Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2010

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) 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 of incorporation)  

(I.R.S. Employer

Identification No.)

90 Pitts Bay Road, Pembroke, HM08, Bermuda

(Address of principal executive offices) (Zip Code)

(441) 292-0888

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

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

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

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

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

The number of the Registrant’s common shares (par value $1.00 per share) outstanding, net of treasury shares, as of August 2, 2010 was 75,590,936.

 

 

 


Table of Contents

PartnerRe Ltd.

INDEX TO FORM 10-Q

 

     Page
PART I—FINANCIAL INFORMATION

ITEM 1.

  

Financial Statements

  
  

Report of Independent Registered Public Accounting Firm

   1
  

Unaudited Condensed Consolidated Balance Sheets—June 30, 2010 and December 31, 2009

   2
  

Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income—Three Months and Six Months Ended June 30, 2010 and 2009

   3
  

Unaudited Condensed Consolidated Statements of Shareholders’ Equity—Six Months Ended June 30, 2010 and 2009

   4
  

Unaudited Condensed Consolidated Statements of Cash Flows—Six Months Ended June 30, 2010 and 2009

   5
  

Notes to Unaudited Condensed Consolidated Financial Statements

   6

ITEM 2.

  

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

   23

ITEM 3.

  

Quantitative and Qualitative Disclosures about Market Risk

   62

ITEM 4.

  

Controls and Procedures

   65
PART II—OTHER INFORMATION

ITEM 1.

  

Legal Proceedings

   65

ITEM 1A.

  

Risk Factors

   65

ITEM 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   66

ITEM 3.

  

Defaults upon Senior Securities

   66

ITEM 4.

  

Reserved

   66

ITEM 5.

  

Other Information

   66

ITEM 6.

  

Exhibits

   66
  

Signatures

   67
  

Exhibit Index

   68

 


Table of Contents

PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of PartnerRe Ltd.

We have reviewed the accompanying condensed consolidated balance sheet of PartnerRe Ltd. and subsidiaries (the “Company”) as of June 30, 2010, and the related condensed consolidated statements of operations and comprehensive income for the three-month and six-month periods ended June 30, 2010 and 2009, and of shareholders’ equity, and of cash flows for the six-month periods ended June 30, 2010 and 2009. These interim condensed consolidated financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of PartnerRe Ltd. and subsidiaries as of December 31, 2009 and the related consolidated statements of operations and comprehensive income, shareholders’ equity, and of cash flows for the year then ended (not presented herein); and in our report dated March 1, 2010, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2009 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 

/S/ DELOITTE & TOUCHE
Deloitte & Touche

Hamilton, Bermuda

August 9, 2010

 

1


Table of Contents

PartnerRe Ltd.

Unaudited Condensed Consolidated Balance Sheets

(Expressed in thousands of U.S. dollars, except parenthetical share and per share data)

 

     June 30,
2010
    December 31,
2009
 

Assets

    

Investments:

    

Fixed maturities, trading securities, at fair value (amortized cost: 2010, $13,018,712; 2009, $13,856,840)

   $ 13,556,761      $ 14,143,093   

Short-term investments, trading securities, at fair value (amortized cost: 2010, $106,680; 2009, $134,830)

     106,773        137,346   

Equities, trading securities, at fair value (cost: 2010, $922,807; 2009, $731,387)

     885,999        795,539   

Other invested assets

     246,664        225,532   
                

Total investments

     14,796,197        15,301,510   

Funds held – directly managed (cost: 2010, $1,850,549; 2009, $2,126,456)

     1,875,305        2,124,826   

Cash and cash equivalents, at fair value, which approximates amortized cost

     1,085,325        738,309   

Accrued investment income

     184,715        218,739   

Reinsurance balances receivable

     2,627,422        2,249,181   

Reinsurance recoverable on paid and unpaid losses

     406,549        367,453   

Funds held by reinsured companies

     859,050        938,039   

Deferred acquisition costs

     672,694        614,857   

Deposit assets

     300,162        313,798   

Net tax assets

     73,414        79,044   

Goodwill

     455,533        455,533   

Intangible assets

     206,044        247,269   

Other assets

     93,724        83,986   
                

Total assets

   $ 23,636,134      $ 23,732,544   
                

Liabilities

    

Unpaid losses and loss expenses

   $ 10,342,589      $ 10,811,483   

Policy benefits for life and annuity contracts

     1,566,899        1,615,193   

Unearned premiums

     2,295,576        1,706,816   

Other reinsurance balances payable

     478,862        426,091   

Deposit liabilities

     314,723        330,015   

Net tax liabilities

     336,588        444,789   

Accounts payable, accrued expenses and other

     208,666        231,441   

Current portion of long-term debt

     200,000        200,000   

Debt related to senior notes

     750,000        250,000   

Debt related to capital efficient notes

     70,989        70,989   
                

Total liabilities

     16,564,892        16,086,817   
                

Shareholders’ Equity

    

Common shares (par value $1.00, issued: 2010, 83,215,032 shares; 2009, 82,585,707 shares)

     83,215        82,586   

Series C cumulative preferred shares (par value $1.00, issued and outstanding: 2010 and 2009, 11,600,000 shares; aggregate liquidation preference: 2010 and 2009, $290,000,000)

     11,600        11,600   

Series D cumulative preferred shares (par value $1.00, issued and outstanding: 2010 and 2009, 9,200,000 shares; aggregate liquidation preference: 2010 and 2009, $230,000,000)

     9,200        9,200   

Additional paid-in capital

     3,387,335        3,357,004   

Accumulated other comprehensive (loss) income:

    

Currency translation adjustment

     (91,235     82,843   

Other accumulated comprehensive (loss) income (net of tax of: 2010, $3,042; 2009, $3,144)

     (3,170     2,084   

Retained earnings

     4,274,755        4,100,782   

Common shares held in treasury, at cost (2010, 7,865,177 shares; 2009, 5,000 shares)

     (600,458     (372
                

Total shareholders’ equity

     7,071,242        7,645,727   
                

Total liabilities and shareholders’ equity

   $ 23,636,134      $ 23,732,544   
                

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

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Table of Contents

PartnerRe Ltd.

Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income

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

 

     For the three
months ended
June 30,
2010
    For the three
months ended
June 30,
2009
    For the six
months ended
June 30,
2010
    For the six
months ended
June 30,
2009
 

Revenues

        

Gross premiums written

   $ 1,140,175      $ 846,149      $ 3,049,501      $ 2,186,528   

Net premiums written

   $ 1,112,735      $ 844,659      $ 2,896,899      $ 2,152,717   

Increase in unearned premiums

     (8,104     (18,530     (638,489     (460,138
                                

Net premiums earned

     1,104,631        826,129        2,258,410        1,692,579   

Net investment income

     174,454        135,593        347,576        268,720   

Net realized and unrealized investment gains

     46,046        306,536        191,519        236,417   

Net realized gain on purchase of capital efficient notes

     —          —          —          88,427   

Other income

     753        3,361        2,028        7,942   
                                

Total revenues

     1,325,884        1,271,619        2,799,533        2,294,085   

Expenses

        

Losses and loss expenses and life policy benefits

     704,631        458,898        1,716,967        977,797   

Acquisition costs

     244,144        181,689        464,251        381,657   

Other operating expenses

     160,151        98,468        288,286        182,062   

Interest expense

     12,803        6,335        19,935        15,482   

Amortization of intangible assets

     7,833        —          12,636        —     

Net foreign exchange (gains) losses

     (11,021     1,202        (14,648     4,550   
                                

Total expenses

     1,118,541        746,592        2,487,427        1,561,548   

Income before taxes and interest in earnings of equity investments

     207,343        525,027        312,106        732,537   

Income tax expense

     17,762        56,954        45,316        116,765   

Interest in earnings of equity investments

     1,346        6,196        3,791        17   
                                

Net income

     190,927        474,269        270,581        615,789   

Preferred dividends

     8,631        8,631        17,263        17,263   
                                

Net income available to common shareholders

   $ 182,296      $ 465,638      $ 253,318      $ 598,526   
                                

Comprehensive income

        

Net income

   $ 190,927      $ 474,269      $ 270,581      $ 615,789   

Change in currency translation adjustment

     (105,335     38,922        (174,078     7,722   

Change in other accumulated comprehensive (loss) income, net of tax

     (1,321     (795     (5,254     1,529   
                                

Comprehensive income

   $ 84,271      $ 512,396      $ 91,249      $ 625,040   
                                

Per share data

        

Net income per common share:

        

Basic net income

   $ 2.36      $ 8.23      $ 3.19      $ 10.58   

Diluted net income

   $ 2.31      $ 8.10      $ 3.13      $ 10.43   

Weighted average number of common shares outstanding

     77,365,445        56,609,822        79,519,198        56,560,784   

Weighted average number of common and common share equivalents outstanding

     78,796,431        57,469,013        81,050,662        57,394,927   

Dividends declared per common share

   $ 0.50      $ 0.47      $ 1.00      $ 0.94   

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

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PartnerRe Ltd.

Unaudited Condensed Consolidated Statements of Shareholders’ Equity

(Expressed in thousands of U.S. dollars)

 

     For the six
months ended
June 30, 2010
    For the six
months ended
June 30, 2009
 

Common shares

    

Balance at beginning of period

   $ 82,586      $ 57,749   

Issue of common shares

     629        201   
                

Balance at end of period

     83,215        57,950   

Preferred shares

    

Balance at beginning and end of period

     20,800        20,800   

Additional paid-in capital

    

Balance at beginning of period

     3,357,004        1,465,688   

Issue of common shares

     30,331        13,743   
                

Balance at end of period

     3,387,335        1,479,431   

Accumulated other comprehensive (loss) income

    

Balance at beginning of period

     84,927        22,808   

Change in currency translation adjustment

     (174,078     7,722   

Change in other accumulated comprehensive (loss) income, net of tax

     (5,254     1,529   
                

Balance at end of period

     (94,405     32,059   

Retained earnings

    

Balance at beginning of period

     4,100,782        2,729,662   

Net income

     270,581        615,789   

Dividends on common shares

     (79,345     (53,151

Dividends on preferred shares

     (17,263     (17,263
                

Balance at end of period

     4,274,755        3,275,037   

Common shares held in treasury

    

Balance at beginning of period

     (372     (97,599

Repurchase of common shares

     (600,086     —     
                

Balance at end of period

     (600,458     (97,599
                

Total shareholders’ equity

   $ 7,071,242      $ 4,767,678   
                

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

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Table of Contents

PartnerRe Ltd.

