For the fiscal year ended December 31, 2006
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-K

 


 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 1-14536

 


PartnerRe Ltd.

(Exact name of Registrant as specified in its charter)

 


 

Bermuda   Not Applicable
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
90 Pitts Bay Road, Pembroke, Bermuda   HM 08
(Address of principal executive offices)   (Zip Code)

(441) 292-0888

(Registrant’s telephone number, including area code)

 


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

 

Title of each class

 

Name of each exchange on which registered

Common Shares, $1.00 par value   New York Stock Exchange
6.75% Series C Cumulative Preferred Shares,
$1.00 par value
  New York Stock Exchange
6.50% Series D Cumulative Preferred Shares,
$1.00 par value
  New York Stock Exchange

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

 


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

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

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

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

Large Accelerated Filer  x    Accelerated Filer  ¨    Non-Accelerated Filer  ¨

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

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of most recently completed second fiscal quarter (June 30, 2006), was $3,633,415,910 based on the closing sales price of the Registrant’s common shares of $64.05 on that date.

The number of the Registrant’s common shares (par value $1.00 per share) outstanding as of February 22, 2007 was 57,118,443.

Documents Incorporated by Reference:

 

Document

  

Part(s) Into Which
Incorporated

Portions of the Registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, relating to the Registrant’s Annual General Meeting of Shareholders scheduled to be held May 10, 2007 are incorporated by reference into Part II and Part III of this report. With the exception of the portions of the Proxy Statement specifically incorporated herein by reference, the Proxy Statement is not deemed to be filed as part of this report.   

 



Table of Contents

TABLE OF CONTENTS

 

           Page

PART I

  

Item 1.

  

Business

   1

Item 1A.

  

Risk Factors

   20

Item 1B.

  

Unresolved Staff Comments

   31

Item 2.

  

Properties

   31

Item 3.

  

Legal Proceedings

   31

Item 4.

  

Submission of Matters to a Vote of Security Holders

   32

PART II

  

Item 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   32

Item 6.

  

Selected Financial Data

   33

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operation

   34

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

   93

Item 8.

  

Financial Statements and Supplementary Data

   99

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   153

Item 9A.

  

Controls and Procedures

   153

Item 9B.

  

Other Information

   156

PART III

  

Item 10.

  

Directors, Executive Officers and Corporate Governance

   156

Item 11.

  

Executive Compensation

   156

Item 12.

  

Security Ownership of Certain Beneficial Owners, Management and Related Stockholder Matters

   156

Item 13.

  

Certain Relationships and Related Transactions, and Director Independence

   156

Item 14.

  

Principal Accountant Fees and Services

   156

PART IV

  

Item 15.

  

Exhibits and Financial Statement Schedules

   157


Table of Contents

PART I

ITEM 1. BUSINESS

General

PartnerRe Ltd. (the Company or PartnerRe), incorporated in Bermuda on August 24, 1993, is an international reinsurance group. The Company provides reinsurance on a worldwide basis through its wholly owned subsidiaries, Partner Reinsurance Company Ltd. (Partner Reinsurance), PartnerRe SA and Partner Reinsurance Company of the U.S. (PartnerRe U.S.). Risks reinsured include, but are not limited to property, casualty, motor, agriculture, aviation/space, catastrophe, credit/surety, engineering, energy, marine, specialty property, specialty casualty, other lines and life/annuity and health. The Company also offers alternative risk products that include weather and credit protection to financial, industrial and service companies on a worldwide basis.

The Company was initially formed to capitalize on a void of capacity in the catastrophe reinsurance market following the significant devastation wrought by Hurricane Andrew in 1992 and the concurrent difficulties being faced by Lloyds of London. After raising nearly $1 billion with its initial public offering, the Company became one of the premier catastrophe reinsurers on a global basis, with acknowledged underwriting skills and disciplined risk management principles.

In 1997, recognizing the limits of a continued monoline strategy, the Company shifted its strategic focus to execute a plan to become a leading multiline reinsurer. Through both organic growth and strategic acquisitions, the Company moved to capitalize on the benefits of diversification—both in terms of geography and business lines. In July 1997, the Company completed the acquisition of SAFR (subsequently renamed PartnerRe SA), a well-established global professional reinsurer based in Paris. In December 1998, the Company completed the acquisition of the reinsurance operations of Winterthur Re, further enhancing the Company’s expansion strategy.

In 2004, the Company formed two operating subsidiaries in Ireland, Partner Reinsurance Ireland Limited (Partner Reinsurance Ireland), and PartnerRe Ireland Insurance Limited (PartnerRe Ireland Insurance). Both companies became operational in 2005.

Business Strategy

The Company assumes and manages global insurance and capital markets risks. Its strategy is founded on a capital-based risk appetite and the selected risks that Management believes will allow the Company to meet its goals for appropriate profitability within that appetite. Management believes that this construct allows the Company to balance cedants’ need for absolute certainty of claims payment with its shareholders’ need for an appropriate return on their capital. Operating Return on Equity (ROE) and diluted book value per share are two of the principal metrics used by Management to measure the Company’s results. Consequently, the Company has set a goal of an average 13% operating ROE and an increase of 10% in diluted book value per share over a reinsurance cycle. Operating ROE is obtained by dividing operating earnings by the net book value of the common shareholders’ equity at the beginning of the year. Operating earnings is defined as net income less after-tax net realized investment gains or losses on investments and preferred share dividends. Diluted book value per share is calculated using common shareholders’ equity, defined as total shareholders’ equity less the aggregate liquidation value of the preferred shares, divided by the number of fully diluted shares outstanding.

The Company has adopted the following five-point strategy:

Diversify risk across products, assets and geographies: PartnerRe writes most lines of business in 150 countries worldwide. The Company’s geographic spread of premiums mirrors that of the global insurance industry. Management believes diversification is a competitive advantage, which increases return per unit of risk,

 

1


Table of Contents

provides access to reinsurance business opportunities worldwide, and reduces the overall volatility of results. It is also the cornerstone of the Company’s risk management approach. The reinsurance business is cyclical, but cycles by line of business and by geography are rarely synchronized. This diversification strategy allows the Company to rapidly deploy capital to risk classes and geographies that offer the greatest return over time.

Maintain a risk appetite moderately above the market: PartnerRe is in the business of assuming risk for an appropriate return. The Company’s products address accumulation risks, complex coverage issues and large exposures faced by clients. The Company’s willingness and ability to assume these risks make PartnerRe an important reinsurer to many of the world’s insurance companies. The Company seeks to focus its book of business on those lines of business and market segments where it perceives greatest potential for profit over time. This means a high proportion of the business written by the Company is in severity lines of business such as casualty, catastrophe, specialized property and aviation, although the Company also writes frequency lines of business such as property, motor and life, which have historically provided modestly lower levels of returns with less volatility.

Actively manage capital across the portfolio and over the cycle: PartnerRe seeks to manage its capital to optimize shareholder returns over the cycle. In order to manage capital across a portfolio and over a cycle, the Company believes two things are critical: an appropriate and common measure of risk-adjusted performance and the ability and willingness to redeploy capital for its most efficient and effective use, either within the business or to return to the shareholders. To achieve effective and efficient capital allocation, the Company has an intense focus on operating ROE. This discipline and focus, supported by strong actuarial and financial analysis, allows the Company to make well-informed decisions at the underwriting and pricing level, as well as in the allocation of capital within its portfolio of reinsurance businesses and within pre-established risk limits.

Add value through underwriting and transactional excellence: Underwriting and transactional excellence is achieved in three principal ways: through the quality of the Company’s people, the structure they operate in, and the effectiveness of various processes and tools. Maintaining continuity and depth in the Company’s management, underwriting, actuarial and financial areas is critical to maintaining an independent view of risk, a core part of the strategy. Equally as important, the Company believes, is organizing its operations around geography, lines of business, distribution or client characteristics and providing and building the right infrastructure to continually improve its capabilities in all transactional areas: underwriting, financial reporting and controls, reserving, pricing and claims.

Achieve superior returns on invested assets in the context of a disciplined risk framework: Strong underwriting must be complemented with prudent financial management, careful reserving and superior asset management in order to achieve the Company’s targeted returns. The Company is committed to maintaining a strong and transparent balance sheet and achieving superior investment returns by gradually expanding its investment portfolio into new risk classes, many of which have more connection with capital markets than with traditional reinsurance markets. The Company assumes investment risk according to the same principles used for reinsurance underwriting, including diversification.

Reinsurance Operations

General

The Company provides reinsurance, which is a specialized service and risk management solution, for its clients in 150 countries around the world. Through its subsidiaries, the Company provides reinsurance of non-life and life risks of ceding companies (primary insurers, cedants or reinsureds) on either a proportional or non-proportional basis through treaties or facultative reinsurance. The Company’s offices are located in Bermuda, Dublin, Greenwich (Connecticut), Hong Kong, Mexico City, Montreal, Paris, Santiago, Seoul, Singapore, Tokyo, Toronto and Zurich.

In a proportional reinsurance arrangement (also known as pro-rata reinsurance, quota-share reinsurance or participating reinsurance), the reinsurer shares a proportional part of the original premiums of the reinsured. In

 

2


Table of Contents

return, the reinsurer assumes a proportional share of the losses incurred by the cedant. The reinsurer pays the ceding company a commission, which is generally based on the ceding company’s cost of acquiring the business being reinsured (including commissions, premium taxes, assessments and miscellaneous administrative expenses) and may also include a profit.

Non-proportional (or excess of loss) reinsurance indemnifies the reinsured against all or a specified portion of losses on underlying insurance policies in excess of a specified amount, which is called a level, retention or attachment point. Non-proportional business is written in layers and a reinsurer or group of reinsurers accepts a band of coverage up to a specified amount. The total coverage purchased by the cedant is referred to as a program and is typically placed with predetermined reinsurers in pre-negotiated layers. Any liability exceeding the upper limit of the program reverts to the ceding company.

Facultative reinsurance (proportional or non-proportional) is the reinsurance of individual risks. The reinsurer separately rates and underwrites each risk rather than assuming all or a portion of a class of risks as in the case of treaty reinsurance.

The Company monitors the performance of its underwriting operations in three segments, Non-life, ART (Alternative Risk Transfer) and Life. The Non-life segment is further divided into three sub-segments, U.S. Property and Casualty (U.S. P&C), Global (Non-U.S.) Property and Casualty (Global (Non-U.S.) P&C) and Worldwide Specialty. Segments and sub-segments represent markets that are reasonably homogeneous in terms of geography, client types, buying patterns, underlying risk patterns and approach to risk management. Together, the Non-life and ART segments represent all of the Company’s non-life business.

The U.S. P&C sub-segment includes property, casualty and motor risks generally originating in the United States and written by PartnerRe U.S. The Global (Non-U.S.) P&C sub-segment includes property, casualty and motor risks generally originating outside of the United States, written by Partner Reinsurance and PartnerRe SA. The Worldwide Specialty sub-segment is comprised of business that is generally considered to be specialized due to the sophisticated technical underwriting required to analyze risks, and is global in nature, inasmuch as appropriate risk management for these lines requires a globally diversified portfolio of risks. This sub-segment consists of several lines of business for which the Company believes it has developed specialized knowledge and underwriting capabilities. These lines of business include agriculture, aviation/space, catastrophe, credit/surety, engineering, energy, marine, specialty property, specialty casualty and other lines.

The ART segment includes structured risk transfer reinsurance, principal finance (previously referred to as structured finance), weather-related products, and strategic investments, including the interest in earnings of the Company’s equity investment in Channel Re Holdings, a non-publicly traded financial guarantee reinsurer based in Bermuda. The new name for the structured finance unit reflects the expansion of this unit into project finance and real estate related asset classes, in addition to the structured finance asset class.

The Life segment includes life, health and annuity lines of business.

The following is a description of specific lines of business written by the Company:

Property—Property business provides reinsurance coverage to insurers for property damage or business interruption losses resulting from fires, catastrophes and other perils covered in industrial and commercial property and homeowners’ policies and is written on both a proportional and non-proportional basis. The Company’s most significant exposure is typically to losses from windstorm and earthquake, although the Company is exposed to losses from sources as diverse as freezes, riots, floods, industrial explosions, fires, hail and a number of other loss events. The Company’s predominant exposure under these property coverages is to property damage. However, other risks, including business interruption and other non-property losses may also be covered under a property reinsurance contract when arising from a covered peril. In accordance with market practice, the Company’s property reinsurance treaties generally exclude certain risks such as war, nuclear, biological and chemical contamination, radiation and environmental pollution.

 

3


Table of Contents

Casualty—The Company’s casualty business includes third party liability, employers’ liability, workers’ compensation and personal accident coverages written on both a proportional and non-proportional basis.

Multiline—The Company’s multiline business provides both property and casualty reinsurance coverages written on both a proportional and non-proportional basis.

Motor—The Company’s motor business includes reinsurance coverages for third party liability and property damage risks arising from both passenger and commercial fleet automobile coverages written by cedants. This business is written predominantly on a proportional basis.

Agriculture—The Company reinsures, primarily on a proportional basis, risks such as flood, drought, hail and disease related to crops, livestock and aquaculture.

Aviation/Space—The Company provides specialized reinsurance protection for airline, general aviation and space insurance business primarily on a proportional basis and through facultative arrangements. Its space business relates to coverages for satellite assembly, launch and operation for commercial space programs.

Catastrophe—The Company provides property catastrophe reinsurance protection, written primarily on a non-proportional basis, against the accumulation of losses caused by windstorm, earthquake, flood or by any other natural hazard that is covered under a comprehensive property policy. Through the use of underwriting tools based on proprietary computer models developed by its research team, the Company combines natural science with highly professional underwriting skills in order to offer capacity at a price commensurate with the risk.

Credit/Surety—Credit reinsurance, written primarily on a proportional basis, provides coverage to commercial credit insurers, and the surety line relates primarily to bonds and other forms of security written by specialized surety insurers.

Engineering—The Company provides reinsurance for engineering projects throughout the world, predominantly on a proportional treaty basis and through facultative arrangements.

Energy (Energy Onshore)—The Company provides reinsurance coverage for the onshore oil and gas industry, mining, power generation and pharmaceutical operations primarily on a proportional basis and through facultative arrangements.

Marine (Marine/Energy Offshore)—The Company provides reinsurance protection and technical services relating to marine hull, cargo, transit and offshore oil and gas operations on a proportional or non-proportional basis.

Specialty Property—The Company provides specialized reinsurance protection for non-U.S. property business that requires specialized underwriting expertise due to the nature of the underlying risk or the complexity of the reinsurance treaty. This reinsurance protection is offered on a proportional, non-proportional or facultative basis.

Specialty Casualty—The Company provides specialized reinsurance protection for non-U.S. casualty business that requires specialized underwriting expertise due to the nature of the underlying risk or the complexity of the reinsurance treaty. This reinsurance protection is offered on a proportional, non-proportional or facultative basis.

ART—The Company supplies (re)insurance and other financial products that provide various types of property and casualty, weather and credit protection to clients. These products include structured reinsurance of property and casualty risks, weather derivatives and total return swaps referencing asset backed securities.

 

4


Table of Contents

Clients for these products include insurance companies, financial institutions and industrial companies. When this protection is in the form of reinsurance, the contracts may be written on either a proportional, non-proportional or facultative basis. The Company also has exposure to financial guaranty reinsurance through its equity investment in Channel Re Holdings Ltd.

Life/Annuity and Health—Life treaties provide reinsurance coverage to primary life insurers and pension funds with respect to individual and group life and health risks. Annuity treaties provide reinsurance coverage to insurers who issue annuity contracts offering long-term retirement benefits to consumers who seek protection against outliving their financial resources. Life business is written primarily on a proportional basis through treaty arrangements.

The Company’s business is produced both through brokers and through direct relationships with insurance companies. In North America, business is primarily written through brokers, while in the rest of the world, the business is written on both a direct and broker basis.

For the year ended December 31, 2006, the Company had two brokers that individually accounted for 10% or more of its gross premiums written. Marsh & McLennan Companies (including Guy Carpenter) accounted for approximately $747 million, or 20% of total gross premiums written, while Aon Group accounted for approximately $663 million, or 18% of total gross premiums written. The following table summarizes the percentage of gross premiums written through these two brokers by segment and sub-segment for the year ended December 31, 2006:

 

     2006

Non-life

  

U.S. P&C

   64%

Global (Non-U.S.) P&C

   28

Worldwide Specialty

   36

ART

   47

Life

   15

The Company’s business is geographically diversified with premiums being written in 150 countries. See Note 19 to Consolidated Financial Statements in Item 8 of Part II of this report, for additional disclosure of the geographic distribution of gross premiums written and financial information about segments and sub-segments.

Risk Management, Underwriting, Underwriting Risk and Exposure Controls, Retrocessions and Claims

Risk Management

In the reinsurance industry, the core of the business model is the assumption of risk. Hence, risk management entails both the determination of an optimum risk-adjusted appetite for assumed business risks, and the reduction or mitigation of risks for which the organization is either not sufficiently compensated, or those risks that could threaten the achievability of its objectives.

All business decisions entail a risk/return trade-off. In the context of assumed business risks, this requires an accurate evaluation of risks to be assumed, and a determination of the appropriate economic returns required as fair compensation for such risks. For other than voluntarily assumed business risks, the decision relates to comparing the probability and potential severity of a risk event against the costs of risk mitigation strategies. In many cases, the potential impact of a risk event is so severe as to warrant significant, and potentially expensive, risk mitigation strategies. In other cases, the probability and potential severity of a risk does not warrant extensive risk mitigation.

The Company sets its appetite for assumed business risks such that it seeks to provide value to its clients, and adequate risk-adjusted returns to its shareholders, but does not overexpose the Company to any one or series of related risks. Assumed business risks are mitigated to the extent the risk mitigation strategies provide a positive return on the Company’s investment.

 

5


Table of Contents

The Company utilizes a multi-level risk management structure, whereby critical exposure limits, return requirement guidelines, capital at risk and key policies are established by the Executive Management and Board of Directors (Board), but day-to-day execution of risk assumption activities and related risk mitigation strategies are delegated to the business units. Reporting on risk management activities is integrated within the Company’s annual planning process, quarterly operations reports, periodic reports on exposures and large losses, and presentations to the Executive Management and Board. Individual business units employ, and are responsible for reporting on, operating risk management procedures and controls, while Group Internal Audit periodically tests these controls to ensure ongoing compliance. See Other Key Issues of Management in Item 7 of Part II of this report for a detailed discussion on the Company’s risk management.

Underwriting

The Company’s underwriting is conducted through specialized underwriting teams with the support of technical staff in disciplines such as actuarial, claims, legal, risk management and finance.

The Company’s underwriters generally speak the local language and/or are native to their country or area of specialization. They develop close working relationships with their ceding company counterparts and brokers through regular visits, gathering detailed information about the cedant’s business and about local market conditions and practices. As part of the underwriting process, the underwriters also focus on the reputation and quality of the proposed cedant, the likelihood of establishing a long-term relationship with the cedant, the geographic area in which the cedant does business and the cedant’s market share, historical loss data for the cedant and, where available, historical loss data for the industry as a whole in the relevant regions, in order to compare the cedant’s historical loss experience to industry averages, and to gauge the perceived insurance and reinsurance expertise and financial strength of the cedant. The Company trains its underwriters extensively and strives to maintain continuity of underwriters within specific geographic markets and areas of specialty.

Underwriting Risk and Exposure Controls

Because the Company underwrites volatile lines of business, such as catastrophe reinsurance, the operating results and financial condition of the Company can be adversely affected by catastrophes and other large losses that may give rise to claims under reinsurance coverages provided by the Company. The Company manages its exposure to catastrophic and other large losses by (i) attempting to limit its aggregate exposure on catastrophe reinsurance in any particular geographic zone, (ii) selective underwriting practices, (iii) diversification of risks by geographic area and by lines and classes of business, and (iv) to a limited extent by purchasing retrocessional reinsurance.

The Company generally underwrites risks with specified limits per treaty program. Like other reinsurance companies, the Company is exposed to multiple insured losses arising out of a single occurrence, whether a natural event such as windstorm, flood or earthquake, or another catastrophe. Any such catastrophic event could generate insured losses in one or many of the Company’s reinsurance treaties and facultative contracts in one or more lines of business. The Company considers such event scenarios as part of its evaluation and monitoring of its aggregate exposures to catastrophic events. The Company reinsures a portion of the risks it underwrites in an effort to control its exposure to losses and to mitigate the effect of any single major event or the frequency of medium-sized events.

Retrocessions

The Company uses retrocessional agreements to a limited extent to reduce its exposure on certain specialty reinsurance risks assumed. These agreements provide for recovery of a portion of losses and loss expenses from retrocessionaires. The Company also utilizes retrocessions in the Life segment to manage the amount of per-event and per-life risks to which it is exposed. Retrocessionaires are selected based on their financial condition and business practices, with stability, solvency and credit ratings being important criteria.

 

6


Table of Contents

The Company remains liable to its cedants to the extent the retrocessionaires do not meet their obligations under retrocessional agreements, and therefore retrocessions are subject to credit risk in all cases and to aggregate loss limits in certain cases. The Company holds collateral, including escrow funds, securities and letters of credit under certain retrocessional agreements. Provisions are made for amounts considered potentially uncollectible and reinsurance losses recoverable from retrocessionaires are reported after allowances for uncollectible amounts. At December 31, 2006, the Company had $169 million of reinsurance recoverables under such arrangements and had established an allowance for uncollectible reinsurance balances recoverable of $11 million, which represented approximately 6% of the balances.

Claims

In addition to managing and settling reported claims and consulting with ceding companies on claims matters, the Company conducts periodic audits of specific claims and the overall claims procedures at the offices of ceding companies. The Company attempts to evaluate the ceding company’s claim adjusting techniques and reserve adequacy and whether it follows proper claims processing procedures. The Company also provides recommendations regarding procedures and processes to the ceding company.

Within the Company’s claims department, there is a special unit that provides central supervision and management of certain long-tail liability claims, including those related to environmental and similar exposures. See Reserves—Asbestos, Environmental and Other Exposures below.

Reserves

General

Loss reserves represent estimates of amounts an insurer or reinsurer ultimately expects to pay in the future on claims incurred at a given time, based on facts and circumstances known at the time that the loss reserves are established. It is possible that the total future payments may exceed, or be less, than such estimates. The estimates are not precise in that, among other things, they are based on predictions of future developments and estimates of future trends in claim severity, frequency and other variable factors such as inflation. During the loss settlement period, it often becomes necessary to refine and adjust the estimates of liability on a claim either upward or downward. Despite such adjustments, the ultimate future liability may exceed or be less than the revised estimates.

As part of the reserving process, insurers and reinsurers review historical data and anticipate the impact of various factors such as legislative enactments and judicial decisions that may affect potential losses from casualty claims, changes in social and political attitudes that may increase exposure to losses, mortality and morbidity trends and trends in general economic conditions. This process assumes that past experience, adjusted for the effects of current developments, is an appropriate basis for anticipating future events.

The Company’s non-life operations are composed of its Non-life and ART segments. The liability for unpaid losses and loss expenses for non-life operations includes amounts determined from loss reports on individual treaties (case reserves), additional case reserves when the Company’s loss estimate is higher than reported by the cedants (ACRs) and amounts for losses incurred but not yet reported to the Company (IBNR). Such reserves are estimated by Management based upon reports received from ceding companies, supplemented by the Company’s own actuarial estimates of reserves for which ceding company reports have not been received, and based on the Company’s own historical experience. To the extent that the Company’s own historical experience is inadequate for estimating reserves, such estimates may be determined based upon industry experience and Management’s judgment. The estimates are continually reviewed and the ultimate liability may be in excess of, or less than, the amounts provided. Any adjustments are reflected in the periods in which they become known.

The liabilities for policy benefits for ordinary life and accident and health policies have been established based upon information reported by ceding companies, supplemented by the Company’s actuarial estimates of

 

7


Table of Contents

mortality, critical illness, persistency and future investment income, with appropriate provision to reflect uncertainty. Future policy benefit reserves for annuity and universal life products are carried at their accumulated values. Reserves for policy claims and benefits include both mortality and critical illness claims in the process of settlement, and claims that have been incurred but not yet reported. Interest rate assumptions used to estimate liabilities for policy benefits for life and annuity contracts ranged from 1.0% to 4.9% at December 31, 2006. Actual experience in a particular period may vary from the assumed experience and, where warranted, the assumptions and the related reserve estimates are revised accordingly. Any revisions are recorded in the period they are determined, which may affect the Company’s operating results in future periods.

See Critical Accounting Policies in Item 7 of Part II of this report for a discussion of the Company’s reserving process.

Changes in Reserves

The following table shows the development of net reserves for unpaid losses and loss expenses for non-life business. The table begins by showing the initial reported year-end gross and net reserves, including IBNR, recorded at the balance sheet date for each of the ten years presented. For years prior to 1997, the Company’s gross and net reserves were equal as no retrocessional protection was purchased. The next section of the table shows the re-estimated amount of the initial reported net reserves for up to ten subsequent years, based on experience at the end of each subsequent year. The re-estimated net liabilities reflect additional information, received from cedants or obtained through reviews of industry trends, regarding claims incurred prior to the end of the preceding financial year. A redundancy (or deficiency) arises when the re-estimation of reserves is less (or greater) than its estimation at the preceding year-end. The cumulative redundancies (or deficiencies) reflect cumulative differences between the initial reported net reserves and the currently re-estimated net reserves. Annual changes in the estimates are reflected in the income statement for each year, as the liabilities are re-estimated. Reserves denominated in foreign currencies are revalued at each year-end’s foreign exchange rates.

The lower section of the table shows the portion of the initial year-end net reserves that was paid (claims paid) as of the end of subsequent years. This section of the table provides an indication of the portion of the re-estimated net liability that is settled and is unlikely to develop in the future. Claims paid are converted to U.S. dollars at the average foreign exchange rates during the year of payment and are not revalued at the current year foreign exchange rates. Because claims paid in prior years are not revalued at the current year’s foreign exchange rates, the difference between the cumulative claims paid at the end of any given year and the immediately previous year, represents the claims paid during the year.

 

8


Table of Contents

Development of Loss and Loss Expense Reserves

(in thousands of U.S. dollars)

 

    1996   1997(1)   1998(2)   1999     2000     2001     2002     2003   2004   2005     2006

Gross liability for unpaid losses and loss expenses

  $ 59,866   $ 1,098,527   $ 2,649,380   $ 2,616,556     $ 2,386,032     $ 3,005,628     $ 3,658,416     $ 4,755,059   $ 5,766,629   $ 6,737,661     $ 6,870,785

Retroceded liability for unpaid losses and loss expenses

    —       126,112     257,398     205,982       203,180       214,891       217,777       175,685     153,018     185,280       138,585
                                                                           

Net liability for unpaid losses and loss expenses

  $ 59,866   $ 972,415   $ 2,391,982   $ 2,410,574     $ 2,182,852     $ 2,790,737     $ 3,440,639     $ 4,579,374   $ 5,613,611   $ 6,552,381     $ 6,732,200

Net liability re-estimated as of:

                     

One year later

    59,866     949,203     2,189,064     2,376,763       2,111,483       3,035,309       3,806,231       4,688,964     5,006,767     6,602,832    

Two years later

    18,632     869,741     2,010,885     2,205,861       2,302,284       3,310,898       3,975,926       4,301,161     5,044,922    

Three years later

    16,373     851,427     1,912,869     2,316,164       2,489,601       3,456,250       3,781,574       4,373,992      

Four years later

    15,395     809,959     1,948,521     2,448,562       2,611,045       3,326,527       3,894,500          

Five years later

    15,013     832,798     2,044,481     2,540,927       2,513,123       3,433,887            

Six years later

    15,112     883,067     2,103,952     2,461,178       2,617,775              

Seven years later

    16,237     918,291     2,036,754     2,553,570                

Eight years later

    15,324     884,965     2,123,245                

Nine years later

    15,098     938,788                  

Ten years later

    14,923                    
                                                                           

Cumulative redundancy (deficiency)

  $ 44,943   $ 33,627   $ 268,737   $ (142,996 )   $ (434,923 )   $ (643,150 )   $ (453,861 )   $ 205,382   $ 568,689   $ (50,451 )  

Cumulative amount of net liability paid through:

                     

One year later

    8,623     231,454     537,682     778,382       615,276       923,165       1,126,882       1,120,756     1,250,534     1,718,996    

Two years later

    11,653     362,692     815,231     1,060,797       960,288       1,391,301       1,713,953       1,573,312     1,821,773    

Three years later

    13,515     410,342     988,069     1,260,298       1,163,105       1,740,277       1,993,947       1,948,203      

Four years later

    13,821     417,613     1,089,279     1,373,693       1,354,886       1,924,833       2,248,980          

Five years later

    13,943     450,723     1,158,620     1,508,343       1,465,515       2,086,252            

Six years later

    14,012     472,093     1,239,898     1,580,951       1,566,719              

Seven years later

    14,115     513,089     1,291,049     1,652,891                

Eight years later

    14,265     539,436     1,343,849                

Nine years later

    14,270     563,015                  

Ten years later

    14,310                    

(1) Liability for unpaid losses and loss expenses includes, for the first time, PartnerRe SA, which the Company acquired in July 1997.
(2) Liability for unpaid losses and loss expenses includes, for the first time, Winterthur Re, which the Company acquired in December 1998.

