Released: 26/02/2010
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have a material impact on the
results and disclosures reported in the consolidated financial statements, but
would result in a re-classification of fixed income securities from available
for sale to fair value through profit or loss and a re-classification of the
net change in unrealised gains and losses on investments from other
comprehensive income to income.
The consolidated balance sheet of the Group is presented in order of decreasing
liquidity.
use of estimates
The preparation of financial statements in conformity with IFRS requires the
Group to make estimates and assumptions that affect the reported and disclosed
amounts at the balance sheet date and the reported and disclosed amounts of
revenues and expenses during the reporting period. Actual results may differ
materially from the estimates made.
The most significant estimate made by management is in relation to losses and
loss adjustment expenses. This is discussed in the risk disclosures section.
Estimates in relation to losses and loss adjustment expenses recoverable are
discussed in section iv. losses below.
Estimates may also be made in determining the estimated fair value of certain
financial instruments. These are discussed in note 11 and in section ii.
investments below. Management judgement is applied in determining impairment
charges.
basis of consolidation
i. subsidiaries
The Group's consolidated financial statements include the assets, liabilities,
shareholders' equity, revenues, expenses and cash flows of LHL and its
subsidiaries. A subsidiary is an entity in which the Group owns, directly or
indirectly, more than 50% of the voting power of the entity or otherwise has
the power to govern its operating and financial policies. The results of
subsidiaries acquired are included in the consolidated financial statements
from the date on which control is transferred to the Group. Intercompany
balances, profits and transactions are eliminated.
Subsidiaries' accounting policies are consistent with the Group's accounting
policies.
ii. associates
Investments, in which the Group has significant influence over the operational
and financial policies of the investee, are initially recognised at cost and
thereafter accounted for using the equity method. Under this method, the Group
records its proportionate share of income or loss from such investments in its
results of operations for the period. Adjustments are made to associates'
accounting policies, where necessary, in order to be consistent with the
Group's accounting policies.
foreign currency translation
The functional currency, which is the currency of the primary economic
environment in which operations are conducted, for all Group entities is U.S.
dollars. Items included in the financial statements of each of the Group's
entities are measured using the functional currency. The consolidated financial
statements are also presented in U.S. dollars.
Foreign currency transactions are recorded in the functional currency for each
entity using the exchange rates prevailing at the dates of the transactions, or
at the average rate for the period when this is a reasonable approximation.
Monetary assets and liabilities denominated in foreign currencies are
translated at period end exchange rates. The resulting exchange differences on
translation are recorded in the consolidated statement of comprehensive income.
Non-monetary assets and liabilities carried at historical cost denominated in a
foreign currency are translated at historic rates. Non-monetary assets and
liabilities carried at fair value denominated in a foreign currency are
translated at the exchange rate at the date the fair value was determined, with
resulting exchange differences recorded in accumulated other comprehensive
income in shareholders' equity.
insurance contracts
i. classification
Insurance contracts are those contracts that transfer significant insurance
risk at the inception of the contract. Contracts that do not transfer
significant insurance risk are accounted for as investment contracts. Insurance
risk is transferred when an insurer agrees to compensate a policyholder if a
specified uncertain future event adversely affects the policyholder.
ii. premiums and acquisition costs
Premiums are first recognised as written at the date that the contract is
bound. The Group writes both excess of loss and pro-rata (proportional)
contracts. For the majority of excess of loss contracts, written premium is
recorded based on the minimum and deposit or flat premium, as defined in the
contract. Subsequent adjustments to the minimum and deposit premium are
recognised in the period in which they are determined. For pro-rata contracts
and excess of loss contracts where no deposit is specified in the contract,
written premium is recognised based on estimates of ultimate premiums provided
by the insureds or ceding companies. Initial estimates of written premium are
recognised in the period in which the contract is bound. Subsequent
adjustments, based on reports of actual premium by the insureds or ceding
companies, or revisions in estimates, are recorded in the period in which they
are determined.
Premiums are earned rateably over the term of the underlying risk period of the
insurance contract, except where the period of risk differs significantly from
the contract period. In these circumstances, premiums are recognised over the
period of risk in proportion to the amount of insurance protection provided.
The portion of the premium related to the unexpired portion of the risk period
is reflected in unearned premiums.
Where contract terms require the reinstatement of coverage after an insured's
or ceding company's loss, the estimated mandatory reinstatement premiums are
recorded as written premiums when a specific loss event occurs. Reinstatement
premiums are not recorded for losses included within the provision for losses
incurred but not reported ("IBNR") which do not relate to a specific loss
event.
Inwards premiums receivable from insureds and cedants are recorded net of
commissions, brokerage, premium taxes and other levies on premiums, unless the
contract specifies otherwise. These balances are reviewed for impairment, with
any impairment loss recognised as an expense in the period in which it is
determined.
