitrage funds | 73,435 | 73,435 | ||||||
| Investment funds | 509,928 | 495,533 | ||||||
| Loans receivable | 381,182 | 381,182 | ||||||
| Total investments | $ | 11,363,883 | $ | 11,143,281 | ||||
17
Fixed Maturity Securities. The Company’s investment policy with respect to fixed maturity securities is generally to purchase instruments with the expectation of holding them to their maturity. However, management of the available for sale portfolio is considered necessary to maintain an approximate matching of assets and liabilities as well as to adjust the portfolio as a result of changes in financial market conditions and tax considerations. At December 31, 2008 (as compared to December 31, 2007), the fixed maturity securities portfolio mix was as follows: U.S. government securities were 12% (15% in 2007); state and municipal securities were 58% (53% in 2007); corporate securities were 10% (11% in 2007); mortgage-backed securities were 17% (18% in 2007); and foreign government bonds were 3% (3% in 2007).
The Company’s philosophy related to holding or selling fixed maturity securities is based on its objective of maximizing total return. The key factors that management considers in its investment decisions as to whether to hold or sell fixed maturity securities are its view of the underlying fundamentals of specific securities as well as its expectations regarding interest rates, credit spreads and currency values. In a period in which management expects interest rates to rise, the Company may sell longer duration securities in order to mitigate the impact of an interest rate rise on the market value of the portfolio. Similarly, in a period in which management expects credit spreads to widen, the Company may sell lower quality securities, and in a period in which management expects certain foreign currencies to decline in value, the Company may sell securities denominated in those foreign currencies. The sale of fixed maturity securities in order to achieve the objective of maximizing total return may result in realized gains; however, there is no reason to expect these gains to continue in future periods.
Equity Securities Available for Sale. Equity securities available for sale primarily represent investments in common and preferred stocks of publicly traded REITs, financial companies and utilities.
Arbitrage Trading Account. The arbitrage trading account is comprised of direct investments in arbitrage securities. Merger arbitrage is the business of investing in the securities of publicly held companies that are the targets in announced tender offers and mergers.
Investment in Arbitrage Funds. Investment in merger arbitrage funds represents investments in limited partnerships that specialize in merger arbitrage, convertible arbitrage and relative value arbitrage. Convertible arbitrage is the business of investing in convertible securities with the goal of capitalizing on price differentials between these securities and their underlying equities. Relative value arbitrage is the business of investing primarily in equity securities with the goal of capitalizing on perceived differences in fundamental values between pairs of companies in similar industries.
Investment Funds. At December 31, 2008 and 2007, the Company’s investment in partnerships and affiliates was $496 million and $546 million, respectively, and included investments in real estate funds of $292 million and $294 million, respectively. In March 2008, the Company sold its 20.1% interest in Kiln Ltd for $174 million and reported a realized investment gain of $70 million.
Loans Receivable. Loans receivable represent commercial real estate mortgage loans and bank loans with maturities of five years or less and floating, LIBOR-based interest rates.
Market Risk. The Company’s market risk generally represents the risk of gain or loss that may result from the potential change in the fair value of the Company’s investment portfolio as a result of fluctuations in credit quality and interest rates. The Company uses various models and stress test scenarios to monitor and manage interest rate risk. In addition, the Company’s international businesses and securities are subject to currency exchange rate risk. As discussed above, the Company attempts to manage its interest rate risk by maintaining an appropriate relationship between the average duration of the investment portfolio and the approximate duration of its liabilities, i.e., policy claims and debt obligations. The average duration for the fixed income portfolio was 3.1 years and 3.3 years at December 31, 2008 and 2007, respectively.
The following table outlines the groups of fixed maturity securities and the components of the interest rate risk at December 31, 2008:
| Effective | ||||||||
| Duration | Fair Value | |||||||
| (Years) | (000s) | |||||||
| Cash and cash equivalents | 0.1 | $ | 1,134,835 | |||||
| U. S. government securities | 3.3 | 1,126,684 | ||||||
| State and municipal | 4.4 | 5,657,690 | ||||||
| Corporate | 3.0 | 973,774 | ||||||
| Foreign | 1.9 | 247,639 | ||||||
| Mortgage-backed securities | 1.4 | 1,685,849 | ||||||
| Loans receivable | 1.3 | 328,868 | ||||||
| Total | 3.1 | $ | 11,155,339 | |||||
18
Duration is a common gauge of the price sensitivity of a fixed income portfolio to a change in interest rates. The Company determines the estimated change in fair value of the fixed maturity securities, assuming immediate parallel shifts in the treasury yield curve while keeping spreads between
individual securities and treasury securities static. The fair value at specified levels at December 31, 2008 would be as follows:
| Estimated Fair Value of | Estimated Change in | |||||||
| Fixed Maturity Securities | Fair Value | |||||||
Change in interest rates | (000s) | (000s) | ||||||
| 300 basis point rise | $ | 10,112,489 | $ | (1,042,849 | ) | |||
| 200 basis point rise | 10,456,005 | (699,333 | ) | |||||
| 100 basis point rise | 10,803,593 | (351,745 | ) | |||||
| Base scenario | 11,155,338 | — | ||||||
| 100 basis point decline | 11,510,987 | 355,649 | ||||||
| 200 basis point decline | 11,870,790 | 715,452 | ||||||
| 300 basis point decline | 12,234,667 | 1,079,329 | ||||||
Arbitrage investing differs from other types of investments in that its focus is on transactions and events believed likely to bring about a change in value over a relatively short time period (usually four months or less). The Company believes that this makes arbitrage investments less vulnerable to changes in general stock market conditions. Potential changes in market conditions are also mitigated by the implementation of hedging strategies, including short sales. Additionally, the arbitrage positions are generally hedged against market declines by purchasing put options, selling call options or entering into swap contracts. The Company’s merger arbitrage securities are primarily exposed to the risk of completion of announced deals, which are subject to regulatory as well as transactional and other risks.
Liquidity and Capital Resources
Cash Flow.Cash flow provided from operating activities was $1.6 billion in 2008, $1.5 billion in 2007 and $1.6 billion in 2006. The levels of cash flow provided by operating activities over these years, which are high by historical measures in relation to both earned premiums and net income, are a result of growth in investment income and relatively low paid losses. Cash flow provided by operating activities in 2008 is net of cash transfers from the arbitrage trading account of $554 million, and in 2006 is net of cash transfers to the arbitrage trading account of $225 million.
As a holding company, the Company derives cash from its subsidiaries in the form of dividends, tax payments and management fees. Maximum amounts of dividends that can be paid without regulatory approval are prescribed by statute. During 2009, the maximum amount of dividends which can be paid without regulatory approval is approximately $392 million. The ability of the holding company to service its debt obligations is limited by the ability of the insurance subsidiaries to pay dividends. In the event dividends, tax payments and management fees available to the holding company were inadequate to service its debt obligations, the Company would need to raise capital, sell assets or restructure its debt obligations.
The Company’s insurance subsidiaries’ principal sources of cash are premiums, investment income, service fees and proceeds from sales and maturities of portfolio investments. The principal uses of cash are payments for claims, taxes, operating expenses and dividends. The Company expects its insurance subsidiaries to fund the payment of losses with cash received from premiums, investment income and fees. The Company targets an average duration for its investment portfolio that is within one year of the average duration of its liabilities so that portions of its investment portfolio mature throughout the claim cycle and are available for the payment of claims if necessary. In the event operating cash flow and proceeds from maturities and prepayments of fixed income securities are not sufficient to fund claim payments and other cash requirements, the remainder of the Company’s cash and investments is available to pay claims and other obligations as they become due. The Company’s investment portfolio is highly liquid, with approximately 86% invested in cash, cash equivalents and marketable fixed income securities as of December 31, 2008. If the sale of fixed income securities were to become necessary, a realized gain or loss equal to the difference between the cost and sales price of securities sold would be recognized.
19
Financing Activity
During 2008, the Company repurchased 20,677,144 shares of its common stock for $553 million. The Company repaid $12 million of subsidiary debt in January 2008 and $89 million of 9.875% senior notes in May 2008.
In February 2007, the Company issued $250 million of 6.25% senior notes due on February 15, 2037. During 2007, the Company repurchased 16,130,773 shares (including 963,773 shares purchased in connection with the Company’s stock option program) of its common stock for $489 million.
During 2006, the Company repaid $100 million of 6.25% senior notes at their maturity in January 2006. The Company also repaid $210 million of junior subordinated debentures on December 15, 2006 contemporaneously with the redemption of $210 million of 8.197% trust preferred securities by the W. R. Berkley Capital Trust. This amount included preferred securities already repurchased by the Company.
At December 31, 2008, the Company had senior notes, junior subordinated debentures and other debt outstanding with a carrying value of $1,271 million and a face amount of $1,287 million. The maturities of the outstanding debt are $1 million in 2009, $150 million in 2010, $3 million in 2012, $200 million in 2013, $200 million in 2015, $150 million in 2019, $76 million in 2022, $7 million in 2035 (prepayable in 2010), $250 million in 2037 and $250 million in 2045 (prepayable in 2010).
At December 31, 2008, stockholders’ equity was $3.0 billion and total capitalization (stockholders’ equity, senior notes, junior subordinated debentures and other debt) was $4.3 billion. The percentage of the Company’s capital attributable to senior notes and other debt and junior subordinated debentures was 29% at December 31, 2008, compared with 28% at December 31, 2007.
Federal and Foreign Income Taxes
The Company files a consolidated income tax return in the U.S. and foreign tax returns in each of the countries in which it has overseas operations. At December 31, 2008, the Company had a deferred tax asset, net of valuation allowance, of $542 million (which primarily relates to loss and loss expense reserves, unrealized investment losses and unearned premium reserves), and a deferred tax liability of $212 million (which primarily relates to deferred policy acquisition costs and intangible assets). The realization of the deferred tax asset is dependent upon the Company’s ability to generate sufficient taxable income in future periods. Based on historical results and the prospects for future operations, management anticipates that it is more likely than not that future taxable income will be sufficient for the realization of this asset.
Reinsurance
The Company follows customary industry practice of reinsuring a portion of its exposures, paying reinsurers a part of the premiums received on the policies it writes. Reinsurance is purchased by the Company principally to reduce its net liability on individual risks and to protect it against catastrophic losses. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, it does make the assuming reinsurer liable to the insurer to the extent of the reinsurance coverage. The Company monitors the financial condition of its reinsurers and attempts to place its coverages only with substantial and financially sound carriers.
For 2009, the Company’s property catastrophe reinsurance provides protection for 100% of the net loss between $10 million and $85 million, and its casualty contingency agreement provides protection for 100% of the net loss between $2 million and $30 million. The catastrophe and casualty contingency reinsurance agreements are subject to certain limits, exclusions and reinstatement premiums. For business written through Lloyd’s, the Company has separate catastrophe excess of loss and quota share agreements secured through its Lloyd’s general agents.
Contractual Obligations
Following is a summary of the Company’s contractual obligations as of December 31, 2008 (amounts in thousands):
| Estimated Payments By Periods | 2009 | 2010 | 2011 | 2012 | 2013 | Thereafter | ||||||||||||||||||
| Gross reserves for losses | $ | 2,210,784 | $ | 1,601,009 | $ | 1,265,431 | $ | 963,112 | $ | 723,821 | $ | 3,179,821 | ||||||||||||
| Operating lease obligations | 23,803 | 21,103 | 17,280 | 13,391 | 10,214 | 25,576 | ||||||||||||||||||
| Purchase obligations | 8,143 | 1,576 | 6,037 | 15,000 | 31,500 | — | ||||||||||||||||||
| Junior subordinated debentures | — | — | — | — | — | 257,217 | ||||||||||||||||||
| Senior notes | 719 | 150,000 | — | 3,030 | 200,000 | 676,503 | ||||||||||||||||||
| Other long-term liabilities | 57,973 | 25,888 | 9,084 | 2,049 | 615 | 40,722 | ||||||||||||||||||
| Total | $ | 2,301,422 | $ | 1,799,576 | $ | 1,297,832 | $ | 996,582 | $ | 966,150 | $ | 4,179,839 | ||||||||||||
20
The estimated payments for reserves for losses and loss expenses in the above table represent the projected (undiscounted) payments for gross loss and loss expense reserves related to losses incurred as of December 31, 2008. The estimated payments in the above table do not consider payments for losses to be incurred in future periods. These amounts include reserves for reported losses and reserves for incurred but not reported losses. Estimated amounts recoverable from reinsurers are not reflected. The estimated payments by year are based on historical loss payment patterns. The actual payments may differ from the estimated amounts due to changes in ultimate loss reserves and in the timing of the settlement of those reserves.
The Company utilizes letters of credit to back certain reinsurance payments and obligations. Outstanding letters of credit were $56 million as of December 31, 2008. The Company has made certain guarantees to state regulators that the statutory capital of certain subsidiaries will be maintained above certain minimum levels. In addition, the Company has commitments to invest up to $253 million in certain investment funds.
Off-Balance Sheet Arrangements
An off-balance sheet arrangement is any transaction, agreement or other contractual arrangement involving an unconsolidated entity under which a company has (1) made guarantees, (2) a retained or contingent interest in transferred assets, (3) an obligation under derivative instruments classified as equity or (4) any obligation arising out of a material variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the Company, or that engages in leasing, hedging or research and development arrangements with the Company. The Company has no arrangements of these types that management believes may have a material current or future effect on our financial condition, liquidity or results of operations.