 

9


Table of Contents

The following table provides a reconciliation of the Company’s re-estimated gross year-end reserves with the re-estimated net year-end reserves provided above (in thousands of U.S. dollars):

 

    1996   1997   1998   1999     2000     2001     2002     2003   2004   2005  

Reconciliation of gross reserves:

                   

Gross liability re-estimated as of December 31, 2006

  $ 14,923   $ 1,068,238   $ 2,370,350   $ 2,775,959     $ 2,857,518     $ 3,677,406     $ 4,124,421     $ 4,531,148   $ 5,178,611   $ 6,800,586  

Re-estimated retroceded liability

    —       129,450     247,105     222,389       239,743       243,519       229,921       157,156     133,689     197,754  
                                                                     

Net liability re-estimated as of December 31, 2006

  $ 14,923   $ 938,788   $ 2,123,245   $ 2,553,570     $ 2,617,775     $ 3,433,887     $ 3,894,500     $ 4,373,992   $ 5,044,922   $ 6,602,832  
                                                                     

Gross cumulative redundancy (deficiency)

  $ 44,943   $ 30,289   $ 279,030   $ (159,403 )   $ (471,486 )   $ (671,778 )   $ (466,005 )   $ 223,911   $ 588,018   $ (62,925 )

The Company’s reserve development is composed of the change in ultimate losses from what the Company originally estimated as well as the impact of the foreign exchange revaluation on reserves. The Company conducts its reinsurance operations in a variety of non-U.S. currencies and records its net reserves in the currency of the treaty, with the principal exposures being to the euro, British pound, Swiss franc, Canadian dollar and Japanese yen. The impact of reporting the Company’s net reserves based on the foreign exchange rates at the balance sheet date can be a significant component of the cumulative redundancy (deficiency) in net reserves and in some years can be the principal component. The following table provides the amount of foreign exchange included in the cumulative redundancy (deficiency) reported above as well as the redundancy (deficiency) excluding the impact of foreign exchange movements on net reserves (in thousands of U.S. dollars):

 

    1996   1997     1998     1999     2000     2001     2002     2003     2004   2005  

Cumulative redundancy (deficiency)

  $ 44,943   $ 33,627     $ 268,737     $ (142,996 )   $ (434,923 )   $ (643,150 )   $ (453,861 )   $ 205,382     $ 568,689   $ (50,451 )

Less: Cumulative redundancy (deficiency) due to foreign exchange

    73     (10,424 )     (2,220 )     (91,466 )     (254,834 )     (451,540 )     (403,467 )     (150,055 )     187,785     (302,199 )
                                                                           

Cumulative redundancy (deficiency) excluding the impact of foreign exchange

  $ 44,870   $ 44,051     $ 270,957     $ (51,530 )   $ (180,089 )   $ (191,610 )   $ (50,394 )   $ 355,437     $ 380,904   $ 251,748  

Since 1997, movements in foreign exchange rates between accounting periods have occasionally resulted in significant variations in the loss reserves of the Company as the U.S dollar, the Company’s reporting currency, appreciated/depreciated against multiple currencies. The Company, however, generally holds investments in the same currencies as its net reserves, with the intent of matching the foreign exchange movements on its assets and liabilities. See Quantitative and Qualitative Disclosures about Market Risk contained in Item 7A of Part II of this report for a discussion of the foreign currency risk on the Company’s assets and liabilities.

 

10


Table of Contents

The Company believes that in order to enhance the understanding of its reserve development, it is useful for investors to evaluate the Company’s reserve development excluding the impact of foreign exchange. The following table shows the development of initial net reserves converted at each year’s average foreign exchange rates (in thousands of U.S. dollars). Using the historical average foreign exchange rates for the development lines of the table has the effect of linking each year’s development with that year’s income statement. This table should not be considered as a substitute for the table provided above as it does not reflect a significant portion of the initial net reserve development that is due to foreign exchange revaluation.

 

    1996   1997   1998   1999     2000     2001     2002     2003   2004   2005

Net liability for unpaid losses and loss expenses

  $ 59,866   $ 972,415   $ 2,391,982   $ 2,410,574     $ 2,182,852     $ 2,790,737     $ 3,440,639     $ 4,579,374   $ 5,613,611   $ 6,552,381

Net liability re-estimated as of:

                   

One year later

    59,866     914,558     2,360,763     2,410,462       2,174,981       2,846,855       3,496,102       4,440,338     5,382,101     6,300,633

Two years later

    18,632     910,660     2,174,414     2,359,852       2,240,526       2,921,908       3,513,647       4,298,493     5,232,707  

Three years later

    16,373     931,411     2,112,196     2,384,937       2,283,941       2,956,308       3,483,720       4,223,937    

Four years later

    15,395     907,124     2,083,108     2,400,881       2,322,084       2,964,307       3,491,033        

Five years later

    15,013     891,916     2,079,706     2,422,798       2,331,252       2,982,347          

Six years later

    15,112     891,921     2,079,261     2,431,416       2,362,941            

Seven years later

    16,288     895,662     2,088,745     2,462,104              

Eight years later

    15,168     904,723     2,121,025              

Nine years later

    15,179     928,364                

Ten years later

    14,996                  
                                                                   

Cumulative redundancy (deficiency)

  $ 44,870   $ 44,051   $ 270,957   $ (51,530 )   $ (180,089 )   $ (191,610 )   $ (50,394 )   $ 355,437   $ 380,904   $ 251,748

 

11


Table of Contents

The following table summarizes the net incurred losses for the year ended December 31, 2006 relating to the current and prior accident years by segment and sub-segment for the Company’s non-life operations, which is composed of its Non-life and ART segments (in millions of U.S. dollars):

 

     U.S. P&C   

Global

(Non-U.S.)
P&C

   

Worldwide

Specialty

    Non-life
segment
   

ART

segment

  

Total

non-life

 

Net incurred losses related to:

              

Current year

   $ 606    $ 571     $ 811     $ 1,988     $ 12    $ 2,000  

Prior years’ net adverse (favorable) development

     6      (66 )     (193 )     (253 )     1      (252 )
                                              

Total net incurred losses

   $ 612    $ 505     $ 618     $ 1,735     $ 13    $ 1,748  
                                              

See Critical Accounting Policies and Estimates—Losses and Loss Expenses and Life Policy Benefits in Item 7 of Part II of this report for a discussion of the net prior year reserve development by reserving lines for the Company’s non-life operations.

Asbestos, Environmental and Other Exposures

The Company’s reserve for unpaid losses and loss expenses as of December 31, 2006 includes $95 million that represents an estimate of its net ultimate liability for asbestos and environmental claims (the gross liability for such claims was $105 million).

Most of the net amount relates to U.S. casualty exposures arising from business written prior to January 1, 1992 by certain companies which were at the time part of the AGF Group and are currently part of PartnerRe SA or PartnerRe U.S. PartnerRe SA ceased writing industrial casualty business covering risks in the United States in 1986. Ultimate loss estimates for such claims cannot be estimated using traditional reserving techniques and there are significant uncertainties in estimating the amount of the Company’s potential losses for these claims. In view of the changes in the legal and tort environment that affect the development of such claims, the uncertainties inherent in estimating asbestos and environmental claims are not likely to be resolved in the near future. The Company actively evaluates potential exposure to asbestos and environmental claims and establishes additional reserves as appropriate. The Company believes that it has made a reasonable provision for these exposures and is unaware of any specific issues that would materially affect its loss and loss expense estimates.

Management believes that the Company may be exposed to claims in its life portfolio that may be significantly higher than expected as a result of spikes in mortality due to causes such as an avian flu pandemic. In addition, the Company may be exposed to Acquired Immune Deficiency Syndrome (AIDS) claims in its life portfolio. However, retrocessional protection mitigates the Company’s exposure to losses on life reinsurance.

There can be no assurance that the reserves established by the Company will not be adversely affected by development of other latent exposures, and further, there can be no assurance that the reserves established by the Company will be adequate. However, they represent Management’s best estimate for ultimate losses based on available information at this time.

Investments

The Company has developed specific investment objectives and guidelines for the management of its investment portfolio. These objectives and guidelines stress diversification of risk, capital preservation, market liquidity and stability of portfolio income. Despite the prudent focus of these objectives and guidelines, the Company’s investments are subject to general market risk, as well as to risks inherent to particular securities.

The Company’s investment strategy is largely unchanged from previous years. To ensure that the Company will have sufficient assets to pay its clients’ claims, the Company’s investment philosophy distinguishes between

 

12


Table of Contents

those assets that are matched against existing liabilities (liability funds) and those that represent shareholders’ equity (capital funds). Liability funds are invested in high-quality fixed income securities. Capital funds are available for investment in a broadly diversified portfolio, which includes investments in preferred and common stocks, private equity investments, investment-grade securities and below-investment-grade bonds and other asset classes that offer potentially higher returns.

The investment portfolio is divided and managed by strategy and legal entity. Each segregated portfolio is managed against a specific benchmark to properly control the risk of each portfolio as well as the aggregate risks of the combined portfolio. The performance of each portfolio and the aggregate investment portfolio is measured against several benchmarks to ensure that they have the appropriate risk and return characteristics.

In order to manage the risks of the investment portfolio, several controls are in place. First, the overall duration (interest rate risk) of the portfolio is managed relative to the duration of the net reinsurance liabilities so that the economic value of changes in interest rates have offsetting effects on the Company’s assets and liabilities. To ensure diversification and avoid aggregation of risks, limits of assets types, economic sector exposure, industry exposure, and individual security exposure are placed on the investment portfolio. These exposures are monitored on an ongoing basis and reported at least quarterly to the Finance and Risk Management Committee of the Board.

See Quantitative and Qualitative Disclosures About Market Risk in Item 7A of Part II of this report for a discussion of the Company’s interest rate and currency management strategies.

Competition

The Company competes with other reinsurers, some of which have greater financial, marketing and management resources than the Company, and it also competes with new market entrants. Competition in the types of reinsurance that the Company underwrites is based on many factors, including the perceived financial strength of the reinsurer, pricing and other terms and conditions, services provided, ratings assigned by independent rating organizations, speed of claims payment and reputation and experience in the lines of reinsurance to be written.

The Company’s competitors include independent reinsurance companies, subsidiaries or affiliates of established worldwide insurance companies, and reinsurance departments of certain primary insurance companies. Management believes that the Company’s major competitors are the larger European, U.S. and Bermuda-based international reinsurance companies, as well as specialty reinsurers.

Management believes the Company ranks among the world’s largest professional reinsurers and is well-positioned in terms of client services and underwriting expertise. Furthermore, the Company’s capitalization and strong financial ratios allow the Company to offer security to its clients.

Employees

The Company had 935 employees at December 31, 2006. The Company may increase its staff over time commensurate with the expansion of operations. The Company believes that its relations with its employees are good.

Regulation

The business of reinsurance is now regulated in most countries, although the degree and type of regulation varies significantly from one jurisdiction to another. As a holding company, PartnerRe Ltd. is not subject to Bermuda insurance regulations, but its various operating subsidiaries are subject to regulations as follows.

 

13


Table of Contents

Bermuda

The Insurance Act of 1978 of Bermuda, amendments thereto and related regulations (the Act), makes no distinction between insurance and reinsurance business and regulates the business of our Bermuda operating subsidiary, Partner Reinsurance. The Act imposes on Bermuda insurance companies solvency and liquidity standards and auditing and reporting requirements and grants to the Bermuda Monetary Authority (the BMA) powers to supervise, investigate and intervene in the affairs of insurance companies. Under the Act, Partner Reinsurance has been designated as a Class 4 (non-life and life) insurer, which is the designation for the largest companies, requiring capital and surplus in excess of $100 million. Failure to maintain required solvency and liquidity margins would prohibit the Company from declaring and paying any dividends without the prior approval of the Minister of Finance. Material aspects of the Bermuda insurance regulatory framework are set forth below:

Classification of Insurers: The Act distinguishes between insurers carrying on long-term business and those carrying on general business. There are four classifications of insurers carrying on general business, with Class 4 insurers subject to the strictest regulation. Partner Reinsurance carries on both long-term and general business. Long-term business includes life insurance and reinsurance and disability insurance and reinsurance with terms in excess of five years. General business includes all types of insurance and reinsurance that are not long-term business.

Principal Representative: An insurer is required to maintain a principal office in Bermuda and to appoint and maintain a representative in Bermuda. The Company’s CEO is the principal representative of Partner Reinsurance.

Approved Independent Auditor: Every registered insurer must appoint an independent auditor who will audit and report annually on the statutory financial statements and the statutory financial return of the insurer, both of which, in the case of Partner Reinsurance, are required to be filed annually with the BMA. Partner Reinsurance’s independent auditor must be approved by the BMA.

Loss Reserve Specialist: As a registered Class 4 insurer, Partner Reinsurance is required to submit an opinion of its approved loss reserve specialist with its statutory financial return in respect of its losses and loss expenses provisions. The loss reserve specialist must be approved by the BMA.

Annual Statutory Financial Return and Statutory Financial Statements: Partner Reinsurance is required to file with the BMA a statutory financial return no later than four months after its financial year end, unless specifically extended upon application to the BMA. The statutory financial return for a Class 4 insurer includes, among other matters, a report of the approved independent auditor on the statutory financial statements of the insurer, solvency certificates, the statutory financial statements, the opinion of the loss reserve specialist and a schedule of reinsurance ceded. The statutory financial statements are not prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and are distinct from the financial statements prepared for presentation to an insurer’s shareholders under The Companies Act 1981 of Bermuda (the Companies Act).

Minimum Solvency Margin and Restrictions on Dividends and Distributions: Under the Act, the value of the general business assets of a Class 4 insurer must exceed the amount of its general business liabilities by an amount greater than the prescribed minimum solvency margin. Partner Reinsurance is required, with respect to its general business, to maintain a minimum solvency margin equal to the greatest of $100 million, 50% of net premiums written, or 15% of net losses and loss expense reserves.

Partner Reinsurance would be prohibited from declaring or paying any dividends during any financial year if it is in breach of its minimum solvency margin or minimum liquidity ratio or if the declaration or payment of such dividends would cause it to fail to meet such margin or ratio. In addition, if it has failed to meet its minimum solvency margin or minimum liquidity ratio on the last day of any financial year, Partner Reinsurance would be prohibited, without the approval of the BMA, from declaring or paying any dividends during the next financial year. Partner Reinsurance is also prohibited from declaring or paying in any

 

14


Table of Contents

financial year dividends of more than 25% of its total statutory capital and surplus (as shown on its previous financial year’s statutory balance sheet) unless it files with the BMA, at least seven days before payment of such dividends, an affidavit stating that it will continue to meet the required margins.

Partner Reinsurance is prohibited, without the approval of the BMA, from reducing by 15% or more its total statutory capital as set out in its previous year’s financial statements, and any application for such approval must include an affidavit stating that it will continue to meet the required margins. In addition, if at any time it fails to meet its solvency margin, Partner Reinsurance is required, within 30 days (45 days where total statutory capital and surplus falls to $75 million or less) after becoming aware of such failure or having reason to believe that such failure has occurred, to file with the BMA a written report containing certain information.

Minimum Liquidity Ratio

The Act provides a minimum liquidity ratio for general business insurers. An insurer engaged in general business is required to maintain the value of its relevant assets at not less than 75% of the amount of its relevant liabilities. Relevant assets include, but are not limited to, cash and time deposits, quoted investments, unquoted bonds and debentures, first liens on real estate, investment income due and accrued, accounts and premiums receivable and reinsurance balances receivable. There are some categories of assets which, unless specifically permitted by the BMA, do not automatically qualify as relevant assets, such as unquoted equity securities, investments in and advances to affiliates and real estate and collateral loans. The relevant liabilities are total general business insurance reserves and total other liabilities less deferred income tax and sundry liabilities (by interpretation, those not specifically defined).

At December 31, 2006, Partner Reinsurance’s solvency margin and liquidity ratio and statutory capital and surplus were well in excess of the minimum levels required by Bermuda regulations.

Partner Reinsurance has branches in Switzerland, Singapore, Hong Kong and Labuan and the operations of these branches are all subject to Bermuda regulations. In addition, the Singapore branch is subject to regulation by the Monetary Authority of Singapore, the Hong Kong branch is subject to regulation under both the Insurance Companies Ordinance of Hong Kong and the Companies Ordinance of Hong Kong and the Labuan branch is subject to regulation by the Labuan Offshore Financial Services Authority, Malaysia. Foreign insurance entities that are effecting or carrying on exclusively reinsurance business in Switzerland are exempt from insurance and reinsurance supervision, provided such entities are not acting for that purpose through a Swiss subsidiary. Thus, the operations of the Swiss branch of Partner Reinsurance are exempt from insurance and reinsurance supervision. Partner Reinsurance has procured a taxation ruling under which the branch is subject to Swiss tax. See European Union below for a discussion of the recent adoption of Directive 2005/68/EC.

France

PartnerRe SA is subject to regulation, mainly pursuant to the French Code des Assurances (the French Insurance Code), and to the supervision of the Autorité de Contrôle des Assurances et des Mutuelles (the ACAM), an independent administrative authority. Pursuant to the requirements of the French Insurance Code, French reinsurers must present and publish their accounts according to the same principles applicable to direct insurers, subject to specified adaptations relevant to reinsurers. Information required to be provided includes quarterly reports showing (1) for the relevant three-month period, as well as for each of the prior seven three-month periods, (i) the number of reinsurance contracts underwritten in the quarter, (ii) the aggregate amount of premiums and paid losses, (iii) the aggregate amount of business and administrative costs incurred, and (iv) the aggregate net amount of revenues in connection with investments and cash; (2) at the end of the relevant three-month period, as well as at the end of the prior three-month period, (i) the aggregate value of assets (per category of assets) supporting technical reserves, and (ii) the aggregate value of other assets; and (3) the estimated impact of the variation of certain external factors on assets and liabilities. In addition, reinsurers must file each year with the ACAM (1) their financial statements in the form to be approved by the shareholders at the annual

 

15


Table of Contents

shareholders’ meeting, (2) detailed information on the Company’s business and its assets and liabilities, and (3) various technical disclosure statements. The ACAM has authority to monitor and compel reinsurers to comply with requirements regarding the nature, timing and content of published information and documents.

European Union

At the European Union (EU) level, European reinsurers, since 1964 (Directive 64-225 of February 25, 1964), have been granted the benefit of the freedom to provide services principle and the rights of establishment principle. Under the first principle, an EU reinsurer may underwrite reinsurance business in any EU country from its home jurisdiction, without having to open a branch or subsidiary in such country, provided local authorities are notified that such activities are occurring. Such notifications have been made by the relevant affiliates of the Company. Under the second principle, a European reinsurer may open branches or organize subsidiaries in any EU country in accordance with such country’s domestic regulatory framework.

In November 2005, the European Parliament adopted Directive 2005/68/EC, the European Union Reinsurance Directive (Reinsurance Directive). This directive seeks to harmonize the supervision of reinsurance business within the European Union by creating a single regulated market. Each member state must adopt the directive into local legislation by December 2007. Upon the adoption of the Reinsurance Directive by France, it is anticipated that PartnerRe SA will be entitled to rely on grandfather provisions that will deem it to be authorized under the new requirements. In addition, it is not anticipated that the regulatory regime that is currently applicable to PartnerRe SA will undergo major revisions as a result of the adoption of the Reinsurance Directive. The impact on Partner Reinsurance Ireland is described in more detail below. As our Swiss branch is not within the European Union, the adoption of the Reinsurance Directive may impact the ability of the branch to write reinsurance business in member states of the EU and restrict our ability to operate our business.

Ireland

PartnerRe Holdings Ireland Ltd is a holding company for Partner Reinsurance Ireland and PartnerRe Ireland Insurance. As a holding company, PartnerRe Holdings Ireland Ltd is not subject to regulation by the Financial Regulator, Ireland (Financial Regulator).

PartnerRe Ireland Insurance is a non-life insurance company incorporated under the laws of Ireland. It is subject to the regulation and supervision of the Financial Regulator pursuant to the Irish Insurance Acts 1909 to 2000, regulations relating to insurance business and the Central Bank and Financial Services Authority of Ireland Acts 2003 and 2004 (together, the Insurance Acts and Regulations). PartnerRe Ireland Insurance was authorized on April 1, 2005 to undertake the business of non-life insurance in various classes of business. PartnerRe Ireland Insurance is required to maintain technical reserves calculated in accordance with the Insurance Acts and Regulations. Assets representing its technical reserves are required to cover PartnerRe Ireland Insurance’s calculated underwriting liabilities. In addition to filing various statutory returns with the Financial Regulator, PartnerRe Ireland Insurance is obligated to prepare annual accounts (comprising balance sheet, profit and loss account and notes) in accordance with the provisions of the European Communities (Insurance Undertakings: Accounts) Regulations, 1996 (the Insurance Accounts Regulations). The accounts must be filed with the Financial Regulator and with the Registrar of Companies in Ireland. Additionally, PartnerRe Ireland Insurance is required to establish and maintain an adequate solvency margin and a minimum guarantee fund, both of which must be free from all foreseeable liabilities.

Partner Reinsurance Ireland is a reinsurance company incorporated under the laws of Ireland. Legislation transposing the Reinsurance Directive (Directive 2005/68/EC) was signed into Irish law on July 15, 2006 as the European Communities (Reinsurance) Regulations 2006 (the Regulations). Under the Regulations, Partner Reinsurance Ireland is authorized to carry on reinsurance business and has until December 10, 2007 to comply with the requirements set out in the Regulations including, but not limited to, those relating to the establishment of technical provisions and reserves, investment of assets, solvency margin and maintenance of a guarantee fund.

 

16


Table of Contents

All Irish reinsurers, including Partner Reinsurance Ireland, will be required to submit a Reinsurance Grandfathering Compliance Submission to the Financial Regulator showing how they will comply with the new regulatory requirements. If Partner Reinsurance Ireland was not in compliance or was unable to demonstrate that it had a compliance plan acceptable to the Financial Regulator, then it might not be allowed to continue to carry on reinsurance business. Partner Reinsurance Ireland expects to be in full compliance with the Regulations in advance of the December 10, 2007 deadline.

United States

PartnerRe U.S. Corporation is a Delaware domiciled holding company for its wholly owned reinsurance subsidiaries, PartnerRe U.S. and PartnerRe Insurance Company of New York (PRNY) (PartnerRe U.S. and PRNY together being the PartnerRe U.S. Insurance Companies). The PartnerRe U.S. Insurance Companies are subject to regulation under the insurance statutes and regulations of their domiciliary state, New York, and all states where they are licensed, accredited or approved to underwrite reinsurance. Currently, the PartnerRe U.S. Insurance Companies are licensed, accredited or approved reinsurers in fifty states and the District of Columbia. Regulations vary from state to state, but generally require insurance holding companies and insurers and reinsurers that are subsidiaries of holding companies to register and file with their state domiciliary regulatory authorities certain reports, including information concerning their capital structure, ownership, financial condition and general business operations. State regulatory authorities monitor compliance with, and periodically conduct examinations with respect to, state mandated standards of solvency, licensing requirements, investment limitations, restrictions on the size of risks which may be reinsured, deposits of securities for the benefit of reinsureds, methods of accounting for reserves for unearned premiums and losses, and other purposes. In general, such regulations are for the protection of reinsureds and, ultimately, their policyholders, rather than security holders of the PartnerRe U.S. Insurance Companies.

Under New York law, the New York Superintendent of Insurance must approve any dividend declared or paid by the PartnerRe U.S Insurance Companies that, together with all dividends declared or distributed by each of them during the preceding twelve months, exceeds the lesser of 10% of their respective statutory surplus as shown on the latest statutory financial statements on file with the New York Superintendent of Insurance, or 100% of their respective adjusted net investment income during that period. New York does not permit a dividend to be declared or distributed, except out of earned surplus. As of December 31, 2006, PartnerRe U.S. had negative statutory earned surplus, which would require regulatory approval before payment of cash dividends.

State laws also require prior notice and/or regulatory agency approval of changes in control of an insurer or its holding company and of certain inter-company transfers of assets, payments of dividends and certain other transactions among affiliates, as well as any material changes within the holding company structure. The insurance laws of the state of domicile of the PartnerRe U.S. Insurance Companies provide that no corporation or other person except an authorized insurer may acquire control of a domestic insurance or reinsurance company unless it has given notice to such company and obtained prior written approval of the state’s chief insurance regulator. Any purchaser of 10% or more of the outstanding voting securities of PartnerRe Ltd. (the ultimate parent company of the PartnerRe U.S. Insurance Companies) could become subject to such change of control regulations and would be required to file certain notices and reports with the Superintendent of Insurance of New York prior to such acquisition.

A committee of state insurance regulators developed the National Association of Insurance Commissioners’ Insurance Regulatory Information System (IRIS) primarily to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance or reinsurance companies operating in their respective states. IRIS identifies thirteen industry ratios and specifies usual values for each ratio. Generally, a company will become subject to regulatory scrutiny if it falls outside the usual ranges with respect to four or more of the ratios, and regulators may then act, if the company has insufficient capital, to constrain the company’s underwriting capacity. No such action has been taken with respect to the PartnerRe U.S. Insurance Companies.

 

17


Table of Contents

The Risk-Based Capital (RBC) for Insurers Model Act (the Model RBC Act), as it applies to property and casualty insurers and reinsurers, was initially adopted by the U.S. National Association of Insurance Commissioners in December 1993. The Model RBC Act or similar legislation has been adopted by the majority of states in the U.S. The main purpose of the Model RBC Act is to provide a tool for insurance regulators to evaluate the capital of insurers with respect to the risks assumed by them and to determine whether there is a need for possible corrective action. U.S. insurers and reinsurers are required to report the results of their RBC calculations as part of the statutory annual statements that such insurers and reinsurers file with state insurance regulatory authorities. The Model RBC Act provides for four different levels of regulatory actions, each of which may be triggered if an insurer’s Total Adjusted Capital (as defined in the Model RBC Act) is less than a corresponding level of risk-based capital. The Company Action Level is triggered if an insurer’s Total Adjusted Capital is less than 200% of its Authorized Control Level RBC (as defined in the Model RBC Act). At the Company Action Level, the insurer must submit a risk-based capital plan to the regulatory authority that discusses proposed corrective actions to improve its capital position. The Regulatory Action Level is triggered if an insurer’s Total Adjusted Capital is less than 150% of its Authorized Control Level RBC. At the Regulatory Action Level, the regulatory authority will perform a special examination of the insurer and issue an order specifying corrective actions that must be followed. The Authorized Control Level is triggered if an insurer’s Total Adjusted Capital is less than 100% of its Authorized Control Level RBC, and at that level the regulatory authority is authorized (although not mandated) to take regulatory control of the insurer. The Mandatory Control Level is triggered if an insurer’s Total Adjusted Capital is less than 70% of its Authorized Control Level RBC, and at that level, the regulatory authority is required to take regulatory control of the insurer. Regulatory control may lead to rehabilitation or liquidation of an insurer. At December 31, 2006, the Total Adjusted Capital of the PartnerRe U.S. Insurance Companies exceeded applicable RBC levels.

Canada

PartnerRe SA is subject to local regulation for its Canadian branch business, specified principally pursuant to Part XIII of the Insurance Companies Act (the Act) applicable to Foreign Property and Casualty Companies and to Foreign Life Companies. The Office of the Superintendent of Financial Institutions, Canada (OSFI) supervises the application of the Act. The Company’s Canadian branch is authorized to insure, in Canada, risks falling within the classes of insurance as specified in the Act and is limited to the business of reinsurance. The branch is licensed in the Provinces of Quebec and Ontario to write both life and non-life reinsurance business. The Company maintains sufficient assets, vested in trust at a Canadian financial institution approved by OSFI, to allow the branch to meet statutory solvency requirements as defined by the regulations. Statutory information required by federal and provincial insurance regulators for both property and casualty and life business includes (1) a yearly business plan (property and casualty and life), (2) quarterly and year-end returns including general information, financial statements, statutory compliance reports and various investment, technical and other information, (3) an auditor’s report, and (4) an opinion of an appointed actuary.

Taxation of the Company and its Subsidiaries

The following summary of the taxation of the Company, Partner Reinsurance, PartnerRe SA and the PartnerRe U.S. Companies is based upon current law. Legislative, judicial or administrative changes may be forthcoming that could affect this summary. Certain subsidiaries, branch offices and representative offices of the Company are subject to taxation related to operations in Canada, Chile, France, Germany, Hong Kong, Ireland, Japan, Luxembourg, Singapore, South Korea, Switzerland and the United States. The discussion below covers the principal locations for which the Company or its subsidiaries are subject to taxation.

Bermuda

The Company and Partner Reinsurance have each received from the Minister of Finance an assurance under The Exempted Undertakings Tax Protection Act, 1966 of Bermuda, to the effect that in the event that there is any legislation enacted in Bermuda imposing tax computed on profits or income, or computed on any capital asset,

 

18


Table of Contents

gain or appreciation, or any tax in the nature of estate duty or inheritance tax, then the imposition of any such tax shall not be applicable to the Company or Partner Reinsurance or to any of their operations or the shares, debentures or other obligations of the Company or Partner Reinsurance until 2016. These assurances are subject to the proviso that they are not construed to prevent the application of any tax or duty to such persons as are ordinarily resident in Bermuda (the Company and Partner Reinsurance are not currently so designated) or to prevent the application of any tax payable in accordance with the provisions of The Land Tax Act 1967 of Bermuda or otherwise payable in relation to the property leased to Partner Reinsurance.

Switzerland

Partner Reinsurance operates a branch in Switzerland that is subject to Swiss taxation, mainly on profits and capital. To the extent that net profits are generated, they are taxed at a rate of approximately 22%. The branch pays capital taxes at a rate of approximately 0.17% on its imputed branch capital calculated according to a procured taxation ruling.

France

The Company’s French subsidiaries, PartnerRe Holdings SA and PartnerRe SA, conduct business in, and are subject to taxation in France. The current statutory rate of tax on corporate profits in France is 34.43%, which was reduced from 34.93% as of January 1, 2006. Payments of dividends by PartnerRe Holdings SA will be subject to withholding taxes.

United States

PartnerRe U.S. Corporation, PartnerRe U.S., PRNY, PartnerRe Asset Management and PartnerRe New Solutions Inc. (collectively the PartnerRe U.S. Companies) transact business in and are subject to taxation in the United States. The Company believes that it and its subsidiaries, other than the PartnerRe U.S. Companies, have operated and will continue to operate their business in a manner that will not cause them to be treated as engaged in a trade or business within the United States. On this basis, the Company does not expect that it and its subsidiaries, other than the PartnerRe U.S. Companies, will be required to pay U.S. corporate income taxes (other than withholding taxes as described below). However, because there is considerable uncertainty as to the activities that constitute a trade or business in the United States, there can be no assurance that the Internal Revenue Service (the IRS) will not contend successfully that the Company, Partner Reinsurance, or PartnerRe SA are engaged in a trade or business in the United States. The maximum federal tax rate is currently 35% for a corporation’s income that is effectively connected with a trade or business in the United States. In addition, U.S. branches of foreign corporations may be subject to the branch profits tax which imposes a tax on U.S. branch after-tax earnings that are deemed repatriated out of the United States, for a potential maximum effective federal tax rate of approximately 54% on the net income connected with a U.S. trade or business.

Foreign corporations not engaged in a trade or business in the United States are subject to U.S. income tax, effected through withholding by the payer, on certain fixed or determinable annual or periodic gains, profits and income derived from sources within the United States as enumerated in Section 881(a) of the Internal Revenue Code, such as dividends and interest on certain investments.