Acquisition costs represent commissions, brokerage, profit commissions and
other variable costs that relate directly to the securing of new contracts and
the renewing of existing contracts. They are generally deferred over the period
in which the related premiums are earned to the extent they are recoverable out
of expected future revenue margins. All other acquisition costs are recognised
as an expense when incurred.
iii. outwards reinsurance
Outwards reinsurance premiums comprise the cost of reinsurance contracts
entered into. Outwards reinsurance premiums are accounted for in the period in
which the contract is bound. The provision for reinsurers' share of unearned
premiums represents that part of reinsurance premiums ceded which are estimated
to be earned in future financial periods. Unearned reinsurance commissions are
recognised as a liability using the same principles. Any amounts recoverable
from reinsurers are estimated using the same methodology as the underlying
losses.
The Group monitors the credit-worthiness of its reinsurers on an ongoing basis
and assesses any reinsurance assets for impairment, with any impairment loss
recognised as an expense in the period in which it is determined.
iv. losses
Losses comprise losses and loss adjustment expenses paid in the period and
changes in the provision for outstanding losses, including the provision for
IBNR and related expenses. Losses and loss adjustment expenses are charged to
income as they are incurred.
A significant portion of the Group's business is in classes with high
attachment points of coverage, including property catastrophe. Reserving for
losses in such programs is inherently complicated in that losses in excess of
the attachment level of the Group's policies are characterised by high severity
and low frequency and other factors which could vary significantly as losses
are settled. This limits the volume of industry loss experience available from
which to reliably predict ultimate losses following a loss event. In addition,
the Group has limited past loss experience, which increases the inherent
uncertainty in estimating ultimate loss levels.
Losses and loss adjustment expenses represent the estimated ultimate cost of
settling all losses and loss adjustment expenses arising from events which have
occurred up to the balance sheet date, including a provision for IBNR. The
Group does not discount its liabilities for unpaid losses. Outstanding losses
are initially set on the basis of reports of losses received from third
parties. Additional case reserves ("ACRs") are determined where the Group's
estimate of the reported loss is greater than that reported. Estimated IBNR
reserves may also consist of a provision for additional development in excess
of losses reported by insureds or ceding companies, as well as a provision for
losses which have occurred but which have not yet been reported by insureds or
ceding companies. IBNR reserves are estimated by management using various
actuarial methods as well as a combination of own loss experience, historical
insurance industry loss experience, underwriters' experience, estimates of
pricing adequacy trends, and management's professional judgement.
The estimation of the ultimate liability arising is a complex process which
incorporates a significant amount of judgement. It is reasonably possible that
uncertainties inherent in the reserving process, delays in insureds or ceding
companies reporting losses to the Group, together with the potential for
unforeseen adverse developments, could lead to a material change in losses and
loss adjustment expenses.
v. liability adequacy tests
At each balance sheet date, the Group performs a liability adequacy test using
current best estimates of future cash outflows generated by its insurance
contracts, plus any investment income thereon. If, as a result of these tests,
the carrying amount of the Group's insurance liabilities is found to be
inadequate, the deficiency is charged to income for the period, initially by
writing off deferred acquisition costs and subsequently by establishing a
provision.
financial instruments
i. cash and cash equivalents
Cash and cash equivalents are carried in the consolidated balance sheet at
amortised cost and includes cash in hand, deposits held on call with banks and
other short-term highly liquid investments with a maturity of three months or
less at the date of purchase. Carrying amounts approximate fair value due to
the short-term nature and high liquidity of the instruments.
Interest income earned on cash and cash equivalents is recognised on the
effective interest rate method. The carrying value of accrued interest income
approximates fair value due to its short-term nature and high liquidity.
ii. investments
The Group's fixed income and equity securities are quoted investments that are
classified as available for sale or fair value through profit and loss and are
carried at estimated fair value. The classification is determined at the time
of initial purchase and depends on the category of investment. Investments with
an embedded conversion option purchased since 1 January 2007 are designated as
at fair value through profit and loss. Movements in estimated fair value relate
primarily to the option component.
Regular way purchases and sales of investments are recognised at estimated fair
value less transaction costs on the trade date and are subsequently carried at
estimated fair value. Estimated fair value of quoted investments is determined
based on bid prices from recognised exchanges, broker-dealers, recognised
indices or pricing vendors. Investments are derecognised when the Group has
transferred substantially all of the risks and rewards of ownership. Realised
gains and losses are included in income in the period in which they arise.
Unrealised gains and losses from changes in estimated fair value of available
for sale investments are included in accumulated other comprehensive income in
shareholders' equity.
On derecognition of an investment, previously recorded unrealised gains and
losses are removed from accumulated other comprehensive income in shareholders'
equity and included in current period income. Changes in estimated fair value
of investments classified as at fair value through profit and loss are
recognised in current period income.
Accretion and amortisation of premiums and discounts on available for sale
fixed income securities are calculated using the effective interest rate method
and are recognised in current period net investment income. Interest income is
recognised on the effective interest rate method. The carrying value of accrued
interest income approximates fair value due to its short-term nature and high
liquidity. Dividends on equity securities are recorded as revenue on the date
the dividends become payable to the holders of record.
