The following discussion and analysis reflects the consolidated results of the Company and its subsidiaries for the years ended December 31, 2013, 2012 and 2011.
As described in more detail below, the Company is facing a challenging and limited growth environment, which is driven by price decreases in most markets and lines of business, reflecting increased competition and excess capacity in the industry, relatively low loss experience and a prolonged period of low interest rates. However, the Company’s strong global franchise and geographical footprint position the Company well for the future as does the acquisition of Paris Re in 2009, which provided enhanced strategic and financial flexibility, and the recent acquisition of PartnerRe Health in 2012, which provided additional diversification into the U.S. accident and health market. While the Company continues to face this challenging business environment, Management has also focused on implementing cost saving initiatives. In 2013, Management announced the restructuring of its business support operations into a single integrated worldwide support platform and changes to the structure of certain of its Non-life operations, both of which are expected to provide greater operational efficiency. Regarding capital management, and as a result of the challenging business environment described above, during 2013 the Company returned approximately $840 million to its common shareholders through share repurchases and dividends. As the Company looks to 2014 and beyond, despite the challenging environment, Management remains confident in the Company’s strong global franchise, geographical footprint and technical underwriting skills and is focused on continuing to maintain its strong relationships with clients and actively managing its capital resources.
The Company generates its Non-life reinsurance and insurance revenue from premiums. Premium rates and terms and conditions vary by line of business depending on market conditions. Pricing cycles are driven by supply of capital in the industry and demand for reinsurance and insurance and other risk transfer products. The
reinsurance and insurance business is also influenced by several other factors, including variations in interest rates and financial markets, changes in legal, regulatory and judicial environments, loss trends, inflation and general economic conditions.
During the January 1, 2014 renewals, all Non-life sub-segments experienced increased cedant retentions and increased competition, which resulted in further declines in pricing and deterioration in terms and conditions. The excess capacity in the industry, which results in cedants retaining more business and decreasing the available premium in the global industry, combined with the growth in insurance-linked securities and other alternative
The Company’s Life and Health segment derives revenues primarily from renewal premiums from existing reinsurance treaties and new premiums from existing or new reinsurance treaties. Within the Life and Health segment, the Company writes mortality (including disability), longevity and, following the acquisition of PartnerRe Health, U.S. accident and health products. The acquisition of the PartnerRe Health business on December 31, 2012 provides additional specialty risks not previously written by the Company. Management believes the existing life business and PartnerRe Health business provide the Company with diversification benefits and balance to its portfolio as they are generally not correlated to the Company’s Non-life business.
In 2013, PartnerRe Health principally operated as a Managing General Agent (MGA), writing all of its business on behalf of third party insurance companies and earning a fee for producing the business. The third party insurance companies then ceded a portion of the original business written through quota-share reinsurance agreements to the Company’s reinsurance subsidiary, such that PartnerRe Health participated in the original premiums and losses incurred related to the business it has produced and ensuring an alignment of interests with the third party insurance companies. During 2013, the Company obtained the necessary licenses and approvals and began transitioning the portfolio to PartnerRe carriers. As of January 1, 2014, virtually all of the PartnerRe Health business is originated directly, without the use of third party insurance companies. As such, PartnerRe Health’s premiums are expected to grow in 2014 and the MGA fees will be substantially reduced.
The acquisition of the PartnerRe Health business resulted in substantial overall premium growth in the Company’s Life and Health segment in 2013 and more modest growth is expected in 2014 as a result of the transition described above. At the January 1, 2014 renewals, opportunities in managed care and specialty lines of the PartnerRe Health business were observed as a result of the implementation of the Patient Protection and Affordable Care Act. In terms of the Company’s Life portfolio, the majority of the premium arises from long-term in-force contracts. The active January 1 renewals impact a relatively limited portion of the short-term in-force premium in the mortality line. For those treaties that actively renewed, pricing conditions and terms were
The Company’s investment operations, including public and private market investments, have experienced volatile market conditions since the middle of 2007. The market conditions remained volatile in 2013, primarily due to increases in risk-free interest rates, improvements in equity markets and narrowing credit spreads, while during 2012 the volatility was due to narrowing spreads and improvements in equity markets.
Assuming constant foreign exchange rates, Management expects net investment income to continue to decrease in 2014 compared to 2013 primarily due to lower reinvestment rates with low yields expected to continue throughout 2014. Management expects this decrease to be partially offset by expected positive cash flow from operations (including net investment income).
The Company measures its performance in several ways. Among the performance measures accepted under U.S. GAAP is diluted net income or loss per share, a measure that focuses on the return provided to the Company’s common shareholders. Diluted net income or loss per share is obtained by dividing net income or loss attributable to PartnerRe Ltd. common shareholders by the weighted average number of common shares and common share equivalents outstanding. Net income or loss attributable to PartnerRe Ltd. common shareholders is defined as net income or loss less preferred dividends and loss on redemption of preferred shares. The Company also utilizes certain non-GAAP measures to assess performance (see the discussion of these non-GAAP measures and the reconciliation of those non-GAAP measures to the most directly comparable GAAP measures in Key Financial Measures below).
an increase of $655 million in pre-tax net realized and unrealized investment losses, mainly as a result of increases in risk-free interest rates during 2013 compared to narrowing spreads and improvements in equity markets in 2012;
an increase of $135 million in income tax expense, resulting from a higher pre-tax net income; and
The increase in net income available to PartnerRe Ltd. common shareholders and diluted net income per share in 2012 compared to 2011 was primarily due to the above factors, partially offset by an increase in preferred dividends following the issuance of preferred shares in June 2011. For diluted net income per share specifically, the increase was also due to a decrease in the diluted number of common shares outstanding as a result of share repurchases during 2012.
As the Company’s reinsurance operations are exposed to low frequency and high severity risk events, some of which are seasonal, results for certain periods may include unusually low loss experience, while results for other periods may include significant catastrophic losses. For example, the Company’s results for 2013 and 2012 included a comparatively lower level of catastrophic losses, while 2011 included an unusually high frequency of high severity catastrophic events as discussed further below. The total impact of large catastrophic losses and large losses on pre-tax net income (loss) for the years ended December 31, 2013, 2012 and 2011 was as follows (in millions of U.S. dollars):
In 2012, credit spreads narrowed, equity markets improved and U.S. and European risk-free interest rates decreased, while the U.S. dollar ending exchange rate at December 31, 2012 weakened against most major currencies compared to December 31, 2011. As a result of these movements, the value of the Company’s investment portfolio and cash and cash equivalents at December 31, 2012 increased compared to December 31, 2011, with the resulting mark-to-market net gain recorded in net income.
During the year ended December 31, 2013, the Company recorded a pre-tax charge of approximately $58 million related to the costs of the restructuring, which was primarily related to the termination plans and certain real estate costs, within other operating expenses. The continuing salary and other employment benefit costs related to the affected employees will be expensed as the employee remains with the Company and provides service.
In addition to the Consolidated Balance Sheets and Consolidated Statements of Operations and Comprehensive Income (Loss), Management uses certain other key measures, some of which are non-GAAP financial measures within the meaning of Regulation G (see below), to evaluate its financial performance and the overall growth in value generated for the Company’s common shareholders.
While growth in Diluted Tangible Book Value per Share plus dividends is the Company’s prime financial measure, Management also uses other key financial measures to monitor performance. At December 31, 2013 and 2012 and for the years ended December 31, 2013, 2012 and 2011 these were as follows:
(1) Diluted tangible book value per common share and common share equivalents outstanding (Diluted Tangible Book Value per Share) is calculated using common shareholders’ equity attributable to PartnerRe Ltd. (total shareholders’ equity less noncontrolling interests and the aggregate liquidation value of preferred shares) less goodwill and intangible assets, net of tax, divided by the weighted average number of common shares and common share equivalents outstanding (assuming exercise of all stock-based awards
Diluted Tangible Book Value per Share at December 31, 2013 and 2012 and the calculation of the growth in Diluted Tangible Book Value per Share plus dividends for the year ended December 31, 2013 were as follows. As described above, this metric is a long-term performance measure, however, the below table shows the total shareholder value creation for the year ended December 31, 2013 in order for the shareholders to monitor performance.