The United States also imposes an excise tax on insurance and reinsurance premiums paid to foreign insurers or reinsurers with respect to risks located in the United States. The rate of tax applicable to reinsurance premiums paid to Partner Reinsurance or PartnerRe SA is 1% of gross premiums.

Canada

PartnerRe SA operates a branch in Canada that is subject to Canadian taxation on its profits. The profits are taxed at the federal level as well as the Ontario and Quebec provincial level at a total rate that varies according to the distribution of profits between the provinces, which rate was approximately 35.2%.

 

19


Table of Contents

Where You Can Find More Information

The Company’s Annual Reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act are available free of charge through the investor information pages of its website, located at www.partnerre.com. Alternatively, the public may read or copy the Company’s filings with the Securities and Exchange Commission (SEC) at the SEC’s Public Reference Room at 100 F Street, N.E., Room 1580, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC (http://www.sec.gov).

 

ITEM 1A. RISK FACTORS

Introduction

We define risk as the possibility that an uncertain event will occur with adverse consequences. We consider the most significant adverse consequence to be the reduction or destruction of value. Managing risk effectively is key to our success. Our business proposition is built around intelligent risk assumptions and careful risk management, as evidenced by our development of the PartnerRe Risk Management Framework, which provides an integrated approach to risk across the entire organization. See Other Key Issues of Management in Item 7 of Part II of this report for a detailed discussion on the Company’s risk management. We believe that risk can be divided into three distinct categories:

Strategic Risk: Strategic risk is any potential impact to the successful implementation of our strategy, which will usually be determined by the successful implementation of a number of our significant objectives. The consequence of being unable to successfully implement our strategies may result in the inability to compete adequately in the marketplace.

Assumed Risk: As a reinsurer, we are in the risk assumption business and are compensated for assuming reinsurance risk. We may be adversely affected if we assume reinsurance or investment risks where the losses exceed expected limits, which could result in significant loss of our capital, our inability to assume subsequent risks and/or our inability to access capital.

Operational Risk: Operational risk is the potential adverse impact internally from people, processes, and systems; or externally from the market or damage to reputation that could result in inability to provide a quality service to our customers; inability to comply with laws, regulations or policies and procedures; impairment of our reputation or negative impact on our financial position.

Cautionary Note Concerning Forward-Looking Statements

Certain statements contained in this document, including Management’s Discussion and Analysis, may be considered forward-looking statements as defined in section 27A of the United States Securities Act of 1933 and section 21E of the United States Securities Exchange Act of 1934. Forward-looking statements are made based upon Management’s assumptions and expectations concerning the potential effect of future events on the Company’s financial performance and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are subject to significant business, economic and competitive risks and uncertainties that could cause actual results to differ materially from those reflected in such forward-looking statements. PartnerRe’s forward-looking statements could be affected by numerous foreseeable and unforeseeable events and developments that may affect our Company directly, or indirectly through our industry. As used in these Risk Factors, the terms “we”, “our” or “us” may, depending upon the context, refer to the Company, to one or more of the Company’s consolidated subsidiaries or to all of them taken as a whole.

 

20


Table of Contents

The following review of important factors should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included herein or elsewhere. The words believe, anticipate, estimate, project, plan, expect, intend, hope, forecast, evaluate, will likely result or will continue or words of similar impact generally involve forward-looking statements. We caution readers not to place undue reliance on these forward-looking statements, which speak only as of their dates. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

STRATEGIC RISK

Our profitability is affected by the cyclical nature of the reinsurance industry.

Historically, the reinsurance industry has experienced significant fluctuations in operating results due to competition, levels of available capacity, trends in cash flows and losses, general economic conditions and other factors. Demand for reinsurance is influenced significantly by underwriting results of primary insurers, including catastrophe losses, and prevailing general economic conditions. The supply of reinsurance is related directly to prevailing prices and levels of capacity that, in turn, may fluctuate in response to changes in rates of return on investments being realized in the reinsurance industry. If any of these factors were to result in a decline in the demand for reinsurance or an overall increase in reinsurance capacity, our profitability could decrease.

We operate in a highly competitive environment.

The reinsurance industry is highly competitive. We compete with a number of worldwide reinsurance companies, including, but not limited to, Berkshire Hathaway’s General Re, Everest Re Group Ltd, Hannover Re, Lloyds, Munich Re, Paris Re Holdings Ltd, Platinum Underwriters, Swiss Re, Transatlantic Reinsurance Company and reinsurance operations of certain primary insurance companies, such as ACE Limited, Axis Capital and XL Capital. Competition in the types of reinsurance that we underwrite is based on many factors, including the perceived financial strength of the reinsurer, pricing, other terms and conditions offered, services provided, ratings assigned by independent rating agencies, speed of claims payment and reputation and experience in the lines of reinsurance to be written. Some competitors have greater financial, marketing and management resources and higher credit ratings than ours.

Consolidation within our industry could adversely impact us.

To the extent consolidations occur within our industry, such consolidated entities may try to use their enhanced market power to negotiate price reductions for our products and services. If competitive pressures reduce our prices, we would expect to write less business. In addition, competition for customers will become more intense and the importance of acquiring and providing good service to each customer will become greater. We could incur additional expenses relating to customer acquisition and retention, further reducing our operating margins. Insurance companies that merge may be able to spread their risks across a consolidated, larger capital base so that they require less reinsurance. We could also experience more robust competition from larger, better capitalized competitors.

Changes in current accounting practices and future pronouncements may materially impact our reported financial results.

Unanticipated developments in accounting practices may require considerable additional expense to comply, particularly if we are required to prepare information relating to prior periods for comparative purposes or to apply the new requirements retroactively. The impact of changes in current accounting practices and future pronouncements cannot be predicted, but may affect the calculation of net income.

 

21


Table of Contents

Regulatory constraints may restrict our ability to operate our business.

Our reinsurance operations are carried out through three main subsidiaries, Partner Reinsurance in Bermuda (which also operates branches in Switzerland, Singapore, Hong Kong and Labuan and representative offices in Mexico and Chile), PartnerRe U.S. in Greenwich, Connecticut and PartnerRe SA in Paris. PartnerRe SA also operates a branch in Toronto and representative offices in Tokyo and South Korea. In addition, we opened an office in Dublin in 2005 and have commenced both insurance and reinsurance operations. Our reinsurance operations are subject to certain insurance laws in each of these jurisdictions. Our main subsidiaries’ regulatory environments are described in detail in Item 1 of Part I of this report under the heading Regulation. Regulations relating to each of our main subsidiaries may in effect restrict each of those subsidiaries’ ability to write new business, to make certain investments and to distribute funds or assets to us.

Our Bermuda-based reinsurance subsidiary, Partner Reinsurance, is incorporated under the laws of Bermuda and is not admitted to do business in the United States. The insurance laws of each state of the United States regulate the sale of insurance and reinsurance within their jurisdiction by foreign insurers, such as Partner Reinsurance, which are not admitted to do business in these jurisdictions. Partner Reinsurance does not intend to maintain an office or to solicit, advertise, settle claims or conduct other insurance or reinsurance activities in any state of the United States or any other jurisdiction in which it is not licensed or otherwise not authorized to engage in such activities. Although Partner Reinsurance does not believe it is or will be in violation of insurance laws or regulations of Bermuda or of any jurisdiction outside Bermuda, inquiries or challenges to Partner Reinsurance’s insurance or reinsurance activities may still be raised in the future. In addition, Partner Reinsurance’s location, regulatory status or restriction on its activities resulting from its regulatory status may limit its ability to conduct business. In general, the statutes and regulations applicable to Partner Reinsurance are less restrictive than those that would be applicable if it were subject to the insurance laws of any state in the United States.

The insurance and reinsurance regulatory framework has been subject to increased scrutiny in many jurisdictions, including Europe and the United States and various states within the United States. In November 2005, the European Parliament adopted Directive 2005/68/EC, the European Union Reinsurance Directive. This directive seeks to harmonize the supervision of reinsurance within the European Union by creating a single regulated market and each member state must adopt the Reinsurance Directive into local legislation by December 2007. While Partner Reinsurance’s Swiss branch is not within the European Union, the adoption of the Reinsurance Directive may impact its ability to write reinsurance business in member states of the EU and restrict our ability to operate our business.

It is not possible to predict the future impact of changing laws or regulations on our operations, and any such changes may limit the way we currently conduct our business.

PartnerRe U.S. is subject to regulation in the State of New York and the U.S. In recent years, the U.S. insurance regulatory framework has come under increased federal scrutiny, and some state legislators have considered or enacted laws that may alter or increase state regulation of insurance and reinsurance companies and holding companies. Moreover, the New York State Attorney General as well as the U.S. Securities and Exchange Commission have recently investigated the accounting treatment for certain reinsurance transactions. It is possible that these investigations could lead to new legislation and regulatory proposals in New York and in other states. Also, the National Association of Insurance Commissioners, which is an association of the insurance commissioners of all 50 states and the District of Columbia, and state insurance regulators regularly reexamine existing laws and regulations. Changes in these laws and regulations or the interpretation of these laws and regulations could have a material adverse effect on our business.

Political, regulatory, governmental and industry initiatives could adversely affect our business.

Government intervention and the possibility of future government intervention have created uncertainty in the insurance and reinsurance markets. Government regulators are generally concerned with the protection of

 

22


Table of Contents

policyholders to the exclusion of others, including shareholders of reinsurers. We believe it is likely there will be increased regulation of, and other forms of government participation in, our industry in the future, which could adversely affect our business by, among other things:

 

   

Providing reinsurance capacity in markets and to consumers that we target or requiring our participation in industry pools and guaranty associations;

 

   

Expanding the scope of coverage under existing policies;

 

   

Regulating the terms of reinsurance policies; or

 

   

Disproportionately benefiting the companies of one country over those of another.

Such a federal initiative was put forward in response to the tightening of supply in certain insurance and reinsurance markets resulting from, among other things, the September 11th tragedy, and consequently the Terrorism Risk Insurance Act of 2002 (TRIA) was enacted to ensure the availability of commercial insurance coverage for terrorist acts in the U.S. In December 2005, the Terrorism Risk Insurance Extension Act (TRIEA) was enacted which renewed the TRIA for another two years. We are currently unable to determine with certainty what impact the TRIEA’s non-renewal would have on us.

Such a state initiative was put forward by the Florida Legislature in response to the tightening of supply in certain insurance and reinsurance markets in Florida resulting from, among other things, recent hurricane damage in Florida, which enacted the Hurricane Preparedness and Insurance Act to ensure the availability of catastrophe insurance coverage for catastrophes in the state of Florida. We are currently unable to determine the impact of this law on us, our customers and the markets in which we participate.

The insurance industry is also affected by political, judicial and legal developments that may create new and expanded theories of liability, which may result in unexpected claim frequency and severity and delays or cancellations of products and services we provide, which could adversely affect our business. Some direct writers are currently facing lawsuits and other actions designed to expand coverage related to Hurricane Katrina losses beyond that which those insurers believed they would be held liable for prior to that event. It is impossible to predict what impact similar actions may have on us in the future.

Current legal and regulatory activities relating to the insurance industry could affect our business and our industry.

Recently, the insurance industry has experienced substantial volatility as a result of current litigation, investigations and regulatory activity by various insurance, governmental and enforcement authorities concerning certain practices within the insurance industry. These practices include the accounting treatment for finite reinsurance or other non-traditional or loss mitigation insurance and reinsurance products.

These investigations have resulted in changes in the insurance and reinsurance markets and industry business practices. While at this time none of these changes have caused an adverse effect on our business, we are unable to predict the potential effects, if any, that future investigations may have upon our industry. Future investigations could materially and adversely affect our business.

If we are downgraded by rating agencies, our standing with brokers and customers could be negatively impacted and our premiums and earnings could decrease.

Third party rating agencies assess and rate the claims paying ability and financial strength of insurers and reinsurers, such as the Company’s subsidiaries, Partner Reinsurance, PartnerRe U.S. and PartnerRe SA. These

 

23


Table of Contents

ratings are based upon criteria established by the rating agencies, and the rating agencies periodically evaluate our reinsurance operations to determine if we continue to meet the criteria of the ratings that have been assigned to us. The claims-paying ability ratings assigned by rating agencies to reinsurance or insurance companies are based upon factors and criteria established independently by each rating agency They are not an evaluation directed to investors in our common shares, preferred shares or debt securities, and are not a recommendation to buy, sell or hold our common shares, preferred shares or debt securities. Rating agencies may downgrade or withdraw their ratings in the future if we do not continue to meet the then current criteria for the ratings previously assigned to us. Such criteria may change, perhaps significantly, at the sole discretion of the rating agencies.

Our current financial strength ratings are:

 

Standard & Poor’s

   AA-/negative outlook

Moody’s

   Aa3/stable

A.M. Best

   A+/stable

Fitch

   AA/stable

If our ratings were significantly downgraded, our competitive position in the reinsurance industry may suffer, and it could be more difficult for us to market our products. Certain business that we write contains terms that give the ceding company or derivative counterparty the right to terminate cover and/or require collateral if our ratings are downgraded. A significant downgrade could result in a significant reduction in the number of reinsurance contracts we write and in a substantial loss of business as client companies, and brokers that place their business, move to other competitors with higher ratings.

Since we rely on a few reinsurance brokers for a large percentage of our business, loss of business provided by these brokers could reduce our premium volume and net income.

We produce our business both through brokers and through direct relationships with insurance company clients. For the year ended December 31, 2006, approximately 69% of gross premiums were produced through brokers. In 2006, we had two brokers that accounted for 38% of our gross premiums written. Because broker-produced business is concentrated with a small number of brokers, we are exposed to concentration risk. Loss of all or a substantial portion of the business produced by significant brokers could significantly reduce our premium volume and net income.

We may require additional capital in the future, which may not be available or may only be available on unfavorable terms.

Our future capital requirements depend on many factors, including our ability to write new business successfully, the frequency and severity of catastrophic events, and our ability to establish premium rates and reserves at levels sufficient to cover losses. We may need to raise additional funds through financings or curtail our growth and reduce our assets. Any equity or debt financing, if available at all, may be on terms that are not favorable to us. Equity financings could be dilutive to our existing shareholders and could result in the issuance of securities that have rights, preferences and privileges that are senior to those of our other securities. If we cannot obtain adequate capital on favorable terms or at all, our business, operating results and financial condition could be adversely affected.

ASSUMED RISK

If actual losses exceed our estimated loss reserves our net income will be reduced.

Our success depends upon our ability to accurately assess the risks associated with the businesses that we reinsure. We establish loss reserves to cover our estimated liability for the payment of all losses and loss expenses incurred with respect to premiums earned on the contracts that we write. Loss reserves do not represent

 

24


Table of Contents

an exact calculation of liability. Loss reserves are estimates involving actuarial and statistical projections at a given time to reflect our expectation of the costs of the ultimate settlement and administration of claims. Losses for short-tail business, which include, but are not limited to, most types of catastrophe, property, motor, physical damage, aviation hull, and marine losses, tend to be reported promptly and settled within a short period of time, barring unusual circumstances. However, losses for casualty and liability lines, often take longer to be reported, and frequently can be impacted by lengthy, unpredictable litigation and by the inflation of loss costs over time.

We expect our casualty business to produce claims that will often be resolved only through lengthy and unpredictable litigation. Although to a lesser extent, this could also be the case for other lines of business. The measures required to resolve such claims, including the adjudication process, present generally more reserve challenges than property-related losses. As a consequence of litigation in all of our lines of business, actual losses and loss expenses paid may substantially deviate from the reserve estimates reflected in our financial statements.

As a result, even when losses are identified and reserves are established for any line of business, ultimate losses and loss expenses (that is, the administrative costs of managing and settling claims) may deviate, perhaps substantially, from estimates reflected in loss reserves in our financial statements. If our loss reserves for business written are inadequate, we will be required to increase loss reserves in the period in which we identify the deficiency. This could cause a material increase in our liabilities, a reduction in our profitability and a reduction of capital.

Although we did not operate prior to 1993, we assumed certain asbestos and environmental exposures through our acquisitions. Our reserves for losses and loss expenses include an estimate of our ultimate liability for asbestos and environmental claims for which we cannot estimate the ultimate value using traditional reserving techniques, and for which there are significant uncertainties in estimating the amount of our potential losses. We and certain of our subsidiaries have received and continue to receive notices of potential reinsurance claims from ceding insurance companies which have in turn received claims asserting asbestos and environmental losses under primary insurance policies, in part reinsured by us. Such claims notices are often precautionary in nature and are generally unspecific, and the primary insurers often do not attempt to quantify the amount, timing or nature of the exposure. Given the lack of specificity in some of these notices, and the legal and tort environment that affects the development of claims reserves, the uncertainties inherent in valuing asbestos and environmental claims are not likely to be resolved in the near future. In addition, the reserves that we have established may be inadequate. If ultimate losses and loss expenses exceed the reserves currently established, we will be required to increase loss reserves in the period in which we identify the deficiency to cover any such claims. This could cause a material increase in our liabilities, a reduction in our profitability and a reduction of capital.

The volatility of the business that we underwrite may result in volatility of our earnings and limit our ability to write future business.

Catastrophe reinsurance comprises approximately 11% of our net premiums written. Catastrophe losses result from events such as windstorms, hurricanes, earthquakes, floods, hail, tornadoes, severe winter weather, fires, explosions and other man-made or natural disasters, the incidence and severity of which are inherently unpredictable. Because catastrophe reinsurance accumulates large aggregate exposures to man-made and natural disasters, our loss experience in this line of business could be characterized as low frequency and high severity. This is particularly the case as we usually provide reinsurance that pays only after the primary insurer has experienced a specified level of loss, which tends to reduce our exposure to higher-frequency, lower-severity losses. This is likely to result in substantial volatility in our financial results for any fiscal quarter or year, and may create downward pressure on the market price of our common shares and limit our ability to make dividend payments and payments on our debt securities.

Notwithstanding our endeavors to manage our exposure to catastrophic and other large losses, the effect of a single catastrophic event or series of events affecting one or more geographic zones, or changes in the relative

 

25


Table of Contents

frequency or severity of catastrophic or other large loss events, could reduce our earnings and limit the funds available to make payments on future claims. The effect of an increase in frequency of mid-size losses in any one reporting period affecting one or more geographic zones, such as an unusual level of hurricane activity, could also reduce our earnings. Should we incur one or more large catastrophe losses, our ability to write future business may be adversely impacted.

By way of illustration, during the past five calendar years, we have incurred the following pre-tax large catastrophe losses, net of reinsurance (in millions of U.S. dollars):

 

Calendar year

   Pre-tax large catastrophe losses

2006

     —  

2005

   $ 900

2004

     176

2003

     —  

2002

     120

We could face unanticipated losses from man-made catastrophic events and these or other unanticipated losses could impair our financial condition, reduce our profitability and decrease the market price of our shares.

We may have substantial exposure to unexpected, large losses resulting from future man-made catastrophic events, such as acts of terrorism, acts of war and political instability, or from other perils. Although we may exclude losses from terrorism and certain other similar risks from some coverage we write, we may continue to have exposure to such unforeseen or unpredictable events. It is difficult to predict the timing of such events with statistical certainty, or estimate the amount of loss any given occurrence will generate. Under U.S. GAAP, we are not permitted to establish reserves for potential losses associated with man-made or other catastrophic events until an event that may give rise to such losses occurs. If such an event were to occur, our reported income would decrease in the affected period. In particular, unforeseen large losses could reduce our profitability or impair our financial condition. Over time, if the severity and frequency of these events remains higher than in the past, it may impact our ability to write future business.

Emerging claim and coverage issues could adversely affect our business.

Unanticipated developments in the law, as well as changes in social and environmental conditions, could potentially result in unexpected claims for coverage under our insurance, reinsurance and other contracts. These developments and changes may materially adversely affect us. For example, we could be subject to developments that impose additional coverage obligations on us beyond our underwriting intent, or to increases in the number or size of claims. With respect to our casualty businesses, these legal, social and environmental changes may not become apparent until some time after their occurrence. Our exposure to these uncertainties could be exacerbated by an increase in insurance and reinsurance contract disputes, arbitration, and litigation.

The full effects of these and other unforeseen emerging claim and coverage issues are extremely hard to predict. As a result, the full extent of our liability under our coverages, and in particular, our casualty reinsurance contracts, may not be known for many years after a contract is issued. In addition, we could be adversely affected by the growing trend of plaintiffs targeting participants in the property-liability insurance industry in purported class action litigation relating to claims handling and other practices.

We are exposed to credit risk relating to our reinsurance brokers and cedants and other counterparties.

In accordance with industry practice, we may pay amounts owed under our policies to brokers, and they in turn pay these amounts to the ceding insurer. In some jurisdictions, if the broker fails to make such an onward payment, we might remain liable to the ceding insurer for the deficiency. Conversely, the ceding insurer may pay

 

26


Table of Contents

premiums to the broker, for onward payment to us in respect of reinsurance policies issued by us. In certain jurisdictions, these premiums are considered to have been paid to us at the time that payment is made to the broker, and the ceding insurer will no longer be liable to us for those amounts, whether or not we have actually received the premiums. We may not be able to collect all premiums receivable due from any particular broker at any given time. We also assume credit risk by writing business on a funds withheld basis. Under such arrangements, the cedant retains the premium they would otherwise pay to the reinsurer to cover future loss payments. In addition, we may be exposed to credit risk from transactions involving banks or derivative counterparties and the credit risk of reinsurers from whom we may purchase retrocessional reinsurance.

The exposure of our investments to interest rate, credit and market risks may limit our net investment income and net income and may affect the adequacy of our capital.

We invest the net premiums we receive until such time as we pay out losses. Investment results comprise a substantial portion of our income. For the year ended December 31, 2006, we had net investment income of $449 million, which represented approximately 11% of total revenues. While our Management has implemented what it believes to be prudent risk management and investment asset allocation practices, we are exposed to interest rate risk, credit and default risk, liquidity risk and market volatility.

Changes in interest rates can negatively affect us in two ways. In a declining interest rate environment, we will be required to invest our funds at lower rates, which would have a negative impact on investment income. In a rising interest rate environment, the market value of our fixed income portfolio may decline, thereby reducing our capital and potentially affecting our ability to write business.

Our fixed income portfolio is primarily invested in high quality, investment-grade securities. However, we invest a smaller portion of the portfolio in below investment-grade securities, including high yield bonds, bank loans, and convertible bonds. These securities, which pay a higher rate of interest, also have a higher degree of credit or default risk. These securities may also be less liquid in times of economic weakness or market disruptions. While we have put in place procedures to monitor the credit risk and liquidity of our invested assets, it is possible that, in periods of economic weakness, we may experience default losses in our portfolio. This may result in a reduction of net income and capital.

We invest a portion of our portfolio in preferred and common stocks or equity-related securities. The value of these assets fluctuates with equity markets. In times of economic weakness, the market value and liquidity of these assets may decline, and may impact net income and capital. Convertible bonds have both a debt and an equity component due to the option to convert the fixed income security to an equity form. Therefore, convertible bonds have both credit and interest rate risk as described above, as well as equity volatility risk.

We also invest in alternative investments, which have different risk characteristics than traditional equity and fixed maturity securities. These alternative investments include mutual funds, equity hedge funds, and private bond and equity investments. Our percentage allocation to these alternative investments, which at December 31, 2006 was approximately 4 percent of our total investment portfolio, may increase or decrease. Fluctuations in the fair value of our alternative investments may reduce our income in any period or year or cause a reduction in our capital.

Our debt, credit and International Swap Dealers Association (ISDA) agreements may limit our financial and operational flexibility, which may affect our ability to conduct our business.

We have incurred indebtedness, and may incur additional indebtedness in the future. Additionally, we have entered into credit facilities and ISDA agreements with various institutions. Under these credit facilities, the institutions provide revolving lines of credit to us and our major operating subsidiaries and issue letters of credit to our clients in the ordinary course of business.

 

27


Table of Contents

The agreements relating to our debt, credit facilities and ISDA agreements contain various covenants that may limit our ability, among other things, to borrow money, make particular types of investments or other restricted payments, sell assets, merge or consolidate. Some of these agreements also require us to maintain specified ratings and financial ratios, including a minimum net worth covenant. If we fail to comply with these covenants or meet required financial ratios, the lenders or counterparties under these agreements could declare a default and demand immediate repayment of all amounts owed to them.

If we are in default under the terms of these agreements, then we would also be restricted in our ability to declare or pay any dividends, redeem, purchase or acquire any shares or make a liquidation payment.

OPERATIONAL RISK

If our non-U.S. operations become subject to U.S. income taxation, our net income will decrease.

We believe that we, Partner Reinsurance and PartnerRe SA, have operated, and will continue to operate, our respective businesses in a manner that will not cause us to be viewed as engaged in a trade or business in the United States and, on this basis, we do not expect that we, Partner Reinsurance or PartnerRe SA, will be required to pay U.S. corporate income taxes (other than potential withholding taxes on certain types of U.S.-source passive income). Because there is considerable uncertainty as to the activities that constitute being engaged in a trade or business within the United States, the IRS may contend that we, Partner Reinsurance or PartnerRe SA are engaged in a trade or business in the United States. If we, Partner Reinsurance or PartnerRe SA are subject to U.S. income tax, our shareholders’ equity and earnings will be reduced by the amount of such taxes, which could be material.

Partner Reinsurance Company of the U.S., PartnerRe Insurance Company of New York, PartnerRe Asset Management and PartnerRe New Solutions Inc. are wholly-owned subsidiaries of PartnerRe U.S. Corporation, conduct business in the United States, and are subject to U.S. corporate income taxes.

The impact of Bermuda’s letter of commitment to the Organization for Economic Cooperation and Development to eliminate harmful tax practices is uncertain and could adversely affect our tax status in Bermuda.

The Organization for Economic Cooperation and Development (OECD) has published reports and launched a global dialogue among member and non-member countries on measures to limit harmful tax competition. These measures are largely directed at counteracting the effects of tax havens and preferential tax regimes in countries around the world. Bermuda was not listed in the most recent report as an uncooperative tax haven jurisdiction because it had previously committed to eliminate harmful tax practices, to embrace international tax standards for transparency, to exchange information and to eliminate an environment that attracts business with no substantial domestic activity. We are not able to predict what changes will arise from the commitment or whether such changes will subject us to additional taxes.

We are a holding company and, if our subsidiaries do not make dividend and other payments to us, we may not be able to pay dividends or make payments on our debt securities and other obligations.

We are a holding company with no operations or significant assets other than the capital stock of our subsidiaries. We rely primarily on cash dividends and payments from Partner Reinsurance, PartnerRe SA and PartnerRe U.S., to pay the operating and interest expenses, shareholder dividends and other obligations of the holding company that may arise from time to time. We expect future dividends and other permitted payments from these subsidiaries to be our principal source of funds to pay expenses and dividends. The payment of dividends by our reinsurance subsidiaries to us is limited under Bermuda and French laws and certain insurance statutes of various U.S. states in which PartnerRe U.S. is licensed to transact business. Therefore, our reinsurance subsidiaries may not always be able to, or may not, pay dividends to us sufficient to pay our expenses, dividends or other obligations.

 

28


Table of Contents

The payment of dividends by Partner Reinsurance to us is limited under Bermuda law and regulations. Under the Insurance Act 1978 and amendments thereto, including the Insurance Amendment Act 1995, and related regulations, Partner Reinsurance is prohibited from paying dividends in any one financial year of more than 25% of its total statutory capital and surplus as of the beginning of such year, unless it files an affidavit stating that it will continue to meet the required solvency margin and minimum liquidity ratio requirements. In addition, if Partner Reinsurance failed to meet its required margins in the previous fiscal year it would be prohibited from declaring or paying any dividends without the approval of the Bermuda Monetary Authority. The Insurance Act requires Partner Reinsurance to maintain a minimum solvency margin and minimum liquidity ratio and prohibits dividends that would result in a breach of these requirements. In addition, Partner Reinsurance is prohibited under the Insurance Act from reducing its statutory capital as of the beginning of any year by more than 15% in any one year without the approval of the Bermuda Monetary Authority.

PartnerRe SA’s ability to pay dividends is subject to French laws and regulations governing French companies generally. Although PartnerRe SA’s ability to pay dividends to us is not restricted under current French laws and regulations specifically applicable to reinsurers, the amount of cash dividends that may be paid in any twelve-month period is generally limited to the net after-tax profits (determined under French accounting and tax rules) generated in that twelve-month period. PartnerRe U.S. may generally pay cash dividends only out of statutory earned surplus. Currently, PartnerRe U.S. has statutory negative earned surplus and therefore cannot pay dividends without prior regulatory approval.

Because we are a holding company, our right, and hence the right of our creditors and shareholders, to participate in any distribution of assets of any subsidiary of ours, upon our liquidation or reorganization or otherwise, is subject to the prior claims of policyholders and creditors of these subsidiaries.

Investors may encounter difficulties in service of process and enforcement of judgments against us in the United States.

We are a Bermuda company and some of our directors and officers are residents of various jurisdictions outside the United States. All, or a substantial portion, of the assets of our officers and directors and of our assets are or may be located in jurisdictions outside the United States. Although we have appointed an agent and irrevocably agreed that the agent may be served with process in New York with respect to actions against us arising out of violations of the United States Federal securities laws in any Federal or state court in the United States, it could be difficult for investors to effect service of process within the United States on our directors and officers who reside outside the United States. It could also be difficult for investors to enforce against us or our directors and officers judgments of a United States court predicated upon civil liability provisions of United States Federal securities laws.

There is no treaty in force between the United States and Bermuda providing for the reciprocal recognition and enforcement of judgments in civil and commercial matters. As a result, whether a United States judgment would be enforceable in Bermuda against us or our directors and officers depends on whether the United States court that entered the judgment is recognized by the Bermuda court as having jurisdiction over us or our directors and officers, as determined by reference to Bermuda conflict of law rules. A judgment debt from a United States court that is final and for a sum certain based on United States Federal securities laws, will not be enforceable in Bermuda unless the judgment debtor had submitted to the jurisdiction of the United States court, and the issue of submission and jurisdiction is a matter of Bermuda law and not United States law.