The Group reviews the carrying value of its available for sale investments for
evidence of impairment. An investment is impaired if its carrying value exceeds
the estimated fair value and there is objective evidence of impairment to the
asset. Such evidence would include a prolonged decline in estimated fair value
below cost or amortised cost, where other factors, such as expected cash flows,
do not support a recovery in value. If an impairment is deemed appropriate,
the difference between cost or amortised cost and estimated fair value is
removed from accumulated other comprehensive income in shareholders' equity and
charged to current period income.
Impairment losses on equity securities are not subsequently reversed through
income. Impairment losses on fixed income securities may be subsequently
reversed through income.
iii. derivative financial instruments
Derivatives are recognised at estimated fair value on the date a contract is
entered into, the trade date, and are subsequently carried at estimated fair
value. Derivative instruments with a positive fair value are recorded as
derivative financial assets and those with a negative fair value are recorded
as derivative financial liabilities. Embedded derivatives that are not closely
related to their host contract are bifurcated and changes in estimated fair
value are recorded through income.
Derivative and embedded derivative financial instruments include option, swap,
forward and future exchange-traded contracts. They derive their value from the
underlying instrument and are subject to the same risks as that underlying
instrument, including liquidity, credit and market risk. Estimated fair values
are based on exchange or broker-dealer quotations, where available, or
discounted cash flow models, which incorporate the pricing of the underlying
instrument, yield curves and other factors, with changes in the estimated fair
value of instruments that do not qualify for hedge accounting recognised in
current period income. For discounted cash flow techniques, estimated future
cash flows are based on management's best estimates and the discount rate used
is an appropriate market rate.
Derivative financial assets and liabilities are offset and the net amount is
reported in the consolidated balance sheet only to the extent there is a
legally enforceable right of offset and there is an intention to settle on a
net basis, or to realise the assets and liabilities simultaneously. Derivative
financial assets and liabilities are derecognised when the Group has
transferred substantially all of the risks and rewards of ownership or the
liability is discharged, cancelled or expired.
iv. long-term debt
Long-term debt is recognised initially at fair value, net of transaction costs
incurred. Thereafter it is held at amortised cost, with the amortisation
calculated using the effective interest rate method. Derecognition occurs when
the obligation has been extinguished.
property, plant and equipment
Property, plant and equipment is carried at historical cost, less accumulated
depreciation and any impairment in value. Depreciation is calculated to
write-off the cost over the estimated useful economic life on a straight-line
basis as follows:
IT equipment 33% per annum
Office furniture and equipment 33% per annum
Leasehold improvements 20% per annum
The assets' residual values, useful lives and depreciation methods are
reviewed, and adjusted if appropriate, at each balance sheet date.
An item of property, plant or equipment is derecognised on disposal or when no
future economic benefits are expected to arise from the continued use of the
asset.
Gains and losses on the disposal of property, plant and equipment are
determined by comparing proceeds with the carrying amount of the asset, and are
included in the consolidated statement of comprehensive income. Costs for
repairs and maintenance are charged to income as incurred.
leases
Rentals payable under operating leases are charged to income on a straight-line
basis over the lease term.
employee benefits
i. equity compensation plans
The Group operates a restricted share scheme. The Group has also operated a
management warrant plan and an option plan in the past. The fair value of the
equity instruments granted is estimated on the date of grant. The estimated
fair value is recognised as an expense pro-rata over the vesting period of the
instrument, adjusted for the impact of any non-market vesting conditions. No
adjustment to the estimated fair value is made in respect of market vesting
conditions.
At each balance sheet date, the Group revises its estimate of the number of
restricted shares, warrants and options that are expected to become
exercisable. It recognises the impact of the revision of original estimates, if
any, in the consolidated statement of comprehensive income, and a corresponding
adjustment is made to other reserves in shareholders' equity over the remaining
vesting period.
On exercise, the differences between the expense charged to the consolidated
statement of comprehensive income and the actual cost to the Group is
transferred to retained earnings. Where new shares are issued, the proceeds
received are credited to share capital and share premium.
ii. pensions
The Group operates a defined contribution plan. On payment of contributions to
the plan there is no further obligation to the Group. Contributions are
recognised as employee benefits in the consolidated statement of comprehensive
income in the period to which they relate.
tax
Income tax represents the sum of the tax currently payable and any deferred
tax. The tax payable is calculated based on taxable profit for the period.
Taxable profit for the period can differ from that reported in the consolidated
statement of comprehensive income due to certain items which are not tax
deductible or which are deferred to subsequent periods.
Deferred tax is recognised on temporary differences between the assets and
liabilities in the consolidated balance sheet and their tax base. Deferred tax
assets or liabilities are accounted for using the balance sheet liability
method. Deferred tax assets are recognised to the extent that realising the
related tax benefit through future taxable profits is likely.
Deferred tax assets and liabilities are offset when there is a legally
enforceable right to offset current tax assets against current tax liabilities
and when the deferred income taxes relate to the same fiscal authority.
own shares
Own shares include shares repurchased under share repurchase authorisations and
held in treasury plus shares repurchased and held in trust for the purposes of
employee equity based compensation schemes. Own shares are deducted from
shareholders' equity. No gain or loss is recognised on the purchase, sale,
cancellation or issue of own shares and any consideration paid or received is
recognised directly in equity.
risk disclosures: introduction
The Group is exposed to risks from several areas including insurance risk,
market risk, liquidity risk, credit risk, operational risk and strategic risk.
