The Company and its subsidiaries currently occupy office space as described below. As a result of the Flagstone acquisition, we own office space and buildings in Hyderabad, India and Luxembourg. We believe our current facilities and the leaseholds with respect thereto are sufficient for us to conduct our operations.
The gain on bargain purchase, net of expenses, arose from the acquisitions of Flagstone on November 30, 2012 and is net of transaction related expenses.
The combined ratio is calculated by combining the losses and loss expenses ratio, the policy acquisition costs ratio and the general and administrative expenses ratio.
The following table sets forth summarized balance sheet data as of December 31, 2014, 2013, 2012, 2011 and 2010:
Book value per diluted common share is calculated based on total shareholders’ equity available to Validus plus the assumed proceeds from the exercise of outstanding options and warrants, divided by the sum of common shares, unvested restricted shares, options and warrants outstanding (assuming their exercise). Book value per diluted common share is a non-GAAP financial measure, as described in more detail in the section entitled “Non-GAAP Financial Measures.”
The following is a discussion and analysis of the Company’s consolidated results of operations for the years ended December 31, 2014, 2013 and 2012 and the Company’s consolidated financial condition, liquidity and capital resources at December 31, 2014 and 2013. This discussion and analysis should be read in conjunction with the Company’s audited Consolidated Financial Statements and related notes thereto included elsewhere within this filing.
The Company conducts its operations worldwide through four operating segments which have been determined under U.S. GAAP segment reporting to be Validus Re, AlphaCat, Talbot and Western World. Validus Re is a Bermuda-based reinsurance segment focused on short-tail lines of reinsurance. AlphaCat is a Bermuda-based investment adviser, managing capital from third parties and the Company in insurance linked securities and other investments in the property catastrophe reinsurance space. Talbot is a specialty insurance segment, primarily operating within the Lloyd's insurance market through Syndicate 1183. Western World is a U.S. based specialty excess and surplus lines insurance company.
On November 30, 2012, the Company acquired all of the outstanding shares of Flagstone. As part of this acquisition, the Company acquired Flagstone Reassurance Suisse, SA, and renamed it Validus Reinsurance (Switzerland) Ltd ("Validus Re Swiss"). Validus Re Swiss is based in Zurich, Switzerland and forms part of Validus Re segment. During October 2013, the Company completed the sale of its wholly owned subsidiary, Flagstone Alliance Insurance and Reinsurance plc.
On December 20, 2013, the Company joined with other investors in capitalizing AlphaCat 2014, a special purpose vehicle formed for the purpose of investing in collateralized reinsurance and retrocessional contracts. The Company has an equity interest and voting rights in AlphaCat 2014 which are below 50%, therefore the investment in AlphaCat 2014 is included as an equity method investment in the Consolidated Financial Statements of the Company.
On December 29, 2014, the Company joined with other investors in capitalizing AlphaCat 2015, a special purpose vehicle formed for the purpose of investing in collateralized reinsurance and retrocessional contracts. The Company has an equity interest and voting rights in AlphaCat 2015 which are below 50%, therefore the investment in AlphaCat 2015 is included as an equity method investment in the Consolidated Financial Statements of the Company.
During the January 2014 renewal season, the Validus Re and AlphaCat segments underwrote $575.2 million in gross premiums written (net of intercompany eliminations between Validus Re and AlphaCat), a decrease of 3.2% from the prior period. This decrease was primarily driven by a challenging rate environment in the Company's U.S. property catastrophe business, which experienced a reduction in rates of approximately 12.5%. During the mid-year 2014 renewal period, the Validus Re segment experienced rate softening across U.S. and international property lines. In particular, although limits placed from the Florida market increased, the availability of capacity resulted in overall pricing reductions for Florida property catastrophe business. The Talbot segment experienced a whole account rate decrease of 3.8% through December 31, 2014.
Book value per diluted common share plus accumulated dividends is considered by management to be the primary indicator of financial performance, as we believe growth in book value on a diluted basis, plus the dividends that have accumulated, ultimately translates into the return that a shareholder will receive. Book value per diluted common share plus accumulated dividends increased by $4.63, or 10.5%, from $43.91 at December 31, 2013 to $48.54 at December 31, 2014. Cash dividends per common share are an integral part of the value created for shareholders. The Company paid quarterly cash dividends of $0.30 per common share and common share equivalent during the year ended December 31, 2014. On February 3, 2015, the Company announced a quarterly cash dividend of $0.32 per common share and $0.32 per common share equivalent for which each outstanding warrant is exercisable, payable on March 31, 2015 to holders of record on March 13, 2015. Book value per diluted common share plus accumulated
Underwriting income measures the performance of the Company’s core underwriting function, excluding revenues and expenses such as net investment income (loss), other insurance related income, finance expenses, net realized and change in net unrealized gains (losses) on investments, foreign exchange gains (losses) and non-recurring items. The Company believes the reporting of underwriting income enhances the understanding of results by highlighting the underlying profitability of the Company’s core insurance and reinsurance operations. Underwriting income for the years ended December 31, 2014, 2013 and 2012 was $526.9 million, $604.9 million and $248.7 million, respectively. Underwriting income is a non-GAAP financial measure, as described in more detail in the section entitled “Non-GAAP Financial Measures."
