For information regarding cross-default and certain other provisions in the Company’s debt and convertible securities documents, see Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.
See Part II, Item 2 “Unregistered Sales of Equity Securities and Use of Proceeds,” below.
The Private Securities Litigation Reform Act of 1995 (“PSLRA”) provides a “safe harbor” for forward-looking statements. Any prospectus, prospectus supplement, the Company’s Annual Report to ordinary shareholders, any proxy statement, any other Form 10-K, Form 10-Q or Form 8-K of the Company or any other written or oral statements made by or on behalf of the Company may include forward-looking statements that reflect the Company’s current views with respect to future events and financial performance. Such statements include forward-looking statements both with respect to the Company in general, and to the insurance and reinsurance sectors in particular (both as to underwriting and investment matters). Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “anticipate,” “will,” “may” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the PSLRA or otherwise.
All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements. The Company believes that these factors include, but are not limited to, the following: (i) changes in the size of the Company’s claims relating to natural or man-made catastrophe losses due to the preliminary nature of some reports and estimates of loss and damage to date; (ii) trends in rates for property and casualty insurance and reinsurance; (iii) the timely and full recoverability of reinsurance placed by the Company with third parties, or other amounts due to the Company; (iv) changes in ratings, rating agency policies or practices; (v) changes in the projected amount of ceded reinsurance recoverables and the ratings and creditworthiness of reinsurers; (vi) the timing of claims payments being faster or the receipt of reinsurance recoverables being slower than anticipated by the Company; (vii) the Company’s ability to successfully implement its business strategy especially during the “soft” market cycle; (viii) increased competition on the basis of pricing, capacity, coverage terms or other factors, which could harm the Company’s ability to maintain or increase its business volumes or profitability; (ix) greater frequency or severity of claims and loss activity than the Company’s underwriting, reserving or investment practices anticipate based on historical experience or industry data; (x) the effects of inflation on the Company’s business, including on pricing and reserving; (xi) developments, including uncertainties related to the depth and duration of the current recession, and future volatility, in the world’s credit, financial and capital markets that adversely affect the performance and valuation of the Company’s investments or access to such markets; (xii) the potential impact on the Company from government-mandated insurance coverage for acts of terrorism; (xiii) the potential for changes to methodologies, estimations and assumptions that underlie the valuation of the Company’s financial instruments that could result in changes to investment valuations; (xiv) changes to the Company’s assessment as to whether it is more likely than not that the Company will be required to sell, or has the intent to sell, available for sale debt securities before their anticipated recovery; (xv) availability of borrowings and letters of credit under the Company’s credit facilities; (xvi) the ability of the Company’s subsidiaries to pay dividends to XL Group plc; (xvii) the potential effect of regulatory developments in the jurisdictions in which the Company operates, including those which could impact the financial markets or increase the Company’s business costs and required capital levels; (xviii) changes in regulation or laws applicable to XL Group plc or its subsidiaries, brokers or customers; (xix) acceptance of the Company’s products and services, including new products and services; (xx) changes in the availability, cost or quality of reinsurance; (xxi) changes in the distribution or placement of risks due to increased consolidation of insurance and reinsurance brokers; (xxii) loss of key personnel; (xxiii) changes in accounting policies or practices or the application thereof; (xxiv) legislative or regulatory developments including, but not limited to, changes in regulatory capital balances that must be maintained by the Company’s operating subsidiaries and governmental actions for the purpose of stabilizing the financial markets; (xxv) the effects of mergers, acquisitions and divestitures; (xvi) developments related to bankruptcies of companies insofar as they affect property and casualty insurance and reinsurance coverages or claims that the Company may have as a counterparty; (xxvii) changes in general economic conditions, including changes in interest rates, credit spreads, foreign currency exchange rates and other factors; (xxviii) changes in applicable tax laws, tax treaties or tax regulations or the interpretation or enforcement thereof; (xxix) the effects of business disruption or economic contraction due to war, terrorism or other hostilities; (xxx) the Company’s ability to realize the expected benefits from the redomestication; (xxxi) any unanticipated costs in connection with the redomestication; and (xxxii) the other factors set forth in the Company’s other documents on file with the SEC. The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included herein or elsewhere. The Company undertakes no obligation to update publicly or revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as required by the federal securities laws.
| | |
| | |
ITEM 3. | | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
| | |
Except as described below, there have been no material changes in the Company’s market risk exposures or how those exposures are managed since December 31, 2009. The following discussion should be read in conjunction with “Quantitative and Qualitative Disclosures about Market Risk,” presented under Item 7A of the Company’s Form 10-K for the year ended December 31, 2009.
Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments. The Company is principally exposed to the following market risks: interest rate risk, foreign currency exchange rate risk, equity price risk, credit risk, and other related market risks.
The majority of the Company’s market risk arises from its investment portfolio which consists of fixed income securities, alternative investments, public equities, private investments, derivatives, other investments, and cash, denominated in both U.S. and foreign currencies, which are sensitive to changes in interest rates, credit spreads, equity prices, foreign currency exchange rates and other related market risks. The Company’s fixed income and equity securities are generally classified as available for sale, and as such changes in interest rates, credit spreads on corporate and structured credit, equity prices, foreign currency exchange rates or other related market instruments will have an immediate effect on comprehensive income and shareholders’ equity but will not ordinarily have an immediate effect on net income. Nevertheless, changes in interest rates, credit spreads, equity prices and other related market instruments effect consolidated net income when, and if, a security is sold or impaired.
On a limited basis the Company enters into derivatives and other financial instruments primarily for risk management purposes. The Company uses derivatives to hedge foreign exchange and interest rate risk related to its consolidated net exposures. From time to time, the Company also uses investment derivative instruments such as futures, options, interest rate swaps, credit default swaps and foreign currency forward contracts to manage the duration of its investment portfolio and foreign currency exposures and also to obtain exposure to a particular financial market. Historically, the Company entered into credit derivatives outside of the investment portfolio in conjunction with the legacy financial guarantee and financial products operations. The Company attempts to manage the risks associated with derivative use with guidelines established by senior management. Derivative instruments are carried at fair value with the resulting changes in fair value recognized in income in the period in which they occur. For further information, see Item 1, Note 6, “Derivative Instruments”, herein.
