New York City, New York (Argo Group U.S and Argonaut Specialty)
Included in consolidated losses and loss adjustment expenses for the year ended December 31, 2009 was $6.3 million in favorable loss reserve development on prior accident years. The Excess and Surplus Lines segment had favorable loss reserve development of $15.4 million primarily within the property, casualty and professional liability lines of business. The Commercial Specialty segment had favorable loss reserve development across multiple lines. The Reinsurance segment had favorable loss reserve development of $9.1 million. The International Specialty segment had unfavorable loss reserve development of $23.5 million, which was offset by additional premiums of $24.1 million primarily within the property lines of business. The Run-off Lines segment had $1.6 million of net favorable loss reserve development primarily driven by $10.8 million favorable loss reserve development on legacy PXRE claims, partially offset by $9.1 million of unfavorable loss reserve development in the U.S run-off lines, including $6.1 million in unfavorable loss reserve development in asbestos and environmental lines.
The net favorable loss and loss adjustment expense development for the year ended December 31, 2010 was approximately 1.9% of total reserves outstanding as of December 31, 2010. The reinsurance - nonproportional assumed property favorable net loss reserve development was driven by $15.6 million of favorable development in Argo Re (primarily consisting of $14.5 million attributable to short-tail non-catastrophe losses), coupled with $2.6 million of favorable development in the PXRE Legacy reserves. The general liability line of business had $15.4 million of favorable prior accident year development primarily driven by favorable Excess and Surplus Lines and Commercial Specialty development, partially offset by $9.5 million of unfavorable reserve development for certain asbestos and environmental claims in the Run-Off Lines segment. The favorable development in the workers compensation and auto physical damage lines of business resulted from better than expected loss frequency and severity. The favorable development in the international property lines of business was primarily attributable to better than expected development on the 2008 hurricane losses, the reduction of reserves on a certain claim and improved claims experience. The unfavorable loss reserve development in the international liability lines was primarily attributable to medical malpractice and general liability lines.
Index to Financial Statements Our loss reserve estimates gradually blend in the results from development and frequency/severity methodologies over time. For general liability estimates, more credibility is assigned to our own loss experience approximately 60 to 72 months after the beginning of an accident year. For property business, our loss reserve estimates also blend in the results from development and frequency/severity methodologies over time. For property lines, in contrast to general liability estimates, full credibility is assigned to our loss experience approximately 24 to 36 months after the beginning of an accident year, where loss reporting and claims closing patterns settle more quickly. Our loss experience receives partial weighting in the estimates 12 to 24 months after the beginning of the accident year.
Consolidated loss reserves were $3,152.2 million (including $185.3 million of reserves attributable to Argo International’s trade capital providers), $3,203.2 million (including $227.9 million of reserves attributable to the trade capital providers) and $2,996.6 million (including $183.3 million of reserves attributable to the trade capital providers) as of December 31, 2010, 2009 and 2008, respectively. Management has recorded its best estimate of loss reserves at each date based on current known facts and circumstances. Due to the significant uncertainties inherent in the estimation of loss reserves, there can be no assurance that future loss development, favorable or unfavorable, will not occur.
Consolidated foreign currency gains were $3.8 million and $0.2 million for the years ended December 31, 2010 and 2009, compared to a $0.5 million loss for the same period ended 2008. Foreign currency exchange gains/losses represent the conversion into U.S. Dollars of transactions that are settled in currencies other than U.S. Dollars.
In 2009, we deemed the value assigned to the former trade name of our International Specialty segment impaired after an evaluation of the value of the name. The expense recognized as a result of this impairment was $5.9 million, which represented the unamortized balance as of the impairment date.
Since we generally manage and monitor the investment portfolio on an aggregate basis, the overall performance of the investment portfolio, and related net investment income, is discussed above on a combined basis under consolidated net investment income rather than within or by segment.
The declines in gross written and earned premiums were primarily due to market conditions. The excess and surplus lines marketplace continues to experience increased competition from both other excess and surplus lines carriers as well as the standard markets, which has led to lower rates and business shifting to the standard markets. Competition within the excess and surplus lines marketplace remains intense, resulting in continued downward pressure on average rate per exposure and the current economic conditions are forcing insureds to reduce coverage or in some cases, cease operations. In addition, insureds in this segment are often the result of new business formations, which have been limited due to the current economic environment. The Excess and Surplus Lines segment has experienced a shift in both product and policyholder mix, resulting in reduced premium writings.
The increase in earned premiums for the year ended December 31, 2009 as compared to the same period in 2008 was primarily attributable to the termination of a ceded quota share reinsurance contract in April 2008. Additionally, earned premiums for the year ended December 31, 2008 were reduced by $4.0 million of reinstatement premiums related to property catastrophe reinsurance contracts resulting from hurricane activity.
Included in losses and loss adjustment expenses for the year ended December 31, 2009 was $19.4 million in higher than anticipated losses attributable to the 2009 accident year primarily within the professional, casualty and property lines. Included in losses and loss adjustment expenses was $15.4 million in favorable loss reserve development on prior accident years within the casualty, professional liability and property lines.
Index to Financial Statements Included in losses and loss adjustment expenses for the year ended December 31, 2008 was $12.7 million in losses resulting from the 2008 hurricane activity. Additionally, $16.7 million of increased losses for the 2008 accident year were recorded for other storm losses and fire losses. Included in losses and loss adjustment expense for the year ended December 31, 2008 was $39.6 million in favorable loss reserve development on prior accident years primarily driven by property lines for the 2006 and 2007 accident years and general liability lines written on both claims-made and occurrence forms related to accident years 2005 and 2006.
The increase in the expense ratio in 2010 as compared to 2009 was primarily attributable due to declining premium volumes. The increase in the expense ratio in 2009 as compared to 2008 was attributable to a reduction in the deferral of acquisition expenses due to declining premium volumes and to increased expenses in the first quarter of 2009 associated with a 2008 acquisition.
The overall $31.2 million decrease in earned premiums for the year ended December 31, 2010 as compared to the same period in 2009 was primarily attributable to the discontinued hotel/motel and religious institution programs and underwriting actions in the grocery and restaurant programs within the Argo Select business unit. Earned premiums within Argo Select decreased $30.3 million, from $141.3 million for the year ended December 31, 2009 to $111.0 million for the same period in 2010. Additionally, earned premiums decreased $4.8 million in our coal mining business due to the impact of the weakened economy on payrolls. Earned premiums for the coal mining business decreased from $66.4 million for the year ended December 31, 2009 to $61.6 million for the same period in 2010. The decreases in earned premiums were partially offset by an increase in earned premiums in our surety lines of business. Surety lines earned premiums increased $5.0 million, from $5.5 million for the year ended December 31, 2009 to $10.5 million for the same period in 2010. The increase in earned premiums for the year ended December 31, 2009 as compared to the same period of 2008 was primarily attributable to growth through an acquisition in the public entity product lines that expanded business into the New England region.
Net fee income, which consists of commissions earned by our managing general underwriters for brokerage business placed outside Argo Group minus the expenses associated with generating the commissions, was $0.2 million for the twelve months ended December 31, 2010 and $0.4 million for the same period in 2009. The decrease for the twelve months ended December 31, 2010 as compared to the same period in 2009 was primarily related to decreased commission income on property premium placed with a third party in the New England region.
Losses and loss adjustment expenses for the year ended December 31, 2010 reflect losses of $32.2 million resulting primarily from earthquake activity and the Deepwater Horizon incident. Included in losses and loss adjustment expenses for the year ended December 31, 2010 was $16.8 million of favorable prior year loss reserve development. The prior year development was primarily the result of $14.5 million of favorable loss reserve development in property catastrophe attritional reserves due to favorable reported loss activity and $1.1 million of favorable loss reserve development on 2008 hurricane reserves. By comparison, 2009 had no major loss events and $3.6 million in favorable loss reserve development for the 2008 accident year due to the hurricane losses developing more favorably than original estimates, plus $4.4 million of favorable development as a result of favorable reported loss activity on non-catastrophe losses. Included in losses and loss adjustment expense for the year ended December 31, 2008 were $16.1 million in losses resulting from hurricane activity.
The International Specialty segment was formed in May 2008 with the purchase of Heritage Underwriting Agency plc, subsequently renamed Argo International Ltd., which is the primary legal platform housing our International Specialty segment focused on the Lloyd’s marketplace. As a result, financial results for 2008 include the last seven months from the acquisition date. The following table summarizes the results of operations for the International Specialty segment:
Fee income represents fees and profit commission derived from the management of third party capital on our underwriting syndicate at Lloyds. Fee income, net, in 2010 represents fees earned in the management of third party capital and is greater than 2009 due to reductions in profit commission estimates in 2009 as a result of changes to the estimated year of account profitability in Lloyd’s Syndicate 1200 at that year end. The 2008 year result is greater than 2009 due to the inclusion of estimated profit commissions as a result of underlying profitability in Lloyd’s Syndicate 1200 at that year end.
In June 2009, we deemed the value assigned to the trade name of Heritage impaired after the renaming of Heritage to Argo International, resulting in a $5.9 million charge.
Underwriting expenses for the year ended December 31, 2010 decreased as compared to 2009 and 2008 due to reduced administrative expenses. Allowance for bad debt expense on uncollectible reinsurance recoverable balances of $6.0 million, $4.8 million and $5.8 million were included for the years ended December 31, 2010, 2009 and 2008, respectively.
Through our subsidiary Argonaut Insurance Company, we are exposed to asbestos liability at the primary level through claims filed against our direct insureds, as well as through its position as a reinsurer of other primary carriers. Argonaut Insurance Company has direct liability arising primarily from policies issued from the 1960s to the early 1980s which pre-dated policy contract wording that excluded asbestos exposure. The majority of the direct policies were issued on behalf of small contractors or construction companies. We believe that the frequency and severity of asbestos claims for such insureds is typically less than that experienced for large, industrial manufacturing and distribution concerns.
Index to Financial Statements The following table represents a reconciliation of total gross and net reserves for the Run-off Lines for each of the years in the three-year period ended December 31, 2010. Amounts in the net column are reduced by reinsurance recoverables.
We perform an extensive actuarial analysis of the asbestos and environmental reserves on at least an annual basis. The process is typically completed in the third quarter of the calendar year and reviewed/updated during the fourth quarter. We continually monitor the status of the claims, and may make adjustments outside of the annual review period. The review entails a detailed analysis of our direct and assumed exposure. Management considers that estimate in determining their best estimate of the asbestos and environmental loss and loss adjustment expense reserves.
The number of claims opened during the three years ended December 31, 2010 were as follows:
Settlement of litigation in the second quarter of 2009 pertaining to a single asbestos case accounted for 138 of the 157 direct claims that were established in 2009. New claims in the reinsurance assumed categories are primarily the result of our having provided coverage for higher limits, which are payable only after other layers of reinsurance are exhausted. Additionally, there tend to be long delays in the ceding companies reporting claims to the reinsurers.
Index to Financial Statements Because of the types of coverages within the Run-off Lines of business still being serviced by Argonaut Insurance Company, a significant amount of subjectivity and uncertainty exists in establishing the reserves for losses and loss adjustment expenses. Factors that increase these uncertainties are: (1) lack of historical data, (2) inapplicability of standard actuarial projection techniques, (3) uncertainties regarding ultimate claim costs, (4) coverage interpretations, and (5) the judicial, statutory and regulatory environments under which these claims may ultimately be resolved. Significant uncertainty remains as to our ultimate liability due to the potentially long waiting period between exposure and emergence of any bodily injury or property damage and the resulting potential for involvement of multiple policy periods for individual claims. Due to these uncertainties, the current trends may not be indicative of future results. Although management has determined and recorded its best estimate of the reserves for losses and loss adjustment expenses for Run-off Lines, current judicial and legislative decisions continue to broaden liability, expand policy scopes and increase the severity of claims payments. As a result of these and other recent developments, the uncertainties inherent in estimating ultimate loss reserves are heightened, further complicating the already complex process of determining loss reserves. The industry as a whole is involved in extensive litigation over these coverages and liability issues, and must contend with the continuing uncertainty in its effort to quantify these exposures.
Index to Financial Statements In March 2010, Argo Group received a dividend in the amount of $17.5 million in cash from Argo Re. In September 2010, Argo Group US received cash dividends of $25.0 million and $30.0 million from Argonaut Insurance Company and Rockwood Casualty Insurance Company, respectively. In October 2010, Argo Group US received a dividend of $50.0 million, comprised of $25.2 million in cash and $24.8 million in securities, from Colony Insurance Company.
On April 30, 2010, each of Argo Group International Holdings, Ltd., Argo Group US, Inc., Argo International Holdings Limited, and Argo Underwriting Agency Limited (the “Borrowers”) entered into a $150,000,000 Credit Agreement (the “New Credit Agreement”) with major money center banks. The New Credit Agreement replaced the $100,000,000 Credit Agreement between the Borrowers and major money center banks, which agreement was terminated in connection with the execution of the New Credit Agreement. The New Credit Agreement and the commitments thereunder expire on April 30, 2013. Borrowings by the Borrowers under the New Credit Agreement may be used for general corporate purposes, including working capital and permitted acquisitions, and each of the Borrowers has agreed to be jointly and severally liable for the obligations of the other Borrowers under the New Credit Agreement.
The New Credit Agreement contains customary events of default. If an event of default occurs and is continuing, the Borrowers might be required immediately to repay all amounts outstanding under the New Credit Agreement. Lenders holding more than 51% of the loans and commitments under the New Credit Agreement may elect to accelerate the maturity of the loans under the New Credit Agreement upon the occurrence and during the continuation of an event of default. No defaults or events of defaults have occurred as of the date of this filing.
Index to Financial Statements LOCs have been filed with Lloyd’s under a third party property deed on behalf of the trade capital providers. LOCs have been filed as part of the terms of whole account quota share reinsurance contracts entered into by the trade capital providers. In the event such LOCs are funded, the outstanding balance would be the responsibility of the trade capital providers.
On February 19, 2010, May 5, 2010, August 10, 2010 and November 3, 2010, the Board of Directors declared a quarterly cash dividend in the amount of $0.12 on each share of common stock outstanding. On March 15, 2010, June 15, 2010, September 15, 2010 and December 15, 2010, Argo Group paid $3.7 million, $3.6 million, $3.5 million, and $3.4 million, respectively to our shareholders of record on March 1, 2010, June 1, 2010, September 1, 2010 and December 1, 2010, respectively. The declaration and payment of dividends is at the discretion of the Board and will depend on our financial results, cash requirements, future prospects and other factors deemed relevant by the Board.
Credit risk is a major factor of our overall enterprise risk, and we have established policies and procedures to evaluate our exposure to credit risk, particularly with respect to our investment holdings and our receivable balances from insureds and reinsurers. We are also exposed to credit risk on losses recoverable from reinsurers and premiums receivable from insureds. Downturns in one sector or market can adversely impact other sectors and may result in higher credit exposure. We do not currently use credit default swaps to mitigate our credit exposure from either investments or counterparties.