Net operating income available to Validus is defined as net income excluding net realized and change in net unrealized gains (losses) on investments, income (loss) from investment affiliate, foreign exchange gains (losses), other income (loss), non-recurring items and operating income (loss) attributable to noncontrolling interest. This measure focuses on the underlying fundamentals of the Company's operations without the influence of gains (losses) from the sale of investments, translation of non-U.S. dollar currencies and non-recurring items. Net operating income available to Validus for the years ended December 31, 2014, 2013 and 2012 was $486.5 million, $589.4 million and $333.7 million, respectively. Net operating income is a non-GAAP financial measure, as described in more detail in the section entitled “Non-GAAP Financial Measures.”
Underwriting income for the three months ended December 31, 2014 was $135.7 million compared to underwriting income of $110.4 million for the three months ended December 31, 2013, an increase of $25.3 million, or 22.9%.
Combined ratio for the three months ended December 31, 2014 was 75.7% which included $84.6 million of favorable loss reserve development on prior accident years, benefiting the loss ratio by 15.1 percentage points compared to a combined ratio for the three months ended December 31, 2013 of 77.6% which included $33.6 million of favorable loss reserve development on prior accident years, benefiting the loss ratio by 6.8 percentage points.
Investment yield for the three months ended December 31, 2014 was 1.84% compared to 1.44% for the three months ended December 31, 2013.
Net income available to Validus for the three months ended December 31, 2014 was $125.9 million, or $1.38 per diluted common share compared to $95.3 million or $0.93 per diluted common share for the three months ended December 31, 2013.
Annualized return on average equity and annualized net operating return on average equity for the three months ended December 31, 2014 were 13.8% and 14.2%, respectively, compared to 10.2% and 10.7% for the three months ended December 31, 2013.
Net premiums earned for the year ended December 31, 2014 were $2.002 billion compared to $2.102 billion for the year ended December 31, 2013, a decrease of $99.6 million, or 4.7%.
Underwriting income for the year ended December 31, 2014 was $526.9 million compared to $604.9 million for the year ended December 31, 2013, a decrease of $78.0 million, or 12.9%.
Combined ratio for the year ended December 31, 2014 was 73.7%, which included $252.2 million of favorable loss reserve development on prior accident years, benefiting the loss ratio by 12.6 percentage points, compared to 71.2%, which included $205.4 million of favorable loss reserve development on prior accident years, benefiting the loss ratio by 9.8 percentage points, for the year ended December 31, 2013.
Losses and loss expenses from notable loss events for the year ended December 31, 2014 was $34.9 million compared to $60.8 million for the year ended December 31, 2013, a decrease of $25.9 million.
Net investment income for the year ended December 31, 2014 was $100.1 million compared to $96.1 million for the year ended December 31, 2013, an increase of $4.0 million, or 4.2%.
Investment yield for the year ended December 31, 2014 was 1.53% compared to 1.38% for the year ended December 31, 2013.
Return on average equity and net operating return on average equity for the year ended December 31, 2014 were 13.1% and 13.2%, respectively compared to 14.0% and 15.5% for the year ended December 31, 2013.
The notable loss event for the year ended December 31, 2014 was Tripoli Airport. The notable loss event for the year ended December 31, 2013 was the European Floods. Notable loss events for the year ended December 31, 2012 were Costa Concordia, Cat 67, U.S. drought, Hurricane Isaac and Hurricane Sandy.
Non-GAAP Financial Measures. In presenting the Company’s results, management has included and discussed underwriting income and operating income that is not calculated under standards or rules that comprise U.S. GAAP. Such measures are referred to as non-GAAP. Non-GAAP measures may be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. Further discussion of these measures is presented in the section entitled “Non-GAAP Financial Measures.”
A decrease in net premiums earned of $99.6 million, primarily within the Validus Re segment, due to a reduction in gross premiums written, the timing of the purchase of retrocessional coverage and the effect of the Flagstone run-off business; and,
A decrease in losses and loss expenses of $21.9 million primarily due to an increase in favorable prior period development of $46.8 million; offset by an increase in current year losses and loss expenses of $24.9 million.
Net operating income available to Validus for the year ended December 31, 2013 was $589.4 million compared to $333.7 million for the year ended December 31, 2012, an increase of $255.7 million. The primary factors driving the increase in net operating income available to Validus were:
An increase in net premiums earned of $228.8 million, primarily due to new agriculture business written by Validus Re and business written in consolidated AlphaCat subsidiaries; and
A decrease in losses and loss expenses of $205.5 million, driven by a significantly lower level of notable loss events, offset by losses on the new agricultural business written by Validus Re; offset by,
An increase in policy acquisition costs of $25.6 million, reflecting the higher level of net premiums earned; and
Net premiums earned for the three months ended December 31, 2014 were $230.5 million compared to $250.3 million for the three months ended December 31, 2013, a decrease of $19.8 million, or 7.9%.
Combined ratio for the three months ended December 31, 2014 was 51.3% compared to 69.1% for the three months ended December 31, 2013.
Other insurance related income for the three months ended December 31, 2014 was $0.8 million compared to $0.9 million for the three months ended December 31, 2013, a decrease of $0.1 million.
Net operating income for the three months ended December 31, 2014 of $132.1 million compared to income of $92.1 million for the three months ended December 31, 2013, an increase of $40.0 million.
