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

Commission file number 001-31721

AXIS CAPITAL HOLDINGS LIMITED

(Exact name of registrant as specified in its charter)

BERMUDA

(State or other jurisdiction of incorporation or organization)

98-0395986

(I.R.S. Employer Identification No.)

92 Pitts Bay Road, Pembroke, Bermuda HM 08

(Address of principal executive offices and zip code)

(441) 496-2600

(Registrant’s telephone number, including area code)

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 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 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

As of July 26, 2010 there were 119,982,422 Common Shares, $0.0125 par value per share, of the registrant outstanding.


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

INDEX TO FORM 10-Q

 

            Page  
     PART I     
   Financial Information    3
Item 1.    Consolidated Financial Statements    4
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    36
Item 3.    Quantitative and Qualitative Disclosures About Market Risk    69
Item 4.    Controls and Procedures    69
   PART II   
   Other Information    70
Item 1.    Legal Proceedings    70
Item 1A.    Risk Factors    70
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds    71
Item 6.    Exhibits    72
   Signatures    73

 

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PART  I FINANCIAL INFORMATION

 

 

Cautionary Statement Regarding Forward-looking Statements

This quarterly report contains forward-looking statements within the meaning of the U.S. federal securities laws. We intend these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in the United States securities laws. In some cases, these statements can be identified by the use of forward-looking words such as “may”, “should”, “could”, “anticipate”, “estimate”, “expect”, “plan”, “believe”, “predict”, “potential” and “intend”. Forward-looking statements contained in this report may include information regarding our estimates of losses related to catastrophes and other large losses, measurements of potential losses in the fair value of our investment portfolio and derivative contracts, our expectations regarding pricing and other market conditions, our growth prospects, and valuations of the potential impact of movements in interest rates, equity prices, credit spreads and foreign currency rates. Forward-looking statements only reflect our expectations and are not guarantees of performance.

These statements involve risks, uncertainties and assumptions. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements. We believe that these factors include, but are not limited to, the following:

 

   

the occurrence of natural and man-made disasters,

 

   

actual claims exceeding our loss reserves,

 

   

general economic, capital and credit market conditions and the persistence of the recent financial crisis,

 

   

the failure of any of the loss limitation methods we employ,

 

   

the effects of emerging claims and coverage issues,

 

   

the failure of our cedants to adequately evaluate risks,

 

   

inability to obtain additional capital on favorable terms, or at all,

 

   

the loss of one or more key executives,

 

   

a decline in our ratings with rating agencies,

 

   

loss of business provided to us by our major brokers,

 

   

changes in accounting policies or practices,

 

   

changes in governmental regulations,

 

   

increased competition,

 

   

changes in the political environment of certain countries in which we operate or underwrite business,

 

   

fluctuations in interest rates, credit spreads, equity prices and/or currency values, and

 

   

the other matters set forth under Item 1A, ‘Risk Factors’ and Item 7, ‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’ included in our Annual Report on Form 10-K for the year ended December 31, 2009.

We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

       Page  

Consolidated Balance Sheets as at June 30, 2010 (Unaudited) and December 31, 2009

   5

Consolidated Statements of Operations for the three and six months ended June  30, 2010 and 2009 (Unaudited)

   6

Consolidated Statements of Comprehensive Income for the three and six months ended June  30, 2010 and 2009 (Unaudited)

   7

Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June  30, 2010 and 2009 (Unaudited)

   8

Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009 (Unaudited)

   9

Notes to the Consolidated Financial Statements (Unaudited)

   10

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED BALANCE SHEETS

JUNE 30, 2010 (UNAUDITED) AND DECEMBER 31, 2009

 

     2010     2009  
     (in thousands)  

Assets

    

Investments:

    

Fixed maturities, available for sale, at fair value
(Amortized cost 2010: $9,880,475; 2009: $9,628,287)

   $ 10,064,335     $ 9,718,355  

Equity securities, available for sale, at fair value
(Cost 2010: $218,303; 2009: $195,011)

     201,173       204,375  

Other investments, at fair value

     547,873       570,276  

Short-term investments, at amortized cost

     131,104       129,098  
                

Total investments

     10,944,485       10,622,104  

Cash and cash equivalents

     1,092,616       788,614  

Restricted cash and cash equivalents

     104,927       75,440  

Accrued interest receivable

     94,686       89,559  

Insurance and reinsurance premium balances receivable

     1,722,586       1,292,877  

Reinsurance recoverable on unpaid and paid losses

     1,545,080       1,424,172  

Deferred acquisition costs

     419,191       302,320  

Prepaid reinsurance premiums

     271,700       301,885  

Securities lending collateral

     107,167       129,814  

Net receivable for investments sold

     —          12,740  

Goodwill and intangible assets

     90,473       91,505  

Other assets

     165,369       175,494  
                

Total assets

   $  16,558,280     $ 15,306,524  
                

Liabilities

    

Reserve for losses and loss expenses

   $ 6,718,776     $ 6,564,133  

Unearned premiums

     2,781,101       2,209,397  

Insurance and reinsurance balances payable

     199,463       173,156  

Securities lending payable

     108,167       132,815  

Senior notes

     993,843       499,476  

Other liabilities

     181,959       227,303  

Net payable for investments purchased

     79,669       —     
                

Total liabilities

     11,062,978       9,806,280  
                

Commitments and Contingencies

    

Shareholders’ equity

    

Preferred shares - Series A and B

     500,000       500,000  

Common shares (2010: 154,549; 2009: 152,465 shares issued and 2010: 120,254; 2009: 132,140 shares outstanding)

     1,930       1,903  

Additional paid-in capital

     2,038,158       2,014,815  

Accumulated other comprehensive income

     221,856       85,633  

Retained earnings

     3,824,111       3,569,411  

Treasury shares, at cost (2010: 34,295; 2009: 20,325 shares)

     (1,090,753     (671,518
                

Total shareholders’ equity

     5,495,302       5,500,244  
                

Total liabilities and shareholders’ equity

   $ 16,558,280     $ 15,306,524  
                

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 AND 2009

 

     Three months ended     Six months ended  
     2010     2009     2010     2009  
     (in thousands, except for per share amounts)  

Revenues

        

Net premiums earned

   $ 735,027     $ 706,770     $  1,431,219     $  1,372,129  

Net investment income

     82,584       112,220       187,203       211,512  

Other insurance related income (loss)

     217       (14,261     843       (23,656

Net realized investment gains (losses):

        

Other-than-temporary impairment losses

     (7,533     (22,896     (14,490     (52,796

Portion of impairment losses transferred to other comprehensive income

     107       1,443       1,556       1,443  

Other realized investment gains (losses)

     32,045       (2,225     53,729       (12,922
                                

Total net realized investment gains (losses)

     24,619       (23,678     40,795       (64,275
                                

Total revenues

     842,447       781,051       1,660,060       1,495,710  
                                

Expenses

        

Net losses and loss expenses

     403,370       378,252       871,632       766,251  

Acquisition costs

     124,176       103,309       240,825       205,285  

General and administrative expenses

     106,062       86,949       205,831       173,506  

Foreign exchange losses (gains)

     (27,229     24,184       (35,376     23,795  

Interest expense and financing costs

     15,697       7,971       24,385       15,892  
                                

Total expenses

     622,076       600,665       1,307,297       1,184,729  
                                

Income before income taxes

     220,371       180,386       352,763       310,981  

Income tax expense

     6,300       12,006       17,661       17,703  
                                

Net income

     214,071       168,380       335,102       293,278  

Preferred share dividends

     9,219       9,219       18,438       18,438  
                                

Net income available to common shareholders

   $  204,852     $  159,161     $ 316,664     $ 274,840  
                                

Weighted average common shares and common share equivalents:

        

Basic

     121,766       137,849       124,961       137,586  
                                

Diluted

     135,665       149,861       138,899       149,448  
                                

Earnings per common share:

        

Basic

   $ 1.68     $ 1.15     $ 2.53     $ 2.00  
                                

Diluted

   $ 1.51     $ 1.06     $ 2.28     $ 1.84  
                                

Cash dividends declared per common share

   $ 0.21     $ 0.20     $ 0.42     $ 0.40  
                                

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 AND 2009

 

     Three months ended     Six months ended  
     2010     2009     2010     2009  
     (in thousands)  

Net income

   $ 214,071     $ 168,380     $ 335,102     $ 293,278  

Other comprehensive income, net of tax:

        

Available for sale investments:

        

Unrealized gains arising during the period

     75,000       254,295       169,589       155,046  

Portion of other-than-temporary impairment losses recognized in other comprehensive income

     (107     (1,443     (1,556     (1,443

Adjustment for re-classification of realized investment (gains) losses and net impairment losses recognized in net income