Management’s Report on Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of Treadway Commission. Based on our evaluation under the framework in Internal Control – Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2008.
21
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
W. R. Berkley Corporation:
W. R. Berkley Corporation:
We have audited W. R. Berkley Corporation and subsidiaries’ (the “Company”) internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2008, and our report dated February 27, 2009 expressed an unqualified opinion on those consolidated financial statements.
KPMG LLP
New York, New York
February 27, 2009
February 27, 2009
22
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
W. R. Berkley Corporation:
W. R. Berkley Corporation:
We have audited the accompanying consolidated balance sheets of W. R. Berkley Corporation and subsidiaries (the “Company”) as of December 31, 2008 and 2007 and the related consolidated statements of income, stockholders’ equity, comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008, based on the criteria established in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 27, 2009 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
KPMG LLP
New York, New York
February 27, 2009
February 27, 2009
23
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
| Years Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| Revenues: | ||||||||||||
| Net premiums written | $ | 4,033,899 | $ | 4,575,989 | $ | 4,818,993 | ||||||
| Change in net unearned premiums | 255,681 | 87,712 | (126,371 | ) | ||||||||
| Net premiums earned | 4,289,580 | 4,663,701 | 4,692,622 | |||||||||
| Net investment income | 537,033 | 634,386 | 549,030 | |||||||||
| Income (loss) from investment funds | (3,553 | ) | 38,274 | 37,145 | ||||||||
| Insurance service fees | 102,856 | 97,689 | 104,812 | |||||||||
| Realized investment gains (losses) | (356,931 | ) | 49,696 | 9,648 | ||||||||
| Revenues from wholly-owned investees | 137,280 | 102,846 | — | |||||||||
| Other income | 2,543 | 1,805 | 1,574 | |||||||||
| Total revenues | $ | 4,708,808 | $ | 5,588,397 | $ | 5,394,831 | ||||||
| Operating costs and expenses: | ||||||||||||
| Losses and loss expenses | 2,688,661 | 2,779,578 | 2,864,498 | |||||||||
| Other operating costs and expenses | 1,475,165 | 1,530,987 | 1,449,166 | |||||||||
| Expenses from wholly-owned investees | 134,037 | 96,444 | — | |||||||||
| Interest expense | 84,623 | 88,996 | 92,522 | |||||||||
| Total expenses | $ | 4,382,486 | $ | 4,496,005 | $ | 4,406,186 | ||||||
| Income before income taxes and minority interest | 326,322 | 1,092,392 | 988,645 | |||||||||
| Income tax expense | (44,919 | ) | (323,070 | ) | (286,398 | ) | ||||||
| Minority interest | (262 | ) | (3,083 | ) | (2,729 | ) | ||||||
| Net income | $ | 281,141 | $ | 766,239 | $ | 699,518 | ||||||
| Earnings per share: | ||||||||||||
| Basic | $ | 1.68 | $ | 4.05 | $ | 3.65 | ||||||
| Diluted | $ | 1.62 | $ | 3.90 | $ | 3.46 | ||||||
See accompanying notes to consolidated financial statements.
24
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(Dollars in thousands)
| December 31, | ||||||||
| 2008 | 2007 | |||||||
Assets | ||||||||
| Investments: | ||||||||
| Fixed maturity securities | $ | 9,689,896 | $ | 9,840,291 | ||||
| Equity securities available for sale | 383,750 | 726,562 | ||||||
| Arbitrage trading account | 119,485 | 301,786 | ||||||
| Investment in arbitrage funds | 73,435 | 210,740 | ||||||
| Investment funds | 495,533 | 545,937 | ||||||
| Loans receivable | 381,182 | 331,401 | ||||||
| Total Investments | 11,143,281 | 11,956,717 | ||||||
| Cash and cash equivalents | 1,134,835 | 951,863 | ||||||
| Premiums and fees receivable | 1,056,096 | 1,199,002 | ||||||
| Due from reinsurers | 931,115 | 904,509 | ||||||
| Accrued investment income | 122,461 | 134,872 | ||||||
| Prepaid reinsurance premiums | 181,462 | 179,495 | ||||||
| Deferred policy acquisition costs | 394,807 | 455,244 | ||||||
| Real estate, furniture and equipment | 260,522 | 204,252 | ||||||
| Deferred federal and foreign income taxes | 329,417 | 174,504 | ||||||
| Goodwill | 107,564 | 102,462 | ||||||
| Trading account receivable from brokers and clearing organizations | 128,883 | 409,926 | ||||||
| Due from broker | 138,411 | 130 | ||||||
| Current federal and foreign income taxes | 76,491 | — | ||||||
| Other assets | 115,813 | 147,029 | ||||||
| Total Assets | $ | 16,121,158 | $ | 16,820,005 | ||||
Liabilities and Stockholders’ Equity | ||||||||
| Liabilities: | ||||||||
| Reserves for losses and loss expenses | $ | 8,999,596 | $ | 8,678,034 | ||||
| Unearned premiums | 1,966,150 | 2,240,690 | ||||||
| Due to reinsurers | 114,974 | 108,178 | ||||||
| Trading account securities sold but not yet purchased | 23,050 | 67,139 | ||||||
| Other liabilities | 694,255 | 726,932 | ||||||
| Junior subordinated debentures | 249,584 | 249,375 | ||||||
| Senior notes and other debt | 1,021,869 | 1,121,793 | ||||||
| Total Liabilities | 13,069,478 | 13,192,141 | ||||||
| Minority interest | 5,361 | 35,496 | ||||||
| Stockholders’ equity: | ||||||||
| Preferred stock, par value $.10 per share: | ||||||||
| Authorized 5,000,000 shares, issued and outstanding – none | — | — | ||||||
| Common stock, par value $.20 per share: | ||||||||
| Authorized 500,000,000 shares, issued and outstanding, net of treasury shares, 161,467,131 and 180,320,775 shares | 47,024 | 47,024 | ||||||
| Additional paid-in capital | 920,241 | 907,016 | ||||||
| Retained earnings | 3,514,531 | 3,271,355 | ||||||
| Accumulated other comprehensive income (loss) | (228,959 | ) | 53,201 | |||||
| Treasury stock, at cost, 73,650,787 and 54,797,143 shares | (1,206,518 | ) | (686,228 | ) | ||||
| Total Stockholders’ Equity | 3,046,319 | 3,592,368 | ||||||
| Total Liabilities and Stockholders’ Equity | $ | 16,121,158 | $ | 16,820,005 | ||||
See accompanying notes to consolidated financial statements.
25
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(Dollars in thousands)
| Years Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
Common stock: | ||||||||||||
| Beginning of period | $ | 47,024 | $ | 47,024 | $ | 47,024 | ||||||
| Stock issued | — | — | — | |||||||||
| End of period | $ | 47,024 | $ | 47,024 | $ | 47,024 | ||||||
Additional paid in capital: | ||||||||||||
| Beginning of period | $ | 907,016 | $ | 859,787 | $ | 821,050 | ||||||
| Stock options exercised, including tax benefits | (10,520 | ) | 26,510 | 20,965 | ||||||||
| Restricted stock units expensed | 23,239 | 19,541 | 15,323 | |||||||||
| Stock options expensed | 214 | 794 | 1,755 | |||||||||
| Stock issued to directors and others | 292 | 384 | 694 | |||||||||
| End of period | $ | 920,241 | $ | 907,016 | $ | 859,787 | ||||||
Retained earnings: | ||||||||||||
| Beginning of period | $ | 3,271,355 | $ | 2,542,744 | $ | 1,873,953 | ||||||
| Net income | 281,141 | 766,239 | 699,518 | |||||||||
| Dividends | (37,965 | ) | (37,628 | ) | (30,727 | ) | ||||||
| End of period | $ | 3,514,531 | $ | 3,271,355 | $ | 2,542,744 | ||||||
Accumulated other comprehensive income (loss), net of tax: | ||||||||||||
| Unrealized investment gains (losses): | ||||||||||||
| Beginning of period | $ | 52,497 | $ | 121,961 | $ | 40,746 | ||||||
| Net change in period | (194,713 | ) | (69,464 | ) | 81,215 | |||||||
| End of period | (142,216 | ) | 52,497 | 121,961 | ||||||||
| Currency translation adjustments: | ||||||||||||
| Beginning of period | 18,060 | 3,748 | (15,843 | ) | ||||||||
| Net change in period | (90,535 | ) | 14,312 | 19,591 | ||||||||
| End of period | (72,475 | ) | 18,060 | 3,748 | ||||||||
| Net pension asset: | ||||||||||||
| Beginning of period | (17,356 | ) | (14,096 | ) | — | |||||||
| Net change in period | 3,088 | (3,260 | ) | — | ||||||||
| Adoption of FAS 158, net of taxes | — | — | (14,096 | ) | ||||||||
| End of period | (14,268 | ) | (17,356 | ) | (14,096 | ) | ||||||
| Total accumulated other comprehensive income (loss) | $ | (228,959 | ) | $ | 53,201 | $ | 111,613 | |||||
Treasury stock: | ||||||||||||
| Beginning of period | $ | (686,228 | ) | $ | (226,009 | ) | $ | (199,853 | ) | |||
| Stock options exercised | 32,195 | 28,455 | 18,816 | |||||||||
| Stock issued to directors and others | 799 | 117 | 89 | |||||||||
| Stock repurchased | (553,284 | ) | (488,791 | ) | (45,061 | ) | ||||||
| End of period | $ | (1,206,518 | ) | $ | (686,228 | ) | $ | (226,009 | ) | |||
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)
(Dollars in thousands)
| Years Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| Net income | $ | 281,141 | $ | 766,239 | $ | 699,518 | ||||||
| Unrealized holding gains (losses) on investment securities arising during the period, net of income taxes | (426,671 | ) | (37,230 | ) | 88,329 | |||||||
| Reclassification adjustment for realized (gains) losses included in net income, net of income taxes | 231,958 | (32,234 | ) | (7,114 | ) | |||||||
| Change in unrealized foreign exchange gains (losses) | (90,535 | ) | 14,312 | 19,591 | ||||||||
| Change in unrecognized pension obligation, net of income taxes | 3,088 | (3,260 | ) | (14,096 | ) | |||||||
| Other comprehensive income (loss) | (282,160 | ) | (58,412 | ) | 86,710 | |||||||
| Comprehensive income (loss) | $ | (1,019 | ) | $ | 707,827 | $ | 786,228 | |||||
See accompanying notes to consolidated financial statements.
26
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Dollars in thousands)
| Years Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| Cash from operating activities: | ||||||||||||
| Net income | $ | 281,141 | $ | 766,239 | $ | 699,518 | ||||||
| Adjustments to reconcile net income to net cash flows from operating activities: | ||||||||||||
| Realized investment (gains) losses | 356,931 | (49,696 | ) | (9,648 | ) | |||||||
| Depreciation and amortization | 83,953 | 73,697 | 65,674 | |||||||||
| Minority interest | 262 | 3,083 | 2,729 | |||||||||
| Equity in undistributed earnings of investment funds | 8,550 | (25,202 | ) | (26,986 | ) | |||||||
| Stock incentive plans | 24,139 | 21,105 | 17,888 | |||||||||
| Change in: | ||||||||||||
| Securities trading account | 182,301 | 152,188 | 4,313 | |||||||||
| Investments in arbitrage funds | 137,305 | (21,888 | ) | (52,548 | ) | |||||||
| Trading account receivable from brokers and clearing organizations | 281,043 | (97,706 | ) | (213,991 | ) | |||||||
| Trading account securities sold but not yet purchased | (44,089 | ) | (102,936 | ) | (28,351 | ) | ||||||
| Premiums and fees receivable | 117,128 | 50,925 | (133,504 | ) | ||||||||
| Due from reinsurers | (35,760 | ) | 45,995 | 27,839 | ||||||||
| Accrued investment income | 11,103 | (18,066 | ) | (15,383 | ) | |||||||
| Prepaid reinsurance premiums | (8,744 | ) | (10,242 | ) | 9,671 | |||||||
| Deferred policy acquisition costs | 53,332 | 7,834 | (25,848 | ) | ||||||||
| Deferred income taxes | (57,321 | ) | (5,060 | ) | (35,554 | ) | ||||||
| Other assets | 36,227 | (48,383 | ) | 6,817 | ||||||||
| Reserves for losses and loss expenses | 416,235 | 798,725 | 1,051,816 | |||||||||
| Unearned premiums | (238,557 | ) | (75,044 | ) | 117,176 | |||||||
| Due to reinsurers | 21,645 | (42,212 | ) | 60,450 | ||||||||
| Other liabilities | (73,864 | ) | 26,528 | 44,092 | ||||||||
| Net cash from operating activities | 1,552,960 | 1,449,884 | 1,566,170 | |||||||||
| Cash flows used in investing activities: | ||||||||||||
| Proceeds from sales, excluding trading account: | ||||||||||||
| Fixed maturity securities | 1,006,604 | 2,065,004 | 922,442 | |||||||||
| Equity securities | 62,254 | 480,867 | 200,950 | |||||||||
| Distributions from investment funds | 184,621 | 132,268 | 52,181 | |||||||||
| Proceeds from maturities and prepayments of fixed maturity securities | 997,171 | 984,504 | 1,322,277 | |||||||||
| Cost of purchases, excluding trading account: | ||||||||||||
| Fixed maturity securities | (2,230,222 | ) | (3,716,828 | ) | (2,862,906 | ) | ||||||
| Equity securities | (172,306 | ) | (551,253 | ) | (543,041 | ) | ||||||
| Contributions to investment funds | (148,039 | ) | (127,134 | ) | (143,772 | ) | ||||||
| Change in loans receivable | (48,524 | ) | (208,148 | ) | (67,089 | ) | ||||||
| Net additions to real estate, furniture and equipment | (78,947 | ) | (31,108 | ) | (42,593 | ) | ||||||
| Change in balances due to (from) security brokers | (138,281 | ) | 1,412 | — | ||||||||
| Payment for business purchased, net of cash acquired | (48,895 | ) | (50,162 | ) | — | |||||||
| Proceeds from sale of business, net of cash divested | — | 2,939 | — | |||||||||
| Other, net | — | — | (6,025 | ) | ||||||||
| Net cash used in investing activities | (614,564 | ) | (1,017,639 | ) | (1,167,576 | ) | ||||||
| Cash flows used in financing activities: | ||||||||||||
| Net proceeds from issuance of senior notes | — | 246,644 | — | |||||||||
| Receipts credited to policyholders’ account balances | — | 3,431 | 16,748 | |||||||||
| Bank deposits received | 17,795 | 7,572 | 10,211 | |||||||||
| Advances from federal home loan bank | 6,325 | (655 | ) | (7,375 | ) | |||||||
| Net proceeds from stock options exercised | 14,806 | 25,676 | 19,405 | |||||||||
| Purchase of junior subordinated debentures | — | — | (210,000 | ) | ||||||||
| Repayment of senior notes | (102,123 | ) | (2,019 | ) | (100,000 | ) | ||||||
| Cash dividends to common stockholders | (46,978 | ) | (36,284 | ) | (29,430 | ) | ||||||
| Purchase of common treasury shares | (553,284 | ) | (488,794 | ) | (45,062 | ) | ||||||
| Other, net | 168 | 271 | 2,762 | |||||||||
| Net cash used in financing activities | (663,291 | ) | (244,158 | ) | (342,741 | ) | ||||||
| Net impact on cash due to change in foreign exchange rates | (92,133 | ) | 9,529 | 25,453 | ||||||||
| Net increase in cash and cash equivalents | 182,972 | 197,616 | 81,306 | |||||||||
| Cash and cash equivalents at beginning of year | 951,863 | 754,247 | 672,941 | |||||||||
| Cash and cash equivalents at end of year | $ | 1,134,835 | $ | 951,863 | $ | 754,247 | ||||||
See accompanying notes to consolidated financial statements.