The primary risk to the Group is insurance risk.
The Group has a comprehensive Enterprise Risk Management ("ERM") program. ERM
is co-ordinated by the Chief Risk Officer ("CRO") who reports to the Board of
Directors on matters related to risk. The Board of Directors sets the overall
risk profile and risk appetite for the Group, while the Group's senior
management team is actively involved in all aspects of risk and capital
management. Risk Committees are in place at the operating entity level. The
Committees provide reports and updates to the operating entity and Group Boards
of Directors. The Risk Committees operate within the framework of agreed Terms
of Reference and help to define and monitor risk tolerance levels over all
categories of risk for the operating entities. This includes the level of
capital the operating entities are willing to expose to certain risks. The
Committees meet formally at least quarterly to review, amongst other things,
established tolerance levels, actual risk levels versus tolerances, emerging
risks and material risk failures or losses. The CRO is responsible for
monitoring the adherence to the tolerance levels. Any risk tolerance breaches
are reported to the Risk Committees, and thus to the Boards of Directors.
Identification of emerging risks, and monitoring of already recognised risks,
is the responsibility of individual risk owners but the process is facilitated
by the CRO. Risk owners periodically perform an exercise to identify the
Group's most significant risks. Risk reports are provided to the management
team on a regular basis to assist in monitoring risk levels, threats and
opportunities. The Group's risk register is a fundamental tool for integrating
risk and capital management into the day to day operations of the Group, and is
a point of reference for decision making and change management. Risk registers
also assist in embedding ERM through the Group and strengthen the risk
assessment, risk identification, risk monitoring and risk mitigation process.
Risk registers are formally reviewed at least quarterly by each risk owner and
the CRO.
The Group's ERM framework has four primary drivers:
a. strategy;
b. culture;
c. process; and
d. infrastructure.
a. strategy
Strategy is the core of the Group's ERM framework and includes risk appetite
and performance targets.
b. culture
The risk management tone is set by the Group Board of Directors and
communicated throughout the organisation by the management team. The management
team ensures consistent communication of risks across the Group and has
established an environment that provides continuous training and development of
employees, and a structured method of performance measurement and remuneration.
c. process
Process incorporates five elements:
* Risk identification;
* Risk assessment;
* Risk mitigation and management;
* Risk measurement and reporting; and
* Roles and responsibilities.
An important component of the ERM process is the quarterly affirmation
certification where each risk owner is required to affirm their key risks and
the performance of control activities under their remit. Risk owners are also
required to comment on control failures or instances of fraud, if they occur,
and the status of policies and procedures as part of their affirmations.
d. infrastructure
Setting and monitoring of risk tolerance limits and the design and monitoring
of controls is supported by the Group's infrastructure, which includes IT
systems and processes and regular management and executive meetings.
internal audit
Internal audit plays a key role by providing an independent opinion regarding
the accuracy and completeness of risks, in addition to verification of the
effectiveness of key and compensating controls. Internal audit's roles and
responsibilities are clearly defined through the Internal Audit Charter. The
head of internal audit reports directly to the Group Audit Committee. The CRO
also receives a copy of each audit report and considers the findings and agreed
actions in the context of the risk policies and risk management strategy of
each area.
The integration of internal audit and ERM into the business helps facilitate
the Group's management in the protection of its assets and reputation.
economic capital model
The foundation of the Group's risk based capital approach to decision making is
its economic capital model ("BLAST"), which is based on the widely accepted
economic capital modeling tool, ReMetrica. Management uses BLAST primarily for
monitoring its insurance risks. However, BLAST is also used to monitor the
entire spectrum of risks including market, credit and operational risks.
BLAST produces data in the form of a stochastic distribution for all classes,
including non-elemental classes. The distribution includes the mean outcome and
the result at various return periods, including very remote events. BLAST
includes the calculation of present and projected financial outcomes for each
insurance class, and also recognises diversification credit. This arises as
individual risks are generally not strongly correlated and are unlikely to all
produce profits or losses at the same time. Diversification credit is
calculated within categories or across a range of risk categories, with the
most significant impact resulting from insurance risks. BLAST also measures the
Group's aggregate insurance exposures. It therefore helps senior management and
the Board of Directors determine the level of capital required to meet the
combined risk from a wide range of categories. Assisted by BLAST, the Group
seeks to achieve an improved risk-adjusted return over time.
BLAST is used in strategic underwriting decisions as part of the Group's annual
planning process. Management utilises BLAST in assessing the impact of
strategic decisions on individual classes of business that the Group writes, or
is considering writing, as well as the overall resulting financial impact to
the Group. BLAST output is reviewed, including the anticipated loss curves and
combined ratios, to determine profitability and risk tolerance headroom by
class. The output from BLAST assists in portfolio optimisation decisions.
In addition, usually on a fortnightly basis, management reviews BLAST output to
monitor its expected losses against its risk tolerances for each class of
business. Should a tolerance breach occur, action is taken to mitigate the
breach and the risk owner is required to produce a breach mitigation plan. A
breach form is required which is approved by the CRO and the operating entity
CEO. Breaches may be reported to members of management, the Risk Management
Forum, the Risk Committee and the Board of Directors, depending on the
circumstances.