     (17,384     23,103       (30,218     64,636  

Foreign currency translation adjustment

     (1,108     1,300       (1,592     (1,667
                                

Comprehensive income

   $  270,472     $  445,635     $  471,325     $  509,850  
                                

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)

SIX MONTHS ENDED JUNE 30, 2010 AND 2009

 

     2010     2009  
     (in thousands)  

Preferred shares - Series A and B

    

Balance at beginning and end of period

   $ 500,000     $ 500,000  
                

Common shares (par value)

    

Balance at beginning of period

     1,903       1,878  

Shares issued

     27       22  
                

Balance at end of period

     1,930       1,900  
                

Additional paid-in capital

    

Balance at beginning of period

     2,014,815       1,962,779  

Shares issued

     1,430       13  

Stock options exercised

     2,641       920  

Share-based compensation expense

     19,272       25,791  
                

Balance at end of period

     2,038,158       1,989,503  
                

Accumulated other comprehensive income (loss)

    

Unrealized appreciation (depreciation) on available for sale investments, net of tax:

    

Balance at beginning of period

     87,438       (702,548

Cumulative effect of change in accounting principle (see Note 3(d))

     —          (38,334

Unrealized gains arising during the period, net of reclassification adjustment

     139,371       219,682  

Portion of other-than-temporary impairment losses

     (1,556     (1,443
                

Balance at end of period

     225,253       (522,643
                

Cumulative foreign currency translation adjustments, net of tax:

    

Balance at beginning of period

     803       —     

Foreign currency translation adjustment

     (1,592     (1,667
                

Balance at end of period

     (789     (1,667
                

Supplemental Executive Retirement Plans (SERPs):

    

Balance at beginning of period

     (2,608     (3,951

Net actuarial gain (loss)

     —          —     
                

Balance at end of period

     (2,608     (3,951
                

Balance at end of period

     221,856       (528,261
                

Retained earnings

    

Balance at beginning of period

     3,569,411       3,198,492  

Cumulative effect of change in accounting principle, net of tax (see Note 3(d))

     —          38,334  

Net income

     335,102       293,278  

Series A and B preferred share dividends

     (18,438     (18,438

Common share dividends

     (61,964     (64,155
                

Balance at end of period

     3,824,111       3,447,511  
                

Treasury shares, at cost

    

Balance at beginning of period

     (671,518     (495,609

Shares repurchased for treasury

     (419,235     (5,925
                

Balance at end of period

     (1,090,753     (501,534
                

Total shareholders’ equity

   $  5,495,302     $  4,909,119  
                

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

SIX MONTHS ENDED JUNE 30, 2010 AND 2009

 

     2010     2009  
     (in thousands)  

Cash flows from operating activities:

    

Net income

   $ 335,102     $ 293,278  

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

    

Net realized investment (gains) losses

     (40,795     64,275  

Loss on insurance derivative contract

     —          25,000  

Net realized and unrealized gains of other investments

     (14,280     (26,110

Amortization of fixed maturities

     24,232       5,319  

Other amortization and depreciation

     6,175       6,684  

Share-based compensation expense

     19,272       25,791  

Changes in:

    

Accrued interest receivable

     (5,127     (8,129

Reinsurance recoverable balances

     (120,908     (65,210

Deferred acquisition costs

     (116,871     (101,753

Prepaid reinsurance premiums

     30,185       (17,441

Reserve for loss and loss expenses

     154,643       317,111  

Unearned premiums

     571,704       508,624  

Insurance and reinsurance balances, net

     (403,402     (545,665

Other items

     98,312       (30,332
                

Net cash provided by operating activities

     538,242       451,442  
                

Cash flows from investing activities:

    

Purchases of:

    

Fixed maturities

     (5,436,355     (5,251,298

Equity securities

     (55,537     (24,689

Other investments

     (20,000     (91,800

Proceeds from the sale of:

    

Fixed maturities

     4,788,803       3,871,643  

Equity securities

     27,772       44,967  

Other investments

     56,682       60,420  

Proceeds from redemption of fixed maturities

     482,894       497,681  

Net (purchases) sales of short-term investments

     (1,819     102,660  

Purchase of other assets

     (4,994     (39,660

Change in restricted cash and cash equivalents

     (29,487     6,272  
                

Net cash used in investing activities

     (192,041     (823,804
                

Cash flows from financing activities:

    

Net proceeds from issuance of senior notes

     494,870       —     

Repurchase of shares

     (419,235     (5,925

Dividends paid - common shares

     (57,439     (59,562

Dividends paid - preferred shares

     (18,438     (18,438

Proceeds from issuance of common shares

     4,098       955  
                

Net cash (used in) provided by financing activities

     3,856       (82,970
                

Effect of exchange rate changes on foreign currency cash

     (46,055     21,794  
                

Increase (decrease) in cash and cash equivalents

     304,002       (433,538

Cash and cash equivalents - beginning of period

     788,614       1,697,581  
                

Cash and cash equivalents - end of period

   $   1,092,616     $   1,264,043  
                

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES

Basis of Presentation

The interim consolidated financial statements include the accounts of AXIS Capital Holdings Limited (“AXIS Capital”) and its subsidiaries (herein referred to as “we,” “us,” “our,” or the “Company”).

The consolidated balance sheet at June 30, 2010 and the consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for the periods ended June 30, 2010 and 2009 have not been audited. The balance sheet at December 31, 2009 is derived from our audited financial statements.

These statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“U.S. GAAP”) for interim financial information and with the Securities and Exchange Commission’s (“SEC”) instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these financial statements reflect all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of our financial position and results of operations for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for a full year. All inter-company accounts and transactions have been eliminated.

The following information should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2009. Tabular dollars and share amounts are in thousands, except per share amounts.

Significant Accounting Policies

There have been no changes to our significant accounting policies as described in our Annual Report on Form 10-K for the year ended December 31, 2009.

Adoption of New Accounting Standards

Fair Value Measurement and Disclosures

Effective January 1, 2010, we adopted new guidance issued by the FASB requiring additional disclosures about transfers into and out of Levels 1 and 2 of the fair value hierarchy and separate disclosures about purchases, sales, issuance, and settlements relating to Level 3 measurements. As these new requirements related solely to disclosures, the adoption did not impact our results of operations, financial condition or liquidity. The additional disclosures have been provided in Note 4 – Fair Value Measurements.

Consolidations

Effective January 1, 2010, we adopted amended FASB guidance related to the consolidation of variable interest entities (“VIEs”). This new guidance modifies the approach for determining the primary beneficiary of a VIE by eliminating the initial quantitative assessment and requiring ongoing qualitative reassessments. The adoption of this guidance did not impact our results of operations or financial condition.

 

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)

 

Recently Issued Accounting Standards Not Yet Adopted

Embedded Credit Derivatives

In March 2010, the FASB issued new guidance clarifying the scope exemption for embedded credit-derivative features. Embedded credit-derivative features related only to the transfer of credit risk in the form of subordination of one financial instrument to another are not subject to potential bifurcation and separate accounting. However, other embedded credit-derivative features are required to be analyzed to determine whether they must be accounted for separately. Additional guidance on whether embedded credit-derivative features in financial instruments issued by structures such as collateralized debt obligations (“CDOs”) and synthetic CDOs are subject to bifurcation and separate accounting. To simplify compliance with this new guidance, an entity may make a one-time election to apply the fair value option to any investment in a beneficial interest in securitized financial assets, regardless of whether such investments contain embedded derivative features. This new guidance is effective as of July 1, 2010, with early adoption being permitted at April 1, 2010. We do not anticipate the adoption of this guidance will significantly impact our results of operations, financial condition or liquidity.

Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses

In July 2010, the FASB issued new guidance requiring disclosures about the nature of credit risk in financing receivables and how that risk is analyzed in determining the related allowance for credit losses, as well as details on changes in the allowance for credit losses during the reporting period. Financing receivables are defined to include instruments such as certain trade receivables, notes receivable and lease receivables, in addition to instruments more traditionally associated with an allowance for credit losses, such as consumer and commercial lending agreements. The new disclosure requirements related to information at the end of a reporting period will become effective at October 1, 2010, while requirements related to activity that occurred during a reporting period will become effective at January 1, 2011. We are presently evaluating the disclosure impact of the adoption of this guidance.

 

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

2. SEGMENT INFORMATION

 

Our underwriting operations are organized around our two global underwriting platforms, AXIS Insurance and AXIS Reinsurance and therefore we have determined that we have two reportable segments, insurance and reinsurance. Except for goodwill and intangible assets, we do not allocate our assets by segment as we evaluate the underwriting results of each segment separately from the results of our investment portfolio.