Unaudited Condensed Consolidated Statements of Cash Flows

(Expressed in thousands of U.S. dollars)

 

     For the six
months ended
June 30, 2010
    For the six
months ended
June 30, 2009
 

Cash flows from operating activities

    

Net income

   $ 270,581      $ 615,789   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Amortization of net premium on investments

     37,518        10,074   

Amortization of intangible assets

     12,636        —     

Net realized and unrealized investment gains

     (191,519     (236,417

Net realized gain on purchase of capital efficient notes

     —          (88,427

Changes in:

    

Reinsurance balances, net

     (443,469     (286,205

Reinsurance recoverable on paid and unpaid losses, net of ceded premiums payable

     7,542        17,380   

Funds held by reinsured companies and funds held – directly managed

     169,847        8,537   

Deferred acquisition costs

     (80,901     (47,052

Net tax assets and liabilities

     (66,175     93,419   

Unpaid losses and loss expenses including life policy benefits

     194,878        (104,921

Unearned premiums

     638,489        460,138   

Other net changes in operating assets and liabilities

     (8,671     (14,789
                

Net cash provided by operating activities

     540,756        427,526   

Cash flows from investing activities

    

Sales of fixed maturities

     4,001,975        2,502,800   

Redemptions of fixed maturities

     561,593        561,895   

Purchases of fixed maturities

     (4,227,623     (3,447,701

Sales and redemptions of short-term investments

     94,045        110,600   

Purchases of short-term investments

     (69,056     (57,602

Sales of equities

     171,643        424,522   

Purchases of equities

     (341,427     (377,434

Other, net

     (138,272     (6,767
                

Net cash provided by (used in) investing activities

     52,878        (289,687

Cash flows from financing activities

    

Cash dividends paid to shareholders

     (96,608     (70,414

Proceeds from issuance of senior notes

     500,000        —     

Repurchase of treasury shares

     (600,086     —     

Issue of common shares

     15,013        4,975   

Contract fees on forward sale agreement

     (2,638     (2,502

Repayment of debt

     —          (200,000

Purchase of capital efficient notes

     —          (94,241
                

Net cash used in financing activities

     (184,319     (362,182

Effect of foreign exchange rate changes on cash

     (62,299     2,353   

Increase (decrease) in cash and cash equivalents

     347,016        (221,990

Cash and cash equivalents—beginning of period

     738,309        838,280   
                

Cash and cash equivalents—end of period

   $ 1,085,325      $ 616,290   
                

Supplemental cash flow information:

    

Taxes paid

   $ 109,841      $ 41,125   

Interest paid

   $ 17,866      $ 18,157   

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

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Table of Contents

PartnerRe Ltd.

Notes to Unaudited Condensed Consolidated Financial Statements

1. Organization

PartnerRe Ltd. (the Company) provides reinsurance on a worldwide basis through its principal wholly-owned subsidiaries, including Partner Reinsurance Company Ltd., Partner Reinsurance Europe Limited, Partner Reinsurance Company of the U.S., PARIS RE SA and PARIS RE Switzerland AG. Risks reinsured include, but are not limited to, property, casualty, motor, agriculture, aviation/space, catastrophe, credit/surety, engineering, energy, marine, specialty property, specialty casualty, multiline and other lines, life/annuity and health and alternative risk products. The Company’s alternative risk products include weather and credit protection to financial, industrial and service companies on a worldwide basis.

2. Significant Accounting Policies

The Company’s Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. The Unaudited Condensed Consolidated Financial Statements include the accounts of the Company and its subsidiaries. Intercompany accounts and transactions have been eliminated.

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. While Management believes that the amounts included in the Unaudited Condensed Consolidated Financial Statements reflect its best estimates and assumptions, actual results could differ from those estimates. The Company’s principal estimates include:

 

   

Unpaid losses and loss expenses;

 

   

Policy benefits for life and annuity contracts;

 

   

Gross and net premiums written and net premiums earned;

 

   

Recoverability of deferred acquisition costs;

 

   

Recoverability of deferred tax assets;

 

   

Valuation of goodwill and intangible assets; and

 

   

Valuation of certain assets and derivative financial instruments that are measured using significant unobservable inputs.

In the opinion of Management, all adjustments (which include normal recurring adjustments) necessary for a fair presentation of results for the interim periods have been made. As the Company’s reinsurance operations are exposed to low-frequency, high-severity risk events, some of which are seasonal, results for certain interim periods may include unusually low loss experience, while results for other interim periods may include significant catastrophic losses. Consequently, the Company’s results for interim periods are not necessarily indicative of results for the full year. These Unaudited Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

The following significant accounting policies were adopted by the Company during the six months ended June 30, 2010. The adoption of these policies did not have an impact on the Company’s consolidated shareholders’ equity or net income.

 

   

In June 2009, the Financial Accounting Standards Board (FASB) issued new accounting guidance which replaced the quantitative approach previously required for determining the primary beneficiary of a variable interest entity (VIE) with a qualitative approach to determine whether the Company has a controlling interest (primary beneficiary) in a VIE at the date when it becomes initially involved in the VIE. The guidance also requires the Company to perform ongoing reassessments, and provide certain disclosures, related to its involvement in VIEs. The Company adopted this guidance as of January 1, 2010.

The Company is involved in the normal course of business with VIEs as a passive investor in certain asset-backed securities, other fixed maturity investments and limited partnerships, that are issued by third party VIEs. The Company’s maximum exposure to loss with respect to these investments is limited to the investment carrying amounts reported in the Company’s Unaudited Condensed Consolidated Balance Sheets and any unfunded commitments. The Company also has three indirect wholly-owned subsidiaries that are considered to be VIEs, which were utilized to issue the Company’s Senior Notes and Capital Efficient Notes (see Note 16 to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009). The Company determined that it was not the primary beneficiary of any of these VIEs as of June 30, 2010.

 

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Table of Contents

PartnerRe Ltd.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

   

In January 2010, the FASB issued new accounting guidance which requires the Company to disclose additional information about its fair value measurements at a greater level of disaggregation. The additional disclosures include information about significant transfers into and/or out of the Level 1 and 2 categories, other disclosures about inputs and valuation techniques, and expanded disclosures related to the Level 3 activity. The Company adopted the guidance related to disclosures at a greater level of disaggregation, disclosures about transfers into and/or out of the Level 1 and 2 categories and other disclosures about inputs and valuation techniques as of January 1, 2010. Expanded disclosures related to the Level 3 activity will be effective for interim and annual periods beginning after December 15, 2010.

3. New Accounting Pronouncements

In March 2010, the FASB issued new accounting guidance for embedded credit derivatives, which clarifies that only a credit derivative related to the subordination of one financial instrument to another is exempt from embedded derivative bifurcation requirements. As a result, entities that have contracts containing an embedded credit derivative feature in a form other than such subordination, may need to separately account for the embedded credit derivative feature. This guidance is effective for interim and annual periods beginning after June 15, 2010, with early adoption permitted. The adoption of this guidance will not have an impact on the Company’s consolidated shareholders’ equity or net income.

In July 2010, the FASB issued new accounting guidance which requires companies to enhance the disclosures related to the credit quality of financing receivables and the allowances for credit losses. This guidance is effective for interim and annual periods ending on or after December 15, 2010. The Company is currently evaluating the impact of the adoption of this guidance on its disclosures.

4. Fair Value

(a) Fair Value of Financial Instrument Assets

The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value by maximizing the use of observable inputs and minimizing the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing an asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about what market participants would use in pricing the asset or liability based on the best information available in the circumstances. The level in the hierarchy within which a given fair value measurement falls is determined based on the lowest level input that is significant to the measurement.

The Company determines the appropriate level in the hierarchy for each financial instrument that it measures at fair value. In determining fair value, the Company uses various valuation approaches, including market, income and cost approaches. The hierarchy is broken down into three levels based on the reliability of inputs as follows:

 

   

Level 1 inputs—Unadjusted, quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.

The Company’s financial instruments that it measures at fair value using Level 1 inputs generally include: equities listed on a major exchange, exchange traded funds and exchange traded derivatives, such as futures and certain weather derivatives, that are actively traded.

 

   

Level 2 inputs—Quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in inactive markets and directly or indirectly observable inputs, other than quoted prices, used in industry accepted models.

The Company’s financial instruments that it measures at fair value using Level 2 inputs generally include: U.S. Treasury bonds; U.S. Government Sponsored Entities; Organization for Economic Co-operation and Development Sovereign Treasury bonds; investment grade and high yield corporate bonds; catastrophe bonds; mortgage-backed securities; asset-backed securities; foreign exchange forward contracts and over-the-counter derivatives such as foreign currency option contracts, equity put and call options, credit default swaps and interest rate swaps.

 

   

Level 3 inputs—Unobservable inputs.

The Company’s financial instruments that it measures at fair value using Level 3 inputs generally include: unlisted equities including preference shares; unit trusts; inactively traded fixed maturities; real estate mutual fund investments; notes receivable and total return swaps.

 

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PartnerRe Ltd.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

The Company’s financial instruments measured at fair value include investments classified as trading securities, certain other invested assets and the segregated investment portfolio underlying the funds held – directly managed account. At June 30, 2010 and December 31, 2009, the Company’s financial instruments measured at fair value were categorized between Levels 1, 2 and 3 as follows (in thousands of U.S. dollars):

 

June 30, 2010

   Quoted prices in
active markets for
identical assets
(Level 1)
    Significant other
observable inputs
(Level 2)
    Significant
unobservable
inputs
(Level 3)
    Total  

Fixed maturities, trading securities

        

U.S. government and agencies

   $ —        $ 1,105,256      $ 9,999      $ 1,115,255   

Other foreign governments

     —          2,640,461        —          2,640,461   

Corporate

     —          6,772,051        15,437        6,787,488   

Asset-backed securities

     —          389,113        225,958        615,071   

Residential mortgage-backed securities

     —          2,367,973        —          2,367,973   

Other mortgage-backed securities

     —          29,659        854        30,513   
                                

Fixed maturities, trading securities

   $ —        $ 13,304,513      $ 252,248      $ 13,556,761   

Short-term investments, trading securities

   $ —        $ 106,773      $ —        $ 106,773   

Equities, trading securities

        

Finance

   $ 93,500      $ —        $ 2,115      $ 95,615   

Consumer noncyclical

     91,893        —          —          91,893   

Energy

     90,883        —          —          90,883   

Technology

     88,867        —          —          88,867   

Industrials

     75,614        —          —          75,614   

Consumer cyclical

     70,808        —          —          70,808   

Communications

     64,544        —          —          64,544   

Other

     87,046        —          —          87,046   

Mutual funds and exchange traded funds

     181,117        —          39,612        220,729   
                                

Equities, trading securities

   $ 844,272      $ —        $ 41,727      $ 885,999   

Other invested assets

        

Foreign exchange forward contracts

   $ —        $ (16,056   $ —        $ (16,056

Foreign currency option contracts

     —          445        —          445   

Futures contracts

     (16,042     —          —          (16,042

Credit default swaps (protection purchased)

     —          (1,207     —          (1,207

Credit default swaps (assumed risks)

     —          (1,406     —          (1,406

Insurance-linked securities

     (5     —          (6,763     (6,768

Total return swaps

     —          —          (7,816     (7,816

Interest rate swaps

     —          (8,104     —          (8,104

Other

     —          423        50,289        50,712   
                                

Other invested assets

   $ (16,047   $ (25,905   $ 35,710      $ (6,242

Funds held – directly managed

        

U.S. government and agencies

   $ —        $ 313,027      $ 357      $ 313,384   

Other foreign governments

     —          439,818        —          439,818   

Corporate

     —          864,189        —          864,189   

Mortgage/asset-backed securities

     —          —          12,577        12,577   

Short-term investments

     —          28,495        —          28,495   

Other invested assets

     —          —          26,825        26,825   
                                

Funds held – directly managed

   $ —        $ 1,645,529      $ 39,759      $ 1,685,288   
                                

Total

   $ 828,225      $ 15,030,910      $ 369,444      $ 16,228,579   

During the three months and six months ended June 30, 2010, there were no significant transfers between Levels 1 and 2.