A. insurance risk
The Group underwrites worldwide short-tail insurance and reinsurance contracts
that transfer insurance risk, including risks exposed to both natural and
man-made catastrophes. The Group's exposure in connection with insurance
contracts is, in the event of insured losses, whether premiums will be
sufficient to cover the loss payments and expenses. Insurance and reinsurance
markets are cyclical and premium rates and terms and conditions vary by line of
business depending on market conditions and the stage of the cycle. Market
conditions are impacted by capacity and recent loss events, amongst other
factors. The Group's underwriters assess likely losses using their experience
and knowledge of past loss experience, industry trends and current
circumstances. This allows them to estimate the premiums sufficient to meet
likely losses and expenses.
The Group considers insurance risk at an individual contract level, at a sector
level, a geographic level, and at an aggregate portfolio level to ensure
careful risk selection, limits on concentration and appropriate portfolio
diversification are accomplished. The Group's four principal classes, or lines,
are property, energy, marine and aviation. These classes are deemed to be the
Group's operating segments. The level of insurance risk tolerance per class per
occurrence and in aggregate is set by the Risk Committees and ultimately
approved by the Board of Directors.
A number of controls are deployed to control the amount of insurance exposure
assumed:
* The Group has a rolling three year strategic plan that helps establish the
over-riding business goals that the Board of Directors aims to achieve;
* A detailed business plan is produced annually which includes expected
premiums and combined ratios by class and considers capital usage and
requirements. The plan is approved by the Board of Directors and is
monitored and reviewed on an on-going basis;
* BLAST is used to measure occurrence risks, aggregate risks and correlations
between classes;
* Each authorised class has a pre-determined normal maximum line structure;
* The Group has pre-determined tolerances on probabilistic and deterministic
losses of capital for certain single events and aggregate losses over a
period of time;
* Risk levels versus tolerances are communicated broadly on a regular basis;
* A daily underwriting meeting is held to peer review insurance proposals,
opportunities and emerging risks;
* Sophisticated pricing models are utilised in certain areas of the
underwriting process, and are updated frequently;
* BLAST and other computer modeling tools are deployed to simulate
catastrophes and resultant losses to the portfolio and the Group; and
* Reinsurance may be purchased to mitigate both frequency and severity of
losses.
The Group also maintains targets for the maximum proportion of capital,
including long-term debt, that can be lost in a single extreme event or a
combination of events.
Some of the Group's business provides coverage for natural catastrophes (i.e.
hurricanes, earthquakes and floods) and is subject to potential seasonal
variation. A proportion of the Group's business is exposed to large catastrophe
losses in North America, Europe and Japan as a result of windstorms. The level
of windstorm activity, and landfall thereof, during the North American,
European and Japanese wind seasons may materially impact the Group's loss
experience. The North American and Japanese wind seasons are typically June to
November and the European wind season November to March. The Group also bears
exposure to large losses arising from other non-seasonal natural catastrophes,
such as earthquakes, from risk losses throughout the year and from war,
terrorism and political risk and other events.
The Group's exposures to certain events, as a percentage of capital, including
long-term debt, are shown below. Net loss estimates are before income tax and
net of reinstatement premiums and outward reinsurance.
as at 31 december 2009 $m % of $m % of
capital capital
zones perils 100 year return period 250 year return
estimated net loss period estimated net
loss
gulf of mexico(1) hurricane 278.5 18.4 391.2 25.9
california earthquake 190.1 12.6 292.6 19.4
pan-european windstorm 163.2 10.8 261.7 17.3
japan earthquake 138.2 9.2 236.1 15.6
japan typhoon 86.3 5.7 170.8 11.3
(1) landing hurricane from florida to texas
as at 31 december 2008 $m % of $m % of
capital capital
zones perils 100 year return period 250 year return
estimated net loss period estimated net
loss
gulf of mexico(1) hurricane 250.2 17.8 357.1 25.4
california earthquake 177.1 12.6 255.6 18.2
pan-european windstorm 143.7 10.2 203.0 14.5
japan earthquake 213.3 15.2 244.2 17.4
japan typhoon 110.3 7.9 170.4 12.1
(1) landing hurricane from florida to texas
There can be no guarantee that the modeled assumptions and techniques deployed
in calculating these figures are accurate. There could also be an unmodeled
loss which exceeds these figures. In addition, any modeled loss scenario could
cause a larger loss to capital than the modeled expectation.
