Sirius Group maintains a professional office in Hamilton, Bermuda, which serves as its headquarters and its registered office. Sirius Group and Sirius Bermuda are headquartered in Hamilton, Bermuda. Sirius International is headquartered in Stockholm, Sweden with various branch offices in Europe, Asia and Bermuda. Sirius America is headquartered in New York, New York with various offices in the U.S. and in Toronto, Canada. IMG is headquartered in Indianapolis, Indiana with various offices in the United Kingdom and Hong Kong. Armada is headquartered in Hunt Valley, Maryland. Sirius Group's home offices and all of its branch offices are leased. We believe that our office space is sufficient for us to conduct our operations for the foreseeable future.
(3)The loss and loss adjustment expense ratio is calculated by dividing loss and loss adjustment expenses by net earned insurance and reinsurance premiums.
(6)The combined ratio is calculated by combining the loss and loss adjustment ratio, the acquisition expense ratio, and the other underwriting expense ratio.
The following is management's discussion and analysis ("MD&A") of the Company's audited consolidated results of operations for the years ended December 31, 2018, 2017, and 2016 and the Company's consolidated financial condition, liquidity and capital resources as of and for the years ended December 31, 2018 and 2017. This discussion and analysis should be read in conjunction with the Company's audited consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. The consolidated financial statements have been prepared in accordance with GAAP.
The following MD&A includes forward-looking statements, which are subject to risks, uncertainties and other factors that could cause our actual results to differ materially from those expressed or implied by our forward-looking statements. See "Cautionary Note Regarding Forward-Looking Statements".
Easterly held a special meeting of Easterly stockholders on November 2, 2018 to approve the completion of the transactions contemplated by the Merger Agreement. Easterly Acquisition Sponsor, LLC (the "Sponsor") and Easterly's other stockholders approved each of the proposals presented at the special meeting. After the special meeting, but prior to the consummation of the Merger, certain Easterly public stockholders exercised their redemption rights as provided for by Easterly's charter. In total, out of the Trust Account balance of $149 million, there were $110 million of redemptions by Easterly public stockholders, which decreased the amount of cash in the Trust Account available for general corporate purposes following the Merger. After the redemption of shares held by Easterly's public stockholders, there was $39 million in the Trust Account. This resulted in the issuance of 2,280,241 common shares to Easterly public stockholders.
Pursuant to the letter agreement among Easterly, the Sponsor and the Company (the "Sponsor Letter"), the private placement warrants issued to the Sponsor at the closing of the Merger were cancelled. Pursuant to the Merger Agreement, each issued and outstanding public warrant was converted into a warrant exercisable for Company common shares. The number of Company common shares subject to converted warrants was equal to the number of shares of Easterly common stock subject to each Easterly warrant immediately prior to the closing of the Merger multiplied by the Exchange Ratio, and each converted warrant had an exercise price per Company common share equal to the exercise price per share of Easterly common stock subject to such Easterly warrant immediately prior to the closing of the Merger divided by the Exchange Ratio. This resulted in the issuance of 6,088,535 converted warrants.
• 11,901,670 Series B preference shares with a cost basis of $196 million, • 1,225,954 of Common shares with a cost basis of $21 million, • 5,418,434 warrants that are exercisable for common shares for a period of five years after the Merger at a strike price equal to 125% of the per share purchase price, or $21.53 with a cost basis of $10 million. • Issuance costs of $2 million
Gross proceeds of the cash in the Easterly Trust Account assumed by Sirius Group upon the closing of the Merger, the Sirius Group Private Placement, and the ESPP sum to $268 million.
In connection with the Merger, the Company and CM Bermuda Ltd. ("CM Bermuda"), the sole holder of the Company's common shares prior to the Merger, entered into a redemption agreement, dated November 2, 2018 (the "CM Bermuda Redemption Agreement"), pursuant to which, effective as of the closing of the Merger, the Company redeemed 9,519,280 of the Company's common shares at a price per share equal to $17.22447 for $164 million, which was paid on November 16, 2018.
In connection with the Merger, the Company, IMG Acquisition Holdings, LLC ("IMGAH") and Sirius Acquisitions Holding Company II completed the transactions contemplated by its previously announced redemption agreement and the Company redeemed all of the outstanding Series A redeemable preference shares, which were held by IMGAH, for $95 million in cash. Effective as of the completion of the redemption, the parties terminated the registration rights agreement and the shareholder's agreement between the Company and IMGAH. In addition, the parties agreed that any remaining contingent consideration in respect of the IMG acquisition, will be paid in cash, not in Series A redeemable preference shares as previously contemplated in the agreement in respect of the IMG acquisition.
On August 16, 2018, Sirius Group acquired 100% ownership of WRM America from WRM America Indemnity Holding Company, LLC for $17 million in cash. WRM America is a New York-domiciled insurer with a run-off book of business mainly comprised of general liability, educator's legal liability, automobile liability and physical damage, property and excess catastrophe liability. As part of the purchase of WRM America, Sirius Group acquired $3 million of indefinite lived intangible assets related to insurance licenses.
Sirius Group provides insurance and reinsurance products for property lines and agriculture ("Global Property"), accident and health ("Global A&H") and specialty lines including Aviation & Space, Marine, Trade Credit, Contingency, Casualty, Surety, and Environmental ("Specialty & Casualty"), which together with Runoff & Other, constitute its four reportable segments.
• Global Property-The Global Property segment consists of Sirius Group's underwriting lines of business which offer other property insurance and reinsurance, property catastrophe excess reinsurance and agriculture reinsurance on a worldwide basis.
• Global A&H-The Global A&H segment consists of Sirius Group's Global A&H insurance and reinsurance underwriting unit along with two managing general underwriters ("MGUs") (IMG and Armada). As part of Global A&H, Sirius Group provides supplemental healthcare and medical travel insurance products as well as related administration services through its MGU subsidiaries.
• Specialty & Casualty-The Specialty & Casualty segment offers insurance and reinsurance specialty & casualty product lines on a worldwide basis. Specialty lines represent unique risks where the more difficult and unusual risks are underwritten. Because specialty lines tend to be the more unusual or high risks, much of the market is characterized by a higher degree of specialization. Specialty & Casualty consists of Aviation & Space, Marine, Trade Credit, Contingency, Casualty, Surety, and Environmental specialty lines.
Optimism in the industry surrounding improved pricing has been negated by another year of significant catastrophe activity, with 2018 and 2017 representing two of the four largest catastrophe years on record. Hurricane Michael and Typhoon Jebi were the two most significant wind events in 2018. We estimate that the market loss for Typhoon Jebi is now in excess of $10 billion. In addition, the Carr, Mendocino, Camp and Woolsey wildfires resulted in projected combined losses of $15 to $17 billion. Based upon current projections, total catastrophe losses for 2018 are estimated to be approximately $72 billion globally. If these trends continue, there will likely be a continued erosion of industry reserves.
Overall, insurance market conditions remained unsettled in 2018. Also, there was little indication that there would be any significant interest rate improvements in the coming months, which would lead to enhanced investment returns. Efforts by Sirius Group to redeploy capital into other business lines to spread risk and secure additional revenue generating ventures remain on track. Global A&H coupled with our two MGUs, IMG and Armada, continued to record strong results in 2018. We have continued to scale up our recent specialty lines of business (Casualty, Environmental, and Surety) to remain vigilant in the marketplace, and to seek potential expansion opportunities through mergers and acquisitions.
We have a strong reputation in the insurance industry and a knowledgeable and experienced management team. We will opportunistically react as the industry evolves, adding underwriting teams who value our underwriting-comes-first culture during a time of market consolidation. We have the resources to provide insurance and reinsurance solutions to a variety of customers. It is our commitment to our long-term and local relationships and customer service that differentiates Sirius Group from its peers.
Sirius Group ended 2018 with a net (loss) attributable to common shareholders of $(43) million and basic earnings per common share of $(0.36). This compares to a net (loss) attributable to common shareholders of $(156) million and basic earnings per common share of $(1.30) in 2017. The increase was primarily due to lower catastrophe losses and net favorable prior year loss reserve development, higher net realized and unrealized investment gains as a result of favorable foreign exchange movements, and higher net service fee income from IMG and Armada. In 2018, Sirius Group recorded catastrophe losses, net of reinsurance and reinstatement premiums, of $194 million compared to $259 million in 2017. Catastrophe losses in 2018 included $91 million for Typhoon Jebi, $36 million for Hurricane Michael, $12 million for the California Wildfires, and $9 million for Typhoon Trami, whereas catastrophe losses in 2017 included $83 million for Hurricane Irma, $79 million for Hurricane Maria and $45 million for Hurricane Harvey. The 2018 results included $7 million of net favorable prior year loss reserve development compared to $1 million in 2017.
Sirius Group ended 2017 with a net (loss) attributable to common shareholder of $(156) million and basic earnings per common share of $(1.30). This compares to a net income attributable to common shareholder of $33 million and basic earnings per common share of $0.27 in 2016. The decreases were due to higher catastrophe losses and lower net favorable prior year loss reserve development, which was partially offset by net service fee income from IMG and Armada and a gain on revaluation of contingent consideration related to the IMG and Armada Earnouts of $49 million. In 2017, Sirius Group recorded catastrophe losses, net of reinsurance and reinstatement premiums, of $259 million compared to $109 million for 2016. Catastrophe losses for 2017 included $83 million for Hurricane Irma, $79 million for Hurricane Maria and $45 million for Hurricane Harvey, whereas catastrophe losses for 2016 included $25 million for the Ecuador Earthquake, $24 million for the Alberta Wildfires, and $23 million for Hurricane Matthew. The 2017 results included $1 million of net favorable prior year loss reserve development compared to $64 million for 2016.
Sirius Group ended 2018 with book value per common share of $14.80 compared to book value per common share of $15.98 as of December 31, 2017, a decrease of 7.4%. The decrease in book value per common share was due to a comprehensive (loss) of $(80) million, the repurchase of CM Bermuda shares of $164 million, and the $36 million charge related to the increase in the redemption value of the Series B preference shares, partially offset by the $70 million of common shares sold in connection with the Merger. Total common shareholders' equity at the end of the fourth quarter of 2018 was $1,704 million.
Sirius Group ended 2017 with book value per common share of $15.98 compared to book value per common share of $16.57 as of December 31, 2016, a decrease of 3.6% due to the comprehensive (loss) recognized.
The return on net (loss) attributable to common shareholders on beginning common shareholders' equity was (2.3)% for 2018 compared to (7.9)% for 2017 due to a lower net (loss) recognized.
The return on net (loss) attributable to common shareholders on beginning common shareholders' equity was (7.9)% for 2017 compared to 1.7% for 2016 due to the net (loss) recognized.
Sirius Group ended 2018 with Adjusted book value per share of $15.24, which incorporates an assumption that the Series B preference shares will convert into common shares on a one-for-one basis, compared to $15.98 as of December 31, 2017, a decrease of 4.6%, due to the comprehensive (loss) recognized.
For the year ended December 31, 2018, Operating (loss) attributable to common shareholders was $(56) million compared to $(128) million for 2017, driven by lower catastrophe losses, partially offset by higher current accident year losses in the Global Property and Specialty & Casualty segments.
Consolidated Results of Operations - Years Ended December 31, 2018, 2017, and
Loss and loss adjustment expenses - Loss and loss adjustment expenses increased 11% to $900 million in 2018 from $811 million in 2017, primarily due to increased net earned insurance and reinsurance premiums, partially offset by lower catastrophe losses and higher net favorable prior year loss reserve development. See "Results of reportable segments" below.
General and administrative expenses - General and administrative expenses decreased 15% to $78 million in 2018 from $92 million in 2017. This decrease was primarily due to $13 million of retention bonus expenses recorded in 2017 relating to the CMIG International acquisition and lower incentive compensation expense. See Note 15 "Common shareholders' equity, mezzanine equity, and non-controlling interests" in Sirius Group's audited financial statements included elsewhere in this Annual Report on Form 10-K with respect to the CMIG International acquisition. The retention bonus expense was reimbursed by White Mountains to Sirius Group on an after-tax basis (recorded as Additional paid-in surplus) as stipulated in the stock purchase agreement between CMIG International and White Mountains. Sirius Group did not incur retention bonus expenses in 2018 related to the CMIG International acquisition. Additionally, the decrease in General and administrative expenses was partially offset by an increase in expenses related to IMG and Armada. In prior periods, all MGU expenses were disclosed within General and administrative expenses. Starting in 2018, certain operating expenses for the MGUs are reflected in unallocated LAE and other underwriting expense, representing costs associated with the support of the Global A&H underwriting team.
