W. R. Berkley and its subsidiaries own or lease office buildings or office space suitable to conduct their operations. At December 31, 2020, the Company had aggregate office space of 4,217,252 square feet, of which 1,105,205 were owned and 3,112,047 were leased.
Rental expense for the Company's operations was approximately $44,291,000, $44,107,000 and $45,778,000 for 2020, 2019 and 2018, respectively. Future minimum lease payments, without provision for sublease income, are $47,477,000 in 2021, $41,442,000 in 2022 and $149,702,000 thereafter.
The Company’s profitability is also affected by its investment income and investment gains. The Company’s invested assets are invested principally in fixed maturity securities. The return on fixed maturity securities is affected primarily by general interest rates, as well as the credit quality and duration of the securities. Returns available on fixed maturity investments have been at low levels for an extended period.
Effective January 1, 2020, the Company adopted new accounting standard ASU 2016-13 Financial Instruments - Credit Losses. Refer to Note 1 in the financial statements for further information on the accounting guidance and impact of its adoption on the Company's results and financial position.
The ongoing COVID-19 pandemic, including the related impact on the U.S. and global economies, has materially and adversely affected our results of operations. For the year ended December 31, 2020, the Company recorded approximately $171 million for COVID-19-related losses, net of reinsurance, and reinstatement premiums of approximately $18 million. The ultimate impact of COVID-19 on the economy and on the Company’s results of operations, financial position and liquidity is uncertain and not within the Company’s control. The scope, duration and magnitude of the direct and indirect effects of COVID-19 continue to evolve in ways that are difficult or impossible to anticipate. Despite the effects of COVID-19 to date, the Company’s financial position and liquidity improved commencing in the second quarter.
The impact of the COVID-19 pandemic on our results of operations, financial position and liquidity is expected to include, among others:
Claim Losses Related to COVID-19 May Exceed Reserves. Given the great uncertainties associated with COVID-19 and its impact and the limited information upon which our current assumptions and assessments have been made, our reserves and underlying estimated level of claim losses and costs arising from COVID-19 may materially change.
Reinsurance. Reinsurers may dispute the applicability of reinsurance to COVID-19 related losses (including the application of reinsurance reinstatements) and, as a result, our reinsurers may refuse to pay reinsurance recoverables related thereto or they may not pay them on a timely basis. In addition, we may be unable to renew our current reinsurance coverages or purchase new coverages with respect to certain exposures under our policies, including COVID-19-related exposures.
Credit Risk. As credit risk is generally a function of the economy, we face greater credit risk from our policyholders, independent agents and brokers in connection with the payment and remittance of premiums as a result of the economic conditions caused by COVID-19. Similarly, our credit risk related to the reimbursement of deductibles from policyholders and in connection with reinsurance recoverables has increased.
Operational Disruptions and Costs. Our operations could be disrupted if key members of our senior management or a significant percentage of our workforce or the workforce of our agents, brokers, suppliers or other third party service providers are unable to continue to work because of illness, government directives or otherwise. In response to the COVID-19 pandemic, we have implemented remote working policies which have resulted in disruptions to our business routines, heightened risk to cybersecurity attacks and data security incidents and a greater dependency on internet and telecommunication access and capabilities.
Our net reserves for losses and loss expenses of approximately $11.6 billion as of December 31, 2020 relate to multiple accident years. Therefore, the impact of changes in frequency or severity for more than one accident year could be higher or lower than the amounts reflected above. The impact of such changes would likely be manifested gradually over the course of many years, as the magnitude of the changes became evident.
Following is a summary of the Company’s net reserves for losses and loss expenses by major line of business as of December 31, 2020 and 2019:
(1)Reserves for excess and assumed workers’ compensation business are net of an aggregate net discount of $483 million and $530 million as of December 31, 2020 and 2019, respectively.
(3)Reinsurance & Monoline Excess includes property and casualty reinsurance as well as operations that solely retain risk on an excess basis.
The ongoing COVID-19 global pandemic has impacted, and will likely continue to impact, the Company’s results through its effect on claim frequency and severity. Loss cost trends have been impacted and will likely be further impacted by COVID-19-related claims in certain lines of business, as well as by other effects of COVID-19 associated with economic conditions, inflation, and social distancing and work from home rules, for example. Although it is still too early to determine the net impact, it appears that the losses incurred due to COVID-19-related claims are being offset, to a certain extent, by lower claim frequency in certain lines of our businesses, including commercial auto, workers’ compensation, and other liability. However, given the continuing nature of the pandemic, the impact of COVID-19 could ultimately increase or decrease overall loss cost trends and is likely to have differing impacts on the Company's different lines of business.
