(3) Based on weighted average basic common shares outstanding of 39.7 million, 40.3 million, 40.4 million, 40.6 million and 41.3 million for 2020, 2019, 2018, 2017 and 2016, respectively.
(4) Based on weighted average diluted common shares outstanding of 39.7 million, 40.4 million, 40.6 million, 40.8 million and 41.6 million for 2020, 2019, 2018, 2017 and 2016, respectively.
(6) Based on 40.0 million, 40.8 million, 40.7 million, 40.8 million and 40.9 million common shares outstanding for December 31, 2020, 2019, 2018, 2017 and 2016, respectively.
The following is a discussion and analysis of our results of operations and financial condition. It should be read in conjunction with the Consolidated Financial Statements and accompanying notes thereto presented under ITEM 8, “Financial Statements and Supplementary Data”.
The industry continues to deal with the impacts of a global pandemic, COVID-19. Globally, many countries mandated that their citizens remain at home and many non-essential businesses have continued to be physically closed. We activated our operational resiliency plan across our global footprint and all of our critical operations are functioning effectively from remote locations. We continue to service and meet the needs of our clients while ensuring the safety and health of our employees and customers.
There will also be a negative impact on future industry underwriting results. With the closing of non-essential businesses, there has been a significant decline in business activity. To the extent that premiums are based on business activity, there will be a decline in premium volume. Incurred losses from the pandemic will be impacted by the duration of the event and will vary by line of business and geographical location. For the full year 2020, our underwriting results include $511.1 million of estimated losses related to the pandemic.
Many regulators had issued moratoriums on the cancellation of policies for the non-payment of premiums and also on non-renewals. We are complying with the various regulatory requests for accommodations to policyholders during this difficult period. The moratoriums combined with the forced closure of businesses may lead to an increase in uncollectible premium expense.
Net Investment Income. Net investment income decreased by 0.7% to $642.5 million in 2020 compared with investment income of $647.1 million in 2019. Net pre-tax investment income, as a percentage of average invested assets, was 2.9% in 2020 compared to 3.3% in 2019. The decreases in both income and yield were primarily the result of lower income from short term investments primarily due to lower interest rates resulting from the market impacts of COVID-19, partially offset by an increase in limited partnership income and higher income from the growing fixed income portfolio.
Net investment income increased by 11.3% to $647.1 million in 2019 compared with investment income of $581.2 million in 2018. Net pre-tax investment income, as a percentage of average invested assets, was 3.3% in 2019 compared to 3.2% in 2018. The increases in both income and yield were primarily the result of higher income from our growing fixed maturity portfolio and higher income from our limited partnerships, partially offset by lower dividend income from our equity portfolio.
Other Income (Expense). We recorded other income of $6.5 million in 2020 and other expense of $4.6 million and $24.3 million in 2019 and 2018, respectively. The changes were primarily the result of fluctuations in foreign currency exchange rates, income related to Mt. Logan Re, changes in value of equity put option
Incurred losses and LAE increased by 33.1% to $6,550.8 million in 2020, compared to $4,922.9 million in 2019, primarily due to a rise of $1,283.4 million in current year attritional losses, mainly due to $511.1 million of losses related to the COVID-19 pandemic and the impact of the increase in premiums earned, as well as $495.0 million of less favorable development on prior years attritional losses in 2020, which primarily resulted from $400.0 of reserve strengthening in the fourth quarter of 2020 associated with higher ultimate loss estimates for long-tail casualty business in the reinsurance segment for accident years 2015 to 2018, notably general liability, professional lines and auto liability. The reserve charge also includes actions on non-CAT property lines, primarily for the 2017 to 2019 accident years and driven by a few large losses to aggregate programs. The increase was partially offset by a decrease of $120.5 million in current year catastrophe losses. The current year catastrophe losses of $425.0 million in 2020 related to Hurricane Laura ($124.0 million), the Northern California wildfires ($44.1 million), Hurricane Zeta ($40.0 million), Hurricane Sally ($32.8 million), the California Glass wildfire ($29.5 million), Nashville tornadoes ($22.9 million), the Derecho storms ($20.5 million), Hurricane Isaias ($20.0 million), Hurricane Delta ($20.0 million), the Oregon wildfires ($17.0 million), the Calgary storms in Canada ($14.7 million), the 2020 U.S. civil unrest ($14.5 million), the Queensland Hailstorm ($10.0 million), the 2020 Australia fires ($8.2 million) and the Australia East Coast Storm ($6.8 million). The $545.5 million of current year catastrophe losses in 2019 related to Typhoon Hagibis ($200.0 million), Hurricane Dorian ($170.9
million), Typhoon Faxai ($124.3 million), Townsville Monsoon ($25.3 million), and the Dallas tornadoes ($25.0 million).
Incurred losses and LAE decreased by 12.9% to $4,922.9 million in 2019, compared to $5,651.4 million in 2018, primarily due to a decrease in current year catastrophe losses of $693.5 million and $531.2 million less of unfavorable development on prior years catastrophe losses in 2019 compared to 2018. These decreases were partially offset by an increase of $415.6 million in current year attritional losses, mainly due to the impact of the increase in premiums earned and changes in the mix of business, and $80.6 million less of favorable development on prior years attritional losses in 2019 compared to 2018. The current year catastrophe losses of $545.5 million in 2019 are outlined above. The $1,239.0 million of current year catastrophe losses in 2018 related to Hurricane Michael ($462.0 million), Camp wildfire ($322.0 million), Woolsey wildfire ($154.0 million), Typhoon Jebi ($80.0 million), Hurricane Florence ($73.8 million), Cyclone Mekunu ($43.7 million), Typhoon Trami ($25.0 million), Australia Hailstorm ($25.0 million), other 2018 California wildfires ($24.6 million), Japan floods ($20.5 million) and the U.S. winter storms ($8.4 million).
Commission, Brokerage, Taxes and Fees. Commission, brokerage, taxes and fees increased by 10.0% to $1,873.3 million for the year ended December 31, 2020 compared to $1,703.7 million for the year ended December 31, 2019. The changes were primarily due to the impact of the increases in premiums earned and changes in the mix of business.
Commission, brokerage, taxes and fees increased by 12.2% to $1,703.7 million for the year ended December 31, 2019 compared to $1,519.0 million for the year ended December 31, 2018. The changes were primarily due to the impact of the increases in premiums earned, higher contingent commissions and changes in the mix of business.
Corporate Expenses. Corporate expenses, which are general operating expenses that are not allocated to segments, were $41.1 million, $33.0 million and $30.7 million for the years ended December 31, 2020, 2019 and 2017, respectively. The increase from 2019 to 2020 was mainly due to costs associated with the relocation of our U.S. corporate offices and higher compensation expenses.
Interest, Fees and Bond Issue Cost Amortization Expense. Interest, fees and other bond amortization expense was $36.3 million, $31.7 million and $31.0 million in 2020, 2019 and 2018, respectively. The changes in expense were primarily due to the movements in the floating interest rate related to the long term subordinated notes, which is reset quarterly per the note agreement. The floating rate was 2.6% as of December 31, 2020. The increase from 2019 to 2020 was also related to the interest expense on the $1,000.0 million senior note issuance in October 2020.
Income Tax Expense (Benefit). We had income tax expense of $71.2 million in 2020, $89.5 million in 2019, and an income tax benefit of $331.2 million in 2018. Income tax expense is primarily a function of the geographic location of the Company’s pre-tax income and the statutory tax rates in those jurisdictions. The effective tax rate (“ETR”) is primarily affected by tax-exempt investment income, foreign tax credits and dividends. Variations in the ETR generally result from changes in the relative levels of pre-tax income, including the impact of catastrophe losses and net capital gains (losses), among jurisdictions with different tax rates. The change in income tax expense was primarily due to the increase in incurred losses, including from COVID 19 reserves and a reserve charge from 2019 to 2020.
During 2018, the Company completed its accounting for the TCJA in accordance with SEC Staff Accounting Bulletin 118, including interpretation of the additional guidance issued by the IRS and U.S. Department of the Treasury, and recognized an income tax benefit of $28.4 million primarily related to the 2017 tax return to tax provision true-up recorded in 2018.
Our combined ratio increased by 7.4 points to 102.9% in 2020, compared to 95.5% in 2019. The loss ratio component increased 9.0 points in 2020 over the same period last year mainly due $511.1 million of losses related to the COVID-19 pandemic in 2020. The commission and brokerage ratio components decreased to 21.6% in 2020 compared to 23.0% in 2019 mainly due to the impact of lower reinstatement premiums in 2020 and changes in the mix of business. The other underwriting expense ratios decreased to 5.8% in 2020 compared to 6.0% in 2019 mainly due to the impact of higher earned premiums in 2020 compared to 2019.
Shareholders’ equity increased by $593.3 million to $9,726.2 million at December 31, 2020 from $9,132.9 million at December 31, 2019, principally as a result of $514.2 million of net income, $419.7 million of unrealized appreciation on investments net of tax, $86.3 million of net foreign currency translation adjustments, $25.6 million of share-based compensation transactions and $0.7 million of net benefit plan obligation adjustments, net of tax, partially offset by $249.1 million of shareholder dividends and the repurchase of 970,892 common shares for $200.0 million and $4.2 million of cumulative adjustment from the adoption of ASU 2016-13.
Net investment income decreased by 0.7% to $642.5 million in 2020 compared with investment income of $647.1 million in 2019. The decrease was primarily due to lower income from short term investments primarily due to lower interest rates resulting from the market impacts of COVID-19, partially offset by an increase in limited partnership income and higher income from the growing fixed income portfolio.
Net investment income increased by 11.3% to $647.1 million in 2019 compared with investment income of $581.2 million in 2018. The increase was primarily due to higher income from our growing fixed maturity portfolio and an increase in limited partnership income, partially offset by lower dividend income from our equity portfolio.
The pre-tax equivalent total return for the bond portfolio was approximately 5.3%, 6.3% and 2.9%, respectively, in 2020, 2019 and 2018. The pre-tax equivalent return adjusts the yield on tax-exempt bonds to the fully taxable equivalent.
Net realized capital gains were $267.6 million and $185.0 million in 2020 and 2019, respectively, and net realized capital losses were $127.1 million in 2018. The net realized capital gains of $267.6 million in 2020 were comprised of $280.4 million of net gains from fair value re-measurements, partially offset by $11.1 million of net realized capital losses from sales of investments and $1.7 million of net allowances for credit losses. In 2019, we recorded $167.0 million of net gains from fair value re-measurements and $38.9 million of net realized capital gains from sales of investments, partially offset by $20.9 million of other-than-temporary impairments. In 2018,
we recorded $67.3 million of net losses from fair value re-measurements, $51.7 million of net realized capital losses from sales of investments and $8.1 million of other-than-temporary impairments. The fixed maturity and equity sales during these years related primarily to adjusting the portfolios for overall market changes and individual credit shifts.
The Reinsurance operation writes worldwide property and casualty reinsurance and specialty lines of business, on both a treaty and facultative basis, through reinsurance brokers, as well as directly with ceding companies. Business is written in the U.S., Bermuda, and Ireland offices, as well as, through branches in Canada, Singapore and the United Kingdom. The Insurance operation writes property and casualty insurance directly and through brokers, surplus lines brokers and general agents within the U.S., Canada and Europe through its offices in the U.S., Canada, Ireland and a branch located in Zurich.
Underwriting results include earned premium less losses and loss adjustment expenses (“LAE”) incurred, commission and brokerage expenses and other underwriting expenses. We measure our underwriting results using ratios, in particular loss, commission and brokerage and other underwriting expense ratios, which, respectively, divide incurred losses, commissions and brokerage and other underwriting expenses by premiums earned.
Premiums. Gross written premiums increased by 14.6% to $7,281.7 million in 2020 from $6,355.9 million in 2019, primarily due to increases in property pro rata business, casualty excess of loss writings and property catastrophe excess of loss business, partially offset by a $35.9 million negative impact from the movement of foreign exchange rates. Net written premiums increased by 18.1% to $6,767.6 million in 2020 compared to $5,732.3 million in 2019. The difference between the change in gross written premiums compared to the change in net written premiums was primarily due to varying utilization of reinsurance. Premiums earned increased by 17.8% to $6,466.1 million in 2020, compared to $5,491.3 million in 2019. The change in premiums earned relative to net written premiums is primarily the result of timing; premiums are earned ratably over the coverage period whereas written premiums are recorded at the initiation of the coverage period.
Incurred losses increased by 34.2% to $4,933.4 million in 2020, compared to $3,675.2 million in 2019. The increase was primarily due to an increase of $1,002.0 million in current year attritional losses, mainly related to $407.1 million of losses from the COVID-19 pandemic and the impact of the increase in premiums earned, as well as $474.1 million of more development on prior years attritional losses in 2020 compared to 2019 primarily resulted from $400.0 of reserve strengthening in the fourth quarter of 2020 associated with higher ultimate loss estimates for long-tail casualty business for accident years 2015 to 2018, notably general liability, professional lines and auto liability. The reserve charge also includes actions on non-CAT property lines, primarily for the 2017 to 2019 accident years and driven by a few large losses to aggregate programs. The increase was partially offset by a decline of $184.5 million in current year catastrophe losses and $33.4 million of less development on prior years catastrophe losses. The current year catastrophe losses of $357.0 million in 2020 related primarily to Hurricane Laura ($105.5 million), the Northern California wildfires ($44.1 million), Hurricane Zeta ($32.0 million), the California Glass wildfire ($29.5 million), Hurricane Delta ($18.0 million), Hurricane Isaias ($17.8 million), the Nashville tornadoes ($17.5 million), the Derecho storms ($17.5 million), the Oregon wildfires ($17.0 million), Hurricane Sally ($16.9 million), the Calgary storms in Canada ($12.2 million), the Queensland hailstorm ($10.0 million), the Australia fires ($8.2 million), the Australia East Coast storm ($6.8 million), and the 2020 U.S. Civil Unrest ($4.1 million). The $541.5 million of current year catastrophe losses in 2019 related primarily to Typhoon Hagibis ($200.0 million), Hurricane Dorian ($166.9 million), Typhoon Faxai ($124.3 million), the 2019 Townsville Monsoon ($25.3 million) and the Dallas tornadoes ($25.0 million).
Incurred losses decreased by 19.9% to $3,675.2 million in 2019, compared to 4,585.6 million in 2018. The decrease was primarily due to a decrease of $654.4 million in current year catastrophe losses and an improvement of $537.7 million on development of prior years catastrophe losses, partially offset by an increase
Incurred losses and LAE increased by 17.1% to $1,247.7 million in 2019 compared to $1,065.8 million in 2018, mainly due to an increase of $178.6 million in current year attritional losses, related to the impact of the increase in premiums earned and $35.8 million less of favorable development on prior years attritional losses. These impacts were partially offset by a decrease of $39.1 million in current year catastrophe losses. The
Commission and brokerage increased by 13.5% to $303.5 million in 2019 compared to $267.4 million in 2018. The increase in 2019 was mainly due to the impact of the increase in premiums earned. Segment other underwriting expenses increased to $280.1 million in 2019 compared to $228.7 million in 2018. The increase was mainly due to the impact of the increase in premiums earned and increased expenses related to the continued build out of the insurance business.
The detailed data required to evaluate ultimate losses for our insurance business is accumulated from our underwriting and claim systems. Reserving for reinsurance requires evaluation of loss information received from ceding companies. Ceding companies report losses to us in many forms dependent on the type of contract and the agreed or contractual reporting requirements. Generally, proportional/quota share contracts require the submission of a monthly/quarterly account, which includes premium and loss activity for the period with corresponding reserves as established by the ceding company. This information is recorded into our records. For certain proportional contracts, we may require a detailed loss report for claims that exceed a certain dollar threshold or relate to a particular type of loss. Excess of loss and facultative contracts generally require individual loss reporting with precautionary notices provided when a loss reaches a significant
percentage of the attachment point of the contract or when certain causes of loss or types of injury occur. Our experienced claims staff handles individual loss reports and supporting claim information. Based on our evaluation of a claim, we may establish additional case reserves (ACRs) in addition to the case reserves reported by the ceding company. To ensure ceding companies are submitting required and accurate data, the Underwriting, Claim, Reinsurance Accounting and Internal Audit departments of the Company perform various reviews of our ceding companies, particularly larger ceding companies, including on-site audits.
Due to the uncertainties discussed above, the ultimate losses attributable to A&E, and particularly asbestos, may be subject to more variability than are non-A&E reserves and such variation could have a material adverse effect on our financial condition, results of operations and/or cash flows. See also ITEM 8, “Financial Statements and Supplementary Data” - Notes 1 and 3 of Notes to the Consolidated Financial Statements.
The allowance is estimated as the amount of reinsurance receivable exposed to loss multiplied by estimated factors for the probability of default. The probability of default is assigned based on each reinsurer's credit rating, or a rating is estimated if no external rating is available. Credit ratings are reviewed and updated at least
As of December 31, 2020, and 2019, the reserve for uncollectible balances was $17.2 million and $15.0 million, respectively. Actual uncollectible amounts may vary, perhaps substantially, from such reserves, impacting income (loss) in the period in which the change in reserves is made. See also ITEM 8, “Financial Statements and Supplementary Data” - Note 11 of Notes to the Consolidated Financial Statements and “Financial Condition - Reinsurance Receivables” below.
losses in the consolidated statements of operations and comprehensive income (loss). Market value declines for the fixed income portfolio, which are considered credit related, are reflected in our consolidated statements of operations and comprehensive income (loss), as realized capital losses. We consider many factors when determining whether a market value decline is credit related, including: (1) we have no intent to sell and, more likely than not, will not be required to sell prior to recovery, (2) the length of time the market value has been below book value, (3) the credit strength of the issuer, (4) the issuer’s market sector, (5) the length of time to maturity and (6) for asset-backed securities, changes in prepayments, credit enhancements and underlying default rates. If management’s assessments change in the future, we may ultimately record a realized loss after management originally concluded that the decline in value was temporary. See also ITEM 8, “Financial Statements and Supplementary Data” - Note 1 of Notes to the Consolidated Financial Statements.
For the portion needed to satisfy global outstanding liabilities, we generally invest in fixed maturities with an average credit quality of Aa3. This global fixed maturity securities portfolio is externally managed by independent, professional investment managers using portfolio guidelines approved by internal management.
Over the past several years, we have expanded the allocation of our investments funded by shareholders’ equity to include: 1) a greater percentage of publicly traded equity securities, 2) emerging market fixed maturities through mutual fund structures, as well as individual holdings, 3) high yield fixed maturities, 4) bank and private loan securities and 5) private equity limited partnership investments. The objective of this portfolio diversification is to enhance the risk-adjusted total return of the investment portfolio by allocating a prudent portion of the portfolio to higher return asset classes. We limit our allocation to these asset classes because of 1) the potential for volatility in their values and 2) the impact of these investments on regulatory and rating agency capital adequacy models. We use investment managers experienced in these markets and adjust our allocation to these investments based upon market conditions. At December 31, 2020, the market value of investments in these investment market sectors, carried at both market and fair value, approximated 76% of shareholders’ equity.
Loss and LAE Reserves. Gross loss and LAE reserves totaled $16,399.0 million and $13,611.3 million at December 31, 2020 and 2019, respectively.
With respect to asbestos only, at December 31, 2020, we had net asbestos loss reserves of $194.1 million, or 97.9%, of total net A&E reserves, all of which was for assumed business.
consideration for entering into the retrocession treaty, Bermuda Re transferred cash of $140.3 million, an amount equal to the net loss reserves as of the closing date. Of the $140.3 million of net loss reserves retroceded, $100.5 million were related to A&E business. The maximum liability retroceded under the retrocession treaty will be $440.3 million, equal to the retrocession payment plus $300.0 million. We will retain liability for any amounts exceeding the maximum liability retroceded under the retrocession treaty.
Industry analysts use the “survival ratio” to compare the A&E reserves among companies with such liabilities. The survival ratio is typically calculated by dividing a company’s current net reserves by the three year average of annual paid losses. Hence, the survival ratio equals the number of years that it would take to exhaust the current reserves if future loss payments were to continue at historical levels. Using this measurement, our net three year asbestos survival ratio was 5.2 years at December 31, 2020. These metrics can be skewed by individual large settlements occurring in the prior three years and therefore, may not be indicative of the timing of future payments.
Our two main operating companies Bermuda Re and Everest Re are regulated by the Bermuda Monetary Authority (“BMA”) and the State of Delaware, Department of Insurance, respectively. Both regulatory bodies have their own capital adequacy models based on statutory capital as opposed to GAAP basis equity. Failure to meet the required statutory capital levels could result in various regulatory restrictions, including business activity and the payment of dividends to their parent companies.
(3) The 2020 BSCR calculation is not yet due to be completed; however, the Company anticipates that Bermuda Re's December 31, 2020 actual capital will exceed the targeted capital level.
We also repurchased $13.2 million of our long-term subordinated notes in 2020. We recognized a realized gain of $2.5 million on the repurchase. We may continue, from time to time, to seek to retire portions of our outstanding debt securities through cash repurchases, in open-market purchases, privately negotiated transactions or otherwise. Such repurchases, if any, will be subject to and depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved in any such transactions, individually or in the aggregate, may be material.
On October 7, 2020, we issued an additional $1,000.0 million of 30 year senior notes with an interest coupon rate of 3.5%. These senior notes will mature on October 15, 2050 and will pay interest semi-annually.
Liquidity. Our liquidity requirements are generally met from positive cash flow from operations. Positive cash flow results from reinsurance and insurance premiums being collected prior to disbursements for claims, which disbursements generally take place over an extended period after the collection of premiums, sometimes a period of many years. Collected premiums are generally invested, prior to their use in such disbursements, and investment income provides additional funding for loss payments. Our net cash flows from operating activities were $2,873.6 million, $1,852.0 million and $610.1 million for the years ended December 31, 2020, 2019 and 2018, respectively. Additionally, these cash flows reflected net tax recoveries of $169.7 million, $148.6 million and $65.1 million in for the years ended December 31, 2020, 2019 and 2018, respectively, as well as net catastrophe loss payments of $661.5 million, $868.8 million, and $1,125.9 million for the years ended December 31, 2020, 2019 and 2018, respectively.
In addition to our cash flows from operations and liquid investments, we also have multiple credit facilities that provide up to $200.0 million of unsecured revolving credit for liquidity and letters of credit but more importantly provide for up to $600.0 million and £52.2 million of collateralized standby letters of credit to support business written by our Bermuda operating subsidiaries.
The Group Credit Facility requires Group to maintain a debt to capital ratio of not greater than 0.35 to 1 and to maintain a minimum net worth. Minimum net worth is an amount equal to the sum of $5,371.0 million plus 25% of consolidated net income for each of Group’s fiscal quarters, for which statements are available ending on or after March 31, 2016 and for which consolidated net income is positive, plus 25% of any increase in consolidated net worth during such period attributable to the issuance of ordinary and preferred shares, which at December 31, 2020, was $6,391.0 million. As of December 31, 2020, the Company was in compliance with all Group Credit Facility covenants.
Exposure to Catastrophes. Like other insurance and reinsurance companies, we are exposed to multiple insured losses arising out of a single occurrence, whether a natural event, such as a hurricane or an earthquake, or other catastrophe, such as an explosion at a major factory. A large catastrophic event can be expected to generate insured losses to multiple reinsurance treaties, facultative certificates and direct insurance policies across various lines of business.
results from multiple models and analytical methods must be combined to estimate potential losses by and across business units. Also, while most models have been updated to incorporate claims information from recent catastrophic events, catastrophe model projections are still inherently imprecise. In addition, uncertainties with respect to future climatic patterns and cycles could add further uncertainty to loss projections from models based on historical data.
Our catastrophe loss projections, segmented by risk zones, are updated quarterly and reviewed as part of a formal risk management review process.
coverage, with the aim of securing cost effective protection from financially secure counterparts. The amount of reinsurance purchased has varied over time, reflecting our view of our exposures and the cost of reinsurance.
Despite these safeguards, a significant cyber incident, including system failure, security breach and disruption by malware or other damage could interrupt or delay our operations and possibly our results. This type of incident may result in a violation of applicable data security, privacy, or other laws, damage our reputation, cause a loss of customers or give rise to regulatory scrutiny as well as monetary fines and other penalties. Management is not aware of a cybersecurity incident that has had a material impact on our operations.
The contractual obligations for senior notes and long term notes are the responsibility of Holdings. We have sufficient cash flow, liquidity, investments and access to capital markets to satisfy these obligations. Holdings generally depends upon dividends from Everest Re, its operating insurance subsidiary for its funding, capital contributions from Group or access to the capital markets. Our various operating insurance and reinsurance subsidiaries have sufficient cash flow, liquidity and investments to settle outstanding reserves for losses and LAE. Management believes that we, and each of our entities, have sufficient financial resources or ready access thereto, to meet all obligations.
Accounting for Long Duration Contracts. In August 2018, FASB issued ASU 2018-12, which discusses changes to the recognition, measurement and presentation of long duration contracts. The main provisions of this guidance address the following: 1) In determining liability for future policy benefits, companies must review cash flow assumptions at least annually and the discount rate assumption at each reporting period date 2) Amortization of deferred acquisition costs has been simplified to be in constant level proportion to either premiums, gross profits or gross margins 3) Disaggregated roll forwards of beginning and ending liabilities for future policy benefits are required. The guidance was originally effective for annual reporting periods beginning after December 15, 2020 and interim periods within that annual reporting period. However, FASB issued ASU 2019-09 in November 2019 and then ASU-2020-11 in November 2021, which ultimately defers the effective date of ASU 2018-12 until annual reporting periods beginning after December 15, 2022. The Company is currently evaluating the impact of the adoption of ASU 2018-12 on its financial statements.
Accounting for Impact on Income Taxes due to Tax Reform. In December 2017, the SEC issued Staff Accounting Bulletin (“SAB”) 118 which provides guidance on the application of FASB Accounting Standards Codification (“ASC”) Topic 740, Income Taxes, due to the enactment of TCJA. SAB 118 became effective upon release. The
Leases. In February 2016, FASB issued ASU 2016-02 (and subsequently issued ASU 2018-11 in July, 2018) which outline new guidance on the accounting for leases. The new guidance requires the recognition of lease assets and lease liabilities on the balance sheets for most leases that were previously deemed operating leases and required only lease expense presentation in the statements of operations. The guidance is effective for annual and interim reporting periods beginning after December 15, 2018. The Company adopted ASU 2016-02 effective January 1, 2019 and elected to utilize a cumulative-effect adjustment to the opening balance of retained earnings for the year of adoption. Accordingly, the Company’s reporting for the comparative periods prior to adoption continue to be presented in the financial statements in accordance with previous lease accounting guidance. The Company also elected to apply the package of practical expedients applicable to the Company in the updated guidance for transition for leases in effect at adoption. The Company did not elect the hindsight practical expedient to determine the lease term of existing leases (e.g. The Company did not re-assess lease renewals, termination options nor purchase options in determining lease terms). The adoption of the updated guidance resulted in the Company recognizing a right-of-use asset of $69,869 thousand as part of other assets and a lease liability of $77,270 thousand as part of other liabilities in the consolidated balance sheet at the time of adoption, as well as de-recognizing the liability for deferred rent that was required under the previous guidance. The cumulative effect adjustment to the opening balance of retained earnings was zero. The adoption of the updated guidance did not have a material effect on the Company’s results of operations or liquidity.
cumulative change adjustment of $1,201 thousand between AOCI and retained earnings, which is disclosed separately within the consolidated statement of changes in shareholders’ equity.
Any issued guidance and pronouncements, other than those directly referenced above, are deemed by the Company to be either not applicable or immaterial to its financial statements.
The tables below display the potential impact of market value fluctuations and after-tax unrealized appreciation on our fixed maturity portfolio (including $1,135.0 million of short-term investments) for the period indicated based on upward and downward parallel and immediate 100 and 200 basis point shifts in interest rates. For legal entities with a U.S. dollar functional currency, this modeling was performed on each security individually. To generate appropriate price estimates on mortgage-backed securities, changes in prepayment expectations under different interest rate environments were taken into account. For legal entities with a non-U.S. dollar functional currency, the effective duration of the involved portfolio of securities was used as a proxy for the market value change under the various interest rate change scenarios.
We had $16,399.0 million and $13,611.3 million of gross reserves for losses and LAE as of December 31, 2020 and 2019, respectively. These amounts are recorded at their nominal value, as opposed to present value, which would reflect a discount adjustment to reflect the time value of money. Since losses are paid out over a period of time, the present value of the reserves is less than the nominal value. As interest rates rise, the present value of the reserves decreases and, conversely, as interest rates decline, the present value increases. These movements are the opposite of the interest rate impacts on the fair value of investments. While the difference between present value and nominal value is not reflected in our financial statements, our financial results will include investment income over time from the investment portfolio until the claims are paid. Our loss and loss reserve obligations have an expected duration of approximately 3.2 years, which is reasonably consistent with our fixed income portfolio. If we were to discount our loss and LAE reserves, net of ceded reserves, the discount would be approximately $1.5 billion resulting in a discounted reserve balance of approximately $13.0 billion, representing approximately 61.6% of the value of the fixed maturity investment portfolio funds.
Foreign Currency Risk. Foreign currency risk is the potential change in value, income and cash flow arising from adverse changes in foreign currency exchange rates. Each of our non-U.S./Bermuda (“foreign”) operations maintains capital in the currency of the country of its geographic location consistent with local regulatory guidelines. Each foreign operation may conduct business in its local currency, as well as the currency of other countries in which it operates. The primary foreign currency exposures for these foreign operations are the Canadian Dollar, the Singapore Dollar, the British Pound Sterling and the Euro. We mitigate foreign exchange exposure by generally matching the currency and duration of our assets to our corresponding operating liabilities. In accordance with FASB guidance, the impact on the market value of available for sale fixed maturities due to changes in foreign currency exchange rates, in relation to functional currency, is reflected as part of other comprehensive income. Conversely, the impact of changes in foreign currency exchange rates, in relation to functional currency, on other assets and liabilities is reflected through net income as a component of other income (expense). In addition, we translate the assets, liabilities and income of non-U.S. dollar functional currency legal entities to the U.S. dollar. This translation amount is reported as a component of other comprehensive income.