The Excess and Surplus Lines segment offers E&S commercial lines liability and property insurance in every U.S. state and the District of Columbia through James River Insurance and its wholly-owned subsidiary, James River Casualty. James River Insurance and James River Casualty are both non-admitted carriers. Non-admitted carriers writing in the E&S market are not bound by most of the rate and form regulations imposed on standard market companies, allowing them flexibility to change the coverage terms offered and the rate charged without the time constraints and financial costs associated with the rate and form filing process. In 2016, the average account in this segment (excluding commercial auto policies) generated annual gross written premiums of approximately $18,000. The Excess and Surplus Lines segment distributes primarily through wholesale insurance brokers. Members of our management team have participated in this market for over three decades and have long-standing relationships with the wholesale agents who place E&S lines accounts. The Excess and Surplus Lines segment produced 50.3% of our gross written premiums and 56.8% of our net written premiums for the year ended December 31, 2016.
The Specialty Admitted Insurance segment focuses on niche classes within the standard insurance markets, such as workers’ compensation coverage for residential contractors, light manufacturing operations, transportation workers and healthcare workers in North Carolina, Virginia, South Carolina, and Tennessee as well as fronting and program business. In our fronting and program business, we retain a small percentage of the risk and seek to earn fee income by allowing other carriers and producers to use our licensure, ratings, and infrastructure. Through Falls Lake National Insurance Company and its subsidiaries, this segment has admitted licenses in 48 states and the District of Columbia and distributes through a variety of sources, including independent retail agents, program administrators and MGAs. The Specialty Admitted Insurance segment produced 24.7% of our gross written premiums and 10.0% of our net written premiums for the year ended December 31, 2016.
We have intercompany reinsurance agreements under which we cede 70% of the pooled net written premiums of our U.S. subsidiaries (after taking into account third-party reinsurance) to JRG Re. This business is ceded to JRG Re under a proportional, or quota-share, reinsurance treaty that provides for an arm’s length ceding commission. We exclude the effects of these agreements for the presentation of the Excess and Surplus Lines and Specialty Admitted Insurance segments included herein consistent with the manner in which we manage the business. At December 31, 2016, 67.3% of our cash and invested assets were held in Bermuda, which benefits from a favorable operating environment, including an absence of corporate income or investment taxes. We pay a 1% excise tax on premiums ceded to JRG Re by our U.S.-based insurance subsidiaries.
expectations, we generally increase our reserves for losses and loss adjustment expenses. Conversely, when claims frequency and severity trends are more favorable than initially anticipated, we generally reduce our reserves for losses and loss adjustment expenses once we have sufficient data to confirm the validity of the favorable trends.
Different reserving methods are appropriate in different situations, and our actuaries use their judgment and experience to determine the weighting of the methods detailed above to use for each accident year and each line of business and, for our Casualty Reinsurance segment, on a contract by contract basis. For example, the current accident year has very little incurred and paid loss development data on which to base reserve projections. As a result, we rely heavily on the Expected Loss Method in estimating reserves for the current accident year. We generally set our initial expected loss ratio for the current accident year consistent with our pricing assumptions. We believe that this is a reasonable and appropriate reserving assumption for the current accident year since our pricing assumptions are actuarially driven and since we expect to make an acceptable return on the new business that we write. If actual loss emergence is better than our initial expected loss ratio assumptions, we will experience favorable development, and if it is worse than our initial expected loss ratio assumptions, we will experience adverse development. Conversely, sufficient incurred and paid loss development is available for our oldest accident years, so more weight is
In applying these methods to develop an estimate of the reserve for losses and loss adjustment expenses, our internal actuaries use judgment to determine three key parameters for each accident year and line of business: the initial expected loss ratios, the incurred and paid loss development factors and the weighting of the five actuarial methods to be used for each accident year and line of business. For the Excess and Surplus Lines and Specialty Admitted Insurance segments, the actuary performs a study on each of these parameters annually in the third quarter and makes recommendations for the initial expected loss ratios, the incurred and paid loss development factors and the weighting of the five actuarial methods by accident year and line of business. Members of the Reserve Committee review and approve the parameter review actuarial recommendations, and these approved parameters are used in the reserve estimation process for the next four quarters at which time a new parameter study is performed. For the Casualty Reinsurance segment, periodic assessments are made on a contract by contract basis with the goal of keeping the initial expected loss ratios and the incurred and paid loss development factors as constant as possible until sufficient evidence presents itself to support adjustments. Method weights are generally less rigid for the Casualty Reinsurance segment given the heterogeneous nature of the various contracts, and the potential for significant changes in mix of business within individual treaties.
insurance that we write is subject to above-average variation in reserve estimates. The Excess and Surplus Lines market is subject to high policyholder turnover and changes in underlying mix of exposures. This turnover and change in underlying mix of exposures can cause actuarial estimates based on prior experience to be less reliable than estimates for more stable, admitted books of business. As a casualty insurer, losses on our policies often take a number of years to develop, making it difficult to estimate the ultimate losses associated with this business. Judicial and regulatory bodies have frequently interpreted insurance contracts in a manner that expands coverage beyond that which was contemplated at the time that the policy was issued. In addition, many of our policies are issued on an occurrence basis, and insureds suffering a loss frequently seek coverage beyond the policies’ original intent. The difficulty in pinpointing actual ultimate losses and loss adjustment expenses (“LAE”) is illustrated by the fact that at December 31, 2016, 74.3% of our net reserve for losses and loss adjustment expenses in the Excess and Surplus Lines segment is for claims that have not been reported.