 

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PartnerRe Ltd.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

 

December 31, 2009

   Quoted prices in
active markets for
identical assets
(Level 1)
   Significant other
observable inputs
(Level 2)
   Significant
unobservable
inputs
(Level 3)
   Total

Fixed maturities, trading securities

   $ —      $ 13,945,500    $ 197,593    $ 14,143,093

Short-term investments, trading securities

     —        137,346      —        137,346

Equities, trading securities

     757,436      —        38,103      795,539

Other invested assets

     —        39,795      16,454      56,249

Funds held – directly managed

     —        1,790,676      39,619      1,830,295
                           

Total

   $ 757,436    $ 15,913,317    $ 291,769    $ 16,962,522

At June 30, 2010 and December 31, 2009, the aggregate carrying amounts of items included in other invested assets that the Company did not measure at fair value were $252.9 million and $169.3 million, respectively, which primarily related to the Company’s investments that are accounted for using the cost method of accounting, equity method of accounting or investment company accounting.

At June 30, 2010 and December 31, 2009, the aggregate carrying amounts of items included in the funds held – directly managed account that the Company did not measure at fair value were $116.7 million and $123.9 million, respectively, which primarily related to other assets and liabilities held by Colisée Re related to the underlying business, which are carried at cost (see Note 7 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009). In addition to the investments underlying the funds held – directly managed account held at fair value of $1,685.3 million and $1,830.3 million at June 30, 2010 and December 31, 2009, respectively, the funds held – directly managed account included cash and cash equivalents, carried at fair value, of $51.5 million and $145.4 million, respectively, and accrued investment income of $21.8 million and $25.2 million, respectively.

At June 30, 2010 and December 31, 2009, substantially all of the accrued investment income and the accrued investment income related to the investments underlying the funds held – directly managed account in the Unaudited Condensed Consolidated Balance Sheets related to investments for which the fair value option was elected.

 

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Table of Contents

PartnerRe Ltd.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

The following tables are reconciliations of the beginning and ending balances for all financial instruments measured at fair value using Level 3 inputs for the three months ended June 30, 2010 and 2009 (in thousands of U.S. dollars):

 

For the three months ended June 30, 2010

   Balance at
beginning of
period
    Realized and
unrealized
investment
gains (losses)
included in net
income
    Net purchases,
sales and
settlements
    Net transfers
(out of)/into
Level 3(a)
   Balance at
end of period
    Change in
unrealized
investment

gains (losses)
relating to
assets held at
end of period
 

Fixed maturities, trading securities

             

U.S. government and agencies

   $ 9,720      $ 272      $ 7      $ —      $ 9,999      $ 272   

Corporate

     10,057        300        5,080        —        15,437        300   

Asset-backed securities

     84,984        7,359        133,615        —        225,958        7,359   

Residential mortgage-backed securities

     95,029        —          (95,029     —        —          —     

Other mortgage-backed securities

     811        123        (80     —        854        123   
                                               

Fixed maturities, trading securities

   $ 200,601      $ 8,054      $ 43,593      $ —      $ 252,248      $ 8,054   

Equities, trading securities

             

Finance

   $ 2,459      $ (1,039   $ 695      $ —      $ 2,115      $ (1,039

Mutual funds and exchange traded funds

     35,670        (1,058     5,000        —        39,612        (1,058
                                               

Equities, trading securities

   $ 38,129      $ (2,097   $ 5,695      $ —      $ 41,727      $ (2,097

Other invested assets

             

Derivatives, net

   $ (7,998   $ 1,772      $ (8,353   $ —      $ (14,579   $ 1,772   

Other

     25,918        (253     24,624        —        50,289        (253
                                               

Other invested assets

   $ 17,920      $ 1,519      $ 16,271      $ —      $ 35,710      $ 1,519   

Funds held – directly managed

             

U.S. government and agencies

   $ 204      $ 153      $ —        $ —      $ 357      $ 153   

Mortgage/asset-backed securities

     13,260        (683     —          —        12,577        (683

Other invested assets

     30,348        (3,523     —          —        26,825        (3,523
                                               

Funds held – directly managed

   $ 43,812      $ (4,053   $ —        $ —      $ 39,759      $ (4,053
                                               

Total

   $ 300,462      $ 3,423      $ 65,559      $ —      $ 369,444      $ 3,423   

 

(a) The Company’s policy is to recognize the transfers between the hierarchy levels at the beginning of the period.

 

For the three months ended June 30, 2009

   Balance at
beginning of
period
    Realized and
unrealized
investment
gains (losses)
included in net
income
    Net purchases,
sales and
settlements
    Net transfers
out of
Level 3
    Balance at
end of period
   Change in
unrealized
investment

gains (losses)
relating to
assets held at
end of period
 

Fixed maturities

   $ 121,578      $ 19,037      $ (4,010   $ (64,630   $ 71,975    $ 18,606   

Short-term investments

     93        (20     —          —          73      (20

Equities

     32,985        1,729        —          —          34,714      1,729   

Other invested assets

     (8,754     16,219        (2,176     —          5,289      15,575   
                                               

Total

   $ 145,902      $ 36,965      $ (6,186   $ (64,630   $ 112,051    $ 35,890   

 

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Table of Contents

PartnerRe Ltd.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

The following tables are reconciliations of the beginning and ending balances for all financial instruments measured at fair value using Level 3 inputs for the six months ended June 30, 2010 and 2009 (in thousands of U.S. dollars):

 

For the six months ended June 30, 2010

   Balance at
beginning of
period
    Realized and
unrealized
investment
gains (losses)
included in net
income
    Net purchases,
sales and
settlements
    Net transfers
(out of)/into
Level 3(a)
    Balance at
end of period
    Change in
unrealized
investment

gains (losses)
relating to
assets held at
end of period
 

Fixed maturities, trading securities

            

U.S. government and agencies

   $ 4,286      $ 272      $ 9,727      $ (4,286   $ 9,999      $ 272   

Corporate

     15,041        423        10,900        (10,927     15,437        423   

Asset-backed securities

     99,952        4,601        124,305        (2,900     225,958        4,576   

Residential mortgage-backed securities

     77,440        191        (77,631     —          —          —     

Other mortgage-backed securities

     874        153        (173     —          854        153   
                                                

Fixed maturities, trading securities

   $ 197,593      $ 5,640      $ 67,128      $ (18,113   $ 252,248      $ 5,424   

Equities, trading securities

            

Finance

   $ 2,488      $ (1,068   $ 695      $ —        $ 2,115      $ (1,068

Industrials

     805        (84     (721     —          —          —     

Mutual funds and exchange traded funds

     34,810        (198     5,000        —          39,612        (198
                                                

Equities, trading securities

   $ 38,103      $ (1,350   $ 4,974      $ —        $ 41,727      $ (1,266

Other invested assets

            

Derivatives, net

   $ (9,361   $ 4,315      $ (17,699   $ 8,166      $ (14,579   $ 2,490   

Other

     25,815        (169     24,643        —          50,289        (169
                                                

Other invested assets

   $ 16,454      $ 4,146      $ 6,944      $ 8,166      $ 35,710      $ 2,321   

Funds held – directly managed

            

U.S. government and agencies

   $ 375      $ (18   $ —        $ —        $ 357      $ (18

Other foreign governments

     3,417        (13     (3,404     —          —          —     

Mortgage/asset-backed securities

     142        (4,431     —          16,866        12,577        (4,426

Other invested assets

     35,685        (8,860     —          —          26,825        (8,860
                                                

Funds held – directly managed

   $ 39,619      $ (13,322   $ (3,404   $ 16,866      $ 39,759      $ (13,304
                                                

Total

   $ 291,769      $ (4,886   $ 75,642      $ 6,919      $ 369,444      $ (6,825

 

(a) The Company’s policy is to recognize the transfers between the hierarchy levels at the beginning of the period.

 

For the six months ended June 30, 2009

   Balance at
beginning of
period
    Realized and
unrealized
investment
gains (losses)
included in net
income
    Net purchases,
sales and
settlements
    Net transfers
out of
Level 3
    Balance at
end of period
   Change in
unrealized
investment

gains (losses)
relating to
assets held at
end of period
 

Fixed maturities

   $ 78,138      $ 18,741      $ (5,936   $ (18,968   $ 71,975    $ 18,622   

Short-term investments

     137        (64     —          —          73      (64

Equities

     33,547        1,226        (59     —          34,714      1,226   

Other invested assets

     (16,136     23,720        (2,295     —          5,289      22,792   
                                               

Total

   $ 95,686      $ 43,623      $ (8,290   $ (18,968   $ 112,051    $ 42,576   

During the six months ended June 30, 2010, certain fixed maturities with a fair value of $18 million were transferred from Level 3 into Level 2. The reclassifications to Level 2 consisted of municipal (included within U.S. government and agencies), corporate and student loans (included within asset-backed securities) fixed maturities. The transfers into Level 2 were due to the availability of quoted prices for similar assets in active markets used for valuation as of June 30, 2010, resulting from the continued recovery of the financial markets. In addition, during the six months ended June 30, 2010, certain derivatives with a fair value in a net liability position of $8 million were transferred out of Level 3 into Level 2 due to the availability of externally modeled quoted prices that use observable inputs.

 

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PartnerRe Ltd.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

During the six months ended June 30, 2010, certain fixed maturities within the investments underlying the funds held – directly managed account with a fair value of $17 million were transferred from Level 2 into Level 3. The reclassification into Level 3 consisted of asset-backed securities and residential and commercial mortgage-backed securities. The transfers into Level 3 were the result of the lack of observable market inputs, leading the Company to apply inputs that were not directly observable.

Changes in the fair value of the Company’s financial instruments subject to the fair value option during the three months and six months ended June 30, 2010 and 2009 were as follows (in thousands of U.S. dollars):

 

     For the three
months ended
June 30,
2010
    For the three
months ended
June 30,
2009
    For the six
months ended
June 30,
2010
    For the six
months ended
June 30,
2009
 

Fixed maturities, trading securities

   $ 165,665      $ 186,819      $ 264,762      $ 138,448   

Short-term investments, trading securities

     7        (206     (2,418     (581

Equities, trading securities

     (126,610     121,199        (101,198     124,689   

Funds held – directly managed

     19,988        N/A        31,167        N/A   
                                

Total

   $ 59,050      $ 307,812      $ 192,313      $ 262,556   

 

N/A: not applicable

All of the above changes in fair value are included in the Unaudited Condensed Consolidated Statements of Operations under the caption Net realized and unrealized investment gains.

The following methods and assumptions were used by the Company in estimating the fair value of each class of financial instrument recorded in the Unaudited Condensed Consolidated Balance Sheets. There have been no material changes in the Company’s valuation techniques during the periods presented.