In addition to and irrespective of jurisdictional issues, Bermuda courts will not enforce a United States Federal securities law that is either penal or contrary to public policy. An action brought pursuant to a public or penal law, the purpose of which is the enforcement of a sanction, power or right at the instance of the state in its

 

29


Table of Contents

sovereign capacity, will not be entered by a Bermuda court. Certain remedies available under the laws of United States jurisdictions, including certain remedies under United States Federal securities laws, would not be available under Bermuda law or enforceable in a Bermuda court, as they would be contrary to Bermuda public policy. Further, no claim can be brought in Bermuda against us or our directors and officers in the first instance for violation of United States Federal securities laws because these laws have no extra jurisdictional effect under Bermuda law and do not have force of law in Bermuda. A Bermuda court may, however, impose civil liability on us or our directors and officers if the facts alleged in a complaint constitute or give rise to a cause of action under Bermuda law.

Operational risks, including human or systems failures, are inherent in our business.

Operational risks and losses can result from fraud, errors by employees, failure to document transactions properly or to obtain proper internal authorization, failure to comply with regulatory requirements, information technology failures, or external events.

We believe our modeling, underwriting and information technology and application systems are critical to our business and reputation, our ability to process transactions and provide high quality customer service. Moreover, our technology and applications have been an important part of our underwriting process and our ability to compete successfully. Such technology is and will continue to be a very important part of our underwriting process. We have also licensed certain systems and data from third parties. We cannot be certain that we will have access to these, or comparable service providers, or that our technology or applications will continue to operate as intended. In addition, we cannot be certain that we would be able to replace these service providers or consultants without slowing our underwriting response time. A major defect or failure in our internal controls or information technology and application systems could result in management distraction, harm to our reputation, a loss or delay of revenues or increased expense. We believe appropriate controls and mitigation actions are in place to prevent significant risk of defect in our internal controls, information technology and application systems, but if such controls and actions are not effective, the adverse effect on our business could be significant.

Foreign currency fluctuations may reduce our net income and our capital levels.

Through our multinational reinsurance operations, we conduct business in a variety of foreign (non-U.S.) currencies, the principal exposures being the euro, the British pound, the Swiss franc, the Canadian dollar and the Japanese yen. Assets and liabilities denominated in foreign currencies are exposed to changes in currency exchange rates. Our reporting currency is the U.S. dollar, and exchange rate fluctuations relative to the U.S. dollar may materially impact our results and financial position. We employ various strategies (including hedging) to manage our exposure to foreign currency exchange risk. To the extent that these exposures are not fully hedged or the hedges are ineffective, our results and level of capital may be reduced by fluctuations in foreign currency exchange rates.

We have imposed various limitations on voting and ownership of our shares, which will limit the ability of investors to acquire more than a certain percentage of our voting shares. The anti-takeover provisions in our bye-laws may discourage takeover attempts.

Under our bye-laws, subject to waiver by our board of directors, no transfer of our common shares or preferred shares is permitted if such transfer would result in a shareholder controlling more than 9.9% of the voting power of our outstanding shares. Any person controlling more than the specified number of shares will be permitted to dispose of any shares purchased which violate the restriction. If we become aware of such ownership, our bye-laws provide that the voting rights with respect to shares directly or indirectly beneficially or constructively owned by any person so owning more than 9.9% of the voting power of the outstanding shares, including our common shares and preferred shares, will be limited to 9.9% of the voting power. The voting rights with respect to all shares held by such person in excess of the 9.9% limitation will be allocated to the other

 

30


Table of Contents

holders of shares, pro rata based on the number of shares held by all such other holders of shares, subject only to the further limitation that no shareholder allocated any such voting rights may exceed the 9.9% limitation as a result of such allocation.

Our bye-laws also contain provisions that may entrench directors and make it more difficult for shareholders to replace directors even if the shareholders consider it beneficial to do so. These provisions include a classified board of directors, meaning that the members of only one of three classes of our directors are elected each year, and could delay or prevent a change of control that a shareholder might consider favorable. For example, these provisions may prevent a shareholder from receiving the benefit from any premium over the market price of our common shares offered by a bidder in a potential takeover. Even in the absence of an attempt to effect a change in management or a takeover attempt, these provisions may adversely affect the prevailing market price of our common shares if they are viewed as discouraging change in management and takeover attempts in the future.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

The Company leases office space in Bermuda where the Company’s principal executive offices are located. Additionally, the Company leases office space in various locations, including Beijing, Dublin, Greenwich (Connecticut), Hong Kong, Mexico City, Montreal, Paris, Santiago, Seoul, Singapore, Tokyo, Toronto and Zurich.

 

ITEM 3. LEGAL PROCEEDINGS

Litigation

The Company’s reinsurance subsidiaries, and the insurance and reinsurance industry in general, are subject to litigation and arbitration in the normal course of their business operations. In addition to claims litigation, the Company and its subsidiaries may be subject to lawsuits and regulatory actions in the normal course of business that do not arise from or directly relate to claims on reinsurance treaties. This category of business litigation typically involves, inter alia, allegations of underwriting errors or misconduct, employment claims or regulatory activity. While the outcome of the business litigation cannot be predicted with certainty, the Company is disputing and will continue to dispute all allegations against the Company and/or its subsidiaries that Management believes are without merit.

As of December 31, 2006, the Company was not a party to any litigation or arbitration that it believes could have a material adverse effect on the financial condition or business of the Company.

Subpoenas

In June 2005, the Company received a subpoena from the United States Attorney for the Southern District of New York requesting information relating to the Company’s finite reinsurance products. In addition, the Company’s wholly owned subsidiary, PartnerRe U.S., received a subpoena from the Florida Office of Insurance Regulation in April 2005 requesting information in connection with its investigation of insurance industry practices related to finite reinsurance activities. The Company has responded promptly to all requests for information.

In January 2007, PartnerRe U.S. received a subpoena from the Attorney General for the State of Connecticut requesting information relating to the Company’s participation in certain underwriting agreements that existed in 2002 and prior. The Company is cooperating fully with this request for information.

 

31


Table of Contents
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of shareholders of the Company during the fourth quarter of the fiscal year ended December 31, 2006.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company has the following securities (with their related symbols) traded on the New York Stock Exchange:

 

Common shares

   PRE

6.75% Series C cumulative preferred shares

   PRE-PrC

6.5% Series D cumulative preferred shares

   PRE-PrD

As of February 22, 2007, the approximate number of common shareholders was 57,800.

The following table provides information about purchases by the Company during the quarter ended December 31, 2006, of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act.

Issuer Purchases of Equity Securities

 

Period

  

(a)

Total number of

shares purchased(1)

  

(b)

Average price paid

per share

  

(c)

Total number of shares

purchased as part of

publicly announced

program(1)

  

(d)
Maximum number of
shares that may yet

be purchased under

the program

10/01/2006-10/31/2006

   —      —      —      4,293,651

11/01/2006-11/30/2006

   —      —      —      4,293,651

12/01/2006-12/31/2006

   —      —      —      4,293,651
                 

Total

   —      —      —     

(1) In 2005, the Company’s Board of Directors approved an increase in the Company’s stock repurchase authorization up to a maximum of 5 million common shares. From this authorization, 4,293,651 common shares remain eligible for repurchase. Unless terminated earlier by resolution of the Company’s Board of Directors, the program will expire when the Company has repurchased all shares authorized for repurchase thereunder.

Other information with respect to the Company’s common shares and related stockholder matters is contained in Notes 10, 11, 12, 13, 14 and 20 to Consolidated Financial Statements in Item 8 of Part II of this report; and under the caption Equity Compensation Plan Information in the Proxy Statement and is incorporated by reference to this item.

 

32


Table of Contents
ITEM 6. SELECTED FINANCIAL DATA

Selected Consolidated Financial Data

(Expressed in millions of U.S. dollars, except per share data)

The following Selected Consolidated Financial Data is presented in accordance with accounting principles generally accepted in the United States. This data should be read in conjunction with the Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements.

 

     For the year ended December 31,  

Statement of Operations Data

   2006     2005     2004     2003     2002  

Gross premiums written

   $ 3,734     $ 3,665     $ 3,888     $ 3,625     $ 2,706  

Net premiums written

     3,689       3,616       3,853       3,590       2,655  

Net premiums earned

   $ 3,667     $ 3,599     $ 3,734     $ 3,503     $ 2,426  

Net investment income

     449       365       298       262       245  

Net realized investment gains (losses)

     47       207       117       87       (7 )

Other income

     24       35       17       21       6  
                                        

Total revenues

     4,187       4,206       4,166       3,873       2,670  

Losses and loss expenses and life policy benefits

     2,111       3,087       2,476       2,366       1,716  

Total expenses

     3,355       4,244       3,673       3,381       2,450  
                                        

Income (loss) before distributions related to trust preferred and mandatorily redeemable preferred securities, taxes and interest in earnings of equity investments

     832       (38 )     493       492       220  

Distributions related to trust preferred and mandatorily redeemable preferred securities

     —         —         —         22       27  

Income tax expense

     95       23       7       2       3  

Interest in earnings of equity investments

     12       10       6       —         —    
                                        

Net income (loss)

   $ 749     $ (51 )   $ 492     $ 468     $ 190  
                                        

Basic net income (loss) per common share

   $ 12.58     $ (1.56 )   $ 8.80     $ 8.23     $ 3.37  

Diluted net income (loss) per common share

   $ 12.37     $ (1.56 )   $ 8.71     $ 8.13     $ 3.28  

Dividends declared and paid per common share

   $ 1.60     $ 1.52     $ 1.36     $ 1.20     $ 1.15  

Non-life Ratios

          

Loss ratio

     55.1 %     86.9 %     65.4 %     65.6 %     69.3 %

Acquisition ratio

     23.1       23.1       23.0       22.2       22.0  

Other operating expense ratio

     6.4       5.9       5.9       5.5       5.5  
                                        

Combined ratio

     84.6 %     115.9 %     94.3 %     93.3 %     96.8 %
     December 31,  

Balance Sheet Data

   2006     2005     2004     2003     2002  

Total investments and cash

   $ 10,679     $ 9,579     $ 8,398     $ 6,797     $ 5,185  

Total assets

     14,948       13,744       12,680       10,903       8,548  

Unpaid losses and loss expenses and policy benefits for life and annuity contracts

     8,301       7,962       7,044       5,917       4,474  

Long-term debt

     620       620       220       220       220  

Debt related to capital efficient notes

     258       —         —         —         —    

Debt related to trust preferred securities

     —         206       206       206       —    

Mandatorily redeemable preferred securities

     —         —         —         200       200  

Trust preferred securities

     —         —         —         —         200  

Shareholders’ equity

     3,786       3,093       3,352       2,594       2,077  

Diluted book value per common and common share equivalents

   $ 56.07     $ 44.57     $ 50.99     $ 42.48     $ 34.02  

Weighted average number of common and common share equivalents outstanding

     57.8       55.0       54.0       53.9       51.9  

Number of common shares outstanding

     57.1       56.7       54.9       53.7       52.4  

The Company adopted SFAS 150 and FIN46(R) in 2003. (See Note 2 to Consolidated Financial Statements.)

 

33


Table of Contents

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

Executive Overview

The Company is a leading global reinsurer with a broadly diversified portfolio of risks. The Company writes all lines of business in virtually all markets worldwide, and differentiates itself through its approach to risk, its strategy to manage risk, and its financial strength. Through its broad product and geographic diversification, its excellent execution capabilities, and its local presence in most major markets, the Company is able to respond quickly to market needs, and capitalize on business opportunities virtually anywhere in the world.

Reinsurance is by its nature a risk assumption business. The Company’s philosophy is to assume its clients’ risks, thereby removing the volatility associated with these risks, and then manage those risks and the risk-related volatility. The Company’s ability to succeed in the risk assumption business is dependent on its ability to accurately analyze and quantify risk, to understand volatility and how risks aggregate or correlate, and to establish the appropriate capital requirements and absolute limits for the risks assumed.

The reinsurance markets have historically been highly cyclical in nature. The cycle is driven by competition, the amount of capital and capacity in the industry, loss events, and investment returns. The Company’s long-term strategy to generate shareholder value focuses on broad product and geographic diversification of risks, assuming a moderately greater degree of risk than the market average, actively managing its capital across its portfolio and over the duration of the cycle, adding value through underwriting and transactional excellence, and achieving superior returns on invested assets in the context of a disciplined risk framework.

The Company generates its revenue primarily from premiums. Premium rates and terms and conditions vary by line of business depending on market conditions. Pricing cycles are driven by supply and demand, and the amount of capital in the industry. The reinsurance business is also influenced by several other factors including variations in interest rates and financial markets, changes in legal, regulatory and judicial environments, loss trends, inflation and general economic conditions. Throughout the late 1990s, the industry’s operating profitability and cash flows declined as a result of declining prices, a deterioration in terms and conditions and increasing loss costs. These negative trends were, however, offset by high investment returns that led to continued growth in capital. Premium rates began to increase in 2001, when the large loss events of that year, including the September 11 tragedy and the Enron bankruptcy, in addition to steep declines in interest rates and equity values, added to the pressure for improvements in pricing and underwriting conditions. In January 2002 through the middle of 2003, the Company experienced the strongest renewal seasons in over five years.

In the second half of 2003, the Company began to see a flattening in the rate of improvements in the terms and conditions of the most profitable lines and a slower rate of improvement in those lines that had not yet reached their peak in terms of profitability. From the middle of 2003 to the end of 2004, this resulted in a slower growth rate in pricing, although there was good pricing discipline in the industry.

During 2005, pricing was generally flat to down, except for those lines specifically affected by the 2004 hurricanes, and led to a reduction in premiums written by the Company in 2005. However, 2005 eventually developed into the worst year in the history of the industry in terms of catastrophe losses, with Hurricane Katrina, which devastated the Gulf Coast in late August, being the largest insured event ever. The catastrophic events of 2005, which included two other significant Atlantic hurricanes, Rita and Wilma, as well as a significant winterstorm and a flood in Europe, followed an unusually active Atlantic hurricane season in 2004. Consequently, the Company observed in 2006 strong pricing increases in the lines and geographies that were affected by the large 2005 catastrophic loss events, including catastrophe covers in the southeastern U.S. and in the U.S. property and energy lines. Pricing in other lines was generally stable.

During the January 1, 2007 renewals, the Company observed strong pricing in U.S. wind-exposed lines, while all other lines saw pricing declines. There was a significant increase in risk retention by cedants, as well as

 

34


Table of Contents

a trend to restructure proportional business to a non-proportional basis, which reduced the overall amount of premiums in the reinsurance marketplace. Nevertheless, the Company wrote a considerable amount of new business during the January 1, 2007 renewals and believes it has maintained profitability on business renewed. While facing the changes in market conditions, the Company has not changed its strategy or approach to business and continues to be opportunistic in writing business in its property, casualty and specialty lines. The Company also continues to maintain balance and diversification in its overall portfolio and to maintain its focus on growth in its Life and ART business segments.

Within the Company’s Life segment, the reinsurance market is differentiated between mortality and longevity products, with mortality being the largest market and longevity being smaller, but growing. For the mortality markets in which the Company writes business, the Company observed stable pricing for continental Europe and Latin America. In contrast, there are much more competitive conditions in the U.K. and Ireland, and while these two markets remain attractive, appropriate risk selection and pricing is important.

The prevailing competitive environment in which most of the ART products are written is currently characterized by high liquidity, high asset valuations, and low credit spreads. This environment has been in place for the last few years and has limited organic growth opportunities. The Company’s response has been to continue to apply underwriting discipline, opportunistically grow in existing classes, and selectively expand its scope to new niche asset classes. In addition to providing more opportunities for profitable growth, this expansion strategy has increased the diversification with the ART segment, and positioned the Company to participate in the next cyclical correction in the nontraditional credit markets.

A key challenge facing the Company is to successfully manage through the less profitable portion of the reinsurance cycle. The Company is confident in its long-term strategy, and believes that by closely monitoring the progression of each line of business, being selective in the business that it writes, and maintaining the diversification and balance of its portfolio, it will continue to optimize returns. Individual lines of business and markets have their own unique characteristics and are at different stages of the reinsurance pricing cycle at any given point in time. Management believes it has achieved appropriate portfolio diversification by product, geography, line and type of business, length of tail, and distribution channel, and that this diversification, in addition to the financial strength of the Company and its strong global franchise, will help to mitigate cyclical declines in underwriting profitability and to achieve a more balanced return over time.

The Company also generates revenue from its substantial and high quality investment portfolio. The Company follows prudent investment guidelines through a strategy that seeks to maximize returns while managing investment risk in line with the Company’s overall objectives of earnings stability and long-term book value growth. Liability funds are used to support the Company’s net reinsurance liabilities, defined as the Company’s operating and reinsurance liabilities, net of reinsurance assets, and are invested in a way that generally matches them to the corresponding liabilities in terms of both duration and currency composition to protect the Company against changes in interest and foreign exchange rates. The Company invests the liability funds in high-quality fixed income securities with the primary objective of preserving liquidity and protecting capital. Capital funds are invested to achieve total returns that enhance growth in shareholders’ equity and are invested in investment-grade and below investment-grade fixed income securities and equity instruments. A key challenge for the Company is achieving the right balance between current investment income and total returns (that include price appreciation or depreciation) in changing market conditions. The Company regularly reviews the allocation of investments to asset classes within its investment portfolio and reallocates investments to those asset classes the Company anticipates will outperform in the near future, subject to limits and guidelines. The Company may also lengthen or shorten the duration of its fixed income portfolio in anticipation of changes in interest rates, or increase or decrease the amount of credit risk it assumes, depending on credit spreads and anticipated economic conditions.

In addition to revenues generated from its underwriting operations and investment activities, the Company’s profitability is significantly affected by the level of its losses and loss expenses incurred. The Company recognizes losses and loss expenses on the basis of actual and expected claims on business written. The

 

35


Table of Contents

Company’s non-life net reserve position at December 31, 2006 was $6.7 billion. Management believes that it follows prudent reserving policies in pursuit of a strong financial position. A key challenge for the Company is the accurate estimation of loss reserves for each line of business, which is critical in order to accurately determine the profitability of each line and allocate the optimal amount of capital to each line. The risk for the Company is that it will allocate too much of its capital to one or more lines of business that are less profitable than anticipated, and not enough capital to those lines of business that eventually prove to be more profitable.

Key Financial Measures

In addition to the Consolidated Balance Sheets and Consolidated Statement of Operations and Comprehensive Income (including net income), Management uses three key measures to evaluate its financial performance, as well as the overall growth in value generated for the Company’s common shareholders.

Diluted Book Value per Share: Management uses diluted book value per share growth as a prime measure of the value the Company is generating for its common shareholders, as Management believes that growth in the Company’s diluted book value per share ultimately translates into growth in the Company’s stock price. Diluted book value per share is calculated using common shareholders’ equity (shareholders’ equity less the liquidation value of preferred shares) divided by the number of fully diluted shares outstanding. Diluted book value per share is impacted by the Company’s net income and external factors such as interest rates, which can drive changes in unrealized gains or losses on its investment portfolio. Since December 31, 2001, the Company has generated a compound annual growth rate in diluted book value per share in excess of 14%.

ROE: Management uses operating return on beginning shareholders’ equity (ROE) as a measure of profitability that focuses on the return to common shareholders. It is calculated using net operating earnings (loss) available to common shareholders (net income excluding after-tax net realized gains or losses on investments and preferred share dividends) divided by beginning common shareholders’ equity. Management has set a minimum 13% ROE target over the reinsurance cycle, which Management believes provides an attractive return to shareholders for the risk assumed. Each business unit and support department throughout the Company is focused on seeking to ensure that the Company meets the 13% return objective. This means that most economic decisions, including capital allocation and underwriting pricing decisions, incorporate an ROE impact analysis. For the purpose of that analysis, an appropriate amount of capital (equity) is allocated to each transaction for determining the transaction’s ROE. Subject to an adequate return for the risk level as well as other factors, such as the contribution of each risk to the overall risk level and risk diversification, capital is allocated to the transactions generating the highest ROE. Management’s challenge consists of (i) allocating an appropriate amount of capital to each transaction based on the incremental risk created by the transaction, (ii) properly estimating the Company’s overall risk level and the impact of each transaction to the overall risk level, and (iii) assessing the diversification benefit, if any, of each transaction. The risk for the Company lies in mis-estimating any one of these factors, which are critical in calculating a meaningful ROE, and entering into transactions that do not contribute to the Company’s 13% ROE objective.

Combined Ratio: The combined ratio is used industry-wide as a measure of underwriting profitability for Non-life business. The combined ratio is the sum of the technical ratio (losses and loss expenses and acquisition costs divided by net premiums earned) and the other operating expense ratio (other operating expenses divided by net premiums earned). A combined ratio under 100% indicates underwriting profitability, as the total losses and loss expenses, acquisition costs and other operating expenses are less than the premiums earned on that business. While an important metric of success, the combined ratio does not reflect all components of profitability, as it does not recognize the impact of interest income earned on premiums between the time premiums are received and the time losses payments are ultimately made to clients. Since 2001, the Company has had four years of underwriting profitability reflected in combined ratios of less than 100% for its Non-life segment. In 2005, when the industry recorded its worst year in history in terms of catastrophe losses, with Hurricane Katrina, which devastated the Gulf Coast, being the largest insured event ever, the Company recorded a net underwriting loss as a result of the significant catastrophic loss events that year and that was reflected in the

 

36


Table of Contents

Company’s Non-life combined ratio of 115.9%. The key challenge for maintaining a profitable combined ratio consists of (i) focusing on underwriting profitable business even in the weaker part of the reinsurance cycle, as opposed to growing the book of business at the cost of profitability, (ii) diversifying the portfolio to achieve a good balance of business, with the expectation that underwriting losses in certain lines or markets may potentially be offset by underwriting profits in other lines or markets, and (iii) maintaining control over expenses.

Other Key Issues of Management

Enterprise Culture

Management is focused on ensuring that the structure and culture of the organization promote intelligent, prudent, transparent and ethical decision-making. Management believes that a sound enterprise culture starts with the tone at the top. The Executive Management holds regular company-wide information sessions to present and review Management’s latest decisions, whether operational, financial or structural, as well as the financial results for the Company. Employees are encouraged to address questions related to the Company’s results, strategy or Management decisions, either anonymously or otherwise to Management so that they can be answered during these information sessions. Management believes that these sessions provide a consistent message to all employees about the Company’s value of transparency. Management also strives to promote a work environment that (i) aligns the skill set of individuals with challenges encountered by the Company, (ii) includes segregation of duties to ensure objectivity in decision making, and (iii) provides a compensation structure that encourages and rewards intelligent and ethical behavior. To that effect, the Company has a written Code of Business Conduct and Ethics and provides employees with a direct communication channel to the Audit Committee in the event they become aware of questionable behavior of Management or anyone else. Finally, Management believes that building a sound internal control environment, including a strong internal audit function, helps ensure that behaviors are consistent with the Company’s cultural values.

Capital Adequacy

A key challenge for Management is to maintain an appropriate level of capital. Management’s first priority is to hold sufficient capital to meet all of the Company’s obligations to cedants, meet regulatory requirements, and support its position as one of the stronger reinsurers in the industry. Holding an excessive amount of capital, however, will reduce the Company’s ROE. Consequently, Management closely monitors its capital needs and capital level throughout the cycle, and actively takes steps to increase or decrease the Company’s capital in order to achieve the proper balance of financial strength and shareholder returns. Capital management is achieved by either deploying capital to fund attractive business opportunities, or in times of excess capital, returning capital to shareholders by way of share repurchases and dividends.

Liquidity and Cash Flows

The Company aims to be a reliable and financially secure partner to its cedants. This means that the Company must maintain sufficient liquidity at all times so that it can support cedants by settling claims quickly. The Company generates cash flows primarily from its underwriting and investment operations. Management believes that a profitable, well-run reinsurance organization will generate sufficient cash from premium receipts to pay claims, acquisition costs and operating expenses in most years. To the extent that underwriting cash flows are not sufficient to cover operating outflows in any year, the Company may utilize cash flows generated from investments and may ultimately liquidate assets from its investment portfolio. Management ensures that its liquidity requirements are supported by maintaining a high-quality, well-balanced and liquid portfolio, and by matching the duration of its investment portfolio with that of its net reinsurance liabilities. In 2007, the Company expects to continue to generate positive operating cash flows. Management also maintains credit facilities with banks that can provide efficient access to cash in the event of an unforeseen cash requirement.

Risk Management

A key challenge in the reinsurance industry is to create economic value through the intelligent assumption of reinsurance and investment risk, but also to limit or mitigate those risks that can destroy tangible as well as

 

37


Table of Contents

intangible value. Management believes that every organization faces numerous risks that could threaten the successful achievement of a company’s goals and objectives. These include choice of strategy and markets, economic and business cycles, competition, changes in regulation, data quality and security, fraud, business interruption and management continuity; all factors which can be viewed as either strategic or operational risks that are common to any industry. (See Risk Factors in Item 1A of Part I of this report). In addition to these risks, the Company operates as an assumer of risk and its results are primarily determined by how well the Company understands, prices and manages risk. While many industries and companies start with a return goal and then attempt to shed risks that may derail that goal, the Company starts with a capital-based risk appetite and then looks for risks that meet its return targets within that framework. Management believes that this construct allows the Company to balance the cedants’ need for absolute certainty of claims payment with shareholders’ need for an adequate return on their capital.

The Company’s risk management framework encompasses all the risks faced by the Company: the strategic risks that it shares with the rest of the reinsurance industry, assumed risks (the reinsurance and capital market risks that it is paid to assume) and the operational risks that are a part of running any business. Management identifies and categorizes risks in terms of their source, their impact on the Company and the preferred strategies for dealing with them. It takes an integrated approach, because it is impossible to manage any of these risks in isolation. There are interrelationships and dependencies between the various categories of risk. Each must be viewed in the context of the whole if their potential impact on the organization is to be fully understood and effectively managed.

The Executive Management and the Board are responsible for managing strategic risks and setting key risk policies and limits. The Board approves maximum limits as a percentage the Company’s economic value, while the Executive Management operates at levels equal to or lower than the maximum limits approved by the Board, depending on current market conditions and the distribution of the Company’s portfolio of risks. The strategic risks include the direction and governance of the Company, as well as its response to key external factors faced by the reinsurance industry. Operational risks are managed by designated functions within the organization. They include failures or weaknesses in financial reporting and controls, non-compliance, poor cash management, fraud, breach of information technology security and reliance on third party vendors. The Company seeks to minimize these risks through robust processes and controls. Controls and monitoring processes throughout the organization seek to ensure that the Executive Management and the Board have a comprehensive view of the Company’s risks and related mitigation strategies at all times. Individual business units manage assumed risks, subject to the limits and policies established by the Executive Management and the Board. These are the reinsurance risks that the Company’s clients want to transfer and are the core of the Company’s business. They also include the capital market risks that the Company assumes in the investment of its assets.

At a strategic level, the Company manages these risks through diversification and absolute limits. At an operational level, risk mitigation strategies for assumed risks include strong processes, technical risk assessment and collaboration among different groups of professionals who each contribute a particular area of expertise.

The Company maintains a risk appetite moderately above the average of the reinsurance market because Management believes that this position offers the best potential for creating shareholder value at an acceptable risk level. The most profitable products generally present the most volatility and potential downside risk. The Company manages that risk through diversification and absolute limits on any one risk. The Company accepts that results on a quarterly basis may be volatile; however, it seeks to protect itself from downside risk that can materially impair its balance sheet. The limits imposed represent the boundaries of risk tolerance and are based on the amount of capital that may be lost.

The major risks to the Company’s balance sheet are typically due to events that Management refers to as shock losses. The Company defines a shock loss as an event that has the potential to materially damage economic value. The Company defines its economic value as the difference between the net present value of tangible assets and the net present value of liabilities, using appropriate risk discount rates. For traded assets, the calculated net present values are equivalent to market values.

 

38


Table of Contents

There are three areas of risk that the Company has currently identified as having the greatest potential for shock losses. These are catastrophe, reserving for casualty and other long-tail lines, and equity investment risk. The Company manages the risk of shock losses by setting limits on its tolerance for specific risks and on the amount of capital that it is willing to expose to such risks. The Company establishes limits to manage the absolute maximum foreseeable loss from any one event and considers the possibility that several shock losses could occur at one time, for example a major catastrophe event accompanied by a collapse in the equity markets. Management believes that the limits that it has placed on shock losses will allow the Company to continue writing business in such an event.

Other risks such as interest rate risk and credit risk have the ability to impact results substantially and may result in volatility in results from quarter to quarter, but Management believes that by themselves, they are unlikely to represent a material downside threat to the Company’s long-term economic value. See Quantitative and Qualitative Disclosures about Market Risk in Item 7A of Part II of this report for additional disclosure on interest rate risk, foreign currency risk, credit risk and equity price risk.

Catastrophe Risk

The Company defines this risk as the risk that the aggregate losses from natural perils materially exceed the net premiums that are received to cover such risks. The Company considers both the loss of capital due to a single large event and the loss of capital that would occur from multiple (but potentially smaller) events in any year.

The Company imposes an absolute limit to catastrophe risk from any single loss through exposure limit caps in each zone and to each peril, with the largest zonal limit set at a maximum of $1.3 billion, compared to an actual of $1.3 billion, as of December 31, 2006. This risk is managed through the real time allocation of catastrophe exposure capacity on each exposure zone to different business units, regular modeling of aggregate loss scenarios through proprietary models, and a combination of quantitative and qualitative analysis. A zone is a geographic area in which the insurance risks are considered to be correlated to a single catastrophic event. Not all zones have the same limit and zones are broadly defined so that it would be highly unlikely for any single event to substantially erode the aggregate exposure limits from more than one zone. Even extremely high severity/low likelihood events will only partially exhaust the limits in any zone, as they are likely to only affect a part of the area covered by a wide zone.

The Company also manages its exposures so that the chance that an economic loss to the Company from all catastrophe losses in any one year exceeds $950 million has a modeled probability of occurring less than once in 75 years. To measure this probability, the Company uses proprietary models that take into account not only the exposures in any zone, but also the likely frequency and severity of catastrophic events. This quantitative analysis is supplemented with the professional judgment of experienced underwriters. At December 31, 2006, the modeled economic loss to the Company from a one in 75 year catastrophic loss was $650 million.

Casualty Reserving Risk

The Company defines this risk as the risk that the estimates of ultimate losses that underlie its booked reserves for casualty and other long-tail lines will prove to be too low, leading to substantial reserve strengthening. The tolerance set by the Company for this risk is measured using total earned premium for casualty and other long-tail lines. Total earned premiums for casualty and other long-tail lines for the four most recent underwriting periods was set at a maximum of $3.7 billion, compared to an actual of $3.0 billion, as of December 31, 2006.

