Our headquarters are located at 26 Reid Street, Hamilton HM 11, Bermuda. Our U.S. corporate headquarters are located at 605 Highway 169 North, Plymouth, Minnesota, 55441, and our registered office is located at Clarendon House, 2 Church Street, Hamilton HM 11, Bermuda. We also maintain branch offices in various cities throughout the United States. Our headquarters, U.S. corporate headquarters and branch offices are leased. Management believes that our office facilities will be suitable and adequate for our current level of operations.
The following tables set forth our selected consolidated financial information for the dates indicated. We have derived the selected consolidated financial information presented below as of and for the years ended December 31, 2016, 2015, 2014, 2013 and 2012 from our consolidated financial statements. See Note 2-"Acquisitions and Dispositions" and Note 18-"Discontinued Operations" of the accompanying consolidated financial statements.
The following discussion contains "forward-looking statements." Statements that are not historical in nature are forward-looking statements. OneBeacon cannot promise that its expectations as stated in such forward-looking statements will turn out to be correct. OneBeacon's actual results could be materially different from and worse than its expectations. See "Forward-Looking Statements" on page 63 for specific important factors that could cause actual results to differ materially from those contained in forward-looking statements.
Overview-Year ended December 31, 2016 versus year ended December 31, 2015
Net income attributable to OneBeacon's common shareholders was $107.4 million for 2016, compared to $36.8 million in 2015. Pre-tax underwriting income was $29.6 million for 2016, reflecting a combined ratio of 97.3%, compared to pre-tax underwriting income of $43.5 million for 2015, reflecting a combined ratio of 96.3%. The decrease in pre-tax underwriting results was driven by the unfavorable performance of our Healthcare business, discussed below, and to a lesser extent, from our Programs business. This unfavorable performance partially offset the strong underwriting results from many of our other businesses, including Accident, and also significant improvement in Entertainment and Ocean Marine, both of which were negatively impacted by elevated loss activity in 2015. Pre-tax net investment results were $88.3 million in 2016, representing a 3.6% total return on average invested assets, compared to $10.8 million in 2015, representing a 0.6% total return on average invested assets, with the significant increase being driven by higher returns in all asset classes. Our other investments portfolio return included a favorable impact from the surplus notes driven by changes in credit spreads, as well as lower adverse impacts from energy exposed private equity funds in 2016 than in 2015. In addition, a higher return in the fixed maturity investments portfolio was driven by interest rate movements in 2016 compared to 2015, while the higher return from our common equity securities portfolio was driven by improved market conditions.
Despite the reserve actions taken through the first three quarters of 2016 case incurred loss activity continued to exceed expectations during the fourth quarter of 2016. The adverse development was driven by recent prior accident years spread across the complex risks, extended care, managed care errors and omissions, and medical excess sub-lines.
As a result of this loss activity, we have refocused our sales activity during 2016 to target more desirable risks. As a result primarily of these actions, as well as a large return premium on a single account, Healthcare premiums have decreased by $14.7 million in 2016. In addition, Programs net written premiums decreased by $32.3 million in 2016, as a result of exiting two larger Programs accounts which were experiencing higher than expected loss ratios.
Through the first nine months of 2014, we recorded $14.3 million of unfavorable loss and LAE reserve development, driven by greater-than-expected large loss activity in several underwriting operating segments, primarily the Other Professional Lines and Management Liability underwriting operating segments. This large loss activity, which occurred mostly during the second and third quarters of 2014, also impacted the 2014 current accident year loss and LAE estimates. Additionally, we incurred higher-than-usual claim coverage determination costs, a component of LAE expenses, during the first nine months of 2014. Other underwriting operating segments also reported increased claim activity, including Entertainment, Government Risks, and Accident.
Consolidated Results-Year ended December 31, 2016 versus year ended December 31, 2015
Our 2016 comprehensive income attributable to OneBeacon's common shareholders was $108.4 million compared to $36.8 million for 2015, with the change driven primarily by a $77.5 million increase in pre-tax investment results due to higher returns in all asset classes as discussed below in "Investments," and to a lesser extent, a $16.3 million tax benefit resulting from the settlements of IRS examinations for tax years 2007 through 2012. Partially offsetting these increases was a $13.9 million decrease in pre-tax underwriting results driven by the factors discussed below in "Underwriting Results."
on more desirable risks, as well as a large return premium on a single account, and increased competition. These decreases were partially offset by increases at several other businesses, most notably our newer Financial Institutions business ($18.0 million).
