The principal executive offices of Alleghany, Alleghany Capital and Roundwood are located in leased office space in New York, New York. TransRe leases office space in New York, New York for its headquarters and office space in almost all of its locations around the world. RSUI leases office space in Atlanta, Georgia for its headquarters and office space in Sherman Oaks, California. CapSpecialty leases office space in Middleton, Wisconsin for its headquarters and office space in its other locations throughout the U.S. Bourn & Koch owns its principal offices and manufacturing facilities, which are located in Rockford, Illinois and leases certain offices and manufacturing facilities, which are located in Olympia, Washington. Kentucky Trailer leases its principal offices and manufacturing facilities, which are located in Louisville, Kentucky. SORC leases office space in Golden, Colorado for its headquarters and owns facilities, mineral rights and land in other locations in the Midwestern and Southeastern U.S. IPS leases office space in Blue Bell, Pennsylvania for its headquarters and office space in its locations around the world. Jazwares leases office space in Sunrise, Florida for its headquarters and office space in its locations around the world. W&W|AFCO Steel owns its principal office in Oklahoma City, Oklahoma, for its headquarters and owns its principal facilities, which are located in Arkansas, Colorado, Oklahoma and Texas. Alleghany Properties leases office space in Sacramento, California. Management considers its facilities suitable and adequate for the current level of operations. See Note 12(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 additional information on our leases.
(1) On April 28, 2017, we acquired W&W|AFCO Steel; on April 15, 2016, we acquired Jazwares; on October 31, 2015, we acquired IPS; on August 30, 2013, we acquired Kentucky Trailer; and on April 26, 2012, we acquired Bourn & Koch. On December 31, 2017, we sold PacificComp.
Underwriting profit is a non-GAAP financial measure for our reinsurance and insurance segments. Underwriting profit represents net premiums earned less net loss and LAE and commissions, brokerage and other underwriting expenses, all as determined in accordance with GAAP and does not include: (i) net investment income; (ii) net realized capital gains; (iii) other than temporary impairment, or “OTTI” losses; (iv) other revenue; (v) other operating expenses; (vi) corporate administration; (vii) amortization of intangible assets; and (viii) interest expense. We use underwriting profit as a supplement to earnings before income taxes, the most comparable GAAP financial measure, to evaluate the performance of our reinsurance and insurance segments and believe that underwriting profit provides useful additional information to investors because it highlights net earnings attributable to our reinsurance and insurance segments’ underwriting performance. Earnings before income taxes may show a profit despite an underlying underwriting loss, and when underwriting losses persist over extended periods, a reinsurance or an insurance company’s ability to continue as an ongoing concern may be at risk. A reconciliation of underwriting profit to earnings before income taxes is presented within “Consolidated Results of Operations.”
Net investment income increased by 2.9 percent in 2017 from 2016, and 2016 approximated net investment income in 2015.
Sales revenues for Alleghany Capital were $906.9 million in 2017, compared with $687.1 million in 2016 and $241.0 million in 2015.
(1) Includes $86.6 million attributable to RSUI and $0.2 million attributable to CapSpecialty.
(4) Attributable to wildfires in the State of California and earthquakes in Mexico.
Our catastrophe losses are more fully described on pages 84, 85 and 92.
(4) The expense ratio is derived by dividing the amount of commissions, brokerage and other underwriting expenses by net premiums earned, all as determined in accordance with GAAP.
The decrease in net premiums earned in 2017 from 2016 primarily reflects a decrease at our reinsurance segment due mainly to a decrease in net premiums written in recent quarters, partially offset by an increase at our insurance segment, reflecting continued growth of premiums written at CapSpecialty and PacificComp.
2016 vs 2015. The increase in gross and net premiums written in 2016 from 2015 is primarily attributable to an increase at our reinsurance segment, primarily reflecting $854.3 million of premiums in 2016 related to the Quota Share Treaty compared with $221.6 million of such premiums in 2015, partially offset by the impact of changes in foreign exchange rates.
Net loss and LAE. The following table presents our consolidated net loss and LAE.
2017 vs 2016. The increase in net loss and LAE in 2017 from 2016 primarily reflects a significant increase in catastrophe losses at our reinsurance and insurance segments. The catastrophe losses in 2017 include $217.7 million related to Hurricane Harvey, $252.1 million related to Hurricane Irma and $216.8 million related to Hurricane Maria, as well as losses from wildfires in the State of California and earthquakes in Mexico.
2017 reinsurance segment net loss and LAE includes $24.4 million of unfavorable prior accident year loss reserve development arising from the U.K. Ministry of Justice’s decision to significantly reduce the discount rate, referred to as the Ogden rate, used to calculate lump-sum bodily injury payouts in personal injury insurance claims in the U.K.
Commissions, brokerage and other underwriting expenses. The following table presents our consolidated commissions, brokerage and other underwriting expenses.
Underwriting profit. The following table presents our consolidated underwriting (loss) profit.
The increase in net realized capital gains in 2017 from 2016 primarily reflects a $98.8 million capital loss due to an impairment charge from a write-down of certain SORC assets as of December 31, 2016, as more fully described in the following pages, partially offset by lower net realized capital gains from the sale of equity securities.
The decrease in OTTI losses in 2017 from 2016 reflects decreases in OTTI losses related to debt securities.
Other revenue and expenses. The following table presents our consolidated other revenue and expenses.
Interest expense. The increase in interest expense in 2017 from 2016 reflects new or increased borrowings at Jazwares, IPS and Bourn & Koch and borrowings at W&W|AFCO Steel. The decrease in interest expense in 2016 from 2015
primarily reflects lower interest expense at our reinsurance segment resulting from the maturity and repayment of TransRe’s 5.75% senior notes due on December 14, 2015, or the “2015 Senior Notes,” on December 14, 2015. 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.
2017 vs 2016. The income tax benefit in 2017 compared with income tax expenses in 2016 reflects the impact of taxable losses arising from Hurricanes Harvey, Irma and Maria. In addition, income taxes in 2016 include prior period income tax expense adjustments. The effective tax rate in 2017 compared with 2016 primarily reflects income tax benefits from taxable losses arising from Hurricanes Harvey, Irma and Maria in 2017 and, to a lesser extent, a tax benefit associated with the December 31, 2017 sale of PacificComp, as well as prior period income tax expense adjustments in 2016, which include $16.1 million of out-of-period reductions to current and deferred TransRe tax assets recorded in 2016 that relate primarily to periods prior to our merger with TransRe in 2012.
2016 vs 2015. The decrease in income taxes in 2016 from 2015 primarily reflects a decrease in earnings before income taxes partially offset by prior period income tax expense adjustments. The increase in the effective tax rate in 2016 from 2015 primarily reflects larger prior period income tax adjustments, higher state income taxes and lower tax-exempt interest income arising from municipal bond securities. Prior period income tax expense adjustments for 2016 include $16.1 million of out-of-period reductions to current and deferred TransRe tax assets recorded in 2016 that relate primarily to periods prior to our merger with TransRe in 2012.
(2) Underwriting profit represents net premiums earned less net loss and LAE and commissions, brokerage and other underwriting expenses, all as determined in accordance with GAAP, and does not include net investment income, net realized capital gains, OTTI losses, other revenue, other operating expenses, corporate administration, amortization of intangible assets and interest expense. Underwriting profit 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.
Reinsurance Segment: Premiums. The following table presents premiums for the reinsurance segment.
Property. The increase in gross premiums written in 2017 from 2016 primarily reflects 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 2.7 percent in 2017 from 2016. The increase in net premiums earned in 2017 from 2016 primarily reflects 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 1.2 percent in 2017 from 2016.
The increase in gross premiums written in 2016 from 2015 primarily reflects $353.2 million of property-related premiums in 2016 compared with $64.7 million in 2015 related to the Quota Share Treaty, and to a lesser extent, increases arising from certain other large whole account quota share treaties. Excluding the impact of changes in foreign exchange rates, gross premiums written increased 29.5 percent in 2016 from 2015. The increase in net premiums earned in 2016 from 2015 primarily reflects net premiums earned related to the Quota Share Treaty, partially offset by higher ceded premiums earned due to an increase in retrocessional coverage purchased in 2016. There were no net premiums earned in 2015 related to the Quota Share Treaty. Excluding the impact of changes in foreign exchange rates, net premiums earned increased 31.9 percent in 2016 from 2015.