Most of the COVID-19-related claims reported to the Company to date involve certain short-tailed lines of business, including contingency and event cancellation, business interruption, and film production delay. The Company expects additional claims to be reported for these lines of business. The Company has also received COVID-19-related claims for longer-tailed casualty lines of business such as workers’ compensation and other liability; however, the estimated incurred loss impact for these reported claims appears to be modest at this time. Given the continuing uncertainty regarding the pandemic's pervasiveness, the future impact that the pandemic may have on claim frequency and severity remains uncertain at this time. In workers’ compensation, for example, nearly two-thirds of the states have enacted rules, legislation or administrative orders creating a presumption that certain “essential” workers who contract COVID-19 did so through the course of their employment. Several other states are considering similar actions, including varying the definition of “essential” workers. While the ultimate impact of these presumptions are unknown at this time, the Company believes that such state actions will likely increase workers’ compensation claims with respect to workers deemed “essential,” although this impact may be partially offset by lower workers’ compensation claim frequency with respect to non-essential workers.
The Company has estimated the potential COVID-19 impact to its contingency and event cancellation, workers’ compensation, and other lines of business under a number of possible scenarios; however, due to COVID-19’s evolving impact and the still limited amount of available data, there remains a high degree of uncertainty around the Company’s COVID-19 reserves. In addition, several states (and international jurisdictions), through regulation, legislation and/or judicial action, continue to seek to expand policy coverage terms beyond the policy’s intended coverage, including, for example, but not limited to, property coverages, where there are attempts to extend business interruption coverage where there is no physical damage or loss to property, and attempts to disregard policy exclusions for communicable disease. Accordingly, losses arising from these actions, and the other factors described above, could exceed the Company’s reserves established for those related policies.
Insurance - Reserves for the Insurance segment developed favorably by $21 million in 2019 (net of additional and return premiums). This overall favorable development resulted from more significant favorable development on workers’ compensation business, which was partially offset by unfavorable development on professional liability and general liability business.
For workers’ compensation, the favorable development was spread across many accident years, including prior to 2010, but was most significant in accident years 2014 through 2018, and particularly 2017 and 2018. The favorable workers’ compensation development reflects a continuation during 2019 of the benign loss cost trends experienced during recent years, particularly the favorable claim frequency trends (i.e., number of reported claims per unit of exposure). The long term trend of declining workers’ compensation frequency can be attributable to improved workplace safety. Loss severity trends were also aided by our continued investment in claims handling initiatives such as medical case management services and vendor savings through usage of preferred provider networks and pharmacy benefit managers. Our initial loss ratio “picks” for this line of business over the past few accident years have contemplated an increase in loss cost trends and reflect decreasing premium rates in the marketplace; reported workers’ compensation losses in 2019 continued to be below our expectations at most of our operating units, and were below the assumptions underlying our initial loss ratio picks and our previous reserve estimates.
Insurance - Reserves for the Insurance segment developed favorably by $19 million in 2018. The favorable development was primarily attributable to workers’ compensation business, and was partially offset by unfavorable development for professional liability business.
For workers’ compensation, the favorable development was spread across many accident years, but was most significant in accident years 2015 through 2017. The favorable workers’ compensation development reflects a continuation during 2018 of the benign loss cost trends experienced during recent years, particularly the favorable claim frequency trends (i.e., number of reported claims per unit of exposure). The long term trend of declining workers' compensation frequency can be attributable to improved workplace safety. Loss severity trends were also aided by our continued investment in claims handling initiatives such as medical case management services and vendor savings through usage of preferred provider networks. Reported
Substantially all discounted workers’ compensation reserves (97% of total discounted reserves at December 31, 2020) are excess workers’ compensation reserves. In order to properly match loss expenses with income earned on investment securities supporting the liabilities, reserves for excess workers’ compensation business are discounted using risk-free discount rates determined by reference to the U.S. Treasury yield curve. These rates are determined annually based on the weighted average rate for the period. Once established, no adjustments are made to the discount rate for that period, and any increases or decreases in loss reserves in subsequent years are discounted at the same rate, without regard to when any such adjustments are recognized. The expected loss and loss expense payout patterns subject to discounting are derived from the Company’s loss payout experience.
The Company’s credit assessment of allowance for expected credit losses uses a third party model for available for sale and held to maturity securities, as well as loans receivable. The allowance for expected credit losses is generally based on the performance of the underlying collateral under various economic and default scenarios that involve subjective judgments and estimates by management. Modeling these securities involves various factors, such as projected default rates, the nature and realizable value of the collateral, if any, the ability of the issuer to make scheduled payments, historical performance and other relevant economic and performance factors. A discounted cash flow analysis is used to ascertain the amount of the allowance for expected credit losses, if any. In general, the model reverts to the rating-level long-term average marginal default rates based on 10 years of historical data, beyond the forecast period. For other inputs, the model in most cases reverts to the baseline long-term assumptions linearly over 5 years beyond the forecast period. The long-term assumptions are based on the historical averages.
A summary of the Company’s non-investment grade fixed maturity securities that were in an unrealized loss position at December 31, 2020 is presented in the table below.
As of December 31, 2020, the Company has recorded an allowance for expected credit losses on fixed maturity securities of $3 million. The Company has evaluated the remaining fixed maturity securities in an unrealized loss position and believes the unrealized losses are due primarily to temporary market and sector-related factors rather than to issuer-specific factors. None of these securities are delinquent or in default under financial covenants. Based on its assessment of these issuers, the Company expects them to continue to meet their contractual payment obligations as they become due.
