Overview-Year ended December 31, 2015 versus year ended December 31, 2014
We ended 2015 with a book value per share of $10.53, reflecting a 3.8% increase, including quarterly dividends of $0.21 per share, on an internal rate of return basis for the year ended December 31, 2015.
Net income attributable to OneBeacon's common shareholders was $36.8 million for 2015, compared to $32.9 million in 2014. Pre-tax underwriting income was $43.5 million for 2015, reflecting a combined ratio of 96.3%, compared to a pre-tax underwriting loss of $20.5 million for 2014, reflecting a combined ratio of 101.7%. The increase in pre-tax underwriting results was driven by the significant impact of loss and loss adjustment expense (LAE) recorded in the fourth quarter of 2014 totaling $109.2 million, as noted below in "2014 Fourth Quarter Reserve Increase." The 2015 pre-tax underwriting results were driven by solid results in most of our underwriting operating segments, but were partially offset by unfavorable results in our Entertainment, Programs, Inland Marine and Ocean Marine businesses. Pre-tax net investment results were $10.8 million for 2015, representing a 0.6% total return on average invested assets, compared to $83.8 million for 2014, representing a 3.5% total return on average invested assets, with the decline being driven by other investments generating significantly lower returns in energy exposed private equity funds relative to the prior year period and negative valuation adjustments on surplus notes provided in conjunction with the financing of the Runoff Transaction, lower equity market performance, and decreased returns for the fixed maturity investment portfolio driven by interest rate movements. In addition, we had a tax benefit in 2015 of $12.9 million compared to a tax benefit of $12.3 million in 2014. The current year tax benefit was driven by the significant unfavorable change in unrealized investment gains in 2015.
Our book value in 2014 was also adversely impacted by $20.6 million associated with discontinued operations, driven primarily by valuation adjustments related to the surplus notes.
A summary of our consolidated underwriting income and pre-tax income from continuing operations is as follows:
The following table provides our consolidated underwriting ratios for our continuing operations:
(1)Reflects the valuation of the Qualified Plan using termination assumptions. See Note 1-"Nature of Operations and Summary of Significant Accounting Policies" and Note 8-"Retirement Plans"of the accompanying consolidated financial statements.
Net favorable prior year loss and LAE reserve development was $1.8 million, or 0.2 points for 2015 primarily attributable to favorable development from several businesses, most notably Technology, and to a lesser extent, from Collector Cars and Boats, Specialty Property and Financial Services, along with certain other businesses. This favorable development was mostly offset by unfavorable development due to several large losses and an increase in small to mid-size claims in Entertainment, and to a lesser extent, unusually heavy loss activity of both large and small claims in Ocean Marine, as well as moderate unfavorable development from certain other businesses. This compared with $89.8 million or 7.6 points, of net unfavorable loss reserve development of which $75.5 million, or 6.4 points, related to the 2014 fourth quarter reserve increase. Of the net unfavorable loss and LAE reserve development resulting from the 2014 fourth quarter reserve increase, $31.9 million related to Other Professional Lines driven primarily by lawyers professional liability and $11.6 million related to Entertainment resulting from several large losses. The remaining net unfavorable prior year loss and LAE reserve development for 2014 primarily related to unfavorable development recognized prior to the 2014 fourth quarter also in our Other Professional Lines (including lawyers professional liability) and Management Liability businesses, offset in part by favorable development in our Healthcare business.
The expense ratio increased 4.2 points to 36.7% for 2015, which was primarily driven by 2014 benefiting from a 2.4 point reduction in the incentive compensation accrual resulting from the 2014 fourth quarter reserve increase and from a transition services agreement with the buyer of our legacy personal lines business, which was terminated on June 30, 2014. Additionally, 2015 was negatively impacted by the exit of the Crop business, separation costs associated with senior management restructuring, and severance costs incurred in the current year.