The increase in gross premiums written in 2016 from 2015 primarily reflects $501.1 million of casualty-related premiums in 2016 compared with $156.9 million in 2015 related to the Quota Share Treaty, partially offset by the impact of changes in foreign exchange rates. Premiums related to the Quota Share Treaty in 2016 reflect elevated premiums written in the first quarter of 2016 due to differences between initial premium estimates at contract inception, which were recorded in the fourth quarter of 2015, and actual data subsequently reported. As a consequence of this change in estimate, premiums written in the fourth quarter of 2015 were understated and premiums written in the first quarter of 2016 were correspondingly increased. In general, when actual data has not been reported by ceding companies, premiums written are estimated based on historical patterns and other relevant factors. Any differences between these estimates and actual data subsequently reported are recorded in the period when actual data becomes available. Excluding the impact of changes in foreign exchange rates, gross premiums written increased 14.5 percent in 2016 from 2015. The increase in net premiums earned in 2016 from 2015 primarily reflects net premiums earned related to the Quota Share Treaty. There were no net premiums earned in 2015 related to the Quota Share Treaty. Excluding the impact of changes in foreign exchange rates, net premiums earned increased 21.7 percent in 2016 from 2015.
The increase in net loss and LAE in 2016 from 2015 primarily reflects the impact of higher net premiums earned, higher catastrophe losses, as well as higher non-catastrophe property losses in the 2016 accident year in connection with the Quota Share Treaty, partially offset by an increase in favorable prior accident year loss reserve development. The catastrophe losses in 2016 relate to wildfire losses in Alberta, Canada, earthquake losses in Japan, earthquake losses in Ecuador, all of which occurred in the second quarter, typhoon and flood losses in China in the third quarter, earthquake losses from an earthquake in New Zealand in the fourth quarter and $21.8 million of losses from Hurricane Matthew, which caused property damage and flooding in the Southeast Coast of the U.S. in October. Catastrophe losses for 2015 relate to the chemical explosion in Tianjin, China in August.
(2) Reflects favorable prior accident year loss reserve development from several catastrophes that occurred in the 2010 through 2015 accident years.
(4) Reflects favorable prior accident year loss reserve development primarily related to the 2011 through 2016 accident years.
Casualty & other. Net loss and LAE in 2017 approximated those in 2016, primarily reflecting higher catastrophe losses and less favorable prior accident year loss reserve development being offset by the impact of lower net premiums earned and lower non-catastrophe losses in the 2017 accident year. Catastrophe losses in 2017 relate primarily to the marine lines of business, and include $20.1 million related to Hurricane Harvey in August 2017, $26.2 million related to Hurricane Irma in September 2017, $15.4 million related to Hurricane Maria in September 2017, $1.6 million related to wildfires in the State of California in the fourth quarter of 2017, and $1.5 million related to earthquakes in Mexico in September 2017. The modest catastrophe losses in 2016 relate primarily to earthquake losses in Ecuador.
(5) Generally reflects favorable prior accident year loss reserve development reserves in a variety of casualty & other lines of business primarily from the 2003 through 2015 accident years.
Casualty & other. The decrease in commissions, brokerage and other underwriting expenses in 2017 from 2016 primarily reflects lower short-term incentive compensation expense accruals arising from the significant catastrophe losses that occurred in 2017, the impact of lower net premiums earned and a decrease in profit commissions related to the Malpractice Treaties. The increase in commissions, brokerage and other underwriting expenses in 2016 from 2015 primarily reflects the impact of higher net premiums earned, partially offset by a slight decrease in employee-related overhead expenses.
Property. The underwriting loss in 2017 compared with the underwriting profit in 2016 primarily reflects significant catastrophe losses from Hurricanes Harvey, Irma and Maria, as discussed above. The decrease in underwriting profit in 2016 from 2015 primarily reflects an increase in catastrophe losses, partially offset by an increase in favorable prior accident year loss reserve development, all as discussed above.
(3) The expense ratio is derived by dividing the amount of commissions, brokerage and other underwriting expenses by net premiums earned, all as determined in accordance with GAAP.
(3) Primarily reflects favorable prior accident year loss reserve development in the umbrella/excess, general liability and professional liability lines of business related to the 2006 through 2011 accident years, partially offset by unfavorable prior accident year loss reserve development in the directors’ and officers’ liability lines of business related to the 2011 through 2014 accident years.
(4) Primarily reflects favorable catastrophe prior accident year loss reserve development related to the 2016 accident year, partially offset by unfavorable prior accident year property loss reserve development in the binding authority lines of business primarily related to the 2015 and 2016 accident years.
(5) Includes favorable prior accident year loss reserve development of ($20.6) million from Super Storm Sandy in 2012 and various other smaller amounts primarily from non-catastrophe property lines of business in recent accident years.
(6) Primarily reflects favorable prior accident year development of ($4.1) million from Super Storm Sandy in 2012, net of reinsurance, and favorable prior accident year loss reserve development related to unallocated LAE reserves.
The favorable prior accident year loss reserve development in 2017, 2016 and 2015 reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods. The favorable prior accident year loss reserve development in 2017 did not impact assumptions used in estimating RSUI’s loss and LAE liabilities for business earned in 2017.
(1) Primarily reflects favorable prior accident year loss reserve development in the casualty lines of business related to the 2010, 2014, 2015 and 2016 accident years.
PacificComp. The increase in net loss and LAE in 2017 from 2016 primarily reflects the impact of higher net premiums earned, partially offset by an increase in favorable prior accident year loss reserve development. The increase in net loss and LAE in 2016 from 2015 primarily reflects the impact of higher net premiums earned, partially offset by favorable prior accident year loss reserve development in 2016.
The favorable prior accident year loss reserve development in 2017 relates primarily to the 2013 and prior accident years, and reflects 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 reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods.
CapSpecialty. The increases in commissions, brokerage and other underwriting expenses in 2017 from 2016 and in 2016 from 2015 primarily reflect the impact of higher net premiums earned and relatively stable overhead expenses.
Insurance Segment: Underwriting profit. The following table presents our underwriting (loss) profit for the insurance segment.
RSUI. The underwriting loss in 2017 compared with the underwriting profit in 2016 primarily reflects the impact of significant catastrophe losses from Hurricanes Harvey, Irma and Maria, as discussed above. The decrease in underwriting profit in 2016 from 2015 primarily reflects higher catastrophe losses and the impact of lower net premiums earned, partially offset by an increase in favorable prior accident year loss reserve development, all as discussed above.
PacificComp. PacificComp reported underwriting losses in 2017, 2016 and 2015 primarily as a result of its expenses relative to comparatively low premiums earned. The decrease in underwriting loss in 2017 from 2016 primarily reflects 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 decrease in underwriting losses in 2016 from 2015 primarily reflects the impact of growing net premiums earned, favorable prior accident year loss reserve development in 2016 and, to a lesser extent, the deferral of certain acquisition costs for new business commencing in 2016, all as discussed above.
The slight increase in net investment income in 2016 from 2015 primarily reflects higher interest income from funds withheld by cedants, partially offset by lower dividend income and lower income from other invested assets. Interest income was reduced in the fourth quarter of 2016 by approximately $7 million of adjustments made to more accurately reflect premium amortization associated with certain bonds.
Net Realized Capital Gains. The decrease in net realized capital gains in 2017 from 2016 primarily reflects lower gains for the equity and bond portfolio 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 PacficComp on December 31, 2017.
absence of compelling evidence that would cause us to call into question the financial condition or near-term business prospects of the issuers of the securities; and (iii) our ability and intent to hold the securities for a period of time sufficient to allow for any anticipated recovery.
See Note 4 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 gross unrealized investment losses for debt and equity securities as of December 31, 2017.
In July 2014, Alleghany Capital acquired a 30 percent equity interest in Jazwares. On April 15, 2016, Alleghany Capital acquired an additional 50 percent of Jazwares’ outstanding equity, bringing its equity ownership interest to 80 percent and, as of that date, the results of Jazwares have been included in our consolidated results. Prior to April 15, 2016, Jazwares was accounted for under the equity method of accounting.
The results of Alleghany Capital for 2017, 2016 and 2015 are presented below.
Net realized capital gains. 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 Jazwares’ outstanding equity, or the “Jazwares Settlement Gain,” partially offset by a $4.8 million loss realized from the sale of a SORC legacy oil field on December 29, 2017. Net realized capital losses in 2016 primarily reflect a $98.8 million capital loss due to an impairment charge from a write-down of certain SORC assets, partially offset by 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.”
