For discussion of our results of operations and changes in financial conditions for year ended December 31, 2019 compared to year ended December 31, 2018 refer to Part II. Item 7. Management’s Discussion and Analysis of Financial Conditions and Results of Operations in our 2019 Form 10-K which was filed with the SEC on February 28, 2020 (the “2019 10-K”) and such discussion is incorporated herein by reference. However, for certain items below in the discussion of our consolidated results of operations, we have included the discussion for the year ended December 31, 2019 compared to year ended December 31, 2018, when applicable, to reflect the adjustments described above and in Note 2, “Revisions of Previously Issued Financial Statements.” These revised discussions replace the applicable discussion in the 2019 10-K.
The following is a comparison of selected data from our results of operations, as well as book value per common share, for the relevant periods:
In March 2020, we transitioned predominantly all of our employees to a remote working environment, leveraging our investments over the last several years in business contingency planning and digital solutions. This has allowed Argo Group and its business functions to operate successfully from the onset of the COVID-19 pandemic through the date of this filing. We are committed to serving the needs of our employees, customers, business partners and shareholders and have developed a COVID-19 response team to monitor our efforts around safeguarding our people, supporting our front office and business operations, understanding and managing our loss exposures and other risks associated with COVID-19. We also consistently seek to keep our employees, customers, business partners and shareholders informed.
(1) For purposes of calculating the percentage points impact on the loss, expense and combined ratios, earned premiums were adjusted to exclude outward reinstatement premium adjustments of $7.6 million, $0.8 million and $9.0 million the years ended December 31, 2020, 2019 and 2018, respectively.
Consolidated earned premiums increased $50.8 million, or 2.9%, for the comparative periods. Earned premiums in our U.S. Operations increased $87.7 million, or 7.8%, while International Operations’ earned premiums decreased $37.1 million, or 6.1%. Consolidated earned premiums for the years ended December 31, 2020 and 2019 included outward catastrophe-related reinsurance reinstatement premiums of $7.6 million (U.S.: $6.4 million; International: $1.2 million) and $0.8 million (International: $0.8 million), respectively.
Consolidated net investment income was $112.7 million for the year ended December 31, 2020 as compared to $151.1 million for the same period in 2019. The year-over-year decrease in consolidated net investment income included a $27.1 million decrease in net investment income from our core portfolio primarily due to a combination of our decision to hold highly liquid investments at the end of the first quarter of 2020 due to concerns around potential business impacts from COVID-19, as well as the drop in treasury and LIBOR rates beginning in the second quarter of 2020, which impacted our reinvestment rate, partially offset by lower investment expenses for the year ended December 31, 2020 as compared to the same period in 2019. Net investment income from our alternatives investment portfolio, which is reported on a one to three-month lag, decreased $11.3 million for the year ended December 31, 2020 as compared to the same period in 2019, primarily due to the volatility in global financial markets in 2020 surrounding the spread of COVID-19. Partially offsetting these losses was a $6.2 million gain in the third quarter of 2020 from a performance-based contingent payment related to net asset sales initiated by an equity investee in the second quarter of 2017, as previously reported.
Consolidated net realized investment losses of $7.2 million for the year ended December 31, 2020 included a $39.9 million charge for expected credit losses on fixed maturity securities recognized under Accounting Standards Update (“ASU”) 2016-13, “Measurement of Credit Losses on Financial Instruments,” which was effective January 1, 2020. We also recognized a $9.4 million loss related to the sale of our reinsurance business, Ariel Re, in the fourth quarter of 2020, as well as $0.5 million related to net foreign currency exchange losses. Partially offsetting these losses were the $32.3 million gain recognized on the sale of our Trident brand and underwriting platform in the second quarter of 2020 and a $10.3 million increase in the fair value of equity securities.
