The following is a discussion and analysis of our results of operations for the years ended December 31, 2020 and 2019, and our financial condition at December 31, 2020 and 2019. This should be read in conjunction with Item 8 'Financial Statements and Supplementary Data' of this report. Unless otherwise noted, tabular dollars are in thousands, except per share amounts. Amounts may not reconcile due to rounding differences.
v) Impairment Losses and the Allowance for Expected Credit Losses - Fixed Maturities Available for Sale 106
•Net loss attributable to common shareholders of $150.7 million, or $(1.79) per common share and diluted common share
•Pre-tax catastrophe and weather-related losses, net of reinsurance and reinstatement premiums, of $774 million (Insurance: $443 million; Reinsurance: $330 million), or 17.7 points, including $360 million, or 8.2 points, attributable to the COVID-19 pandemic. Other catastrophe and weather-related losses were $414 million, or 9.4 points, associated with Hurricanes Laura, Sally, Zeta and Delta, the Midwest derecho, wildfires across the West Coast of the United States and other weather-related events
•Reserve for losses and loss expenses of $13.9 billion and reinsurance recoverable on unpaid and paid losses and loss expenses of $4.9 billion
•Debt of $1.3 billion and a debt to total capital ratio(3) of 19.8%
•Common shareholders’ equity of $4.7 billion; book value per diluted common share of $55.09
(3)The debt to total capital ratio is calculated by dividing debt by total capital. Total capital represents the sum of total shareholders’ equity and debt.
AXIS Capital, through its operating subsidiaries, is a global provider of specialty lines insurance and treaty reinsurance with operations in Bermuda, the U.S., Europe, Singapore and Canada. Our underwriting operations are organized around our global underwriting platforms, AXIS Insurance and AXIS Re.
We provide our clients and distribution partners with a broad range of risk transfer products and services, and meaningful capacity, backed by excellent financial strength. We manage our portfolio holistically, aiming to construct the optimum portfolio of risks, consistent with our risk appetite and the development of our franchise. We nurture an ethical, entrepreneurial, disciplined and diverse culture that promotes outstanding client service, intelligent risk taking and the achievement of superior risk-adjusted returns for our shareholders. We believe that the achievement of our objectives will position us as a global leader in specialty risks. The execution of our business strategy in 2020 included the following:
•implementing a global response strategy to help manage and mitigate the impact of the COVID-19 pandemic, spanning underwriting, investments, capital and liquidity, operations and employee welfare;
•increasing our relevance in a select number of attractive specialty lines insurance and treaty reinsurance markets, and continuing the implementation of a more focused distribution strategy;
•continuing to grow a leadership position in the areas of our business with strong potential for profitable growth including U.S. excess and surplus lines, North America professional lines and Lloyd's specialty insurance business;
•investing in data and technology capabilities, and tools to empower our underwriters and enhance the service we provide to our customers;
•broadening risk-funding sources and the development of vehicles that utilize third-party capital; and
•growing our corporate citizenship program to give back to our communities and help contribute to a more sustainable future.
Rates, terms and conditions across virtually all insurance lines and geographies continued to see accelerating improvement through the fourth quarter of 2020. We expect many specialty segments will experience further pricing improvements as carriers assess pricing, portfolio construction and account preferences through the course of 2021. The insurance market continues to improve capacity and capital remains available and willing to support business with a broad range of return hurdles in certain pockets. In this market environment, we are focusing on those lines of business and market segments that are adequately priced, and we are trading off growth for profitability in other areas.
We are encouraged by the pricing improvements that we are seeing across both the insurance and reinsurance segments. While there is positive rate momentum across most lines and markets, not all lines are at adequate levels and, in multiple cases, more rate is needed to deliver adequate returns, particularly given recent high loss experience in the market, the COVID-19 pandemic and lower interest rates. Where prices appropriately reflect these trends to deliver adequate profitability we will look to grow within our risk and volatility guidelines. With the most balanced book in the history of our company, we believe AXIS is well positioned to drive profitable growth within the current market environment.
COVID-19, and its related impacts, are an emerging and evolving risk to which we are exposed from an underwriting, investments, capital and liquidity, operations and employee welfare perspective. We have implemented a global response strategy to help manage and mitigate these risks.
Our team continues to track the situation closely, including stress and scenario testing on existing underwriting and investment exposures, taking into consideration among other assumptions, the possible severity and duration of the outbreak.
The estimate of ultimate losses related to the COVID-19 pandemic is subject to significant uncertainty. This uncertainty is driven by the inherent difficulty in making assumptions around the impact of the COVID-19 pandemic due to the lack of comparable events, the ongoing nature of the event, and its far-reaching impacts to world-wide economies and the health of the global population.
Actual losses for this event may ultimately differ materially from current estimates.
In the first quarter, we reduced our 2020 expense budget by approximately $50 million based on the specific impacts of the COVID-19 pandemic on our business. These temporary expense savings were realized by reducing performance-related compensation, travel and entertainment costs, and other savings due to the pandemic and the remote working environment.
(1)The general and administration expense ratio included corporate expenses not allocated to underwriting segments of 2.3%, 2.8% and 2.3% for 2020, 2019 and 2018, respectively. Refer to 'Management’s Discussion and Analysis of Financial Condition and Results of Operations - Other Expenses (Revenues), Net' for additional information.
Refer to 'Management's Discussion and Analysis of Financial Condition and Results of Operations - Results by Segment' for further details on underwriting expenses.
The increases in professional lines, liability, and property lines were due to new business and favorable rate changes. The increase in accident and health lines was due to new business. The increase in aviation lines was due to timing differences.
Net premiums earned in 2020 increased by $109 million, or 5%, compared to 2019. The increase was primarily driven by increases in gross premiums earned in professional lines, liability, marine, and credit and political risk lines, together with decreases in ceded premiums earned in property and aviation lines, partially offset by increases in ceded premiums earned in professional lines and liability lines, and a decrease in gross premiums earned in property lines.
After adjusting for the impact of the catastrophe and weather-related losses, the current accident year loss ratio decreased to 55.1% in 2020 from 57.0% in 2019. The decrease was principally due to improved loss experience in property, aviation, marine, and credit and political risk lines, and the impact of favorable pricing over loss trends, partially offset by changes in business mix.
The underwriting-related general and administrative expense ratio decreased to 16.5% in 2020 from 18.3% in 2019, mainly driven by decreases in the allocation of corporate costs to the segment, travel and entertainment expenses, and professional fees, together with an increase in net premiums earned, partially offset by an increase in personnel costs.
The decrease in catastrophe lines was attributable to decreases in premiums ceded to strategic partners and a non-renewal of a catastrophe bond. The decrease in accident and health lines was attributable to the restructuring of an existing quota share retrocessional treaty. The decrease in credit and surety lines was attributable to a decrease in premiums ceded to a quota share retrocessional treaty and the restructuring of existing quota share retrocessional treaties. The decrease in agriculture lines was attributable to a non-renewal of a large quota share retrocessional treaty.
Comparatively, in 2019, catastrophe and weather-related losses, net of reinstatement premiums, were $252 million or 10.7 points, primarily attributable to Japanese Typhoons Hagibis, Faxai and Tapah, Hurricane Dorian, Australia Wildfires, and other weather-related events.
After adjusting for the impact of the catastrophe and weather-related losses, the current accident year loss ratio decreased to 60.6% in 2020 from 64.0% in 2019. The decrease was principally due to changes in business mix and improved loss experience in agriculture and aviation lines.
The acquisition cost ratio decreased to 22.6% in 2020 from 23.2% in 2019, principally related to changes in business mix and the impact of retrocessional contracts.
(1)Pre-tax yield is calculated by dividing net investment income by the average month-end amortized cost balances.
2020 versus 2019: Net investment gains in 2020 were $129 million compared to net investment gains of $91 million in 2019. Net investment gains reported in 2020 mainly reflected net realized gains on the sale of U.S Government, agency RMBS and exchange traded funds and net unrealized gains on equity securities. Net investment gains reported in 2019 mainly reflected net unrealized gains on equity securities and net realized gains on the sale of U.S. government and agency RMBS.
Generally, sales of individual securities occur when there are changes in the relative value, credit quality, or duration of a particular issue. We may also sell securities to re-balance our investment portfolio in order to change exposure to particular asset classes or sectors.
The impairment losses (refer to 'Critical Accounting Estimates - Impairment losses' for further details) recognized in net income by asset class were as follows:
From time to time, we economically hedge foreign exchange exposure and interest rate risk with derivative contracts.
(1)Change in net unrealized gains (losses) on fixed maturities is calculated by taking net unrealized gains (losses) at period end less net unrealized gains (losses) at the prior period end.
(3)Pre-tax total return on cash and investments excluding foreign exchange rate movements is a non-GAAP financial measure as defined in Item 10(e) of SEC Regulation S-K. The reconciliation to pre-tax total return on cash and investments, the most comparable GAAP financial measure, included foreign exchange gains (losses) of $55 million, $25 million and $(48) million for the years ended December 31, 2020, 2019 and 2018, respectively.
The following table provides a summary of other expenses (revenues), net:
Corporate expenses include holding company costs necessary to support our worldwide insurance and reinsurance operations and costs associated with operating as a publicly-traded company. As a percentage of net premiums earned, corporate expenses decreased to 2.3% in 2020 from 2.8% in 2019.
The decrease in corporate expenses in 2020 was primarily related to decreases in information technology costs, travel and entertainment costs, personnel costs, and professional fees, partially offset by a decrease in the allocation of corporate costs to the insurance segment.
We believe that the following financial indicators are important in evaluating performance and measuring the overall growth in value generated for common shareholders:
The decrease in operating ROACE in 2020, compared to 2019, was primarily driven by the underwriting loss and a decrease in investment income, partially offset by the income tax benefit, and decreases in corporate expenses and the amortization of VOBA associated with the acquisition of Novae.
We believe in returning excess capital to shareholders by way of dividends. Accordingly, dividend policy is an integral part of the value we create for shareholders. Our Board of Directors have approved seventeen successive annual increases in quarterly common share dividends.
In 2019, the increase in total value of $7.47, or 15%, was driven by net income generated and net unrealized investment gains reported in other comprehensive income.
(1)Tax cost (benefit) of $18 million, $12 million and $(12) million for the years ended December 31, 2020, 2019 and 2018, respectively. Tax impact is estimated by applying the statutory rates of applicable jurisdictions, after consideration of other relevant factors including the ability to utilize capital losses.
(6)Refer to Item 8, Note 13 to the Consolidated Financial Statements 'Earnings Per Common Share' for further details.