The SORC assets that were written-down in 2016 relate specifically to SORC’s acquisition of a certain legacy oil field for the sole purpose of applying enhanced oil recovery techniques. After completing construction of its underground facility in 2014, SORC commenced its drilling program in 2015. The drilling program, however, was delayed by third-party equipment problems that were subsequently corrected as well as a longer than expected trial-and-error process determining the optimum well completion technique for the reservoir, and efforts to address a lack of vertical permeability in the reservoir formation. SORC engaged a third-party petroleum engineering firm to provide an assessment of its oil-recovery prospects and based on this assessment and other factors including oil prices, SORC wrote-down its legacy oil field assets to estimated fair value as of December 31, 2016. On December 29, 2017, SORC sold this legacy oil field and recorded a realized capital loss of $4.8 million.
Net realized capital losses in 2015 primarily reflect a $25.8 million capital loss related to an impairment charge related to a write-off of our investment in ORX.
The primary components of corporate activities are Alleghany Properties and activities at the Alleghany parent company. The following table presents the results for corporate activities.
Other revenue. The decrease in other revenue in 2017 from 2016 primarily reflects lower real estate sales activity at Alleghany Properties. The increase in other revenue in 2016 from 2015 primarily reflects a gain on the sale of a retail shopping center by Alleghany Properties in 2016.
(Losses) earnings before income taxes. The decrease in losses before income taxes in 2017 from 2016 primarily reflects realized capital gains in 2017, compared with realized capital losses in 2016, as well as higher net investment income, partially offset by an increase in corporate administration, all as discussed above. The decrease in losses before income taxes in 2016 from 2015 primarily reflects the absence of OTTI losses in 2016 which were significant in 2015, an increase in other revenue and a decrease in corporate administration, partially offset by an increase in realized capital losses, all as discussed above.
(4) Represents reinsurance recoverables secured by funds held, trust agreements or letters of credit.
(5) Approximately 78 percent of our reinsurance recoverables balance as of December 31, 2017 was due from reinsurers having an A.M. Best financial strength rating of A (Excellent) or higher.
We had no allowance for uncollectible reinsurance as of December 31, 2017.
For short-tail lines, loss reserves primarily consist of reserves for reported claims. The process of recording quarterly and annual liabilities for unpaid loss and LAE for short-tail lines is primarily focused on maintaining an appropriate reserve level for reported claims and IBNR. Specifically, we assess the reserve adequacy of IBNR in light of such factors as the current levels of reserves for reported claims and expectations with respect to reporting lags, catastrophe events, historical data, legal developments, and economic conditions, including the effects of inflation.
Standard actuarial methodologies employed to estimate ultimate losses incorporate the inherent lag from the time claims occur to when they are reported to an insurer and, if applicable, to when an insurer reports the claims to a reinsurer. Certain actuarial methodologies may be more appropriate than others in instances where this lag may not be consistent from period to period. Consequently, additional actuarial judgment is employed in the selection of methodologies to best incorporate the potential impact of this situation.
We believe that the reserves for unpaid loss and LAE established by our reinsurance and insurance subsidiaries are adequate as of December 31, 2017; 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.
Loss Frequency and Severity. Loss frequency and severity are measures of loss activity that are considered in determining the key assumptions described above. Loss frequency is a measure of the number of claims per unit of insured exposure, and loss severity is a measure of the average size of claims. Factors affecting loss frequency include the effectiveness of loss controls and safety programs, changes in economic conditions or weather patterns. Factors affecting loss severity include changes in policy limits, retentions, rate of inflation and judicial interpretations. Another factor affecting estimates of loss frequency and severity is the loss reporting lag, which is the period of time between the occurrence of a loss and the date the loss is reported to our reinsurance or insurance operating subsidiary. The length of the loss reporting lag affects their ability to accurately predict loss frequency, which are more predictable for lines with short reporting lags, as well as the amount of reserves needed for IBNR. If the actual level of loss frequency and severity is higher or lower than expected, the ultimate losses will be different than management’s estimates. A small percentage change in an estimate can result in a material effect on our reported earnings. The following table presents the impact of changes, which could be favorable or unfavorable, in frequency and severity on our loss estimates for claims occurring in 2017:
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 reserve development. We adjusted our prior year loss and LAE reserve estimates during 2017, 2016 and 2015 based on current information that differed from previous assumptions made at the time such loss and LAE reserves were previously estimated. The following table presents the (favorable) unfavorable prior accident year loss reserve development for 2017, 2016 and 2015:
(3) Includes favorable prior accident year loss reserve development of ($27.7) million from Super Storm Sandy in 2012 and various smaller amounts on catastrophes that occurred in the 2010, 2011, 2013 and 2014 accident years, partially offset by unfavorable prior accident year development from the New Zealand earthquake in 2010.
(7) Represents the 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.
(9) Represents unfavorable prior accident year development on Commuted A&E Liabilities related to the Commutation Agreement, as discussed above.
(13) Primarily reflects favorable prior accident year loss reserve development in the umbrella/excess lines of business related to the 2005 through 2011 accident years.
(17) Includes favorable prior accident year loss reserve development of ($20.6) million from Super Storm Sandy in 2012 and various other smaller amounts primarily from non-catastrophe property lines of business in recent accident years.
(21) Represents certain specialty lines of business written through a program administrator in connection with a terminated program related to the 2010 and 2009 accident years and reflects (favorable) loss emergence compared with loss emergence patterns assumed in earlier periods for such business.
(22) Primarily reflects favorable prior accident year loss reserve development related to the 2013 and prior accident years.
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 business, improve risk-adjusted portfolio returns and enable them to increase gross premium writings and risk capacity without requiring additional capital. Our reinsurance and insurance subsidiaries purchase reinsurance and retrocessional coverages from highly-rated third-party reinsurers. If the assuming reinsurers are unable or unwilling to meet the obligations assumed under the applicable reinsurance agreements, our reinsurance and insurance subsidiaries would remain liable for such reinsurance portion not paid by these reinsurers. Recoverables recorded with respect to claims ceded to reinsurers under reinsurance contracts are predicated in large part on the estimates for unpaid losses and, therefore, are also subject to a significant degree of uncertainty. In addition to the factors cited above, reinsurance recoverables may prove uncollectible if a reinsurer is unable or unwilling to perform under a contract. Reinsurance purchased by our reinsurance and insurance subsidiaries does not relieve them of their obligations to their own policyholders or cedants. Additional information regarding the use of, and risks related to the use of reinsurance by our reinsurance and insurance subsidiaries can be found on pages 44, 45, 57 and 58 of this Form 10-K. Also see Note 1(f) and Note 5 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 reinsurance recoverables.
Fair values for partnership and non-marketable equity investments are initially valued at the transaction price. Subsequently, fair value is based on the performance of the portfolio of investments or results of operations of the investee. Significant improvements or disruptions in the financial markets may result in directionally similar or opposite changes to the portfolio of the investee, depending on how management of the investee has correlated the portfolio of investments to the
The determination that an investment has incurred an OTTI loss in value requires the judgment of management and consideration of the fundamental condition of the issuer, its near-term business prospects and all the relevant facts and circumstances.
enhancements and pre-refunding. For mortgage and asset-backed securities, we discount our best estimate of future cash flows at an effective rate equal to the original effective yield of the security or, in the case of floating rate securities, at the current coupon. Our models include assumptions about prepayment speeds, default and delinquency rates, underlying collateral (if any), credit ratings, credit enhancements and other observable market data. For corporate bonds, we review business prospects, credit ratings and available information from asset managers and rating agencies for individual securities.
We must make certain judgments in the determination of assumed reinsurance premiums written and earned. For pro rata contracts, premiums written and earned are generally based on reports received from ceding companies. For excess-of-loss contracts, premiums are generally recorded as written based on contract terms and are earned ratably over the periods the related coverages are provided. Unearned premiums and ceded unearned premiums represent the portion of gross premiums written and ceded premiums written, respectively, relating to the unexpired periods of such coverages. The relationship between net premiums written and net premiums earned will, therefore, generally vary depending on the volume and inception dates of the business assumed and ceded and the mix of such business between pro rata and excess-of-loss reinsurance.
If an event of default occurs, then, to the extent permitted in the Credit Agreement, the lenders may direct the administrative agent to, or the administrative agent may, with the consent of lenders holding more than 50% of the aggregate
The following table presents the dividends paid to Alleghany by its reinsurance and insurance subsidiaries in 2017, 2016 and 2015:
(1) Dividends to Alleghany were reduced as a consequence of significant TransRe and RSUI catastrophe losses in the third quarter of 2017.
Common Stock Repurchases. In July 2014, our Board of Directors authorized the repurchase of shares of our common stock at such times and at prices as management determines to be advisable, up to an aggregate of $350.0 million, or the
“2014 Repurchase Program.” In November 2015, our Board of Directors authorized the repurchase, upon the completion of the 2014 Repurchase Program, of additional shares of our common stock, at such times and at prices as management determines to be advisable, up to an aggregate of $400.0 million, or the “2015 Repurchase Program.” In the first quarter of 2016, we completed the 2014 Repurchase Program and subsequent repurchases have been made pursuant to the 2015 Repurchase Program. As of December 31, 2017, we had $363.2 million remaining under our share repurchase authorization.
