Our headquarters are located at 14 Wesley Street, 5th Floor, Hamilton HM 11, Bermuda. Our U.S. corporate headquarters are located at 601 Carlson Parkway, Minnetonka, Minnesota 55305 and our registered office is located at Clarendon House, 2 Church Street, Hamilton HM 11, Bermuda. We also maintain branch offices in various cities throughout the United States. Our headquarters, U.S. corporate headquarters and our branch offices are leased. We also own a building in Canton, Massachusetts that houses certain limited corporate functions, as well as field and business operations personnel. In November 2011, we entered into a lease for most of our Canton building. The lease began in June 2012. As our facilities needs change over time, we may lease additional portions of the building. We intend to retain a portion of the building to house certain limited corporate functions, as well as field and business operations personnel. Management considers our office facilities suitable and adequate for our current level of operations.
The following tables set forth our selected consolidated financial information for the dates indicated. We have derived the selected consolidated financial information presented below as of and for the years ended December 31, 2013, 2012, 2011, 2010 and 2009 from our consolidated financial statements.
Our comprehensive loss attributable to OneBeacon’s common shareholders for 2012 was $22.1 million, which included a $91.5 million estimated after tax loss on sale for the Runoff Transaction and a $24.3 million loss from discontinued operations, partially offset by $97.5 million of net income from continuing operations.
The Specialty Products segment is comprised of eight operating segments, including a new Crop underwriting operating segment, as well as the Collector Cars and Boats underwriting operating segment that was exited in the first quarter of 2013 (see Note 2-"Acquisitions and Dispositions" of the accompanying consolidated financial statements), representing an aggregation based on those that offer distinct products and tailored coverages and services to a broad customer base across the United States. In addition to Crop and Collector Cars and Boats, the Specialty Products segment includes the Professional Insurance, Specialty Property, Environmental, Tuition Reimbursement, Programs, and Surety underwriting operating segments. During 2013, we received approval to provide multiple peril crop insurance through the federal crop insurance program administered by the U.S. Department of Agriculture's Risk Management Agency. We have entered into an exclusive agreement with a managing general agency, The Climate Corporation, to provide coverages through the federal program and other supplemental coverages, including crop-hail. We began writing crop business in the fourth quarter of 2013.
Our insurance subsidiaries enter into ceded reinsurance contracts from time to time to protect their businesses from losses due to concentration of risk, to manage their operating leverage ratios and to limit losses arising from catastrophic events. The majority of such reinsurance contracts are executed through excess-of-loss treaties and catastrophe contracts under which the reinsurer indemnifies for a specified part or all of certain types of losses over stipulated amounts arising from any one occurrence or event. We have also entered into quota share treaties with reinsurers under which all risks meeting prescribed criteria covered on a pro rata basis. The amount of each risk ceded by us is subject to maximum limits which vary by line of business and type of coverage.
Reinsurance premiums, commissions, expense reimbursements and reserves related to reinsured business are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums ceded to other companies are reported as a reduction of premiums written. Expense allowances received in connection with reinsurance ceded have been accounted for as a reduction of the related policy acquisition costs and are deferred and amortized accordingly.
Our executive compensation policies are designed with one goal in mind, namely, the maximization of shareholder value over long periods of time. We believe that this goal is best pursued by utilizing a pay-for-performance program that serves to attract and retain superior executive talent and provide management with performance-based incentives to maximize
Compensation of our senior management team, including our named executive officers, consists primarily of three components: base salary, annual bonus and long-term incentive awards. Base salaries have been capped at $500,000. Annual bonus targets for all senior executives are 50%, with the exception of the Chief Executive Officer at 75%, of base salary. Long-term incentives for senior executives have in the past been comprised of performance shares and/or performance units. Under these instruments, payouts are explicitly tied to OneBeacon's performance over a three-year period and are highly variable (the actual number of shares/units paid out at the end of the cycle will range from 0% to 200% of target depending on performance against established goals). See Note 9-"Employee Share-Based Incentive Compensation Plans" of the accompanying consolidated financial statements.
Our share-based compensation plans consist of performance shares, which are typically settled in cash, and restricted shares. Compensation cost is measured and recognized based on the current market price of the underlying common shares and on the number of shares that are expected to vest.
In February 2011, 2012 and 2013, the Compensation Committee granted performance shares with a goal of growth in book value per share of 11%, 10% and 13%, respectively, for the 2011-2013, 2012-2014 and 2013-2015 performance cycles, respectively. As of December 31, 2013, 142,138 performance shares, 181,290 performance shares and 179,000 performance shares were outstanding with respect to the 2011-2013, 2012-2014 and 2013-2015 performance cycles, respectively.
On March 1, 2012, OneBeacon issued 300,000 shares of restricted stock to certain employees that vest in equal installments on February 28, 2014 and 2015. On May 25, 2011, OneBeacon issued 630,000 shares of restricted stock to its CEO that vest in equal installments on February 22, 2014, 2015, 2016 and 2017. Concurrently with the 2011 grant of restricted stock, 35,000 performance shares issued to the CEO for the 2011-2013 performance share cycle were forfeited. Performance share awards to the CEO for each year through 2016 are being reduced by 35,000 shares. The restricted shares contain dividend participation features, and therefore, are considered participating securities. At December 31, 2013 and 2012, the Company had unvested restricted shares outstanding of 915,000 and 927,000, respectively.