This risk management discussion and the estimated amounts generated from the sensitivity and value at risk (“VaR”) analyses for the investment portfolio presented in this document are forward-looking statements of market risk assuming certain adverse market conditions occur. Actual results in the future may differ materially from these estimated results due to, among other things, actual developments in the global financial markets and changes in the composition of the Company’s investment portfolio. The results of analysis used by the Company to assess and mitigate risk should not be considered projections of future events of losses. See generally “Cautionary Note Regarding Forward-Looking Statements,” in Item 2.
Interest Rate Risk
The Company’s fixed income portfolio is exposed to interest rate risk. Interest rate risk is the price sensitivity of a fixed income security to changes in interest rates. The Company manages interest rate risk within the context of its overall asset liability management strategy by setting duration targets for its investment portfolio in line with the estimated duration of its liabilities, thus mitigating the overall economic effect of interest rate risk and within the constraints of the Company’s risk appetite. Nevertheless, the Company remains exposed to interest rate risk with respect to the Company’s overall net asset position and more generally from an accounting standpoint since the assets are marked to market, thus subject to market conditions, while liabilities are accrued at a static rate.
In addition, while the Company’s debt is not carried at fair value and not adjusted for market changes, changes in market interest rates could have an impact on debt values at the time of refinancing.
Foreign Currency Exchange Rate Risk
Many of the Company’s non-U.S. subsidiaries maintain both assets and liabilities in local currencies, therefore foreign exchange risk is generally limited to net assets denominated in foreign currencies.
Foreign currency exchange rate gains and losses in the Company’s Statement of Income arise for accounting purposes when net assets or liabilities are denominated in foreign currencies that differ from the functional currency of those subsidiaries. While unrealized foreign exchange gains and losses on underwriting balances are reported in earnings, the offsetting unrealized gains and losses on invested assets are recorded as a separate component of shareholders’ equity, to the extent that the asset currency does not match that entity’s functional currency. This results in an accounting mismatch that will result in foreign exchange gains or losses in the consolidated statements of income depending on the movement in certain currencies. In order to improve administrative efficiencies as well as to address this accounting imbalance, the Company formed several branches with Euro and U.K. pound Sterling functional currencies. Management continues to focus on attempting to limit this type of exposure in the future.
84
Foreign currency exchange rate risk in general is reviewed as part of the Company’s risk management process. Within its asset liability framework for the investment portfolio, the Company pursues a general policy of holding the assets and liabilities in the same currency and as such the Company is not exposed to the risks associated with foreign exchange movements within its investment portfolio as currency impacts on the assets are generally matched by corresponding impacts on the related liabilities. Foreign exchange contracts within the investment portfolio are utilized to manage individual portfolio foreign exchange exposures, subject to investment management service providers’ guidelines established by management. These contracts are generally not designated as specific hedges for financial reporting purposes and, therefore, realized and unrealized gains and losses on these contracts are recorded in income in the period in which they occur. These contracts generally have maturities of three months or less. The Company also attempts to manage the foreign exchange volatility arising on certain transactions denominated in foreign currencies. These include, but are not limited to, premium receivable, reinsurance contracts, claims payable and investments in subsidiaries.
The principal currencies creating foreign exchange risk for the Company are the U.K. pound Sterling, the Euro, the Swiss Franc and the Canadian dollar. The following tables provide more information on the Company’s exposure to foreign exchange rate risk at September 30, 2010 and December 31, 2009:
| | | | | | | | |
September 30, 2010
(Foreign Currency in millions) | | Euro | | U.K. Pound | | Swiss Franc | | Canadian
Dollar |
|
|
|
|
|
|
|
|
|
Net exposure to key foreign currencies | | 169.2 | | 39.4 | | 265.2 | | 216.6 |
| | | | | | | | |
| | | | | | | | |
December 31, 2009
(Foreign Currency in millions) | | Euro | | U.K. Pound | | Swiss Franc | | Canadian
Dollar |
|
|
|
|
|
|
|
|
|
Net exposure to key foreign currencies | | 258.6 | | (120.0 | ) | 261.9 | | 508.1 |
| | | | | | | | |
|
|
|
|
|
|
|
|
|
Credit Risk
The Company is exposed to direct credit risk within its investment portfolio as well as through general counterparties, including customers and reinsurers. Credit risk relates to the uncertainty of an obligor’s continued ability to make timely payments in accordance with the contractual terms of the instrument or contract. The Company manages credit risk through established investment credit policies which address quality of obligors and counterparties, industry limits, and diversification requirements. The Company’s exposure to market credit spreads primarily relates to market price and cash flow variability associated with changes in credit spreads.
Certain of the Company’s underwriting activities expose it to indirect credit risk in that profitability of certain strategies can correlate with credit events at the issuer level, industry level or country level. The Company manages these risks through established underwriting policies which operate in accordance with established limit and escalation frameworks.
The Company has established Risk Governance processes by which oversight and decision-making authorities with respect to risks are granted to individuals and strategies within the enterprise. The Company’s governance framework establishes accountabilities for tasks and outcomes as well as escalation criteria. Governance processes are designed to ensure that transactions and activities, individually and in the aggregate, are carried out in accordance with the Company’s risk policies, philosophies, appetites, limits and risk concentrations, and in a manner consistent with expectations of excellence of integrity, accountability and client service.