Contractual Obligations. We have certain obligations to make future payments under contracts and credit-related financial instruments and commitments. The following table presents certain long-term aggregate contractual obligations and credit-related financial commitments as of December 31, 2017:
Energy Holdings. As of December 31, 2017, we had holdings in energy sector businesses of $977.6 million, comprised of $349.3 million of debt securities, $485.0 million of equity securities and $143.3 million of Alleghany’s equity attributable to SORC.
The obligations and cash outflow of our reinsurance and insurance subsidiaries include claim settlements, commission expenses, administrative expenses, purchases of investments, and interest and principal payments on TransRe’s 8.00% senior notes due on November 30, 2039. In addition to premium collections, cash inflow is obtained from interest and dividend income and maturities and sales of investments. Because cash inflow from premiums is received in advance of cash outflow required to settle claims, our reinsurance and insurance operating units accumulate funds which they invest pending the need for liquidity. As the cash needs of a reinsurance or an insurance company can be unpredictable due to the uncertainty of the claims settlement process, the portfolios of our reinsurance and insurance subsidiaries consist primarily of debt securities and short-term investments to ensure the availability of funds and maintain a sufficient amount of liquid securities.
Included in other activities is debt associated with Alleghany Capital’s operating subsidiaries, which totaled $101.0 million as of December 31, 2017. The $101.0 million includes $38.2 million of borrowings by W&W|AFCO Steel under its available credit facility and term loans, $33.3 million of borrowings by Jazwares under its available credit facility, $15.1 million of term loans at Bourn & Koch related to borrowings to finance an acquisition, $10.1 million of debt at
Investment Strategy and Holdings. Our investment strategy seeks to preserve principal and maintain liquidity while trying to maximize our risk-adjusted, after-tax rate of return. Our investment decisions are guided mainly by the nature and timing of expected liability payouts, management’s forecast of cash flows and the possibility of unexpected cash demands, for example, to satisfy claims due to catastrophe losses. Our consolidated investment portfolio currently consists mainly of highly rated and liquid debt and equity securities listed on national securities exchanges. The overall credit quality of the debt securities portfolio is measured using the lowest rating of S&P, Moody’s or Fitch. In this regard, the overall weighted-average credit quality rating of our debt securities portfolio as of December 31, 2017 and 2016 was AA-. Although many of our debt securities, which consist predominantly of municipal bonds, 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, 2017. The following table presents the ratings of our debt securities as of December 31, 2017:
Our debt securities portfolio has been designed to enable management to react to investment opportunities created by changing interest rates, prepayments, tax and credit considerations or other factors, or to circumstances that could result in a mismatch between the desired duration of debt securities and the duration of liabilities, and, as such, is classified as AFS.
catastrophe events in a relatively short period of time; (ii) the sale of investments into a depressed marketplace to fund these paid losses; (iii) the uncollectibility of reinsurance recoverables on these paid losses; (iv) the significant decrease in the value of collateral supporting reinsurance recoverables; or (v) a significant reduction in our net premium collections.
On a consolidated basis, our invested assets increased to approximately $18.8 billion as of December 31, 2017 from approximately $18.1 billion as of December 31, 2016, primarily reflecting the impact of an increase in unrealized appreciation on our equity and, to a lesser extent, our bond portfolio, partially offset by the net impact on invested asset balances arising from the sale of PacificComp and the acquisition of approximately 80 percent of the equity in W&W|AFCO Steel.
(2) 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.
Although we are responsible for the determination of the fair value of our financial assets and the supporting methodologies and assumptions, we employ third-party valuation service providers to gather, analyze and interpret market information and derive fair values based upon relevant methodologies and assumptions for individual instruments. When those providers are unable to obtain sufficient market observable information upon which to estimate the fair value for a particular security, fair value is determined either by requesting a quote, which is generally non-binding, from brokers who are knowledgeable about these securities or by employing widely accepted internal valuation models.
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 internal 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
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 CMBS and other asset-backed securities, as well as a small portion of 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. Our Level 2 liabilities consist of the Senior Notes.
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 certain RMBS, CMBS, other asset-backed securities (primarily, collateralized loan obligations), U.S. and foreign corporate bonds (including privately issued securities), partnership investments and non-marketable equity investments.
Since Level 3 valuations are based on techniques that use significant inputs that are unobservable with little or no market activity, the fair values under the market approach for Level 3 securities are less credible than under the income approach; however, the market approach, where feasible, is used to corroborate the fair values determined by the income approach. The market approach primarily relies on the securities’ relationships to quoted transaction prices for similarly structured instruments. To the extent that transaction prices for similarly structured instruments are not available for a particular security, other market approaches are used to corroborate the fair values determined by the income approach, including option adjusted spread analyses.
Unobservable inputs, significant to the measurement and valuation of mortgage-backed and asset-backed securities, are generally used in the income approach, and include assumptions about prepayment speed and
collateral performance, including default, delinquency and loss severity rates. Significant changes to any one of these inputs, or combination of inputs, could significantly change the fair value measurement for these securities.
(1) Primarily includes government agency pass-through securities guaranteed by a government agency or government sponsored enterprise, among other types of RMBS.
Municipal Bonds. The following table provides the fair value of our municipal bonds as of December 31, 2017, 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.
Natural disasters such as hurricanes, other windstorms, earthquakes and other catastrophes have the potential to materially and adversely affect our operating results. Other risks, such as an outbreak of a pandemic disease, a major terrorist event, the bankruptcy of a major company or a marine and/or aviation disaster, could also have a material adverse effect on our business and operating results.
We evaluate catastrophe events and assess the probability of occurrence and magnitude through the use of industry recognized models and other techniques. We supplement these models by judgmentally interpreting and adjusting when appropriate the modeled output and by periodically monitoring the exposure risks of our operations. There is no single standard methodology to project possible losses from catastrophe exposures. Further, there are no industry standard assumptions used in projecting these losses, and the form and quality of the data obtained, including data obtained from insureds and ceding companies, and used in these models are not uniformly compatible with the data requirements of all models. Therefore, the use of different methodologies and assumptions could materially change the projected losses. Finally, these modeled losses may not be comparable with estimates made by other companies.
Although the analytical tools used to estimate catastrophe exposure are useful in both pricing and monitoring catastrophe risk, the estimates derived by use of these techniques are inherently uncertain and do not reflect our maximum exposures to these events. Although the models are frequently updated, these projections are nevertheless inherently imprecise. It is highly likely that our losses will vary, perhaps materially, from these estimates.
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 March 2017, the FASB issued guidance that reduces the amortization period for the premium on certain purchased callable debt securities to the earliest call date. The guidance applies specifically to noncontingent call features that are callable at a predetermined and fixed price and date. The accounting for purchased callable debt securities held at a discount is not affected. This guidance is effective in the first quarter of 2019 for public entities, with early adoption permitted. We have adopted this guidance in the fourth quarter of 2017, and recorded a cumulative effect reduction of approximately $13 million directly to opening 2017 retained earnings and an offsetting increase in opening 2017 accumulated other comprehensive income. The implementation did not have a material impact on our results of operations and financial condition.
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 is generally included within the scope of this guidance. This guidance is effective in the first quarter of 2018 for public entities, with early adoption permitted in 2017. We will adopt this guidance in the first quarter of 2018 using the modified retrospective transition approach. We have completed an analysis of our noninsurance revenues and have concluded that the implementation did not have a material impact on our results of operations and financial condition.
In January 2016, the FASB issued guidance that changes the recognition and measurement of certain financial instruments. This guidance requires investments in equity securities (except those accounted for under the equity method of accounting) to be measured at fair value with changes in fair value recognized in net income. For equity securities that do not have readily determinable fair values, measurement may be at cost, adjusted for any impairment and changes resulting from observable price changes for a similar investment of the same issuer. This guidance also changes the presentation and disclosure of financial instruments by: (i) requiring that financial instrument disclosures of fair value use the exit price notion; (ii) requiring separate presentation of financial assets and financial liabilities by measurement category and form, either on the balance sheet or the accompanying notes to the financial statements; (iii) requiring separate presentation in other comprehensive income for the portion
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. 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.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), Alleghany Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 21, 2018 expressed an unqualified opinion thereon.