Intangible asset amortization expenses - Intangible asset amortization expenses increased to $16 million in 2018 from $10 million in 2017 due to the amortization of the intangible assets related to the IMG and Armada acquisitions, which were both acquired during the second quarter of 2017.
Impairment of intangible assets - Impairment of intangible assets increased 60% to $8 million in 2018 from $5 million in 2017. In 2018 and 2017, Sirius Group recognized an impairment related to trade names acquired as part of the acquisition of IMG.
Interest expense on debt - Interest expense on debt increased 41% to $31 million in 2018 from $22 million in 2017 due to interest expense of $12 million related to the 2017 SEK Subordinated Notes, which were issued in September 2017. See "Financing" below.
Gross written premiums - Gross written premiums in 2017 was $1,439 million, an increase of $170 million or 13% compared to gross written premiums of $1,269 million in 2016, with Specialty & Casualty up 27%, Global Property up 15%, and Global A&H up 14%. See "Results of reportable segments" below.
Net investment income, Net realized investment gains (losses), Net unrealized investment gains (losses) and Net foreign exchange gains (losses) - Net investment income increased 1% to $57 million in 2017 from $56 million in 2016. Sirius Group reported net realized investment (losses) of $(27) million in 2017, which included $(19) million of net realized foreign currency (losses), compared to net realized investment gains of $288 million in 2016, which included $50 million of net realized foreign currency gains. Net unrealized investment (losses) were $(11) million in 2017, which included $(52) million of net unrealized foreign currency (losses), compared to net unrealized investment (losses) of $(238) million in 2016, which included $(8) million of net unrealized foreign currency (losses). During the first quarter of 2016, Sirius Group sold its investment in Symetra, which generated a net realized investment gain of $223 million and a net unrealized investment (loss) of $(219) million, for a total net impact of $4 million. In 2017, net realized and net unrealized investment (losses) were primarily related to foreign currency (losses). Additionally, Sirius Group recorded $9 million of non-investment related foreign exchange gains in 2017 compared to $(11) million of non-investment related foreign exchange (losses) in 2016. See "Foreign Currency Translation" below.
Loss and loss adjustment expenses - Loss and loss adjustment expenses increased 56% to $811 million in 2017 from $519 million in 2016, primarily due to higher catastrophe losses and lower net favorable prior year loss reserve development in 2017. See "Results of Reportable Segments" below.
Other underwriting expenses - Other underwriting expenses decreased 1% to $106 million in 2017 from $107 million in 2016 primarily due to lower variable incentive expense accruals. See "Results of reportable segments" below.
General and administrative expenses - General and administrative expenses increased 8% to $92 million in 2017 from $85 million in 2016. General and administrative expenses in 2017 included $45 million of expenses related to IMG and Armada and $13 million of retention bonus expenses for management and employees as a result of our acquisition by CMIG International. The retention bonus expenses were reimbursed by White Mountains to Sirius Group on an after-tax basis (recorded as Additional paid-in surplus) as stipulated in the stock purchase agreement between CMIG International and White Mountains. General and administrative expenses in 2016 included $37 million of transaction bonus expenses and $18 million of retention bonus expenses, both of which were reimbursed by White Mountains to Sirius Group on an after-tax basis (recorded as Additional paid-in surplus).
Interest expense on debt - Interest expense on debt decreased 37% to $22 million in 2017 from $35 million in 2016 due to a lower interest rate on the $400.0 million face value of senior unsecured notes ("2016 SIG Senior Notes") versus the $400.0 million face value of senior unsecured notes that were issued in 2007 (the "2007 SIG Senior Notes"), which were retired in 2016. The retirement of the 2007 SIG Senior Notes in 2016 resulted in a $6 million prepayment penalty, which was recorded as a component of interest expense. See "Financing" below.
The following is a summary of Sirius Group's total pre-tax net investment results and performance metrics for the years ended 2018, 2017, and 2016:
(3)Excludes non-investment related foreign exchange gains (losses) for the years ended December 31, 2018, 2017, and 2016 of $22.7 million, $9.2 million and $(11.0) million, respectively.
Sirius Group's pre-tax total gross return on invested assets was (0.9)% in 2018 compared to 4.1% in 2017. The 2018 result included foreign currency losses on investments, which decreased the total pre-tax return by (1.2)% as the U.S. dollar strengthened against foreign currencies. The 2017 result included foreign currency gains on investments, which contributed 1.2% to the total pre-tax return. The currency gains were mainly generated from Swedish Krona ("SEK") and Euro ("EUR") holdings as both currencies strengthened in excess of 10% against the U.S. dollar. Foreign currency losses on investments reduced the 2016 return by 1.3% as our SEK, EUR and British Pound Sterling ("GBP") holdings weakened against the U.S. dollar.
Net realized and unrealized investment (losses) gains on investments, excluding foreign currency, were $(74) million in 2018 compared to $33 million in 2017. The increase in investment losses for 2018 was driven by losses arising from investments in global equities consistent with overall market performance, the impact of rising interest rates on our fixed income portfolio, and underperformance of risk assets in Europe and Asia. In 2017, Sirius Group benefited from its deployment into equity, alternative investment strategies and overall better market conditions in 2017.
As of December 31, 2018, the equity and other long-term investments portfolio included $439 million of U.S. dollar and $149 million of non-U.S. dollar denominated securities.
As of December 31, 2017, the equity and other long-term investments portfolio included $290 million of U.S. dollar and $176 million of non-U.S. dollar denominated securities.
In 2017, the equity portfolio returned 16.8% on a U.S. dollar basis and 13.8% in local currencies. The S&P 500 returned 21.8% for the same period.
Sirius Group's pre-tax total return on invested assets was 4.1% for 2017 compared to 0.9% for 2016. The 2017 result included foreign currency gains on investments, which contributed 1.2% to the total pre-tax return. The currency gains were mainly generated from SEK and EUR holdings as both currencies strengthened in excess of 10% against the U.S. dollar. Foreign currency losses on investments reduced the 2016 return by 1.3% as SEK, EUR and GBP holdings weakened against the U.S. dollar.
As of December 31, 2017, Sirius Group held $399 million of non-U.S. denominated fixed income securities. Given the low, and in many cases negative, interest rate environment throughout Europe, Sirius Group redeployed $249 million of EUR and GBP fixed income into USD fixed income and EUR equities during 2017.
The fixed income portfolio returned 2.9% for 2017 on a U.S. dollar basis and 1.8% in local currencies for the same period. The U.S. fixed income portfolio returned 1.9% versus the BarcAg1-3 of 0.9%. Our non-U.S. fixed income portfolio returned 0.8% in original currencies which compared to the OMRX return of 0.3%.
A summary of the impact of foreign currency translation on Sirius Group's consolidated financial results for the years ended December 31, 2018, 2017, and 2016 was as follows:
(1)Component of Net realized investment gains (losses) on the Consolidated Statements of (Loss) Income
Gross written premiums increased 31% to $962 million in 2018 from $732 million in 2017, due primarily to an increase in Other Property ($218 million), of which $130 million was due to a fronting arrangement. This fronting arrangement records offsetting gross and ceded loss and commission results, less a margin to Sirius Group. Net written premiums increased 18% to $655 million in 2018 from $556 million in 2017, due to an increase in Other Property ($92 million) from favorable rate changes and new opportunities. The Other Property fronting arrangement did not significantly impact Global Property's net written or earned insurance and reinsurance premiums for either 2018 or 2017.
Global Property produced a net combined ratio of 113% in 2018 compared to 122% in 2017. The decrease in the combined ratio was driven by lower catastrophe losses offset by higher net unfavorable prior year loss reserve development and higher current year losses in certain Other Property accounts.
Gross written premiums increased 15% to $732 million in 2017 from $635 million in 2016, due primarily to an increase in Other Property ($41 million) due to increased treaty participations. Net written premiums increased 8% to $556 million in 2017 from $514 million in 2016, due to the aforementioned increase in Other Property from increased treaty participations.
Gross written premiums increased 31% to $962 million in 2018 from $732 million in 2017, due to an Other Property fronting arrangement, which was $130 million of the total increase. The remaining increases in Other Property and Property Catastrophe Excess were driven by favorable rate changes and new opportunities.
Global Property's net earned insurance and reinsurance premiums increased 17% to $564 million in 2017 from $482 million in 2016. The primary driver was Agriculture, which increased by $32 million, or 89%, due to an increased share in U.S. agricultural insurance programs.
Global A&H consists of Sirius Group's Global A&H insurance and reinsurance underwriting unit along with two MGUs (IMG and Armada).
Global A&H produced a net combined ratio of 93% in 2018 compared to 95% in 2017. The decrease in the combined ratio was due to net favorable prior year loss reserve development of $15 million (4 points) in 2018 compared to $4 million (1 point) of net favorable prior year loss reserve development in 2017; in both periods, the net favorable prior year loss reserve development was driven by lower than expected claims activity. The increase in the net acquisition expense ratio from the prior period was due to retaining A&H business previously ceded to a subsidiary of IMG, which was acquired by Sirius Group in May 2017, and increased primary insurance writings. Additionally, net earned insurance and reinsurance premiums increased 17% to $358 million in 2018 from $307 million in 2017.
(4)The combined ratio is calculated by combining the loss ratio, the acquisition expense ratio, and the other underwriting expense ratio.
Specialty & Casualty recorded an underwriting (loss) of $(3) million in 2018 compared to underwriting income of $1 million in 2017. Specialty & Casualty had $18 million (8 points) of favorable prior year loss reserve development in 2018, primarily driven by Aviation & Space ($8 million) and Marine ($7 million), compared to $12 million (7 points) of favorable prior year loss reserve development in 2017, primarily driven by Marine ($5 million) and Trade Credit ($4 million). Catastrophe losses, net of reinsurance and reinstatement premiums, were $2 million (1 point), in 2018 compared to $14 million (9 points) in 2017, mainly due to Hurricanes Irma, Maria, and Harvey (primarily in Marine).
Other underwriting expenses increased 65% to $28 million in 2018 from $17 million in 2017. The increase in Other underwriting expenses was primarily driven by Casualty, as well as the Surety and Environmental lines of business, which were newly launched in late 2017.
Gross written premiums increased 27% to $218 million in 2017 from $171 million in 2016, primarily a result of re-entering the U.S. casualty reinsurance market in 2017. Net written premiums increased 41% to $193 million in 2017 from $137 million in 2016, due to the same reason.
Specialty & Casualty produced a combined ratio of 100% for 2017 compared to 95% in 2016. The increase in the combined ratio was driven by higher loss and LAE ratios in Aviation & Space, Trade Credit, and Marine.
Other underwriting expenses increased 13% to $17 million in 2017 from $15 million in 2016. The increase in Other underwriting expenses was primarily driven by Casualty which was newly launched in 2017.
Net earned insurance and reinsurance premiums increased 21% to $163 million in 2017 from $135 million in 2016. Net earned insurance and reinsurance premiums increased for all Specialty & Casualty lines, with the largest increases in Casualty and Aviation & Space. The increase in Casualty was due to our re-entry into the U.S. casualty reinsurance market in 2017.
Runoff & Other consists of business related to asbestos and environmental risks and other long-tailed liability exposures, in addition to results from Sirius Global Solutions, which specializes in the acquisition and management of runoff liabilities for insurance and reinsurance companies both in the U.S. and internationally.
The negative gross written premiums in Runoff & Other relates to the cancellation of Mount Beacon Insurance's inforce business per a consent order approved by the Florida Office of Insurance Regulation. Mount Beacon Insurance recognized $12 million of negative gross written premiums and a corresponding change in gross unearned insurance and reinsurance premiums with a decrease in ceded written premiums and ceded unearned insurance and reinsurance premiums (100% of which were ceded to Florida Specialty). This cancellation did not impact net earned insurance and reinsurance premiums.