We present our results of operations in the way we believe will be meaningful and useful to investors, analysts, rating agencies and others who use our financial information to evaluate our performance. Some of the measurements we use are considered non-GAAP financial measures under SEC rules and regulations. In this Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"), we present underwriting-related general and administrative expenses, consolidated underwriting income (loss), operating income (loss) (in total and on a per share basis), operating return on average common equity ("operating ROACE"), amounts presented on a constant currency basis, and pre-tax total return on cash and investments excluding foreign exchange movements which are non-GAAP financial measures as defined in Item 10(e) of SEC Regulation S-K. We believe that these non-GAAP financial measures, which may be defined and calculated differently by other companies, help explain and enhance the understanding of our results of operations. However, these measures should not be viewed as a substitute for those determined in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP").
Corporate expenses include holding company costs necessary to support our worldwide insurance and reinsurance operations and costs associated with operating as a publicly-traded company. As these costs are not incremental and/or directly attributable to our underwriting operations, these costs are excluded from underwriting-related general and administrative expenses, and therefore, consolidated underwriting income (loss). General and administrative expenses, the most comparable GAAP financial measure to underwriting-related general and administrative expenses, also includes corporate expenses.
Consolidated underwriting income (loss) is a pre-tax measure of underwriting profitability that takes into account net premiums earned and other insurance related income (loss) as revenues and net losses and loss expenses, acquisition costs and underwriting-related general and administrative expenses as expenses. While this measure is presented in Item 8, Note 3 to the Consolidated Financial Statements 'Segment Information', it is considered a non-GAAP financial measure when presented elsewhere on a consolidated basis.
Reorganization expenses are related to the transformation program which was launched in 2017. This program encompasses the integration of Novae, which commenced in the fourth quarter of 2017, the realignment of our accident and health business, together with other initiatives designed to increase efficiency and enhance profitability, while delivering a customer-centric operating model. Reorganization expenses are primarily driven by business decisions, the nature and timing of which are not related to the underwriting process, therefore, these expenses are excluded from consolidated underwriting income (loss).
Amortization of intangible assets including VOBA arose from business decisions, the nature and timing of which are not related to the underwriting process, therefore, these expenses are excluded from consolidated underwriting income (loss).
We believe that the presentation of underwriting-related general and administrative expenses and consolidated underwriting income (loss) provides investors with an enhanced understanding of our results of operations, by highlighting the underlying pre-tax profitability of our underwriting activities. The reconciliation of consolidated underwriting income (loss) to net income (loss), the most comparable GAAP financial measure, is presented in 'Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Summary - Consolidated Results of Operations'.
Foreign exchange losses (gains) in our consolidated statements of operations primarily relate to the impact of foreign exchange rate movements on net insurance-related liabilities. In addition, we recognize unrealized foreign exchange losses (gains) on our equity securities and foreign exchange losses (gains) realized on the sale of our available for sale investments and equity securities in net investment gains (losses). We also recognize unrealized foreign exchange losses (gains) on our available for sale investments in other comprehensive income (loss). These unrealized foreign exchange losses (gains) generally offset a large portion of the foreign exchange losses (gains) reported in net income (loss), thereby minimizing the impact of foreign exchange rate movements on total shareholders’ equity. As a result, foreign exchange losses (gains) in our consolidated statements of operations in isolation are not a meaningful contributor to the performance of our business.
Reorganization expenses are related to the transformation program which was launched in 2017. This program encompasses the integration of Novae, which commenced in the fourth quarter of 2017, the realignment of our accident and health business, together with other initiatives designed to increase efficiency and enhance profitability, while delivering a customer-centric operating model. Reorganization expenses are primarily driven by business decisions, the nature and timing of which are not related to the underwriting process, therefore, these expenses are excluded from operating income (loss).
Certain users of our financial statements evaluate performance exclusive of after-tax net investment gains (losses), foreign exchange losses (gains), reorganization expenses and interest in income (loss) of equity method investments to understand the profitability of recurring sources of income.
We also present operating income (loss) per diluted common share and operating ROACE, which are derived from the operating income (loss) measure and are reconciled above to the most comparable GAAP financial measures, earnings (loss) per diluted common share and return on average common equity ("ROACE"), respectively.
Pre-Tax Total Return on Cash and Investments excluding Foreign Exchange Movements
(2)Includes U.S. government-sponsored agencies, residential mortgage-backed securities ("RMBS") and commercial mortgage-backed securities ("CMBS").
Non-U.S. government securities include bonds issued by non-U.S. governments and their agencies along with supranational organizations (collectively also known as sovereign debt securities).
Details of exposures to governments in the eurozone and other non-U.S. government concentrations by fair value are as follows:
Details of the fair values of our RMBS and CMBS portfolios by credit rating are as follows:
Agency RMBS consist of bonds issued by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association which are primarily AAA rated and are supported by loans which are diversified across geographical areas. At December 31, 2020, agency RMBS had an average duration of 3.2 years (2019: 3.4 years).
CMBS mainly include investment-grade bonds originated by non-agencies. At December 31, 2020, approximately 99% (2019: 99%) of our CMBS were rated AA or better. At December 31, 2020, the weighted average estimated subordination percentage of the portfolio was 29% (2019: 29%), which represents the current weighted average estimated percentage of the capital structure subordinated to the investment holding that is available to absorb losses before the security incurs the first dollar loss of principal. At December 31, 2020, CMBS had an average duration of 4.8 years (2019: 5.1 years) and weighted average life of 5.5 years (2019: 6.1 years).
Details of the fair value of our ABS portfolio by underlying collateral and credit rating are as follows:
At December 31, 2020, the average duration our ABS portfolio was 0.9 years (2019: 0.7 years) and the weighted average life was 3.6 years (2019: 3.5 years).
Details of the fair value of our municipals portfolio by state and between Revenue bonds and General Obligation ("G.O.") bonds are as follows:
G.O. bonds are backed by the full faith and credit of the authority that issued the debt and are secured by the taxing powers of those authorities. Revenue bonds are backed by the revenue stream generated by the services provided by the issuer (e.g. sewer, water or utility projects). As issuers of revenue bonds do not have the ability to draw from tax revenues or levy taxes to fund obligations, revenue bonds may carry a greater risk of default than G.O. bonds. At December 31, 2020, 75% (2019: 96%) of municipals are taxable with the remainder being tax exempt.
The decrease in gross unrealized losses on investment-grade fixed maturities reflected the impact of the tightening of credit spreads on investment grade corporate debt securities.
The increase in gross unrealized losses on non-investment grade fixed maturities reflected the impact of the widening of credit spreads on non-investment grade high yield corporate debt securities.
At December 31, 2020, net unrealized gains on equity securities were $97 million (2019: $75 million). The increase was due to improved performance of global equity markets.
During 2020, investment in commercial mortgage loans increased to $593 million from $433 million, an increase of $160 million. The commercial mortgage loans are high quality and collateralized by a variety of commercial properties and are diversified geographically throughout the U.S. and by property type to reduce the risk of concentration. At December 31, 2020 and 2019, there were no credit losses or past due amounts associated with our commercial mortgage loans portfolio.
During 2016, we paid $108 million including direct transactions costs to acquire 19% of the common equity of Harrington Reinsurance Holdings Limited ("Harrington"), the parent company of Harrington Re Ltd. ("Harrington Re"), an independent reinsurance company jointly sponsored by the Company and The Blackstone Group L.P. ("Blackstone"). Harrington is not a variable interest entity that is required to be included in the consolidated financial statements. We account for our ownership interest in Harrington under the equity method of accounting.
In our consolidated results, our ownership interest in Harrington is reported in interest in income (loss) of equity method investments. Interest in income (loss) of equity method investments was $(4) million in 2020, compared to $10 million in 2019. The decrease was attributable to negative investment returns realized by Harrington.
The insurance and reinsurance business of our operating subsidiaries inherently provide liquidity, as premiums are received in advance (sometimes substantially in advance) of the time losses are paid. However, the amount of cash required to fund loss payments can fluctuate significantly from period to period, due to the low frequency/high severity nature of certain types of business we write.
Consolidated cash flows from operating, investing and financing activities in the last three years were as follows:
•Investing cash inflows in 2020 principally related to the net proceeds from the sale and redemption of fixed maturities of $816 million, partially offset by net purchases of mortgage loans of $160 million, short-term investments of $123 million, and other assets of $45 million. Investing cash inflows in 2019 principally related to the net purchases of fixed maturities of $693 million, net purchases of equity securities of $22 million, partially offset by net proceeds from the sale of other investments of $31 million.
The 3.900% Senior Notes and the 4.900% Junior Subordinated Notes were issued to finance the repayment of unsecured senior notes of $500 million that matured in June 2020 and to finance the redemption of Series D preferred shares on January 17, 2020 (refer to 'Preferred Shares' below for further details).
On December 24, 2019, the Participating Subsidiaries amended an existing $500 million secured letter of credit facility with Citibank Europe plc (the "$500 million Facility") to extend the expiration date to December 31, 2023.
Letters of credit issued under the $250 million Facility and the $500 million Facility are principally to be used to support the reinsurance obligations of the Participating Subsidiaries. These facilities are subject to certain covenants, including the requirement to maintain sufficient collateral to cover the obligations outstanding under the facilities. Such obligations include contingent reimbursement obligations for outstanding letters of credit and fees payable to Citibank. In the event of default, Citibank may exercise certain remedies, including the exercise of control over pledged collateral and the termination of the facility to any or all of the Participating Subsidiaries.
At December 31, 2020, letters of credit outstanding were $339 million (refer to Item 8, Note 10 to the Consolidated Financial Statements 'Debt and Financing Arrangements' for further details).
During the year ended December 31, 2020, common equity decreased by $23 million. The following table reconciles opening and closing common equity positions:
During 2020, we repurchased 194,000 common shares from employees to satisfy withholding tax liabilities related to the vesting of share-settled restricted stock units granted under our 2007 and 2017 Long-Term Equity Compensation Plans for a total cost of $10 million. A common share repurchase plan has not yet been authorized for 2021.
The following are the most recent financial strength ratings from internationally recognized agencies in relation to our principal insurance and insurance operating subsidiaries:
(2) On May 5, 2020, A.M. Best revised its rating and outlook from A+ and negative to A and stable, respectively. The revised rating was based on unfavorable trends in operating performance over the past five years, particularly emanating from the insurance segment. The revised outlook continues to reflect our strong balance sheet, favorable business profile and appropriate risk management practices.
(2)In the ordinary course of business, we renew and enter into new leases for office space which expire at various dates (refer to Item 8, Note 12 to the Consolidated Financial Statements 'Leases' for further details).
We believe that the material items requiring such subjective and complex estimates are:
We believe that the amounts included in the consolidated financial statements reflect management's best judgment. However, factors such as those described in Item 1A 'Risk Factors' could cause actual events or results to differ materially from the underlying assumptions and estimates which could lead to a material adverse impact on our results of operations, financial condition or liquidity.
