Net earnings attributable to Alleghany stockholders were $39.5 million in 2018, compared with $90.1 million in 2017 and $456.9 million in 2016.
Net investment income increased by 11.0 percent in 2018 from 2017, and increased by 2.9 percent in 2017 from 2016.
Net premiums written increased by 1.7 percent in 2018 from 2017, and decreased by 2.5 percent in 2017 from 2016.
Underwriting loss was $161.5 million in 2018, compared with an underwriting loss of $316.4 million in 2017 and an underwriting profit of $401.3 million in 2016.
The combined ratio for our reinsurance and insurance segments was 103.2 percent in 2018, compared with 106.4 percent in 2017 and 91.9 percent in 2016.
Catastrophe losses, net of reinsurance, were $657.7 million in 2018, compared with $818.1 million in 2017 and $226.0 million in 2016.
Earnings before income taxes for Alleghany Capital were $58.1 million in 2018, compared with $52.8 million in 2017 and $21.2 million in 2016. Operating earnings before income taxes were $81.6 million in 2018, compared with $50.7 million in 2017 and $30.5 million in 2016.
As of December 31, 2018, we had total assets of $25.3 billion and total stockholders’ equity attributable to Alleghany stockholders of $7.7 billion. As of December 31, 2018, we had consolidated total investments of approximately $17.5 billion, consisting of $11.8 billion invested in debt securities, $3.6 billion invested in equity securities, $0.9 billion invested in short-term investments, $0.7 billion invested in commercial mortgage loans and $0.5 billion invested in other invested assets.
(2) Includes $33.8 million attributable to RSUI and $0.1 million attributable to CapSpecialty.
Alleghany’s segments are reported in a manner consistent with the way management evaluates the businesses. As such, Alleghany classifies its businesses into three reportable segments - reinsurance, insurance and Alleghany Capital. Alleghany determined that Alleghany Capital qualified as a reportable segment in the first quarter of 2018, reflecting the increased significance of Alleghany Capital’s business to Alleghany and its projected growth. Corporate activities are not classified as a segment.
See Note 13 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional detail on our segments and corporate activities. The tables below present the results for our segments and for corporate activities for 2018, 2017 and 2016:
The increase in net premiums written in 2018 from 2017 primarily reflects higher gross premiums written, partially offset by higher ceded premiums written due to an increase in retrocessional coverage purchased in 2018 at our reinsurance segment and, to a lesser extent, higher ceded premiums written at RSUI.
A detailed comparison of premiums by segment for 2018, 2017 and 2016 is contained on pages 83, 84 and 90.
2018 vs 2017. The decrease in net loss and LAE in 2018 from 2017 primarily reflects significantly lower catastrophe losses at our reinsurance and insurance segments and the impact of the sale of PacificComp. The catastrophe losses in 2018 primarily include $183.4 million related to Typhoon Jebi, $182.0 million related to wildfires in California, $135.2 million related to Hurricane Michael, $70.4 million related to Hurricane Florence and $33.7 million related to Typhoon Trami. The catastrophe losses in 2017 primarily included $252.1 million related to Hurricane Irma, $217.7 million related to Hurricane Harvey and $216.8 million related to Hurricane Maria, as well as losses related to wildfires in California and earthquakes in Mexico.
Net loss and LAE in 2017 for the reinsurance segment included $24.4 million of unfavorable prior accident year loss reserve development related to the U.K. Ministry of Justice’s reduction in the discount rate used to calculate lump-sum bodily injury payouts in personal injury insurance claims in the U.K.
2018 vs 2017. The decrease in commissions, brokerage and other underwriting expenses in 2018 from 2017 primarily reflects the impact of the sale of PacificComp, partially offset by an increase at CapSpecialty due primarily to the impact of higher net premiums earned.
2017 vs 2016. The slight decrease in commissions, brokerage and other underwriting expenses in 2017 from 2016 primarily reflected a decrease at our reinsurance segment from the impact of lower net premiums earned and losses arising from Hurricanes Irma, Harvey and Maria on short-term incentive compensation expense accruals, largely offset by an increase at our insurance segment due to the impact of higher net premiums earned at CapSpecialty and PacificComp.
A detailed comparison of commissions, brokerage and other underwriting expenses by segment for 2018, 2017 and 2016 is contained on pages 86 and 93.
Underwriting profit. The following table presents our consolidated underwriting (loss) profit:
2017 vs 2016. The underwriting loss in 2017 compared with the underwriting profit in 2016 primarily reflected significant catastrophe losses related to Hurricanes Irma, Harvey and Maria at our reinsurance and insurance segments, as discussed above.
2018 vs 2017. The increase in net investment income in 2018 from 2017 primarily reflects higher dividend income primarily resulting from an increase in the size of our equity securities portfolio during the first three quarters of 2018 and, to a lesser extent, an increase in interest income primarily resulting from higher yields on short-term investments and floating-rate debt securities, partially offset by the impact of the sale of PacificComp.
The increase in net investment income in 2018 from 2017 also reflects higher income from AIHL’s limited partnership interests in certain subsidiaries of Ares, as defined below, partially offset by lower income from other partnerships. Partnership income in 2018 includes a $12.9 million increase in the carrying value of our equity investment in Ares. See Note 4(i) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information.
The net realized capital losses in 2018 compared with net realized capital gains in 2017 primarily reflect the absence of net realized capital gains from equity securities in 2018 as a result of our adoption of the new investment accounting guidance discussed above, net realized capital losses taken in 2018 from the sale of debt securities and a $35.4 million capital loss due to an impairment charge from the write-down of certain SORC assets arising from a decline in energy prices as of December 31, 2018, partially offset by a $45.7 million gain on AIHL’s conversion of its limited partnership interests in certain subsidiaries of Ares into Ares common units. See Note 4(i) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on AIHL’s conversion.
The decrease in OTTI losses in 2018 from 2017 primarily reflects the absence of impairments from equity securities in 2018 resulting from our adoption of the new investment accounting guidance, as discussed above.
2017 vs 2016. The increase in net investment income in 2017 from 2016 primarily related to higher interest income, partially offset by a decrease in income from other invested assets. The increase in interest income primarily reflected growth in funds withheld and commercial mortgage loan balances, higher yields on short term investments and floating-rate debt securities, as well as the fact that interest income in the fourth quarter of 2016 was reduced by approximately $7 million of adjustments made to more accurately reflect premium amortization associated with certain bonds. The decrease in income from other invested assets primarily reflected a $12.6 million charge on our equity investment in Ares in early 2017. The charge on our equity investment in Ares reflected our share
of a one-time payment recorded by Ares related to an acquisition by its affiliated entity. In connection with this acquisition, Ares agreed to make certain transaction support payments to the sellers of the acquired entity. Ares expects to receive future management fees derived from the assets under management of the acquired entity.
A detailed comparison of investment results for 2018, 2017 and 2016 is contained on pages 94 and 95.
Noninsurance revenue and expenses. The following table presents our consolidated noninsurance revenue and expenses:
On February 7, 2018, W&W|AFCO Steel acquired the outstanding equity of Hirschfeld for $109.1 million, consisting of $94.4 million in cash and $14.7 million of incremental debt. On October 1, 2018, Alleghany Capital acquired its approximately 85 percent equity in Concord for $136.6 million, consisting of $68.6 million in cash paid on October 1, 2018, $38.2 million of potential contingent consideration based on future profitability and $29.8 million of incremental debt.
The increase in noninsurance revenue in 2017 from 2016 primarily reflected the acquisition of W&W|AFCO Steel. The increase in other operating expenses in 2017 from 2016 primarily reflected the acquisition of W&W|AFCO Steel and finders’ fees, legal and accounting costs and other transaction-related expenses at the Alleghany Capital level, partially offset by a decrease in the long-term incentive compensation of our reinsurance and insurance segments, as discussed above.
Corporate administration. The decrease in corporate administration expense in 2018 from 2017 primarily reflects lower long-term incentive compensation expense accruals at Alleghany, driven by the impact of depreciation in the value of our debt and equity securities portfolios in 2018 compared with appreciation in 2017 in the value of our equity and, to a lesser extent, debt securities portfolios, partially offset by the impact of lower catastrophe losses in 2018. The increase in corporate administration expense in 2017 from 2016 primarily reflected higher long-term incentive compensation expense accruals at Alleghany, driven by the impact of appreciation in the value of our equity and, to a lesser extent, debt securities portfolios, partially offset by losses arising from Hurricanes Irma, Harvey and Maria.
