The following is a list of locations of buildings we own and their approximate size:
We are a multinational specialty property and casualty insurer focused on generating consistent underwriting profits. We provide insurance coverage for small businesses and products with high volumes of insureds and loss profiles that we believe are predictable. We target lines of insurance that we believe generally are under served by the market. We have grown by hiring teams of underwriters with expertise in our specialty lines, through acquisitions of companies and assets that, in each case, provide access to distribution networks and renewal rights to established books of specialty insurance business. We have operations in four business segments:
We transact business primarily through our twelve insurance subsidiaries domiciled in the United States and four insurance subsidiaries domiciled in Europe. We are authorized to write business in all 50 states in the United States and in the European Union. Our principal operating subsidiaries are rated "A" (Excellent) by A.M. Best Company ("A.M. Best").
We evaluate our operations by monitoring key measures of growth and profitability, including return on equity and net combined ratio. Our return on equity was 23.1%, 17.5% and 21.2% for the years ended December 31, 2013, 2012 and 2011, respectively. Our overall financial objective is to produce a return on equity of 15.0% or more over the long term. In addition, we target a net combined ratio of 95.0% or lower over the long term, while seeking to maintain optimal operating leverage in our insurance subsidiaries commensurate with our A.M. Best rating objectives. Our net combined ratio was 90.5%, 90.1% and 91.6% for the years ended December 31, 2013, 2012 and 2011, respectively. A key factor in achieving our targeted net combined ratio is a continuous focus on our net expense ratio. Our strategy across our segments is to maintain premium rates, deploy capital judiciously, manage our expenses and focus on the sectors in which we have expertise, which we believe should provide opportunities for greater returns.
Investment income is also an important part of our business. Because the period of time between our receipt of premiums and the ultimate settlement of claims is often several years or longer, we are able to invest cash from premiums for significant periods of time. Our net investment income was $84.8 million, $68.2 million and $55.5 million for the years ended December 31, 2013, 2012 and 2011, respectively. We held 20.8% and 19.0% of total invested assets in cash and cash equivalents as of December 31, 2013 and 2012, respectively.
On May 13, 2013, we completed the acquisition of Mutual Insurers Holding Company (“MIHC”) and its subsidiaries. MIHC's primary operating subsidiary, First Nonprofit Insurance Company (“FNIC”), is the third largest provider of property and casualty insurance products to nonprofit organizations in the U.S. Immediately prior to the acquisition, MIHC converted from a mutual form to a stock form of ownership in a transaction “sponsored” by us. As required by the plan of conversion and applicable Delaware law, we offered shares of our common stock, at a discount to the market price, to the members of MIHC who held policies as of December 31, 2012 and the directors, officers and employees of MIHC and its subsidiaries. We received subscriptions for approximately $0.5 million, resulting in the issuance by us of 18,052 shares of our common stock at a discounted price of 20% from our market trading price, or approximately $0.1 million. Pursuant to the stock purchase agreement, after the expiration of the offering, we purchased all of the authorized shares of capital stock of MIHC at a purchase price equal to the greater of the gross proceeds received by us in the offering, and $8.0 million. We made a payment to MIHC of $48.5 million, which included the $0.5 million in proceeds we received in the offering, for the stock of FNIC. Additionally, as part of the transaction, we were required to make a contribution to First Nonprofit Foundation, a tax exempt corporation principally funded by FNIC's predecessor and managed for the benefit of nonprofit organizations, in the amount of $7.9 million, which represented $8.0 million, as discussed above, less the discount of approximately $0.1 million on the shares issued by us in the transaction. The remaining $40.6 million of cash contributed to MIHC was retained by us. Additionally, we assumed $6.5 million of debt in the transaction. In accordance with FASB ASC 805-10 Business Combinations, we recorded an acquisition price of approximately $14.5 million.
As a result of this transaction, we recorded approximately $32 million of written premium for the year ended December 31, 2013 related to FNIC since the date of acquisition.
On April 19, 2013, we completed the acquisition of all the issued and outstanding shares of common stock of Sequoia Insurance Company and its subsidiaries, Sequoia Indemnity Company and Personal Express Insurance Company (“Sequoia”) for approximately $60.0 million. Sequoia offers low hazard, property/casualty insurance products, including workers' compensation and commercial package insurance, to small businesses in several western states, with California representing Sequoia's largest market.
In accordance with FASB ASC 944-805 Business Combinations, we adjusted to fair value Sequoia's loss and LAE reserves by taking the acquired loss reserves recorded and discounting them based on expected reserve payout pattern using a current risk free rate. This risk free interest rate was then adjusted based on different cash flow scenarios that use different payout and ultimate reserve assumptions deemed to be reasonably possible based upon the inherent uncertainties present in determining the amount and timing of payment of such reserves. The difference between the acquired loss and LAE reserves and our best estimate of the fair value of such reserves at acquisition date is amortized ratably over the payout period of the acquired loss and LAE reserves and was approximately $7.4 million. Additionally, we recorded $11.8 million of intangible assets that consist primarily of licenses and trademarks and have an indefinite life. The intangible assets, as well as Sequoia's results of operations, are included as a component of the Small Commercial Business segment from the date of acquisition. As a result of this transaction, we recorded a preliminary acquisition gain of approximately $13.3 million.
We recorded intangible assets of approximately $34.3 million related to customer relationships and assigned a life of fifteen years. CCPH is included as a component of our Specialty Risk and Extended Warranty segment. As a result of this transaction, we recognized a gain on the acquisition of approximately $25.5 million.
On December 31, 2012, we completed the acquisition of First Nonprofit Companies, Inc. ("FNC") for approximately $55 million. FNC serves approximately 1,500 nonprofit and government entities covering approximately $5 billion of annual payroll. FNC offers unique services as well as insurance programs which are designed to allow nonprofit and government entities to economically manage their unemployment tax obligations. In accordance with FASB ASC 805-10 Business Combinations, we recorded a purchase price of approximately $55 million, which consisted primarily of goodwill and intangible assets of $28.2 million and $40.5 million, respectively. The intangible assets consist of customer relationships and have a life of 18 years. The goodwill and intangibles are included as a component of the Small Commercial Business segment from the date of acquisition. As a result of this transaction, we recorded approximately $22.7 million of fee income for the year ended December 31, 2013 since the date of acquisition.
In July 2012, we completed the acquisition of CNH Capital Insurance Agency Inc. and CNH Capital Canada Insurance Agency, Ltd., collectively known as "CNH Capital Insurance Agencies," from CNH Capital, the financial services business of CNH Global N.V., for approximately $34 million. The acquisition allows us to enhance and expand CNH Capital Insurance Agencies' offering of equipment extended service contracts and other insurance products to Case IH, Case Construction, New Holland Agriculture and New Holland Construction equipment dealers in the United States and Canada. Additionally, we entered into service and license agreements with CNH Capital whereby we will make future payments based on gross revenues of the CNH Capital Insurance Agencies. In accordance with FASB ASC 805-10, Business Combinations, we recorded a purchase price of $34 million, which consisted primarily of goodwill and intangible assets of approximately $21.3 million and $19.4 million, respectively. The intangible assets consist of renewal rights and licenses and have asset lives of between 5 years and 10 years. The goodwill and intangibles are included as a component of our Specialty Risk and Extended Warranty segment. As a result of this transaction, we recorded approximately $30.0 million and $9.8 million of fee income during the years ended December 31, 2013 and 2012, respectively, from the date of acquisition. Additionally, we recorded approximately $52.8 million and $29.6 million of written premium for the years ended December 31, 2013 and 2012, respectively, from the date of acquisition.
We recorded $11.6 million, $9.3 million and $4.9 million of income during the years ended December 31, 2013, 2012 and 2011, respectively, related to our equity investment in NGHC.
Through July 31, 2013, we had a quota share reinsurance agreement (“Personal Lines Quota Share”) among Integon National Insurance Company (“Integon”), lead insurance company on behalf of the NGHC Insurers, as cedent, and the Company, ACP Re, Ltd., and Maiden Insurance Company, Ltd., as reinsurers. The Personal Lines Quota Share provided that the reinsurers, severally, in accordance with their participation percentages, received 50% of the net premium of the NGHC Insurers and assumed 50% of the related net losses. We had a 20% participation in the Personal Lines Quota Share, by which we received 10% of the net premiums of the personal lines business and assumed 10% of the related net losses. The Personal Lines Quota Share provided that the reinsurers pay a provisional ceding commission equal to 32.0% of ceded earned premium, net of premiums ceded by the personal lines companies for inuring reinsurance, subject to adjustment to a maximum of 34.5% if the loss ratio for the reinsured business is 60.0% or less and a minimum of 30.0% if the loss ratio is 64.5% or higher. On August 1, 2013, we and our wholly-owned subsidiary, Technology Insurance Company, Inc. (“TIC”) received notice from Integon that Integon was terminating, effective August 1, 2013, TIC's participation in the Personal Lines Quota Share. The termination is on a run-off basis, meaning TIC will continue to receive net premiums and assume related net losses with respect to policies in force as of July 31, 2013 through the expiration of such policies. As we retained all assumed written premium through July 31, 2013 and the continuing cash flows associated with the business, we will not present the Personal Lines Reinsurance segment as a discontinued operation in accordance with ASC 205-20 Discontinued Operations. As a result of this agreement, we assumed $65.8 million, $118.1 million and $102.6 million of business from the NGHC Insurers during the years ended December 31, 2013, 2012 and 2011, respectively.
We provide NGHC and its affiliates information technology development services in connection with the development and licensing of a policy management system at a cost which is currently 1.25% of gross written premium of NGHC and its affiliates plus our costs for development and support services. In addition, we provide NGHC and its affiliates printing and mailing services at a per piece cost for policy and policy related materials, such as invoices, quotes, notices and endorsements, associated with the policies we process for NGHC and its affiliates on the policy management system. We recorded approximately $24.2 million, $14.4 million and $4.0 million of fee income for the years ended December 31, 2013, 2012 and 2011, respectively, related to this agreement.
As a result of the above service agreements with NGHC, we recorded fees totaling approximately $25.9 million, $15.9 million and $5.6 million for the years ended December 31, 2013, 2012 and 2011, respectively. As of December 31, 2013, the outstanding balance payable by NGHC related to these service fees and reimbursable costs was approximately $11.4 million.
We account for investments in life settlements in accordance with ASC 325-30, Investments in Insurance Contracts, which states that an investor shall elect to account for its investments in life settlement contracts by using either the investment method or the fair value method. The election is made on an instrument-by-instrument basis and is irrevocable. We have elected to account for these policies using the fair value method. We determine fair value based upon our estimate of the discounted cash flow related to policies (net of the reserves for improvements in mortality, the possibility that the high net worth individuals represented in our portfolio may have access to better health care, the volatility inherent in determining the life expectancy of insureds with significant reported health impairments, the possibility that the issuer of the policy or a third party will contest the payment of the death benefit payable to us, and the future expenses related to the administration of the portfolio), which incorporates current life expectancy assumptions, premium payments, the credit exposure to the insurance company that issued the life settlement contracts and the rate of return that a buyer would require on the contracts as no comparable market pricing is available.
Total capital contributions of approximately $70.8 million and $40.1 million were made to the LSC Entities during the years ended December 31, 2013 and 2012, respectively, for which we contributed approximately $35.4 million and $20.1 million in those same periods. The LSC Entities used the contributed capital to pay premiums and purchase policies. Our investments in life settlements and premium finance loans were approximately $233.0 million and $193.9 million as of December 31, 2013 and 2012, respectively, and are included in Prepaid expenses and other assets on the Consolidated Balance Sheet. We recorded a gain on investments in life settlement contracts net of profit commission for the years ended December 31, 2013, 2012 and 2011 of approximately $3.8 million, $13.8 million and $46.9 million, respectively, related to the life settlement contracts.
Net Earned Premium. Net earned premium is the earned portion of our net written premiums. We earn insurance premiums on a pro rata basis over the term of the policy. At the end of each reporting period, premiums written that are not earned are classified as unearned premiums, which are earned in subsequent periods over the remaining term of the policy. Our workers’ compensation insurance and commercial package policies typically have a term of one year. Thus, for a one-year policy written on July 1, 2013 for an employer with a constant payroll during the term of the policy, we would earn half of the premiums in 2013 and the other half in 2014. We earn our specialty risk and extended warranty coverages over the estimated
Service and Fee Income. We currently generate service and fee income from the following sources:
Servicing carrier - We act as a servicing carrier for workers’ compensation assigned risk plans in nine states. In addition, we also offer claims adjusting and loss control services for fees to unaffiliated third parties.
Ceding commission is a commission we receive from ceding gross written premium to third party reinsurers. We earn commissions on reinsurance premiums ceded in a manner consistent with the recognition of the direct acquisition costs of the underlying insurance policies, generally on a pro-rata basis over the terms of the policies reinsured. In connection with the Maiden Quota Share, which is our primary source of ceding commission, the amount we receive is a blended rate based on a contractual formula contained in the individual reinsurance agreements, and the rate may not correlate specifically to the cost structure of our individual segments. As such, we allocate earned ceding commissions to our segments based on each segment’s proportionate share of total acquisition costs and other underwriting expenses recognized during the period. Ceding commission is netted against acquisition costs and other underwriting expenses.
Life Settlement profit commission. Investments in life settlements are accounted for in accordance with ASC 325-30, Investments in Insurance Contracts, and we have elected to account for our investment in life settlements using the fair value method. We retain a third party service provider to perform certain administration functions to effectively manage the life settlement contracts held by Tiger and AMTCH II and a portion of their fee is contingent on the overall profitability of the life settlement contracts. We accrue the related profit commission on life settlements at fair value, in relation to life settlements purchased prior to December 31, 2010. This profit commission is calculated based on the discounted anticipated cash flows and the provisions of the underlying contract. In addition, we accrue a best estimate in relation to profit commission due on certain life settlement contracts acquired subsequent to December 31, 2010 as no contractual relationship currently exists.
Notwithstanding the inherent uncertainty, we have not experienced material variability in our loss development factors. We believe that it is reasonably likely that we could experience a 5% deviation in our loss and loss adjustment expense reserves due to changes in the elements that underlie loss development, such as claims frequency or severity. For example, as of December 31, 2013, the average cost per workers’ compensation claim was $11,691, which was a 1.9% increase over the claims severity from 2001 - 2012 of $11,470. In 2013, claims frequency (number of claims per $1.0 million of payroll) decreased to .092 from .0933, a decrease of 1.4%, for the period between 2001 and 2013.
Deferred Policy Acquisition Costs. We defer commission expenses, premium taxes and assessments as well as certain underwriting and safety costs that vary with and are primarily related to the successful acquisition of insurance policies. These acquisition costs are capitalized and charged to expense ratably as premiums are earned. We may realize deferred policy acquisition costs only if the ratio of loss and loss adjustment expense reserves (calculated on a discounted basis) to the premiums to be earned is less than 100%, as it historically has been. If, hypothetically, that ratio were to be above 100%, we
As of December 31, 2013, if the actual results of the future premiums audits were 1% lower than the historical results used in calculating EBUB, the result would be a decrease in EBUB and net earned premium of $8.0 million or $5.2 million after tax. If the actual results of the future premiums audits were 1% higher than the historical results used in calculating EBUB, the result would be an increase in EBUB, and net earned premium of $6.6 million or $4.3 million after tax.
We report fixed-maturity securities and equity securities at their estimated fair values based on quoted market prices or a recognized pricing service, with unrealized gains and losses, net of tax effects, reported as a separate component of comprehensive income in stockholders’ equity. We determine realized gains and losses on the specific identification method.
Income Taxes - We join our domestic subsidiaries and certain non-domestic subdivisions in the filing of a consolidated federal income tax return and are party to federal income tax allocation agreements. Under the tax allocation agreements, we pay to or receive from our subsidiaries the amount, if any, by which the group’s federal income tax liability was affected by virtue of inclusion of the subsidiary in the consolidated federal return.
We own various Luxembourg-domiciled reinsurance entities. In connection with these entities, we acquire cash and equalization reserves of the reinsurance companies. An equalization reserve is a catastrophe reserve in excess of required reserves established pursuant to Luxembourg law. Equalization reserves are required to be established for Luxembourg statutory and tax purposes, but are not recognized under U. S. GAAP. The equalization reserves originally established by the seller under Luxembourg law allowed the reinsurer to offset any taxable income. Equalization reserves are calculated on a line of business basis and are subject to a theoretical maximum amount, or cap, based on the expected premium volume described in the business plan of the reinsurance company as approved by the Luxembourg regulators, subject to reassessment every five years. Each year, the Luxembourg reinsurer is required to adjust its equalization reserves by an amount equal to its statutory net income or net loss, determined based on premiums and investment income less incurred losses and other operating expenses. The yearly adjustment of the equalization reserve generally results in zero pretax income on a Luxembourg statutory and tax basis, as follows: in a year in which the reinsurer’s operations result in a statutory loss, the equalization reserves are taken down in an amount to balance the income statement to zero pretax income, and in a year in which the operations result in a gain, the equalization reserves are increased in an amount to balance the income statement to zero pretax income. If the reinsurer were to produce underwriting income in excess of the equalization reserve cap, or if the cap were to be reduced below the amount of the carried equalization reserves, the reinsurer would incur Luxembourg tax on the amount of such excess income or the amount by which the reserves exceeded the reduced cap, as applicable.
Acquisition Gain on Purchase. We recognized a gain on acquisition related to the purchase of CCPH, FNIC and Sequoia during year ended December 31, 2013 of approximately $57.4 million compared to recognizing no gain on acquisition for the year ended December 31, 2012.
Provision for Income Tax. Income tax expense for the year ended December 31, 2013 was $98.0 million, which resulted in an effective tax rate of 26.1%. Income tax expense for the year ended December 31, 2012 was $21.3 million, which resulted in an effective tax rate of 10.8%. The increase in our effective tax rate during 2013 compared to 2012 resulted primarily from the gain recognized on the acquisitions of CCPH, Sequoia and FNIC and the recognition of non-recurring gains related to a third quarter internal reorganization of our European operations. Additionally, for the years ended December 31, 2013 and 2012, income tax expense included a tax benefit of $10.0 million and $25.6 million, respectively, attributable to the reduction of the deferred tax liability associated with the equalization reserves of our Luxembourg reinsurers. The effect of this $10.0 million and $25.6 million tax benefit reduced the effective rate by approximately 3% and 10% in 2013 and 2012, respectively.
Equity in Earnings of Unconsolidated Subsidiaries - Related Party. Equity in earnings of unconsolidated subsidiaries - related party increased by $2.3 million for the year ended December 31, 2013 to $11.6 million compared to $9.3 million for the year ended December 31, 2012. The increase resulted primarily from a realized gain of approximately $8.6 million from a decrease in our ownership percentage of NGHC from 21.25% to 15.4% as a result of NGHC's sale of shares in a 144A offering in June 2013, partially offset by a decline in earnings from our proportionate share of equity income from NGHC's results of operations.
Net Earned Premium. Net earned premium increased $382.0 million, or 36.8%, to $1,418.9 million from $1,036.9 million for the years ended December 31, 2012 and 2011, respectively. The increase by segment was: Small Commercial Business - $96.3 million; Specialty Risk and Extended Warranty - $94.8 million; Specialty Program - $177.2 million; and Personal Lines Reinsurance - $13.7 million. The increase to Specialty Risk and Extended Warranty related to our change of reinsurers on April 1, 2011 for our European medical liability business, which resulted in an increase in our retention rate of net written premium on this business from 20% to 60% and the assumption of all remaining unearned premium on this business from the prior reinsurer on a cut off basis.
Net Investment Income. Net investment income increased $12.7 million, or 22.9%, to $68.2 million from $55.5 million for the years ended December 31, 2012 and 2011, respectively. The increase resulted primarily from having a higher average balance of fixed security investment securities during 2012 of $2.1 billion compared to $1.4 billion during 2011.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $244.4 million, or 36.0%, to $922.7 million for the year ended December 31, 2012 from $678.3 million for the year ended December 31, 2011. Our loss ratio for the years ended December 31, 2012 and 2011 was 65.0% and 65.4%, respectively. The decrease in the loss ratio in 2012 resulted from lower current year accident selected ultimate losses as compared to selected ultimate losses from the prior accident year. The slight decrease in selected ultimate losses resulted from a decrease in loss and loss adjustment expenses in our Specialty Risk and Extended Warranty segment due to an increase in warranty claims as compared to casualty claims. This decrease was mostly offset by an increase in our loss and loss adjustment expenses in our other two segments due to an increase in policies written in California, which were primarily workers' compensation policies.
Net Gain on Investment in Life Settlement Contracts. Gain on investment in life settlement contracts was $13.8 million compared to $46.9 million for the years ended December 31, 2012 and 2011. The gain in the year ended December 31, 2011 was generated by the purchase of a large pool of distressed life settlement contracts in 2011 and the conversion of premium finance loans acquired in 2010 into life settlement contracts in 2011. During the year ended December 31, 2012, we purchased or converted fewer contracts.
Net Written Premium. Net written premium increased $460.9 million, or 97.2%, to $935.3 million from $474.4 million for the years ended December 31, 2013 and 2012, respectively. The increase in net premium resulted from an increase in gross written premium for the year ended December 31, 2013 compared to the year ended December 31, 2012, as well as an increase in the retention rate of gross written premium period over period. Our retention rates for the segment were 56.3% and 50.8% for the years ended December 31, 2013 and 2012, respectively. This was partially offset by an increase in our assigned risk business in 2013, for which we cede 100 percent of our gross written business.
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $101.9 million, or 91.9%, to $212.8 million for the year ended December 31, 2013 from $110.9 million for the year
ended December 31, 2012. The expense ratio decreased to 25.5% for the year ended December 31, 2013 compared to 26.6% for the year ended December 31, 2012. The decrease in the expense ratio resulted both from a change in our business mix and economies of scale. During the year ended December 31, 2013, a higher percentage of the gross written premium increase was attributable to workers' compensation business, which has lower policy acquisition expenses. Additionally, salary expense increased at a slower rate than earned premium due to the leveraging of our existing employee base. Acquisition costs and other underwriting expenses were reduced by ceding commission earned during the years ended December 31, 2013 and 2012 of $117.1 million and $69.9 million, respectively. The ceding commission increased period over period as a result of an increase in net earned premium, as the segment received its allocation of ceding commission for its proportionate share of our overall policy acquisition expense.
Net Written Premium. Net written premium increased $319.5 million, or 51.2%, to $944.1 million from $624.6 million for the years ended December 31, 2013 and 2012, respectively. The increase in net written premium resulted from an increase of gross written premium for the year ended December 31, 2013 compared to the year ended December 31, 2012, as well as a higher retention of business during 2013 compared to 2012. Our overall retention rate for the segment was 62.5% and 55.8% for the years ended December 31, 2013 and 2012, respectively, as certain new programs written during the year ended December 31, 2013 are not covered by the Maiden Quota Share.
Net Earned Premium. Net earned premium increased $270.3 million, or 49.9%, to $811.8 million for the year ended December 31, 2013 from $541.6 million for the year ended December 31, 2012. As premiums written earn ratably over the term of a policy, which on average is 24 months, the increase in net premium earned resulted from growth in net written premium in 2013 and 2012.
Net Earned Premium Less Expenses Included in Combined Ratio (Underwriting Income). Net earned premium less expenses included in combined ratio increased to $115.1 million for the year ended December 31, 2013 compared to $87.9 million for the year ended December 31, 2012. This increase resulted primarily from an increase in the level of earned premium during the year ended December 31, 2013 compared to 2012, partially offset by higher loss and loss adjustment expenses during the year ended December 31, 2013 as compared to the year ended December 31, 2012.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $116.8 million, or 49.0%, to $355.1 million for the year ended December 31, 2013 compared to $238.3 million for the year ended December 31, 2012. Our loss ratio for the segment for the year ended December 31, 2013 decreased to 68.2% from 68.4% for the year ended December 31, 2012. The loss ratio for 2013 and 2012 were consistent as current accident year selected ultimate losses were consistent with selected ultimate losses from prior years.
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $40.2 million, or 40.8%, to $138.7 million for the year ended December 31, 2013 from $98.4 million for the year ended December 31, 2012. The expense ratio decreased to 26.6% for the year ended December 31, 2013 from 28.2% for the year ended December 31, 2012. The decrease in the expense ratio resulted both from a change in business mix and economies of scale. During the year ended December 31, 2013, a higher percentage of gross written premium was attributable to workers' compensation business, which has lower policy acquisition expenses than other types of business written in this segment. Acquisition costs and other underwriting expenses were reduced by ceding commission earned during the years ended December 31, 2013 and 2012 of $76.3 million and $62.0 million, respectively. The ceding commission increased period over period as a result of an increase in net earned premium, as the segment received its allocation of ceding commission for its proportionate share of our overall policy acquisition expense.
Personal Lines Reinsurance Segment Results of Operations 2013 Compared to 2012
Our investment portfolio, including cash and cash equivalents but excluding life settlement contracts, other investments and equity investments, increased $1.8 billion, or 78.1%, to $4.2 billion at December 31, 2013 from $2.3 billion as of December 31, 2012. Our investment portfolio is classified as available-for-sale, as defined by ASC 320, Investments - Debt and Equity Securities. This increase in our investment portfolio during the year ended December 31, 2013 related, primarily, to the acquisitions of CCPH, Sequoia and FNIC and proceeds from our preferred stock and $250 million 6.125% notes offerings. Our fixed maturity securities, gross, had a fair value of $3.4 billion and an amortized cost of $3.4 billion as of December 31, 2013. Our fixed securities, net of securities pledged, had a fair value of $3.1 billion and an amortized cost of $3.1 billion as of December 31, 2013. Our equity securities are reported at fair value and totaled $15.1 million with a cost of $16.0 million as of December 31, 2013. Securities sold but not yet purchased represent our obligations to deliver the specified security at the contracted price and thereby create a liability to purchase the security in the market at prevailing rates. We account for sales of securities under repurchase agreements as collateralized borrowing transactions and we record these sales at their contracted amounts.
The table below summarizes the credit quality of our fixed maturity securities as of December 31, 2013 and 2012, as rated by Standard and Poor’s.
The table below summarizes the average duration by type of fixed maturity as well as detailing the average yield as of December 31, 2013 and 2012:
Quarterly, our Investment Committee (“Committee”) evaluates each security that has an unrealized loss as of the end of the subject reporting period for OTTI. We generally consider an investment to be impaired when it has been in a significant unrealized loss position (in excess of 35% of cost if the issuer has a market capitalization of under $1 billion and in excess of 25% of cost if the issuer has a market capitalization of $1 billion or more) for over 24 months. In addition, the Committee uses a set of quantitative and qualitative criteria to review our investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of our investments. The criteria the Committee primarily considers include:
the length of time the security’s fair value has been below its amortized cost;
whether management intends to sell the security and, if not, whether it is not more than likely than not that the Company will be required to sell the security before recovery of its amortized cost basis;
The impairment charges of our fixed-maturities and equity securities for the years ended December 31, 2013, 2012 and 2011 are presented in the table below:
The table below summarizes the gross unrealized losses of our fixed maturity and equity securities by length of time the security has continuously been in an unrealized loss position as of December 31, 2013:
There are 1,034 securities at December 31, 2013 that account for the gross unrealized loss, none of which we deem to be OTTI. Significant factors influencing our determination that unrealized losses were temporary included the magnitude of the unrealized losses in relation to each security’s cost, the nature of the investment and management’s intent not to sell these securities and it being not more likely than not that we will be required to sell these investments before anticipated recovery of fair value to our cost basis.
We are organized as a holding company with twelve domestic and four international insurance company subsidiaries, as well as various other non-insurance subsidiaries. Our primary liquidity needs include payment of interest on various debt facilities, shareholder dividends and taxes. Our income is generated primarily from our insurance subsidiaries, service and fee income and investment income.
of these, exceeds our projections, we may have to raise additional capital sooner to support our growth. If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements and, as a result, our business, financial condition and results of operations could be adversely affected.
We also purchase life settlement contracts that require us to make premium payments on individual life insurance policies to maintain the policies. We seek to manage the funding of premium payments required. Historically, we have funded these premium payments from operations. We presently expect to maintain sufficient cash flow from operations to meet future premium payments.
Net cash provided by operating activities was approximately $915.4 million for the year ended December 31, 2013, compared to $531.5 million for the same period in 2012. The increase in cash provided from operations resulted primarily from an increase in gross written premium written in 2013 compared to 2012. Additionally, we had increased cash collections in 2013 related to the earning of the tail end of premium written in 2012 for Specialty Risk and Extended Warranty segment policies that generally have a longer policy life and therefore a longer cash collection cycle.
Net cash used in investing activities was $929.6 million for the year ended December 31, 2013. Net cash used in investing activities was $594.0 million for the year ended December 31, 2012. In 2013, net cash used in investing activities primarily included approximately $816 million for the net purchase of fixed and equity securities, approximately $51 million for the acquisition of and premium payments for life settlement contracts, approximately $40 million for capital expenditures and approximately $21 million for an increase of restricted cash, partially offset by the net receipt of cash for approximately $20 million from life settlement contract payouts. In 2012, net cash used in investing activities primarily included approximately $418 million for the net purchase of fixed and equity securities, approximately $53 million for the acquisition of and premium payments for life settlement contracts, approximately $27 million for capital expenditures and approximately $64 million for the acquisition of FNC and CNH, partially offset by the net receipt of cash in the approximate amount of $15 million obtained in the acquisition of Luxembourg reinsurance companies.
In 2007, we entered into a master agreement with Maiden, as amended, by which our Bermuda subsidiary, AII, and Maiden Insurance entered into a quota share reinsurance agreement (the “Maiden Quota Share”), as amended. Under this agreement, AII retrocedes to Maiden Insurance an amount equal to 40% of the premium written by our U.S., Irish and U.K. insurance companies (the “AmTrust Ceding Insurers”), net of the cost of unaffiliated inuring reinsurance (and in the case of the our U.K. insurance subsidiary, AEL, net of commissions) and 40% of losses excluding certain business that we commenced writing after the effective date, including tour European medical liability business included in the table above, and risks, other than workers’ compensation risks and certain business written by our Irish subsidiary, AmTrust International Underwriters Limited (“AIU”), for which the AmTrust Ceding Insurers’ net retention exceeds $5 million (“Covered Business”).
The Maiden Quota Share was renewed through July 1, 2016 and will automatically renew for successive three-year terms unless either AII or Maiden Insurance notifies the other of its election not to renew not less than nine months prior to the end of any such three-year term. In addition, either party is entitled to terminate on thirty days’ notice or less upon the occurrence of certain early termination events, which include a default in payment, insolvency, change in control of AII or Maiden Insurance,
run-off, or a reduction of 50% or more of the shareholders’ equity of Maiden Insurance or the combined shareholders’ equity of AII and the AmTrust Ceding Insurers.
Borrowings under the Credit Agreement bear interest at (x) the greatest of (a) the Administrative Agent’s prime rate, (b) the federal funds effective rate plus 0.5 percent or (c) the adjusted LIBO rate for a one month interest period on such day plus 1 percent, plus (y) a margin that is adjusted on the basis of our consolidated leverage ratio. Eurodollar borrowings under the credit agreement will bear interest at the adjusted LIBO rate for the interest period in effect plus a margin that is adjusted on the basis of our consolidated leverage ratio. The interest rate on the credit facility as of December 31, 2013 and 2012 was 1.50% and 2.50%, respectively. We recorded total interest expense of approximately $1.8 million and $1.9 million for the years ended December 31, 2013 and 2012, respectively, under revolving credit agreements.
In December 2011, we issued $175 million aggregate principal amount of our 5.5% convertible senior notes due 2021 (the “Convertible Notes”) to certain initial purchasers in a private placement. In January 2012, we issued an additional $25 million of the Convertible Notes to cover the initial purchasers' overallotment option. The Convertible Notes bear interest at a rate equal to 5.5% per year, payable semiannually in arrears on June 15th and December 15th of each year.
The Convertible Notes will mature on December 15, 2021 (the “Maturity Date”), unless earlier purchased by us or converted into shares of our common stock, par value $0.01 per share (the “Common Stock”). Prior to September 15, 2021, the Convertible Notes will be convertible only upon satisfaction of certain conditions, and thereafter, at any time prior to the close of business on the second scheduled trading day immediately preceding the Maturity Date. The conversion rate at December 31, 2013 is equal to 38.2129 shares of Common Stock per $1,000 principal amount of Convertible Notes, which corresponds to a conversion price of approximately $26.17 per share of Common Stock. The conversion rate is subject to adjustment upon the occurrence of certain events as set forth in the indenture governing the Convertible Notes. Upon conversion of the Convertible Notes, we will, at our election, pay or deliver, as the case may be, cash, shares of Common Stock, or a combination of cash and shares of Common Stock.
We entered into two interest rate swap agreements related to these junior subordinated debentures, which effectively convert the interest rate on the trust preferred securities from a variable rate to a fixed rate on two of the four tranches to an average rate of approximately 3.5%. Each agreement is for a period of five years and expire in 2016 and 2017.
On November 26, 2013, in connection with our acquisition of Sagicor, we entered into a four-year £200 million credit facility agreement with ING Bank, N.V., London Branch, individually and as Agent and Security Trustee on November 26, 2013. The credit facility is a letter of credit facility that is used to support our capacity at Lloyd’s as a member of Syndicates 2526, 1206 and 44 for the 2014 underwriting year of account, as well as prior open years of account. As of December 31, 2013, we had outstanding letters of credit of $322.6 million in place under this credit facility (which represented nearly the full availability under the facility, as required by Lloyd's).
We, through one of our subsidiaries, have a secured letter of credit facility with Comerica Bank. We utilize the letter of credit facility to comply with the deposit requirements of the State of California and the U.S. Department of Labor as security for our obligations to workers’ compensation and federal Longshore and Harbor Workers’ Compensation Act policyholders. The credit limit is for $75 million and was utilized for $48.5 million for the year ended December 31, 2013. We are required to pay a letter of credit participation fee for each letter of credit in the amount of 0.40%.
We, through certain subsidiaries, have additional existing stand-by letters of credit with various lenders in the amount of $27.8 million as of December 31, 2013.
The following table sets forth certain of our contractual obligations as of December 31, 2013:
We are required by certain purchase agreements to pay the seller in the future based on the passage of time, volume of premium writings or a profitability metric. Also, we may be required by the terms of certain purchase agreements to pay the seller an annual minimum override payment based on a contractually defined formula. The amount payable to the seller under these agreements could be materially higher if the premiums produced generate a higher payment than the calculated minimum payment. We are required by certain agreements to pay fees based on profitability of certain subsidiary companies.
The interest related to the debt by period is as follows: $35.4 million - less than 1 year, $63.4 million - 1 - 3 years, $62.4 million - 3 - 5 years and $199.4 million - more than 5 years. In addition, included within debt and interest is $168 million related to the Maiden collateral loan and $2.6 million of associated interest.