We underwrite and manage a variety of largely non-correlated specialty insurance products through five insurance underwriting segments and our Investing segment. Our insurance underwriting segments are U.S. Property & Casualty, Professional Liability, Accident & Health, U.S. Surety & Credit and International. We market our insurance products through a network of independent agents and brokers, through managing general agents owned by the company, and directly to consumers. In addition, we assume insurance written by other insurance companies.
We produced total revenue of $2.5 billion, of which 88% related to net earned premium and 9% related to net investment income.
We purchased $42.2 million of our common stock at an average cost of $40.02 per share. At year-end, we had $207.6 million remaining under our current $300.0 million share buyback authorization.
We increased our regular quarterly cash dividend to $0.225 per share, marking the 17th consecutive year of increases and the largest increase in the quarterly cash dividend in our history. We declared dividends of $0.78 per share and paid $72.0 million of dividends in 2013.
The following sections discuss our key operating results. The reason for any significant variations between 2012 and 2011 are the same as those discussed for variations between 2013 and 2012, unless otherwise noted. Amounts in tables are in thousands, except for earnings per share, percentages, ratios and number of employees.
During the past three years, we recognized the following pretax net losses, including reinstatement premium, for these major catastrophic events: 1) 2013 - European floods ($15.0 million) and German hail storms ($13.0 million); 2) 2012 - Superstorm Sandy ($30.8 million); and 3) 2011 - Japan earthquake and tsunami ($46.1 million), Hurricane Irene ($23.3 million), New Zealand earthquakes ($17.7 million), United States tornados ($13.3 million), Thailand floods ($10.0 million) and Denmark storms ($7.5 million). The remaining catastrophes, which we refer to as “small catastrophes” and that primarily impacted our property treaty line of business, were not individually significant events to us. We reinsure a portion of our exposure to catastrophic events, although we incur some additional cost for reinstatement premium to continue our reinsurance coverage for future loss events. The following table summarizes our accident year catastrophe losses, as well as the impact on our net earnings and key metrics.
We recognized net favorable loss development of $73.7 million in 2013 and $70.0 million in 2012, which included, in the respective periods, $7.3 million and $21.4 million of net favorable development related to prior year catastrophes. We recognized net adverse development of $10.1 million in 2011, which included $8.1 million of net favorable development related to prior year catastrophes. See the “Loss and Loss Adjustment Expense” and “Segment Operations” sections below for discussion of our loss activity and the “Critical Accounting Policies” section below for discussion of our policies and procedures related to establishing and reviewing loss reserves.
Net investment income, which is included in our Investing segment, decreased 1% in 2013, primarily due to reduced reinvestment yields. Net investment income increased 5% in 2012 due to growth in our investment portfolio, partially offset by the effect of reduced reinvestment yields. The cost basis of our fixed maturity and equity securities portfolios increased 4% in 2013 and 11% in 2012, from $5.5 billion at December 31, 2011 to $6.1 billion at December 31, 2012 and $6.4 billion at December 31, 2013, primarily from cash flow from operations. Our investment expense increased in both 2012 and 2013 due to growth in the portfolio and expanded investment advisory and accounting fees.
We incur expenses for insurance claims paid or payable to policyholders, as well as the potential liability for incurred but not reported claims, and the expense to adjust and settle all claims (collectively referred to as loss and loss adjustment expense). Our net loss ratio is the percentage of our loss and loss adjustment expense divided by our net earned premium in each year.
Loss development represents an increase or decrease in estimates of ultimate losses related to business written in prior accident years. We record such increases or decreases as loss and loss adjustment expense in the current reporting year. Favorable development means our original ultimate loss estimate was higher than the current estimate. Adverse development means the current ultimate loss estimate is higher than our original estimate. Loss development occurs as we review our loss exposure with our actuaries, increasing or decreasing estimates of our ultimate losses as a result of such reviews and as losses are finally settled or claims exposure changes.
