Following the offer to acquire Novae Group plc ("Novae") on July 5, 2017, we suspended our open market share repurchase program. We acquired the shares of Novae on October 2, 2017.
The insurance market has begun to respond to the cumulative effects of many years of price deterioration and the record significant catastrophe activity incurred in 2017. Market conditions and rates across most lines have generally improved, with catastrophe exposed property lines experiencing the most upward rate momentum. While market conditions have improved they will likely remain variable through the year and possibly beyond as carriers assess pricing, portfolio construction and account preferences. In this competitive market environment with mixed market conditions, we are focusing on lines of business and market segments that are adequately priced. In addition, our acquisition of Novae increases our scale and
We also present non-GAAP operating income per diluted common share and annualized non-GAAP operating return on average common equity ("annualized non-GAAP operating ROACE"), which are derived from the non-GAAP operating income measure and can be reconciled to the most comparable GAAP financial measures as follows:
agreement with Northshore Re II Limited ('Northshore'). In connection with the reinsurance agreement, Northshore issued notes to unrelated investors in an amount equal to the full $350 million of coverage provided under the reinsurance agreement covering a three year period. At the time of the agreement, we performed an evaluation of Northshore to determine if it meets the definition of a variable interest entity ('VIE'). We concluded that Northshore is a VIE but we do not have a variable interest in the entity, as the variability in results is expected to be absorbed entirely by the investors in Northshore. Accordingly, Northshore is not consolidated in our consolidated financial statements. The premium ceded to Northshore for the year ended December 31, 2017 was $27 million.
Net premiums earned in our reinsurance segment in 2017 increased by $114 million or 6%, compared to 2016. The increase in net premiums earned was driven by an increase in gross premiums earned attributable to our agriculture, motor and property lines partially offset by an increase in ceded premium earned in professional lines, agriculture and property lines together with a decrease in gross premiums earned in our professional lines.
$43 million of net favorable prior year reserve development on liability business due to progressively increased weight given by management to experience based indications on earlier accident years, particularly 2008 through 2010.
$46 million of net favorable prior year reserve development on liability business, primarily related to the 2003 through 2010 accident years, reflecting the greater weight management is giving to experience based indications.
2016 versus 2015: The current accident year loss ratio increased to 67.4% in 2016 from 65.7% in 2015. The increase was primarily due to an increase in catastrophe and weather-related losses. During 2016, we incurred pre-tax catastrophe and weather-related net losses (net of reinstatement premiums) of $83 million, or 4.4 points attributable to the Fort McMurray wildfires, U.S. weather-related events, Hurricane Matthew, the Japanese, Ecuadorian and South Island earthquakes, the North Calgary hailstorm and the European floods. Comparatively, in 2015 we incurred $46 million or 2.4 points of net losses attributable to catastrophe and weather-related events.
largely offset by a tax charge of $42 million related to the revaluation of net deferred tax assets associated with the reduction in the U.S. corporate income tax rate from 35% to 21% enacted as part of the U.S. Tax Reform.
The following table provides a summary of the OTTI recognized in earnings by asset class:
Pre-tax return on cash and investments excluding foreign exchange movements is a non-GAAP financial measure as defined in Item 10(e) of SEC Regulation S-K. The reconciliation to pre-tax total return on cash and investments, the most comparable GAAP financial measure included foreign exchange gains (losses) of $80 million, $(79) million and $(105) million for the years ended December 31, 2017, 2016 and 2015 respectively.
The fair value of our total hedge funds decreased by $134 million in 2017 driven by $168 million of net redemptions offset by $34 million of price appreciation. Certain of these funds may be subject to restrictions on redemptions which may limit our ability to liquidate these investments in the short term. See Item 8, Note 6(c) to the Consolidated Financial Statements 'Investments' for further details on these restrictions and details on unfunded commitments relating to our other investment portfolio.
Investing cash inflows in 2017 principally related to the net sale of equity securities of $342 million (2016: $3 million, 2015: $81 million outflow), net proceeds from the sale and redemption of fixed maturities of $300 million (2016: $221 million, 2015: $172 million outflow) and the net proceeds from the sale of other investments of $108 million (2016: $25 million, 2015: $169 million), partially offset by cash used for the purchase of Novae and Aviabel.
In light of the volatility of global equity markets we have experienced in recent years, we generally impair equities for which we do not forecast a recovery to cost within two years. Further, we generally impair an equity security if its fair value is 15% below its cost. We have also established parameters for identifying potential impaired equity securities for fundamental analysis based on the severity, in either percentage or absolute dollar terms, of the unrealized loss position.
Fixed maturities and equity securities classified as "available for sale" are reported at fair value at the balance sheet date (see Note 7 'Fair Value Measurements'). The change in fair value (net unrealized gain (loss)) on available for sale investments, net of tax, is included as a separate component of accumulated other comprehensive income (loss) ("AOCI") in shareholders’ equity.
Upon recognition of an OTTI charge, the new cost basis for the security is the previous amortized cost for a fixed maturity or cost for an equity security less the OTTI charge recognized in net income. The new cost basis is not adjusted for subsequent recoveries in fair value except for fixed maturities whereby the difference between the new cost basis and the expected cash flows is accreted on a quarterly basis to net investment income over the remaining life of the fixed maturity.
Reinsurance recoverable related to case reserves is estimated on a case-by-case basis by applying the terms of any applicable reinsurance coverage to individual case reserve estimates. The estimate of reinsurance recoverable related to IBNR reserves is generally developed as part of the loss reserving process.
In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)" which provides a new comprehensive model for lease accounting. The guidance will require a lessee to recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. This guidance is effective for
VOBA: VOBA was computed as the difference between the fair value of unearned obligations and the unearned premiums reserve recorded by Novae at the acquisition date. Key inputs used in the valuation model used for this intangible asset included the fair value of the unearned premium computed as the present value of future unearned cash flows, plus the present value of the costs associated with holding capital to support these exposures together with the fair value of reserves computed as the present value of future net losses and loss expense payments, plus the present value of the costs associated with holding capital to support those payments.
At December 31, 2017, the Company had $16 million (2016: $12 million) of unfunded commitments as a limited partner in multi-strategy hedge funds. Once the full amount of committed capital has been called by the General Partner of each of these funds, the assets will not be fully returned until after the completion of the funds' investment term. These funds have investment terms ranging from 2 years to the dissolution of the underlying fund.
During 2017, the Company made a $75 million commitment as a limited partner of an open-ended commercial mortgage income fund. At December 31, 2017, this commitment remains unfunded.
For the year ended December 31, 2017, the Company recorded an impairment charge of $9 million, related to a U.S. based insurance company, which reduced the carrying value of the investment to $nil. This charge is included in interest in loss of equity method investments in the Consolidated Statement of Operations.
Non-Agency RMBS include mostly investment-grade bonds originated by non-agencies. The fair values of these securities are determined using an option adjusted spread model or other relevant models, which use inputs including available trade information or broker quotes, prepayment and default projections based on historical statistics of the underlying collateral and current market data. As the significant inputs used to price these securities are observable market inputs, the fair values of Non-Agency RMBS are classified as Level 2.
Short-term investments primarily comprise highly liquid securities with maturities greater than three months but less than one year from the date of purchase. These securities are classified as Level 2 because these securities are typically not actively traded due to their approaching maturity and, as such, their amortized cost approximates fair value.
Short-tail business generally includes exposures for which losses are usually known and paid within a relatively short period of time after the underlying loss event has occurred. The majority of development for an accident year or underwriting year is expected to be recognized in the subsequent one to three years. The key actuarial assumptions for short-tail business in early accident years were primarily developed with reference to industry benchmarks for both expected loss ratios and loss development patterns. As the Company's own historical loss experience amassed, it gained credibility and became relevant for consideration in establishing these key actuarial assumptions. As a result, the Company gradually increased the weighting assigned to its own historical experience in selecting the expected loss ratios and loss development patterns utilized to establish estimates of ultimate losses for an accident year. Due to the relatively short reporting and settlement patterns for short-tail business, more weight is generally placed upon experience-based methods and other qualitative considerations in establishing reserves for both recent and more mature accident years.
estimates of the size of insured industry losses from the catastrophic event and the Company's corresponding market share;
On August 2, 2016, Novae entered into a new syndicated bank financing facility, which provides the company with a combined letter of credit and revolving credit facility of $229 million and a term loan of $67 million.
During October and November 2016, the Company repurchased 1,957,045 Series C preferred shares at an average purchase price of $25.67 per share for $50 million. In connection with the repurchase of these shares, a loss on redemption of $1 million (calculated as the difference between the redemption price and the carrying value), was recognized in determining net income available to common shareholders.
The fair value of share-settled restricted stock units and cash-settled restricted stock units that vested during 2017 was $125 million (2016: $67 million; 2015: $75 million), including $44 million attributable to service-based restricted stock units granted in 2014 which were subject to a three year cliff vesting period. At December 31, 2017, there were $94 million (2016: $85 million) of unrecognized compensation costs which are expected to be recognized over the weighted average period of 2.5 years (2016: 2.3 years).
Corporate members of Lloyd’s and Lloyd’s syndicates are bound by the rules of Lloyd’s, which are prescribed by Bye-laws and Requirements made by the Council of Lloyd’s under powers conferred by the Lloyd’s Act 1982. These rules prescribe members’ membership subscription, the level of their contribution to the Lloyd’s Central Fund and the assets they must deposit with Lloyd’s in support of their underwriting. The Council of Lloyd’s has broad powers to sanction breaches of its rules, including the power to restrict or prohibit a member’s participation on Lloyd’s Syndicates.
Corporate Capital UK Limited FAL requirements. At December 31, 2017 fixed maturities and short term investments with a fair value of $564 million and equity securities with a fair value of $59 million, respectively, were restricted to satisfy Novae Corporate Underwriting Limited FAL requirements (see Note 6 'Investments').
During the three months ended September 30, and December 31, 2017, the Company recognized transaction and reorganization expenses of $6 million and $21 million, respectively, related to the acquisition and integration of Novae. Refer to Item 8, Note 18 of the Consolidated Financial Statements 'Transaction and Reorganization Expenses' for further details.
The Company's accident and health line of business is currently included in the Company's insurance segment. During the first quarter of 2018, the Company plans to realign its accident and health line of business. As a result of the realignment, this business will also be included in the Company's reinsurance segment.
The alignment of the Company's accident and health line of business will impact the presentation of the Company's reporting segments. Work is ongoing to recast the Company’s current and prior periods within its financial systems to conform to the new presentation. The Company expects to complete this work during the first quarter of 2018 and to reflect the results of its accident and health business in the Company's insurance and reinsurance segments for the three month period ended March 31, 2018.