Fixed maturities and short-term investments

Substantially all of the Company’s fixed maturities and short-term investments are categorized as Level 2 within the fair value hierarchy. The Company receives prices from independent pricing sources to measure the fair values of its fixed maturity investments. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. Each source has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing source applies the credit spread for a comparable security that has traded recently to the current yield curve to determine a reasonable fair value. The Company uses a pricing service ranking to consistently select the most appropriate pricing service in instances where it receives multiple quotes on the same security. When fair values are unavailable from these independent pricing sources, quotes are obtained directly from broker-dealers who are active in the corresponding markets. Most of the Company’s fixed maturities are priced from the pricing services or dealer quotes. The Company will typically not make adjustments to prices received from pricing services or dealer quotes; however, in instances where the quoted external price for a security uses significant unobservable inputs, the Company will categorize that security as Level 3. The Company’s inactively traded fixed maturities are classified as Level 3. For all fixed maturity investments, the bid price is used for estimating fair value.

To validate prices, the Company compares the fair value estimates to its knowledge of the current market and will investigate prices that it considers not to be representative of fair value. The Company also reviews an internally generated fixed maturity price validation report which converts prices received for fixed maturity investments from the independent pricing sources and from broker-dealers quotes and plots option adjusted spreads (OAS) and duration on a sector and rating basis. The OAS is calculated using established algorithms developed by an independent risk analytics platform vendor. The OAS on the fixed maturity price validation report are compared for securities in a similar sector and having a similar rating, and outliers are identified and investigated for price reasonableness. In addition, the Company completes quantitative analyses to compare the performance of each fixed maturity investment portfolio to the performance of an appropriate benchmark, with significant differences identified and investigated.

Equities

The majority of the Company’s equities are categorized as Level 1 within the fair value hierarchy. In determining the fair value for equities and exchange traded funds categorized as Level 1, the Company uses prices received from independent pricing sources based on closing exchange prices. Equities categorized as Level 3 are generally mutual funds invested in securities other than the common stock of publicly traded companies, where the net asset value is not provided on a daily basis.

To validate prices, the Company completes quantitative analyses to compare the performance of each equity investment portfolio to the performance of an appropriate benchmark, with significant differences identified and investigated.

 

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Table of Contents

PartnerRe Ltd.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

Other invested assets

The Company’s exchange traded derivatives, such as futures, options and certain weather derivatives are categorized as Level 1 and foreign exchange forward contracts, foreign currency option contracts, equity put and call options, interest rate swaps, and credit default swaps are categorized as Level 2 within the fair value hierarchy. Included in the Company’s Level 3 categorization are unlisted equities including preference shares, unit trusts, credit linked notes, notes receivable and total return swaps. The Company will generally either (i) receive a price based on a manager’s or trustee’s valuation for the asset; or (ii) develop an internal discounted cash flow model to measure fair value. Where the Company receives prices from the manager or trustee, these prices are based on the manager’s or trustee’s estimate of fair value for the assets and are generally audited on an annual basis. Where the Company develops its own discounted cash flow models, the inputs will be specific to the asset in question, based on appropriate historical information, adjusted as necessary, and using appropriate discount rates. As part of the Company’s modeling to determine the fair value of an investment, the Company considers counterparty credit risk as an input to the model, however, the majority of the Company’s counterparties are highly rated institutions and the failure of any one counterparty would not have a significant impact on the Company’s financial statements.

To validate prices, the Company will compare them to benchmarks, where appropriate, or to the business results generally within that asset class and specifically to those particular assets. In addition, the fair value measurements of all Level 3 investments are presented to, and peer reviewed by, an internal valuation committee that the Company has established.

Funds held – directly managed

The segregated investment portfolio underlying the funds held – directly managed account is comprised of fixed maturities, short-term investments and other invested assets which are fair valued on a basis consistent with the methods described above. Substantially all fixed maturities and short-term investments within the funds held – directly managed account are categorized as Level 2 within the fair value hierarchy.

The other invested assets within the segregated investment portfolio underlying the funds held – directly managed account, which are categorized as Level 3 investments, are primarily real estate mutual fund investments carried at fair value. For the real estate mutual fund investments, the Company receives a price based on the real estate fund manager’s valuation for the asset and further adjusts the price, if necessary, based on appropriate current information on the real estate market.

To validate prices within the segregated investment portfolio underlying the funds held – directly managed account, the Company utilizes the methods described above.

(b) Fair Value of Financial Instrument Liabilities

The methods and assumptions used by the Company in estimating the fair value of each class of financial instrument liability recorded in the Unaudited Condensed Consolidated Balance Sheet at June 30, 2010, for which the Company does not measure that instrument at fair value, did not change from December 31, 2009, except for the fair value of the capital efficient notes (CENts), which was based on quoted market prices.

The fair value of the Senior Notes, issued on March 10, 2010, was based on quoted market prices (see Note 5).

The carrying values and fair values of the financial instrument liabilities recorded in the Unaudited Condensed Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009 were as follows (in thousands of U.S. dollars):

 

     June 30, 2010    December 31, 2009
     Carrying
Value
   Fair Value    Carrying
Value
   Fair Value

Policy benefits for life and annuity contracts (1)

   $ 1,566,899    $ 1,566,899    $ 1,615,193    $ 1,615,193

Current portion of long-term debt

     200,000      200,000      200,000      199,494

Debt related to senior notes (2)

     750,000      760,220      250,000      264,438

Debt related to capital efficient notes (3)

     63,384      60,020      63,384      56,355

 

(1) Policy benefits for life and annuity contracts included short-duration and long-duration contracts.
(2) PartnerRe Finance A LLC and PartnerRe Finance B LLC, the issuers of the Senior Notes, do not meet consolidation requirements under U.S. GAAP. Accordingly, the Company shows the related intercompany debt of $750.0 million and $250.0 million in its Unaudited Condensed Consolidated Balance Sheets at June 30, 2010 and December 31, 2009, respectively.
(3) PartnerRe Finance II Inc., the issuer of the CENts, does not meet consolidation requirements under U.S. GAAP. Accordingly, the Company shows the related intercompany debt of $71.0 million in its Unaudited Condensed Consolidated Balance Sheets at June 30, 2010 and December 31, 2009, respectively.

 

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Table of Contents

PartnerRe Ltd.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

5. Debt Related to Senior Notes

On March 10, 2010, PartnerRe Finance B LLC (PartnerRe Finance B), an indirect wholly-owned subsidiary of the Company, issued $500.0 million aggregate principal amount of 5.500% Senior Notes (Senior Notes). The Senior Notes will mature on June 1, 2020 and may be redeemed at the option of the issuer, in whole or in part, at any time. Interest on the Senior Notes is payable semi-annually commencing on June 1, 2010 at an annual fixed rate of 5.500%, and cannot be deferred.

The Senior Notes are ranked as senior unsecured obligations of PartnerRe Finance B. The Company has fully and unconditionally guaranteed all obligations of PartnerRe Finance B under the Senior Notes. The Company’s obligations under this guarantee are senior and unsecured and rank equally with all other senior unsecured indebtedness of the Company. The proceeds from the Senior Notes were used for general corporate purposes.

Contemporaneously, PartnerRe U.S. Holdings, a wholly-owned subsidiary of the Company, issued a 5.500% promissory note, with a principal amount of $500.0 million to PartnerRe Finance B. Under the terms of the promissory note, PartnerRe U.S. Holdings promises to pay to PartnerRe Finance B the principal amount on June 1, 2020, unless previously paid. Interest on the promissory note is payable semi-annually commencing on June 1, 2010 at an annual fixed rate of 5.500%, and cannot be deferred.

6. Net Income per Share

The reconciliation of basic and diluted net income per share is as follows (in thousands of U.S. dollars or shares, except per share amounts):

 

 

     For the three
months ended
June 30,
2010
   For the three
months ended
June 30,
2009
   For the six
months ended
June 30,
2010
   For the six
months ended
June 30,
2009

Numerator:

           

Net income

   $ 190,927    $ 474,269    $ 270,581    $ 615,789

Less: preferred dividends

     8,631      8,631      17,263      17,263
                           

Net income available to common shareholders

   $ 182,296    $ 465,638    $ 253,318    $ 598,526
                           

Denominator:

           

Weighted average number of common shares outstanding—basic

     77,365.4      56,609.8      79,519.2      56,560.8

Share options and other (1)

     1,431.0      859.2      1,531.5      834.1
                           

Weighted average number of common and common share equivalents outstanding—diluted

     78,796.4      57,469.0      81,050.7      57,394.9
                           

Basic net income per share

   $ 2.36    $ 8.23    $ 3.19    $ 10.58

Diluted net income per share (1)

   $ 2.31    $ 8.10    $ 3.13    $ 10.43

 

(1) At June 30, 2010 and 2009, share options to purchase 840.4 thousand and 969.4 thousand common shares, respectively, were excluded from the calculation of diluted weighted average number of common and common share equivalents outstanding because their exercise prices were greater than the average market price of the common shares.

7. Derivatives

The Company’s derivative instruments are recorded in the Unaudited Condensed Consolidated Balance Sheets at fair value, with changes in fair value mainly recognized in either net foreign exchange gains and losses or net realized and unrealized investment gains and losses in the Unaudited Condensed Consolidated Statements of Operations or accumulated other comprehensive income or loss in the Unaudited Condensed Consolidated Balance Sheets, depending on the nature of the derivative instrument. The Company’s objectives for holding or issuing these derivatives are as follows:

Foreign Exchange Forward Contracts

The Company utilizes foreign exchange forward contracts as part of its overall currency risk management and investment strategies. From time to time, the Company also utilizes foreign exchange forward contracts to hedge a portion of its net investment exposure resulting from the translation of its foreign subsidiaries and branches whose functional currency is other than the U.S. dollar.

Foreign Currency Option Contracts and Futures Contracts

The Company also utilizes foreign currency option contracts to mitigate foreign currency risk. The Company uses exchange traded treasury note futures contracts to manage portfolio duration and commodity and equity futures to hedge certain investments.

 

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Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

Credit Default Swaps

The Company purchases protection through credit default swaps to mitigate the risk associated with its underwriting operations, most notably in the credit/surety line, and to manage market exposures.

The Company also assumes credit risk through credit default swaps to replicate investment positions. The original term of these credit default swaps is generally five years or less and there are no recourse provisions associated with these swaps. While the Company would be required to perform under exposure assumed through credit default swaps in the event of a default on the underlying issuer, no issuer was in default at June 30, 2010. The counterparties on the Company’s assumed credit default swaps are all highly rated financial institutions.

Insurance-Linked Securities

The Company has entered into various weather derivatives, weather futures and a longevity total return swap for which the underlying risks include parametric weather risks for the weather derivatives and weather futures, and longevity risk for the longevity total return swap.

Total Return and Interest Rate Swaps and Interest Rate Derivatives

The Company has entered into total return swaps referencing various project and principal finance obligations. The Company has also entered into interest rate swaps to mitigate interest rate risk on certain total return swaps and interest rate derivatives to mitigate exposure to interest rate volatility.