The presentation of Diluted Tangible Book Value per Share is a non-GAAP financial measure within the meaning of Regulation G and should be considered in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP (see Comment on Non-GAAP Measures). The reconciliation of Diluted Tangible Book Value per Share to the most directly comparable GAAP financial measure, diluted book value per common share and common share equivalents outstanding, at December 31, 2013 and 2012 was as follows (in millions of U.S. dollars):
(1) Diluted book value per common share and common share equivalents outstanding (Diluted Book Value per Share) is calculated using common shareholders’ equity attributable to PartnerRe Ltd. (total shareholders’ equity less noncontrolling interests and the aggregate liquidation value of preferred shares) divided by the weighted average number of common shares and common share equivalents outstanding (assuming exercise of all stock-based awards and other dilutive securities).
Operating earnings or loss attributable to PartnerRe Ltd. common shareholders (operating earnings or loss) and operating earnings or loss per common share and common share equivalent outstanding (diluted operating earnings or loss per share): Management uses operating earnings or loss and diluted operating earnings or loss per share to measure its financial performance as these measures focus on the underlying fundamentals of the Company’s operations by excluding net realized and unrealized gains or losses on investments (except where the Company has made a strategic investment in an investee whose operations are insurance or reinsurance related and where the Company does not control the investee’s activities), net foreign exchange gains or losses, loss on redemption of preferred shares and certain interest in earnings or losses of
Operating earnings increased by $58 million, from $664 million in 2012 to $722 million in 2013. The increase was primarily due to an improvement in the Non-life and Life and Health underwriting results, driven by a lower level of large catastrophic and large losses and a higher level of favorable prior year loss development, and partially offset by a higher level of mid-sized loss activity. These increases were partially offset by a decline in net investment income driven by lower reinvestment rates and higher operating expenses driven by restructuring charges. Diluted operating earnings per share increased from $10.43 in 2012 to $12.79 in 2013, driven by the same factors as operating earnings and the accretive impact of share repurchases.
Operating earnings increased by $1,306 million, from a loss of $642 million in 2011 to an income of $664 million in 2012 primarily due to an increase in the Non-life underwriting result of $1,429 million, partially offset by an increase in income tax expense on the higher level of operating earnings. Diluted operating earnings per share increased from a loss of $9.50 in 2011 to earnings of $10.43 in 2012, driven by the same factors as operating earnings and the accretive impact of share repurchases.
The other lesser factors contributing to the increases or decreases in operating earnings in 2013 compared to 2012 and in 2012 compared to 2011 are further described in Review of Net Income (Loss) below.
Operating ROE increased modestly from 12.3% in 2012 to 12.7% in 2013. The increase in Operating ROE was primarily due to higher operating earnings in 2013 compared to 2012, as described above, and the accretive impact of share repurchases, which were partially offset by a higher beginning diluted book value per share at January 1, 2013 compared to January 1, 2012. The factors contributing to increases or decreases in operating earnings are described further in Review of Net Income (Loss) below.
level of catastrophic losses incurred, Management believes that it is more appropriate to measure performance based on an average Operating ROE target over the reinsurance cycle rather than focusing on the results for single periods.
Combined ratio: The combined ratio is used industry-wide as a measure of underwriting profitability for Non-life business. A combined ratio under 100% indicates underwriting profitability, as the total losses and loss expenses, acquisition costs and other operating expenses are less than the premiums earned on that business. While an important metric of underwriting profitability, the combined ratio does not reflect all components of profitability, as it does not recognize the impact of investment income earned on premiums between the time premiums are received and the time loss payments are ultimately made to clients. The key challenges in managing the combined ratio metric consist of (i) focusing on underwriting profitable business even in the weaker part of the reinsurance cycle, as opposed to growing the book of business at the cost of profitability, (ii) diversifying the portfolio to achieve a good balance of business, with the expectation that underwriting losses in certain lines or markets may potentially be offset by underwriting profits in other lines or markets, and (iii) maintaining control over expenses.
The Non-life combined ratio decreased by 2.5 points, from 87.8% in 2012 to 85.3% in 2013. The decrease in the combined ratio in 2013 compared to 2012 was primarily due to a lower level of large catastrophic losses and large losses of 5.3 points (from 8.7 points 2012 to 3.4 points in 2013) and a lower other operating expense ratio of 0.9 points (from 7.0 points in 2012 to 6.1 points in 2013) driven by an increased level of net premiums earned, which were partially offset by a higher level of mid-sized loss activity. The impact on the combined ratio of the catastrophic events for each period is analyzed above.
catastrophic losses and large losses of 36.5 points (from 45.2 points in 2011 to 8.7 points in 2012). The impact on the combined ratio by catastrophic event for each year is analyzed above.
The Company’s Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). The preparation of financial statements in conformity with U.S. GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The following presents a discussion of those accounting policies and estimates that Management believes are the most critical to its operations and require the most difficult, subjective and complex judgment. If actual events differ significantly from the underlying assumptions and
The amount of time that elapses before a claim is reported to the cedant and then subsequently reported to the reinsurer is commonly referred to in the industry as the reporting tail. Lines of business for which claims are reported quickly are commonly referred to as short-tail lines; and lines of business for which a longer period of time elapses before claims are reported to the reinsurer are commonly referred to as long-tail lines. In general, for reinsurance, the time lags are longer than for primary business due to the delay that occurs between the cedant becoming aware of a loss and reporting the information to its reinsurer(s). The delay varies by reinsurance market (country of cedant), type of treaty, whether losses are first paid by the cedant and the size of the loss. The delay could vary from a few weeks to a year or sometimes longer. The Company considers agriculture, catastrophe, energy, property, motor business written in the U.S., proportional motor business written outside of the U.S., specialty property and structured risk to be short-tail lines; aviation/space, credit/surety, engineering, marine and multiline to be medium-tail lines; and casualty, non-proportional motor business written outside of the U.S. and specialty casualty to be long-tail lines of business. For all lines, the Company’s objective is to estimate ultimate losses and loss expenses. Total loss reserves are then calculated by subtracting losses paid. Similarly, IBNR reserves are calculated by subtraction of case reserves and ACRs from total loss reserves.
principal sources of information available to the Company consist of information obtained during pricing and qualitative information supplied by the cedant. However, the lack of sensitivity to reported or paid losses means that the method is usually inappropriate at later stages of development.
The ultimate losses estimated under this method are derived from estimates of specific events based on reported claims, client and broker discussions, review of potential exposures, market loss estimates, modeled analysis and other event specific criteria.
As an example of the sensitivity of the Company’s reserves to reserving parameter assumptions by reserving line, the effect on the Company’s reserves of higher/lower a priori loss ratio selections, higher/lower loss development factors and higher/lower tail factors based on amounts recorded at December 31, 2013 was as follows:
The Company believes that the illustrated sensitivities to the reserving parameter assumptions are indicative of the potential variability inherent in the estimation process of those parameters. Some reserving lines show little sensitivity to a priori loss ratio, loss development factor or tail factor as the Company may use reserving methods such as the Expected Loss Ratio method in several of its reserving cells within those lines. It is not appropriate to sum the total impact for a specific factor or the total impact for a specific reserving line as the lines of business are not perfectly correlated.
The net Non-life prior year favorable loss development for the years ended December 31, 2013, 2012 and 2011 was driven by the following factors (in millions of U.S. dollars):
Actual losses paid and reported compared with the Company’s expectations, and the changes of the Company’s reserving parameter assumptions in response to the emerging development for each reserving line during the year ended December 31, 2013 were as follows:
Credit / Surety: Aggregate losses reported in 2013 were modestly higher than expected for North America business, giving rise to a modest level of adverse development. For the Company’s Global
Engineering: Aggregate losses reported in 2013 were lower than expected and the Company reflected this experience by selecting lower loss ratios. The lower than expected losses were partially offset by increases in premium adjustments for proportional business reflecting increased exposure on several underwriting years.
Marine / Energy Offshore: Aggregate losses reported in 2013 were significantly lower than expected and impacted most underwriting years driven entirely by the Energy Offshore business. The Company reduced its loss ratios for all underwriting years to reflect the lower than expected loss emergence.
Aggregate losses reported in 2013 for the North America motor line were lower than expected resulting in the Company reducing its loss ratios.
A significant amount of judgment was used to estimate the range of potential losses related to the New Zealand Earthquakes and the Japan Earthquake, and there remains a considerable degree of uncertainty related to the range of possible ultimate losses associated with the New Zealand Earthquakes. Loss estimates arising from earthquakes are inherently more uncertain than those from other catastrophic events and the Company believes the ultimate losses arising from the New Zealand Earthquakes and the Japan Earthquake may be materially in excess of, or less than, the amounts provided for in the Consolidated Balance Sheet at December 31, 2013.
