Travelers 2009 Annual Report Download - page 34

$500 million is available on a proportional basis until index-based losses reach a maximum $3.10 billion
limit. With regard to the Longpoint Re II program, the two reinsurance agreements entered into on
December 18, 2009 provide protection for covered events occurring before or on December 18, 2012
and December 18, 2013, respectively. The Company will be entitled to begin recovering amounts under
the two reinsurance agreements if the index-based losses in the covered area for a single occurrence
reach an initial attachment amount of $2.250 billion. The full $250 million coverage amount of each
agreement is available on a proportional basis until index-based losses reach a maximum $2.850 billion
limit. The Company has not incurred any losses subject to either the Longpoint Re or Longpoint Re II
agreements since their inception.
As with any reinsurance agreement, there is credit risk associated with collecting amounts due
from reinsurers. With regard to Longpoint Re, this credit risk is mitigated by securing the $500 million
limit with a combination of assets held in a trust and a Total Return Swap with Goldman Sachs
International that is guaranteed by The Goldman Sachs Group, Inc. The value of the trust assets was
estimated to be approximately $407 million at December 31, 2009. Under the Total Return Swap, in the
event that there is a realized investment loss on the trust assets, Goldman Sachs International is
required to pay an amount equal to such realized investment loss for deposit into the trust. Two of the
assets of the trust held at December 31, 2008 failed to meet the investment guidelines of the trust and,
accordingly, were sold during the first quarter 2009. Pursuant to the Total Return Swap, upon sale of
these assets, Goldman Sachs International contributed $78 million in cash to the trust. The proceeds
from the sale of these assets and the amounts contributed by Goldman Sachs International were used
to buy replacement securities. With regard to Longpoint Re II, the credit risk is mitigated by two
reinsurance trust accounts, one for each agreement. Each reinsurance trust account has been funded by
Longpoint Re II with money market funds that invest solely in direct government obligations backed by
the U.S. government with maturities of no more than 13 months. The money market funds must have a
principal stability rating of at least AAAm by Standard & Poor’s. Other permissible investments include
repurchase and reverse repurchase agreements collateralized by direct government obligations backed
by the U.S. government with terms of no more than 397 calendar days, and cash.
At the time the agreements were entered into with Longpoint Re and Longpoint Re II, the
Company evaluated the applicability of the accounting guidance that addresses variable interest entities
or VIEs. Under this guidance, an entity that is formed for business purposes is considered a VIE if:
(a) the equity investors lack the direct or indirect ability through voting rights or similar rights to make
decisions about an entity’s activities that have a significant effect on the entity’s operations, or (b) the
equity investors do not provide sufficient financial resources for the entity to support its activities.
Additionally, a company that absorbs a majority of the expected losses from a VIE’s activities or is
entitled to receive a majority of the entity’s expected residual returns, or both, is considered to be the
primary beneficiary of the VIE and is required to consolidate the VIE in the company’s financial
statements.
As a result of the evaluation of the reinsurance agreements with Longpoint Re and Longpoint
Re II, the Company concluded that both were VIEs because the conditions described in items (a) and
(b) above were present. However, while both entities were determined to be VIEs, the Company
concluded that it did not have a variable interest in either entity, as the variability in both entities’
results, caused by the reinsurance agreements, is expected to be absorbed entirely by the investors in
the catastrophe bonds issued by the two entities and residual amounts earned by the two entities, if
any, are expected to be absorbed by the equity investors (the Company has neither an equity nor a
residual interest in Longpoint Re or Longpoint Re II).
Accordingly, the Company is not the primary beneficiary of Longpoint Re or Longpoint Re II and
does not consolidate either entity in the Company’s consolidated financial statements. Additionally,
because the Company has no intention to pursue any transaction that would result in it acquiring
interest in and becoming the primary beneficiary of Longpoint Re or Longpoint Re II, the
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