Details of annual gross premiums written by line of business are provided
below:
2009 2008
$m % $m %
property 317.3 50.5 302.7 47.5
energy 175.5 28.0 185.2 29.0
marine 73.7 11.7 78.6 12.3
aviation 61.3 9.8 71.6 11.2
total 627.8 100.0 638.1 100.0
Details of annual gross premiums written by geographic area of risks insured
are provided below:
2009 2008
$m % $m %
worldwide offshore 227.3 36.2 232.6 36.5
U.S. and Canada 158.3 25.2 112.8 17.7
worldwide, including the U.S. and Canada 119.2 19.0 124.2 19.4
(1)
europe 36.2 5.8 42.0 6.6
worldwide, excluding the U.S. and Canada 35.6 5.7 48.5 7.6
(2)
far east 13.2 2.1 17.3 2.7
middle east 11.9 1.9 12.4 1.9
rest of world 26.1 4.1 48.3 7.6
total 627.8 100.0 638.1 100.0
(1) worldwide, including the U.S. and Canada, comprises insurance and
reinsurance contracts that insure or reinsure risks in more than one geographic
area
(2) worldwide, excluding the U.S. and Canada, comprises insurance and
reinsurance contracts that insure or reinsure risks in more than one geographic
area, but that specifically exclude the U.S. and Canada
Sections a to d below describe the risks in each of the four principal lines of
business written by the Group.
a. property
Gross premiums written, for the year:
2009 2008
$m $m
property direct and facultative 88.6 93.8
property catastrophe excess of loss 76.3 23.4
terrorism 69.1 75.5
property retrocession 61.2 76.4
property political risk 15.5 28.1
other property 6.6 5.5
total 317.3 302.7
Property direct and facultative business is typically written on a first loss
basis, i.e. for a limit smaller than the total insured values, on an excess of
loss basis, where the exposure is excess of a deductible retained by the
insured, plus lower layers of coverage provided by other (re)insurers. Cover is
generally provided to medium to large commercial and industrial enterprises
with high value locations for non-elemental perils, including fire and
explosion, and elemental (natural catastrophe) perils including flood,
windstorm, earthquake and tornado. Not all risks include both elemental and
non-elemental coverage. Coverage usually includes indemnification for both
property damage and business interruption.
Property catastrophe excess of loss covers elemental risks and is written on an
excess of loss treaty basis. The property catastrophe excess of loss portfolio
is written within the U.S. and also internationally. Cover is offered for
specific perils and regions or countries.
Terrorism business is written on an excess of loss basis and can be written
either ground up (i.e. the insured does not retain a deductible) or for primary
or high excess layers, with cover provided for U.S. and worldwide property
risks, but excluding nuclear, chemical and biological coverage in most
territories. Cover is, as for direct and facultative business, generally
provided to medium to large commercial and industrial enterprises. Policies are
typically written for scheduled locations and exposure is controlled by setting
limits on aggregate exposure within a "blast zone" radius. Some national pools
are also written, which may include nuclear, chemical and biological coverage.
Property retrocession is written on an excess of loss basis through treaty
arrangements and covers elemental perils. Programs are often written on a
pillared basis, with separate geographic zonal limits for risks in the U.S. and
Canada and for risks outside the U.S. and Canada.
Political risk cover is generally written on a ground up excess of loss basis,
on an individual case by case basis, and coverage can vary significantly
between policies. Within its political risk class the Group also offers cover
for sovereign and quasi-sovereign credit risk. The Group does not currently
write private obligor trade credit.
The Group is exposed to large natural catastrophic losses, such as windstorm
and earthquake loss, from assuming property catastrophe excess of loss and
property retrocession portfolio risks and also from its property direct and
facultative portfolio. Exposure to such events is controlled and measured by
setting limits on aggregate exposures in certain classes per geographic zone
and through loss modeling. The accuracy of the latter exposure analysis is
limited by the quality of data and effectiveness of the modeling. It is
possible that a catastrophic event significantly exceeds the expected modeled
event loss. The Group's appetite and exposure guidelines to large losses are
set out in the preceding section, A. insurance risk.
Reinsurance may be purchased to mitigate exposures to large natural catastrophe
losses in the U.S. and Canada. Reinsurance may also be purchased to reduce the
Group's worldwide exposure to large risk losses.
b. energy
Gross premiums written, for the year:
2009 2008
$m $m
worldwide offshore energy 100.5 76.3
gulf of mexico offshore energy 53.8 74.3
construction energy 10.7 21.5
onshore energy 7.8 10.0
other energy 2.7 3.1
total 175.5 185.2
Energy risks are written mostly on a direct excess of loss basis and may be
ground up or on primary or high excess of loss. Worldwide offshore energy
policies are typically "package" policies which may include physical damage,
business interruption and third party liability sections. Coverage can include
fire and explosion and occasionally elemental perils. Individual assets covered
can be high value and are therefore mostly written on a subscription basis.
Gulf of Mexico offshore energy programs cover elemental and non-elemental
risks. The largest exposure is from hurricanes in the Gulf of Mexico. Exposure
to such events is controlled and measured through loss modeling. The accuracy
of this exposure analysis is limited by the quality of data and effectiveness
of the modeling. It is possible that a catastrophic event exceeds the expected
event loss. The Group's appetite and exposure guidelines to large losses are
set out in the preceding section, A. insurance risk. Most policies have
sub-limits on coverage for elemental losses.
Construction energy contracts generally cover all risks of platform and
drilling units under construction. Onshore energy risks can include onshore
Gulf of Mexico and worldwide energy installations and are largely subject to
the same loss events as described above.
Reinsurance protection may be purchased to protect a portion of loss from
elemental and non-elemental energy claims, and from the accumulation of
smaller, attritional losses.
c. marine
Gross premiums written, for the year:
2009 2008
$m $m
marine hull and total loss 25.6 30.6
marine hull war 20.0 11.3
marine builders risk 16.7 26.3
marine P&I clubs 10.0 9.2
other marine 1.4 1.2
total 73.7 78.6
Marine business is predominantly written on an excess of loss basis. With the
exception of the marine P&I clubs where high excess layers are written, most
policies are written on a ground up basis. Marine hull and total loss is
generally written on a direct basis and covers marine risks on a worldwide
basis, primarily for physical damage. Marine hull war is direct insurance of
loss of vessels from war, piracy or terrorist attack. Marine builders risk
covers the building of ocean going vessels in specialised yards worldwide.
Marine P&I is mostly the reinsurance of The International Group of Protection
and Indemnity Clubs. Marine cargo programs are not normally written.
The largest expected exposure in the marine class is from physical loss rather
than from elemental loss events.
Reinsurance may be purchased to reduce the Group's exposure to both large risk
losses and an accumulation of smaller, attritional losses.
d. aviation
Gross premiums written, for the year:
2009 2008
$m $m
AV52 52.9 51.2
aviation reinsurance - 13.7
other aviation 8.4 6.7
total 61.3 71.6
AV52 is written on a risk attaching excess of loss basis and provides coverage
for third party liability, excluding own passenger liability, resulting from
acts of war or hijack of aircraft, excluding U.S. commercial airlines and
certain other countries whose governments provide a backstop coverage. Other
aviation business includes aviation hull war risks and contingent hull, which
the Group writes from time to time. The Group does not presently write general
aviation business, including hull and liabilities.
Reinsurance may be purchased to mitigate exposures to an AV52 event loss.
reinsurance
The Group, in the normal course of business and in accordance with its risk
management practices, seeks to reduce certain types of loss that may arise from
events that could cause unfavourable underwriting results by entering into
reinsurance arrangements. Reinsurance does not relieve the Group of its
obligations to policyholders. Under the Group's reinsurance security policy,
reinsurers are assessed and approved as appropriate security based on their
financial strength ratings, amongst other factors. The Group Reinsurance
Security Committee ("GRSC") has defined limits by reinsurer by rating and an
aggregate exposure to a rating band. The GRSC considers reinsurers that are not
rated or do not fall within the pre-defined rating categories on a case by case
basis, and would usually require collateral to be posted to support such
obligations. The GRSC monitors the credit-worthiness of its reinsurers on an
ongoing basis and meets formally at least quarterly.
Reinsurance protection is typically purchased on an excess of loss basis and
occasionally includes industry loss warranty covers. The mix of reinsurance
cover is dependent on the specific loss mitigation requirements, market
conditions and available capacity. The structure varies between types of peril
and subclass. The Group regularly reviews its catastrophe exposures and may
purchase reinsurance in order to reduce the Group's net exposure to a large
natural catastrophe loss and/or to reduce net exposures to other large losses.
There is no guarantee that reinsurance coverage will be available to meet all
potential loss circumstances, as it is possible that the cover purchased is not
sufficient. Any loss amount which exceeds the program would be retained by the
Group. Some parts of the reinsurance program have limited reinstatements
therefore the number of claims which may be recovered from second or subsequent
losses in those particular circumstances is limited.
insurance liabilities
For most insurance and reinsurance companies, the most significant judgement
made by management is the estimation of loss and loss adjustment expense
reserves. The estimation of
the ultimate liability arising from claims made under insurance and reinsurance
contracts is a critical estimate for the Group.
Under generally accepted accounting principles, loss reserves are not permitted
until the occurrence of an event which may give rise to a claim. As a result,
only loss reserves applicable to losses incurred up to the reporting date are
established, with no allowance for the provision of a contingency reserve to
account for expected future losses or for the emergence of new types of latent
claims. Claims arising from future events can be expected to require the
establishment of substantial reserves from time to time. All reserves are
reported on an undiscounted basis.
Loss and loss adjustment expense reserves are maintained to cover the Group's
estimated liability for both reported and unreported claims. Reserving
methodologies that calculate a point estimate for the ultimate losses are
utilised, and then a range is developed around these point estimates. The point
estimate represents management's best estimate of ultimate loss and loss
adjustment expenses. The Group's internal actuaries review the reserving
assumptions and methodologies on a quarterly basis with loss estimates being
subject to a quarterly corroborative review by independent actuaries, using
U.S. generally accepted actuarial principles. This independent review is
presented to the Group's Audit Committee. The Group has also established Large
Loss and Reserve Committees at the operating entity level, which have
responsibility for the review of large claims, their development and any
changes in reserving methodology and assumptions on a quarterly basis.