The following tables display Sirius Group's underwriting ratios prior to cessions to reinsurers ("Gross"), cessions to reinsurers ("Ceded") and after cessions to reinsurers ("Net") basis. See "Reinsurance Protection" in Item 1 "Business" for further information.
Sirius Group's net combined ratio was 5 points higher than the gross combined ratio in 2017 due to the costs of property retrocessional protections with limited ceded loss recoveries which was partially offset by ceded loss recoveries in Marine and Trade Credit.
Sirius Group's net combined ratio was 6 points higher than the gross combined ratio in 2016 due to the costs of property and Aviation & Space retrocessional protections with limited ceded loss recoveries.
In connection with the closing of the Merger, the Company completed the Sirius Group Private Placement. The price per share of $17.22447 for the common shares and Series B preference shares issued in the Sirius Group Private Placement was the same. Sirius Group believes that the Merger and the Private Placement were parts of an overall integrated capitalization strategy for the Company, which should be assessed on a combined basis, not as separate transactions.
Adjusted book value and Adjusted book value per share are non-GAAP financial measures used to show the Company's total worth on a per-share basis and are useful to management and investors in analyzing the intrinsic value of the Company.
The Company uses Operating (loss) attributable to common shareholders as a measure to evaluate the underlying fundamentals of its operations and believes it to be a useful measure of its corporate performance. Operating (loss) attributable to common shareholders as used herein differs from net (loss) income attributable to common shareholders, which the Company believes is the most directly comparable GAAP measure, by the exclusion of net realized and unrealized gains and losses on investments, net foreign exchange gains (losses) and the associated income tax expense or benefit. The Company's management believes that Operating (loss) attributable to common shareholders is useful to investors because it removes the variability arising from fluctuations in the Company's fixed maturity investment portfolio, equity investments trading, investments-related derivatives, and net foreign exchange gains (losses) and the associated income tax expense or benefit of those fluctuations. The following is a reconciliation of net (loss) income attributable to common shareholders to Operating (loss) attributable to common shareholders for the years ended December 31, 2018, 2017, and 2016.
(1)Adjustment for income tax (benefit) expense represents the income tax benefit (expense) associated with the adjustment for net realized and unrealized losses (gains) on investments and the income tax benefit (expense) associated with the adjustment for net foreign exchange gains. The income tax impact is estimated by applying the statutory rates of applicable jurisdictions, after consideration of other relevant factors.
Sirius International has the ability to pay dividends up to Sirius Bermuda subject to the availability of unrestricted equity, calculated in accordance with the Swedish Act on Annual Accounts in Insurance Companies and the SFSA. Unrestricted equity is calculated on a consolidated group account basis and on a parent account basis. Differences between the two include but are not limited to accounting for goodwill, subsidiaries (with parent accounts stated at original foreign exchange rates), taxes and pensions. Sirius International's ability to pay dividends is limited to the "lower of" unrestricted equity as calculated within the group and parent accounts. As of December 31, 2018, Sirius International had $373 million (based on the December 31, 2018 SEK to USD exchange rate) of unrestricted equity on a parent account basis (the lower of the two approaches) available to pay dividends in 2019. The amount of dividends available to be paid by Sirius International in any given year is also subject to cash flow and earnings generated by Sirius International's business, the maintenance of adequate solvency capital ratios for Sirius International and the consolidated Sirius International UK Holdings Ltd. group, as well as to dividends received from its subsidiaries, including Sirius America. Earnings generated by Sirius International's business that are allocated to the Safety Reserve are not available to pay dividends (see "Safety Reserve" below). During 2018, Sirius International did not declare a dividend and paid $20 million of dividends declared in 2017.
During 2018 and 2017, the Company did not pay any dividends to its shareholders. The Company paid $27 million in dividends to its former parent on April 18, 2016. As of December 31, 2018, Sirius Group had $52 million of net unrestricted cash, short-term investments, and fixed maturity investments outside of its regulated and unregulated insurance and reinsurance operating subsidiaries.
Subject to certain limitations under Swedish law, Sirius International is permitted to transfer pre-tax income amounts into an untaxed reserve referred to as a "Safety Reserve." As of December 31, 2018, Sirius International's Safety Reserve amounted to SEK 10.7 billion, or $1.2 billion (based on the December 31, 2018 SEK to USD exchange rate). Under GAAP, an amount equal to the Safety Reserve, net of a related deferred tax liability established at the Swedish tax rate, is classified as shareholder's equity. Generally, this deferred tax liability is only required to be paid by Sirius International if it fails to maintain prescribed levels of premium writings and loss reserves in future years. As a result of the indefinite deferral of these taxes, Swedish regulatory authorities apply no taxes to the Safety Reserve when calculating solvency capital under Swedish insurance regulations.
The following table illustrates Sirius Group's consolidated insurance float position as of December 31, 2018 and 2017:
Management believes that Sirius Group has the flexibility and capacity to obtain funds externally as needed through debt or equity financing on both a short-term and long-term basis. However, Sirius Group can provide no assurance that, if needed, it would be able to obtain additional debt or equity financing on satisfactory terms, if at all.
The following table summarizes Sirius Group's capital structure as of December 31, 2018 and 2017:
On September 22, 2017, Sirius Group issued floating rate callable subordinated notes denominated in Swedish kronor ("SEK") in the amount of SEK 2,750 million (or $346 million on date of issuance) at a 100% issue price ("2017 SEK Subordinated Notes"). The 2017 SEK Subordinated Notes were issued in an offering that was exempt from the registration requirements of the Securities Act of 1933 (the "Securities Act"). The 2017 SEK Subordinated Notes bear interest on their principal amount at a floating rate equal to the applicable Stockholm Interbank Offered Rate ("STIBOR") for the relevant interest period plus an applicable margin, payable quarterly in arrears on March 22, June 22, September 22, and December 22 in each year commencing on December 22, 2017, until maturity in September 2047.
Sirius Group incurred $5 million in expenses related to the issuance of the 2016 SIG Senior Notes (including $3 million in underwriting fees), which have been deferred and are being recognized into interest expense over the life of the 2016 SIG Senior Notes.
Taking into effect the amortization of the original issue discount and all underwriting and issuance expenses, the 2016 SIG Senior Notes yield an effective rate of approximately 4.7% per annum. Sirius Group recorded $19 million of interest expense, inclusive of amortization of issuance costs on the 2016 SIG Senior Notes, for both 2018 and 2017, respectively.
In connection with the closing of the Merger, Sirius Group issued 11,901,670 of the 15,000,000 authorized Series B preference shares, with a par value of $0.01 per share, to the Preference Share Investors as part of the Sirius Group Private Placement. The Series B Preference shares contain both a mandatory conversion and optional redemption features, with the optional redemption features allowing for settlement in either common shares or cash. Sirius Group accounts for the Series B preference shares outside of permanent equity as mezzanine equity in the Consolidated Balance Sheets as its ability to settle in common shares cannot be assured, and thus we presume that Sirius Group will be required to settle the Series B preference shares in cash, as if it were a redemption feature.
The Company adjusts the carrying value of the Series B preference shares to equal the redemption value at the end of each reporting period. As of December 31, 2018, the balance of the Series B preference shares was $232 million.
On November 8, 2017, Sirius International entered into four standby letter of credit facility agreements totaling $215 million to provide capital support for Lloyd's Syndicate 1945. The first letter of credit is a renewal of a $125 million facility with Nordea Bank Finland plc, $100 million of which is issued on an unsecured basis. The second letter of credit is a $25 million secured facility with Lloyd's Bank plc. Lloyd's Bank plc had previously participated in this program but in a different capacity. The third letter of credit agreement is a $30 million unsecured facility with Barclays Bank plc. The fourth letter of credit agreement is a $35 million facility with DNB Bank ASA London Branch, $25 million of which is issued on an unsecured basis. Each facility is renewable annually. The above referenced facilities are subject to various affirmative, negative and financial covenants that the Company considers to be customary for such borrowings, including certain minimum net worth and maximum debt to capitalization standards.
Sirius International has other secured letter of credit and trust arrangements with various financial institutions to support its insurance operations. As of December 31, 2018 and 2017, these secured letter of credit and trust arrangements were collateralized by pledged assets and assets in trust of SEK 2.9 billion and SEK 2.1 billion, or $321 million and $261 million (based on the December 31, 2018 and 2017 SEK to USD exchange rates, respectively). As of December 31, 2018 and 2017, Sirius America's trust arrangements were collateralized by pledged assets and assets in trust of $56 million and $56 million, respectively. As of December 31, 2018 and 2017, Sirius Bermuda's trust arrangements were collateralized by pledged assets and assets in trust of $320 million and $123 million, respectively.
Sirius Group is not party to any off-balance sheet transaction, agreement or other contractual arrangement as defined by Item 303(a)(4) of Regulation S-K to which an entity unconsolidated with Sirius Group is a party that management believes is reasonably likely to have a current or future effect on its financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that Sirius Group believes is material to investors.
(4) Swedish and German employees of Sirius International can participate in defined benefit plans which are based on the employees' pension entitlements and length of employment. Refer to Note 14 "Employment benefit plans and compensation plans" in Sirius Group's audited financial statements included elsewhere in this Annual Report on Form 10-K for further details describing the projected pension benefit obligation.
(9) The Series B Preference shares contain both a mandatory conversion and optional redemption features, with the optional redemption features allowing for settlement in either common shares or cash. Sirius Group accounts for the Series B preference shares outside of permanent equity as mezzanine equity in the Consolidated Balance Sheets as its ability to settle in common shares cannot be assured, and thus we presume that Sirius Group will be required to settle the Series B preference shares in cash, as if it were a redemption feature. Therefore, these commitments are excluded from the table above.
Sirius Group primarily derives cash from the net inflow of premiums less claim payments related to underwriting activities and from net investment income. The insurance and reinsurance business inherently provides liquidity, as premiums are received in advance of the time claims are paid. However, the amount of cash required to fund claim payments can fluctuate significantly from period to period, due to the low frequency and high severity nature of certain types of business we write. Sirius Group's remaining cash flows are generally reinvested in our investment portfolio. In addition, as previously disclosed, Sirius Group has access to a $300 million senior unsecured revolving credit facility that provides access to loans for working capital and general corporate purposes, and letters of credit to support obligations under insurance and reinsurance agreements and retrocessional agreements.
During 2018, 2017, and 2016, Sirius Group made long-term incentive payments totaling $6 million, $16 million and $23 million, respectively.
On November 16, 2018, in connection with the Merger, the Company completed a post-closing adjustment that was settled in cash to CM Bermuda. Based on the reported book value per share of $16.44 as of September 30, 2018, pursuant to the Merger Agreement, Sirius Group paid $1.6 million to CM Bermuda. See Note 3 "Significant Transactions" in Sirius Group's audited financial statements included elsewhere in this Annual Report on Form 10-K for a more detailed discussion.
On December 29, 2017, Sirius Group settled approximately 82% of the Armada Earnout with Armada Enterprise for $31 million.
On October 25, 2017, Sirius Group's indirect wholly-owned subsidiary SIG, redeemed all of the SIG Preference Shares. The redemption price equaled the $1,000 liquidation preference per preference share. Sirius Group accounted for the SIG Preference Shares as a conditionally redeemable instrument within Non-controlling interests.
On September 22, 2017, Sirius Group issued SEK 2,750.0 million (or $346.1 million on date of issuance) of 2017 SEK Subordinated Notes at a 100% issue price. Net proceeds were $341 million, after taking into effect issuance costs.
On April 3, 2017, Sirius Group purchased 100% of Armada and its subsidiaries. Included in the total consideration was $123 million of cash.
See Note 3 "Significant Transactions" in Sirius Group's audited financial statements included elsewhere in this Annual Report on Form 10-K for a more detailed discussion.
During 2016, Sirius Group paid $27 million of dividends to its immediate parent.
During 2016, as stipulated in the stock purchase agreement between CMIG International and White Mountains, White Mountains paid Sirius Group $5 million for certain long-term incentive payments that Sirius Group paid to its employees.
On April 18, 2016, in conjunction with the acquisition by CMIG International, Sirius Group sold its investment in OneBeacon Insurance Group, Ltd. in connection with the sale of Sirius Group to CMIG International and received proceeds of $178 million.
During 2016, Sirius Global Solutions partnered with another company to form Florida Specialty Acquisition LLC ("FSA"). Sirius Global Solutions paid $16 million to acquire 100% of FSA's common shares. FSA acquired Mount Beacon and its subsidiaries, including Mount Beacon Insurance for $17 million during 2016.
As part of its risk management process, management periodically engages external actuarial and claims consultants to independently evaluate the adequacy of the net carried loss and LAE reserves. These analyses generally include assessments of special liabilities such as asbestos and environmental claims. Management considers the results of the independent analysis as a supplement to internal recommendations when determining carried loss and LAE reserve amounts.
Sirius Group relies heavily on information reported by MGUs and ceding companies, as discussed above. In order to determine the accuracy and completeness of such information, Sirius Group underwriters, actuaries, and claims personnel perform audits of certain MGUs and ceding companies, where customary. Generally, ceding company audits are not customary outside the United States. In such cases, Sirius Group reviews information from ceding companies for unusual or unexpected results. Any material findings are discussed with the ceding companies. Sirius Group sometimes encounters situations where it is determined that a claim presentation from a ceding company is not in accordance with contract terms. Most situations are resolved without the need for litigation or arbitration. However, in the infrequent situations where a resolution is not possible, Sirius Group vigorously defends its position in such arbitration or litigation.
There are possible variations from current estimates of loss reserves due to changes in a few of the many key assumptions. In order to quantify the potential volatility in the loss reserve estimates for Global Property, Sirius Group employs a stochastic simulation approach to produce a range of results around the central estimate and estimated probabilities of possible outcomes. Both the probabilities and the related modeling are subject to inherent uncertainties. The simulation relies on a significant number of assumptions, such as variation in industry losses for major events, historical loss reserve development volatility, and unanticipated inflation.
For major events, Sirius Group develops assessments of the ultimate losses associated with each individual event. Estimates are based on information from ceding companies and by applying overall estimates of insured industry losses to Sirius Group's exposure information.
Net incurred loss activity for asbestos and environmental for the years ended December 31, 2018, 2017, and 2016 was as follows:
Sirius Group recorded $4 million, $6 million, and an insignificant amount of environmental losses in 2018, 2017, and 2016, respectively, on its already existing reserves.
Sirius Group's reserves for A&E losses as of December 31, 2018 represent management's best estimate of its ultimate liability based on information currently available. However, as case law expands, and medical and clean-up costs increase and industry settlement practices change, Sirius Group may be subject to asbestos and environmental losses beyond currently estimated amounts. Sirius Group cannot reasonably estimate at the present time loss reserve additions arising from any such future adverse developments and cannot be sure that allocated loss reserves will be sufficient to cover additional liability arising from any such adverse developments.
The following tables show gross and net loss and LAE payments for A&E exposures for the years ended December 31, 2009 through December 31, 2018:
As of December 31, 2018, Sirius Group had 1,722 open claim files for asbestos and 372 open claim files for environmental exposures. Sirius Group's A&E claim activity for the last three years is illustrated in the table below:
See Note 9 "Fair value measurements" in Sirius Group's audited financial statements included elsewhere in this Annual Report on Form 10-K for a summary of fair value measurements for investments as of December 31, 2018 and 2017 by level.
Hedge fund and private equity fund returns are commonly measured against the benchmark returns of hedge fund indices and/or the S&P 500 Index. The historical returns for each index in the past five years are listed below:
Goodwill represents the excess of purchase price over the fair value of nets assets acquired from the acquisitions of IMG and Armada. Intangible assets with a finite life are amortized over the estimated useful life of the asset. Intangible assets with an indefinite useful life are not amortized.
During 2018, Sirius Group determined that the Global A&H operating segment was appropriate for purposes of testing goodwill for impairment. The Global A&H operating segment produces discrete financial information that management regularly reviews and its components have similar economic characteristics. The components of the Global A&H operating segment have similar economic characteristics including (1) the nature of the products and services; (2) the nature of the production processes; (3) the type or class of customer for their products and services; (4) the methods used to distribute the products or providing services; and (5) the nature of the regulatory environment, if applicable (e.g. insurance). Based on management's consideration of these five factors, it was determined that all of the components of the Company's Global A&H operating segment have similar economic characteristics in that all components primarily write accident and health insurance products ranging from disability, travel medical, stop-loss, accident and ex-pat health coverage written on a global basis. The acquisitions of both Armada and IMG were executed with the long term goal of generating insurance operating results by moving the business written by these MGUs to Sirius Group's insurance carriers, supplemented in the near term by the fee based revenue produced through the brokering of this business that is currently being underwritten by external insurance carriers.
For the years ended December 31, 2018 and 2017, Sirius Group recognized an impairment of $8 million and $5 million related to a trade name intangible asset, with an indefinite life, acquired as part of the acquisition of IMG. The impairments resulted from lower than anticipated growth when comparing the forecasted results against a reforecast of results at year end. A quantitative impairment review of the IMG trade name intangible asset was performed by applying the royalty replacement method to determine the asset's fair value as of December 31, 2018 and 2017, respectively. Under the royalty replacement method, the fair value of IMG's trade names intangible asset was determined based on a market participant's view of the royalty that would be paid to license the right to use the trade name. This quantitative analysis incorporated several assumptions including forecasted future revenues and cash flows, estimated royalty rate, based on similar licensing transactions and market royalty rates, and discount rate, which incorporates assumptions such as weighted-average cost of capital and risk premium.
Sirius Group accounts for insurance and reinsurance policies that it writes in accordance with authoritative guidance. Premiums written are recognized as revenues and are earned ratably over the term of the related policy or reinsurance treaty. Unearned premiums represent the portion of premiums written that are applicable to future insurance or reinsurance coverage provided by policies or treaties in force. Sirius Group also charges fees on certain insurance policies.
Sirius Group's primary business is predominantly accident and health insurance. In recent years, we have expanded our primary business capabilities in the United States, which has resulted in increased accident and health insurance business. During 2017, Sirius Group acquired IMG and Armada to further expand the accident and health business. Both acquired entities are MGUs. Sirius Group further expanded its primary insurance platform launching its primary Surety and Environmental insurance platforms in the U.S. in late 2017. In mid-2018, we began writing primary Casualty insurance through Pie Insurance, a start-up specializing in a data driven approach to workers compensation insurance, where we also have a minority investment and carrier relationship.
Reinsurance premiums, commissions, expense reimbursements and reserves related to reinsured business are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Reinsurance premiums ceded are expensed over the period the reinsurance coverage is provided. Ceded unearned insurance and reinsurance premiums represent the portion of premiums ceded applicable to the unexpired term of policies in force.
Sirius Group's reinsurance protection primarily consists of proportional and non-proportional protections to cover aviation, trade credit, energy, marine and property exposures. Attachment points and coverage limits vary by region around the world. Sirius Group's core proportional property reinsurance programs provide protection for parts of the non-proportional treaty accounts written in Europe, the Americas, Caribbean, Asia, the Middle East and Australia. These reinsurance protections are designed to increase underwriting capacity where appropriate, and to reduce exposure both to large catastrophe losses and to a frequency of smaller loss events.
The following table summarizes Sirius Group's premium estimates and related commissions and expenses as of December 31, 2018 and 2017:
Current accounting guidance related to business combinations requires us to estimate and recognize the fair value of liabilities related to potential earnout obligations as of the acquisition dates for all acquisitions subject to earnout provisions. During 2017, we completed two acquisitions resulting in the initial recognition of $122 million of earnout obligations.
The fair value of these earnout obligations is based on the present value of the expected future payments to be made to the sellers of the acquired entities in accordance with the provisions outlined in the respective purchase agreements. In determining fair value, we estimate the acquired entity's future operating results and obtain market participant assumptions. Based on these inputs, we estimate future payments in accordance with the earnout formula and performance targets specified in each purchase agreement. We then discount these payments to present value using a risk-adjusted rate that takes into consideration market-based rates of return that reflect the ability of the acquired entity to achieve the targets. Changes in estimated future operating results, market participant assumptions, or the risk-adjusted discount rate would result in a change in the fair value of recorded earnout obligations.
The amounts recorded as earnout payables, which are primarily based upon the estimated future operating results of the acquired entities subsequent to the acquisition date, are measured at fair value as of the acquisition date and are included on that basis in the recorded purchase price consideration. See Note 3 "Significant transactions" and Note 9 "Fair value measurements" in Sirius Group's audited financial statements included elsewhere in this Annual Report on Form 10-K for a more detailed discussion. We will record subsequent changes in these estimated earnout obligations in our consolidated statement of (loss) income when incurred.
As of December 31, 2018, the aggregate amount of the maximum earnout obligations related to these acquisitions was $74 million, of which $29 million was recorded, based on the estimated fair value of the expected future payments to be made. The maximum potential earnout payables represent the maximum amount of additional consideration that could be paid pursuant to the terms of the purchase agreements. See Note 3 "Significant transactions" in Sirius Group's audited financial statements included elsewhere in this Annual Report on Form 10-K for additional discussion on 2017 business combinations.
For a more detailed discussion of our net deferred tax asset and our framework for assessing its recoverability, see Note 12 "Income taxes" in Sirius Group's audited financial statements included elsewhere in this Annual Report on Form 10-K.
Recognition of the benefit of a given tax position is based upon whether a company determines that it is more likely than not that a tax position will be sustained upon examination based upon the technical merits of the position. In evaluating the more likely than not recognition threshold, Sirius Group must presume that the tax position will be subject to examination by a taxing authority with full knowledge of all relevant information. If the recognition threshold is met, then the tax position is measured at the largest amount of benefit that is more than 50% likely of being realized upon ultimate settlement.
With few exceptions, Sirius Group is no longer subject to U.S. federal, state or non-U.S. income tax examinations by tax authorities for years before 2014.
The Tax Cut and Jobs Act was enacted into law in the U.S. in December 2017. Among other provisions, the Act includes a new 21% corporate tax rate, the impacts of which (including on our deferred tax assets) were already taken into account in our financial results for the year ended December 31, 2017. The Act also includes a new base erosion and anti-abuse tax ("BEAT"). Proposed regulations interpreting and applying some of these provisions have been issued by the U.S. Department of the Treasury and the IRS, and additional guidance may be forthcoming. It is not possible to predict if, when or in what form such guidance will be provided and whether such guidance will be applied on a retroactive basis. The BEAT levies a significant tax on cross border payments to related group companies. This tax will subject intragroup reinsurance arrangements to a base erosion tax on premiums ceded. While Sirius Group intends to operate in a manner that limits its exposure to BEAT, at this time, subject to revision or finalization of proposed regulations issued in December 2018 and other additional guidance, uncertainty about the financial impact on Sirius Group of this new tax remains and no assurance can be given that Sirius Group will not be subject to material amounts of BEAT in the future. Accordingly, BEAT could materially impact our provision for taxes in the future.
In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments (ASC 326), which establishes new guidance for the recognition of credit losses for financial assets measured at amortized cost. The new guidance, which applies to financial assets that have the contractual right to receive cash, including reinsurance receivables, requires reporting entities to estimate the credit losses expected over the life of a credit exposure using historical information, current information and reasonable and supportable forecasts that affect the collectability of the financial asset. The new guidance is effective for annual and interim periods beginning after December 15, 2019. We plan to adopt the standard on its effective date of January 1, 2020. We do not expect the standard to have a material impact on our reported consolidated financial condition, results of operations, cash flows or required disclosures.
We have served as the Company's auditor since at least 2001, which includes periods before the Company became subject to SEC reporting requirements. We have not been able to determine the specific year we began serving as auditor of the Company.
Sirius International Insurance Group, Ltd. (the "Company") is a Bermuda exempted company whose principal businesses are conducted through its wholly and majority owned insurance subsidiaries (collectively with the Company, "Sirius Group"). The company provides insurance, reinsurance, and insurance services on a worldwide basis.
The accompanying consolidated financial statements at December 31, 2018, have been prepared in accordance with generally accepted accounting principles in the United States of America ("GAAP") and the rules and regulations of the U.S. Securities and Exchange Commission ("SEC"). The accompanying consolidated financial statements present the consolidated results of operations, financial condition, and cash flows of the Company and its subsidiaries and those entities in which the Company has control and a majority economic interest as well as those variable interest entities ("VIEs") that meet the requirements for consolidation. All intercompany transactions have been eliminated in consolidation.