The estimation of IBNR is necessary due to potential development on reported claims and the time lag between when a loss event occurs and when it is actually reported, which is referred to as a reporting lag. Reporting lags may arise from a number of factors, including but not limited to, the nature of the loss, the use of intermediaries and complexities in the claims adjusting process. As we do not have specific information on IBNR, it must be estimated. IBNR is calculated by deducting incurred losses (i.e. paid losses and case reserves) from management’s best estimate of ultimate losses. In contrast to case reserves, which are established at the contract level, IBNR reserves are generally estimated at an aggregate level and cannot be identified as reserves for a particular loss event or contract (refer to 'Reserving for Significant Catastrophic Events' below for further details).
data vary based on a number of factors including our historical track record and the development profile for the reserve class being evaluated (refer to 'Claim Tail Analysis' below for further details).
Multiple actuarial methods are available to estimate ultimate losses. Each method has its own assumptions and its own advantages and disadvantages, with no single estimation method being better than the others in all situations and no one set of assumption variables being meaningful for all reserve classes. The relative strengths and weaknesses of the particular estimation methods when applied to a particular group of claims can also change over time.
Short-tail business generally includes exposures for which losses are usually known and paid within a relatively short period of time after the underlying loss event has occurred. Our short-tail business primarily relates to property coverages and includes terrorism, accident and health, discontinued lines - Novae, marine, and aviation hull and war business in the insurance segment, together with the catastrophe, property, engineering, agriculture, marine and aviation, accident and health, and discontinued lines - Novae business in the reinsurance segment.
The key actuarial assumptions for short-tail business in early accident years were primarily developed with reference to industry benchmarks for expected loss ratios and loss development patterns. As our historical loss experience amassed, it gained credibility and became relevant for consideration in establishing these key actuarial assumptions. As a result, we gradually increased the weighting assigned to our historical loss experience in selecting the expected loss ratios and loss development patterns utilized to establish estimates of ultimate losses for an accident year. Due to the relatively short reporting and settlement patterns for short-tail business, we generally place more weight on experience-based methods and other qualitative considerations in establishing reserves for recent and more mature accident years (refer to Item 8, Note 8 to the Consolidated Financial Statements 'Reserve for losses and loss expenses' for detail on the reserve classes, the expected claim tails, and prior year development).
With respect to key actuarial assumptions, we rely on our loss experience when establishing expected loss ratios and selected loss development patterns. Loss reporting patterns for professional lines business tend to be volatile, causing instability in actuarial indications based on incurred loss data until an accident year or underwriting year matures. Consequently, initial loss reserves for an accident year or underwriting year are generally based on an ELR method and the consideration of relevant qualitative factors. As accident years and underwriting years mature, we increasingly give more weight to methods that reflect our experience until selections are based almost exclusively on experience-based methods. We evaluate the appropriateness of the transition to experience-based methods at the reserve class level, commencing this transition when we believe that our incurred loss development is sufficient to produce meaningful actuarial indications. The rate at which we transition fully to sole reliance on experience-based methods can vary by reserve class and by year, depending on our assessment of the stability and relevance of such indications. For some professional lines in the insurance segment, we also rely on the evaluation of the open claim inventory in addition to the commonly employed actuarial methods when establishing reserves.
Our transition from the ELR method to experience-based methods began in 2008, when we commenced gradual transition for the 2004 and prior accident years. As our loss history continued to develop, the transition was expanded to include additional accident years (refer to Item 8, Note 8 to the Consolidated Financial Statements 'Reserve for losses and loss expenses' for detail on the reserve classes, the expected claim tails, and prior year development).
•inherent uncertainties about loss trends, claims inflation (e.g. medical, judicial, social) and general economic conditions; and
•the possibility of future litigation, legislative or judicial change that may impact future loss experience relative to the prior industry loss experience relied on in reserve estimation.
Claims for this business tend to be characterized by their severity risk, as opposed to their frequency risk therefore, claim payment and reporting patterns are anticipated to be volatile. Under the notification provisions of our credit insurance policies, we anticipate being advised of an insured event within a relatively short time period. Consequently, we generally estimate ultimate losses based on a contract-by-contract analysis which considers the contracts’ terms, the facts and circumstances of underlying loss events and qualitative input from claims managers.
In some instances, on becoming aware of a loss event related to credit and political risk business, we negotiate a final settlement of all of our policy liabilities for a fixed amount. In most circumstances, this occurs when the insured moves to realize the benefit of the collateral that underlies the insured loan or facility and presents us with a net settlement proposal that represents a full and final payment by us under the terms of the policy. In consideration for this payment, we secure a cancellation of the policy, or a release of all claims, and waive our right to pursue a recovery of these settlement payments against the security that may have been available to us under the insured loan or facility agreement. In certain circumstances, cancellation by way of net settlement or full payment can result in an adjustment to the premium associated with the policy.
We cannot estimate losses from widespread catastrophic events, such as hurricanes and earthquakes, using the traditional actuarial methods described above. The magnitude and complexity of losses associated with certain of these events inherently increase the level of uncertainty and, therefore, the level of management judgment involved in arriving at loss reserve estimates. As a result, actual losses for these events may ultimately differ materially from current estimates.
The estimate of loss reserves related to the COVID-19 pandemic is subject to significant uncertainty. This uncertainty is driven by the inherent difficulty in making assumptions around the impact of the COVID-19 pandemic due to the lack of comparable events, the ongoing nature of the event, and its far-reaching impacts on world-wide economies and the health of the population. These assumptions include:
•the response of government bodies including legislative, regulatory or judicial actions and social influences that could alter the interpretation of the our contracts;
•estimates of the size of insured industry losses from the catastrophic event and our corresponding market share;
There are additional risks that affect our ability to accurately estimate ultimate losses for catastrophic events. For example, the estimates of loss reserves related to hurricanes and earthquakes can be affected by factors including, but not limited to, the inability to access portions of impacted areas, infrastructure disruptions, the complexity of factors contributing to losses, legal and regulatory uncertainties, complexities involved in estimating business interruption losses and additional living expenses, the impact of demand surge, fraud and the limited nature of information available. For hurricanes, additional complex coverage factors may include determining whether damage was caused by flooding or wind, evaluating general liability and pollution exposures, and mold damage. The timing of a catastrophe, for example, near the end of a reporting period, can also affect the level of information available to us to estimate loss reserves for that reporting period.
Our quarterly loss reserving process involves the collaboration of our underwriting, claims, actuarial, legal, ceded reinsurance and finance departments, includes various segmental committee meetings and culminates with the approval of a single point best estimate by our Group Reserving Committee, which comprises senior management. In selecting this best estimate, management considers actuarial estimates and applies informed judgment regarding qualitative factors that may not be fully captured in these actuarial estimates. Such factors include, but are not limited to, the timing of the emergence of claims, volume and complexity of claims, social and judicial trends, potential severity of individual claims and the extent of our historical loss data versus industry information. While these qualitative factors are considered in arriving at the point estimate, no specific provisions for qualitative factors are established.
With regard to establishing the fair value of reserves for losses and loss expenses for Novae at the acquisition date, weight was given to the observable value of these reserves based on the RITC transaction of the 2015 and prior years of account of Syndicate 2007, which was completed prior to the allocation of purchase price. Management made no change to the initial estimate when establishing its best estimate of reserves for losses and loss expenses at December 31, 2017. This is consistent with our general approach of recognizing all or part of the anticipated cost of third-party liability commutations if the transaction has either completed or is considered sufficiently likely to be completed in the near term.
Beginning in 2013, we significantly enhanced the capabilities and resources dedicated to the actuarial reserving function. Consequently, from the first quarter of 2014, management began to rely on its internal actuarial reserving function for its quarterly loss reserving process rather than utilizing the services of an independent actuarial firm. On an annual basis, we use an independent actuarial firm to provide an actuarial opinion on the reasonableness of loss reserves for each of our operating subsidiaries and statutory reporting entities as these actuarial opinions are required to meet various insurance regulatory requirements. The actuarial firm also discusses its conclusions from the annual review with management and presents its findings to the Audit Committee of the Board of Directors.
The effect on estimates of gross loss reserves of reasonably likely changes in the two key assumptions used to estimate gross loss reserves at December 31, 2020 was as follows:
*To facilitate comparison of information across periods, certain reclassifications have been made to prior year amounts to conform to the current year's presentation. These reclassifications did not impact the results of operations, financial condition or liquidity.
Reinsurance recoverable related to case reserves is estimated on a case-by-case basis by applying the terms of applicable reinsurance cover to individual case reserve estimates. Reinsurance recoverable related to IBNR is generally developed as part of our loss reserving process, therefore, its estimation is subject to similar risks and uncertainties as the estimation of IBNR. Estimates of amounts to be ceded under excess of loss reinsurance contracts also take into account pricing information for those contracts and require greater judgment than estimates for proportional contracts.
We estimate a case-specific allowance for expected credit losses against reinsurance recoverable balances that we deem are unlikely to be collected in full. In addition, we estimate an allowance for expected credit losses on the remainder of the reinsurance recoverable balance using a default analysis. The principal components of the default analysis are reinsurance recoverable balances by reinsurer and default factors applied to estimate uncollectible amounts based on reinsurers’ credit ratings and the length of collection periods. The default factors are based on a model developed by a major rating agency. The default analysis considers current and forecasted economic conditions.
At December 31, 2020 the allowance for expected credit losses was $24 million and at December 31, 2019, the provision for uncollectible amounts was $18 million. We have not written off any significant reinsurance recoverable balances in the last three years.
For the majority of our insurance business, a fixed premium which is identified in the policy is recorded at the inception of the policy. This premium is adjusted if underlying insured values change. We actively monitor underlying insured values and any adjustments to premiums are recognized in the period in which they are determined. Gross premiums written on a fixed premium basis accounted for 86% and 87% of the segment’s gross premiums written for the years ended December 31, 2020 and 2019, respectively. Some of this business is written through MGAs, third parties granted authority to bind risks on our behalf in accordance with our underwriting guidelines. For this business, premiums are recorded based on monthly statements received from MGAs or best estimates based on historical experience.
For the credit and political risk line of business, we write certain policies on a multi-year basis. Premiums in respect of these policies are recorded at the inception of the policy based on management’s best estimate of premiums to be received, including assumptions relating to prepayments/refinancing. At December 31, 2020, the average duration of unearned premiums for credit and political risk line of business was 5.3 years (2019: 5.9 years).
Many of our excess of loss reinsurance contracts also include provisions that require an automatic reinstatement of coverage in the event of a loss. In a year of significant loss events, reinstatement premiums will be higher than in a year in which there are no large loss events. Reinstatement premiums are recognized and earned at the time a loss event occurs and losses are recorded. While the reinstatement premium amount is defined by contract terms, recognition of reinstatement premiums is based on estimates of losses and loss expenses, which reflect management’s judgment (refer to 'Critical Accounting Estimates - Reserve for Losses and Loss Expenses' above for further details).
•Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement. The unobservable inputs reflect our judgments about assumptions that market participants might use.