favorable calendar year emergence (39.7% calendar year loss ratio compared to our expected calendar year loss ratio of 46.0%). Favorable reserve development in the Specialty Admitted Insurance segment was $3.8 million, and primarily came from accident years 2010 through 2014, as losses on our workers’ compensation business written prior to 2015 continued to develop more favorably than we had anticipated. The Specialty Admitted Insurance segment’s favorable development from accident years 2010 - 2014 was partially offset by unfavorable development for the 2015 accident year. In addition, $4.2 million of adverse development occurred in the Casualty Reinsurance segment, with the majority of this adverse development coming from two contracts from the 2012 and 2013 underwriting years that experienced higher loss development in 2016 than expected.
A $27.4 million redundancy developed in 2014 on the reserve for losses and loss adjustment expenses held at December 31, 2013. This favorable reserve development included $27.3 million of favorable development in the Excess and Surplus Lines segment. The Excess and Surplus Lines segment favorable development included $7.9 million of favorable development from the 2011 accident year, $5.0 million of favorable development from the 2009 accident year, and $4.2 million of favorable development from the 2007 accident year. This favorable development occurred because our actuarial studies at December 31, 2014 for the Excess and Surplus Lines segment indicated that our loss experience on our mature casualty business continued to be below our initial expected ultimate loss ratios driven by favorable 2014 calendar year emergence (33.1% calendar year loss ratio compared to our expected calendar year loss ratio of 42.4%). Favorable reserve development in the Specialty Admitted Insurance segment was $5.9 million and primarily came from accident years 2007 through 2012, as losses on our workers’ compensation business written prior to 2013 continued to develop more favorably than we had anticipated. In addition, $5.7 million of adverse development occurred in the Casualty Reinsurance segment, with the majority of this adverse development coming from one reinsurance contract from the 2011 underwriting year that experienced higher loss development in 2014 than expected.
At December 31, 2014, the Company held two municipal bonds issued by the Commonwealth of Puerto Rico. These bonds were backed by future sales tax revenues in Puerto Rico. Puerto Rico’s weak economic conditions and heavy debt burden, combined with the passage of new legislation that allowed public corporations to defer or reduce payments on outstanding debt, heightened the risk of default on the bonds. We concluded that the bonds, which had been downgraded to below investment grade, were other-than-temporarily impaired, and we recognized impairment losses of  $1.4 million on these bonds for the year ended December 31, 2014. We recognized an additional $660,000 impairment loss on these bonds in 2015 before selling them during the second quarter of 2015. We concluded that none of the other fixed maturity securities in an unrealized loss position at December 31, 2016, 2015 or 2014 had experienced an other-than temporary impairment. At December 31, 2016, all of our fixed maturity securities had a fair value greater than 80% of their cost or amortized cost. We concluded that our fixed maturity securities were not other-than-temporarily impaired at December 31, 2016 based in part on the fact that they had never missed a scheduled principal or interest payment, and that they were rated investment grade by a nationally recognized statistical rating organization.
We concluded that none of the equity securities in our portfolio at December 31, 2016, 2015 or 2014 had experienced an other-than-temporary impairment.
on two loans at December 31, 2015 was needed on bank loans to companies in the energy sector with oil and gas exposure. At December 31, 2016, our exposure to bank loans of oil and gas companies consisted of four loans with a carrying value of $9.8 million and a market value of $8.4 million. Management also concluded that three non-energy sector loans were impaired at December 31, 2016. The impaired loans had an allowance for credit losses of  $221,000. At December 31, 2015, one non-energy sector loan was impaired with an allowance for credit losses of  $34,000. The aggregate allowance for credit losses was $943,000 at December 31, 2016 on five impaired loans with a total carrying value of  $6.5 million and unpaid principal of  $7.6 million. At December 31, 2015, the aggregate allowance for credit losses was $4.3 million on five impaired loans.
The fair values of fixed maturity securities and equity securities have been determined using fair value prices provided by our investment manager, who utilizes internationally recognized independent pricing services. The prices provided by the independent pricing services are generally based on observable market data in active markets (e.g. broker quotes and prices observed for comparable securities). Values for U.S. Treasury and publicly-traded equity securities are generally based on Level 1 inputs which use the market approach valuation technique. The values for all other fixed maturity securities (including state and municipal securities and obligations of U.S. government corporations and agencies) generally incorporate significant Level 2 inputs, and in some cases, Level 3 inputs, using the market approach and income approach valuation techniques.
The fair values of cash and cash equivalents and short-term investments approximate their carrying values due to their short-term maturity.
In the determination of the fair value for bank loan participations and certain high yield bonds, the Company’s investment manager endeavors to obtain data from multiple external pricing sources. External pricing sources may include brokers, dealers, and price data vendors that provide a composite price based on prices from multiple dealers. Such external pricing sources typically provide valuations for normal institutional size trading units of such securities using methods based on market transactions for comparable securities, and various relationships between securities, as generally recognized by institutional dealers. For investments in which the investment manager determines that only one external pricing source is appropriate or if only one external price is available, the investment is generally recorded based on such price.