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the years ended December 31, 2008, 2007 and 2006
For the years ended December 31, 2008, 2007 and 2006
(1) Summary of Significant Accounting Policies
(A) Principles of consolidation and basis of presentation
The consolidated financial statements, which include the accounts of W. R. Berkley Corporation and its subsidiaries (the “Company”), have been prepared on the basis of U. S. generally accepted accounting principles (“GAAP”). All significant intercompany transactions and balances have been eliminated. Reclassifications have been made in the 2007 and 2006 financial statements to conform them to the presentation of the 2008 financial statements. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the revenues and expenses reflected during the reporting period. The most significant items on our balance sheet that involve a greater degree of accounting estimates that are subject to change in the future are the valuation of investments, other than temporary impairments, loss and loss adjustment expense reserves and premium estimates. Current market conditions increase the risk and complexity of the judgments in these estimates. Actual results could differ from those estimates.
(B) Revenue recognition
Premiums written are recorded at the inception of the policy. Reinsurance premiums written are estimated based upon information received from ceding companies and subsequent differences arising on such estimates are recorded in the period they are determined. Insurance premiums are earned ratably over the policy term. Fees for services are earned over the period that services are provided.
Audit premiums are recognized when they are reliably determinable. The accrual for earned but unbilled audit premiums decreased net premiums written and premiums earned by $28 million in 2008, and increased net premiums written and premiums earned by $10 million in 2007 and $22 million in 2006.
Revenues from wholly-owned investees are derived from services provided to the general aviation market, including fuel and line service, aircraft sales and maintenance, avionics and engineering services and parts fabrication. Revenue is recognized upon delivery of aircraft, delivery of fuel, shipment of parts and or upon completion of services.
(C) Cash and cash equivalents
Cash equivalents consist of funds invested in money market accounts and investments with an effective maturity of three months or less when purchased.
(D) Investments
Fixed maturity securities classified as available for sale are carried at estimated fair value, with unrealized gains and losses, net of applicable income taxes, excluded from earnings and reported as a component of comprehensive income and a separate component of stockholders’ equity. Fixed maturity securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost. Premiums and discounts are amortized using the effective interest method. Premiums and discounts on mortgage-backed and asset-backed securities are adjusted for the effects of actual and anticipated prepayments on a retrospective basis.
Equity securities classified as available for sale are carried at estimated fair value, with unrealized gains and losses, net of applicable income taxes, excluded from earnings and reported as a component of comprehensive income and a separate component of stockholders’ equity.
Equity securities that the Company purchased with the intent to sell in the near-term are classified as trading account securities and are reported at estimated fair value. Realized and unrealized gains and losses from trading activity are reported as net investment income. The trading account includes direct investments in arbitrage securities and investments in arbitrage-related limited partnerships. Short sales and short call options are presented as trading securities sold but not yet purchased. Unsettled trades and the net margin balances held by the clearing broker are presented as trading account receivable from brokers and clearing organizations.
Investment funds are carried under the “equity method of accounting”, whereby the Company reports its share of the income or loss from such investments as net investment income. The Company’s share of the earnings of investment funds is generally reported on a one-quarter lag in order to facilitate the timely completion of the Company’s financial statements.
Loans receivable represent commercial real estate mortgage loans and bank loans and are carried at amortized cost.
28
Fair value is generally determined based on either quoted market prices. For publicly traded securities for which quoted prices are unavailable, the Company determines fair value based on independent broker quotations and other observable market data. For securities traded only in private negotiations, the Company determines fair value based primarily on the cost of such securities, which is adjusted to reflect prices of recent placements of securities of the same issuer, financial data, projections and business developments of the issuer and other relevant information.
Realized gains or losses represent the difference between the cost of securities sold and the proceeds realized upon sale. The cost of securities is adjusted where appropriate to include a provision for decline in value which is considered to be other than temporary. An other than temporary decline is considered to occur in investments where there has been a sustained reduction in market value and where the Company does not expect the fair value to recover prior to the time of sale or maturity. Since equity securities do not have a contractual cash flow at maturity, the Company considers whether the price of an equity security is expected to recover within a reasonable period of time. The Company uses the specific identification method where possible, and the first-in, first-out method in other instances, to determine the cost of securities sold. Realized gains or losses, including any provision for decline in value, are included in the statement of income.
(E) Per share data
The Company presents both basic and diluted earnings per share (“EPS”) amounts. Basic EPS is calculated by dividing net income by weighted average number of common shares outstanding during the year. Diluted EPS is based upon the weighted average number of common and common equivalent shares outstanding during the year and is calculated using the treasury stock method for stock incentive plans. Common equivalent shares are excluded from the computation in periods in which they have an anti-dilutive effect. Stock options for which the exercise price exceeds the average market price over the period have an anti-dilutive effect on EPS and, accordingly, are excluded from the calculation.
(F) Deferred policy acquisition costs
Acquisition costs (primarily commissions and premium taxes) incurred in writing insurance and reinsurance business are deferred and amortized ratably over the terms of the related contracts. Deferred policy acquisition costs are limited to the amounts estimated to be recoverable from the applicable unearned premiums and the related anticipated investment income after giving effect to anticipated losses, loss adjustment expenses and expenses necessary to maintain the contracts in force.
(G) Reserves for losses and loss expenses
Reserves for losses and loss expenses are an accumulation of amounts determined on the basis of (1) evaluation of claims for business written directly by the Company; (2) estimates received from other companies for reinsurance assumed by the Company; and (3) estimates for losses incurred but not reported (based on Company and industry experience). These estimates are periodically reviewed and, as experience develops and new information becomes known, the reserves are adjusted as necessary. Such adjustments are reflected in the statement of income in the period in which they are determined. The Company discounts its reserves for excess and assumed workers’ compensation claims using a risk-free or statutory rate. (See Note 11 of Notes to Consolidated Financial Statements.)
(H) Reinsurance ceded
The unearned portion of premiums ceded to reinsurers is reported as prepaid reinsurance premiums. The estimated amounts of reinsurance recoverable on unpaid losses are reported as due from reinsurers. To the extent any reinsurer does not meet its obligations under reinsurance agreements, the Company must discharge its liability. Amounts due from reinsurers are reflected net of funds held where the right of offset is present. The Company has provided reserves for estimated uncollectible reinsurance.
(I) Deposit accounting
Contracts that do not meet the risk transfer provisions of FAS 113, “Accounting and Reporting for Reinsurance of Short Duration and Long Duration Contracts,” are accounted for using the deposit accounting method. Under this method, an asset or liability is recognized at the inception of the contract based on consideration paid or received. The amount of the deposit asset or liability is adjusted at subsequent reporting dates using the interest method with a corresponding credit or charge to interest income or expense. Deposit liabilities for assumed reinsurance contracts were $45 million and $48 million at December 31, 2008 and 2007, respectively.
(J) Federal and foreign income taxes
The Company files a consolidated income tax return in the U.S. and foreign tax returns in each of the countries in which it has its overseas operations. The Company’s method of accounting for income taxes is the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are measured using tax rates currently in effect or expected to apply in the years in which those temporary differences are expected to reverse. Interest and penalties, if any, are reported as income tax expense.
29
(K) Foreign currency
Gains and losses resulting from foreign currency transactions (transactions denominated in a currency other than the entity’s functional currency) are included in the statement of income. Unrealized gains or losses resulting from translating the results of non-U.S. dollar denominated operations are reported as accumulated other comprehensive income. Revenues and expenses denominated in currencies other than U.S. dollars are translated at the weighted average exchange rate during the year. Assets and liabilities are translated at the rate of exchange in effect at the balance sheet date.
(L) Real estate, furniture and equipment
Real estate, furniture and equipment are carried at cost less accumulated depreciation. Depreciation is calculated using the estimated useful lives of the respective assets. Depreciation expense was $37,843,000, $32,766,000 and $29,614,000 for 2008, 2007 and 2006, respectively.
(M) Comprehensive income
Comprehensive income encompasses all changes in stockholders’ equity (except those arising from transactions with stockholders) and includes net income, net unrealized holding gains or losses on available for sale securities, unrealized foreign currency translation adjustments and changes in unrecognized pension obligations.
(N) Goodwill and other intangible assets
Goodwill and other intangibles assets are tested for impairment on an annual basis. The Company’s impairment test as of December 31, 2008 indicated that there were no impairment losses related to goodwill and other intangible assets.
(O) Stock options
The costs resulting from all share-based payment transactions with employees are recognized in the financial statements using a fair-value-based measurement method.
(P) Statement of cash flows
Interest payments were $84,284,000, $81,291,000 and $93,580,000 in 2008, 2007 and 2006, respectively. Income taxes paid were $181,948,000, $288,763,000 and $295,823,000 in 2008, 2007 and 2006, respectively. Other non-cash items include acquisitions and dispositions, unrealized investment gains and losses and pension expense. (See Note 2, Note 8 and Note 23 of Notes to Consolidated Financial Statements.)
30
(Q) Change in accounting
The Company adopted FASB Interpretation 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes” effective January 1, 2007. The adoption of FIN 48 had no impact on the Company’s financial condition or results of operations. The Company believes there are no tax positions that would require disclosure under FIN 48.
In the fourth quarter of 2008, the Company changed its method of accounting for cash distributions received in excess of the carrying value of an equity method investment provided that the Company is not liable for the obligations of the investee nor otherwise committed to provide financial support. Previously such distributions were reported as a deferred credit and recognized in earnings upon disposal of the Company’s interest in the investee. Under the new method, such distributions are recognized as a realized gain upon receipt. The Company believes that the newly adopted accounting principle is preferable because it better reflects the economics of the transaction. The Company received cash distributions in excess of the carrying value of an investment in 2007, and the accounting change was applied retrospectively to the 2007 financial statements. Adjustments made to the 2007 financial statements as a result of the accounting change were as follows: .
| 2007 | 2007 | |||||||
| As | As | |||||||
| (Dollars in thousands, except per share amounts) | reported | restated | ||||||
| Selected income statement line items: | ||||||||
| Realized investment gains | $ | 14,938 | $ | 49,696 | ||||
| Total revenues | 5,553,639 | 5,588,397 | ||||||
| Income before income taxes and minority interest | 1,057,634 | 1,092,392 | ||||||
| Income tax expense | 310,905 | 323,070 | ||||||
| Net income | 743,646 | 766,239 | ||||||
| Earnings per share: | ||||||||
| Basic | 3.94 | 4.05 | ||||||
| Diluted | 3.78 | 3.90 | ||||||
| Selected balance sheet line items: | ||||||||
| Deferred federal income taxes | $ | 186,669 | $ | 174,504 | ||||
| Total assets | 16,832,170 | 16,820,005 | ||||||
| Other liabilities | 761,690 | 726,932 | ||||||
| Total liabilities | 13,226,899 | 13,192,141 | ||||||
| Retained earnings | 3,248,762 | 3,271,355 | ||||||
| Stockholders’ equity | 3,569,775 | 3,592,368 | ||||||
(R) Recent accounting pronouncements
In December 2007, the FASB issued FAS 141r (revised 2007), “Business Combinations,” and FAS 160, “Noncontrolling Interests in Consolidated Financial Statements.” These standards, which are effective for 2009, will simplify, and converge internationally the accounting for business combinations and the reporting of noncontrolling interests in consolidated financial statements. The Company does not expect the adoption of FAS 141 and 160 to have a material impact on the Company’s financial condition or results of operations.