Refer to Item 8, Note 6 to the Consolidated Financial Statements 'Fair Value Measurements' for further information on the valuation techniques including significant inputs and assumptions generally used in estimating the fair values of our financial instruments.
At December 31, 2020, the fair values of 95% (2019: 95%) of total fixed maturities and equity securities were based on prices provided by globally recognized independent pricing services where we have a current and detailed understanding of how their prices were derived. The remaining securities were priced by either non-binding broker quotes or internal valuation models.
At December 31, 2020 and 2019, we have not adjusted any pricing provided by independent pricing services (refer to 'Management Pricing Validation' below). In addition, total Level 3 fixed maturities and equity securities amounted to $15 million (2019: $8 million), less than 1% of total fixed maturities and equity securities (refer to Item 8, Note 6 to the Consolidated Financial Statements 'Fair Value Measurements' for further information).
Other privately held investments include convertible preferred shares, common shares, convertible notes and a variable yield security. These investments are initially valued at cost which approximates fair value. In subsequent measurement periods, the fair values of these investments are generally determined using capital statements obtained from each investee. In 2020, the fair value of the variable yield security was determined using an externally developed discounted cash flow model.
Fixed maturities classified as available for sale are reported at fair value at the balance sheet date. Our available for sale ("AFS") investment portfolio is the largest component of consolidated total assets and it is a multiple of shareholders’ equity. As a result, impairment losses could be material to our financial condition and operating results particularly during periods of dislocation in financial markets.
If a fixed maturity is impaired and we intend to sell the security or it is more likely than not that we will be required to sell the security before its anticipated recovery, the full amount of the impairment loss is charged to net income and is included in net investment gains (losses) in the consolidated statements of operations. The new cost basis for the security is the amortized cost basis less the impairment charge recognized in net income. The new cost basis is not adjusted for subsequent increases in fair value.
From time to time, we may sell fixed maturities subsequent to the balance sheet date that we did not intend to sell at the balance sheet date. Conversely, we may not sell fixed maturities that we intended to sell at the balance sheet date. These changes in intent may arise due to events occurring subsequent to the balance sheet date. The types of events that may result in a change in intent include, but are not limited to, significant changes in the economic facts and circumstances related to the specific issuer, changes in liquidity needs, or changes in tax laws or the regulatory environment.
On a quarterly basis, we assess whether unrealized losses on fixed maturities represent credit impairments by considering the below factors:
If a security is assessed to be credit impaired, it is subject to a discounted cash flow analysis by comparing the present value of expected future cash flows with the amortized cost basis. If the present value of expected cash flows is less than the amortized cost, a credit loss exists and an allowance for expected credit losses is recognized. If the present value of expected future cash flows is equal to or greater than the amortized cost basis, an expected credit loss does not exist.
Our credit impairment review process excludes fixed maturities guaranteed, either explicitly or implicitly, by the U.S. government and its agencies (U.S. Government, U.S. Agency and U.S. Agency RMBS) because we anticipate these securities will not be settled below amortized cost. These securities are evaluated for intention to sell at a loss.
At December 31, 2020, we were not party to any off-balance sheet arrangements, as defined by Item 303(a)(4) of Regulation S-K to which an entity unconsolidated with the Company is a party that management believes is reasonably likely to have a current or future effect on its financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that we believe is material to investors.
Consolidated Statements of Operations for the years ended December 31, 2020, 2019 and 2018 115
Note 2 - Basis of Presentation and Significant Accounting Policies 121
We have audited the accompanying consolidated balance sheets of AXIS Capital Holdings Limited and subsidiaries (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income, changes in shareholders' equity, and cash flows, for each of the three years in the period ended December 31, 2020, and the related notes and the schedules listed in the Index at Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
Reserve for losses and loss expenses - Refer to Notes 2 and 8 to the consolidated financial statements
•We tested the completeness and accuracy of the underlying data that served as the basis for the Company’s actuarial analysis, including historical claims data, to test the reasonableness of key inputs to the actuarial estimate.
-We independently developed an estimate of the reserves for selected classes of business, compared our estimates to those booked by the Company, and evaluated the differences.
AXIS Capital Holdings Limited ("AXIS Capital" and together with its wholly owned subsidiaries the "Company"), was incorporated on December 9, 2002, under the laws of Bermuda. The Company provides a broad range of insurance and reinsurance products on a worldwide basis. The Company's principal operating subsidiaries, located in Bermuda, the United States ("U.S."), Europe, Singapore and Canada are described below:
•AXIS Re SE is a European public limited liability company, incorporated as a reinsurer under the laws of Ireland. AXIS Re SE is also a Societas Europaea (SE). AXIS Re SE also conducts reinsurance business through its branch in Switzerland, AXIS Re SE, Dublin (Zurich Branch).
Tabular dollar and share amounts are in thousands, with the exception of per share amounts. All amounts are reported in U.S. dollars.
•the allowance for credit losses associated with available for sale securities.
Net investment income includes interest income and the amortization of market premiums and discounts and is presented net of investment expenses. Investment income is recognized when earned. Purchases and sales of fixed maturities are recorded on a trade-date basis and realized gains (losses) on sales of fixed maturities are determined based on the specific identification method. Realized gains (losses) on fixed maturities are included in net investment gains (losses) in the consolidated statements of operations.
In instances where the Company intends to hold the impaired fixed maturity, the Company determines whether the decline in fair value below the amortized cost basis has resulted from a credit loss or other factors. If the Company does not anticipate to fully recover the amortized cost, an allowance for expected credit losses is established. The allowance for expected credit losses is limited to the difference between a security's amortized cost basis and its fair value. The allowance for expected credit losses is charged to net income and is included in net investment gains (losses).
c.downgrades in the security's credit rating by a credit rating agency; and
d.failure of the issuer to make scheduled principal or interest payments.
The non-credit impairment amount of the loss is recognized in other comprehensive income.
c.the reason for the decline (e.g. credit spread widening, credit event, foreign exchange rate movements);
e.the collateral structure and credit support of the security, if applicable.
Mortgage loans, held for investment are reported at amortized cost which is calculated as the unpaid principal balance, adjusted for any unamortized premium or discount, deferred fees or expenses, and is net of valuation allowances.
Interest income and prepayment fees are recognized when earned. Interest income is recognized based on an effective yield method which gives effect to the amortization of premiums and accretion of discounts.
Other investments are recorded at fair value (refer to Note 6 'Fair Value Measurements'). Changes in fair value and realized gains (losses) are reported in net investment income in the consolidated statements of operations.
Cash equivalents include money-market funds, fixed interest deposits and reverse repurchase agreements with a maturity of under 90 days when purchased. Cash and cash equivalents are recorded at amortized cost, which approximates fair value due to the short-term, liquid nature of these securities. Restricted cash primarily relates to funds held in trust to support obligations in regulatory jurisdictions where the Company operates as a non-admitted carrier and to support the underwriting activities of Syndicate 1686 and Syndicate 2007 at Lloyd's.
Acquisition costs vary with and are directly related to the successful acquisition efforts of acquiring new or renewing existing insurance and reinsurance contracts and consist primarily of fees and commissions paid to brokers and premium taxes. Acquisition costs are shown net of commissions on reinsurance purchased. Net acquisition costs are deferred and charged to net income as the related premium is earned. Insurance and reinsurance premium balances receivable is presented net of acquisition costs when contract terms provide for the right of offset.
The Company reviews its reserve for losses and loss expenses on a quarterly basis. Case reserves are primarily established based on amounts reported by clients and/or their brokers. Management estimates IBNR after reviewing detailed actuarial analyses and applying informed judgment regarding qualitative factors that may not be fully captured in the actuarial estimates. A variety of actuarial methods are utilized in this process, including the Expected Loss Ratio, Chain Ladder and Bornhuetter Ferguson methods. The estimate is highly dependent on management’s judgment as to which method(s) are most appropriate for a particular accident/underwriting year and line of business. Historical claims data is often supplemented with industry benchmarks when applying these methodologies.
Any adjustments to estimates of reserve for losses and loss expenses are recognized in the period in which they are determined. While the Company believes that its reserves for losses and loss expenses are adequate, this estimate requires significant judgment and new information, events or circumstances may result in ultimate losses that are materially greater or less than provided for in the consolidated balance sheets.
Reinsurance recoverable on unpaid losses and loss expenses ("reinsurance recoverable") related to case reserves is estimated on a case-by-case basis by applying the terms of applicable reinsurance cover to individual case reserve estimates. Reinsurance recoverable related to IBNR is generally developed as part of the Company's loss reserving process, therefore, its estimation is subject to similar risks and uncertainties as the estimation of IBNR.
Following the adoption of Accounting Standard Update ("ASU") 2016-13, "Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments," (refer to 'New Accounting Standards Adopted in 2020' below):
A case-specific allowance for expected credit losses is estimated based on the Company's analysis of amounts due, historical delinquencies and write-offs. In addition, the Company uses a default analysis which is based on the reinsurers' credit rating and the length of collection periods to estimate allowances for expected credit losses on the remainder of the reinsurance recoverable balance. The default analysis considers current and forecasted economic conditions.
The allowance for expected credit losses is recognized in net income (loss). Any adjustment to the allowance for expected credit losses is recognized in the period in which it is determined. Write-offs of reinsurance recoverable balances, together with associated allowances for expected credit losses, are recognized in the period in which balances are deemed uncollectible. The Company does not have a history of significant write-offs.
Retroactive reinsurance reimburses a ceding company for liabilities incurred as a result of past insurable events covered under contracts subject to the reinsurance. In certain instances, reinsurance contracts cover losses both on a prospective basis and on a retroactive basis and where practical the Company bifurcates the prospective and retrospective elements of these reinsurance contracts and accounts for each element separately. Initial gains in connection with retroactive reinsurance contracts are deferred and amortized into income over the settlement period while losses are recognized immediately. When changes in the estimated amount recoverable from the reinsurer or in the timing of receipts related to that amount occur, a cumulative amortization adjustment is recognized in net income in the period in which the change is determined so that the deferred gain reflects the balance that would have existed had the revised estimate been available at the inception of the reinsurance transaction.
Monetary assets and liabilities denominated in foreign currency are remeasured to functional currency at the rates of exchange in effect at the balance sheet date with the resulting foreign exchange losses (gains) generally being recognized in
unit exceeds the fair value, an impairment loss is recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit.
For other definite lived intangible assets the Company tests for recoverability whenever events or changes in circumstances indicate its carrying amount may not be recoverable. The Company recognizes an impairment loss if the carrying amount of the asset is not recoverable and exceeds its fair value. The carrying amount of a definite lived intangible asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset.