Net investment income increased to $45.9 million for 2015, compared to $43.4 million for 2014. Net realized and change in unrealized investment gains decreased significantly to negative $35.1 million, compared to positive $40.4 million in 2014, due to unfavorable results in the other investments portfolio driven by lower returns in energy exposed sector private equity funds and a negative valuation impact from the surplus notes of $13.6 million recorded in 2015 resulting from increased credit spreads. The 2015 return was also significantly impacted by decreased returns in the common equity securities portfolio due to lower equity market performance as well as decreased returns in the fixed maturity portfolio driven by interest rate movements.
Consolidated Results-Year ended December 31, 2014 versus year ended December 31, 2013
Arrangement, and a decrease of $8.6 million investment pre-tax results compared to 2013. Total expenses increased to $1,224.4 million for 2014 from $1,060.8 million for 2013, resulting primarily from an increase in loss and LAE of $193.0 million to $815.1 million for 2014, impacted by the 2014 fourth quarter reserve increase as well as loss provisions associated with the increase in earned premium and other factors discussed below in "Underwriting Results."
Consolidated net written premiums increased 11.8% to $1,216.9 million in 2014, resulting primarily from growth in net written premiums from our newer businesses, particularly Crop, Programs and Surety. Excluding the $79.5 million increase in net written premiums for these newer businesses, as well as an increase of $11.7 million in net written premiums related to Star & Shield Insurance Exchange (Star & Shield), a White Mountains affiliate, premiums grew by 3.5% in 2014.
Our combined ratio for 2014 of 101.7% reflected a 69.2% loss and LAE ratio and a 32.5% expense ratio, which compared to a combined ratio for 2013 of 92.4%, consisting of a 55.5% loss and LAE ratio and a 36.9% expense ratio.
Current accident year non-catastrophe losses for 2014 were $711.5 million, or 60.4 points, reflecting the impact of the 2014 fourth quarter reserve increase, compared to $613.0 million, or 54.7 points, for 2013, which was positively impacted by the lower loss and LAE ratio in the Collector Cars and Boats business.
Catastrophe losses were $13.8 million, or 1.2 points, for 2014, primarily resulting from wind and thunderstorms in the southern, central and eastern United States, as well as ice and snow storms in the midwestern and northeastern United States, compared to $9.1 million, or 0.8 points, for 2013, primarily resulting from storms in the southern United States and rainstorms in Colorado.
Net investment income increased to $43.4 million for 2014, compared to $43.0 million for 2013. Net realized and change in unrealized investment gains decreased to $40.4 million, compared to $49.4 million in 2013, as a decreased return in 2014 in the common equity securities portfolio driven by lower equity market returns more than offset improvements in 2014 in the fixed maturity portfolio return as the 2013 results were adversely impacted by increases in interest rates.
Our income tax (expense) benefit related to pre-tax income from continuing operations for 2014 and 2013 represented net effective tax rates of (29.1)% and 19.9%, respectively. The effective tax rates for 2014 and 2013, were lower than the U.S. statutory rate of 35% due to income generated in jurisdictions other than the United States, principally representing interest income taxed in a jurisdiction with a lower effective tax rate and, for the 2014 period, a $5.0 million favorable settlement of the 2005-2006 IRS exam. The rate for 2013 was impacted by a $6.8 million tax benefit associated with the Reciprocal Note Restructure. The effective tax rate on non-U.S. income for 2014 and 2013 was 1.3% and 0.5%, respectively.
We purchase reinsurance in order to minimize loss from large risks or catastrophic events. We also purchase individual property reinsurance coverage for certain risks to reduce large loss volatility through property-per-risk excess of loss reinsurance programs and individual risk facultative reinsurance. We also maintain excess of loss casualty reinsurance programs that provide protection for individual risk or catastrophe losses involving workers compensation, general liability, automobile liability, professional liability or umbrella liability. The availability and cost of reinsurance protection is subject to market conditions, which are outside of our control. Limiting our risk of loss through reinsurance arrangements serves to mitigate the impact of large losses; however, the cost of this protection in an individual period may exceed the benefit.
The Investing, Financing and Corporate segment includes the investing and financing activities for OneBeacon on a consolidated basis, and certain other activities conducted through the Company and our intermediate subsidiaries.
Financial results for our Specialty Products reportable segment were as follows:
Net written premiums for Specialty Products decreased to $533.0 million for 2015 from $606.9 million for 2014, primarily due to the negative $44.4 million impact of the Crop business, a $33.6 million decrease at our Other Professional Lines business, reflecting our exit from the lawyers liability business that was sold in December of 2014, a $33.3 million decrease at our Healthcare business largely due to increased competition and change in underwriting appetite and a $20.1 million negative impact due to the termination of an affiliated reinsurance treaty. These decreases were partially offset by increases of $48.3 million and $18.5 million in our newer Programs and Surety businesses, respectively.
The Specialty Products combined ratio for 2015 decreased to 90.8% from 108.7% for 2014, as the loss and LAE ratio decreased by 23.2 points to 55.5% and the expense ratio increased by 5.3 points to 35.3%.
The 23.2 point decrease in the loss and LAE ratio, was primarily due to the impact of the 2014 fourth quarter reserve increase which had a 13.8 point unfavorable impact on the 2014 combined ratio as well as the solid results at most of our underwriting operating segments in 2015. The 23.2 point decrease in the loss and LAE ratio was comprised of a 7.7 point decrease in current accident year non-catastrophe losses, a 14.8 point favorable change in net prior year loss reserve development, and a 0.7 point decrease in catastrophe losses.
The 2015 results also reflected fairly benign catastrophe losses of 0.3 points compared with 1.0 point of catastrophe losses in 2014, primarily related to wind and thunderstorms in the midwestern and southern United States impacting Financial Services and Programs, as well as ice and snow storms in the midwestern and northeastern United States primarily impacting Financial Services.
The 5.3 point increase in the expense ratio for 2015, compared to 2014, was primarily driven by lower incentive compensation expense in 2014 resulting from the 2014 fourth quarter reserve increase, the adverse impact from the exit of the Crop business, and 2014 benefiting from a transition services agreement with the buyer of our legacy personal lines business, which was terminated on June 30, 2014. Additionally, the current year ratio was adversely impacted by separation costs associated with senior management restructuring and severance costs incurred in the current year.
Specialty Products-Year ended December 31, 2014 versus year ended December 31, 2013
The 2014 results included 10.6 points of net unfavorable prior year loss reserve development, of which 8.9 points related to the 2014 fourth quarter reserve increase, primarily driven by Other Professional Lines (including lawyers professional liability) as well as Management Liability and Specialty Property. The remaining amount of net unfavorable prior year loss reserve development for 2014 was primarily driven by unfavorable development recorded prior to the 2014 fourth quarter also in our Other Professional Lines and Management Liability businesses, offset in part by favorable development in our Healthcare business. Net unfavorable prior year loss reserve development in 2013 of 1.1 points, primarily related to a few large claims in Specialty Property, reduced in part by favorable prior year loss reserve development in Healthcare.
The 2014 results also included 1.0 point of catastrophe losses, primarily related to wind and thunderstorms in the midwestern and southern United States impacting Financial Services and Programs, as well as ice and snow storms in the midwestern and northeastern United States primarily impacting Financial Services, which compared with 0.6 points of catastrophe losses in 2013 primarily related to storms in the southern and midwestern United States impacting Financial Services and Collector Cars and Boats.
The Specialty Industries combined ratio for 2015 increased to 101.3% compared to 95.0% for 2014, as the loss and LAE ratio increased by 3.2 points to 63.3% and the expense ratio increased 3.1 points to 38.0%.
The 2015 results included 3.5 points of net unfavorable prior year loss reserve development primarily driven by Entertainment due to several large losses and an increase in small to mid-size claims, and to a lesser extent, unusually heavy loss activity of both large and small claims in Ocean Marine which were partially offset by favorable prior year loss reserve development in Technology, and to a lesser extent Government Risks. The 2014 results included 4.7 points of net unfavorable prior year loss reserve development primarily related to Entertainment, Government Risks, the transportation business within Accident and Inland Marine, all of which were driven by the 2014 fourth quarter reserve increase. This unfavorable prior year loss reserve development in 2014 was partially offset by favorable prior year loss reserve development in Ocean Marine.
Specialty Industries-Year ended December 31, 2014 versus year ended December 31, 2013
The 5.4 point increase in the loss and LAE ratio was comprised of a 0.7 point decrease in current accident year non-catastrophe losses that was more than offset by a 5.8 point unfavorable change in prior year loss reserve development and a 0.3 point increase in catastrophe losses.
The 2014 results included 4.7 points of net unfavorable prior year loss reserve development primarily related to Entertainment, Government Risks, the transportation business within Accident, and Inland Marine, all of which were driven by the 2014 fourth quarter reserve increase. This unfavorable prior year loss reserve development in 2014 was partially offset by favorable prior year loss reserve development in Ocean Marine. This compared to 1.1 points of net favorable prior year loss reserve development in 2013 primarily related to Ocean Marine and Technology, offset in part by a few large claims in Entertainment.
Investing, Financing and Corporate reported pre-tax income from continuing operations of $62.9 million in 2014, compared to $99.6 million in 2013. The decrease was primarily related to lower investment returns in 2014, as well as to other
As described in Note 1-"Nature of Operations and Summary of Significant Accounting Policies" and Note 2-"Acquisitions and Dispositions," on December 23, 2014, we completed the sale of our Runoff Business to Armour. During 2015, we recorded the final settlement of certain post-closing items related to the Runoff Transaction, resulting in a positive adjustment to the loss on sale of $0.3 million, after-tax.
The loss from discontinued operations, net of tax, of $0.5 million for the year ended December 31, 2015 was the result of post-closing expenses incurred in connection with the Runoff Business.
These changes, along with certain other adjustments, resulted in a net increase in the estimated loss on sale of $28.9 million ($18.8 million after-tax) for the full year 2014, resulting in a pre-tax loss on sale at closing of $97.9 million ($63.7 million after tax) recognized since the Runoff Transaction was announced in October of 2012.
The $71.5 million ($46.5 million after tax) increase in Runoff Business loss and LAE reserves was recorded in the fourth quarter of 2013 as a component of discontinued operations and offset by an equal after tax amount which decreased the estimated ultimate loss on sale of the Runoff Business. The terms of the Stock Purchase Agreement prescribe that the buyer assumed the risk that loss and LAE reserves develop unfavorably from September 30, 2012 onward, resulting in the offset.
A summary of our consolidated pre-tax investment results is as follows:
Our common equity securities and other investments portfolio returned (3.0)% for 2015, compared to 8.0% for 2014. Our common equity securities portfolio returned 2.3% and 8.2% for 2015 and 2014, respectively. These were good and strong absolute results, respectively, that outperformed the S&P 500 Index by 90 basis points for 2015 but underperformed that index by 550 basis points for 2014.
During the second quarter of 2015, OneBeacon instructed Prospector Partners LLC (Prospector), which formerly managed the majority of its publicly-traded common equity securities, to liquidate its separate account portfolios and redeemed its investment in a Prospector-managed hedge fund and used the proceeds to purchase passive equity vehicles and the Company subsequently terminated the investment management agreement with Prospector. As the separate account portfolios were liquidated, OneBeacon reinvested the bulk of the proceeds into exchange traded funds (ETFs) that seek to provide investment results that, before expenses, generally correspond to the performance of the S&P 500, Russell 1000 and Russell 1000 Value indices. As of December 31, 2015, OneBeacon had $183.3 million invested in ETFs. The following summarizes OneBeacon's investments in ETFs by exposure to each index:
In the third and fourth quarter of 2015, the ETF investments earned the effective market return, before expenses, in each respective fund. OneBeacon continues to have publicly-traded common equity securities actively managed through WM Advisors. The portfolio had overweight exposure to consumer and communications sectors and underweight exposure to financial and technology sectors compared to the S&P 500 Index.
Investment Returns-Year ended December 31, 2014 versus year ended December 31, 2013
The following table presents the composition of our reported investment portfolio balances:
The breakdown of our fixed maturity portfolio as of December 31, 2015 by credit class, based upon issue credit ratings provided by Standard & Poor's, or if unrated by Standard & Poor's, long-term obligation ratings provided by Moody's, is as follows:
The weighted average duration of our fixed maturity portfolio as of December 31, 2015 is approximately 2.2 years. The maturity distribution for fixed maturity investments held as of December 31, 2015 is as follows:
payments on our common shares, common share repurchases, purchases of investments, payments made to tax authorities, contributions to our operating subsidiaries, and holding company operating expenses.
During 2016, Split Rock has the ability to pay dividends and make distributions without the prior approval of regulatory authorities, subject to meeting all appropriate liquidity and solvency requirements, of up to $37.4 million, which is equal to 15% of its December 31, 2015 statutory capital and surplus. During the year ended December 31, 2015, Split Rock made no capital distributions and paid no dividends to its immediate parent. During the year ended December 31, 2014 Split Rock paid $10.0 million of capital distributions and $10.0 million of dividends to its immediate parent. During the year ended December 31, 2015, OneBeacon Ltd., through an intermediary holding company, contributed $85.0 million to Split Rock as additional paid-in capital.
As described in Note 10-"Common Shareholders' Equity" of the accompanying consolidated financial statements, during the years ended December 31, 2015 and 2014 the Company declared and paid cash dividends totaling $80.0 million and during the year ended December 31, 2013 the Company declared and paid cash dividends totaling $80.2 million of regular quarterly cash dividends to our common shareholders.
Insurance float is an important aspect of our insurance operations. Insurance float represents funds that an insurance company holds for a limited time. In an insurance operation, float arises because premiums are collected before losses are paid. This interval can extend over many years. During that time, the insurer invests the funds. When the premiums that an insurer collects do not cover the losses and expenses it eventually must pay, the result is an underwriting loss, which can be considered as the cost of insurance float. One manner in which we calculate our insurance float is by taking our insurance liabilities and subtracting insurance assets. Although insurance float can be calculated using numbers determined under GAAP, insurance float is not a GAAP concept and, therefore, there is no comparable GAAP measure.
The following table illustrates our consolidated insurance float position and two operational leverage ratios based on insurance float as of December 31, 2015 and 2014.
On September 29, 2015 the Company and OBH, as co-borrowers and co-guarantors, entered into a revolving credit facility administered by U.S. Bank N.A. and also including BMO Harris Bank N.A., which has a total commitment of $65.0 million and has a maturity date of September 29, 2019 (the "Credit Facility"). As of December 31, 2015 the Credit Facility was undrawn.
In November 2012, OneBeacon U.S. Holdings, Inc. (OBH) issued $275.0 million face value of senior unsecured notes (2012 Senior Notes) through a public offering, at an issue price of 99.9% and received $272.9 million of proceeds. The 2012 Senior Notes bear an annual interest rate of 4.6% payable semi-annually in arrears on May 9 and November 9, until maturity on November 9, 2022, and are fully and unconditionally guaranteed as to the payment of principal and interest by the Company.
In December 2015, the lease agreement with Fifth Third expired and the Company purchased the leased assets under the agreement with a remaining book value of $1.3 million for a nominal fee. At the end of the lease term with US Bancorp on December 31, 2016, the Company will purchase the leased furniture and equipment assets for a nominal fee, and all rights, title and interest will transfer back to it. As of December 31, 2015 and 2014, the Company had a capital lease obligation of $1.7 million and $7.1 million, respectively, included within other liabilities and a capital lease asset of $2.4 million and $7.0 million, respectively, included within other assets. The underlying assets of the US Bancorp lease will continue to be depreciated over their respective useful lives and OneBeacon's future annual rental payments are $1.7 million for the year ending December 31, 2016.
Represents expected future cash outflows resulting from loss and LAE payments. The amounts presented are gross of reinsurance recoverables on unpaid losses of $186.0 million and net of the discount on our workers compensation loss and LAE reserves of $1.1 million as of December 31, 2015.
Includes expected future cash outflows under our non-qualified, non-contributory, defined benefit pension plan and our 401(k) savings and employee stock ownership plan. Our pension plans were curtailed in 2002. See Note 8-"Retirement Plans" of the accompanying consolidated financial statements.
We do not finance our operations through the securitization of trade receivables, special purpose entities or synthetic leases. Further, we have not entered into any material arrangement requiring us to guarantee payment of third-party debt, lease payments or to fund losses of an unconsolidated special purpose entity.
We also have future binding commitments to fund certain limited partnership investments. These commitments, which total $8.2 million as of December 31, 2015, do not have fixed funding dates and are therefore excluded from the table above.
On August 22, 2007, our Board authorized us to repurchase up to $200.0 million of OneBeacon's Class A common shares from time to time, subject to market conditions. Shares may be repurchased on the open market or through privately negotiated transactions. This authorization does not have a stated expiration date. Since the inception of this authorization, the Company has repurchased and retired 5.8 million of its Class A common shares. During 2015, 166,368 shares were repurchased under the share repurchase authorization for $2.1 million at an average share price of $12.62. During 2014 and 2013, no shares were repurchased under the share repurchase authorization. The amount of authorization remaining is $85.6 million as of December 31, 2015.
During 2015, 2014, and 2013, we repurchased 112,051, 106,366, and 3,300 common shares, respectively, to satisfy employee income tax withholding, pursuant to employee benefit plans. Shares repurchased pursuant to employee benefit plans do not fall under the board authorizations referred to above.
Cash flows from operations for the years ended December 31, 2015, 2014 and 2013
For 2015, net cash flows provided from operations were $191.9 million, consisting of $192.4 million provided from continuing operations and $0.5 million used for discontinued operations. For 2014, net cash flows provided from operations was $97.5 million, consisting of $152.0 million provided from continuing operations and $54.5 million used for discontinued operations. For 2013, net cash flows provided from operations was $128.7 million, consisting of $205.4 million provided from continuing operations and $76.7 million used for discontinued operations. Net cash flows for operations in 2014 and 2013 were reduced by the run-off of reserves related to the Runoff Business, which are included in discontinued operations.
Net cash flows relating to continuing operations in 2015 increased $40.4 million relative to 2014, primarily due to increased cash collateral received related to our Surety business and lower incentive payments which more than offset increased loss and LAE payments relative to the prior year. Net cash flows relating to continuing operations in 2014 decreased $53.4 million relative to 2013, primarily due to outflows from loss and LAE payments exceeding inflows from premiums driven by larger claims in 2014, premium advances to the Federal Crop Insurance Corporations related to our Crop Business in 2014, and a $39.6 million decrease in net collateral receipts related to our Surety business.
During 2015, we made payments with respect to our long-term incentive compensation plans totaling $8.6 million, in cash or by deferral into certain of our non-qualified compensation plans. These payments were made primarily with respect to 181,290 performance shares and 129,100 performance units for the 2012-2014 performance cycle.
During 2013, we repurchased and retired 3,300 common shares for less than $0.1 million to satisfy employee income tax withholding, pursuant to employee benefit plans that do not fall under the board authorization.
Assets carried at fair value include fixed maturity investments, common equity securities, convertible fixed maturity investments prior to their disposition in 2015, surplus notes, and interests in hedge funds and private equity funds. Valuation of assets measured at fair value requires us to make estimates and apply judgment to matters that may carry a significant degree of uncertainty. In determining our estimates of fair value, we use a variety of valuation approaches and inputs. Whenever possible, we estimate fair value using valuation methods that maximize the use of observable prices and other inputs.
For investments in active markets, we use quoted market prices to determine fair value. In circumstances where quoted market prices are unavailable, we utilize fair value estimates based upon reference to other observable inputs other than quoted prices, including matrix pricing, benchmark interest rates, market comparables, broker quotes and other relevant observable inputs. Where observable inputs are not available, the estimated fair value is based upon internal pricing models using assumptions that include inputs that may not be observable in the marketplace but which reflect our best judgment given the circumstances and are consistent with what other market participants would use when pricing such instruments.
As of December 31, 2015 and 2014, approximately 92% and 90%, respectively, of the investment portfolio recorded at fair value was priced based upon quoted market prices or other observable inputs. Investments valued using Level 1 inputs include fixed maturity investments, primarily investments in U.S. Treasuries, common equity securities and short-term investments, which include U.S. Treasury Bills. Investments valued using Level 2 inputs comprise fixed maturity investments, which has been disaggregated into classes, including debt securities issued by corporations, municipal obligations, mortgage and asset-backed securities, foreign government obligations and preferred stocks. Investments valued using Level 2 inputs also include convertible fixed maturity investments and certain ETFs that track U.S. stock indices such as the S&P 500 but are traded on foreign exchanges and that management values using the fund’s published NAV to account for the difference in market close times. Fair value estimates for investments that trade infrequently and have few or no observable market prices are classified as Level 3 measurements. Level 3 fair value estimates based upon unobservable inputs include our investments in surplus notes, hedge funds and private equity funds, as well as certain investments in fixed maturity investments and common equity securities, where quoted market prices are unavailable or not considered reasonable. We determine when transfers between levels have occurred as of the beginning of the period.
Municipal obligations: The fair value of municipal obligations is determined from an evaluated pricing model that uses information from market makers, broker-dealers, buy-side firms, and analysts along with general market information. Key inputs include benchmark yields, reported trades, issuer financial statements, material event notices and new issue data, as well as broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including type, coupon, credit quality ratings, duration, credit enhancements, geographic location and market research publications.
The fair values of OneBeacon's investments in hedge funds and private equity funds have been classified as Level 3 under the fair value hierarchy since the fund managers do not provide sufficient information to independently evaluate the pricing inputs and methods for each underlying investment, and therefore the inputs are considered to be unobservable. As of December 31, 2015 and 2014, OneBeacon did not record a liquidity adjustment to the net asset value related to its investments in hedge funds or private equity funds. Also classified as Level 3 under the fair value hierarchy are surplus notes provided in conjunction with the financing of the Runoff Transaction which are measured at their estimated fair value based on discounted expected cash flows, with changes in fair value reported in total revenues as net realized and change in unrealized investment gains.
See Note 5-"Investments" of the accompanying consolidated financial statements for tables that summarize the changes in OneBeacon's fair value instruments by level for the years ended December 31, 2015 and 2014 and for the amount of total gains (losses) included in earnings attributable to change in unrealized investment gains for Level 3 investments for the years ended December 31, 2015, 2014 and 2013.
In circumstances where the underlying investments are publicly traded, such as the investments made by hedge funds, the fair value of the underlying investments is determined using current market prices. In circumstances where the underlying investments are not publicly traded, such as the investments made by private equity funds, the private equity fund managers have considered the need for a liquidity discount on each of the underlying investments when determining the fund's net asset value. In circumstances where our portion of a fund's net asset value is deemed to differ from fair value due to illiquidity or other factors associated with our investment in the fund, including counterparty credit risk, the net asset value is adjusted accordingly.
Under the contractual terms of both the seller priority and pari passu notes, scheduled interest payments accrue at 6% until the scheduled maturity date of March 15, 2020 and at a floating interest rate thereafter, should any principal remain outstanding. As required by the Pennsylvania Insurance Department (PID), interest on the notes is not compounding. The notes restrict the Issuer's ability to make distributions to the holders of its equity interest. All such distributions are prohibited while the seller priority note is outstanding, and while the pari passu note is outstanding, distributions are permitted only if the Issuer concurrently repays a pro rata amount of any outstanding principal on the pari passu note.
Represents the sensitivity to changes in the estimate of the liquidity spread added to account for OneBeacon's sole ownership of the notes, lack of a liquid trading market, and ongoing regulatory approval risk.
Represents the sensitivity to changes in the estimate of the underlying equivalent credit quality of the notes. Such credit quality is approximated by comparing the expected percentage of discounted payments missed, as calculated in a proprietary stochastic simulation, to a series of benchmarks derived from data published by Standard & Poor's. Note that a 'notch' is defined as the difference between, for example, a 'B' and 'B+' rated instrument.
As of both December 31, 2015 and 2014, other investments reported at fair value represented approximately 5% and 7%, respectively, of the total investment portfolio and consisted of the following:
Excludes the carrying value of $14.7 million and $16.8 million as of December 31, 2015 and 2014, respectively, associated with a tax advantaged federal affordable housing development fund accounted for using the proportional amortization method.
The fair values as of December 31, 2015 for assets measured using Level 3 inputs are as follows:
quarter due to the inherent uncertainty in loss and LAE, persistent or large variances would indicate that prior assumptions and/or reliance on certain reserving methods may need to be revised going forward.
Upon completion of each quarterly review, our actuaries select indicated reserve levels based on the results of the actuarial methods described previously, which are the primary consideration in determining management's best estimate of required reserves. However, in making its best estimate, management also considers other qualitative factors that may lead to a difference between held reserves and actuarially indicated reserve levels. Typically, these factors exist when management and our actuaries conclude that there is insufficient historical incurred and paid loss information or that there is particular uncertainty about whether trends included in the historical incurred and paid loss information are likely to repeat in the future. Such factors include, among others, recent entry into new markets or new products, improvements in the claims department that are expected to lessen future ultimate loss costs, legal and regulatory developments, or other volatilities that may arise.
General liability occurrence policies cover businesses for any liability resulting from bodily injury and property damage arising from general business operations, accidents on a premises and the products manufactured or sold. General liability-occurrence reserves generally include two components: bodily injury and property damage. Bodily injury payments reimburse the claimant for damages pertaining to physical injury as a result of the policyholder's legal obligation arising from non-intentional acts such as negligence, subject to the insurance policy provisions. In some cases the damages can include future wage loss (which is a function of future earnings power and wage inflation) and future medical treatment costs. Property damage payments result from damages to the claimant's private property arising from the policyholder's legal obligation for non-intentional acts. In most cases, property damage losses are a function of costs as of the loss date, or soon thereafter.
Examples of common reserving factors that can change and, thus, affect estimated general liability reserves include:
Changes in claim handling philosophies (e.g., case reserving standards), including the use of third party claims administrators
The general liability occurrence and property coverages, described above, are often provided under a multiple peril package policy which includes both general liability and property insurance. Because commercial multiple peril provides a combination of property and liability coverage, typically for small businesses, it includes both short- and long-tail coverages. The reserving risk for this line is dominated by the liability coverage portion of this product, except occasionally in the event of catastrophic or large single losses.
Surety is generally considered a short tailed coverage. As a new business, lack of historical data means external data is heavily relied upon where available and applicable. Surety reserving factors that can change and, thus, affect estimated surety reserves include probability of default of the bond which can be impacted by general economic conditions, size of payment (severity) which is impacted by the bond limit, or amount and collectability of assets or other collateral available to mitigate loss.
competitive forces and the cyclicality of the property and casualty insurance industry;
Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements, and there can be no assurance that the anticipated results or developments will be realized or, even if substantially realized, that they will have the expected consequences. The forward-looking statements in this report speak only as of the date on which they are made. We assume no obligation to update publicly any such forward-looking statements, whether as a result of new information, future events or otherwise.