On September 12, 2017, AIHL signed a definitive agreement to sell PacificComp to CopperPoint Mutual Insurance Company (“CopperPoint”) for total cash consideration of approximately $158 million. The transaction closed on December 31, 2017, at which time: (i) approximately $442 million of PacificComp assets, consisting primarily of debt securities, and approximately $316 million of PacificComp liabilities, consisting primarily of loss and loss adjustment expenses (“LAE”) reserves, were transferred; and (ii) AIHL recorded an after-tax gain of approximately $16 million, which included a tax benefit. In connection with the transaction, AIHL Re will continue to provide adverse development reinsurance coverage on PacificComp’s pre-acquisition claims, subject to certain terms and conditions. AIHL Re’s obligations, which are guaranteed by Alleghany, are subject to: (i) an aggregate limit of $150.0 million; and (ii) a final commutation and settlement as of December 31, 2024.
Stranded Oil Resources Corporation (“SORC”), an exploration and production company focused on enhanced oil recovery, headquartered in Golden, Colorado;
IPS-Integrated Project Services, LLC (“IPS”), a technical engineering-focused service provider focused on the global pharmaceutical and biotechnology industries, headquartered in Blue Bell, Pennsylvania;
a 45 percent equity interest in Wilbert Funeral Services, Inc. (“Wilbert”), a provider of products and services for the funeral and cemetery industries and precast concrete markets, headquartered in Overland Park, Kansas.
outstanding equity, bringing its equity ownership interest to 80 percent and, as of 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.
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 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.
Investments consist of debt securities, equity securities, short-term investments, commercial mortgage loans and other invested assets. Alleghany considers all of its marketable equity securities, debt securities and short-term investments as available-for-sale (“AFS”). Debt securities consist of securities with an initial fixed maturity of more than one year. Debt securities typically take the form of bonds. Equity securities generally consist of securities that represent ownership interests in an enterprise. Equity securities typically take the form of common stock or non-redeemable preferred stock. Mutual funds are also classified as equity securities, including funds that invest mostly in debt securities. Short-term investments include commercial paper, certificates of deposit, money market instruments and any fixed maturity investment with an initial maturity of one year or less.
stockholders’ equity until realized. If a decline in fair value is deemed to be other than temporary, the investment is written down to its fair value and the amount of the write-down is recorded as an other than temporary impairment (“OTTI”) loss on the statement of earnings. In addition, any portion of such decline related to debt securities that is believed to arise from factors other than credit is recorded as a component of other comprehensive income rather than against earnings.
Net investment income consists primarily of: (i) interest income from debt securities, short-term investments, commercial mortgage loans, funds withheld by cedants and cash, including any premium amortization or discount accretion; (ii) dividend income from equity securities; and (iii) investment income from other invested assets, which generally includes distributions when receivable and earnings from investments accounted for under the equity method; less expenses related to investments. Interest income is accrued when earned. Premiums and discounts arising from the purchase of certain debt securities are treated as a yield adjustment over the estimated useful life of the securities, adjusted for anticipated prepayments using the retrospective interest method. Under this method, the effective yield on a security is estimated. Such estimates are based on the prepayment terms of the security, past actual cash flows, and assumptions as to future expected cash flow. The future expected cash flow assumptions consider various prepayment assumptions based on historical experience, as well as current market conditions. Periodically, the effective yield is re-estimated to reflect actual prepayments and updated future expected cash flow assumptions. Upon a re-estimation, a security’s book value is restated at the most recently calculated effective yield, assuming that yield had been in effect since the security was purchased. This treatment results in an increase or decrease to net investment income (accretion of premium or amortization of discount) at the new measurement date.
Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between willing, able and knowledgeable market participants at the measurement date. Fair value measurements are not adjusted for transaction costs. In addition, 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. Observable inputs are market participant assumptions based on market data obtained from sources independent of the reporting entity. Unobservable inputs are the reporting entity’s own assumptions about market participant assumptions based on the best information available under the circumstances. In assessing the appropriateness of using observable inputs in making its fair value determinations, Alleghany considers whether the market for a particular security is “active” or not based on all the relevant facts and circumstances. A market may be considered to be inactive if there are relatively few recent transactions or if there is a significant decrease in market volume. Furthermore, Alleghany considers whether observable transactions are “orderly” or not. Alleghany does not consider a transaction to be orderly if there is evidence of a forced liquidation or other distressed condition; as such, little or no weight is given to that transaction as an indicator of fair value.
Although Alleghany is responsible for the determination of the fair value of its financial assets and the supporting methodologies and assumptions, it employs third-party valuation service providers to gather, analyze and interpret market information and derive fair values based upon relevant methodologies and assumptions for individual instruments. When those providers are unable to obtain sufficient market observable information upon which to estimate the fair value for a particular security, fair value is determined either by requesting a quote, which is generally non-binding, from brokers who are knowledgeable about these securities or by employing widely accepted internal valuation models.
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 internal 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 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. Alleghany’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment. In making the assessment, Alleghany considers 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 certain RMBS, CMBS, other asset-backed securities (primarily, collateralized loan obligations), U.S. and foreign corporate bonds (including privately issued securities), partnership investments and non-marketable equity investments.
Alleghany’s Level 3 liabilities consist of the debt of Alleghany Capital’s operating subsidiaries.
Goodwill and other intangible assets, net of amortization, are recorded as a consequence of business acquisitions. Goodwill represents the excess, if any, of the amount paid to acquire subsidiaries and other businesses over the fair value of their net assets as of the date of acquisition. Other intangible assets are recorded at their fair value as of the acquisition date. A significant amount of judgment is needed to determine the fair value as of the date of acquisition of other intangible assets and the net assets acquired in a business acquisition. The determination of the fair value of other intangible assets and net assets often involves the use of valuation models and other estimates, which involve many assumptions and variables and are inherently subjective. Other intangible assets that are not deemed to have an indefinite useful life are amortized over their estimated useful lives. Goodwill and intangible assets that have an indefinite useful life are not subject to amortization.
Goodwill and other intangible assets deemed to have an indefinite useful life are tested annually in the fourth quarter of every year for impairment. Goodwill and other intangible assets are also tested whenever events and changes in circumstances suggest that the carrying amount may not be recoverable. A significant amount of judgment is required in performing goodwill and other intangible asset impairment tests. These tests may include estimating the fair value of Alleghany’s operating subsidiaries, which include Alleghany Capital’s operating subsidiaries, and other intangible assets. If it is determined that an asset has been impaired, the asset is written down by the amount of the impairment, with a corresponding charge to net earnings. Subsequent reversal of any impairment charge is not permitted.
With respect to goodwill, a qualitative assessment is first made to determine whether it is necessary to perform quantitative testing. This initial assessment includes, among other factors, consideration of: (i) past, current and projected future earnings and equity; (ii) recent trends and market conditions; and (iii) valuation metrics involving similar companies that are publicly-traded and acquisitions of similar companies, if available. If this initial qualitative assessment indicates that the fair value of an operating subsidiary may be less than its carrying amount, a second step is taken, involving a comparison between the estimated fair value of the operating subsidiary with its respective carrying amount including goodwill. Under GAAP, fair value refers to the amount for which the entire operating subsidiary may be bought or sold. The methods for estimating the fair value of an operating subsidiary values include asset and liability fair values and other valuation techniques, such as discounted cash flows and multiples of earnings or revenues. All of these methods involve significant estimates and assumptions. If the carrying value exceeds estimated fair value, there is an indication of potential impairment, and a third step is performed to measure the amount of impairment. The third step involves calculating an implied fair value of goodwill by measuring the excess of the estimated fair value of the operating subsidiary over the aggregate estimated fair value of the individual assets less liabilities. If the carrying value of goodwill exceeds the implied fair value of goodwill, an impairment charge is recorded for the excess.
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 Subpart F income rules 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
A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. This determination is based upon a review of all available information, both positive and negative, including Alleghany’s earnings history, the timing, character and amount of future earnings potential, the reversal of taxable temporary differences and the tax planning strategies available.
Each of Alleghany’s reinsurance and insurance subsidiaries establishes reserves on its balance sheet for unpaid loss and LAE related to its property and casualty reinsurance and insurance contracts. As of any balance sheet date, there are claims that have not yet been reported, and some claims may not be reported for many years after the date a loss occurs. As a result of this historical pattern, the liability for unpaid loss and LAE includes significant estimates for IBNR claims. Additionally, reported claims are in various stages of the settlement process. Each claim is settled individually based upon its merits, and certain claims may take years to settle, especially if legal action is involved. As a result, the liabilities for unpaid loss and LAE include significant judgments, assumptions and estimates made by management relating to the actual ultimate losses that will arise from the claims.
Basic earnings per share of common stock is based on the average number of shares of outstanding common stock, par value $1.00 per share, of Alleghany (“Common Stock”) during the period, retroactively adjusted for stock dividends, where applicable. Diluted earnings per share of Common Stock are based on those shares used to calculate basic earnings per share of Common Stock plus the dilutive effect of stock-based compensation awards, retroactively adjusted for stock dividends, where applicable.
See Note 14 for information on long-term compensation plans, which include stock-based compensation plans.
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.
payment or payments that are expected to be received from the customers for those goods and services. Noninsurance revenues and related operating expenses from manufactured products are generally recognized at the time title transfers to the customer, which typically occurs at the point of shipment or delivery to the customer, depending on the terms of the sales arrangement. Noninsurance revenues and related operating expenses from services are generally recognized as the services are performed. Services provided pursuant to a contract are recognized either over the contract period or upon completion of the elements specified in the contract, depending on the terms of the contract.
Certain prior year amounts have been reclassified to conform to the 2017 presentation of the financial statements.
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 has adopted this guidance as of December 31, 2016 and the implementation did not have an impact on its results of operations and financial condition. See Note 1(k) and Note 6 for the new disclosures.
In January 2016, the FASB issued guidance that changes the recognition and measurement of certain financial instruments. This guidance requires investments in equity securities (except those accounted for under the equity method of accounting) to be measured at fair value with changes in fair value recognized in net income. For equity securities that do not have readily determinable fair values, measurement may be at cost, adjusted for any impairment and changes resulting from observable price changes for a similar investment of the same issuer. This guidance also changes the presentation and disclosure of financial instruments by: (i) requiring that financial instrument disclosures of fair value use the exit price notion; (ii) requiring separate presentation of financial assets and financial liabilities by measurement category and form,
either on the balance sheet or the accompanying notes to the financial statements; (iii) requiring separate presentation in other comprehensive income for the portion of the change in a liability’s fair value resulting from instrument-specific credit risk when an election has been made to measure the liability at fair value; and (iv) eliminating the requirement to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet. This guidance is effective for fiscal years beginning after December 15, 2017 for public entities, including interim periods within those fiscal years. Except for the change in presentation for instrument-specific credit risk, this guidance does not permit early adoption. Alleghany will adopt this guidance in the first quarter of 2018. As of January 1, 2018, approximately $734 million of net unrealized gains of equity securities, net of deferred taxes, were reclassified from accumulated other comprehensive income to retained earnings. Subsequently, all changes in unrealized gains or losses of equity securities, net of deferred taxes, will be presented in the Consolidated Statements of Earnings rather than the Consolidated Statements of Comprehensive Income. The implementation did not have a material impact on its financial condition. See Note 4(a) for further information on Alleghany’s unrealized gains and losses of equity securities.
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. 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.
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.
On April 28, 2017, Alleghany Capital acquired approximately 80 percent of the equity in W&W|AFCO Steel for $164.5 million, including $163.9 million in cash paid on May 1, 2017 and $0.6 million of estimated purchase price adjustments. In connection with the acquisition, Alleghany recorded $41.1 million, $25.3 million and $70.0 million of goodwill, indefinite-lived intangible assets and finite-lived intangible assets, respectively. Indefinite-lived intangible assets relate to trade name and finite-lived intangible assets relate to customer relationships.
On April 15, 2016, Alleghany Capital acquired an additional 50 percent of Jazwares’ outstanding equity for $162.8 million, bringing its equity ownership interest to 80 percent and, as of 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 $162.8 million purchase price includes $122.1 million in cash paid on April 18, 2016 and $40.7 million of potential contingent consideration based on future profitability. In connection with the acquisition, $130.0 million, $52.4 million and $89.7 million of goodwill, indefinite-lived intangible assets and finite-lived intangible assets, respectively, were recorded. Indefinite-lived intangible assets relate to trade name and finite-lived intangible assets relate to license agreements, customer relationships and owned content.
On October 31, 2015, Alleghany Capital acquired approximately 84 percent of the equity in IPS for $106.3 million, including $89.9 million in cash paid on November 2, 2015, $12.5 million of potential contingent consideration based on future profitability and $3.9 million of estimated purchase price adjustments. In connection with the acquisition, $23.5 million, $27.9 million and $49.3 million of goodwill, indefinite-lived intangible assets and finite-lived intangible assets, respectively, were recorded. Indefinite-lived intangible assets relate to trade name, and finite-lived intangible assets relate to customer relationships, back-log and covenants not-to-compete.
(1) Goodwill and intangible assets have been reduced by amounts written-down in prior periods.
Trade names and state and foreign insurance licenses have an indefinite useful life. The economic useful lives of significant intangible assets in the reinsurance and insurance segments are as follows: agency relationships - 15 years;
The following table presents the carrying values and estimated fair values of Alleghany’s consolidated financial instruments as of December 31, 2017 and 2016:
(1) This table includes AFS investments (debt and equity securities, as well as partnership and non-marketable equity investments carried at fair value that are included in other invested assets). This table excludes investments accounted for using the equity method and commercial mortgage loans that are carried at unpaid principal balance. The fair value of short-term investments approximates amortized cost. The fair value of all other categories of investments is discussed below.
(2) Includes $1,101.3 million and $903.8 million of collateralized loan obligations as of December 31, 2017 and 2016, respectively.
In 2017, Alleghany transferred $5.5 million of financial instruments into Level 3 principally due to a decrease in observable inputs related to the valuation of such assets and, specifically, a decrease in broker quotes. Of the $5.5 million of transfers, $3.8 million related to U.S. corporate bonds, $1.4 million related to common stock and $0.3 million related to foreign corporate bonds. There were no other material transfers between Levels 1, 2 or 3 in 2017.
The following tables present reconciliations of the changes during 2017 and 2016 in Level 3 assets measured at fair value:
(2) There were no OTTI losses recorded in net earnings related to Level 3 instruments still held as of December 31, 2017 and 2016.
The following table presents the amortized cost or cost and the estimated fair value of debt securities by contractual maturity as of December 31, 2017. 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.
As of December 31, 2017, non-income producing invested assets were insignificant.
The proceeds from sales of AFS securities were $8.3 billion, $7.0 billion and $9.6 billion in 2017, 2016 and 2015, respectively.
Realized capital gains and losses for 2017 primarily reflects 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 reflect sales of equity and debt securities, a gain of $13.2 million on April 15, 2016 in connection with Alleghany
Realized capital gains from equity securities in 2015 include the sales of certain equity securities resulting from a partial restructuring of the equity portfolio, the sales of certain equity securities which had their cost basis reduced in earlier periods for the recognition of OTTI losses, and a $25.8 million capital loss due to an impairment charge related to a write-off of Alleghany’s investment in ORX.
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 cost basis of securities for the recognition of OTTI losses, the remaining gross unrealized investment losses for debt and equity securities as of December 31, 2017 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.
The following tables present gross unrealized losses and related fair values for equity securities and debt securities, grouped by duration of time in a continuous unrealized loss position, as of December 31, 2017 and 2017:
As of December 31, 2017, Alleghany held a total of 1,182 debt and equity securities that were in an unrealized loss position, of which 415 securities, all debt securities, were in an unrealized loss position continuously for 12 months or more. The unrealized losses associated with these debt securities consisted primarily of losses related to municipal bonds and U.S. Government obligations.
Investments with fair values of approximately $2.4 billion as of December 31, 2017, the substantial majority of which were debt securities and equity securities, were deposited with governmental authorities as required by law.
In December 2012, TransRe obtained an ownership interest in Pillar Capital Holdings Limited (“Pillar Holdings”), a Bermuda-based insurance asset manager focused on collateralized reinsurance and catastrophe insurance-linked securities. Additionally, TransRe invested $175.0 million and AIHL invested $25.0 million in limited partnership funds managed by Pillar Holdings (the “Funds”). The objective of the Funds is to create portfolios with attractive risk-reward characteristics and low correlation with other asset classes, using the extensive reinsurance and capital market experience of the principals of Pillar Holdings. Alleghany has concluded that both Pillar Holdings and the Funds (collectively, the “Pillar Investments”) represent variable interest entities and that Alleghany is not the primary beneficiary, as it does not have the ability to direct the activities that most significantly impact each entity’s economic performance. Therefore, the Pillar Investments are not consolidated and are accounted for under the equity method of accounting. Alleghany’s potential maximum loss in the Pillar Investments is limited to its cumulative net investment. As of December 31, 2017, Alleghany’s carrying value in the Pillar Investments, as determined under the equity method of accounting, was $217.9 million, which is net of returns of capital received from the Pillar Investments.