In classifying particular financial securities in the fair value hierarchy, the Company uses its judgment to determine whether the market for a security is active and whether significant pricing inputs are observable. The Company determines the existence of an active market by assessing whether transactions occur with sufficient frequency and volume to provide reliable pricing information. The Company determines whether inputs are observable based on the use of such information by pricing services and external investment managers, the uninterrupted availability of such inputs, the need to make significant adjustments to such inputs and the volatility of such inputs over time. If the market for a security is determined to be inactive or if significant inputs used to price a security are determined to be unobservable, the security is categorized in Level 3 of the fair value hierarchy.
Independent pricing services - Substantially all of the Company’s fixed maturity securities available for sale were priced by independent pricing services (generally one U.S. pricing service plus additional pricing services with respect to a limited number of foreign securities held by the Company). The prices provided by the independent pricing services are generally based on observable market data in active markets (e.g., broker quotes and prices observed for comparable securities). The determination of whether markets are active or inactive is based upon the volume and level of activity for a particular asset class. The Company reviews the prices provided by pricing services for reasonableness based upon current trading levels for similar securities. If the prices appear unusual to the Company, they are re-examined and the value is either confirmed or revised. In addition, the Company periodically performs independent price tests of a sample of securities to ensure proper valuation and to verify our understanding of how securities are priced. As of December 31, 2020, the Company did not make any adjustments to the prices provided by the pricing services. Based upon the Company’s review of the methodologies used by the independent pricing services, these securities were classified as Level 2.
Net Income to Common Stockholders. The following table presents the Company’s net income to common stockholders and net income per diluted share for the years ended December 31, 2020 and 2019.
Premiums. Gross premiums written were $8,848 million in 2020, an increase of 7% from $8,262 million in 2019. The increase was due to the growth in the Insurance segment of $439 million and $147 million in the Reinsurance & Monoline Excess segment. Approximately 79% of premiums expiring in 2020 were renewed, and 80% of premiums expiring in 2019 were renewed.
Average renewal premium rates for insurance and facultative reinsurance increased 11.3% in 2020 and 4.8% in 2019, when adjusted for changes in exposures. Average renewal premium rates for insurance and facultative reinsurance excluding workers' compensation increased 13.6% in 2020 and 6.9% in 2019, when adjusted for changes in exposures.
Premiums earned increased 4% to $6,931 million in 2020 from $6,633 million in 2019. Insurance premiums (including the impact of rate changes) are generally earned evenly over the policy term, and accordingly recent rate increases will be earned over the upcoming quarters. Premiums earned in 2020 are related to business written during both 2020 and 2019. Audit premiums were $128 million in 2020 compared with $199 million in 2019.
Net Investment Income. Following is a summary of net investment income for the years ended December 31, 2020 and 2019:
Insurance Service Fees. The Company earns fees from an insurance distribution business, a third-party administrator, and as a servicing carrier of workers' compensation assigned risk plans for certain states. Insurance service fees were $89 million in 2020 and $93 million in 2019. The decrease was primarily due to a reduction of assigned risk plan business.
losses on equity securities of $25 million. In 2019, the gains reflected net realized gains on investment sales of $36 million and increased by a change in unrealized gains on equity securities of $85 million.
Change in Allowance for Expected Credit Losses on Investments. Effective January 1, 2020, the Company adopted accounting guidance for credit losses on financial instruments. The cumulative effect adjustment from the change in accounting principle was $25 million after-tax, which decreased opening retained earnings and increased AOCI. Based on credit factors, the allowance for expected credit losses is increased or decreased depending on the percentage of unrealized loss relative to amortized cost by security, changes in rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. For the year ended December 31, 2020, the pre-tax change in allowance for expected credit losses on investments decreased by $29 million ($23 million after-tax), which is reflected in net investment gains (losses).
Losses and Loss Expenses. Losses and loss expenses increased to $4,469 million in 2020 from $4,131 million in 2019. The consolidated loss ratio was 64.5% in 2020 and 62.3% in 2019. Catastrophe losses, net of reinsurance recoveries, were $340 million (including losses of approximately $171 million related to COVID-19) in 2020 compared with $90 million in 2019. Favorable prior year reserve development (net of premium offsets) was $16 million in 2020 compared with $19 million in 2019. The loss ratio excluding catastrophe losses and prior year reserve development decreased 1.4 points to 59.8% in 2020 from 61.2% in 2019.
A summary of loss ratios in 2020 compared with 2019 by business segment follows:
•Insurance - The loss ratio of 64.9% in 2020 was 2.5 points higher than the loss ratio of 62.4% in 2019. Catastrophe losses were $307 million in 2020 compared with $68 million in 2019. The Company reflected a best estimate (net of reinsurance) based upon available information for COVID-19-related losses of approximately $161 million, which was included in catastrophe losses and primarily related to contingency and event cancellation coverage, workers’ compensation and short-tail lines. Favorable prior year reserve development was $24 million in 2020 compared with $21 million in 2019. The loss ratio excluding catastrophe losses and prior year reserve development decreased 1.4 points to 60.2% in 2020 from 61.6% in 2019.