Amortization of intangible assets. The increase in amortization expense in 2018 from 2017 primarily reflects the W&W|AFCO Steel, Hirschfeld and Concord acquisitions. The increase in amortization expenses in 2017 from 2016 primarily reflected the amortization of net intangible assets related to the acquisition of W&W|AFCO Steel, partially offset by a decrease in amortization expense at IPS, as certain of IPS’s intangible assets were fully amortized as of December 31, 2016.
Reinsurance Segment: Premiums. The following table presents premiums for the reinsurance segment:
The increase in gross premiums written in 2017 from 2016 primarily reflected reinstatement premiums written on treaties impacted by catastrophe losses and an increase in gross premiums written related to the Quota Share Treaty, partially offset by cancellations, non-renewals and reduced participations in certain international treaties. Gross premiums written related to the Quota Share Treaty were $364.3 million and $353.2 million in 2017 and 2016, respectively. Excluding the impact of changes in foreign currency exchange rates, gross premiums written increased by 2.7 percent in 2017 from 2016. The increase in net premiums earned in 2017 from 2016 primarily reflected increased premiums earned related to the Quota Share Treaty and $30.2 million of net reinstatement premiums earned on treaties impacted by catastrophe losses, partially offset by higher ceded premiums earned due to an increase in retrocessional coverage purchased in 2017. Excluding the impact of changes in foreign currency exchange rates, net premiums earned increased by 1.2 percent in 2017 from 2016.
Casualty & other. The increase in gross premiums written in 2018 from 2017 primarily reflects the impact of the Renewal Rights Purchase, an increase in casualty-related Quota Share Treaty premiums written and an increase in premiums written by the North America and Asia-Pacific operations. Gross premiums written related to the Quota Share Treaty were $456.8 million and $416.6 million in 2018 and 2017, respectively, reflecting an increase in casualty-related premiums written, partially offset by a reduction of TransRe’s quota share participation. Excluding the impact of changes in foreign currency exchange rates, gross premiums written increased by 9.8 percent in 2018 from 2017. The increase in net premiums earned in 2018 from 2017 primarily reflects an increase in gross premiums written in recent quarters. Excluding the impact of changes in foreign currency exchange rates, net premiums earned increased by 5.0 percent in 2018 from 2017.
Net loss and LAE in 2017 approximated those in 2016, primarily reflecting higher catastrophe losses and less favorable prior accident year loss reserve development, offset by the impact of lower net premiums earned and lower non-catastrophe losses in the 2017 accident year. Catastrophe losses in 2017 related primarily to the marine lines of business and included $26.2 million related to Hurricane Irma, $20.1 million related to Hurricane Harvey, $15.4 million related to Hurricane Maria, $1.6 million related to wildfires in California and $1.5 million related to earthquakes in Mexico. The modest catastrophe losses in 2016 related primarily to earthquake losses in Ecuador.
(3) Primarily reflects favorable prior accident year loss reserve development in the longer-tailed casualty lines of business in the 2002 through 2010 accident years and in the shorter-tailed casualty lines of business (specifically, ocean marine, automobile liability and accident and health) in the 2017 accident year, partially offset by unfavorable prior accident year loss reserve development in the professional liability lines of business in the 2015 accident year.
(4) Primarily reflects favorable prior accident year loss reserve development in: (i) longer-tailed professional liability and general liability lines of business in the 2003 through 2012 accident years; and (ii) shorter-tailed casualty lines of business in the 2010 through 2014 accident years; partially offset by unfavorable prior accident year loss reserve development in shorter-tailed casualty lines of business in the 2015 and 2016 accident years.
Property. The slight increase in commissions, brokerage and other underwriting expenses in 2018 from 2017 primarily reflects higher commission rates, partially offset by the impact of slightly lower net premiums earned. The increase in commissions, brokerage and other underwriting expenses in 2017 from 2016 primarily reflected the impact of higher net premiums earned and an increase in commission rates, partially offset by lower short-term incentive compensation expense accruals arising from the significant catastrophe losses in 2017.
Property. The decrease in underwriting loss in 2018 from 2017 primarily reflects lower catastrophe losses, partially offset by an increase in non-catastrophe losses, all as discussed above. The underwriting loss in 2017, compared with the underwriting profit in 2016, primarily reflected significant catastrophe losses related to Hurricanes Maria, Irma and Harvey, as discussed above.
The increases in net premiums earned in 2018 from 2017 and in 2017 from 2016 primarily reflect increases in gross premiums written.
PacificComp. The results shown for 2018 reflect the sale of PacificComp on December 31, 2017. The increases in gross premiums written and net premiums earned in 2017 from 2016 primarily reflected premium growth due to PacificComp’s distribution initiatives and growth in targeted segments of the workers’ compensation market in California.
Net loss and LAE in 2018, 2017 and 2016 include (favorable) unfavorable prior accident year loss reserve development as presented in the table below:
(1) Primarily reflects favorable prior accident year loss reserve development in the umbrella/excess lines of business in the 2005 through 2012 accident years, partially offset by unfavorable prior accident year loss reserve development in the directors’ and officers’ liability lines of business in the 2009, 2012 and 2016 accident years.
(2) Primarily reflects favorable prior accident year loss reserve development in the umbrella/excess lines of business in the 2005 through 2011 accident years.
The favorable prior accident year loss reserve development in 2018, 2017 and 2016 reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods. The favorable prior accident year loss reserve development in 2018 did not impact assumptions used in estimating RSUI’s loss and LAE liabilities for business earned in 2018.
(1) Primarily reflects favorable prior accident year loss reserve development in the surety lines of business in the 2016 and 2017 accident years.
(2) Primarily reflects favorable prior accident year loss reserve development in the casualty lines of business in the 2010, 2014, 2015 and 2016 accident years.
PacificComp. The increase in net loss and LAE in 2017 from 2016 primarily reflected the impact of higher net premiums earned, partially offset by an increase in favorable prior accident year loss reserve development.
The favorable prior accident year loss reserve development in 2017 related primarily to the 2013 and prior accident years and reflected favorable loss emergence compared with loss emergence patterns assumed in earlier periods. The favorable prior accident year loss reserve development in 2016 related primarily to the 2012 and prior accident years and reflected favorable loss emergence compared with loss emergence patterns assumed in earlier periods.
RSUI. The increase in commissions, brokerage and other underwriting expenses in 2018 from 2017 primarily reflects the impact of higher wage and healthcare costs, partially offset by lower short-term incentive compensation expense accruals and slightly lower commission expense incurred. The decrease in commissions, brokerage and other underwriting expenses in 2017 from 2016 primarily reflected the impact of lower net premiums earned and the impact of losses arising from Hurricanes Irma, Harvey and Maria on short-term incentive compensation expense accruals.
As decreases in net premiums earned exceeded the decreases in commissions, brokerage and other underwriting expenses, RSUI’s expense ratio increased in 2017 from 2016.
CapSpecialty. The increase in commissions, brokerage and other underwriting expenses in 2018 from 2017 primarily reflects the impact of higher net premiums earned and relatively stable overhead expenses. The increase also reflects one-time acquisition expenses arising from CapSpecialty’s purchase of certain renewal rights associated with a small environmental block of business. The increase in commissions, brokerage and other underwriting expenses in 2017 from 2016 primarily reflected the impact of higher net premiums earned and relatively stable overhead expenses.
PacificComp. PacificComp reported underwriting losses in 2017 and 2016 primarily as a result of its expenses relative to comparatively low premiums earned. The decrease in underwriting loss in 2017 from 2016 primarily reflected the impact of growing net premiums earned and, to a lesser extent, an increase in favorable prior accident year loss reserve development, all as discussed above.
The slight increase in net investment income in 2017 from 2016 primarily related to higher interest income, partially offset by a decrease in income from other invested assets. The increase in interest income primarily reflected growth in funds withheld and commercial mortgage loan balances, higher yields on short term investments and floating-rate debt securities, as well as the fact that interest income in the fourth quarter of 2016 was reduced by approximately $7 million of adjustments made to more accurately reflect premium amortization associated with certain bonds. The decrease in income from other invested assets primarily reflected a $12.6 million charge on our equity investment in Ares. The charge on our equity investment in Ares reflected our share of a one-time payment recorded by Ares in early 2017 related to an acquisition by its affiliated entity. In connection with this acquisition, Ares agreed to make certain transaction support payments to the sellers of the acquired entity. Ares expects to receive future management fees derived from the assets under management of the acquired entity.