General and administrative expenses for the three months ended December 31, 2014 were $21.0 million compared to $21.6 million for the three months ended December 31, 2013, a decrease of $0.6 million, or 2.9%.
Non-GAAP Financial Measures. In presenting the Company’s results, management has included and discussed underwriting income and operating income that are not calculated under standards or rules that comprise U.S. GAAP. Such measures are referred to as non-GAAP. Non-GAAP measures may be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. Further discussion of these measures is presented in the section entitled “Non-GAAP Financial Measures.”
The decrease in gross premiums written in the property lines of $113.6 million was primarily due to reductions in business written in the catastrophe excess of loss and per risk lines of $87.4 million and $5.7 million, respectively. These decreases were as a result of current market conditions, the impact of a program that was withdrawn and a number of non-renewals due to both unfavorable pricing and the proposed inclusion of terror exposure on some programs without appropriate premium for the additional risk. The decrease in gross premiums written of $3.0 million in the marine lines was primarily due to non-renewals and some business historically written in the marine lines being renewed in the specialty lines. This decrease was partially offset by positive premium adjustments. The increase in gross premiums written of $11.0 million in the specialty lines was primarily due to new composite and trade credit business of $22.0 million and $16.5 million, respectively; offset by a $31.5 million reduction in agricultural business as a result of reduced participation in a number of quota share agreements.
Reinsurance premiums ceded in the property lines decreased by $17.8 million, due to significant restructuring of retrocessional coverage purchased, reflecting more favorable market conditions in the current year. The decrease in reinsurance premiums ceded in the specialty lines of $26.9 million was due primarily to the non-renewal of proportional coverage that was purchased in the first quarter of 2013 related to the agriculture business.
The changes in net premiums written were driven by factors highlighted above in respect of gross premiums written and reinsurance premiums ceded.
The specialty ratio has increased by 9.0 percentage points due to the decrease in reinsurance coverage purchased on the agriculture business.
The decreases in the property and marine lines net premiums earned were as a result of lower gross premiums written and the tail of the Flagstone run-off as premiums were earned in the year ended December 31, 2013 with no comparative amounts for the year ended December 31, 2014. The increase in the specialty lines net premiums earned was due primarily to various adjustments on existing business.
The property lines incurred no losses and loss expenses from notable loss events during the year ended December 31, 2014. In comparison, for the year ended December 31, 2013 the property lines incurred $55.3 million of losses and loss expenses from a single notable loss event, the European Floods, which represented 8.2 percentage points of the property lines loss ratio. Net of $4.8 million of reinstatement premiums, the effect of this event on net operating income was a reduction of $50.5 million.
The property lines current year loss ratio, excluding the impact of notable and non-notable loss events, decreased by 5.5 percentage points as a result of lower attritional losses in the current year. The favorable development of $76.1 million, on prior accident years for the year ended December 31, 2014, was primarily due to lower claims emergence on attritional losses and favorable loss development on Hurricane Sandy.
The acquisition cost ratio for the marine lines decreased 2.6 percentage points primarily due to adjustments to estimates on proportional lines in the respective years. The acquisition cost ratio for the specialty lines has decreased by 1.2 percentage points due to changes on renewed agricultural policies.
The decrease in general and administrative expenses of $16.5 million or 18.1% was primarily due to a reduction in office and infrastructure costs related to entities that are no longer in use as a result of efficiencies achieved through rationalization of historical Flagstone entities. Also contributing to the decrease was a reduction in professional fees and staff costs associated with the wind-up of certain Flagstone entities. This was partially offset by an increase in staff costs related to underwriting operations in Dublin, Ireland and Zurich, Switzerland compared to the year ended December 31, 2013. The increase in share compensation expenses of $2.1 million or 27.0% was primarily due to a higher level of awards being issued in 2013 compared to earlier years.
The decrease in the combined ratio for the year ended December 31, 2014 of 4.4 percentage points compared to the year ended December 31, 2013 was due to the movement in the underlying ratios as discussed above.
The decrease in net investment income for the year ended December 31, 2014 was $6.7 million or 8.3% primarily due to a decrease in the balance of fixed maturities and a slightly lower overall yield on such investments. Net investment income from other investments includes distributed and undistributed net income from certain investments.
The decrease in other insurance related income for the year ended December 31, 2014 was $16.1 million or 83.6% primarily due to the gain recorded on the redemption of part of Validus Re's investment in the AlphaCat ILS funds during the year ended December 31, 2013.
Net premiums earned for the three months ended December 31, 2014 were $34.1 million compared to $37.6 million for the three months ended December 31, 2013, a decrease of $3.6 million.
Underwriting income for the three months ended December 31, 2014 was $29.2 million compared to $28.0 million for the three months ended December 31, 2013, an increase of $1.2 million.
Income from operating affiliates for the three months ended December 31, 2014 was $4.1 million compared to income from operating affiliates of $5.5 million for the three months ended December 31, 2013, a decrease of $1.4 million.
The combined ratio for the three months ended December 31, 2014 was 14.3% compared to 25.6% for the three months ended December 31, 2013, a decrease of 11.3 percentage points.
Net investment income for the three months ended December 31, 2014 was $1.7 million compared to $1.0 million for the three months ended December 31, 2013, an increase of $0.7 million.
Net operating income available to AlphaCat for the three months ended December 31, 2014 was $8.9 million compared to $11.8 million for the three months ended December 31, 2013, a decrease of $2.9 million.
Managed gross premiums written for the year ended December 31, 2014 were $135.2 million compared to $143.1 million for the year ended December 31, 2013, a decrease of $8.0 million or 5.6%. A reconciliation of managed gross premiums written to gross premiums written, the most comparable U.S. GAAP financial measure, is presented in the section entitled "Non-GAAP Financial Measures."
The decrease in AlphaCat net premiums written was driven by factors highlighted above in respect of gross premiums written and reinsurance premiums ceded. The ratios of net premiums written to gross premiums written were 96.8% and 99.6% for the years ended December 31, 2014 and 2013, respectively.
The property lines current year loss ratio, excluding the impact of notable and non-notable loss events, was lower by 10.3 percentage points as a result of lower attritional losses in the current year. The favorable development of $12.2 million, on prior accident years for the year ended December 31, 2014, relates the partial release of reserves originally established in the third quarter of 2013 on an aggregate excess of loss contract.
There were no losses and loss expenses from notable loss events for the year ended December 31, 2014. In comparison, losses and loss expenses from notable loss events for the year ended December 31, 2013 was $0.8 million from a single notable loss event, the European Floods, which represented 0.6 percentage points of the loss ratio.
The decrease in the combined ratio for the year ended December 31, 2014 of 19.4 percentage points compared to the year ended December 31, 2013 was due to the movement in the underlying ratios as discussed above.
Net investment income for the year ended December 31, 2014 and 2013 was comparable.
Losses and loss expenses from notable loss events for the three months ended December 31, 2014 was $nil compared to ($1.7) million for the three months ended December 31, 2013, an increase of $1.7 million.
Net operating income for the three months ended December 31, 2014 was $11.3 million compared to $33.4 million for the three months ended December 31, 2013, a decrease of $22.1 million.
The notable loss event for the year ended December 31, 2014 was Tripoli Airport. The notable loss event for the year ended December 31, 2013 was the European Floods. Notable loss events for the year ended December 31, 2012 were Costa Concordia, Cat 67, Hurricane Isaac and Hurricane Sandy.
The changes in mix of business were consistent with the changes in gross premiums written discussed above.
The changes in Talbot net premiums written were driven by the factors highlighted above in respect of gross premiums written and reinsurance premiums ceded.
The marine lines current year loss ratio, excluding the impact of notable and non-notable loss events, decreased by 5.2 percentage points as a result of lower attritional losses in the current year. The favorable development $31.4 million, on prior accident years for the year ended December 31, 2014, primarily relates to favorable development on attritional losses.
The specialty lines current year loss ratio, excluding the impact of notable and non-notable loss events, increased by 10.0 percentage points as a result of higher attritional losses in the current year. The favorable development $56.0 million, on prior accident years for the year ended December 31, 2014, primarily relates to favorable development on attritional losses.
The property acquisition cost ratio increased by 1.6 percentage points due to lower ceded acquisition costs on quota share premiums as a result of the Latin American business being written directly through Validus Re Swiss. This business was previously written through Talbot and ceded to Validus Re. The increase in the marine acquisition cost ratio of 1.0 percentage points was due to profit commission adjustments that reduced costs for the year ended December 31, 2013.
The following table presents the losses and loss expenses ratio, policy acquisition costs ratio, general and administrative expenses ratio, expense ratio and combined ratio for the years ended December 31, 2014, 2013 and 2012.
The following table presents results of operations for the year ended December 31, 2014:
Net premiums earned exceeded net premiums written as Western World discontinued writing binding authority commercial auto business during the three months ended December 31, 2014.
The results of Western World have been included in the Company's consolidated results from the October 2, 2014 date of acquisition.
Upon closing the acquisition, an adjustment of $34,736 was made to reduce deferred acquisition costs to reflect fair value. These deferred acquisition costs would otherwise have been expensed in the amounts of $12,914 during the year ended December 31, 2014 and $21,822 million in 2015.
Upon closing the acquisition, an adjustment of $34,736 was made to reduce deferred acquisition costs to reflect fair value. These deferred acquisition costs would otherwise have been expensed in the amount of $12,914 during the year ended December 31, 2014, benefiting the policy acquisition cost ratio by 17.6% points. The remaining adjustment of $21,822 would have been expensed in 2015.
The following table presents the losses and loss expenses ratio, policy acquisition cost ratio, general and administrative expenses ratio, expense ratio and combined ratio for the year ended December 31, 2014.
The combined ratio for the year ended December 31, 2014 reflects the underlying ratios highlighted above.
Corporate share compensation expenses for the year ended December 31, 2014 were $11.4 million compared to $9.9 million for the year ended December 31, 2013, an increase of $1.5 million or 14.9%. The increase of $1.5 million was primarily due to a higher level of awards being issued in 2013 compared to earlier years.
Corporate finance expenses for the year ended December 31, 2014, net of eliminations related to the operating segments, were $45.8 million compared to $42.1 million for the year ended December 31, 2013, an increase of $3.7 million or 8.8%.
Transaction expenses for the year ended December 31, 2014 were $8.1 million compared to $nil for the year ended December 31, 2013. The transaction expenses relate to costs incurred in connection with the acquisition of Western World, which was completed on October 2, 2014. Western World results have been included in the Company's consolidated results from the October 2, 2014 date of acquisition. Transaction expenses are primarily comprised of legal, financial advisory and audit related services.
Income from investment affiliate for the year ended December 31, 2014 was $3.6 million higher than for the year ended December 31, 2013. The income from investment affiliate relates to the income earned from the Company's investment in the Aquiline Financial Services Fund II L.P. which is recorded on a three-month lag and therefore reflects the underlying performance of that fund for the one year period ended September 30, 2014 and 2013, respectively.
The Company's reporting currency is the U.S. dollar. As a significant portion of the Company's operations are transacted in currencies other than the U.S. dollar, fluctuations in foreign exchange rates may affect period-to-period comparisons. The Company's largest foreign currency fluctuation exposure is to the following currencies, with the movement in each currency against the U.S. dollar for the years ended December 31, 2014, 2013 and 2012 shown in the table below:
Foreign exchange losses for the year ended December 31, 2014 were $10.6 million compared to gains of $2.5 million for the year ended December 31, 2013, an unfavorable movement of $13.1 million, or 524.4%, due primarily to the U.S. dollar strengthening against the Australian and New Zealand dollars, the Euro, the Swiss Franc and the Japanese yen.
For the year ended December 31, 2013, net income available to noncontrolling interest was $9.7 million, which was comprised of operating income of $11.6 million, as discussed in the AlphaCat Segment Results of Operations, and a non-operating loss of $1.9 million, primarily on the investment portfolio within PaCRe.
Operating income should not be viewed as a substitute for U.S. GAAP net income as there are inherent material limitations associated with the use of operating income as compared to using net income, which is the most directly comparable U.S. GAAP financial measure. The most significant limitation is the ability of users of the financial information to make comparable assessments of operating income with other companies, particularly as operating income may be defined or calculated differently by other companies. Therefore, the Company provides prominence in this filing to the use of the most comparable U.S. GAAP financial measure, net income, which includes the reconciling items in the table above. The Company compensates for these limitations by providing both clear and transparent disclosure of net income and reconciliation of operating income to net income.
Managed gross premiums written represents gross premiums written by the Company and its operating affiliates. Managed gross premiums written differs from total gross premiums written, which the Company believes is the most directly comparable GAAP measure, due to the inclusion of premiums written on behalf of the Company's operating affiliates, AlphaCat Re 2011 and AlphaCat Re 2012, which are accounted for under the equity method of accounting. A reconciliation of managed gross premiums written to gross premiums written, the most comparable U.S. GAAP financial measure, for the years ended December 31, 2014, 2013 and 2012 is presented in the table below.
The following tables present reconciliations of book value per diluted common share to book value per common share, the most comparable U.S. GAAP financial measure, at December 31, 2014 and December 31, 2013.
At December 31, 2014, the Company held investments totaling $7.4 billion, compared to $7.0 billion at December 31, 2013, an increase of $0.4 billion, or 5.2%, primarily as a result of the acquisition of Western World. A significant portion of (re)insurance contracts written by the Company provide short-tail reinsurance coverage for losses resulting mainly from natural and man-made catastrophes, which could result in payment of a substantial amount of losses at short notice. Accordingly, the Company’s investment portfolio is primarily structured to provide liquidity, which means the investment portfolio contains a significant amount of relatively short-term fixed maturity investments. The Company’s investment policies specifically require certain minimum thresholds of cash, short-term investments, and highly-rated fixed maturity securities relative to our consolidated net reserves and estimates of probable maximum loss exposures to provide necessary liquidity in a wide range of reasonable scenarios. At December 31, 2014, the average duration of the Company’s fixed maturity and short term investment portfolio, excluding assets held in trust on behalf of operating affiliates, was 2.16 years (December 31, 2013: 1.84 years). This duration is reviewed regularly based on changes in the duration of the Company's liabilities and in general market conditions.
The Company’s investment portfolio is also structured to preserve capital. The Company’s investment policies require certain minimum credit quality standards, including a minimum weighted average portfolio rating of A+. Further limits on securities rated BBB and below are also mandated. In addition, the Company stress-tests the downside risks within its asset portfolio using internal and external inputs and stochastic modeling processes to help define and limit asset risks to acceptable levels that are consistent
The estimated fair value of investments at December 31, 2014 and 2013 were as follows:
Included in the short-term investments balance are assets held in trust to support AlphaCat's fully collateralized reinsurance transactions. Also, included in the short-term investments balance are investments held by one AlphaCat ILS fund which is consolidated by the Company but in which the Company has an equity interest of less than 100%. The remaining interests are held by third party investors and included in the Consolidated Balance Sheets as redeemable noncontrolling interest.
Included in the other investments balance are investments held by PaCRe in which the Company has an equity interest of 10%. The remaining 90% interest is held by third party investors and included in the Consolidated Balance Sheets as noncontrolling interest.
As part of the ongoing risk management process, the Company monitors the aggregation of country or jurisdiction risk exposure. Jurisdiction risk exposure is the risk that events within a jurisdiction, such as currency crises, regulatory changes and other political events, will adversely affect the ability of obligors within the jurisdiction to honor their obligations. The following table provides a breakdown of the fair value of jurisdiction risk exposures outside the United States within the Company’s fixed maturity portfolio:
Credit exposures represent only direct exposure to fixed maturities and short-term investments of the parent issuer and its major subsidiaries. These exposures exclude asset and mortgage backed securities that were issued, sponsored or serviced by the parent.
Equity ownership in the three funds were 7.9%, 39.7% and 9.1% as at December 31, 2014.
The amount of recorded reserves represents management’s best estimate of expected losses and loss expenses on premiums earned. For the year ended December 31, 2014, favorable loss reserve development on prior accident years was $252.2 million, of which $87.6 million related to the Validus Re segment, $12.2 million related to the AlphaCat segment, $141.2 million related to the Talbot segment and $11.2 million related to the Western World segment. Current year incurred losses included $34.9 million of losses from notable loss events, of which $22.5 million related to the Validus Re segment and $12.5 million related to the Talbot segment.
As at December 31, 2012, the reserve for potential development on 2011 notable loss events was $42.2 million. During the year ended December 31, 2013, the Company allocated the full $42.2 million to the New Zealand earthquake and Gryphon Alpha mooring failure, both 2011 events. Contract complexity, the nature and number of perils arising from these events, limits and sub limits exposed, the quality, flow and timing of information received by the Company, information regarding retrocessional covers, assumptions, both explicit and implicit, regarding future paid and reported loss development patterns, frequency and severity trends, claims settlement practices and potential changes in the legal environment led to complexity and volatility in the ultimate loss estimates for these events. As at December 31, 2012 and December 31, 2013, the reserve for potential development on 2010 and 2011 notable loss events had been fully allocated, respectively. No RDE has been established for 2012, 2013 or 2014 notable loss events; therefore, as at December 31, 2014 the Company had no remaining reserve for potential development on notable loss events.
Validus Holdings, Ltd. is a holding company and conducts no operations of its own. The Company relies primarily on cash dividends and other permitted payments from operating subsidiaries within the Validus Re, AlphaCat, Talbot and Western World segments to pay dividends, finance expenses and other holding company expenses. There are restrictions on the payment of dividends from most operating subsidiaries, primarily due to regulatory requirements in the jurisdictions in which the operating subsidiaries are domiciled. Please refer to Part I, Item 1, "Regulation" for further discussion on the regulatory requirements in the jurisdictions in which the Company operates. Please also refer to Part II, Item 5, “Market for Registrants Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities” for further discussion of the Company’s dividend policy. The Company believes the dividend/distribution capacity of the Company’s subsidiaries will provide the Company with sufficient liquidity for the foreseeable future. The Company continues to generate substantial cash from operating activities and remains in a strong financial position, with resources available for reinvestment in existing businesses, strategic acquisitions and managing capital structure to meet its short and long-term objectives.
The following table details the capital resources of certain subsidiaries of the Company on an unconsolidated basis:
We anticipate that cash flows from operations will continue to be sufficient to cover cash outflows under our contractual commitments as well as most loss scenarios through the foreseeable future. Refer to the “Capital Resources” section below for further information on our anticipated obligations.
Net cash provided by (used in) investing activities during the year ended December 31, 2014 was $121.6 million compared to ($321.4) million for the year ended December 31, 2013, a favorable movement of $443.0 million. This favorable movement was due primarily to a decrease in the purchase of fixed maturity investments of $1.0 billion and a decrease in the change in restricted cash of $200.5 million, offset by an increase in cash paid, net of cash acquired, of $643.5 million to purchase Western World.
As part of the acquisition of Flagstone Reinsurance Holdings, S.A., the Company assumed $137.2 million of junior subordinated deferrable interest debentures due 2036 (the “Flagstone 2006 Junior Subordinated Deferrable Debentures”). The Flagstone 2006 Junior Subordinated Deferrable Debentures mature on September 15, 2036 and have been redeemable at the Company's option at par since September 15, 2011. In addition, the Company assumed $113.7 million of junior subordinated deferrable interest debentures due 2037 (the “Flagstone 2007 Junior Subordinated Deferrable Debentures”). $88.8 million of the Flagstone 2007 Junior Subordinated Deferrable Debentures mature on July 30, 2037 and have been redeemable at the Company's option at par since July 30, 2012. $25.0 million of the Flagstone 2007 Junior Subordinated Deferrable Debentures mature on September 15, 2037 and have been redeemable at the Company's option at par since September 15, 2012.
Total capitalization available to Validus equals total shareholder's equity less noncontrolling interest plus Senior Notes and Junior Subordinated Deferrable Debentures.
The Company does not include notes payable to operating affiliate investors within total capitalization, since these are issued to some of the Company's operating affiliates specifically for the purpose of purchasing capital market products and writing collateralized reinsurance.
Shareholders' equity available to Validus at December 31, 2014 was $3,588.0 million.
On February 6, 2013, the Company approved a special dividend in the amount of $2.00 per common share and common share equivalent. The dividend was paid on February 26, 2013 to shareholders and warrant holders of record on February 19, 2013.
The Company may from time to time repurchase its securities, including common shares, Junior Subordinated Deferrable Debentures and Senior Notes. On February 3, 2015, the Board of Directors of the Company approved a further increase to the Company's common share repurchase authorization to $750.0 million. This amount is in addition to the $2,274.4 million of common shares repurchased by the Company through February 3, 2015 under its previously authorized share repurchase programs.
The following table details the Company’s debt and financing arrangements as at December 31, 2014.
The arrangement is indicated as evergreen if, unless written notice to the contrary is given, it automatically renews on a regular basis.
The reserve for losses and loss expenses represents an estimate, including actuarial and statistical projections at a given point in time of an insurer’s or reinsurer’s expectations of the ultimate settlement and administration costs of claims incurred. As a result, it is likely that the ultimate liability will differ from such estimates, perhaps significantly. Such estimates are not precise in that, among other things, they are based on predictions of future developments and estimates of future trends in loss severity and frequency and other variable factors such as inflation, litigation and tort reform. Moreover, in certain circumstances, the Company has necessitated the use of industry loss emergence patterns in deriving IBNR. Further, expected losses and loss ratios are typically developed using vendor and proprietary computer models and these expected loss ratios are a material component in the calculation deriving IBNR. Actual loss ratios will deviate from expected loss ratios and ultimate loss ratios will be greater or less than expected loss ratios. During the loss settlement period, it often becomes necessary to refine and adjust the estimates of liability on a claim either upward or downward. Even after such adjustments, ultimate liability will exceed or be less than the revised estimates. The actual payment of the reserve for losses and loss expenses will differ from estimated payouts.
The 2010 Senior Notes mature on January 26, 2040, and are redeemable at the Company’s option in whole or any time or in part from time to time at a make-whole redemption price. The Company may redeem the notes in whole, but not in part, at any time upon the occurrence of certain tax events as described in the notes prospectus supplement. The 2010 Senior Notes bear interest at the rate of 8.875% per annum from January 26, 2010 to maturity or early redemption.
The 2007 Junior Subordinated Deferrable Debentures (the "2007 JSDs") mature on June 15, 2037, are redeemable at the Company’s option at par beginning June 15, 2012, and require quarterly interest payments by the Company to the holders of the 2007 Junior Subordinated Deferrable Debentures. Interest is payable at a floating rate of three-month LIBOR plus 295 basis points, reset quarterly. The Company has entered into an interest rate swap which fixed the rate of interest on the 2007 JSDs at 5.18%. The term of the swap is matched to the maturity date of the 2007 JSDs. The interest payments in the table above reflect the Company's contractual obligations with respect to the swap.
Please refer to Note 22 (f) to the Consolidated Financial Statements in Part II, Item 8 for further details describing the Aquiline commitments. There is no defined contractual commitment date, therefore it is included in the less than one year category.
Please refer to Note 22 (f) to the Consolidated Financial Statements in Part II, Item 8 for further details describing the AlphaCat 2015 commitment. The remaining commitment will be called and deployed throughout 2015, therefore it is included in the less than one year category.
The Company has performed an impairment analysis of its carried goodwill and indefinite-lived intangible assets as required by U.S. GAAP. Based on this analysis, management has concluded that an impairment valuation is not required against the carried goodwill and carried indefinite-lived intangible assets. For information about goodwill and intangible assets refer to Note 5, "Goodwill and other intangible assets" to the Consolidated Financial Statements in Part II, Item 8.
The following table summarizes the financial strength ratings of the Company and its principal reinsurance and insurance subsidiaries from internationally recognized rating agencies as of February 24, 2015:
The Company’s Consolidated Financial Statements have been prepared in accordance with U.S. GAAP. The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect reported and disclosed amounts of assets and liabilities, as well as disclosure of contingent assets and liabilities as at the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Management believes the following accounting policies are critical to the Company’s financial reporting as the application of these policies requires management to make significant judgments. Management believes the estimates that require the most subjective and complex judgments are (1) reserve for losses and loss expenses, (2) premiums, (3) reinsurance premiums ceded and reinsurance recoverables and (4) investment valuation.
There will also be a time lag between a loss occurring and it being reported, first by the original claimant to its insurer, via the insurance broker, and, for reinsurance business, subsequently from the insurer to the reinsurer via the reinsurance broker.
For the Company’s insurance business written by Talbot and Western World, where a longer reserving history exists, the Company examines the development of its own historical paid and incurred losses to identify trends, which it then incorporates into the reserving process where it deems appropriate.
During 2010 and 2011, given the complexity and severity of notable loss events, explicit reserves for potential development on 2010 and 2011 notable loss events (RDE) were included within the Company's IBNR reserving process. As uncertainties surrounding initial estimates on notable loss events developed, this reserve has been allocated to specific notable loss events. No RDE was established for 2012, 2013 or 2014 notable loss events.
Each of these factors may lead to associated volatility for each notable loss event as well as consideration of the total reserve for loss events in the aggregate. Consequently, all of these factors are considered in the aggregate for the events occurring in the quarter, recognizing that it is more likely that one or some of the events may deteriorate significantly, rather than all deteriorating proportionately. The establishment of each quarter's requirement for a reserve for potential development on notable loss events takes place as part of the quarterly evaluation of the Company's overall reserve requirements. It is not directly linked in isolation to any one significant/notable loss in the quarter. The reserve for potential development on notable loss events is evaluated by our in-house actuaries as part of their normal process in setting of indicated reserves for the quarter. In ensuing quarters, senior management and the in-house actuaries revisit and re-estimate certain events previously considered in the catastrophe loss event process as well as events that have subsequently emerged in the current quarter. To the extent that there has been adverse development on a notable loss event, if there is RDE remaining from that accident year, an allocation from the respective accident year RDE will be made to the notable loss event. If there is no remaining RDE relating to the accident year of the loss, then adverse development will be recorded for the notable loss event.