Policy acquisition and insurance operating expenses are comprised of commissions paid to agents and brokers, premium taxes and other assessments and internal underwriting costs. Policy acquisition and insurance operating expenses increased 1% and net premiums earned increased 4% from 2019. The expense ratio (policy acquisition and insurance operating expenses expressed as a percentage of premiums earned) was 30.4% in 2020 and 31.5% in 2019. The improvement is primarily attributable to higher net premiums earned and lower travel and entertainment expenses due to the global pandemic. However, to the extent our net premiums earned decrease, due to the impact of the COVID-19 pandemic or otherwise, our expense ratio would be expected to increase.
Service expenses, which represent the costs associated with the fee-based businesses, decreased 15% to $86 million in 2020 from $101 million in 2019. The decrease is primarily due to a reduction of assigned risk plan business.
Other costs and expenses represent general and administrative expenses of the parent company and other expenses not allocated to business segments, including the cost of certain long-term incentive plans and new business ventures. Other costs and expenses decreased to $185 million in 2020 from $201 million in 2019 primarily due to a reduction in non-recurring performance-based compensation costs which occurred in 2019 and reduced travel-related expenses due to COVID-19 in 2020.
Expenses from Non-Insurance Businesses. Expenses from non-insurance businesses represent costs associated with businesses engaged in the distribution of promotional merchandise, world-wide textile solutions, and aviation-related businesses that include (i) cost of goods sold related to aircraft and products sold and services provided and (ii) general and administrative expenses. Expenses from non-insurance businesses were $384 million in 2020 compared to $403 million in 2019. The decrease mainly relates to a reduction of aviation-related business impacted by COVID-19 in 2020.
Investment Funds. At December 31, 2020, the carrying value of investment funds was $1,309 million, including investments in financial services funds of $434 million, real estate funds of $311 million, transportation funds of $190 million, energy funds of $141 million, and other funds of $233 million. Investment funds are primarily reported on a one-quarter lag.
Real Estate. Real estate is directly owned property held for investment. At December 31, 2020, real estate properties in operation included a long-term ground lease in Washington D.C., an office complex in New York City, office buildings in West Palm Beach and Palm Beach, Florida, an office building in London, and the completed portion of a mixed-use project in Washington D.C. In addition, part of the previously mentioned mixed-use project in Washington D.C. is under development. The Company expects to fund further development costs for the project with a combination of its own funds and external financing. During the fourth quarter of 2020, the Company sold an office complex in New York City.
Cash Flow. Cash flow provided from operating activities increased to $1,617 million in 2020 from $1,144 million in 2019, primarily due to an increase in premium receipts, net of reinsurance and commissions settled and the timing of loss and loss expense payments as well as payments to tax authorities.
The Company's insurance subsidiaries' principal sources of cash are premiums, investment income, service fees and proceeds from sales and maturities of portfolio investments. The principal uses of cash are payments for claims, taxes, operating expenses and dividends. The Company expects its insurance subsidiaries to fund the payment of losses with cash received from premiums, investment income and fees. The Company generally targets an average duration for its investment portfolio that is within 1.5 years of the average duration of its liabilities so that portions of its investment portfolio mature throughout the claim cycle and are available for the payment of claims if necessary. In the event operating cash flow and proceeds from maturities and prepayments of fixed maturity securities are not sufficient to fund claim payments and other cash requirements, the remainder of the Company's cash and investments is available to pay claims and other obligations as they become due. The Company's investment portfolio is highly liquid, with approximately 79% invested in cash, cash equivalents and marketable fixed maturity securities as of December 31, 2020. If the sale of fixed maturity securities were to become necessary, a realized gain or loss equal to the difference between the cost and sales price of securities sold would be recognized.
Equity. The Company repurchased 6,363,301 and 269,072 shares of its common stock in 2020 and 2019, respectively. The aggregate cost of the repurchases was $346 million in 2020 and $18 million in 2019. In 2020, the Board declared regular quarterly cash dividends of $0.11 per share in the first quarter, and $0.12 per share in each of the remaining three quarters for a total of $84 million in aggregate dividends in 2020. At December 31, 2020, total common stockholders’ equity was $6.3 billion, common shares outstanding were 177,825,150 and stockholders’ equity per outstanding share was $35.49.
Total Capital. Total capitalization (equity, debt and subordinated debentures) was $9.0 billion at December 31, 2020. The percentage of the Company’s capital attributable to senior notes, subordinated debentures and other debt was 30% at December 31, 2020 and December 31, 2019.
The Company files a consolidated income tax return in the U.S. and foreign tax returns in each of the countries in which it has overseas operations. At December 31, 2020, the Company had a gross deferred tax asset (net of valuation allowance) of $414 million (which primarily relates to loss and loss expense reserves and unearned premium reserves) and a gross deferred tax liability of $427 million (which primarily relates to deferred policy acquisition costs, unrealized investment gains and investment funds). The realization of the deferred tax asset is dependent upon the Company's ability to generate sufficient taxable income in future periods. Based on historical results and the prospects for future operations, management anticipates that it is more likely than not that future taxable income will be sufficient for the realization of this asset.
