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 September 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 October 25, 2010 there were 123,613,982 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      35   
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      74   

 

2


Table of Contents

 

 

 

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.

 

3


Table of Contents

 

 

 

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

       Page  

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

   5

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

   6

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

   7

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

   8

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

   9

Notes to the Consolidated Financial Statements (Unaudited)

   10

 

4


Table of Contents

 

AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED BALANCE SHEETS

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

 

     2010     2009  
     (in thousands)  

Assets

  

Investments:

    

Fixed maturities, available for sale, at fair value
(Amortized cost 2010: $10,285,643; 2009: $9,628,287)

   $ 10,664,824     $ 9,718,355  

Equity securities, available for sale, at fair value
(Cost 2010: $237,656; 2009: $195,011)

     251,005       204,375  

Other investments, at fair value

     533,072       570,276  

Short-term investments, at amortized cost

     129,042       129,098  
                

Total investments

     11,577,943       10,622,104  

Cash and cash equivalents

     1,057,864       788,614  

Restricted cash and cash equivalents

     147,529       75,440  

Accrued interest receivable

     92,758       89,559  

Insurance and reinsurance premium balances receivable

     1,536,944       1,292,877  

Reinsurance recoverable on unpaid and paid losses

     1,551,612       1,424,172  

Deferred acquisition costs

     402,887       302,320  

Prepaid reinsurance premiums

     234,850       301,885  

Securities lending collateral

     -            129,814  

Net receivable for investments sold

    
-    
  
    12,740  

Goodwill and intangible assets

     89,744       91,505  

Other assets

     154,399       175,494  
                

Total assets

   $  16,846,530     $  15,306,524  
                

Liabilities

    

Reserve for losses and loss expenses

   $ 6,934,528     $ 6,564,133  

Unearned premiums

     2,614,239       2,209,397  

Insurance and reinsurance balances payable

     123,127       173,156  

Securities lending payable

     -            132,815  

Senior notes

     993,976       499,476  

Other liabilities

     240,338       227,303  

Net payable for investments purchased

     91,384       -       
                

Total liabilities

     10,997,592       9,806,280  
                

Commitments and Contingencies

    

Shareholders’ equity

    

Preferred shares - Series A and B

     500,000       500,000  

Common shares (2010: 154,697; 2009: 152,465 shares issued
and 2010: 119,958; 2009: 132,140 shares outstanding)

     1,931       1,903  

Additional paid-in capital

     2,046,297       2,014,815  

Accumulated other comprehensive income

     371,625       85,633  

Retained earnings

     4,033,018       3,569,411  

Treasury shares, at cost (2010: 34,739; 2009: 20,325 shares)

     (1,103,933     (671,518
                

Total shareholders’ equity

     5,848,938       5,500,244  
                

Total liabilities and shareholders’ equity

   $ 16,846,530     $ 15,306,524  
                

See accompanying notes to Consolidated Financial Statements.

 

5


Table of Contents

 

AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009

 

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

Revenues

        

Net premiums earned

   $  758,873     $ 706,025     $  2,190,092     $  2,078,154  

Net investment income

     111,800       134,788       299,004       346,300  

Other insurance related income (loss)

     884       (135,738     1,727       (159,394

Net realized investment gains (losses):

        

Other-than-temporary impairment losses

     (2,091     (283,418     (16,581     (336,214

Portion of impairment losses transferred to (from) other comprehensive income

     (272     4,080       1,284       5,523  

Other realized investment gains

     78,894       25,973       132,622       13,051  
                                

Total net realized investment gains (losses)

     76,531        (253,365     117,325       (317,640
                                

Total revenues

     948,088       451,710       2,608,148       1,947,420  
                                

Expenses

        

Net losses and loss expenses

     422,154       311,109       1,293,787       1,077,360  

Acquisition costs

     123,788       113,423       364,614       318,708  

General and administrative expenses

     103,435       92,009       309,266       265,515  

Foreign exchange losses (gains)

     24,961       6,784       (10,415     30,579  

Interest expense and financing costs

     15,800       7,977       40,185       23,869  
                                

Total expenses

     690,138       531,302       1,997,437       1,716,031  
                                

Income (loss) before income taxes

     257,950       (79,592     610,711       231,389  

Income tax expense

     9,890       7,082       27,550       24,785  
                                

Net income (loss)

     248,060       (86,674     583,161       206,604  

Preferred share dividends

     9,218       9,218       27,656       27,656  
                                

Net income (loss) available to common shareholders

   $  238,842     $ (95,892   $ 555,505     $ 178,948  
                                

Weighted average common shares and common share equivalents:

        

Basic

     120,091       137,904       123,320       137,693  
                                

Diluted

     134,406       137,904       137,382       150,258  
                                

Earnings (loss) per common share

        

Basic

   $ 1.99     $ (0.70   $ 4.50     $ 1.30  
                                

Diluted

   $ 1.78     $ (0.70   $ 4.04     $ 1.19  
                                

Cash dividends declared per common share

   $ 0.21     $ 0.20     $ 0.63     $ 0.60  
                                

See accompanying notes to Consolidated Financial Statements.

 

6


Table of Contents

 

AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009

 

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

Net income (loss)

   $ 248,060     $ (86,674   $ 583,161     $ 206,604  

Other comprehensive income, net of tax:

        

Available for sale investments:

        

Unrealized gains arising during the period

     231,879       357,290       401,468       512,336  

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

     272       (3,393     (1,284     (4,836

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

     (84,255     247,428       (114,473     312,064  

Foreign currency translation adjustment

     1,873       1,910       281       243  
                                

Comprehensive income

   $  397,829     $  516,561     $ 869,153     $  1,026,411  
                                

See accompanying notes to Consolidated Financial Statements.

 

7


Table of Contents

 

AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)

NINE MONTHS ENDED SEPTEMBER 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

     28       23  
                

Balance at end of period

     1,931       1,901  
                

Additional paid-in capital

    

Balance at beginning of period

     2,014,815       1,962,779  

Shares issued

     580       509  

Stock options exercised

     3,851       2,475  

Share-based compensation expense

     27,051       37,654  
                

Balance at end of period

     2,046,297       2,003,417  
                

Accumulated other comprehensive income (loss)

    

Balance at beginning of period

     85,633       (706,499

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

     286,995       824,400  

Portion of other-than-temporary impairment losses

     (1,284     (4,836
                

Balance at end of period

     373,149       78,682  
                

Cumulative foreign currency translation adjustments, net of tax:

    

Balance at beginning of period

     803       -       

Foreign currency translation adjustment

     281       243  
                

Balance at end of period

     1,084       243  
                

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

     371,625       74,974  
                

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

     583,161       206,604  

Series A and B preferred share dividends

     (27,656     (27,656

Common share dividends

     (91,898     (96,307
                

Balance at end of period

     4,033,018       3,319,467  
                

Treasury shares, at cost

    

Balance at beginning of period

     (671,518     (495,609

Shares repurchased for treasury

     (432,415     (6,043
                

Balance at end of period

     (1,103,933     (501,652
                

Total shareholders’ equity

   $  5,848,938     $  5,398,107  
                

See accompanying notes to Consolidated Financial Statements.

 

8


Table of Contents

 

AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009

 

     2010      2009  
     (in thousands)  

Cash flows from operating activities:

     

Net income

   $ 583,161      $ 206,604  

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

     

Net realized investment (gains) losses

     (117,325)         317,640  

Loss on insurance derivative contract

     -             161,000  

Net realized and unrealized gains of other investments

     (38,476)         (63,322)   

Amortization of fixed maturities

     40,004        11,018  

Other amortization and depreciation

     10,081        11,650  

Share-based compensation expense

     27,051        37,654  

Changes in:

     

Accrued interest receivable

     (3,199)         (2,937)   

Reinsurance recoverable balances

     (127,440)         (27,819)   

Deferred acquisition costs

     (100,567)         (90,643)   

Prepaid reinsurance premiums

     67,035        (5,369)   

Reserve for loss and loss expenses

     370,395        335,131  

Unearned premiums

     404,842        385,671  

Insurance and reinsurance balances, net

     (294,096)         (343,335)   

Other items

     45,454        (39,237)   
                 

Net cash provided by operating activities

     866,920        893,706  
                 

Cash flows from investing activities:

     

Purchases of:

     

Fixed maturities

     (9,297,089)         (8,260,119)   

Equity securities

     (96,209)         (33,995)   

Other investments

     (45,000)         (91,800)   

Proceeds from the sale of:

     

Fixed maturities

      7,975,262         6,174,388  

Equity securities

     48,970        55,703  

Other investments

     120,680        86,190  

Proceeds from redemption of fixed maturities

     829,109        726,060  

Net sales (purchases) of short-term investments

     2,766        (13,552)   

Purchase of other assets

     (11,977)         (43,398)   

Change in restricted cash and cash equivalents

     (72,089)         (7,425)   
                 

Net cash used in investing activities

     (545,577)         (1,407,948)   
                 

Cash flows from financing activities:

     

Net proceeds from issuance of senior notes

     494,870        -       

Repurchase of shares

     (432,415)         (6,043)   

Dividends paid - common shares

     (83,090)         (85,218)   

Dividends paid - preferred shares

     (27,656)         (27,656)   

Proceeds from issuance of common shares

     4,459        3,007  
                 

Net cash used in financing activities

     (43,832)         (115,910)   
                 

Effect of exchange rate changes on foreign currency cash

     (8,261)         41,525  
                 

Increase (decrease) in cash and cash equivalents

     269,250        (588,627)   

Cash and cash equivalents - beginning of period

     788,614        1,697,581  
                 

Cash and cash equivalents - end of period

   $  1,057,864      $  1,108,954  
                 

See accompanying notes to Consolidated Financial Statements.

 

9


Table of Contents

 

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 September 30, 2010 and the consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for the periods ended September 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.

Embedded Credit Derivatives

Effective July 1, 2010, we adopted amended FASB guidance that clarified the bifurcation 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 (e.g. a mortgage-backed or asset-backed security with multiple tranches) are not subject to bifurcation and separate accounting. The adoption of this guidance did not impact our results of operations, financial condition or liquidity.

 

10


Table of Contents

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

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 be effective for our December 31, 2010, year end reporting; 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.

Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

In October 2010, the FASB issued guidance modifying the definition of the types of costs that can be capitalized in relation to the acquisition of new and renewal insurance contracts. The amended guidance requires costs to be incremental or directly related to the successful acquisition of new or renewal contracts in order to be capitalized as a deferred acquisition cost. Capitalized costs would include incremental direct costs, such as commissions paid to brokers. Additionally, the portion of employee salaries and benefits directly related to time spent for acquired contracts would be capitalized. Costs that fall outside the revised definition must be expensed when incurred. This new guidance is effective for January 1, 2012 and may be adopted either prospectively or retrospectively. Earlier adoption is permitted, provided the guidance is applied at the beginning of the Company’s financial year. The transitional provisions of this guidance also indicate that if the application of this guidance would result in the capitalization of acquisition costs that had not previously been capitalized, the Company may elect not to capitalize those types of costs. We are presently evaluating the impact of the adoption of this guidance on our results of operation and financial position.

 

11


Table of Contents

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 September 30, 2010 and 2009:

 

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

Gross premiums written

   $ 433,550     $  317,137     $ 750,687     $  413,922     $  361,392     $  775,314      

Net premiums written

     309,277       317,045       626,322       239,781       355,363       595,144      

Net premiums earned

     320,184       438,689       758,873       278,637       427,388       706,025      

Other insurance related income (loss)

     884       -            884       (135,898     160       (135,738    

Net losses and loss expenses

     (150,860     (271,294     (422,154     (111,228     (199,881     (311,109    

Acquisition costs

     (38,962     (84,826     (123,788     (29,613     (83,810     (113,423    

General and administrative expenses

     (64,147     (22,292     (86,439     (55,685     (18,719     (74,404    
                                                      

Underwriting income (loss)

   $  67,099     $ 60,277       127,376     $ (53,787   $ 125,138       71,351      
                                          
   

Corporate expenses

         (16,996         (17,605    

Net investment income

         111,800           134,788      

Net realized investment gains (losses)

         76,531           (253,365    

Foreign exchange losses

         (24,961         (6,784    

Interest expense and financing costs

         (15,800         (7,977    
                              

Income (loss) before income taxes

       $  257,950         $ (79,592    
                              
   

Net loss and loss expense ratio

     47.1%        61.8%        55.6%        39.9%        46.8%        44.1%       

Acquisition cost ratio

     12.2%        19.4%        16.3%        10.6%        19.6%        16.1%       

General and administrative expense ratio

     20.0%        5.1%        13.7%        20.0%        4.4%        13.0%       
                                                      

Combined ratio

     79.3%        86.3%        85.6%        70.5%        70.8%        73.2%       
                                                      
   

Goodwill and intangible assets

   $ 89,744     $ -          $ 89,744     $ 93,049     $ -          $ 93,049      
                                                      
                                                          

 

12


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

2. SEGMENT INFORMATION (CONTINUED)

 

 

      2010     2009         
Nine months ended September 30,    Insurance     Reinsurance     Total     Insurance     Reinsurance     Total         
   

Gross premiums written

   $  1,419,372     $  1,696,389     $  3,115,761     $  1,304,844     $  1,708,606     $  3,013,450      

Net premiums written

     982,969       1,675,927       2,658,896       764,932       1,693,526       2,458,458      

Net premiums earned

     878,117       1,311,975       2,190,092       853,235       1,224,919       2,078,154      

Other insurance related income (loss)

     1,727       -            1,727       (160,659     1,265       (159,394    

Net losses and loss expenses

     (437,057     (856,730     (1,293,787     (451,143     (626,217     (1,077,360    

Acquisition costs

     (110,670     (253,944     (364,614     (84,122     (234,586     (318,708    

General and administrative expenses

     (189,802     (66,960     (256,762     (159,059     (54,515     (213,574    
                                                      

Underwriting income (loss)

   $  142,315     $ 134,341       276,656     $ (1,748   $ 310,866       309,118      
                                          
   

Corporate expenses

         (52,504         (51,941    

Net investment income

         299,004           346,300      

Net realized investment gains (losses)

         117,325           (317,640    

Foreign exchange (losses) gains

         10,415           (30,579    

Interest expense and financing costs

         (40,185         (23,869    
                              

Income before income taxes

       $ 610,711         $ 231,389      
                              
   

Net loss and loss expense ratio

     49.8%        65.3%        59.1%        52.9%        51.1%        51.8%       

Acquisition cost ratio

     12.6%        19.4%        16.6%        9.9%        19.2%        15.4%       

General and administrative expense ratio

     21.6%        5.1%        14.1%        18.6%        4.4%        12.8%       
                                                      

Combined ratio

     84.0%        89.8%        89.8%        81.4%        74.7%        80.0%       
                                                      
   

Goodwill and intangible assets

   $ 89,744     $ -          $ 89,744     $ 93,049     $ -          $ 93,049      
                                                      
                                                          

 

13


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

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 September 30, 2010               

Fixed maturities

              

U.S. government and agency

   $ 1,339,503      $ 33,029      $ (17   $ 1,372,515      $ -       

Non-U.S. government

     769,425       23,523        (4,836     788,112        -       

Corporate debt

     4,085,798       237,285        (14,277     4,308,806        (491 )  

Agency MBS(1)

     2,043,754       52,445        (1,997     2,094,202        -       

Non-Agency CMBS

     467,848       33,470        (107     501,211        (166 )  

Non-Agency RMBS

     228,505       3,782        (11,033     221,254        (10,885

ABS(2)

     665,359       13,011        (15,054     663,316        (3,746 )  

Municipals

     685,451       32,040        (2,083     715,408        (389 )  
                                            

Total fixed maturities

   $  10,285,643      $  428,585      $ (49,404   $  10,664,824      $  (15,677
                                            
                

Equity securities

   $ 237,656      $ 20,940      $ (7,591   $ 251,005       
                                        
   
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 collateralized 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 actively manage allocations to non-controlling tranches of 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.

 

14


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

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:

 

      12 months or greater     Less than 12 months     Total  
      Fair
Value
     Unrealized
Losses
   

Fair

Value

     Unrealized
Losses
   

Fair

Value

     Unrealized
Losses
 
   
At September 30, 2010                  

Fixed maturities

                 

U.S. government and agency

   $ -           $ -          $ 33,884      $ (17   $ 33,884      $ (17

Non-U.S. government

     -             -            182,167        (4,836     182,167        (4,836

Corporate debt

     19,856        (2,588     335,700        (11,689     355,556        (14,277

Agency MBS

     775        (24     738,434        (1,973     739,209        (1,997

Non-Agency CMBS

     11,046        (79     6,136        (28     17,182        (107

Non-Agency RMBS

     112,427         (10,913     8,330        (120     120,757        (11,033

ABS

     44,528        (14,958     41,305        (96     85,833        (15,054

Municipals

     25,964        (1,678     48,658        (405     74,622        (2,083
                                                     

Total fixed maturities

   $  214,596      $ (30,240   $  1,394,614      $ (19,164   $  1,609,210      $ (49,404
                                                     
                   

Equity securities

   $ 10,506      $ (2,551   $ 40,681      $ (5,040   $ 51,187      $ (7,591
                                                     
   
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 September 30, 2010, 448 fixed maturities (2009: 832) were in an unrealized loss position of $49 million (2009: $134 million) of which $15 million (2009: $20 million) of this balance was related to securities below investment grade or not rated.

At September 30, 2010, 157 (2009: 312) securities have been in continuous unrealized loss position for 12 months or greater and have a fair value of $215 million (2009: $705 million). These securities were primarily ABS and non-agency RMBS with a weighted average S&P credit rating of BB- and BBB, 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 September 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.

 

15


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

3. INVESTMENTS (CONTINUED)

 

 

Equity Securities

At September 30, 2010, 82 securities (2009: 95) were in an unrealized loss position and 40 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 September 30, 2010 and December 31, 2009.

 

b) Other Investments

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

 

     September 30, 2010     December 31, 2009       
   

Funds of hedge funds

  $ 231,453       43.4%      $ 256,877       45.0%       

Hedge funds

    143,393       26.9%        94,630       16.6%       
                                     

Total hedge funds

    374,846       70.3%        351,507       61.6%       
                                     
   

Long/short credit

    78,491       14.7%        84,392       14.8%       

Distressed securities

    22,799       4.3%        22,957       4.0%       
                                     

Total credit funds

    101,290       19.0%        107,349       18.8%       
                                     
   

CLO - equity tranched securities

    56,936       10.7%        61,332       10.8%       

Short duration high yield fund

    -            -    %        50,088       8.8%       
                                     
   

Total other investments

  $ 533,072       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

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.
   

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.
        

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 nine months ended September 30, 2010, no gates were imposed on our redemption requests. At September 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.

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

 

16


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

3. INVESTMENTS (CONTINUED)

 

otherwise deemed liquid by the fund, may investors redeem their interest. At September 30, 2010, the fair value of our hedge funds held in side-pockets was $4 million (2009: $4 million).

 

Credit Fund Type    Investment Strategy

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.
   

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.

      

At September 30, 2010, we had $44 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 September 30, 2010 and December 31, 2009, none of our credit funds had established side-pockets.

At September 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
September 30,
    Nine months ended
September 30,
 
      2010     2009     2010     2009  
   

Fixed maturities

   $ 89,580     $ 98,337     $ 267,471     $ 290,935  

Other investments

     25,094       38,646       39,374       57,384  

Cash and cash equivalents

     1,517       1,052       4,241       5,940  

Equities

     917       689       2,837       2,452  

Short-term investments

     308       81       735       524  
                                  

Gross investment income

     117,416       138,805       314,658       357,235  

Investment expenses

     (5,616     (4,017     (15,654     (10,935
                                  

Net investment income

   $ 111,800     $ 134,788     $  299,004     $  346,300  
                                  
                                  

 

17


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

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
September 30,
    Nine months ended
September 30,
 
      2010     2009     2010     2009  
   

Gross realized gains

   $  105,701     $ 51,610     $ 224,661     $ 136,191  

Gross realized losses

     (17,559     (23,880     (93,138     (122,487

Net OTTI recognized in earnings

     (2,363     (279,338     (15,297     (330,691
                                  

Net realized gains (losses) on fixed maturities and equities

     85,779       (251,608     116,226       (316,987
   

Change in fair value of investment derivatives(1)

     (6,333     (341     (3,503     668  
   

Fair value hedges:(1)

          

Derivative instruments

     (66,760     (21,154     25,463       (27,801

Hedged investments

     63,845       19,738       (20,861     26,480  
                                  

Net realized investment gains (losses)

   $ 76,531     $  (253,365   $  117,325     $  (317,640
                                  
                                  

(1) Refer to Note 6 – Derivative Instruments

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

 

      Three months ended
September 30,
     Nine months ended
September 30,
 
      2010      2009      2010      2009  
               

Fixed maturities:

             

Corporate debt

   $ -           $ 263,496      $ 1,650      $ 276,522  

Agency MBS

     -             -             -             344  

Non-Agency CMBS

     88        -             413        10,843  

Non-Agency RMBS

     772        4,733        4,715        12,335  

ABS

     -             675        1,126        10,658  

Municipals

     -             -             19        -       
                                     
       860        268,904        7,923        310,702  
   

Equities

     1,503        10,434        7,374        19,989  
                                     

Total OTTI recognized in earnings

   $ 2,363      $ 279,338      $ 15,297      $ 330,691  
                                     
                                     

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 nine months ended September 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.