One of the greatest risks in long-tail lines of business, and particularly in U.S. casualty, is that the loss trends are higher than the assumptions underlying the Company’s ultimate loss estimates, resulting in ultimate losses that exceed recorded loss reserves. When loss trends prove to be higher than those underlying the reserving assumptions, the risk is great because of a stacking up effect: for long-tail lines, the Company carries reserves to cover claims arising from several years of underwriting activity and these reserves are likely to be adversely affected by unfavorable loss trends. The effect is likely to be more pronounced for recent underwriting years because, with the passage of time, actual loss emergence and data provide greater confidence around the adequacy of ultimate liability estimates for older underwriting years. Management believes that the volume of long-tail business most exposed to these reserving uncertainties should be limited.

 

39


Table of Contents

The Company manages and mitigates the reserve risk for long-tail lines in a variety of ways. Underwriters and pricing actuaries follow a disciplined underwriting process that utilizes all available data and information, including industry trends. The Company establishes prudent reserving policies for determining carried reserves. These policies are systematic and Management endeavors to apply them consistently over time. See Critical Accounting Policies and Estimates—Losses and Loss Expenses and Life Policy Benefits below.

Equity Investment Risk

The Company defines this risk as the risk of a substantial decline in the value of its equity and equity-like securities (defined as all securities other than investment-grade securities) during the year. The tolerance set by the Company for this risk is measured using the value of equity and equity-like securities as a percentage of available economic capital and was set at a maximum of $2.55 billion, compared to an actual of $1.6 billion, as of December 31, 2006. Assuming equity risk (and equity-like risks such as high yield bonds and convertible securities) within that part of the investment portfolio that is not required to support liability funds provides valuable diversification from other risk classes, along with the potential for higher returns. However, an overweight position could lead to a large loss of capital and impair the balance sheet in the case of a market crash. The Company sets strict limits on investments in any one name and any one industry, which creates a diversified portfolio and allows Management to focus on the systemic effects of equity risks. Systemic risk is managed by asset allocation, subject to strict caps on other than investment-grade bonds as a percentage of capital. The Company’s fully integrated information system provides real-time data on the investment portfolios, allowing for continuous monitoring and decision-support. Each portfolio is managed against a pre-determined benchmark to enable alignment with appropriate risk parameters and achievement of desired returns. See Quantitative and Qualitative Disclosures about Market Risk—Equity Price Risk in Item 7A of Part II of this report.

Critical Accounting Policies and Estimates

The Company’s Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). The preparation of financial statements in conformity with U.S. GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The following presents a discussion of those accounting policies and estimates that Management believes are the most critical to its operations and require the most difficult, subjective and complex judgment. If actual events differ significantly from the underlying assumptions and estimates used by Management, there could be material adjustments to prior estimates that could potentially adversely affect the Company’s results of operations, financial condition and liquidity. These critical accounting policies and estimates should be read in conjunction with the Company’s Notes to Consolidated Financial Statements, including Note 2, Significant Accounting Policies, for a full understanding of the Company’s accounting policies. The sensitivity estimates that follow are based on outcomes that the Company considers reasonably likely to occur.

Losses and Loss Expenses and Life Policy Benefits

Losses and Loss Expenses

Because a significant amount of time can elapse between the assumption of risk, occurrence of a loss event, the reporting of the event to an insurance company (the primary company or the cedant), the subsequent reporting to the reinsurance company (the reinsurer) and the ultimate payment of the claim on the loss event by the reinsurer, the Company’s liability for unpaid losses and loss expenses (loss reserves) is based largely upon estimates. The Company categorizes loss reserves into three types of reserves: reported outstanding loss reserves (case reserves), additional case reserves (ACRs) and incurred but not reported (IBNR) reserves. Case reserves represent unpaid losses reported by the Company’s cedants and recorded by the Company. ACRs are established for particular circumstances where, on the basis of individual loss reports, the Company estimates that the particular loss or collection of losses covered by a treaty may be greater than those advised by the cedant. IBNR reserves represent a provision for claims that have been incurred but not yet reported to the Company, as well as future loss development on losses already reported, in excess of the case reserves and ACRs. Unlike case reserves and ACRs, IBNR reserves are often calculated at an aggregated level and cannot usually be directly

 

40


Table of Contents

identified as reserves for a particular loss or treaty. The Company updates its estimates for each of the aforementioned categories on a quarterly basis using information received from its cedants. The Company also estimates the future unallocated loss adjustment expenses (ULAE) associated with the loss reserves and these form part of the Company’s loss adjustment expense reserves. The Company’s Non-life loss reserves for each category, line and sub-segment are reported in the tables included later in this section.

The amount of time that elapses before a claim is reported to the cedant and then subsequently reported to the reinsurer is commonly referred to in the industry as the reporting tail. Lines of business for which claims are reported quickly are commonly referred to as short-tail lines; and lines of business for which a longer period of time elapses before claims are reported to the reinsurer are commonly referred to as long-tail lines. In general, for reinsurance, the time lags are longer than for primary business due to the delay that occurs between the cedant becoming aware of a loss and reporting the information to its reinsurer(s). The delay varies by reinsurance market (country of cedant), type of treaty, whether losses are paid by the cedant and the size of the loss. The delay could vary from a few weeks to a year or sometimes longer. For both short and long-tail lines, the Company’s objective is to estimate ultimate losses and loss expenses. Total loss reserves are then calculated by subtracting losses paid. Similarly, IBNR reserves are calculated by subtraction of case reserves and ACRs from total loss reserves.

The Company analyzes its ultimate losses and loss expenses after consideration of the loss experience of various reserving cells. The Company assigns treaties to reserving cells and allocates losses from the treaty to the reserving cell. The reserving cells are selected in order to ensure that the underlying treaties have homogeneous loss development characteristics (e.g., reporting tail) but are large enough to make estimation of trends credible. The selection of reserving cells is reviewed annually and changes over time as the business of the Company evolves. For each reserving cell, the Company tabulates losses in reserving triangles that show the total reported or paid claims at each financial year end by underwriting year cohort. An underwriting year is the year during which the reinsurance treaty was entered into as opposed to the year in which the loss occurred (accident year), or the calendar year for which financial results are reported. For each reserving cell, the Company’s estimates of loss reserves are reached after a review of the results of several commonly accepted actuarial projection methodologies. In selecting its best estimate, the Company considers the appropriateness of each methodology to the individual circumstances of the cell and underwriting year for which the projection is made. The methodologies that the Company employs include, but may not be limited to, paid and reported Chain Ladder methods, Expected Loss Ratio methods, paid and reported Bornhuetter-Ferguson (B-F) methods, and paid and reported Benktander methods. In addition, the Company uses other methodologies to estimate liabilities for specific types of claims. For example, internal and vendor catastrophe models are typically used in the estimation of loss and loss expenses at the early stages of catastrophe losses before loss information is reported to the reinsurer. In the case of asbestos and environmental claims, the Company has established reserves for future loss and allocated loss expenses based on the results of periodic actuarial studies, which consider the underlying exposures of the Company’s cedants.

The reserve methodologies employed by the Company are dependent on data that the Company collects. This data consists primarily of loss amounts and loss payments reported by the Company’s cedants, and premiums written and earned reported by cedants or estimated by the Company. The actuarial methods used by the Company to project loss reserves that it will pay in the future (future liabilities) do not generally include methodologies that are dependent on claim counts reported, claim counts settled or claim counts open as, due to the nature of the Company’s business, this information is not routinely provided by cedants for every treaty. Consequently, actuarial methods relying on this information cannot be used by the Company to estimate loss reserves

A brief description of the reserving methods commonly employed by the Company and a discussion of their particular advantages and disadvantages is as follows:

Chain Ladder (CL) Development Methods (Reported or Paid)

These methods use the underlying assumption that losses reported (paid) for each underwriting year at a particular development stage follow a stable pattern. For example, the Chain Ladder development method

 

41


Table of Contents

assumes that on average, every underwriting year will display the same percentage of ultimate liabilities reported by the Company’s cedants (say x%) at 24 months after the inception of the underwriting year. The percentages reported (paid) are established for each development stage (e.g., at 12 months, 24 months, etc.) after examining historical averages from the loss development data. These are sometimes supplemented by external benchmark information. Ultimate liabilities are estimated by multiplying the actual reported (paid) losses by the reciprocal of the assumed reported (paid) percentage (e.g., 1/x%). Reserves are then calculated by subtracting paid claims from the estimated ultimate liabilities.

The main strengths of the method are that it is reactive to loss emergence (payments) and that it makes full use of historical experience on claim emergence (payments). For homogeneous low volatility lines, under stable economic conditions the method can often produce good estimates of ultimate liabilities and reserves. However, the method has weaknesses when the underlying assumption of stable patterns is not true. This may be the consequence of changes in the mix of business, changes in claim inflation trends, changes in claim reporting practices or the presence of large claims, among other things. Furthermore, the method tends to produce volatile estimates of ultimate liabilities in situations where there is volatility in loss reported (paid) patterns. In particular, when the expected percentage reported (paid) is low, small deviations between actual and expected claims can lead to very volatile estimates of ultimate liabilities and reserves. Consequently, this method is often unsuitable for projections at early development stages of an underwriting year. Finally, the method fails to incorporate any information regarding market conditions, pricing, etc., which could improve the estimate of liabilities and reserves. It therefore tends not to perform very well in situations where there are rapidly changing market conditions.

Expected Loss Ratio (ELR) Method

This method estimates ultimate losses for an underwriting year by applying an estimated loss ratio to the earned premium for that underwriting year. Although the method is insensitive to actual reported or paid losses, it can often be useful at the early stages of development when very few losses have been reported or paid, and the principal sources of information available to the Company consist of information obtained during pricing and qualitative information supplied by the cedant. However, the lack of sensitivity to reported or paid losses means that the method is usually inappropriate at later stages of development.

Bornhuetter-Ferguson (B-F) Methods (Reported or Paid)

These methods aim to address the concerns of the Chain Ladder development methods, which are the variability at early stages of development and the failure to incorporate external information such as pricing. However, the B-F methods are more sensitive to paid and reported losses than the Expected Loss Ratio method above, and can be seen as a blend of the Expected Loss Ratio and Chain Ladder development methods. Unreported (unpaid) claims are calculated using an expected reporting (payment) pattern and an externally determined estimate of ultimate liabilities (usually determined by multiplying an a priori loss ratio with estimates of premium volume). The accuracy of the a priori loss ratio is a critical assumption in this method. Usually a priori loss ratios are initially determined on the basis of pricing information, but may also be adjusted to reflect other information that subsequently emerges about underlying loss experience. Although the method tends to provide less volatile indications at early stages of development and reflects changes in the external environment, this method can be slow to react to emerging loss development (payment). In particular, to the extent that the a priori loss ratios prove to be inaccurate (and are not revised), the B-F methods will produce loss estimates that take longer to converge with the final settlement value of loss liabilities.

Benktander Methods (Reported or Paid)

These methods can be viewed as a blend between the Chain Ladder development and the B-F methods described above. The blend is based on predetermined weights at each development stage that depend on the reported (paid) development patterns. Although mitigated to some extent, this method still exhibits the same advantages and disadvantages as the B-F method, but the mechanics of the calculation imply that it is more reactive to loss emergence (payment) than the B-F method.

 

42


Table of Contents

Often the selected best estimate is a blend of the results from two or more methods (e.g., weighted averages). The judgment as to which method(s) is most appropriate for a particular underwriting year and reserving cell could change over time as new information emerges regarding underlying loss activity and other data issues. Furthermore, as each line is typically composed of several reserving cells, it is likely that the reserves for the line will be dependent on several reserving methods. This is because reserves for a line are the result of aggregating the reserves for each constituent reserving cell and that a different method could be selected for each reserving cell. Although it is not appropriate to refer to reserves for a line as being determined by a particular method, the table below summarizes the methods that were given principal weight in selecting the best estimates of reserves in each reserving line in 2006, 2005 and 2004, and can therefore be viewed as key drivers of selected reserves. The table distinguishes methods for mature and immature underwriting years as they are often different. The definition of maturity is specific to line and is related to the reporting tail. If at the reserve evaluation date, a significant proportion of losses for the underwriting year are expected to have been reported, then the underwriting year is deemed to be mature, otherwise it is deemed to be immature. For short-tail lines, such as property or agriculture, immature years can refer to the one or two most recent underwriting years, while for longer tail lines, such as casualty, immature years can refer to the three or four most recent underwriting years.

To the extent that the principal reserving methods used for major components of a reserving line are different, these are separately identified in the table below.

 

Reserving line for

Non-life Segment

 

Non-life

Sub-segment

 

Immature

Underwriting

Years

 

Mature

Underwriting

Years

Property

  U.S. P&C   Expected Loss Ratio   Reported B-F

Property / Specialty Property

  Global (Non-U.S.) P&C / Worldwide Specialty / ART   Expected Loss Ratio   Reported CL

Casualty

  U.S. P&C   Expected Loss Ratio   Reported B-F

Casualty / Specialty Casualty

  Global (Non-U.S.) P&C / Worldwide Specialty   Expected Loss Ratio   Reported B-F / Paid B-F

Multiline

  U.S. P&C   Expected Loss Ratio / Reported B-F   Reported B-F

Motor

  U.S. P&C   Expected Loss Ratio / Reported B-F   Reported B-F

Motor—Proportional

  Global (Non-U.S.) P&C   Expected Loss Ratio   Reported B-F

Motor—Non-proportional

  Global (Non-U.S.) P&C   Expected Loss Ratio / Reported B-F   Reported B-F / Paid B-F

Agriculture

  Worldwide Specialty   Expected Loss Ratio   Reported CL

Aviation/Space

  Worldwide Specialty   Paid B-F / Reported B-F   Reported B-F

Catastrophe

  Worldwide Specialty   Expected Loss Ratio based on exposure analysis   Reported B-F

Credit/Surety

  Worldwide Specialty   Reported B-F /Reported CL   Reported B-F / Reported CL

Engineering

  Worldwide Specialty   Reported B-F   Reported B-F

Energy Onshore

  Worldwide Specialty   Expected Loss Ratio   Reported CL

Marine/Energy Offshore

  Worldwide Specialty   Reported B-F   Reported B-F

Other (1)

  U.S. P&C / Global (Non-U.S.) P&C / Worldwide Specialty   Periodic actuarial studies   Periodic actuarial studies

(1) The other reserving line is primarily related to asbestos and environments claims and non-active lines of business. See below and Note 4 to the Consolidated Financial Statements for a discussion on asbestos and environment claims.

The reserving methods used by the Company are dependent on a number of key parameter assumptions. The principal parameter assumptions underlying the methods used by the Company are:

(i) the loss development factors used to form an expectation of the evolution of reported and paid claims for several years following the inception of the underwriting year. These are often derived by

 

43


Table of Contents

examining the Company’s data after due consideration of the underlying factors listed below. In some cases, where the Company lacks sufficient volume to have statistical credibility, external benchmarks are used to supplement the Company’s data;

(ii) the tail factors used to reflect development of paid and reported losses after several years have elapsed since the inception of the underwriting year;

(iii) the a priori loss ratios used as inputs in the B-F methods; and

(iv) the selected loss ratios used as inputs in the Expected Loss Ratio method.

The validity of all parameter assumptions used in the reserving process is reaffirmed on a quarterly basis. Reaffirmation of the parameter assumptions means that the actuaries determine that the parameter assumptions continue to form a sound basis for projection of future liabilities. Parameter assumptions used in projecting future liabilities are themselves estimates based on historical information. As new information becomes available (e.g., additional losses reported), the Company’s actuaries determine whether a revised estimate of the parameter assumptions that reflects all available information is consistent with the previous parameter assumptions employed. In general, to the extent that the revised estimate of parameter assumptions are within a close range of the original assumptions, the Company determines that the parameter assumptions employed continue to form an appropriate basis for projections and continue to use the original assumptions in its models. In this case, any differences could be attributed to the imprecise nature of the parameter estimation process. However, to the extent that the deviations between the two sets of estimates are not within a close range of the original assumptions, the Company reacts by adopting the revised assumptions as a basis for its reserve models. Notwithstanding the above, even where the Company has experienced no material deviations from its original assumptions during any quarter, the Company will generally revise the reserving parameter assumptions at least once a year to reflect all accumulated available information.

In addition to examining the data, the selection of the parameter assumptions is dependent on several underlying factors. The Company’s actuaries review these underlying factors and determine the extent to which these are likely to be stable over the timeframe during which losses are projected, and the extent to which these factors are consistent with the Company’s data. If these factors are determined to be stable and consistent with the data, the estimation of the reserving parameter assumptions are mainly carried out using actuarial and statistical techniques applied to the Company’s data. To the extent that the actuaries determine that they cannot continue to rely on the stability of these factors, the statistical estimates of parameter assumptions are modified to reflect the direction of the change. The main underlying factors upon which the estimates of reserving parameters are predicated are:

(i) the cedant’s business practices will proceed as in the past with no material changes either in submission of accounts or cash flows;

(ii) any internal delays in processing accounts received by the cedant are not materially different from that experienced historically, and hence the implicit reserving allowance made in loss reserves through the methods continues to be appropriate;

(iii) case reserve reporting practices, particularly the methodologies used to establish and report case reserves, are unchanged from historical practices;

(iv) the Company’s internal claim practices, particularly the level and extent of use of ACRs are unchanged;

(v) historical levels of claim inflation can be projected into the future and will have no material effect on either the acceleration or deceleration of claim reporting and payment patterns;

(vi) the selection of reserving cells results in homogeneous and credible future expectations for all business in the cell and any changes in underlying treaty terms are either reflected in cell selection or explicitly allowed in the selection of trends;

 

44


Table of Contents

(vii) in cases where benchmarks are used, they are derived from the experience of similar business; and

(viii) the Company can form a credible initial expectation of the ultimate loss ratio of recent underwriting years through a review of pricing information, supplemented by qualitative information on market events.

The Company’s best estimate of total loss reserves is typically in excess of the midpoint of the actuarial reserve estimates. The Company believes that there is potentially significant risk in estimating loss reserves for long-tail lines of business and for immature underwriting years that may not be adequately captured through traditional actuarial projection methodologies. As discussed above, these methodologies usually rely heavily on projections of prior year trends into the future. In selecting its best estimate of future liabilities, the Company considers both the results of actuarial point estimates of loss reserves as well as the potential variability of these estimates as captured by a reasonable range of actuarial reserve estimates. Selected reserves are always within the indicated reasonable range of estimates indicated by the Company’s actuaries. In determining the appropriate best estimate, the Company reviews (i) the position of overall reserves within the actuarial reserve range, (ii) the result of bottom up analysis by underwriting year reflecting the impact of parameter uncertainty in actuarial calculations, and (iii) specific qualitative information on events that may have an effect on future claims but which may not have been adequately reflected in actuarial mid-estimates, such as potential for outstanding litigation, claims practices of cedants, etc.

Carried loss reserves for the U.S. P&C sub-segment are considered to be predominantly long-tail due to the significant volume of U.S. casualty business written in this sub-segment. The casualty line comprised 68% of the net premiums written for this sub-segment, or 16% of the Company’s total net premiums written in 2006. The remaining business within this sub-segment, property and motor, is considered to be short-tail. Within the Global (Non-U.S.) P&C sub-segment, the Company considers both its casualty business as well as its non-proportional motor business to be long-tail. These two lines represented 22% of the net premiums written in the Global (Non-U.S.) P&C sub-segment, or 5% of the Company’s total net premiums written in 2006. Management considers the short-tail lines within the Global (Non-U.S.) P&C sub-segment to be property and proportional motor. The Worldwide Specialty sub-segment is primarily comprised of lines of business that are thought to be either short or medium-tail. The short-tail lines consist of agriculture, catastrophe, energy, credit/surety and specialty property and account for 61% of the net premiums written in this sub-segment, or 26% of the Company’s total net premiums written in 2006. Aviation/space, engineering and marine are considered by the Company to have a medium-tail and represent 31% of this sub-segment’s 2006 net premiums written, or 13% of the Company’s total net premiums written in 2006. Specialty casualty business is considered to be long-tail and represents 8% of net premiums written in this sub-segment, or 3% of the Company’s total net premiums written in 2006.

The following table summarizes the net prior year favorable (adverse) reserve development for the Company’s non-life operations, which is composed of its Non-life and ART segments, for the years ended December 31, 2006, 2005 and 2004 (in millions of U.S. dollars):

 

     2006     2005     2004  

Prior year net favorable (adverse) reserve development:

      

Non-life segment:

      

U.S. P&C

   $ (6 )   $ (48 )   $ (30 )

Global (Non-U.S) P&C

     66       67       (24 )

Worldwide Specialty

     193       212       193  
                        

Total Non-life segment

     253       231       139  

ART segment

     (1 )     —         —    
                        

Total net non-life prior year reserve development

   $ 252     $ 231     $ 139  

For a discussion of net prior year favorable (adverse) reserve development by segment and sub-segment, see Results by Segment below and Note 4 to Consolidated Financial Statements in Item 8 of Part II of this report.

 

45


Table of Contents

The table below summarizes the net prior year favorable (adverse) reserve development for the year ended December 31, 2006 by reserving line for the Company’s non-life operations (in millions of U.S. dollars):

 

Reserving lines

  

Net favorable
(adverse)

prior year

reserve
development

 

Property / Specialty Property

   $ 78  

Casualty / Specialty Casualty

     46  

Multiline

     5  

Motor—U.S. business

     (7 )

Motor—Non-U.S. Proportional business

     15  

Motor—Non-U.S. Non-proportional business

     (23 )

Agriculture

     22  

Aviation/Space

     42  

Catastrophe

     (25 )

Credit/Surety

     31  

Engineering

     21  

Energy Onshore

     22  

Marine/Energy Offshore

     30  

Other

     (5 )
        

Total net non-life prior year reserve development

   $ 252  

The following paragraphs discuss how losses paid and reported during the year ended December 31, 2006 compared with the Company’s expectations and how the Company modified its reserving parameter assumptions in line with the emerging development in each reserving line.

Property: Aggregate losses reported for the U.S. property line were higher than expected, mainly for the 2005 hurricanes. The Company did not materially alter its reserving assumptions in this line, except for selecting higher loss ratios. Losses reported for the Non-U.S. property line were slightly lower than expected. The Company reflected this experience by lowering its loss ratio picks for the 2005 underwriting year and selecting slightly faster loss development patterns.

Casualty: Aggregate losses reported and losses paid for the Non-U.S. casualty line were significantly below the Company’s expectations for most underwriting years. Aggregate losses reported for the U.S. casualty line were significantly lower than expected mainly for the 2004, 2005, and 2006 underwriting years. However, given the long-tail nature of this line (U.S. and Non-U.S.), the Company did not materially change its loss development assumptions.

Multiline: Aggregate reported losses were modestly lower than expected. Except for the 2005 underwriting year, most years had reported losses lower than expected. The Company reflected this experience by selecting slightly lower tail factors and faster loss development patterns.

Motor:

 

   

Aggregate losses reported for the U.S. motor line were slightly higher than expected, mainly for the 2004, 2005 and 2006 underwriting years. The Company reflected this development by selecting reserving methods which give a greater weight to the observed development for the 2005 underwriting year.

 

   

Aggregate losses reported for the Non-U.S. motor proportional line were slightly lower than expected, principally because of lower than expected development in the 2005 and 2004 underwriting years. The Company selected lower loss development factors for these underwriting years.

 

46


Table of Contents
   

Although aggregate losses reported for the Non-U.S. motor non-proportional line were in aggregate lower than expectations, a more in-depth analysis of the underlying movements revealed that losses reported from French cedants were significantly in excess of expectations, which was a continuation of trends that the Company observed in prior years. The Company reacted by raising significantly its loss tail factors and a priori loss ratios assumptions for non-proportional French business, while it did not materially change its loss development assumptions for other territories.

Agriculture: The aggregate losses reported during the year were significantly below the Company’s expectations, primarily for the 2006 and 2005 underwriting years. The Company lowered its loss ratio picks for the 2005 underwriting year but did not otherwise materially alter its reserving assumptions.

Aviation/Space: The overall losses reported during the year were significantly lower than the Company’s expectations, primarily for the 2005 underwriting year, but the effect was uniform across all underwriting years. Paid losses were also modestly lower than expected across all underwriting years. The Company reflected this experience by lowering its a priori loss ratios for the 2005 underwriting year and selecting slightly faster loss development patterns.

Catastrophe: Losses reported in this line are largely a function of the presence or absence of catastrophic events during the year. During 2006, significantly fewer catastrophes occurred than the Company expected. Losses reported in respect of prior year catastrophe events were overall in line with expectations. However, the Company established an additional IBNR reserve of $20 million in respect of 2005 U.S. catastrophe losses as a result of a general concern given recent litigation developments and evolving out of court settlement trends that may affect some of the Company’s cedants in the future and hence the claims reported to the Company.

Credit/Surety: The aggregate losses reported during the year were slightly lower than expected, primarily for the 2005 underwriting year, but also for several more mature underwriting years. Losses reported for the 2006 underwriting year were significantly higher than expected, although loss reporting patterns at this early stage can be very volatile. The Company reflected this experience by lowering its loss development factors and loss ratio selections particularly for the Non-U.S. 2004 and 2005 years.

Engineering: The aggregate reported losses were modestly lower than expectations, while losses paid were significantly lower than expected. The Company has not materially changed its reserving assumptions, but in selecting its ultimate liabilities it has, in part, given greater weight to estimates from methods that are consistent with the observed development.

Energy Onshore: Aggregate reported losses were significantly lower than expected, although to a large extent this is due to the relative absence of large losses during the 2006 financial year. Loss reporting for this line is very sensitive to the presence or absence of large losses. The Company did not materially change its reserving assumptions for this line.

Marine/Energy Offshore: The aggregate reported losses during the year were significantly lower than expected. The main reason was significantly lower than expected development for relatively mature underwriting years, whereas development for the 2005 and 2006 years has been closer to expectations. The Company reflected this development by reducing its loss development factor assumptions and loss ratio selections.

As an example of the sensitivity of the Company’s reserves to reserving parameter assumptions, the tables below summarize, by reserving line, the effect on the Company’s reserves of higher/lower a priori loss ratio selections, higher/lower loss development factors and higher/lower tail factors. The Company believes that the illustrated sensitivity to the reserving parameter assumptions is reasonably likely to occur and is indicative of the potential variability inherent in the estimation process of those parameters.

 

47


Table of Contents

Reserving line selected assumptions

  

Higher

a priori

loss ratio

  

Higher

loss
development
factors

  

Higher

tail

Factors (*)

   

Lower

a priori

loss ratio

   

Lower

loss
development

factors

   

Lower

tail

Factors (*)

 

Property / Specialty Property

     5 points      3 months      2 %     (5) points       3 months       (2 )%

Casualty / Specialty Casualty

     10      6      10       (10)       6       (10 )

Multiline

     5      6      5       (5)       6       (5 )

Motor—U.S. business

     5      3      2       (5)       3       (2 )

Motor—Non-U.S. Proportional business

     5      3      2       (5)       3       (2 )

Motor—Non-U.S. Non-proportional business

     10      12      10       (10)       12       (10 )

Agriculture

     5      3      2       (5)       3       (2 )

Aviation/Space

     5      3      5       (5)       3       (5 )

Catastrophe

     5      3      2       (5)       3       (2 )

Credit/Surety

     5      3      2       (5)       3       (2 )

Engineering

     10      6      5       (10)       6       (5 )

Energy Onshore

     5      3      2       (5)       3       (2 )

Marine/Energy Offshore

     5      3      5       (5)       3       (5 )

Reserving lines selected sensitivity

(in million of U.S. dollars)

  

Higher

a priori

loss ratio

  

Higher

loss
development
factors

  

Higher

tail

Factors (*)

   

Lower

a priori

loss ratio

   

Lower

loss
development

factors

   

Lower

tail

Factors (*)

 

Property / Specialty Property

   $ 10    $ 20    $ —       $ (10 )   $ (15 )   $ —    

Casualty / Specialty Casualty

     200      135      110       (200 )     (125 )     (130 )

Multiline

     10      20      15       (10 )     (15 )     (15 )

Motor—U.S. business

     5      10      —         (5 )     (10 )     (5 )

Motor—Non-U.S. Proportional business

     —        15      —         —         —         —    

Motor—Non-U.S. Non-proportional business

     20      50      45       (20 )     (45 )     (45 )

Agriculture

     —        5      —         —         —         —    

Aviation/Space

     15      35      15       (15 )     (25 )     (10 )

Catastrophe

     —        —        —         —         —         —    

Credit/Surety

     15      25      —         (15 )     (10 )     —    

Engineering

     15      40      15       (15 )     (30 )     (15 )

Energy Onshore

     —        —        —         —         —         —    

Marine/Energy Offshore

     5      15      5       (5 )     (10 )     —    

(*) Tail factors are defined as aggregate development factors after 10 years from the inception of an underwriting year.

Some reserving lines show little sensitivity to a priori loss ratio, loss development factor or tail factor as the Company may use reserving methods such as the Expected Loss Ratio method in several of its reserving cells within those lines. It is not appropriate to add together the total impact for a specific factor or the total impact for a specific reserving line as the lines of business are not perfectly correlated.

 

48


Table of Contents

Case reserves are reported to the Company by its cedants, while ACRs and IBNR are estimated by the Company. The following table shows the gross reserves reported by cedants (case reserves), those estimated by the Company (ACRs and IBNR) and the total net loss reserves recorded as of December 31, 2006 by reserving line for the Company’s non-life operations (in millions of U.S. dollars):

 

Reserving lines

   Case reserves    ACRs   

IBNR

reserves

  

Total gross

loss reserves

recorded

  

Ceded loss

reserves

   

Total net

loss reserves

recorded

Property / Specialty Property

   $ 476    $ 3    $ 295    $ 774    $ —       $ 774

Casualty / Specialty Casualty

     793      111      1,821      2,725      (45 )     2,680

Multiline

     77      11      122      210      (2 )     208

Motor—U.S. business

     63      2      70      135      —         135

Motor—Non-U.S. Proportional business

     165      —        31      196      (17 )     179

Motor—Non-U.S. Non-proportional business

     386      9      483      878      (3 )     875

Agriculture

     12      4      111      127      —         127

Aviation/Space

     210      7      195      412      (32 )     380

Catastrophe

     256      127      41      424      —         424

Credit/Surety

     185      1      90      276      —         276

Engineering

     131      5      193      329      (9 )     320

Energy Onshore

     48      9      18      75      (1 )     74

Marine/Energy Offshore

     90      4      79      173      (20 )     153

Other

     55      1      81      137      (10 )     127
                                          

Total non-life reserves

   $ 2,947    $ 294    $ 3,630    $ 6,871    $ (139 )   $ 6,732

The net loss reserves represent the Company’s best estimate of future losses and loss expense amounts. Loss reserves are estimates involving actuarial and statistical projections at a given time to reflect the Company’s expectations of the costs of the ultimate settlement and administration of claims. Estimates of ultimate liabilities are contingent on many future events and the eventual outcome of these events may be different from the assumptions underlying the reserve estimates. In the event that the business environment and social trends diverge from historical trends, the Company may have to adjust its loss reserves to amounts falling significantly outside its current estimate range. Management believes that the recorded loss reserves represent its best estimate of future liabilities based on information available as of December 31, 2006. The estimates are continually reviewed and the ultimate liability may be in excess of, or less than, the amounts provided, for which any adjustments will be reflected in the period in which the need for an adjustment is determined. The Company estimates its net loss reserves using single actuarial point estimates. Ranges around these actuarial point estimates are developed using stochastic simulations and techniques and provide an indication as to the degree of variability of the loss reserves. The Company interprets the ranges produced by these techniques as confidence intervals around the Company’s best estimates for each Non-life sub-segment. However, due to the inherent volatility in the business written by the Company, there can be no guarantee that the final settlement of the loss reserves will fall within these ranges. The actuarial point estimates recorded by the Company and the range of estimates around these point estimates at December 31, 2006, were as follows for each Non-life sub-segment (in millions of U.S. dollars):

 

    

Recorded Point

Estimate

   High    Low

Net Non-life segment loss reserves:

        

U.S. P&C

   $ 2,172    $ 2,435    $ 1,732

Global (Non-U.S.) P&C

     2,259      2,395      1,964

Worldwide Specialty

     2,295      2,321      2,048

It is not appropriate to add together the ranges of each sub-segment in an effort to determine a high and low range around the Company’s total Non-life carried loss reserves.

 

49


Table of Contents

Included in the business that is considered to have a long reporting tail is the Company’s exposure to asbestos and environmental claims. The Company’s net reserves for unpaid losses and loss expenses as of December 31, 2006 included $95 million that represents an estimate of its net ultimate liability for asbestos and environmental claims. The majority of this loss and loss expense reserve relates to U.S. casualty exposures arising from business written by PartnerRe SA and PartnerRe U.S. (See Note 4 to Consolidated Financial Statements.) Ultimate loss estimates for such claims cannot be estimated using traditional reserving techniques and there are significant uncertainties in estimating the amount of the Company’s potential losses for these claims. In view of the changes in the legal and tort environment that affect the development of such claims, the uncertainties inherent in estimating asbestos and environmental claims are not likely to be resolved in the near future. There can be no assurance that the loss reserves established by the Company will not be adversely affected by development of other latent exposures, and further, there can be no assurance that the reserves established by the Company will be adequate. The Company does, however, actively evaluate potential exposure to asbestos and environmental claims and establishes additional reserves as appropriate. The Company believes that it has made a reasonable provision for these exposures and is unaware of any specific issues that would materially affect its loss and loss expense estimates.

Life Policy Benefits

Liabilities for policy benefits for ordinary life and accident and health policies have been established based upon information reported by cedants, supplemented by the Company’s actuarial estimates of mortality, critical illness, persistency and future investment income, with appropriate provision to reflect uncertainty. Future policy benefit reserves for annuity and universal life products are carried at their accumulated values. Reserves for policy claims and benefits include both mortality and critical illness claims in the process of settlement, and claims that have been incurred but not yet reported. Interest rate assumptions used to estimate liabilities for policy benefits for life and annuity contracts at December 31, 2006 ranged from 1.0% to 4.9%. Actual experience in a particular period may vary from the assumed experience and, consequently, may affect the Company’s operating results in future periods.

The Life segment reported net favorable development for prior accident years during the year ended December 31, 2006 of $12 million. The net favorable development was primarily related to the refinement of the Company’s reserving methodologies related to certain proportional guaranteed minimum death benefit treaties and the receipt of additional reported loss information from its cedants. The Life segment reported no development on prior accident years during the years ended December 31, 2005 and 2004.

Premiums and Acquisition Costs

The Company provides proportional and non-proportional reinsurance coverage to cedants (insurance companies). In most cases, cedants seek protection for business that they have not yet written at the time they enter into reinsurance agreements and have to estimate the volume of premiums they will cede to the Company. Reporting delays are inherent in the reinsurance industry and vary in length by reinsurance market (country of cedant) and type of treaty. As delays can vary from a few weeks to a year or sometimes longer, the Company produces accounting estimates to report premiums and acquisition costs until it receives the cedants’ actual results. Approximately 44% of the Company’s reported net premiums written for 2006, 2005 and 2004 were based upon estimates.

Under proportional treaties, which represented 67% of gross premiums written for the year December 31, 2006, the Company shares proportionally in both the premiums and losses of the cedant and pays the cedant a commission to cover the cedant’s acquisition costs. Under this type of treaty, the Company’s ultimate premiums written and earned and acquisition costs are not known at the inception of the treaty and must be estimated until the cedant reports its actual results to the Company. Under non-proportional treaties, which represented 33% of gross premiums written for the year December 31, 2006, the Company is typically exposed to loss events in excess of a predetermined dollar amount or loss ratio and receives a fixed or minimum premium, which is subject to upward adjustment depending on the premium volume written by the cedant.

 

50


Table of Contents

Reported premiums written and earned and acquisition costs on proportional treaties are generally based upon reports received from cedants and brokers, supplemented by the Company’s own estimates of premiums written and acquisition costs for which ceding company reports have not been received. Premium and acquisition cost estimates are determined at the individual treaty level. The determination of estimates requires a review of the Company’s experience with cedants, familiarity with each geographic market, a thorough understanding of the individual characteristics of each line of business, and the ability to project the impact of current economic indicators on the volume of business written and ceded by the Company’s cedants. Estimates for premiums and acquisition costs are updated continuously as new information is received from the cedants. Differences between such estimates and actual amounts are recorded in the period in which estimates are changed or the actual amounts are determined.

The magnitude and impact of a change in premium estimate differs for proportional and non-proportional treaties. Non-proportional treaties generally include a fixed minimum premium and an adjustment premium, which is generally less than 5% of the fixed minimum premium. While fixed minimum premiums require no estimation, adjustment premiums are estimated and could be subject to changes in estimates. Although proportional treaties may be subject to larger changes in premium estimates, as the Company generally receives cedant statements in arrears and must estimate all premiums for periods ranging from one month to more than one year (depending on the frequency of cedant statements), the pre-tax impact is mitigated by changes in the cedant’s related reported losses. The impact of the change in estimate on premiums earned and pre-tax results varies depending on when the change becomes known during the risk period and the underlying profitability of the treaty. For the year ended December 31, 2006, the Company recorded reductions of $22 million and $40 million of net premiums written and net premiums earned, respectively, related to changes in premium estimates of prior year reported premiums. These reductions, after the corresponding adjustments to acquisition costs and losses and loss expenses, decreased pre-tax income by approximately $9 million.

A 5% increase (decrease) in net premium written estimates and the corresponding acquisition costs for all of the Company’s Non-life non-proportional treaties would increase (decrease) the 2006 pre-tax income by approximately $21 million, assuming the changes become known at the mid-point of the risk period.

For proportional treaties, the impact of a change in net premium written estimates on pre-tax income varies depending on the losses and loss expenses and acquisition costs of the treaty affected by the change. For example, a 5% increase (decrease) in net premiums written and the corresponding acquisition costs in 2006 across all Non-life proportional treaties would increase (decrease) pre-tax income by approximately $12 million, assuming the 2006 reported technical ratio and that the changes become known at the mid-point of the risk period.

A 1% increase (decrease) in acquisition costs for all of the Company’s Non-life treaties (both proportional and non-proportional) for the year ended December 31, 2006, would decrease (increase) pre-tax income by approximately $4 million, assuming no change in premium estimates and that the changes become known at the mid-point of the risk period.

Other-than-Temporary Impairment of Investments

The Company regularly evaluates the fair value of its investments to determine whether a decline in fair value below the amortized cost basis (original cost basis for equities) is other-than-temporary. If the decline in fair value is judged to be other-than-temporary, the amortized cost of the individual security is written down to fair value as its new cost basis, and the amount of the write-down is included as a realized investment loss in the Consolidated Statements of Operations, which reduces net income in the period in which the determination of other-than-temporary impairment is made. In contrast, temporary losses are recorded as unrealized investment losses, which do not impact net income, but reduce accumulated other comprehensive income in the Consolidated Balance Sheets, except for those related to trading securities, which are recorded immediately as realized losses in net income.

To determine whether securities with unrealized investment losses are impaired, the Company evaluates, for each specific issuer or security, whether events have occurred that are likely to prevent the Company from

 

51


Table of Contents

recovering its investment in the security. In the determination of other-than-temporary impairment, the Company considers several factors and circumstances, including general economic and financial market conditions, the issuer’s overall financial condition, the issuer’s credit and financial strength ratings, general market conditions in the industry or geographic region in which the issuer operates, the length of time for which the fair value of an issuer’s securities remains below cost or amortized cost on a continuous basis, and other factors that may raise doubt about the issuer’s ability to continue as a going concern. During 2006, 2005 and 2004, the Company recorded other-than-temporary impairment charges of $27 million, $8 million and $11 million, respectively.

As of December 31, 2006, the Company held more than 500 investment positions that carried total gross unrealized losses of $88 million, including $51 million on securities that carried unrealized losses for more than 12 continuous months. Most unrealized losses were caused by increases in interest rates since the Company’s purchase of the investments, and the Company intends to hold these investments until recovery. Also in Management’s judgment, the Company had no significant unrealized losses caused by other factors or circumstances, including an issuer’s specific corporate risk or due to industry or geographic risk, for which an other-than-temporary impairment charge has not been taken. If the Company had written down 10% of all securities that were in an unrealized loss position for more than 12 continuous months at December 31, 2006, net income for 2006 would have been reduced by $5 million, pre-tax. However, there would be no change in the Company’s carrying value of investments, comprehensive income or shareholders’ equity, as the realization of the unrealized market value depreciation would transfer the loss from the accumulated other comprehensive income section of the Consolidated Balance Sheet to net income on the Consolidated Statement of Operations and retained earnings on the Consolidated Balance Sheet. See Financial Condition, Liquidity and Capital Resources in Item 7 of Part II of this report.

Income Taxes

FASB Statement No. 109 “Accounting for Income Taxes” (SFAS 109) provides that a deferred tax asset or liability is recognized for the estimated future tax effects attributable to temporary differences and carryforwards. SFAS 109 also establishes procedures to assess whether a valuation allowance should be established for deferred tax assets. All available evidence, both positive and negative, is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed for some portion or all of a deferred tax asset. Management must use its judgment in considering the relative impact of negative and positive evidence.

The Company has estimated the future tax effects attributed to temporary differences and has a deferred tax asset at December 31, 2006 of $165 million. The most significant components of the deferred tax asset relate to loss reserve discounting for tax purposes in the United States and operating tax loss carryforwards in France. At December 31, 2006, the deferred tax asset relating to the French tax loss carryforward was $63 million, which is subject to an indefinite carryforward period. The change in valuation allowance related to tax loss carryforwards resulted in a tax (benefit) charge of $(0.8) million, $(15.5) million and $16.3 million for the years ended December 31, 2006, 2005 and 2004, respectively.

The Company has projected future taxable income in the tax jurisdictions in which the deferred tax assets arise. These projections are based on Management’s projections of premium and investment income, and technical and expense ratios. Based on these projections, Management evaluates the need for a valuation allowance. A 10% reduction in the deferred tax asset of $165 million as of December 31, 2006 would result in a $16 million charge to net income and a corresponding reduction in total assets.

The deferred tax liabilities as of December 31, 2006 were $88 million. In accordance with SFAS 109, the Company has assumed that the future reversal of deferred tax liabilities will result in an increase in taxes payable in future years. Underlying this assumption is an expectation that the Company will continue to be subject to taxation in the various tax jurisdictions and the Company will continue to generate taxable revenues in excess of deductions. A 10% reduction in the deferred tax liability as of December 31, 2006 would result in a tax benefit of $9 million booked to net income and a corresponding reduction in total liabilities. See New Accounting Pronouncements below for a discussion on the impact of the adoption of FIN 48.

 

52


Table of Contents

Goodwill

On January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” (SFAS 142). SFAS 142 requires that the Company make an annual assessment as to whether the value of the Company’s goodwill asset is impaired. This assessment is performed at the reporting unit level. The Company has established September 30 as the date for performing the Company’s annual impairment test. Impairment, which can be either partial or full, is based on a fair value analysis by individual reporting unit. Based upon the Company’s assessment at the reporting unit level, there was no impairment of its goodwill asset of $430 million as of December 31, 2006.

In making an assessment of the value of its goodwill, the Company uses both market based and non-market based valuations. Assumptions underlying these valuations include an analysis of the Company’s stock price relative to both its book value and its net income in addition to forecasts of future cash flows and future profits. Significant changes in the data underlying these assumptions could result in an assessment of impairment of the Company’s goodwill asset. In addition, if the current economic environment and/or the Company’s financial performance were to deteriorate significantly, this could lead to an impairment of goodwill, the write-off of which would be recorded against net income in the period such deterioration occurred. If a 10% decline in the fair value of the reporting units occurred, this would not result in an impairment of the goodwill asset at December 31, 2006.

Valuation of Certain Derivative Financial Instruments

As part of its ART operations, the Company utilizes non-traded derivatives. The changes in fair value of these derivatives are recorded in other income in the Consolidated Statements of Operations and are included in the determination of net income in the period in which they are recorded. The Company uses internal valuation models to estimate the fair value of these derivatives and develops assumptions that require significant judgment, such as the timing of future cash flows of reference securities, credit spreads and general levels of interest rates. The Company uses its best estimate of assumptions to estimate the fair value of its derivative positions. Significant changes in the data underlying these assumptions could result in a significantly different valuation of the derivatives and significant adjustments to net income in the period in which the Company makes the adjustment.

On aggregate, the Company is not significantly exposed to changes in the valuation of its total return and interest rate swap portfolio due to changes in the general level of interest rates. However, at December 31, 2006, the Company estimated that a 100 basis point increase or decrease in all risk spread assumptions used in the Company’s internal valuation models would result in an $11 million decrease or increase, respectively, in the fair value of its total return and interest rate swap portfolio.

For weather derivatives, the Company develops assumptions for weather measurements as of the valuation date of the derivative and for probable future weather observations based on forecasts and statistical analysis of historical data. At December 31, 2006, the Company estimated that the valuation of its outstanding weather derivative contract could either increase or decrease by up to $1 million based on historical and forecast weather patterns known as of that date.

Results of Operations

The following discussion of Results of Operations contains forward-looking statements based upon assumptions and expectations concerning the potential effect of future events that are subject to uncertainties. See Item 1A of Part I of this report for a complete list of the Company’s risk factors. Any of these risk factors could cause actual results to differ materially from those reflected in such forward-looking statements.

The Company’s reporting currency is the U.S dollar. The Company’s subsidiaries and branches have one of the following functional currencies: U.S. dollar, euro or Canadian dollar. As a significant portion of the

 

53


Table of Contents

Company’s operations is performed in foreign currencies, fluctuations in foreign exchange rates may affect year over year comparisons. To the extent that fluctuations in foreign exchange rates affect comparisons, their impact has been quantified, when possible, and discussed in each of the relevant sections. See Note 2(j) to Consolidated Financial Statements of Item 8 of Part II of this report for a discussion on translation of foreign currencies.

The foreign exchange fluctuations for the principal currencies in which the Company transacts business were as follows:

 

   

the U.S. dollar strengthened, on average, against the euro, British pound, Swiss franc and Japanese yen, while it weakened against the Canadian dollar, in 2006 compared to 2005;

 

   

the U.S. dollar weakened, on average, against these currencies in 2005 compared to 2004; and

 

   

the U.S. dollar weakened against these currencies, except for the Japanese Yen, at December 31, 2006 compared to December 31, 2005.

Overview

The Company measures its performance in several ways. Among the performance measures accepted under U.S. GAAP is diluted net income per share, a measure that focuses on the return provided to the Company’s common shareholders. Diluted net income per share is obtained by dividing net income available to common shareholders by the weighted average number of common and common share equivalents outstanding. As the effect of dilutive securities would have been antidilutive in 2005 due to the Company’s reported net loss, the fully diluted per share figure for the year ended December 31, 2005 was compiled using the basic weighted average number of common shares outstanding.

As the Company’s reinsurance operations are exposed to low-frequency high-severity risk events, results for certain years may include unusually low loss experience, while results for other years may include significant catastrophic losses. For example, the Company’s results for 2006 included no significant catastrophic loss, while 2005 and 2004 included losses from large catastrophic events. To the extent that losses related to large catastrophic events affect the year over year comparison of the Company’s results, their impact has been quantified and discussed in each of the relevant sections.

Net income or loss, preferred dividends, net income or loss available to common shareholders and diluted net income or loss per share for the years ended December 31, 2006, 2005 and 2004 were as follows (in millions of U.S. dollars, except per share data):

 

    

For the year

ended

December 31,

2006

  

For the year

ended

December 31,

2005

   

For the year

ended

December 31,

2004

Net income (loss)

   $ 749    $ (51 )   $ 492

Less: preferred dividends

     34      35       21
                     

Net income (loss) available to common shareholders

   $ 715    $ (86 )   $ 471

Diluted net income (loss) per share

   $ 12.37    $ (1.56 )   $ 8.71

Net income, net income available to common shareholders and diluted net income per share for 2006 have increased significantly compared to 2005, primarily as a result of a lower level of large catastrophic losses in 2006. Results for 2005 included pre-tax losses, net of reinstatement and additional premiums, of $900 million related to European winterstorm Erwin, the Central European floods, and Hurricanes Katrina, Rita and Wilma (jointly referred to as the large 2005 catastrophic loss events).

The decrease in net income, net income available to common shareholders and diluted net income per share in 2005 compared to 2004 was primarily attributable to the unprecedented amount of large catastrophic losses for

 

54


Table of Contents

the Company and the industry during 2005. While the results for 2004 included the impact of four Atlantic hurricanes and the Indian Ocean tsunami, totaling $176 million, net of reinstatement and additional premiums, the amount of large catastrophic losses increased to $900 million in 2005.

The following tables reflect the combined impact of the 2004 and 2005 large catastrophic losses on the Company’s pre-tax net income by segments and sub-segments for the years ended December 31, 2005 and 2004 (in millions of U.S. dollars). While 2006 had no large catastrophic losses, the Company incurred additional reserve development of $22 million, net of reinstatement and additional premiums of $9 million, related to the large 2005 catastrophic loss events. The impact of this development on the Company’s pre-tax net income for 2006 will be discussed as part of the net prior year loss development of each segment and sub-segment below.

 

2005 Calendar Year

 

Segment or sub-segment

  

Net losses and loss

expenses

    Acquisition costs    

Reinstatement or

additional

premiums earned

  

Impact on pre-tax

net income

 

U.S. P&C

   $ (128 )   $ —       $ —      $ (128 )

Global (Non-U.S.) P&C

     (61 )     —         —        (61 )

Worldwide Specialty

     (741 )     (2 )     48      (695 )
                               

Non-life segment

   $ (930 )   $ (2 )   $ 48    $ (884 )

ART

     (29 )     —         13      (16 )

Life

     —         —         —        —    
                               

Total

   $ (959 )   $ (2 )   $ 61    $ (900 )
  

2004 Calendar Year

 

Segment or sub-segment

  

Net losses and loss

expenses

    Acquisition costs    Reinstatement
premiums earned
  

Impact on pre-tax

net income

 

U.S. P&C

   $ (49 )   $ —      $ —      $ (49 )

Global (Non-U.S.) P&C

     (34 )     —        —        (34 )

Worldwide Specialty

     (85 )     —        5      (80 )
                              

Non-life segment

   $ (168 )   $ —      $ 5    $ (163 )

ART

     (8 )     —        —        (8 )

Life

     (5 )     —        —        (5 )
                              

Total

   $ (181 )   $ —      $ 5    $ (176 )

Preferred share dividends did not change significantly between 2006 and 2005. Preferred share dividends increased in 2005 after the Company issued Series D cumulative preferred shares (Series D preferred shares) in the fourth quarter of 2004. In the same quarter, the Company settled the purchase contracts associated with its PEPS units in exchange for newly issued common shares of the Company and the Company purchased and cancelled the Series B cumulative preferred shares (Series B preferred shares) that were part of its PEPS units. The increase in preferred share dividends during 2005 is largely offset by a decrease in interest expense related to the Series B preferred shares.

Review of Net Income (Loss)

Management analyzes the Company’s net income (loss) in three parts: underwriting result, net investment income and other components of net income. Underwriting result consists of net premiums earned and other income less losses and loss expenses and life policy benefits, acquisition costs and other operating expenses. Investment income includes interest and dividends, net of investment expenses, generated by the Company’s investment portfolio, as well as interest income generated on funds held and certain ART transactions. Other components of net income include net realized investment gains and losses, interest expense, net foreign exchange gains and losses, income tax expense or benefit and interest in earnings of equity investments.

 

55


Table of Contents

The components of net income (loss) income for the years ended December 31, 2006, 2005 and 2004 were as follows (in millions of U.S. dollars):

 

    

For the year

ended

December 31,

2006

   

% Change

2006 over

2005

   

For the year

ended

December 31,

2005

   

% Change

2005 over

2004

   

For the year

ended

December 31,

2004

 

Underwriting result:

          

Non-life

   $ 484     NM     $ (497 )   NM     $ 196  

ART

     21     159 %     8     NM       (4 )

Life

     (22 )   (33 )     (33 )   (31 )%     (48 )

Corporate expenses

     (62 )   22       (51 )   21       (42 )

Net investment income

     449     23       365     22       298  

Net realized investment gains

     47     (77 )     207     76       117  

Interest expense

     (61 )   87       (33 )   (19 )     (41 )

Net foreign exchange (losses) gains

     (24 )   555       (4 )   NM       17  

Income tax expense

     (95 )   316       (23 )   203       (7 )

Interest in earnings of equity investments

     12     23       10     54       6  
                            

Net income (loss)

   $ 749     NM     $ (51 )   NM     $ 492  

NM: not meaningful

Underwriting result is a key measurement that the Company uses to manage and evaluate its segments and sub-segments, as it is a primary measure of underlying profitability for the Company’s core reinsurance operations, separate from the investment results. The Company believes that in order to enhance the understanding of its profitability, it is useful for investors to evaluate the components of net income separately and in the aggregate. Underwriting result should not be considered a substitute for net income as it does not reflect the overall profitability of the business, which is also impacted by investment results and other items.

2006 over 2005

The underwriting result for the Non-life segment increased by $981 million, from a loss of $497 million in 2005 to a gain of $484 million in 2006. The increase was principally attributable to:

 

   

a decrease in the level of large catastrophic losses of $884 million, net of reinstatement premiums, for the U.S P&C sub-segment ($128 million), Global (Non-U.S.) P&C sub-segment ($61 million) and Worldwide Specialty sub-segment ($695 million);

 

   

an increase of approximately $91 million resulting from the normal fluctuations in profitability between periods; and

 

   

an increase of $22 million in net favorable reserve development on prior accident years, from $231 million in 2005 to $253 million in 2006, including net adverse development of $25 million (net of reinstatement premiums of $4 million) related to the large 2005 catastrophic loss events. The components of the net favorable loss development on prior accident year losses are described in more detail in the discussion of individual sub-segments in the next section; and was partially offset by

 

   

an increase in other operating expenses of $16 million, resulting primarily from higher bonus accruals in 2006.

Underwriting result for the ART segment increased by $13 million, from $8 million in 2005 to $21 million in 2006. While 2005 included a net underwriting loss of $16 million related to the large catastrophic losses, 2006 included one large loss of $6 million, as well as net favorable loss development of $3 million (net of additional premiums) related to the 2005 hurricanes. This segment also benefited in 2006 from the early termination of a number of longer term contracts, which led to accelerated profit recognition for the terminated contracts, and stronger results on weather products, explaining most of the growth in underwriting result for this segment.

 

56


Table of Contents

Underwriting result for the Life segment improved from a loss of $33 million in 2005 to a loss of $22 million in 2006, primarily due to net favorable reserve development of $12 million in 2006, partially offset by higher operating expenses, resulting principally from higher bonus accruals in 2006.

Corporate expenses increased by $11 million, from $51 million in 2005 to $62 million in 2006. The net increase in operating expenses resulted primarily from an increase in personnel costs of $12 million, including bonus accruals and stock-based compensation expense, partially offset by decreases in consulting and professional fees and other costs. Bonuses are tied to results and the bonus accruals were minimal in 2005 as a result of negative operating results.

The Company reported net investment income of $449 million in 2006 compared to $365 million in 2005. The 23% increase in net investment income was primarily attributable to the increase in the asset base resulting from the investment of the Company’s significant cash flows from operations, which totaled $492 million after the purchase of approximately $390 million of equity trading securities in 2006, and a full year of net investment income on cash proceeds of $549 million from the Company’s capital raises in October 2005. The higher interest rates prevailing during 2006 relative to 2005 for the U.S. dollar, euro and other currencies also contributed to the increase in net investment income.

Net realized investment gains decreased by $160 million, from $207 million in 2005 to $47 million in 2006. Realized investment gains and losses are generally a function of multiple factors, with the most significant being the prevailing interest rates and equity market conditions, the timing of disposition of fixed maturities and equity securities, and charges for the recognition of other-than-temporary impairments in the Company’s investment portfolio. Although the sale of equity securities generated net realized investment gains in 2006, net realized investment gains on equity securities were $71 million lower than 2005. Following a rise in interest rates during 2006, the majority of the Company’s fixed income securities decreased in value compared to December 31, 2005, and sales generated $53 million in net realized investment losses and other-than-temporary impairments, compared to net realized investment gains of $25 million in 2005.

Interest expense increased by $28 million in 2006 compared to 2005 due to a full year of interest on the $400 million long-term debt issued by the Company in October 2005. In addition, the Company incurred interest expense of $6 million upon the redemption of its trust preferred securities in December 2006, representing the unamortized portion of the trust preferred securities’ issuance costs. The Company also incurred interest on debt related to both its capital efficient notes (issued on November 7, 2006) and trust preferred securities for a limited period of time prior to the trust preferred securities’ redemption on December 21, 2006.

Foreign exchange losses were $24 million and $4 million in 2006 and 2005, respectively. The Company hedges a significant portion of its currency risk exposure, as discussed in the Quantitative and Qualitative Disclosures about Market Risk in Item 7A of Part II of this report. The increase in the foreign exchange loss in 2006 is largely a function of (1) the comparative interest rate differential between the functional currency of the reporting unit and the currency being hedged, which increased the cost of hedging instruments used by the Company; (2) currency movements against the Company’s functional currencies for unhedged positions; and (3) the difference between the period-end foreign exchange rates, which are used to revalue the balance sheet, and the average foreign exchange rates, which are used to revalue the income statement.

Income tax expense increased by $72 million from $23 million in 2005 to $95 million in 2006. The increase in income tax expense is primarily a result of the increase in pre-tax income and the geography (or tax jurisdiction) distribution of that income. The Company’s taxable entities generated a higher pre-tax income and tax expense in 2006 compared to 2005. In addition, the 2005 tax expense included the reduction of $15 million in the valuation allowance in Switzerland. Management concluded in 2005 that it was appropriate to release the valuation allowance as a result of the positive evidence, under SFAS 109, of the ability of the Swiss operations to generate significant taxable income in 2005 despite an unprecedented level of losses in the industry. The Company also updated, in 2005, its in-depth analysis of various tax exposures and, based upon its analysis, tax reserves were reduced by $16 million.

 

57


Table of Contents

2005 over 2004

The underwriting result for the Non-life segment decreased by $693 million, from a gain of $196 million in 2004 to a loss of $497 million in 2005. The decrease was principally attributable to:

 

   

an increase in the level of large catastrophic losses of $721 million, net of reinstatement premiums, for the U.S P&C sub-segment ($79 million), Global (Non-U.S.) P&C sub-segment ($27 million) and Worldwide Specialty sub-segment ($615 million);

 

   

a decrease of approximately $73 million resulting from a decrease volume of business and the normal fluctuations in profitability between periods; and was partially offset by

 

   

an increase of $92 million in net favorable reserve development on prior accident years, from $139 million in 2004 to $231 million in 2005; and

 

   

a decrease in other operating expenses of $9 million, resulting primarily from lower bonus accruals in 2005.

Underwriting result for the ART segment increased in 2005 despite an increase of $8 million of large catastrophic losses (net of additional premiums). While the weather line returned to profitability in 2005, following incurred realized and unrealized losses on weather derivative instruments due to unusual weather patterns in Japan during 2004, the structured risk transfer line incurred losses on the 2005 hurricanes, which mitigated the positive impact of the weather and principal finance lines.

Underwriting result for the Life segment improved in 2005 primarily due to a $5 million charge to reduce deferred acquisition costs on annuity treaties retained in the sale of PartnerRe Life Insurance Company of the U.S., as well as a $5 million loss on the Indian Ocean tsunami which were included in the 2004 underwriting results.

Corporate expenses increased by $9 million, from $42 million during 2004 to $51 million during 2005. The increase resulted primarily from an increase of $7 million in equity-based compensation expenses as a result of the adoption in 2003, on a prospective basis, of the fair value method of accounting for equity-based awards. Addition of staff in corporate departments and increases in other infrastructure costs were more than offset by reductions in bonus accruals of $8 million during 2005.

The Company reported net investment income of $365 million in 2005 compared to $298 million in 2004. The increase in investment income is primarily attributable to investment of the Company’s significant cash flows from operations, which amounted to $1,032 million in 2005 and $1,264 million in 2004. In addition, net cash proceeds of $549 million from the Company’s capital raises in October 2005 also contributed to the growth in net investment income. Changes in average foreign exchange rates contributed approximately 1% of the increase as a result of the decline of the U.S. dollar, on average, against the euro and other currencies during the year.

Net realized investment gains increased by $90 million, from $117 million during 2004 to $207 million during 2005, primarily as a result of realized gains within the Company’s equity portfolio.

Interest expense decreased by $8 million in 2005 compared to 2004 as distributions on the Series B preferred shares, which amounted to $11 million per year and were presented as interest expense, ended in the fourth quarter of 2004. This decrease was partially offset by interest expense of $3 million related to the $400 million long-term debt issued in October 2005.

The reduction of net foreign exchange from a gain of $17 million in 2004, to a loss of $4 million in 2005 is explained by the combined effect of the fluctuation of the U.S. dollar against the euro and other currencies from 2004 to 2005, as well as the Company’s hedging activities.

Income tax expense increased by $16 million, from $7 million during 2004 to $23 million during 2005, primarily as a result of a change in the geography of pre-tax income (loss). The Company’s taxable entities

 

58


Table of Contents

generated a higher pre-tax income and tax expense during 2005 than 2004, as a significant portion of the large catastrophic losses were incurred by a non-taxable entity in 2005. This was partially offset by a reduction, in 2005, of $15 million in the valuation allowance in Switzerland and the reduction of tax reserves of $16 million as the results of the Company’s in-depth analysis of various tax exposures. The 2004 tax expense was net of a tax recovery in the amount of $6 million related to the settlement of a tax arbitration in France and a favorable adjustment of $6 million, net of valuation allowance, resulting from adjustments to prior year income tax returns in Switzerland.

Results by Segment

The Company monitors the performance of its underwriting operations in three segments, Non-life, ART and Life. The Non-life segment is further divided into three sub-segments, U.S. P&C, Global (Non-U.S.) P&C and Worldwide Specialty. Segments and sub-segments represent markets that are reasonably homogeneous in terms of geography, client types, buying patterns, underlying risk patterns and approach to risk management. See the description of the Company’s segments and sub-segments as well as a discussion of how the Company measures its segment results in Note 19 to Consolidated Financial Statements included in Item 8 of Part II of this report.

Segment results are shown net of intercompany transactions. Business reported in the Global (Non-U.S.) P&C and Worldwide Specialty sub-segments and the Life segment is, to a significant extent, denominated in foreign currencies and is reported in U.S. dollars at the weighted average foreign exchange rates for each year. The U.S. dollar has fluctuated against the euro and other currencies during each of the three years presented and this should be considered when making year over year comparisons.

Non-life Segment

U.S. P&C

The technical result of the U.S. P&C sub-segment has fluctuated in the last three years reflecting varying levels of large loss events and development on prior years’ reserves, which distorted year-to-year comparisons as discussed below. This sub-segment includes the U.S. casualty line, which represented approximately 68%, 69% and 65% of net premiums written for 2006, 2005 and 2004, respectively. This line typically tends to have a higher loss ratio and a lower technical result, due to the long-tail nature of the risks involved. Casualty treaties typically provide for investment income on premiums invested over a longer period as losses are typically paid later than for other lines. Investment income, however, is not considered in the calculation of technical result.

The following table provides the components of the technical result and the corresponding ratios for this sub-segment (in millions of U.S. dollars):

 

     2006    

% Change

2006 over

2005

    2005    

% Change

2005 over

2004

    2004  

Gross premiums written

   $ 843     3 %   $ 820     (17 )%   $ 991  

Net premiums written

     843     3       819     (17 )     990  

Net premiums earned

   $ 850     3     $ 828     (7 )   $ 893  

Losses and loss expenses

     (612 )   (20 )     (764 )   9       (699 )

Acquisition costs

     (212 )   6       (200 )   (2 )     (204 )
                            

Technical result (1)

   $ 26     NM     $ (136 )   >1000     $ (10 )

Loss ratio (2)

     72.1 %       92.2 %       78.2 %

Acquisition ratio (3)

     24.9         24.2         22.8  
                            

Technical ratio (4)

     97.0 %       116.4 %       101.0 %

NM: not meaningful
(1) Technical result is defined as net premiums earned less losses and loss expenses and acquisition costs.
(2) Loss ratio is obtained by dividing losses and loss expenses by net premiums earned.
(3) Acquisition ratio is obtained by dividing acquisition costs by net premiums earned.
(4) Technical ratio is defined as the sum of the loss ratio and the acquisition ratio.

 

59


Table of Contents

Premiums

The U.S. P&C sub-segment represented 23%, 23% and 26% of total net premiums written in 2006, 2005, and 2004, respectively.

2006 over 2005

Gross and net premiums written and net premiums earned were 3% higher in 2006 compared to 2005. The property line had an increase in net premiums written and earned in 2006, while the motor line had a decrease and the casualty line was mainly flat. In addition to new treaties in the property and casualty lines, cedants reported fewer downward premium adjustments in 2006 in the motor line than in the same period in 2005.

While there were noticeable differences in market conditions by line of business in 2006, the market continued to provide profitable opportunities. The property line was the line most affected by the 2005 hurricanes, and catastrophe-exposed business benefited from improvements in pricing and terms and conditions during the 2006 renewals. Short-tail lines not exposed to catastrophes continued to see competitive conditions. While the decrease in the motor line was due to treaty cancellations given the prevailing market conditions, the casualty line saw relatively stable market conditions. Notwithstanding the sustained competition in this sub-segment, as well as the higher risk retention by cedants, the Company was able to pursue business that met its profitability objectives.

2005 over 2004

The decrease in gross and net premiums written and net premiums earned in 2005 over 2004 resulted from all lines but was more evident in the motor and casualty lines. The Company observed increased competition in the short-tail motor and property lines, as primary companies retained more risk and reinsurers were competing for a declining amount of business. Although pricing and terms and conditions remained fairly stable in 2005 for the long-tail casualty line, the Company’s net premiums written also decreased for this line. Approximately a third of the decline in net premiums written for this sub-segment resulted from reduced premium estimates from cedants for prior underwriting years, while the remainder resulted from timing of renewals, lower renewal premiums due to the increased risk retention by cedants, the cancellation of programs (or non-renewals) where the renewal terms did not meet the Company’s profitability objectives and increased competition among reinsurers.

Losses and loss expenses and loss ratio

2006 over 2005

The losses and loss expenses and loss ratio reported for 2006 reflected a) no large catastrophic losses; b) net adverse development on prior accident years of $6 million, or 0.7 points on the loss ratio of this sub-segment, including a net adverse loss development of $11 million related to the 2005 hurricanes; and c) an increase in the book of business and exposure as evidenced by the increase in net premiums earned. The net adverse loss development of $6 million included net adverse loss development for prior accident years of $15 million in the property and motor lines, partially offset by net favorable development of $9 million in the casualty line. The net adverse loss development during 2006 on the 2005 hurricanes was partially offset by loss reductions driven by lower than expected loss activity. Other than for losses related to the 2005 hurricanes, loss information provided by cedants in 2006 for prior accident years in this sub-segment included no individually significant losses but a series of attritional losses. Upon consideration of the attritional loss information, the Company increased its overall expected ultimate loss estimates for the property and motor lines (decreased for the casualty line), which had the net effect of increasing (decreasing for casualty line) prior year loss estimates.

The decrease of $152 million in losses and loss expenses from 2005 to 2006 included:

 

   

a decrease in large catastrophic losses of $128 million; and

 

60


Table of Contents
   

a decrease of $42 million in net adverse prior year development; and was partially offset by

 

   

an increase in losses and loss expenses of approximately $18 million resulting from a combination of the increase in the book of business and exposure, modestly lower profitability on the business written in 2005 and 2006 that was earned in 2006, and normal fluctuations in profitability between periods.

2005 over 2004

The losses and loss expenses and loss ratio reported in 2005 reflected a) losses related to the large 2005 catastrophic loss events of $128 million or 15.5 points on the loss ratio of this sub-segment; b) net adverse loss development on prior accident years of $48 million, or 5.8 points on the loss ratio; and c) a decrease in the book of business and exposure as evidenced by the decrease in net premiums earned. The net adverse loss development of $48 million included net adverse loss development for prior accident years in the casualty and motor lines of $58 million, partially offset by net favorable loss development in the shorter-tail property line of $10 million. The net adverse loss development in the casualty line in 2005 was primarily due to a revaluation of the loss development assumptions used by the Company to estimate future liabilities in a number of recent underwriting years on a limited number of treaties, predominantly in the specialty casualty line. In addition, but to a less significant degree, the Company observed the emergence of unforeseen loss activity in certain older underwriting years within the non-proportional casualty portfolio. The net adverse loss development for motor primarily reflects actual loss experience during 2005 being worse than expected. Loss information provided by cedants for prior accident years in 2005 for all lines in this sub-segment included no individually significant losses but a series of attritional losses. Based on the Company’s assessment of this loss information, the Company increased its expected ultimate loss ratios for the casualty and motor lines (decreased for the property line), which had the net effect of increasing (decreasing for the property line) prior year loss estimates for this sub-segment.

The increase of $65 million in losses and loss expenses from 2004 to 2005 is explained by:

 

   

an increase in large catastrophic losses of $79 million; and

 

   

an increase of $18 million in net adverse prior year development; and was partially offset by

 

   

a decrease in losses and loss expenses of approximately $32 million resulting from the decrease in the book of business and exposure.

Acquisition costs and acquisition ratio

2006 over 2005

The acquisition costs and acquisition ratio increased in 2006 compared to 2005 primarily as a result of a modest shift from non-proportional to proportional business, which generally carries higher acquisition costs and acquisition ratio.

2005 over 2004

While the Company’s book of business and exposure declined in 2005 compared to 2004, the acquisition costs for 2005 did not change significantly. A shift from non-proportional business to proportional business, and reductions of acquisition costs in 2004 on treaties with experience credits in the form of sliding scale and profit commission adjustments, resulted in a lower acquisition ratio in 2004 than 2005.

Technical result and technical ratio

2006 over 2005

The increase of $162 million in the technical result and the corresponding decrease in the technical ratio from 2005 compared to 2006 was primarily attributable to a reduction in large catastrophic losses of $128 million, a reduction in net adverse prior year development of $42 million, partially offset by a decrease of approximately $8 million resulting from the normal fluctuations in profitability between periods.

 

61


Table of Contents

2005 over 2004

The decrease of $126 million in the technical result and the corresponding increase in the technical ratio from 2004 compared to 2005 was explained by an increase of $79 million in the level of large catastrophic losses, an increase of $18 million in net adverse prior year development and a reduction of approximately $29 million resulting from premiums adjustments and the normal fluctuations in profitability between periods.

2007 Outlook

During the January 1, 2007 renewals, the Company saw diverse market conditions. Pricing improved for catastrophe-exposed business compared to 2006, while terms and conditions weakened and pricing declined for all other lines as a result of the competitive market conditions and increased risk retention by cedants. The Company’s book of business was slightly reduced at the January 1, 2007 renewals in this sub-segment. Based on overall pricing indications and renewal information received from cedants and brokers, and assuming similar conditions experienced during the January 1, 2007 renewals continue throughout the year, Management expects a slight decline in gross and net premiums written and net premiums earned for this sub-segment in 2007.

Global (Non-U.S.) P&C

The technical result of the Global (Non-U.S.) P&C sub-segment has fluctuated in the last three years, reflecting varying levels of large loss events and development on prior years’ reserves, which distorted year-to-year comparisons as discussed below. The Global (Non-U.S.) P&C sub-segment is composed of short-tail business, in the form of property and proportional motor business, that represented approximately 78% of net premiums written for 2006 in this sub-segment, and long-tail business, in the form of casualty and non-proportional motor business, that represented the balance of net premiums written.

The following table provides the components of the technical result and the corresponding ratios for this sub-segment (in millions of U.S. dollars):

 

     2006    

% Change

2006 over

2005

    2005    

% Change

2005 over

2004

    2004  

Gross premiums written

   $ 763     (9 )%   $ 837     (11 )%   $ 944  

Net premiums written

     760     (9 )     835     (12 )     945  

Net premiums earned

   $ 775     (10 )   $ 860     (7 )   $ 929  

Losses and loss expenses

     (505 )   (21 )     (637 )   (13 )     (730 )

Acquisition costs

     (210 )   (3 )     (217 )   (9 )     (238 )
                            

Technical result

   $ 60     1000     $ 6     NM     $ (39 )

Loss ratio

     65.1 %       74.1 %       78.6 %

Acquisition ratio

     27.1         25.3         25.6  
                            

Technical ratio

     92.2 %       99.4 %       104.2 %

NM: not meaningful

Premiums

The Global (Non-U.S.) P&C sub-segment represented 21%, 23% and 24% of total net premiums written in 2006, 2005 and 2004, respectively.

2006 over 2005

The decline in gross and net premiums written and net premiums earned in 2006 resulted from the motor and casualty lines and was partially offset by a slight increase in the property line. Competitive market

 

62


Table of Contents

conditions, as well as increases in risk retention by cedants prevailed in 2006 for this sub-segment, which reduced the opportunities for growth. In addition to the continued increased risk retention by cedants, the reduction in the motor line resulted from the Company’s decision to non-renew treaties that did not meet the Company’s profitability objectives. The Company has remained selective in an increasingly competitive environment and has chosen to retain only that business that met its profitability objectives, rather than focusing on premium volume. The strengthening of the U.S. dollar, on average, in 2006 compared to 2005 also contributed to the decrease in net premiums written in this sub-segment, as premiums denominated in currencies that have depreciated against the U.S. dollar were converted into U.S dollars at a lower weighted average exchange rate. Without the negative contribution of foreign exchange, gross and net premiums written would have declined by 6% and net premiums earned would have declined by 9%.

2005 over 2004

The decline in gross and net premiums written and net premiums earned in 2005 resulted from all lines in this sub-segment, but was more pronounced in the casualty line. Increased competition and increased risk retention by cedants were the principal reasons for the decrease in premium volume in this sub-segment. The weakening of the U.S. dollar, on average, in 2005 compared to 2004 partially offset the decrease in net premiums written in this sub-segment. Without the positive contribution of foreign exchange, gross and net premiums written would have declined by 16% and net premiums earned would have declined by 11%.

Losses and loss expenses and loss ratio

2006 over 2005

The losses and loss expenses and loss ratio reported in 2006 reflected a) no large catastrophic losses; b) net favorable loss development on prior accident years of $66 million, or 8.6 points on the loss ratio of this sub-segment, including $6 million of net favorable loss development on the large 2005 catastrophic loss events; and c) a decrease in the book of business and exposure as evidenced by the decrease in net premiums earned. The net favorable loss development of $66 million, which included net favorable development of $79 million in the property and casualty lines, partially offset by net adverse development of $13 million in the motor and other lines, resulted from a reassessment of the loss development assumptions used by the Company to estimate future liabilities due to what it believed were favorable experience trends in these lines of business (adverse experience trends for the motor line), as losses reported by cedants during 2006 for prior accident years, and for treaties where the risk period expired, were lower (higher for the motor line) than the Company expected. Loss information provided by cedants in 2006 for prior accident years included no individually significant losses, but a series of attritional losses. Based on the Company’s assessment of this loss information, the Company decreased its expected ultimate loss ratios for the property and casualty lines (increased for the motor line), which had the net effect of decreasing (increasing for the motor line) prior year loss estimates for this sub-segment.

The decrease of $132 million in losses and loss expenses from 2005 to 2006 included:

 

   

a decrease in losses and loss expenses of approximately $72 million resulting from a combination of effect of the decrease in the book of business and exposure, modestly lower profitability on the business written in 2005 and 2006 that was earned in 2006, and normal fluctuations in profitability between periods; and

 

   

a decrease in large catastrophic losses of $61 million; and was partially offset by

 

   

a decrease of $1 million in net favorable prior year development.

2005 over 2004

The losses and loss expenses and loss ratio reported in 2005 reflected a) losses related to the large 2005 catastrophic loss events of $61 million, or 7.1 points on the loss ratio of this sub-segment; b) net favorable loss

 

63


Table of Contents

development on prior accident years of $67 million, or 7.9 points on the loss ratio; and c) a decrease in the book of business and exposure as evidenced by the decrease in net premiums earned. The net favorable loss development of $67 million included net favorable loss development for prior accident years in the property and casualty lines of $76 million, partially offset by net adverse loss development in the motor line of $9 million. The net favorable loss development was primarily due to favorable loss emergence, as losses reported by cedants during 2005 for prior accident years and for treaties where the risk period expired were lower (higher for motor line) than the Company expected. Loss information provided by cedants in 2005 for prior accident years for all lines in this sub-segment included no individually significant losses but a series of attritional losses. Based on the Company’s assessment of this loss information, the Company decreased its expected ultimate loss ratios for the property and casualty lines (increased for the motor line), which had the net effect of decreasing the level of prior year loss estimates for this sub-segment.

The decrease of $93 million in losses and loss expenses and loss ratio from 2004 to 2005 is explained by:

 

   

an increase of $91 million in the level of net favorable prior year development; and

 

   

a decrease in losses and loss expenses of approximately $29 million, resulting from the decrease in the book of business and exposure; and was partially offset by

 

   

an increase in large catastrophic losses of $27 million.

Acquisition costs and acquisition ratio

2006 over 2005

The decrease in acquisition costs in 2006 compared to 2005 was primarily due to the reduction in the Company’s book of business and exposure, as evidenced by the 10% decrease in net premiums earned. This was partially offset by a higher commission rate and sliding scale commissions due to improving loss experience and increased competition in this sub-segment. The increase in the related acquisition ratio results from the commission adjustments and increased competition.

2005 over 2004

The decrease in acquisition costs in 2005 compared to 2004 was due to the reduction in the Company’s book of business and exposure. The acquisition ratio was comparable for both years.

Technical result and technical ratio

2006 over 2005

The increase of $54 million in the technical result and the corresponding decrease in the technical ratio from 2005 to 2006 was primarily explained by a decrease of $61 million in large catastrophic losses, partially offset by a decrease of profitability of approximately $6 million resulting from a combination of the reduction in the book of business and exposure, and a higher a priori loss ratio in 2006 reflecting compressed margins as pricing is not keeping up with loss cost trends and a reduction in net favorable prior year development of $1 million.

2005 over 2004

The increase of $45 million in the technical result and the corresponding decrease in the technical ratio from 2004 to 2005 was explained by an increase of $91 million in net favorable prior year development, partially offset by an increase of $27 million in the level of large catastrophic losses, and a reduction of approximately $19 million in profitability resulting from normal fluctuations in profitability between periods.

2007 Outlook

During the January 1, 2007 renewals, the Company observed a continuation of the trend by cedants to increase their retentions and reinsurers to increase their competitive behavior. Terms and conditions weakened

 

64


Table of Contents

and pricing declined in several markets as a result of the increased competition and the Company’s book of business was slightly reduced at the January 1, 2007 renewals in this sub-segment. Based on overall pricing indications and renewal information received from cedants and brokers, and assuming similar conditions experienced during the January 1, 2007 renewals continue throughout the year, Management expects a slight decline in gross and net premiums written and net premiums earned for this sub-segment in 2007.

Worldwide Specialty

The Worldwide Specialty sub-segment is usually the most profitable sub-segment; however, it is important to note that this sub-segment is exposed to volatility resulting from catastrophic and other large losses, and thus, profitability in any one year is not necessarily predictive of future profitability. The results of 2006 and 2005 demonstrate this volatility, as 2006 had an unusually low level of large catastrophic losses and 2005 contained an unprecedented level of large catastrophic losses. This impacted the technical result and ratio for this sub-segment and distorted year-to-year comparisons as discussed below.

The following table provides the components of the technical result and the corresponding ratios for this sub-segment (in millions of U.S. dollars):

 

     2006    

% Change

2006 over

2005

    2005    

% Change

2005 over

2004

    2004  

Gross premiums written

   $ 1,586     3 %   $ 1,533     —   %   $ 1,531  

Net premiums written

     1,564     4       1,501     (1 )     1,509  

Net premiums earned

   $ 1,524     5     $ 1,456     (3 )   $ 1,500  

Losses and loss expenses

     (618 )   (54 )     (1,334 )   79       (744 )

Acquisition costs

     (307 )   —         (308 )   (5 )     (323 )
                            

Technical result

   $ 599     NM     $ (186 )   NM     $ 433  

Loss ratio

     40.5 %       91.6 %       49.6 %

Acquisition ratio

     20.2         21.2         21.6  
                            

Technical ratio

     60.7 %       112.8 %       71.2 %

NM: not meaningful

Premiums

The Worldwide Specialty sub-segment represented 42%, 42% and 39% of total net premiums written in 2006, 2005 and 2004, respectively.

2006 over 2005

Gross and net premiums written and net premiums earned increased by 3%, 4% and 5%, respectively, in 2006 compared to 2005. While 2005 included $48 million of reinstatement premiums and $11 million of back-up covers related to the large catastrophic events, 2006 included no reinstatement premiums or back-up covers. The Company observed improvements in pricing and terms and conditions since the third quarter of 2005 for catastrophe-exposed lines, such as the catastrophe, energy and marine lines. In response to the level of demand and attractive risk-adjusted pricing, Management increased the allocation of capacity to the catastrophe-exposed lines, which also resulted in growth in premiums written in 2006 compared to 2005. The agriculture, engineering and specialty property lines also increased in 2006, while higher cedant retention and increased competition resulted in a decrease in premiums written for the other lines of business in this sub-segment. The strengthening of the U.S. dollar, on average, in 2006 compared to 2005 impeded growth in net premiums written in this sub-segment, as premiums denominated in currencies that have depreciated against the U.S. dollar were converted into U.S dollars at a lower weighted average exchange rate. Without the negative contribution of foreign exchange, gross and net premiums written would have increased by 5% and 6%, respectively.

 

65


Table of Contents

2005 over 2004

Following the large 2005 catastrophic losses, reinstatement premiums of $48 million and back-up covers of $11 million were recorded in the catastrophe line in this sub-segment, which slowed the decline in net premiums written. While the 2005 events reversed the price competition in catastrophe-exposed lines (generally short-tail lines), the decline in pricing, and net premiums written, continued in other lines in this sub-segment. The weakening of the U.S. dollar, on average, in 2005 compared to 2004 partially offset the decrease in net premiums written in this sub-segment. Without the positive contribution of foreign exchange, gross and net premiums written would have declined by 2% and 3%, respectively, and net premiums earned would have declined by 4%.

Losses and loss expenses and loss ratio

2006 over 2005

The losses and loss expenses and loss ratio reported in 2006 for this sub-segment reflected a) no large catastrophic losses; and b) net favorable loss development on prior accident years in the amount of $193 million, or 12.6 points on the loss ratio of this sub-segment, including net adverse loss development of $24 million related to the large 2005 catastrophic losses. The net favorable loss development of $193 million in 2006 included net favorable loss development for all lines of business with the exception of the catastrophe line, which reported a net adverse loss development of $25 million. The net adverse loss development on the large 2005 catastrophic loss events included $20 million of an additional IBNR reserve established by the Company as a result of a general concern given recent litigation developments and evolving out of court settlement trends that may affect some of the Company’s cedants in the future. Excluding the net adverse development on the large 2005 catastrophic losses, the net favorable loss development for this sub-segment was primarily due to net favorable loss emergence, as losses reported by cedants during 2006 for prior accident years, including treaties where the risk period expired, were lower than the Company expected. Other than for losses related to the 2005 hurricanes, loss information provided by cedants in 2006 for prior accident years included no individually significant losses, but a series of attritional losses. Based on the Company’s assessment of this loss information, the Company decreased its expected ultimate loss ratios for all lines, except for the catastrophe line, which had the net effect of decreasing (increasing for the catastrophe line) the level of prior year loss estimates.

The decrease of $716 million in losses and loss expenses from 2005 to 2006 included:

 

   

a decrease in large catastrophic losses of $741 million; and was partially offset by

 

   

a decrease of $19 million in net favorable prior year development; and

 

   

an increase in losses and loss expenses of approximately $6 million resulting from the combination of the increase in the book of business and exposure and normal fluctuations in profitability between periods.

2005 over 2004

The losses and loss expenses and loss ratio reported in 2005 reflected a) losses related to the large 2005 catastrophic loss events in the amount of $741 million or 49.4 points on the loss ratio of this sub-segment (the loss ratio was adjusted for related reinstatement premiums); b) net favorable loss development on prior accident years in the amount of $212 million, or 14.5 points on the loss ratio; and c) a decrease in the book of business and exposure as evidenced by the decrease in net premiums earned. The net favorable loss development of $212 million included net favorable loss development in all lines, with the exception of net adverse loss development for the agriculture line of $10 million. The net favorable loss development was primarily due to favorable loss emergence, as losses reported by cedants during 2005 for prior accident years, and for treaties where the risk period expired, were lower (higher for agriculture) than the Company expected. Loss information provided by cedants in 2005 for prior accident years for all lines included no individually significant losses, but a series of attritional losses. Based on the Company’s assessment of this loss information, the Company has decreased its expected ultimate loss ratios for all lines (increased for the agriculture line), which had the net effect of decreasing the level of prior year loss estimates (increasing for the agriculture line).

 

66


Table of Contents

The increase of $590 million in losses and loss expenses and loss ratio from 2004 to 2005 is explained by:

 

   

an increase in large catastrophic losses of $656 million; and was partially offset by

 

   

a decrease in losses and loss expenses of approximately $47 million, resulting from the decrease in the book of business and exposure; and

 

   

an increase of $19 million in net favorable prior year development.

Acquisition costs and acquisition ratio

2006 over 2005

The decrease in acquisition costs and acquisition ratio in 2006 compared to 2005 was primarily attributable to a) adjustments for certain treaties in the third quarter of 2005, which resulted in higher acquisition costs for 2005, as well as b) normal shifts between lines of business that carry different acquisition ratios.

2005 over 2004

The decrease in acquisition costs in 2005 compared to 2004 resulted from the reduction in the Company’s book of business and exposure, as evidenced by the decrease in net premiums earned, and shifts in the mix of business as certain lines carry lower acquisition costs. Although the acquisition ratio is flat, two trends offset each other in 2005. The increase in net favorable prior year loss development resulted in increased sliding scale commissions and profit commission adjustments, which increased the acquisition ratio. Reinstatement premiums received by the Company following Hurricanes Katrina, Rita and Wilma carried lower acquisition costs than the average for this sub-segment, which had the effect of decreasing the acquisition ratio.

Technical result and technical ratio

2006 over 2005

The increase of $785 million in the technical result and the corresponding decrease in the technical ratio from 2005 to 2006 was primarily explained by a decrease of $695 million in large catastrophic losses, and an increase in profitability of approximately $109 million resulting from higher net premiums earned for the wind-exposed lines, which suffered no large catastrophic losses in 2006, partially offset by a reduction in net favorable prior year development of $19 million.

2005 over 2004

The decrease of $619 million in the technical result and the corresponding increase in the technical ratio from 2004 to 2005 was explained by an increase of $615 million in the level of large catastrophic losses, net of reinstatement premiums, and a reduction of approximately $23 million resulting from normal fluctuations in profitability between periods, partially offset by an increase of $19 million in net favorable prior year development.

2007 Outlook

During the January 1, 2007 renewals, the Company observed a continuation of the trend by cedants to increase their retentions. Terms and conditions weakened and pricing declined in several markets, as a result of increased competition, and the Company’s book of business was slightly reduced at the January 1, 2007 renewals in this sub-segment. For catastrophe-exposed lines, such as catastrophe, energy and marine, the Company observed improvements in pricing, as well as increased risk retention by cedants. Based on overall pricing indications and renewal

 

67


Table of Contents

information received from cedants and brokers, and assuming similar conditions experienced during the January 1, 2007 renewals continue throughout the year, Management expects a slight decline in gross and net premiums written and net premiums earned for this sub-segment in 2007.

ART Segment

The ART segment is comprised of structured risk transfer reinsurance, principal finance (previously referred to as structured finance), weather-related products and strategic investments, including the interest in earnings of the Company’s equity investment in Channel Re Holdings. The new name for the principal finance unit reflects the expansion of this unit into project finance and real estate related asset classes, in addition to the structured finance asset class.

As revenues in this segment are recorded either as premiums or other income (in the case of derivative contracts and contracts that do not qualify for reinsurance accounting), premiums alone are not a representative measure of activity in ART. This segment is very transaction driven, and revenues and profit trends will be uneven, especially given the relatively small size of this segment. Accordingly, profitability or growth in any year is not necessarily predictive of future profitability or growth.

The Company’s share of the results of Channel Re Holdings amounted to $12 million, $10 million and $6 million for the years ended December 31, 2006, 2005 and 2004, respectively. The Company records income on its investment in Channel Re Holdings on a one-quarter lag. The 2006 and 2005 results are not comparable to 2004, as 2004 represented results for an eight-month period from February 2004, the date of the Company’s acquisition of an ownership interest in Channel Re Holdings, to September 30, 2004.

The following table provides the components of the underwriting result and the interest in earnings of equity investments for this segment (in millions of U.S. dollars):

 

     2006     2005     2004  

Gross premiums written

   $ 35     $ 27     $ 5  

Net premiums written

     35       27       5  

Net premiums earned

   $ 31     $ 25     $ 6  

Losses and loss expenses

     (13 )     (32 )     (7 )

Acquisition costs

     (3 )     (3 )     (1 )
                        

Technical result

   $ 15     $ (10 )   $ (2 )

Other income

     24       31       11  

Other operating expenses

     (18 )     (13 )     (13 )
                        

Underwriting result

   $ 21     $ 8     $ (4 )

Interest in earnings of equity investments

   $ 12     $ 10     $ 6  

2006 over 2005

The ART segment had good growth in underwriting result during 2006 compared to 2005, despite continued difficult market conditions. Underwriting result increased by $13 million, from $8 million in 2005 to $21 million in 2006. While the 2005 results were adversely impacted by $16 million, net of additional premiums, related to the large catastrophic losses, the corresponding period of 2006 included one large loss of $6 million, as well as net favorable loss development of $3 million (net of additional premiums) related to the 2005 hurricanes. This segment also benefited from the early termination of a number of longer term contracts, which led to accelerated profit recognition for the terminated contracts, and stronger results on weather products. All lines of business were profitable in 2006, with the structured risk transfer and the Company’s interest in the earnings of Channel Re Holdings generating the largest contribution to pre-tax net income.

 

68


Table of Contents

2005 over 2004

The ART segment had good growth in underwriting result during 2005 compared to 2004, despite market conditions that impeded opportunities. Low interest rates, which tend to reduce the attractiveness of structured risk transfer business for clients, and low credit spreads, which reduced the opportunities in the principal finance business, were prevalent in both years.