The Company follows customary industry practice of reinsuring a portion of its exposures in exchange for paying reinsurers a part of the premiums received on the policies it writes. Reinsurance is purchased by the Company principally to reduce its net liability on individual risks and to protect against catastrophic losses. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, it does make the assuming reinsurer liable to the insurer to the extent of the reinsurance coverage. The Company monitors the financial condition of its reinsurers and attempts to place its coverages only with financially sound carriers. Reinsurance coverage and retentions vary depending on the line of business, location of the risk and nature of loss. The Company’s reinsurance purchases include the following:
•Facultative reinsurance - The Company also purchases facultative reinsurance on certain individual policies or risks that are in excess of treaty reinsurance capacity.
•Effective January 1, 2021, Lifson Re will be a participant on the majority of the Company’s reinsurance placements for a 22.5% share of the placed amounts. This pertains to all traditional treaty reinsurance/retrocessional placements for both property and casualty business where there is more than one open market reinsurer participating. Lifson Re has been capitalized with more than $250 million of equity from a small group of sophisticated global investors with long-term investment horizons, including a minority participation by the Company. Lifson Re will participate on a fully collateralized basis.
Following is a summary of earned premiums and loss and loss expenses ceded to reinsurers for each of the three years ended December 31, 2020:
Ceded earned premiums increased 12.9% in 2020 to $1,500 million. The ceded losses and loss expenses ratio increased 1 point to 64% in 2020 from 63% in 2019.
(1)S&P rating, or if not rated by S&P, A.M. Best rating.
Following is a summary of the Company's contractual obligations as of December 31, 2020:
We have audited the accompanying consolidated balance sheets of W. R. Berkley Corporation and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes and financial statement schedules II to VI (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 18, 2021 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
As discussed in Notes 1 and 13 to the consolidated financial statements, the Company estimates the reserves for losses and loss expenses (reserves) using a variety of actuarial techniques and methods. The key assumptions used to arrive at the best estimate of recorded reserves are expected loss ratios, rate of loss cost inflation, reported and paid loss emergence patterns, loss frequency and severity, and the loss reporting lag. Such amounts are adjusted for certain qualitative factors. The reserves as of December 31, 2020 were $13,784 million.
factors; the weighting of actuarial methods when more than one was used; the impact of qualitative factors; and whether payments are fixed and reliably determinable for certain reserves subject to discounting.
The following are the primary procedures we performed to address the critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls over the Company’s reserving process. This included controls over the Company’s process to develop the Company’s best estimate of reserves based on actuarial methodologies and assumptions employed by the Company’s actuaries. We involved actuarial professionals with specialized skills and knowledge, who assisted in:
•evaluating the Company’s ability to discount certain reserves by comparing the expected payout pattern of claims paid to actual claims paid;
•evaluating the Company’s actuarial point estimate by performing independent actuarial analyses for certain of the larger, more complex operating units;
The consolidated financial statements, which include the accounts of W. R. Berkley Corporation and its subsidiaries (the "Company"), have been prepared on the basis of U.S. generally accepted accounting principles ("GAAP"). All significant intercompany transactions and balances have been eliminated. Reclassifications have been made in the 2019 and 2018 financial statements as originally reported to conform to the presentation of the 2020 financial statements.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the revenues and expenses reflected during the reporting period. The most significant items on our balance sheet that involve a greater degree of accounting estimates that are subject to change in the future are the valuation of investments, allowance for expected credit losses on investments, reserves for losses and loss expenses and premium estimates. Actual results could differ from those estimates.
Insurance service fee revenue represents servicing fees for program administration and claims management services provided by the Company, including workers' compensation assigned risk plans, as well as insurance brokerage and risk management services. Fees for program administration, claims management and risk management services are primarily recognized ratably over the related contract period for which the underlying services are rendered. Commissions for insurance brokerage are generally recognized when the underlying insurance policy is effective.
Equity securities with readily determinable fair values are measured at fair value, with changes in the fair value recognized in net income within net realized and unrealized gains on investments.
For available for sale securities in an unrealized loss position where the Company intends to sell, or it is more likely than not that it will be required to sell the security before recovery in value, the amortized cost basis is written down to fair value through net investment gains. For available for sale securities in an unrealized loss position where the Company does not intend to sell, or it is more likely than not that it will not be required to sell the security before recovery in value, the Company evaluates whether the decline in fair value has resulted from credit losses or all other factors (non-credit factors). In making this assessment, the Company considers the extent to which fair value is less than amortized cost, changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, an allowance for expected credit losses is recorded for the credit loss through net investment gains, limited by the amount that the fair value is less than the amortized cost basis. The allowance is adjusted for any change in expected credit losses and subsequent recoveries through net investment gains. The impairment related to non-credit factors is recognized in other comprehensive income.
The Company presents both basic and diluted net income per share (“EPS”) amounts. Basic EPS is calculated by dividing net income by weighted average number of common shares outstanding during the year (including 7,767,874 common shares held in a grantor trust). The common shares held in the grantor trust are for delivery upon settlement of vested but mandatorily deferred restricted stock units ("RSUs"). Shares held by the grantor trust do not affect diluted shares outstanding since the shares deliverable under vested RSUs were already included in diluted shares outstanding. Diluted EPS is based upon the weighted average number of basic and common equivalent shares outstanding during the year and is calculated using the treasury stock method for stock incentive plans. Common equivalent shares are excluded from the computation in periods in which they have an anti-dilutive effect.