(2) Acquisitions and Dispositions
In 2008, the Company acquired the following companies for a total cost of $55 million, which was paid primarily in cash.
| • | Summit Aviation, Inc., a fixed based operator located in Middletown, Delaware. | ||
| • | Remaining 20% interest in W. R. Berkley Insurance (Europe), Limited. |
In 2007, the Company acquired the following companies for a total cost of $98 million, which was paid primarily in cash.
| • | Atlantic Aero Holdings, Inc., a fixed base operator located in Greensboro, North Carolina. | ||
| • | Western Acquisition Corp., a fixed base operator located in Boise, Idaho. | ||
| • | Berkley Life and Health Insurance Company (formerly known as Investors Guaranty Life Insurance Company), an inactive, widely licensed life insurance company. | ||
| • | CGH Insurance Group, Inc., the owner of American Mining Insurance Company. |
31
The following table summarizes the estimated fair value of net assets acquired and liabilities assumed at the date of acquisition. The Company has not completed the purchase price allocation for the 2008 acquisitions; as such, the amounts presented below are subject to refinement.
| (Dollars in thousands) | 2008 | 2007 | ||||||
| Investments | $ | — | $ | 66,358 | ||||
| Cash and cash equivalents | 6,112 | 48,114 | ||||||
| Receivables and other assets | — | 27,018 | ||||||
| Real estate, furniture and equipment | 16,541 | 23,387 | ||||||
| Deferred policy acquisition costs | — | 345 | ||||||
| Deferred federal income taxes | (4,815 | ) | 677 | |||||
| Intangible assets | 3,658 | 11,068 | ||||||
| Goodwill | 6,229 | 34,395 | ||||||
| Other assets | 3,696 | 20,918 | ||||||
| Total assets acquired | $ | 31,421 | $ | 232,280 | ||||
| Reserve for losses and loss expenses | (1,570 | ) | 89,906 | |||||
| Unearned premiums | — | 1,977 | ||||||
| Other liabilities | 8,428 | 28,426 | ||||||
| Debt | — | 13,695 | ||||||
| Total liabilities assumed | $ | 6,858 | $ | 134,004 | ||||
| Minority interest | (30,444 | ) | — | |||||
| Net assets acquired | $ | 55,007 | $ | 98,276 | ||||
The weighted average useful life of the intangible assets acquired in 2008 and 2007 was 10 years and 4 years, respectively. Approximately $25 million of the 2007 goodwill is expected to be deductible for tax purposes, none of the 2008 goodwill is expected to be deductible for tax purposes.
In March 2007, the Company sold its interest in Berkley International Philippines, Inc. and its subsidiaries (“BIPI”) for $25 million. The Company reported a pre-tax realized gain of $2 million from the sale of BIPI. BIPI’s revenues were $21 million and $14 million in 2006 and 2005, respectively, and its pre-tax earnings were $4.5 million and $0.5 million in 2006 and 2005, respectively.
(3) Investments in Fixed Maturity Securities
At December 31, 2008 and 2007, investments in fixed maturity securities were as follows:
| (Dollars in thousands) | Gross | Gross | ||||||||||||||||||
| Amortized | Unrealized | Unrealized | Fair | Carrying | ||||||||||||||||
| Type of Investment | Cost | Gains | Losses | Value | Value | |||||||||||||||
| December 31, 2008 | ||||||||||||||||||||
| Held to maturity: | ||||||||||||||||||||
| State and municipal | $ | 68,876 | $ | 742 | $ | (3,693 | ) | $ | 65,925 | $ | 68,876 | |||||||||
| Mortgage-backed securities | 50,039 | 4,390 | — | 54,429 | 50,039 | |||||||||||||||
| Corporate | 4,993 | 301 | — | 5,294 | 4,993 | |||||||||||||||
| Total held to maturity | 123,908 | 5,433 | (3,693 | ) | 125,648 | 123,908 | ||||||||||||||
| Available for sale: | ||||||||||||||||||||
| United States government and government agency | 1,083,677 | 46,713 | (3,706 | ) | 1,126,684 | 1,126,684 | ||||||||||||||
| State and municipal | 5,591,712 | 136,804 | (136,751 | ) | 5,591,765 | 5,591,765 | ||||||||||||||
| Mortgage-backed securities | 1,707,471 | 27,747 | (103,798 | ) | 1,631,420 | 1,631,420 | ||||||||||||||
| Corporate | 1,095,414 | 9,398 | (136,332 | ) | 968,480 | 968,480 | ||||||||||||||
| Foreign | 238,877 | 12,283 | (3,521 | ) | 247,639 | 247,639 | ||||||||||||||
| Total available for sale | 9,717,151 | 232,945 | (384,108 | ) | 9,565,988 | 9,565,988 | ||||||||||||||
| Total investment in fixed maturity securities | $ | 9,841,059 | $ | 238,378 | $ | (387,801 | ) | $ | 9,691,636 | $ | 9,689,896 | |||||||||
| December 31, 2007 | ||||||||||||||||||||
| Held to maturity: | ||||||||||||||||||||
| State and municipal | $ | 68,997 | $ | 8,814 | $ | (44 | ) | $ | 77,767 | $ | 68,997 | |||||||||
| Mortgage-backed securities | 56,121 | 2,735 | (20 | ) | 58,836 | 56,121 | ||||||||||||||
| Corporate | 4,993 | 630 | — | 5,623 | 4,993 | |||||||||||||||
| Total held to maturity | 130,111 | 12,179 | (64 | ) | 142,226 | 130,111 | ||||||||||||||
| Available for sale: | ||||||||||||||||||||
| United States government and government agency | 1,449,147 | 25,768 | (1,149 | ) | 1,473,766 | 1,473,766 | ||||||||||||||
| State and municipal | 5,100,193 | 78,803 | (12,475 | ) | 5,166,521 | 5,166,521 | ||||||||||||||
| Mortgage-backed securities | 1,691,017 | 14,782 | (9,262 | ) | 1,696,537 | 1,696,537 | ||||||||||||||
| Corporate | 1,046,038 | 8,864 | (9,346 | ) | 1,045,556 | 1,045,556 | ||||||||||||||
32
| (Dollars in thousands) | Gross | Gross | ||||||||||||||||||
| Amortized | Unrealized | Unrealized | Fair | Carrying | ||||||||||||||||
| Type of Investment | Cost | Gains | Losses | Value | Value | |||||||||||||||
| Foreign | 316,589 | 12,202 | (991 | ) | 327,800 | 327,800 | ||||||||||||||
| Total available for sale | 9,602,984 | 140,419 | (33,223 | ) | 9,710,180 | 9,710,180 | ||||||||||||||
| Total investment in fixed maturity securities | $ | 9,733,095 | $ | 152,598 | $ | (33,287 | ) | $ | 9,852,406 | $ | 9,840,291 | |||||||||
The amortized cost and fair value of fixed maturity securities at December 31, 2008, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because certain issuers may have the right to call or prepay obligations:
| (Dollars in thousands) | Amortized | |||||||
| Cost | Fair Value | |||||||
| Due in one year or less | $ | 306,680 | $ | 312,383 | ||||
| Due after one year through five years | 2,176,852 | 2,221,988 | ||||||
| Due after five years through ten years | 2,909,193 | 2,893,951 | ||||||
| Due after ten years | 2,690,824 | 2,577,465 | ||||||
| Mortgage-backed securities | 1,757,510 | 1,685,849 | ||||||
| Total | $ | 9,841,059 | $ | 9,691,636 | ||||
At December 31, 2008 and 2007, there were no investments, other than investments in United States government and government agency securities, which exceeded 10% of stockholders’ equity. At December 31, 2008, investments with a carrying value of $97 million were on deposit in trust accounts established as security for reinsurance clients, investments with a carrying value of $68 million were on deposit with Lloyd’s in support of the Company’s underwriting activities at Lloyd’s, investments with a carrying value of $650 million were on deposit with state insurance departments and investments with a carrying value of $56 million were held on deposit in trust accounts as security for letters of credit issued in support of the Company’s reinsurance operations.
(4) Investments in Equity Securities Available for Sale
At December 31, 2008 and 2007, investments in equity securities were as follows:
| (Dollars in thousands) | Gross | Gross | ||||||||||||||||||
| Unrealized | Unrealized | Fair | Carrying | |||||||||||||||||
| Type of Investment | Cost | Gains | Losses | Value | Value | |||||||||||||||
| December 31, 2008 | ||||||||||||||||||||
| Common stocks | $ | 39,343 | $ | 49,333 | $ | (7,833 | ) | $ | 80,843 | $ | 80,843 | |||||||||
| Preferred stocks | 399,451 | 95 | (96,639 | ) | 302,907 | 302,907 | ||||||||||||||
| Total | $ | 438,794 | $ | 49,428 | $ | (104,472 | ) | $ | 383,750 | $ | 383,750 | |||||||||
| December 31, 2007 | ||||||||||||||||||||
| Common stocks | $ | 93,425 | $ | 54,079 | $ | — | $ | 147,504 | $ | 147,504 | ||||||||||
| Preferred stocks | 677,848 | 2,571 | (101,361 | ) | 579,058 | 579,058 | ||||||||||||||
| Total | $ | 771,273 | $ | 56,650 | $ | (101,361 | ) | $ | 726,562 | $ | 726,562 | |||||||||
(5) Arbitrage Trading Account and Arbitrage Funds
At December 31, 2008 and 2007, the fair value and carrying value of the arbitrage trading account and arbitrage funds and related assets and liabilities were as follows:
| (Dollars in thousands) | 2008 | 2007 | ||||||
| Arbitrage trading account | $ | 119,485 | $ | 301,786 | ||||
| Investment in arbitrage funds | 73,435 | 210,740 | ||||||
| Related assets and liabilities: | ||||||||
| Receivables from brokers | $ | 128,883 | $ | 409,926 | ||||
| Securities sold but not yet purchased | (23,050 | ) | (67,139 | ) | ||||
The primary focus of the trading account is merger arbitrage, convertible arbitrage and relative value arbitrage. Merger arbitrage is the business of investing in the securities of publicly held companies which are the targets in announced tender offers and mergers. Convertible arbitrage is the business of investing in convertible securities with the goal of capitalizing on price differentials between these securities and their underlying equities. Relative value arbitrage is the business of investing primarily in equity securities with the goal of capitalizing on perceived differences in fundamental values between pairs of companies in similar industries. Arbitrage investing differs from other types of investing in its focus on transactions and events believed likely to bring about a change in value over a relatively short time period (usually four months or less). The Company believes that this makes arbitrage investments less vulnerable to changes in general financial market conditions.
The Company uses put options, call options and swap contracts in order to mitigate the impact of potential changes in market conditions on the merger arbitrage trading account. These options and contracts are reported at fair value. As of December 31, 2008, the fair value of long option
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contracts outstanding was $2,257,000 (notional amount of $46,973,000) and the fair value of short option contracts outstanding was $952,000 (notional amount of $53,342,000). Other than with respect to the use of these trading account securities, the Company does not make use of derivatives.
(6) Investment Funds
Investment funds include the following:
| Carrying Value | Income (Loss) | |||||||||||||||||||
| as of December 31, | from Investment Funds | |||||||||||||||||||
| (Dollars in thousands) | 2008 | 2007 | 2008 | 2007 | 2006 | |||||||||||||||
| Real estate | $ | 291,947 | $ | 294,446 | $ | (42,490 | ) | $ | 25,007 | $ | 23,421 | |||||||||
| Kiln Ltd | — | 108,722 | 10,697 | 16,052 | 15,883 | |||||||||||||||
| Energy | 94,736 | 41,085 | 30,785 | 1,323 | 2,014 | |||||||||||||||
| Other | 108,850 | 101,684 | (2,545 | ) | (4,108 | ) | (4,173 | ) | ||||||||||||
| Total | $ | 495,533 | $ | 545,937 | $ | (3,553 | ) | $ | 38,274 | $ | 37,145 | |||||||||
In March 2008, the Company sold its 20.1% interest in Kiln Ltd for $174 million and reported a realized gain of $70 million.