The fair values and the related notional values of derivatives included in the Company’s Unaudited Condensed Consolidated Balance Sheets at June 30, 2010 and December 31, 2009 were as follows (in thousands of U.S. dollars):

 

     June 30, 2010    December 31, 2009
     Fair
Value
    Notional
Value
   Fair
Value
    Notional
Value

Derivatives designated as hedges

         

Foreign exchange forward contracts (net investment hedge)

   $ —        $ —      $ 4,840      $ —  

Interest rate derivatives

     —          —        6,354        400,000
                     

Total derivatives designated as hedges

   $ —           $ 11,194     

Derivatives not designated as hedges

         

Foreign exchange forward contracts

   $ (16,056   $ 1,385,554    $ 1,137      $ 1,333,862

Foreign currency option contracts

     445        112,457      1,680        108,205

Futures contracts

     (16,042     770,585      27,866        1,825,297

Credit default swaps (protection purchased)

     (1,207     172,912      (2,056     192,996

Credit default swaps (assumed risks)

     (1,406     27,500      566        22,500

Insurance-linked securities

     (6,768     116,115      (149     48,962

Total return swaps

     (7,816     170,369      (1,195     229,165

Interest rate swaps

     (8,104     —        (8,166     —  

Other

     61        —        130        —  
                     

Total derivatives not designated as hedges

   $ (56,893      $ 19,813     
                     

Total derivatives

   $ (56,893      $ 31,007     

The fair value of all derivatives at June 30, 2010 and December 31, 2009 is recorded in other invested assets in the Company’s Unaudited Condensed Consolidated Balance Sheets. The effective portion of net investment hedging derivatives recognized in accumulated other comprehensive income at December 31, 2009 was a loss of $66.3 million. The effective portion of interest rate derivatives recognized in accumulated other comprehensive income at December 31, 2009 was a gain of $6.4 million. There were no net investment hedges or interest rate derivatives outstanding at June 30, 2010.

The gains and losses in the Unaudited Condensed Consolidated Statements of Operations for derivatives not designated as hedges for the three and six months ended June 30, 2010 and 2009 were as follows (in thousands of U.S. dollars):

 

     For the
three months  ended
June 30, 2010
    For the
three months ended
June 30, 2009
   For the
six months  ended
June 30, 2010
   For the
six months ended
June 30, 2009

Foreign exchange forward contracts

   $ 14,557      $ 22,221    $ 10,542    $ 2,035

Foreign currency option contracts

     (1,066     3,989      1,134      2,184
                            

 

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Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

     For the
three months  ended
June 30, 2010
    For the
three months ended
June 30, 2009
    For the
six months  ended
June 30, 2010
    For the
six months ended
June 30, 2009
 

Total included in net foreign exchange gains and losses

   $ 13,491      $ 26,210      $ 11,676      $ 4,219   

Futures contracts

   $ (55,170   $ 39,434      $ (76,115   $ 34,200   

Credit default swaps (protection purchased)

     311        (8,261     (341     (8,836

Credit default swaps (assumed risks)

     (1,400     6,347        (1,379     77   

Insurance-linked securities

     2,676        50        3,814        571   

Total return swaps

     (212     12,983        2,409        19,203   

Interest rate swaps

     (104     1,620        393        3,202   

Interest rate derivatives

     —          —          (3,848     —     

Other

     55        213        (66     230   
                                

Total included in net realized and unrealized investment gains and losses

   $ (53,844   $ 52,386      $ (75,133   $ 48,647   
                                

Total derivatives not designated as hedges

   $ (40,353   $ 78,596      $ (63,457   $ 52,866   

8. Off-Balance Sheet Arrangements

On April 28, 2010, under the terms of the amendment to the forward sale agreement with the forward counterparty, the remaining $200 million forward sale agreement matured. Subsequent to maturity and commencing on April 28, 2010, there was a 40 day valuation period, whereby the Company could deliver up to 3.4 million common shares over the valuation period, subject to a minimum price per share of $59.05 and a maximum price per share of $84.15. As a result of the Company’s share price trading between the minimum and the maximum price per share during the valuation period, the Company did not deliver any common shares to the forward counterparty.

See Off-Balance Sheet Arrangements in Notes 15 and 18 to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

9. Credit Agreements

In the normal course of its operations, the Company enters into agreements with financial institutions to obtain unsecured and secured credit facilities. These facilities are used primarily for the issuance of letters of credit, although a portion of these facilities may also be used for liquidity purposes.

On May 14, 2010, the Company entered into an agreement to modify an existing credit facility with Credit Suisse AG. Under the terms of the agreement, this credit facility was increased from a $100 million unsecured credit facility to a $250 million combined credit facility, with the initial $100 million being unsecured and any utilization above that being secured. This credit facility matures on May 14, 2011, and can be extended automatically to May 14, 2012.

See Note 21 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for a discussion of the credit facilities available to the Company.

10. Commitments and Contingencies

(a) Concentration of Credit Risk

The Company’s investment portfolio is managed following prudent standards of diversification and a prudent investment philosophy. The Company is not exposed to any significant credit concentration risk on its investments, except for debt securities issued or guaranteed by the U.S. and other AAA rated sovereign governments. As of June 30, 2010, the Company’s fixed maturity investments included $787 million, or 11.1% of the Company’s total shareholders’ equity, of AAA rated debt securities issued by the government of France. As of December 31, 2009, the Company’s fixed maturity investments included $814 million, or 10.6% of the Company’s total shareholders’ equity, of AAA rated debt securities issued by the government of France. The Company keeps cash and cash equivalents in several banks and may keep up to $500 million, excluding custodial accounts, at any point in time in any one bank.

See Note 19(a) to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for a complete description of the Company’s credit risks and the related credit risk management strategies and controls.

(b) Employment Agreements

In April 2010, as part of the Company’s integration of PARIS RE (Paris Re), the Company announced a voluntary termination plan (voluntary plan) available to certain eligible employees in France. During the three months and six months ended June 30, 2010, the Company recorded charges of $33.8 million and $35.2 million, respectively, related to the voluntary plan within other operating

 

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Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

expenses. Employees participating in the voluntary plan have no compulsory notice periods, however, their expected leaving dates are over the next 18 months. Participating employees will continue to receive salary and other employment benefits until they leave the Company. The continuing salary and other employment benefits costs related to participating employees will be expensed as the employee provides service and remains with the Company.

(c) Legal Proceedings

Legal proceedings at June 30, 2010 have not changed significantly since December 31, 2009. See Note 19(e) to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

11. Segment Information

The Company monitors the performance of its operations in three segments, Non-life, Life and Corporate and Other as described in Note 22 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. The Non-life segment is further divided into five sub-segments: U.S., Global (Non-U.S.) P&C, Global (Non-U.S.) Specialty, Catastrophe and Paris Re.

Because the Company does not manage its assets by segment, net investment income is not allocated to the Non-life segment. However, because of the interest-sensitive nature of some of the Company’s Life products, net investment income is considered in Management’s assessment of the profitability of the Life segment. The following items are not considered in evaluating the results of the Non-life and Life segments: net realized and unrealized investment gains and losses, net realized gain on purchase of CENts, interest expense, amortization of intangible assets, net foreign exchange gains and losses, income tax expense or benefit and interest in earnings and losses of equity investments. Segment results are shown before consideration of intercompany transactions.

Management measures results for the Non-life segment on the basis of the loss ratio, acquisition ratio, technical ratio, other operating expense ratio and combined ratio (defined below). Management measures results for the Non-life sub-segments on the basis of the loss ratio, acquisition ratio and technical ratio. Management measures results for the Life segment on the basis of the allocated underwriting result, which includes revenues from net premiums earned, other income or loss and allocated net investment income for Life, and expenses from life policy benefits, acquisition costs and other operating expenses.

 

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Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

The following tables provide a summary of the segment revenues and results for the three months and six months ended June 30, 2010 and 2009 (in millions of U.S. dollars, except ratios):

Segment Information

For the three months ended June 30, 2010

 

     U.S.     Global
(Non-U.S.)

P&C
    Global
(Non-U.S.)
Specialty
    Catastrophe     Paris Re     Total
Non-life
Segment
    Life
Segment
    Corporate
and Other
    Total  

Gross premiums written

   $ 170      $ 144      $ 288      $ 125      $ 246      $ 973      $ 167      $ —        $ 1,140   

Net premiums written

   $ 170      $ 142      $ 285      $ 125      $ 217      $ 939      $ 167      $ 7      $ 1,113   

Decrease (increase) in unearned premiums

     14        32        (18     (63     27        (8     6        (6     (8
                                                                        

Net premiums earned

   $ 184      $ 174      $ 267      $ 62      $ 244      $ 931      $ 173      $ 1      $ 1,105   

Losses and loss expenses and life policy benefits

     (95     (112     (173     19        (175     (536     (169     —          (705

Acquisition costs

     (60     (45     (63     (5     (46     (219     (25     —          (244
                                                                        

Technical result

   $ 29      $ 17      $ 31      $ 76      $ 23      $ 176      $ (21   $ 1      $ 156   

Other income (loss)

               1        1        (1     1   

Other operating expenses

               (82     (13     (65     (160
                                          

Underwriting result

             $ 95      $ (33     n/a      $ (3

Net investment income

                 20        154        174   
                                    

Allocated underwriting result (1)

               $ (13     n/a        n/a   

Net realized and unrealized investment gains

                   46        46   

Interest expense

                   (13     (13

Amortization of intangible assets

                   (8     (8

Net foreign exchange gains

                   11        11   

Income tax expense

                   (17     (17

Interest in earnings of equity investments

                   1        1   
                              

Net income

                   n/a      $ 191   
                              

Loss ratio (2)

     51.4     64.4     64.9     (30.4 )%      71.8     57.6      

Acquisition ratio (3)

     32.4        25.6        23.5        8.1        18.9        23.4         
                                                      

Technical ratio (4)

     83.8     90.0     88.4     (22.3 )%      90.7     81.0      

Other operating expense ratio (5)

               8.8         
                        

Combined ratio (6)

               89.8      
                        

 

(1) Allocated underwriting result is defined as net premiums earned, other income or loss and allocated net investment income less life policy benefits, acquisition costs and other operating expenses.
(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.
(5) Other operating expense ratio is obtained by dividing other operating expenses by net premiums earned.
(6) Combined ratio is defined as the sum of the technical ratio and the other operating expense ratio.