Credit Risk – Investment Portfolio
Credit risk is the exposure to adverse changes in the creditworthiness of individual investment holdings, issuers, groups of issuers, industries and countries. A widening of credit spreads will increase the net unrealized loss position, will increase losses associated with credit based non-qualifying derivatives where the Company assumes credit exposure, and, if issuer credit spreads increase significantly or for an extended period of time, would likely result in higher other-than-temporary impairments. All else held equal, credit spread tightening will reduce net investment income associated with new purchases of fixed maturities. In addition, market volatility can make it difficult to value certain of the Company’s securities if trading becomes less frequent. As such, valuations may include assumptions or estimates that may have significant period to period changes which could have a material adverse effect on the Company’s consolidated results of operations or financial condition.
The table below shows the Company’s aggregate fixed income portfolio by credit rating in percentage terms of the Company’s aggregate fixed income exposure (including fixed maturities, short-term investments, cash and cash equivalents and net payable for investments purchased) at September 30, 2010.
| | | |
| | Percentage of Aggregate Fixed Income Portfolio | |
| |
| |
AAA | | 53.5 | |
AA | | 14.7 | |
A | | 21.3 | |
BBB | | 6.8 | |
BB & below | | 3.7 | |
NR | | — | |
| |
| |
Total (1) | | 100.0 | % |
| |
|
|
(1) | Included in the above are $457.4 million or 1.3% of the portfolio which represents medium term notes rated at the average credit rating of the underlying asset pools backing the notes. |
At September 30, 2010, the average credit quality of the Company’s aggregate fixed income investment portfolio was “AA”, excluding operating cash.
85
The Company is closely monitoring its corporate financial bond holdings given the events of the past three years. The table below summarizes the Company’s significant exposures (defined as bonds issued by financial institutions with an amortized cost in excess of $50.0 million) to corporate bonds of financial issuers held within its available for sale and held to maturity investment portfolio at September 30, 2010, representing both amortized cost and unrealized gains (losses):
| | | | | | | | |
(U.S. dollars in millions) | | | | | | |
Issuer (by Global Ultimate Parent) | | | Amortized Cost
September 30, 2010 (1) | | Unrealized Gain/
(Loss)
September 30, 2010 | |
| | |
| |
| |
Bank of America Corporation | | $ | 195.1 | | $ | (4.6 | ) |
Lloyds Banking Group plc | | | 171.7 | | | 4.9 | |
Rabobank Nederland NV | | | 159.6 | | | 3.0 | |
The Goldman Sachs Group, Inc. | | | 134.9 | | | 3.5 | |
Morgan Stanley | | | 127.6 | | | 3.0 | |
JPMorgan Chase & Co. | | | 125.1 | | | (3.0 | ) |
HSBC Holdings plc | | | 122.4 | | | (0.9 | ) |
Citigroup Inc. | | | 117.4 | | | (0.4 | ) |
Barclays plc | | | 115.3 | | | (15.3 | ) |
Banco Santander, S.A. | | | 110.5 | | | (16.5 | ) |
BNP Paribas | | | 108.2 | | | (0.5 | ) |
Wells Fargo & Company | | | 107.8 | | | 3.8 | |
Australia and New Zealand Banking Group Limited | | | 100.8 | | | 2.8 | |
Bank of Nova Scotia, The | | | 99.2 | | | 2.7 | |
Credit Agricole SA | | | 85.0 | | | (2.8 | ) |
Credit Suisse Group AG | | | 81.6 | | | 3.0 | |
Aviva Plc | | | 80.0 | | | (11.1 | ) |
National Australia Bank Limited | | | 78.5 | | | (0.3 | ) |
UBS AG | | | 77.1 | | | 0.7 | |
Westpac Banking Corporation | | | 71.3 | | | 2.6 | |
Nationwide Building Society | | | 68.8 | | | (4.3 | ) |
Standard Chartered plc | | | 68.7 | | | 0.2 | |
RFS Holdings B.V. | | | 66.2 | | | 5.1 | |
BPCE | | | 65.0 | | | 0.4 | |
Canadian Imperial Bank Of Commerce | | | 64.7 | | | 1.7 | |
Assicurazioni Generali S.P.A. | | | 58.8 | | | (8.3 | ) |
Legal & General Group plc | | | 56.5 | | | (4.6 | ) |
Nordea Bank | | | 56.2 | | | 0.1 | |
Bank of Montreal | | | 55.7 | | | 2.1 | |
Danske Bank | | | 53.9 | | | (4.8 | ) |
Metlife, Inc. | | | 52.4 | | | 3.3 | |
Northern Rock Plc | | | 51.3 | | | 0.4 | |
U.S. Bancorp | | | 51.0 | | | (0.1 | ) |
| |
|
(1) | Government-guaranteed paper has been excluded from the above figures. |
Within the Company’s corporate financial bond holdings, the Company is further monitoring its exposures to hybrid securities, representing Tier One and Upper Tier Two securities of various financial institutions. The following table summarizes the top ten exposures to hybrid securities, listed by amortized cost representing both amortized cost and unrealized (losses):
86
| | | | | | | | | | | | | |
(U.S. dollars in millions) | | | | | | | | | | | | | |
Issuer (by Global Ultimate Parent) | | Tier One
Amortized Cost
September 30, 2010 | | Upper Tier Two
Amortized Cost
September 30, 2010 | | Total
Amortized Cost
September 30, 2010 | | Net Unrealized
(Loss)
September 30, 2010 | |
| |
| |
| |
| |
| |
Barclays, Plc | | $ | 53.7 | | $ | 58.6 | | $ | 112.3 | | $ | (15.1 | ) |
Banco Santander, S.A. | | | 47.8 | | | 33.4 | | | 81.2 | | | (15.8 | ) |
Aviva PLC | | | 5.7 | | | 53.2 | | | 58.9 | | | (10.1 | ) |
Assicurazioni Generali S.P.A | | | 58.8 | | | — | | | 58.8 | | | (8.3 | ) |
Danske Bank A/S | | | 33.9 | | | 19.9 | | | 53.8 | | | (4.7 | ) |
Credit Agricole SA | | | 10.3 | | | 41.5 | | | 51.8 | | | (4.0 | ) |
Unicredit S.P.A. | | | 35.7 | | | — | | | 35.7 | | | (4.9 | ) |
Bank of America Corporation | | | 29.7 | | | — | | | 29.7 | | | (5.1 | ) |
BNP Paribas | | | 27.8 | | | — | | | 27.8 | | | (2.7 | ) |
HSBC Holdings PLC | | | 27.2 | | | — | | | 27.2 | | | (2.1 | ) |
| |
|
| |
|
| |
|
| |
|
| |
Total | | $ | 330.6 | | $ | 206.6 | | $ | 537.2 | | $ | (72.8 | ) |
| |
|
| |
|
| |
|
| |
|
| |
At September 30, 2010, the top 10 corporate holdings listed below represent the direct exposure to the corporations listed below, including their subsidiaries, and excludes any securitized, credit enhanced and collateralized asset or mortgage backed securities, cash and cash equivalents, pooled notes and any OTC derivative counterparty exposure, if applicable.
