Lancashire Holdings Limited Lancashire Annual Report & Accounts 2010 Accounts & Report Annual www.lancashiregroup.com Five years of Lancashire Four business segments Three strategic priorities Two underwriting centres One goal ANNUAL REPORT & ACCOUNTS 2010 CONTACT INFOrmaTION REGISTERED OFFICE LEGAL COUNSEL TO THE COMPANY Lancashire Holdings Limited As to English and U.S. law: Power House Dewey & LeBoeuf LLP Contents 7 Par-la-Ville Road No 1 Minster Court Hamilton HM 11 Mincing Lane Bermuda London EC3R 7YL United Kingdom Overview 01 Corporate responsibility 32 Phone: + 1 441 278 8950 Fax: + 1 441 278 8951 As to Bermuda law: Five reasons to invest in Lancashire 01 Our values and ethics 32 Conyers, Dill & Pearman Strategic priorities 02 Brokers and clients 33 BERMUDA OFFICE Clarendon House At a glance - Financial highlights 06 Employees 33 Lancashire Insurance Company Limited 2 Church Street At a glance - How we operate 08 Regulators 35 Power House Hamilton HM 11 Chairman’s statement 10 Rating agencies 35 7 Par-la-Ville Road Bermuda Letter to shareholders from the CEO and President 12 Investor relations 35 Hamilton HM 11 Letter to shareholders from the CFO 15 Environment 36 Bermuda AUDITORS In the community 36 Ernst & Young LLP Phone: + 1 441 278 8950 1 More London Place UNDERWRITING COMES FIRST Fax: + 1 441 278 8951 London SE1 2AF EFFECTIVELY BALANCE OPERATE NIMBLY RISK AND RETURN THROUGH THE CYCLE United Kingdom CROSS-CYCLE RETURN OF RISK FREE PLUS 13% PROFITABLE 4 YEARS OUT OF 5 11 PEAK – ZONE PML LIMITS OF UK OFFICE 25% OF CAPITAL Our strategy 37 Lancashire Insurance Company (UK) Limited REGISTRAR SHAREHOLDER RETURN The Level 11, Vitro Capita Registrars (Jersey) Limited Lancashire 60 Fenchurch Street P.O. Box 532 Foundation London EC3M 4AD St Helier Business review 16 United Kingdom Jersey JE4 5UW Channel Islands Key performance indicators (KPIs) 16 Directors & governance 40 Phone: + 44 (0) 20 7264 4000 Business structure and locations 18 Fax: + 44 (0) 20 7264 4077 DEPOSITARY Capita IRG Trustees Limited Distribution 19 The Board 40 MIDDLE EAST OFFICE The Registry Renewal price index 19 Directors’ report 42 Lancashire Marketing Services (Middle East) Limited 34 Beckenham Road Investments 19 Corporate governance 47 Level 2 Beckenham Our classes of business 20 Directors’ remuneration report 54 Liquidity and cash flow 23 Building no. 4 Kent BR3 4TU 2010 Financial performance 24 Gate Village United Kingdom Underwriting results 25 Financials 64 Dubai International Financial Center Investment performance 27 Dubai, UAE Other operating expenses 28 Statement of Directors’ responsibilities 64 Phone: + 971 4 425 5100 Capital 28 Independent auditors’ report 65 Fax: + 971 4 425 5111 Repurchase program 28 Consolidated financial statements 66 Dividends 28 Accounting policies 70 Capital management 28 Risk disclosures 76 This report is printed on Marazion Ultra. Marazion Ultra is made Business environment and outlook 30 Notes to the accounts 99 Enterprise risk management 31 in the EU using chemical woodfree pulp. The pulp is bleached using Chlorine Dioxide, not Chlorine gas. This production method produces Elemental Chlorine Free (“ECF”) pulp which is less harmful to the environment. Shareholder information 126 Note regarding forward-looking statements 126 The printer is an EMAS certified CarbonNeutral® Company and 24 Glossary 127 its Environmental Management System is certified to ISO14001. 2010 financial Contact information IBC 100% of the inks used are vegetable oil based, 95% of press 2010 performance chemicals are recycled for further use and on average 99% of any waste associated with this production will be recycled. Designed and produced by Merchant. www.merchant.co.uk Printed by Park Communications. .Q^MZMI[WV[\WQV^M[\QV4IVKI[PQZM <PQ[Q[_PI\_MLW" 4IVKI[PQZMX]\[]VLMZ_ZQ\QVONQZ[\ 4IVKI[PQZMPI[IZMX]\I\QWVNWZ[\ZMVO\P QV\PMNIKMWNKPITTMVOM[ 4IVKI[PQZMILWX\[IKWV[MZ^I\Q^M QV^M[\UMV\[\ZI\MOa 4IVKI[PQZMKWUU]VQKI\M[KTMIZTaIVLWXMVTa 4IVKI[PQZMLMTQ^MZ[QVL][\Za TMILQVOZM\]ZV[ ?MPI^M[\]KS_Q\PW]Z[\ZI\MOa· WXMZI\QVOI[IVQUJTMNWK][ML[XMKQITQ\aQV[]ZMZ <]ZV\PMXIOM\WTMIZVUWZM 01 Lancashire Holdings Limited | Annual Report & Accounts 2010 STRATEGIC PRIORITIES Our long-term goal is to achieve an above average risk adjusted return. Since inception, we have produced a 20.3% compound annual return. How do we do this? By keeping it simple. 1 Underwriting comes first. 2 Effectively balance risk and return. 3 Operate nimbly through the cycle. Lancashire Holdings Limited | Annual Report & Accounts 2010 02 STRATEGIC PRIORITIES At Lancashire,underwriting always comes first. Each risk underwritten must bear scrutiny on an individual basis and as part of our overall portfolio. APPROPRIATE MIX OF TECHNOLOGY AND CULTURE If we can achieve this, year in year out, consistently, we believe it will generate a superior return for shareholders Culture and techniques BLAST proprietary model Daily underwriting call Remetrica platform In our five years of underwriting, our strategy hasn’t changed. Collegiate approach Lancashire custom features We grow when it makes sense to do so, when attractive opportunities are there. When those opportunities go away, Multiple pricing assessments Blends multiple types we shrink. We write well-priced good quality business. We of risk No hard premium targets don’t believe in pushing for growth when there is no good Optimisation capability reason to grow. Underwriters compensated to improve risk-return on Group RoE of portfolio We will continue to improve the expected contribution that underwriting makes to Lancashire’s RoE, within agreed risk tolerances. We will reduce capital needs per dollar of premium and enhance our operating leverage. COMBINED RATIO % 90 80 70 60 50 40 What’s next? 30 20 Make our insurance portfolio even more efficient. 10 Maximise its contribution to RoE. 0 INCEPTION TO DATE 06 07 08 09 10 03 Lancashire Holdings Limited | Annual Report & Accounts 2010 STRATEGIC PRIORITIES We aim to make an attractive return, within a controlled level of risk. To effectively balance risk and return requires co-ordination across all departments – time and effort very well spent. RETURN ON EQUITY At Lancashire, risk management is part of our DNA. % It permeates every facet of our business, every decision we 40 make. We believe that our balance between risk and return is 30 UK FLOODS appropriate. We are making returns at least commensurate US WINTER STORM ‘KLAUS’ CHILEAN EARTHQUAKE & DEEPWATER HORIZON with the levels of risk we accept. 20 US TORNADO STORMS 10 HURRICANE IKE & FINANCIAL MARKET MELTDOWN How do we get there? We reduce our risk in softening markets 0 INCEPTION TO DATE 06 07 08 09 10 and increase it in hardening markets. We adjust our insurance portfolio to make it as efficient as possible and we continually PROBABLE MAXIMUM LOSS AS A PERCENTAGE OF CAPITAL develop and enhance our risk measures. We learn and grow from past mistakes. % 30 25 20 15 10 5 0 1 Jan 1 Jan 1 Jan 1 Jan 1 Jan What’s next? 07 08 09 10 11 Keep learning. 1 in 100 – wind 1 in 250 – quake Keep adapting. Probable maximum loss estimates shown are the largest 1 in 100 year windstorm and Get the balance right. the largest 1 in 250 year earthquake as at each date; these estimates are before income tax, net of reinstatement premiums and net of outward reinsurance. Lancashire Holdings Limited | Annual Report & Accounts 2010 04 STRATEGIC PRIORITIES The cycle changes. So do we. We achieve this by adapting our underwriting, managing our capital, being patient and keeping our eyes open. Operate nimbly through the cycle. ACTIVE PORTFOLIO REBALANCING Operating nimbly sometimes means doing less business to % achieve a greater return. It means giving back money to shareholders when we don’t need it. Occasionally it means 100 asking for more. It means staying small so decisions can be 80 made quickly. 60 40 20 0 06 07 08 09 10 Property Energy Aviation Marine CONSTANT ADJUSTMENT OF CAPITAL $b 1.5 1.0 What’s next? 0.5 Be smart. Be prepared. 0.0 Be ready for the next market changing event. (0.5) 06 07 08 09 10 Equity Sub-debt Retained Earnings Dividends Share repurchases 05 Lancashire Holdings Limited | Annual Report & Accounts 2010 AT A GLANCE Financial highlights RETURN ON EQUITY COMBINED RATIO 23.3% 54.4% 2006 – 17.8% 2007 – 31.4% 2008 – 7.8% 2009 – 26.5% 2006 – 44.3% 2007 – 46.3% 2008 – 86.3% 2009 – 44.6% PROFIT AFTER TAX INVESTMENT RETURN $330.8m 4.2% 2006 – $159.3m 2007 – $390.9m 2008 – $97.5m 2009 – $385.4m 2006 – 6.1% 2007 – 6.2% 2008 – 3.1% 2009 – 3.9% GROSS PREMIUMS WRITTEN OPERATING HIGHLIGHTS $m 800 Excellent underwriting performance. An accident year 700 loss ratio of 42.9% despite numerous natural disasters 600 around the world and the total loss of the Deepwater 500 400 Horizon drilling unit; 300 Underwriting discipline maintained. Increased appetite 200 for energy risks, but reductions in other lines; 100 0 06 07 08 09 10 Solid investment return. Conservative portfolio Property Energy Aviation Marine positioning continues with some expansion into emerging market debt; and Active capital management. Continuing to “right size” capital via special dividends and share repurchases as the market outlook changes. Lancashire Holdings Limited | Annual Report & Accounts 2010 06 AT A GLANCE RETURN ON EQUITY COMBINED RATIO TOTAL INVESTMENT RETURN SINCE INCEPTION SINCE INCEPTION SINCE INCEPTION % % % 35 90 7 30 80 6 70 25 5 60 20 50 4 15 40 3 30 10 2 20 5 10 1 INCEPTION TO DATE INCEPTION TO DATE 0 INCEPTION TO DATE 0 0 06 07 08 09 10 06 07 08 09 10 06 07 08 09 10 .Q^M[\ZMVO\P[WN4IVKI[PQZM¼[J][QVM[[[\ZI\MOa.Q^M 4IVKI[PQZMX]\[]VLMZ_ZQ\QVONQZ[\ ZW\MK\QWV 4IVKI[PQZMNWK][M[Q\[QV^M[\UMV\[\ZI\MOaWVJITIVKM[PMM\X aKTM 4IVKI[PQZMUIVIOM[ZQ[SIVLZM\]ZV\PZW]OP\PM]VLMZ_ZQ\QVOK 4IVKI[PQZM[\Ia[VQUJTMIVLILIX\IJTM 4IVKI[PQZM\PZQ^M[WVWXXWZ\]VQ\aIVLQVVW^I\QWV 07 Lancashire Holdings Limited | Annual Report & Accounts 2010 AT A GLANCE How we operate THE DAILY UNDERWRITING CALL 3LOCATIONS 5DAYS A WEEK HAMILTON BERMUDA 43 STAFF 52WEEKS A YEAR 103POTENTIAL PARTICIPANTS* We hold a daily Underwriting and Marketing Conference Call to evaluate business across all lines, to learn from each other, AT THE SAME TIME EVERY DAY BY VIDEO CONFERENCE, INTERNET, PHONE (OR IF NECESSARY CARRIER PIGEON).