 

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PartnerRe Ltd.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

Segment Information

For the three months ended June 30, 2009

 

     U.S.     Global
(Non-U.S.)
P&C
    Global
(Non-U.S.)
Specialty
    Catastrophe     Total
Non-life
Segment
    Life
Segment
    Corporate
and Other
    Total  

Gross premiums written

   $ 248      $ 120      $ 232      $ 125      $ 725      $ 116      $ 5      $ 846   

Net premiums written

   $ 249      $ 118      $ 232      $ 125      $ 724      $ 116      $ 5      $ 845   

Decrease (increase) in unearned premiums

     9        43        —          (73     (21     7        (5     (19
                                                                

Net premiums earned

   $ 258      $ 161      $ 232      $ 52      $ 703      $ 123      $ —        $ 826   

Losses and loss expenses and life policy benefits

     (164     (83     (152     22        (377     (85     3        (459

Acquisition costs

     (63     (38     (50     (4     (155     (27     —          (182
                                                                

Technical result

   $ 31      $ 40      $ 30      $ 70      $ 171      $ 11      $ 3      $ 185   

Other income

             1        —          2        3   

Other operating expenses

             (55     (11     (32     (98
                                        

Underwriting result

           $ 117      $ —          n/a      $ 90   

Net investment income

               15        121        136   
                                  

Allocated underwriting result (1)

             $ 15        n/a        n/a   

Net realized and unrealized investment gains

                 307        307   

Interest expense

                 (6     (6

Net foreign exchange losses

                 (2     (2

Income tax expense

                 (57     (57

Interest in earnings of equity investments

                 6        6   
                            

Net income

                 n/a      $ 474   
                            

Loss ratio (2)

     63.7     51.5     65.5     (43.0 )%      53.6      

Acquisition ratio (3)

     24.2        23.7        21.5        7.9        22.0         
                                              

Technical ratio (4)

     87.9     75.2     87.0     (35.1 )%      75.6      

Other operating expense ratio (5)

             7.9         
                      

Combined ratio (6)

             83.5      
                      

 

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Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

Segment Information

For the six months ended June 30, 2010

 

     U.S.     Global
(Non-U.S.)
P&C
    Global
(Non-U.S.)
Specialty
    Catastrophe     Paris Re     Total
Non-life
Segment
    Life
Segment
    Corporate
and Other
    Total  

Gross premiums written

   $ 462      $ 485      $ 667      $ 371      $ 707      $ 2,692      $ 354      $ 3      $ 3,049   

Net premiums written

   $ 462      $ 482      $ 637      $ 371      $ 594      $ 2,546      $ 349      $ 2      $ 2,897   

Increase in unearned premiums

     (45     (142     (115     (218     (106     (626     (12     (1     (639
                                                                        

Net premiums earned

   $ 417      $ 340      $ 522      $ 153      $ 488      $ 1,920      $ 337      $ 1      $ 2,258   

Losses and loss expenses and life policy benefits

     (245     (305     (358     (105     (405     (1,418     (299     —          (1,717

Acquisition costs

     (121     (84     (113     (12     (85     (415     (49     —          (464
                                                                        

Technical result

   $ 51      $ (49   $ 51      $ 36      $ (2   $ 87      $ (11   $ 1      $ 77   

Other income (loss)

               2        1        (1     2   

Other operating expenses

               (160     (27     (101     (288
                                          

Underwriting result

             $ (71   $ (37     n/a      $ (209

Net investment income

                 37        311        348   
                                    

Allocated underwriting result (1)

               $ —          n/a        n/a   

Net realized and unrealized investment gains

                   191        191   

Interest expense

                   (20     (20

Amortization of intangible assets

                   (13     (13

Net foreign exchange gains

                   15        15   

Income tax expense

                   (45     (45

Interest in earnings of equity investments

                   4        4   
                              

Net income

                   n/a      $ 271   
                              

Loss ratio (2)

     58.7     89.6     68.6     68.4     83.0     73.9      

Acquisition ratio (3)

     28.9        24.7        21.8        8.0        17.4        21.6         
                                                      

Technical ratio (4)

     87.6     114.3     90.4     76.4     100.4     95.5      

Other operating expense ratio (5)

               8.3         
                        

Combined ratio (6)

               103.8      
                        

 

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Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

Segment Information

For the six months ended June 30, 2009

 

     U.S.     Global
(Non-U.S.)
P&C
    Global
(Non-U.S.)
Specialty
    Catastrophe     Total
Non-life
Segment
    Life
Segment
    Corporate
and Other
    Total  

Gross premiums written

   $ 561      $ 419      $ 591      $ 330      $ 1,901      $ 281      $ 5      $ 2,187   

Net premiums written

   $ 561      $ 417      $ 563      $ 330      $ 1,871      $ 277      $ 5      $ 2,153   

Increase in unearned premiums

     (61     (99     (84     (199     (443     (14     (3     (460
                                                                

Net premiums earned

   $ 500      $ 318      $ 479      $ 131      $ 1,428      $ 263      $ 2      $ 1,693   

Losses and loss expenses and life policy benefits

     (326     (158     (309     11        (782     (198     2        (978

Acquisition costs

     (126     (79     (110     (12     (327     (55     —          (382
                                                                

Technical result

   $ 48      $ 81      $ 60      $ 130      $ 319      $ 10      $ 4      $ 333   

Other income

             3        1        4        8   

Other operating expenses

             (109     (21     (52     (182
                                        

Underwriting result

           $ 213      $ (10     n/a      $ 159   

Net investment income

               30        239        269   
                                  

Allocated underwriting result (1)

             $ 20        n/a        n/a   

Net realized and unrealized investment gains

                 236        236   

Net realized gain on purchase of capital efficient notes

                 89        89   

Interest expense

                 (15     (15

Net foreign exchange losses

                 (5     (5

Income tax expense

                 (117     (117

Interest in earnings of equity investments

                 —          —     
                            

Net income

                 n/a      $ 616   
                            

Loss ratio (2)

     65.2     49.6     64.5     (8.6 )%      54.8      

Acquisition ratio (3)

     25.2        24.9        23.0        8.9        22.9         
                                              

Technical ratio (4)

     90.4     74.5     87.5     0.3     77.7      

Other operating expense ratio (5)

             7.6         
                      

Combined ratio (6)

             85.3      
                      

 

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PartnerRe Ltd.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

12. Subsequent Events

On July 7, 2010, the Company agreed to sell its entire ownership of ChannelRe Holdings (ChannelRe), a Bermuda based non-publicly traded financial guaranty reinsurer, in consideration for cash of $9.7 million. Following the sale, the Company no longer has an ownership interest in ChannelRe and has no contractual obligations to provide capital or other financial support to ChannelRe. The carrying value of the Company’s investment in ChannelRe immediately prior to its sale was $nil, resulting in a realized gain on sale of $9.7 million, which the Company will record in its Consolidated Statements of Operations for the three months and nine months ended September 30, 2010 (see Note 24 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009).

On July 12, 2010, the Company repaid the $200 million remaining half of the original $400 million loan agreement with Citibank N.A. (see Note 15 to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009).

On July 12, 2010, the Company announced certain changes in its executive management group. Related to these changes, on July 28, 2010, the Company entered into a separation agreement with a member of executive management. As a result, the Company expects to recognize an additional pre-tax charge of approximately $10 million during the remainder of 2010.

On July 16, 2010, the Company terminated its existing $660 million five-year syndicated unsecured credit facility, which had a maturity date of September 30, 2010, and entered into a new $750 million three-year syndicated unsecured credit facility. The new facility has the following terms: (i) a maturity date of July 16, 2013, (ii) a $250 million accordion feature, which enables the Company to potentially increase its available credit from $750 million to $1 billion, and (iii) a minimum consolidated tangible net worth requirement. The Company’s ability to increase its available credit to $1 billion is subject to the agreement of the credit facility participants, which may be limited. The Company’s breach of any of the covenants would result in an event of default, upon which the Company may be required to repay any outstanding borrowings and replace or cash collateralize letters of credit issued under these facilities. The new facility will predominantly be used for the issuance of letters of credit, although the Company and its subsidiaries have access to a revolving line of credit of up to $375 million as part of this facility.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Executive Overview

The Company is a leading global reinsurer, with a broadly diversified and balanced portfolio of traditional reinsurance risks and capital markets risks.

Successful risk management is the foundation of the Company’s value proposition, with diversification of risks at the core of its risk management strategy. The Company’s ability to succeed in the risk assumption and management 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. All risks are managed by the Company within an integrated framework of policies and processes that ensure the intelligent and consistent evaluation and valuation of risk, and ultimately provide an appropriate return to shareholders.

The Company’s economic objective is to manage a portfolio of risks that will generate compound annual diluted book value per share growth of 10 percent and an average operating return on beginning shareholders’ equity of 13 percent over a reinsurance cycle.

See Executive Overview—Key Financial Measures and Other Key Issues of Management in Item 7 of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

Risk Management

A key challenge in the reinsurance industry is to create economic value through the intelligent assumption of reinsurance and capital markets and investment risk, but also to limit or mitigate those risks that can destroy tangible as well as 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 and Risk Factors in Item 1A of Part II of the Company’s Quarterly Report on Form 10-Q for the three months ended March 31, 2010. In addition to these risks, the Company assumes risks and its results are primarily determined by how well the Company understands, prices and manages assumed 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 the shareholders’ need for an adequate return on their capital. See Executive Overview—Other Key Issues of Management—Risk Management in Item 7 of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for a complete description of the Company’s risks, risk management framework and the related risk management strategies and controls.

The Company manages assumed risk at a strategic level through diversification, risk appetite, and absolute limits. For each key risk, the Board approves a risk appetite that the Company defines as the percentage of economic capital the Company is willing to expose to economic loss with a modeled probability of occurring once every 15 years and once every 75 years. The Company manages its exposure to key risks such that the modeled economic loss at a 1 in 15 year and a 1 in 75 year return period are less than the economic capital the Company is willing to expose to the key risks at those return periods.

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 impact 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, plus the unrecognized value of our Life portfolio. For traded assets, the calculated net present values are equivalent to market values.

There are four areas of risk that the Company has currently identified as having the greatest potential for shock losses: catastrophe, reserving for casualty and other long-tail lines, equity and equity-like investment risk and longevity risk. The Company manages the risk of shock losses by setting risk appetite and limits, as described above and below, for each type of shock loss. 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 should such an event occur.

See Executive Overview—Other Key Issues of Management—Risk Management in Item 7 of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for a discussion of the Company’s exposure to catastrophe risk, casualty reserving risk and equity investment risk.

 

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During the three months ended March 31, 2010, Management identified longevity risk as the fourth area of risk having the potential for shock losses. Management considers longevity exposure to have a material accumulation potential and has established a limit to manage the risk of loss associated with this exposure. The Company defines longevity risk as the potential for increased actual and future expected annuity payments resulting from annuitants living longer than expected, or the expectation that annuitants will live longer in the future. Assuming longevity risk, through reinsurance or capital markets transactions, is part of the Company’s strategy of building a diversified portfolio of risks. While longevity risk is highly diversifying in relation to other risks in the Company’s portfolio (e.g. mortality products), longevity risk itself is a systemic risk with little opportunity to diversify within the risk class. Longevity risk accumulates across cedants, geographies, and over time because mortality trends can impact diverse populations in the same manner. Longevity risk can manifest slowly over time as experience proves annuitants are living longer than original expectations, or abruptly as in the case of a “miracle drug” that increases the life expectancy of all annuitants simultaneously.

In order to determine a longevity limit metric for the purposes of risk accumulation, the Company examined extreme scenarios and measured its exposure to loss under those scenarios. Examples of these scenarios included, but were not limited to, immediate elimination of major causes of death and an extreme improvement scenario equivalent to the adverse result of every annuitant’s life expectancy increasing to approximately 100 years. The Company did not rely upon modeled losses to determine the limit metric, but did benchmark the scenario results against existing tests, scenarios and models. For risk accumulation purposes, the Company selected the most extreme scenario and added an additional margin for error.

The Company selected a longevity limit of $2 billion. To measure utilization of the longevity limit (accumulation of longevity exposure), the Company accumulates the net present value of adverse loss resulting from the application of the selected extreme scenario and additional margin applied to every in-force longevity treaty and the notional value of any longevity insurance-linked security.

Other risks such as interest rate risk and credit spread risk have the ability to impact results substantially and may result in volatility in results from period to period, 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 3 of Part I of this report for additional disclosure on interest rate risk, credit spread risk, foreign currency risk, counterparty credit risk and equity price risk.

The Company seeks to maintain 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. Management believes that the Company’s actual risk profile is equal to or less than the average of the reinsurance market because of the level of diversification achieved in the portfolio, the strict adherence to risk appetite and limits, and the risk mitigation strategies employed.