| | | | |
Top 10 Corporate Holdings (1) | | | Percentage of Aggregate
Fixed Income Portfolio (2) |
| | |
|
Pfizer Inc. | | 0.6 | % |
General Electric Company | | 0.6 | % |
Bank of America Corporation | | 0.6 | % |
Lloyds Banking Group PLC | | 0.5 | % |
Wal-Mart Stores, Inc. | | 0.5 | % |
Rabobank Nederland NV | | 0.5 | % |
AT&T Inc. | | 0.5 | % |
Verizon Communications, Inc. | | 0.5 | % |
BP PLC | | 0.5 | % |
Glaxosmithkline PLC | | 0.4 | % |
| |
|
(1) | Corporate issuers exclude government-backed, government-sponsored enterprises and cash and cash equivalents. |
| |
(2) | Includes fixed maturities, short-term investments, cash and cash equivalents and net payable for investments purchased and excludes government-guaranteed paper. |
87
At September 30, 2010, the top 5 corporate sector exposures listed below represented 28.5% of the aggregate fixed income investment portfolio and 79.8% of all corporate holdings.
| | | | | | | | |
(U.S. dollars in millions) | | | | | |
Top 5 Sector Exposures | | | Fair Value | | Percentage of
Aggregate
Fixed Income
Portfolio | |
| | |
| |
| |
Financials (1) | | $ | 4,483.3 | | | 12.9 | % |
Consumer, Non-Cyclical | | | 2,179.7 | | | 6.3 | % |
Utilities | | | 1,336.1 | | | 3.8 | % |
Communications | | | 962.5 | | | 2.8 | % |
Energy | | | 927.6 | | | 2.7 | % |
| |
|
| |
|
| |
Total | | $ | 9,889.2 | | | 28.5 | % |
| |
|
| |
|
| |
| | |
|
| (1) | Government-guaranteed paper has been excluded from the above figures. |
Within the Company’s fixed income portfolios, the Company is further monitoring its exposures to holdings representing risk in certain Eurozone countries. In particular, the Company has government holdings of $1.2 million, corporate holdings of $203.7 million and structured credit holdings of $1.0 million in Greece, Ireland, Italy, Portugal and Spain. The corporate holdings primarily consist of multinationals with low reliance on local economics and systemically important industries such as utilities and telecoms.
The Company also has exposure to market movement related to credit risk associated with its mortgage-backed and asset-backed securities. The table below shows the breakdown of the $10.1 billion structured credit portfolio, of which 77.0% is AAA rated:
| | | | | | | |
(U.S. dollars in millions) | | Fair Value | | Percentage of
Structured Portfolio | |
| |
| |
| |
CMBS | | $ | 1,236.9 | | | 12.2 | % |
Non-Agency RMBS | | | 1,159.6 | | | 11.5 | % |
Core CDO (non-ABS CDOs and CLOs) | | | 731.7 | | | 7.2 | % |
Other ABS | | | 1,371.4 | | | 13.5 | % |
Agency RMBS | | | 5,633.0 | | | 55.6 | % |
| |
|
| |
|
| |
Total | | $ | 10,132.6 | | | 100.0 | % |
| |
|
| |
|
| |
Credit Risk – Other
Credit derivatives are purchased within the Company’s investment portfolio, have been sold through a limited number of contracts written as part of the Company’s previous XL Financial Solutions business, and were previously entered into through the Company’s prior reinsurance agreements with Syncora, as described below. From time to time, the Company may purchase credit default swaps to hedge an existing position or concentration of holdings. The credit derivatives are recorded at fair value. For further details with respect to the Company’s exposure to Credit derivatives see Item 1, Note 6 to the Company’s Consolidated Financial Statements, “Derivative Instruments”, herein.
The Company has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, alternatives and other investment funds and other institutions. Many of these transactions expose the Company to credit risk in the event of default of the Company’s counterparty. In addition, with respect to secured transactions, the Company’s credit risk may be exacerbated when the collateral held by the Company cannot be sold or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure that is due. The Company also has exposure to financial institutions in the form of unsecured debt instruments, derivative transactions, revolving credit facility and letter of credit commitments and equity investments. There can be no assurance that any such losses or impairments to the carrying value of these assets would not materially and adversely affect the Company’s business and results of operations.
With regards to unpaid losses and loss expenses recoverable and reinsurance balances receivable, the Company has credit risk should any of its reinsurers be unable or unwilling to settle amounts due to the Company; however, these exposures are not marked to market. For further information relating to reinsurer credit risk, see Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations –Unpaid Losses and Loss Expenses Recoverable and Reinsurance Balances Receivable.”
88
The Company is exposed to credit risk in the event of non-performance by the other parties to its derivative instruments in general; however, the Company does not anticipate non-performance. The difference between the notional principal amounts and the associated market value is the Company’s maximum credit exposure.