Contracts that do not meet the risk transfer requirements of GAAP are accounted for using the deposit accounting method. Under this method, an asset or liability is recognized at the inception of the contract based on consideration paid or received. The amount of the deposit asset or liability is adjusted at subsequent reporting dates using the interest method with a
corresponding credit or charge to interest income or expense. Deposit liabilities for assumed reinsurance contracts were $38 million and $41 million at December 31, 2020 and 2019, respectively.
The Company files a consolidated income tax return in the U.S. and foreign tax returns in countries where it has overseas operations. The Company's method of accounting for income taxes is the asset and liability method. Under this method, deferred tax assets and liabilities are measured using tax rates currently in effect or expected to apply in the years in which those temporary differences are expected to reverse. Interest and penalties, if any, are reported as income tax expense. The Company believes there are no tax positions that would require disclosure under GAAP. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that all or a portion of the deferred tax assets will not be realized.
Comprehensive income encompasses all changes in stockholders' equity (except those arising from transactions with stockholders) and includes net income, net unrealized holding gains or losses on available for sale securities and unrealized foreign currency translation adjustments.
the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. This guidance also applies a new current expected credit loss model for determining credit-related impairments for financial instruments measured at amortized cost, such as reinsurance recoverables. The updated guidance was effective for reporting periods beginning after December 15, 2019. Prior to January 1, 2020, for available for sale securities the portion of the decline in value considered to be a credit loss (i.e., the difference between the present value of cash flows expected to be collected and the amortized cost basis of the security) was recognized in earnings as an other-than-temporary impairment. The portion of the decline in value not considered to be a credit loss (i.e., the difference in the present value of cash flows expected to be collected and the fair value of the security) was recognized in other comprehensive income.
The adoption of this guidance on January 1, 2020 resulted in the recognition of an allowance for expected credit losses in connection with operating assets (premiums and fees receivable and due from reinsurers) of $5.7 million (net of tax) and a corresponding cumulative effect adjustment that decreased common stockholders' equity. Certain investments (primarily fixed maturity securities available for sale) established an allowance for expected credit loss of $24.8 million (net of tax), with a cumulative effect adjustment decreasing retained earnings by $24.8 million (net of tax) and increasing accumulated other comprehensive (loss) income ("AOCI") by $25.0 million (net of tax), resulting in $0.2 million net impact to total common stockholders' equity.
(1) Represents the amount of impairment that has resulted from credit-related factors. The change in the allowance for expected credit losses, excluding the cumulative effect adjustment resulting from changes in accounting principles, is recognized in the consolidated statements of income. Amount excludes unrealized losses relating to non-credit factors.
The following table presents the rollforward of the allowance for expected credit losses for available for sale securities for the year ended December 31, 2020:
(1) Amortized cost is reduced by the allowance for expected credit losses of $798 thousand related to held to maturity securities.
At December 31, 2020 and 2019, investments in equity securities were as follows:
In 2020, properties in operation included a long-term ground lease in Washington, D.C., an office complex in New York City, office buildings in West Palm Beach and Palm Beach, Florida, an office building in London, U.K., and the completed portion of a mixed-use project in Washington D.C. Properties in operation are net of accumulated depreciation and amortization of $86,970,000 and $59,832,000 as of December 31, 2020 and 2019, respectively. Related depreciation expense was $27,090,000 and $15,033,000 for the years ended December 31, 2020 and 2019, respectively. Future minimum rental income expected on operating leases relating to properties in operation is $66,558,703 in 2021, $68,750,145 in 2022, $62,144,246 in 2023, $59,270,828 in 2024, $55,265,048 in 2025 and $643,109,471 thereafter.
The Company borrowed $101,750,000 through a non-recourse loan secured by the West Palm Beach office building in 2018. The loan matures in November 2028 and carries a fixed interest rate of 4.21%. The carrying value does not reflect the outstanding financing, but rather is reflected in subsidiary debt referenced in Note 15, Indebtedness.
A mixed-use project in Washington, D.C. has been under development in 2020 and 2019, with the completed portion as noted above reported in properties in operation as of December 31, 2020.
At December 31, 2020 and December 31, 2019, loans receivable are as follows:
The real estate loans are secured by commercial real estate primarily located in New York. These loans generally earn interest at floating LIBOR-based interest rates and have maturities (inclusive of extension options) through August 2025. The commercial loans are with small business owners who have secured the related financing with the assets of the business. Commercial loans primarily earn interest on a fixed basis and have varying maturities generally not exceeding 10 years.
Loans receivable in non-accrual status were $0.2 million as of both December 31, 2020 and 2019.
The following table presents the rollforward of the allowance for expected credit losses for loans receivable for the year ended December 31, 2020:
The Company monitors the performance of its loans receivable and assesses the ability of the borrower to pay principal and interest based upon loan structure, underlying property values, cash flow and related financial and operating performance of the property and market conditions.