Certain subsidiaries and branches of the Company operate in jurisdictions where they are subject to taxation. Current and deferred income taxes are charged or credited to net income, or in certain cases to AOCI, based on enacted tax laws and rates applicable in the relevant jurisdiction in the period in which the tax becomes accruable or realizable. Deferred income taxes are provided for all temporary differences between the bases of assets and liabilities used in the consolidated balance sheets and those used in the various jurisdictional tax returns. When the assessment indicates that it is more likely than not that a portion of a deferred tax asset will not be realized in the foreseeable future, a valuation allowance against deferred tax assets is recorded. The Company recognizes the tax benefits of uncertain tax positions only when the position is more-likely-than-not to be sustained on audit by the relevant taxing authorities.
The Company recognizes a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term related to office property and equipment leases.
The Company accounts for non-lease components separately from lease components. As a result, the non-lease components associated with the Company's leases are not included in the lease liabilities and right-of-use assets in the Company's consolidated balance sheets.
Effective January 1, 2020, the Company adopted ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments," using the modified retrospective approach for insurance and reinsurance premium balances receivable, reinsurance recoverable on unpaid losses and loss expenses and mortgage loans, held for investment. The Company assessed that the impact of adoption of ASU 2016-13 was $nil. This guidance replaced the "incurred loss" impairment methodology with an approach based on "expected losses" to estimate credit losses on certain types of financial instruments and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The guidance requires financial assets to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the cost of the financial asset to present the net carrying value at the amount expected to be collected on the financial asset.
Insurance and reinsurance premium balances receivable of $2,738 million at December 31, 2020 was presented net of an allowance for expected credit losses. The allowance for expected credit losses was estimated based on the Company's analysis of amounts due, historical delinquencies and write-offs, and current economic conditions, together with reasonable and supportable forecasts of short-term economic conditions, giving consideration to the potential impact from the COVID-19 pandemic. At December 31, 2020, the allowance for credit losses expected to be recognized over the life of premium balances receivable was $9 million.
Effective January 1, 2020, the Company adopted the targeted changes to the impairment model for available for sale securities introduced in ASU 2016-13 using the prospective transition approach. The updated guidance amends the previous other-than-temporary impairment model by requiring the recognition of impairments related to credit losses through an allowance account and limits the amount of credit loss to the difference between a security's amortized cost basis and its fair value. In addition, the length of time a security has been in an unrealized loss position no longer impacts the determination of whether a credit loss exists.
The following table presents gross premiums written by the geographical location of the Company's subsidiaries:
The table below provides details of goodwill and intangible assets related to the Company's insurance segment:
For the year ended December 31, 2020, the Company's impairment review of goodwill and indefinite lived intangibles resulted in the recognition of an impairment loss of $1 million related to the exit from certain program business. For the year ended December 31, 2019, the Company's impairment review of goodwill and indefinite lived intangibles did not result in the recognition of an impairment loss. For the year ended December 31, 2018, the Company's impairment review of goodwill and indefinite lived intangibles resulted in the recognition of an impairment loss of $4 million related to the termination of the Managing General Agent ("MGA") contract intangible asset identified in connection with the acquisition of Novae.
The tables below provide details of the gross amount and accumulated amortization by category of VOBA and intangible assets:
The table below provides details of estimated amortization expense of VOBA and intangible assets with a finite life:
The estimated remaining average useful life of finite lived intangible assets is 9 years.
(3)Asset-backed securities ("ABS") include debt tranched securities collateralized primarily by auto loans, student loans, credit card receivables and collateralized loan obligations ("CLOs").
The Company also invests in limited partnerships which represent 60% of the Company's other investments. The investments in limited partnerships include hedge funds, direct lending funds, private equity funds, real estate funds and CLO equity tranched securities, which are variable interests issued by VIEs (refer to Note 5(c) 'Other Investments'). The Company does not have the power to direct the activities that are most significant to the economic performance of these VIEs therefore the Company is not the primary beneficiary of these VIEs.
The following table provides details of the Company's mortgage loans held for investment:
The primary credit quality indicators for commercial mortgage loans are the debt service coverage ratio which compares a property’s net operating income to amounts needed to service the principal and interest due under the loan, (generally, the lower the debt service coverage ratio, the higher the risk of experiencing a credit loss) and the loan-to-value ratio which compares the unpaid principal balance of the loan to the estimated fair value of the underlying collateral (generally, the higher the loan-to-value ratio, the higher the risk of experiencing a credit loss). The debt service coverage ratio and loan-to-value ratio, as well as the values utilized in calculating these ratios, are updated annually, on a rolling basis.
The following table provides a summary of the Company's other investments, together with additional information relating to the liquidity of each category:
•Multi-strategy funds: Seek to achieve above-market returns by pursuing multiple investment strategies to diversify risks and reduce volatility. This category includes funds of hedge funds which invest in a large pool of hedge funds across a diversified range of hedge fund strategies.
•Direct lending funds: Seek to achieve attractive risk-adjusted returns, including current income generation, by investing in funds which provide financing directly to borrowers.
•Private equity funds: Seek to achieve attractive risk-adjusted returns by investing in private transactions over the course of several years.
•Real estate funds: Seek to achieve attractive risk-adjusted returns by making and managing investments in real estate and real estate securities and businesses.
At December 31, 2020, the Company had $151 million (2019: $170 million) of unfunded commitments as a limited partner in direct lending funds. Once the full amount of committed capital has been called by the General Partner of each of these funds, the assets will not be fully returned until the completion of the fund's investment term. These funds have investment terms ranging from five to fifteen years and the General Partners of certain funds have the option to extend the term by up to three years.
At December 31, 2020, the Company had $166 million (2019: $261 million) of unfunded commitments as a limited partner in private equity funds. The life of the funds is subject to the dissolution of the underlying funds. The Company expects the overall holding period to be over five years.
During 2015, the Company made a $50 million commitment as a limited partner of a bank revolver opportunity fund. The fund has an investment term of seven years and the General Partners have the option to extend the term by up to two years. At December 31, 2020, this commitment remains unfunded. It is not anticipated that the full amount of this fund will be drawn.
During 2016, the Company paid $108 million including direct transaction costs to acquire 19% of the common equity of Harrington Reinsurance Holdings Limited ("Harrington"), the parent company of Harrington Re Ltd. ("Harrington Re"), an independent reinsurance company jointly sponsored by the Company and The Blackstone Group L.P. ("Blackstone"). Through long-term service agreements, the Company will serve as Harrington Re's reinsurance underwriting manager and Blackstone will serve as exclusive investment management service provider. As an investor, the Company expects to benefit from underwriting profit generated by Harrington Re and the income and capital appreciation Blackstone seeks to deliver through its investment management services. In addition, the Company has entered into an arrangement with Blackstone under which underwriting and investment related fees will be shared equally. Harrington is not a VIE that is required to be included in the Company's consolidated financial statements. The Company accounts for its ownership interest in Harrington
The Company evaluates available for sale securities for expected credit losses when fair value is below amortized cost. If the Company intends to sell or will be required to sell the security before its anticipated recovery, the full amount of the impairment loss is charged to net income. If the Company does not intend to sell or will not be required to sell the security before its anticipated recovery, an allowance for expected credit losses is established and the portion of the loss that relates to credit losses is recorded in net income.
A summary of credit loss activity by asset class, the significant inputs and the methodology used to estimate credit losses are described below.
Non-U.S. government securities are evaluated for expected credit losses primarily through qualitative assessments of the likelihood of credit losses using information such as severity of unrealized losses, credit ratings and price volatility. At December 31, 2020, the gross unrealized losses were less than $1 million and were mainly due to foreign exchange losses. At December 31, 2020, the Company does not anticipate any credit losses on its non-U.S. government fixed maturities.
Previously, the evaluation of non-U.S. government securities for credit losses included duration of loss and foreign exchange losses. At December 31, 2019, the gross unrealized losses of $2 million were mainly due to foreign exchange losses. In 2019, the OTTI charge on non-U.S. government fixed maturities mainly related to unrealized foreign exchange losses on certain securities where the forecasted recovery of the amortized cost of these securities was uncertain.
To estimate expected credit losses for non-agency RMBS, the Company's projected cash flows incorporated underlying data from widely accepted third-party data sources along with certain internal assumptions and judgments regarding the future performance of the security. These assumptions included default, delinquency, loss severity and prepayment rates. The assumptions used to calculate credit losses in 2020 have not changed significantly since December 31, 2019.
At December 31, 2020, the fair value of the Company's non-agency RMBS was $140 million (2019: $85 million), consisting primarily of $85 million (2019: $54 million) of Prime and $23 million (2019: $11 million) of Alt-A MBS. At December 31, 2020, the allowance for expected credit losses on non-agency RMBS related to loss severity where the forecasted recovery to amortized cost is uncertain.
The Company's investments in ABS consist mainly of CLO debt tranched securities ("CLO Debt") purchased primarily as new issues between 2017 and 2020. Substantially all of these new issues had credit ratings of AA or better. The Company utilizes a scenario-based approach to review its CLO Debt portfolio based on the current asset market price. The Company also reviews subordination levels of these securities to determine their ability to absorb credit losses of underlying collateral. If losses are forecast to be below the subordination level for a tranche held by the Company, the security is determined not to have a credit loss. At December 31, 2020 and 2019, the Company does not anticipate any credit losses on its CLO Debt.
In order to support the Company's obligations in regulatory jurisdictions where it operates as a non-admitted carrier, the Company provides collateral in the form of assets held in trust and, to a lesser extent, letters of credit (refer to Note 10(b) 'Debt and Financing Arrangements').
In addition, the Company operates in the Lloyd’s market through its corporate members, AXIS Corporate Capital UK Limited and AXIS Corporate Capital UK II Limited, which provide 70% and 30%, respectively of Syndicate 1686's capital support. AXIS Corporate Capital UK II Limited is the sole corporate member of Syndicate 2007. Lloyd’s sets capital requirements for corporate members annually through the application of a capital model that is based on regulatory rules pursuant to Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking up and pursuit of business of Insurance and Reinsurance (Solvency II) ("Solvency II").
The capital provided to support underwriting, or Funds at Lloyd’s ("FAL"), may be satisfied by cash, certain investments and letters of credit provided by approved banks (refer to Note 11 'Commitments and Contingencies' and Note 21 'Statutory Financial Information').
At December 31, 2020 collateral held in trust for third-party agreements of $1,903 million (2019: $1,856 million) included $45 million (2019: $365 million) of fixed maturities and equity securities, and cash of $225 million (2019: $16 million) held on deposit to support the underwriting activities of Syndicate 2007, and also included $297 million (2019: $169 million) of fixed maturities and equity securities, and cash of $178 million (2019: $181 million) held on deposit to support the underwriting activities of Syndicate 1686.
At December 31, 2020, the Company held $91 million (2019: $nil) of reverse repurchase agreements. These loans are fully collateralized, are generally outstanding for a short period of time and are presented on a gross basis as part of cash and cash equivalents in the Company's consolidated balance sheets. The required collateral for these loans is either cash or U.S. Treasuries at a minimum rate of 102% of the loan principal. At maturity, the Company receives principal and interest income. The Company monitors the estimated fair value of the securities loaned and borrowed on a daily basis with additional collateral obtained as necessary throughout the duration of the transaction.
•Level 1 - Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.
At each valuation date, the Company uses the market approach valuation technique to estimate the fair value of its fixed maturities portfolio, where possible. The market approach includes, but is not limited to, prices obtained from third-party pricing services for identical or comparable securities and the use of "pricing matrix models" using observable market inputs such as yield curves, credit risks and spreads, measures of volatility, and prepayment speeds. Pricing from third-party pricing services is sourced from multiple vendors, where available, and the Company maintains a vendor hierarchy by asset type based on historical pricing experience and vendor expertise. Where prices are unavailable from pricing services, the Company obtains non-binding quotes from broker-dealers who are active in the corresponding markets. The valuation techniques including significant inputs and assumptions generally used to determine the fair values of the Company's fixed maturities by asset class as well as the classifications of the fair values of these securities in the fair value hierarchy are described in detail below.
Equity securities include common stocks, preferred stocks, exchange-traded funds and bond mutual funds. As the fair values of common stocks, preferred stocks and exchange-traded funds are based on unadjusted quoted market prices in active markets, the fair values of these securities are classified as Level 1. As bond mutual funds have daily liquidity, the fair values of these securities are classified as Level 2.
Other privately held investments include convertible preferred shares, common shares, convertible notes and a variable yield security. These investments are initially valued at cost, which approximates fair value. In subsequent measurement periods, the fair values of these investments are generally determined using capital statements obtained from each investee company. In order to assess the reasonableness of the information received from each investee company, the Company maintains an understanding of current market conditions, historical results, and emerging trends that may impact the results of operations, financial condition or liquidity of investee companies. In addition, the Company engages in regular communication with management at the investee companies. In 2020, the fair value of the variable yield security was determined using an externally developed discounted cash flow model. As the significant inputs used to price these investments are unobservable, the fair values of other privately held investments are classified as Level 3.
Overseas deposits include investments in private funds held by Syndicate 2007 where the underlying investments are primarily U.S. government, non-U.S. government and corporate debt securities. The funds do not trade on an exchange, therefore, they are not included in available for sale investments. As the significant inputs used to price the underlying investments are observable market inputs, the fair values of overseas deposits are classified as Level 2.
Short-term investments primarily comprise highly liquid securities with maturities greater than three months but less than one year from the date of purchase. These securities are typically not actively traded due to their approaching maturity, therefore their amortized cost approximates fair value. The fair values of short-term investments are classified as Level 2.
Note: Fixed maturities of $15 million that are classified as Level 3 are excluded from the above table as these securities are priced using broker-dealer quotes. In addition, other privately held investments of $48 million that are classified as Level 3 are excluded from the above table as these investments are priced using capital statements received from investee companies.
The CLO-Equities market continues to be relatively inactive with only a small number of transactions being observed, particularly related to transactions involving CLO-Equities held by the Company. Accordingly, the fair value of the Company's indirect investment in CLO-Equities is determined using a discounted cash flow model prepared by an external investment manager.
The default and loss severity rates are the most judgmental unobservable market inputs to the discounted cash flow model to which the valuation of the Company's indirect investment in CLO-Equities is most sensitive. A significant increase (decrease) in either of these significant inputs in isolation would result in a lower (higher) fair value estimate for the investment in CLO-Equities and, in general, a change in default rate assumptions would be accompanied by a directionally similar change in loss severity rate assumptions. Collateral spreads and estimated maturity dates are less judgmental inputs as they are based on the historical average of actual spreads and the weighted average life of the current underlying portfolios, respectively. A significant increase (decrease) in either of these significant inputs in isolation would result in a higher (lower) fair value estimate for the investment in CLO-Equities. In general, these inputs have no significant interrelationship with each other or with default and loss severity rates.
The following table presents changes in Level 3 for financial instruments measured at fair value on a recurring basis:
(1) Realized gains (losses) on fixed maturities and realized and unrealized gains (losses) on other assets and other liabilities included in net income are included in net investment gains (losses). Realized and unrealized gains (losses) on other investments included in net income are included in net investment income.
(3) Change in unrealized gains (losses) relating to assets and liabilities held at the reporting date.
There were no transfers out of Level 3 into Level 2 during 2020. The transfers out of Level 3 into Level 2 during 2019 were primarily due to the availability of observable market inputs and multiple quotes from pricing vendors for certain fixed maturities.
The fair values of hedge funds, direct lending funds, private equity funds and real estate funds are estimated using net asset valuations ("NAVs") as advised by external fund managers or third-party administrators. For these funds, NAVs are based on the manager's or administrator's valuation of the underlying holdings in accordance with the fund's governing documents and in accordance with U.S. GAAP.
At December 31, 2020, the Company's debt was recorded at amortized cost with a carrying value of $1,310 million (2019: $1,808 million) and a fair value of $1,485 million (2019: $1,896 million). The fair value of the Company's debt is based on prices obtained from a third-party pricing service and is determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As the yields for the risk-free yield curve and the spreads are observable market inputs, the fair value of the Company's debt is classified as Level 2.
The following tables map the Company's lines of business to reserve classes and the expected claim tails:
•Loss Development Method (also referred to as the "Chain Ladder Method" or "Link Ratio Method"): This method assumes that the losses incurred/paid for each accident year or underwriting year at a particular development stage follow a relatively similar pattern. It assumes that on average, every accident year or underwriting year will display the same percentage of ultimate losses incurred/paid at the same point in time after the inception of that year. The percentages incurred/paid are established for each development stage (e.g. 12 months, 24 months, etc.) after examining averages from historical loss development data and/or external industry benchmark information. Ultimate losses are then estimated by multiplying the actual incurred/paid losses by the reciprocal of the established incurred/paid percentage. The strengths of this method are that it reacts to loss emergence/payments and that it makes full use of historical claim emergence/payment experience. However, this method has weaknesses when the underlying assumption of stable loss development/payment patterns is not valid. This could be the consequence of changes in business mix, claim inflation trends or claim reporting practices and/or the presence of large claims, among other things. Furthermore, this method tends to produce volatile estimates of ultimate losses where there is volatility in the underlying incurred/paid patterns. In
particular, where the expected percentage of incurred/paid losses is low, small deviations between actual and expected claims can lead to very volatile estimates of ultimate losses. As a result, this method is often unsuitable at early development stages for an accident year or underwriting year.
As part of the loss reserving process, the Company's actuaries employ the estimation method(s) that they believe will produce the most reliable estimate of ultimate losses, at that particular evaluation date, for each reserve class and accident year or underwriting year combination. Often, this is a blend (i.e. weighted average) of the results of two or more appropriate actuarial methods. These ultimate loss estimates are generally utilized to evaluate the adequacy of ultimate loss estimates for previous accident or underwriting years, established in the prior reporting period. For the initial estimate of the current accident or underwriting year, the available claim data is typically insufficient to produce a reliable estimate of ultimate losses. As a result, initial estimates for an accident or underwriting year are generally based on the ELR Method for longer tailed lines and a BF Method for shorter tailed lines. The initial ELR for each reserve class is established collaboratively by the Company's actuaries, underwriters and management at the start of the year as part of the planning process, taking into consideration prior accident years’ or underwriting years' experience and industry benchmarks, adjusted after considering factors such as loss and exposure trends, rate differences, changes in contract terms and conditions, business mix changes and other known differences between the current year and prior accident or underwriting years. The initial expected loss ratios for a given accident or underwriting year may be modified over time if the underlying assumptions, such as loss development or premium rate changes, differ from the original assumptions.
In contrast to short and medium-tail business, the claim tail for long-tail business is expected to be notably longer, as claims are often reported and ultimately paid or settled years, or even decades, after the related loss events occur. Long-tail business consists primarily of insurance and reinsurance liability reserve classes and reinsurance motor reserve class.
Net reserves for losses and loss expenses related to the COVID-19 pandemic represents the Company's best estimate of losses and loss expenses that have been incurred at December 31, 2020. The determination of net reserves for losses and loss expenses is based on the Company's ground-up assessment of coverage from individual contracts and treaties across all lines of business, and includes a review of modeling analyses and market information, where appropriate. In addition, the Company considers information received from clients, brokers and loss adjusters together with global shelter-in-place orders and the outcomes of recent court judgments, including the UK Supreme Court ruling.
The estimate of net reserves for losses and loss expenses related to the COVID-19 pandemic is subject to significant uncertainty. This uncertainty is driven by the inherent difficulty in making assumptions around the impact of the COVID-19 pandemic due to the lack of comparable events, the ongoing nature of the event, and its far-reaching impacts on world-wide economies and the health of the population. These assumptions include:
While the Company believes its estimate of net reserves for losses and loss expenses is adequate for losses and loss expenses that have been incurred at December 31, 2020 based on current facts and circumstances, the Company continues to monitor the appropriateness of these assumptions as new information comes to light and adjustments are made to the estimate of ultimate losses related to the COVID-19 pandemic if there are developments that are different from previous expectations. Adjustments are recorded in the period in which they are identified. Actual losses for this event may ultimately differ materially from the Company's current estimates.
•discussions of the impact of the event with customers and brokers; and
While the Company believes its estimate of net reserves for losses and loss expenses is adequate for losses and loss expenses that have been incurred at December 31, 2020 based on current facts and circumstances, the Company monitors changes in paid and incurred losses in relation to each significant catastrophe in subsequent reporting periods and adjustments are made to estimates of ultimate losses for each event if there are developments that are different from previous expectations. Adjustments are recorded in the period in which they are identified. Actual losses for these events may ultimately differ materially from the Company's current estimates.
The Company's loss reserving process involves the collaboration of its underwriting, claims, actuarial, legal, ceded reinsurance and finance departments, includes various segmental committee meetings and culminates with the approval of a single point best estimate by the Company's Group Reserving Committee, which comprises senior management. In selecting this best estimate, management considers actuarial estimates and applies informed judgment regarding qualitative factors that may not be fully captured in these actuarial estimates. Such factors include, but are not limited to, the timing of the
emergence of claims, volume and complexity of claims, social and judicial trends, potential severity of individual claims and the extent of Company historical loss data versus industry information. While these qualitative factors are considered in arriving at the point estimate, no specific provisions for qualitative factors are established.
On December 15, 2019, the Company entered into a quota share retrocessional agreement with Harrington Re, a related party, which was deemed to have met the established criteria for retroactive reinsurance accounting. The Company recognized reinsurance recoverable on unpaid losses of $59 million related to this reinsurance agreement. This transaction was conducted at market rates consistent with negotiated arms-length contracts.
On April 16, 2018, the Company entered into a quota share retrocessional agreement with Harrington Re, a related party, which was deemed to have met the established criteria for retroactive reinsurance accounting. The Company recognized reinsurance recoverable on unpaid losses of $108 million related to this reinsurance agreement. This transaction was conducted at market rates consistent with negotiated arms-length contracts.
The following sections provide further details on net prior year reserve development by segment, reserving class and accident year.
•$17 million of net favorable prior year reserve development on marine business primarily due to better than expected loss emergence mainly related to the 2018 accident year.
•$36 million of net adverse prior year reserve development on professional lines business primarily due to reserve strengthening within the European professional indemnity and financial institutions books of business and the commercial management solutions book of business mainly related to the 2018 and 2019 accident years and an increase in the loss estimate attributable to a specific large claim related to the 2009 accident year.
•$19 million of net favorable prior year reserve development on credit and political risk business primarily due to better than expected loss emergence mainly related to recent accident years.
•$12 million of net favorable prior year reserve development on professional lines business reflecting generally favorable experience on older accident years as the Company continued to transition to more experience based actuarial methods.
•$11 million of net favorable prior year reserve development on property and other business primarily due to better than expected loss emergence related to the 2017 catastrophe events and SuperStorm Sandy, partially offset by reserve strengthening within the international book of business mainly related to the 2018 accident year.
In 2020, we recognized $7 million of net favorable prior year reserve development, the principal components of which were:
•$37 million of net favorable prior year reserve development on credit and surety business primarily due to better than expected loss emergence related to multiple accident years.
•$30 million of net adverse prior year reserve development on liability business due to reserve strengthening within the U.S. casualty, the U.S. multiline/regional and the European books of business mainly related to the 2016 to 2019 accident years and an increase in the loss estimate attributable to a specific large claim related to the 2009 accident year.
•$15 million of net adverse prior year reserve development on professional lines business due to an increase in the loss estimate attributable to a specific large claim related to the 2016 accident year and reserve strengthening within the European book of business mainly related to the 2016 to 2018 accident years.
•$53 million of net favorable prior year reserve development on credit and surety business primarily due to better than expected loss emergence mainly related to accident years 2015 through 2017.
•$133 million of net adverse prior year reserve development on property and other business primarily due to an increase in loss estimates attributable to Hurricanes Irma and Michael consistent with industry trends, an increase in the loss
The following tables present net incurred and paid claims development by accident year, total incurred-but-not-reported liabilities plus expected development on reported claims, cumulative reported claims frequency and average annual percentage payout of incurred claims by age for each reserve class. The loss development tables are presented on an accident year basis for the insurance and reinsurance segments. The Company does not discount reserves for losses and loss expenses.
The discontinued lines - Novae includes the international direct and facultative property line of business that Novae exited or placed into run-off in the fourth quarter of 2016.
This reserve class includes the marine line of business which provides cover for traditional marine classes, including offshore energy, renewable offshore energy, cargo, liability, recreational marine, fine art, specie, and hull and war. Offshore energy coverage includes physical damage, business interruption, operators extra expense and liability coverage for all aspects of offshore upstream energy, from exploration and construction through the operation and distribution phases. The complex nature of claims arising under marine policies tends to result in reporting and payment patterns that are longer than those of the property and other reserve class. Exposure to natural perils such as windstorm and earthquake can result in volatility.
The credit insurance coverage is primarily for lenders seeking to mitigate the risk of non-payment from their borrowers. In order to claim compensation under a credit insurance contract, the insured (most often a bank) cannot assign, without the Company's prior agreement, the insured contract (most often a loan) to any third party and is normally obliged to hold a material portion of insured asset on their books, unhedged and uninsured. Claims for this business tend to be characterized by their severity risk, as opposed to their frequency risk. Claim reporting and payment patterns are anticipated to be volatile. Under the notification provisions of credit insurance policies issued by the Company, it anticipates being advised of an insured event within a relatively short time period. Consequently, the Company generally estimates ultimate losses based on a contract-by-contract analysis which considers the contracts’ terms, the facts and circumstances of underlying loss events and qualitative input from claims managers.
The property line of business provides protection for property damage and related losses resulting from natural and man-made perils that are covered in underlying personal and commercial lines insurance policies written by the Company's cedants. The predominant exposure is to property damage, but other risks, including business interruption and other non-property losses, may also be covered when arising from a covered peril. The most significant perils covered by policies in this portfolio include windstorm, tornado and earthquake, but other perils such as freezes, riots, floods, industrial explosions, fires, hail and a number of other loss events are also included. This business is written on a proportional and excess of loss basis.
The accident and health line of business includes personal accident, specialty health, accidental death, travel, life and disability reinsurance products which are offered on a proportional and catastrophic or per life excess of loss basis.
This reserve class includes the credit and surety line of business which provides reinsurance of trade credit insurance products and includes proportional and excess of loss structures. The underlying insurance indemnifies sellers of goods and services in the event of a payment default by the buyer of those goods and services. Surety reinsurance provides protection for losses arising from a broad array of surety bonds issued by insurers to satisfy regulatory demands or contract obligations in a variety of jurisdictions around the world. The Company also provides mortgage reinsurance to mortgage guaranty insurers and U.S. government sponsored entities for losses related to credit risk transfer into the private sector.
With respect to key actuarial assumptions, the Company relies on its loss experience when establishing expected loss ratios and selecting loss development patterns. Loss reporting patterns for professional lines business tend to be volatile, causing instability in actuarial indications based on incurred loss data until an underwriting year matures. Consequently, initial reserves for losses and loss expenses for an underwriting year are generally based on the ELR Method and the consideration of relevant qualitative factors. As underwriting years mature, the Company increasingly gives more weight to methods that reflect its experience until its selections are based almost exclusively on experience-based methods. The Company evaluates the appropriateness of the transition to experience-based methods at the reserve class level, commencing this transition when it believes that its incurred loss development is sufficient to produce meaningful actuarial indications. The rate at which the Company transitions fully to sole reliance on experience-based methods can vary by reserve class and by year, depending on its assessment of the stability and relevance of such indications.
In 2017, the U.K. Ministry of Justice announced a decrease in the discount rate to be used to calculate lump sum awards in U.K. bodily injury cases, known as the Ogden Rate. Effective March 20, 2017, the Ogden rate changed from plus 2.5% to minus 0.75%. This resulted in a trend toward a lower number of claims settlements using PPOs and an increase in projected ultimate losses, particularly related to recent accident years.
Effective August 5, 2019, the Ogden rate changed from minus 0.75% to minus 0.25%. This resulted in a decrease in projected ultimate losses, particularly related to recent accident years.
Claim reporting and payment patterns are typically long-tail in nature and, therefore, subject to increased uncertainty surrounding future loss development. In particular, claims can be subject to inflation from a number of sources including, but not limited to, economic and medical inflation, judicial inflation mass tort and changing social trends.
The following table reconciles the reserve for losses and loss expenses at December 31, 2020, included in the loss development tables to the reserve for losses and loss expenses reported in the consolidated balance sheet:
The following table presents gross and net premiums written and earned:
The tables below provide the key terms of the Company's debt:
(2) The Junior Notes accrue interest from the date of issuance to, but excluding, January 15, 2030 (the "Par Call Date") at the fixed rate of 4.900% and from, and including, the Par Call Date, at a rate equal to the Five-Year Treasury Rate as of the Reset Interest Determination Date, plus 3.186%. Interest of the Junior Notes is payable semi-annually on January 15 and July 15 of each year, beginning on July 15, 2020.
The 5.150% Senior Notes are ranked as unsecured senior obligations of AXIS Specialty Finance PLC, a 100% owned finance subsidiary. AXIS Capital has fully and unconditionally guaranteed all obligations of AXIS Specialty Finance PLC under the 5.150% Senior Notes. AXIS Capital's obligations under this guarantee are unsecured senior obligations and rank equally with all other senior obligations of AXIS Capital.
The changes were made to permit the 5.150% Senior Notes to qualify as Tier 3 ancillary capital under eligible capital requirements of the Bermuda Monetary Authority. Because this amendment does not materially adversely affect the interests of the holders of the 5.150% Senior Notes, the First Supplemental Indenture was entered into without consent of any holders
of the 5.150% Senior Notes. The First Supplemental Indenture relates to the 5.150% Senior Notes only and does not affect any other series of securities issued under the Indenture.
The 4.000% Senior Notes are ranked as unsecured senior obligations of AXIS Specialty Finance PLC, a 100% owned finance subsidiary. AXIS Capital has fully and unconditionally guaranteed all obligations of AXIS Specialty Finance PLC under the 4.000% Senior Notes. AXIS Capital's obligations under this guarantee are unsecured senior obligations and rank equally with all other senior obligations of AXIS Capital.
The 3.900% Senior Notes are ranked as unsecured senior obligations of AXIS Specialty Finance LLC, a 100% owned finance subsidiary. AXIS Capital has fully and unconditionally guaranteed all obligations of AXIS Specialty Finance LLC under the 3.900% Senior Notes. AXIS Capital's obligations under this guarantee are unsecured senior obligations and rank equally with all other senior obligations of AXIS Capital.
The Company has the option to redeem the Senior Notes at any time and from time to time, in whole or in part, at a ''make-whole'' redemption price, which is equal to the greater of the aggregate principal amount or the sum of the present values of the remaining scheduled payments of principal and interest. The related indentures contain various covenants, including limitations on liens on the stock of restricted subsidiaries, restrictions as to the disposition of the stock of restricted subsidiaries and limitations on mergers and consolidations. The Company was in compliance with all the covenants contained in the indentures at December 31, 2020.
On March 27, 2017, the Participating Subsidiaries amended their existing $500 million Facility to include an additional $250 million of secured letter of credit capacity (the "$250 million Facility") pursuant to a Committed Facility Letter and an amendment to the Master Reimbursement Agreement. Under the terms of the $250 million Facility, letters of credit to a maximum aggregate amount of $250 million are available for issuance on behalf of the Participating Subsidiaries once the $500 million Facility has been fully utilized.
On December 24, 2019, the expiration date of the $500 million Facility was extended to December 31, 2023.
The assets that potentially subject the Company to concentrations of credit risk consist principally of cash and investments, reinsurance recoverable on unpaid and paid claims and insurance and reinsurance premiums balances receivable, as described below:
The Company's fixed maturity investment portfolio, which represents approximately $12 billion or 47% of its total assets, is exposed to potential losses arising from the diminished creditworthiness of issuers of bonds as well as third-party counterparties such as custodians. The Company's investment portfolio is managed by external investment managers in accordance with its investment guidelines. The Company limits credit risk through diversification, issuer exposure limits graded by ratings and, with respect to custodians, through contractual and other legal remedies. Excluding U.S. government and agency securities, the Company limits its concentration of credit risk to any single corporate issuer to 2% or less of its investment grade fixed maturities portfolio for securities rated A- or above and 1% or less of its investment grade fixed maturities portfolio for securities rated below A-.
At December 31, 2020, the three largest balances by reinsurer accounted for 13%, 10% and 7% (2019: 12%, 10% and 9%) of reinsurance recoverable on unpaid and paid losses and loss expenses.
At December 31, 2020, 87.6% (December 31, 2019: 89.1%) of the Company's reinsurance recoverable on unpaid and paid losses and loss expenses, gross of collateral were collectible from reinsurers rated the equivalent of A- or better by A.M. Best.
For the year ended December 31, 2020, bad debt expense was $nil (2019: $nil; 2018: $nil).
In the normal course of business, the Company purchases reinsurance and retrocessional (collectively referred to as "reinsurance") protection for its insurance and reinsurance business. Minimum reinsurance premiums are contractually due in advance on a quarterly basis. At December 31, 2020, the Company had outstanding reinsurance purchase commitments of $13 million (2019: $57 million), all of which is due before June 30, 2023. Actual payments under the reinsurance contracts will depend on the underlying subject premium and may exceed the minimum reinsurance premiums.
The Company operates in the Lloyd’s market through its corporate members, AXIS Corporate Capital UK Limited and AXIS Corporate Capital UK II Limited, which provide 70% and 30%, respectively of Syndicate 1686's capital support. AXIS Corporate Capital UK II Limited is the sole corporate member of Syndicate 2007. Lloyd’s sets capital requirements for corporate members annually through the application of a capital model that is based on regulatory rules pursuant to Solvency II.
The capital provided to support underwriting or FAL may be satisfied by cash, certain investments and letters of credit provided by approved banks.
At December 31, 2020, investments and cash of $1.2 billion (2019: $1.3 billion) were restricted to satisfy the Company's FAL requirements (refer to Note 5 'Investments' and Note 21 'Statutory Financial Information').
As the lease contracts generally do not provide an implicit discount rate, the Company uses its incremental borrowing rate based on information available at the commencement date to determine the present value of lease payments. The incremental borrowing rate is based on a borrowing with a term that is similar to the term of the associated lease. The Company has made an accounting policy election not to include renewal, termination, or purchase options that are not reasonably certain of exercise when determining the term of the borrowing.
Operating lease rentals are expensed on a straight-line basis over the life of the lease beginning on the commencement date.
(2) Sublease income largely relates to office properties in New York and London.
The following table presents the scheduled maturity of the Company's operating lease liabilities at December 31, 2020:
The following table presents the scheduled maturity of the Company's operating lease liabilities at December 31, 2019:
For the year ended December 31, 2018, the total lease expense was $33 million.
The following table presents a comparison of earnings (loss) per common share and earnings (loss) per diluted common share:
The Company's Board of Directors has not authorized a common share repurchase plan since December, 31, 2017.
(2) Shares are repurchased from employees to satisfy withholding tax liabilities related to the vesting of share-settled restricted stock units.
On November 7, 2016, the Company issued $550 million of 5.50% Series E preferred shares, par value $0.0125 per share, with a liquidation preference of $2,500 per share. The Company may redeem the Series E preferred shares on or after November 7, 2021 at a redemption price of $2,500 per share. Dividends on the Series E preferred shares are non-cumulative. Holders of the Series E preferred shares will be entitled to receive, only when, as and if declared by the Board of Directors, non-cumulative cash dividends from the original issue date, quarterly in arrears on the fifteenth day of January, April, July and October of each year, commencing on January 15, 2017. To the extent declared, dividends accumulate, with respect to each dividend period, in an amount per share equal to 5.50% of the liquidation preference per annum.
Share-settled restricted stock units granted pursuant to the 2017 Plan or the 2007 Plan either cliff vest at the end of a three year period, vest in accordance with a three year graded vesting schedule in three annual installments beginning on the grant date, or vest in accordance with a four year graded vesting schedule in four annual installments beginning on the grant date.
end of a three year period. Compensation expense is recognized on a straight-line basis over the applicable requisite service period and is subject to periodic adjustment based on the achievement of established performance criteria during the applicable performance period. Performance restricted stock units granted are either share-settled awards or cash-settled liability awards.
death, permanent disability, or certain terminations following a change in control of the Company occurring within two years
of the change in control event. Notwithstanding these vesting provisions, the Compensation Committee of the Company's Board of Directors has broad authority to accelerate vesting at its discretion.
(3) Fair value is based on the closing price of the Company's common shares on the vest date.
A member of the Company’s Board of Directors, Mr. Charles Davis, is the Chief Executive Officer of Stone Point Capital, LLC ("Stone Point"). In the ordinary course of business, the Company engages SKY Harbor Capital Management, LLC, an affiliate of Stone Point, to provide asset management services for certain short duration high yield debt portfolios. For the year ended December 31, 2020, total fees paid to SKY Harbor Capital Management, LLC, were $3 million (2019: $3 million; 2018: $2 million).
The Company has invested $7 million in NXT Capital Senior Loan Fund II, LP and $18 million in NXT Capital Senior Loan Fund III, LP. The manager of these funds is an indirect subsidiary of NXT Capital Inc. ("NXT Capital"). Investment funds managed by Stone Point indirectly owned approximately 43% of NXT Capital until this ownership interest was sold in August 2018. For the year ended December 31, 2018, fees paid to NXT Capital were $1 million.
The Company's investment portfolio includes certain investments where it is considered to have the ability to exercise significant influence over the operating and financial policies of the investee. Significant influence is generally deemed to exist where the Company has an investment of 20% or more in the common stock of a corporation or an investment greater than 3% to 5% in closed end funds, limited partnerships, LLCs or similar investment vehicles. At December 31, 2020, the Company has $404 million (2019: $410 million) of investments where it is deemed to have the ability to exercise such significant influence. The Company generally pays management and performance fees to the investment managers of these investments. The Company considers all fees paid to the investment managers to be at market rates consistent with negotiated arms-length contracts.
For the year ended December 31, 2020, reorganization expenses were $8 million (2019: $37 million and 2018: $67 million), respectively, related to the Company's transformation program which was launched in 2017. This program encompasses the integration of Novae, which commenced in the fourth quarter of 2017, the realignment of the Company's accident and health business, together with other initiatives designed to increase efficiency and enhance profitability while delivering a customer-centric operating model.
(1) At December 31, 2020 and 2019, the total operating loss carryforwards includes Lloyd's deferred year of account losses of $39 million and $50 million, respectively.
The following table summarizes total operating and capital loss carryforwards and tax credits:
(1) At December 31, 2020, all remaining operating and capital loss carryforwards and tax credits can be carried forward indefinitely.
(2) At December 31, 2020 and 2019, the U.K. operating loss carryforward includes Lloyd's deferred year of account losses of $206 million and $293 million, respectively.
At December 31, 2020 and 2019, there were no unrecognized tax benefits.
The Company's insurance and reinsurance operations are subject to insurance and reinsurance laws and regulations in the jurisdictions in which they operate, the most significant of which include Bermuda, Ireland, and the U.S. In addition, the Company is regulated by Lloyd's. These regulations include certain restrictions on the amount of dividends or other distributions, such as loans or cash advances, available to shareholders without prior approval from insurance regulatory authorities.
Under the Insurance Act 1978, amendments thereto and related regulations of Bermuda (the "Act"), the Company's Bermuda subsidiary, AXIS Specialty Bermuda is required to maintain minimum statutory capital and surplus equal to the greater of a minimum solvency margin ("MSM") and the Enhanced Capital Requirement ("ECR"). The MSM is the greater of $100 million, 50% of net premiums written, 15% of net reserve for losses and loss expenses, and 25% of the ECR. The Company's ECR is calculated based on a standard risk-based capital model developed by the Bermuda Monetary Authority ("BMA"). In 2016, the BMA implemented an Economic Balance Sheet ("EBS") framework which is used as the basis to determine the ECR. At December 31, 2020 and 2019, the required and available statutory capital and surplus were based on this EBS framework.
The capital provided to support underwriting, or FAL, is not available for distribution for the payment of dividends or for working capital requirements. Corporate members may also be required to maintain funds under the control of Lloyd’s in excess of their capital requirements and such funds also may not be available for distribution for the payment of dividends. Lloyd’s sets the corporate members’ required capital annually through the application of a capital model that is based on regulatory rules pursuant to Solvency II.
FAL may be satisfied by cash, certain investments and letters of credit provided by approved banks. At December 31, 2020, fixed maturities and short-term investments with a fair value of $746 million (2019: $725 million) and cash of $12 million (2019: $22 million), respectively, were restricted to satisfy AXIS Corporate Capital UK Limited FAL requirements. At December 31, 2020, fixed maturities and short-term investments with a fair value of $361 million (2019: $513 million), equity securities with a fair value of $23 million (2019: $49 million), and cash of $14 million (2019: $5 million) were restricted to satisfy AXIS Corporate Capital UK II Limited FAL requirements (refer to Note 5 'Investments').
The Company's operating subsidiaries in Bermuda and the U.S. maintain branch offices in Singapore and Canada, respectively. The Company's Irish operating subsidiaries maintain branch offices in Switzerland, the U.K, Belgium, and the Netherlands. As branch offices are not considered separate entities for regulatory purposes, the required and actual statutory capital and surplus amounts for each jurisdiction in the table above, include amounts related to the applicable branch offices. The Company's branch offices in Singapore and Canada are subject to additional minimum capital or asset requirements in their countries of domicile. At December 31, 2020 and 2019, the actual capital/assets for each of these branches exceeded the relevant local regulatory requirements.
Total statutory net income (loss) of the Company's operating subsidiaries was $85 million, $364 million, and $268 million for 2020, 2019 and 2018, respectively. The differences between statutory financial statements and statements prepared in accordance with U.S. GAAP vary by jurisdiction, however, the primary differences are that statutory financial statements may not reflect deferred acquisition costs, certain net deferred tax assets, goodwill and intangible assets, unrealized gains (losses) on fixed maturities or certain unauthorized reinsurance recoverable balances.
(2)Underwriting-related general and administrative expenses include those general and administrative expenses that are incremental and/or directly attributable to the Company's underwriting operations. Underwriting-related general and administrative expenses is a non-GAAP financial measure as defined in Item 10(e) of SEC Regulation S-K. The reconciliation to general and administrative expenses, the most comparable GAAP financial measure, also included corporate expenses of $27 million, $21 million, $27 million and $27 million for the quarters ended December 31, September 30, June 30 and March 31, 2020, respectively. During the quarters ended December 31, September 30, June 30 and March 31, 2019, corporate expenses were $32 million, $29 million, $32 million and $36 million, respectively. Corporate expenses include holding company costs necessary to support the Company's worldwide insurance and reinsurance operations and costs associated with operating as a publicly-traded company. As these costs are not incremental and/or directly attributable to the Company's underwriting operations, these costs are excluded from underwriting-related general and administrative expenses, and therefore, consolidated underwriting income (loss).
Due to geographic spread, the complexity of the damages and the recent timing of these events, it is not possible at this time to provide an accurate estimate of the financial impact these events will have on the Company's first quarter results.