Investments for which external sources are not available or are determined by the investment manager not to be representative of fair value are recorded at fair value as determined by the investment manager. In determining the fair value of such investments, the investment manager considers one or more of the following factors: type of security held, convertibility or exchangeability of the security, redeemability of the security (including the timing of redemptions), application of industry accepted valuation models, recent trading activity, liquidity, estimates of liquidation value, purchase cost and prices received for securities with similar terms of the same issuer or similar issuers. At December 31, 2016 and 2015 there were bank loan participations with an unpaid principal balance of $2.3 million and $5.3 million, respectively, and a carrying value of  $2.0 million and $4.6 million, respectively, for which external sources were unavailable to determine fair value.
We review fair value prices provided by our outside investment managers for reasonableness by comparing the fair values provided by the managers to those provided by our investment custodian. We also review and monitor changes in unrealized gains and losses. We obtain an understanding of the methods, models, and inputs used by our investment managers and independent pricing services, and controls are in place to validate that prices provided represent fair values. Our control process includes, but is not limited to, initial and ongoing evaluation of the methodologies used, a review of specific securities and an
At December 31, 2016, we have $181.8 million of goodwill and $38.9 million of net intangible assets on our consolidated balance sheet, primarily resulting from the acquisition of James River Group in December 2007.
The goodwill reported on the December 31, 2016 balance sheet is an asset of the Excess and Surplus Lines segment only. Goodwill is tested annually for impairment in the fourth quarter of each calendar year, or more frequently if events or changes in circumstances indicate that the carrying amount of the Company’s reporting units, including goodwill, may exceed their fair values. The Company first assesses qualitative factors in determining whether it is necessary to perform the quantitative goodwill impairment test. If management determines that it is more likely than not that the fair value of a reporting unit is less than the carrying value based on qualitative factors, the Company would be required to perform the quantitative goodwill impairment test. In addition, we generally perform the quantitative analysis at least every third year, even if the qualitative factors do not indicate a need for quantitative testing. Accordingly, we performed quantitative testing in 2016, even through our qualitative analysis did not indicate that it was more likely than not that our good will was impaired. During quantitative goodwill impairment testing, the fair value of the reporting units is determined using a combination of a market approach and an income approach which projects the future cash flows produced by the reporting units and discounts those cash flows to their present value. The projection of future cash flows is necessarily dependent upon assumptions about the future levels of income as well as business trends, prospects, market, and economic conditions. The results of the two approaches are weighted to determine the fair value of each reporting unit. When the fair value is less than the carrying value of the net assets of the reporting unit, including goodwill, an impairment loss is charged to earnings. To determine the amount of any goodwill impairment, the implied fair value of reporting unit goodwill is compared to the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination is determined. That is, the fair value of a reporting unit is assigned to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination. The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. The Company’s annual testing performed in the fourth quarters of 2016, 2015 and 2014 indicated that no impairment of goodwill had occurred.
Intangible assets are initially recognized and measured at fair value. Specifically identified intangible assets with indefinite lives include trademarks and state insurance licenses and authorities. Intangible assets with indefinite useful lives are reviewed for impairment at least annually. In evaluating whether there has been impairment to the intangible asset, management determines the fair value of the intangible asset and compares the resulting fair value to the carrying value of the intangible asset. If the carrying value exceeds the fair value, the intangible asset is written down to fair value, and the impairment is reported through earnings. During the fourth quarters of 2016, 2015 and 2014, the indefinite-lived intangible assets for trademarks and insurance licenses and authorities were tested for impairment. There were no impairments recognized in 2016, 2015 or 2014. The Relief From Royalty method utilized in our evaluation of the value of our trademarks requires a number of assumptions including the projected gross written premium base against which the royalty savings rate is applied, the size of the royalty rate to be applied, the discount rate and the terminal value (if any) of the trademarks at the end of the projection period.
undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group. That assessment is based on the carrying amount of the asset or asset group at the date it is tested for recoverability. An impairment loss is measured as the amount by which the carrying amount of a long-lived asset or asset group exceeds its fair value. Intangible assets for customer and broker relationships that have specific lives and are subject to amortization were reviewed for impairment during the fourth quarters of 2016, 2015 and 2014. There were no impairments recognized in 2016, 2015 or 2014.
In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). The guidance applies to all companies that either enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards, such as insurance contracts. Under this guidance, a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under the current guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU No. 2014-09 becomes effective for the Company during the first quarter of 2018 and must be applied retrospectively. The Company is currently evaluating ASU No. 2014-09 to determine the potential impact that adopting this standard will have on reported fee income. The Company does not believe adoption will have a material impact on its consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. Among other things, this ASU will require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. This ASU is effective for interim and annual reporting periods beginning after December 15, 2017. Upon adoption, a cumulative-effect adjustment to the balance sheet will be made as of the beginning of the fiscal year of adoption. The Company has not yet completed the analysis of how adopting this ASU will affect its consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). Under current guidance for lessees, leases are only included on the balance sheet if certain criteria, classifying the agreement as a capital lease, are met. This update will require the recognition of a right-of-use asset and a corresponding lease liability, discounted to the present value, for all leases that extend beyond 12 months. This ASU is effective for annual and interim reporting periods beginning after December 15, 2018. Early adoption is permitted. Upon adoption, leases will be recognized and measured at the beginning of the earliest period presented using a modified retrospective approach. The Company is currently evaluating ASU 2016-02 to determine the potential impact that adopting this standard will have on its consolidated financial statements.