(1) The net realized gains or losses on investment sales represent the total gains or losses from the purchase dates of the equity securities. The change in unrealized gains consists of two components: (i) the reversal of the gain or loss recognized in previous periods on equity securities sold and (ii) the change in unrealized gain or loss resulting from mark-to-market adjustments on equity securities still held.
(2) For 2020, net investment gains on real estate includes an $105 million gain from the sale of a New York City complex that occurred during the fourth quarter.
Substantially all of the securities in an unrealized loss position are rated investment grade, except for the securities in the foreign government classification. In general, fair value in all classifications were negatively affected by market disruptions caused, in significant part, by COVID-19. A significant amount of the unrealized loss on foreign government securities is the result of changes in currency exchange rates.
For Level 3 securities, the Company generally uses a discounted cash flow model to estimate the fair value of fixed maturity securities. The cash flow models are based upon assumptions as to prevailing credit spreads, interest rate and interest rate volatility, time to maturity and subordination levels. Projected cash flows are discounted at rates that are adjusted to reflect illiquidity, where appropriate.
For the year ended December 31, 2020, a fixed maturity security was transferred from Level 2 into Level 3 as a result of observable valuation inputs no longer being available. For the year ended December 31, 2019, there were two common stocks transferred into Level 3 in the arbitrage trading account where publicly traded prices were no longer available, and both were sold by year end.
Loss reserves included in the Company’s financial statements represent management’s best estimates based upon an actuarially derived point estimate and other considerations. The Company uses a variety of actuarial techniques and methods to derive an actuarial point estimate for each operating unit. These methods may include paid loss development, incurred loss development, paid and incurred Bornhuetter-Ferguson methods and frequency and severity methods. In circumstances where one actuarial method is considered more credible than the others, that method is used to set the point estimate. The actuarial point estimate may also be based on a judgmental weighting of estimates produced from each of the methods considered. Industry loss experience is used to supplement the Company’s own data in selecting “tail factors” in areas where the Company’s own data is limited. The actuarial data is analyzed by line of business, coverage and accident or policy year, as appropriate, for each operating unit.
The establishment of the actuarially derived loss reserve point estimate also includes consideration of qualitative factors that may affect the ultimate losses. These qualitative considerations include, among others, the impact of re-underwriting initiatives, changes in claims handling procedures, changes in the mix of business, changes in distribution sources and changes in policy terms and conditions.
Claim counts for assumed reinsurance will vary based on whether the business is written on a facultative or treaty basis. Further variability as respects treaty claim counts may be reflective of the nature of the treaty, line of business coverage, and type of participation such as quota share or excess of loss contracts. Accordingly, the claim counts have been excluded from the below Reinsurance & Monoline Excess segment tables due to this variability.
The following tables present undiscounted incurred and paid claims development as of December 31, 2020, net of reinsurance, as well as cumulative claim frequency and the total of incurred but not reported liabilities (IBNR). The information about incurred and paid claims development for the years ended December 31, 2011 to 2019 is presented as supplementary information. To enhance the comparability of the loss development data, the Company has removed the impact of foreign exchange rate movements by using the December 31, 2020 exchange rate for all periods. Beginning with accident year 2012, the Company's U.K. and European insurance business is included in the Insurance segment's tables for Other Liability, Professional Liability, Commercial Automobile and Short-Tail Lines. Prior to 2012, the actuarial analysis for its U.K. and European insurance business was performed on an underwriting year basis and accident year data is not available for those years.
(2)Claims occurring during the current year are net of loss reserve discounts of $10 million, $20 million and $24 million in 2020, 2019, and 2018, respectively.
Most of the COVID-19-related claims reported to the Company to date involve certain short-tailed lines of business, including contingency and event cancellation, business interruption, and film production delay. The Company expects additional claims to be reported for these lines of business. The Company has also received COVID-19-related claims for longer-tailed casualty lines of business such as workers’ compensation and other liability; however, the estimated incurred loss impact for these reported claims appears to be modest at this time. Given the continuing uncertainty regarding the pandemic's pervasiveness, the future impact that the pandemic may have on claim frequency and severity remains uncertain at this time. In workers’ compensation, for example, nearly two-thirds of the states have enacted rules, legislation or administrative orders creating a presumption that certain “essential”
workers who contract COVID-19 did so through the course of their employment. Several other states are considering similar actions, including varying the definition of “essential” workers. While the ultimate impact of these presumptions are unknown at this time, the Company believes that such state actions will likely increase workers’ compensation claims with respect to workers deemed “essential,” although this impact may be partially offset by lower workers’ compensation claim frequency with respect to non-essential workers.
Favorable prior year development (net of additional and return premiums) was $16 million in 2020.
For professional liability business, unfavorable development was driven mainly by large losses reported in the directors and officers (“D&O”), lawyers professional and excess hospital professional liability lines of business. For these lines of business, we continue to see an increase in the number of large losses reported and a lengthening of the reporting “tail” beyond historical levels. We believe a contributing cause is rising social inflation in the form of, for example, higher jury awards on cases that go to trial, and the corresponding higher demands from plaintiffs and higher values required to reach settlement on cases that do not go to trial. The unfavorable development for professional liability affected mainly accident years 2016 through 2018.
Reinsurance & Monoline Excess - Reserves for the Reinsurance & Monoline Excess segment developed unfavorably by $8 million in 2020. The unfavorable development in the segment was driven by non-proportional assumed liability business written in both the U.S. and U.K., and was partially offset by favorable development on excess workers’ compensation business. The unfavorable non-proportional assumed liability development was concentrated in accident years 2014 through 2018, and related primarily to accounts insuring construction projects and professional liability exposures.
Favorable prior year development (net of additional and return premiums) was $19 million in 2019.
For workers’ compensation, the favorable development was spread across many accident years, including prior to 2010, but was most significant in accident years 2014 through 2018, and particularly 2017 and 2018. The favorable workers’ compensation development reflects a continuation during 2019 of the benign loss cost trends experienced during recent years, particularly the favorable claim frequency trends (i.e., number of reported claims per unit of exposure). The long term trend of declining workers’ compensation frequency can be attributable to improved workplace safety. Loss severity trends were also aided by our continued
investment in claims handling initiatives such as medical case management services and vendor savings through usage of preferred provider networks and pharmacy benefit managers. Our initial loss ratio “picks” for this line of business over the past few accident years have contemplated an increase in loss cost trends and reflect decreasing premium rates in the marketplace; reported workers’ compensation losses in 2019 continued to be below our expectations at most of our operating units, and were below the assumptions underlying our initial loss ratio picks and our previous reserve estimates.
Discounting - The Company discounts its liabilities for certain workers’ compensation reserves. The amount of workers’ compensation reserves that were discounted was $1,655 million and $1,731 million at December 31, 2020 and 2019, respectively. The aggregate net discount for those reserves, after reflecting the effects of ceded reinsurance, was $483 million and $530 million at December 31, 2020 and 2019, respectively. At December 31, 2020, discount rates by year ranged from 0.7% to 6.5%, with a weighted average discount rate of 3.6%.
The Company also discounts reserves for certain other long-duration workers’ compensation reserves (representing approximately 3% of total discounted reserves at December 31, 2020), including reserves for quota share reinsurance and reserves related to losses regarding occupational lung disease. These reserves are discounted at statutory rates prescribed or permitted by the Department of Insurance of the State of Delaware.
The following table presents the amounts due from reinsurers as of December 31, 2020:
Indebtedness consisted of the following as of December 31, 2020 (the difference between the face value and the carrying value is unamortized discount and debt issuance costs):
(2) Includes non-recourse loan in the amount of $102 million secured by an office building. See Note 8, Real Estate, for more details.
(3) In January 2021, the Company called its $110 million aggregate principal amount of 5.900% subordinated debentures for redemption on March 1, 2021. Additionally in February 2021, the Company issued $300 million aggregate principal amount of 4.125% subordinated debentures due 2061.
The Company has not provided U.S. deferred income taxes on the undistributed earnings of approximately $111 million of its non-U.S. subsidiaries since these earnings are intended to be permanently reinvested in the non-U.S. subsidiaries. In the future, if such earnings were distributed the Company projects that the incremental tax, if any, will be immaterial.
The Company’s insurance subsidiaries are restricted by law as to the amount of dividends they may pay without the approval of regulatory authorities. The Company’s lead insurer, Berkley Insurance Company ("BIC"), directly or indirectly owns all of the Company’s other insurance companies. During 2021, the maximum amount of dividends that can be paid by BIC without such approval is approximately $721 million.
The significant variances between SAP and GAAP are that for statutory purposes bonds are carried at amortized cost, unrealized gains and losses on equity securities are recorded in surplus, acquisition costs are charged to income as incurred, deferred Federal income taxes are subject to limitations, excess and assumed workers’ compensation reserves are discounted at different discount rates and certain assets designated as “non-admitted assets” are charged against surplus. The Commissioner of Insurance of the State of Delaware has allowed BIC to recognize a non-tabular discount on certain workers' compensation loss reserves, which is a permitted practice that differs from SAP. The effect of using this permitted practice was an increase to BIC’s statutory capital and surplus by $200 million at December 31, 2020.
See Note 3, Investments in Fixed Maturity Securities, for a description of assets held on deposit as security.
The estimated fair values of the Company’s fixed maturity securities, equity securities available for sale and arbitrage trading account securities are based on various valuation techniques that rely on fair value measurements as described in Note 12 above. The fair value of loans receivable is estimated by using current institutional purchaser yield requirements for loans with similar credit characteristics, which is considered a Level 2 input. The fair value of the senior notes and other debt and the subordinated debentures is based on spreads for similar securities, which is considered a Level 2 input.
Pursuant to the Company's stock incentive plan, the Company may issue restricted stock units ("RSUs") to employees of the Company and its subsidiaries. The RSUs generally vest three to five years from the award date and are subject to other vesting and forfeiture provisions contained in the award agreement. The following table summarizes RSU information for the three years ended December 31, 2020:
The following table summarizes the outstanding LTIP awards as of December 31, 2020:
(1) Certain amounts included in earned premiums of each segment are related to inter-segment transactions.