In July 2013, AIHL invested $250.0 million in Ares Management LLC (“Ares”), an asset manager, in exchange for a 6.25 percent equity stake in Ares, with an agreement to engage Ares to manage up to $1.0 billion in certain investment strategies. In May 2014, Ares completed an initial public offering of its common units. Upon completion of the initial public offering, Alleghany’s equity investment in Ares converted to limited partner interests in certain Ares subsidiaries that are convertible into an aggregate 5.9 percent interest in Ares common units. These interests may be converted at any time at Alleghany’s discretion. Until Alleghany determines to convert its limited partner interests into Ares common units, Alleghany classifies its investment in Ares as a component of other invested assets and accounts for its investment using the equity method of accounting. As of December 31, 2017, AIHL’s carrying value in Ares was $212.4 million, which is net of returns of capital received from Ares.
Alleghany had no allowance for uncollectible reinsurance as of December 31, 2017 and 2016.
The following table presents property and casualty premiums written and earned for 2017, 2016 and 2015:
RSUI reinsures its property lines of business through a program consisting of surplus share treaties, facultative placements, per risk and catastrophe excess-of-loss treaties. RSUI’s catastrophe reinsurance program and property per risk reinsurance program run on an annual basis from May 1 to the following April 30 and portions expired on April 30, 2017. Both programs were renewed on May 1, 2017 with substantially similar terms as the expired programs.
In the third quarter of 2015, AIHL Re and CapSpecialty (specifically, the insurance subsidiaries of CapSpecialty) entered into an intercompany reinsurance contract, effective July 1, 2015, pursuant to which AIHL Re provides CapSpecialty with coverage primarily for adverse development on certain net loss and allocated LAE in excess of its carried reserves at June 30, 2015. AIHL Re’s commitments are intended to cover the statutory collateral requirements at CapSpecialty, if and when necessary, and AIHL Re’s obligations are subject to an aggregate limit of $50.0 million. In connection with such intercompany reinsurance agreement, Alleghany and AIHL Re entered into a contract whereby Alleghany will guarantee the recoverable balances owed to CapSpecialty from AIHL Re up to $50.0 million. The above agreements had no impact on Alleghany’s consolidated results of operations and financial condition.
The following table presents the activity in the liability for loss and LAE in 2017, 2016 and 2015:
Gross loss and LAE reserves and reinsurance recoverables as of December 31, 2017 increased from December 31, 2016, primarily reflecting significant catastrophe losses, partially offset by the sale of PacificComp, which closed on December 31, 2017. Catastrophe losses, net of reinsurance, in 2017 included $217.7 million related to Hurricane Harvey in August 2017, $252.1 million related to Hurricane Irma in September 2017, and $216.8 million related to Hurricane Maria in September 2017.
Gross loss and LAE reserves as of December 31, 2016 increased from December 31, 2015, reflecting increases in the reinsurance and insurance segments. The increase in gross loss and LAE reserves at the reinsurance segment primarily reflects the impact of higher net premiums earned and higher catastrophe losses, partially offset by favorable prior accident year loss reserve development. The increase in gross loss and LAE reserves at the insurance segment primarily reflects higher 2016 accident year losses and higher catastrophe losses, partially offset by favorable prior accident year loss reserve development.
The following table presents (favorable) unfavorable prior accident year loss reserve development for 2017, 2016 and 2015:
(1) Reflects favorable prior accident year loss reserve development from several catastrophes that occurred primarily in the 2016 accident year.
(9) Represents unfavorable prior accident year loss reserve development related to a commutation and release agreement entered into on November 30, 2015 by TransRe with AIG Property Casualty, Inc., National Indemnity Company and Resolute Management, Inc. with respect to certain reinsurance contracts, including contracts covering asbestos-related illness and environmental impairment liabilities for 1986 and prior years.
(10) Primarily reflects favorable prior accident year loss reserve development in: (i) longer-tailed professional liability and general liability lines of business related to the 2003 through 2012 accident years; and (ii) shorter-tailed casualty lines of business related to 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.
(14) Primarily reflects favorable prior accident year loss reserve development in the umbrella/excess, general liability and professional liability lines of business related to the 2006 through 2012 accident years.
(16) Primarily reflects favorable catastrophe prior accident year loss reserve development related to the 2016 accident year, partially offset by unfavorable prior accident year property loss reserve development in the binding authority lines of business primarily related to the 2015 and 2016 accident years.
(19) Primarily reflects favorable prior accident year loss reserve development in the casualty lines of business related to the 2010, 2014, 2015 and 2016 accident years.
Reinsurance Segment - Casualty & Other - Shorter-Tailed Lines of Business(1)
(1) The vast majority of the CapSpecialty’s loss and LAE reserves relate to its casualty lines of business.
(1) Includes unallocated LAE, which aggregate to 1.3 percent of gross loss and LAE reserves as of December 31, 2017. Net loss and LAE Reserves by component are shown in the preceding tables, and consolidated gross loss and LAE reserves is presented in the Consolidated Balance Sheets.
The following table presents supplemental information about average historical loss and LAE duration, net of reinsurance, as of December 31, 2017.
On July 31, 2017, Alleghany entered into a five-year credit agreement (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 Alleghany’s credit rating, among other factors. The Credit Agreement contains representations, warranties and covenants customary for bank loan facilities of this nature.
There were no borrowings under the Credit Agreement in 2017 and there were no outstanding borrowings under the Credit Agreement as of December 31, 2017. There were no borrowings under the Prior Credit Agreement in 2017 or 2016.
In addition to the Credit Agreement, several of Alleghany Capital’s subsidiaries have credit agreements with third-party financial institutions. Any borrowings under such agreements are not guaranteed by Alleghany or Alleghany Capital. See Note 8(c) for information on the borrowings arising from these credit agreements.
On September 9, 2014, Alleghany completed a public offering of $300.0 million aggregate principal amount of its 4.90% senior notes due on September 15, 2044 (the “2044 Senior Notes”). The 2044 Senior Notes are unsecured and unsubordinated general obligations of Alleghany. Interest on the 2044 Senior Notes is payable semi-annually on March 15 and September 15 of each year. The terms of the 2044 Senior Notes permit redemption prior to their maturity. The indenture under which the 2044 Senior Notes were issued contains covenants that impose conditions on Alleghany’s ability to create liens on, or engage in sales of, the capital stock of AIHL, TransRe or RSUI. The 2044 Senior Notes were issued at approximately 99.3 percent of par, resulting in proceeds after underwriting discount, commissions and other expenses of $294.3 million and an effective yield of approximately 5.0 percent.
On December 14, 2005, TransRe completed a public offering of $750.0 million aggregate principal amount of its 2015 Senior Notes. Prior to the merger with TransRe, a portion of the 2015 Senior Notes was repurchased by TransRe. On October 15, 2014, TransRe redeemed $300.0 million aggregate principal amount of the 2015 Senior Notes. On December 14, 2015, the remaining $367.0 million outstanding aggregate principal amount of TransRe’s 2015 Senior Notes matured and was repaid.
engage in sales of, the capital stock of certain of its subsidiaries, including Transatlantic Reinsurance Company, TransRe Zurich Ltd. or Fair American Insurance and Reinsurance Company.
The following table presents income tax expense (benefit) for 2017, 2016 and 2015:
(Losses) earnings before income taxes from domestic operations were ($132.7) million, $407.7 million and $376.7 million in 2017, 2016 and 2015, respectively. Earnings before income taxes from foreign operations was $169.4 million, $240.1 million and $380.7 million in 2017, 2016 and 2015, respectively. Foreign tax expense was primarily attributable to the U.K., Canada and France.
The increase in the effective tax rate in 2016 from 2015 primarily reflects larger prior period income tax expense adjustments, higher state income taxes and lower tax-exempt interest income arising from municipal bond securities. Prior period income tax expense adjustments for 2016 include $16.1 million of out-of-period reductions to current and deferred TransRe tax assets recorded in 2016 that relate primarily to periods prior to Alleghany’s merger with TransRe in 2012.
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, 2017 and 2016:
A valuation allowance is provided against deferred tax assets when, in the opinion of management, it is more likely than not that a portion of the deferred tax asset will not be realized. As of December 31, 2017 and 2016, Alleghany recognized $18.3 million and $25.2 million, respectively, of deferred tax assets for certain state net operating and capital loss carryovers, and a valuation allowance of $18.3 million and $25.2 million, respectively, has been established against these deferred tax assets as Alleghany does not currently anticipate it will generate sufficient income in these states to absorb such loss carryovers.