We had an underwriting profit of  $29.5 million for the year ended December 31, 2016. This compares to an underwriting profit of  $27.6 million for the prior year. On a consolidated basis, the Company recognized $23.7 million and $16.3 million of net favorable reserve development for the years ended December 31, 2016 and 2015, respectively.
$7.6 million of net realized investment gains and $4.5 million of net realized investment losses for the years ended December 31, 2016 and 2015, respectively. Net realized investment gains in 2016 include net realized gains from equity securities of  $4.8 million and net realized gains from fixed maturity securities of  $1.8 million. Net realized investment losses in 2015 were primarily from the sale of fixed maturity securities and bank loan participations. We sold fixed maturity securities and bank loan participations in 2015 to fund the $47.4 million of dividends paid to our common
We define adjusted net operating income as net income excluding certain non-operating expenses such as net realized investment gains and losses, expenses related to due diligence costs for various merger and acquisition activities, professional service fees related to the filing of registration statements for the offering of securities, severance costs associated with terminated employees, and interest expense and other income and expenses on a leased building that we are deemed to own for accounting purposes. We use adjusted net operating income as an internal performance measure in the management of our operations because we believe it gives our management and other users of our financial information useful insight into our results of operations and our underlying business performance. Adjusted net operating income should not be viewed as a substitute for net income calculated in accordance with GAAP, and our definition of adjusted net operating income may not be comparable to that of other companies.
The combined ratio is a measure of underwriting performance and represents the relationship of incurred losses, loss adjustment expenses and other operating expenses to net earned premiums. Our combined ratio for the year ended December 31, 2016 was 94.3%. A combined ratio of less than 100% indicates an underwriting profit, while a combined ratio greater than 100% reflects an underwriting loss. It included $23.7 million, or 4.6 percentage points, of net favorable reserve development on direct and assumed business underwritten by the Company on prior accident years, including $24.1 million of favorable reserve development from the Excess and Surplus Lines segment and $3.8 million of favorable reserve development from the Specialty Admitted Insurance segment partially offset by $4.2 million of adverse development from the Casualty Reinsurance segment.
Excess Casualty division (representing 11.7% of this segment’s 2016 business) which increased $5.9 million (or 19.0%) over the prior year.
For the Specialty Admitted Insurance segment, gross written premiums increased 100.3% year over year. Gross written premiums for 2016 included $142.6 million ($20.0 million on a net basis) from fronting and program business where there had been $55.0 million ($12.4 million on a net basis) of gross written premiums in 2015. We did not begin writing fronting and program business until the fourth quarter of 2013. We cede a significant portion of the specialty admitted fronting and program business to third-party reinsurers. As a result, neither our net written premiums nor level of assumed risk for this segment has increased at a rate which corresponds to the increase in our gross written premiums. In addition, workers’ compensation gross written premiums increased 10.2% for 2016 over 2015.
It is our policy to audit payroll for each expired workers’ compensation insurance policy in the Specialty Admitted Insurance segment to determine the difference between the original estimated payroll at the time the policy was written and the final actual payroll of the insured after the policy is completed. Audit premiums increased both written and earned premiums for the year ended December 31, 2016 by $3.1 million (in the prior year, audit premiums increased both written and earned premiums by $1.6 million).
For the Casualty Reinsurance segment, gross written premiums increased 6.9%, from $172.5 million for the year ended December 31, 2015 to $184.3 million for the year ended December 31, 2016. The Casualty Reinsurance segment generally writes large casualty-focused treaties that are expected to have lower
volatility relative to property and catastrophe treaties. We rarely write stand-alone property reinsurance. When treaties that include property exposure are written, it is done with relatively low catastrophe sub-limits.
Underwriting results include fee income of $10.1 million and $3.2 million for the years ended December 31, 2016 and 2015, respectively.
Combined Ratio. The combined ratio of the Excess and Surplus Lines segment for the year ended December 31, 2016 was 84.3%, comprised of a loss ratio of 62.6% and an expense ratio of 21.7%. The combined ratio of the Excess and Surplus Lines segment for the year ended December 31, 2015 was 80.2%, comprised of a loss ratio of 54.5% and an expense ratio of 25.8%.
Underwriting profit includes fee income of $4.2 million and $1.8 million for the years ended December 31, 2016 and 2015, respectively.
Combined Ratio. The combined ratio of the Specialty Admitted Insurance segment for the year ended December 31, 2016 was 94.5%, comprised of a loss ratio of 59.1% and an expense ratio of 35.4%. This compares to the combined ratio in the prior year of 97.5%, comprised of a loss ratio of 60.7% and an expense ratio of 36.7%.