The remaining significant risks and uncertainties related to the New Zealand Earthquakes include the ongoing cedant revisions of loss estimates for each of these events, the degree to which inflation impacts construction materials required to rebuild affected properties, the characteristics of the Company’s program participation for certain affected cedants and potentially affected cedants, and the expected length of the claims settlement period. In addition, there is additional complexity related to the New Zealand Earthquakes given multiple earthquakes occurred in the same region in a relatively short period of time, resulting in cedants continuing to revise their allocation of losses between the various events and between different treaties, under which the Company may provide different amounts of coverage.
In addition to the sum of the point estimates originally recorded for each of the New Zealand Earthquakes and Japan Earthquake, at December 31, 2011 the Company recorded additional gross reserves of $50 million (net reserves of $48 million after the impact of retrocession) specifically related to these events within its Catastrophe sub-segment. The additional gross reserves recorded were in consideration of the number of events, the complexity of certain events and the continuing uncertainties in estimating the ultimate losses for these events in the aggregate. The Company continues to evaluate the additional gross reserves that were recorded as part of its
effective December 31, 2012, following the acquisition of PartnerRe Health, the Company also writes specialty accident and health business, including Health Maintenance Organizations (HMO) reinsurance, medical reinsurance and provider and employer excess of loss programs.
The Company categorizes life reserves into three types of reserves: case reserves, IBNR and reserves for future policy benefits. Case reserves represent unpaid losses reported by the Company’s cedants and recorded by the Company. IBNR reserves represent a provision for claims that have been incurred but not yet reported to the Company, as well as future loss development on losses already reported, in excess of the case reserves. Reserves
for future policy benefits, which relate to future events occurring on policies in force over an extended period of time, are calculated as the present value of future expected benefits to be paid, reduced by the present value of future expected premiums. Such liabilities are established based on methods and underlying assumptions in accordance with U.S. GAAP and applicable actuarial standards. Principal assumptions used in the establishment of reserves for future policy benefits have been determined based upon information reported by ceding companies, supplemented by the Company’s actuarial estimates of mortality, critical illness, persistency and future investment income, with appropriate provision to reflect uncertainty. Case reserves, IBNR reserves and reserves for future policy benefits are generally calculated at the treaty level. The Company updates its estimates for each of the aforementioned categories on a periodic basis using information received from its cedants.
The reserves for accident and health business are established in accordance with the provisions for short duration insurance contracts under U.S. GAAP. Reserves are initially calculated using the Expected Loss Ratio method. Subsequently, the Company’s reserving methodology utilizes actual reported loss experience and the Bornhuetter-Ferguson method to calculate IBNR.
Total gross policy benefits for life and annuity contracts include provisions for adverse deviation of $127 million and $104 million at December 31, 2013 and 2012, respectively. The increase in the provision for adverse deviation is primarily driven by a new longevity swap written in 2013.
Under non-proportional treaties, which represented 24% of the Company’s total gross premiums written for the year ended December 31, 2013, the Company is typically exposed to loss events in excess of a predetermined dollar amount or loss ratio and receives a fixed or minimum premium, which is subject to upward adjustment depending on the premium volume written by the cedant. In addition, many of the non-proportional treaties include reinstatement premium provisions. Reinstatement premiums are recognized as written and earned at the time a loss event occurs, where coverage limits for the remaining life of the contract are reinstated under pre-defined contract terms. The accrual of reinstatement premiums is based on Management’s estimate of losses and loss expenses associated with the loss event.
The amounts recorded within net premiums written and earned that related to changes in prior year premium estimates reported by cedants for each Non-life sub-segment for the year ended December 31, 2013 were as follows (in millions of U.S. dollars):
The Company has projected future taxable income in the tax jurisdictions in which the deferred tax assets arise. These projections are based on Management’s projections of premium and investment income, capital gains and losses, and technical and expense ratios. Based on these projections and an analysis of the ability to utilize loss and foreign tax credits carryforwards at the taxable entity level, Management evaluates the need for a valuation allowance. The valuation allowance of $46 million, recorded at December 31, 2013, primarily related to a foreign tax credit carryforward in Ireland of $25 million and a tax loss carryforward in Singapore of $21 million.
Valuation of Investments and Funds Held - Directly Managed, including certain Derivative Financial Instruments
The Company defines fair value as the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company measures the fair value of its financial instruments according to a fair value hierarchy that prioritizes the information used to measure fair value into three broad levels.
The Company is exposed to changes in the expected amount of future cash flows of the reference assets in its total return swap portfolio. The Company’s total return swap portfolio primarily references certain bonds issued by U.S. municipalities. At December 31, 2013, the notional value of the total return swap portfolio categorized as Level 3 was $32 million and the fair value of the assets underlying the total return swap portfolio categorized as Level 3 was $31 million. The Company estimated that each 1% increase or decrease in the amount of all expected future cash flows related to the reference assets would result in a $2 million increase or decrease, respectively, in the fair value of its total return swap portfolio at December 31, 2013.
At December 31, 2013, the Company’s insurance-linked securities that are classified as Level 3 include longevity swaps and weather derivatives, with an insignificant combined fair value. At December 31, 2013, the notional exposure of the longevity swaps and weather derivatives classified as Level 3 was $133 million and $36 million, respectively. At December 31, 2013, the Company estimated that a 10% improvement in the mortality assumption used in the Company’s internal valuation models for its longevity swaps would result in a $4 million decrease in the fair value of its longevity swap portfolio. The weather derivatives categorized as Level 3 are exposed to wind events, and any change in the assumptions used in the Company’s internal models would have an insignificant impact on the fair value of weather derivatives at December 31, 2013.
Intangible assets represent the fair value adjustments related to unpaid losses and loss expenses and the fair values of renewal rights, customer relationships and U.S. licenses arising from the acquisitions of Paris Re and PartnerRe Health. Definite-lived intangible assets are amortized over their useful lives, generally ranging from eleven to thirteen years. The Company recognizes the amortization of all intangible assets in the Consolidated Statement of Operations. Indefinite-lived intangible assets are not subject to amortization. The carrying values of intangible assets are reviewed for indicators of impairment on at least an annual basis. Impairment is recognized if the carrying values of the intangible assets are not recoverable from their undiscounted cash flows and are measured as the difference between the carrying value and the fair value. Based upon the Company’s assessment, there was no impairment of its intangible assets of $187 million at December 31, 2013.
the U.S. dollar average exchange rate was stronger against most currencies, except the euro and Swiss franc, in 2013 compared to 2012 and was stronger against most currencies, except the Japanese yen, in 2012 compared to 2011; and
(1) Interest in earnings or losses of equity investments represents the Company’s aggregate share of earnings or losses related to several private placement investments and limited partnerships within the Corporate and Other segment.
(3) Amortization of intangible assets relates to intangible assets acquired in the acquisition of Paris Re in 2009 and PartnerRe Health in 2012. The acquisition of PartnerRe Health was effective December 31, 2012 and, accordingly, no amortization expense related to the intangible assets acquired has been recorded during the years ended December 31, 2012 and 2011.
Large catastrophic losses and large losses-a decrease of $174 million (decrease of 5.3 points in the technical ratio) compared to no significant catastrophic losses from $316 million (8.7 points on the technical ratio) in 2012 related to Superstorm Sandy and the U.S. drought that impacted the agriculture line of the North America sub-segment to $142 million (3.4 points on the technical ratio) in 2013 related to the German Hailstorm, Alberta Floods and European Floods.
These factors driving the increase in the Non-life underwriting result and the corresponding decrease in the combined ratio in 2013 compared to 2012 were partially offset by:
The current accident year technical result, adjusted for large catastrophic losses and large losses-a decrease in the technical result (and a corresponding increase in the technical ratio) primarily driven by higher losses reported by a large cedant in the agriculture line of business of the Company’s North America sub-segment and a higher level of mid-sized loss activity in the Global Specialty and Catastrophe sub-segments. These decreases were partially offset by higher upward premium adjustments in the Global (Non-U.S.) P&C sub-segment and a modestly lower level of mid-sized loss activity in the Global (Non-U.S.) P&C and North America sub-segments.
The underwriting result for the Life and Health segment, which does not include allocated investment income, improved by $28 million, from a loss of $16 million in 2012 to a gain of $12 million in 2013. The improvement in the Life and Health underwriting result was primarily due to higher net favorable prior year loss development, driven by the mortality line of business. See Results by Segment below.
Net realized and unrealized investment losses increased by $655 million, from gains of $494 million in 2012 to losses of $161 million in 2013. The net realized and unrealized investment losses of $161 million in 2013 were primarily due to increases in risk-free interest rates and were partially offset by improvements in worldwide equity markets and narrower credit spreads. See Corporate and Other - Net Realized and Unrealized Investment Gains (Losses) below for more details.
of Part II of this report for additional information related to derivatives.
The following addresses those areas where the Company believes it has exposure to material market risk in its operations.
At December 31, 2013, the Company estimates that the hypothetical case of an immediate 100 basis points or 200 basis points parallel shift in global bond curves would result in a change in the fair value of investments exposed to interest rate risk, the fair value of funds held - directly managed account exposed to interest rate risk, total invested assets, and shareholders’ equity as follows (in millions of U.S. dollars):
The changes do not take into account any potential mitigating impact from the equity market, taxes or the corresponding change in the economic value of the Company’s reinsurance liabilities, which, as noted above, would substantially offset the economic impact on invested assets, although the offset would not be reflected in the Consolidated Balance Sheet.
The impact of an immediate change in interest rates on the fair value of investments and funds held - directly managed exposed to interest rate risk, the Company’s total invested assets and shareholders’ equity, in both absolute terms and as a percentage of total invested assets and shareholders’ equity, has not changed significantly at December 31, 2013 compared to December 31, 2012.
Interest rate movements also affect the economic value of the Company’s outstanding debt obligations and preferred securities in the same way that they affect the Company’s fixed maturity investments. This can result in a liability whose economic value is different from the carrying value reported in the Consolidated Balance Sheet given the Company records the carrying value of its outstanding debt obligations and preferred securities at the original issued principal amount. The Company believes that the economic fair value of its outstanding Senior Notes, CENts and preferred shares at December 31, 2013 was as follows (in millions of U.S. dollars):
(1) PartnerRe Finance A LLC and PartnerRe Finance B LLC, the issuers of the Senior Notes, do not meet consolidation requirements under U.S. GAAP. Accordingly, the Company shows the related intercompany debt of $750 million in its Consolidated Balance Sheets at December 31, 2013 and 2012.
The fair value of the Company’s outstanding debt obligations decreased modestly at December 31, 2013 compared to December 31, 2012, primarily due to rising U.S. risk-free interest rates.
As with interest rates, changes in credit spreads impact the shareholders’ equity of the Company as invested assets are carried at fair value, which includes changes in credit spreads. As a result, an increase in credit spreads will result in a decrease in the fair value of the Company’s investments (including the investment portfolio underlying the funds held - directly managed account) and a corresponding decrease, net of applicable taxes, in the Company’s shareholders’ equity. A decrease in credit spreads would have the opposite effect.
(3) Includes total investments, cash and cash equivalents, the investment portfolio underlying the funds held - directly managed account and accrued interest.
The impact of an immediate change in credit spreads on the fair value of investments and funds held - directly managed exposed to credit spread risk, the Company’s total invested assets and shareholders’ equity, in both absolute terms and as a percentage of total invested assets and shareholders’ equity, has not changed significantly at December 31, 2013 compared to December 31, 2012.
Through its multinational reinsurance operations, the Company conducts business in a variety of non-U.S. currencies, with the principal exposures being the euro, Canadian dollar, British pound, New Zealand dollar, and Australian dollar. As the Company’s reporting currency is the U.S. dollar, foreign exchange rate fluctuations may materially impact the Company’s Consolidated Financial Statements.
For the Company’s capital funds, including its net investment in foreign subsidiaries and branches and equity securities, the Company does not typically employ hedging strategies. However, from time to time the Company does enter into net investment hedges to offset foreign exchange volatility (see Currency in Item 7 of Part II of this report).
(1) As the U.S. dollar is the Company’s reporting currency, there is no currency risk attached to the U.S. dollar and it is excluded from this table. The U.S. dollar accounted for the difference between the Company’s total foreign currency exposure in this table and the total assets and total liabilities in the Company’s Consolidated Balance Sheet at December 31, 2013.
At December 31, 2013, the Company’s net foreign currency exposure in its Consolidated Balance Sheet, after the effect of derivatives, was $241 million. The Company’s most significant net foreign currency exposure at December 31, 2013 was to the Canadian dollar which reflects the unhedged net investment in its Canadian branches. The decrease of $420 million in the Company’s net foreign currency exposure to $241 million at December 31, 2013 compared to $661 million at December 31, 2012 is primarily related to a decrease in the Company’s net foreign currency exposure to the euro.
At December 31, 2013, assuming all other variables remain constant and disregarding any tax effects, a change in the U.S. dollar of 10% or 20% relative to all of the other currencies held by the Company simultaneously would result in a change in the Company’s net assets of $24 million and $48 million, respectively, inclusive of the effect of foreign exchange forward contracts and other derivative financial instruments.
managed account), respectively, at December 31, 2013. Within the segregated investment portfolio underlying the funds held - directly managed account, the single largest corporate issuer and the top 10 corporate issuers accounted for less than 4% and less than 32% of total corporate fixed maturity securities underlying the funds held - directly managed account at December 31, 2013, respectively.
The Company keeps cash and cash equivalents in several banks and ensures that there are no significant concentrations at any point in time, in any one bank.
To a lesser extent, the Company also has credit risk exposure as a party to foreign exchange forward contracts and other derivative contracts. To mitigate this risk, the Company monitors its exposure by counterparty, aims to diversify its counterparty credit risk and ensures that counterparties to these contracts are high credit quality international banks or counterparties. These contracts are generally of short duration (approximately 90 days) and settle on a net basis, which means that the Company is exposed to the movement of one currency against the other, as opposed to the notional amount of the contracts. At December 31, 2013, the Company’s absolute notional value of foreign exchange forward contracts and foreign currency option contracts was $2,045 million, while the net fair value of those contracts was an unrealized loss of $8 million.
The Company is subject to the credit risk of its cedants in the event of their insolvency or their failure to honor the value of the funds held balances due to the Company for any other reason. However, the Company’s credit risk in some jurisdictions is mitigated by a mandatory right of offset of amounts payable by the Company to a cedant against amounts due to the Company. In certain other jurisdictions the Company is able to mitigate this risk, depending on the nature of the funds held arrangements, to the extent that the Company has the contractual ability to offset any shortfall in the payment of the funds held balances with amounts owed by the Company to cedants for losses payable and other amounts contractually due. Funds held balances for which the
The Company has exposure to credit risk as it relates to its business written through brokers if any of the Company’s brokers is unable to fulfill their contractual obligations with respect to payments to the Company. In addition, in some jurisdictions, if the broker fails to make payments to the insured under the Company’s policy, the Company might remain liable to the insured for the deficiency. The Company’s exposure to such credit risk is somewhat mitigated in certain jurisdictions by contractual terms. See Risk Factors in Item 1A of Part I of this report for information related to two brokers that accounted for approximately 43% of the Company’s gross premiums written for the year ended December 31, 2013.
Other than the items discussed above, the concentrations of the Company’s counterparty credit risk exposures have not changed materially at December 31, 2013, compared to December 31, 2012.
There was no material change in the absolute or percentage impact of an immediate change of 10% in the S&P 500 Index on the Company’s equity portfolio, total invested assets and shareholders’ equity at December 31, 2013 compared to December 31, 2012.
PartnerRe Ltd. (PartnerRe or the Company) predominantly provides reinsurance and certain specialty insurance lines on a worldwide basis through its principal wholly-owned subsidiaries, including Partner Reinsurance Company Ltd. (PartnerRe Bermuda), Partner Reinsurance Europe SE (PartnerRe Europe) and Partner Reinsurance Company of the U.S. (PartnerRe U.S.). Risks reinsured include, but are not limited to, property, casualty, motor, agriculture, aviation/space, catastrophe, credit/surety, engineering, energy, marine, specialty property, specialty casualty, multiline and other lines, mortality, longevity, accident and health and alternative risk products. The Company’s alternative risk products include weather and credit protection to financial, industrial and service companies on a worldwide basis.
The Company was incorporated in August 1993 under the laws of Bermuda. The Company commenced operations in November 1993 upon completion of the sale of common shares and warrants pursuant to subscription agreements and an initial public offering.
The Company’s Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). The Consolidated Financial Statements include the accounts of the Company and its subsidiaries. Intercompany accounts and transactions have been eliminated.
Actual and anticipated losses and loss expenses, other costs and investment income related to underlying premiums are considered in determining the recoverability of deferred acquisition costs related to the Company’s Non-life business. Actual and anticipated loss experience, together with the present value of future gross premiums, the present value of future benefits, settlement and maintenance costs are considered in determining the recoverability of deferred acquisition costs related to the Company’s Life business.
Cash equivalents are carried at fair value and include fixed income securities that, at purchase, have a maturity of three months or less.
Goodwill represents the excess of the purchase price over the fair value of the net assets acquired of PartnerRe SA, Winterthur Re, Paris Re and PartnerRe Health. The Company assesses the appropriateness of its
valuation of goodwill on at least an annual basis or more frequently if events or changes in circumstances indicate that the carrying amount may not be recoverable. If, as a result of the assessment, the Company determines that the value of its goodwill is impaired, goodwill will be written down in the period in which the determination is made.
The Company utilizes derivative financial instruments as part of its overall currency risk management strategy. The Company recognizes all derivative financial instruments, including embedded derivative instruments, as either assets or liabilities in the Consolidated Balance Sheets and measures those instruments at fair value. On the date the Company enters into a derivative contract, Management designates whether the derivative is to be used as a hedge of an identified underlying exposure (a designated hedge). The accounting for gains and losses associated with changes in the fair value of a derivative and the effect on the Consolidated Financial Statements depends on its hedge designation and whether the hedge is highly effective in achieving offsetting changes in the fair value of the asset or liability being hedged.
value of foreign currency option contracts and foreign exchange forward contracts which are included in net foreign exchange gains and losses in the Consolidated Statements of Operations. Margin balances required by counterparties, which are equal to a percentage of the total value of open futures contracts, are included in cash and cash equivalents.
The Company enters from time to time into total return and interest rate swaps. Margins related to these swaps are included in other income or loss in the Consolidated Statements of Operations and any changes in the fair value of the swaps are included in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations.
Diluted net income or loss per common share is defined as net income or loss attributable to PartnerRe Ltd. common shareholders divided by the weighted average number of common shares and common share equivalents outstanding, calculated using the treasury stock method for all potentially dilutive securities. Net income or loss attributable to PartnerRe Ltd. common shareholders is defined as net income or loss less preferred share dividends. When the effect of dilutive securities would be anti-dilutive, these securities are excluded from the calculation of diluted net income or loss per share. Basic net income or loss per share is defined as net income or loss attributable to PartnerRe Ltd. common shareholders divided by the weighted average number of common shares outstanding for the period, giving no effect to dilutive securities.
Segments and sub-segments represent markets that are reasonably homogeneous in terms of geography, client types, buying patterns, underlying risk patterns or approach to risk management.
The Company’s financial instruments that it measures at fair value using Level 2 inputs generally include: U.S. government issued bonds; U.S. government sponsored enterprises bonds; U.S. state, territory and municipal entities bonds; non-U.S. sovereign government, supranational and government related bonds consisting primarily of bonds issued by non-U.S. national governments and their agencies, non-U.S. regional governments and supranational organizations; investment grade and high yield corporate bonds; catastrophe bonds; mortality bonds; asset-backed securities; mortgage-backed securities; certain equities traded on foreign exchanges; certain fixed income mutual funds; foreign exchange forward contracts; over-the-counter derivatives such as foreign currency option contracts, credit default swaps, interest rate swaps and TBAs.
At December 31, 2013 and 2012, the aggregate carrying amounts of items included in Other invested assets that the Company did not measure at fair value were $185.8 million and $262.2 million, respectively, which related to the Company’s investments that are accounted for using the cost method of accounting, equity method of accounting or investment company accounting.
In addition to the investments underlying the funds held - directly managed account held at fair value of $561.3 million and $833.2 million at December 31, 2013 and 2012, respectively, the funds held - directly managed account also included cash and cash equivalents, carried at fair value, of $84.8 million and $53.7 million, respectively, and accrued investment income of $6.7 million and $10.2 million, respectively. At December 31, 2013 and 2012, the aggregate carrying amounts of items included in the funds held - directly managed account that the Company did not measure at fair value were $133.0 million and $33.6 million, respectively, which primarily related to other assets and liabilities held by Colisée Re related to the underlying business, which are carried at cost (see Note 5).
At December 31, 2013 and 2012, substantially all of the accrued investment income in the Consolidated Balance Sheets relate to the Company’s investments and the investments underlying the funds held - directly managed account for which the fair value option was elected.
During the year ended December 31, 2013, there were no transfers between Level 1 and Level 2. During the year ended December 31, 2012, certain equities traded on foreign exchanges with a fair value of $1.1 million were transferred from Level 2 to Level 1 given they were trading in an active market at December 31, 2012.
Disclosures about the fair value of financial instruments that the Company does not measure at fair value exclude insurance contracts and certain other financial instruments. At December 31, 2013 and 2012, the fair values of financial instrument assets recorded in the Consolidated Balance Sheets not described above, approximate their carrying values.
(1) Purchases and issuances of derivatives include issuances of $0.8 million.
Asset-backed securities-Asset-backed securities primarily consist of bonds issued by U.S. and foreign corporations that are predominantly backed by student loans, automobile loans, credit card receivables, equipment leases, and special purpose financing. With the exception of special purpose financing, these asset-backed securities are generally priced by independent pricing services and brokers. The pricing provider applies dealer quotes and other available trade information, prepayment speeds, yield curves and credit spreads to the valuation. The Company generally classifies these securities in Level 2. Special purpose financing securities are generally inactively traded and are priced based on valuation models using unobservable inputs. The Company generally classifies these securities in Level 3. The significant unobservable inputs used in the fair value measurement of these asset-backed securities classified as Level 3 are prepayment speeds and credit spreads. Significant increases (decreases) in these prepayment speeds and credit spreads in isolation could result in a significantly lower (higher) fair value measurement.
Other mortgage-backed securities-Other mortgage-backed securities primarily consist of commercial mortgage-backed securities. These securities are generally priced by independent pricing services and brokers. The pricing provider applies dealer quotes and other available trade information, prepayment speeds, yield curves and credit spreads to the valuation. The Company generally classifies these securities in Level 2.
common stock of publicly traded companies, where the net asset value is not provided on a daily basis, and inactively traded common stocks. The significant unobservable inputs used in the fair value measurement of inactively traded common stocks classified as Level 3 include market return information, weighted using management’s judgment, from comparable selected publicly traded companies in the same industry, in a similar region and of a similar size, including net income multiples, tangible book value multiples, comparable returns, revenue multiples, adjusted earnings multiples and projected return on equity ratios. Significant increases (decreases) in any of these inputs could result in a significantly higher (lower) fair value measurement. Significant unobservable inputs used in measuring the fair value measurement of inactively traded common stocks also include a liquidity discount. A significant increase (decrease) in the liquidity discount could result in a significantly lower (higher) fair value measurement.
The Company’s exchange traded derivatives, such as futures are generally classified as Level 1 as their fair values are quoted prices in active markets. The Company’s foreign exchange forward contracts, foreign currency option contracts, credit default swaps, interest rate swaps and TBAs are generally classified as Level 2 within the fair value hierarchy and are priced by independent pricing services.
Included in the Company’s Level 3 classification, in general, are certain inactively traded weather derivatives, notes and loan receivables, notes securitizations, annuities and residuals, private equities and longevity and other total return swaps. For Level 3 instruments, the Company will generally (i) receive a price based on a manager’s or trustee’s valuation for the asset; (ii) develop an internal discounted cash flow model to measure fair value; or (iii) use market return information, adjusted if necessary and weighted using management’s judgment, from comparable selected publicly traded equity funds, in a similar region and of a similar size. Where the Company receives prices from the manager or trustee, these prices are based on the manager’s or trustee’s estimate of fair value for the assets and are generally audited on an annual basis. Where the Company develops its own discounted cash flow models, the inputs will be specific to the asset in question, based on appropriate historical information, adjusted as necessary, and using appropriate discount rates. The significant unobservable inputs used in the fair value measurement of other invested assets classified as Level 3 include credit spreads, prepayment speeds, constant default rates, gross revenue to fair value ratios, net income multiples, tangible book value multiples and other valuation ratios. Significant increases (decreases) in any of these inputs in isolation could result in a significantly lower (higher) fair value measurement. Significant unobservable inputs used in the fair value measurement of other invested assets classified as Level 3 also include an assessment of the recoverability of intangible assets and market return information, weighted using management’s judgment, from comparable selected publicly traded companies in the same industry, in a similar region and of a similar size. Significant increase (decrease) in these inputs in isolation could result in a significantly higher (lower) fair value measurement. As part of the Company’s modeling to determine the fair value of an investment, the Company considers counterparty credit risk as an input to the model, however, the majority of the Company’s counterparties are investment grade rated institutions and the failure of any one counterparty would not have a significant impact on the Company’s consolidated financial statements.
To validate prices, the Company will compare them to benchmarks, where appropriate, or to the business results generally within that asset class and specifically to those particular assets.
The other invested assets within the segregated investment portfolio underlying the funds held - directly managed account, which are classified as Level 3 investments, are primarily real estate mutual fund investments carried at fair value. For the real estate mutual fund investments, the Company receives a price based on the real estate fund manager’s valuation for the asset and further adjusts the price, if necessary, based on appropriate current information on the real estate market. Significant increases (decreases) to the adjustment to the real estate fund manager’s valuation could result in a significantly lower (higher) fair value measurement.
To validate prices within the segregated investment portfolio underlying the funds held - directly managed account, the Company utilizes the methods described above.
At December 31, 2013 and 2012, the fair values of financial instrument liabilities recorded in the Consolidated Balance Sheets approximate their carrying values, with the exception of the debt related to senior notes (Senior Notes) and the debt related to capital efficient notes (CENts).
The methods and assumptions used by the Company in estimating the fair value of each class of financial instrument liability recorded in the Consolidated Balance Sheets for which the Company does not measure that instrument at fair value were as follows:
the fair value of the CENts was calculated based on discounted cash flow models using observable market yields and contractual cash flows based on the aggregate principal amount outstanding of $63 million from PartnerRe Finance II Inc. at December 31, 2013 and 2012.
The carrying values and fair values of the Senior Notes and CENts at December 31, 2013 and 2012 were as follows (in thousands of U.S. dollars):
At December 31, 2013 and 2012, the Company’s debt related to the Senior Notes and CENts was classified as Level 2 in the fair value hierarchy.
The components of the net realized and unrealized investment (losses) gains for the years ended December 31, 2013, 2012 and 2011 were as follows (in thousands of U.S. dollars):
Other than the funds held - directly managed account, the Company generally earns investment income on funds held by reinsured companies based upon a predetermined interest rate, either fixed contractually at the
At December 31, 2013 and 2012, approximately $200.6 million and $167.5 million, respectively, of cash and cash equivalents and approximately $2,477.8 million and $2,532.0 million, respectively, of securities were deposited, pledged or held in escrow accounts in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions and insurance laws.
The Company has agreed, subject to certain exceptions, not to dispose of or hedge any of the common shares in an investment with a fair value of $121 million, which is included in equities, prior to April 28, 2014.
In addition to the investments underlying the funds held - directly managed account in the above table at December 31, 2013 and 2012, were cash and cash equivalents of $84.8 million and $53.7 million, respectively, other assets and liabilities of $132.9 million and $33.4 million, respectively, and accrued investment income of $6.7 million and $10.2 million, respectively. The other assets and liabilities represent working capital assets held by Colisée Re related to the underlying business.
The distribution of fixed maturities underlying the funds held - directly managed account at December 31, 2013, by contractual maturity date, is shown below (in thousands of U.S. dollars). Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.
The components of the net realized and unrealized investment (losses) gains on the funds held - directly managed account for the years ended December 31, 2013, 2012 and 2011 were as follows (in thousands of U.S. dollars):
The components of net investment income underlying the funds held - directly managed account for the years ended December 31, 2013, 2012 and 2011 were as follows (in thousands of U.S. dollars):
The Company’s derivative instruments are recorded in the Consolidated Balance Sheets at fair value, with changes in fair value recognized in either net foreign exchange gains and losses or net realized and unrealized investment gains and losses in the Consolidated Statements of Operations or accumulated other comprehensive income or loss in the Consolidated Balance Sheets, depending on the nature of the derivative instrument. The Company’s objectives for holding or issuing these derivatives are as follows:
The Company also assumes credit risk through credit default swaps to replicate investment positions. The original term of these credit default swaps is generally five years or less and there are no recourse provisions associated with these swaps. While the Company would be required to perform under exposure assumed through credit default swaps in the event of a default on the underlying issuer, no issuer was in default at December 31, 2013. The counterparties on the Company’s assumed credit default swaps are all investment grade rated financial institutions.
The net fair values and the related net notional values of derivatives included in the Company’s Consolidated Balance Sheets at December 31, 2013 and 2012 were as follows (in thousands of U.S. dollars):
(1) At December 31, 2013 and 2012, insurance-linked securities include a longevity swap for which the notional amount is not reflective of the overall potential exposure of the swap. As such, the Company has included the probable maximum loss under the swap within the net notional exposure as an approximation of the notional amount.
The gains and losses in the Consolidated Statements of Operations for derivatives not designated as hedges for the years ended December 31, 2013, 2012 and 2011 were as follows (in thousands of U.S. dollars):
The gross and net fair values of derivatives that are subject to offsetting in the Consolidated Balance Sheets at December 31, 2013 and 2012 were as follows (in thousands of U.S. dollars):
(1) Amounts include all derivative instruments, irrespective of whether there is a legally enforceable master netting arrangement in place.
The Company’s goodwill and intangible assets at December 31, 2013 and 2012 were as follows (in thousands of U.S. dollars):
On December 31, 2012, the Company acquired 100% of the outstanding common shares of PartnerRe Health for $72 million plus tangible book value, consistent with the Company’s diversified strategy.
Intangible asset amortization during the years ended December 31, 2013, 2012 and 2011 totaled $27.2 million, $31.8 million and $44.8 million, respectively, of which $nil, $nil and $8.4 million, respectively, is recorded within acquisition costs and $27.2 million, $31.8 million and $36.4 million, respectively, is recorded within amortization of intangible assets in the Consolidated Statements of Operations. The amount recorded within acquisition costs in the Consolidated Statements of Operations approximates the amount of Paris Re’s deferred acquisition costs that would have been recorded as acquisition costs had they not been fair valued under purchase accounting.
8. Unpaid Losses and Loss Expenses and Policy Benefits for Life and Annuity Contracts
The reconciliation of the beginning and ending gross and net liability for unpaid losses and loss expenses, excluding policy benefits for life and annuity contracts, for the years ended December 31, 2013, 2012 and 2011 was as follows (in thousands of U.S. dollars):
emergence related to certain catastrophic and large loss events. The net favorable loss development for prior accident years in 2012 was driven by all lines of business, with the property line being the most pronounced. The net favorable loss development for prior accident years in 2011 was driven by all lines of business, most notably by the motor line. The net favorable loss development in each year was primarily due to favorable loss emergence.
For the Catastrophe sub-segment, the Company reported net favorable loss development for prior accident years in 2013, 2012 and 2011. The net favorable loss development in each year was primarily due to favorable loss emergence.
The net favorable prior year loss development of $39 million in 2013 was primarily related to the guaranteed minimum death benefit (GMDB) business and, to a lesser extent, certain short-term treaties in the mortality line of business. The net favorable development was primarily due to favorable claims experience, data updates received from cedants and improvements in the capital markets related to the GMDB business.
The net favorable prior year loss development of $14 million in 2012 was primarily related to the GMDB business, mainly driven by improvements in the capital markets, and certain short-term treaties in the mortality line of business.
Net premiums written, net premiums earned and losses and loss expenses and life policy benefits are reported net of reinsurance in the Company’s Consolidated Statements of Operations. Assumed, ceded and net amounts for the years ended December 31, 2013, 2012 and 2011 were as follows (in thousands of U.S. dollars):
For each of the years ended December 31, 2013, 2012 and 2011, the Company incurred interest expense and paid interest of $17.2 million in relation to the 2008 Senior Notes issued by PartnerRe Finance A.
On March 13, 2009, PartnerRe Finance II, under the terms of a tender offer, paid holders $500 per $1,000 principal amount of CENts tendered, and purchased approximately 75% of the issue, or $186.6 million, for $93.3 million. Contemporaneously, under the terms of a cross receipt agreement, PartnerRe U.S. Holdings paid PartnerRe Finance II consideration of $93.3 million for the extinguishment of $186.6 million of the principal amount of PartnerRe U.S. Holdings’ 6.440% Fixed-to-Floating Rate promissory note due December 1, 2066. All other terms and conditions of the remaining CENts and promissory note remain unchanged. A pre-tax gain of $88.4 million, net of deferred issuance costs and fees, was realized on the foregoing transactions during the year ended December 31, 2009. At December 31, 2013 and 2012, the aggregate principal amount of the CENts and promissory note outstanding was $63.4 million and $71.0 million, respectively.
For each of the years ended December 31, 2013, 2012 and 2011, the Company incurred interest expense and paid interest of $4.6 million in relation to the CENts.
During 2011, the Company repurchased, under its authorized share repurchase program, 5.4 million of its common shares at a total cost of $396.2 million, representing an average cost of $73.41 per share.
During the years ended December 31, 2013, 2012 and 2011, the Company had outstanding Series C, Series D and Series E cumulative redeemable preferred shares (Series C preferred shares, Series D preferred shares, Series E preferred shares) and during the year ended December 31, 2013 issued Series F non-cumulative redeemable preferred shares (Series F preferred shares) as follows (in millions of U.S. dollars or shares, except percentage amounts):
The reconciliation of basic and diluted net income (loss) per share and dividends declared per common share for the years ended December 31, 2013, 2012 and 2011 is as follows (in thousands of U.S. dollars, except share and per share data):
(1) At December 31, 2013, 2012 and 2011, share based awards to purchase 14.8 thousand, 554.7 thousand and 2,854.4 thousand common shares, respectively, were excluded from the calculation of diluted weighted average number of common shares and common share equivalents outstanding because their exercise prices were greater than the average market price of the common shares. In addition, dilutive securities, in the form of share options and other, of 687.3 thousand shares were not included in the weighted average number of common shares and common share equivalents outstanding for the purpose of computing the diluted net loss per share because to do so would have been anti-dilutive for the year ended December 31, 2011.
During the year ended December 31, 2013, the Company and third party investors contributed approximately $28 million and $47 million, respectively, of Lorenz Re’s non-voting redeemable preferred share capital, which is redeemable at the option of the Company. Lorenz Re’s preferred shares are expected to be redeemed following the commutation of the portfolio back to the Company on or before June 1, 2016.
The Company’s ability to pay common and preferred shareholders’ dividends and its corporate expenses is dependent mainly on cash dividends from PartnerRe Bermuda, PartnerRe Europe and PartnerRe U.S. (collectively, the reinsurance subsidiaries), which are the Company’s most significant subsidiaries. The payment of such dividends by the reinsurance subsidiaries to the Company is limited under Bermuda and Irish laws and certain statutes of various U.S. states in which PartnerRe U.S. is licensed to transact business. The restrictions are generally based on net income and/or certain levels of policyholders’ earned surplus as determined in accordance with the relevant statutory accounting practices. At December 31, 2013, there were no restrictions on the Company’s ability to pay common and preferred shareholders’ dividends from its retained earnings, except for the reinsurance subsidiaries’ dividend restrictions described below.
The reinsurance subsidiaries are required to file annual statements with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory basis), maintain minimum levels of solvency and liquidity and comply with risk-based capital requirements and licensing rules. At December 31, 2013, the reinsurance subsidiaries’ solvency, liquidity and risk-based capital amounts were in excess of the minimum levels required. The typical adjustments to insurance statutory basis amounts to convert to U.S. GAAP include elimination of certain statutory reserves, deferral of certain acquisition costs, recognition of goodwill, intangible assets and deferred income taxes, valuation of bonds at fair value and presentation of ceded reinsurance balances gross of assumed balances.
PartnerRe Bermuda may declare dividends subject to it continuing to meet its minimum solvency and capital requirements, which are to hold statutory capital and surplus equal to or exceeding the Target Capital Level, which is equivalent to 120% of the Enhanced Capital Requirement (ECR). The ECR is calculated with reference to the Bermuda Solvency Capital Requirement model, which is a risk-based capital model. At December 31, 2013, the maximum dividend that PartnerRe Bermuda could pay without prior regulatory approval was approximately $1,009 million.
PartnerRe U.S. may declare dividends subject to it continuing to meet its minimum solvency and capital requirements and is generally limited to paying dividends from earned surplus. The maximum dividend that can be declared and paid without prior approval is limited, together with all dividends declared and paid during the preceeding twelve months, to the lesser of net investment income for the previous twelve months or 10% of its total statutory capital and surplus. At December 31, 2013, the maximum dividend that PartnerRe U.S. could pay without prior regulatory approval was $nil as a result of dividends having already been declared and paid during 2013.
The statutory net income (loss) of the Company’s reinsurance subsidiaries for the years ended December 31, 2013, 2012 and 2011 was as follows (in millions of U.S. dollars):
The required and actual statutory capital and surplus of the Company’s reinsurance subsidiaries at December 31, 2013 and 2012 was as follows (in millions of U.S. dollars):
Of the Company’s total net assets of $6.7 billion at December 31, 2013, the total amount of restricted net assets for the Company’s consolidated subsidiaries was $4.9 billion and primarily related to the statutory dividend restrictions described above.
Income tax returns are open for examination for the tax years 2008-2013 in Canada and Switzerland, 2009-2013 in Ireland, 2010-2013 in the United States, 2011-2013 in France and 2012-2013 in Singapore. As a global organization, the Company may be subject to a variety of transfer pricing or permanent establishment challenges by taxing authorities in various jurisdictions. While management believes that adequate provision has been made in the Consolidated Financial Statements for any potential assessments that may result from tax examinations for all open tax years, the completion of tax examinations for open years may result in changes to the amounts recognized in the Consolidated Financial Statements.
Income tax expense for the years ended December 31, 2013, 2012 and 2011 was as follows (in thousands of U.S. dollars):
Income (loss) before taxes attributable to the Company’s domestic and foreign operations and a reconciliation of the actual income tax rate to the amount computed by applying the effective tax rate of 0% under Bermuda (the Company’s domicile) law to income (loss) before taxes was as follows for the years ended December 31, 2013, 2012 and 2011 (in thousands of U.S. dollars):
The components of net tax assets and liabilities at December 31, 2013 and 2012 were as follows (in thousands of U.S. dollars):
The total amount of unrecognized tax benefits for the years ended December 31, 2013, 2012 and 2011 was as follows (in thousands of U.S. dollars):
In addition, the Committee is authorized to grant performance awards to eligible senior executives. These performance awards will, if the Committee intends such award to qualify as “qualified performance based compensation” under Section 162(m) of the Internal Revenue Code (IRC), become earned and payable only if pre-established targets relating to certain performance measures are achieved. The individual maximum number of shares underlying any such share-denominated award granted in any calendar year will be 0.5 million shares, and the individual maximum amount of any such cash-denominated award in any calendar year shall not exceed $5.0 million.
At December 31, 2013, 0.4 million shares, of which a total of 0.1 million shares can be issued as either RS or RSUs and 0.3 million shares can be issued as share options or SSARs, remained available for issuance under this plan.
The PartnerRe Ltd. Employee Share Purchase Plan (ESPP), which was approved by the Company’s shareholders, has a twelve month offering period with two purchase periods of six months each. All employees are eligible to participate in the ESPP and can contribute between 1% and 10% of their base salary toward the purchase of the Company’s shares up to the limit set by the IRC. Employees who enroll in the ESPP may purchase the Company’s shares at a 15% discount of the lower fair value on either the enrolment date or purchase date. Participants in the ESPP are eligible to receive dividends on their shares as of the purchase date. A total of 0.6 million common shares may be issued under the ESPP. At December 31, 2013, 0.2 million shares remained available for issuance under this plan.
The Swiss Share Purchase Plan (SSPP) has two offering periods per year with two purchase periods of six months each. Swiss employees, who work at least 20 hours per week, are eligible to participate in the SSPP and can contribute between 1% and 8% of their base salary toward the purchase of the Company’s shares up to a maximum of 5,000 Swiss francs per annum. Employees who enroll in the SSPP may purchase the Company’s shares at a 40% discount of the fair value on the purchase date. There is a restriction on transfer or sale of these shares for a period of two years following purchase. Participants in the SSPP are eligible to receive dividends on their shares as of the purchase date. A total of 0.4 million common shares may be issued under the SSPP. At December 31, 2013, 0.2 million shares remained available for issuance under this plan.
The Company values share options issued with a Black-Scholes valuation model and used the following assumptions for the years ended December 31, 2013, 2012 and 2011:
During the years ended December 31, 2013, 2012 and 2011, the Company issued 329,174 RSUs and PSUs, 294,184 RSUs and 314,182 RSUs with a weighted average grant date fair value of $89.44, $65.33 and $81.20, respectively. The Company values RSUs and PSUs issued under all plans at the fair value of its common shares at the date of grant, as defined by the plan document.
The activity related to the Company’s RSUs and PSUs for the year ended December 31, 2013 was as follows:
The RSUs that vested during the years ended December 31, 2013, 2012 and 2011 had a fair value of $22.8 million, $5.5 million and $18.3 million, respectively.
The total unrecognized share-based compensation expense related to unvested RSUs and PSUs was approximately $27.3 million at December 31, 2013, which is expected to be recognized over a weighted-average period of 2.0 years.
During the years ended December 31, 2013, 2012 and 2011, the Company issued 125,561 SSARs, 356,900 SSARs, and 210,582 SSARs with a weighted average grant date fair value of $11.25, $7.34 and $10.32, respectively.
The activity related to the Company’s SSARs for the year ended December 31, 2013 was as follows:
The total unrecognized share-based compensation expense related to unvested SSARs was approximately $2.0 million at December 31, 2013, which is expected to be recognized over a weighted-average period of 1.6 years.
The Company incurred expenses for these defined contribution arrangements of $14.5 million, $15.7 million and $16.0 million for the years ended December 31, 2013, 2012 and 2011, respectively.
At December 31, 2013 and 2012, the funded status was included in Accounts payable, accrued expenses and other in the Consolidated Balance Sheets. The total amounts recognized in Accumulated other comprehensive (loss) income at December 31, 2013 and 2012 were $12.9 million (net of $3.4 million of taxes) and $22.8 million (net of $6.1 million of taxes), respectively.
The assumptions used to determine the Zurich Plan’s pension obligation and net periodic benefit cost for the years ended December 31, 2013, 2012 and 2011 were as follows:
The Company does not believe that any of the Zurich Plan’s assets will be returned to the Company during 2014.
The Company monitors the performance of the notes receivable based on the type of underlying collateral and by assigning a “performing” or a “non-performing” indicator of credit quality to each individual receivable. At December 31, 2013, the Company’s notes receivable of $24.5 million were all performing and were collateralized by residential property and commercial property of $19.8 million and $4.7 million, respectively. At December 31, 2012, the Company’s notes receivable of $46.7 million were all performing and were collateralized by residential property and commercial property of $31.3 million and $15.4 million, respectively.
The Company has exposure to credit risk related to reinsurance balances receivable and reinsurance recoverable on paid and unpaid losses. The credit risk exposure related to these balances is mitigated by several factors, including but not limited to, credit checks performed as part of the underwriting process, monitoring of aged receivable balances and the contractual right to offset premiums receivable or funds held balances against unpaid losses and loss expenses. The Company regularly reviews its reinsurance recoverable balances to estimate an allowance for uncollectible amounts based on quantitative and qualitative factors. At December 31, 2013 and 2012, the Company has recorded a provision for uncollectible premiums receivable of $8 million and $9 million, respectively. See also Note 9 for discussion of credit risk related to reinsurance recoverable on paid and unpaid losses.
one cedant and is supported by an underlying portfolio of investments, which are managed by the Company (see Note 5). However, the Company’s credit risk in some jurisdictions is mitigated by a mandatory right of offset of amounts payable by the Company to a cedant against amounts due to the Company. In certain other jurisdictions the Company is able to mitigate this risk, depending on the nature of the funds held arrangements, to the extent that the Company has the contractual ability to offset any shortfall in the payment of the funds held balances with amounts owed by the Company to cedants for losses payable and other amounts contractually due.
The Company leases office space under operating leases expiring in various years through 2019. The leases are renewable at the option of the lessee under certain circumstances. The following is a schedule of future minimum rental payments, exclusive of escalation clauses, on non-cancelable leases at December 31, 2013 (in thousands of U.S. dollars):
The Company has entered into service agreements and lease contracts that provide for business and information technology support and computer equipment. Future payments under these contracts amount to $15 million through 2018.
The Company has entered into strategic investments with unfunded capital commitments. In the next five years, the Company expects to fund capital commitments totaling $162 million with $67 million, $52 million, $31 million, $12 million and $nil to be paid during 2014, 2015, 2016, 2017 and 2018, respectively.
The Company has committed to a $100 million participation in a 10 year structured letter of credit facility issued by a high credit quality international bank, which has a final maturity of December 29, 2020. At December 31, 2013, the letter of credit facility has not been drawn down and it can only be drawn down in the event of certain specific scenarios, which the Company considers remote. Unless cancelled by the bank, the credit facility automatically extends for one year, each year until maturity.
The Company’s reinsurance subsidiaries, and the insurance and reinsurance industry in general, are subject to litigation and arbitration in the normal course of their business operations. In addition to claims litigation, the Company and its subsidiaries may be subject to lawsuits and regulatory actions in the normal course of business that do not arise from or directly relate to claims on reinsurance treaties. This category of business litigation typically involves, among other things, allegations of underwriting errors or omissions, employment claims or regulatory activity. While the outcome of business litigation cannot be predicted with certainty, the Company will dispute all allegations against the Company and/or its subsidiaries that Management believes are without merit.
On November 14, 2011, the Company entered into an agreement to renew and modify an existing credit facility. Under the terms of the agreement, this credit facility was increased from a $250 million to a $300 million combined credit facility, with the first $100 million being unsecured and any utilization above the initial $100 million being secured. This credit facility matures on November 14, 2014.
In addition, the Company maintains committed secured letter of credit facilities. These facilities are used for the issuance of letters of credit, which must be fully secured with cash and/or government bonds and/or investment grade bonds. The agreements include default covenants, which could require the Company to fully secure the outstanding letters of credit to the extent that the facility is not already fully secured, and disallow the issuance of any new letters of credit. Included in the Company’s secured credit facilities at December 31, 2013 is a $250 million secured credit facility, which matures on December 4, 2016, and a $200 million secured credit facility, which matures on December 31, 2014. At December 31, 2013, no conditions of default existed under these facilities.
The Company was party to agreements with Atradius N.V. (a company in which a board member was a supervisory director until May 2012) and ING Group N.V. (a company in which a board member is a supervisory director since May 2012). All agreements entered into with Atradius N.V. and ING Group N.V. were completed on an arm’s-length basis.
Included in the Consolidated Balance Sheets were the following balances related to Atradius N.V. at December 31, 2012 (in thousands of U.S. dollars):
In the normal course of its underwriting activities, the Company and certain subsidiaries entered into reinsurance contracts with ING Group N.V. The activity included in the Consolidated Statements of Operations related to ING Group N.V. for the years ended December 31, 2013 and 2012 includes net premiums earned of $2.6 million and $3.4 million, respectively, and losses and loss expenses and life policy benefits of $1.3 million and $0.8 million, respectively. Included in the Consolidated Balance Sheets at December 31, 2013 and 2012 were unpaid losses and loss expenses of $12.9 million and $12.7 million, respectively.
Management measures results for the Non-life segment on the basis of the loss ratio, acquisition ratio, technical ratio, other operating expense ratio and combined ratio (all defined below). Management measures results for the Non-life sub-segments on the basis of the loss ratio, acquisition ratio and technical ratio. Management measures results for the Life and Health segment on the basis of the allocated underwriting result, which includes revenues from net premiums earned, other income or loss and allocated net investment income for Life and Health, and expenses from life policy benefits, acquisition costs and other operating expenses.
The following tables provide a summary of the segment results for the years ended December 31, 2013, 2012 and 2011 (in millions of U.S. dollars, except ratios):
The following table provides the distribution of net premiums written by line of business for the years ended December 31, 2013, 2012 and 2011:
We have audited the accompanying consolidated balance sheets of PartnerRe Ltd. and subsidiaries (the Company) as of December 31, 2013 and 2012, and the related consolidated statements of operations and comprehensive income (loss), shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2013. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.