Underwriting result increased in 2005 compared to 2004, despite a higher level of large catastrophic losses of $8 million, net of additional premiums. While the weather line returned to profitability in 2005, following incurred realized and unrealized losses on weather derivative instruments due to unusual weather patterns in Japan during 2004, the structured risk transfer line incurred losses on the 2005 hurricanes, which mitigated the positive impact of the weather and principal finance lines. Except for the structured risk transfer line, all lines of business were profitable in 2005, with the weather products and the Company’s interest in the earnings of Channel Re Holdings generating the largest contribution to pre-tax net income.

2007 Outlook

The Company expects that current interest rates and tight credit spreads will continue to impede growth in the structured risk transfer and principal finance lines, as well as the growth in the Company’s earnings from Channel Re Holdings. The Company intends to balance these trends by cautiously exploring new business initiatives in related risk categories (including project finance and real estate related asset classes) that should contribute to growth over time.

Life Segment

The following table provides the components of the allocated underwriting result for this segment (in millions of U.S. dollars):

 

     2006    

% Change

2006 over

2005

    2005    

% Change

2005 over

2004

    2004  

Gross premiums written

   $ 507     13 %   $ 448     8 %   $ 417  

Net premiums written

     487     12       434     7       404  

Net premiums earned

   $ 487     13     $ 430     6     $ 406  

Life policy benefits

     (363 )   14       (320 )   8       (296 )

Acquisition costs

     (117 )   (3 )     (120 )   (12 )     (136 )
                            

Technical result

   $ 7     NM     $ (10 )   (61 )   $ (26 )

Other operating expenses

     (29 )   28       (23 )   2       (22 )

Net investment income

     51     8       48     8       44  
                            

Allocated underwriting result (1)

   $ 29     98     $ 15     NM     $ (4 )

NM: not meaningful
(1) Allocated underwriting result is defined as net premiums earned and allocated net investment income less life policy benefits, acquisition costs and other operating expenses.

Premiums

The Life segment represented 13%, 12% and 11% of total net premiums written in 2006, 2005 and 2004, respectively.

2006 over 2005

The increase in gross and net premiums written and net premiums earned during 2006 compared to 2005 was attributable to growth in all lines of business, but was more evident in the mortality line. Growth in the

 

69


Table of Contents

mortality line resulted from intrinsic growth in the business written by the Company’s cedants, which resulted in more volume ceded to the Company on existing treaties, and new business generated by the Company. The longevity line reported a modest increase of 1% resulting from the Company not writing any new treaties in 2006 for this line of business. Furthermore, the U.S. dollar strengthened, on average, in 2006 compared to 2005 and premiums denominated in currencies that have depreciated against the U.S. dollar were converted into U.S dollars at a lower weighted average exchange rate. Without the negative contribution of foreign exchange, gross and net premiums written and net premiums earned would have increased by 14%, 13% and 14%, respectively.

2005 over 2004

The increases in gross and net premiums written and net premiums earned during 2005 compared to 2004 resulted primarily from three factors. First, the Company increased its book of mortality business at the end of 2004, which resulted in higher net premiums earned in 2005. Second, the Company experienced growth in mortality lines, partially offset by a reduction in longevity and health products in 2005. Finally, the U.S. dollar weakened, on average, in 2005 compared to 2004. Without the positive contribution of foreign exchange, gross and net premiums written and net premiums earned would have increased by 6%, 5% and 4%, respectively.

Life policy benefits

2006 over 2005

Life policy benefits increased by $43 million, or 14%, in 2006 compared to 2005. This was primarily attributable to the increase in the book of business and exposure, as evidenced by the 13% increase in net premiums earned for this segment. Life policy benefits in 2006 included net favorable prior year reserve development of $12 million. The net favorable reserve development included favorable development of $17 million in the mortality line, partially offset by adverse development of $5 million in the longevity line. The favorable development in the mortality line was related to the refinement of the Company’s reserving methodologies related to certain proportional guaranteed minimum death benefit treaties and the receipt of additional reported loss information from its cedants, while the adverse development in the longevity line was related to higher losses reported by cedants.

2005 over 2004

The increase in life policy benefits in 2005 compared to 2004 resulted primarily from the growth in the Company’s book of business and exposure, as evidenced by the increase in net premiums earned. The comparison was also affected by a reclassification made in 2004 for one large treaty where the cedant reported a reduction in life policy benefits and an equivalent increase in acquisition costs. This reclassification affected the comparison of life policy benefits and acquisition costs for the years 2005 and 2004. The Indian Ocean tsunami resulted in additional life policy benefits of $5 million in 2004.

Acquisition costs

2006 over 2005

The decrease of $3 million, or 3%, in acquisition costs in 2006 compared to 2005 was primarily attributable to shifts in the mix of business.

2005 over 2004

In 2004, acquisition costs included a $5 million charge to reduce deferred acquisition costs on annuity treaties retained in the sale of PartnerRe Life Insurance Company of the U.S. A prolonged period of low interest rates had a negative effect on these treaties, and resulted in a charge reflecting the actual experience to date as well as a revised projection of future results given updated assumptions. Without the effect of this charge and the

 

70


Table of Contents

reclassification discussed above, which increased acquisition costs in 2004, there would have been an increase in acquisition costs in 2005 compared to 2004. A shift in the mix of business for this segment in 2005 resulted in a higher proportion of mortality business, which tends to carry higher acquisition costs in the early years of the treaties.

Net investment income

2006 over 2005

Net investment income for 2006 increased by 8% for this segment compared to 2005, resulting primarily from the growth in the book of business and higher net investment income reported in 2006 by a cedant on a longevity treaty.

2005 over 2004

The increase in net investment income for 2005 compared to 2004 is also primarily attributable to the growth in the book of business.

Allocated underwriting result

2006 over 2005

The increase of $14 million in allocated underwriting result in 2006 compared to 2005 was primarily attributable to the $12 million of net favorable prior year development recorded in 2006, and the increase in net investment income allocated to this segment in 2006, partially offset by higher operating expenses, resulting principally from higher bonus accruals in 2006.

2005 over 2004

The increase of $19 million in allocated underwriting result in 2005 compared to 2004 was primarily attributable to the $5 million life policy benefits related to the Indian Ocean tsunami in 2004, the $5 million charge taken in 2004 to reduce deferred acquisition costs, and the increase of $4 million in net investment income allocated to this segment in 2005.

2007 Outlook

Based on pricing indications and renewal information received from cedants and brokers, and assuming constant foreign exchange rates, Management expects slight growth in gross and net premiums written and net premiums earned for this segment in 2007.

 

71


Table of Contents

Premium Distribution by Line of Business

The distribution of net premiums written by line of business for the years ended December 31, 2006, 2005 and 2004 was as follows:

 

     2006     2005     2004  

Non-life

      

Property and Casualty

      

Property

   19 %   19 %   19 %

Casualty

   19     19     21  

Motor

   6     8     10  

Worldwide Specialty

      

Agriculture

   5     3     4  

Aviation/Space

   5     6     6  

Catastrophe

   11     11     9  

Credit/Surety

   6     7     6  

Engineering

   5     4     5  

Energy

   2     1     1  

Marine

   3     3     2  

Specialty property

   2     2     3  

Specialty casualty

   3     4     3  

ART

   1     1     —    

Life

   13     12     11  
                  

Total

   100 %   100 %   100 %

There were modest shifts in the distribution of net premiums written by line and segment in 2006, 2005 and 2004, which reflected the Company’s response to existing market conditions as discussed below. Additionally, the distribution of net premiums written may also be affected by the timing of renewals of treaties or the shift in treaty structure from a proportional to non-proportional basis, which can significantly reduce premiums written. Foreign exchange fluctuations affected the comparison for all lines.

 

   

Casualty: increased competition, increased risk retention from cedants and lower cedant premium estimates for prior years are the principal reasons for the decrease in casualty premium volume in 2005.

 

   

Motor: the decrease in both 2006 and 2005 resulted from higher risk retention by cedants, prevailing market conditions and Management’s decision not to renew certain treaties in the U.S. P&C and Global (Non-U.S.) P&C sub-segments when the profitability did not meet the Company’s objectives.

 

   

Catastrophe: the catastrophe line benefited from improvements in pricing and terms and conditions following the 2004 and 2005 hurricanes. In response to the level of demand and attractive risk-adjusted pricing, Management increased the allocation of capacity to the catastrophe line, which also resulted in growth in premiums written during 2006 (after adjustment for reinstatement premiums in 2005). Non-life reinstatement premiums of $48 million related to the 2005 hurricanes and European winterstorm Erwin resulted in an increase in premium volume in 2005.

 

   

Life: as part of its diversification strategy, the Company continues to steadily increase the proportion of its life portfolio.

2007 Outlook

During the January 1, 2007 renewals, the Company observed a continuation of the trend by cedants to increase their retentions. Terms and conditions weakened and pricing declined in several markets, as a result of the increased competition and the Company’s book of business was slightly reduced at the January 1, 2007 renewals. Based on renewal information received from cedants and brokers, and assuming similar conditions experienced during the January 1, 2007 renewals continue throughout the year, Management expects the premium distribution by line in 2007 to be similar to 2006.

 

72


Table of Contents

Premium Distribution by Treaty Type

The Company typically writes business on either a proportional or non-proportional basis. On proportional business, the Company shares proportionally in both the premiums and losses of the cedant. On non-proportional business, the Company is typically exposed to loss events in excess of a predetermined dollar amount or loss ratio. In both proportional and non-proportional business, the Company typically reinsures a large group of primary insurance contracts written by the ceding company. In addition, the Company writes a small percentage of its business on a facultative basis. Facultative arrangements are generally specific to an individual risk and can be written on either a proportional or non-proportional basis. Generally, the Company has more influence over pricing, as well as terms and conditions, in non-proportional and facultative arrangements.

The distribution of gross premiums written by treaty type for the years ended December 31, 2006, 2005 and 2004 was as follows:

 

     2006     2005     2004  

Non-life Segment

      

Proportional

   51 %   50 %   53 %

Non-Proportional

   29     32     29  

Facultative

   5     5     7  

ART Segment

      

Non-Proportional

   1     1     —    

Life Segment

      

Proportional

   13     11     10  

Non-Proportional

   1     1     1  
                  

Total

   100 %   100 %   100 %

The distribution of gross premiums written by treaty type is affected by changes in the allocation of capacity among lines of business, as well as reinstatement premiums related to large catastrophic losses, which originate from non-proportional treaties. In addition, changes in average foreign exchange rates affect the year-to-year comparisons for all treaty types.

Non-life Segment

The 2005 period included $48 million of non-proportional reinstatement premiums related to the large 2005 catastrophic losses, which accounted for the modest shift in the distribution of gross premiums by treaty type for 2005 compared to 2004.

Life Segment

The increase in the percentage of proportional gross premiums written for the Life segment resulted from the increase in the Company’s mortality business.

2007 Outlook

The Company observed during the January 1, 2007 renewals that cedants continue to increase their retention levels, which in certain cases results in a shift from seeking reinsurance coverage written on a proportional basis to a non-proportional basis. Based on renewal information from cedants and brokers, and assuming similar conditions experienced during the January 1, 2007 renewals continue throughout the year, Management expects that increased retention by cedants will result in a slight shift from a proportional basis to a non-proportional basis in 2007 for the Non-life segment.

 

73


Table of Contents

Premium Distribution by Geographic Region

The geographic distribution of gross premiums written for the years ended December 31, 2006, 2005 and 2004 was as follows:

 

     2006     2005     2004  

North America

   43 %   41 %   40 %

Europe

   42     46     45  

Asia, Australia and New Zealand

   8     8     9  

Latin America, Caribbean and Africa

   7     5     6  
                  

Total

   100 %   100 %   100 %

The distribution of gross premiums for all non-U.S. regions was affected by foreign exchange fluctuations and distorts the year-to-year comparisons. In 2006, Management increased the allocation of capacity to areas exposed to U.S. wind as U.S. wind-exposed lines showed improvements in pricing and terms and conditions following the 2004 and 2005 hurricanes. This resulted in growth of premiums written in North America in 2006. In 2005, gross premiums written included $59 million of reinstatement premiums for the Non-life and ART segments related to the 2005 hurricanes, which increased the distribution in North America compared to 2004.

2007 Outlook

Based on January 1, 2007 renewal information from cedants and brokers, and assuming similar conditions experienced during the January 1, 2007 renewals continue throughout the year, Management expects the distribution of gross premiums written by geographic region in 2007 to be similar to 2006.

Premium Distribution by Production Source

The Company generates its gross premiums written both through brokers and through direct relationships with cedants. The percentage of gross premiums written by source for the years ended December 31, 2006, 2005 and 2004 was as follows:

 

     2006     2005     2004  

Broker

   69 %   63 %   64 %

Direct

   31     37     36  

The shift from direct to broker in 2006 compared to 2005 and 2004 reflected the increase of gross premiums written in North America, where premiums are written predominantly on a broker basis, and a modest shift of gross premiums written from direct to broker for the rest of the world in 2006.

2007 Outlook

Based on January 1, 2007 renewal information from cedants and brokers, and assuming similar conditions experienced during the January 1, 2007 renewals continue throughout the year, Management expects the production source of gross premiums written in 2007 to be similar to 2006.

 

74


Table of Contents

Investment Income

The table below provides net investment income by asset source for the years ended December 31, 2006, 2005 and 2004 (in millions of U.S. dollars):

 

     2006    

% Change

2006 over

2005

    2005    

% Change

2005 over

2004

    2004  

Fixed maturities

   $ 334     16 %   $ 288     17 %   $ 246  

Short-term investments, trading securities, and cash and cash equivalents

     61     141       26     221       8  

Equities

     33     21       27     38       20  

Funds held and other

     40     (1 )     41     —         41  

Investment expenses

     (19 )   13       (17 )   4       (17 )
                            

Net investment income

   $ 449     23     $ 365     22     $ 298  

2006 over 2005

Net investment income increased in 2006 compared to 2005 for the following reasons:

 

   

net investment income from fixed maturities, short-term investments, trading securities, and cash and cash equivalents increased in 2006 compared to 2005, primarily due to an increase in the asset base resulting from the reinvestment of cash flows from operations of $492 million generated in 2006, after the purchase of approximately $390 million of trading securities, cash proceeds of $549 million received from the Company’s capital raises in October 2005, as well as higher interest rates in 2006; and

 

   

net investment income from equity securities increased in 2006 compared to 2005, primarily due to an increase in the average asset base during the year, partially offset by a decrease in allocation to equity securities during the second quarter of 2006; partially reduced by

 

   

a decrease in investment income on funds held, as the funds held asset base at the beginning of 2006 was $129 million lower than at the beginning of 2005; and

 

   

an increase in investment expenses resulting from the increase in the asset base.

The strengthening of the U.S. dollar, on average, in 2006 compared to 2005 had minimal effect on the increase in net investment income.

2005 over 2004

Net investment income increased in 2005 compared to 2004 for the following reasons:

 

   

net investment income from fixed maturities, equities, short-term investments, trading securities, and cash and cash equivalents increased in 2005 compared to 2004, primarily due to the increase in the asset base resulting from positive cash flows from operations of $1,264 million for 2004 and $1,032 million for 2005. Cash flows from 2004 generated a full year of net investment income in 2005, while cash flows from 2005 were generated during the year and had a smaller positive impact on 2005’s net investment income;

 

   

after incurring large catastrophic losses in 2005, the Company received $549 million of additional capitalization in October 2005. At December 31, 2005, a significant portion of these funds was invested in cash equivalents and this contributed to the increase in the Company’s net investment income for this category of assets in 2005;

 

   

the Company converted its entire MBS portfolio into cash and invested in MBS TBA dollar rolls during 2004, which resulted in the Company holding over $1.5 billion in cash at June 30, 2004 and September 30, 2004. While holding MBS TBA dollar roll instruments, the Company received a total

 

75


Table of Contents
 

return similar to what it would have if it had held a long position in the MBS portfolio. In accordance with U.S. GAAP, the Company recorded the total return on MBS TBA dollar rolls as realized gains. If the Company had instead held a long MBS portfolio, it would have recorded approximately $6 million higher net investment income (and correspondingly lower realized gains); and

 

   

the weakening of the U.S. dollar, on average, in 2005 compared to 2004 contributed to the increase in net investment income. Without the positive contribution of foreign exchange, net investment income would have increased by 21%.

2007 Outlook

Current economic indicators continue to suggest moderate global economic growth. Assuming constant foreign exchange rates, the Company expects that the combination of the following items should contribute to higher net investment income in 2007 compared to 2006:

 

   

higher interest rates during 2006, which are expected to persist during 2007;

 

   

larger asset base at December 31, 2006; and

 

   

expected positive cash flows from operations generated during 2007, despite continuing expected claim payments on the large 2005 catastrophic loss events, although at a lower level than in 2006.

Net Realized Investment Gains

The Company’s portfolio managers have dual investment objectives of optimizing current investment income and achieving capital appreciation. To meet these objectives, it is often desirable to buy and sell securities to take advantage of changing market conditions and to reposition the investment portfolios. Accordingly, recognition of realized gains and losses is considered by the Company to be a normal consequence of its ongoing investment management activities.

Proceeds from the sale of investments classified as available for sale for 2006, 2005 and 2004 were $13,550 million, $9,968 million and $7,299 million, respectively. Realized investment gains and losses on securities classified as available for sale for the years ended December 31, 2006, 2005 and 2004 were as follows (in millions of U.S. dollars):

 

     2006     2005     2004  

Gross realized gains

   $ 268     $ 294     $ 154  

Gross realized losses excluding other-than-temporary impairments

     (205 )     (101 )     (53 )

Other-than-temporary impairments

     (27 )     (8 )     (11 )
                        

Total net realized investment gains on available for sale securities

   $ 36     $ 185     $ 90  

The components of net realized investment gains or losses for the years ended December 31, 2006, 2005 and 2004 were as follows (in millions of U.S. dollars):

 

     2006     2005     2004  

Net realized investment gains on available for sale securities, excluding other-than-temporary impairments

   $ 63     $ 193     $ 101  

Other-than-temporary impairments

     (27 )     (8 )     (11 )

Net realized investment gains on trading securities

     22       15       8  

Change in net unrealized investment gains or losses on trading securities

     11       2       (2 )

Net realized and unrealized investment gains or losses on equity securities sold but not yet purchased

     (10 )     (10 )     —    

Net realized and unrealized investment gains (losses) on designated hedging activities

     10       —         —    

Net realized and unrealized (losses) gains on other invested assets

     (1 )     3       29  

Other realized and unrealized investment (losses) gains

     (21 )     12       (8 )
                        

Total net realized investment gains

   $ 47     $ 207     $ 117  

 

76


Table of Contents

Realized investment gains and losses are generally a function of multiple factors, with the most significant being the prevailing interest rates, equity market conditions, the timing of disposition of fixed maturities and equity securities, and charges for the recognition of other-than-temporary impairments in the Company’s investment portfolio.

Following an overall rise in interest rates during 2006 compared to 2005, the majority of the Company’s fixed income securities decreased in value and sales of fixed income securities generated more realized investment losses than realized investment gains. Although the Company’s equity securities also experienced net realized investment losses in the difficult capital market environment prevailing during the second quarter of 2006, the equity portfolios benefited from a favorable environment during the first, third and fourth quarters of 2006 and generated more realized investment gains than realized investment losses, albeit at a lower level than in 2005. The realization of the unrealized market value appreciation or depreciation does not change the Company’s shareholders’ equity, as it merely transfers the gain or loss from the accumulated other comprehensive income section of the Consolidated Balance Sheet to net income on the Consolidated Statement of Operations and retained earnings on the Consolidated Balance Sheet.

During the years ended December 31, 2006, 2005 and 2004, the Company recorded charges for other-than-temporary impairments relating to its investment portfolio of $27 million, $8 million and $11 million, respectively. Typically, the Company considers impairment to have occurred when events have occurred that are likely to prevent the Company from recovering its investment in the security. The increase in 2006 is mainly due to a sustained higher interest rate environment relative to 2005, leading to larger unrealized losses on the Company’s fixed income portfolios. Approximately 60% of the impairments recorded in 2006 and 2005 related to securities of the industrial and manufacturing sector, while the balance was related to securities of the banking and finance sector. Approximately 48% of the impairments recorded in 2004 related to securities of the banking and finance sector, while the balance was spread over many sectors.

Other-than-temporary impairments are recorded as realized investment losses in the Consolidated Statements of Operations, which reduces net income and net income per share. Temporary losses are recorded as unrealized investment losses, which do not impact net income and net income per share but reduce accumulated other comprehensive income in the Consolidated Balance Sheet, except for those related to trading securities, which are recorded immediately as realized investment losses. (See Critical Accounting Policies and Estimates—Other-than-Temporary Impairment of Investments above, Financial Condition, Liquidity and Capital Resources—Investments below and Note 2(f) to Consolidated Financial Statements in Item 8 of Part II of this report).

Other Operating Expenses

Other operating expenses were as follows (in millions of U.S. dollars):

 

     2006   

% Change

2006 over

2005

    2005   

% Change

2005 over

2004

    2004

Other operating expenses

   $ 310    14 %   $ 272    —   %   $ 271

Other operating expenses are comprised primarily of personnel and infrastructure costs and represented 8.4%, 7.5% and 7.3% of total net premiums earned (both life and non-life) in 2006, 2005 and 2004, respectively.

2006 over 2005

The overall increase of 14% for 2006 consisted primarily of increases in personnel costs of $41 million, including bonus accruals and stock-based compensation expense, and $2 million in consulting and professional fees, partially offset by decreases of $5 million in fixed asset depreciation and other costs. The strengthening of the U.S. dollar, on average, in 2006 compared to 2005 impeded growth of other operating expenses. Without the contribution of foreign exchange, other operating expenses would have increased by 15% in 2006 compared to 2005. The ratio of operating expenses to net premiums earned increased in 2006 primarily because of higher compensation expenses, which are tied to the results of the Company.

 

77


Table of Contents

2005 over 2004

Although operating expenses were nearly flat in 2005 compared to 2004, increases in salaries, stock-based compensation, IT asset depreciation and rent and facilities totaling $22 million were offset by reductions in bonus accruals and consulting fees of $21 million. The ratio of operating expenses to net premiums earned increased in 2005 because net premiums earned decreased in 2005.

Other Income

Other income for the years ended December 31, 2006, 2005 and 2004 was $24 million, $35 million and $17 million, respectively, and primarily reflected income on the Company’s ART contracts that were accounted for using the deposit accounting method or were considered to be derivatives. See the discussion of the ART segment included in the section Review of Net Income (Loss) above.

Other income also included approximately $4 million and $6 million in 2005 and 2004, respectively, relating to a Non-life treaty that was accounted for using the deposit accounting method.

Financial Condition, Liquidity and Capital Resources

Investments

The total of investments and cash and cash equivalents was $10.7 billion at December 31, 2006, compared to $9.6 billion at December 31, 2005. The major factors influencing the increase in 2006 were:

 

   

net cash provided by operating activities of $882 million, after excluding $390 million net purchases of trading securities;

 

   

net proceeds of $36 million from the issuance of the capital efficient notes, the redemption of the trust preferred securities, less associated financing costs, and $10 million contract fees related to the forward sale agreement;

 

   

net issuance of the Company’s common shares under the Company’s equity plans of $17 million;

 

   

increase in the market value (realized and unrealized) of the investment portfolio of $12 million resulting from the increase in market value of the equity portfolio of $106 million, offset by the decrease in market value of the fixed income portfolio of $94 million;

 

   

increase in net payable for securities purchased, including equity securities sold but not yet repurchased, of $10 million; and

 

   

other factors, the primary one being the net positive influence of the effect of a weaker U.S. dollar relative to the euro and other currencies as it relates to the conversion of invested assets and cash balances into U.S. dollars, amounting to approximately $268 million; offset by

 

   

dividend payments on common and preferred shares totaling $125 million.

The Company employs a prudent investment philosophy. It maintains a high-quality, well-balanced and liquid portfolio having the dual objectives of optimizing current investment income and achieving capital appreciation. The Company’s invested assets are comprised of total investments, cash and cash equivalents and accrued investment income. From a risk management perspective, the Company allocates its invested assets into two categories: liability funds and capital funds. Liability funds represent invested assets supporting the net reinsurance liabilities, defined as the Company’s operating and reinsurance liabilities net of reinsurance assets, and are invested entirely in high-quality fixed income securities. The preservation of liquidity and protection of capital are the primary investment objectives for these assets. The portfolio managers are required to adhere to investment guidelines as to minimum ratings and issuer and sector concentration limitations. Liability funds are invested in a way that generally matches them to the corresponding liabilities in terms of both duration and

 

78


Table of Contents

currency composition to protect the Company against changes in interest and foreign exchange rates. Capital funds represent the capital of the Company and contain most of the asset classes typically viewed as offering a higher risk and higher return profile, subject to risk assumption and portfolio diversification guidelines, which include issuer and sector concentration limitations. Capital funds may be invested in investment-grade and below investment-grade fixed income securities, preferred and common stocks, private equity investments, and convertible fixed-income securities. The Company believes that an allocation of a portion of its investments to equities is both prudent and desirable, as it helps to achieve broader asset diversification (lower risk) and maximizes the portfolio’s total return over time.

The Company’s investment strategy allows the use of derivative instruments such as futures contracts, credit default swaps, written covered call options and foreign exchange forward contracts, subject to strict limitations. Derivative instruments may be used to replicate investment positions or to manage currency and market exposures and duration risk that would be allowed under the Company’s investment policy if implemented in other ways. The Company may also use written covered call options to enhance the investment performance of the equity portfolios, under strict guidelines and limitations. The Company’s investment strategy also allows, to a limited extent, the use of equity short sales, which represent sales of securities not owned at the time of the sale. These short sales are incorporated within a market neutral strategy, which involves holding long equity securities and a close-to-equal dollar amount of offsetting short equity securities. The objective of the market neutral strategy is to neutralize any effects from the stock market as a whole and to generate absolute positive returns.

At December 31, 2006, the liability funds totaled $6.6 billion and were comprised of cash and cash equivalents and high-quality fixed income securities. The capital funds, which totaled $4.2 billion, were comprised of cash and cash equivalents, investment-grade and below investment-grade fixed income securities, preferred and common stocks, private equity investments, and convertible fixed income securities. At December 31, 2006 and 2005, approximately 96% and 94%, respectively, of the fixed income securities were rated investment-grade (BBB- or higher) by Standard & Poor’s (or estimated equivalent).

Approximately 96% of the invested assets currently held by the Company are publicly traded and, accordingly, market valuations for such securities are readily available. For those securities not publicly traded (4% of the Company’s invested assets or approximately $423 million), consisting primarily of its investment in Channel Re Holdings and other investments in non-publicly traded companies, private placement equity investments, private equity funds, and other specialty asset classes, the valuation techniques depend on the nature of the individual asset. The valuation techniques used by the Company’s investment managers are reviewed by the Company and are generally commensurate with standard valuation techniques for each asset class.

At December 31, 2006, the average duration of the Company’s investment portfolio was 4.1 years, compared to 3.3 years at December 31, 2005. The Company increased the duration of its investment portfolio during 2006 to more closely match the natural duration of its liabilities. At December 31, 2006, the fixed maturities, short-term investments and cash and cash equivalents had an average yield to maturity at market of 4.9% compared to 4.5% at December 31, 2005, reflecting the increase in interest rates during 2006.

The Company’s investment portfolio generated a total return of 7.8%, 0.8% and 9.1% for the years ended December 31, 2006, 2005 and 2004, respectively. Investment income and the increase in the market value of the equity portfolios as well as the weaker U.S. dollar during 2006 contributed to the positive total return. The total return was partially reduced by the impact of the increase in interest rates during the period.

For accounting purposes, the Company’s investment portfolio is categorized according to two separate accounting classifications—available for sale and trading securities. For a description of the different accounting treatments afforded to these separate accounting classifications, see Note 2(f) to Consolidated Financial Statements.

At December 31, 2006, investments classified as available for sale comprised approximately 94% of the Company’s total investments (excluding other invested assets), with 6% being classified as trading securities.

 

79


Table of Contents

Included in the available for sale category is the Company’s portfolio of fixed maturity securities, comprised primarily of investment-grade securities issued by the U.S. government or U.S. government sponsored agencies, state and foreign governments, corporate debt securities, mortgage and asset-backed securities, short-term investments and equity securities. In addition, as part of its investment strategy, the Company invests a small percentage of its portfolio in below investment-grade bonds, which are also classified as available for sale.

The cost, gross unrealized gains, gross unrealized losses and fair value of investments classified as available for sale at December 31, 2006 and 2005, were as follows (in millions of U.S. dollars):

 

2006

   Cost(1)   

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

   

Fair

Value

Fixed maturities

          

—U.S. government

   $ 1,519    $ 4    $ (12 )   $ 1,511

—states or political subdivisions of states of the U.S.

     1      —        —         1

—other foreign governments

     1,554      18      (15 )     1,557

—corporate

     2,859      32      (26 )     2,865

—mortgage/asset-backed securities

     1,920      8      (26 )     1,902
                            

Total fixed maturities

     7,853      62      (79 )     7,836

Short-term investments

     134      —        —         134

Equities

     921      103      (9 )     1,015
                            

Total

   $ 8,908    $ 165    $ (88 )   $ 8,985

 

2005

   Cost(1)   

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

   

Fair

Value

Fixed maturities

          

—U.S. government

   $ 923    $ 2    $ (10 )   $ 915

—states or political subdivisions of states of the U.S.

     6      —        —         6

—other foreign governments

     1,678      34      (9 )     1,703

—corporate

     2,558      37      (30 )     2,565

—mortgage/asset-backed securities

     1,518      1      (21 )     1,498
                            

Total fixed maturities

     6,683      74      (70 )     6,687

Short-term investments

     231      —        —         231

Equities

     1,246      99      (11 )     1,334
                            

Total

   $ 8,160    $ 173    $ (81 )   $ 8,252

 


(1) Cost is amortized cost for fixed maturities and short-term investments and original cost for equity securities, net of other-than-temporary impairments.

 

80


Table of Contents

The following table presents the continuous periods during which the Company has held investment positions that were carried at an unrealized loss (excluding investments classified as trading securities) at December 31, 2006 (in millions of U.S. dollars):

 

     Less than 12 months     12 months or more     Total  
    

Fair

Value

  

Gross

Unrealized

Losses

   

Fair

Value

  

Gross

Unrealized

Losses

   

Fair

Value

  

Gross

Unrealized

Losses

 

Fixed maturities

               

—U.S. government

   $ 705    $ (5 )   $ 298    $ (7 )   $