Total cash and investments of $15.9 billion; fixed maturities, cash and short-term securities comprise 89% of total cash and investments and have an average credit rating of AA-
We present our results of operations in the way we believe will be most meaningful and useful to investors, analysts, rating agencies and others who use our financial information to evaluate our performance. Some of the measurements we use are considered non-GAAP financial measures under SEC rules and regulations. In this Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"), we present underwriting-related general and administrative expenses, consolidated underwriting income (loss), operating income (loss) (in total and on a per share basis), operating return on average common equity ("operating ROACE"), amounts presented on a constant currency basis, pre-tax total return on cash and investments excluding foreign exchange movements, ex-PGAAP operating income (loss) (in total and on a per share basis) and ex-PGAAP operating ROACE which are non-GAAP financial measures as defined in Item 10(e) of SEC Regulation S-K. We believe that these non-GAAP financial measures, which may be defined and calculated differently by other companies, better explain and enhance the understanding of our results of operations. However, these measures should not be viewed as a substitute for those determined in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP").
We believe that presentation of underwriting-related general and administrative expenses and consolidated underwriting income (loss) provides investors with an enhanced understanding of our results of operations, by highlighting the underlying pre-tax profitability of our underwriting activities. The reconciliation of consolidated underwriting income (loss) to net income (loss), the most comparable GAAP financial measure, is presented in 'Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Summary - Results of Operations'.
of which are not related to the underwriting process, therefore, this income (loss) is excluded from operating income
Return on average common equity ("ROACE") is calculated by dividing net income (loss) available (attributable) to common shareholders for the year by the average common shareholders' equity determined using the common shareholders' equity balances at the beginning and end of the year.
Consolidated underwriting income (loss) is a non-GAAP financial measure as defined in Item 10(e) of SEC Regulation S-K. The reconciliation to net income (loss), the most comparable GAAP financial measure, is provided in 'Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Summary - Results of Operation'.
The decrease in the insurance segment ceded premiums written of $6 million or 0.4% was attributable to property lines, partially offset by an increase in liability lines.
At December 31, 2019, net reserve for losses and loss expenses included estimated amounts for numerous catastrophe events. We caution that the magnitude and/or complexity of losses arising from these events, in particular Japanese Typhoons Hagibis, Faxai and Tapah, Hurricane Dorian, and the Australia Wildfires which occurred in 2019 together with Hurricanes Michael and Florence, California Wildfires and Typhoon Jebi which occurred in 2018 as well as Hurricanes Harvey, Irma and Maria and the California Wildfires which occurred in 2017 inherently increase the level of uncertainty and, therefore, the level of management judgment involved in arriving at estimated net reserve for losses and loss expenses. As a result, actual losses for these events may ultimately differ materially from current estimates.
Short-tail business includes the underlying exposures in the property and other, marine, and aviation reserve classes in the insurance segment, and the underlying exposures in the property and other reserve class in the reinsurance segment.
2019 versus 2018: Net premiums earned in 2019 decreased by $32 million or 1% ($18 million or 1% on a constant currency basis) compared to 2018. The decrease in net premiums earned was primarily driven by increases in ceded premiums earned in accident and health, credit and surety, and motor lines, together with decreases in gross premiums earned in motor and credit and surety lines, partially offset by increases in gross premium earned in accident and health, and marine and other lines.
The OTTI charges (refer to 'Critical Accounting Estimates - OTTI' for further details) recognized in net income by asset class were as follows:
The severity of the unrealized loss position as a percentage of amortized cost for all non-investment grade fixed maturities in an unrealized loss position including any impact of foreign exchange losses (gains) was as follows:
AXIS Capital’s operating subsidiaries primarily derive cash from the net inflow of premiums less claim payments related to underwriting activities and from net investment income. Historically, these cash receipts have been sufficient to fund the operating expenses of these subsidiaries, as well as to fund dividend payments to AXIS Capital. The subsidiaries’ remaining cash flows are generally invested in our investment portfolio. The remaining cash flows have also been used to fund common share repurchases and to fund acquisitions in recent periods.
Investing cash inflows in 2018 principally related to the net proceeds from the sale and redemption of fixed maturities of $364 million, net proceeds from the sale and redemption of equity securities of $173 million and the net proceeds from the sale of other investments of $181 million.