Changes to the reserve for potential development on notable loss events will be considered in light of changes to previous loss estimates from notable loss events in this re-estimation process. To the extent that there are continued complexity and volatility factors relating to notable loss events in the aggregate, additions to the RDE may be established for a specific accident year, as illustrated in the RDE roll forward table above.
The Company’s reserving methodology was not changed materially in the year ended December 31, 2014 from the methodology used in the year ended December 31, 2013. Management’s best estimate of the gross reserve for losses and loss expenses and loss reserves recoverable at December 31, 2014 were $3.2 billion and $377.5 million, respectively. The following table sets forth a breakdown between gross case reserves and gross IBNR by segment at December 31, 2014.
Management’s best estimate of the gross reserve for losses and loss expenses and loss reserves recoverable at December 31, 2013 were $3.0 billion and $370.2 million, respectively. The following table sets forth a breakdown between gross case reserves and gross IBNR by segment at December 31, 2013.
Management’s best estimate of the net reserve for losses and loss expenses at December 31, 2014 is $2.9 billion. The following tables show the effect on estimated net reserves for losses and loss expenses as of December 31, 2014 of a change in two of the most critical assumptions in establishing reserves: (1) loss emergence patterns, accelerated or decelerated by three and six months; and (2) expected loss ratios varied by plus or minus five and ten percent. Management believes that a reasonably likely scenario is represented by such a standard, as used by some professional actuaries as part of their review of an insurer’s or reinsurer’s reserves. Utilizing this standard as a guide, management has selected these variances to determine reasonably likely scenarios of variability in the loss emergence and loss ratio assumptions. These scenarios consider normal levels of catastrophe events. Loss reserves may vary beyond these scenarios in periods of heightened or reduced claim activity. The reserves resulting from the changes in the assumptions are not additive and should be considered separately. The following tables vary the assumptions employed therein independently. In addition, the tables below do not adjust any parameters other than the ones described above. Specifically, reinsurance collectability was not explicitly stressed as part of the calculations below.
Net reserve for losses and loss expenses at December 31, 2014-Sensitivity to loss emergence patterns
Description: For insurance business, written premium estimates are determined from the business plan estimates of premiums by class, the aggregate of underwriters’ estimates on a policy-by-policy basis, and projections of ultimate premiums using generally accepted actuarial methods. In particular, direct insurance premiums are recognized in accordance with the type of contract written. The majority of our insurance premium is accepted on a direct open market or facultative (proportional or non-proportional) basis. We receive a premium which is identified in the policy and this premium will typically adjust only if the underlying insured values adjust.
Premium earning: For contracts written on a losses occurring basis or claims made basis, being the majority of our insurance and excess of loss reinsurance business, premium income is generally earned proportionately over the expected risk period, usually 12 months. For contracts written on a risks attaching basis, being primarily our pro-rata reinsurance business, premiums are attached straight line over the period of the policy and generally earned over a 24 month period due to the fact that some of the underlying exposures may attach towards the end of the contract, and such underlying exposures generally have a 12 month coverage period. The portion of the premium related to the unexpired portion of the policy at the end of any reporting period is presented on the consolidated balance sheet as unearned premiums. Changes in circumstance subsequent to contract inception can impact the earning period. For example, when the exposure limit for a contract is reached, we fully earn any associated unearned premium.
Description: As discussed in Item 1 “Business” the Company primarily uses ceded reinsurance for risk mitigation purposes. Validus Re purchases reinsurance on an excess of loss and a proportional basis together with ILW coverage. Talbot purchases reinsurance on an excess of loss and a proportional basis together with a relatively small amount of facultative reinsurance and ILWs. Western World purchases reinsurance on an excess of loss basis with a relatively small amount of facultative reinsurance.
The Company uses a default analysis to estimate uncollectible reinsurance. The primary components of the default analysis are reinsurance recoverable balances by reinsurer and default factors used to determine the portion of a reinsurer’s balance deemed to be uncollectible. Default factors require considerable judgment and are determined using the current rating, or rating equivalent, of each reinsurer as well as other key considerations and assumptions.
Judgments and Uncertainties: The Company’s external investment accounting service provider receives prices from independent pricing sources to measure the fair values of a majority of the Company's investments. These independent pricing sources are prioritized with respect to reliability to ensure that only the highest priority pricing inputs are used. The independent pricing sources are received via automated feeds from indices, pricing and broker-dealers services. Pricing is also obtained from other external investment managers. This information is applied consistently across all portfolios. The Company’s external investment accounting service provider confirms and documents all prices received from broker-dealers on a daily basis for quality control and audit purposes.
Reference is made to Item 15 (a) of this Report for the Consolidated Financial Statements of Validus Holdings, Ltd. and the Notes thereto, as well as the Schedules to the Consolidated Financial Statements.