Equity Price Risk
The Company’s equity investment portfolio as well as other investments, primarily representing certain derivatives and certain affiliate investments, are exposed to mark to market movements associated with equity price risk. Equity price risk is the potential loss arising from changes in the market value of equities. At September 30, 2010, the Company’s equity portfolio was approximately $19.0 million as compared to $12.0 million at December 31, 2009. This excludes fixed income fund investments that generally do not have the risk characteristics of equity investments. At September 30, 2010 and December 31, 2009, the Company’s direct allocation to equity securities was a negligible percentage of the total investment portfolio (including cash and cash equivalents, accrued investment income and net payable for investments purchased). The Company also estimates the equity risk embedded in certain alternative and private investments. Such estimates are derived from market exposures provided to the Company by certain individual fund investments and/or internal statistical analyses.
Other Market Risks
The Company’s private investment portfolio is invested in limited partnerships and other entities which are not publicly traded. In addition to normal market risks, these positions may also be exposed to liquidity risk, risks related to distressed investments, and risks specific to startup or small companies. At September 30, 2010, the Company’s exposure to private investments was $320.3 million, as compared to $322.4 million at December 31, 2009.
The Company’s alternative investment portfolio, which is exposed to equity and credit risk as well as certain other market risks, had a total exposure of $917.8 million making up approximately 2.6% of the total investment portfolio (including cash and cash equivalents, accrued investment income and net payable for investments purchased) at September 30, 2010, as compared to December 31, 2009, where the Company had a total exposure of $800.2 million representing approximately 2.4% of the total investment portfolio.
At September 30, 2010, bond and stock index futures outstanding had a net long position of $71.9 million as compared to a net long position of $81.8 million at December 31, 2009. The Company may reduce its exposure to these futures through offsetting transactions, including options and forwards.
As noted above, the Company also invests in certain derivative positions which can be impacted by market value movements. For further details on derivative instruments see Item 1, Note 6 to the Company’s Consolidated Financial Statements, “Derivative Instruments”, herein.
Sensitivity and Value-at-Risk Analysis
The table below summarizes the Company’s assessment of the estimated impact on the value of the Company’s investment portfolio at September 30, 2010 associated with an immediate and hypothetical: +100bps increase in interest rates, a -10% decline in equity markets, a +100bps widening in spreads and a +10% widening in spreads. The table also reports the 95%, 1-year VaRs for the Company’s investment portfolios at September 30, 2010, excluding foreign exchange.
The interest rate, spread risk, and VaR referenced in the table below include the impact of market movements on the Company’s held to maturity fixed maturities from the Company’s Life investment portfolios. While the market value of these holdings is sensitive to prevailing interest rates and credit spreads, the Company’s book value is not impacted as these holdings are carried at amortized cost. At September 30, 2010, if the Company were to exclude these impacts in order to present the impact of these risks to the Company’s book value, the interest rate risk would be reduced by approximately $312.3 million, absolute spread risk would be reduced by approximately $214.1 million, relative spread risk would be reduced by approximately $18.8 million, and VaR would be reduced by approximately $418.2 million.
The table below excludes the impact of foreign exchange rate risk on the investment portfolio. The investment portfolio is managed on an asset-liability matched basis, and, accordingly, any foreign exchange movements impact the assets and liabilities equally. See foreign exchange rate risk for further details. The Company considers that the investment portfolio VaR estimated results as well as P&C and Life investment portfolios VaR estimated results excluding foreign exchange rate risk are the more relevant and appropriate metrics to consider when assessing the actual risk of the portfolio.
89
The estimated results below also do not include any risk contributions from our various operating affiliates (strategic, investment manager or financial operating affiliates) or other investments carried at amortized cost.
| | | | | | | | | | | | | | | | |
(U.S. dollars in thousands) | | Interest
Rate
Risk(2) | | Equity
Risk
(3) | | Absolute
Spread
Risk (4) | | Relative
Spread
Risk (5) | | VaR
(6), (7) | |
| |
| |
| |
| |
| |
| |
| | | | | | | | | | | | | | | | |
Total Investment Portfolio (1) | | $ | (1,255.6 | ) | $ | (57.1 | ) | $ | (1,261.3 | ) | $ | (223.3 | ) | $ | 1,471.9 | |
| | | | | | | | | | | | | | | | |
A. P&C Investment Portfolio | | $ | (705.2 | ) | $ | (57.1 | ) | $ | (788.6 | ) | $ | (136.2 | ) | $ | 864.3 | |
| | | | | | | | | | | | | | | | |
(I) P&C Fixed Income Portfolio | | | (705.2 | ) | | — | | | (788.6 | ) | | (136.2 | ) | | 842.9 | |
| | | | | | | | | | | | | | | | |
(a) Cash & 0-1 Yr | | | (5.9 | ) | | — | | | — | | | — | | | 8.2 | |
| | | | | | | | | | | | | | | | |
(b) Total Government Related | | | (210.5 | ) | | — | | | (149.3 | ) | | (4.8 | ) | | 176.0 | |
| | | | | | | | | | | | | | | | |
(c) Total Corporate Credit | | | (313.0 | ) | | — | | | (358.6 | ) | | (49.5 | ) | | 381.1 | |
| | | | | | | | | | | | | | | | |
(d) Total Structured Credit | | | (175.8 | ) | | — | | | (291.3 | ) | | (82.1 | ) | | 430.4 | |
| | | | | | | | | | | | | | | | |
(II) P&C Non-Fixed Income Portfolio | | | — | | | (57.1 | ) | | — | | | — | | | 92.5 | |
| | | | | | | | | | | | | | | | |
(e) Equity Portfolio | | | — | | | (1.2 | ) | | — | | | — | | | 5.2 | |
| | | | | | | | | | | | | | | | |
(f) Alternative Portfolio | | | — | | | (23.0 | ) | | — | | | — | | | 55.3 | |
| | | | | | | | | | | | | | | | |
(g) Private Investments | | | — | | | (32.9 | ) | | — | | | — | | | 70.7 | |
| | | | | | | | | | | | | | | | |
B. Life Investment Portfolio | | $ | (540.9 | ) | $ | — | | $ | (435.4 | ) | $ | (84.9 | ) | $ | 721.3 | |