The limits and actual exposures of the Company for its major risks were as follows:

 

Risk

   Limit at
June 30, 2010
   Utilized at
June 30, 2010
   Utilized at
December 31, 2009

Catastrophe risk – largest zonal limit

   $   2.8 billion    $   2.4 billion    $ 2.4 billion

Casualty reserving risk – total earned premiums for casualty and other long-tail lines for the four most recent underwriting periods

     6.3 billion      3.2 billion      3.4 billion

Equity investment risk – value of equity and equity-like securities

     4.0 billion      1.3 billion      1.2 billion

Longevity risk – net present value loss from extreme mortality improvement scenario

     2.0 billion      0.5 billion      N/A

 

N/A: not applicable

The risk appetite and modeled economic loss for the Company’s major risks were as follows:

 

Risk

   Risk Appetite at
June 30, 2010(1)
   Modeled
Economic Loss  at
June 30, 2010(1)
   Modeled
Economic Loss at
December 31, 2009

Catastrophe risk – 1 in 75 year annual aggregate loss

   $ 1.6 billion    $ 1.2 billion    $ 1.3 billion

Casualty reserving risk – casualty and other long-tail lines
1 in 15 year prior years reserve development

     0.8 billion      0.5 billion      0.5 billion

Equity investment risk – 1 in 75 year decline in value

     1.2 billion      0.4 billion      0.4 billion

 

(1) The Company has not defined a risk appetite for longevity risk as it believes that establishing a limit is currently the most appropriate risk management metric. In addition, the Company has not relied upon a modeled economic loss for longevity risk.

 

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Critical Accounting Policies and Estimates

Critical Accounting Policies and Estimates of the Company at June 30, 2010 have not changed materially compared to December 31, 2009. See Critical Accounting Policies and Estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. The following discussion updates specific information related to the Company’s estimates for losses and loss expenses and life policy benefits and valuation of investments and funds held – directly managed, including certain derivative financial instruments.

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. 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 and sub-segment are reported in the table 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. For all 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’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 reserving cell and underwriting year for which the projection is made.

See Critical Accounting Policies and Estimates—Losses and Loss Expenses and Life Policy Benefits in Item 7 of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for additional information on the reserving methodologies employed by the Company, the principal reserving methods used for the reserving lines, the principal parameter assumptions underlying the methods and the main underlying factors upon which the estimates of reserving parameters are predicated.

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 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. The selected best estimates of reserves are always within the indicated reasonable range of estimates indicated by the Company’s actuaries.

During the three months and six months ended June 30, 2010 and 2009, the Company reviewed its estimate for prior year losses for each sub-segment of the Non-life segment and, in light of developing data, determined to adjust its ultimate loss ratios for prior accident years. The following table summarizes the net prior year favorable reserve development for the Company’s Non-life segment for the three months and six months ended June 30, 2010 and 2009 (in millions of U.S. dollars):

 

     For the three
months ended
June 30,
2010
   For the three
months ended
June 30,
2009
   For the six
months ended
June 30,
2010
   For the six
months ended
June 30,
2009

Net prior year favorable reserve development:

           

Non-life segment

           

U.S.

   $ 47    $ 56    $ 69    $ 77

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

     17      35      51      87

Global (Non-U.S.) Specialty

     39      31      73      56

Catastrophe

     8      21      10      23

Paris Re

     10      N/A      11      N/A
                           

Total net Non-life prior year favorable reserve development

   $ 121    $ 143    $ 214    $ 243

 

N/A: not applicable

 

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The net favorable reserve development on prior accident years for the three months and six months ended June 30, 2010 and 2009 was driven by the following factors (in millions of U.S. dollars):

 

     For the three
months ended
June 30,
2010
   For the three
months ended
June 30,
2009
   For the six
months ended
June 30,
2010
    For the six
months ended
June 30,
2009

Net prior year favorable reserve development:

          

Non-life segment

          

Net prior year reserve development due to changes in premiums

   $ —      $ 17    $ (6   $ 27

Net prior year reserve development due to all other factors(1)

     121      126      220        216
                            

Total net Non-life prior year favorable reserve development

   $ 121    $ 143    $ 214      $ 243

 

(1) Net prior year reserve development due to all other factors includes, but is not limited to, loss experience, changes in assumptions and changes in methodology.

For a discussion of net prior year favorable reserve development by Non-life sub-segment, see Results by Segment below. See Critical Accounting Policies and Estimates—Losses and Loss Expenses and Life Policy Benefits in Item 7 of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for additional information by reserving lines.

The following table shows the gross reserves reported by cedants (case reserves), those estimated by the Company (ACRs and IBNR reserves) and the total gross, ceded and net loss reserves recorded as of June 30, 2010 for each Non-life sub-segment (in millions of U.S. dollars):

 

     Case reserves    ACRs    IBNR
reserves
   Total gross
loss reserves
recorded
   Ceded loss
reserves
    Total net
loss reserves
recorded

U.S.

   $ 706    $     138    $     1,874    $ 2,718    $ (27   $ 2,691

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

     1,116      8      929      2,053      (30     2,023

Global (Non-U.S.) Specialty

     1,092      35      967      2,094      (64     2,030

Catastrophe

     105      144      46      295      —          295

Paris Re

     1,352      —        1,831      3,183      (236     2,947
                                          

Total Non-life

   $ 4,371    $ 325    $ 5,647    $ 10,343    $ (357   $ 9,986

The net loss reserves represent the Company’s best estimate of future losses and loss expense amounts based on information available as of June 30, 2010. Loss reserves are estimates involving actuarial and statistical projections at a given time that reflect the Company’s expectations of the costs of the ultimate settlement and administration of claims. These estimates are continually reviewed and the ultimate liability may be in excess of, or less than, the amounts provided, and any adjustments will be reflected in the period in which the need for an adjustment is determined.

The Company’s best estimates are point estimates within a reasonable range of actuarial reserve estimates. These ranges 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 point 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 point estimates recorded by the Company, and the range of actuarial estimates around these point estimates at June 30, 2010, were as follows for each Non-life sub-segment (in millions of U.S. dollars):

 

     Recorded Point
Estimate
   High    Low

Net Non-life sub-segment loss reserves:

        

U.S.

   $ 2,691    $ 2,921    $ 2,064

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

     2,023      2,151      1,777

Global (Non-U.S.) Specialty

     2,030      2,101      1,778

Catastrophe

     295      320      270

Paris Re

     2,947      3,091      2,774

 

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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 net Non-life carried loss reserves.

Of the $2,947 million of net loss reserves for the PARIS RE (Paris Re) sub-segment, the Company considers only $1,624 million of net loss reserves for accident years 2006 and subsequent to be subject to loss reserve variability. The remaining $1,323 million of net loss reserves for accident years 2005 and prior are guaranteed by Colisée Re, pursuant to the Reserve Agreement. See Summary of certain agreements between AXA SA, Colisée Re and Paris Re in Item 1 of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

Based on information currently available and the range of potential estimated ultimate liabilities, the Company believes that the unpaid loss and loss expense reserves for U.S. and Global (Non-U.S.) specialty casualty, U.S., Global (Non-U.S.) and Paris Re credit/surety lines of business and other potentially exposed classes of business contemplate a reasonable provision for exposures related to the effect of increased financial stress in the world economies. The Company is unaware of any specific issues that would materially affect its unpaid loss and loss expenses estimates related to this exposure.

Life Policy Benefits

Policy benefits for life and annuity contracts relate to the business in the Company’s Life segment, which predominantly includes reinsurance of longevity, subdivided into standard and non-standard annuities, and mortality business, which includes traditional death and disability covers (with various riders), term assurance and critical illness (TCI) written in the UK and Ireland, and guaranteed minimum death benefit (GMDB) written in Continental Europe.

The Company categorizes life reserves into three types: reported outstanding loss reserves (case reserves), incurred but not reported (IBNR) reserves and reserves for future policy benefits. Such liabilities are established based on methods and underlying assumptions in accordance with U.S. GAAP and applicable actuarial standards. Principal assumptions used in the establishment of reserves for future policy benefits have been determined based upon information reported by ceding companies, supplemented by the Company’s actuarial estimates of mortality, critical illness, persistency and future investment income, with appropriate provision to reflect uncertainty.

For the traditional life portfolio, case reserves, IBNR reserves and reserves for future policy benefits are mainly calculated at the treaty level. The Company updates its estimates for each of the aforementioned categories on a quarterly basis using information received from its cedants.

For long duration products, a reserve adequacy test is periodically performed based on the latest best estimate assumptions by line of business, including an experience analysis and a review of likely future experience. If such review produces reserves in excess of those currently held, then the locked-in assumptions will be revised and a loss recognized.

See Critical Accounting Policies and Estimates—Losses and Loss Expenses and Life Policy Benefits—Life Policy Benefits in Item 7 of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for additional information on the reserving methodologies employed by the Company for its longevity and mortality lines.

The Life segment reported net adverse development on prior accident years of $28 million and $17 million during the three months and six months ended June 30, 2010, respectively, primarily driven by adverse development of $20 million in the longevity line, due to an improvement in the mortality trend related to an impaired life annuity (ILA) treaty, and adverse development of $8 million resulting from the GMDB business, where the payout is linked to the performance of underlying capital market assets in France. For the three months ended June 30, 2009, the Life segment reported net favorable development on prior accident years of $4 million and net adverse development on prior accident years of $3 million for the six months ended June 30, 2009, primarily due to certain GMDB treaties. See Results by Segment below.

Valuation of Investments and Funds Held – Directly Managed, including certain Derivative Financial Instruments

The Company defines fair value as the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company measures the fair value of its financial instruments according to a fair value hierarchy that prioritizes the information used to measure fair value into three broad levels.

Under the fair value hierarchy, Management uses certain assumptions and judgments to derive the fair value of its investments, particularly for those assets with significant unobservable inputs, commonly referred to as Level 3 assets. The Company’s Level 3 assets totaled $369 million and $292 million at June 30, 2010 and December 31, 2009, respectively. For additional information related to the transfers into, and out of, the Company’s Level 3 classification during the three months and six months ended June 30, 2010, see Note 4 to Unaudited Condensed Consolidated Financial Statements included in Item 1 of Part I of this report.

 

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For additional information on the valuation techniques, methods and assumptions that were used by the Company to estimate the fair value of its fixed maturities, short-term investments, equities, other invested assets and investments underlying the funds held – directly managed account, see Note 4 to Unaudited Condensed Consolidated Financial Statements included in Item 1 of Part I of this report. For additional information on the Company’s use of derivative financial instruments, see Note 7 to Unaudited Condensed Consolidated Financial Statements included in Item 1 of Part I of this report.

Results of Operations—for the Three Months and Six Months Ended June 30, 2010 and 2009

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 1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 and Item 1A of Part II of this report for a review of important 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 significant subsidiaries and branches have one of the following functional currencies: U.S. dollar, euro or Canadian dollar. As a significant portion of the Company’s operations is transacted in foreign currencies, fluctuations in foreign exchange rates may affect period-to-period 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(m) to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for a discussion of 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 average exchange rate was weaker against most currencies in the three months and six months ended June 30, 2010 compared to the same periods in 2009; and

 

   

the U.S. dollar strengthened against most currencies, except the Canadian dollar, at June 30, 2010 compared to December 31, 2009.

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. Net income available to common shareholders is defined as net income less preferred dividends.

The year over year comparison of the Company’s results is primarily affected by the acquisition of Paris Re in the fourth quarter of 2009, integration costs incurred in the three months ended June 30, 2010, losses related to large catastrophic events and the Deepwater Horizon Drilling Platform (Deepwater Horizon) in the six months ended June 30, 2010 and the effects of the global financial and economic crisis in 2009. To the extent that these events have affected the year over year comparison of the Company’s results, their impact has been quantified and discussed in each of the relevant sections. An overview of each of these events is provided below.

The results of Paris Re are only included in the Company’s Consolidated Statements of Operations and Cash Flows from October 2, 2009, the date of acquisition, and Paris Re’s technical results are presented as a separate Non-life sub-segment below. Consequently, results of the Paris Re sub-segment for the three months and six months ended June 30, 2009 are not presented or discussed below. In our discussion and analysis of comparative periods, we have quantified the contribution of additional revenue or expense and additional assets, liabilities and equity resulting from the acquisition wherever such amounts are material and identifiable.

In April 2010, as part of the Company’s integration of Paris Re, the Company announced a voluntary termination plan (voluntary plan) available to certain eligible employees in France. During the three months and six months ended June 30, 2010, the Company recorded charges of $33.8 million and $35.2 million, respectively, related to the voluntary plan within other operating expenses. Employees participating in the voluntary plan have no compulsory notice periods, however, their expected leaving dates are over the next 18 months. Participating employees will continue to receive salary and other employment benefits until they leave the Company. The continuing salary and other employment benefits costs related to participating employees will be expensed as the employee provides service and remains with the Company.

As the Company’s reinsurance operations are exposed to low-frequency high-severity risk events, some of which are seasonal, results for certain periods may include unusually low loss experience, while results for other periods may include significant catastrophic losses. Consequently, the Company’s results for interim periods are not necessarily indicative of results for the full year.

 

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In the three months ended March 31, 2010, the Company incurred net losses of $334 million, related to the combined impact of the Chile Earthquake and Atlantic storm Xynthia (Storm Xynthia). During the three months ended June 30, 2010, the Company decreased its loss estimates related to these events for all sub-segments, except for Global (Non-U.S.) P&C, which had a positive impact on the Company’s technical result and pre-tax income of $17 million (see Results by Segment below for further details). Loss estimates arising from earthquakes are inherently more uncertain than those from other catastrophic events and additional uncertainty exists, specifically with respect to the Chile Earthquake, due to the place of occurrence and magnitude of the event. The Company’s actual losses from the Chile Earthquake and Storm Xynthia may exceed the estimated losses as a result of, among other things, an increase in industry insured loss estimates, the expected lengthy claims development period, in particular for the Chile Earthquake, and the receipt of additional information from cedants, brokers and loss adjusters.

The following table reflects the combined impact of the Chile Earthquake and Storm Xynthia and the impact on the Company’s technical result and pre-tax income by segment and sub-segment during the six months ended June 30, 2010 (in millions of U.S. dollars):

 

     U.S.     Global
(Non-U.S.)
P&C
    Global
(Non-U.S.)
Specialty
    Catastrophe     Paris Re     Total
Non-life
Segment
    Life
Segment
    Corporate
and Other
   Total  

Gross losses and loss expenses and life policy benefits

   $ (8   $ (118   $ (20   $ (98   $ (118   $ (362   $ (2   $ —      $ (364

Reinsurance recoverable

     —          —          —          —          39        39        —          —        39  
                                                                       

Net losses and loss expenses and life policy benefits

   $ (8   $ (118   $ (20   $ (98   $ (79   $ (323   $ (2   $ —      $ (325

Reinstatement premiums earned

     —          —          —          4        4        8        —          —        8  
                                                                       

Impact on technical result and pre-tax income

   $ (8   $ (118   $ (20   $ (94   $ (75   $ (315   $ (2   $ —      $ (317

In addition to the above, on April 20, 2010, Deepwater Horizon in the Gulf of Mexico exploded and subsequently sank. The Company has exposure to this event primarily through its U.S., Global (Non-U.S.) Specialty and Paris Re sub-segments and incurred net losses of $63 million, net of reinstatement premiums. The Company’s loss estimate remains preliminary, given the on-going nature of the event, and the significant uncertainty regarding liability exposure, primarily related to pollution.

The following table reflects the impact of Deepwater Horizon on the Company’s technical result and pre-tax income by segment and sub-segment during the three months ended June 30, 2010 (in millions of U.S. dollars):

 

     U.S.     Global
(Non-U.S.)
P&C
   Global
(Non-U.S.)
Specialty
    Catastrophe    Paris Re     Total
Non-life
Segment
    Life
Segment
   Corporate
and Other
   Total  

Gross losses and loss expenses and life policy benefits

   $ (5   $ —      $ (34   $ —      $ (66   $ (105   $ —      $ —      $ (105

Reinsurance recoverable

     —          —        14        —        25        39        —        —        39   
                                                                    

Net losses and loss expenses and life policy benefits

   $ (5   $ —      $ (20   $ —      $ (41   $ (66   $ —      $ —      $ (66

Reinstatement premiums earned

     —          —        —          —        3        3        —        —        3   
                                                                    

Impact on technical result and pre-tax income

   $ (5   $ —      $ (20   $ —      $ (38   $ (63   $ —      $ —      $ (63

During the three months ended March 31, 2010, the trends in the financial markets observed during the most part of 2009 continued with the narrowing of the credit spreads and improvements in worldwide equity markets, while U.S. risk-free interest rates remained essentially unchanged and European risk-free interest rates declined. The U.S. dollar strengthened against most currencies compared to its position at December 31, 2009. During the three months ended June 30, 2010, U.S. and European risk-free interest rates decreased while credit spreads widened, and worldwide equity markets declined. The U.S. dollar continued strengthening against most currencies compared to its position at March 31, 2010. As a result of these movements, the fair value of the Company’s investment portfolio decreased as of June 30, 2010 compared to December 31, 2009, which was primarily driven by the impact of foreign exchange as well as equities, and was partially offset by an increase in the fair value of fixed maturities. The Company’s results of operations for the three months and six months ended June 30, 2010 include net unrealized gains on fixed maturities, which were partially offset by net unrealized losses on equities.

The impacts of the global financial and economic crisis on the Company’s reinsurance underwriting operations have abated in the three months and six months ended June 30, 2010. The Company has continued to review its loss estimates and has modestly decreased its reserves during the three months and six months ended June 30, 2010 in certain affected lines of business for certain underwriting years, reflecting actual claims activity being less than anticipated based on information provided by cedants. The Company’s loss reserves related to the impacted lines of business represent Management’s best estimate of the cost to settle the ultimate liabilities related to these events based on information available at June 30, 2010.

These events in the three months and six months ended June 30, 2010 and the continuing uncertainty or volatility in the capital or credit markets are discussed below in Review of Net Income and Financial Condition, Liquidity and Capital Resources, and may continue to affect our results of operations and financial condition in the future.

Net income, preferred dividends, net income available to common shareholders and diluted net income per share for the three months and six months ended June 30, 2010 and 2009 were as follows (in millions of U.S. dollars, except per share data):

 

     For the three
months ended
June 30,
2010
   % Change
2010 over
2009
    For the three
months ended
June 30,
2009
   For the six
months ended
June 30,
2010
   % Change
2010 over
2009
    For the six
months ended
June 30,
2009

Net income

   $ 191    (60 )%    $ 474    $ 271    (56 )%    $ 616

Less: preferred dividends

     9    —          9      17    —          17
                               

Net income available to common shareholders

   $ 182    (61   $ 465    $ 254    (58   $ 599

Diluted net income per share

   $ 2.31    (71   $ 8.10    $ 3.13    (70   $ 10.43

Three-month result

The decrease in net income, net income available to common shareholders and diluted net income per share for the three months ended June 30, 2010 compared to 2009 resulted primarily from:

 

   

a decrease in net realized and unrealized investment gains of $261 million;

 

   

a decrease in Life underwriting result of $33 million, driven by net adverse prior year loss development;

 

   

an increase in other corporate operating expenses of $33 million, driven by the charges related to the voluntary plan; and

 

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a decrease in Non-life underwriting result of $22 million, largely driven by losses related to Deepwater Horizon and partially offset by an increase in prior quarter favorable development; which were partially offset by

 

   

an increase in net investment income of $38 million, driven by the inclusion of Paris Re’s net investment income; and

 

   

a decrease in income tax expense of $40 million.

Six-month result

The decrease in net income, net income available to common shareholders and diluted net income per share for the six months ended June 30, 2010 compared to 2009 resulted primarily from:

 

   

a decrease in Non-life underwriting result of $284 million, largely driven by large catastrophic losses related to the Chile Earthquake and Storm Xynthia, and losses related to Deepwater Horizon;

 

   

no activity related to the Company’s capital efficient notes (CENts) in the six months ended June 30, 2010 compared to a gain of $89 million on purchase of CENts in the six months ended June 30, 2009;

 

   

an increase in other corporate operating expenses of $49 million, primarily driven by the charges related to the voluntary plan;

 

   

a decrease in net realized and unrealized investment gains of $45 million; and

 

   

a decrease in Life underwriting result of $27 million, primarily driven by net adverse prior year loss development; partially offset by

 

   

an increase in net investment income of $79 million, driven by the inclusion of Paris Re’s net investment income; and

 

   

a decrease in income tax expense of $72 million.

These items are further described in the Review of Net Income below.

Review of Net Income

Management analyzes the Company’s net income in three parts: underwriting result, investment result and other components of net income. Underwriting result consists of net premiums earned and other income or loss less losses and loss expenses and life policy benefits, acquisition costs and other operating expenses. Investment result consists of net investment income, net realized and unrealized investment gains and losses and interest in earnings or losses of equity investments. Net investment income includes interest and dividends, net of investment expenses, generated by the Company’s investment activities, as well as interest income generated on funds held assets. Net realized and unrealized investment gains and losses include sales of the Company’s fixed income, equity and other invested assets and investments underlying the funds held – directly managed account and changes in net unrealized gains and losses. Interest in earnings or losses of equity investments includes the Company’s strategic investments. Other components of net income include net realized gain on the purchase of the Company’s CENts in 2009, technical result and other income or loss, other operating expenses, interest expense, amortization of intangible assets, net foreign exchange gains and losses and income tax expense.

The components of net income for the three months and six months ended June 30, 2010 and 2009 were as follows (in millions of U.S. dollars):

 

     For the three
months ended
June 30,
2010
    % Change
2010 over
2009
    For the three
months ended
June 30,
2009
    For the six
months ended
June 30,
2010
    % Change
2010 over
2009
    For the six
months ended
June 30,
2009
 

Underwriting result:

            

Non-life

   $ 95      (18 )%    $ 117      $ (71   NM   $ 213   

Life

     (33   NM        —          (37   285        (10

Investment result:

            

Net investment income

     174      29        136        348      29        269   

Net realized and unrealized investment gains

     46      (85     307        191      (19     236   

Interest in earnings of equity investments

     1      (78     6        4      NM        —     

Corporate and Other:

            

Net realized gain on purchase of capital efficient notes

     —        —          —          —        NM        89   

Technical result(1)

     1      (83     3        1      (69