The Internal Revenue Code provides for limits on the utilization of certain tax benefits following a corporate ownership change. Upon the closing of the merger with TransRe, TransRe was subject to an annual limitation on its ability to
Alleghany’s income tax returns are currently under examination by the Internal Revenue Service for the 2012, 2013 and 2014 tax years. TransRe’s income tax returns, which all relate to periods prior to the merger with Alleghany, are currently under examination by the Internal Revenue Service. The following table presents the tax years of Alleghany and TransRe tax returns that remain subject to examination by major tax jurisdictions as of December 31, 2017.
In July 2014, the Alleghany Board of Directors authorized the repurchase of shares of Common Stock at such times and at prices as management determines to be advisable, up to an aggregate of $350.0 million (the “2014 Repurchase Program”). In November 2015, the Alleghany Board of Directors authorized the repurchase, upon the completion of the 2014 Repurchase Program, of additional shares of Common Stock, at such times and at prices as management determines to be advisable, up to an aggregate of $400.0 million (the “2015 Repurchase Program”). In the first quarter of 2016, Alleghany completed the 2014 Repurchase Program and subsequent repurchases have been made pursuant to the 2015 Repurchase Program. As of December 31, 2017, Alleghany had $363.2 million remaining under its share repurchase authorization.
The following table presents a reconciliation of the changes during 2017 and 2016 in accumulated other comprehensive income attributable to Alleghany stockholders:
(1) See Note 1(r) for additional information regarding Alleghany’s adoption of new investment accounting guidance in 2017.
The following table presents reclassifications out of accumulated other comprehensive income attributable to Alleghany stockholders during 2017 and 2016:
As of December 31, 2017, approximately $6.6 billion of Alleghany’s total equity of $8.5 billion was unavailable for dividends or advances to Alleghany from its subsidiaries. The remaining $1.9 billion was available for dividends or advances to Alleghany from its subsidiaries, or was retained at the Alleghany parent company-level and, as such, was available to pay dividends to Alleghany’s stockholders as of December 31, 2017.
(2) In 2017, 2016 and 2015, TRC paid dividends of $270.0 million, $350.0 million and $400.0 million, respectively, to the TransRe holding company.
As of December 31, 2017, a maximum amount of $37.1 million was available for dividends by TRC without prior approval of the applicable regulatory authorities.
The statutory net income of Alleghany’s reinsurance and insurance subsidiaries was $144.4 million and $688.9 million for the years ended December 31, 2017 and 2016, respectively. As of December 31, 2017 and 2016, the combined statutory capital and surplus of Alleghany’s reinsurance and insurance subsidiaries was $6.9 billion and $6.7 billion, respectively. As of December 31, 2017, the amount of statutory capital and surplus necessary to satisfy regulatory requirements was not significant in relation to the actual statutory capital and surplus of Alleghany’s reinsurance and insurance companies in the U.S.
The following table presents a reconciliation of the earnings and share data used in the basic and diluted (losses) earnings per share computations for 2017, 2016 and 2015:
Loss and LAE include amounts for risks relating to asbestos-related illness and environmental impairment. The following table presents such gross and net reserves as of December 31, 2017 and 2016:
The reserves carried for such claims, including the IBNR portion, are based upon known facts and current law at the respective balance sheet dates. However, significant uncertainty exists in determining the amount of ultimate liability for asbestos-related illness and environmental impairment losses. This uncertainty is due to, among other reasons, inconsistent and changing court resolutions and judicial interpretations with respect to underlying policy intent and coverage and uncertainties as to the allocation of responsibility for resultant damages, among other reasons. Further, possible future changes in statutes, laws, regulations, theories of liability and other factors could have a material effect on these liabilities and, accordingly, future earnings.
The reinsurance segment consists of property and casualty reinsurance operations conducted by TransRe’s reinsurance operating subsidiaries and is further reported through two major product lines - property and casualty & other. TransRe provides property and casualty reinsurance to insurers and reinsurers through brokers and on a direct basis to ceding companies. TransRe also writes a modest amount of insurance business, which is included in the reinsurance segment. A significant portion of the premiums earned by TransRe’s operations are generated by offices located in Canada, Europe, Asia, Australia, Africa and those serving Latin America and the Caribbean. Although the majority of the premiums earned by these offices typically relate to the regions where they are located, a significant portion may be derived from other regions of the world, including the U.S. In addition, although a significant portion of the assets and liabilities of these foreign offices generally relate to the countries where ceding companies and reinsurers are located, most investments are located in the country of domicile of these offices.
The components of other activities are Alleghany Capital and corporate activities. Alleghany Capital consists of manufacturing and service operations, oil and gas operations and corporate operations and investments at the Alleghany Capital level. Manufacturing and service operations are conducted through Bourn & Koch, Kentucky Trailer, IPS, Jazwares, W&W|AFCO Steel, beginning April 28, 2017, and Alleghany Capital’s investment in Wilbert, beginning August 1, 2017. Oil and gas operations are conducted through SORC, and Alleghany Capital’s investment in ORX until it was sold on December 23, 2016. ORX was accounted for under the equity method of accounting.
In addition, corporate activities include interest expense associated with Alleghany Senior Notes, whereas interest expense associated with the TransRe Senior Notes is included in “Total Segments” and interest expense associated with other debt is included in Alleghany Capital. Information related to the Alleghany and TransRe Senior Notes and other debt can be found in Note 8.
The following tables present segment results for Alleghany’s two reportable segments and for other activities for 2017, 2016 and 2015:
Information associated with Alleghany’s foreign operations in its reinsurance segment (representing the vast majority of Alleghany’s foreign operations), is as follows:
Foreign gross premiums written in 2017, 2016 and 2015 were approximately $1.5 billion, $1.5 billion and $1.6 billion, respectively.
Amounts recognized as compensation expense in the consolidated statements of earnings and comprehensive income with respect to long-term compensation awards under plans for parent company-level employees and directors were $17.1 million, $17.1 million and $19.7 million in 2017, 2016 and 2015, respectively. The amount of related income tax benefit in the consolidated statements of earnings and comprehensive income with respect to these plans was $3.6 million, $6.0 million and $6.9 million in 2017, 2016 and 2015, respectively. In 2017, 2016 and 2015, $7.1 million, $5.7 million and $4.7 million of Common Stock at fair market value, respectively, and $19.3 million, $14.4 million and $10.9 million of cash, respectively, was paid by Alleghany under these plans for parent company-level employees and directors. As noted above, as of December 31, 2017 and 2016, all outstanding awards were accounted for under the fair-value-based method of accounting.
TransRe has a Book Value Unit Plan and a Mid-Term Incentive Plan (collectively, the “TransRe Plans”) for the purpose of providing incentives to key employees of TransRe. Under the TransRe Plans, book value units (“BVUs”) and mid-term incentive plan (“MTIP”) awards are issued. BVUs and MTIP awards may only be settled in cash. The fair value of each BVU is calculated as the stockholder’s equity of TransRe, adjusted for certain capital transactions, divided by the adjusted number of
RSUI has a Restricted Stock Unit Plan (the “RSUI Plan”) for the purpose of providing equity-like incentives to key employees of RSUI. Under the RSUI Plan, restricted stock units (“units”) are issued. Additional units, defined as the “Deferred Equity Pool,” were issued in 2017, 2016 and 2015 and may be created in the future if certain financial performance measures are met. Units may only be settled in cash. The fair value of each unit is calculated as the stockholder’s equity of RSUI, adjusted for certain capital transactions and accumulated compensation expense recognized under the RSUI Plan, divided by the sum of RSUI common stock outstanding and the original units available under the RSUI Plan. The units vest on the fourth anniversary of the date of grant and contain certain restrictions, relating to, among other things, forfeiture in the event of termination of employment and transferability. In 2017, 2016 and 2015, RSUI recorded $26.3 million, $25.4 million and $22.7 million, respectively, in compensation expense related to the RSUI Plan. During the same periods, a deferred tax benefit of $5.5 million, $8.9 million and $7.9 million, respectively, related to the compensation expense were recorded.
Long-term incentive plans exist at certain other subsidiaries for the purpose of providing equity-like incentives to key employees. The awards under such plans were not material to Alleghany’s results of operations, financial condition or cash flows for the three years ended December 31, 2017.
In addition, Alleghany, TransRe and W&W|AFCO Steel have defined benefit pensions plans for certain of their employees, as further described below.
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, 2017 and 2016 was $34.1 million and $30.2 million, respectively, and the related fair value of plan assets was $3.4 million and $2.4 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, 2017 and 2016, the projected benefit obligation was $71.8 million and $65.4 million, respectively, and the related fair value of plan assets was $52.4 million and $48.7 million, respectively.
Selected quarterly financial data for 2017 and 2016 are presented below:
We have audited Alleghany Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Alleghany Corporation and subsidiaries’ (the “Company”) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria.