Risk Management

Derivatives Spur Odyssey Re Restatement

The reinsurer also dug up internal controls lapses that amounted to a material weakness.
Stephen TaubOctober 18, 2006

To correct the way it accounted for its investments in convertible bonds and derivatives, Odyssey Re Holdings Corp. filed an amended 10-K that restated the property-casualty reinsurer’s results for the five years ended 2005. The result: a net increase in shareholders’ equity of $16 million as of December 31, 2005.

In terms of earnings, the aggregate effect of the restatements resulted in: an increase in 2005 net loss by $12.2 million; an increase in 2004 net income by $6.9 million; an increase in 2003 net income by $12.4 million; an increase 2002 net income by $11.2 million; and an increase 2001 net loss by $3.4 million.

The company revealed that it had unearthed a material weakness in its compliance with generally accepted accounting principles. The weakness was that it didn’t maintain effective controls, review procedures, and communications concerning investment accounting. To address the material weakness, management said it would put in place a remediation to bolster its existing controls of the company.

The company also revealed that its management had dug up flaws in the controls, review procedures, and communications involved in making its investment conform with generally accepted accounting principles. Those missteps add up to a material weakness, Odyssey Re reported.

This is the company’s second restatement stemming from its accounting for investments. On August 28, it filed a quarterly report for second-quarter 2006 that included the restatement of financials for the three months ended March 31 to correct for accounting errors associated with certain investments held by the company.

On July 27 Odyssey Re issued a press release reporting that it would restate its financial results for 2001 through 2005 and for the three months ended March 31 and that previous financial statements for those periods shouldn’t be relied upon.

The corrections are partly linked to the reinsurer’s accounting treatment “for convertible bond securities held as investments and other fixed income securities with embedded derivatives held as investments, Odyssey Re reported

Some of securities held as investments bought between 2001 and 2005 were carried at fair value in accordance with the Financial Accounting Board’s statement 115, Accounting for Certain Investments in Debt and Equity Securities, according to the company.

The company said it restated the accounting for those investments to make it comply with SFAS 133: Accounting for Derivative Instruments and Hedging Activities, according to Odyssey Re.

Under SFAS 133, changes in the fair value attributable to the embedded derivative in a convertible bond or other security are required to be recognized in income directly through realized gains or losses. Instead, the company had been recording those changes through unrealized gains and losses, a component of other comprehensive income.

The restatement also involved changes in the accounting treatment for gains or losses from equity investments for which the company uses the equity method of accounting, the company reported.