The following tables summarize the underwriting results of our operating segments for the periods indicated and the carrying values of goodwill and intangible assets at June 30, 2010 and 2009:

 

      2010     2009  
Three months ended June 30,    Insurance     Reinsurance     Total     Insurance     Reinsurance     Total  

Gross premiums written

   $   612,893     $   326,980     $   939,873     $   526,764     $   387,877     $   914,641  

Net premiums written

     466,880       322,058       788,938       313,136       387,877       701,013  

Net premiums earned

     301,652       433,375       735,027       298,975       407,795       706,770  

Other insurance related income (loss)

     217       -            217       (14,956     695       (14,261

Net losses and loss expenses

     (155,494     (247,876     (403,370     (187,211     (191,041     (378,252

Acquisition costs

     (40,567     (83,609     (124,176     (28,306     (75,003     (103,309

General and administrative expenses

     (64,045     (22,817     (86,862     (52,893     (17,525     (70,418
                                                  

Underwriting income

   $ 41,763     $ 79,073       120,836     $ 15,609     $ 124,921       140,530  
                                        

Corporate expenses

         (19,200         (16,531

Net investment income

         82,584           112,220  

Net realized investment gains (losses)

         24,619           (23,678

Foreign exchange (losses) gains

         27,229           (24,184

Interest expense and financing costs

         (15,697         (7,971
                          

Income before income taxes

       $ 220,371         $ 180,386  
                          
   

Net loss and loss expense ratio

     51.6%        57.2%        54.9%        62.6%        46.8%        53.5%   

Acquisition cost ratio

     13.4%        19.3%        16.9%        9.5%        18.4%        14.6%   

General and administrative expense ratio

     21.2%        5.3%        14.4%        17.7%        4.3%        12.3%   
                                                  

Combined ratio

     86.2%        81.8%        86.2%        89.8%        69.5%        80.4%   
                                                  
   

Goodwill and intangible assets

   $ 90,473     $ -          $ 90,473     $ 95,058     $ -          $ 95,058  
                                                  
                                                  

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

2. SEGMENT INFORMATION (CONTINUED)

 

      2010     2009  
Six months ended June 30,    Insurance     Reinsurance     Total     Insurance     Reinsurance     Total  

Gross premiums written

   $   985,822     $  1,379,252     $  2,365,074     $   890,922     $  1,347,214     $  2,238,136  

Net premiums written

     673,692       1,358,881       2,032,573       525,151       1,338,163       1,863,314  

Net premiums earned

     557,933       873,286       1,431,219       574,598       797,531       1,372,129  

Other insurance related income (loss)

     843       -            843       (24,761     1,105       (23,656

Net losses and loss expenses

     (286,197     (585,435     (871,632     (339,915     (426,336     (766,251

Acquisition costs

     (71,708     (169,117     (240,825     (54,509     (150,776     (205,285

General and administrative expenses

     (125,655     (44,668     (170,323     (103,374     (35,796     (139,170
                                                  

Underwriting income

   $ 75,216     $ 74,066       149,282     $ 52,039     $ 185,728       237,767  
                                        

Corporate expenses

         (35,508         (34,336

Net investment income

         187,203           211,512  

Net realized investment gains (losses)

         40,795           (64,275

Foreign exchange (losses) gains

         35,376           (23,795

Interest expense and financing costs

         (24,385         (15,892
                          

Income before income taxes

       $ 352,763         $ 310,981  
                          
   

Net loss and loss expense ratio

     51.3%        67.0%        60.9%        59.2%        53.5%        55.8%   

Acquisition cost ratio

     12.9%        19.4%        16.8%        9.4%        18.9%        15.0%   

General and administrative expense ratio

     22.5%        5.1%        14.4%        18.0%        4.5%        12.6%   
                                                  

Combined ratio

     86.7%        91.5%        92.1%        86.6%        76.9%        83.4%   
                                                  
   

Goodwill and intangible assets

   $ 90,473     $ -          $ 90,473     $ 95,058     $ -          $ 95,058  
                                                  
                                                  

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

3. INVESTMENTS

 

a)

Fixed Maturities and Equities

The amortized cost or cost and fair values of our fixed maturities and equities were as follows:

 

      Amortized
Cost or
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   

Fair

Value

   Non-credit
OTTI
in  AOCI(3)
 

At June 30, 2010

               

Fixed maturities

               

U.S. government and agency

   $ 1,394,728    $ 33,738    $ (36   $ 1,428,430    $ -       

Non-U.S. government

     784,486      5,742      (35,460     754,768      -       

Corporate debt

     3,971,256      154,373      (63,651     4,061,978      (491 )  

Agency MBS(1)

     1,641,101      64,380      (377     1,705,104      -       

Non-Agency CMBS

     583,506      29,004      (3,009     609,501      (264 )  

Non-Agency RMBS

     234,834      2,218      (16,079     220,973      (10,199

ABS(2)

     661,375      8,791      (15,229     654,937      (4,098 )  

Municipals

     609,189      21,874      (2,419     628,644      (389 )  
                                       

Total fixed maturities

   $  9,880,475    $  320,120    $  (136,260   $  10,064,335    $  (15,441
                                       
   

Equity securities

   $ 218,303    $ 9,058    $ (26,188   $ 201,173     
                                   
   

At December 31, 2009

               

Fixed maturities

               

U.S. government and agency

   $ 1,859,874    $ 8,511    $ (11,726   $ 1,856,659    $ -       

Non-U.S. government

     687,843      11,937      (2,966     696,814      -       

Corporate debt

     3,482,450      126,093      (27,777     3,580,766      (6,071 )  

Agency MBS(1)

     1,529,208      41,425      (4,374     1,566,259      -       

Non-Agency CMBS

     670,949      10,545      (28,283     653,211      (505 )  

Non-Agency RMBS

     257,865      324      (35,207     222,982      (8,673 )  

ABS(2)

     455,831      6,926      (19,618     443,139      (10,798

Municipals

     684,267      18,495      (4,237     698,525      (389 )  
                                       

Total fixed maturities

   $ 9,628,287    $ 224,256    $ (134,188   $ 9,718,355    $ (26,436
                                       
   

Equity securities

   $ 195,011    $ 17,834    $ (8,470   $ 204,375     
                                   
                                       
(1) Agency mortgage-backed securities (MBS) include agency residential MBS (RMBS) and agency commercial MBS (CMBS).
(2) Asset-backed securities (ABS) include debt tranched securities collateralized by sub-prime mortgages, auto loans, credit cards, and other asset types. This asset class also includes an insignificant position in collateralized loan obligations (CLOs) and collaterlized debt obligations (CDOs).
(3) Represents the non-credit component of the other-than-temporary impairment (OTTI) losses, adjusted for subsequent sales of securities. It does not include the change in fair value subsequent to the impairment measurement date.

In the normal course of investing activities, we make passive investments in structured securities (variable interests) issued by VIEs. These structured securities include RMBS, CMBS and ABS and are included in the above table. Additionally, within our other investments portfolio, we also invest in limited partnerships (hedge and credit funds) and CLO equity tranched securities, which are all variable interests issued by VIEs (see Note 3(b)). For these variable interests, we do not have the power to direct the activities that are most significant to the economic performance of the VIEs and accordingly we are not the primary beneficiary for any of these VIEs. Our maximum exposure to loss on these interests is limited to the amount of our investment. We have not provided financial or other support with respect to these structured securities other than our original investment.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

3. INVESTMENTS (CONTINUED)

 

Gross Unrealized Loss

The following tables summarize fixed maturities and equities in an unrealized loss position and the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position:

 

At June 30, 2010    12 months or greater     Less than 12 months     Total  
      Fair
Value
   Unrealized
Losses
    Fair
Value
   Unrealized
Losses
    Fair
Value
   Unrealized
Losses
 

Fixed maturities

                 

U.S. government and agency

   $ 2,081    $ (8   $ 23,286    $ (28   $ 25,367    $ (36

Non-U.S. government

     -          -            421,555      (35,460     421,555      (35,460

Corporate debt

     37,293      (5,532     797,596      (58,119     834,889      (63,651

Agency MBS

     2,219      (132     94,323      (245     96,542      (377

Non-Agency CMBS

     38,122      (2,912     15,449      (97     53,571      (3,009

Non-Agency RMBS

     114,434      (15,771     27,085      (308     141,519      (16,079

ABS

     44,535      (15,014     74,218      (215     118,753      (15,229

Municipals

     19,687      (1,802     40,967      (617     60,654      (2,419
                                               

Total fixed maturities

   $  258,371    $ (41,171   $  1,494,479    $ (95,089   $  1,752,850    $  (136,260
                                               
   

Equity securities

   $ 12,370    $ (6,059   $ 131,912    $ (20,129   $ 144,282    $ (26,188
                                               
   

At December 31, 2009

                 
   

Fixed maturities

                 

U.S. government and agency

   $ 22,902    $ (915   $ 1,252,602    $  (10,811   $ 1,275,504    $ (11,726

Non-U.S. government

     -          -            352,313      (2,966     352,313      (2,966

Corporate debt

     160,213      (19,245     630,678      (8,532     790,891      (27,777

Agency MBS

     1,587      (80     427,025      (4,294     428,612      (4,374

Non-Agency CMBS

     273,845      (27,180     79,561      (1,103     353,406      (28,283

Non-Agency RMBS

     181,700      (32,787     13,042      (2,420     194,742      (35,207

ABS

     51,626      (18,721     94,008      (897     145,634      (19,618

Municipals

     13,432      (1,624     117,825      (2,613     131,257      (4,237
                                               

Total fixed maturities

   $ 705,305    $  (100,552   $ 2,967,054    $ (33,636   $ 3,672,359    $ (134,188
                                               
   

Equity securities

   $ 31,368    $ (6,025   $ 86,947    $ (2,445   $ 118,315    $ (8,470
                                               
                                               

Fixed Maturities

At June 30, 2010, 583 fixed maturities (2009: 832) were in an unrealized loss position of $136 million (2009: $134 million) of which $17 million (2009: $20 million) of this balance was related to securities below investment grade or not rated.

At June 30, 2010, 183 (2009: 312) securities have been in continuous unrealized loss position for 12 months or greater and have a fair value of $258 million (2009: $705 million). These securities were primarily corporate debt, non-agency CMBS, non-agency RMBS, and ABS with a weighted average S&P credit rating of BBB+, AA-, BBB+, and BB-, respectively. We concluded that these securities as well as the remaining securities in an unrealized loss position are temporarily depressed and are expected to recover in value as the securities approach maturity or as market spreads return to more normalized levels. Further, at June 30, 2010, we did not intend to sell these securities in an unrealized loss position and it is more likely than not that we will not be required to sell these securities before the anticipated recovery of their amortized costs.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

3. INVESTMENTS (CONTINUED)

 

Equity Securities

At June 30, 2010, 138 securities (2009: 95) were in an unrealized loss position and 44 of these securities (2009: 56) have been in a continuous unrealized loss position for 12 months or greater. Based on our OTTI quarterly review process and our ability and intent to hold these securities for a reasonable period of time sufficient for a full recovery, we concluded that the above equities in an unrealized loss position were temporarily impaired at June 30, 2010 and December 31, 2009.

 

b) Other Investments

The table below shows our portfolio of other investments reported at fair value:

 

      June 30, 2010    December 31,  2009
   

Hedge funds

   $  110,968    20.3%    $ 94,630    16.6%

Funds of hedge funds

     225,456    41.1%      256,877    45.0%
                         

Total hedge funds

     336,424    61.4%      351,507    61.6%
                         

Distressed securities

     22,989    4.2%      22,957    4.0%

Long/short credit

     78,108    14.2%      84,392    14.8%
                         

Total credit funds

     101,097    18.4%      107,349    18.8%
                         

CLO - equity tranched securities

     58,566    10.7%      61,332    10.8%

Short duration high yield fund

     51,786    9.5%      50,088    8.8%
                         

Total other investments

   $ 547,873    100.0%    $  570,276    100.0%
                         
                         

The major categories and related investment strategies for our investments in hedge and credit funds are as follows:

 

Hedge Fund Type    Investment Strategy

Hedge funds

   Seek to achieve attractive risk-adjusted returns primarily through multi-strategy and long/short equity approaches. Multi-strategy funds invest in a variety of asset classes on a long and short basis and may employ leverage. Long/short equity funds invest primarily in equity securities (or derivatives) on a long and short basis and may employ leverage.
   

Funds of hedge funds

   Seek to achieve attractive risk-adjusted returns by investing in a large pool of hedge funds across a diversified range of hedge fund strategies.

In aggregate, 94% of our hedge fund allocation is redeemable within one year and 100% is redeemable within two years, subject to prior written redemption notice varying from 45 to 95 days. This includes recognition of certain funds we hold which restrict new investor redemptions during a lock-up period. A lock-up period is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. Another common restriction is the suspension of redemptions (known as “gates”) which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the fund’s net assets or to prevent certain adverse regulatory, or any other reasons that may render the manager unable to promptly and accurately calculate the fund’s net asset value. During the six months ended June 30, 2010 and 2009, no gates were imposed on our redemption requests. At June 30, 2010, the only redemptions receivable relate to a December 31, 2009 redemption whereby $2 million is being held back until the completion of the fund’s annual audit.

 

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3. INVESTMENTS (CONTINUED)

 

Additionally, certain hedge funds may be allowed to invest a portion of their assets in illiquid securities, such as private equity or convertible debt. In such cases, a common mechanism used is a side-pocket, whereby the illiquid security is assigned to a designated account. Generally, the investor loses its redemption rights in the designated account. Only when the illiquid security is sold, or otherwise deemed liquid by the fund, may investors redeem their interest. At June 30, 2010, the fair value of our hedge funds held in side-pockets was $4 million (2009: $4 million).

 

Credit Fund Type    Investment Strategy

Distressed securities

   Seek to achieve attractive risk-adjusted returns by executing a strategy which assesses the issuer’s ability to improve its operations and often attempts to influence the process by which the issuer restructures its debt.
   

Long/short credit

   Seek to achieve attractive risk-adjusted returns by executing a credit trading strategy involving selective long and short positions in primarily below investment-grade credit.

At June 30, 2010, we had $45 million of a long/short credit fund that we do not have the ability to liquidate at our own discretion as the fund is beyond its investment period and is currently distributing capital to its investors. Of the remaining credit fund holdings, 32% of the carrying value has annual or semi-annual liquidity and 68% has quarterly liquidity, subject to prior written redemption notice varying from 65 to 95 days. At June 30, 2010 and December 31, 2009, none of our credit funds had established side-pockets.

At June 30, 2010, we have no unfunded commitments relating to our investments in hedge and credit funds.

 

c) Net Investment Income

Net investment income was derived from the following sources:

 

      Three months ended
June 30,
    Six months ended
June 30,
 
      2010     2009     2010     2009  

Fixed maturities

   $  86,772     $  100,901     $  177,890     $  192,598  

Other investments

     (1,985     11,868       14,280       18,738  

Cash and cash equivalents

     989       2,032       2,724       4,888  

Equities

     1,332       1,392       1,920       1,763  

Short-term investments

     207       177       427       443  
                                  

Gross investment income

     87,315       116,370       197,241       218,430  

Investment expenses

     (4,731     (4,150     (10,038     (6,918
                                  

Net investment income

   $ 82,584     $ 112,220     $ 187,203     $ 211,512  
                                  
                                  

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

3. INVESTMENTS (CONTINUED)

 

d) Net Realized Investment Gains (Losses)

The following table provides an analysis of net realized investment gains (losses):

 

      Three months ended
June 30,
    Six months ended
June 30,
 
      2010     2009     2010     2009  

Gross realized gains

   $   58,997     $   23,502     $  118,960     $   84,582  

Gross realized losses

     (34,240     (23,350     (75,578     (98,607

Net OTTI recognized in earnings

     (7,426     (21,453     (12,934     (51,353
                                  

Net realized gains (losses) on fixed maturities and equities

     17,331       (21,301     30,448       (65,378
   

Change in fair value of investment derivatives(1)

     2,988       (391     2,830       1,009  
   

Fair value hedges:(1)

          

Derivative instruments

     57,296       (26,713     92,223       (6,648

Hedged investments

     (52,996     24,727       (84,706     6,742  
                                  

Net realized investment gains (losses)

   $ 24,619     $ (23,678   $ 40,795     $ (64,275
                                  
                                  
(1)

Refer to Note 6 – Derivative Instruments

The following table summarizes the OTTI recognized in earnings by asset class:

 

      Three months ended
June 30,
   Six months  ended
June 30,
      2010    2009    2010    2009

Fixed maturities:

             

Corporate debt

   $ -        $ 1,604    $ 1,650    $ 13,026

Agency MBS

     -          344      -          344

Non-Agency CMBS

     325      10,843      325      10,843

Non-Agency RMBS

     2,879      2,622      3,943      7,602

ABS

     -          -          1,126      9,983

Municipals

     19      -          19      -    
                             
       3,223      15,413      7,063      41,798

Equities

     4,203      6,040      5,871      9,555
                             

Total OTTI recognized in earnings

   $  7,426    $  21,453    $  12,934    $  51,353
                             
                             

On April 1, 2009, we adopted a new accounting standard which amended the previous OTTI recognition model for fixed maturities. For securities in an unrealized loss position that we intend to sell at the end of the reporting period, we recognized the entire unrealized loss position as a credit loss in earnings. For the remaining impaired fixed maturities, we have recorded only the estimated credit losses in earnings rather than the entire unrealized loss position. Because the new accounting standard does not allow for retrospective application, the OTTI amounts reported in the above table for the six months ended June 30, 2010, are not measured on the same basis as prior period amounts and accordingly these amounts are not comparable. The adoption of this new accounting standard on April 1, 2009 resulted in $38 million net after-tax increase to retained earnings with a corresponding decrease to accumulated other comprehensive income (loss), resulting in no change to our shareholders’ equity.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

3. INVESTMENTS (CONTINUED)

 

The following table provides a roll forward of the credit losses, (“credit loss table”), before income taxes, for which a portion of the OTTI was recognized in AOCI:

 

      Three months ended
June 30,
    Six months ended
June 30,
 
      2010     2009     2010     2009  

Balance at beginning of period

   $ 157,842     $ -          $ 162,390     $ -       

Additions for:

          

Credit losses remaining in retained earnings related to adoption of accounting standard

     -            45,347       -            45,347  

Credit impairments recognized on securities not previously impaired

     844       2,513       1,188       2,513  

Additional credit impairments recognized on securities previously impaired

     191       187       777       187  

Increases due to changes in the timing of cash flows

     -            -            25       -       

Reductions for:

          

Decreases due to changes in the timing of cash flows

     (460     -            -            -       

Securities previously impaired due to subsequent intent to sell

     (65     -            (65     -       

Securities sold/redeemed during the period

     (11,389     (10,818     (17,352     (10,818
                                  

Balance at end of period

   $  146,963     $   37,229     $  146,963     $   37,229  
                                  
                                  

Credit losses are calculated based on the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to the impairment. The significant inputs and the methodology used to estimate the credit losses for which a portion of the OTTI was recognized in AOCI were as follows:

Corporate Debt:

Our projected cash flows for corporate debt securities, excluding medium-term notes (“MTNs”), are primarily driven by our assumptions regarding the probability of default and the severity associated with those defaults. Our default and loss severity rates are based on credit rating, credit analysis, industry analyst reports and forecasts, Moody’s historical default data and any other data relevant to the recoverability of the security. At December 31, 2009, the weighted average default rate and loss severity rate were 34% and 100%, respectively, for determining the credit losses on our impaired corporate debt securities. For the three and six months ended June 30, 2010, we have not impaired any corporate debt securities except for securities we intended to sell. Additionally, we have sold some previously impaired corporate debt, resulting in a decrease in credit loss impairments of $8 million and $8 million, respectively, in the above credit loss table.

For MTNs, our projected cash flows also include significant inputs such as future credit spreads and the use of leverage over the expected duration of each of the medium-term notes. At June 30, 2010, we have not modified our significant inputs since December 31, 2009, which were as follows:

 

Default rates, per annum

   3% - 5%

Loss severity rates, per annum

   45% - 70%

Collateral spreads, per annum

   5.2% - 6.7%

Leveraged duration

   6.5 - 8.5 years
      

Agency MBS:

For agency MBS in an unrealized loss position, we do not impair these securities as they represent AAA-rated holdings backed by either the explicit or implicit guarantee of the U.S. government. We believe the risk of loss in this asset class is very remote and linked to the overall credit-worthiness of the U.S. government. At June 30, 2010, the fair value of our agency MBS was $1.7 billion (2009: $1.6 billion), which included $0.4 million (2009: $4.4 million) of gross unrealized losses.

 

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3. INVESTMENTS (CONTINUED)

 

Non-agency CMBS:

Our investment in commercial MBS are diversified and rated highly with approximately 78% (2009: 79%) rated AAA by S&P, with a weighted average estimated subordination percentage of 28% at June 30, 2010 (2009: 27%). Based on discounted cash flows, the current level of subordination is sufficient to cover the estimated loan losses on the underlying collateral of the CMBS.

Non-agency RMBS:

For non-agency RMBS, we project expected cash flows to be collected by incorporating underlying data from widely accepted third-party data sources along with certain internal assumptions and judgments regarding the future performance of the security. At June 30, 2010, the fair value of our non-agency RMBS was $221 million (2009: $223 million), consisting primarily of $151 million (2009: $136 million) of Prime and $55 million (2009: $70 million) of Alt-A MBS.

We used the following weighted average significant inputs to estimate the credit loss for potentially impaired Prime and Alt-A MBS in an unrealized loss position at June 30, 2010:

 

Vintage    Fair Value    Default Rate     Delinquency Rate     Loss Severity Rate     Prepayment Rate  

Prime:

             

Pre-2004

   $ 10,915    1.2% - 2.0   3.7% - 4.9   1.8% - 21.7   0.5% - 34.1

2004

     17,364    1.5%      3.7%      18.2%      27.2%   

2005

     17,287    1.6%      4.1%      19.8%      14.2%   

2006

     19,263    8.5%      22.2%      42.3%      31.3%   

2007

     14,460    4.0%      9.7%      27.0%      33.0%   
                   
     $ 79,289    3.7%      9.5%      25.1%      21.1%   
                   

Alt-A:

             

Pre-2004

   $ 6,674    1.3% - 4.3   4.3% - 7.7   37.7% - 41.0   10.0% - 12.5

2004

     18,882    4.4%      14.4%      31.9%      12.3%   

2005

     21,403    6.5%      18.2%      44.8%      8.5%   

2006

     —      —        —        —        —     

2007

     2,676    10.8%      35.8%      0.0%      7.9%   
                   
     $  49,635    5.4%      16.0%      36.8%      10.3%   
                   
                                 

We used the following weighted average significant inputs to estimate the credit loss for potentially impaired Prime and Alt-A MBS in an unrealized loss position at December 31, 2009:

 

Vintage    Fair Value    Default Rate     Delinquency Rate     Loss Severity Rate     Prepayment Rate  

Prime:

             

Pre-2004

   $ 29,429    1.1% - 1.2   2.3% - 5.1   10.5% - 15.3   19.1% - 26.5

2004

     10,515    2.4%      5.4%      26.5%      16.7%   

2005

     30,282    1.7%      4.0%      25.4%      14.5%   

2006

     16,892    13.6%      30.6%      44.9%      8.1%   

2007

     21,411    4.2%      10.5%      40.5%      11.7%   
                   
     $  108,529    4.0%      9.4%      28.6%      14.7%   
                   

Alt-A:

             

Pre-2004

   $ 5,386    1.4% - 2.4   2.8% - 8.4   38.9% - 40.5   11.3% - 12.1

2004

     20,502    5.0%      13.7%      31.3%      12.4%   

2005

     36,954    4.6%      13.5%      33.3%      5.8%   

2006

     2,075    20.9%      51.6%      49.7%      11.3%   

2007

     3,458    23.3%      55.7%      54.9%      10.7%   
                   
     $ 68,375    5.9%      16.2%      34.8%      8.7%   
                   
                                 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

3. INVESTMENTS (CONTINUED)

 

These significant inputs require significant management judgment and vary for each structured security based on the underlying property type, vintage, loan to collateral value ratio, geographic concentration, and current level of subordination. We also corroborate our credit loss estimate with the independent investment manager’s credit loss estimate for each structured debt security with a significant unrealized loss position.

For the three and six months ended June 30, 2010, based on expected cash flows to be collected, we have recorded additional credit losses of $2 million and $4 million, respectively, on non-agency RMBS.

ABS:

The majority of the unrealized losses on ABS at June 30, 2010 were related to CLO debt tranched securities. We used the following weighted average significant inputs to estimate the credit loss for these securities at June 30, 2010:

 

      June 30, 2010    December 31,  2009

Default rate, per annum

   4.4%    4.4%

Loss severity rate, per annum

   50.0%    50.0%

Collateral spreads, per annum

   3.3%    3.1%
           

Our assumptions on default and loss severity rates are established based on an assessment of actual experience to date for each CLO debt tranche and review of recent credit rating agencies’ default and loss severity forecasts. Based on projected cash flows at June 30, 2010, we do not anticipate credit losses on the CLO debt tranched securities.

 

4. FAIR VALUE MEASUREMENTS

Fair Value Hierarchy

Fair value is defined as the price to sell an asset or transfer a liability (i.e. the “exit price”) in an orderly transaction between market participants. We use a fair value hierarchy that gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. The hierarchy is broken down into three levels as follows:

 

   

Level 1—Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access. Valuation adjustments and block discounts are not applied to Level 1 instruments.

 

   

Level 2—Valuations based on quoted prices in active markets for similar assets or liabilities, quoted prices for identical assets or liabilities in inactive markets, or for which significant inputs are observable (e.g. interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.

 

   

Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement. The unobservable inputs reflect our own assumptions about assumptions that market participants might use.

The availability of observable inputs can vary from financial instrument to financial instrument and is affected by a wide variety of factors including, for example, the type of financial instrument, whether the financial instrument is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment.

Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This may lead us to change the selection of our valuation technique (from market to cash flow approach) or may cause us to use multiple valuation techniques to estimate the fair value of a financial instrument. This circumstance could cause an instrument to be reclassified between levels.

 

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4. FAIR VALUE MEASUREMENTS (CONTINUED)

 

We used the following methods and assumptions in estimating the fair value of our financial instruments as well as the general classification of such financial instruments pursuant to the above fair value hierarchy.

Fixed Maturities

At each valuation date, we use various valuation techniques to estimate the fair value of our fixed maturities portfolio. These techniques include, but are not limited to, prices obtained from third party pricing services for identical or comparable securities and the use of “pricing matrix models” using observable market inputs such as yield curves, credit risks and spreads, measures of volatility, and prepayment speeds. Pricing from third party pricing services are sourced from multiple vendors, and we maintain a vendor hierarchy by asset type based on historical pricing experience and vendor expertise. The following describes the techniques generally used to determine the fair value of our fixed maturities by asset class.

U.S. government and agency

U.S. government and agency securities consist primarily of bonds issued by the U.S. Treasury and mortgage pass-through agencies such as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association. As the fair values of our U.S. Treasury securities are based on unadjusted market prices, they are classified within Level 1. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are classified within Level 2.

Non-U.S. government

Non-U.S. government securities comprise bonds issued by non-U.S. governments and their agencies along with supranational organizations (also known as sovereign debt securities). The fair value of these securities is based on prices obtained from international indices or a valuation model that includes the following inputs: interest rate yield curves, cross-currency basis index spreads, and country credit spreads for structures similar to the sovereign bond in terms of issuer, maturity and seniority. As the significant inputs are observable market inputs, the fair value of non-U.S. government securities are classified within Level 2.

Corporate debt

Corporate debt securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As these spreads and the yields for the risk-free yield curve are observable market inputs, the fair values of our corporate debt securities are classified within Level 2. Where pricing is unavailable from pricing services, we obtain unbinding quotes from broker-dealers. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, securities are classified within Level 3 and consisted primarily of private corporate debt securities at June 30, 2010.

MBS

Our portfolio of RMBS and CMBS are originated by both agencies and non-agencies. The fair values of these securities are determined through the use of a pricing model (including Option Adjusted Spread) which uses prepayment speeds and spreads to determine the appropriate average life of the MBS. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As the significant inputs used to price MBS are observable market inputs, the fair values of the MBS are classified within Level 2. Where pricing is unavailable from pricing services, we obtain unbinding quotes from broker-dealers to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. These securities are classified within Level 3 and consist primarily of certain non-agency RMBS and CMBS at June 30, 2010.

 

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4. FAIR VALUE MEASUREMENTS (CONTINUED)

 

ABS

ABS include mostly investment-grade bonds backed by pools of loans with a variety of underlying collateral, including automobile loan receivables, credit card receivables, and CLO debt tranched securities originated by a variety of financial institutions. Similarly to MBS, the fair values of ABS are priced through the use of a model which uses prepayment speeds and spreads sourced primarily from the new issue market. As the significant inputs used to price ABS are observable market inputs, the fair values of ABS are classified within Level 2. Where pricing is unavailable from pricing services, we obtain unbinding quotes from broker-dealers or use a discounted cash flow model to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. At June 30, 2010, the use of a discounted cash flow model was limited to our investment in CLO debt tranched securities and included the following significant inputs: default and loss severity rates, collateral spreads, and risk free yield curves (see Note 3(d) for quantitative inputs). As most of these inputs are unobservable, these securities are classified within Level 3.

Municipals

Our municipal portfolio comprises bonds issued by U.S. domiciled state and municipality entities. The fair value of these securities is determined using spreads obtained from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the municipals are observable market inputs, municipals are classified within Level 2.

Equity Securities

Equity securities include U.S. and foreign common stocks as well as a foreign bond mutual fund. For common stocks we classified these within Level 1 as their fair values are based on quoted market prices in active markets. Our investment in the foreign bond mutual fund has daily liquidity, with redemption based on the net asset value of the fund. Accordingly, we have classified this investment as Level 2.

Other Investments

The short-duration high yield fund is classified within Level 2 as its fair value is estimated using the net asset value reported by Bloomberg and it has daily liquidity.

The hedge and credit funds are classified within Level 3 as we estimate their respective fair values using net asset values as advised by external fund managers or third party administrators. Refer to Note 3 for further details on this asset class.

The CLO – equity tranched securities (“CLO – Equities”) are classified within Level 3 as we estimate the fair value for these securities based on an discounted cash flow model due to the lack of observable, relevant trade in the secondary markets. At June 30, 2010, our discounted cash flow model included the following significant unobservable inputs.

 

Default rates:

    

- for 2010

   4.6%

- thereafter per annum

   4.4%

Loss severity rate per annum

   50.0%

Collateral spreads per annum

   2.5% - 4.1%
      

Derivative Instruments

Our foreign currency forward contracts and options are customized to our hedging strategies and trade in the over-the-counter derivative market. We estimate the fair value for these derivatives using models based on significant observable market inputs from third party pricing vendors, non-binding broker-dealer quotes and/or recent trading activity. Accordingly, we classified these derivatives within Level 2.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

4. FAIR VALUE MEASUREMENTS (CONTINUED)

 

The table below presents the financial instruments measured at fair value on a recurring basis.

 

      Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Other Observable
Inputs (Level 2)
  

Significant
Unobservable
Inputs

(Level 3)

   Total Fair
Value

At June 30, 2010

             

Assets

             

Fixed maturities

             

U.S. government and agency

   $ 872,696    $ 555,734    $ -        $ 1,428,430

Non-U.S. government

     -          754,768      -          754,768

Corporate debt

     -          4,058,878      3,100      4,061,978

Agency MBS

     -          1,705,104      -          1,705,104

Non-Agency CMBS

     -          605,901      3,600      609,501

Non-Agency RMBS

     -          218,000      2,973      220,973

ABS

     -          608,121      46,816      654,937

Municipals

     -          628,644      -          628,644
                             
       872,696      9,135,150      56,489      10,064,335

Equity securities

     148,430      52,743      -          201,173

Other investments

     -          51,786      496,087      547,873

Other assets (see Note 6)

     -          7,633      -          7,633
                             

Total

   $  1,021,126    $  9,247,312    $  552,576    $  10,821,014
                             
   

At December 31, 2009

             

Assets

             

Fixed maturities

             

U.S. government and agency

   $ 1,207,033    $ 649,626    $ -        $ 1,856,659

Non-U.S. government

     -          696,814      -          696,814

Corporate debt

     -          3,562,636      18,130      3,580,766

Agency MBS

     -          1,566,259      -          1,566,259

Non-Agency CMBS

     -          650,802      2,409      653,211

Non-Agency RMBS

        216,343      6,639      222,982

ABS

     -          399,554      43,585      443,139

Municipals

     -          698,525      -          698,525
                             
       1,207,033      8,440,559      70,763      9,718,355

Equity securities

     142,716      61,659      -          204,375

Other investments

     -          50,088      520,188      570,276

Other assets (see Note 6)

     -          9,968      -          9,968
                             

Total

   $ 1,349,749    $ 8,562,274    $ 590,951    $ 10,502,974
                             
                             

During 2010 and 2009, we had no transfers between Levels 1 and 2.

 

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4. FAIR VALUE MEASUREMENTS (CONTINUED)

 

Level 3 financial instruments

The following tables present changes in Level 3 for financial instruments measured at fair value on a recurring basis for the periods indicated:

 

      Fixed Maturities                
      Corporate
Debt
    Non-Agency
CMBS
    Non-Agency
RMBS
    ABS     Total     Other
Investments
    Total
Assets
 

Three months ended June 30, 2010

                

Balance at beginning of period

   $ 18,169     $ 3,447     $ 3,420     $ 47,663     $ 72,699     $ 487,466     $ 560,165  

Total net realized and unrealized gains included in net income(1)

     -            -            -            -            -            6,988       6,988  

Total net realized and unrealized losses included in net income(1)

     -            (119     (581     (1,134     (1,834     (9,542     (11,376

Change in net unrealized gains included in other comprehensive income

     2,128       1,061       872       2,300       6,361       -            6,361  

Change in net unrealized losses included in other comprehensive income

     -            -            -            -            -            -            -       

Purchases

     -            -            -            -            -            20,000       20,000  

Sales

     (12     (207     (211     (2,004     (2,434     (1,810     (4,244

Settlements / distributions

     -            (582     (132     (9     (723     (7,015     (7,738

Transfers into Level 3

     -            -            -            -            -            -            -       

Transfers out of Level 3

     (17,185     -            (395     -            (17,580     -            (17,580
                                                          

Balance at end of period

   $ 3,100     $ 3,600     $ 2,973     $ 46,816     $ 56,489     $ 496,087     $ 552,576  
                                                          
   

Level 3 gains / losses included in earnings attributable to the change in unrealized gains /losses relating to those assets held at the reporting date

   $ -          $ (119   $ (581   $ (1,134   $ (1,834   $ (2,554   $ (4,388
                                                          
   

Six months ended June 30, 2010

                

Balance at beginning of period

   $ 18,130     $ 2,409     $ 6,639     $ 43,585     $ 70,763     $ 520,188     $ 590,951  

Total net realized and unrealized gains included in net income(1)

     -            -            -            -            -            12,727       12,727  

Total net realized and unrealized losses included in net income(1)

     (1,550     (119     (581     (1,134     (3,384     (146     (3,530

Change in net unrealized gains included in other comprehensive income

     3,751       1,093       1,146       2,406       8,396       -            8,396  

Change in net unrealized losses included in other comprehensive income

     (34     (238     (20     (24     (316     -            (316

Purchases

     -            3,474       -            4,000       7,474       20,000       27,474  

Sales

     (12     (206     (211     (2,004     (2,433     (44,404     (46,837

Settlements / distributions

     -            (694     (485     (13     (1,192     (12,278     (13,470

Transfers into Level 3

     -            -            780       -            780       -            780  

Transfers out of Level 3

     (17,185     (2,119     (4,295     -            (23,599     -            (23,599
                                                          

Balance at end of period

   $ 3,100     $ 3,600     $ 2,973     $ 46,816     $ 56,489     $ 496,087     $ 552,576  
                                                          
   

Level 3 gains / losses included in earnings attributable to the change in unrealized gains /losses relating to those assets held at the reporting date

   $ (1,550   $ (119   $ (581   $ (1,134   $ (3,384   $ 12,581     $ 9,197  
                                                          
                                                          
(1) Realized gains and losses on fixed maturities are included in net realized investment gains (losses). Realized gains and (losses) on other investments are included in net investment income.

 

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4. FAIR VALUE MEASUREMENTS (CONTINUED)

 

      Fixed Maturities                     
      Corporate
Debt
    Non-Agency
CMBS
    Non-Agency
RMBS
    ABS     Total     Other
Investments
    Total
Assets
    Other
Liabilities

Three months ended June 30, 2009

                  

Balance at beginning of period

   $ 17,534     $ 565     $ 49,034     $ 47,758     $ 114,891     $ 451,982     $ 566,873     $ 72,597

Total net realized and unrealized gains included in net income(1)

     -            -            -            -            -            33,629       33,629       -    

Total net realized and unrealized losses included in net income(1)

     -            -            -            -            -            (18,041     (18,041     15,000

Change in net unrealized gains included in other comprehensive income

     150       -            5,308       7,725       13,183       -            13,183       -    

Change in net unrealized losses included in other comprehensive income

     (956     (10     (333     (1,443     (2,742     -            (2,742     -    

Purchases

     -            -            -            -            -            51,800       51,800       -    

Sales

     -            -            -            -            -            (19,325     (19,325     -    

Settlements / distributions

     (29     -            (5,647     (203     (5,879     (6,278     (12,157     -    

Transfers into Level 3

     224       -            14,212       20,032       34,468       -            34,468       -    

Transfers out of Level 3

     -            (555     (41,882     (25,526     (67,963     -            (67,963     -    
                                                                

Balance at end of period

   $ 16,923     $ -          $ 20,692     $ 48,343     $ 85,958     $ 493,767     $ 579,725     $ 87,597
                                                                
   

Level 3 gains / losses included in earnings attributable to the change in unrealized gains / losses relating to those assets and liabilities held at the reporting date

   $ -          $ -          $ -          $ -          $ -          $ 15,588     $ 15,588     $ 15,000
                                                                

Six months ended June 30, 2009

                  

Balance at beginning of period

   $ -          $ -          $ -          $ -          $ -          $ 450,542     $ 450,542     $ 62,597

Total net realized and unrealized gains included in net income(1)

     -            -            -            -            -            40,859       40,859       -    

Total net realized and unrealized losses included in net income(1)

     -            -            -            (373     (373     (18,987     (19,360     25,000

Change in net unrealized gains included in other comprehensive income

     150       107       6,627       8,134       15,018       -            15,018       -    

Change in net unrealized losses included in other comprehensive income

     (2,240     (32     (707     (3,895     (6,874     -            (6,874     -    

Purchases

     -            -            -            -            -            91,800       91,800       -    

Sales

     -            -            -            -            -            (61,369     (61,369     -    

Settlements / distributions

     (29     -            (8,726     (397     (9,152     (9,078     (18,230     -    

Transfers into Level 3

     19,042       480       65,380       70,400       155,302       -            155,302       -    

Transfers out of Level 3

     -            (555     (41,882     (25,526     (67,963     -            (67,963     -    
                                                                

Balance at end of period

   $ 16,923     $ -          $ 20,692     $ 48,343     $ 85,958     $ 493,767     $ 579,725     $ 87,597
                                                                
                    

Level 3 gains / losses included in earnings attributable to the change in unrealized gains / losses relating to those assets and liabilities held at the reporting date

   $ -          $ -          $ -          $ (373   $ (373   $ 21,872     $ 21,499     $ 25,000
                                                                
                                                                
(1) Realized gains and losses on fixed maturities are included in net realized investment gains (losses). Realized gains and (losses) on other investments are included in net investment income. Losses on other liabilities are included in other insurance related income (loss).

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

4. FAIR VALUE MEASUREMENTS (CONTINUED)

 

Following the adoption of the new Fair Value Measurements and Disclosures guidance on January 1, 2010, transfers into and out of Level 3 reflect the fair value of the securities at the end of the reporting period. This transition was applied prospectively and accordingly the transfers into and out of Level 3 from Level 2 for the three and six months ended June 30, 2010, are not comparable with prior periods as transfers into Level 3 were previously recorded at the fair value of the security at the beginning of the reporting period.

Transfers into Level 3 from Level 2

During the three months ended June 30, 2010, we had no transfers. For the same period in 2009, we transferred $14 million and $20 million of non-agency RMBS and ABS, respectively.

During the six months ended June 30, 2010, we transferred $1 million of non-agency RMBS. For the same period in 2009, we transferred $19 million, $65 million, and $70 million of corporate debt, non-agency RMBS and ABS, respectively.

The transfers to Level 3 from Level 2 were made due to a reduction in the volume of recently executed transactions or a lack of available quotes from pricing vendors and broker-dealers. None of the above transfers were as a result of changes in valuation methodology that we made.

Transfers out of Level 3 into Level 2

During the three months ended June 30, 2010, we transferred $17 million of corporate debt securities. The transfers were primarily related to a private corporate debt security as a result of entering into an agreement with the issuer to take delivery of a new corporate debt security, which its fair value measurement was based on observable market inputs at June 30, 2010. For the same period in 2009, we transferred $42 million and $26 million of non-agency RMBS and ABS, respectively.

During the six months ended June 30, 2010, we transferred $17 million, $2 million, and $4 million of corporate debt, non-agency CMBS and non-agency RMBS, respectively. For the same period in 2009, we transferred $1 million, $42 million, and $26 million of non-agency CMBS, non-agency RMBS, and ABS, respectively.

Except as noted above, the transfers out of Level 3 into Level 2 made in 2009 and 2010 were primarily due to the availability of multiple quotes from pricing vendors and broker-dealers as a result of the return of liquidity in the credit markets.

Fair Values of Financial Instruments

The carrying amount of financial assets and liabilities presented on the Consolidated Balance Sheets as at June 30, 2010, and December 31, 2009 approximated their fair values with the exception of senior notes. At June 30, 2010, the senior notes are recorded at amortized cost with a carrying value of $994 million (2009: $499 million) and a fair value of $997 million (2009: $510 million).