Other long-term investments consist primarily of hedge funds, private equity funds, other investments in limited partnerships and other private equity securities. The fair value of other long-term investments is generally based upon Sirius Group's proportionate interest in the underlying fund's net asset value, which is deemed to approximate fair value. In addition, due to a lag in reporting, some of the fund managers, fund administrators, or both, are unable to provide final fund valuations as of the Company's reporting date. In these circumstances, Sirius Group estimates the return of the current period and uses all credible information available. This includes utilizing preliminary estimates reported by its fund managers and using information that is available to Sirius Group with respect to the underlying investments, as necessary. The changes in fair value are reported in pre-tax revenues in Net unrealized investment (losses). Actual final fund valuations may differ from Sirius Group's estimates and these differences are recorded in the period they become known as a change in estimate.
Cash includes amounts on hand and demand deposits with banks and other financial institutions. Amounts presented in the statement of cash flows are shown net of balances acquired and sold in the purchase or sale of the Company's consolidated subsidiaries.
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies. The collectability of reinsurance recoverables is subject to the solvency of the reinsurers. Sirius Group is selective in regard to its reinsurers, principally placing reinsurance with those reinsurers with a strong financial condition, industry ratings, and underwriting ability. Management monitors the financial condition and ratings of its reinsurers on an ongoing basis.
Reinsurance premiums, commissions, expense reimbursements, and reserves related to reinsured business are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Reinsurance premiums ceded are expensed over the period the reinsurance coverage is provided. Ceded unearned insurance and reinsurance premiums represent the portion of premiums ceded applicable to the unexpired term of policies in force. Funds held by ceding companies represent amounts due to Sirius Group in connection with certain assumed reinsurance agreements in which the ceding company retains a portion of the premium to provide security against future loss payments. The funds held by ceding companies are generally invested by the ceding company and a contractually agreed interest amount is credited to Sirius Group and recognized as investment income. Funds held under reinsurance treaties represent contractual payments due from Sirius Group that have been retained to secure such obligations.
Share-based compensation plans are accounted for in accordance with the Accounting Standards Codification ("ASC") Topic 718 "Compensation - Stock Compensation" Sirius Group recognizes the compensation expense for stock restricted share and performance share awards based on the fair value of the award on the date of grant over the requisite service period. Awards under both the 2016 Long Term Incentive Plan and 2018 Omnibus plan vest over three years. The Company has elected to recognize forfeitures as they occur rather than estimating service-based forfeitures over the requisite service period.
Certain Sirius Group employees in Europe participate in defined benefit plans. The liability for the defined benefit plans that is reported on the Consolidated Balance Sheets is the current value of the defined benefit obligation at the end of the period, reduced by the fair value of the plan's managed assets, with adjustments for actuarial gains and losses. The defined benefit pension plan obligation is calculated annually by independent actuaries. The current value of the defined benefit obligation is determined through discounting of expected future cash flows, using interest rates determined by current market interest rates. The service costs and actuarial gains and losses on the defined benefit obligation and the fair value on the plan assets are recognized in the Consolidated Statements of Income.
Earnings per share is reported in accordance with ASC Topic 260 Earnings per Share. Basic earnings (loss) per share is computed by dividing net income (loss) available to Sirius Group common shareholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income available to Sirius Group common shareholders by the weighted-average number of common shares outstanding adjusted to give effect to potentially dilutive securities. (See Note 16.)
The Tax Cuts and Jobs Act (the "TCJA") which was enacted into law in the U.S. in December 31, 2017 includes a new base erosion and anti-abuse tax ("BEAT"), which is essentially a minimum tax that is potentially applicable to certain otherwise deductible payments made by U.S. entities to non-U.S. affiliates, including cross-border interest payments and reinsurance premiums. The statutory BEAT rate is 5% in 2018 and will rise to 10% in 2019-2025 and then 12.5% in 2026 and thereafter. The TCJA also includes provisions for Global Intangible Low-Taxed Income ("GILTI") under which taxes on foreign income are imposed on the excess of a deemed return on tangible assets of certain foreign subsidiaries. Consistent with accounting guidance, Sirius Group will treat BEAT as an in period tax charge when incurred in future periods for which no deferred taxes need to be provided and has made an accounting policy election to treat GILTI taxes in a similar manner.
Goodwill represents the excess of the purchase price of an acquisition over the fair value of the identifiable net assets acquired and is assigned to the applicable reporting unit at acquisition. Goodwill is evaluated for impairment on an annual basis. Sirius Group initially evaluates goodwill using a qualitative approach to determine whether it is more likely than not that the fair value of goodwill is greater than its carrying value. If the results of the qualitative evaluation indicate that it is more likely than not that the carrying value of goodwill exceeds its fair value, Sirius Group performs the quantitative test for impairment.
Indefinite-lived intangible assets are evaluated for impairment similar to goodwill. Finite-lived intangible are amortized on a straight-line basis over their estimated useful lives. The amortization periods approximate the period over which Sirius Group expects to generate future net cash inflows from the use of these assets. All of these assets are subject to impairment testing for the impairment or disposal of long-lived assets when events or conditions indicate that the carrying value of an asset may not be fully recoverable from future cash flows.
Non-controlling interests consist of the ownership interests of non-controlling shareholders in consolidated subsidiaries, and are presented separately on the balance sheet.
Effective January 1, 2018, Sirius Group adopted ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (ASC 825-10). The new guidance modifies the guidance for financial instruments, including investments in equity securities. Under the new guidance, all equity securities with readily determinable fair values are required to be measured at fair value with changes therein recognized through current period earnings. In addition, the new guidance requires a qualitative assessment for equity securities without readily determinable fair values to identify impairment, and for impaired equity securities to be measured at fair value. Sirius Group measures its portfolio of investment securities at fair value with changes therein recognized through current period earnings and, accordingly, adoption did not have any impact on its consolidated financial statements.
In March 2017, the Financial Accounting Standards Board ("FASB") issued ASU 2017-08, Premium Amortization on Purchased Callable Debt Securities (ASC 310-20), which changes the amortization period for certain purchased callable debt securities. Under the new guidance, for investments in callable debt securities held at a premium, the premium will be amortized over the period to the earliest call date. The new guidance does not change the amortization period for callable debt securities held at a discount. The new guidance is effective for annual and interim periods beginning after December 15, 2018. We plan to adopt the standard on its effective date of January 1, 2019. We do not expect the standard to have a material impact on our reported consolidated financial condition, results of operations, cash flows or required disclosures.
In connection with the closing of the Merger, the Company completed a private placement of Series B preference shares, common shares, and warrants (the "Sirius Group Private Placement") at a price per share equal to (i) 1.05 multiplied by (ii) the Sirius Group September 30 Adjusted DBVPS, or $17.22447. Investors in the Sirius Group Private Placement included affiliated funds of Gallatin Point Capital, The Carlyle Group, Centerbridge Partners, L.P. and Bain Capital Credit (the "Preference Share Investors"), together with certain employees, directors and "friends & family. The Sirius Group Private Placement raised proceeds of $226.1 million, resulting in the purchase of:
• 11,901,670 Series B preference shares with a cost basis of $195.8 million, • 1,225,954 of Common shares with a cost basis of $20.8 million, • 5,418,434 warrants that are exercisable for common shares for a period of five years after the Merger at a strike price equal to 125% of the per share purchase price, or $21.53 with a cost basis of $9.6 million. • Issuance costs of $2.0 million
In connection with the Merger, Sirius Group implemented the Employee Share Purchase Plan ("ESPP"), which provided all employees of Sirius Group with a one-time opportunity to purchase between 100 and 1,000 Company common shares at a price equal to 85% of market value for the first 100 shares and 100% of market value for the next 900 shares. For this purpose, market value of the Company common shares was equal to 1.05 times the Sirius Group September 30 Adjusted DBVPS. Employees had the option of paying for the shares upfront or, in the case of employees who are not executive officers, through a loan that is repaid over a two-year period through payroll deductions. Through the ESPP, 405 employees purchased 149,236 Company common shares prior to the consummation of the Merger, with a cost basis of $2.6 million. (See Note 14.)
On August 16, 2018, Sirius Group acquired 100% ownership of WRM America Indemnity Company, Inc. ("WRM America") from WRM America Indemnity Holding Company, LLC for $16.9 million in cash. WRM America is a New York-domiciled insurer with a run-off book of business mainly comprised of general liability, educator's legal liability, automobile liability and physical damage, property and excess catastrophe liability. As part of the purchase of WRM America, Sirius Group acquired $3.1 million of indefinite lived intangible assets related to insurance licenses.
During 2018, Sirius Group obtained $136.0 million, or 7%, of its gross written premiums through IMG. During 2017 and 2016, Sirius Group received 11% and 14% of its gross written premiums through IMG, respectively.
On November 5, 2018, the Company, redeemed all of the outstanding Series A redeemable preference shares, which were held by IMGAH, for $95.0 million in cash. Effective as of the completion of the redemption, the parties terminated the registration rights agreement and the shareholder's agreement between the Company and IMGAH.
The Liquidation Preference of the Series A redeemable preference shares was reflected as Mezzanine equity in the balance sheet as at December 31, 2017. It was not subject to fair value or remeasurement, except for accrued dividends. At December 31, 2017, the Series A redeemable preference shares are carried at $106.1 million.
On April 3, 2017, Sirius Group purchased 100% of Armada and its subsidiaries from Armada Enterprises LLC ("Seller"). Armada is an insurance services and health care technology business that creates specialty employee benefit products and serves to strengthen health care coverage and access. The purchase of Armada was undertaken to expand and accelerate the growth of Sirius Group's Global A&H platform in the United States, to diversify Sirius Group's revenues to include fee based revenues, and to gain access to Armada's distribution networks. Total consideration for the acquisition consisted of (1) the purchase of 50% of Armada by Sirius Group for $123.4 million, and (2) the redemption by Armada of the remaining 50% held by Seller for a redemption price based on a three year contingent earn-out mechanism that could result in an additional payment to Seller of up to $125.0 million ("Armada Earnout"), with fair value of $79.1 million at acquisition date, resulting in a total enterprise value of $202.5 million.
During 2017, Armada's revenues and net income after acquisitions, inclusive of intangible asset amortization expenses, were $24.7 million and $9.7 million, respectively.
On April 18, 2016, Sirius Group sold its investment in OneBeacon Insurance Group, Ltd. ("OneBeacon") at fair value to White Mountains Insurance Group ("White Mountains" or "former parent") for proceeds of $178.3 million in connection with the sale of Sirius Group to CM International Holding Pte. Ltd ("CMIG International") and recorded $22.1 million of Additional paid-in surplus for the excess of fair value over the equity method carrying value of OneBeacon. (See Note 19.).
On April 18, 2016, Sirius Global Solutions sold Ashmere Insurance Company to White Mountains for proceeds of $18.5 million in connection of the sale of Sirius Group by White Mountains.
On February 1, 2016, Sirius Group sold its investment in Symetra Financial Corporation ("Symetra") for proceeds of $559.8 million, or $32.00 per share.
The Company's Global Property, Global A&H, Specialty & Casualty, and Runoff & Other reportable segments each have managers who are responsible for the overall profitability of their respective segments and who are directly accountable to the Company's chief operating decision maker, the Chief Executive Officer ("CEO") of the Company. The CEO assesses segment operating performance, allocates capital, and makes resource allocation decisions based on Technical profit (loss), Underwriting profit (loss), and Underwriting profit (loss), including net service fee revenue.
Sirius Group does not allocate its assets by segment, with the exception of goodwill and intangible assets, and, accordingly, investment income is not allocated to each segment.
(1)Loss and allocated LAE are part of Loss and loss adjustment expenses on the Consolidated Statements of (Loss) Income (the sum of Loss and allocated LAE and Unallocated LAE is equal to Loss and loss adjustment expenses on the Consolidated Statements of (Loss) Income).
(9)Ratios considered not meaningful ("NM") to Runoff & Other and Corporate Elimination.
(3)Service fee revenue is part of Other revenue on the Consolidated Statements of (Loss) Income (the sum of Service fee revenue and Other revenue is equal to Other revenue on the Consolidated Statements of (Loss) Income).
(4)Managing general underwriter unallocated LAE represents IMG and Armada generated operating expenses following their integration with the Accident and Health insurance and reinsurance underwriting unit, representing costs associated with the claims process. In prior periods, all Armada and IMG expenses were disclosed within General and administrative expenses, MGU + Runoff & Other.
(5)Managing general underwriter other underwriting expenses represent IMG and Armada generated operating expenses following their integration with the Accident and Health insurance and reinsurance underwriting unit, representing costs associated with the underwriting process. In prior periods, all Armada and IMG expenses were disclosed within General and administrative expenses, MGU + Runoff & Other.
(7)Other revenue is presented net of Service fee revenue and is comprised mainly of gains (losses) from derivatives (see Note 13) (the sum of Service fee revenue and Other revenue is equal to Other revenue on the Consolidated Statements of (Loss) Income).
The following tables provide summary information regarding net premiums written by client location and underwriting location by reportable segment for the years ended December 31, 2018, 2017, and 2016:
Sirius Group establishes loss and LAE reserves that are estimates of future amounts needed to pay claims and related expenses for events that have already occurred. Sirius Group also obtains reinsurance whereby another reinsurer contractually agrees to indemnify Sirius Group for all or a portion of the reinsurance risks underwritten by Sirius Group. Such arrangements, where one reinsurer provides reinsurance to another reinsurer, are usually referred to as "retrocessional reinsurance" arrangements. Sirius Group establishes estimates of amounts recoverable from retrocessional reinsurance in a manner consistent with the loss and LAE liability associated with reinsurance contracts offered to its customers (the "ceding companies"), net of an allowance for uncollectible amounts. Net reinsurance loss reserves represent loss and LAE reserves reduced by retrocessional reinsurance recoverable on unpaid losses.
In addition to those factors which give rise to inherent uncertainties in establishing loss and LAE reserves, the inherent uncertainties of estimating such reserves are even greater for the reinsurer, due primarily to: (1) the claim-tail for reinsurers and insurers working through MGUs being further extended because claims are first reported to either the original primary insurance company or the MGU and then through one or more intermediaries to reinsurers, (2) the diversity of loss development patterns among different types of reinsurance treaties, facultative contracts or direct insurance contracts, (3) the necessary reliance on the ceding companies, intermediaries, and MGUs for information regarding reported claims and (4) the differing reserving practices among ceding companies and MGUs.
The actuarial methods are used to calculate a point estimate of loss and LAE reserves for each company within Sirius Group. These point estimates are then aggregated to produce an actuarial point estimate for Sirius Group. Once a point estimate is established, Sirius Group's actuaries estimate loss reserve ranges to measure the sensitivity of the actuarial assumptions used to set the point estimates. These ranges are calculated from historical variations in loss ratios, payment, and reporting patterns by class and type of business. Management then establishes an estimate for the carried loss and LAE reserves shown in the financial statement. The management selection is within the range of loss reserve estimates provided by Sirius Group's actuaries.
During the year ended December 31, 2016, Sirius Group had net favorable prior year loss reserve development of $63.7 million. The major reductions in loss reserve estimates were recognized in the Global Property ($26.8 million) and Specialty & Casualty ($24.8 million) segments. The decrease in Global Property was driven by Other Property ($23.4 million) due primarily to reductions in the ultimate loss estimates for natural catastrophes that occurred between 2010 and 2015 due to lower than expected claims activity. The decrease in Specialty & Casualty was mainly due to Aviation & Space and Marine with decreases of $11.5 million and $7.2 million, respectively. Asbestos losses of $13.6 million in 2016 were offset by other long tail favorable loss reserve development in Runoff & Other.
In the Runoff & Other segment, Sirius Group's reserves include provisions made for claims that assert damages from asbestos and environmental ("A&E") related exposures primarily at Sirius America. Asbestos claims relate primarily to injuries asserted by those who came in contact with asbestos or products containing asbestos. Environmental claims relate primarily to pollution and related clean-up cost obligations, particularly as mandated by U.S. federal and state environmental protection agencies. In addition to the factors described above regarding the reserving process, Sirius Group estimates its A&E reserves based upon, among other factors, facts surrounding reported cases and exposures to claims, such as policy limits and deductibles, current law, past and projected claim activity, and past settlement values for similar claims, as well as analysis of industry studies and events, such as recent settlements and asbestos-related bankruptcies. The cost of administering A&E claims, which is an important factor in estimating loss reserves, tends to be higher than in the case of non-A&E claims due to the higher legal costs typically associated with A&E claims.
Sirius Group recorded a decrease of $6.9 million, an increase of $59.0 million, and an increase of $13.6 million of asbestos-related incurred losses and LAE on its asbestos reserves in 2018, 2017, and 2016, respectively. The 2018 decrease was driven by favorable loss reserve development primarily due to benign claims activity on the Sirius Global Solutions portfolio. The 2017 increase was primarily a result of an in-depth analysis of Sirius Group's loss reserves undertaken in the second quarter of 2017. The 2016 increase was primarily the result of management's monitoring of a variety of metrics including actual paid and reported claims activity.
Sirius Group recorded $4.0 million, $6.1 million, and $0.4 million of environmental losses in 2018, 2017, and 2016, respectively, on its already existing reserves.
Sirius Group's reserves for A&E losses as of December 31, 2018 represent management's best estimate of its ultimate liability based on information currently available. However, as case law expands, medical and clean-up costs increase, and industry settlement practices change, Sirius Group may be subject to asbestos and environmental losses beyond currently estimated amounts. Sirius Group cannot reasonably estimate at the present time loss reserve additions arising from any such future adverse developments and cannot be sure that allocated loss reserves will be sufficient to cover additional liability arising from any such adverse developments.
The following tables present Sirius Group's loss and LAE reserves, net of reinsurance, by type as of December 31, 2018 and 2017:
The following table groupings, reflecting the Other Property, Property Catastrophe Excess, Agriculture, Accident & Health, Aviation & Space, Trade credit, Environmental, Marine, Surety, Contingency, Casualty, and Runoff & Other lines of business include three sections.
The second table (middle section grouping) presents cumulative paid loss and allocated LAE, net of reinsurance for each of the previous 10 accident years, as of each of the previous 10 year-end evaluations. Also included in this table is a calculation of the liability for loss and allocated LAE as of December 31, 2018 which is then included in the reconciliation to the consolidated balance sheet presented above. The liability as of December 31, 2018 is calculated as the cumulative incurred loss and allocated LAE from the first table less the cumulative paid loss and allocated from the second table, plus any outstanding liabilities from accident years prior to 2009.
The third table (bottom section of grouping) is supplementary information about the average historical claims duration as of December 31, 2018. It shows the weighted average annual percentage payout of incurred loss and allocated LAE by accident year as of each age. For example, the first column is calculated as the incremental paid loss and allocated LAE in the first calendar year for each given accident year (e.g. calendar year 2010 for accident year 2010, calendar year 2011 for accident year 2011) divided by the cumulative incurred loss and allocated LAE as of December 31, 2018 for that accident year. The resulting ratios are weighted together using cumulative incurred loss and allocated LAE as of December 31, 2018.
Sirius Group's reinsurance protection primarily consists of pro-rata and excess of loss protections that protect all of its reportable segments. Attachment points and coverage limits vary by region around the world.
Sirius Group periodically purchases industry loss warranties ("ILW") contracts to augment its overall retrocessional program. The following ILW contracts are currently in force:
Sirius Group purchases excess of loss reinsurance protection for its facultative and primary insurance property books. The protection was renewed at January 1, 2019 for business written in Stockholm, Hamburg and Singapore, providing $32.5 million of protection in excess of $2.5 million. For the business written by Syndicate 1945, an excess of loss reinsurance protection of $10.0 million in excess of retention of $5.0 million on a per risk basis was placed for 12 months at June 30, 2018. Due to reduced exposures, this was cancelled December 31, 2018 and not replaced. For catastrophe losses from business written by Syndicate 1945, Sirius Group has 50% of a $12.0 million protection in excess of retention of $3.0 million placed for 12 months at January 1, 2019.
In connection with the CMIG International acquisition, White Mountains required Sirius Group to purchase ILWs, referred to as the WTM Covers, to mitigate the potential impact of major natural catastrophe events on Sirius Group's balance sheet pending the close of the sale to CMIG International. The cost and potential economic benefit provided by the WTM Covers inure to White Mountains. All but one of these contracts expired in May or June 2016; the other was a United States second event cover for an industry loss at $15 billion with a limit of $5 million that expired on July 15, 2016. Under the Stock Purchase Agreement ("SPA") between CMIG International and White Mountains, shortly after the sale of the Company, White Mountains paid the Company $16.5 million on an after-tax basis, which the Company recorded as paid-in surplus. The costs of these programs are part of the Runoff & Other reportable segment.
The following table summarizes the WTM Covers purchased in connection with the CMIG International acquisition that expired in 2016:
At December 31, 2018, Sirius Group had reinsurance recoverables on paid losses of $55.0 million and reinsurance recoverables of $350.2 million on unpaid losses. At December 31, 2017, Sirius Group had reinsurance recoverables on paid losses of $17.5 million and reinsurance recoverables of $319.7 million on paid unpaid losses. Because retrocessional reinsurance contracts do not relieve Sirius Group of its obligation to its insureds, the collectability of balances due from Sirius Group's reinsurers is important to its financial strength. Sirius Group monitors the financial strength and ratings of retrocessionaires on an ongoing basis. Uncollectible amounts historically have not been significant.
The following tables provide a listing of Sirius Group's gross and net recoverable amounts by the reinsurer's Standard & Poor's Financial Services LLC ("Standard & Poor's") rating and the percentage of total recoverables as of December 31, 2018 and 2017. With certain reinsurers if Standard & Poor's rating was not available, an A.M. Best rating was used.
Sirius Group's net investment income is comprised primarily of interest income along with associated amortization of premium and accretion of discount on Sirius Group's fixed maturity investments, dividend income from its equity investments, and interest income from its short-term investments.
Net investment income for the years ended December 31, 2018, 2017, and 2016 consisted of the following:
(2)Includes net realized gains of $222.5 related to Symetra in 2016. (See Note 3.)
(3)Includes $35.7, $(51.7), and $(7.7) of unrealized gains (losses) due to foreign currency during 2018, 2017, and 2016, respectively.
The cost or amortized cost and fair value of Sirius Group's fixed maturity investments as of December 31, 2018 and 2017 are presented below by contractual maturity. Actual maturities could differ from contractual maturities because borrowers may have the right to call or prepay certain obligations with or without call or prepayment penalties.
The following table summarizes the ratings and fair value of fixed maturity investments held in Sirius Group's investment portfolio as of December 31, 2018 and 2017:
(1)Credit ratings are assigned based on the following hierarchy: 1) Standard & Poor's and 2) Moody's Investor Service.
(1)2017 figures have been revised to correct for a misclassification in prior disclosure of subcategories within agency and non-agency mortgage-backed securities: total agency balances increased by $39.7 and total non-agency balances decreased by the same amount.
(2)Represents publicly traded mortgage-backed securities which carry the full faith and credit guaranty of the U.S. government (i.e., GNMA) or are guaranteed by a government-sponsored entity (i.e., FNMA, FHLMC).
The cost or amortized cost, gross unrealized investment gains and losses, net foreign currency gains and losses, and fair values of Sirius Group's equity securities and other long-term investments as of December 31, 2018 and 2017, were as follows:
Other long-term investments at fair value consist of the following as of December 31, 2018 and 2017:
Sirius Group holds investments in hedge funds and private equity funds, which are included in other long-term investments. The fair value of these investments has been estimated using the net asset value of the funds. As of December 31, 2018, Sirius Group held investments in 9 hedge funds and 27 private equity funds. The largest investment in a single fund was $54.8 million as of December 31, 2018 and $31.4 million as of December 31, 2017.
The following table summarizes investments in hedge funds and private equity interests by investment objective and sector as of December 31, 2018 and 2017:
Certain of the hedge fund and private equity fund investments in which Sirius Group is invested are no longer active and are in the process of disposing of their underlying investments. Distributions from such funds are remitted to investors as the fund's underlying investments are liquidated. As of December 31, 2018, no distributions were outstanding from these investments.
As of December 31, 2018, Sirius Group held $0.3 million of collateral in the form short-term investments associated with Interest Rate Cap agreements. (See Note 13.)
As of December 31, 2018 and 2017, Sirius Group reported $5.0 million and $0.3 million, respectively, in Accounts receivable on unsettled investment sales.
During 2017, two fixed maturity securities classified as Level 3 measurements in the prior period were recategorized as a Level 2 measurement because quoted market prices for similar securities that were considered reliable and could be validated against an alternative source were available as of December 31, 2017. These measurements comprise "Transfers out" of Level 3 and "Transfers in" to Level 2 of $18.4 million for the period ended December 31, 2017.
(1) As of December 31, 2018, each asset type consists of one security.
(1) As of December 31, 2017, each asset type consists of one security.
(1)Fair value estimated by internal pricing and considered a Level 3 measurement.
Sirius Group measures the fair value of certain assets on a non-recurring basis, generally quarterly, annually, or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. These include goodwill, indefinite-lived intangible assets, and long-lived assets. Sirius Group uses a variety of techniques to measure the fair value of these assets when appropriate, as described below:
For the years ended December 31, 2018 and 2017, Sirius Group recognized an impairment of Intangible assets with an indefinite life that relate to a trade name intangible asset acquired as part of the acquisition of IMG. The impairments resulted from lower than anticipated growth when comparing the forecasted results against a reforecast of results at year end. A quantitative impairment review of the IMG trade name intangible asset was performed by applying the royalty replacement method to determine the asset's fair value as of December 31, 2018 and 2017, respectively. Under the royalty replacement method, the fair value of IMG's trade names intangible asset was determined based on a market participant's view of the royalty that would be paid to license the right to use the trade name. This quantitative analysis incorporated several assumptions including forecasted future revenues and cash flows, estimated royalty rate, based on similar licensing transactions and market royalty rates, and discount rate, which incorporates assumptions such as weighted-average cost of capital and risk premium. As a result of the impairment testing, the carrying value of IMG's trade names intangible asset exceeded its estimated fair value and an impairment of $ 8.0 million and $5.0 million was recorded as Impairment of intangible assets on the Consolidated Statements of (Loss) Income for the years ended December 31, 2018 and 2017, respectively. For the year ended December 31, 2016, Sirius Group did not recognize any impairments on Intangible assets with an indefinite life.
The amortization of intangibles assets for the year ended December 31, 2018 and 2017 was $15.8 million and $10.2 million, respectively. There was no amortization of intangible assets during the year ended December 31, 2016.
On November 1, 2016, Sirius Group issued $400.0 million face value of senior unsecured notes ("2016 SIG Senior Notes") at an issue price of 99.209% for net proceeds of $392.4 million after taking into effect both deferrable and non-deferrable issuance costs. The SIG Senior Notes were issued in an offering that was exempt from the registration requirements of the Securities Act of 1933. The 2016 SIG Senior Notes bear an annual interest rate of 4.6%, payable semi-annually in arrears on May 1 and November 1, in each year commencing on May 1, 2017, until maturity in November 2026.
During 2016, using the funds received from the issuance of the 2016 SIG Senior Notes, Sirius Group retired the $400.0 million face value of senior unsecured notes that were issued in 2007 ("2007 SIG Senior Notes"). The retirement of the 2007 SIG Senior Notes resulted in a $5.7 million loss recorded in interest expense, which includes the write-off of the remaining $0.1 million in unamortized deferred costs and original issue discount at the time of retirement.
In anticipation of the issuance of the 2007 SIG Senior Notes, Sirius Group entered into an interest rate lock agreement to hedge its interest rate exposure from the date of the agreement until the pricing of the 2007 SIG Senior Notes. The agreement was terminated on March 15, 2007 with a loss of $2.4 million, which was recorded in other comprehensive income. The loss was reclassified from accumulated other comprehensive income over the life of the 2007 SIG Senior Notes using the interest method and was included in interest expense until it was retired in 2016. When the 2007 SIG Senior Notes were retired, the $0.1 million loss remaining in accumulated other comprehensive income was reclassified to interest expense.
On April 25, 2017, Sirius Group made a payment of $3.8 million to retire the Old Lyme Note that was originally issued as part of the acquisition of the runoff loss reserve portfolio of Old Lyme Insurance Company Ltd. As part of the acquisition in 2011, Sirius Group entered into a five-year $2.1 million note that was subject to upward adjustments for favorable loss reserve development (up to 50% of $6.0 million) and downward adjustments for any adverse loss reserve development. From inception, Sirius Group had favorable loss reserve development of $3.4 million on the Old Lyme loss reserve position that resulted in an increase of $1.7 million on the Old Lyme Note.
On November 9, 2018, Sirius International renewed two standby letter of credit facility agreements totaling $160 million to provide capital support for Lloyd's Syndicate 1945. The first letter of credit is a renewal of a $125 million facility with Nordea Bank Finland Abp, London Branch, which is issued on an unsecured basis. The second letter of credit is a $35 million facility with DNB Bank ASA, Sweden Branch, $25 million of which is issued on an unsecured basis. Each facility is renewable annually. The above referenced facilities are subject to various affirmative, negative and financial covenants that the Company considers to be customary for such borrowings, including certain minimum net worth and maximum debt to capitalization standards.
Total interest expense incurred by Sirius Group for its indebtedness was $30.8 million, $22.4 million, and $34.6 million in 2018, 2017, and 2016. Total interest paid by Sirius Group for its indebtedness was $30.0 million, $22.0 million, and $31.6 million in 2018, 2017, and 2016, respectively.
The Company and its Bermuda domiciled subsidiaries are not subject to Bermuda income tax under current Bermuda law. In the event there is a change in the current law such that taxes are imposed, the Company and its Bermuda domiciled subsidiaries would be exempt from such tax until March 31, 2035, pursuant to the Bermuda Exempted Undertakings Tax Protection Act of 1966. The Company has subsidiaries and branches that operate in various other jurisdictions around the world that are subject to tax in the jurisdictions in which they operate. The jurisdictions in which the Company's subsidiaries and branches are subject to tax are Australia, Belgium, Canada, Denmark, Germany, Gibraltar, Hong Kong (China), Luxembourg, Malaysia, the Netherlands, Shanghai (China), Singapore, Spain, Sweden, Switzerland, the United Kingdom, and the United States.
A reconciliation of taxes calculated using the 22% Swedish statutory rate (the rate at which the majority of Sirius Group's worldwide operations are taxed) to the income tax (expense) benefit on pre-tax income follows:
Effective January 1, 2019, Sweden enacted reductions in its corporate tax rate from 22% to 21.4% from 2019 and then to 20.6% from 2021. This resulted in a reduction in the net deferred tax liability for Sirius Group's Swedish entities as of December 31, 2018 in the amount of $15.4 million. Further, as part of the same enacted tax legislation, Sweden introduced a standard taxable yield on property and casualty insurance companies' safety reserves. Insurers recognizing a safety reserve must recognize an annual standard yield on safety reserve as taxable income. The standard income is equal to the government bond rate at the end of November the year before the year during which the insurers income year ends multiplied by the opening balance of the safety reserve for that year. In addition, an insurer with a safety reserve opening balance on January 1, 2021 is required to recognize notional taxable income equal to 6% of the safety reserve at the start of that income year. As a result of this newly enacted one-time tax determined by reference to the future safety reserve balance, Sirius Group has recorded a deferred tax expense of $15.3 million as of December 31, 2018.
Net income tax payments to national, state, and local governments totaled $19.1 million, $16.7 million, and $8.3 million for the years ended December 31, 2018, 2017, and 2016, respectively.
As of December 31, 2018, there are U.S. foreign tax credits carryforwards available of $16.7 million, of which an insignificant amount expires in 2019, and the remaining, which Sirius Group expects to use, will begin to expire in 2022. As of December 31, 2018, there are alternative minimum tax credit carryforwards of $0.1 million which do not expire and are expected to become fully refundable beginning in the 2022 tax year under the TCJA. Further, there are Swedish foreign tax credits carryforwards available of $11.9 million, which Sirius Group expects to use, and will expire between 2021 and 2023.
Of the $64.6 million valuation allowance as of December 31, 2018, $64.6 million relates to net operating loss carryforwards in Luxembourg subsidiaries and an insignificant amount relates to other deferred tax assets in Swedish and United States subsidiaries.
(1)Standard & Poor's ratings as detailed above are: "AA-" (Very Strong, which is the fourth highest of twenty-three creditworthiness ratings) and "A" (Strong, which is the sixth highest of twenty-three credit worthiness ratings).
During 2016, Sirius Group executed a foreign currency forward to manage currency exposure against a foreign currency investment. During 2017, the foreign currency forward expired and was not renewed. The foreign currency forward was not designated or accounted for under hedge accounting. Changes in fair value are presented within Net foreign exchange gains (losses). The fair value of the foreign currency forward was estimated using a non-binding single broker quote and, accordingly, was classified as a Level 3 measurement. Sirius Group did not provide or hold any collateral associated with the forwards.
Sirius Group holds assets and assumes liabilities related to weather and weather contingent risk management products. Weather and weather contingent derivative contracts are entered into with the objective of generating profits in normal climatic conditions. Accordingly, Sirius Group's weather and weather contingent derivatives are not designed to meet the criteria for hedge accounting under GAAP. Sirius Group receives payment of premium at the contract inception in exchange for bearing the risk of variations in a quantifiable weather index. Changes in fair value are recognized as unrealized gains or losses and are presented within Other revenue. Management uses available market data and internal pricing models based upon consistent statistical methodologies to estimate the fair value. Because of the significance of the unobservable inputs used to estimate the fair value of Sirius Group's weather risk contracts, the fair value measurements of the contracts are deemed to be Level 3 measurements in the fair value hierarchy as at December 31, 2018 and 2017. Sirius Group does not provide or hold any collateral associated with the weather derivatives.
During 2018, Sirius Group executed trades in equity futures contracts to hedge against a long position in Common equities. During 2018, the equity futures contracts were exited and were not renewed. The equity futures contracts were not designated or accounted for under hedge accounting. Changes in fair value are presented within Net realized investment gains (losses). The fair value of the equity put options is widely available and have quoted prices in active markets and accordingly, were classified as a Level 1 measurement.
The following table summarizes information on the classification and net impact on earnings, recognized in the Company's Consolidated Statements of (Loss) Income relating to derivatives during the years ended December 31, 2018, 2017 and 2016:
(1)There were no Foreign currency forwards at December 31, 2017 and an insignificant amount at December 31, 2016 on the Consolidated Balance Sheets.
The breakdown of the investment of plan assets for the years ended December 31, 2018 and 2017 are as follows:
The Swedish actuaries follow the Swedish industry DUS14 mortality rate. The discount rate used to calculate the Swedish benefit obligation was derived from the expected return of an investment in Swedish covered mortgage bonds with a duration in accordance with the duration of the pension obligation. The duration of the Swedish pension liability is approximately 20 years.
The German actuaries follow the Germany industry Richttafeln 2018 G mortality rates and standard turnover values for the years ended December 31, 2018 and 2017. The discount rate used to calculate the German benefit obligation was derived from markets yields on high quality corporate bonds with durations consistent with plan obligations. The duration of the German pension liability is approximately 18 years. The following tables present a reconciliation of the beginning and ending funded status and the net amounts recognized for the defined benefit plans for the years ended December 31, 2018 and 2017:
(1)At December 31, 2018, the Swedish plan had a funding status of $3.0 and the German plan had a funding status of $(4.1). At December 31, 2017, the Swedish plan had a funding status of $3.1 and the German plan had a funding status of $(4.4).
Under the Swedish plan, a 100 basis point discount rate decrease would increase the 2019 defined benefit obligation by $2.3 million, with all other items remaining the same. Under the German plan, a 50 basis point decrease in the discount rate would increase the benefit obligation by $0.5 million, with all other items remaining the same. Conversely, a 50 basis point increase in the discount rate would decrease the benefit obligation by $0.4 million.
The employer benefit payments/settlements for the years ended December 31, 2018 and 2017 were $0.4 million and $0.2 million, respectively. As at December 31, 2018, the projected benefit payments required for the defined pension benefits plans are as follows:
Sirius International Holding Company, Inc. ("SIHC") sponsors a defined contribution plan (the "SIHC 401(k) Plan") which offers participants the ability to invest their balances in several different investment options. The SIHC 401(k) Plan provides qualifying employees with matching contributions of 100% up to the first 2% and 50% of the next 4% of salary (subject to U.S. federal limits on allowable contributions in a given year). Total expense for matching contributions to the plan was $0.8 million, $1.3 million, and $0.7 million in 2018, 2017, and 2016, respectively. Additionally, all participants in the SIHC 401(k) Plan can earn a variable contribution of up to 7% of their salary, subject to the applicable IRS annual covered compensation limits ($0.3 million for 2018) and contingent upon Sirius Group's performance. During 2018, there were no variable contributions to the SIHC 401(k) Plan. Total expense for variable contributions to the SIHC 401(k) Plan was $0.3 million and $0.4 million in 2017 and 2016, respectively.
IMG sponsors a 401(k) retirement savings plan (the "IMG 401(k) Plan"). IMG 401(k) Plan participants may elect to have a percentage of their salaries contributed to the IMG 401(k) Plan on a pre-tax basis subject to annual limits prescribed under the Internal Revenue Code. IMG makes safe harbor matching contributions to the IMG 401(k) Plan equal to 100% of participants' deferrals up to the first 1% of eligible compensation and 50% of participants' deferrals between 1% and 6% of eligible compensation. IMG may also elect to make discretionary contributions to the IMG 401(k) Plan which are allocated based on compensation. IMG made matching contributions to the IMG 401(k) Plan of $0.6 million during 2018 and $0.3 million from the date of acquisition to December 31, 2017.
Armada maintains a qualified 401(k) plan (the "Armada 401(k) Plan"). Under provisions of the Armada 401(k) Plan, Armada may make discretionary, matching contributions. Matching contributions into the Armada 401(k) Plan totaled $0.2 million during 2018 and $0.1 million from the date of acquisition to December 31, 2017.
Sirius Group has historically awarded long-term incentive compensation in the form of three-year, cliff-vested, performance units or phantom performance shares that can be paid in cash, or upon Sirius Group becoming public, Sirius Group common shares, at the discretion of the Compensation Committee. A new long-term incentive award is granted each year so that there are three different performance cycles outstanding at any given time.
The Company's 2016 Long Term Incentive Plan (the "LTIP"), amended and restated in August 2018, provides for the issuance of Performance Units or Performance Share awards to an eligible employee. Only performance shares were awarded for the three outstanding cycles.
Performance shares compound through the end of the three-year award period based on the weighted average underwriting return on capital ("UROC"), return on equity ("ROE") produced by the Company and other performance metrics during the period. The performance goals are determined by the Compensation Committee of the Board of Directors upon granting of awards.
For the years ended December 31, 2018, 2017, and 2016, under the SPA, White Mountains paid Sirius Group for certain incentive awards that the Company paid to its employees, with $1.4 million, $2.5 million, and $5.4 million, respectively, recorded as Additional paid-in surplus.
As of December 31, 2018, 203,589 shares were purchased up front and 552,594 shares were pledged to be purchased over three years under the 2018 Omnibus Incentive Plan. Share-based compensation expense of $0.6 million was recognized during the year ended December 31, 2018 related to these purchases.
Under the 2018 Omnibus Incentive Plan, participants are awarded Performance Share Units one-for-one against any shares purchased through the 2018 Omnibus Incentive Plan, the Sirius Group Private Placement, or the ESPP up to their award amount.
Sirius Group recorded compensation expense for the year ended December 31, 2018 of $1.5 million related to the Performance Share Units.
On February 27, 2019, Sirius Group terminated the obligation that requires participants to purchase shares through the 2018 Omnibus Incentive Plan.
Certain non-employee independent directors received share-based compensation in the form of common shares which vest after one year of issuance. During 2018, Sirius Group granted non-employee directors 24,475 shares and recognized share-based compensation expense of $0.4 million.
The following table presents changes in the Company's issued and outstanding Common shares for the years ended December 31, 2018, 2017, and 2016, respectively:
(1)On April 27, 2016, the Company split its common shares by a multiple of 10,000 resulting in 120,000,000 common shares issued and outstanding and changed the par value of the common shares from $1.00 per share to $0.01 per share.
On November 5, 2018, the Company repurchased 9,519,280 common shares from CM Bermuda in connection with the Merger ("redeemed shares") for $164.0 million. (See Note 3.) The redeemed shares were canceled and the cost of the redeemed shares are included as a reduction to Additional paid-in surplus.
On October 25, 2017, the Company's indirect wholly-owned subsidiary, Sirius International Group, Ltd., redeemed all of its outstanding 250,000 Fixed/Floating Perpetual Non-Cumulative Preference Shares ("SIG Preference Shares"). The redemption price equaled the $1,000 liquidation preference per preference share. Sirius Group accounted for the SIG Preference Shares as a conditionally redeemable instrument within Non-controlling interests.
As of December 31, 2018 and 2017, Sirius Group recorded non-controlling interest of $1.7 million and $0.2 million, respectively, in Alstead Re Insurance Company ("Alstead Re"). (See Note 20.)
The Series A redeemable preference shares qualify as participating securities which requires the application of the two-class method to compute both basic and diluted earnings per share. The two-class method is an earnings allocation formula that treats participating securities as having rights to earnings that would otherwise have been available to common shareholders. The Series A redeemable preference shares have no obligation to absorb losses of the Company in periods of net loss.
(1)On April 27, 2016, the Company split its common shares by a multiple of 10,000 resulting in 120,000,000 common shares. The stock split has been applied retroactively to January 1, 2016.
(2)Due to the net loss incurred during the year ended December 31, 2018, all potentially dilutive securities have been excluded from Diluted earnings per share as they would be anti-dilutive. As of December 31, 2018, there were a total of 23,433,114 potentially dilutive securities excluded from the calculation of Diluted earnings per share. As of both December 31, 2017 and 2016, there were no potentially dilutive securities.
Sirius Group's insurance and reinsurance operations are subject to regulation and supervision in each of the jurisdictions where they are domiciled and licensed to conduct business. Generally, regulatory authorities have broad supervisory and administrative powers over such matters as licenses, standards of solvency, premium rates, policy forms, investments, security deposits, methods of accounting, form and content of financial statements, reserves for unpaid loss and LAE, reinsurance, minimum capital and surplus requirements, dividends and other distributions to shareholders, periodic examinations, and annual and other report filings. In general, such regulation is for the protection of policyholders rather than shareholders.
Sirius Group has two Bermuda based insurance subsidiaries: Sirius Bermuda, a Class 4 insurer, and Alstead Re, a Class 3A insurer. Each of these Bermuda insurance subsidiaries are registered under the Insurance Act and are subject to regulation and supervision of the BMA. The BSCR for Sirius Bermuda and Alstead Re as at December 31, 2018 has not been determined as of the filing of this Annual Report on Form 10-K. The BSCR for Sirius Bermuda and Alstead Re as at December 31, 2017 was $902 million and $3 million, respectively. Actual statutory capital and surplus of the Bermuda based insurance subsidiaries as at December 31, 2018 was $2.2 billion. In addition, the Bermuda based insurance subsidiaries are required to maintain a minimum liquidity ratio. As of December 31, 2018, all liquidity ratio requirements were met.
Sirius International is subject to regulation and supervision by the Swedish Financial Supervisory Authority ("SFSA"). Sirius International's total regulatory capital as of December 31, 2018 was $1.7 billion. In accordance with SFSA regulations, Sirius International holds restricted equity of $1.3 billion as a component of Swedish regulatory capital. This restricted equity cannot be paid as dividends. Under Solvency II, the SFSA also acts as the European Economic Area group supervisor, with Sirius International UK Holding Ltd. ("SIUK") serving as the highest European entity subject to the SFSA's group supervision. Solvency II regulation in Europe gives the SFSA the option to waive European-level group supervision if certain legal requirements are met. As of December 31, 2018, the SFSA has not exercised this option.
Lloyd's permits its corporate and individual members ("Members") to underwrite insurance risks through Lloyd's syndicates. Members of Lloyd's may participate in a syndicate for one or more underwriting years by providing capital to support the syndicate's underwriting. All syndicates are managed by Lloyd's approved managing agents. Managing agents receive fees and profit commissions in respect of the underwriting and administrative services they provide to the syndicates. Lloyd's prescribes, in respect of its managing agents and Members, certain minimum standards relating to their management and control, solvency and various other requirements.
Sirius America and the insurance subsidiaries of Sirius Global Solutions are subject to regulation and supervision by the National Association of Insurance Commissioners ("NAIC") and the department of insurance in the state of domicile. The NAIC uses risk-based capital ("RBC") standards for U.S. property and casualty insurers as a means of monitoring certain aspects affecting the overall financial condition of insurance companies. As of December 31, 2018, the available capital of Sirius Group's U.S. insurance and reinsurance operating subsidiaries exceeded their respective RBC requirements.
Empire Insurance Company ("Empire") policyholders' surplus, as reported to regulatory authorities as of December 31, 2018 and 2017 was $10.7 million and $10.5 million, respectively. Empire's statutory net income (loss) for the years ended December 31, 2018, 2017, and 2016 was $0.1 million, $(0.3) million and $0.0 million, respectively. The minimum policyholders' surplus necessary to satisfy Empire's regulatory requirements was $8.8 million as of December 31, 2018, and the NAIC risk-based capital authorized control level was $1.0 million.
Sirius Group's top tier regulated insurance and reinsurance operating subsidiary is Sirius Bermuda. Sirius Bermuda's ability to pay dividends is limited under Bermuda law and regulations. Under the Insurance Act, Sirius Bermuda is restricted with respect to the payment of dividends. Sirius Bermuda is prohibited from declaring or paying in any financial year dividends of more than 25% of its total statutory capital and surplus (as shown on its previous financial year's statutory balance sheet) unless it files, at least seven days before payment of such dividends, with the BMA an affidavit stating that it will continue to meet the required margins following the declaration of those dividends. Accordingly, Sirius Bermuda can pay approximately $539.3 million to its parent company, Sirius International Group, Ltd., during 2019 without providing an affidavit to the BMA. Sirius Bermuda indirectly owns Sirius International Insurance Corporation, Sirius America Insurance Company and Sirius Group's other insurance and reinsurance operating companies, each of which are limited in their ability to pay dividends by the insurance laws of their relevant jurisdictions.
(1)The ownership percentage of NEC Cypress Buyer LLC was greater than 20% at December 31, 2017 but was less than 20% at December 31, 2018 and is included in the table for comparative purposes.
On April 18, 2016, Sirius Group sold its investment in OneBeacon at fair value to its former parent for proceeds of $178.3 million in connection with the sale of Sirius Group to CMIG International and recorded $22.1 million of additional paid-in surplus for the excess of fair value over the equity method carrying value of OneBeacon. (See Note 3.)
The following table presents financial information for OneBeacon as of March 31, 2016:
Sirius Group has determined that Alstead Re is a VIE for which Sirius Group is the primary beneficiary and is required to consolidate it. The following table presents Alstead Re's assets and liabilities, as classified in the Consolidated Balance Sheets as at December 31, 2018 and 2017:
Sirius Group underwrites a significant amount of its reinsurance business through reinsurance intermediaries that represent the ceding company. There is credit risk associated with payments of (re)insurance balances to Sirius Group in regards to these brokers' ability to fulfill their contractual obligations. These intermediaries are fairly large and well established, and there are no indications they are financially distressed.
The following table shows Sirius Group's net written premiums by geographic region based on the location of the ceding company for the years ended December 31, 2018, 2017, and 2016:
Sirius Group conducts a significant portion of its business outside of the United States. As a result, a significant portion of Sirius Group's assets, liabilities, revenues, and expenses are denominated in currencies other than the U.S. dollar and are therefore subject to foreign currency risk. Sirius Group's foreign currency risk cannot be eliminated entirely and significant changes in foreign exchange rates may adversely affect Sirius Group's results of operations and financial condition.
Sirius Group leases certain office space under non-cancellable operating leases that expire on various dates. The future annual minimum rental payments required under non-cancellable leases for office space are as follows:
Total rental expense for the years ended December 31, 2018, 2017, and 2016 was $11.7 million, $10.2 million, and $6.2 million, respectively. Sirius Group also has various other lease obligations, which are not significant in the aggregate.