In determining appropriate reserve levels for the year ended December 31, 2020, we maintained the same general processes and disciplines that were used to set reserves at prior reporting dates. No significant changes in methodologies were made to estimate the reserves since the last reporting date; however, at each reporting date we reassess the actuarial estimate of the reserve for loss and loss adjustment expenses and record our best estimate. Consistent with prior reserve valuations, as claims data becomes more mature for prior accident years, actuarial estimates were refined to weigh certain actuarial methods more heavily in order to respond to any emerging trends in the paid and reported loss data. While prior accident years’ net reserves for losses and loss adjustment expenses for some lines of business have developed favorably in recent years, this does not imply that more recent accident years’ reserves also will develop favorably; pricing, reinsurance costs, legal environment, general economic conditions including changes in inflation and many other factors impact our ultimate loss estimates.
Consolidated gross reserves for losses and loss adjustment expenses were $5,406.0 million (including $243.7 million of reserves attributable to our Syndicate 1200 and 1910 trade capital providers) and $5,157.6 million (including $238.5 million of reserves attributable to our Syndicate 1200 and 1910 trade capital providers) as of December 31, 2020 and 2019, respectively. Management has recorded its best estimate of loss reserves at each date based on current known facts and circumstances. Due to the significant uncertainties inherent in the estimation of loss reserves, there can be no assurance that future loss development, favorable or unfavorable, will not occur.
Consolidated underwriting, acquisition and insurance expenses were $679.4 million and $666.0 million for the years ended December 31, 2020 and 2019, respectively. The consolidated expense ratios were 38.1% and 38.5%, for the years ended December 31, 2020 and 2019, respectively. The slight increase in expenses in 2020 compared to 2019 was primarily due to decreasing our third-party capital at Lloyd’s and, as such, retaining certain costs in 2020 that were previously allocated to trade capital providers, severance costs in International Operations, retention bonuses in our Reinsurance business, which we subsequently sold, as well as the continued investment in strategic growth areas of our business. The expense ratios were relatively flat for the comparative periods. The expense ratio for our U.S. Operations was slightly improved in 2020 compared to 2019, while International Operations experienced deterioration for the comparative periods.
As noted above in the discussion of net realized gains for the year ended December 31, 2020, we recognized a $9.4 million loss related to the sale of Ariel Re in the fourth quarter of 2020. Of that amount, $9.2 million related to goodwill written off as a result of the disposal.
We are primarily engaged in writing property and casualty insurance. We have two primary reporting segments: U.S. Operations and International Operations. Additionally, we have a Run-off Lines segment for products that we no longer underwrite.
We consider many factors, including the nature of each segment’s insurance products, production sources, distribution strategies and regulatory environment, in determining how to aggregate reporting segments.
•Liability includes a broad range of primary and excess casualty products primarily underwritten as insurance and, to a lesser extent reinsurance, for risks on both an admitted and non-admitted basis in the United States. Internationally, Argo Group underwrites non-U.S. casualty risks primarily exposed in the U.K., Canada, and Australia.
•Professional includes various professional lines products including errors & omissions and management liability coverages (including directors and officers).
The following table summarizes the results of operations for the U.S. Operations segment:
The increase in gross written and net earned premiums for the year ended December 31, 2020 compared to the same period in 2019 was primarily due to growth in surety, partially offset by reduced animal mortality programs business.
The loss ratios for the years ended December 31, 2020 and 2019 were 63.6% and 61.7%, respectively. The higher loss ratio in 2020, as compared to 2019, was driven by a 3.6 percentage point impact from an increase in catastrophe losses, which includes COVID-19-related claims, partially offset by an improvement of 1.2 percentage points related to lower net unfavorable prior-year reserve development in 2020 as compared to 2019, as well as a 0.5 percentage point improvement in the current accident year non-catastrophe loss ratio.
The current accident year non-catastrophe loss ratio for the years ended December 31, 2020 and 2019 were 58.5% and 59.0%, respectively. The improvement in 2020 primarily related to rate improvement achieved over the past several quarters, as well as reduced claim activity during 2020 due to the impacts of the economic slowdown, partially offset by increases in liability and professional lines.
Net unfavorable prior-year reserve development for the year ended December 31, 2020 was $2.4 million (0.2 percentage points) and primarily related to liability and professional lines, partially offset by favorable experience in specialty and property. The net favorable prior-year reserve development for the year ended December 31, 2019 was $15.7 million (1.4 percentage points) and related primarily to unfavorable prior-year reserve development on liability claims within our E&S lines business, as well as in property lines, partially offset by favorable prior-year reserve development in specialty lines.
Catastrophe losses for the year ended December 31, 2020 were $56.2 million (4.9 percentage points), which included reserves associated with COVID-19 of $6.5 million, primarily related to expected costs associated with potential litigation related to property exposures. The remaining catastrophe losses of $49.7 million for the year ended December 31, 2020 were mainly attributable to wildfires, Hurricanes Laura, Delta, Zeta and Sally, and number of smaller storms across the U.S. Catastrophe losses for the year ended December 31, 2019 were $14.4 million (1.3 percentage points) and included Hurricane Dorian and other U.S. storms, including Midwest floods.
The improvement in the expense ratio for the year ended December 31, 2020 as compared to the same period 2019 was primarily concentrated in non-acquisition expenses, which benefited from continued execution on premium growth that outpaced the internal expense growth through continued investments in talent and technologies. Additionally, travel and entertainment expenses were significantly reduced as a result of the COVID-19 pandemic. To a lesser extent, the acquisition ratio also improved, driven by higher ceding commissions on certain reinsurance contracts during 2020. Partially offsetting the year-over-year expense ratio improvement was $6.4 million of catastrophe-related outward reinstatement premiums incurred in 2020, whereas none was incurred in 2019.
The increase in gross written and net earned premiums for the year ended December 31, 2020 as compared to the same period in 2019 was due to growth in our Bermuda Insurance operation primarily as a result of favorable rate changes and new and expanded business, as well as growth in our Brazilian operation as a result of new directors and officers business opportunities.
The decrease in gross written and net earned premiums for the year ended December 31, 2020 as compared to the same period in 2019 was driven by lower written premiums in Syndicate 1200, mainly due to re-underwriting efforts in accident and health and the impact of COVID-19 to the political risks, and contingency events markets, as well as lower written and earned premiums in Reinsurance resulting from no longer underwriting a large fronting arrangement.
The loss ratios for the years ended December 31, 2020 and 2019 were 74.9% and 85.0%, respectively. The reduced loss ratio in 2020, as compared to 2019, was driven by a year-over-year improvement of 19.2 percentage points from net favorable prior-year reserve development in 2020 compared to net unfavorable prior-year reserve development in 2019, as well as a 9.3 percentage point improvement in the current accident year non-catastrophe loss ratio, partially offset by an 18.4 percentage point increase in catastrophe losses, which includes COVID-19 related claims.
The increase in the expense ratio for the year ended December 31, 2020 as compared to the same period in 2019 was primarily due to a combination of the lower earned premium base, higher non-acquisition costs in our Europe operations, including severance costs, retention bonuses in our Reinsurance business, which we subsequently sold, and an increase in non-acquisition expenses in our Lloyd’s syndicates due to decreasing our use of third-party capital at Lloyd’s and, as such, retaining certain costs during 2020 that were previously allocated to trade capital providers.
Argonaut also assumed risk as a reinsurer, primarily for the period from 1970 to 1975, a portion of which was assumed from the London market. Argonaut also reinsured risks on policies written by domestic carriers. Such reinsurance typically provided coverage for limits attaching at a relatively high level, which are payable only after other layers of reinsurance are exhausted. Some of the claims now being filed on policies reinsured by Argonaut are on behalf of claimants who may have been exposed at some time to asbestos incorporated into buildings they occupied, but have no apparent medical problems resulting from such exposure. Additionally, lawsuits are being brought against businesses that were not directly involved in the manufacture or installation of materials containing asbestos. We believe that a significant portion of claims generated out of this population of claimants may result in incurred losses generally lower than the asbestos claims filed over the past decade and could be below the attachment level of Argonaut.
Losses and loss adjustment expenses for the year ended December 31, 2019 included $12.0 million of net unfavorable loss reserve development on prior accident years, of which $7.5 million was in asbestos and environmental lines and $6.3 million in other run-off lines, partially offset by $1.8 million of net favorable loss reserves development on prior accident years in risk management.
Because of the types of coverage within the Run-off Lines of business still being serviced by Argonaut, a significant amount of subjectivity and uncertainty exists in establishing the reserves for losses and loss adjustment expenses. Factors that increase these uncertainties are: (1) lack of historical data, (2) inapplicability of standard actuarial projection techniques, (3) uncertainties regarding ultimate claim costs, (4) coverage interpretations and (5) the judicial, statutory and regulatory environments under which these claims may ultimately be resolved. Significant uncertainty remains as to our ultimate liability due to the potentially long waiting period between exposure and emergence of any bodily injury or property damage and the resulting potential for involvement of multiple policy periods for individual claims. Due to these uncertainties, the current trends may not be indicative of future results. Although we have determined and recorded our best estimate of the reserves for losses and loss adjustment expenses for Run-off Lines, current judicial and legislative decisions continue to broaden liability, expand the scope of coverage and increase the severity of claims payments. As a result of these and other recent developments, the uncertainties inherent in estimating ultimate loss reserves are heightened, further complicating the already complex process of determining loss reserves. The industry as a whole is involved in extensive litigation over coverages and liability issues continue to make it difficult to quantify these exposures.
Underwriting, acquisition and insurance expenses for the Run-off Lines segment consists primarily of administrative expenses. The increase in underwriting expenses for the year ended December 31, 2020 as compared to the same period in 2019 was primarily due to increased legal expenses incurred during 2020.
On October 12, 2020, ArgoGlobal, the Lloyd’s insurer and member of Argo, announced a reinsurance-to-close (“RITC”) transaction with legacy specialist RiverStone. Pursuant to the terms of the transaction, RiverStone will undertake an RITC of ArgoGlobal’s Syndicate 1200 for 2017 and prior years with net technical provision of approximately $217 million. The transaction received regulatory approval on January 29, 2021, with the RITC becoming effective on January 1, 2021.
For the years ended December 31, 2020 and 2019, net cash used in investing activities was $24.3 million and $142.8 million, respectively. Included in the net cash used in investing activities for the year ended December 31, 2020 was the $38 million cash inflow related to the sale of Trident assets and the $30 million cash inflow related to the sale of Ariel Re, net of $1.7 million cash transferred. During the second half of 2020, we minimized our investment of U.S. operating cash balances in money market funds as the earnings credit rate on these accounts exceeded money market fund yields. As a result, cash increased versus prior year end with a correspondent decrease in short-term investment. The remaining decrease in cash flows used in investing activities from 2019 to 2020 was the result of the increase in maturities of fixed maturity investments, partially offset by an increase in cash used to purchased fixed maturity securities and a decrease in sales of fixed maturity investments and equity securities. As of December 31, 2020 and 2019, $542.6 million and $845.0 million, respectively, of the investment portfolio were invested in short-term investments.
Under certain insurance programs (i.e., large deductible programs and surety bonds) and various reinsurance agreements, collateral and letters of credit (“LOCs”) are held for our benefit to secure performance of insureds and reinsurers in meeting their obligations. At December 31, 2020, the amount of such collateral and LOCs held under insurance and reinsurance agreements was $816.8 million and $1,131.4 million, respectively. Collateral can also be provided in the form of trust accounts. As we are the beneficiary of these trust accounts only to secure future performance, these amounts are not reflected in our consolidated balance sheets. Collateral provided by an insured or reinsurer may exceed or fall below the amount of their total outstanding obligation.
Argo Re is the primary direct subsidiary of Argo Group and is subject to Bermuda insurance laws. As part of the Maybrooke liquidation, Ariel Reinsurance, Ltd. was merged into Argo Re Ltd. effective December 31, 2017. Argo Ireland is indirectly owned by Argo Re and is a mid-level holding company subject to Irish laws, and its primary subsidiary is Argo Group U.S., Inc. Argo Group U.S., Inc. is a mid-level holding company subject to Delaware laws. Argo Group U.S., Inc. is the parent of all of our U.S. insurance subsidiaries.
The payment of dividends by Argo Re is limited under Bermuda insurance laws which require Argo Re to maintain certain measures of solvency and liquidity. As of December 31, 2020, the unaudited statutory capital and surplus of Argo Re was $1,482.8 million, and the amount required to be maintained was $201.3 million, thereby allowing Argo Re the potential to pay dividends or capital distributions within the parameters of the solvency and liquidity margins. We believe that the dividend and capital distribution capacity of Argo Re will provide us with sufficient liquidity to meet the operating and debt service commitments, as well as other obligations.
In December 2020, Argo Re paid a cash dividend of $58.8 million to Argo Group which was used to repay intercompany balances related primarily to dividend payments, interest payments and other corporate expenses.
Included in the Credit Agreement is a provision that allows up to $200.0 million of the revolving credit facility to be used for LOCs, subject to availability. As of December 31, 2020, there was no borrowings outstanding and $70.5 million in LOCs against the revolving credit facility.
Trust Preferred Securities. Through a series of trusts, that are wholly-owned subsidiaries (non-consolidated), we issued trust preferred securities. The interest on the underlying debentures is variable with the rates being reset quarterly and subject to certain interest rate ceilings. Interest payments are payable quarterly. The debentures are all unsecured and are subordinated to other indebtedness. All are redeemable subject to certain terms and conditions at a price equal to 100% of the principal plus accrued and unpaid interest.
A summary of our outstanding junior subordinated debentures at December 31, 2020 is presented below:
Subordinated Debentures. Unsecured junior subordinated debentures with a principal balance of $91.8 million were assumed through the February 2017 acquisition of Maybrooke Holdings, S.A. (“the Maybrooke debt”), the since-liquidated holding company of our Ariel Re platform. As part of the liquidation of the Maybrooke holding company and the organizational restructuring of its former subsidiary companies, the acquired debt was ultimately assigned to Argo Re and is carried on our consolidated balance sheet at $85.1 million, which represents the debt’s fair value at the date of acquisition plus accumulated accretion of discount to par value, as required by accounting for business combinations under ASC 805. At December 31, 2020, the Maybrooke debt was eligible for redemption at par. Interest accrues on the Maybrooke debt based on a variable rate, which is reset quarterly. Interest payments are payable quarterly. A summary of the terms of the Maybrooke debt outstanding at December 31, 2020 is presented below:
Dividends to the Series A Preferences Shares will be payable on a non-cumulative basis only when, as and if declared by our Board or a duly authorized committee thereof, quarterly in arrears on the 15th of March, June, September, and December of each year, commencing on September 15, 2020, at a rate equal to 7.00% of the liquidation preference per annum (equivalent to $1,750 per Series A Preference Share and $1.75 per depositary share per annum) up to but excluding September 15, 2025. Beginning on September 15, 2025, any such dividends will be payable on a non-cumulative basis, only when, as and if declared by our Board or a duly authorized committee thereof, during each reset period, at a rate per annum equal to the Five-Year U.S. Treasury Rate as of the most recent reset dividend determination date (as described in the Company’s prospectus supplement dated July 7, 2020) plus 6.712% of the liquidation preference per annum.
For the year ended December 31, 2020, the Board declared quarterly dividends in the aggregate amount of $768.058 per preferred share. Cash dividends paid for the year ended December 31, 2020 totaled $4.6 million.
For the year ended December 31, 2020, the Board declared quarterly dividends in the aggregate amount of $1.24 per share. Cash dividends paid for the year ended December 31, 2020 totaled $43.0 million.
On February 12, 2021, the Board declared a quarterly cash dividend in the amount of $0.31 on each share of common stock outstanding. The dividend will be paid on March 12, 2021 to our shareholders of record on February 26, 2021.
On May 3, 2016, the Board authorized the repurchase of up to $150.0 million of our common shares (“2016 Repurchase Authorization”). The 2016 Repurchase Authorization supersedes all the previous repurchase authorizations. As of December 31, 2020, availability under the 2016 Repurchase Authorization for future repurchases of our common shares was $53.3 million.
•potentially long waiting periods between exposure and emergence of any bodily injury or property damage;
•difficulty in identifying sources of environmental or asbestos contamination and in properly allocating responsibility and/or liability for damage;
•potential for an environmental or asbestos claim to involve many insurance providers over many policy periods;
•historical data concerning asbestos and environmental losses which is more limited than historical information on other types of claims;
•Changes in the interpretations and processes of the workers compensation commissions’ oversight of claim;
•Changes in the cost of medical treatments, including prescription drugs, and underlying fee schedules;
Recorded gross reserves for workers compensation were $526.8 million as of December 31, 2020. The two most important assumptions for workers compensation reserves are loss development factors and loss cost trends, particularly medical cost inflation. Loss development patterns are dependent on medical cost inflation. Approximately 55% of the workers compensation net reserves are related to future medical costs. A review of National Council on Compensation Insurance data suggests that the annual growth in industry medical claim costs has varied from -2% to +13% since 1991. Across the entire reserve base, a 1% change in calendar year medical inflation could change the estimated net reserve by $15.0 million, in either direction.
In establishing our best estimate for reserves, we consider facts currently known and the present judicial and legislative environment. However, given the expansion of coverage and liability by the courts, legislation in the recent past and possibility of similar interpretations in the future, particularly with regard to asbestos and environmental claims, additional loss reserves may develop in future periods. These potential increases cannot be reasonably estimated at the present time. Any increases could have an adverse impact on future operating results, liquidity, risk-based capital ratios and ratings assigned to our insurance subsidiaries by the nationally recognized insurance rating agencies.
Effective January 1, 2020, the Company adopted ASU 2016-13, requiring the Company to estimate expected credit losses on available-for-sale securities. Where we intend to sell or will be required to sell an investment prior to recovery, a credit loss will be recognized through income as a realized loss. For fixed maturities for which a decline in the fair value between amortized cost is due to credit-related factors, an allowance is established. If a decline in the value of a particular investment is believed to be non-credit-related, the decline is recorded as an unrealized loss, net of tax, in other comprehensive income as a separate component of shareholders’ equity. We evaluate our investments for impairment. We regularly monitor the difference between the estimated fair values of our investments and their cost or book values to identify underperforming investments. For fixed maturities securities, the evaluation for a credit loss is generally based on the present value of expected cash flows of the security as compared to the amortized book value. For mortgage-backed securities, frequency and severity inputs are used in projecting future cash flows of the securities. Loss frequency is measured as the credit default rate, which includes such factors as loan-to-value ratios and credit scores of borrowers. Loss severity includes such factors as trends in overall housing prices and house prices that are obtained at foreclosure. For the year ended December 31, 2020, we recorded an allowance for credit losses of $6.6 million. In 2019, $20.3 million of realized losses due to the recognition of other-than-temporary impairments were recognized.
Deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of Argo Group’s United States, Brazil, Ireland, Italy, Switzerland, Belgium, Malta and U.K. subsidiaries’ assets and liabilities. Deferred tax liabilities are recognized for temporary differences that will result in taxable amounts in future years. Deferred tax assets are recognized for deductible temporary differences and tax operating loss and tax credit carryforwards. The deferred tax assets and liabilities are measured by applying the enacted tax rates and laws in effect for the years in which such differences are expected to reverse. The components of our deferred tax asset are temporary differences primarily attributable to loss reserve discounting, unearned premium reserves and net operating loss carryforwards. Our deferred tax liabilities resulted primarily from unrealized gains in the investment portfolio, deferred acquisition costs and depreciable fixed assets.
For additional information regarding our deferred tax assets and liabilities, please see Note 17, “Income Taxes” in the Notes to the Consolidated Financial Statements, included in Item 8, “Financial Statements and Supplementary Data” beginning on page.
For the year ended December 31, 2020, all of our reporting units passed the impairment test. As a result of this testing for the year ended December 31, 2019, we determined that the goodwill of the European reporting unit, which is included in our International Operations segment, was fully impaired and recorded a pre-tax charge of $15.6 million. For further discussion on this impairment of goodwill, see Note 1, “Business and Significant Accounting Policies” in the Notes to the Financial Statements.
The report of the independent auditors, consolidated financial statements of Argo Group and supplementary financial statements called for by this Item 8 are included in this report beginning on page and are incorporated herein by reference.