The extent of reliance on management's judgement in the reserving process
differs as to whether the business is insurance or reinsurance, whether it is
short-tail or long-tail and whether the business is written on an excess of
loss or on a pro-rata basis. Over a typical annual period, the Group expects to
write the large majority of programs on a direct excess of loss basis. The
Group does not currently write a significant amount of long-tail business.
a. insurance versus reinsurance
Loss reserve calculations for direct insurance business are not precise in that
they deal with the inherent uncertainty of future contingent events. Estimating
loss reserves requires management to make assumptions regarding future
reporting and development patterns, frequency and severity trends, claims
settlement practices, potential changes in the legal environment and other
factors, such as inflation. These estimates and judgements are based on
numerous factors, and may be revised as additional experience or other data
becomes available or reviewed as new or improved methodologies are developed or
as current laws change.
Furthermore, as a broker market reinsurer, management must rely on loss
information reported to brokers by other insurers who must estimate their own
losses at the policy level, often based on incomplete and changing information.
The information management receives varies by cedant and may include paid
losses, estimated case reserves, and an estimated provision for IBNR reserves.
Additionally, reserving practices and the quality of data reporting may vary
among ceding companies which adds further uncertainty to the estimation of the
ultimate losses.
b. short-tail versus long-tail
In general, claims relating to short-tail property risks, such as the majority
of risks underwritten by the Group, are reported more promptly by third parties
than those relating to long-tail risks, including the majority of casualty
risks. However, the timeliness of reporting can be affected by such factors as
the nature of the event causing the loss, the location of the loss, and whether
the losses are from policies in force with insureds, primary insurers or with
reinsurers.
c. excess of loss versus proportional
For excess of loss business, management are aided by the fact that each policy
has a defined limit of liability arising from one event. Once that limit has
been reached, there is no further exposure to additional losses from that
policy for the same event. For proportional business, generally an initial
estimated loss and loss expense ratio (the ratio of losses and loss adjustment
expenses incurred to premiums earned) is used, based upon information provided
by the insured or ceding company and/or their broker and management's
historical experience of that treaty, if any, and the estimate is adjusted as
actual experience becomes known.
d. time lags
There is a time lag inherent in reporting from the original claimant to the
primary insurer to the broker and then to the reinsurer. Also, the combination
of low claims frequency and high severity makes the available data more
volatile and less useful for predicting ultimate losses. In the case of
proportional contracts, reliance is placed on an analysis of a contract's
historical experience, industry information, and the professional judgement of
underwriters in estimating reserves for these contracts. In addition, if
available, reliance is placed partially on ultimate loss ratio forecasts as
reported by insureds or cedants, which are normally subject to a quarterly or
six month lag.
e. uncertainty
As a result of the time lag described above, an estimation must be made of IBNR
reserves, which consist of a provision for additional development in excess of
the case reserves reported by insureds or ceding companies, as well as a
provision for claims which have occurred but which have not yet been reported
by insureds or ceding companies. Because of the degree of reliance that is
necessarily placed on insureds or ceding companies for claims reporting, the
associated time lag, the low frequency/high severity nature of much of the
business that the Group underwrites, and the varying reserving practices among
ceding companies, reserve estimates are highly dependent on management
judgement and therefore uncertain. During the loss settlement period, which may
be years in duration, additional facts regarding individual claims and trends
often will become known, and current laws and case law may change, with a
consequent impact on reserving.The claims count on the types of insurance and
reinsurance that the Group writes, which are low frequency and high severity in
nature, is generally low.
For certain catastrophic events there is greater uncertainty underlying the
assumptions and associated estimated reserves for losses and loss adjustment
expenses. Complexity resulting from problems such as policy coverage issues,
multiple events affecting one geographic area and the resulting impact on
claims adjusting (including the allocation of claims to the specific event and
the effect of demand surge on the cost of building materials and labour) by,
and communications from, insureds or ceding companies, can cause delays to the
timing with which the Group is notified of changes to loss estimates.
At 31 December 2009 management's estimates for IBNR represented 43.8% of total
net loss reserves (2008 - 32.6%). The majority of the estimate relates to
potential claims on non-elemental risks where timing delays in insured or
cedant reporting may mean losses could have occurred which the Group were not
made aware of by the balance sheet date.
B. market risk
The Group is at risk of loss due to movements in market factors. These include
investment, insurance, debt and currency risks. These risks, and the management
thereof, are described below.
a. investment risk
Movements in investments resulting from changes in interest and inflation
rates, amongst other factors, may lead to an adverse impact on the value of the
Group's investment portfolio. Investment guidelines are established by the
Investment Committee of the Board of Directors to manage this risk. Investment
guidelines set parameters within which the Group's external investment managers
must operate. Important parameters include guidelines on permissible assets,
duration ranges, credit quality and maturity. Investment guidelines exist at
the individual portfolio level and for the Group's consolidated portfolio.
Compliance with guidelines is monitored on a monthly basis. Any adjustments to
the investment guidelines are approved by the Investment Committee and the
Board of Directors.
Within the Group guidelines is a sub-set of guidelines for the portion of funds
required to meet near term obligations and cash flow needs following an extreme
event. The funds to cover this potential liability are designated as the "core"
portfolio and the portfolio duration is matched to the duration of the
insurance liabilities, within an agreed range. The core portfolio is invested
in fixed income securities and cash and cash equivalents. The core portfolio
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