 

18


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

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
September 30,
    Nine months ended
September 30,
        
      2010     2009     2010     2009         

Balance at beginning of period

   $ 146,963     $ 37,229     $ 162,390     $ -           

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

     -            -            -            45,347      

Credit impairments recognized on securities not previously impaired

     167       265,257       1,355       267,770      

Additional credit impairments recognized on securities previously impaired

     1,396       677       2,173       864      

Change in recoveries of future cash flows expected to be collected

     (141     670       (116     670      

Intent to sell of securities previously impaired

     (764     -            (829     -           

Securities sold/redeemed/matured

     (44,682     (10,585     (62,034     (21,403    
                                      

Balance at end of period

   $  102,939     $  293,248     $  102,939     $  293,248      
                                      
                                          

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 nine months ended September 30, 2010, we have impaired one corporate debt security.

During the three and nine months ended September 30, 2010, we have sold some previously impaired corporate debt securities, resulting in a decrease in credit loss impairments of $1 million (2009: $9 million) and $9 million (2009: $19 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 September 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     
           

During the three and nine months ended September 30, 2010, certain MTNs matured with realized gains of $11 million and $12 million, respectively, resulting in no additional credit losses. The previously estimated credit loss impairments on these matured MTNs were $44 million and have been reported as a reduction of the remaining estimated credit loss impairments for 2010 in the above credit loss table.

During the three months ended September 30, 2009, we recognized $263 million of estimated credit losses on MTNs, which are included in the above credit loss table. In response to the credit crisis, the MTNs managers reduced their leverage levels which in turn lowered the credit duration of the MTNs. As credit markets recovered and credit spreads tightened in 2009, price appreciation was not as pronounced as the depreciation during 2008 due to the lower credit duration of the MTNs. The tightening of credit spreads was

 

19


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

3. INVESTMENTS (CONTINUED)

 

more significant and much quicker than anticipated which has hindered the ability of the MTN managers to reinvest the underlying cash flows at wider credit spreads. Consequently, we revised the significant inputs in our projected cash flows for the MTNs, resulting in a significant credit impairment charge in the third quarter of 2009.

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 remote and linked to the overall credit-worthiness of the U.S. government. At September 30, 2010, the fair value of our agency MBS was $2.1 billion (2009: $1.6 billion), which included $2 million (2009: $4 million) of gross unrealized losses.

Non-agency CMBS:

Our investment in CMBS are diversified and rated highly with approximately 76% (2009: 79%) rated AAA by S&P, with a weighted average estimated subordination percentage of 28% at September 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 September 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. At September 30, 2010, we had gross unrealized losses of $11 million on these securities.

At December 31, 2009, our non-agency RMBS had gross unrealized losses of $35 million, consisting of $13 million of Prime, $16 million of Alt-A and $6 million of Subprime 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 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
                     
                                       

These 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 nine months ended September 30, 2010, based on expected cash flows to be collected, we have recorded additional credit losses of $1 million and $2 million, respectively, on non-agency RMBS.

 

20


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

3. INVESTMENTS (CONTINUED)

 

 

ABS:

The majority of the unrealized losses on ABS at September 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:

 

     

 

September 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 September 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.

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.

 

21


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

4. FAIR VALUE MEASUREMENTS (CONTINUED)

 

 

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 of private corporate debt securities at September 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.

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 September 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

 

22


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

4. FAIR VALUE MEASUREMENTS (CONTINUED)

 

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. We sold our investment in this fund during the current quarter.

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 September 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.

 

23


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

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 September 30, 2010

            

Assets

            

Fixed maturities

            

U.S. government and agency

   $ 1,008,283      $ 364,232     $ -           $ 1,372,515  

Non-U.S. government

     -             788,112       -             788,112  

Corporate debt

     -             4,305,706       3,100        4,308,806  

Agency MBS

     -             2,094,202       -             2,094,202  

Non-Agency CMBS

     -             501,211       -             501,211  

Non-Agency RMBS

     -             221,254       -             221,254  

ABS

     -             621,093       42,223        663,316  

Municipals

     -             715,408       -             715,408  
                                    
       1,008,283        9,611,218       45,323        10,664,824  

Equity securities

     171,454        79,551       -             251,005  

Other investments

     -             -            533,072        533,072  

Other assets (see Note 6)

     -             184       -             184  

Other liabilities (see Note 6)

     -             (9,968     -             (9,968
                                    

Total

   $  1,179,737      $  9,680,985     $  578,395      $  11,439,117  
                                    
   

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.

 

24


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

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 September 30, 2010                 

Balance at beginning of period

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

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

     -            -            -            -            -            23,469       23,469  

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

     -            -            -            -            -            -            -       

Change in net unrealized gains included in other comprehensive income

     -            180       92       -            272       -            272  

Change in net unrealized losses included in other comprehensive income

     -            -            (7     (47     (54     -            (54

Purchases

     -            -            -            -            -            25,000       25,000  

Sales

     -            -            -            -            -            (3,588     (3,588

Settlements / distributions

     -            -            (207     (356     (563     (7,896     (8,459

Transfers into Level 3

     -            -            -            -            -            -            -       

Transfers out of Level 3

     -            (3,780     (2,851     (4,190     (10,821     -            (10,821
                                                          

Balance at end of period

   $ 3,100     $ -          $ -          $  42,223     $  45,323     $  533,072     $  578,395  
                                                          
   

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

   $ -          $ -          $ -          $ -          $ -          $ 23,469     $ 23,469  
                                                          
                  
Nine months ended September 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)

     -            -            -            -            -            35,818       35,818  

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

     (1,550     (119     (581     (1,134     (3,384     -            (3,384

Change in net unrealized gains included in other comprehensive income

     3,751       1,273       1,238       2,406       8,668       -            8,668  

Change in net unrealized losses included in other comprehensive income

     (34     (238     (27     (71     (370     -            (370

Purchases

     -            3,474       -            4,000       7,474       45,000       52,474  

Sales

     (12     (206     (211     (2,004     (2,433     (47,992     (50,425

Settlements / distributions

     -            (694     (692     (369     (1,755     (19,942     (21,697

Transfers into Level 3

     -            -            780       -            780       -            780  

Transfers out of Level 3

     (17,185     (5,899     (7,146     (4,190     (34,420     -            (34,420
                                                          

Balance at end of period

   $ 3,100     $ -          $ -          $ 42,223     $ 45,323     $ 533,072     $ 578,395  
                                                          
                  

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   $ -          $ -          $ -          $ (1,550   $ 35,818     $ 34,268  
                                                          
                                                          
(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.

 

25


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

4. FAIR VALUE MEASUREMENTS (CONTINUED)

 

 

 

 

 

 

     Fixed Maturities                       
     Corporate
Debt
    Non-Agency
CMBS
    Non-Agency
RMBS
    ABS     Municipals     Total     Other
Investments
    Total
Assets
    Other
Liabilities
 
                                                        
Three months ended September 30, 2009                                                      

Balance at beginning of period

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

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

    -            -            -            -            -            -            34,345       34,345       136,000  

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

    -            -            -            -            -            -            -            -            -       

Change in net unrealized gains included in other comprehensive income

    163       -            1,297       771       21       2,252       -            2,252       -       

Change in net unrealized losses included in other comprehensive income

    (1,149     (83     (795     (54     -            (2,081     -            (2,081     -       

Purchases

    -            -            1,760       5,899       -            7,659       -            7,659       4,808  

Sales

    -            -            -            -            -            -            (30,577     (30,577     -       

Settlements / distributions

    (111     -            (952     (886     -            (1,949     (4,733     (6,682     -       

Transfers into Level 3

    436       9,590       -            25,956       4,447       40,429       -            40,429       -       

Transfers out of Level 3

    -            -            (7,557     (1,334     -            (8,891     -            (8,891     -       
                                                                         

Balance at end of period

  $ 16,262     $ 9,507     $ 14,445     $ 78,695     $ 4,468     $ 123,377     $ 492,802     $ 616,179     $ 228,405  
                                                                         
   

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

  $ -          $ -          $ -          $ -          $ -          $ -          $ 34,345     $ 34,345     $ 136,000  
                                                                         
   
Nine months ended September 30, 2009                                                      

Balance at beginning of period

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

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

    -            -            -            -            -            -            73,114       73,114       161,000  

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

    -            -            -            (373     -            (373     (16,897     (17,270     -       

Change in net unrealized gains included in other comprehensive income

    313       107       7,924       8,905       21       17,270       -            17,270       -       

Change in net unrealized losses included in other comprehensive income

    (3,389     (114     (1,502     (3,949     -            (8,954     -            (8,954     -       

Purchases

    -            -            1,760       5,899       -            7,659       91,800       99,459       4,808  

Sales

    -            -            -            -            -            -            (91,947     (91,947     -       

Settlements / distributions

    (140     -            (9,678     (1,283     -            (11,101     (13,810     (24,911     -       

Transfers into Level 3

    19,478       10,069       65,380       96,356       4,447       195,730       -            195,730       -       

Transfers out of Level 3

    -            (555     (49,439     (26,860     -            (76,854     -            (76,854     -       
                                                                         

Balance at end of period

  $  16,262     $ 9,507     $ 14,445     $ 78,695     $  4,468     $  123,377     $  492,802     $  616,179     $  228,405  
                                                                         
   

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   $ 56,217     $ 55,844     $ 161,000  
                                                                         
                                                                         
(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).

 

26


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

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 nine months ended September 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

The transfers to Level 3 from Level 2 made in 2009 and 2010 were 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 transfers were as a result of changes in valuation methodology that we made.

Transfers out of Level 3 into Level 2

During the nine months ended September 30, 2010, the transfer relating to corporate debt was in relation to one issuer a result of entering into an agreement to take delivery of a new corporate debt security, which its fair value measurement was based on observable market inputs at September 30, 2010. The remaining transfers out of Level 3 into Level 2 made in 2009 and 2010 were primarily due to the availability of observable market inputs and 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 September 30, 2010, and December 31, 2009 approximated their fair values with the exception of senior notes. At September 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 $1,041 million (2009: $510 million).

 

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:

 

      Nine months ended September 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

     1,525,564       1,380,535  

Prior years

     (231,777     (303,175
                  
       1,293,787       1,077,360  
                  

 

Net paid losses related to:

      

Current year

     (207,922     (155,452

Prior years

     (835,972     (736,702
                  
       (1,043,894     (892,154
                  

Foreign exchange and other

     (23,208     89,659  
                  

 

Net reserve for losses and loss expenses, end of period

     5,409,760       5,205,097  

Reinsurance recoverable on unpaid losses, end of period

     1,524,768       1,374,817  
                  

Gross reserve for losses and loss expenses, end of period

   $ 6,934,528     $ 6,579,914  
                  
                  

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 nine months ended September 30, 2010, we recognized net loss and loss expenses of $215 million in relation to the February 2010 Chilean and September 2010 New Zealand earthquakes. Our estimates for these events

 

27


Table of Contents

AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

5. RESERVE FOR LOSSES AND LOSS EXPENSES (CONTINUED)

 

were derived from ground-up assessments of our individual contracts and treaties in the affected regions and are consistent with our market share in the regions. As part of our estimation process, we also considered current industry insured loss estimates, market share analyses, catastrophe modeling analyses and the information available to date from clients, brokers and loss adjusters. Industry-wide insured loss estimates and our own loss estimates for these events are subject to change, as additional actual loss data becomes available. Actual losses in relation to these events may ultimately differ materially from current loss estimates.

Net losses and loss expenses incurred include net favorable prior period reserve development of $232 million and $303 million for the nine months ended September 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 September 30,      Nine months ended September 30,  
      2010      2009      2010      2009  
   

Insurance

   $ 27,823      $ 55,401      $ 83,732      $ 138,167  

Reinsurance

     43,884        66,698        148,045        165,008  
                                     

Total

   $ 71,707      $ 122,099      $ 231,777      $ 303,175  
                                     
                                     

Overall, a significant portion of the net favorable prior period reserve development in the third quarters of 2010 and 2009 was generated from the property, marine, and aviation lines of our insurance segment and the property and catastrophe lines of our reinsurance segment. These lines of business, the majority of which have short tail exposures, contributed $32 million and $59 million of the total net favorable reserve development in the third 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 $25 million and $69 million of the net favorable reserve development in the third 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 2007 and prior, with less weighting being given to information