Change in the fair value of equity securities. In the first quarter of 2018, we adopted new investment accounting guidance which required changes in the fair value of equity securities, except those accounted for under the equity method, to be recognized in net earnings. In earlier periods, equity securities were considered to be AFS and were included in the analysis of OTTI. See Note 1(r) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information regarding our adoption of this new guidance.
The decrease in net realized capital gains in 2017 from 2016 primarily reflected lower gains for the equity and debt securities portfolios and a $7.9 million write-down of certain reinsurance segment assets, partially offset by gains on the sale of certain exchange-traded funds in 2017 and an $8.4 million pre-tax gain realized on the sale of PacificComp.
OTTI losses in 2016 reflected $45.2 million of unrealized losses that were deemed to be other than temporary and, as such, were required to be charged against earnings. Of the $45.2 million of OTTI losses, $23.3 million related to equity securities, primarily in the retail, financial service, technology, chemical and entertainment sectors, and $21.9 million related to debt securities, primarily in the energy sector. The determination that unrealized losses on equity and debt securities were other than temporary was primarily due to the severity and duration of the decline in the fair value of equity and debt securities relative to their costs.
The Alleghany Capital segment consists of: (i) industrial operations conducted through Bourn & Koch, Kentucky Trailer, W&W|AFCO Steel beginning April 28, 2017 (the date on which Alleghany Capital acquired approximately 80 percent of the equity thereof), and a 45 percent equity interest in Wilbert, beginning August 1, 2017 (the date on which Alleghany Capital acquired its equity interest therein); (ii) non-industrial operations conducted through IPS, Jazwares and Concord, beginning October 1, 2018 (the date on which Alleghany Capital acquired approximately 85 percent of the equity thereof); and (iii) corporate operations at the Alleghany Capital level.
The following tables present the results of the Alleghany Capital segment for 2018, 2017 and 2016:
(2) Operating earnings before income taxes is a non-GAAP financial measure and does not replace earnings before income taxes determined in accordance with GAAP as a measure of profitability. See “Comment on Non-GAAP Financial Measures” herein for additional detail on the presentation of our results of operations. Operating earnings before income taxes represents noninsurance revenue and net investment income less other operating expenses and interest expense, and does not include: (i) amortization of intangible assets; (ii) change in the fair value of equity securities; (iii) net realized capital gains; (iv) OTTI impairment losses; and (v) income taxes.
The changes in Alleghany Capital’s equity for 2018, 2017 and 2016 are presented in the table below:
(2) Primarily reflects funding provided by Alleghany Capital for the purchase of 50 percent of Jazwares’ outstanding equity on April 15, 2016 in addition to its pre-existing 30 percent ownership.
Noninsurance revenue. The increase in noninsurance revenue in 2018 from 2017 primarily reflects an increase in industrial operations, due primarily to the acquisitions of Hirschfeld and W&W|AFCO Steel and, to a lesser extent, higher sales at Kentucky Trailer and Bourn & Koch. The increase in noninsurance revenue in 2018 from 2017 also reflects an increase in non-industrial operations due primarily to higher sales at Jazwares and IPS, as well as the acquisition of Concord. The increase in noninsurance revenue in 2017 from 2016 primarily reflected the acquisition of W&W|AFCO Steel.
Net investment income. The increase in net investment income in 2018 from 2017 and in 2017 from 2016 primarily reflects Alleghany Capital’s earnings from its investment in Wilbert.
Net realized capital gains. Net realized capital gains in 2018 primarily reflect gains from the sale of certain investments and equipment, as well as certain foreign currency exchange rate impacts. Net realized capital gains in 2017 primarily reflect a $20.9 million capital gain due to a bulk settlement of certain contingent consideration obligations that were made by Alleghany Capital in connection with its acquisition of Jazwares’ outstanding equity, or the “Jazwares Settlement Gain.” Net realized capital gains in 2016 primarily reflected a gain of $13.2 million recognized by Alleghany Capital on April 15, 2016 in connection with its acquisition of an additional 50 percent equity ownership in Jazwares, when its pre-existing 30 percent equity ownership was remeasured at estimated fair value, or the “Jazwares Remeasurement Gain.”
Other operating expenses in 2018 and 2017 also reflect significant finders’ fees, legal and accounting costs and other transaction-related expenses, primarily related to Alleghany Capital’s acquisition of Concord in 2018, W&W|AFCO Steel’s acquisition of Hirschfeld in 2018, Kentucky Trailer’s acquisition of CEI in 2018 and Alleghany Capital’s acquisition of W&W|AFCO Steel in 2017. Finders’ fees, legal and accounting costs and other transaction-related expenses were $7.7 million, $7.2 million and $7.4 million for 2018, 2017 and 2016, respectively.
The increase in other revenue and other operating expenses in 2017 from 2016 primarily reflects the acquisition of W&W|AFCO Steel.
The primary components of corporate activities are Alleghany Properties, SORC and activities at the Alleghany parent company. The following table presents the results for corporate activities.
Net investment income. The increase in net investment income in 2018 from 2017 primarily reflects higher dividend income resulting from an increase in the size of the equity security portfolio held at the Alleghany parent company-level during the first three quarters of 2018. The increase in net investment income in 2017 from 2016 primarily reflected higher income from new investments in other invested assets resulting from the purchase of certain non-marketable equity investments at the Alleghany parent company.
Change in the fair value of equity securities. In the first quarter of 2018, we adopted new investment accounting guidance which required changes in the fair value of equity securities, except those accounted for under the equity method, to be recognized in net earnings. See Note 1(r) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information regarding our adoption of this new guidance.
The change in the fair value of equity securities in 2018 reflects depreciation of the equity securities held at the Alleghany parent company-level, primarily from holdings in the energy sector.
Net realized capital losses. Net realized capital losses in 2018 primarily reflect a $35.4 million capital loss due to an impairment charge from the write-down of certain SORC assets arising from a decline in energy prices as of December 31, 2018. The net realized capital loss in 2017 primarily reflected a loss from the sale of a legacy oil field by SORC, partially offset by gains on the sale of certain exchange-traded funds. Net realized capital losses in 2016 primarily reflected a $98.8 million capital loss due to an impairment charge from the write-down of certain SORC assets.
Corporate administration. The decrease in corporate administration expense in 2018 from 2017 primarily reflects lower long-term incentive compensation expense accruals at Alleghany, driven by the impact of depreciation in the value of our debt and equity securities portfolios in 2018 compared with appreciation in the value of our equity and, to a lesser extent, debt securities portfolios in
2017, partially offset by the impact of lower catastrophe losses in 2018. The increase in corporate administration expense in 2017 from 2016 primarily reflected higher long-term incentive compensation expense accruals at Alleghany, driven by the impact of appreciation of our equity and, to a lesser extent, debt securities portfolios, partially offset by losses arising from Hurricanes Irma, Harvey and Maria.
Interest expense. Interest expense in 2018, 2017 and 2016 was approximately the same.
(3) Primarily consists of commercial multi-peril and surety lines of business, as well as loss and LAE reserves for terminated lines of business and loss reserves acquired in connection with prior acquisitions for which the sellers provided loss reserve guarantees.
Changes in Gross and Net Loss and LAE Reserves between December 31, 2018 and December 31, 2017. Gross and net loss and LAE reserves as of December 31, 2018 increased from December 31, 2017, primarily reflecting catastrophe losses in 2018, partially offset by payments on catastrophe losses incurred in 2017 and favorable prior accident year loss reserve development. The 2018 catastrophe losses, net of reinsurance, include $183.4 million related to Typhoon Jebi, $182.0 million related to wildfires in California, $135.2 million related to Hurricane Michael, $70.4 million related to Hurricane Florence and $33.7 million related to Typhoon Trami.
The following table presents information regarding concentration of our reinsurance recoverables and the ratings profile of our reinsurers as of December 31, 2018:
(4) Approximately 70 percent of our reinsurance recoverables balance as of December 31, 2018 was due from reinsurers having an A.M. Best financial strength rating of A (Excellent) or higher, with a majority of the other reinsurance recoverables being secured by funds held, trust agreements or letters of credit.