| | | | | | | | | | | | | | | | |
(III) Life Fixed Income Portfolio | | | (540.9 | ) | | — | | | (435.4 | ) | | (84.9 | ) | | 721.3 | |
| | | | | | | | | | | | | | | | |
(i) Cash & 0-1 Yr | | | — | | | — | | | — | | | — | | | 0.2 | |
| | | | | | | | | | | | | | | | |
(j) Total Government Related | | | (221.2 | ) | | — | | | (82.5 | ) | | (3.3 | ) | | 320.8 | |
| | | | | | | | | | | | | | | | |
(k) Total Corporate Credit | | | (269.6 | ) | | — | | | (295.8 | ) | | (70.1 | ) | | 346.3 | |
| | | | | | | | | | | | | | | | |
(l) Total Structured Credit | | | (50.1 | ) | | — | | | (57.1 | ) | | (11.5 | ) | | 79.8 | |
| | | | | | | | | | | | | | | | |
(IV) Life Non-Fixed Income Portfolio | | | — | | | — | | | — | | | — | | | — | |
| | |
| |
(1) | The Company’s Total Investment Portfolio comprises the Company’s P&C Investment Portfolio and Life Investment Portfolio as well as the Company’s Business and Other Investments which do not form part of the Company’s P&C Investment Portfolio or Life Investment Portfolio. The individual results reported in the above table for the Company’s Total Investment Portfolio therefore represent the aggregate impact on the Company’s P&C Investment Portfolio, Life Investment Portfolio and the Company’s Business and Other Investments. |
(2) | The estimated impact on the fair value of the Company’s fixed income portfolio of an immediate hypothetical +100 bps adverse parallel shift in global bond curves. |
(3) | The estimated impact on the fair value of the Company’s investment portfolio of an immediate hypothetical -10% change in the value of equity exposures in the Company’s equity portfolio, certain equity-sensitive alternative investments and private equity investments. This includes the Company’s estimate of equity risk embedded in the alternatives and private investment portfolio with such estimates utilizing market exposures provided to the Company by certain individual fund investments and /or internal statistical analyses. |
(4) | The estimated impact on the fair value of the Company’s fixed income portfolio of an immediate hypothetical +100 basis point increase in all global corporate and structured credit spreads to which the Company’s fixed income portfolio is exposed. This excludes exposure to credit spreads in the Company’s alternative investments, private investments and counterparty exposure. |
(5) | The estimated impact on the fair value of the Company’s fixed income portfolio of an immediate hypothetical +10% increase in all global corporate and structured credit spreads to which the Company’s fixed income portfolio is exposed. This excludes exposure to credit spreads in the Company’s alternative investments, private investments and counterparty exposure. |
(6) | The VaR results are based on a 95% confidence interval, with a one year holding period, excluding foreign exchange rate risk. The Company’s investment portfolio VaR at September 30, 2010 is not necessarily indicative of future VaR levels. |
(7) | The VaR results are the standalone VaRs, based on the prescribed methodology, for each component of the Company’s Total Investment Portfolio. The standalone VaRs of the individual components are non-additive, with the difference between the summation of the individual component VaRs and their respective aggregations being due to diversification benefits across the individual components. In the case of the VaR results for the Company’s Total Investment Portfolio, the results also include the impact associated with the Company’s Business and Other Investments. |
Stress Testing
VaR does not provide the means to estimate the magnitude of the loss in the 5% of occurrences when the Company expects the VaR level to be exceeded. To complement the VaR analysis based on normal market environments, the Company considers the impact on the investment portfolio in several different stress scenarios to analyze the effect of unusual market conditions. The Company establishes certain stress scenarios which are applied to the actual investment portfolio. As these stress scenarios and estimated gains and losses are based on scenarios established by the Company, they will not necessarily reflect future stress events or gains and losses from such events. The results of the stress scenarios are reviewed on a regular basis to ensure they are appropriate, based on current shareholders equity, market conditions and the Company’s total risk tolerance. It is important to note that when assessing the risk of the Company’s investment portfolio, the Company does not take into account either the value or risk associated with the liabilities arising from the Company’s operations.
90
| | |
| | |
ITEM 4. | | CONTROLS AND PROCEDURES |
| | |
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of disclosure controls and procedures pursuant to Rules 13a-15 and 15d-15 promulgated under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective to provide reasonable assurance that all material information relating to the Company required to be included in this report has been made known to them in a timely fashion.
Changes in Internal Control Over Financial Reporting
There have been no changes in internal control over financial reporting identified in connection with the Company’s evaluation required pursuant to Rules 13a-15 and 15d-15 promulgated under the Securities Exchange Act of 1934, as amended, that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
91
PART II–OTHER INFORMATION
| | |
| | |
ITEM 1. | | LEGAL PROCEEDINGS |
| | |
In November 2006, a subsidiary of XL Group Ltd. (“XL-Cayman”) received a grand jury subpoena from the Antitrust Division of the U.S. Department of Justice (“DOJ”) and a subpoena from the Securities and Exchange Commission (the “SEC”), both of which sought documents in connection with an investigation into the municipal Guaranteed Investment Contracts (“GIC”) market and related products. In June 2008, subsidiaries of XL-Cayman also received a subpoena from the Connecticut Attorney General and an Antitrust Civil Investigative Demand from the Office of the Florida Attorney General in connection with a coordinated multi-state Attorneys General investigation into the matters referenced in the DOJ and SEC subpoenas. At various times during the period from late 2006 through 2008, the subsidiaries produced documents and other information in response to the aforementioned subpoenas and demands. XL Group plc plans to cooperate fully with any further information requests that it may receive in connection with these investigations.
Commencing in March 2008, XL-Cayman and two of its subsidiaries were named, along with approximately 20 other providers and insurers of municipal GICs and similar derivative products in the U.S. (collectively “Municipal Derivatives”) as well as fourteen brokers of such products, in several purported federal antitrust class actions. The Judicial Panel on Multidistrict Litigation ordered that these be consolidated for pretrial purposes and assigned them to the Southern District of New York. The consolidated amended complaint filed in August 2008 alleges that there was a conspiracy among the defendants during the period from January 1, 1992 to the present to rig bids and otherwise unlawfully decrease the yield for Municipal Derivative products. The purported class of plaintiffs consists of purchasers of Municipal Derivatives. On October 21, 2008 most of the defendants filed motions to dismiss the consolidated amended complaint. The District Judge granted the motions by order dated April 29, 2009, but allowed plaintiffs leave to file a second amended complaint. Plaintiffs filed a Second Consolidated Amended Class Action Complaint on June 18, 2009, but did not include XL-Cayman or any of its subsidiaries as a defendant. The remaining defendants in that action again moved to dismiss, which motion was denied by the Court on March 25, 2010.
In addition, XL-Cayman and three of its subsidiaries (along with numerous other parties) were named as defendants in eleven individual (i.e., non-class) actions filed by various municipalities or other local government bodies in California state and federal courts. The allegations are similar to the allegations in the Second Consolidated Amended Class Action Complaint described above. The defendants removed the state court cases to federal court, and all eleven cases were then transferred to the Southern District of New York by the Judicial Panel on Multidistrict Litigation. On April 26, 2010, the District Judge dismissed all eleven cases against XL-Cayman and its subsidiaries without prejudice, but denied motions to dismiss as respects most of the other defendants. Since then several additional similar actions have been filed, but none of these includes XL-Cayman or any of its subsidiaries as a defendant.
In August 2005, plaintiffs in a proposed class action (the “Class Action”) that was consolidated into a multidistrict litigation in the United States District Court for the District of New Jersey, captioned In re Brokerage Antitrust Litigation, MDL No. 1663, Civil Action No. 04-5184 (the “MDL”), filed a consolidated amended complaint (the “Amended Complaint”), which named as new defendants approximately 30 entities, including Greenwich Insurance Company, Indian Harbor Insurance Company and XL-Cayman. In the MDL, the Class Action plaintiffs asserted various claims purportedly on behalf of a class of commercial insureds against approximately 113 insurance companies and insurance brokers through which the named plaintiffs allegedly purchased insurance. The Amended Complaint alleged that the defendant insurance companies and insurance brokers conspired to manipulate bidding practices for insurance policies in certain insurance lines and failed to disclose certain commission arrangements and asserted statutory claims under the Sherman Act, various state antitrust laws and the Racketeer Influenced and Corrupt Organizations Act (“RICO”), as well as common law claims alleging breach of fiduciary duty, aiding and abetting a breach of fiduciary duty and unjust enrichment. By Opinion and Order dated August 31, 2007, the Court dismissed the Sherman Act claims with prejudice and, by Opinion and Order dated September 28, 2007, the Court dismissed the RICO claims with prejudice. The plaintiffs then appealed both Orders to the U.S. Court of Appeals for the Third Circuit. On August 16, 2010, the Third Circuit affirmed in large part the District Court’s dismissal. The Third Circuit reversed the dismissal of certain Sherman Act and RICO claims alleged against several defendants including XL-Cayman and two of its subsidiaries but remanded those claims to the District Court for further consideration of their adequacy. In light of its reversal and remand of certain of the federal claims, the Third Circuit also reversed the District Court’s dismissal (based on the District Court’s declining to exercise supplemental jurisdiction) of the state-law claims against all defendants. On October 1, 2010 the remaining defendants including XL-Cayman and two of its subsidiaries filed motions to dismiss the remanded federal claims and the state-law claims. It is expected that briefing on the motions will be completed in November 2010.
Various XL entities have been named as defendants in three of the many tag-along actions that have been consolidated into the MDL for pretrial purposes. The complaints in these tag-along actions make allegations similar to those made in the Amended Complaint but do not purport to be class actions. On April 4, 2006, a tag-along complaint was filed in the U.S. District Court for the Northern District of Georgia on behalf of New Cingular Wireless Headquarters LLC and several other corporations against approximately 100 defendants, including Greenwich Insurance Company, XL Specialty Insurance Company, XL Insurance America, Inc., XL Insurance Company Limited, Lloyd’s syndicates 861, 588 and 1209 and XL-Cayman. On or about May 21, 2007, a tag-along complaint was filed in the U.S. District Court for the District of New Jersey on behalf of Henley Management Company, Big Bear Properties, Inc., Northbrook Properties, Inc., RCK Properties, Inc., Kitchens, Inc., Aberfeldy LP and Payroll and Insurance Group, Inc. against multiple defendants, including “XL Winterthur International.” On October 12, 2007, a complaint in a third tag-along
92
action was filed in the U.S. District Court for the Northern District of Georgia by Sears, Roebuck & Co., Sears Holdings Corporation, Kmart Corporation and Lands’ End Inc. against many named defendants including X.L. America, Inc., XL Insurance America, Inc., XL Specialty Insurance Company and XL Insurance (Bermuda) Ltd. By order entered on or about October 5, 2010, the District Court ruled that the tag-along actions, including the three in which the XL entities are named defendants, will remain stayed pending the District Court’s decision on defendants’ October 1, 2010 motions to dismiss the remaining claims in the Class Action.
XL-Cayman and one of its subsidiaries (collectively “the XL Entities”), Syncora, four Syncora officers, and various underwriters of Syncora securities were named in a Consolidated Amended Complaint (“CAC”) filed in August 2008 on behalf of shareholders of Syncora in the Southern District of New York. By Order dated March 31, 2010, Judge Deborah Batts granted motions to dismiss all claims asserted in the CAC as against all defendants principally on the basis of absence of loss causation and, granted the Plaintiffs leave to amend the CAC. The Plaintiffs filed a further amended complaint in June 2010. This complaint alleges violations of the Securities Act of 1933 arising out of the secondary public offering of Syncora common shares held by the XL Entities on June 6, 2007 as well as under the Securities Exchange Act of 1934 arising out of trading in Syncora securities during the asserted class period of July 24, 2007 to December 20, 2007. The principal allegations are that Syncora failed to appropriately and timely disclose its processes with respect to underwriting certain derivative contracts and insurance of tranches of structured securities. A subsidiary of XL-Cayman is named as a party that sold stock in the secondary public offering and XL-Cayman is named as a party that “controlled” Syncora during the relevant time period. On September 10, 2010, all of the defendants including the XL Entities filed motions to dismiss the June 2010 amended complaint. The principal bases for the XL Entities’ motion are (a) plaintiffs have not adequately alleged falsity of any of the challenged disclosures, and (b) plaintiffs have not adequately alleged “loss causation” arising out of corrections of the assertedly misrepresented or omitted facts in the relevant offering materials. Briefing in scheduled to be completed November 24, 2010.
In connection with the secondary offering of Syncora shares, a subsidiary of XL-Cayman and Syncora each agreed to indemnify the several underwriters of that offering against certain liabilities, including liabilities under the Securities Act of 1933 for payment of legal fees and expenses, settlements and judgments incurred with respect to litigation such as this. The XL-Cayman subsidiary and Syncora have agreed to each bear 50% of this indemnity obligation.
XL Group plc and its subsidiaries are subject to litigation and arbitration in the normal course of its business. These lawsuits and arbitrations principally involve claims on policies of insurance and contracts of reinsurance and are typical for the company and for the property and casualty insurance and reinsurance industry in general. Such legal proceedings are considered in connection with the company’s loss and loss expense reserves. Reserves in varying amounts may or may not be established in respect of particular claims proceedings based on many factors, including the legal merits thereof. In addition to litigation relating to insurance and reinsurance claims, XL Group plc and its subsidiaries are subject to lawsuits and regulatory actions in the normal course of business that do not arise from or directly relate to claims on insurance or reinsurance policies. This category of business litigation typically involves, amongst other things, allegations of underwriting errors or misconduct, employment claims, regulatory activity, shareholder disputes or disputes arising from business ventures. The status of these legal actions is actively monitored by management. XL Group plc believes that the expected ultimate outcome of all outstanding litigation and arbitration will not have a material adverse effect on its consolidated financial condition, operating results and/or cash flow, although an adverse resolution of one or more of these items could have a material adverse effect on the company’s results of operations in a particular fiscal quarter or year.
93
Refer to Item 1A. Risk Factors in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for further information.
| | |
| | |
ITEM 2. | | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
| | |
(c) Purchases of Equity Securities by the Issuer and Affiliate Purchasers
The following table provides information about purchases by the Company during the three months ended September 30, 2010 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:
| | | | | | | | | | | | | |
Period | | Total Number
of Shares
Purchased (1)(2) | | Average Price
Paid
per Share | | Total Number
of Shares
Purchased as
Part of
Publicly
Announced Plans
or Programs | | Approximate Dollar
Value of Shares
that May Yet Be
Purchased Under
the Plans
or Programs (2) | |
| |
| |
| |
| |
| |
July 1-31, 2010 | | | 77 | | | 17.44 | | | — | | | 375.4 million | |
August 1-31, 2010 | | | 5,276,017 | | | 17.91 | | | 5,274,900 | | | 281.0 million | |
September 1-30, 2010 | | | 8,617,708 | | | 20.20 | | | 8,617,708 | | | 106.8 million | |
| |
|
| |
|
| |
|
| |
|
| |
Total | | | 13,893,802 | | | 19.33 | | | 13,892,608 | | | 106.8 million | |
| |
|
| |
|
| |
|
| |
|
| |
| | |
| |
(1) | During the three months ended September 30, 2010, 1,194shares were purchased in connection with the vesting of restricted shares granted under the Company’s restricted stock plan. These purchases were made in connection with satisfying tax withholding obligations of those employees. These shares were not purchased as part of the Company’s share repurchase program noted below. |
|
(2) | During the third quarter of 2007, the Company’s Board of Directors approved a share buyback program, authorizing the Company to purchase up to $500.0 million of its Class A ordinary shares. As of July 1, 2010, $375.4 million ordinary shares remained available for purchase under the program. During the third quarter of 2010, the Company purchased and cancelled 13.9 million ordinary shares under the program for $268.6 million. In addition, the Company purchased and cancelled 4.9 million ordinary shares during October 2010 for $106.8 million. In combination, these purchases totaled $375.4 million, the full amount remaining from the Company’s share buyback program. On November 2, 2010, the Company announced that its Board of Directors approved a new share buyback program, authorizing the Company to purchase up to $1.0 billion of its Class A ordinary shares. |
94
The following exhibits are filed as exhibits to this Quarterly Report:
| | |
31 | | Rule 13a-14(a)/15d-14(a) Certifications |
| | |
32 | | Section 1350 Certification |
| | |
101.INS | | XBRL Instance Document* |
| | |
101.SCH | | XBRL Taxonomy Extension Schema Document* |
| | |
101.CAL | | XBRL Taxonomy Extension Calculation Linkbase Document* |
| | |
101.DEF | | XBRL Taxonomy Extension Definition Linkbase Document* |
| | |
101.LAB | | XBRL Taxonomy Extension Label Linkbase Document* |
| | |
101.PRE | | XBRL Taxonomy Extension Presentation Linkbase Document* |
| | |
| |
* | These interactive data files are furnished and deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended and otherwise are not subject to liability under those sections. |
95
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | |
Date: November 5, 2010 | | |
| | XL Group plc |
| | (Registrant) |
| | |
| | /s/ MICHAEL S. MCGAVICK |
| |
|
| | Name: Michael S. McGavick |
| | Title: Chief Executive Officer and Director |
| | XL Group plc |
| | |
Date: November 5, 2010 | | |
| | /s/ IRENE M. ESTEVES |
| |
|
| | Name: Irene M. Esteves |
| | Title: Executive Vice President and Chief Financial Officer |
| | XL Group plc |
96