Our quarterly loss reserving process begins with the collection and analysis of paid and incurred claim data for each of the segments. The segmental data is disaggregated by reserve class and further disaggregated by underwriting year and accident year. Underwriting year or accident year information is used to analyze our business and to estimate loss reserves. Reserve classes are selected to ensure that the underlying contracts have homogeneous loss development characteristics, while remaining large enough to make the estimation of trends credible. Reserve classes are reviewed on a regular basis and adjusted over time as our business evolves. The paid and incurred claim data, in addition to industry benchmarks, serves as a key input to many of the methods employed by our actuaries. The relative weights assigned to our historical loss data versus industry data vary based on a number of factors including our historical track record and the development profile for the reserve class being evaluated (refer to 'Claim Tail Analysis' below for further details).
Due to the relatively short reporting and settlement patterns for short-tail business, we generally place more weight on experience-based methods and other qualitative considerations in establishing reserves for recent and more mature accident years. Refer to 'Underwriting Results - Consolidated - Prior Year Reserve Development' for further details.
Our insurance credit and political risk business consists primarily of credit insurance and confiscation, expropriation, nationalization and deprivation coverages ("CEND"). Claims for this business tend to be characterized by their severity risk, as opposed to their frequency risk therefore, claim payment and reporting patterns are anticipated to be volatile. Under the notification provisions of our credit insurance policies, we anticipate being advised of an insured event within a relatively short time period. Consequently, we generally estimate ultimate losses based on a contract-by-contract analysis which considers the contracts’ terms, the facts and circumstances of underlying loss events and qualitative input from claims managers.
Our quarterly loss reserving process involves the collaboration of our underwriting, claims, actuarial, legal, ceded reinsurance and finance departments, includes various segmental committee meetings and culminates with the approval of a single point best estimate by our Group Reserving Committee, which comprises senior management. In selecting this best estimate, management considers actuarial estimates and applies informed judgment regarding qualitative factors that may not be fully captured in these actuarial estimates. Such factors include, but are not limited to: the timing of the emergence of claims, volume and complexity of claims, social and judicial trends, potential severity of individual claims and the extent of our historical loss data versus industry information. While these qualitative factors are considered in arriving at the point estimate, no specific provisions for qualitative factors are established.
As a result of this review process, any adjustments to premium estimates are recognized in the period in which they are determined. Changes in premium estimates could be material to gross premiums written in the period. Changes in premium estimates could be also material to net premiums earned in the period in which they are determined as any adjustment may be substantially or fully earned. Gross premiums written for proportional reinsurance contracts, including adjustments to premium estimates established in prior years, accounted for 52% and 62% of the reinsurance segment’s gross premiums written for the years ended December 31, 2019 and 2018, respectively.
Line slip or proportional insurance policies and proportional reinsurance contracts are generally written on a "risks attaching" basis, covering claims that relate to the underlying policies written during the terms of these contracts. As the underlying business incepts throughout the contract term which is typically one year, and the underlying business typically has a one year coverage period, these premiums are generally earned evenly over a 24-month period.
For the purpose of evaluating goodwill for impairment, the Company may first perform a qualitative assessment to determine whether it is necessary to perform a quantitative goodwill impairment test. If determined to be necessary, the quantitative test compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired. If the carrying amount of the reporting unit exceeds the fair value, an impairment loss is recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit.
The Company's investments in CMBS are diversified and primarily rated AA or better. At December 31, 2019, CMBS had a weighted average estimated subordination percentage of 29% (2018: 31%). Based on discounted cash flows at December 31, 2019, the current level of subordination is sufficient to cover the estimated loan losses on the underlying collateral of the CMBS.
Note: Fixed maturities and insurance-linked securities that are classified as Level 3 of $8 million are excluded from the above table as these securities are priced using broker-dealer quotes. In addition, other privately held investments of $37 million that are classified as Level 3 are excluded from the above table as these investments are priced using capital statements received from investee companies.
At December 31, 2019, the carrying value of mortgage loans held-for-investment approximated their fair value. The fair values of mortgage loans are primarily determined by estimating expected future cash flows and discounting them using current interest rates for similar mortgage loans with similar credit risk or are determined from pricing for similar loans. As mortgage loans are not actively traded, their fair values are classified as Level 3.
The following is a brief description of the reserve estimation methods commonly employed by the Company's actuaries including a discussion of their particular strengths and weaknesses:
Expected Loss Ratio Method ("ELR Method"): This method estimates ultimate losses for an accident year or underwriting year by applying an expected loss ratio to the earned or written premium for that year. Generally, expected loss ratios are based on one or more of (a) an analysis of historical loss experience to date, (b) pricing information and (c) industry data, adjusted as appropriate, to reflect changes in rates, loss and exposure trends, and terms and conditions. This method is insensitive to actual incurred losses for the accident year or underwriting year in question and is, therefore, often useful in the early stages of development when very few losses have been incurred. Conversely, the lack of sensitivity to incurred/paid losses for the accident year or underwriting year in question means that this method is usually inappropriate in later stages of an accident year or underwriting year’s development.
For the year ended December 31, 2019, the insurance professional lines reserve class recorded net favorable prior year reserve development of $12 million (2018: $32 million, 2017: $26 million), reflecting generally favorable experience on older accident years as the Company continued to transition to more experience based actuarial methods.
For the year ended December 31, 2019, the insurance credit and political risk reserve class recorded net favorable prior year reserve development of $19 million reflecting generally better than expected loss emergence.
The terrorism line of business provides cover for physical damage and business interruption of an insured following an act of terrorism and includes kidnap and ransom, and crisis management insurance.
With respect to key actuarial assumptions, the Company relies on its experience when establishing expected loss ratios and selected loss development patterns. Loss reporting patterns for professional lines business tend to be volatile, causing instability in actuarial indications based on incurred loss data until an underwriting year matures. Consequently, initial loss reserves for an underwriting year are generally based on the ELR Method and the consideration of relevant qualitative factors. As underwriting years mature, the Company increasingly gives more weight to methods that reflect its experience until its selections are based almost exclusively on experience-based methods. The Company evaluates the appropriateness of the transition to experience-based methods at the reserve class level, commencing this transition when it believes that its incurred loss development is sufficient to produce meaningful actuarial indications. The rate at which the Company transitions fully to sole reliance on experience-based methods can vary by reserve class and by year, depending on its assessment of the stability and relevance of such indications.
The 5.875% Senior Notes are ranked as unsecured senior obligations of AXIS Specialty Finance LLC, a 100% owned finance subsidiary. AXIS Capital has fully and unconditionally guaranteed all obligations of AXIS Specialty Finance LLC under the 5.875% Senior Notes. AXIS Capital’s obligations under this guarantee are unsecured senior obligations and rank equally with all other senior obligations of AXIS Capital.
Interest expense recognized in relation to the Senior Notes includes interest payable, amortization of the offering discounts and amortization of debt offering expenses. The offering discounts and debt offering expenses are amortized over the period of time during which the Senior Notes are outstanding. For the year ended December 31, 2019, the Company incurred interest expense of $67 million (2018: $64 million, 2017: $51 million).
From time to time, the Company is subject to routine legal proceedings, including arbitrations, arising in the ordinary course of business. These legal proceedings generally relate to claims asserted by or against the Company in the ordinary course of its insurance or reinsurance operations. Estimated amounts payable related to these proceedings are included in reserve for losses and loss expenses in the Company's consolidated balance sheets.
For the year ended December 31, 2018, the total lease expense was $33 million (2017: $29 million).
Grants provided under the 2017 Plan and the 2007 Plan generally allow for accelerated vesting provisions on the employee’s death, permanent disability, or certain terminations following a change in control of the Company occurring within two years of the change in control event. Notwithstanding these vesting provisions, the Compensation Committee of the Company's Board has broad authority to accelerate vesting at its discretion.
The Company's Chairman, Mr. Butt received consulting fees for the year ended December 31, 2019 of $0.4 million (2018: $0.5 million; 2017: $0.5 million) pursuant to the terms of a consulting agreement by and between Mr. Butt and the Company dated May 3, 2012, as amended, most recently on July 18, 2019 to extend the term of the agreement to December 31, 2020.