Loss Ratio. The loss ratio for the year ended December 31, 2016 of 59.1% included $3.8 million, or 7.3 percentage points of net favorable development on prior accident years. The loss ratio for the year ended December 31, 2015 of 60.7% included $3.5 million, or 8.4 percentage points of net favorable development on prior accident years. The favorable development in both 2016 and 2015 reflects the fact that actual loss emergence of the workers’ compensation book for prior accident years has been better than expected.
Underwriting Profit. As a result of the items discussed above, the underwriting profit improved from $1.1 million for the year ended December 31, 2015 to $2.9 million for the year ended December 31, 2016.
Underwriting Results. As a result of the items discussed above, the underwriting loss for the Casualty Reinsurance segment for the year ended December 31, 2016 was $194,000 compared to an underwriting loss of $2.6 million for the year ended December 31, 2015.
The $7.8 million increase in net investment income year-over-year was largely driven by the performance of the Company’s private investments. Strong performance by our other private investments, most notably a limited partnership that invests in equity tranches of collateralized loan obligations (CLOs), more than offset a decline in income from the renewable energy investments. The limited partnership, with a carrying value of  $17.5 million at December 31, 2016, reported income of  $4.6 million in 2016 compared to a loss of  $958,000 in 2015. Excluding the private investments, our net investment income increased by $4.2 million over the prior year due to a 6.8% increase in our cash and invested assets from $1,350.7 million at December 31, 2015 to $1,442.1 million at December 31, 2016 and an increase in investment yield.
partnerships that invest in concentrated portfolios of publicly-traded small cap equities, loans of middle market private equity sponsored companies, and equity tranches of collateralized loan obligations (CLOs). Income from these partnerships was $5.3 million in 2016 compared to losses of  $1.5 million in 2015. Together, these limited partnerships had a carrying value of  $23.9 million at December 31, 2016. Income from the Company’s investments in renewable energy LLCs and limited partnerships is recognized under the equity method of accounting. The Company also holds $4.5 million of subordinated notes issued by a bank holding company affiliated with the Chairman and Chief Executive Officer of the Company. Interest income from the notes was $343,000 for the years ended December 31, 2016 and 2015.
For the year ended December 31, 2016, we recognized net realized investment gains of $7.6 million. These realized investment gains included $1.8 million and $4.8 million, respectively, of net realized investment gains recognized on the sale of fixed maturity and equity securities. In addition, the Company recognized $579,000 of net realized gains on sales of bank loan participations and $415,000 of net realized gains related to changes in the allowance for credit losses on bank loan participations.
In conjunction with its outside investment managers, the Company performs quarterly reviews of all securities within its investment portfolio to determine whether any impairment has occurred. The Company previously held two municipal bonds issued by the Commonwealth of Puerto Rico. Puerto Rico’s weak economic conditions and heavy debt burden heightened the risk of default on the bonds and management concluded that the bonds, which had been downgraded to below investment grade, were other-than-temporarily impaired. The Company recognized impairment losses of  $660,000 on these bonds for the year ended December 31, 2015. The bonds were sold during the second quarter of 2015 and a net realized gain of $22,000 was recognized on the sales.
At December 31, 2015, the Company held participations in two loans issued by companies that produce and supply power to Puerto Rico through power purchase agreements with PREPA, a public corporation and governmental agency of the Commonwealth of Puerto Rico. PREPA’s credit strength and ability to make timely payments was impacted by the economic conditions in Puerto Rico, thus raising doubt about the companies’ ability to meet the debt obligations held by the Company. At December 31, 2015, the allowance for credit losses on these loans was $414,000. The loans had a carrying value of $3.9 million at December 31, 2015 and unpaid principal of  $4.6 million. In June 2016, one of the loans was repaid in full at its scheduled maturity. Management concluded that the remaining loan, scheduled to mature in 2017, remained impaired at December 31, 2016. The allowance for credit losses on the loan was $177,000 at December 31, 2016. The loan had a carrying value of  $1.7 million and unpaid principal of  $2.0 million at December 31, 2016.
At December 31, 2016, our available-for-sale investment portfolio of fixed maturity and equity securities had net unrealized gains of  $2.7 million representing 0.3% of the cost or amortized cost of the portfolio. Additionally, at December 31, 2016, 99.0% of our fixed maturity security portfolio was rated “BBB-” or better (“investment grade”) by Standard & Poor’s or had an equivalent rating from another nationally recognized statistical rating organization. Fixed maturity securities with ratings below investment grade by Standard & Poor’s or another nationally recognized statistical rating organization at December 31, 2016 had an aggregate fair value of  $9.2 million and an aggregate net unrealized loss of  $979,000. The average duration of our investment portfolio was 3.6 years at December 31, 2016.
The following table sets forth the composition of the Company’s portfolio of fixed maturity securities (both available-for-sale and trading) by rating as of December 31, 2016:
At December 31, 2016, our portfolio of available-for-sale fixed maturity securities contained corporate fixed maturity securities with a fair value of  $378.4 million. A summary of these securities by industry segment is shown below as of December 31, 2016:
Our effective tax rate fluctuates from period to period based on the relative mix of income reported by country and the respective tax rates imposed by each tax jurisdiction. For U.S.-sourced income, our U.S. federal income tax expense differs from the amounts computed by applying the federal statutory income tax rate to income before taxes due primarily to interest income on tax-advantaged state and municipal securities (state and municipal securities represented 10.4% and 10.6% of our available-for-sale securities at December 31, 2016 and 2015, respectively), dividends received income, and tax credits on certain renewable energy investments. For the years ended December 31, 2016 and 2015, our effective tax rate was 6.1% and 10.5%, respectively. Income taxes for 2015 included $2.5 million of U.S. withholding taxes on an intercompany dividend paid from the U.S. holding company to our U.K. intermediate holding company resulting in a higher effective tax rate in 2015 compared to 2016.
Underwriting profit includes fee income of  $4.5 million and $1.8 million for the year ended December 31, 2015 and 2014, respectively.
We had an underwriting profit of $27.6 million for the year ended December 31, 2015. This compares to an underwriting profit of  $26.7 million for the prior year. On a consolidated basis, the Company recognized $16.3 million of net favorable reserve development for the year ended December 31, 2015 and $27.4 million of favorable reserve development for the year ended December 31, 2014.
The results of operations include $4.5 million of net realized investment losses for the year ended December 31, 2015 and $1.3 million of net realized investment losses for the year ended December 31, 2014. Net realized investment losses in 2015 were primarily from the sale of fixed maturity securities and bank loan participations. We sold fixed maturity securities and bank loan participations in 2015 to fund the $47.4 million of dividends paid to our common shareholders in 2015. Also included in net realized investment losses in 2015 are $3.9 million of impairment losses on two bank loans to oil and gas companies in the energy sector whose market values had declined
Other expenses for the year ended December 31, 2014 included $14.9 million of expenses associated with our initial public offering, including $2.8 million of legal fees, $2.0 million of audit and filing related fees, and $10.2 million associated with the conversion of awards under a previous equity incentive plan.
Our combined ratio for the year ended December 31, 2014 was 93.3%. The combined ratio for the year ended December 31, 2014 included $27.4 million, or 6.9 percentage points, of net favorable reserve development on direct and assumed business underwritten by the Company on prior accident years, including $27.3 million of favorable reserve development from the Excess and Surplus Lines segment and
$5.9 million of favorable reserve development from the Specialty Admitted Insurance segment offset by $5.7 million of adverse development from the Casualty Reinsurance segment.
Our expense ratio was 33.5% and 33.4% for the years ended December 31, 2015 and 2014, respectively. The expense ratio for 2015 reflects the 16.4% increase in our net earned premiums compared to the prior year without a proportional increase in other operating expenses, offset by the additional costs of being a publicly-traded company for a full year in 2015.
For the Excess and Surplus Lines segment, gross written premiums for the year ended December 31, 2015 increased 22.2% over the prior year. The average annual gross written premiums per policy decreased 21.8% over the prior year. However, policy submissions for new business were 3.1% higher for the year ended December 31, 2015 than the year ended December 31, 2014. The gross written premiums increase was most notable in the following divisions within the Excess and Surplus Lines segment:
General Casualty division (representing 33.9% of this segment’s 2015 business) which increased $44.1 million (or 73.0%) over the prior year. Our commercial auto business was a component of this increase. Gross written premiums from our commercial auto business were $67.2 million for 2015 and $34.5 million in 2014.
For the Specialty Admitted Insurance segment, during the year ended December 31, 2015, gross written premiums increased 53.2% compared to the prior year. Gross written premiums for 2015 included $55.0 million ($12.4 million on a net basis) from fronting and program business where there had been $29.3 million ($9.0 million on a net basis) of gross written premiums in 2014. We did not begin writing fronting and program business until the fourth quarter of 2013. We cede a significant portion of the specialty admitted fronting and program business to third-party reinsurers. As a result, neither our net written premiums nor level of assumed risk for this segment has increased at a rate which corresponds to the increase in our gross written premiums. Workers’ compensation gross written premiums also increased 19.4% for 2015 over 2014.
For the Casualty Reinsurance segment, gross written premiums decreased 16.5%, from $206.7 million for the year ended December 31, 2014 to $172.5 million for the year ended December 31, 2015. The decrease in written premiums in 2015 from 2014 is primarily attributable to the very competitive environment for reinsurance. Despite the decrease in gross written and net written premiums for 2015, our net earned premiums (which tend to smooth out quarter-to-quarter variances) had a 3.6% increase over the prior year.
Underwriting profit includes fee income of  $1.3 million and $873,000 for the years ended December 31, 2015 and 2014, respectively.
Combined Ratio. The combined ratio of the Specialty Admitted Insurance segment for the year ended December 31, 2015 was 97.5%, comprised of a loss ratio of 60.7% and an expense ratio of 36.7%. This compares to the combined ratio in the prior year of 99.9%, comprised of a loss ratio of 53.4% and an expense ratio of 46.5%.
For the years ended December 31, 2015 and 2014, the total operating expenses of the Corporate and Other segment were $18.6 million and $9.1 million, respectively. The variance from the prior year principally relates to share-based compensation related expenses.
Net investment income was $44.8 million for the year ended December 31, 2015 compared to $43.0 million in the prior year. The increase in net investment income was primarily attributable to growth in our cash and invested assets. Cash and invested assets increased $40.1 million or 3.1% in 2015 (from $1,310.6 million at December 31, 2014 to $1,350.7 million at December 31, 2015) due to our profitability, a 4.7% increase in net written premiums, and our positive cash flows from operations. Dividend payments of  $70.0 million on September 30, 2014 and $47.4 million in 2015 reduced our investable assets. Additionally, net investment income was affected by an increase in the approximate duration of our portfolio (from 3.1 years at December 31, 2014 to 3.5 years at December 31, 2015) and declining portfolio yields, which partially offset some of the increase associated with the higher asset base.
Of our total cash and invested assets of   $1,350.7 million at December 31, 2015, $106.4 million represents the cash and cash equivalents portion of the portfolio. The majority of the portfolio, or $973.8 million, is comprised of fixed maturity and equity securities that are classified as available-for-sale and carried at fair value with unrealized gains and losses on these securities reported, net of applicable taxes, as a separate component of accumulated comprehensive income or loss. Also included in our investments are $191.7 million of bank loan participations, $54.5 million of other invested assets, $19.3 million of short-term investments, and $5.0 million of fixed maturity securities classified as trading and held at the U.S. holding company. Our trading portfolio is carried at fair value with changes to the value reported as net investment income in our consolidated income statement.
Market values of energy sector holdings were negatively impacted in 2015 by declining oil and gas prices. Net realized investment losses of  $4.5 million for the year ended December 31, 2015 were principally related to impairments of two energy loans totaling $3.9 million and $3.6 million of net realized losses on sales of bank loans, mostly in the energy sector. Sales of fixed maturities and equities, a portion of which were used to fund the special dividend in the fourth quarter, generated net realized gains of  $2.0 million and $1.0 million, respectively, offsetting some of the energy sector losses. For the year ended December 31, 2014, we recognized net realized investment losses of  $1.3 million. The realized losses included $2.0 million in impairment losses related to our investment exposure to entities located in the Commonwealth of Puerto Rico.
rating organization. Fixed maturity securities with ratings below investment grade by Standard & Poor’s or another nationally recognized statistical rating organization at December 31, 2015 had an aggregate fair value of  $9.4 million and an aggregate net unrealized loss of  $5.2 million.
In addition to the $973.8 million of available-for-sale securities, the Company holds $191.7 million of bank loan participations, $5.0 million of fixed maturity securities classified as trading (which are held at our U.S. holding company), $19.3 million of short-term investments, and other invested assets of  $54.5 million for a total invested asset balance at December 31, 2015 of  $1,244.3 million.
The payment of dividends by our subsidiaries to us is limited by statute. In general, the laws and regulations applicable to our domestic insurance subsidiaries limit the aggregate amount of dividends or other distributions that they may declare or pay within any 12-month period without advance regulatory approval. Generally, the limitations are based on the greater of statutory net income for the preceding year or 10.0% of statutory surplus at the end of the preceding year. In addition, insurance regulators have broad powers to prevent reduction of statutory surplus to inadequate levels and could refuse to permit the payment of dividends calculated under any applicable formula. See Item 1 - “U.S. Insurance Regulation - State Regulation” for additional information. Pursuant to Bermuda regulations, the maximum amount of dividend and return of capital available to be paid by a reinsurer is determined pursuant to a formula. See Item 1 “Regulation - Bermuda Insurance Regulation - Restrictions on Dividends and Distributions” for additional information. Under this formula, the maximum amount of dividends and return on capital available to us from JRG Re in 2017 is calculated to be approximately $89.5 million. However, this dividend amount is subject to annual enhanced solvency requirement calculations. Additionally, the maximum amount of dividends available to the U.S. holding company from our U.S. insurance subsidiaries during 2017 without regulatory approval is $18.5 million.
The senior revolving credit facility contains certain financial and other covenants (including risk-based capital, minimum shareholders’ equity levels, maximum ratios of total debt outstanding to total capitalization and minimum fixed charge coverage ratios) with which the Company was in compliance at December 31, 2016.
In May 2004, we issued $15.0 million of senior debt due April 29, 2034, with net proceeds to us of $14.5 million. The senior debt is not redeemable by the holder or subject to sinking fund requirements. Interest accrues quarterly and is payable in arrears at a floating rate per annum equal to the 3-month LIBOR plus 3.85%. This senior debt is currently redeemable at par prior to its stated maturity at our option in whole or in part. The terms of this senior debt contain certain covenants, with which we are in compliance and which, among other things, restrict our ability to assume senior indebtedness secured by our U.S. holding company’s common stock or its subsidiaries’ capital stock or to issue shares of its subsidiaries’ capital stock.
The following table summarizes the nature and terms of the junior subordinated debt and trust preferred securities outstanding at December 31, 2016 (including the Company’s repurchase of a portion of these Trust Preferred Securities):
At December 31, 2016 and December 31, 2015, the ratio of total debt and trust preferreds securities outstanding to total capitalization (defined as total debt and trust preferreds securities plus total shareholders’ equity) was 21.7% and 22.0%, respectively. Having debt as part of our capital structure allows us to generate a higher return on equity and greater book value per share results than we could by using equity capital alone.
Our insurance segments enter into reinsurance contracts to limit our exposure to potential losses arising from large risks, to protect against the aggregation of several risks in a common loss occurrence, and to provide additional capacity for growth. Our reinsurance is contracted under excess of loss and quota share reinsurance contracts. In excess of loss reinsurance, the reinsurer agrees to assume all or a portion of the ceding company’s losses in excess of a specified amount. The premiums payable to the reinsurer are negotiated by the parties based on their assessment of the amount of risk being ceded to the reinsurer because the reinsurer does not share proportionately in the ceding company’s losses. In quota share reinsurance, the reinsurer agrees to assume a specified percentage of the ceding company’s losses arising out of a defined class of business in exchange for a corresponding percentage of premiums. For the years ended December 31, 2016, 2015, and 2014 our net premium retention was 75.6%, 82.3% and 86.8%, respectively.
Up to $1.0 million per occurrence, subject to a $1.0 million aggregate deductible.
In our Excess and Surplus Lines segment, we write a small book of excess property insurance, but we do not write primary property insurance. In our Excess and Surplus Lines segment, we have a surplus share reinsurance treaty in effect that was specifically designed to cover property risks. The surplus share treaty along with facultative reinsurance helps ensure that our net retained limit per risk will be $5.0 million or below.
We use catastrophe modeling software to analyze the risk of severe losses from hurricanes and earthquakes on our exposure. We utilize the model in our risk selection, pricing, and to manage our overall portfolio probable maximum loss (“PML”) accumulations. A PML is an estimate of the amount we would expect to pay in any one catastrophe event within a given annual probability of occurrence (i.e. a return period or loss exceedance probability). Based upon our modeling, a $45.0 million gross catastrophe loss would exceed our 1,000 year PML. In the event of a $45.0 million gross property catastrophe loss to the Company, we estimate our pre-tax cost at approximately $7.9 million, including reinstatement premiums and net retentions. In addition to this retention, we would retain any losses in excess of our reinsurance coverage limits.
Our Specialty Admitted Insurance segment purchases reinsurance for at least 50% of the exposed limits on specialty admitted property-casualty business. The segment enters into reinsurance contracts for the individual risk workers’ compensation business and fronting and program business. While the segment focuses on casualty business, incidental property risk is incurred in the fronting and program business. The segment is covered for $4.0 million in excess of  $1.0 million per occurrence to manage exposure to an approximate 1,000 year PML. The following is a summary of our Specialty Admitted Insurance segment’s ceded reinsurance in place as of December 31, 2016:
Quota share coverage for 50% of the first $600,000 per occurrence and excess of loss coverage for $29.4 million in excess of $600,000.(1)
In the aggregate, we believe our pre-tax group-wide PML from a 1,000 year catastrophe event would not exceed $10.0 million, inclusive of reinstatement premiums payable.
We also have a clash and contingency reinsurance treaty to cover both the Excess and Surplus Lines and Specialty Admitted Insurance segments in the event of a claims incident involving more than one of our insureds. The treaty covers $6.0 million in excess of a $2.5 million retention for loss occurrences within the treaty term. This coverage has two reinstatements in the event we exhaust any of the coverage.
These reinsurers are unrated or below A-. All material reinsurance recoverable amounts from these reinsurers are collateralized.
Cash and cash equivalents comprised 5.6% of total cash and invested assets at December 31, 2014. Net cash used in financing activities in 2014 is a result of the $70.0 million dividend to shareholders in 2014. A portion of this dividend was funded by additional borrowings on our unsecured revolving credit facility of   $20.0 million. In addition, we drew down an additional $10.0 million on our unsecured revolving credit facility in December 2014 to provide additional operating flexibility at the Bermuda holding company.
For the years ended December 31, 2016, 2015 and 2014, the Company recognized $5.5 million, $3.7 million, and $589,000, respectively, of share-based compensation expense. The amount of unrecognized share-based compensation expense to be recognized over the remaining weighted-average service period of 1.7 years at December 31, 2016 is $6.9 million.
options with a weighted average exercise price of  $27.68 per share, 9,810 options with a weighted average exercise price of  $21.00 per share; and 55,000 options with a weighted average exercise price of  $15.65 lapsed or were forfeited during 2016, 2015, and 2014, respectively. The Company also granted 340,474 restricted stock units (“RSUs”) in December 2014 and 60,291 RSUs in February 2016. The RSUs vest over one to five years.
The amounts in the above table represent our gross estimates of known liabilities as of December 31, 2016 and do not include any allowance for claims for future events within the time period specified. Accordingly, it is highly likely that the total amounts paid out in the time periods shown will be greater than those indicated in the table.
Interest on debt obligations was calculated using the LIBOR rate as of December 31, 2016 with the assumption that interest rates would remain flat over the remainder of the period that the debt was outstanding.
evaluating our performance because our objective is to consistently earn underwriting profits. We evaluate the performance of our segments and allocate resources based primarily on underwriting profit (loss). Our definition of underwriting profit (loss) may not be comparable to that of other companies.
Our income before taxes and net income for the years ended December 31, 2016, 2015 and 2014 reconcile to our adjusted net operating income as follows: