The following is a discussion and analysis of our results of operations for the years ended December 31, 2018, 2017 and 2016 and our financial condition at December 31, 2018 and 2017. This should be read in conjunction with Item 8 'Consolidated Financial Statements and the accompanying notes' of this report. Tabular dollars are in thousands, except per share amounts. Amounts in tables may not reconcile due to rounding differences.
Results by Segment: Years ended December 31, 2018, 2017 and 2016
Estimated pre-tax catastrophe and weather-related losses, net of reinstatement premiums, of $430 million (insurance: $204 million and reinsurance: $226 million), or 9.0 points on current accident year loss ratio related to the California Wildfires, Hurricanes Michael and Florence, Typhoon Jebi as well as U.S. and European weather-related events
Total cash and investments of $15.0 billion; fixed maturities, cash and short-term securities comprise 89% of total cash and investments and have an average credit rating of AA-
Total debt of $1.3 billion and a debt to total capital ratio of 21.1%
Common shareholders’ equity of $4.3 billion; diluted book value per common share of $49.93
Operating income (loss) and operating income (loss) per diluted common share are non-GAAP financial measures as defined in Item 10(e) of SEC Regulation S-K. The reconciliations of non-GAAP measures to the most comparable GAAP financial measures (net income (loss) available (attributable) to common shareholders and earnings per diluted common share, respectively) are provided in 'Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Summary - Results of Operations'.
Consolidated underwriting income (loss) is a non-GAAP financial measure as defined in Item 10(e) of SEC Regulation S-K. The reconciliation to net income (loss) before income taxes and interest in income (loss) of equity method investments, the most comparable GAAP measure, is presented in the 'Management's Discussion and Analysis of Financial Condition - Executive Summary - Results of Operations.'
increasing our relevance in a select number of attractive specialty insurance and global reinsurance markets and continuing the implementation of a more focused distribution strategy;
continuing to grow a leadership position in business lines with strong growth potential including U.S. excess and surplus lines, and North America professional lines;
increasing our presence at Lloyd's of London ("Lloyd's") achieved through our acquisition of Novae Group plc ("Novae") in 2017 which provides us with access to Lloyd's worldwide licenses and an extensive distribution network;
launching a new phase of our transformation efforts, an enterprise-wide program to enhance all of our functions and position us to lead in a transforming industry;
In January 2019, we obtained protection for our insurance and reinsurance segments through a reinsurance agreement with Alturas. In connection with the reinsurance agreement, Alturas issued notes on December 19, 2018 to unrelated investors in an amount equal to the full $130 million of coverage provided under the reinsurance agreement covering a one year period. At the time of the agreement, we concluded that we do not have a variable interest in Alturas as the variability in results is expected to be absorbed entirely by the investors in Alturas. Accordingly, the results of Alturas are not included in our consolidated financial statements.
Underwriting-related general and administrative expenses include those general and administrative expenses that are incremental and/or directly attributable to our individual underwriting operations. While this measure is presented in Item 8, Note 4 to the Consolidated Financial Statements 'Segment Information', it is considered a non-GAAP financial measure when presented elsewhere on a consolidated basis.
Corporate expenses include holding company costs necessary to support our worldwide insurance and reinsurance operations and costs associated with operating as a publicly-traded company. As these costs are not incremental and/or directly attributable to our individual underwriting operations, these expenses are excluded from underwriting-related general and administrative expenses and, therefore, consolidated underwriting income (loss). General and administrative expenses, the most comparable GAAP financial measure to underwriting-related general and administrative expenses, also includes corporate expenses.
Interest expense and financing costs primarily relate to interest payable on our senior notes and notes payable. As these expenses are not incremental and/or directly attributable to our individual underwriting operations, these expenses are excluded from underwriting-related general and administrative expenses, and therefore, consolidated underwriting income (loss).
Bargain purchase gain, recognized upon the acquisition of Compagnie Belge d'Assurances Aviation NV/SA ("Aviabel"), reflects the excess of the fair value of the net identifiable assets acquired over the fair value of consideration transferred and is not indicative of future revenues of the Company, therefore, this revenue is excluded from consolidated underwriting income (loss).
Transaction and reorganization expenses are primarily driven by business decisions, the nature and timing of which are not related to the underwriting process, therefore, these expenses are excluded from consolidated underwriting income (loss).
The revaluation of net deferred tax asset ("DTA") represents a tax expense recognized in the fourth quarter of 2017 related to the revaluation of our net DTA, due to the reduction in the U.S. corporate income tax rate from 35% to 21% enacted as part of the Tax Cuts and Jobs Act of 2017 ("U.S. Tax Reform"). The nature and timing of the tax expense associated with the U.S. Tax Reform is not related to the underwriting process, therefore, this expense is excluded from consolidated underwriting income (loss).
Loss on repurchase of preferred shares arose from capital transactions that are not reflective of underlying business performance, therefore, this expense is excluded from consolidated underwriting income (loss).
We believe that presentation of underwriting-related general and administrative expenses and consolidated underwriting income (loss) provides investors with an enhanced understanding of our results of operations, by highlighting the underlying pre-tax profitability of our underwriting activities. The reconciliation of consolidated underwriting income (loss) to income (loss) before income taxes and interest in income (loss) of equity method investments, the most comparable GAAP financial measure, is presented in the 'Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Summary - Results of Operations'.
Foreign exchange losses (gains) in our consolidated statements of operations primarily relate to the impact of foreign exchange rate movements on net insurance related-liabilities. However, this movement is only one element of the overall impact of foreign exchange rate fluctuations on our financial position. In addition, we recognize unrealized foreign exchange losses (gains) on our available-for-sale investments in other comprehensive income (loss) and foreign exchange losses (gains) realized upon the sale of these investments in net investments gains (losses). These unrealized and realized foreign exchange gains (losses) generally offset a large portion of the foreign exchange losses (gains) reported separately in net income (loss) available (attributable) to common shareholders, thereby minimizing the impact of foreign exchange rate movements on total shareholders’ equity. As such, foreign exchange losses (gains) in our Statements of Operations in isolation are not a fair representation of the performance of our business.
The revaluation of net deferred tax asset represents a tax expense recognized in the fourth quarter of 2017 related to the revaluation of our net DTA, due to the reduction in the U.S. corporate income tax rate from 35% to 21% enacted as part of the Tax Cuts and Jobs Act of 2017 ("U.S. Tax Reform"). The nature and timing of the tax expense associated with the U.S. Tax Reform is not related to the underwriting process, therefore, this expense is excluded from operating income (loss).
Bargain purchase gain, recognized upon the acquisition of Compagnie Belge d'Assurances Aviation NV/SA ("Aviabel"), reflects the excess of the fair value of the net identifiable assets acquired over the fair value of consideration transferred and is not indicative of future revenues of the Company, therefore, this revenue is excluded from operating income (loss).
Loss on repurchase of preferred shares arose from capital transactions that are not reflective of underlying business performance and therefore, is excluded from operating income (loss).
Certain users of our financial statements evaluate performance exclusive of after-tax net investment gains (losses), foreign exchange losses (gains), transaction and reorganization expenses, revaluation of net deferred tax asset, bargain purchase gain and loss on repurchase of preferred shares to understand the profitability of recurring sources of income.
We believe that showing net income (loss) available (attributable) to common shareholders exclusive of after-tax net investment gains (losses), foreign exchange losses (gains), transaction and reorganization expenses, bargain purchase gain, revaluation of net deferred tax asset and loss on repurchase of preferred shares reflects the underlying fundamentals of our business. In addition, we believe that this presentation enables investors and other users of our financial information to analyze performance in a manner similar to how our management analyzes the underlying business performance. We also believe this measure follows industry practice and, therefore, facilitates comparison of our performance with our peer group. We believe that equity analysts and certain rating agencies that follow us, and the insurance industry as a whole, generally exclude these items from their analyses for the same reasons. The reconciliation of operating income (loss) to net income (loss) available (attributable) to common shareholders, the most comparable GAAP measure, is presented in the 'Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Summary - Results of Operations'.
We present gross premiums written, net premiums written and net premiums earned on a constant currency basis in this MD&A. The amounts presented on a constant currency basis are calculated by applying the average foreign exchange rate from the current year to the prior year amounts. We believe this presentation enables investors and other users of our financial information to analyze growth in gross premiums written, net premiums written and net premiums earned on a constant basis. The reconciliation to gross premiums written, net premiums written and net premiums earned on a GAAP basis is presented in the 'Management’s Discussion and Analysis of Financial Condition and Results of Operations - Underwriting Results - Consolidated'.
Underwriting-related general and administrative expenses is a non-GAAP measure as defined in Item 10(e) of SEC Regulation S-K. The reconciliation to total general and administrative expenses, the most comparable GAAP measure, also included corporate expenses of $108,221, $129,945 and $120,016 for the years ended December 31, 2018, 2017 and 2016, respectively. Refer to 'Management’s Discussion and Analysis of Financial Condition and Results of Operations - Other (Expenses) Revenues, Net' for additional information related to the corporate expenses. Refer to 'Management’s Discussion and Analysis of Financial Condition and Results of Operations - Non-GAAP Financial Measures' for additional information.
Operating income (loss) is a non-GAAP financial measure as defined in Item 10(e) of SEC Regulation S-K. The reconciliations to the most comparable GAAP financial measures (net income (loss) available (attributable) to common shareholders) is provided in the table above, and a discussion of the rationale for the presentation of this item is included in 'Management’s Discussion and Analysis of Financial Condition and Results of Operations - Non-GAAP Financial Measures'.
We also present operating income per diluted common share and operating return on average common equity ("operating ROACE"), which are derived from the operating income measure and can be reconciled to the most comparable GAAP financial measures as follows:
Return on average common equity ("ROACE") is calculated by dividing net income (loss) available (attributable) to common shareholders for the year by the average common shareholders' equity determined by using the common shareholders' equity balances at the beginning and end of the year.
Operating ROACE, a non-GAAP measure as defined in Item 10(e) of SEC Regulation S-K, is calculated by dividing operating income (loss) for the year by the average common shareholders' equity. The reconciliation to ROACE, the most comparable GAAP measure, is presented in the table above. Refer to 'Management’s Discussion and Analysis of Financial Condition and Results of Operations - Non-GAAP Financial Measures' for additional information.
2018 versus 2017: Total underwriting income increased by $537 million in 2018, compared to 2017, primarily driven by a decrease in catastrophe and weather-related losses and a decrease in the current accident year loss ratio excluding catastrophe and weather-related losses.
Our insurance segment underwriting income increased by $319 million in 2018, compared to 2017. The increase in underwriting income was primarily driven by a decrease in catastrophe and weather-related losses, a decrease in the current accident year loss ratio excluding catastrophe and weather-related losses, an increase in net favorable prior year reserve development and a decrease in the general and administrative expense ratio, partially offset by an increase in the acquisition cost ratio.
Our insurance segment underwriting income decreased by $264 million in 2017, compared to 2016. The decrease in underwriting income was primarily driven by an increase in catastrophe and weather-related losses, an increase in acquisition costs and an increase in the current accident year loss ratio excluding catastrophe and weather-related losses.
In addition, net investment income increased by $43 million in 2018 compared to 2017, attributable to contributions from fixed income, due to an increase in yields as well as the larger investment base associated with the acquisitions of Novae and Aviabel. Comparatively, net investment income increased by $13 million in 2017 compared to 2016, attributable to contributions from fixed income following the acquisitions of Novae and Aviabel.
Interest expense and financing costs increased to $67 million in 2018 from $55 million in 2017. The increase was primarily attributable to costs associated with the 4.0% Senior Notes issued in the fourth quarter of 2017. Interest expense and financing costs increased by $4 million in 2017 compared to 2016, primarily attributable to costs associated with Dekania Notes issued by Novae in 2004.
The financial results for 2018 resulted in a tax benefit of $29 million primarily attributable to the geographic distribution of pre-tax losses with the benefit being driven by losses in our U.K. and European operations, partially offset by income in our U.S. operations.
On October 2, 2017, we acquired Novae, a diversified property and casualty (re)insurance business which operates through Syndicate 2007 at Lloyd’s. The acquisition of Novae was undertaken to accelerate the growth strategy of our international insurance business, and to significantly scale up its capabilities to enable us to even better serve our clients and brokers. At the acquisition date, we identified VOBA, which represents the present value of the expected underwriting profit within policies that were in-force at the closing date of the transaction, of $257 million.
Interest in income (loss) of equity method investments represents our share of income (loss) related to investments where we have significant influence over the operating and financial policies of the investee.
Interest in loss of equity method investments of $2 million in 2016 represented our share of losses of an investee.
Book value per diluted common share represents total common shareholders’ equity divided by the number of common shares and diluted common share outstanding, determined using the treasury stock method. Cash settled awards are excluded.
Our objective is to generate superior returns on capital that appropriately reward our common shareholders for the risks we assume and to grow revenue only when we expect the returns will meet or exceed our requirements. We recognize that the nature of underwriting cycles and the frequency or severity of large loss events in any one year may challenge the ability to achieve a profitability target in any specific period, therefore our goal is to achieve top-quintile industry operating ROACE and growth in book value per diluted common share adjusted for dividends, with volatility consistent with the industry average across underwriting cycles.
ROACE reflects the impact of net income (loss) available (attributable) to common shareholders including net investment gains (losses), foreign exchange losses (gains), transaction and reorganization expenses, revaluation of net deferred tax assets, bargain purchase gain and loss on repurchase of preferred shares.
ROACE increased in 2018, compared to 2017, primarily driven by the underwriting income generated and foreign exchange gains in 2018 compared to the underwriting loss generated and foreign exchange losses in 2017. An increase in net investment income and a decrease in corporate expenses, also contributed to the increase in ROACE. These benefits were partially offset by an increase in amortization of VOBA and intangible assets associated with the acquisition of Novae, net investment losses, as well as transaction and reorganization expenses. In addition, ROACE in 2018 was impacted by a decrease in average common equity due to net unrealized investment losses reported in other comprehensive income and common share dividends declared.
ROACE decreased in 2017, compared to 2016, which was primarily driven by the underwriting loss generated and foreign exchange losses in 2017 compared to underwriting income generated and foreign exchange gains in 2016. Transaction and reorganization expenses, together with amortization of VOBA and intangible assets associated with the acquisition of Novae incurred in 2017, also contributed to the decrease in ROACE. In addition, ROACE in 2017 was negatively impacted by a tax charge associated with the revaluation of net deferred tax assets. These expenses were partially offset by an increase in net investment income and net realized investment gains together with the benefit of the bargain purchase gain.
The increase in operating ROACE in 2018, compared to 2017, was primarily driven by the underwriting income generated in 2018, an increase in net investment income, an increase in the tax benefit, as well as a decrease in corporate expenses, partially offset by an increase in the amortization expenses associated with the acquisition of Novae.
The decrease in operating ROACE in 2017, compared to 2016, was primarily driven by the underwriting loss generated in 2017, as well as the amortization expenses associated with the acquisition of Novae partially offset by an increase in net investment income and a tax benefit in 2017 compared to a tax expense in 2016.
Ex-PGAAP operating ROACE excludes the impact of amortization of VOBA and intangible assets, net of tax and amortization of acquisition costs, net of tax both associated with Novae's balance sheet at October 2, 2017. Ex-PGAAP operating ROACE for the years ending 2018 and 2017 was 4.7% and (5.1)%, respectively.
In 2017, our book value per diluted common share decreased by 8%, driven by net loss attributable to common shareholders of $416 million and common dividends declared, partially offset by net unrealized investment gains. The net unrealized investment gains in 2017 reflected a tightening of credit spreads and the weakening of the U.S. dollar against the euro and pound sterling which positively impacted the market values of non-U.S. government and corporate debt securities.
We believe in returning excess capital to our shareholders by way of dividends as well as share repurchases. Accordingly, our dividend policy is an integral part of the value we create for our shareholders. Our cumulatively strong earnings have permitted our Board of Directors to approve fifteen successive annual increases in quarterly common share dividends.
Taken together, we believe that growth in book value per diluted common share and common share dividends declared represent the total value created for our common shareholders. As companies in the insurance industry have differing dividend payout policies, we believe that investors use the book value per diluted common share adjusted for dividends metric to measure comparable performance across the industry.
Book value per diluted common share adjusted for dividends decreased in 2018, due to net unrealized investment losses reported in other comprehensive income.
In 2017, the decrease in book value per diluted common share adjusted for dividends was due to the net loss attributable to common shareholders, partially offset by net unrealized investment gains included in other comprehensive income.
2018 versus 2017: Gross premiums written in 2018 increased by $1,354 million or 24% compared to 2017 due to increases in our insurance and reinsurance segments.
The increase in our insurance segment's gross premiums written of $983 million or 35% included $923 million attributable to property, marine, professional lines, and credit and political risk lines associated with our acquisition of Novae. In addition, gross premiums written increased by $60 million or 2% ($45 million or 2% on a constant currency basis) primarily attributable to professional lines and liability lines, partially offset by a decrease in property, marine, and accident and health lines.
The increase in our reinsurance segment's gross premiums written of $371 million or 14% included $100 million attributable to catastrophe, and marine and aviation lines associated with our acquisition of Novae. In addition, gross premiums written increased by $271 million or 10% ($192 million or 7% on a constant currency basis(1)) primarily attributable to credit and surety, motor, accident and health, and catastrophe lines.
The increase in our reinsurance segment's gross premiums written of $204 million or 8% was attributable to catastrophe, agriculture, property and motor lines, partially offset by a decrease in credit and surety lines. The increase in gross premiums written was driven by new business, favorable premium adjustments and reinstatement premium, partially offset by the impact of foreign exchange movements and a lower level of premiums written on a multi-year basis in 2017, compared to 2016.
Ceded premiums written in 2017 were $1,529 million, or 28% of gross premiums written, compared to $1,217 million, or 24%, in 2016. The increase in the ceded premiums written was mainly attributable to our reinsurance segment due to an increase in premiums ceded to retrocessional treaties which cover catastrophe, credit and surety, and agriculture lines.
Net premiums earned in our reinsurance segment in 2018 increased by $97 million or 4% compared to 2017. The increase in net premiums earned included $50 million primarily attributable to catastrophe, and marine and aviation lines associated with our acquisition of Novae. In addition, net premiums earned increased $47 million or 2% ($27 million or 1% on a constant
2017 versus 2016: Net premiums earned in 2017 increased by $443 million or 12%, compared to 2016 due to increases in our insurance and reinsurance segments.
Net premiums earned in our reinsurance segment in 2017 increased by $161 million or 7%, compared to 2016. The increase in net premiums earned was driven by an increase in gross premiums earned attributable to agriculture, motor and property lines partially offset by an increase in ceded premium earned in professional lines, agriculture and property lines together with a decrease in gross premiums earned in professional lines.
Other insurance related income in 2018 of $11 million compared to other insurance related loss in 2017 of $1 million, an increase of $12 million, was primarily driven by our reinsurance segment.
2018 versus 2017: The current accident year loss ratio decreased to 70.7% in 2018 from 84.1% in 2017. The decrease was primarily due to a decrease in catastrophe and weather-related losses. During 2018, we incurred pre-tax catastrophe and weather-related losses, net of reinstatement premiums, of $430 million or 9.0 points, attributable to the California Wildfires, Hurricanes Michael and Florence, Typhoon Jebi as well as U.S. and European weather-related events. Comparatively, in 2017 we incurred $835 million or 20.4 points of losses attributable to catastrophe and weather-related events.
After adjusting for the impact of the catastrophe and weather-related losses, our current accident year loss ratio decreased to 61.7% in 2018 from 63.7% in 2017. The decrease in the current accident year loss ratio after adjusting for the impact of the catastrophe and weather-related losses was principally due to changes in business mix predominately related to the acquisition of Novae, together with favorable impact of rate and trend, partially offset by elevated loss experience in reinsurance property lines.
2017 versus 2016: The current accident year loss ratio increased to 84.1% in 2017 from 67.4% in 2016. The increase was primarily due to an increase in catastrophe and weather-related losses. During 2017, we incurred pre-tax catastrophe and weather-related losses, net of reinstatement premiums, of $835 million or 20.4 points, attributable to Hurricanes Harvey, Irma
and Maria, the two earthquakes in Mexico, the wildfires in Northern and Southern California, and other U.S. weather-related events. Comparatively, in 2016 we incurred $204 million or 5.6 points of losses attributable to catastrophe and weather-related events.
After adjusting for the impact of the catastrophe and weather-related losses, our current accident year loss ratio increased to 63.7% in 2017 from 61.8% in 2016. The increase in the current accident year loss ratio after adjusting for the impact of the catastrophe and weather-related losses was principally due to elevated loss experience in insurance and reinsurance property lines, together with the impact of the Ogden Rate change on reinsurance motor lines, and adverse impact of the rate and trend, partially offset by favorable changes in business mix in accident and health lines.
Our net favorable prior year reserve development arises from changes to losses and loss expense estimates related to loss events that occurred in previous calendar years. The following table presents prior year reserve development by segment:
Medium-tail business consists primarily of our insurance and reinsurance professional reserve classes, our insurance credit and political risk reserve class and our reinsurance credit and surety reserve class.
Our insurance liability reserve class recorded net adverse prior year development of $22 million, $8 million and $8 million in 2018, 2017 and 2016, respectively. The net adverse prior year reserve development on our insurance liability reserve class in 2018 was primarily related to reserve strengthening within our U.S. excess casualty book of business. The net adverse prior year reserve development in 2017 and 2016 was primarily attributable to reserve strengthening within our run-off Bermuda excess casualty book of business.
Our reinsurance liability reserve class contributed net favorable prior year reserve development of $23 million, $43 million and $44 million in 2018, 2017 and 2016, respectively. The net favorable prior year reserve development for 2018 was due to progressively increased weight given by management to experience based indications on older accident years. Net favorable prior year reserve development in 2017 and 2016 was also primarily due to the progressively increased weight given by management to experience based indications on older accident years, which have generally been favorable.
$65 million of net favorable prior year reserve development on property and other lines business primarily due to overall better than expected loss emergence related to the 2017 catastrophe events.
$32 million of net favorable prior year reserve development on professional lines business due to the recognition of better than expected loss experience, particularly on the 2014 and 2015 accident years.
$22 million of net adverse prior year reserve development on liability business primarily due to reserve strengthening within our U.S. excess casualty book of business mainly driven by a higher frequency of large auto and general liability claims mainly related to the 2015 accident year.
$28 million of net favorable prior year reserve development on marine business due to better than expected loss emergence on more recent accident years including a large case reserve reduction on a 2013 accident year claim.
$12 million of net favorable prior year reserve development on property and other business primarily due to overall better than expected loss emergence related to the 2016 accident year.
$12 million of net favorable prior year reserve development on marine business driven by better than expected loss emergence primarily driven by reductions in mid-size loss estimates impacting accident year 2015.
In 2017, we recognized $140 million of net favorable prior year reserve development, the principal components of which were:
$44 million of net favorable prior year reserve development on professional lines business, reflecting the generally favorable experience on older accident years, particularly 2009 through 2012, as we continue to transition to more experience based methods.
In 2016, we recognized $243 million of net favorable prior year reserve development, the principal components of which were:
The decrease in the acquisition cost ratio to 19.9% in 2017 from 20.2% in 2016 was driven by a decrease in our reinsurance segment. The decrease in our reinsurance segment's acquisition cost ratio was primarily attributable to changes in business mix, together with favorable adjustments related to loss sensitive features and reinstatement premiums. This decrease was partially offset by an increase in our insurance segment's acquisition cost ratio driven by changes in business mix in accident and health lines.
The decrease in general and administrative expense ratio to 13.1% in 2018 from 14.0% in 2017 was primarily driven by an increase in net premiums earned and fees associated with arrangements with strategic capital partners and a decrease in personnel costs and professional fees, partially offset by an increase in information technology expenses and an increase in general and administrative expenses associated with the acquisition of Novae.
2018 versus 2017: Ceded premiums written in 2018 were $1,473 million, or 39%, of gross premiums written, compared to $1,039 million, or 37%, in 2017. The increase in ceded premiums written included $308 million primarily attributable to property, professional lines, marine, and credit and political risk lines associated with our acquisition of Novae. In addition, ceded premiums written increased by $126 million driven by our property, professional lines and liability lines.
2017 versus 2016: Ceded premiums written in 2017 were $1,039 million or 37% of gross premiums written, compared to $913 million, or 38% in 2016. The increase in ceded premiums written included $102 million primarily attributable to property and professional lines associated with our acquisition of Novae. In addition, ceded premiums written increased by $25 million driven by liability lines, partially offset by a decrease in premiums ceded in property lines.
2018 versus 2017: Net premiums earned in 2018 increased by $546 million or 30% compared to 2017. The increase in net premiums earned included $575 million primarily attributable to property, marine, credit and political risk and professional lines associated with our acquisition of Novae. Excluding the impact of Novae, net premiums earned decreased by $29 million or 2% ($40 million or 2% on a constant currency basis) attributable to property lines, partially offset by an increase in liability lines.
2017 versus 2016: Net premiums earned in 2017 increased by $282 million or 18% compared to 2016. The increase in net premiums earned included $162 million primarily attributable to property and marine lines associated with our acquisition of Novae. In addition, net premiums earned increased by $120 million or 8% ($110 million or 7% on a constant currency basis) attributable to accident and health, property and aviation lines.
This increase was driven by an increase in gross premiums earned in accident and health lines due to strong premium growth in recent periods together with premium growth in aviation lines associated with our recent acquisition of Aviabel, partially offset by a decrease in ceded premiums earned in property lines.
The increase in the acquisition cost ratio to 14.9% in 2017 from 13.5% in 2016, was primarily attributable to changes in business mix in accident and health lines.
2018 versus 2017: Gross premiums written in 2018 increased by $371 million or 14% compared to 2017. The increase in gross written premiums included $100 million attributable to catastrophe, and marine and aviation lines associated with our acquisition of Novae. In addition, gross premiums written increased by $271 million or 10% ($192 million or 7% on a constant currency basis) primarily attributable to credit and surety, motor, accident and health, catastrophe, professional lines and liability lines, partially offset by a decrease in marine and other lines.
The increase in credit and surety, and motor lines was largely due to restructuring of large quota share treaties which affected the timing of premium recognition, together with the favorable impact of foreign exchange movements as the weakening of the U.S. dollar drove comparative premium increases in treaties denominated in foreign currencies in the first quarter, and new business opportunities. In addition, the increase in credit and surety lines was due to favorable premium adjustments. The increase in motor lines was also attributable to rate increases in U.K. non-proportional motor business following the reduction in the Ogden Rate during the first quarter of 2017. The increase in accident and health, catastrophe, liability and professional lines was due to new business. Increased line sizes on a number of treaties also contributed to the increase in catastrophe and liability lines. These increases were partially offset by a decrease in marine and other lines due to the non-renewal of a large treaty.
2017 versus 2016: Gross premiums written in 2017 increased by $204 million or 8% compared to 2016. The increase in gross written premiums was attributable to catastrophe, agriculture, property and motor lines, partially offset by a decrease in credit and surety lines.
2017 versus 2016: Premiums ceded in 2017 were $490 million or 18%, of gross premiums written, compared to $304 million or 12% in 2016. The increase was due to an increase in premiums ceded to retrocessional treaties which cover catastrophe, credit and surety, and agriculture lines.
2018 versus 2017: Net premiums earned in 2018 increased by $97 million or 4% compared to 2017. The increase in net premiums earned included $50 million primarily attributable to catastrophe, and marine and aviation lines associated with our acquisition of Novae. In addition, net premiums earned increased by $47 million or 2% ($27 million or 1% on a constant currency basis) driven by an increase in gross premiums earned in motor, liability and property lines, partially offset by an increase in ceded premiums earned in liability, agriculture and motor lines, together with a decrease in gross premiums earned in marine and other, and agriculture lines.
Other insurance related income in 2018 of $7 million compared to other insurance related loss in 2017 of $4 million, an increase of $11 million, primarily related to net realized losses on our weather and commodities derivative portfolio which were recognized in 2017.
Other insurance related loss in 2017 of $4 million compared to other insurance related income in 2016 of $7 million, a decrease of $11 million, primarily related to a decrease in realized gains on our weather and commodities derivative portfolio and a decrease in profit commissions associated with third party retrocessions, partially offset by fees from strategic capital partners and an increase in realized gains on economic hedges purchased to protect agriculture lines against fluctuations in commodity prices.
2018 versus 2017: The current accident year loss ratio decreased to 74.2% in 2018 from 84.1% in 2017. The decrease was primarily due to a decrease catastrophe and weather-related losses. During 2018, we incurred pre-tax catastrophe and weather-related losses, net of reinstatement premiums, of $226 million, or 9.4 points attributable to the California wildfires, Hurricanes Michael and Florence, Typhoon Jebi and other U.S. weather-related events. Comparatively, in 2017 we incurred $422 million or 18.5 points of net losses attributable to catastrophe and weather-related events.
After adjusting for the impact of the catastrophe and weather-related losses, our current accident year loss ratio decreased to 64.8% in 2018 from 65.6% in 2017. The decrease in the current accident year loss ratio after adjusting for the impact of the catastrophe and weather-related losses was principally due to the impact of significant rate increases in U.K. non-proportional motor business following the reduction in the Ogden Rate during the first quarter of 2017, partially offset by elevated attritional and mid-size loss experience in property lines.
The general and administrative expense ratio of 5.1% in 2018 was comparable to 5.3% in 2017.
The decrease in the general and administrative expense ratio to 5.3% in 2017 from 7.1% in 2016, was primarily driven by a decrease in performance-related compensation costs, together with an increase in fees from our strategic capital partners.
Our corporate expenses include holding company costs necessary to support our worldwide insurance and reinsurance operations and costs associated with operating as a publicly-traded company. As a percentage of net premiums earned, corporate expenses were 2.3%, 3.1% and 3.2% in 2018, 2017 and 2016, respectively. The decrease in corporate expenses in 2018 compared to 2017 was primarily driven by an increase in the allocations of corporate costs to our insurance and reinsurance segments, together with a decrease in personnel costs, partially offset by an increase in information technology project costs.
Foreign exchange gains in 2016 were driven primarily by the impact of the strengthening of the U.S. dollar on the re-measurement of net insurance-related liabilities mainly denominated in pound sterling.
Interest expense and financing costs increased by $4 million in 2017 compared to 2016, primarily attributable to costs associated with the Dekania Notes issued by Novae on June 30, 2004.
Income tax (benefit) primarily results from income (loss) generated by our foreign operations in the U.S. and Europe. Our effective tax rate, which is calculated as income tax (benefit) expense divided by income before tax including interest in loss of equity method investments, was (217.9)%, 2.0%, and 1.2%, in 2018, 2017, and 2016, respectively. This effective rate can vary between years depending on the distribution of net income (loss) among tax jurisdictions, as well as other factors.
The tax benefit of $29 million in 2018 was primarily attributable to the geographic distribution of pre-tax losses with the benefit being driven by losses in our U.K. and European operations, partially offset by income in our U.S. operations.
The tax expense of $6 million in 2016 was primarily by attributable to the geographic distribution of pre-tax income with the expense being driven by income in our European and U.S. operations.
2018 versus 2017: Net investment income in 2018 was $356 million compared to net investment income of $313 million in 2017, an increase of $43 million or 14%, due to an increase in yields as well as a larger investment base associated with the acquisitions of Novae and Aviabel.
2017 versus 2016: Net investment income in 2017 was $313 million compared to net investment income of $305 million in 2016, an increase of $8 million or 2%, attributable to our acquisitions of Novae and Aviabel.
Other investments include hedge funds, direct lending funds, private equity funds, real estate funds, other privately held investments, indirect investments in CLO-Equities and overseas deposits. These investments are recorded at fair value, with changes in fair value and income distributions reported in net investment income. Consequently, the pre-tax return on other investments may vary materially period over period, particularly during volatile equity and credit markets.
The following table provides details of total net investment income from other investments:
Fixed maturities classified as available for sale are reported at fair value. The effect of market movements on fixed maturities is reported in net investment gains (losses) only when these securities are sold or impaired.
Equity securities are reported at fair value. The effect of market movements on equity securities is also reported in net investment gains (losses) when securities are sold or impaired. In addition, changes in the fair value of equity securities are reported in net investment gains (losses) as opposed to other comprehensive income following the adoption of ASU 2016-01 in the first quarter of 2018.
2018 versus 2017: Net investment losses in 2018 were $150 million compared to net investment gains of $28 million in 2017. Net investment losses reported in 2018 primarily reflected net realized investment losses on the sale of agency RMBS, U.S. government and corporate debt securities and net unrealized investment losses on equity securities of $67 million which were reported in net investment gains (losses) as opposed to other comprehensive income following the adoption of ASU 2016-01.
Given that none of our derivative instruments are designated as hedges under current accounting guidance, net unrealized gains (losses) on the hedged securities were recorded in accumulated other comprehensive income in the statement of changes in shareholders’ equity.
Our investment strategy is to take a long-term view by actively managing our investment portfolio to maximize total return within certain guidelines and constraints. In assessing returns under this approach, we include net investment income, net investment gains (losses), the change in unrealized investment gains (losses) on fixed maturities, and interest in income (loss) of equity method investments generated by our investment portfolio. The following table provides details of the total return on cash and investments for the periods indicated:
Pre-tax total return on average cash and investments excluding foreign exchange rate movements is a non-GAAP financial measure as defined in Item 10(e) of SEC Regulation S-K. The reconciliation to pre-tax total return on cash and investments, the most comparable GAAP financial measure, included foreign exchange gains (losses) of $(48) million, $80 million and $(79) million for the years ended December 31, 2018, 2017 and 2016, respectively.
At December 31, 2018, fixed maturities had a weighted average credit rating of AA- (2017: AA-), a book yield of 3.1% (2017: 2.5%), an average duration of 3.0 years (2017: 3.3 years) and duration inclusive of interest rate swaps of 2.8 years (2017: 3.2 years). At December 31, 2018, fixed maturities together with short-term investments and cash and cash equivalents (i.e. total investments of $13.4 billion), had a weighted average credit rating of AA- (2017: AA-), an average duration of 2.6 years (2017: 3.0 years), and duration inclusive of interest rate swaps of 2.5 years (2017: 2.9 years).
securities, we measure the country of risk exposure based on a number of factors including, but not limited to, location of management, principal operations and country of revenues.
Corporate debt securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The table below provides details of our corporate debt securities portfolio by sector:
The table provides details of the fair value of our RMBS and CMBS portfolios by credit rating:
Agency RMBS consist of bonds issued by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association which are primarily AAA rated and are supported by loans which are diversified across geographical areas. At December 31, 2018, our agency RMBS had an average duration of 3.9 years (2017: 4.3 years).
ABS include mostly investment-grade bonds backed by pools of loans with a variety of underlying collateral, including auto loans, student loans, credit card receivables and collateralized loan obligations ("CLOs") originated by a variety of financial institutions. The table below provides details of the fair value of our ABS portfolio by underlying collateral and credit rating:
At December 31, 2018, the gross unrealized investment losses on our fixed maturities portfolio were $215 million (2017: $91 million).
The increase in gross unrealized losses on investment-grade fixed maturities reflected the impact of the widening of credit spreads on investment grade corporate debt and the increase in U.S. Treasury rates.
The table below provides information on the severity of the unrealized loss position as a percentage of amortized cost for all non-investment grade fixed maturities in an unrealized loss position and includes any impact of foreign exchange:
The increase in gross unrealized losses on non-investment grade fixed maturities is primarily due to the impact of the widening of credit spreads on non-investment grade high yield corporate debt.
At December 31, 2018, net unrealized investment gains on equity securities were $16 million (2017: $83 million). The decrease was due to a decline in valuations reflective of the performance of the global equity markets.
diversified geographically throughout the U.S. and by property type to reduce the risk of concentration. At December 31, 2018 and 2017, there were no credit losses or past due amounts associated with our commercial mortgage loans portfolio.
During 2018, the fair value of total hedge funds decreased by $169 million in 2018 driven by $178 million of net redemptions offset by $9 million of price appreciation. Certain of these funds may be subject to restrictions on redemptions which may limit our ability to liquidate these investments in the short term. Refer to Item 8, Note 6(c) to the Consolidated Financial Statements 'Investments' for further details on these restrictions and details of unfunded commitments relating to our other investment portfolio.
Overseas deposits include investments in private funds held by Syndicate 2007 in which the underlying investments are primarily U.S. government, non-U.S. government and corporate debt securities. The funds do not trade on an exchange therefore are not included within the available for sale investments category.
During 2016, we paid $108 million including direct transactions costs to acquire 19% of the common equity of Harrington Reinsurance Holdings Limited ("Harrington"), the parent company of Harrington Re, an independent reinsurance company jointly sponsored by AXIS Capital and The Blackstone Group L.P. ("Blackstone"). Harrington is not a VIE. Given that we exercise significant influence over this investee we account for our ownership in Harrington under the equity method of accounting.
As a holding company, AXIS Capital has no operations of its own and its assets consist primarily of investments in its subsidiaries. Accordingly, AXIS Capital’s future cash flows depend on the availability of dividends or other statutorily permissible distributions, such as returns of capital, from its subsidiaries. The ability to pay such dividends and/or distributions is limited by the applicable laws and regulations of the various countries and states in which AXIS Capital’s subsidiaries operate (refer to Item 8, Note 20 to the Consolidated Financial Statements 'Statutory Financial Information' for further details), as well as the need to maintain capital levels to adequately support insurance and reinsurance operations and to preserve financial strength ratings issued by independent rating agencies. During 2018, AXIS Capital received $200 million (2017: $768 million; 2016: $550 million) of distributions from its subsidiaries. AXIS Capital’s primary uses of funds are dividend payments to both common and preferred shareholders, share repurchases, interest and principal payments on debt, capital investments in subsidiaries and payment of corporate operating expenses. We believe the dividend/distribution capacity of AXIS Capital’s subsidiaries, which was $1.0 billion at December 31, 2018, will provide AXIS Capital with sufficient liquidity for the foreseeable future.
Refer to consolidated statements of cash flows included in Item 8, ‘Financial Statements and Supplementary Data’, for further details.
Financing cash outflows primarily related to dividends paid to common and preferred shareholders on a recurring basis of $176 million in 2018 (2017: $188 million, 2016: $172 million). Financing cash outflows also included common share repurchases of $10 million in 2018 ( 2017: $286 million and 2016: $510 million). We note that market share repurchases are discretionary; the timing and amount of the additional repurchase transactions will depend on a variety of factors including, but not limited to, global (re)insurance and financial market conditions and opportunities, capital management and regulatory considerations (refer to 'Capital Resources - Share Repurchases' below for further details).
Should claim payment obligations accelerate beyond our ability to fund payments from operating cash flows, we would utilize our cash and cash equivalent balances and/or liquidate a portion of our investment portfolio. Our investment portfolio is heavily weighted towards conservative, high quality and highly liquid securities. We expect that, if necessary, approximately $12.8 billion of cash and invested assets at December 31, 2018 could be available in one to three business days under normal market conditions; of this amount, $5.5 billion relates to restricted assets, which primarily support our obligations in regulatory jurisdictions where we operate as a non-admitted carrier (refer to Item 8, Note 6(g) to the Consolidated Financial Statements 'Investments' for further details). For context, our largest 1-in-250 year return period, single occurrence, single-zone modeled probable maximum loss (Southeast U.S. Hurricane) is approximately $620 million, net of reinsurance; our claim payments pertaining to such an event would be paid out over a period spanning many months. Our internal risk tolerance framework aims to limit both the loss of capital due to a single event, and the loss of capital that would occur from multiple but perhaps smaller events, in any year (refer to Item 1 'Risk and Capital Management' for further details).
At December 31, 2018, our consolidated balance sheet reflected a decrease in debt due to the full redemption of our Dekania Notes.
On May 20, 2013, we issued 9 million of 5.50% Series D preferred shares with a liquidation preference of $25.00 per share for gross proceeds of $225 million. Dividends on the Series D preferred shares are non-cumulative. To the extent declared, dividends will accumulate, with respect to each dividend period, in an amount per share equal to 5.50% of the liquidation preference per annum. We may redeem these shares on or after June 1, 2018 at a redemption price of $25.00 per share.
A common share repurchase plan has not been authorized for 2019.
On March 28, 2018, certain of AXIS Capital’s operating subsidiaries (the "Participating Subsidiaries") amended their existing $250 million secured letter of credit facility with Citibank Europe plc (the "$250 Million Facility") under their aggregate
$750 million secured letter of credit facility with Citibank Europe plc (the "$750 Million Facility") to extend the expiration date to March 31, 2019.
At December 31, 2018, we had $395 million outstanding under the LOC Facility.
The following are the most recent financial strength ratings from internationally recognized agencies in relation to our principal (re)insurance operating subsidiaries:
The table below provides details of our contractual obligations and commitments at December 31, 2018 by period due:
We are obligated to pay claims for specified loss events covered by the (re)insurance contracts that we write. Loss payments represent our most significant future payment obligation. In contrast to our other contractual obligations, our cash payments are not determinable from the terms specified
We have $507 million of unfunded investment commitments related to our other investments portfolio, which are callable by our investment managers. Refer to Item 8, Note 6(c) to the Consolidated Financial Statements 'Investments' for further details. In addition, we have $4 million of unfunded commitments related to our commercial mortgage loans portfolio.
Debt (interest payments) includes $8 million of unamortized discount and debt insurance expenses.
The Company believes that the amounts included in the consolidated financial statements reflect its best judgment. However, factors such as those described in Item 1A 'Risk Factors' could cause actual events or results to differ materially from the underlying assumptions and estimates which could lead to a material adverse impact on the Company's results of operations, financial condition or liquidity.
With respect to our reinsurance business, we are generally notified of losses by ceding companies and/or their brokers. For excess of loss contracts, we are typically notified of insured losses on specific contracts and record a case reserve for the estimated ultimate liability arising from the claim. For contracts written on a proportional basis, we typically receive aggregated claims information and record a case reserve based on that information. However, our proportional reinsurance contracts typically require that losses in excess of pre-defined amounts be separately notified so we can adequately evaluate them. Our claims department evaluates each specific loss notification we receive and records additional case reserves when a ceding company’s reserve for a claim is not considered adequate.
The estimation of IBNR is necessary due to the time lags between when a loss event occurs and when it is actually reported, which is referred to as a reporting lag. Reporting lags may arise from a number of factors, including but not limited to: the nature of the loss, the use of intermediaries and complexities in the claims adjusting process. As we do not have specific information on IBNR, it must be estimated. IBNR is calculated by deducting incurred losses (i.e. paid losses and case reserves) from management’s best estimate of ultimate losses. In contrast to case reserves, which are established at the contract level, IBNR reserves are generally estimated at an aggregate level and cannot be identified as reserves for a particular loss event or contract (refer to 'Reserving for Significant Catastrophic Events' below for further details).
loss ratios are based on one or more of (a) an analysis of historical loss experience to date, (b) pricing information and (c) industry data, adjusted as appropriate, to reflect changes in rates and terms and conditions. This method is insensitive to actual incurred losses for the accident year or underwriting year in question and is, therefore, often useful in the early stages of development when very few losses have been incurred. Conversely, the lack of sensitivity to incurred/paid losses for the accident year or underwriting year in question means that this method is usually inappropriate in later stages of an accident year or underwriting year’s development.
As part of our quarterly loss reserve review process, our actuaries employ the estimation method(s) that they believe will produce the most reliable estimate of ultimate losses, at that particular evaluation date, for each reserve class and accident year or underwriting year combination. Often, this is a blend (i.e. weighted average) of the results of two or more appropriate actuarial methods. These ultimate loss estimates are generally utilized to evaluate the adequacy of our ultimate loss estimates for previous accident or underwriting years, established in the prior reporting period. For the initial estimate of the current accident or underwriting year, the available claim data is typically insufficient to produce a reliable estimate of ultimate losses. As a result, our initial estimate for an accident or underwriting year is generally based on the ELR Method for longer tailed lines and a BF method for shorter tailed lines. The initial ELR for each reserve class is established collaboratively by our actuaries, underwriters and management at the start of the year as part of the planning process, taking into consideration prior accident years’ or underwriting years' experience and industry benchmarks, adjusted after considering factors such as exposure trends, rate differences, changes in contract terms and conditions, business mix changes and other known differences between the current year and prior accident or underwriting years. The initial expected loss ratios for a given accident or underwriting year may be modified over time if the underlying assumptions, such as loss development or premium rate changes, differ from the original assumptions.
In our earlier years, we placed significant reliance on industry benchmarks in establishing our expected loss ratios and selecting loss development patterns. Over time, we have placed more reliance on our historical loss experience in establishing these ratios and selecting these patterns where we believe the weight of our own actual experience has become sufficiently credible for consideration. The weight given to our experience differs for each of our three claim tail classes (refer to 'Claim Tail Analysis' below for further details). In establishing expected loss ratios for our insurance segment, we give consideration to a number of other factors, including exposure trends, rate adequacy on new and renewal business, ceded reinsurance costs, changes in claims emergence and our underwriters’ view of terms and conditions in the market environment. For our
reinsurance segment, expected loss ratios are based on a contract-by-contract review, which considers information provided by clients together with estimates provided by our underwriters and actuaries about the impact of changes in pricing, terms and conditions and coverage. We also have considered the market experience of some classes of business as compiled and analyzed by an independent actuarial firm, as appropriate.
The following table shows total loss reserves for each of our reportable segments, segregated between case reserves and IBNR and by significant reserve class. This table is presented on a gross basis and, therefore, does not include the benefit of reinsurance recoverables on unpaid losses ("reinsurance recoveries").
Our short-tail business generally includes exposures for which losses are usually known and paid within a relatively short period of time after the underlying loss event has occurred. Our short-tail business primarily relates to property coverages and includes terrorism, accident and health, discontinued lines - Novae, marine and certain aviation business within our insurance segment, together with the property, catastrophe, engineering, agriculture, marine and other, accident and health, and discontinued lines - Novae business within our reinsurance segment.
Due to the relatively short reporting and settlement patterns for our short-tail business, we generally place more weight upon experience-based methods and other qualitative considerations in establishing reserves for recent and more mature accident years. As our experience developed more favorably than our initial expectations, we recognized favorable prior year development on short-tail business in recent years (refer to 'Underwriting Results - Consolidated - Prior Year Reserve Development' for further details).
We believe that there continues to be a relatively higher level of uncertainty around ultimate loss estimates for the business classes impacted by the global financial crisis in the 2007 to 2009 accident years. As a result, we continue to rely upon the evaluation of the open claims inventory in addition to the consideration of the actuarial indications, while exercising a greater degree of caution in recognizing potential favorable loss emergence, when establishing loss reserves for these accident years.
To date, our key actuarial assumptions for our long-tail business have been derived extensively from industry benchmarks supplemented with our own historical experience. Given our relatively short operating history in comparison to the development tail for this business, we do not believe that our own historical loss development for our long-tail business has amassed an appropriate volume to serve as a fully credible input into the key actuarial assumptions previously outlined.
Due to the length of the development tail for this business, our reserve estimates for most accident years and underwriting years are predominantly based on the BF or ELR method and the consideration of qualitative factors. As part of our quarterly reserving process, we monitor actual paid and incurred loss emergence relative to expected loss emergence based on our selected loss development patterns. The drivers of any unfavorable loss emergence are investigated and, as a result, have led to an immediate recognition of adverse development in some instances. Prior to the fourth quarter of 2012, we did not recognize any favorable loss emergence. As a result, during some periods, we recognized net adverse development for our insurance liability business in light of unfavorable loss emergence for certain reserve class and accident year combinations (refer to 'Underwriting Results - Consolidated - Prior Year Reserve Development' for further details).
Our results of operations for 2018, 2017 and 2016 were impacted by natural catastrophe activity (refer to 'Underwriting Results - Consolidated - Current Accident Year Loss Ratio' for further details).
Our quarterly reserving process involves the collaboration of our underwriting, claims, actuarial, legal, ceded reinsurance and finance departments, includes various segmental committee meetings and culminates with the approval of a single point best estimate by our Group Reserving Committee, which comprises senior management. In selecting this best estimate, management considers actuarial estimates and applies informed judgment regarding qualitative factors that may not be fully captured in these actuarial estimates. Such factors include, but are not limited to: the timing of the emergence of claims, volume and complexity of claims, social and judicial trends, potential severity of individual claims and the extent of internal historical loss data versus industry information. While these qualitative factors are considered in arriving at the point estimate, no specific provisions for qualitative factors are established.
With regard to establishing the fair value of reserves for losses and loss expenses for Novae at the acquisition date, weight was given to the observable value of these reserves based on the RITC transaction of the 2015 and prior years of account of Syndicate 2007, which was completed prior to the allocation of purchase price. Management made no change to the initial estimate when establishing its best estimate of reserves for losses and loss expenses at December 31, 2017. This is consistent with our general approach of recognizing all or part of the anticipated cost of third party liability commutations if the transaction has either completed or is considered sufficiently likely to be completed in the near term.
The results show the cumulative increase (decrease) in our loss reserves across all accident years. For example, if our assumed loss development pattern for our insurance property and other business was three months shorter with no accompanying change in our ELR assumption, our loss reserves may decrease by approximately $70 million. Each of the impacts set forth in the tables is estimated individually, without consideration for any correlation among key assumptions or among reserve classes. Therefore, it would be inappropriate to take each of the amounts and add them together in an attempt to estimate total volatility. While we believe the variations in the expected loss ratios and loss development patterns presented could be reasonably expected, our own historical data regarding variability is generally limited and actual variations may be greater or less than these amounts. It is also important to note that the variations are not meant to be a "best-case" or "worst-case" series of scenarios and, therefore, it is possible that future variations in our loss reserves may be more or less than the amounts presented. While we believe that these are reasonably likely scenarios, we do not believe this sensitivity analysis should be considered an actual reserve range.
The second estimate is the amount of reinsurance recoverable on unpaid and paid losses that we believe ultimately will not be recovered from reinsurers. We are selective in choosing our reinsurers, placing reinsurance principally with reinsurers with a strong financial condition and industry ratings. The amount we ultimately collect may differ from our estimate due to the ability and willingness of reinsurers to pay our claims, which may be negatively impacted by factors such as insolvency, contractual disputes over contract language or coverage and/or other reasons. In addition, economic conditions and/or operational performance of a particular reinsurer may deteriorate and this could also affect the ability and willingness of a reinsurer to meet their contractual obligations.
We apply case-specific provisions against reinsurance recoverable on unpaid and paid losses that we deem unlikely to be collected in full. In addition, we use a default analysis to estimate our provision for uncollectible amounts on the remainder of the reinsurance recoverable balance. The principal components of the default analysis are reinsurance recoverable balances by reinsurer and default factors applied to estimate uncollectible amounts based on our reinsurers’ credit ratings. The default factors are based on a model developed by a major rating agency.
At December 31, 2018 and 2017, the provision for uncollectible amounts was $21 million and $17 million, respectively. We have not written off any significant reinsurance recoverable balances in the last three years.
At December 31, 2018, the use of different assumptions within our approach could have a material effect on our provision for uncollectible amounts. To the extent the creditworthiness of our reinsurers deteriorates due to an adverse event affecting the reinsurance industry, such as a large number of major catastrophes, actual uncollectible amounts could be significantly greater than our provision for uncollectible amounts. Given the various considerations used to estimate our provision for uncollectible amounts, we cannot precisely quantify the effect a specific industry event may have on our provision for uncollectible amounts.
For the majority of our insurance business, we receive a fixed premium which is identified in the policy and recorded as unearned premium at the inception of the contract. This premium is adjusted only if underlying insured values ultimately differ. We actively monitor underlying insured values and recognize any adjustments to gross premiums written in the period in which they are determined. Gross premiums written on a fixed premium basis accounted for approximately 88%, 88% and 89% of the segment’s gross premiums written for the years ended December 31, 2018, 2017 and 2016, respectively. Some of this business is written through MGAs, third parties granted authority to bind risks on our behalf in accordance with our underwriting guidelines. For this business, we either record gross premiums written based on monthly statements received from MGAs or we record our best estimate based upon our historical experience. Due to inherent reporting delays, we generally record premiums associated with business written by MGAs one month in arrears.
In our credit and political risk line of business, we write certain policies on a multi-year basis. We record premiums in respect of these policies at the inception of the contract based on management’s best estimate of total premiums to be received,
including assumptions relating to prepayments/refinancing. These premiums are generally payable in installments. At December 31, 2018, the average duration of the outstanding unearned premiums written for our credit and political risk line of business was 5.7 years (2017: 5.5 years).
Many of our excess of loss reinsurance contracts also include provisions that require an automatic reinstatement of coverage in the event of a loss. In a year of large loss events, reinstatement premiums will be higher than in a year in which there are no such events. Reinstatement premiums are recognized and earned at the time a loss event occurs and losses are recorded. While the reinstatement premium amount is defined by contract terms, our recognition of reinstatement premiums is dependent on our estimate of losses and loss expenses, which reflect management’s best judgment (refer to 'Critical Accounting Estimates - Reserve for Losses and Loss Expenses' above for further details).
For proportional reinsurance contracts, we recognize gross premiums written based on estimates at the inception of the contract. We review these premium estimates on a quarterly basis and evaluate their reasonability in light of actual premiums reported by cedants. Factors contributing to changes in initial premium estimates may include:
As a result of this review process, we recognize any adjustments to premium estimates in gross premiums written in the period in which they are determined. Changes in premium estimates could be material to gross premiums written and may directly and significantly impact net premiums earned favorably or unfavorably in the period in which they are determined as the adjustment may be substantially or fully earned. Gross premiums written for proportional reinsurance contracts, including adjustments to premium estimates established in prior years, accounted for 62%, 68% and 63% of our reinsurance segment’s gross premiums written for the year ended December 31, 2018, 2017 and 2016, respectively.
Our historical experience has shown that cumulative adjustments to our annual initial premium estimates for proportional reinsurance contracts have ranged from 0% to 5% over the last 5 years. Giving more weight to recent years where premium volume was comparable to current levels, we believe that a reasonably likely change to our 2018 premiums estimate for proportional reinsurance contracts would be 3% in either direction. A change of this magnitude would result in a change in our gross premiums written of approximately $54 million, and after applying our current loss and expense ratios, would have an immaterial impact on our pre-tax net income. However, larger variations, positive or negative, are possible.
Line slip and proportional (re)insurance contracts are generally written on a "risks attaching" basis, covering claims that relate to the underlying policies written during the terms of such contracts. As the underlying business incepts throughout the contract term (typically one year) and typically has a one-year coverage period, we generally earn these premiums evenly over a 24-month period.
Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement. The unobservable inputs reflect our judgments about assumptions that market participants might use.
Refer to Item 8, Note 7 to the Consolidated Financial Statements 'Fair Value Measurements' for further information on the valuation techniques including significant inputs and assumptions generally used in estimating the fair values of our financial instruments.
While we obtain pricing from pricing services and/or broker-dealers, management is ultimately responsible for determining the fair value measurements of all securities. To ensure fair value measurement is applied consistently and in accordance with U.S. GAAP, we annually update our understanding of the pricing methodologies used by the pricing services and broker-dealers.
The fair values of hedge funds, direct lending funds, private equity funds and real estate funds are estimated using net asset values (NAVs) as advised by external fund managers or third party administrators (refer to Item 8, Note 7 to the Consolidated Financial Statements 'Fair Value Measurements' for further information).
The default and loss severity rates are the most judgmental unobservable market inputs to which the valuation of CLO-Equities is most sensitive.
As the significant inputs used to price CLO-Equities are unobservable, the fair values of these securities are classified as Level 3.
The following significant inputs were used in our discounted cash flow models.
As the significant inputs used to price other privately held securities are unobservable, the fair value of these securities are classified as Level 3.
Overseas deposits include investments in private funds held by Syndicate 2007 in which the underlying investments are primarily U.S. government, Non-U.S. government and corporate debt securities. The funds do not trade on an exchange, therefore are not included within available for sale investments. As the significant inputs used to price the underlying investments are observable market inputs, the fair values of overseas deposits are classified as Level 2.
The financial condition, near-term and long-term prospects for the issuer of the security, including relevant industry conditions and trends, and the implications of rating agency actions, and offering prices.
The collateral structure and credit support of the security, if applicable.
The following discussion provides further details regarding our processes for identification of impairments that are other-than-temporary for fixed maturities, and equity securities prior to the adoption of Accounting Standards Update ("ASU") 2016-01 "Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities," and the recognition of the related OTTI charges.
Fixed maturities classified as available for sale are reported at fair value at the balance sheet date. Our available for sale ("AFS") investment portfolio is the largest component of our consolidated total assets and it is a multiple of our shareholders’ equity. As a result, an OTTI charge could be material to our financial condition and operating results particularly during periods of dislocation in financial markets.
Our credit impairment review process excludes fixed maturities guaranteed (either explicitly or implicitly) by the U.S. government and its agencies (U.S. Government, U.S. Agency and U.S. Agency RMBS) because we anticipate these securities will not be settled below amortized cost. These securities are still evaluated for intention to sell at a loss.
Following the adoption of Accounting Standards Update ("ASU") 2016-01 "Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities"
Equity securities are recognized at fair value. Effective January 1, 2018, following the adoption of ASU 2016-01 the change in the fair values (net unrealized investment gains (losses)) of equity securities, net of tax is recognized in net investments gains (losses) in the consolidated statements of operations.
As part of our impairment review process, we considered our ability and intent to hold an equity security in an unrealized loss position for a reasonable period of time to allow for a full recovery. As an equity security does not have a maturity date, the forecasted recovery for an equity security was inherently more judgmental than for a fixed maturity security.
In light of the volatility of global equity markets experienced in recent years, we generally impaired an equity security where we did not forecast a recovery to cost within two years. Further, we generally impaired an equity security if its fair value was 15% below its cost. We also had established parameters in place for identifying potential impaired equity securities for fundamental analysis based on the severity, in either percentage or absolute dollar terms, of the unrealized loss position.
To the Board of Directors and Shareholders of AXIS Capital Holdings Limited
We have audited the accompanying consolidated balance sheets of AXIS Capital Holdings Limited and subsidiaries (the "Company") as of December 31, 2018 and 2017, the related consolidated statements of operations, comprehensive income, changes in shareholders' equity, and cash flows, for each of the three years in the period ended December 31, 2018, and the related notes and the schedules listed in the Index at Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.
In 2018, total consideration paid for an agreement for the Reinsurance to Close ("RITC") of the 2015 and prior years of account of Syndicate 2007 was $819 million of which $600 million was settled by way of a transfer of securities and was treated as a non-cash activity in the consolidated statement of cash flows (refer to Note 9 'Reserve for Losses and Loss Expenses').
In 2017, non-cash foreign exchange losses were attributable to the reclassification of the cumulative translation adjustment balance related to AXIS Specialty Australia from accumulated other comprehensive income in the consolidated balance sheet to foreign exchange losses (gains) in the consolidated statement of operations due to the wind-down of that operation which was substantially complete at March 31, 2017 (refer to Note 9 'Reserve for Losses and Loss Expenses' and Note 19 'Other Comprehensive Income (Loss)').
In 2016, total consideration paid for a quota share and adverse development reinsurance cover was $170 million of which $92 million was settled by a transfer of securities and was treated as a non-cash activity in the consolidated statement of cash flows (refer to Note 9 'Reserve for Losses and Loss Expenses').
AXIS Re SE ("AXIS Re") is a European public limited liability company, incorporated as a reinsurer under the laws of Ireland. AXIS Re SE is also a Societas Europaea (SE). AXIS Re also conducts reinsurance business through its branch in Switzerland, AXIS Re SE, Dublin (Zurich Branch).
The Company operates in the Lloyd's of London ("Lloyd's") market through AXIS Corporate Capital UK Limited which is the sole corporate member of AXIS Syndicate 1686 ("Syndicate 1686"). Effective August 4, 2017, AXIS Managing Agency Ltd. ("AXIS Managing Agency") assumed management of Syndicate 1686, replacing the Company's third-party managing agency agreement with Asta Managing Agency Limited, which had been in place since 2014. Effective January 1, 2019, AXIS Corporate Capital UK Limited and Novae Corporate Underwriting Limited ("NCUL") will provide 70% and 30%, respectively, of Syndicate 1686's capital support.
On October 2, 2017, AXIS Specialty UK Holdings Limited, a wholly owned subsidiary of the Company, acquired a 100% ownership interest in Novae Group plc ("Novae"). Novae operates in the Lloyd's market through NCUL, the sole corporate member of Novae Syndicate 2007 ("Syndicate 2007") and owns Lloyd’s managing agency, Novae Syndicates Limited ("NSL") which operated in the Lloyd’s insurance market and managed Syndicate 2007 until January 1, 2018, when the Company received authorization from Lloyd’s for AXIS Managing Agency to commence management and oversight of Syndicate 2007.
To facilitate comparison of information across periods, certain reclassifications have been made to prior year amounts to conform to the current year's presentation.
These reclassifications did not impact results of operations, financial condition or liquidity.
Net investment income includes interest income and the amortization of market premiums and discounts and is presented net of investment expenses. Investment income is recognized when earned. Purchases and sales of fixed maturities are recorded on a trade-date basis and realized investment gains (losses) on sales of fixed maturities are determined based on the specific identification method. Realized investment gains (losses) on fixed maturities are included in net investments gains (losses) in the consolidated statements of operations.
The Company recognizes investment income from fixed maturities based on the constant effective yield method, which includes an adjustment for estimated principal repayments, if applicable. The effective yield used to determine the amortization of fixed maturities subject to prepayment risk (e.g. asset-backed, mortgage-backed and other structured securities) is recalculated and adjusted periodically based upon historical and/or projected future cash flows. Adjustments to the yield for highly-rated prepayable fixed maturities are accounted for using the retrospective method. Adjustments to the yield for other prepayable fixed maturities are accounted for using the prospective method.
(iii) the reason for the decline (e.g. credit spread widening, credit event, foreign exchange rate movements);
(v) the collateral structure and credit support of the security, if applicable.
The Company recognizes the non-credit component of the impairment (i.e. related to interest rates, market conditions, etc.) in other comprehensive income.
Equity securities are reported at fair value (refer to Note 7 'Fair Value Measurements'). Effective January 1, 2018, following the adoption of ASU 2016-01, the change in the fair values (net unrealized investment gains (losses)) of equity securities, net of tax is recognized in net investments gains (losses) in the consolidated statements of operations.
Mortgage loans held-for-investment are reported at amortized cost which is calculated as the unpaid principal balance, adjusted for any unamortized premium or discount, deferred fees or expenses, and is net of valuation allowances. Interest income and prepayment fees are recognized when earned. Interest income is recognized based on an effective yield method which gives effect to the amortization of premiums and accretion of discounts.
Reinsurance premiums are recorded at the inception of the contract and are estimated based on information received from ceding companies. For multi-year contracts where (re)insurance premiums are payable in annual installments, premiums are recorded at the inception of the contract based on management’s best estimate of total premiums to be received. However, premiums are normally recognized on an annual basis for multi-year contracts where the cedant has the ability to unilaterally commute or cancel coverage within the term of the policy. The remaining annual premiums are included as written at each successive anniversary date within the multi-year term.
Acquisition costs vary with and are directly related to the successful acquisition efforts of acquiring new or renewing existing (re)insurance contracts and consist primarily of fees and commissions paid to brokers and premium taxes. Acquisition costs are shown net of commissions earned on ceded reinsurance. Net acquisition costs are deferred and charged to expense as the related premium is earned. Insurance and reinsurance premiums balance receivable is presented net of acquisition costs when contract terms provide for the right of offset.
Anticipated losses and loss expenses, other costs and investment income related to these premiums are considered in assessing the recoverability of deferred acquisition costs. If deferred amounts are estimated to be unrecoverable, they are expensed. Compensation expenses for personnel involved in contract acquisition, as well as advertising costs, are expensed as incurred.
Reserve for losses and loss expenses represents an estimate of the unpaid portion of the ultimate liability for losses and loss expenses for (re)insured events that have occurred at or before the balance sheet date. These amounts reflect both claims that have been reported ("case reserves") and claims that have been incurred but not yet reported ("IBNR") and are reduced for estimated amounts of salvage and subrogation recoveries.
In the normal course of business, the Company purchases reinsurance protection to limit its ultimate losses from catastrophic events and to reduce its loss aggregation risk. The premiums paid to reinsurers (i.e. ceded premiums written) are expensed over the coverage period. Prepaid reinsurance premiums represent the portion of premiums ceded which relate to the unexpired term of the contracts in force. Reinstatement premiums ceded are recognized and earned at the time a loss event occurs, where the coverage limits for the remaining life of the contract are reinstated under pre-defined contract terms.
Reinsurance recoverable related to case reserves is estimated on a case-by-case basis by applying the terms of any applicable reinsurance cover to individual case reserve estimates. Reinsurance recoverable related to IBNR is generally developed as part of our loss reserving process, therefore, its estimation is subject to similar risks and uncertainties as the estimation of IBNR.
Reinsurance recoverable is presented net of a provision for uncollectible amounts, reflecting the amount the Company believes ultimately will not be recovered due to reinsurer insolvency, contractual disputes and/or some other reason. The Company applies case-specific provisions against reinsurance recoverable on unpaid and paid losses that it deems unlikely to be collected in full. In addition, the Company uses a default analysis to estimate the provision for uncollectible amounts on the remainder of the reinsurance recoverable balance.
The estimates of reinsurance recoverable and the associated provision for uncollectible amounts require management’s judgment and are reviewed in detail on a quarterly basis. Any adjustments to the provision for uncollectible amounts are recognized in the period in which they are determined.
The Company’s reporting currency is the U.S. dollar. Assets and liabilities of the Company's subsidiaries and branches where the functional currency is not the U.S. dollar, are translated into U.S. dollars using the rates of exchange in effect at the balance sheet date, and revenue and expenses are translated using the weighted average foreign exchange rates for the period. The effect of translation adjustments is reported as a separate component of AOCI in the consolidated statement of change shareholders’ equity.
The Company is authorized to issue restricted shares, restricted stock units, performance units, stock options, stock appreciation rights and other equity-based awards to its employees and directors. The Company's plan includes both share-settled and cash-settled service and performance based awards.
The fair value of share-settled service and performance based awards is based on the market value of the Company's common share measured at the grant date and is expensed over the requisite service period.
Effective, January 1, 2017, the Company made an accounting policy election to account for forfeitures when they occur.
During 2013, the Company began to write derivative based risk management products designed to address weather and commodity price risks, with the objective of generating profits on a portfolio basis. Effective July 1, 2017, the Company no longer writes derivative-based risk management products which address weather risks.
From time to time the Company may also enter into (re)insurance contracts that meet the Financial Accounting Standards Board's ("FASB") definition of a derivative contract.
The Company measures all derivative instruments at fair value (refer to Note 7 'Fair Value Measurements') and recognizes them as either assets or liabilities in the consolidated balance sheets. Subsequent changes in fair value and any realized gains or losses are recognized in the consolidated statements of operations.
The Company recognizes goodwill and other intangible assets in connection with certain acquisitions. Goodwill represents the excess of the purchase price paid over the fair value of the net assets acquired in these acquisition and is not amortized. Other intangible assets with a finite life are amortized over the estimated useful live of the intangible asset. Other intangible assets with an indefinite life are not amortized.
For the purposes of evaluating goodwill for impairment, the Company may first perform a qualitative assessment to determine whether it is necessary to perform a quantitative goodwill impairment test. If determined to be necessary, the quantitative test compares the fair value of a reporting unit with its carrying amount, including goodwill. Subsequent to the adoption of ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment" (refer to 'New Accounting Standards Adopted in 2018' below) if the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired. If the carrying amount of the reporting unit exceeds the fair value, an impairment loss is recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit.
Certain subsidiaries and branches of the Company operate in jurisdictions where they are subject to taxation. Current and deferred income taxes are charged or credited to net income, or in certain cases to AOCI, based upon enacted tax laws and rates applicable in the relevant jurisdiction in the period in which the tax becomes accruable or realizable. Deferred income taxes are provided for all temporary differences between the bases of assets and liabilities used in the consolidated balance
sheets and those used in the various jurisdictional tax returns. When the assessment indicates that it is more likely than not that a portion of a deferred tax asset will not be realized in the foreseeable future, a valuation allowance against deferred tax assets is recorded. The Company recognizes the tax benefits of uncertain tax positions only when the position is more-likely-than-not to be sustained upon audit by the relevant taxing authorities.
requires equity investments (except those accounted for under the equity method of accounting, investments that are consolidated or those that meet a practicability exception) to be measured at fair value with changes in fair value recognized in net income;
Upon adoption of this guidance, net unrealized investment gains on equity securities of $70 million, net of deferred income taxes of $13 million, were reclassified from accumulated other comprehensive income to retained earnings.
Effective January 1, 2018, the Company adopted Accounting Standards Update ("ASU") 2014-09 "Revenue from Contracts with Customers (Topic 606)," using the modified retrospective transition approach. This guidance affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards, such as accounting for insurance contracts. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
The Company generated fee income of $32 million for the year ended December 31, 2018 which is within the scope of this ASU. These fees represent service fees earned by the Company's reinsurance segment related to services provided to
strategic capital partners and are recognized when the related services have been performed. Given that the timing and measurement of revenue associated with impacted contracts did not change, the adoption of this guidance did not have a material impact on the Company's results of operations, financial condition and liquidity.
Effective January 1, 2018, the Company adopted ASU 2017-09 "Compensation - Stock Compensation (Topic 718) - Scope of Modification Accounting," which provides clarity and reduces diversity in practice of applying the guidance in Topic 718 to a change to the terms or conditions of a share-based payment award. This ASU provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. The guidance states that an entity should account for the effects of a modification unless all the following are met:
the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified; and the classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified.
Effective January 1, 2018, the Company adopted ASU 2018-02 "Income Statement - Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income" which was a response to a financial reporting issue that arose as a consequence of the U.S. federal government tax bill, H.R.1, An Act to Provide for
As a consequence of U.S. Tax Reform, the Company recognized a tax benefit of $2 million related to the revaluation of net deferred tax liabilities associated with the reduction in the U.S. corporate income tax rate from 35% to 21%, attributable to net unrealized investment gains associated with investments held by the Company's U.S. domiciled entities. Upon adoption of this guidance, the tax benefit of $2 million was reclassified from accumulated other comprehensive income into retained earnings.
In July 2018, the FASB issued ASU 2018-11, "Leases (Topic 842) - Targeted Improvements" which provides an additional (and optional) transition method to adopt the new lease guidance. A company electing this additional (and optional) transition method must provide the required Topic 840 disclosures for all periods that continue to be in accordance with Topic 840. However, these amendments do not change the existing disclosure requirements in Topic 840, in particular these amendments do not create interim disclosure requirements. This guidance is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted.
In addition to electing the package of practical expedients, the Company will make an accounting policy election not to record leases with an initial term of 12 months or less (short-term) in the Company's consolidated balance sheets. The Company will recognize expense for short-term lease payments on a straight-line basis over the lease term in the Company's consolidated statements of operations. At December 31, 2018, the Company expects the adoption of this guidance will result in the recognition of lease assets and lease liabilities of approximately $149 million in the Company's consolidated balance sheets at January 1, 2019, related to existing office property and equipment leases. The adoption of this guidance will not impact the Company's results of operations and liquidity.
In March 2017, the FASB issued ASU 2017-08 "Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20) - Premium Amortization on Purchased Callable Debt Securities" which shortens the amortization period for certain purchased callable debt securities held at a premium. The Company plans to adopt this guidance effective January 1, 2019. The adoption of this guidance will not impact the Company's results of operations, financial condition and liquidity.
In August 2018, the FASB issued ASU 2018-13 "Fair Value Measurement (Topic 820) - Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement" to improve the effectiveness of fair value measurement disclosures. This guidance is effective for interim and annual reporting periods, beginning after December 15, 2019, with early adoption permitted. The Company plans to adopt this guidance effective January 1, 2019. As this guidance relates solely to financial statement disclosures, the adoption of ASU 2016-18, will not impact the Company's results of operations, financial condition and liquidity.
On October 2, 2017 (the "closing date" or the "acquisition date"), AXIS Specialty UK Holdings Limited, a wholly owned subsidiary of the Company, acquired a 100% ownership interest in Novae Group plc ("Novae") for an aggregate purchase price of $617 million. Novae is a diversified property and casualty (re)insurance business operating through Syndicate 2007 at Lloyd’s. The results of Novae are included in the results of the Company's insurance and reinsurance segments from that date. The acquisition of Novae was undertaken to accelerate the growth strategy of the Company's international insurance business, and to significantly scale up its capabilities to enable the Company to even better serve its clients and brokers.
In addition, the Company identified finite lived intangible assets of $385 million, including Value of Business Acquired ("VOBA") which represents the present value of the expected underwriting profit within policies that were in-force at the closing date of the transaction, of $257 million and finite lived intangible assets primarily related to distribution networks of $128 million. The Company also identified indefinite lived intangible assets related to Lloyd's syndicate capacity of $95 million (refer to Note 5 'Goodwill and Intangible Assets' for further information).
Other assets: To reflect an investment at fair value and deferred tax assets on fair value adjustments;
Lloyd's syndicate capacity: The value of Lloyd's syndicate capacity, which represents Novae's right to underwrite a certain allocated limit of premium in the Lloyd's market.
SME brokers: These relationships consist of Novae's brokers with the exception of the large brokers listed above and consideration was given to the expectation of the renewal of these relationships and the associated expenses.
MGA contract: Represents the value of managing agent fees and profit commission Novae earns related to the provision of underwriting services to Special Purpose Arrangement, SPA 6129.
The purchase price was allocated to the assets acquired and liabilities assumed of Aviabel based on estimated fair values on the closing date. Consequently, the Company recognized investments with a fair value of $182 million, reserves for losses and loss expenses with a fair value of $79 million, and a bargain purchase gain of $15 million. The bargain purchase gain arose as the fair values of the net identifiable assets acquired exceeded the fair value of the consideration transferred at the acquisition date.
The allocation of the purchase price was based on information included in unaudited financial statements at March 31, 2017. The fair values of the assets acquired and liabilities assumed may be subject to adjustments, which may impact the amounts recorded for the assets acquired and liabilities assumed, as well as the bargain purchase gain.
In connection with the acquisition of Novae, the Company incurred transaction and integration related expenses of $26 million (2017: $27 million). The transaction and integration related expenses included due diligence, legal, accounting, investment banking fees and expenses, as well as integration expenses related to the integration of Novae into the Company's operations and compensation-related costs associated with the termination of certain employees. These expenses are included in transaction and reorganization expenses in the consolidated statement of operations.
The Company's insurance segment offers specialty insurance products to a variety of niche markets on a worldwide basis. The product lines in this segment are property, marine, terrorism, aviation, credit and political risk, professional lines, liability, accident and health, together with discontinued lines - Novae, which represents lines of business that Novae exited or placed into run-off in the three month periods ended December 31, 2016 and March 31, 2017.
The Company's reinsurance segment provides treaty reinsurance to insurance companies on a worldwide basis. The product lines in this segment are catastrophe, property, professional lines, credit and surety, motor, liability, agriculture, engineering, marine and other, accident and health, together with discontinued lines - Novae, which represents lines of business that Novae exited or placed into run-off in the three month periods ended December 31, 2016 and March 31, 2017. The reinsurance segment also wrote derivative based risk management products designed to address weather and commodity price risks until July 1, 2017.
The estimated remaining useful lives of finite lived intangible assets range from 1 to 14 years.
The amortized cost and fair values of the Company's fixed maturities classified as available for sale were as follows:
Asset-backed securities ("ABS") include debt tranched securities collateralized primarily by auto loans, student loans, credit card receivables, collateralized debt obligations ("CDOs") and collateralized loan obligations ("CLOs").
Represents the non-credit component of the other-than-temporary impairment ("OTTI") losses, adjusted for subsequent sales, maturities and redemptions. It does not include the change in fair value subsequent to the impairment measurement date.
Effective January 1, 2018, the Company adopted ASU No. 2016-01, which requires equity securities to be measured at fair value with changes in fair value recognized in net income therefore equity securities at fair value are excluded from the table above at December 31, 2018.
At December 31, 2018, 1,656 fixed maturities (2017: 627) had been in a continuous unrealized loss position for twelve months or greater and had a fair value of $3,570 million (2017: $1,533 million). Following a credit impairment review, it was concluded that these securities as well as the remaining securities in an unrealized loss position were temporarily impaired at December 31, 2018, and were expected to recover in value as the securities approach maturity. At December 31, 2018, the Company did not intend to sell the securities in an unrealized loss position and it is more likely than not that the Company will not be required to sell these securities before the anticipated recovery of their amortized costs.
Syndicate 2007 holds overseas deposits which include investments in private funds where the underlying investments are primarily U.S. government, Non-U.S. government and corporate debt securities. The funds do not trade on an exchange therefore are not included within available for sale investments.
During 2016, the Company paid $108 million including direct transaction costs to acquire 19% of the common equity of Harrington Reinsurance Holdings Limited ("Harrington"), the parent company of Harrington Re Ltd. ("Harrington Re"), an independent reinsurance company jointly sponsored by AXIS Capital and The Blackstone Group L.P. ("Blackstone"). Through long-term service agreements, AXIS Capital will serve as Harrington Re's reinsurance underwriting manager and Blackstone will serve as exclusive investment management service provider. As an investor, the Company expects to benefit from underwriting profit generated by Harrington Re and the income and capital appreciation Blackstone seeks to deliver through its investment management services. In addition, the Company has entered into an arrangement with Blackstone under which underwriting and investment related fees will be shared equally. Harrington is not a VIE. Given that the Company exercises significant influence over the operating and financial policies of this investee, the Company accounts for its ownership interest in Harrington under the equity method of accounting. The Company's proportionate share of the underlying equity in net assets resulted in a basis difference of $5 million which represents initial transactions costs.
Effective January 1, 2018, the Company adopted ASU No. 2016-01. The change in fair value of equity securities is now recognized in net income.
The following table provides a roll forward of credit losses ("credit loss table") before income taxes, for which a component of the OTTI charge was recognized in AOCI:
The Company's investments in ABS at December 31, 2018 consist mainly of CLO debt tranched securities ("CLO Debt") purchased primarily as new issues during 2017 through 2018. Substantially all of these new issues had credit ratings of AA or better. The Company utilizes a scenario-based approach to reviewing its CLO Debt portfolio based on the current asset market price. The Company also reviews subordination levels of these securities to determine their ability to absorb credit losses of underlying collateral. If losses are forecast to be below the subordination level for a tranche held by the Company, the security is determined not to be impaired. At December 31, 2018, the Company concluded that there are no credit losses anticipated for any of its CLO Debt.
At each valuation date, the Company uses the market approach valuation technique to estimate the fair value of its fixed maturities portfolio, when possible. This market approach includes, but is not limited to, prices obtained from third party pricing services for identical or comparable securities and the use of "pricing matrix models" using observable market inputs such as yield curves, credit risks and spreads, measures of volatility, and prepayment speeds. Pricing from third party pricing services is sourced from multiple vendors, when available, and the Company maintains a vendor hierarchy by asset type based on historical pricing experience and vendor expertise. When prices are unavailable from pricing services, the Company obtains non-binding quotes from broker-dealers who are active in the corresponding markets. The valuation techniques including significant inputs and assumptions generally used to determine the fair values of the Company's fixed maturities by asset class as well as the classifications of the fair values of these securities in the fair value hierarchy are described in detail below.
Corporate debt securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As the yields for the risk-free yield curve and the spreads are observable market inputs, the fair values of corporate debt securities are generally classified as Level 2. Where pricing is unavailable from pricing services, the Company obtains non-binding quotes from broker-dealers to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, the fair values of these securities are classified as Level 3.
binding quotes from broker-dealers to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, the fair values of these securities are classified as Level 3.
The fair value of the indirect investment in CLO-Equities is classified as Level 3 as the fair value of this security is estimated using an income approach valuation technique, specifically an externally developed discounted cash flow model due to the lack of observable and relevant trades in secondary markets.
Derivative instruments include foreign exchange forward contracts and exchange traded interest rate swaps that are customized to the Company's economic hedging strategies and trade in the over-the-counter derivative market. The fair values of these derivatives are determined using a market approach valuation technique based on significant observable market inputs from third party pricing vendors, non-binding broker-dealer quotes and/or recent trading activity. As the significant inputs used to price these securities are observable market inputs, the fair values of these derivatives are classified as Level 2.
Insurance-linked securities comprise an investment in a catastrophe bond. As pricing is unavailable from pricing services, the Company obtains non-binding quotes from broker-dealers to estimate the fair value of this security. Pricing is generally unavailable when there is a low volume of trading activity and current transactions are not orderly therefore the fair value of this security is classified as Level 3.
During 2018 and 2017, the Company had no transfers between Levels 1 and 2.
The following table quantifies the significant unobservable inputs used in estimating fair values at December 31, 2018 of investments classified as Level 3 in the fair value hierarchy.
On a quarterly basis, the Company's valuation process for its indirect investment in CLO-Equities includes a review of the underlying cash flows and key assumptions used in the discounted cash flow model. The above significant unobservable inputs are reviewed and updated based on information obtained from secondary markets, including information received from the managers of the Company's CLO-Equity portfolio. In order to assess the reasonableness of the inputs the Company uses in its models, the Company maintains an understanding of current market conditions, historical results, as well as emerging trends that may impact future cash flows. In addition, the assumptions the Company uses in its models are updated through regular communication with industry participants and ongoing monitoring of the deals in which the Company participates (e.g. default and loss severity rate trends).
Other underwriting-related derivatives are initially valued at cost which approximates fair value. In subsequent measurement periods, the fair values of these derivatives are determined using internally developed discounted cash flow models which uses appropriate discount rates. The selection of an appropriate discount rate is judgmental and is the most significant unobservable input used in the valuation of these derivatives. A significant increase (decrease) in this input in isolation could result in a significantly lower (higher) fair value measurement for the derivative contracts. In order to assess the reasonableness of the inputs the Company uses in the discounted cash flow model, the Company maintains an understanding of current market conditions, historical results, as well as contract specific information that may impact future cash flows.
Unrealized investment gains (losses) on fixed maturities are included in other comprehensive income ("OCI").
The transfers out of Level 3 into Level 2 made during 2018 and 2017 were primarily due to the availability of observable market inputs and multiple quotes from pricing vendors for certain fixed maturities.
If there is a reporting lag between the current period end and reporting date of the latest available fund valuation for any hedge fund, the Company estimates fair values by starting with the most recently available fund valuation and adjusting for return estimates as well as any subscriptions, redemptions and distributions that took place during the current period. Return estimates are obtained from the relevant fund managers therefore the Company does not typically have a reporting lag in fair value measurements of these funds. Historically, the Company's valuation estimates incorporating these return estimates have not significantly diverged from the subsequently received NAVs.
For direct lending funds, private equity funds, real estate funds and two of the Company's hedge funds, valuation statements are typically released on a reporting lag therefore the Company estimates the fair value of these funds by starting with the most recent fund valuations and adjusting for capital calls, redemptions, drawdowns and distributions. Return estimates are not available from the relevant fund managers for these funds therefore the Company typically has a reporting lag in its fair value measurements of these funds. In 2018, funds reported on a lag represented 61% (2017: 44%) of the Company's total other investments balance.
The balance sheet classifications of derivatives recorded at fair value are shown in the following table.
The Company's derivative instruments are generally traded under International Swaps and Derivatives Association master netting agreements, which establish terms that apply to all transactions. In the event of a bankruptcy or other stipulated event, master netting agreements provide that individual positions be replaced with a new amount, usually referred to as the termination amount, determined by taking into account market prices and converting into a single currency. Effectively, this contractual close-out netting reduces credit exposure from gross to net exposure. A reconciliation of gross derivative assets and liabilities to the net amounts presented in the consolidated balance sheets, with the difference being attributable to the impact of master netting agreements, is shown in the following table.
Net asset and liability derivatives are classified within other assets and other liabilities on the consolidated balance sheets.
Refer to Note 6 'Investments' for information on reverse repurchase agreements.
The Company's investment portfolio contains a large percentage of fixed maturities which exposes it to significant interest rate risk. As part of overall management of this risk, the Company may use interest rate swaps.
The Company's (re)insurance subsidiaries and branches operate in various countries. Some of its business is written in currencies other than the U.S. dollar, therefore the underwriting portfolio is exposed to significant foreign currency risk. The Company manages foreign currency risk by seeking to match its foreign-denominated net liabilities under (re)insurance contracts with cash and investments that are denominated in the same currencies. The Company uses derivative instruments, specifically, forward contracts to economically hedge foreign currency exposures.
During 2013, the Company began to write derivative-based risk management products designed to address weather risks with the objective of generating profits on a portfolio basis. The majority of this business consisted of receiving a payment at contract inception in exchange for bearing the risk of variations in a quantifiable weather-related phenomenon, such as temperature. Where a client wished to minimize the upfront payment, these transactions were structured as swaps or collars. In general, the Company's portfolio of such derivative contracts was of short duration, with contracts being predominantly seasonal in nature. In order to economically hedge a portion of this portfolio, the Company also purchased weather derivatives. Effective July 1, 2017, the Company no longer writes derivative-based risk management products which address weather risks.
The Company enters into insurance and reinsurance contracts that are accounted for as derivatives. These insurance or reinsurance contracts provide indemnification to an insured or cedant as a result of a change in a variable as opposed to an identifiable insurable event. The Company considers these contracts to be part of its underwriting operations.
The Company's reserving process begins with the collection and analysis of paid and incurred claim data for each of the Company's segments. The segmental data is disaggregated by reserve class and further disaggregated by underwriting year and accident year. Underwriting year information is used to analyze the Company's business and subsequently allocate reserves to the respective accident years. Reserve classes are selected to ensure that the underlying contracts have homogeneous loss development characteristics, while remaining large enough to make the estimation of trends credible. The Company's reserve classes are reviewed on a regular basis and adjusted over time as the Company's business evolves. The paid and incurred claim data, in addition to industry benchmarks, serves as a key input to many of the methods employed by the Company's actuaries. The relative weights assigned to the Company's own historical loss data versus industry data vary according to the length of the development profile for the reserve class being evaluated (refer to 'Net Incurred and Paid Claims Development Tables By Accident Year' below for further details by reserve class).
Loss Development Method (also referred to as the "Chain Ladder Method" or "Link Ratio Method"): This method assumes that the losses incurred/paid for each accident year or underwriting year at a particular development stage follow a relatively similar pattern. It assumes that on average, every accident year or underwriting year will display the same percentage of ultimate losses incurred/paid at the same point in time after the inception of that year. The percentages incurred/paid are established for each development stage (e.g. 12 months, 24 months, etc.) after examining historical averages from historical loss development data and/or external industry benchmark information. Ultimate losses are then estimated by multiplying the actual incurred/paid losses by the reciprocal of the established incurred/paid percentage. The strengths of this method are that it reacts to loss emergence/payments and that it makes full use of historical claim emergence/payment experience. However, this method has weaknesses when the underlying assumption of stable loss development/payment patterns is not valid. This could be the consequence of changes in business mix, claim inflation trends or claim reporting practices and/or the presence of large claims, among other things. Furthermore,
Bornhuetter-Ferguson Method ("BF Method"): This method can be seen as a combination of the ELR and Loss Development Methods, under which the Loss Development Method is given progressively more weight as an accident year or underwriting year matures. The main advantage of the BF Method is that it provides a more stable estimate of ultimate losses than the Loss Development Method at earlier stages of development, while remaining more sensitive to emerging loss development than the ELR Method. In addition, the BF Method allows for the incorporation of external market information through the use of expected loss ratios, whereas the Loss Development Method does not incorporate such information.
As part of the loss reserve review process, the Company's actuaries employ the estimation method(s) that they believe will produce the most reliable estimate of ultimate losses, at that particular evaluation date, for each reserve class and accident year or underwriting year combination. Often, this is a blend (i.e. weighted average) of the results of two or more appropriate actuarial methods. These ultimate loss estimates are generally utilized to evaluate the adequacy of ultimate loss estimates for previous accident or underwriting years, established in the prior reporting period. For the initial estimate of the current accident or underwriting year, the available claim data is typically insufficient to produce a reliable estimate of ultimate losses. As a result, initial estimates for an accident or underwriting year are generally based on the ELR Method for longer tailed lines and a BF Method for shorter tailed lines. The initial ELR for each reserve class is established collaboratively by actuaries, underwriters and management at the start of the year as part of the planning process, taking into consideration prior accident years’ or underwriting years' experience and industry benchmarks, adjusted after considering factors such as exposure trends, rate differences, changes in contract terms and conditions, business mix changes and other known differences between the current year and prior accident or underwriting years. The initial expected loss ratios for a given accident or underwriting year may be modified over time if the underlying assumptions, such as loss development or premium rate changes, differ from the original assumptions.
In earlier years, significant reliance was placed on industry benchmarks in establishing expected loss ratios and selecting loss development patterns. Over time, more reliance has been placed on historical loss experience in establishing these ratios and selecting these patterns where the Company believes the weight of its own actual experience has become sufficiently credible for consideration. The weight given to the Company's experience differs for each of the three claim tail classes. In establishing expected loss ratios for the insurance segment, consideration is given to a number of other factors, including exposure trends, rate adequacy on new and renewal business, ceded reinsurance costs, changes in claims emergence and underwriters’ view of terms and conditions in the market environment. For the reinsurance segment, expected loss ratios are based on a contract-by-contract review, which considers information provided by clients together with estimates provided by underwriters and actuaries about the impact of changes in pricing, terms and conditions and coverage. Market experience of some classes of business as compiled and analyzed by an independent actuarial firm has also been considered, as appropriate.
The Company's reserving process involves the collaboration of underwriting, claims, actuarial, legal, ceded reinsurance and finance departments, includes various segmental committee meetings and culminates with the approval of a single point best estimate by the Company's Group Reserving Committee, which comprises senior management. In selecting this best estimate, management considers actuarial estimates and applies informed judgment regarding qualitative factors that may not be fully captured in these actuarial estimates. Such factors include, but are not limited to; the timing of the emergence of claims, volume and complexity of claims, social and judicial trends, potential severity of individual claims and the extent of internal historical loss data versus industry information. While these qualitative factors are considered in arriving at the point estimate, no specific provisions for qualitative factors are established.
The table below provides a reconciliation of beginning and ending net reserves for unpaid losses and loss expenses for the years indicated:
The Company writes business with loss experience generally characterized as low frequency and high severity in nature, which can result in volatility in its financial results. During 2018, 2017 and 2016, the Company recognized net losses and loss expenses, net of reinstatement premiums, of $430 million, $835 million and $204 million, respectively, attributable to catastrophe and weather-related events.
On January 1, 2018, AXIS Managing Agency Ltd., the managing agent of Syndicate 2007 entered into an agreement for the RITC of the 2015 and prior years of account of Syndicate 2007. This agreement was accounted for as a novation reinsurance contract. At December 31, 2018, foreign exchange and other included a reduction in reserves for losses and loss expenses of $819 million related to this transaction.
On April 1, 2017, the Company acquired 100% ownership interest in Aviabel. At December 31, 2017, foreign exchange and other included reserves for losses and loss expenses of $79 million and reinsurance recoverables on unpaid and paid losses of $5 million related to this acquisition.
These reserve classes contributed $86 million of net favorable prior year reserve development in 2018 reflecting the recognition of overall better than expected loss emergence related to the 2017 catastrophe events. These reserve classes contributed $60 million and $148 million of net favorable prior year reserve development in 2017 and 2016, respectively, reflecting the recognition of better than expected loss emergence.
Long-tail business consists primarily of the insurance and reinsurance liability reserve classes and the reinsurance motor reserve class.
At December 31, 2018, net reserve for losses and loss expenses includes estimated amounts for numerous catastrophe events. The magnitude and/or complexity of losses arising from these events, in particular the California Wildfires and Hurricanes Michael and Florence which occurred in 2018 as well as Hurricanes Harvey, Irma and Maria, and the two earthquakes in Mexico which occurred in 2017, inherently increase the level of uncertainty and, therefore, the level of management judgment involved in arriving at estimated net reserves for losses and loss expenses. As a result, actual losses for these events may ultimately differ materially from current estimates.
With regard to Novae, the Company entered into an agreement for the RITC of the 2015 and prior years of account of Syndicate 2007 on January 1, 2018. This agreement was accounted for as a novation reinsurance contract which resulted in a reduction in reserves for losses and loss expenses of $819 million. Consequently, the retrospective treatment for the acquisition of Novae was adopted at December 31, 2018 as the data necessary to produce the loss development tables by accident year was available.
With regard to Aviabel, the retrospective treatment for the acquisition was also adopted at December 31, 2018 as the data necessary to produce the loss development tables by accident year was available.
This reserve class includes the professional line of business which provides directors’ and officers’ liability, errors and omissions liability, employment practices liability, fiduciary liability, crime, professional indemnity, cyber and privacy insurance, medical malpractice and other financial insurance related covers for commercial enterprises, financial institutions, not-for-profit organizations and other professional service providers. This reserve class also includes discontinued lines - Novae specifically
This reserve class includes the liability line of business which primarily targets primary and low/mid-level excess and umbrella commercial liability risks in the U.S. wholesale markets in addition to primary and excess of loss employers, public and products liability predominately in the U.K. This reserve class also includes discontinued lines - Novae specifically the international liability line of business that Novae exited or placed into run-off in the fourth quarter of 2016. Target industry sectors include construction, manufacturing, transportation and trucking and other services. The delay between the writing of a contract, notification and subsequent settlement of a claim in respect of that contract results in claim reporting and payment patterns that are typically long-tail in nature. A consequence of the claim development tail is that this line of business is particularly exposed, among a number of uncertainties, to the potential for unanticipated levels of claim inflation relative to that assumed when the contracts were written. Factors influencing claim inflation on this class can include, but are not limited to, underlying economic and medical inflation, judicial inflation, mass tort and changing social trends.
The presentation of net incurred and paid claims development tables by accident year for the reinsurance segment is challenging due to the need to allocate loss information related to proportional treaties to the appropriate accident years. Information related to proportional treaty reinsurance contracts is generally submitted to the Company using quarterly bordereau reporting by underwriting year, with a supplemental listing of large losses. The large losses can be allocated to the corresponding accident years accurately. However, the remaining losses can generally only be allocated to accident years based on estimated premiums earned and loss reporting patterns. To the extent management’s assumptions and allocation procedures differ from the actual loss development patterns, the actual loss development may differ materially from the net incurred and paid claims development presented in the tables below.
The reporting of cumulative claims frequency for the reserve classes within the reinsurance segment is deemed to be impracticable. The information necessary to provide cumulative claims frequency for these reserve classes is not available to the Company.
This reserve class includes catastrophe, property, engineering, agriculture, marine and other, accident and health, and discontinued lines - Novae.
The marine and other line of business includes marine, aviation and personal accident reinsurance.
With respect to key actuarial assumptions, the Company is progressively giving more weight to its own experience when establishing expected loss ratios and selecting loss development patterns, though it continues to consider industry benchmarks. Loss reporting patterns for professional lines business tend to be volatile, causing instability in actuarial indications based on incurred loss data until an accident year matures. Consequently, initial loss reserves for an accident year or underwriting year are generally based upon the ELR Method and the consideration of relevant qualitative factors. As accident and underwriting years mature, the Company increasingly gives more weight to methods that reflect its actual experience until its selections are based almost exclusively on experience-based methods. The Company evaluates the appropriateness of the transition to experience-based methods at the reserve class level, commencing this transition when it believes that its incurred loss development is sufficient to produce meaningful actuarial indications. The rate at which the Company transitions fully to sole reliance on experience-based methods can vary by reserve class and by year, depending on its assessment of the stability and relevance of such indications.
This reserve class includes the liability line of business which provides cover to insurers of standard casualty business, excess and surplus casualty business and specialty casualty programs. The primary focus of the underlying business is general liability, although workers' compensation and auto liability covers are also written. This reserve class includes discontinued lines - Novae specifically the general liability reinsurance line of business that Novae exited or placed into run-off in the first quarter of 2017.
In the normal course of business, the Company purchases treaty and facultative reinsurance protection to limit its ultimate losses from catastrophic events and reduce its loss aggregation risk.
All of these reinsurance covers provide the Company the right to recover a portion of specified losses and loss expenses from reinsurers. However, to the extent that reinsurers do not meet their obligations under these agreements due to solvency issues, contractual disputes or other reasons, the Company remains liable. The Company predominantly cedes its business to reinsurers rated A- or better by internationally recognized rating agencies.
On March 23, 2010, AXIS Specialty Finance LLC, a 100% owned finance subsidiary, issued $500 million aggregate principal amount of 5.875% senior unsecured debt (the ''5.875% Senior Notes'') at an issue price of 99.624%. The net proceeds of the issuance, after consideration of the offering discount and underwriting expenses and commissions, totaled approximately $495 million. Interest on the 5.875% Senior Notes is payable semi-annually in arrears on June 1 and December 1 of each year, beginning on June 1, 2010. Unless previously redeemed, the 5.875% Senior Notes will mature on June 1, 2020. The 5.875% Senior Notes are ranked as unsecured senior obligations of AXIS Specialty Finance LLC. AXIS Capital has fully and unconditionally guaranteed all obligations of AXIS Specialty Finance LLC under the 5.875% Senior Notes. AXIS Capital’s obligations under this guarantee are unsecured senior obligations and rank equally with all other senior obligations of AXIS Capital.
On March 13, 2014, AXIS Specialty Finance PLC, a 100% owned finance subsidiary, issued $250 million aggregate principal amount of 2.65% senior unsecured notes (the "2.65% Senior Notes") at an issue price of 99.896% and $250 million aggregate principal amount of 5.15% senior unsecured notes (the "5.15% Senior Notes", and, together with the 5.875% Senior Notes and the 2.65% Senior Notes, the "Senior Notes") at an issue price of 99.474%. The net proceeds of the issuance, after consideration of the offering discount and underwriting expenses and commissions, totaled approximately $248 million and $246 million for the 2.65% Senior Notes and the 5.15% Senior Notes, respectively. Interest on the 2.65% Senior Notes and the 5.15% Senior Notes is payable semi-annually in arrears on April 1 and October 1 of each year, beginning on October 1, 2014. Unless previously redeemed, the 2.65% Senior Notes and the 5.15% Senior Notes will mature on April 1, 2019 and April 1, 2045, respectively. The 2.65% Senior Notes and the 5.15% Senior Notes are ranked as unsecured senior obligations of AXIS Specialty Finance PLC. AXIS Capital has fully and unconditionally guaranteed all obligations of AXIS Specialty Finance PLC under the 2.65% Senior Notes and the 5.15% Senior Notes. AXIS Capital's obligations under this guarantee are unsecured senior obligations and rank equally with all other senior obligations of AXIS Capital.
On December 6, 2017, AXIS Specialty Finance PLC, a 100% owned finance subsidiary, issued $350 million aggregate principal amount of 4.0% senior unsecured notes (the "4.0% Senior Notes") at an issue price of 99.78%. The net proceeds of the issuance, after consideration of the offering discount and underwriting expenses and commissions, totaled approximately $347 million. Interest on the 4.0% Senior Notes is payable semi-annually in arrears on June 6 and December 6 of each year, beginning on June 6, 2018. Unless previously redeemed, the 4.0% Senior Notes will mature on December 6, 2027. The 4.0% Senior Notes are ranked as unsecured senior obligations of AXIS Specialty Finance PLC. AXIS Capital has fully and unconditionally guaranteed all obligations of AXIS Specialty Finance PLC under the 4.0% Senior Notes. AXIS Capital's obligations under this guarantee are unsecured senior obligations and rank equally with all other senior obligations of AXIS Capital.
On June 30, 2004, Novae issued $15 million aggregate principal amount of LIBOR plus 3.50% subordinated unsecured notes (the "$15 million Dekania Notes") and $11 million aggregate principal amount of LIBOR plus 4.05% subordinated unsecured notes (the "$11 million Dekania Notes"). On September 29, 2004, Novae issued $10 million aggregate principal amount of LIBOR + 3.50% subordinated notes (the "$10 million Dekania Notes" and together with the "$15 million Dekania Notes" and the "$11 million Dekania Notes" the "Dekania Notes"). The net proceeds of the issuance, after consideration of the offering discount and underwriting expenses and commissions, totaled approximately $35 million. Interest on the Dekania Notes was payable quarterly in arrears on February 15, May 15, August 15 and November 15 of each year. On November 15, 2018, the Company fully redeemed the Dekania Notes at par.
On December 18, 2015, the Participating Subsidiaries renewed the $500 million secured LOC Facility with Citibank for a four year term commencing December 31, 2015, pursuant to certain updates to the LOC Facility Documents. All other material terms and conditions remained unchanged.
The terms and conditions of the $500 million secured letter of credit facility under the $750 million Facility remain unchanged. The $500 million secured letter of credit facility expires December 31, 2019.
At December 31, 2018, letters of credit outstanding under the LOC Facility totaled $395 million. At December 31, 2018, the Company was in compliance with all LOC Facility covenants.
On August 2, 2016, Novae entered into a syndicated bank financing facility, which provided the company with a combined letter of credit and revolving credit facility of $229 million and a term loan of $67 million.
At December 31, 2018, 89.5% (December 31, 2017: 88.8%) of the Company's reinsurance recoverable on unpaid and paid losses were collectible from reinsurers rated the equivalent of A- or better by internationally recognized rating agencies.
These contractual rights contribute to the mitigation of credit risk, together with the monitoring of aged premium balances receivable. In light of these mitigating factors, and considering that a significant portion of premium balances receivable are not currently due based on the terms of the underlying contracts, the Company does not utilize specific credit quality indicators to monitor its premium balances receivable.
At December 31, 2018, the Company recorded an allowance for estimated uncollectible premium balances receivable of $4 million (2017: $6 million).
In the ordinary course of business, the Company renews and enters into new leases for office space which expire at various dates. For the year ended December 31, 2018, operating lease expense was $33 million (2017: $29 million; 2016: $25 million).
In the normal course of business, the Company purchases reinsurance and retrocessional (collectively referred to as "reinsurance") protection for its insurance and reinsurance lines of business. Minimum reinsurance premiums are contractually due in advance on a quarterly basis. At December 31, 2018, the Company had outstanding reinsurance purchase commitments of $39 million, all of which is due before March 31, 2022. Actual payments under the reinsurance contracts will depend on the underlying subject premium and may exceed the minimum premium.
From time to time, the Company is subject to routine legal proceedings, including arbitrations, arising in the ordinary course of business. These legal proceedings generally relate to claims asserted by or against the Company in the ordinary course of insurance or reinsurance operations. Estimated amounts payable related to these proceedings are included in the reserve for losses and loss expenses in the Company's consolidated balance sheets.
At December 31, 2018 the Company has $507 million (2017: $414 million) of unfunded investment commitments related to its other investment portfolio, which are callable by investment managers (refer to Note 6(c) 'Investments'). At December 31, 2018 the Company has $4 million (2017: $16 million) of unfunded investment commitments to purchase commercial mortgage loans.
During 2018, the total cash dividends declared per common share were $1.57 (2017: $1.53; 2016: $1.43).
On December 31, 2017, authorization under the Board-authorized share repurchase plan for common share repurchases through 2017 expired. A common share repurchase plan has not been authorized for 2018 or 2019.
Amounts in 2016 include common shares acquired under the accelerated share repurchase program of 1,358,380 (see below for more detail).
During August 2015, under the terms of this agreement, the Company paid $300 million to Goldman Sachs and initially repurchased 4,149,378 common shares. The initial shares acquired represented 80% of the $300 million total paid to Goldman Sachs and were calculated using the Company’s stock price at the activation of the program. The ASR program was accounted for as an equity transaction. At December 31, 2015, $240 million of common shares repurchased were included as treasury shares in the consolidated balance sheets with the remaining $60 million included as a reduction to additional paid-in capital.
On January 15, 2016, Goldman Sachs early terminated the ASR agreement and delivered 1,358,380 additional common shares to the Company, resulting in the reclassification of $60 million from additional paid-in capital to treasury shares. In total, the Company repurchased 5,507,758 common shares under the ASR agreement at an average price of $54.47.
During October and November 2016, the Company repurchased 1,957,045 Series C preferred shares at an average purchase price of $25.67 per share for $50 million. In connection with the repurchase of these shares, a loss on redemption of $1 million, was recognized in determining net income available to common shareholders.
On April 17, 2017, the Company redeemed the remaining 14,042,955 Series C preferred shares, for an aggregate liquidation preference of $351 million.
On May 20, 2013, the Company issued $225 million of 5.50% Series D preferred shares, par value $0.0125 per share, with a liquidation preference of $25.00 per share. The Company may redeem the Series D preferred shares on or after June 1, 2018 at a redemption price of $25.00 per share. Dividends on the Series D preferred shares are non-cumulative. Holders of the Series D preferred shares will be entitled to receive, only when, as and if declared by the board of directors, non-cumulative cash dividends from the original issue date, quarterly in arrears on the first day of March, June, September and December of each year, commencing on September 1, 2013. To the extent declared, these dividends will accumulate, with respect to each dividend period, in an amount per share equal to 5.50% of the liquidation preference per annum.
At December 31, 2018, the Company had not redeemed any of the $225 million of 5.50% Series D preferred shares.
In 2018, total dividends declared on Series D preferred shares were $1.375 per share, of which $1.0313 was paid in 2018 and the remaining $0.34375 is payable in 2019. In 2017, total dividends declared on Series D preferred shares were $1.3750 per share, of which $1.0313 was paid in 2017 and $0.3438 was paid in 2018. In 2016, total dividends declared and paid on Series D preferred shares were $1.375 per share.
In 2018, total dividends declared on Series E preferred shares were $137.5 per share of which, $103.13 was paid in 2018 and the remaining $34.375 was paid in 2019. In 2017, total dividends declared and paid on Series E preferred shares were $137.5 per share of which, $103.13 was paid in 2017 and $34.375 was paid in 2018. In 2016, total dividends declared on Series E preferred shares were $34.375 per share, which were subsequently paid in 2017.
During 2018, total pension expenses were $27 million (2017: $24 million and 2016: $23 million) for the above retirement benefits.
In May 2017, shareholders approved the establishment of the AXIS Capital Holdings Limited 2017 Long-Term Equity Compensation Plan (the "2017 Plan"). The 2017 Plan provides for, among other things, the issuance of restricted shares, restricted stock units (share-settled awards and cash-settled awards), performance units (share-settled awards and cash-settled awards), stock options, stock appreciation rights and other equity-based awards to the Company's employees and directors. The 2017 Plan authorizes the issuance of a total of 3,400,000 common shares. The Company's 2017 Plan replaced its 2007 Long-Term Equity Compensation Plan ("2007 Plan") upon expiration of the 2007 Plan in May 2017. All remaining shares available pursuant to the 2007 Plan have been canceled although awards made pursuant to the 2007 Plan prior to its expiration remain in effect in accordance with the terms of the 2007 Plan. At December 31, 2018, 2,824,592 equity-based awards remained available for grant pursuant to the 2017 Plan. The grant date fair value of each award is established at the fair market value of the Company's common shares at the date of grant.
Restricted stock awards ("RSAs") granted pursuant to the 2007 Plan generally vest in accordance with a four year graded vesting schedule in four annual installments beginning on the grant date.
Restricted stock units ("RSUs") granted pursuant to the 2017 Plan or the 2007 Plan either cliff vest at the end of a three year period, vest in accordance with a three year graded vesting schedule, or vest in accordance with a four year graded vesting schedule in four annual installments beginning on the grant date.
Cash-settled restricted stock units ("Cash-settled RSUs") granted pursuant to the 2017 Plan or the 2007 Plan are liability awards and generally cliff vest at the end of a three year period, or vest in accordance with a four year graded vesting schedule in four annual installments beginning on the grant date.
Performance-vesting restricted stock units ("PSUs") granted pursuant to the 2017 Plan or the 2007 Plan, represent the right to receive a specified number of common shares in the future, based upon the achievement of established performance criteria and continued service during the applicable performance period. Awards granted pursuant to these plans generally cliff vest at the end of a three year period. Compensation expense is recognized on a straight-line basis over the applicable requisite service period and is subject to periodic adjustment based upon the achievement of established performance criteria during the applicable performance period. PSUs granted are either share-settled awards or cash-settled liability awards.
In 2016, the Company established the AXIS Executive RSU Retirement Plan (the "Plan") to reward certain eligible long-term employees of the Company for their dedicated service. The Plan was implemented in 2017. Subject to certain conditions being met, eligible employees will not forfeit all of their outstanding RSUs or Cash-settled RSUs on or following their retirement. Absent the Plan, outstanding RSUs are generally forfeited upon termination of employment.
The following table provides an activity summary of the Company's cash-settled RSUs:
(1) Cash-settled restricted stock units that vested during the year ended December 31, 2017 included 307,556 service based restricted stock units which were granted in 2014 and were subject to a three year cliff vesting period.
At December 31, 2018, the liability for cash-settled restricted stock units, included in other liabilities in the consolidated balance sheets, was $21 million (2017: $22 million).
During the year ended December 31, 2018, the fair value of share-settled restricted stock units and cash-settled restricted stock units that vested was $51 million (2017: $125 million, including $44 million attributable to service based restricted stock units which were granted in 2014 and were subject to a three year cliff vesting period; 2016: $67 million). At December 31, 2018, there was $87 million (2017: $94 million) of unrecognized share-based compensation costs which are expected to be recognized over the weighted average period of 2.4 years (2017: 2.5 years).
For the year ended December 31, 2018 the Company incurred share-based compensation costs of $54 million (2017: $68 million; 2016: $74 million) related to restricted stock awards, share-settled restricted stock units, and cash-settled restricted stock units. In addition, the Company recorded associated tax benefits of $8 million (2017: $15 million; 2016: $16 million).
A member of the Company’s Board of Directors, Mr. Charles Davis, is the Chief Executive Officer of Stone Point Capital, LLC ("Stone Point"). In the ordinary course of business, the Company engages SKY Harbor Capital Management, LLC, an affiliate of Stone Point, to provide asset management services for certain short duration high yield debt portfolios. For the year ended December 31, 2018, total fees paid to SKY Harbor Capital Management, LLC, were $2 million (2017: $2 million; 2016: $3 million).
The Company has invested $18 million in NXT Capital Senior Loan Fund II and $20 million in NXT Capital Senior Loan Fund III. The manager of these funds is an indirect subsidiary of NXT Capital Inc. ("NXT Capital"). Investment funds managed by Stone Point indirectly owned approximately 43% of NXT Capital until this ownership interest was sold in August 2018. For the year ended December 31, 2018, fees paid to NXT Capital were $1 million (2017: $1 million; 2016: $1 million).
Harrington and Harrington Re commenced operations in 2016 (refer to Note 6 'Investments'). AXIS Capital has the ability to exercise significant influence over the operating and financial policies of Harrington and Harrington Re. In the normal course of business, the Company entered into certain reinsurance transactions with Harrington Re. For the year ended December 31, 2018, the Company ceded reinsurance premiums of $194 million (2017: $213 million) and ceded losses of $142 million (2017: $119 million) to Harrington Re. In addition, Harrington Re paid certain acquisition costs and administrative fees to the Company. At December 31, 2018, the amount of reinsurance recoverable on unpaid and paid losses was $363 million (2017: $152 million) and the amount of ceded reinsurance payable included in insurance and reinsurance balances payable was $115 million (2017: $142 million) in the consolidated balance sheets. All transactions were conducted at market rates consistent with negotiated arms-length contracts.
The Company's U.S. subsidiaries are subject to federal, state and local corporate income taxes and other taxes applicable to U.S. corporations. The provision for federal income taxes has been determined under the principles of the consolidated tax provisions of the U.S. Internal Revenue Code and Regulations. Should the U.S. subsidiaries pay a dividend outside the U.S. group, withholding taxes will apply. The Company's U.S. subsidiaries are not under examination but remain subject to examination in the U.S. for tax years 2015 through 2018.
At December 31, 2018 and 2017, the total operating loss carryforwards includes Lloyd's deferred year of account losses of $68 million and $19 million, respectively.
As a result of the Company's acquisitions of Aviabel and Novae in 2017, $103.8 million of net deferred tax liabilities were acquired or established at the acquisition dates.
All operating and capital loss carryforwards and tax credits can be carried forward indefinitely with the exception of the U.S. net operating loss, which will expire in 2037.
At December 31, 2018 and 2017, the U.K. operating loss carryforward includes Lloyd's deferred year of account losses of $403 million and $113 million, respectively.
The following table presents the distribution of income before income taxes between domestic and foreign jurisdictions as well as a reconciliation of the actual income tax rate to the amount computed by applying the effective tax rate of 0% under Bermuda law to income before income taxes:
The following table presents reclassification amounts from accumulated other comprehensive income ("AOCI") to net income (loss) available (attributable) to common shareholders:
Amounts in parentheses are charges to net income (loss) available (attributable) to common shareholders
The Company's insurance and reinsurance operations are subject to insurance and/or reinsurance laws and regulations in the jurisdictions in which they operate, the most significant of which include Bermuda, Ireland, the U.S. In addition, the Company is regulated by Lloyd's. These regulations include certain restrictions on the amount of dividends or other distributions, such as loans or cash advances, available to shareholders without prior approval of the insurance regulatory authorities.
Under the Insurance Act 1978, amendments thereto and Related Regulations of Bermuda (the "Act"), the Company's Bermuda subsidiary, AXIS Specialty Bermuda is required to maintain minimum statutory capital and surplus equal to the greater of a minimum solvency margin ("MSM") and the Enhanced Capital Requirement ("ECR"). The MSM is the greater of $100 million, 50% of net premiums written, 15% of the net reserve for losses and loss expenses and 25% of the ECR. The Company's ECR is calculated based on a standard risk-based capital model developed by the Bermuda Monetary Authority ("BMA"). In 2016, the BMA implemented an Economic Balance Sheet ("EBS") framework which was used as the basis to determine the ECR. At December 31, 2018 and 2017, the required and available statutory capital and surplus were based on this EBS framework.
Under the Act, AXIS Specialty Bermuda is restricted as to the payment of dividends for amounts greater than 25% of the prior year’s statutory capital and surplus, whereby an affidavit signed by at least two members of the Board of Directors is required, attesting that any dividend in excess of this amount would not cause the Company to fail to meet its relevant margins. At December 31, 2018, the maximum dividend AXIS Specialty Bermuda could pay, without a signed affidavit, having met minimum levels of statutory capital and surplus requirements, was approximately $0.9 billion (2017: $0.9 billion).
Effective January 1, 2016, the Company's Irish subsidiaries, AXIS Specialty Europe SE and AXIS Re SE, are required to maintain the Minimum Capital Requirement ("MCR") subject to a monetary minimum floor, and the Solvency Capital Requirement ("SCR") at all times. The capital requirements are calculated by reference to Solvency II definitions. If an entity falls below the MCR or SCR, the Central Bank of Ireland is authorized to take action to restore the financial position of the Company's Irish subsidiaries. During 2018 and 2017, the Company's Irish subsidiaries were in compliance with these requirements.
The Company operates in the Lloyd’s market through AXIS Corporate Capital UK Limited which is the sole corporate member of Syndicate 1686. Syndicate 1686 was managed by a third party managing agency, Asta Managing Agency Limited until August 2017 when the Company received final authorization from Lloyd's, the Prudential Regulation Authority ("PRA") and the Financial Conduct Authority ("FCA") for its own Lloyd's managing agent, AXIS Managing Agency Ltd. ("AXIS Managing Agency"). Effective August 4, 2017, AXIS Managing Agency assumed management of Syndicate 1686, replacing the Company's third-party managing agency agreement with Asta Managing Agency Limited, which had been in place since 2014.
In addition, the Company operates in the Lloyd's market through Novae Corporate Underwriting Limited, the sole corporate member of Syndicate 2007. The Company owned Lloyd’s managing agency, Novae Syndicates Limited ("NSL"), which operated in the Lloyd’s insurance market and managed Syndicate 2007 and SPA 6129, until it was deregistered in 2018. On January 1, 2018, the Company received authorization from Lloyd’s for AXIS Managing Agency to commence management and oversight of Syndicate 2007 and SPA 6129.
December 31, 2018, fixed maturities and short term investments with a fair value of $528 million (2017: $564 million), equity securities with a fair value of $40 million (2017: $59 million), and cash of $16 million (2017: $nil) were restricted to satisfy Novae Corporate Underwriting Limited FAL requirements (refer to Note 6 'Investments').
Total statutory net income (loss) of the Company's operating subsidiaries was $268 million, $(94) million, $598 million for 2018, 2017 and 2016, respectively. The differences between statutory financial statements and statements prepared in accordance with U.S. GAAP vary by jurisdiction, however, the primary differences are that statutory financial statements may not reflect deferred acquisition costs, certain net deferred tax assets, goodwill and intangible assets, unrealized investment gains (losses) on fixed maturities or certain unauthorized reinsurance recoverable balances.
During the three months ended March 31, June 30, September 30 and December 31, 2018, the Company recognized transaction and reorganization expenses of $13 million, $19 million, $16 million and $19 million, respectively, related to its transformation program which was launched in 2017. This program encompasses the integration of Novae which commenced in the fourth quarter of 2017, the realignment of the accident and health business, together with other initiatives designed to increase the Company's efficiency and enhance the Company's profitability while delivering a customer-centric operating model. During the three months ended September 30 and December 31, 2017, the Company recognized transaction and reorganization expenses of $6 million and $21 million, respectively.
During the three months ended March 31, June 30, September 30 and December 31, 2018, the Company recognized amortization of VOBA of $57 million, $53 million, $39 million, $23 million, respectively, related to the acquisition of Novae. During the three months ended December 31, 2017, the Company recognized amortization of VOBA of $50 million. Refer to Item 8, Note 3 and Note 5 to the Consolidated Financial Statements 'Business Combinations' and 'Goodwill and Intangible Assets' for further details.
During the three months ended December 31, 2017, the Company recognized tax expense of $42 million due to the revaluation of net deferred tax asset pursuant to the U.S. Tax Reform. Refer to Item 8, Note 18 to the Consolidated Financial Statements 'Income Taxes' for further details.