The tables below detail our net loss and loss adjustment expense and our net loss ratios on a consolidated basis and for our segments.
Loss and loss adjustment expense decreased 1% in 2013 and 7% in 2012. The 2013 decrease was primarily due to a lower accident year net loss ratio. The 2012 decrease was driven by: 1) net favorable loss development in 2012, compared to net adverse development in 2011, 2) lower accident year catastrophe losses in 2012 and 3) a slightly lower non-catastrophe accident year loss ratio in 2012. Excluding catastrophes, our accident year net loss ratio was 58.5% for 2013, 59.1% for 2012 and 60.0% for 2011. The net favorable loss development in 2013 and 2012 included adverse development of $70.3 million and $48.9 million, respectively, related to reserve increases on Spanish surety bonds in the International segment. The 2011 net adverse loss development included adverse development of $104.2 million related to our diversified financial products (DFP) line of business in the Professional Liability segment and $12.8 million related to the Spanish surety bonds. See the “Segment Operations” section below for additional discussion of the changes in net loss development and net loss ratios for each segment.
The amount of claims paid fluctuates year-over-year due to the timing of claims settlement, the occurrence of catastrophic events and commutations, and the mix of our business. Our net paid loss ratio decreased slightly in both 2013 and 2012 due to offsetting changes in the amount of claims paid across our different lines of business.
Other operating expense increased 3% in 2013 and 9% in 2012. The 2013 increase related to higher employee compensation and benefit costs, partially offset by a benefit recorded in 2013 related to an indemnification liability. We reduced the indemnification liability, which related to a 2001 subsidiary sale, by $5.1 million due to favorable claims activity and successful subrogation recoveries. The 2012 increase was primarily due to increased compensation expense, including higher bonus expense directly related to higher pretax earnings in 2012, and the year-over-year fluctuation in foreign currency benefit/expense. We recognized foreign currency expense of $5.3 million and $6.2 million in 2013 and 2012, compared to a benefit of $1.1 million in 2011. The foreign currency benefit/expense related to changes in the value of the British pound sterling and the Euro relative to the U.S. dollar.
Our income taxes are due to U.S. Federal, state, local and foreign jurisdictions. Our effective income tax rate was 28.9% for 2013, compared to 29.4% for 2012 and 28.1% for 2011. Fluctuations in our effective tax rates are due to the relationship of pretax income and tax-exempt investment income. Our pretax income was substantially higher in 2013 and 2012 than in 2011, whereas our tax-exempt investment income increased slightly each year. The lower effective rate in 2011 related to the increased benefit from tax-exempt investment income relative to a lower pretax income base.
We recognized favorable development in 2013 in our aviation line of business primarily for treaty years 2011 and prior due to better than expected actuarially-indicated results since our prior annual review. We experienced substantially lower losses and loss ratios in our E&O line of business in 2013, due to favorable development in 2013 (primarily for underwriting years 2010 and 2011), compared to adverse development in 2012 and 2011 (both years primarily related to underwriting years 2005 - 2010).
The public risk line of business recognized adverse development in 2012 due to deteriorating results compared to actuarial expectations, particularly from large property losses, related to underwriting years 2009 and 2010. This adverse development was partially offset by favorable development from release of $2.5 million of catastrophe reserves related to Hurricane Irene (2011).
The public risk line of business incurred catastrophe losses of: 1) 2013 - Midwest tornados ($2.0 million); 2) 2012 - Superstorm Sandy ($3.8 million) and United States spring storms ($3.2 million); and 3) 2011 - Hurricane Irene ($5.0 million). Various lines of business incurred additional catastrophe losses of $4.3 million in 2012, mainly for Superstorm Sandy, and $1.2 million in 2011.
Operating expense increased in 2012 and 2013 due to increasing compensation costs, mainly related to new underwriting teams. The segment’s expense ratio was lower in 2013 primarily due to higher ceding commissions (that offset policy acquisition costs) from increased writings of our highly-ceded sports and entertainment disability product.
Our Professional Liability segment pretax earnings increased $7.5 million in 2013, compared to 2012, due to an improved net loss ratio, primarily related to re-underwriting of our diversified financial products (DFP) line of business in U.S. D&O beginning in 2012. The segment’s pretax earnings increased $74.6 million in 2012, compared to 2011, primarily due to $25.9 million of net favorable loss development in 2012 compared to $47.1 million of net adverse development in 2011.
The 2013 net favorable development consisted of $15.5 million in U.S. D&O and $10.8 million in International D&O. Our 2013 review indicated better than expected experience for underwriting years prior to 2007 as well as 2009 and 2010 (totaling $64.2 million), partially offset by reserve strengthening of $37.9 million in underwriting years 2007 and 2008, which were impacted by the worldwide financial crisis. Reserves for DFP performed slightly better than expected in the past year, but no changes were made to the estimated ultimate losses given the continued evaluation and re-underwriting of this line of business.
The 2011 net adverse development related to our DFP line of business, which provides coverage for private equity partnerships, hedge funds, investment managers and similar groups. In 2011, DFP recorded $104.2 million of adverse development, as well as $37.3 million of additional losses related to our increase in the ultimate loss ratio for accident year 2011. These reserve changes resulted primarily from revised assumptions with regards to the frequency and severity of claims in the 2008 - 2011 accident years, with the majority of the impact in the 2009 - 2011 accident years. Our expectation prior to our third quarter 2011 review was that the frequency and severity of claims after 2008 would be more consistent with our experience prior to the worldwide financial crisis in 2007 and 2008. However, our reserve review indicated that loss experience was emerging consistent with the financial crisis period, prompting our revised assumptions at that time. Our U.S. D&O and International D&O lines of business had favorable development of $32.2 million and $24.9 million, respectively, in 2011, which partially offset the adverse development from DFP. The favorable D&O development resulted from our scheduled reserve review, which indicated lower than expected actual experience in accident years prior to 2006, resulting in greater reliance on our historical loss patterns in the actuarial estimates for these more mature years.
The Accident & Health segment’s pretax earnings increased 12% in 2013 and 20% in 2012 due to growth in net earned premium and the impact of net favorable loss development in 2013 and 2012. Medical stop-loss premium increased due to writing new business and rate increases on renewal business. The segment results included net favorable loss development of $18.0 million in 2013, $10.5 million in 2012 and $1.3 million in 2011.
The majority of our stop-loss business provides annual coverage for groups of employees, and claims are reported and settled within 12 to 15 months for each reporting year. We generally conducted our annual review of reserves in the fourth quarter. However, in the third quarter of 2012, we exited two lines of business that had previously been reported in this segment. As a result, we conducted our 2012 reserve review in the third quarter. Our 2013 reserve review indicated lower than expected claims activity related to the 2012 and 2011 underwriting years. The 2012 development related to lower than expected claims activity related to the 2011 underwriting year.
Our U.S. Surety & Credit segment pretax earnings increased 10% in 2013 and 24% in 2012, due to the increased net favorable loss development in each year. Net earned premium for our surety line of business decreased in 2013 and 2012, primarily due to competition and economic conditions impacting the construction industry. Gross written premium increased in 2013 as market conditions began to improve.
The segment had net favorable loss development of $37.9 million in 2013, $25.4 million in 2012 and $11.3 million in 2011. Our annual reserve review, which we conducted in the fourth quarter, indicated that actual loss experience for the 2011 and prior underwriting years was significantly better in 2013 than the actuarial expectations in our 2012 review. As a result, we recognized favorable development of $20.6 million for surety and $17.3 million for credit. The 2012 development included $18.0 million for surety and $7.4 million for credit, and the 2011 development included $10.0 million for surety and $1.3 million for credit. The 2012 and 2011 development related to lower than expected loss experience in underwriting years prior to 2011 and 2010, respectively.
The segment’s pretax earnings were impacted by net catastrophe losses, including reinstatement premium, for these major catastrophic events: 1) 2013 - European floods ($15.0 million) and German hail storms ($13.0 million); 2) 2012 - Superstorm Sandy ($23.9 million); and 3) 2011 - Japan earthquake and tsunami ($39.1 million), Hurricane Irene ($18.1 million), New Zealand earthquakes ($17.6 million), United States tornados ($12.3 million) and Denmark storms ($7.5 million). The remaining losses were small catastrophes that impacted our property treaty business. The following table summarizes the segment’s accident year catastrophe losses, as well as the impact on key metrics:
The totals in the above table include favorable development from prior years’ catastrophes of $6.0 million, $18.9 million and $7.6 million in 2013, 2012 and 2011, respectively, related primarily to these events: 1) 2013 - Superstorm Sandy; 2) 2012 - Hurricane Irene and the Japan earthquake and tsunami; and 3) 2011 - the 2005 hurricanes.
The segment’s expense ratio increased in 2013 due to higher compensation and benefits expense, as well as higher technology costs related to implementation of new systems during the year.
Our Investing segment includes our total investment portfolio, as well as all investment income, investment related expenses, realized investment gains and losses, and other-than-temporary impairment credit losses on investments. Our insurance segments generate the cash flow underlying these investments. We manage all investments and evaluate our investment results centrally and, thus, include them in a separate segment for reporting purposes.
The following tables summarize the results and certain key metrics of our Investing segment.
In the past several years, the average yield on our fixed maturity securities has continued to decline due to persistently lower interest rates on new investments. We have addressed this issue by investing longer-term, especially in tax-exempt municipal bonds, in anticipation of a prolonged low interest rate environment and, since 2012, by investing in new classes of securities with attractive yields and low/no duration. These new classes of investments include bank loans (classified as corporate securities), collateralized loan obligations (classified as asset-backed securities) and global publicly-traded equity securities. At December 31, 2013, our investments included $144.7 million of bank loans, $88.0 million of collateralized loan obligations and $517.5 million of equity securities, compared to $132.8 million, none and $284.6 million, respectively, at December 31, 2012.
The weighted average duration of our fixed maturity securities portfolio increased from 4.7 years at December 31, 2012 to 5.1 years at December 31, 2013. The higher duration directly relates to increased prevailing interest rates and spreads, primarily in the second quarter of 2013, due to investor concerns that the U.S. Federal government would tighten its fiscal policies. In 2013, rates on 10-year U.S. Treasury notes rose 126 basis points to their highest level in two years. Duration dropped in 2012, primarily due to the impact of lower market interest rates, at that time, on our municipal securities with call options and structured securities with prepayment options.
The average tax equivalent yield of our fixed maturity securities portfolio was 4.5%, 4.7% and 4.8% in 2013, 2012 and 2011, respectively. These yields reflect general declines in market interest rates over the three years, partially offset by longer average duration of our new investments. Our general policy has been to hold our available for sale securities through periods of fluctuating interest rates. We sell securities and recognize realized gains and losses from these sales if we can reinvest the proceeds at a higher effective yield or if the security has credit-related issues.
At December 31, 2013, we held corporate securities issued by foreign corporations with an aggregate fair value of $497.0 million. In addition, we held securities issued by foreign governments, agencies or supranational entities with an aggregate fair value of $147.4 million. The following table details our holdings of foreign debt at December 31, 2013.
The impact of foreign currency expense fluctuated year-over-year principally due to changes in the value of the British pound sterling and the Euro relative to the U.S. dollar. We hold available for sale securities denominated in non-functional currencies to economically hedge the currency exchange risk on our loss reserves denominated in non-functional currencies. The foreign currency benefit/expense related to loss reserves is recorded through the income statement, while the foreign currency benefit/expense related to available for sale securities is recorded through other comprehensive income within shareholders’ equity. This accounting mismatch may cause fluctuations in our reported foreign currency benefit/expense in future periods.
We believe we have sufficient sources of liquidity at both a consolidated and insurance company legal entity level at a reasonable cost to pay claims and meet our other contractual obligations and liabilities as they become due in the short-term and long-term. Our current sources of liquidity include: 1) significant operating cash flow generated by our insurance companies, 2) a $6.7 billion investment portfolio, most of which is held by our insurance companies, 3) our revolving loan and standby letter of credit facilities and 4) a $1.0 billion shelf registration. Our insurance companies have sufficient resources to pay potential claims. Based on historical payment patterns and claims history, as of year-end 2013 we project that our insurance companies will pay approximately $1.6 billion of claims and collect approximately $0.4 billion of reinsurance recoveries in 2014. In addition to expected cash flow from their 2014 operations, these companies had $6.0 billion of investments available to fund claims payments, if needed. Our sources of liquidity are discussed below.
We manage the liquidity of our insurance companies such that each subsidiary’s anticipated claims payments will be met by its own current operating cash flows, cash, short-term investments or investment maturities. Our insurance companies receive substantial cash from premiums, reinsurance recoverables, surety collateral, outward commutations, proceeds from sales and redemptions of investments, and investment income. Their principal cash outflows are for the payment of claims and loss adjustment expenses, premium payments to reinsurers, return of surety collateral, inward commutations, purchases of investments, policy acquisition costs, operating expenses, taxes and dividends paid to the parent company. We report all of the insurance companies’ investing activity in our Investing segment for segment reporting purposes. Our parent company’s principal cash inflows relate to its investment portfolio and dividends paid by the insurance companies, and its principal cash outflows relate to debt service, operating expenses, dividends paid to shareholders and common stock purchases. Cash provided by operating activities can fluctuate due to timing differences in the collection of premium receivables, reinsurance recoverables and surety collateral; the payment of losses, premium payables and return of surety collateral; and the completion of commutations.
The net effect of payment of claims and collection of recoverables related to the Spanish surety bonds is expected to continue to impact our cash provided by operating activities in 2014, although the amount and timing of such payments and receipts are not determinable at this time.
At December 31, 2013, we held a $6.7 billion investment portfolio, which included $178.8 million of liquid short-term investments. Our fixed maturity and equity securities portfolios are classified as available for sale. We expect to hold our fixed maturity securities until maturity, but we would be able to sell these securities, as well as our equity securities to generate cash if needed. See the “Investing Segment” section above for additional information about our investment portfolio. The parent company holds $684.6 million of cash and investments at December 31, 2013, which are available to cover the holding company’s required cash disbursements in 2014.
We maintain a $600.0 million Revolving Loan Facility (Facility), of which $239.1 million of available capacity remained at December 31, 2013. During the past three years, we used the Facility primarily to fund repurchases of our common stock. We expect to continue to use the Facility to opportunistically repurchase stock in 2014. We also have a $90.0 million Standby Letter of Credit Facility (Standby Facility) that is used to guarantee our performance in our Lloyd’s of London syndicate. The Facility expires in April 2017, and the Standby Facility expires in December 2017. See Note 7, “Notes Payable” to the Consolidated Financial Statements for additional information related to the Facilities and our long-term indebtedness.
During 2013, we purchased 1.1 million shares of our common stock in the open market for a total cost of $42.2 million and a weighted-average cost of $40.02 per share under the Plan. Since our repurchase program began in 2008, we have purchased 25.2 million shares for $728.4 million, or $28.86 per share, through December 31, 2013. At February 14, 2014, $185.7 million of repurchase authority remains under the Plan.
The following table summarizes our total contractual cash payment obligations by estimated payment date at December 31, 2013.
(6) Purchase obligations primarily relate to agreements with vendors to purchase maintenance and administrative services for our technology systems and to license software.
Inflation can also affect interest rates. A significant increase in interest rates could increase our net investment income related to newly invested cash flow and could also have a material adverse effect on the fair value of our investments. In addition, the interest rate payable under our Revolving Loan Facility fluctuates with market interest rates. See