(7) Investment Income
Investment income consists of the following:
| (Dollars in thousands) | 2008 | 2007 | 2006 | |||||||||
| Investment income earned on: | ||||||||||||
| Fixed maturity securities, including cash | $ | 497,549 | $ | 500,378 | $ | 441,421 | ||||||
| Equity securities available for sale | 38,144 | 57,502 | 35,662 | |||||||||
| Arbitrage trading account (a) | 6,032 | 80,253 | 74,551 | |||||||||
| Gross investment income | 541,725 | 638,133 | 551,634 | |||||||||
| Investment expense | (4,692 | ) | (3,747 | ) | (2,604 | ) | ||||||
| Net investment income | $ | 537,033 | $ | 634,386 | $ | 549,030 | ||||||
| (a) | Investment income earned from net trading account activity includes unrealized trading losses of $334,000 in 2008 and unrealized trading gains of $2,450,000 in 2007 and $250,000 in 2006. |
(8) Realized and Unrealized Investment Gains and Losses
Realized and unrealized investment gains and losses are as follows:
| (Dollars in thousands) | 2008 | 2007 | 2006 | |||||||||
| Realized investment gains and losses: | ||||||||||||
| Fixed maturity securities: | ||||||||||||
| Gains | $ | 20,444 | $ | 4,255 | $ | 14,562 | ||||||
| Losses | (6,458 | ) | (5,467 | ) | (10,250 | ) | ||||||
| Equity securities available for sale | (9,377 | ) | 16,519 | 4,537 | ||||||||
| Sale of investment funds | 72,010 | 34,758 | — | |||||||||
| Sale of subsidiary | — | 2,302 | — | |||||||||
| Provision for other than temporary impairments | (433,550 | ) | (2,680 | ) | (100 | ) | ||||||
| Other gains | — | 9 | 899 | |||||||||
| Total realized investment gains (losses) | (356,931 | ) | 49,696 | 9,648 | ||||||||
| Income taxes | 124,973 | (17,462 | ) | (2,534 | ) | |||||||
| $ | (231,958 | ) | $ | 32,234 | $ | 7,114 | ||||||
| (Dollars in thousands) | 2008 | 2007 | 2006 | |||||||||
| Change in unrealized gains and losses of available for sales securities: | ||||||||||||
| Fixed maturity securities | $ | (258,359 | ) | $ | 66,237 | $ | 10,800 | |||||
| Equity securities available for sale | (10,333 | ) | (167,133 | ) | 93,130 | |||||||
| Investment funds | (33,595 | ) | 5,940 | 9,608 | ||||||||
| Cash and cash equivalents | 76 | (1 | ) | 1 | ||||||||
| Total change in unrealized gains and losses | (302,211 | ) | (94,957 | ) | 113,539 | |||||||
| Income taxes | 107,291 | 26,155 | (33,498 | ) | ||||||||
| Minority interest | 207 | (662 | ) | 1,174 | ||||||||
| $ | (194,713 | ) | $ | (69,464 | ) | $ | 81,215 | |||||
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(9) Securities in an Unrealized Loss Position
The following table summarizes all securities in an unrealized loss position at December 31, 2008 and 2007 by the length of time those securities have been continuously in an unrealized loss position (dollars in thousands):
| Less Than 12 Months | 12 Months or Greater | Total | ||||||||||||||||||||||
| Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
| Fair Value | Losses | Fair Value | Losses | Fair Value | Losses | |||||||||||||||||||
| December 31, 2008 | ||||||||||||||||||||||||
| U.S. government and agency | $ | 25,031 | $ | 3,494 | $ | 8,197 | $ | 212 | $ | 33,228 | $ | 3,706 | ||||||||||||
| State and municipal | 1,081,558 | 65,944 | 485,805 | 74,500 | 1,567,363 | 140,444 | ||||||||||||||||||
| Mortgage-backed securities | 327,563 | 57,032 | 211,762 | 46,766 | 539,325 | 103,798 | ||||||||||||||||||
| Corporate | 377,313 | 83,277 | 228,738 | 53,055 | 606,051 | 136,332 | ||||||||||||||||||
| Foreign | 17,519 | 3,521 | — | — | 17,519 | 3,521 | ||||||||||||||||||
| Fixed maturity securities | 1,828,984 | 213,268 | 934,502 | 174,533 | 2,763,486 | 387,801 | ||||||||||||||||||
| Common stocks | 5,952 | 7,833 | — | — | 5,952 | 7,833 | ||||||||||||||||||
| Preferred stocks | 123,930 | 44,062 | 109,103 | 52,577 | 233,033 | 96,639 | ||||||||||||||||||
| Total | $ | 1,958,866 | $ | 265,163 | $ | 1,043,605 | $ | 227,110 | $ | 3,002,471 | $ | 492,273 | ||||||||||||
| December 31, 2007 | ||||||||||||||||||||||||
| U.S. government and agency | $ | 28,059 | $ | 160 | $ | 16,770 | $ | 989 | $ | 44,829 | $ | 1,149 | ||||||||||||
| State and municipal | 439,307 | 6,711 | 517,768 | 5,808 | 957,075 | 12,519 | ||||||||||||||||||
| Mortgage-backed securities | 212,769 | 3,040 | 488,392 | 6,242 | 701,161 | 9,282 | ||||||||||||||||||
| Corporate | 169,732 | 4,940 | 262,731 | 4,406 | 432,463 | 9,346 | ||||||||||||||||||
| Foreign | 57,129 | 985 | 14,807 | 6 | 71,936 | 991 | ||||||||||||||||||
| Fixed maturity securities | 906,996 | 15,836 | 1,300,468 | 17,451 | 2,207,464 | 33,287 | ||||||||||||||||||
| Preferred stocks | 465,933 | 94,188 | 39,600 | 7,173 | 505,533 | 101,361 | ||||||||||||||||||
| Total | $ | 1,372,929 | $ | 110,024 | $ | 1,340,068 | $ | 24,624 | $ | 2,712,997 | $ | 134,648 | ||||||||||||
Fixed Maturity Securities — In determining whether declines in fair values of fixed maturity securities are other than temporary, management assesses the issuer’s ability to continue to meet its contractual payment obligations as they become due and whether the Company has the ability and intent to hold the investment until it recovers or matures. The Company’s assessment of its intent to hold an investment until it recovers or matures is based on conditions at the time the assessment is made, including general market conditions, the Company’s overall investment strategy and management’s view of the underlying value of an investment relative to its current price. Additionally, for certain securitized financial assets with contractual cash flows (including asset-backed securities), the Company updates its best estimate of the present value of expected cash flows over the life of the security. If management determines that the fair value of the securitized financial asset and the present value of the asset’s cash flows estimated at the current financial reporting date are less than the present value of the estimated cash flows at the date of purchase, an other-than-temporary impairment is recognized and the securitized financial asset is written down to fair value.
On March 31, 2008, the Company purchased $58 million of senior subordinated secured notes (the “Notes”) from a residential mortgage lender (the “Borrower”) in connection with a recapitalization plan. At December 31, 2008, the Notes had an amortized cost of $58 million and an estimated market value of $15 million. The market value reflects uncertainty with respect to the Borrower’s ability to restructure or refinance certain bank debt that expires on March 16, 2009. The Company believes that the expected cash flow from the Borrower’s assets significantly exceeds its debt obligations, and accordingly the Company does not consider the Notes to be other than temporarily impaired.
Other than the Notes referred to above, there were 60 fixed maturity securities for which unrealized losses were 20% or greater than amortized cost at December 31, 2008. Those securities had an aggregate unrealized loss of $172 million. The Company has evaluated these securities and believes the unrealized losses are due primarily to temporary market and sector-related factors rather than to issuer-specific factors. The Company does not consider these securities to be other than temporarily impaired.
Perpetual Preferred Securities — In assessing other than temporary impairments of perpetual preferred securities, the Company applies an impairment model similar to that used for a fixed maturity security provided there has been no evidence of deterioration in credit of the issuer. Otherwise, impairment tests for perpetual preferred securities are similar to those used for common stock.
The Company owns perpetual preferred securities issued by two U.S. banks that were rated investment grade at December 31, 2008 and were downgraded to below investment grade subsequent to year end. These securities had a carrying value of $47 million and an unrealized loss of $21 million at December 31, 2008. The rating downgrades were generally due to current and expected financial performance, asset quality problems globally and the possibility that dividends would be deferred. As a result of these downgrades, we are required to evaluate the securities for other
35
than temporary impairment using the equity security model rather than the debt security model. Based on the duration and severity of the decline, the Company does not consider the securities to be other than temporarily impaired as of December 31, 2008.
Other than the two securities referred to above, there were 44 securities for which unrealized losses were 20% or greater than amortized cost at December 31, 2008. Those securities, which had an aggregate unrealized loss of $66 million, are primarily investment grade securities issued by banks, insurers and REITs. The Company has the ability and intent to hold these securities at least until the investment impairment is recovered. The Company believes these unrealized losses are due primarily to temporary market and sector-related factors rather than to issuer-specific factors and does not consider these securities to be other than temporarily impaired.
Common Stock — In determining whether declines in fair values of common stock are other than temporary, management assesses (1) the severity and duration of the impairment, (2) the historic and implied volatility of the security, (3) recoveries or additional declines in fair value subsequent to the balance sheet date, (4) the financial condition and near-term prospects of the issuer, (5) whether the market decline was affected by macroeconomic conditions or by specific information pertaining to an individual security and (6) the length of the forecasted recovery period.
At December 31, 2008, the Company owned a common stock of a monoline insurance company with a fair value of $6 million and an unrealized loss of $8 million. The insurer’s stock price was highly volatile in the fourth quarter of 2008, and the Company’s investment in the insurer had been in an unrealized loss position for less than two months at year-end. As of the most recent reporting date, the insurer’s book value was significantly above the average cost per share. The Company does not consider the stock to be other than temporarily impaired. There were no other common stocks in an unrealized loss position at December 31, 2008.
Because of changing economic and market conditions affecting issuers of debt and equity securities and the performance of the underlying collateral affecting certain classes of assets, it is reasonably possible that we will recognize other-than-temporary impairments in the future.
(10) Fair Value Measurements
On January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“FAS 157”), which was issued by the Financial Accounting Standards Board in September 2006. FAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The adoption of FAS 157 did not have a material impact on the Company’s financial condition or results of operations.
FAS 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs may only be used to measure fair value to the extent that observable inputs are not available.
Because many fixed income securities do not trade on a daily basis, the Company utilizes pricing models and processes which may include benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Market inputs used to evaluate securities include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. Quoted prices are often unavailable for recently issued securities, securities that are infrequently traded or securities that are only traded in private transactions. For publicly traded securities for which quoted prices are unavailable, the Company determines fair value based on independent broker quotations and other observable market data. For securities traded only in private negotiations, the Company determines fair value based primarily on the cost of such securities, which is adjusted to reflect prices of recent placements of securities of the same issuer, financial data, projections and business developments of the issuer and other relevant information.
The following table presents the assets and liabilities measured at fair value on a recurring basis as of December 31, 2008 by Level (dollars in thousands):
| Total | Level 1 | Level 2 | Level 3 | |||||||||||||
| Assets: | ||||||||||||||||
| Fixed maturity securities available for sale | $ | 9,565,988 | $ | — | $ | 9,417,349 | $ | 148,639 | ||||||||
| Equity securities available for sale | 383,750 | 19,829 | 254,701 | 109,220 | ||||||||||||
| Arbitrage trading account | 119,485 | 115,723 | 3,409 | 353 | ||||||||||||
| Total assets | $ | 10,069,223 | $ | 135,552 | $ | 9,675,459 | $ | 258,212 | ||||||||
| Liabilities: | ||||||||||||||||
| Securities sold but not yet purchased | $ | 23,050 | $ | 23,050 | $ | — | $ | — | ||||||||
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The following table summarizes changes in Level 3 assets (dollars in thousands):
| Equity | ||||||||||||||||
| Securities | Arbitrage | |||||||||||||||
| Fixed | Available | Trading | ||||||||||||||
| Total | Maturities | for Sale | Account | |||||||||||||
| Balance as of January 1, 2008 | $ | 90,918 | $ | 23,725 | $ | 62,911 | $ | 4,282 | ||||||||
| Realized and unrealized gains and losses: | ||||||||||||||||
| Included in earnings | (7,202 | ) | (5,975 | ) | (1,227 | ) | — | |||||||||
| Included in other comprehensive loss | 892 | (5,753 | ) | 6,645 | — | |||||||||||
| Purchases, sales and maturities, net | 42,503 | 5,894 | 40,891 | (4,282 | ) | |||||||||||
| Transfer in of securities for which observable inputs are no longer available | 131,101 | 130,748 | — | 353 | ||||||||||||
| Balance as of December 31, 2008 | $ | 258,212 | $ | 148,639 | $ | 109,220 | $ | 353 | ||||||||
(11) Reserves for Losses and Loss Expenses
The table below provides a reconciliation of the beginning and ending reserve balances:
| (Dollars in thousands) | 2008 | 2007 | 2006 | |||||||||
| Net reserves at beginning of year | $ | 7,822,897 | $ | 6,947,597 | $ | 5,867,290 | ||||||
| Net reserves of company acquired | — | 68,392 | — | |||||||||
| Net provision for losses and loss expenses (a): | ||||||||||||
| Claims occurring during the current year (b) | 2,829,830 | 2,837,647 | 2,791,500 | |||||||||
| (Decrease)/Increase in estimates for claims occurring in prior years (c) | (195,710 | ) | (105,879 | ) | 26,663 | |||||||
| Loss reserve discount accretion | 54,494 | 46,808 | 39,507 | |||||||||
| 2,688,614 | 2,778,576 | 2,857,670 | ||||||||||
| Net payments for claims: | ||||||||||||
| Current year | 644,213 | 538,364 | 456,073 | |||||||||
| Prior years | 1,744,712 | 1,433,304 | 1,321,290 | |||||||||
| 2,388,925 | 1,971,668 | 1,777,363 | ||||||||||
| Net reserves at end of year | 8,122,586 | 7,822,897 | 6,947,597 | |||||||||
| Ceded reserves at end of year | 877,010 | 855,137 | 836,672 | |||||||||
| Gross reserves at end of year | $ | 8,999,596 | $ | 8,678,034 | $ | 7,784,269 | ||||||
| (a) | Net provision for loss and loss expenses excludes $47, $1,002, and $6,828, in 2008, 2007 and 2006, respectively, relating to the policyholder benefits incurred on life insurance that are included in the statement of income. | |
| (b) | Claims occurring during the current year are net of loss reserve discounts of $97,698, $117,177 and $133,965 in 2008, 2007 and 2006, respectively. | |
| (c) | The increase(decrease) in estimates for claims occurring in prior years is net of loss reserve discounts of $15,556, $17,736 and $29,940 in 2008, 2007 and 2006, respectively. On an undiscounted basis, the estimates for claims occurring in prior years decreased by $180,154 and $88,143 in 2008 and 2007, respectively, and increased by$56,603 in 2006. |
For the year ended December 31, 2008, the Company reported losses and loss expenses of $2,689 million. Estimates for claims occurring in prior years decreased by $196 million. On an accident year basis, the change in prior year reserves is comprised of an increase in estimates for claims occurring in accident years 2002 and prior of $81 million and a decrease in estimates for claims occurring in accident years 2003 through 2007 of $277 million. The changes in prior year loss reserve estimates are generally the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as additional information becomes known regarding individual claims and aggregate claim trends.
By segment, prior year reserves decreased by $108 million for specialty, $40 million for alternative markets, $26 million for regional, $12 million for reinsurance and $10 million for international. For primary business lines, prior year reserves decreased by $125 million for general liability, $36 million for workers’ compensation, $16 million for commercial automobile and $7 million for property. The decrease in prior year reserves for general liability reflects the favorable loss reserve trends for excess and surplus lines for accident years 2003 through 2007.
Environmental and asbestos — To date, known environmental and asbestos claims have not had a material impact on the Company’s operations. These claims have not materially impacted the Company because its subsidiaries generally did not insure large industrial companies that are subject to significant environmental and asbestos exposures.
37
The Company’s net reserves for losses and loss adjustment expenses relating to asbestos and environmental claims were $39,646,000 and $41,590,000 at December 31, 2008 and 2007, respectively. The Company’s gross reserves for losses and loss adjustment expenses relating to asbestos and environmental claims were $56,957,000 and $60,836,000 at December 31, 2008 and 2007, respectively. Net incurred losses and loss expenses for reported asbestos and environmental claims were approximately $440,000, $7,029,000, and $3,000,000 in 2008, 2007 and 2006, respectively. Net paid losses and loss expenses for asbestos and environmental claims were approximately $2,384,000, $2,912,000 and $2,980,000 in 2008, 2007 and 2006, respectively. The estimation of these liabilities is subject to significantly greater than normal variation and uncertainty because it is difficult to make an actuarial estimate of these liabilities due to the absence of a generally accepted actuarial methodology for these exposures and the potential effect of significant unresolved legal matters, including coverage issues as well as the cost of litigating the legal issues. Additionally, the determination of ultimate damages and the final allocation of such damages to financially responsible parties are highly uncertain.
Discounting — The Company discounts its liabilities for excess and assumed workers’ compensation business because of the long period of time over which losses are paid. Discounting is intended to appropriately match losses and loss expenses to income earned on investment securities supporting the liabilities. The expected losses and loss expense payout pattern subject to discounting was derived from the Company’s loss payout experience. For non-proportional business, reserves for losses and loss expenses have been discounted using risk-free discount rates determined by reference to the U.S. Treasury yield curve. These discount rates range from 3.1% to 6.5% with a weighted average discount rate of 4.6%. For proportional business, reserves for losses and loss expenses have been discounted at the statutory rate permitted by the Department of Insurance of the State of Delaware of 2.5%. The aggregate net discount, after reflecting the effects of ceded reinsurance, is $846,748,000, $787,988,000 and $699,883,000 at December 31, 2008, 2007 and 2006, respectively. The increase in the aggregate discount from 2007 to 2008 and from 2006 to 2007 resulted from the increase in excess and assumed workers’ compensation gross reserves.
(12) Reinsurance
The following is a summary of reinsurance financial information:
| (Dollars in thousands) | 2008 | 2007 | 2006 | |||||||||
| Written premiums: | ||||||||||||
| Direct | $ | 3,898,488 | $ | 4,173,856 | $ | 4,208,893 | ||||||
| Assumed | 621,638 | 879,374 | 1,068,021 | |||||||||
| Ceded | (486,227 | ) | (477,241 | ) | (457,921 | ) | ||||||
| Total net written premiums | $ | 4,033,899 | $ | 4,575,989 | $ | 4,818,993 | ||||||
| Earned premiums: | ||||||||||||
| Direct | $ | 4,075,360 | $ | 4,202,673 | $ | 4,124,131 | ||||||
| Assumed | 704,555 | 933,169 | 1,037,806 | |||||||||
| Ceded | (490,335 | ) | (472,141 | ) | (469,315 | ) | ||||||
| Total net earned premiums | $ | 4,289,580 | $ | 4,663,701 | $ | 4,692,622 | ||||||
| Ceded losses incurred | $ | 295,179 | $ | 263,072 | $ | 276,347 | ||||||
The Company reinsures a portion of its exposures principally to reduce its net liability on individual risks and to protect against catastrophic losses. Estimated amounts due from reinsurers are reported net of reserves for uncollectible reinsurance of $4,895,000, $2,859,000 and $2,531,000 as of December 31, 2008, 2007 and 2006, respectively.
(13) Senior Notes and Other Debt
Senior notes and other debt consist of the following (the difference between the face value and the carrying value is unamortized discount):
| (Dollars in thousands) | 2008 | 2007 | ||||||||||||||||||
| Description | Rate | Maturity | Face Value | Carrying Value | Carrying Value | |||||||||||||||
| Senior notes | 9.875 | % | May 15, 2008 | $ | — | $ | — | $ | 88,638 | |||||||||||
| Subsidiary debt | Various | 2009 through 2012 | 3,749 | 3,749 | 4,460 | |||||||||||||||
| Senior notes | 5.125 | % | September 30, 2010 | 150,000 | 149,451 | 149,130 | ||||||||||||||
| Senior notes | 5.875 | % | February 15, 2013 | 200,000 | 198,632 | 198,300 | ||||||||||||||
| Senior notes | 5.60 | % | May 15, 2015 | 200,000 | 198,815 | 198,629 | ||||||||||||||
| Senior notes | 6.15 | % | August 15, 2019 | 150,000 | 148,487 | 148,345 | ||||||||||||||
| Senior notes | 8.70 | % | January 1, 2022 | 76,503 | 75,829 | 75,803 | ||||||||||||||
| Subsidiary debt | 7.65 | % | June 30, 2023 | — | — | 11,747 | ||||||||||||||
| Senior notes | 6.25 | % | February 15, 2037 | 250,000 | 246,906 | 246,741 | ||||||||||||||
| Total debt | $ | 1,030,252 | $ | 1,021,869 | $ | 1,121,793 | ||||||||||||||
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(14) Junior Subordinated Debentures
Junior subordinated debentures consist of the following (the difference between the face value and the carrying value is unamortized discount):
| (Dollars in thousands) | 2008 | 2007 | ||||||||||||||||||
| Description | Rate | Maturity | Face Value | Carrying Value | Carrying Value | |||||||||||||||
| Company debt | 6.75 | % | July 26, 2045 | $ | 250,000 | $ | 242,367 | $ | 242,158 | |||||||||||
| Subsidiary debt | LIBOR +3.75% | March 2035 | 7,217 | 7,217 | 7,217 | |||||||||||||||
| Total | $ | 257,217 | $ | 249,584 | $ | 249,375 | ||||||||||||||
In 2005, the Company issued $250,000,000 aggregate principal amount of 6.75% Junior Subordinated Debentures due July 26, 2045 (the “6.75% Junior Subordinated Debentures”) to W. R. Berkley Capital Trust II (the “Trust”). The Trust simultaneously issued an equal amount of 6.75% mandatorily redeemable preferred securities (the “6.75% Trust Preferred Securities”), which are fully and unconditionally guaranteed by the Company to the extent the Trust has funds available for repayment of distributions. The 6.75% Trust Preferred Securities are subject to mandatory redemption in a like amount (i) in whole but not in part upon repayment of the 6.75% Junior Subordinated Debentures at maturity, (ii) in whole but not in part, at any time contemporaneously with the optional prepayment of the 6.75% Junior Subordinated Debentures by the Company upon the occurrence and continuation of certain events and (iii) in whole or in part, on or after July 26, 2010, contemporaneously with the optional prepayment by the Company of the 6.75% Junior Subordinated Debentures.
In 2007, the Company acquired CGH Insurance Group, Inc., which has $7,217,000 of outstanding subordinated debentures that mature in 2035 and are pre-payable in 2010.
(15) Income Taxes
Income tax expense consists of (dollars in thousands):
| Current | Deferred | |||||||||||
| Expense | Benefit | Total | ||||||||||
| December 31, 2008: | ||||||||||||
| Domestic | $ | 77,650 | $ | (63,630 | ) | $ | 14,020 | |||||
| Foreign | 24,493 | 6,406 | 30,899 | |||||||||
| Total expense | $ | 102,143 | $ | (57,224 | ) | $ | 44,919 | |||||
| December 31, 2007: | ||||||||||||
| Domestic | $ | 313,803 | $ | (8,227 | ) | $ | 305,576 | |||||
| Foreign | 15,018 | 2,476 | 17,494 | |||||||||
| Total expense | $ | 328,821 | $ | (5,751 | ) | $ | 323,070 | |||||
| December 31, 2006: | ||||||||||||
| Domestic | $ | 311,924 | $ | (34,171 | ) | $ | 277,753 | |||||
| Foreign | 10,026 | (1,381 | ) | 8,645 | ||||||||
| Total expense | $ | 321,950 | $ | (35,552 | ) | $ | 286,398 | |||||
A reconciliation of the income tax expense and the amounts computed by applying the Federal and foreign income tax rate of 35% to pre-tax income are as follows:
| (Dollars in thousands) | 2008 | 2007 | 2006 | |||||||||
| Computed “expected” tax expense | $ | 108,630 | $ | 379,699 | $ | 344,666 | ||||||
| Tax-exempt investment income | (71,614 | ) | (67,128 | ) | (63,358 | ) | ||||||
| Change in valuation allowance | 1,095 | (7,604 | ) | 3,046 | ||||||||
| Other, net | 6,808 | 18,103 | 2,044 | |||||||||
| Total expense | $ | 44,919 | $ | 323,070 | $ | 286,398 | ||||||
39
At December 31, 2008 and 2007, the tax effects of differences that give rise to significant portions of the deferred tax asset and deferred tax liability are as follows:
| (Dollars in thousands) | 2008 | 2007 | ||||||
| Deferred tax asset | ||||||||
| Loss reserve discounting | $ | 178,788 | $ | 205,967 | ||||
| Deferred taxes on unrealized investments losses | 83,324 | — | ||||||
| Unearned premiums | 118,691 | 137,439 | ||||||
| Net operating loss carry forwards | 2,395 | 1,932 | ||||||
| Write downs for other-than-temporary impairments | 80,963 | 3,162 | ||||||
| Restricted stock units | 25,797 | 17,625 | ||||||
| Other | 54,740 | 65,199 | ||||||
| Gross deferred tax asset | 544,698 | 431,324 | ||||||
| Less valuation allowance | (3,113 | ) | (2,018 | ) | ||||
| Deferred tax asset | 541,585 | 429,306 | ||||||
| Deferred tax liability | ||||||||
| Amortization of intangibles | 10,592 | 7,782 | ||||||
| Deferred policy acquisition costs | 129,475 | 150,993 | ||||||
| Deferred taxes on unrealized investment gains | — | 25,624 | ||||||
| Other | 72,101 | 70,403 | ||||||
| Deferred tax liability | 212,168 | 254,802 | ||||||
| Net deferred tax asset | $ | 329,417 | $ | 174,504 | ||||
The Company had current income tax receivable of $76,491,000 at December 31, 2008, and a current income tax payable of $14,331,000 at December 31, 2007. At December 31, 2008, the Company had foreign net operating loss carry forwards of $6,843,000, which expire beginning in 2009. The Company has provided a valuation allowance of $887,000 on these carryforwards. In addition, the Company has a net foreign tax credit carry forward for U.S. income tax purposes in the amount of $2,226,000, which expires beginning in 2012. The Company has provided a full valuation allowance against this amount. The net change in the valuation relates primarily to these items. The statute of limitations has closed for the Company’s tax returns through December 31, 2004.
The realization of the deferred tax asset is dependent upon the Company’s ability to generate sufficient taxable income in future periods. Based on historical results and the prospects for future current operations, management anticipates that it is more likely than not that future taxable income will be sufficient for the realization of this asset.
(16) Dividends from Subsidiaries and Statutory Financial Information (unaudited)
The Company’s insurance subsidiaries are restricted by law as to the amount of dividends they may pay without the approval of regulatory authorities. During 2009, the maximum amount of dividends which can be paid without such approval is approximately $392 million. Combined net income and policyholders’ surplus of the Company’s consolidated insurance subsidiaries, as determined in accordance with statutory accounting practices, are as follows:
| (Dollars in thousands) | 2008 | 2007 | 2006 | |||||||||
| Net income | $ | 377,347 | $ | 767,021 | $ | 625,305 | ||||||
| Policyholders’ surplus | $ | 3,322,389 | $ | 3,695,106 | $ | 3,535,398 | ||||||
The significant variances between statutory accounting practices and GAAP are that for statutory purposes bonds are carried at amortized cost, acquisition costs are charged to income as incurred, deferred Federal income taxes are subject to limitations, excess and assumed workers’ compensation reserves are discounted at different discount rates and certain assets designated as “non-admitted assets” are charged against surplus.
The NAIC has risk-based capital (“RBC”) requirements that require insurance companies to calculate and report information under a risk-based formula which measures statutory capital and surplus needs based on a regulatory definition of risk in a company’s mix of products and its balance sheet. All of the Company’s insurance subsidiaries have an RBC amount above the authorized control level RBC, as defined by the NAIC. The Company has certain guarantees that provide that RBC levels of certain subsidiaries will remain above their authorized control levels.
40
(17) Stockholders’ Equity
Common equity. The weighted average number of shares used in the computation of basic earnings per share was 166,956,000, 188,981,000 and 191,809,000 for 2008, 2007 and 2006, respectively. The weighted average number of shares used in the computations of diluted earnings per share was 173,454,000, 196,698,000 and 201,961,000 for 2008, 2007 and 2006, respectively. Treasury shares have been excluded from average outstanding shares from the date of acquisition. The difference in calculating basic and diluted earnings per share is attributable entirely to the dilutive effect of stock-based compensation plans.
Changes in shares of common stock outstanding, net of treasury shares, are as follows:
| (Amounts in thousands) | 2008 | 2007 | 2006 | |||||||||
| Balance, beginning of year | 180,321 | 192,772 | 191,264 | |||||||||
| Shares issued | 1,823 | 3,680 | 2,925 | |||||||||
| Shares repurchased | (20,677 | ) | (16,131 | ) | (1,417 | ) | ||||||
| Balance, end of year | 161,467 | 180,321 | 192,772 | |||||||||
On May 11, 1999, the Company declared a dividend distribution of one Right for each outstanding share of common stock. Each Right entitles the holder to purchase a unit consisting of one one-thousandth of a share of Series A Junior Participating Preferred Stock at a purchase price of $120 per unit (subject to adjustment) upon the occurrence of certain events relating to potential changes in control of the Company. The Rights expire on May 11, 2009, unless earlier redeemed by the Company as provided in the Rights Agreement.
(18) Fair Value of Financial Instruments
The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments as of December 31, 2008 and 2007:
| (Dollars in thousands) | 2008 | 2007 | ||||||||||||||
| Carrying | Carrying | |||||||||||||||
| Amount | Fair value | Amount | Fair Value | |||||||||||||
| Investments | $ | 11,143,281 | $ | 11,092,707 | $ | 11,956,717 | $ | 11,963,327 | ||||||||
| Cash and cash equivalents | 1,134,835 | 1,134,835 | 951,863 | 951,863 | ||||||||||||
| Junior subordinated debentures | 249,584 | 188,717 | 249,375 | 214,058 | ||||||||||||
| Senior notes and other debt | 1,021,869 | 836,914 | 1,121,793 | 1,113,705 | ||||||||||||
The estimated fair value of investments is generally based on quoted market prices as of the respective reporting dates. The fair value of the senior notes and other debt and the junior subordinated debentures are based on rates available for borrowings similar to the Company’s outstanding debt as of the respective reporting dates.
(19) Lease Obligations
The Company and its subsidiaries use office space and equipment under leases expiring at various dates. These leases are considered operating leases for financial reporting purposes. Some of these leases have options to extend the length of the leases and contain clauses for cost of living, operating expense and real estate tax adjustments. Rental expense was $23,802,000, $21,438,000 and $19,348,000 for 2008, 2007 and 2006, respectively. Future minimum lease payments (without provision for sublease income) are: $23,803,000 in 2009; $21,103,000 in 2010; $17,280,000 in 2011; $13,391,000 in 2012 and $35,790,000 thereafter.
(20) Commitments, Litigation and Contingent Liabilities
The Company’s subsidiaries are subject to disputes, including litigation and arbitration, arising in the ordinary course of their insurance and reinsurance businesses. The Company’s estimates of the costs of settling such matters are reflected in its aggregate reserves for losses and loss expenses, and the Company does not believe that the ultimate outcome of such matters will have a material adverse effect on its financial condition or results of operations.
41
At December 31, 2008, the Company had commitments to invest up to $253 million in certain investment funds and a subsidiary of the Company had commitments to extend credit under future loan agreements and unused lines of credit up to $3 million.
At December 31, 2008, investments with a carrying value of $97 million were on deposit in trust accounts established as security for reinsurance clients, investments with a carrying value of $68 million were on deposit with Lloyd’s in support of the Company’s underwriting activities at Lloyd’s, investments with a carrying value of $650 million were on deposit with state insurance departments and investments with a carrying value of $56 million were held on deposit in trust accounts as security for letters of credit issued in support of the Company’s reinsurance operations.
(21) Stock Incentive Plan
The Company has a stock incentive plan (the “Stock Incentive Plan”) under which 36,070,313 shares of common stock were reserved for issuance. Pursuant to the Stock Incentive Plan, stock options may be granted at prices determined by the Board of Directors but not less than fair market value on the date of grant. Stock options vest according to a graded schedule of 25%, 50%, 75% and 100% on the third, fourth, fifth and sixth year anniversary of grant date. Stock options expire on the tenth year anniversary of the grant date.
The following table summarizes stock option information:
| 2008 | 2007 | 2006 | ||||||||||||||||||||||
| Shares | Price(a) | Shares | Price(a) | Shares | Price(a) | |||||||||||||||||||
| Outstanding at beginning of year | 8,384,422 | $ | 8.84 | 12,088,263 | $ | 8.29 | 15,160,182 | $ | 7.99 | |||||||||||||||
| Exercised | 1,780,705 | 8.00 | 3,664,659 | 7.01 | 2,909,916 | 6.67 | ||||||||||||||||||
| Canceled | 37,340 | 9.40 | 39,182 | 11.49 | 162,003 | 9.58 | ||||||||||||||||||
| Outstanding at year end | 6,566,377 | $ | 9.06 | 8,384,422 | $ | 8.84 | 12,088,263 | $ | 8.29 | |||||||||||||||
| Options exercisable at year end | 6,537,403 | $ | 9.04 | 7,431,072 | $ | 8.55 | 9,494,263 | $ | 7.67 | |||||||||||||||
| Stock available for future grant (b) | 3,953,053 | 5,156,486 | 5,778,540 | |||||||||||||||||||||
| (a) | Weighted average exercise price. | |
| (b) | Includes restricted stock units. |
The following table summarizes information about stock options outstanding at December 31, 2008:
| Options Outstanding | Options Exercisable | |||||||||||||||||||
| Weighted | Weighted | |||||||||||||||||||
| Range of | Remaining | Weighted | Average | |||||||||||||||||
| Exercise | Number | Contractual | Average | Number | Exercise | |||||||||||||||
| Prices | Outstanding | Life (in years) | Price | Exercisable | Price | |||||||||||||||
| $0 to $5.00 | 1,115,045 | 1.25 | $ | 3.51 | 1,115,045 | $ | 3.51 | |||||||||||||
| $5.01 to $9.39 | 2,598,364 | 2.19 | 9.30 | 2,598,364 | 9.30 | |||||||||||||||
| $9.40 to $17.62 | 2,852,968 | 3.37 | 11.01 | 2,823,994 | 10.98 | |||||||||||||||
| Total | 6,566,377 | 2.54 | $ | 9.06 | 6,537,403 | $ | 9.04 | |||||||||||||
Pursuant to the Stock Incentive Plan, the Company may also issue Restricted Stock Units (RSUs) to officers of the Company and its subsidiaries. The RSUs generally vest five years from the award date and are subject to other vesting and forfeiture provisions contained in the award agreement. The following table summarizes RSU information for the three years ended December 31, 2008:
| (Dollars in thousands) | 2008 | 2007 | 2006 | |||||||||
| RSUs granted: | ||||||||||||
| Units | 1,369,500 | 727,250 | 727,950 | |||||||||
| Market value at grant date | $ | 33,847 | $ | 21,856 | $ | 24,798 | ||||||
| RSUs canceled: | ||||||||||||
| Units | 128,727 | 66,014 | 83,580 | |||||||||
| Market value at grant date | $ | 2,213 | $ | 1,973 | $ | 3,782 | ||||||
| RSUs outstanding at end of period: | ||||||||||||
| Units (1) | 4,971,231 | 4,738,656 | 4,077,420 | |||||||||
| Market value at grant date | $ | 142,099 | $ | 110,465 | $ | 90,370 | ||||||
| (1) | 1,008,198 RSU units vested during 2008. |
42
The market value of RSUs at the date of grant are recorded as unearned compensation, a component of stockholders’ equity, and expensed over the vesting period. Following is a summary of changes in unearned compensation for the three years ended December 31, 2008:
| (Dollars in thousands) | 2008 | 2007 | 2006 | |||||||||
| Unearned compensation at beginning of year | $ | 60,108 | $ | 59,555 | $ | 53,862 | ||||||
| RSUs granted, net of cancellations | 31,634 | 19,883 | 21,016 | |||||||||
| RSUs expensed | (23,239 | ) | (19,330 | ) | (15,323 | ) | ||||||
| Unearned compensation at end of year | $ | 68,503 | $ | 60,108 | $ | 59,555 | ||||||
(22) Compensation Plans
The Company and its subsidiaries have profit sharing plans in which substantially all employees participate. The plans provide for minimum annual contributions of 5% of eligible compensation; contributions above the minimum are discretionary and vary with each participating subsidiary’s profitability. Employees become eligible to participate in the profit sharing plans on the first day of the month following the first full three months in which they are employed. The plans provide that 40% of the contributions vest immediately and that the remaining 60% vest at varying percentages based upon years of service. Profit sharing expense amounted to $25,847,000, $27,241,000 and $24,864,000 for 2008, 2007 and 2006, respectively. The Company’s foreign subsidiaries provide pension benefits in accordance with local regulations. The pension expense for these foreign subsidiaries amounted to $1,474,000, $796,000 and $540,000 for 2008, 2007 and 2006 respectively.
The Company has a Long-Term Incentive Compensation Plan (“LTIP”) that provides for incentive compensation to key executives based on the growth in the Company’s book value per share. Key employees are awarded participation units (“Units”) that vest five years from the award date or upon achievement of the maximum value of the award (except for certain executive officers), whichever occurs first. In 2004, the Company awarded 100,000 Units that achieved their maximum value of $250 per Unit in 2007. Compensation expense related to the 2004 grant (net of forfeitures) was $4,495,000 and $8,015,000 in 2007 and 2006 respectively. In 2006, the Company awarded 129,000 Units with a maximum value of $250 per Unit. Compensation expense related to the 2006 grant was $3,554,000, $10,282,000 and $8,599,000 in 2008, 2007 and 2006, respectively. In 2008, the Company awarded 164,500 units with a maximum value of $250 per unit. Compensation expense related to the 2008 grant was $3,644,000 in 2008.
(23) Retirement Benefits
The Company has an unfunded noncontributory defined benefit plan that covers its chief executive officer and chairman of the board. The plan was amended on December 17, 2007 to provide that the benefits payments shall commence on the earliest of (i) January 2, 2014, (ii) the date of death or (iii) a change in control of the Company. The Company assumed a benefit commencement date of January 2, 2014 for the 2007 valuation, whereas for the 2006 valuation, the Company assumed a benefit commencement date of October 31, 2017. The discount rate used to derive the projected benefit obligation and related retirement expense was 6.95% in 2008 and 6.5% in 2007. The discount rate assumption used to determine the benefit obligation for 2008 was based on a yield curve approach. Under this approach, a weighted average yield is determined from a hypothetical portfolio of AA bonds. Following is a summary of the projected benefit obligation as of December 31, 2008 and 2007:
| (Dollars in thousands) | 2008 | 2007 | ||||||
| Projected benefit obligation: | ||||||||
| Beginning of year | $ | 37,165 | $ | 28,775 | ||||
| Interest cost | 2,416 | 1,753 | ||||||
| Actuarial gain | (1,730 | ) | (3,724 | ) | ||||
| Plan amendment | — | 10,361 | ||||||
| End of year | $ | 37,851 | $ | 37,165 | ||||
Following is a summary of the amounts recognized in accumulated other comprehensive income (loss) as of December 31, 2008 and 2007:
| (Dollars in thousands) | 2008 | 2007 | ||||||
| Net actuarial loss | $ | 846 | $ | 12,937 | ||||
| Prior service cost | 21,106 | 13,768 | ||||||
| Net pension asset | $ | 21,952 | $ | 26,705 | ||||
43
The components of net periodic pension benefit cost are as follows:
| (Dollars in thousands) | 2008 | 2007 | 2006 | |||||||||
| Components of net periodic benefit cost: | ||||||||||||
| Interest cost | $ | 2,416 | $ | 1,753 | $ | 1,640 | ||||||
| Amortization of unrecognized: | ||||||||||||
| Prior service costs | 3,023 | 1,267 | 1,266 | |||||||||
| Net actuarial loss | — | 352 | 593 | |||||||||
| Net periodic pension cost | $ | 5,439 | $ | 3,372 | $ | 3,499 | ||||||
The changes in plan assets and projected benefit obligation recognized in other comprehensive income (loss) are as follows:
| (Dollars in thousands) | 2008 | 2007 | ||||||
| Changes in plan assets and projected benefit obligation: | ||||||||
| Net actuarial gain | $ | (1,730 | ) | $ | (3,724 | ) | ||
| Plan amendment | — | 10,361 | ||||||
| Amortization of: | ||||||||
| Prior service costs | (3,023 | ) | (1,267 | ) | ||||
| Net actuarial loss | — | (352 | ) | |||||
| Total recognized in other comprehensive income (loss) | $ | (4,753 | ) | $ | 5,018 | |||
The estimated prior service cost that will be amortized from accumulated other comprehensive income (loss) into periodic benefit cost during 2009 is $3,023,000.
Effective on December 31, 2006, the Company adopted FASB Statement No. 158 (FAS 158), “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” which requires an employer to recognize the over-funded or under-funded status of defined benefit plans as an asset or liability on its consolidated balance sheet. The impact of adopting FAS 158 is presented below.
| Before | After | |||||||||||
| Application | Application | |||||||||||
| (Dollars in thousands) | of FAS 158 | Adjustments | of FAS 158 | |||||||||
| Other assets | $ | 145,669 | $ | (15,028 | ) | $ | 130,641 | |||||
| Deferred income taxes | 135,044 | 7,590 | 142,634 | |||||||||
| Other liabilities | 647,938 | 6,658 | 654,596 | |||||||||
| Total stockholders’ equity | $ | 3,349,255 | $ | (14,096 | ) | $ | 3,335,159 | |||||
(24) Supplemental Financial Statement Data
Other operating costs and expenses consist of the following:
| (Dollars in thousands) | 2008 | 2007 | 2006 | |||||||||
| Amortization of deferred policy acquisition costs | $ | 998,539 | $ | 1,002,367 | $ | 978,029 | ||||||
| Other underwriting expenses | 305,012 | 328,152 | 289,188 | |||||||||
| Service company expenses | 87,397 | 90,561 | 88,961 | |||||||||
| Other costs and expenses | 84,217 | 109,907 | 92,988 | |||||||||
| Total | $ | 1,475,165 | $ | 1,530,987 | $ | 1,449,166 | ||||||
44
(25) Industry Segments
The Company’s operations are presently conducted in five segments of the insurance business: specialty lines of insurance, regional property casualty insurance, alternative markets, reinsurance and international.
Our specialty segment underwrites complex and sophisticated third-party liability risks, principally within the excess and surplus lines. The primary lines of business are premises operations, professional liability, commercial automobile, products liability and property lines. The companies within the segment are divided along the different customer bases and product lines that they serve. The specialty units deliver their products through a variety of distribution channels depending on the customer base and particular risks insured. The customers in this segment are highly diverse.
Our regional segments provide commercial insurance products to customers primarily in 45 states. Key clients of this segment are small-to-mid-sized businesses and state and local governmental entities. The regional subsidiaries are organized geographically, which provides them with the flexibility to adapt to local market conditions, while enjoying the superior administrative capabilities and financial strength of the Company. The regional operations are organized geographically based on markets served.
Our alternative markets operations specialize in developing, insuring, reinsuring and administering self-insurance programs and other alternative risk transfer mechanisms. Our clients include employers, employer groups, insurers, and alternative market funds seeking less costly, more efficient ways to manage exposure to risks. In addition to providing insurance, the alternative markets segment also provides a wide variety of fee-based services, including consulting and administrative services.
Our reinsurance operations specialize in underwriting property casualty reinsurance on both a treaty and a facultative basis. The principal reinsurance units are facultative reinsurance, which writes individual certificates and program facultative business, treaty reinsurance, which functions as a traditional reinsurer in specialty and standard reinsurance lines, and Lloyd’s reinsurance, which writes property and casualty reinsurance through Lloyd’s.
Our international segment offers personal and commercial property casualty insurance in United Kingdom, Continental Europe, South America, commercial insurance and reinsurance in Australia, Canada and Hong Kong.
45
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Income tax expense and benefits are calculated based upon the Company’s overall effective tax rate.
Summary financial information about the Company’s operating segments is presented in the following table. Income (loss) before income taxes by segment consists of revenues less expenses related to the respective segment’s operations, including allocated investment income. Identifiable assets by segment are those assets used in or allocated to the operation of each segment.
| Revenues | ||||||||||||||||||||||||
| Investment | Pre-tax | Net | ||||||||||||||||||||||
| Earned | Income and | Income | Income | |||||||||||||||||||||
| (Dollars in thousands) | Premiums | Funds | Other | Total | (Loss) | (Loss) | ||||||||||||||||||
| December 31, 2008: | ||||||||||||||||||||||||
| Specialty | $ | 1,618,915 | $ | 188,120 | $ | 3,778 | $ | 1,810,813 | $ | 375,429 | $ | 271,156 | ||||||||||||
| Regional | 1,237,258 | 80,538 | — | 1,317,796 | 108,719 | 82,281 | ||||||||||||||||||
| Alternative markets | 626,858 | 105,674 | 99,090 | 831,622 | 201,879 | 146,460 | ||||||||||||||||||
| Reinsurance | 519,717 | 116,046 | — | 635,763 | 117,946 | 93,399 | ||||||||||||||||||
| International | 286,832 | 35,184 | — | 322,016 | 52,943 | 36,162 | ||||||||||||||||||
| Corporate, other and eliminations (1) | — | 7,918 | 139,811 | 147,729 | (173,663 | ) | (116,359 | ) | ||||||||||||||||
| Realized investment losses | — | — | (356,931 | ) | (356,931 | ) | (356,931 | ) | (231,958 | ) | ||||||||||||||
| Consolidated | $ | 4,289,580 | $ | 533,480 | $ | (114,252 | ) | $ | 4,708,808 | $ | 326,322 | $ | 281,141 | |||||||||||
| December 31, 2007: | ||||||||||||||||||||||||
| Specialty | $ | 1,772,547 | $ | 233,080 | $ | 400 | $ | 2,006,027 | $ | 516,931 | $ | 359,313 | ||||||||||||
| Regional | 1,250,914 | 96,886 | — | 1,347,800 | 215,228 | 149,587 | ||||||||||||||||||
| Alternative markets | 651,909 | 125,698 | 97,292 | 874,899 | 248,080 | 173,822 | ||||||||||||||||||
| Reinsurance | 740,439 | 153,416 | — | 893,855 | 178,302 | 131,238 | ||||||||||||||||||
| International | 247,892 | 36,666 | — | 284,558 | 44,457 | 29,386 | ||||||||||||||||||
| Corporate, other and eliminations (1) | — | 26,914 | 104,648 | 131,562 | (160,302 | ) | (109,341 | ) | ||||||||||||||||
| Realized investment gains | — | — | 49,696 | 49,696 | 49,696 | 32,234 | ||||||||||||||||||
| Consolidated | $ | 4,663,701 | $ | 672,660 | $ | 252,036 | $ | 5,588,397 | $ | 1,092,392 | $ | 766,239 | ||||||||||||
| December 31, 2006: | ||||||||||||||||||||||||
| Specialty | $ | 1,752,507 | $ | 200,421 | $ | — | $ | 1,952,928 | $ | 479,105 | $ | 332,462 | ||||||||||||
| Regional | 1,205,912 | 83,957 | — | 1,289,869 | 201,417 | 139,737 | ||||||||||||||||||
| Alternative markets | 658,805 | 114,914 | 104,812 | 878,531 | 291,416 | 201,486 | ||||||||||||||||||
| Reinsurance | 859,411 | 133,709 | — | 993,120 | 135,424 | 102,065 | ||||||||||||||||||
| International | 215,987 | 32,907 | — | 248,894 | 34,447 | 24,550 | ||||||||||||||||||
| Corporate, other and eliminations (1) | — | 20,267 | 1,574 | 21,841 | (162,812 | ) | (107,896 | ) | ||||||||||||||||
| Realized investment gains | — | — | 9,648 | 9,648 | 9,648 | 7,114 | ||||||||||||||||||
| Consolidated | $ | 4,692,622 | $ | 586,175 | $ | 116,034 | $ | 5,394,831 | $ | 988,645 | $ | 699,518 | ||||||||||||
Identifiable assets by segment are as follows (dollars in thousands):
| Years Ended December 31, | 2008 | 2007 | ||||||
| Specialty | $ | 5,594,747 | $ | 5,885,082 | ||||
| Regional | 2,652,459 | 2,713,397 | ||||||
| Alternative markets | 3,463,508 | 3,261,318 | ||||||
| Reinsurance | 4,231,514 | 4,906,650 | ||||||
| International | 879,271 | 870,404 | ||||||
| Corporate, other and eliminations (1) | (700,341 | ) | (816,846 | ) | ||||
| Consolidated | $ | 16,121,158 | $ | 16,820,005 | ||||
| (1) | Corporate, other and eliminations represent corporate revenues and expenses, realized investment gains and losses and other items that are not allocated to business segments. |
46
Net premiums earned by major line of business are as follows (dollars in thousands):
| 2008 | 2007 | 2006 | ||||||||||
Specialty | ||||||||||||
| Premises operations | $ | 596,314 | $ | 730,874 | $ | 744,351 | ||||||
| Commercial automobile | 268,438 | 277,170 | 267,091 | |||||||||
| Products liability | 183,786 | 228,749 | 257,992 | |||||||||
| Property | 208,534 | 210,791 | 164,784 | |||||||||
| Professional liability | 155,967 | 155,171 | 158,124 | |||||||||
| Other | 205,876 | 169,792 | 160,165 | |||||||||
| Total specialty | 1,618,915 | 1,772,547 | 1,752,507 | |||||||||
Regional | ||||||||||||
| Commercial multiple peril | 455,366 | 474,574 | 468,978 | |||||||||
| Commercial automobile | 361,793 | 364,467 | 348,126 | |||||||||
| Workers’ compensation | 250,770 | 251,774 | 246,151 | |||||||||
| Other | 169,329 | 160,099 | 142,657 | |||||||||
| Total regional | 1,237,258 | 1,250,914 | 1,205,912 | |||||||||
Alternative Markets | ||||||||||||
| Excess workers’ compensation | 289,764 | 311,786 | 308,290 | |||||||||
| Primary workers’ compensation | 243,571 | 250,628 | 270,193 | |||||||||
| Other | 93,523 | 89,495 | 80,322 | |||||||||
| Total alternative markets | 626,858 | 651,909 | 658,805 | |||||||||
Reinsurance | ||||||||||||
| Casualty | 444,606 | 609,398 | 758,635 | |||||||||
| Property | 75,111 | 131,041 | 100,776 | |||||||||
| Total reinsurance | 519,717 | 740,439 | 859,411 | |||||||||
International | 286,832 | 247,892 | 215,987 | |||||||||
| Total | $ | 4,289,580 | $ | 4,663,701 | $ | 4,692,622 | ||||||
(26) Quarterly Financial Information (unaudited)
The following is a summary of quarterly financial data (in thousands except per share data):
| Three months ended | ||||||||||||||||||||||||||||||||
| March 31, | June 30, | September 30, | December 31, | |||||||||||||||||||||||||||||
| 2008 | 2007 | 2008 | 2007 | 2008 (b) | 2007 (c) | 2008 | 2007 | |||||||||||||||||||||||||
| Revenues | $ | 1,375,204 | $ | 1,359,021 | $ | 1,199,139 | $ | 1,386,583 | $ | 1,055,630 | $ | 1,442,790 | $ | 1,078,835 | $ | 1,400,003 | ||||||||||||||||
| Net income (loss) | 188,438 | 188,426 | 80,257 | 190,633 | (27,880 | ) | 203,056 | 40,326 | 184,124 | |||||||||||||||||||||||
| Net income (loss) per share (a): | ||||||||||||||||||||||||||||||||
| Basic | 1.07 | .98 | .48 | .98 | (.17 | ) (b) | 1.09 | .25 | 1.01 | |||||||||||||||||||||||
| Diluted | 1.03 | .93 | .46 | .93 | (.17 | ) (b) | 1.05 | .24 | .97 | |||||||||||||||||||||||
| (a) | Earnings (loss) per share (“EPS”) in each quarter is computed using the weighted-average number of shares outstanding during that quarter while EPS for the full year is computed using the weighted-average number of shares outstanding during the year. Thus, the sum of the four quarters EPS does not necessarily equal the full-year EPS. | |
| (b) | For the three months ended September 30, 2008, the anti-dilutive effects of 6,086 potential common shares outstanding were excluded from the outstanding diluted shares due to the third quarter loss. | |
| (c) | The third quarter 2007 was restated to reflect the change in accounting. See note 1. |
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(27) Subsequent Event
The Company’s share of the earnings or losses of investment funds is generally reported on a one-quarter lag in order to facilitate the timely completion of the Company’s financial statements. Subsequent to December 31, 2008, the Company received the 2008 financial statements for certain real estate and energy funds. The Company’s share of net losses reported by these funds for their 2008 fourth quarter was $111 million pre-tax, or $72 million after-tax. The Company will report this loss, together with the results for investment funds for which 2008 financial statements have not yet been received, in its income statement for the first quarter of 2009.
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