The income tax expense related to pre-tax income from continuing operations for the years ended December 31, 2013, 2012 and 2011 represented net effective tax rates of 18.9%, 7.9% and 12.4%, respectively. Our effective tax rate for 2013 was lower than the U.S. statutory rate of 35% due to a reduction in the valuation allowance as a result of the $6.8 million tax benefit associated with the restructuring of a surplus note with HGIE, a reciprocal which is included in our consolidated results as a variable interest entity, and income generated in jurisdictions other than the United States, principally representing interest income taxed in a jurisdiction with a lower effective tax rate. Our effective tax rate for the years ended December 31, 2012 and 2011 were lower than the U.S. statutory rate of 35% due to income generated in jurisdictions other than the United States, principally representing interest income taxed in a jurisdiction with a lower effective tax rate. For the years ended December 31, 2013, 2012 and 2011, the effective tax rate on non-U.S. income was 0.5%, 0.6% and 0.3%, respectively, and the effective rate on U.S. income was 28.1%, 26.1% and 31.6%, respectively.
As described in Note 1-"Nature of Operations and Summary of Significant Accounting Policies" and Note 2-"Acquisitions and Dispositions" of the accompanying consolidated financial statements, in October 2012, we entered into the Stock Purchase Agreement with respect to the sale of our Runoff Business to Armour. Pursuant to the terms of the Stock Purchase Agreement, at closing, we will transfer to Armour all of the issued and outstanding shares of common stock of certain legal entities that will contain the assets, liabilities (including gross and ceded loss reserves) and capital supporting the business as well as certain elements of the Runoff Business infrastructure, including staff and office space. Additionally, as part of the Runoff Transaction, we may provide, under certain scenarios, financing in the form of surplus notes.
The Runoff Transaction is subject to various closing conditions, primarily the receipt of regulatory approvals. The regulatory review process has included a third party actuarial review of the Runoff Business loss and LAE reserves, completed in September of 2013, as well as independent stochastic modeling of the future cash flows of the Runoff Business. At closing, Armour and/or OneBeacon Insurance Company (OBIC) and certain legal entities within the ongoing OneBeacon structure will enter into various ancillary agreements, including the amendment of existing reinsurance agreements and administrative services agreements, to support the separation of the Runoff Business and subsequent transfer to Armour. Also as part of the Runoff Transaction, at closing, OneBeacon and Armour will enter into a Transition Services Agreement (TSA), pursuant to which we will provide certain transition services to Armour during the term of the TSA, which has an initial term of one year. We have concluded that continuing involvement after the closing of the transaction is insignificant relative to the business being sold.
During the fourth quarter of 2013, and as part of our annual certification process, we completed a comprehensive actuarial analysis of the non-A&E loss and LAE reserves associated with the Runoff Business. In addition to our internal actuaries taking into account the differing assumptions, methods, and analyses produced by the independent actuarial review and other factors, management considered other sources of information, including runoff claims staffing models and related costs. For our A&E reserve estimates associated with the Runoff Business, we primarily rely on the internal study of our legacy A&E exposures completed in 2011 and on our subsequent monitoring of quarterly A&E activity, including the comparison of that activity against what was assumed in that most recent study. See “Critical Accounting Estimates” in Item 7 - "Management’s Discussion and Analysis of Financial Condition and Results to Operations.”
As a result of the comprehensive actuarial analysis conducted by our actuaries during the fourth quarter of 2013, we recorded $71.5 million of unfavorable prior year non-A&E loss and LAE development related to the Runoff Business. The increase in loss reserves was concentrated in the workers compensation, personal auto liability, and excess liability lines of business. In addition, we increased our estimate of adjusting and other expenses, a component of LAE reserves. We have not revised our estimate of net ultimate A&E payments. See "Discontinued Operations" in Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations."
In October 2013, we and Armour amended the Stock Purchase Agreement to extend the date by which either party may terminate the Stock Purchase Agreement to July 31, 2014. If the required regulatory approval to close the Runoff Transaction has not been obtained on or prior to July 31, 2014, either we or Armour may unilaterally extend the termination date of the Stock Purchase Agreement by no more than 90 days. We expect the Runoff Transaction to close in mid-2014.
On February 22, 2012, we completed the sale of our AutoOne Insurance business (AutoOne) to Interboro Holdings, Inc. (Interboro) (the AutoOne Transaction). AutoOne had offered products and services to assigned risk markets primarily in New York and New Jersey. AutoOne has been presented as discontinued operations in the statements of operations and cash flows with the prior periods reclassified to conform to the current presentation. The AutoOne disposal group excludes investing and financing activities from amounts classified as discontinued operations. OneBeacon's investing and financing operations are conducted on an overall consolidated level and, accordingly, there are no separately identifiable investing or financing cash flows associated with AutoOne. Pursuant to the terms of the AutoOne Transaction, at closing, the legal entities included in the sale held an agreed upon level of invested assets and capital.
Our comprehensive income attributable to OneBeacon's common shareholders was $166.6 million for 2013, compared to a comprehensive loss of $22.1 million for 2012. Net income attributable to OneBeacon's common shareholders was $146.0 million for 2013, compared to a net loss of $19.2 million for 2012. The improvement in net income (loss) compared to the prior year period was primarily due to a $115.3 million improvement in the after-tax results of discontinued operations, substantially all of which related to the loss in 2012 from the Runoff Transaction. Additionally, we recognized a $23.0 million pre-tax ($15.0 million after tax) gain from the sale of Essentia in 2013, a $6.8 million tax benefit from the Reciprocal Note Restructure, and a $4.0 million pre-tax benefit related to the Licensing Arrangement. These improvements to net income (loss) for 2013 were offset significantly by a $18.8 million decrease in pre-tax net investment results, primarily driven by changes in the market value of our fixed maturity portfolio as a result of increases in interest rates. The $20.6 million change in other comprehensive income (loss) items in 2013 primarily reflects the impact of positive investment returns and an increase in the discount rate used to estimate our qualified pension plan projected benefit obligation in 2013, as compared to a $2.9 million after tax decrease in our pension plans in 2012 driven by an increase in the plan's projected benefit obligation, resulting from a lower discount rate, offset by positive investment returns.
reserve development for 2013, as unfavorable development on a few large claims in both Specialty Property and Entertainment were offset by favorable development in Professional Insurance, IMU and Technology. This compared to favorable loss reserve development of $7.4 million, or 0.7 points, for 2012, primarily resulting from favorable development in Technology and Professional Insurance that was partially offset by adverse development within Specialty Property and Energy. The expense ratio improved 3.2 points to 36.9% for 2013. Our expense ratio was positively impacted by a 3.4 point decrease in policy acquisition expenses for 2013, compared to 2012, driven by our exit of the Collector Cars and Boats business, which carried a high acquisition expense ratio.
Our combined ratio was 97.5% for 2012, compared to 92.1% for 2011. The increase in the combined ratio for 2012 was primarily due to the impact of Superstorm Sandy in 2012, as well as a 2.2 point decrease in favorable loss reserve development compared to 2011. Favorable loss reserve development was $7.4 million, or 0.7 points, in 2012 compared to $29.8 million, or 2.9 points, for the prior year period. The favorable loss reserve development for 2012 was primarily in the workers' compensation, multiple peril liability and general liability lines. This favorable development was offset somewhat by adverse loss reserve development on a few excess property claims. Catastrophe losses were $47.7 million, or 4.2 points, for 2012, due primarily to the impact of Superstorm Sandy. The year ended December 31, 2011 included $36.7 million, or 3.6 points, of catastrophe losses primarily related to hurricane Irene, tornados in the southeastern and midwestern United States as well as storms and freezing weather in the northeastern and southwestern United States. Total net written premiums increased 11.0% in 2012 to $1,179.2 million, compared to $1,062.7 million for the prior year, due to the growth from both our Specialty Products and Specialty Industries segments. The expense ratio increased 2.2 points, primarily due to our investment in new businesses and costs associated with actions taken to migrate certain corporate functions to Minnesota in 2012.
Reinsurance protection. For 2012, our net combined ratio was lower than our gross combined ratio by 0.8 points, primarily due to the significant amount of reinsurance cessions related to Superstorm Sandy, which were partially off-set by the impact of the cost of facultative reinsurance and property reinsurance, and also the cost of catastrophe reinsurance and marine reinsurance.
Net written premiums for Specialty Products decreased to $509.6 million for 2013 from $630.9 million for 2012. The decrease was due to a decline in net written premiums of $180.3 million from our Collector Cars and Boats underwriting operating segment that we exited January 1, 2013. This decrease was offset, in part, by increases in net written premiums of $20.2 million from Programs which we began writing in 2012, $8.8 million from Surety which we began writing in 2012, $8.2 million from Professional Insurance primarily related to management liability, $6.4 million from Specialty Property, $5.3 million from Environmental which we began writing in 2011, $0.8 million from Tuition Reimbursement, and $9.3 million related to our new businesses, including Crop.
Professional Insurance, and Collector Cars and Boats. The decrease in the expense ratio for 2013, compared to 2012, was primarily due to a 5.7 point decrease in policy acquisition expenses, due primarily to lower expense in Collector Cars and Boats which carried a higher acquisition ratio. This decrease in policy acquisition expense was partially offset by a 1.8 point increase in other underwriting expense, driven by increased non-claims litigation expenses and incentive compensation accruals, offset in part by decreased fringe benefits and information technology expenses.
Net written premiums for Specialty Products increased 10.5% to $630.9 million in 2012 from $571.2 million in 2011. The increase was due to increases in net written premiums of $25.8 million from Professional Insurance primarily related to the management liability line, $13.1 million from Collector Cars and Boats driven by growth in new business as well as retention, $9.0 million from Specialty Property, $5.3 million from Environmental which we began writing in 2011, $4.5 million from Tuition Reimbursement, $1.7 million from Surety which we began writing in 2012, and $0.3 million from Programs which we began writing in 2012.
Net written premiums for Specialty Industries increased to $579.0 million in 2013 from $548.3 million in 2012. The increase in 2013 was due to increases in net written premiums of $21.1 million from our Government Risks underwriting operating segment, $20.9 million from IMU (which includes $6.2 million of energy business net written premiums that were included in Energy in 2012), $10.8 million from Technology, $5.4 million from Entertainment, and $3.9 million from Accident, which were primarily due to rate increases and new business, as well as solid retention levels. These increases were partially offset by a $25.2 million decrease in net written premiums from the Energy underwriting operating segment, which we exited in the first quarter of 2013.