We had no allowance for uncollectible reinsurance as of December 31, 2018.
As noted above, as of any balance sheet date, not all claims that have occurred have been reported to us, and if reported may not have been settled. The time period between the occurrence of a loss and the time it is settled is referred to as the “claim tail.” In general, actuarial judgments for shorter-tailed lines of business normally have much less of an effect on the determination of the loss reserve amount than when those same judgments are made regarding longer-tailed lines of business. Reported losses for the shorter-tailed classes, such as property classes, generally reach the ultimate level of incurred losses in a relatively short period of time. Rather than having to rely on actuarial assumptions for many accident years, these assumptions are generally only relevant for the more recent accident years. Therefore, these assumptions tend to be less critical and the reserves calculated pursuant to these assumptions are subject to less variability for the shorter-tailed lines of business.
personnel, to help ensure that reported data is supported by proper documentation and conforms to contract terms, and is analyzed, as appropriate, by its underwriting and actuarial personnel. Such analysis often includes a detailed review of reported data to assess the underwriting results of assumed reinsurance and to explain any significant departures from expected performance. Over time, reported loss information is ultimately corroborated when the underlying claims are paid.
We believe that the reserves for unpaid loss and LAE established by our reinsurance and insurance subsidiaries are adequate as of December 31, 2018; however, additional reserves, which could have a material impact upon our financial condition, results of operations and cash flows, may be necessary in the future.
Our net reserves for loss and LAE of $10.4 billion as of December 31, 2018 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. We believe the above analysis provides a reasonable benchmark for sensitivity, as we believe it is within historical variation for our reserves. Currently, none of the scenarios is believed to be more likely than the others. See Note 1(k) and Note 6 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on our loss and LAE.
Prior Year Development. Our reinsurance and insurance subsidiaries continually evaluate the potential for changes, both favorable and unfavorable, in their estimates of loss and LAE liabilities and use the results of these evaluations to adjust both recorded liabilities and underwriting criteria. With respect to liabilities for unpaid loss and LAE established in prior years, these liabilities are periodically analyzed and their expected ultimate cost adjusted, where necessary, to reflect favorable or unfavorable development in loss experience and new information, including, for certain catastrophic events, revised industry estimates of the magnitude of a catastrophe. Adjustments to previously recorded liabilities for unpaid loss and LAE, both favorable and unfavorable, are reflected in our financial results in the periods in which these adjustments are made and are referred to as prior accident year loss reserve development. We adjusted our prior year loss and LAE reserve estimates during 2018, 2017 and 2016 based on current information that differed from previous assumptions made at the time such loss and LAE reserves were previously estimated. See Note 6(b) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for a table presenting the favorable and unfavorable prior accident year loss reserve development for 2018, 2017 and 2016.
Reinsurance. Our reinsurance and insurance subsidiaries reinsure portions of the risks they underwrite in order to reduce the effect of individual or aggregate exposure to losses, manage capacity, protect capital resources, reduce volatility in specific lines of
A three-tiered hierarchy for inputs is used in management’s determination of fair value of financial instruments that emphasizes the use of observable inputs over the use of unobservable inputs by requiring that the observable inputs be used when available. Assets classified as Level 3 principally include certain other asset-backed securities (primarily, collateralized loan obligations) and, to a lesser extent, U.S. and foreign corporate bonds (including privately issued securities), partnership investments, non-marketable equity investments, residential mortgage-backed securities, or “RMBS,” and commercial mortgage-backed securities, or “CMBS.” The valuation of Level 3 assets requires the greatest degree of judgment. These measurements may be made under circumstances in which there is little, if any, market activity for the asset. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment. In making the assessment, we consider factors specific to the asset.
We hold our debt securities as AFS and as such, these securities are recorded at fair value. We continually monitor the difference between amortized cost and the estimated fair value of our debt investments, which involves uncertainty as to whether declines in value are temporary in nature. The analysis of a security’s decline in value is performed in its functional currency. If the decline is deemed temporary, we record the decline as an unrealized loss in stockholders’ equity. If the decline is deemed to be other than temporary, we write our amortized cost-basis down to the fair value of the security and record an OTTI loss on our statement of earnings. In addition, any portion of such decline related to a debt security that is believed to arise from factors other than credit is recorded as a component of other comprehensive income rather than charged against earnings.
General. In general, we follow a policy of maintaining a relatively liquid financial condition at our unrestricted holding companies. This policy has permitted us to expand our operations through internal growth at our subsidiaries and through acquisitions of, or substantial investments in, operating companies. As of December 31, 2018, we held total marketable securities and cash of $1,122.3 million, compared with $1,383.4 million as of December 31, 2017. The decrease in 2018 primarily reflects depreciation in the value of our equity securities portfolio held at the holding company level, a special dividend on our common stock and repurchases of shares of our common stock, each as discussed below, as well as contributions to Alleghany Capital to fund the acquisitions of Concord and Hirschfeld, partially offset by the receipt of dividends from TransRe, RSUI and certain Alleghany Capital subsidiaries. The $1,122.3 million is comprised of $352.1 million at the Alleghany parent company, $714.4 million at AIHL and $55.8 million at the TransRe holding company. We also hold certain non-marketable investments at our unrestricted holding companies. We believe that we have and will have adequate internally generated funds, cash resources and unused credit facilities to provide for the currently foreseeable needs of our business, and we had no material commitments for capital expenditures as of December 31, 2018.
Stockholders’ equity attributable to Alleghany stockholders was approximately $7.7 billion as of December 31, 2018, compared with approximately $8.5 billion as of December 31, 2017. The decrease in stockholders’ equity in 2018 primarily reflects depreciation in the value of our debt securities portfolio due to an increase in interest rates and credit spreads in 2018, as well as a special dividend on our common stock and repurchases of our common stock, all as discussed below, partially offset by net earnings. As of December 31, 2018, we had 14,576,509 shares of our common stock outstanding, compared with 15,390,500 shares of our common stock outstanding as of December 31, 2017.
Credit Agreement. On July 31, 2017, we entered into a five-year credit agreement, or the “Credit Agreement,” with certain lenders party thereto, which provides for an unsecured revolving credit facility in an aggregate principal amount of up to $300.0 million. The credit facility is scheduled to expire on July 31, 2022, unless earlier terminated. Borrowings under the Credit Agreement will be available for working capital and general corporate purposes, including permitted acquisitions and repurchases of Common Stock. Borrowings under the Credit Agreement bear a floating rate of interest based in part on our credit rating, among other
Dividends from Subsidiaries. See Note 10(c) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for information on dividend restrictions and dividends received from our reinsurance and insurance subsidiaries.
Dividends. From 1999 through 2011, we declared stock dividends in lieu of cash dividends every year. Our Board of Directors determined not to declare a dividend, cash or stock, for 2012 through 2017. In February 2018, our Board of Directors declared a special dividend of $10.00 per share for stockholders of record on March 5, 2018. On March 15, 2018, we paid dividends to stockholders totaling $154.0 million.
(1) “Senior Notes” refers to: (i) the Alleghany Senior Notes, consisting of the 2020 Senior Notes, the 2022 Senior Notes and the 2044 Senior Notes; and (ii) TransRe’s 8.00% senior notes due on November 30, 2039. See Note 8 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on the Senior Notes and other debt.
Our reinsurance and insurance subsidiaries have obligations to make certain payments for loss and LAE pursuant to insurance policies and reinsurance contracts they issue. These future payments are reflected as reserves on our consolidated financial statements. With respect to loss and LAE, there is typically no minimum contractual commitment associated with insurance policies and reinsurance contracts, and the timing and ultimate amount of actual claims related to these reserves is uncertain.
Energy Holdings. As of December 31, 2018, we had holdings in energy sector businesses of $385.2 million, comprised of $288.9 million of debt securities, $8.3 million of equity securities and $88.0 million of our equity attributable to SORC.
Financial strength is also a high priority of our subsidiaries, whose assets stand behind their financial commitments to their customers and vendors. We believe that our subsidiaries have and will have adequate internally generated funds, cash resources and unused credit facilities to provide for the currently foreseeable needs of their businesses. Our subsidiaries had no material commitments for capital expenditures as of December 31, 2018.
Included in Alleghany Capital is debt associated with its operating subsidiaries, which totaled $284.5 million as of December 31, 2018. The $284.5 million includes:
$66.6 million of term loans at Kentucky Trailer primarily related to borrowings to finance small acquisitions, its December 28, 2018 acquisition of a controlling interest in CEI and borrowings under its available credit facility;
$13.8 million of term loans at Bourn & Koch primarily related to borrowings to finance its acquisition of DTI in 2016; and
With respect to corporate activities, SORC has relied on Alleghany almost entirely to support its operations. From its formation in 2011 through December 31, 2018, we have invested $267.7 million in SORC.
are insured by third-party financial guaranty insurance companies, the impact of such insurance was not significant to the debt securities credit quality rating as of December 31, 2018. The following table presents the ratings of our debt securities as of December 31, 2018:
Fair Value. The following table presents the carrying values and estimated fair values of our consolidated financial instruments as of December 31, 2018 and 2017:
Valuation service providers typically obtain data about market transactions and other key valuation model inputs from multiple sources and, through the use of widely accepted valuation models, provide a single fair value measurement for individual securities for which a fair value has been requested under the terms of service agreements. The inputs used by the valuation service providers include, but are not limited to, market prices from recently completed transactions and transactions of comparable securities, interest rate yield curves, credit spreads, currency rates and other market observable information, as applicable. The valuation models take into account, among other things, market observable information as of the measurement date as well as the specific attributes of the security being valued including its term, interest rate, credit rating, industry sector and, when applicable, collateral quality and other issue or issuer specific information. When market transactions or other market observable data is limited, the extent to which judgment is applied in determining fair value is greatly increased.
Level 2: Valuations are based on direct and indirect observable inputs other than quoted market prices included in Level 1. Level 2 inputs include quoted prices for similar assets in active markets and inputs other than quoted prices that are observable for the asset, such as the terms of the security and market-based inputs. Terms of the security include coupon, maturity date and any special provisions that may, for example, enable the investor, at its election, to redeem the security prior to its scheduled maturity date (such provisions may apply to all debt securities except U.S. Government obligations). Market-based inputs include interest rates and yield curves that are observable at commonly quoted intervals and current credit rating(s) of the security. Market-based inputs may also include credit spreads of all
Level 3: Valuations are based on techniques that use significant inputs that are unobservable. The valuation of Level 3 assets requires the greatest degree of judgment. These measurements may be made under circumstances in which there is little, if any, market activity for the asset. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment. In making the assessment, we consider factors specific to the asset. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement is classified is determined based on the lowest level input that is significant to the fair value measurement in its entirety Assets classified as Level 3 principally include other asset-backed securities (primarily, collateralized loan obligations) and, to a lesser extent, U.S. and foreign corporate bonds (including privately issued securities), partnership investments, non-marketable equity investments, RMBS, CMBS and commercial mortgage loans.
The following tables present the estimated fair values of our financial instruments measured at fair value and the level of the fair value hierarchy of inputs used as of December 31, 2018 and 2017:
(2) Includes $1,266.9 million and $1,101.3 million of collateralized loan obligations as of December 31, 2018 and 2017, respectively.
(3) Includes partnership and non-marketable equity investments accounted for at fair value, and excludes investments accounted for using the equity method.
Municipal Bonds. The following table provides the fair value of our municipal bonds as of December 31, 2018, categorized by state and revenue source. Special revenue bonds are debt securities for which the payment of principal and interest is available solely from the cash flows of the related projects. As issuers of revenue bonds do not have the ability to draw from tax revenues or levy taxes to fund obligations, revenue bonds may carry a greater risk of default than general obligation bonds.
Projections of potential catastrophe losses are typically expressed in terms of the probable maximum loss, or “PML.” The PMLs shown are Occurrence Exceedance Probability, or “OEP,” losses, which reflect losses that may occur in any single event due to the defined peril in the indicated region. These modeled losses are estimated based upon contracts in force at January 1, 2019 for TransRe and December 1, 2018 for RSUI. Modeled results also reflect losses arising from certain of our invested assets that have specific catastrophe exposures. In any given year, we may experience losses from multiple events and may also experience events that impact multiple geographies, and therefore, we may experience losses significantly larger than the OEP PMLs shown in any given year.
“Florida, Wind” and “California, Earthquake” have the highest modeled after-tax net catastrophe costs for a 100 and 250 year return period, respectively. These costs would represent approximately 6 percent and 8 percent, respectively, of stockholders’ equity attributable to Alleghany as of December 31, 2018, compared with approximately 6 percent and 8 percent, respectively, as of December 31, 2017. If multiple severe catastrophe events occur in any one year, or a single catastrophe event affects more than one geographic area, the potential economic cost to us could be materially higher than any one of the amounts shown above.
In February 2018, the FASB issued guidance on certain tax effects caused by the Tax Act. The Tax Act, among other things, reduced the U.S. corporate federal income tax rate from 35.0 percent to 21.0 percent, effective January 1, 2018, for the 2018 tax year. Under such circumstances, GAAP requires that the value of deferred tax assets and liabilities be reduced through tax expense. The new guidance provides an option to reclassify any stranded tax amounts that remain in accumulated other comprehensive income to retained earnings, either retrospectively or at the beginning of the period in which the adoption is elected. This guidance became effective in the first quarter of 2018 for public entities, with early adoption permitted in 2017. We adopted this new guidance in the first quarter of 2018 and have elected to reclassify stranded tax amounts that remain in accumulated other comprehensive income, in the amount of approximately $135 million, to retained earnings as of January 1, 2018. See Note 10(b) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements & Supplementary Data” of this Form 10-K for additional information on accumulated other comprehensive income. See Note 9 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on the Tax Act and its impact on us.
In May 2015, the FASB issued guidance that requires disclosures related to short-duration insurance contracts. The guidance applies to property and casualty insurance and reinsurance entities, among others, and requires the following annual disclosure related to the liability for loss and LAE: (i) net incurred and paid claims development information by accident year for up to ten years; (ii) a reconciliation of incurred and paid claims development information to the aggregate carrying amount of the liability for loss and LAE; (iii) liabilities for IBNR by accident year and in total; (iv) a description of reserving methodologies (as well as any changes to those methodologies); (v) quantitative information about claim frequency by accident year; and (vi) the average annual percentage payout of incurred claims by age and by accident year. In addition, the guidance also requires insurance entities to disclose for annual and interim reporting periods a roll-forward of the liability for loss and LAE. This guidance was effective for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016, with early adoption permitted. We adopted this guidance as of December 31, 2016 and the implementation did not have an impact on our results of operations and financial condition. See Note 1(k) and Note 6 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K, for the new disclosures.
In May 2014, the FASB, together with the International Accounting Standards Board, issued guidance on the recognition of revenue from contracts with customers. Under this guidance, revenue is recognized as the transfer of goods and services to customers takes place and in amounts that reflect the payment or payments that are expected to be received from the customers for those goods and services. This guidance also requires new disclosures about revenue. Revenues related to insurance and reinsurance contracts and revenues from investments are not impacted by this guidance, whereas noninsurance revenues arising from the sale of manufactured goods and services are generally included within the scope of this guidance. This guidance, and all related amendments, became effective in the first quarter of 2018 for public entities, with early adoption permitted in 2017. We adopted this guidance in the first quarter of 2018 using the modified retrospective transition approach and the implementation did not have a material impact on our results of operations and financial condition. See Note 13 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements & Supplementary Data” of this Form 10-K for further information on Alleghany’s noninsurance revenues.
In June 2016, the FASB issued guidance on credit losses. Under this guidance, a company is required to measure all expected credit losses on loans, reinsurance recoverables and other financial assets accounted for at cost or amortized cost, as applicable. Estimates of expected credit losses are to be based on historical experience, current conditions and reasonable and supportable forecasts. Credit losses for securities accounted for on an AFS basis are to be measured in a manner similar to GAAP as currently applied and cannot exceed the amount by which the fair value is less than the amortized cost. Credit losses for all financial assets are to be recorded through an allowance for credit losses. Subsequent reversals in credit loss estimates are permitted and are to be recognized in earnings. This guidance also requires new disclosures about the significant estimates and judgments used in estimating credit losses, as well as the credit quality of financial assets. This guidance is effective in the first quarter of 2020 for public entities, with early adoption permitted. We will adopt this guidance in the first quarter of 2020 and do not currently believe that the implementation will have a material impact on our results of operations and financial condition. See Note 4 and 5(b) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for further information on Alleghany’s investments and reinsurance recoverables, respectively.
In August 2017, the FASB issued guidance that simplifies the requirements to achieve hedge accounting, better reflects the economic results of hedging in the financial statements and improves the alignment between hedge accounting and a company’s risk management activities. This guidance is effective in the first quarter of 2019 for public entities, with early adoption permitted. We will adopt this guidance in the first quarter of 2019 and do not currently believe that the implementation will have a material impact on our results of operations and financial condition.
In August 2018, the FASB issued guidance that changes the financial statement disclosure requirements for measuring fair value. With respect to financial instruments classified as “Level 3” in the fair value disclosure hierarchy, the guidance requires certain additional disclosures for public entities related to amounts included in other comprehensive income and significant unobservable inputs used in the valuation, while removing disclosure requirements related to an entity’s overall valuation processes. The guidance also removes certain disclosure requirements related to transfers between financial instruments classified as “Level 1” and “Level 2” and provides clarification on certain other existing disclosure requirements. This guidance is effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted with respect to any eliminated or modified disclosures. We will adopt this guidance in the first quarter of 2020 and we do not currently believe that the implementation will have a material impact on our results of operations and financial condition.
We have audited the accompanying consolidated balance sheets of Alleghany Corporation and subsidiaries (the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of earnings and comprehensive income, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2018, and the related notes and the financial statement schedules listed in the Index at Item 15(a)(2) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Alleghany Corporation and subsidiaries at December 31, 2018 and 2017, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.
Although Alleghany’s primary sources of revenues and earnings are its reinsurance and insurance operations and investments, Alleghany also generates revenues and earnings from a diverse portfolio of middle market businesses that are owned and managed primarily through its wholly-owned subsidiary Alleghany Capital Corporation (“Alleghany Capital”). Alleghany Capital’s businesses include:
IPS-Integrated Project Services, LLC (“IPS”), a technical service provider focused on the global pharmaceutical and biotechnology industries, headquartered in Blue Bell, Pennsylvania;
In July 2014, Alleghany Capital acquired a 30 percent equity interest in Jazwares. On April 15, 2016, Alleghany Capital acquired a controlling interest in Jazwares and, beginning on that date, the results of Jazwares have been included in Alleghany’s consolidated results. Prior to April 15, 2016, Jazwares was accounted for under the equity method of accounting. The results of W&W|AFCO Steel have been included in Alleghany’s consolidated results beginning with its acquisition by Alleghany Capital on April 28, 2017. On February 7, 2018, W&W|AFCO Steel acquired Hirschfeld Holdings, LP (“Hirschfeld”). The results of Concord have been included in Alleghany’s consolidated results beginning with its acquisition by Alleghany Capital on October 1, 2018.
Wilbert is accounted for under the equity method of accounting and is included in other invested assets. The results of Wilbert have been included in Alleghany’s consolidated results beginning with its acquisition by Alleghany Capital on August 1, 2017.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Alleghany relies on historical experience and on various other assumptions that it believes to be reasonable under the circumstances to make judgments about the carrying value of assets and liabilities and reported revenues and expenses that are not readily apparent from other sources. Actual results may differ materially from those reported results to the extent that those estimates and assumptions prove to be inaccurate. Changes in estimates are reflected in the Consolidated Statements of Earnings and Comprehensive Income in the period in which the changes are made.
The three-tiered hierarchy used in management’s determination of fair value is broken down into three levels based on the reliability and observability of inputs as follows:
Level 2: Valuations are based on direct and indirect observable inputs other than quoted market prices included in Level 1. Level 2 inputs include quoted prices for similar assets in active markets and inputs other than quoted prices that are observable for the asset, such as the terms of the security and market-based inputs. Terms of the security include coupon, maturity date and any special provisions that may, for example, enable the investor, at its election, to redeem the security prior to its scheduled maturity date (such provisions may apply to all debt securities except U.S. Government obligations). Market-based inputs include interest rates and yield curves that are observable at commonly quoted intervals and current credit rating(s) of the security. Market-based inputs may also include credit spreads of all debt securities except U.S. Government obligations, and currency rates for certain foreign government obligations and foreign
corporate bonds denominated in foreign currencies. Fair values are determined using a market approach that relies on the securities’ relationships to quoted prices for similar assets in active markets, as well as the other inputs described above. In determining the fair values for the vast majority of commercial mortgage-backed securities (“CMBS”) and other asset- backed securities, as well as a small portion of residential mortgage-backed securities (“RMBS”), an income approach is used to corroborate and further support the fair values determined by the market approach. The income approach primarily involves developing a discounted cash flow model using the future projected cash flows of the underlying collateral, and the terms of the security. Level 2 assets generally include short-term investments and most debt securities. Alleghany’s Level 2 liabilities consist of the Senior Notes, as defined in Note 1(n).
Alleghany employs specific control processes to determine the reasonableness of the fair values of its financial assets and liabilities. Alleghany’s processes are designed to ensure that the values received or internally estimated are accurately recorded and that the data inputs and the valuation techniques used are appropriate, consistently applied and that the assumptions are reasonable and consistent with the objective of determining fair value. Alleghany assesses the reasonableness of individual security values received from valuation service providers through various analytical techniques. In addition, Alleghany validates the reasonableness of fair values by comparing information obtained from Alleghany’s valuation service providers to other third-party valuation sources for selected securities. Alleghany also validates prices obtained from brokers for selected securities through reviews by those who have relevant expertise and who are independent of those charged with executing investing transactions.
Alleghany files a consolidated federal income tax return with its subsidiaries. Alleghany’s consolidated federal income tax return includes as part of its taxable income all items of income of non-U.S. subsidiaries that are subject to current U.S. income tax, currently pursuant to provisions of the Internal Revenue Code. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Current tax liabilities or assets are recognized for the estimated taxes payable or refundable on tax returns for the current year.
Casualty claims can have a very long claim tail, in certain situations extending for many years. In addition, casualty claims are more susceptible to litigation and the legal environment and can be significantly affected by changing contract interpretations, all of which contribute to extending the claim tail. For long-tail casualty lines of business, estimating the ultimate liabilities for unpaid loss and LAE is a more complex process and depends on a number of factors, including the line and volume of the business involved.
Debt consists of senior notes issued by Alleghany (the “Alleghany Senior Notes”), senior notes issued by TransRe (the “TransRe Senior Notes,” and together with the Alleghany Senior Notes, the “Senior Notes”) and other debt. The Senior Notes and other debt are carried at unpaid principal balance, including any unamortized premium or discount and any unamortized debt issuance costs.
In May 2015, the FASB issued guidance that requires disclosures related to short-duration insurance contracts. The guidance applies to property and casualty insurance and reinsurance entities, among others, and requires the following annual disclosure related to the liability for loss and LAE: (i) net incurred and paid claims development information by accident year for up to ten years; (ii) a reconciliation of incurred and paid claims development information to the aggregate carrying amount of the liability for loss and LAE; (iii) liabilities for IBNR by accident year and in total; (iv) a description of reserving methodologies (as well as any changes to those methodologies); (v) quantitative information about claim frequency by accident year; and (vi) the average annual percentage payout of incurred claims by age and by accident year. In addition, the guidance also requires insurance entities to disclose for annual and interim reporting periods a roll-forward of the liability for loss and LAE. This guidance was effective for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016, with early adoption permitted. Alleghany adopted this guidance as of December 31, 2016 and the implementation did not have an impact on Alleghany’s results of operations and financial condition. See Note 1(k) and Note 6 for the new disclosures.
In January 2017, the FASB issued guidance that simplifies the subsequent measurement of goodwill. Under this guidance, if an initial qualitative assessment indicates that the fair value of an operating subsidiary may be less than its carrying amount, an impairment charge is recognized for the amount by which the carrying amount of the operating subsidiary exceeds its estimated fair value. Any resulting impairment loss recognized cannot exceed the total amount of goodwill associated with the operating subsidiary. This guidance is effective in the first quarter of 2020 for public entities, with early adoption permitted. Alleghany will adopt this guidance in the first quarter of 2020 and does not currently believe that the implementation will have a material impact on its results of operations and financial condition. See Note 2 for further information on Alleghany’s goodwill.
In addition to W&W|AFCO Steel’s acquisition of Hirschfeld, several other subsidiaries of Alleghany Capital have made smaller acquisitions for the three years ended December 31, 2018, including:
The following table presents the amount of goodwill and intangible assets, net of accumulated amortization expense, reported on Alleghany’s consolidated balance sheets as of December 31, 2018 and 2017:
(1) Goodwill and intangible assets have been reduced by amounts written-down in prior periods, as applicable.
(3) Primarily represents goodwill and other intangible assets related to the acquisition of: (i) Concord on October 1, 2018; (ii) Hirschfeld by W&W|AFCO Steel on February 8, 2018; (iii) W&W|AFCO Steel on April 28, 2017; (iv) Jazwares on April 15, 2016; (v) IPS on October 31, 2015; (vi) Bourn & Koch on April 26, 2012; and (vii) a controlling interest in Kentucky Trailer on August 30, 2013. Also reflects minor acquisitions made by Jazwares in 2016 and 2018, Bourn & Koch in 2016, and Kentucky Trailer in 2015, 2014 and 2018.
The following tables present Alleghany’s financial instruments measured at fair value and the level of the fair value hierarchy of inputs used as of December 31, 2018 and 2017:
As further described in Note 4(i), on March 15, 2018, most of AIHL’s limited partnership interests in certain subsidiaries of Ares Management LLC (“Ares”) were converted into Ares common units. As a result of the conversion, as of March 15, 2018, $208.2 million of Ares common units, classified as equity securities, was transferred into Level 1, and $58.7 million of Ares limited partnership interests, classified as other invested assets, was transferred into Level 3. On September 24, 2018, AIHL’s remaining $56.9 million of Ares limited partnership interests were converted into Ares common units and, as a result, was transferred from Level 3 other invested assets into Level 1 common stocks.
Other than the $56.9 million of Ares-related other invested assets transferred out of Level 3, in 2018, Alleghany transferred out of Level 3 an additional $164.7 million of financial instruments, principally due to an increase in observable inputs related to the valuation of such assets. Specifically, during 2018, there was a decrease in the weight given to non-binding broker quotes, and as such, there was a corresponding increase in quoted prices for similar assets in active markets. Of the $164.7 million of transfers, $150.6 million related to RMBS, $11.0 million related to other asset-backed securities and $3.1 million related to several other types of securities.
(2) There were no OTTI losses recorded in net earnings related to Level 3 instruments still held as of December 31, 2018 and 2017.
The following table presents the amortized cost or cost and estimated fair value of debt securities by contractual maturity as of December 31, 2018. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Realized capital gains and losses for 2018 primarily reflect a $45.7 million gain on AIHL’s conversion of its limited partnership interests in certain subsidiaries of Ares into Ares common units. See Note 4(i) for additional information on this conversion. Realized capital gains and losses for 2018 also reflect net realized capital losses taken in 2018 from the sale of debt securities and a $35.4 million capital loss due to an impairment charge from the write-down of certain SORC assets arising from a decline in energy prices as of December 31, 2018. Realized capital gains and losses for 2017 primarily reflected sales of certain exchange-traded funds, sales of certain equity securities resulting from a partial restructuring of the equity portfolio, an $8.4 million pre-tax gain realized on the sale of PacificComp on December 31, 2017, a $20.9 million realized gain on a bulk settlement of certain contingent consideration liabilities by Alleghany Capital, a $4.8 million loss realized on the from the sale of a SORC legacy oil field on December 29, 2017 and a $7.9 million write-down of certain reinsurance segment assets. Realized capital gains and losses in 2016 primarily reflected sales of equity and debt securities, a gain of $13.2 million on April 15, 2016 in connection with Alleghany Capital’s acquisition of an additional 50 percent equity ownership in Jazwares, when its pre-existing 30 percent equity ownership was remeasured at estimated fair value, and a $98.8 million capital loss incurred by Alleghany Capital due to an impairment charge from the write-down of certain SORC assets.
The following table presents the amounts of gross realized capital gains and gross realized capital losses for 2018, 2017 and 2016:
If Alleghany intends to sell, or it is more likely than not that Alleghany will sell, a debt security before recovery of its amortized cost basis, the total amount of the unrealized loss position is recognized as an OTTI loss in earnings. To the extent that a debt security that is in an unrealized loss position is not impaired based on the preceding, Alleghany will consider a debt security to be impaired when it believes it to be probable that Alleghany will not be able to collect the entire amortized cost basis. For debt securities in an unrealized loss position as of the end of each quarter, Alleghany develops a best estimate of the present value of expected cash flows. If the results of the cash flow analysis indicate that Alleghany will not recover the full amount of its amortized cost basis in the debt security, Alleghany records an OTTI loss in earnings equal to the difference between the present value of expected cash flows and the amortized cost basis of the debt security. If applicable, the difference between the total unrealized loss position on the debt security and the OTTI loss recognized
OTTI losses in 2017 reflected $16.9 million of unrealized losses that were deemed to be other than temporary and, as such, were required to be charged against earnings. Of the $16.9 million of OTTI losses, $15.1 million related to equity securities, primarily in the retail sector, and $1.8 million related to debt securities. The determination that unrealized losses on equity and debt securities were other than temporary was primarily due to the duration of the decline in the fair value of equity and debt securities relative to their costs.
Upon the ultimate disposition of the securities for which OTTI losses have been recorded, a portion of the loss may be recoverable depending on market conditions at the time of disposition. After adjusting the amortized cost basis of securities for the recognition of OTTI losses, the remaining gross unrealized investment losses for debt securities as of December 31, 2018 were deemed to be temporary, based on, among other factors: (i) the duration of time and the relative magnitude to which the fair value of these investments had been below cost were not indicative of an OTTI loss; (ii) the absence of compelling evidence that would cause Alleghany to call into question the financial condition or near-term business prospects of the issuer of the security; and (iii) Alleghany’s ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery.
As of December 31, 2018, the carrying value of Alleghany’s commercial mortgage loan portfolio was $676.5 million, representing the unpaid principal balance on the loans. As of December 31, 2018, there was no allowance for loan losses. The commercial mortgage loan portfolio consists primarily of first mortgages on commercial properties in major metropolitan areas in the U.S. The loans earn interest at fixed- and floating-rates, mature in two to ten years from loan origination and the principal amounts of the loans were no more than approximately two-thirds of the property’s appraised value at the time the loans were made. The estimated fair value of the commercial mortgage loan portfolio approximated carrying value as of December 31, 2018.
Amounts recoverable from reinsurers are recognized in a manner consistent with the claims liabilities associated with the reinsurance placement and presented on the balance sheet as reinsurance recoverables. Such balances as of December 31, 2018 and 2017 are presented in the table below:
(4) Approximately 70 percent of Alleghany’s reinsurance recoverables balance as of December 31, 2018 was due from reinsurers having an A.M. Best Company, Inc. financial strength rating of A (Excellent) or higher, with a majority of the other reinsurance recoverables being secured by funds held, trust agreements or letters of credit.
Alleghany had no allowance for uncollectible reinsurance as of December 31, 2018 and 2017.
Alleghany’s reinsurance and insurance subsidiaries reinsure portions of the risks they underwrite or assume with multiple reinsurance programs. A summary of the more significant programs follows.
(2) Primarily represents the impact on net reserves arising from the sale of PacificComp.
Gross loss and LAE reserves as of December 31, 2018 increased from December 31, 2017, primarily reflecting catastrophe losses in 2018, partially offset by payments on catastrophe losses incurred in 2017 and favorable prior accident year loss reserve development. The 2018 catastrophe losses, net of reinsurance, include $183.4 million related to Typhoon Jebi, $182.0 million related to wildfires in California, $135.2 million related to Hurricane Michael, $70.4 million related to Hurricane Florence and $33.7 million related to Typhoon Trami.
The following table presents the (favorable) unfavorable prior accident year loss reserve development for 2018, 2017 and 2016:
(6) Reflects favorable prior accident year loss reserve development primarily in the 2011 through 2015 accident years.