 

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

5. RESERVE FOR LOSSES AND LOSS EXPENSES

 

The following table shows a reconciliation of our beginning and ending gross unpaid losses and loss expenses for the periods indicated:

 

      Six months ended
June 30,
 
      2010     2009  

Gross reserve for losses and loss expenses, beginning of period

   $ 6,564,133     $ 6,244,783  

Less reinsurance recoverable on unpaid losses, beginning of period

     (1,381,058     (1,314,551
                  

Net reserve for losses and loss expenses, beginning of period

     5,183,075       4,930,232  
                  
   

Net incurred losses related to:

      

Current year

      1,031,704       947,327  

Prior years

     (160,072     (181,076
                  
       871,632       766,251  
                  
   

Net paid losses related to:

      

Current year

     (102,327     (54,467

Prior years

     (604,286     (525,573
                  
       (706,613     (580,040
                  

Foreign exchange and other

     (135,778     54,381  
                  

Net reserve for losses and loss expenses, end of period

     5,212,316       5,170,824  

Reinsurance recoverable on unpaid losses, end of period

     1,506,460       1,391,070  
                  

Gross reserve for losses and loss expenses, end of period

   $ 6,718,776     $   6,561,894  
                  
                  

We write business with loss experience generally characterized as low frequency and high severity in nature, which results in volatility in our financial results. During the six months ended June 30, 2010, we recognized net loss and loss expenses of $133 million in relation to the February 2010 Chilean earthquake. Our estimate was derived from a ground-up assessment of our individual contracts and treaties in the affected regions and is consistent with our market share in the region. As part of our estimation process, we also considered current industry insured loss estimates, market share analysis, catastrophe modeling analysis and the information available to date from clients, brokers and loss adjusters. Industry-wide insured loss estimates and our own loss estimate for the Chilean earthquake are subject to change, as additional actual loss data becomes available. Actual losses in relation to this event may ultimately differ materially from current loss estimates.

Net losses and loss expenses incurred include net favorable prior period reserve development of $160 million and $181 million for the six months ended June 30, 2010 and 2009, respectively. Prior period reserve development arises from changes to loss estimates recognized in the current year that relate to losses incurred in previous calendar years.

The following table summarizes net favorable reserve development by segment:

 

      Three months ended
June 30,
   Six months ended
June 30,
      2010    2009    2010    2009

Insurance

   $ 30,541    $ 46,860    $ 55,910    $ 82,766

Reinsurance

     48,065      49,882      104,162      98,310
                             

Total

   $ 78,606    $ 96,742    $   160,072    $   181,076
                             
                             

Overall, a significant portion of the net favorable prior period reserve development in the second quarters of 2010 and 2009 was generated from the property, marine, terrorism (included in “other”) and aviation lines of our insurance segment and the property, catastrophe and crop (included in “other”) lines of our reinsurance segment. These lines of business, the majority of which have short

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

5. RESERVE FOR LOSSES AND LOSS EXPENSES (CONTINUED)

 

tail exposures, contributed $38 million and $71 million of the total net favorable reserve development in the second quarters of 2010 and 2009, respectively. The favorable development on these lines of business primarily reflects the recognition of better than expected loss emergence, rather than explicit changes in our actuarial assumptions.

Approximately $36 million and $9 million of the net favorable reserve development in the second quarter of 2010 and 2009, respectively, was generated from professional lines insurance and reinsurance business. This favorable development was driven by increased incorporation of our own historical claims experience into our ultimate expected loss ratios for accident years 2006 and prior, with less weighting being given to information derived from industry benchmarks. We began to give weight to our own loss experience on 2005 and prior accident year professional lines business in 2008 because they had developed a reasonable level of credible loss data. However, the impact of this change was somewhat muted in the second quarter of 2009 due to the strengthening of reserves on the 2008 accident year in relation to the credit crisis.

During the second quarter of 2010, we recognized net favorable prior period reserve development of $13 million on our credit and bond reinsurance business, primarily on the 2009 accident year and, to a lesser extent, the 2007 and 2008 accident years, in recognition of better than expected loss experience. Partially offsetting the net favorable development recognized in the second quarter of 2010, we recognized $6 million in net adverse prior period development on our credit and political risk insurance business, primarily due to reduced recovery estimates on 2009 accident year credit business, after taking into consideration updated publicly available information and discussions with our insureds. The impact of the reduced recovery estimates was somewhat offset by favorable development on the 2008 and 2007 accident years, as a result of better than expected loss emergence on both traditional political risk (i.e. confiscation, expropriation, nationalization and deprivation, or “CEND”) and credit related business. During the second quarter of 2010, we concluded the settlement and policy cancellation on one peak credit insurance exposure, Blue City Investments 1 Limited; the net payment fell within the provision established in prior periods. During the second quarter of 2009, we recognized favorable reserve development of $13 million on our insurance liability lines of business, following incorporation of more of our own reinsurance recovery experience on our excess and surplus (“E&S”) umbrella lines.

For the six months ended June 30, 2010 and 2009, our net favorable development included $89 million and $149 million, respectively, in relation to the primarily short tail exposure lines outlined above. This favorable development primarily reflects the recognition of better than expected loss emergence, rather than explicit changes in our actuarial assumptions. Development on our professional lines business accounted for $72 million and $24 million for the six months ended June 30, 2010 and 2009, respectively, with the rationale being consistent with that outlined above.

 

6. DERIVATIVE INSTRUMENTS

The following table summarizes information on the location and amounts of derivative fair values on the consolidated balance sheet at June 30, 2010:

 

            Asset Derivatives    Liability  Derivatives
      Notional
Amount
   Balance Sheet
Location
   Fair
value
   Balance Sheet
Location
   Fair
Value

Derivatives designated as hedging instruments

             

Foreign exchange contracts

   $   561,720    Other assets    $   3,942    Other liabilities    $ -    
                        

Derivatives not designated as hedging instruments

                

Relating to investment portfolio:

                

Foreign exchange contracts

   $ 74,844    Other assets    $ 3,511    Other liabilities    $ -    
                        

Relating to underwriting portfolio:

                

Foreign exchange contracts

   $ 25,669    Other assets    $ 180    Other liabilities    $ -    
                        

Total derivatives

         $   7,633       $ -    
                        
                                

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

6. DERIVATIVE INSTRUMENTS (CONTINUED)

 

The following table summarizes information on the location and amounts of derivative fair values on the consolidated balance sheet at December 31, 2009:

 

            Asset Derivatives    Liability  Derivatives
      Notional
Amount
   Balance Sheet
Location
   Fair
value
   Balance Sheet
Location
   Fair
Value

Derivatives designated as hedging instruments

             

Foreign exchange contracts

   $  659,617    Other assets    $  9,557    Other liabilities    $ -    
                        

Derivatives not designated as hedging instruments

                

Relating to investment portfolio:

                

Foreign exchange contracts

   $ 21,436    Other assets    $ 411    Other liabilities    $ -    
                        

Total derivatives

         $ 9,968       $ -    
                        
                                

For the fair value hierarchy level, refer to Note 4 – Fair Value Measurements.

The following table provides the total unrealized and realized gains (losses) on derivatives recorded in earnings:

 

     

Location of Gain (Loss) Recognized

in Income on Derivative

   Three months ended
June 30,
    Six months ended
June 30,
 
         2010    2009     2010    2009  

Derivatives in fair value hedging relationships

            

Foreign exchange contracts

   Net realized investment gains (losses)    $  57,296    $ (26,713   $  92,223    $ (6,648
                                   

Derivatives not designated as hedging instruments

               

Relating to investment portfolio:

               

Foreign exchange contracts

   Net realized investment gains (losses)    $ 2,988    $ (391   $ 2,830    $     1,009  

Relating to underwriting portfolio:

               

Longevity risk derivative

   Other insurance related income (loss)      -           (15,000     -          (25,000

Currency collar options:

               

Put options - Long

   Foreign exchange gains (losses)      -          -            -          2,331  

Call options - Short

   Foreign exchange gains (losses)      -          -            -          97  

Foreign exchange contracts

   Foreign exchange gains (losses)      4,352      (7,043     7,416      (3,891

Catastrophe-related risk

   Other insurance related income (loss)      -          80       -          45  
                                   

Total

      $ 7,340    $ (22,354   $ 10,246    $ (25,409
                                   
                                     

Derivative Instruments Designated as a Fair Value Hedge

The hedging relationship foreign currency contracts were entered into to mitigate the foreign currency exposure of two available for sale fixed maturity portfolios denominated in Euros. The hedges were designated and qualified as a fair value hedge. The net impact of the hedges is recognized in net realized investment gains (losses).

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

6. DERIVATIVE INSTRUMENTS (CONTINUED)

 

The following table provides the net earnings impact of the fair value hedges:

 

      Three months ended
June 30,
    Six months ended
June 30,
 
      2010     2009     2010     2009  

Foreign exchange contracts

   $   57,296     $ (26,713   $   92,223     $ (6,648

Hedged investment portfolio

     (52,996       24,727       (84,706       6,742