The Specialty Industries combined ratio for 2012 increased to 97.1% from 96.0% for 2011. The loss and LAE ratio was unchanged at 57.7% while the expense ratio increased by 1.1 points to 39.4%. The year ended December 31, 2012 included 1.1 points of favorable loss reserve development primarily related to Technology, compared to 2.8 points of favorable loss reserve development primarily related to Technology in the prior year. This 1.7 point decrease in favorable loss reserve development was offset by a 1.7 point decrease in current accident year losses, compared to 2011. The year ended December 31, 2012 included 4.7 points of catastrophe losses, primarily related to Superstorm Sandy and thunderstorms in the midwestern, mid-Atlantic, and northeastern United States, which primarily impacted IMU, as compared to 6.8 points of catastrophe losses in 2011, primarily related to hurricane Irene, storms and freezing weather in the northeastern and southwestern United States impacting primarily IMU, and tornadoes in the southeastern and midwestern United States most notably impacting IMU and Technology. The increase in the expense ratio was due to a 2.2 point increase in other underwriting expenses primarily for Entertainment and Technology, partially offset by a 1.1 point decrease in policy acquisition expenses primarily related to Entertainment.
Beginning in 2013, we received approval to provide multiple peril crop insurance (MPCI) through the federal crop insurance program administered by the Risk Management Agency (RMA), which is a division of the U.S. Department of Agriculture. We entered into an exclusive agreement with a managing general agency, The Climate Corporation, to provide coverages through the federal program and other supplemental coverages, including crop-hail (a separate, non-federally subsidized product that is regulated by each state). In the federal crop insurance program, the RMA sets the policy terms and conditions, rates and forms, and is also responsible for setting compliance standards. As a participating company, we report all details of underwritten policies to the RMA and are party to a Standard Reinsurance Agreement (SRA). The SRA defines the relationship between participating companies and the Federal Crop Insurance Corporation.
A summary of results from our Investing, Financing and Corporate reportable segment is as follows:
Investing, Financing and Corporate-Year ended December 31, 2013 versus year ended December 31, 2012
Investing, Financing and Corporate reported pre-tax income from continuing operations of $97.7 million in 2013, compared to $80.8 million in 2012. The increase was primarily related to a $23.0 million pre-tax ($15.0 million after tax) gain from the sale of Essentia and a $4.0 million pre-tax benefit related to the Licensing Arrangement, mostly offset by a significant decrease in investment returns. As described in greater detail in "Summary of Investment Results" below, net investment income decreased to $41.1 million in 2013, compared to $53.6 million in 2012, and net realized and change in unrealized investment gains decreased to $49.4 million in 2013, compared to $55.7 million in 2012. Interest expense decreased to $13.0 million for 2013, compared to $16.9 million for 2012, reflecting the lower interest rate of 4.6% on our senior notes for 2013 compared to an interest rate of 5.875% on senior notes prior to their refinancing in the fourth quarter of 2012. See "Liquidity and Capital Resources-Financing."
As a result of the comprehensive actuarial analysis conducted by our actuaries during the fourth quarter of 2013, we recorded $71.5 million of unfavorable prior year non-A&E loss and LAE development related to the Runoff Business. The increase in loss reserves was concentrated in the workers compensation, personal auto liability, and excess liability lines of business. In addition, we increased our estimate of adjusting and other expenses, a component of LAE reserves. We have not revised our estimate of net ultimate A&E payments.
As of December 31, 2013, the recorded net unpaid loss and LAE reserves associated with the Runoff Business totaled $188.4 million. Management believes that the recorded net loss and LAE reserves reflect a reasonable provision for expected future loss and LAE payments and represent management’s best estimate within a range of reasonable estimates.
The 2012 loss from discontinued operations of $24.3 million, net of tax, consisted of $24.0 million related to the Runoff Business and $0.3 million related to AutoOne. The loss related to the Runoff Business resulted from unfavorable loss reserve development primarily driven by case incurred development on a small number of claims related to multiple peril liability lines and general liability lines and also the impact of an adverse court ruling in Mississippi regarding a disputed assessment from an involuntary pool for hurricane Katrina claims.
In connection with purchase accounting for the OneBeacon Acquisition, we were required to adjust to fair value our loss and LAE reserves and the related reinsurance recoverables. Loss and LAE reserves and the related reinsurance recoverable presented in the summary of reclassified balances within assets and liabilities held for sale as December 31, 2013 and 2012 are net of $136.9 million and $150.1 million, respectively, related to the outstanding pre-tax unaccreted adjustment.
Our total common equity securities, convertible fixed maturity and other investments portfolio returned 18.3% for 2013, driven by strong equity market performance, compared to 6.4% for 2012. Our total common equity securities portfolio returned 24.5% and 7.5% for 2013 and 2012, respectively, or underperformed by 790 basis points and 850 basis points, respectively, the S&P 500 Index benchmark. During 2013, our total common equity securities portfolio had overweight exposure to the gold mining sector and underweight exposure to the consumer discretionary sector compared to the S&P 500 Index. Our convertible fixed maturity investments portfolio, which returns typically lag in a strong equity market, returned 6.7% and 6.2% for 2013 and 2012, respectively. Other investments, which are composed principally of hedge funds and private equities, returned 8.3% and 4.8% for 2013 and 2012, respectively. The change in net unrealized investment gains in common equity securities was an increase of $32.1 million during 2013, driven by a strong common equities market.
Our total pre-tax investment results were $109.3 million, a return of 4.4% on average invested assets for 2012, compared to $82.0 million, a return of 3.0% for 2011. Net investment income in 2012 was $53.6 million, a decrease of $17.8 million, compared to $71.4 million in 2011. The decrease was principally due to lower fixed maturity investment yields and a reduction in average invested assets as a result of losses paid related to the Runoff Business, as well as the closing of AutoOne and return of capital to shareholders. Net realized investment gains were $50.8 million in 2012, a decrease of $6.0 million compared to $56.8 million in 2011. The change in net unrealized investment gains was an increase of $4.9 million in 2012, compared to a decrease in net unrealized investment gains of $46.2 million in 2011.
The following three investment tables include carrying values of $236.3 million and $338.1 million of fixed maturity investments which have been reclassified to assets held for sale in the consolidated balance sheet as part of the Runoff Transaction as of December 31, 2013 and 2012, respectively.
The breakdown of our fixed maturity portfolio, including convertible fixed maturity investments, at December 31, 2013 by credit class, based upon issue credit ratings provided by Standard & Poor's, or if unrated by Standard & Poor's, long-term obligation ratings provided by Moody's, is as follows:
The weighted average duration of our fixed maturity portfolio, including convertible fixed maturity investments, at December 31, 2013 is approximately 2.2 years. The maturity distribution for fixed maturity investments, including convertible fixed maturity investments, held at December 31, 2013 is as follows:
capital structure. We believe this structural protection mitigates the risk of loss tied to refinancing challenges facing the commercial real estate market. As of December 31, 2013, on average less than 1% of the underlying loans were reported as non-performing for all CMBS held. We are not an originator of residential mortgage loans and did not hold any residential mortgage-backed securities (RMBS) categorized as sub-prime as of December 31, 2013. Our investments in hedge funds and private equity funds contain negligible amounts of sub-prime mortgage-backed securities as of December 31, 2013. We consider sub-prime mortgage-backed securities to be those that have underlying loan pools that exhibit weak credit characteristics or are issued from dedicated sub-prime shelves or dedicated second-lien shelf registrations (i.e., we consider investments backed primarily by second-liens to be sub-prime risks regardless of credit scores or other metrics).
There are also mortgage backed securities that we categorize as "non-prime" (also called "Alt A" or "A-") that are backed by collateral that has overall credit quality between prime and sub-prime, as determined based on our review of the characteristics of their underlying mortgage loan pools, such as credit scores and financial ratios. As of December 31, 2013, we held one mortgage-backed security with a market value of $7.3 million that was classified as non-prime. Our non-agency residential mortgage-backed portfolio is generally of moderate average life, fixed rate and structurally senior. We do not own any collateralized debt obligations, including residential mortgage-backed collateralized debt obligations.
The classification of the underlying collateral quality and the tranche levels of our non-agency RMBS securities are as follows as of December 31, 2013:
At issuance, Super Senior, or in the case of resecuritization, the underlying securities, were rated AAA by Standard & Poor's, Aaa by Moody's, or AAA by Fitch and were senior to other AAA or Aaa bonds.
The amount of fixed and floating rate securities and their tranche levels are as follows as of December 31, 2013:
At issuance, Super Senior, or in the case of resecuritization, the underlying securities, were rated AAA by Standard & Poor's, Aaa by Moody's or AAA by Fitch and were senior to other AAA or Aaa bonds.
Holding company level. The primary sources of cash for OneBeacon Insurance Group, Ltd. (OneBeacon Ltd.) and certain of our intermediate holding companies are expected to be distributions and tax sharing payments received from our insurance operating subsidiaries, capital raising activities, net investment income, and proceeds from sales and maturities of holding company investments. The primary uses of cash are expected to be interest payments on our debt obligations, repurchases and retirements of our debt obligations, dividend payments on our common shares, common share repurchases, purchases of investments, payments made to tax authorities, contributions to our operating subsidiaries, and holding company operating expenses.
Generally, our top tier regulated U.S. insurance operating subsidiaries have the ability to pay dividends during any 12-month period without the prior approval of regulatory authorities in an amount set by formula based on the greater of prior year statutory net income or 10% of prior year end statutory surplus, subject to the availability of unassigned funds. OBIC, our primary top tier regulated insurance operating subsidiary, has the ability to pay $86.6 million of dividends during 2014 without prior approval of regulatory authorities, subject to the availability of unassigned funds. The amount of dividends available to be paid by OBIC in any given year is also subject to cash flow and earnings generated by OBIC's business, which now just comprises the Runoff Business, as well as to dividends received from its subsidiaries, including ASIC, the lead U.S. insurance operating subsidiary for the Ongoing Business. At December 31, 2013, OBIC had $0.6 billion of unassigned funds and $0.9 billion of statutory surplus.
ASIC has the ability to pay dividends during any 12-month period without the prior approval of regulatory authorities in an amount set by formula based on the lesser of net investment income, as defined by statute, or 10% of statutory surplus, in both cases as most recently reported to regulatory authorities, subject to the availability of earned surplus, and subject to dividends paid in prior periods. ASIC has the ability to pay $23.9 million of dividends during 2014 without prior approval of regulatory authorities, subject to the availability of earned surplus. Given the changes in structure noted above, and in order for ASIC to pay dividends consistent with being the lead insurance company for our Ongoing Business, ASIC may require prior approval by regulatory authorities in order to make additional distributions until it builds up a historical net investment income stream and earned surplus balance under its new structure. At December 31, 2013, ASIC had $94.6 million of earned surplus and $0.7 billion of statutory surplus.
Split Rock has the ability to declare or pay dividends during any 12-month period without the prior approval of Bermuda regulatory authorities on condition that any such declaration or payment of such dividend does not cause a breach of any of its regulatory solvency and liquidity requirements. If Split Rock fails to meet its regulatory solvency or liquidity requirements on the last day of any financial year, it is prohibited from declaring or paying any dividends during the next financial year without the approval of the BMA.
In addition, under the Companies Act 1981 of Bermuda (the Companies Act), Split Rock is prohibited from declaring or paying a dividend, or making a distribution out of contributed surplus, if there are reasonable grounds for believing that in each case:
• Split Rock is, or would after the payment be, unable to pay its liabilities as they become due; or
During 2014, Split Rock has the ability to make capital distributions without the prior approval of regulatory authorities, subject to meeting all appropriate liquidity and solvency requirements, of up to $20.3 million, which is equal to 15% of its December 31, 2013 statutory capital, excluding earned surplus. During the year ended December 31, 2013, we, through an intermediary holding company, contributed $135.1 million to Split Rock. Split Rock did not pay any dividends in 2013.
The following table summarizes our debt to capital ratio at December 31, 2013 and 2012:
In November 2012, OneBeacon U.S. Holdings, Inc. (OBH) issued $275.0 million face value of senior unsecured notes (2012 Senior Notes) through a public offering, at an issue price of 99.9% and received $272.9 million of proceeds. The 2012 Senior Notes bear an annual interest rate of 4.6% payable semi-annually in arrears on May 9 and November 9, until maturity on November 9, 2022, and are fully and unconditionally guaranteed as to the payment of principal and interest by OneBeacon Ltd. OBH incurred $2.8 million in expenses related to the issuance of the 2012 Senior Notes (including the $1.8 million underwriting discount), which have been deferred and are being recognized into interest expense over the life of the 2012 Senior Notes. Taking into effect the amortization of the original issue discount and all underwriting and issuance expenses, the 2012 Senior Notes have an effective yield to maturity of approximately 4.7% per annum. The proceeds from the 2012 Senior Notes were utilized to repurchase and retire, for $275.9 million, the remaining $269.8 million balance outstanding on our previously held senior notes issued in 2003 (2003 Senior Notes).
The balances included in the table above regarding our long-term incentive compensation plans include amounts payable for performance shares and units, as well as deferred compensation balances. Exact amounts to be paid cannot be predicted with certainty as the ultimate amounts of these liabilities are based on future performance. The estimated payments reflected in the table are based on current accrual factors (common share price and pay-out percentage) and assume that all outstanding balances were 100% vested as of December 31, 2013.
On August 22, 2007, our Board authorized us to repurchase up to $200.0 million of OneBeacon's Class A common shares from time to time, subject to market conditions. Shares may be repurchased on the open market or through privately negotiated transactions. This authorization does not have a stated expiration date. Since the inception of this authorization, the Company has repurchased and retired 5.6 million of its Class A common shares. During 2013 and 2012, no shares were repurchased under the share repurchase authorization. The amount of authorization remaining is $87.7 million.
Detailed information concerning our cash flows during the years ended December 31, 2013, 2012 and 2011 follows:
During 2013, we declared and paid $80.2 million, respectively, of regular quarterly cash dividends to holders of OneBeacon's common shares.
During 2012, we received cash proceeds, net of issuance costs, of $271.9 million in connection with the issuance of our 2012 Senior Notes.
We measure certain assets at estimated fair value in our consolidated financial statements, with changes therein recognized in current period earnings. In addition, we disclose estimated fair value for certain assets and liabilities measured at historical or amortized cost. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an exit price). Fair value measurements are categorized into a hierarchy that distinguishes between inputs based on market data from independent sources (observable inputs) and a reporting entity's internal assumptions based upon the best information available when external market data is limited or unavailable (unobservable inputs). Quoted prices in active markets for identical assets or liabilities have the highest priority (Level 1),
Includes $236.3 million and $338.1 million of fixed maturity investments reclassified to assets held for sale in the December 31, 2013 and 2012 consolidated balance sheets, respectively, as part of the Runoff Transaction.
Excludes the carrying value of $19.7 million and $21.1 million as of December 31, 2013 and 2012, respectively, associated with a tax advantaged federal affordable housing development fund accounted for using the equity method.
The changes in Level 3 fair value measurements for the year ended December 31, 2013 are as follows:
Excludes the carrying value of $19.7 million associated with a tax advantaged federal affordable housing development fund accounted for using the equity method.
“Transfers out” of Level 3 fixed maturity investments of $74.9 million for the year ended December 31, 2013 were comprised of three mortgage-backed securities which had been previously classified as a Level 3 measurement and were recategorized as a Level 2 measurement when quoted market prices for similar securities that were considered reliable and could be validated against an alternative source became available.
Uncertainties in estimating ultimate loss and LAE are magnified by the time lag between when a claim actually occurs and when it is reported and settled. This time lag is sometimes referred to as the "claim-tail." The claim-tail for most property coverages is typically short (usually a few days up to a few months). The claim-tail for liability/casualty coverages, such as automobile liability, general liability, products liability, multiple peril coverage, and workers compensation, can be especially long as claims are often reported and ultimately paid or settled years, even decades, after the related loss events occur. During the long claims reporting and settlement period, additional facts regarding coverages written in prior accident years, as well as about actual claims and trends may become known and, as a result, we may adjust our reserves. If management determines that an adjustment is appropriate, the adjustment is booked in the accounting period in which such determination is made. Accordingly, should reserves need to be increased or decreased in the future from amounts currently established, future results of operations would be negatively or positively impacted, respectively.
Historical paid loss development methods: These methods use historical loss payments over discrete periods of time to estimate future losses. Historical paid loss development methods assume that the ratio of losses paid in one period to losses paid in an earlier period will remain constant. These methods necessarily assume that factors that have affected paid losses in the past, such as inflation or the effects of litigation, will remain constant in the future. Because historical paid loss development methods do not use case reserves to estimate ultimate losses, they can be more reliable than the other methods discussed below that look to case reserves (such as actuarial methods that use incurred losses) in situations where there are significant changes in how case reserves are established by a company's claims adjusters. However, historical paid loss development methods are more leveraged, meaning that small changes in payments have a larger impact on estimates of ultimate losses, than actuarial methods that use incurred losses because cumulative loss payments take much longer to equal the expected ultimate losses than cumulative incurred amounts. In addition, and for similar reasons, historical paid loss development methods are often slow to react to situations when new or different factors arise than those that have affected paid losses in the past.
More recently, since the 1990s, we have experienced an influx of claims from commercial insureds, including many non-Fortune 500-sized accounts written during the 1970s and 1980s, who are named as defendants in asbestos lawsuits. As a number of large well-known manufacturers of asbestos and asbestos-containing products have gone into bankruptcy, plaintiffs have sought recoveries from peripheral defendants, such as installers, transporters or sellers of such products, or from owners of premises on which the plaintiffs' exposure to asbestos allegedly occurred. At December 31, 2013, 547 policyholders had asbestos-related claims against us. In 2013, 94 new insureds with such peripheral involvement presented asbestos claims under prior policies we had written.
Historically, most asbestos claims have been asserted as product liability claims. Recently, insureds who have exhausted the available products liability limits of their insurance policies have sought from insurers such as us payment for asbestos claims under the premises and operations coverage of their liability policies, which may not be subject to similar aggregate limits. We expect this trend to continue. However, to date there have been fewer of these premises and operations coverage claims than product liability coverage claims. This may be due to a variety of factors, including that it may be more difficult for underlying plaintiffs to establish losses as stemming from premises and operations exposures, which requires proof of the defendant's negligence, rather than products liability under which strict legal liability applies. Premises and operations claims may vary significantly and policyholders may seek large amounts, although such claims frequently settle for a fraction of the initial alleged amount. Accordingly, there is a great deal of variation in damages awarded for the actual injuries. As of December 31, 2013, there were approximately 407 active claims by insureds against us without product liability coverage asserting operations or premises coverage, which may not be subject to aggregate limits under the policies.
During 2011, we completed a study of our legacy A&E exposures. Based on the results of the study, we increased the central estimate of incurred losses ceded to NICO from $2.2 billion to $2.3 billion, an increase of $121.9 million, net of underlying reinsurance. Due to the NICO Cover, there was no impact to income or equity from the change in the estimate. We review A&E activity each quarter and compare that activity to what was assumed in the most recently completed A&E study. Through December 31, 2013, that activity has been in line with expectations, generally, so we have not revised our estimate of ultimate payments.
Our reserves for A&E losses, net of Third-Party Recoverables but prior to NICO recoveries, were $0.6 billion at December 31, 2013. An industry benchmark of reserve adequacy is the "survival ratio," computed as a company's reserves divided by its historical average yearly loss payments. This ratio indicates approximately how many more years of payments the reserves can support, assuming future yearly payments are equal to historical levels. Our survival ratio was 7.8 years at December 31, 2013. This was computed as the ratio of A&E reserves, net of Third-Party Recoverables prior to the NICO Cover of $0.6 billion plus the remaining unused portion of the NICO Cover of $198.3 million, to the average A&E loss payments over the three-year period ended December 31, 2013, net of Third-Party Recoverables. Our survival ratio was 10.4 years at December 31, 2012. We believe that as a result of the NICO Cover and our historical third-party reinsurance programs, we should not experience material financial loss from A&E exposures under current coverage interpretations and that our survival ratio is consistent with industry survival ratios. However, the survival ratio is a simplistic measure estimating the number of years it would be before the current ending loss reserves for these claims would be paid using recent annual average payments subject to adjustments for unusual items. Many factors, such as aggressive settlement procedures, mix of business and coverage provided, have a significant effect on the amount of A&E reserves and payments and the resultant survival ratio. Thus, caution should be exercised in attempting to determine reserve adequacy for these claims based simply on this survival ratio.
Our A&E claims activity, substantially all of which relates to Runoff Business, the operations of which have been included in discontinued operations and the loss and LAE reserves of which are included in liabilities held for sale on the December 31, 2013 and 2012 consolidated balance sheets, is illustrated in the table below:
For loss and allocated loss adjustment expense reserves, excluding A&E, the key assumption as of December 31, 2013 was that the impact of the various reserving factors, as described below, on future paid losses would be similar to the impact of those factors on the historical loss data with the exception of severity trends. Severity trends have been relatively stable over the relevant historical period. The actuarial methods used would project losses assuming continued stability in severity trends. Management has considered future increases in loss severity trends including the impact of inflation in making its reserve selections.
The major causes of material uncertainty (reserving factors) generally will vary for each product line, as well as for each separately analyzed component of the product line. The following section details reserving factors by product line. There could be other reserving factors that may impact ultimate claim costs. Each reserving factor presented will have a different impact on estimated reserves. Also, reserving factors can have offsetting or compounding effects on estimated reserves. For example, in workers compensation, the use of expensive medical procedures that result in medical cost inflation may enable workers to return to work faster, thereby lowering indemnity costs. Thus, in almost all cases, it is impossible to discretely measure the effect of a single reserving factor and construct a meaningful sensitivity expectation. Actual results will likely vary from
expectations for each of these assumptions, resulting in an ultimate claim liability that is different from that being estimated currently.
Changes in the interpretations and processes of various workers compensation bureaus' oversight of claims
Multiple peril represents a package policy sold to insureds or to members of trade associations or other groups that include general liability and property insurance. General liability covers businesses for any liability resulting from bodily injury and property damage arising from general business operations, accidents on a premises and the products manufactured or sold. Property covers losses to a business' premises, inventory and equipment as a result of weather, fire, theft and other causes. Because commercial multiple peril provides a combination of property and liability coverage typically for small businesses, it includes both short- and long-tail coverages. For property coverage, it generally takes a relatively short period of time to close claims, while for the other coverages, generally for the liability coverages, it takes a longer period of time to close claims. The
In addition to the development described for the lines of business above, management also recorded a $4.3 million net decrease in reserves in other lines of business as a result of its review of loss reserves at December 31, 2011. The change in reserves for each other line of business was not individually significant.
Amounts included in Runoff Business have been reclassified to liabilities held for sale in the December 31, 2013 and 2012 consolidated balance sheets.
Unpaid loss and LAE reserves, net of reinsurance recoverable on unpaid losses, for our Ongoing Business by line of business at December 31, 2013 and 2012 were as follows:
The following table shows the recorded reserves and the high and low ends of our range of reasonable loss and LAE reserves, net of reinsurance recoverable on unpaid losses, estimates for our Ongoing Business by line of business at December 31, 2013.
As part of the comprehensive actuarial analysis conducted by our actuaries during the fourth quarter of 2013, we updated our view of the range of reasonable estimates for our Runoff Business. This review resulted in a wider, more highly skewed range for reserves other than A&E, driven primarily by the impact of varying inflation assumptions on the workers’ compensation and unlimited medical automobile no-fault lines of business. As a result, the runoff percentage in the range is lower in 2013 despite recording runoff reserves at the actuarial central estimate.
During 2013, in our Ongoing Business, we experienced unexpected adverse development in underlying case incurred and paid data in some of our newer business segments. This emergence has resulted in an upward shift in the actuarial range for the General Liability, Auto Liability and Other lines of business. As this emergence is relatively recent, and in light of evaluating less seasoned data associated with the new businesses relative to expected results, management has not revised its best estimate of reserves and therefore our carried reserves are lower in the range of reserves.
Multiple peril liability: Recorded loss and LAE reserves, net of reinsurance recoverables excluding the GRC Cover, for multiple peril, for the Ongoing Business were $50.8 million and for Runoff Businesses were $82.3 million at December 31, 2013. Reported loss development patterns are a key assumption for these lines of business, particularly for more mature accident years. Historically, assumptions on reported loss development patterns have been impacted by, among other things, emergence of new types of claims (e.g. construction defect claims) or a shift in the mixture between smaller, more routine claims and larger, more complex claims. If case reserve adequacy for multiple peril claims changed by 10.0 points this would have changed the estimated net reserve for Ongoing Business by approximately $2 million and for Runoff Business by approximately $7 million at December 31, 2013, in either direction.
The collectibility of reinsurance recoverables is subject to the solvency and willingness to pay of the reinsurer. We are selective in choosing our reinsurers, placing reinsurance principally with those reinsurers with a strong financial condition, industry ratings and underwriting ability. Management monitors the financial condition and ratings of our reinsurers on an ongoing basis. See Note 4-"Reinsurance" and Note 19-"Discontinued Operations" of the accompanying consolidated financial statements for additional information on our reinsurance programs.
These statements are based on certain assumptions and analyses made by us in light of our experience and judgments about historical trends, current conditions and expected future developments, as well as other factors believed to be appropriate in the circumstances. However, whether actual results and developments will conform to our expectations is subject to a number of risks, uncertainties or other factors which are described in more detail beginning on page 19 of this Form 10-K, that could cause actual results to differ materially from expectations, including:
claims arising from catastrophic events, such as hurricanes, windstorms, earthquakes, floods or terrorist attacks;
our ability to continue meeting our debt and related service obligations or to pay dividends;