(7) Represents certain malpractice treaties pursuant to which the increased underwriting profits created by the favorable prior accident year loss reserve development are largely retained by the cedants. As a result, the favorable prior accident year loss reserve development is largely offset by an increase in profit commission expense incurred when such favorable prior accident year loss reserve development occurs.
(8) Represents unfavorable prior accident year loss reserve development related to the U.K. Ministry of Justice’s reduction in the discount rate used to calculate lump-sum bodily injury payouts in personal injury insurance claims in the U.K to negative 0.75 percent as of March 20, 2017 from 2.50 percent.
(9) Primarily reflects favorable prior accident year loss reserve development in the longer-tailed casualty lines of business in the 2002 through 2010 accident years and in the shorter-tailed casualty lines of business (specifically, ocean marine, automobile liability and accident and health) in the 2017 accident year, partially offset by unfavorable prior accident year loss reserve development in the professional liability lines of business in the 2015 accident year.
(11) Generally reflects favorable prior accident year loss reserve development reserves in a variety of casualty & other lines of business primarily in the 2003 through 2015 accident years.
(12) Primarily reflects favorable prior accident year loss reserve development in the umbrella/excess lines of business in the 2005 through 2012 accident years, partially offset by unfavorable prior accident year loss reserve development in the directors’ and officers’ liability lines of business in the 2009, 2012 and 2016 accident years.
(15) Primarily reflects favorable prior accident year loss reserve development related to Hurricane Irma in the 2017 accident year and, to a lesser extent, Hurricane Matthew in the 2016 accident year, as well as various other losses not classified as catastrophes in recent accident years.
(18) Primarily reflects favorable prior accident year loss reserve development in the surety lines of business in the 2016 and 2017 accident years.
(19) Primarily reflects favorable prior accident year loss reserve development in the casualty lines of business in the 2010, 2014, 2015 and 2016 accident years.
(20) Represents certain specialty lines of business written through a program administrator in connection with a terminated program in the 2010 and 2009 accident years and reflects (favorable) loss emergence compared with loss emergence patterns assumed in earlier periods for such business.
The following is information about incurred and paid loss and LAE development, net of reinsurance. The information for 2009 through 2017 is unaudited and is provided as supplementary information. Information is also included for the portion of unpaid loss and LAE, net of reinsurance recoverables, that relate to IBNR and, for the insurance segment, the cumulative number of reported insurance claims. For the reinsurance segment, reported insurance claim information is generally not received from the cedants, and such information is therefore impracticable to disclose.
Reinsurance Segment - Casualty & other - Longer-Tailed Lines of Business(1)
There were no borrowings under the Credit Agreement in 2018 and 2017 and there were no outstanding borrowings under the Credit Agreement as of December 31, 2018. There were no borrowings under the Prior Credit Agreement in 2017 or 2016.
$56.3 million of borrowings by Jazwares under its available credit facility;
$13.8 million of term loans at Bourn & Koch primarily related to borrowings to finance an acquisition from 2016; and
None of these liabilities are guaranteed by Alleghany or Alleghany Capital.
The following table presents the tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities as of December 31, 2018 and 2017:
Alleghany believes that, as of December 31, 2018, it had no material uncertain tax positions. Interest and penalties related to unrecognized tax expenses (benefits) are recognized in income tax expense, when applicable. There were no material liabilities for interest or penalties accrued as of December 31, 2018.
In the U.S., Alleghany’s reinsurance and insurance subsidiaries are subject to insurance laws and regulations that restrict the amount and timing of dividends they may pay without the prior approval of regulatory authorities. Under the insurance holding company laws and regulations, Alleghany’s reinsurance and insurance subsidiaries may not pay an “extraordinary” dividend or distribution without the approval of state insurance regulators. In general, an “extraordinary” dividend or distribution is defined as a dividend or distribution that, together with other dividends and distributions made within the preceding 12 months, exceeds the lesser (or, in some jurisdictions, the greater) of (i) 10 percent of the statutory surplus of the reinsurer or insurer as of the end of the prior calendar year (or, in certain states, as of the end of the prior quarter) and (ii) the net income during the prior calendar year (or, in certain states, the adjusted statutory net investment income). In addition, certain states where Alleghany’s reinsurance and insurance subsidiaries are domiciled prohibit a domestic insurance company from paying dividends except out of earned surplus.
The following table presents the dividends paid to Alleghany by its reinsurance and insurance subsidiaries in 2018, 2017 and 2016:
In February 2018, the Alleghany Board of Directors declared a special dividend of $10.00 per share for stockholders of record on March 5, 2018. On March 15, 2018, Alleghany paid dividends to stockholders totaling $154.0 million.
(1) Contingently issuable shares were potentially available in the periods presented, but were not included in the diluted earnings per share computations because the impact was anti-dilutive to the earnings per share calculation.
the aggregate minimum payments under operating leases with initial or remaining terms of more than one year as of December 31, 2018:
Alleghany’s segments are reported in a manner consistent with the way management evaluates the business. As such, Alleghany classifies its business into three reportable segments - reinsurance, insurance and Alleghany Capital. Alleghany determined that Alleghany Capital qualified as a reportable segment in the first quarter of 2018, reflecting the increased significance of Alleghany Capital’s business to Alleghany and corporate activities.
Reinsurance and insurance underwriting activities are evaluated separately from investment and other activities. Segment accounting policies are described in Note 1.
The following tables present segment results for Alleghany’s three reportable segments and for corporate activities for 2018, 2017 and 2016:
(1) Primarily consists of the following assumed reinsurance lines of business: directors’ and officers’ liability; errors and omissions liability; general liability; medical malpractice; ocean marine and aviation; auto liability; accident and health; mortgage reinsurance; surety; and credit.
The following table presents identifiable assets, the portion of identifiable assets related to cash and invested assets, and equity attributable to Alleghany, for Alleghany’s reportable segments and for corporate activities as of December 31, 2018:
(1) For 2018, the vast majority of noninsurance revenues were recognized as goods and services transferred to customers over time. For 2017 and 2016, approximately 72 percent and 44 percent, respectively, of noninsurance revenues that were recognized as services were transferred to customers over time, with the remainder recognized as goods transferred at a point in time. See Note 1(r) additional information regarding Alleghany’s adoption of new revenue recognition accounting guidance effective in the first quarter of 2018.
Significant portions of the reinsurance segment’s gross premiums written are produced by a limited number of brokers. Gross premiums written produced by the reinsurance segment’s three largest brokers were approximately 26 percent, 18 percent and 15 percent in 2018, 24 percent, 19 percent, and 16 percent in 2017 and 25 percent, 20 percent and 16 percent in 2016.
Alleghany and certain of its subsidiaries provide a variety of retirement benefits. Alleghany provides supplemental retirement benefits through deferred compensation programs and profit sharing plans for certain of its parent company-level officers and employees. In addition, Alleghany’s subsidiaries sponsor both qualified, defined contribution retirement plans for substantially all employees, including executives, and non-qualified plans only for executives, some of which provide for voluntary salary reduction contributions by employees and matching contributions by each respective subsidiary, subject to specified limitations.
annual salary at the time of an officer’s death. After retirement, death benefits that inure to the beneficiaries are generally equal to the annual salary of the officer as of the date of retirement.
These employee retirement plans are not material to Alleghany’s results of operations, financial condition or cash flows for the three years ended December 31, 2018.
Alleghany has an unfunded, noncontributory defined benefit pension plan for parent company-level executives, which was frozen as of December 31, 2013, and a funded, noncontributory defined benefit pension plan for parent company-level employees. The projected benefit obligations of the defined benefit pension plans as of December 31, 2018 and 2017 was $32.3 million and $34.1 million, respectively, and the related fair value of plan assets was $3.3 million and $3.4 million, respectively.
TransRe has an unfunded, noncontributory defined benefit plan and a funded noncontributory defined benefit plan for certain of its employees in the U.S. Benefits under TransRe’s defined benefit plans were frozen as of December 31, 2009. As of December 31, 2018 and 2017, the projected benefit obligation was $65.5 million and $71.8 million, respectively, and the related fair value of plan assets was $49.1 million and $52.4 million, respectively.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of Alleghany Corporation and subsidiaries as of December 31, 2018 and 2017, and the related consolidated statements of earnings and comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2018 and the related notes and the financial statement schedules listed in the Index at Item 15(a)(2) of the Company and our report dated February 20, 2019 expressed an unqualified opinion thereon.
The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.