Travelers 2011 Annual Report Download - page 32

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
$2.208 billion. The full $250 million coverage amount of each agreement is available on a proportional
basis until index-based losses reach a maximum $2.793 billion limit. The Company has not incurred any
losses that have resulted or are expected to result in a recovery under the Longpoint Re II agreements
since their inception. For the period May 1, 2012 through April 30, 2013, the attachment point for the
index-based losses and the maximum limit will be based on the new version of the third-party
proprietary computer model used to estimate potential hurricane losses for the entire industry,
discussed in ‘‘Item 7—Management’s Discussion and Analysis of Financial Condition and Results of
Operations—Catastrophe Modeling.’’ The Company has not yet determined the state weightings for the
May 1, 2012 reset. However, it is estimated that the attachment point for the index-based losses and
the maximum limit on the reinsurance agreements in the Longpoint Re II program will increase by as
much as 70%, reflecting increases in the third-party model’s industry estimate of covered losses. The
Company regularly reviews its catastrophe reinsurance coverage and may seek additional catastrophe
reinsurance coverage, either through general catastrophe reinsurance or through catastrophe bonds, to
provide protection against the higher potential retention of catastrophe losses resulting from the
expected increase in the attachment point.
As with any reinsurance agreement, there is credit risk associated with collecting amounts due
from reinsurers. 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 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 agreement with Longpoint Re II, the Company
concluded that it was a VIE because the conditions described in items (a) and (b) above were present.
However, while Longpoint Re II was determined to be a VIE, the Company concluded that it did not
have a variable interest in the entity, as the variability in its results, caused by the reinsurance
agreements, is expected to be absorbed entirely by the investors in the catastrophe bonds issued by the
Longpoint Re II and residual amounts earned by it, if any, are expected to be absorbed by the equity
investors (the Company has neither an equity nor a residual interest in Longpoint Re II).
Accordingly, the Company is not the primary beneficiary of Longpoint Re II and does not
consolidate that 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 II, the consolidation of that entity in the Company’s
consolidated financial statements in future periods is unlikely.
Northeast Catastrophe Reinsurance Treaty. In addition to its general catastrophe treaty and its
multi-year catastrophe bond program, the Company also is party to a Northeast General Catastrophe
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