Our combined ratio for 2016 of 97.3% reflected a 59.6% loss and LAE ratio and a 37.7% expense ratio, which compared to a combined ratio for 2015 of 96.3%, also reflecting a 59.6% loss and LAE ratio but a lower expense ratio of 36.7%.
Net investment income increased to $50.6 million in 2016, compared to $45.9 million in 2015 driven by a $2.4 million interest payment on the surplus notes, along with a higher asset allocation to fixed maturity investments. Net realized and change in unrealized investment gains increased significantly to positive $37.7 million in 2016, compared to negative $35.1 million in 2015, due to favorable 2016 results in the other investments portfolio driven by a valuation impact from the surplus notes of positive $20.4 million resulting primarily from changes in credit spreads compared to negative $13.6 million in 2015, and to a lesser extent, lower negative returns in energy sector exposed private equity funds in 2016 compared to 2015. The 2016 return was also significantly impacted by increased returns in the fixed maturity investments portfolio driven by interest rate movements in 2016 compared to 2015 and increased returns in the common equity securities portfolio due to improved market conditions.
The $6.1 million favorable change in other revenues (expenses) compared to 2015, was driven by the prior year impact of a $3.7 million negative adjustment to the pre-tax gain on sale of Essentia and $3.0 million of income in 2016 from the excess invested assets remaining after the termination of the OneBeacon qualified pension plan. The prior year also included a $1.6 million pre-tax write-off of certain capitalized software and a $1.2 million loss on the sale of real estate, which were offset by a $3.0 million (pre-tax) payment received in connection with the early termination of our exclusive agreement with Climate Crop Insurance Agency (Crop Transaction Fee).
Our pre-tax underwriting income was $43.5 million for 2015, reflecting a combined ratio of 96.3%, compared to a pre-tax underwriting loss of $20.5 million for 2014, reflecting a combined ratio of 101.7%.
The 9.6 point decrease in the loss and LAE ratio was substantially a result of the impact of the 2014 fourth quarter reserve increase, which had a 9.3 point impact on the 2014 combined ratio. The 9.6 point decrease in the loss and LAE ratio was comprised of a 2.0 point decrease in current accident year non-catastrophe losses, a 7.8 point favorable change in prior year loss reserve development, and partially offset by a 0.2 point increase in catastrophe losses. Current accident year non-catastrophe
losses for 2015 were $685.9 million, or 58.4 points, compared to $711.5 million, or 60.4 points for 2014, as an increase in the provision for 2015 was more than offset by the 2014 impact of the 2014 fourth quarter reserve increase.
Net investment income increased to $45.9 million in 2015, compared to $43.4 million in 2014. Net realized and change in unrealized investment gains decreased significantly to negative $35.1 million in 2015, compared to positive $40.4 million in 2014, due to unfavorable results in the other investments portfolio driven by lower returns in energy exposed sector private equity funds and a valuation impact from the surplus notes of negative $13.6 million recorded in 2015 resulting from increased credit spreads. The 2015 return was also significantly impacted by decreased returns in the common equity securities portfolio due to lower equity market performance as well as decreased returns in the fixed maturity portfolio driven by interest rate movements.
There was no net after-tax change in benefit plan assets and obligations impact to comprehensive income in 2015. As of December 31, 2015, the projected benefit obligations of the terminated Qualified Plan was estimated using termination assumptions as the settlement was imminent and the likelihood that the Qualified Plan would return from termination was remote. This compared to a decrease in comprehensive income in 2014 of $12.0 million, primarily reflecting the impact of a decrease in the discount rate, as well a change in the mortality assumptions used to estimate our pension plan projected benefit obligation.
Our reportable segments are Specialty Products, Specialty Industries, and Investing, Financing and Corporate.
Specialty Products-Year ended December 31, 2016 versus year ended December 31, 2015
The Specialty Products combined ratio for 2016 increased to 107.5% from 90.8% for 2015, as the loss and LAE ratio increased by 16.1 points to 71.6% and the expense ratio increased by 0.6 points to 35.9%.
The 16.1 point increase in the loss and LAE ratio was comprised of a 2.8 point increase in current accident year non-catastrophe losses, a 13.1 point unfavorable change in net prior year loss reserve development, and a 0.2 point increase in catastrophe losses.
The current accident year non-catastrophe loss ratio for 2016 was 62.2% compared to 59.4% for 2015, driven primarily by Healthcare related to the extended care, and to a lesser extent, medical excess sub-lines, as well as higher accident year provisions in Programs due to continued elevated losses across several programs, and Other Professional Lines, primarily due to higher than expected losses in the architects and engineers sub-line, and were modestly offset by the improved performance of several other business.
The 2016 results included $46.7 million, or 8.9 points, of net unfavorable prior year loss reserve development driven by the Healthcare Development Impact ($40.7 million), and to a lesser extent, in the architects and engineers sub-line ($14.8 million) within Other Professional Lines and Programs ($13.3 million) relating to continued adverse results in auto-related programs, which was partially offset by favorable development primarily in Financial Services ($8.2 million), the media sub-line ($4.8 million) within Other Professional Lines and Specialty Property ($4.8 million). The 2015 results included $23.6 million, or 4.2 points, of net favorable prior year loss reserve development, primarily attributable to favorable development from the exited Collector Cars and Boats business, Specialty Property, Financial Services, Surety, Environmental, and Crop businesses. This favorable development was partially offset by unfavorable development in the Programs business.
The 0.6 point increase in the expense ratio for 2016, compared to 2015, was primarily driven by the negative impact of lower earned premium volumes and increased commissions due to business mix in 2016 more than offsetting reduced salary and incentive compensation expense driven by headcount reductions in 2016 and lower relative incentive compensation performance factors. Additionally, the 2015 ratio was adversely impacted by the impact from the exit of the Crop business, separation costs associated with senior management restructuring, and severance costs.
Net written premiums for Specialty Products decreased $73.9 million, or 12.2%, to $533.0 million for 2015 from $606.9 million for 2014, primarily due to the negative $44.4 million impact of the Crop business, a $33.6 million decrease at our Other Professional Lines business, reflecting our exit from the lawyers liability business that was sold in December of 2014, a $33.3 million decrease at our Healthcare business largely due to increased competition and change in underwriting appetite and a $20.1 million negative impact due to the termination of an affiliated reinsurance treaty. These decreases were partially offset by increases of $48.3 million and $18.5 million in our newer Programs and Surety businesses, respectively.
Net written premiums for Specialty Industries decreased $43.8 million, or 7.3%, to $559.8 million for 2016 from $603.6 million for 2015. The significant decrease in 2016 was driven by Entertainment ($26.5 million) due to a refinement of our underwriting appetite given recent loss experience, and to a lesser extent, decreases across all other underwriting operating segments, most notably Ocean Marine ($7.0 million) driven by market conditions and competition.
The 14.6 point decrease in the loss and LAE ratio was comprised of a 4.9 point decrease in current accident year non-catastrophe losses, a 9.0 point favorable change in prior year loss reserve development and a 0.7 point decrease in catastrophe losses.
The 1.4 point increase in the expense ratio was primarily driven by the negative impact of lower earned premiums and increased commissions due to business mix in 2016 more than offsetting reduced salary and incentive compensation expense driven by headcount reductions and lower relative incentive compensation performance factors. Additionally, the 2015 ratio was adversely impacted by separation costs associated with senior management restructuring and severance costs.
The 2015 results included 3.5 points of net unfavorable prior year loss reserve development primarily driven by Entertainment due to several large losses and an increase in small to mid-size claims, and to a lesser extent, unusually heavy
loss activity of both large and small claims in Ocean Marine which were partially offset by favorable prior year loss reserve development in Technology, and to a lesser extent Government Risks. The 2014 results included 4.7 points of net unfavorable prior year loss reserve development primarily related to Entertainment, Government Risks, the transportation business within Accident and Inland Marine, all of which were driven by the 2014 fourth quarter reserve increase. This unfavorable prior year loss reserve development in 2014 was partially offset by favorable prior year loss reserve development in Ocean Marine.
The 3.1 point increase in the expense ratio was primarily driven by lower incentive compensation expense in 2014 resulting from the 2014 fourth quarter reserve increase as well as 2014 benefiting from a transition services agreement with the buyer of our legacy personal lines business, which was terminated on June 30, 2014. Additionally, the 2015 ratio was adversely impacted by separation costs associated with senior management restructuring and severance costs.
Investing, Financing and Corporate-Year ended December 31, 2016 versus year ended December 31, 2015
Investing, Financing and Corporate reported pre-tax income from continuing operations of $67.5 million in 2016, compared to a pre-tax loss of $16.7 million in 2015. The increase was primarily related to significantly higher investment returns in 2016. As described in greater detail in "Summary of Investment Results" below, net investment income increased to $50.6 million in 2016, compared to $45.9 million in 2015, while net realized and change in unrealized investment gains increased significantly to positive $37.7 million in 2016, compared to negative $35.1 million in 2015. In addition, there was a $5.9 million favorable change in other revenues (expenses) compared to 2015 driven by the prior year impact of a $3.7 million negative adjustment to the pre-tax gain on sale of Essentia, and $3.0 million of income in 2016 resulting from the excess invested assets that previously supported the Qualified Plan, which was terminated in 2016.
Investing, Financing and Corporate reported a pre-tax loss from continuing operations of $16.7 million in 2015, compared to pre-tax income of $62.9 million in 2014. The decrease was primarily related to substantially lower investment returns in 2015, and a $3.7 million negative adjustment to the pre-tax gain on sale of Essentia. In addition, net other revenues (expenses) included a $1.6 million pre-tax write-off of certain capitalized software associated with senior management restructuring, as well as an additional loss on the sale of real estate of $1.2 million in 2015. These other expenses were partially offset by the $3.0 million (pre-tax) of other revenues from the Crop Transaction Fee. As described in greater detail in "Summary of Investment Results" below, net investment income increased slightly to $45.9 million in 2015, compared to $43.4 million in 2014, while net realized and change in unrealized investment gains decreased significantly to negative $35.1 million in 2015, compared to positive $40.4 million in 2014.
As described in Note 1-"Nature of Operations and Summary of Significant Accounting Policies" and Note 2-"Acquisitions and Dispositions," on December 23, 2014, we completed the sale of our Runoff Business to Armour and the results of operations for the Runoff Business have been classified as discontinued operations and are presented as such, net of related income taxes, in the statements of operations and comprehensive income and cash flows for all periods. Our investing and financing activities are managed on a consolidated basis reported within the Investing, Financing and Corporate segment. Therefore, no investment or financing activity is included in discontinued operations.
There was no gain or loss related to discontinued operations for the year ended December 31, 2016.
The loss from discontinued operations, net of tax, of $0.2 million for the year ended December 31, 2015 included $0.5 million of post-closing expenses incurred in connection with the Runoff Business and a $0.3 million gain from sale of discontinued operations representing a positive adjustment to the estimated loss on sale taking into consideration the final settlement of certain post-closing items.
As part of the closing of the Runoff Transaction on December 23, 2014, the $101.0 million par value surplus notes issued had a fair value of $64.9 million at closing based on an internal discounted cash flow model, resulting in a valuation adjustment of $36.1 million, pre-tax, included in loss from sale of discontinued operations. Subsequent to the closing, the surplus notes became part of the our investment portfolio, categorized within other investments, and subsequent changes in the value thereon are reflected in continuing operations. See Note 5-"Investment Securities" for further disclosures regarding these surplus notes.
Also during 2014, our expectation of the treatment of a $7.4 million reserve charge recorded during the quarter ended June 30, 2013 changed. Previously, we had expected that the $7.4 million of assets to support this reserve charge would be transferred to Armour at the closing of the Runoff Transaction. However, OneBeacon and Armour agreed instead to increase the cap on seller financing. As a result, the $7.4 million reserve charge ($4.8 million after-tax) was recorded as a reduction to the estimated loss on sale of discontinued operations.
During the third quarter of 2016, OneBeacon established a portfolio of high-yield fixed maturity investments. Given the risk profile of these investments, OneBeacon’s management believes that returns associated with the high-yield fixed maturity investments are more appropriately included with the returns from common equity securities and other investments instead of with returns associated with short-term investments and investment grade fixed maturity investments. See “NON-GAAP FINANCIAL MEASURES” on page 48.
Investment Returns-Year ended December 31, 2016 versus year ended December 31, 2015
Sales and maturities of investments, excluding short-term investments and other investments, increased to $1,681.3 million from $1,371.5 million for the years ended December 31, 2016 and 2015, respectively, due to increased maturities in the fixed maturity investments portfolio, and purchases of these investments decreased slightly to $1,655.9 million from $1,657.0 million for the years ended December 31, 2016 and 2015, respectively.
We maintain a high quality fixed income portfolio with a relatively short duration of approximately 2.5 years excluding short-term investments and approximately 2.4 years including short-term investments as of December 31, 2016. Our fixed income portfolio returned 2.3% in 2016, compared to 1.4% in 2015, outperforming the longer duration Bloomberg Barclays U.S. Intermediate Aggregate Index returns of 2.0% and 1.2% for 2016 and 2015, respectively. Modest increases in treasury rates during both periods contributed to our outperformance.
Excluding high-yield fixed maturity investments, our fixed income portfolio returned 2.3% in 2016, outperforming the longer duration Bloomberg Barclays U.S. Intermediate Aggregate Index return of 2.0% in 2016.
Our common equity securities and other investments portfolio returned 10.9% in 2016, compared to (3.0)% in 2015, underperforming the S&P 500 Index returns of 12.0% and 1.4% in 2016 and 2015, respectively.
The portfolio of common equity securities, other investments and high-yield fixed maturity investments returned 10.1% in 2016, which underperformed the S&P 500 Index return of 12.0%.
OneBeacon invests in ETFs that seek to provide investment results that, before expenses, generally correspond to the performance of broad market indices.
OneBeacon has established relationships with third party registered investment advisers to actively manage a portion of its common equity securities portfolio. The largest of these relationships have been with Prospector Partners LLC (Prospector) and Lateef Investment Management (Lateef). During the second quarter of 2015, OneBeacon instructed Prospector to liquidate its separate account portfolios and redeemed its investments in hedge funds managed by Prospector. OneBeacon has since terminated its investment management agreements with Prospector. OneBeacon continues to have common equity securities actively managed by Lateef, though the allocation to Lateef was significantly reduced in the fourth quarter of 2016. Proceeds from both the 2015 Prospector liquidation and 2016 Lateef reduction were largely reinvested in ETFs.
During the third quarter of 2016, OneBeacon established a portfolio of high-yield fixed maturity investments. The high-yield portfolio had a fair value of $91.0 million as of December 31, 2016.
Sales and maturities of investments, excluding short-term investments and other investments, decreased to $1,371.5 million from $2,585.1 million for the years ended December 31, 2015 and 2014, respectively, and purchases of these investments decreased to $1,657.0 million from $2,409.2 million for the years ended December 31, 2015 and 2014, respectively. These decreases reflect increased transactional volume in 2014 related to the completion of the Runoff Transaction.
Our other investments portfolio returned (11.8)% for 2015, underperforming the S&P 500 Index return of 1.4%, compared to 7.6% for 2014, underperforming the S&P 500 Index return of 13.7%. The 2015 returns were heavily impacted by negative valuations from our energy exposed private equity funds and the surplus notes.
(1) Includes $71.9 million and $51.5 million of surplus notes as of December 31, 2016 and 2015, respectively, received in conjunction with the financing of the Runoff Transaction.
The breakdown of our fixed maturity portfolio as of December 31, 2016 by credit class, based upon issue credit ratings provided by Standard & Poor's, or if unrated by Standard & Poor's, long-term obligation ratings provided by Moody's, is as follows:
The maturity distribution for fixed maturity investments held as of December 31, 2016 is as follows:
(1) High-yield fixed maturity investments returned 0.7% for the year ended December 31, 2016.
Holding company level. The primary sources of cash for the Company and certain of our intermediate subsidiaries are expected to be distributions and tax sharing payments received from our insurance operating subsidiaries, capital raising activities, net investment income, and proceeds from sales and maturities of holding company investments. The primary uses of cash are expected to be interest payments on our debt obligations, repurchases and retirements of our debt obligations, dividend payments on our common shares, common share repurchases, purchases of investments, payments made to tax authorities, contributions to our operating subsidiaries, and holding company operating expenses.
In 2017, Split Rock has the ability to distribute statutory capital without the prior approval of the Bermuda Monetary Authority, provided it does not reduce its total statutory capital, as shown in its previous financial year’s statutory financial statements, by 15% or more.
Based upon the limitations described above, Split Rock currently has the ability to distribute up to $31.5 million of statutory capital and pay up to $60.1 million of dividends during 2017 without the prior approval of regulatory authorities. During 2016, Split Rock paid $25.0 million of dividends to its immediate parent and paid no such dividends during 2015. Also, during 2015, OneBeacon Ltd., through an intermediary holding company, contributed $85.0 million to Split Rock as statutory capital.
During the years ended December 31, 2016 and 2015, our unregulated insurance operating subsidiaries paid $5.7 million and $5.3 million, respectively, of dividends to their immediate parent. As of December 31, 2016, our unregulated insurance operating subsidiaries had $56.4 million of net unrestricted cash, short-term investments and fixed maturity investments and $71.9 million of other investments consisting of the surplus notes.
As described in Note 10-"Common Shareholders' Equity," during the years ended December 31, 2016, 2015 and 2014 OneBeacon Ltd. declared and paid regular quarterly dividends to its common shareholders totaling $79.2 million, $80.0 million and $80.0 million, respectively.
Insurance float can increase in a number of ways, including through acquisitions of insurance operations, organic growth in existing insurance operations and recognition of losses that do not immediately cause a corresponding reduction in investment assets. Conversely, insurance float can decrease in a number of other ways, including sales of insurance operations, shrinking or run-off of existing insurance operations, the acquisition of operations that do not have substantial investment assets (e.g., an agency) and the recognition of gains that do not cause a corresponding increase in investment assets. We intend to generate low-cost float over time through a combination of organic growth and acquisitions.
Certain operational leverage metrics can be measured with ratios that are calculated using insurance float. There are many activities that do not change the amount of insurance float at an insurance company but can have a significant impact on the company's operational leverage metrics. For example, investment gains and losses, debt issuances and repurchases/repayments,
The following table illustrates our consolidated insurance float position and two operational leverage ratios based on insurance float as of December 31, 2016 and 2015.
The Credit Facility contains various affirmative, negative and financial covenants which OneBeacon considers to be customary for such borrowings, including certain minimum net worth and maximum debt to capitalization standards. These covenants can restrict the Company in several ways, including its ability to incur additional indebtedness. An uncured breach of
these covenants could result in an event of default under the Credit Facility, which would allow lenders to declare any amounts owed under the Credit Facility to be immediately due and payable.
In November 2012, OBH issued $275.0 million face value of senior unsecured notes (2012 Senior Notes) through a public offering, at an issue price of 99.9% and received $272.9 million of proceeds. The 2012 Senior Notes bear an annual interest rate of 4.6% payable semi-annually in arrears on May 9 and November 9, until maturity on November 9, 2022, and are fully and unconditionally guaranteed as to the payment of principal and interest by the Company.
The 2012 Senior Notes were issued under indentures that contain restrictive covenants which, among other things, limit the ability of the Company, OBH, and their respective subsidiaries to create liens and enter into sale and leaseback transactions and limits the ability of OneBeacon to consolidate, merge or transfer their properties and assets. The indentures do not contain any financial ratios or specified levels of net worth or liquidity to which the Company or OBH must adhere. In addition, a failure by the Company or its subsidiaries to pay principal and interest on covered debt, where such failure results in the acceleration of at least $75 million of the principal amount of covered debt, could trigger the acceleration of the 2012 Senior Notes.
During each of the years ended December 31, 2016, 2015 and 2014, we paid $12.7 million of interest on the 2012 Senior Notes.
As of December 31, 2016, the Company and OBH were in compliance with all of the covenants under the 2012 Senior Notes and the Credit Facility, and anticipate they will continue to remain in compliance with these covenants for the foreseeable future.
Upon expiration of the lease agreement with US Bancorp in December 2016, the leased assets under the agreement with a remaining book value of $1.3 million reverted ownership back to the Company, and there is no longer a capital lease asset or obligation. As of December 31, 2015, the Company had a capital lease obligation of $1.7 million included within other liabilities and a capital lease asset of $2.4 million included within other assets.
Below is a schedule of our material contractual obligations and commitments due by period as of December 31, 2016:
Represents expected future cash outflows resulting from loss and LAE payments. The amounts presented are gross of reinsurance recoverables on unpaid losses of $172.9 million and net of the discount on our workers compensation loss and LAE reserves of $1.6 million as of December 31, 2016.
We also have future binding commitments to fund certain limited partnership investments. These commitments, which total $15.0 million as of December 31, 2016, do not have fixed funding dates and are therefore excluded from the table above.
Cash flows from operations for the years ended December 31, 2016, 2015 and 2014
During 2015, we made payments with respect to our long-term incentive compensation plans totaling $8.6 million, in cash or by deferral into certain of our non-qualified compensation plans. These payments were made primarily with respect to 129,100 performance units, 3,965,000 long-term cash awards, and 181,290 performance shares for the 2012-2014 performance cycle.
During 2016, we declared and paid $79.2 million of regular quarterly cash dividends to holders of OneBeacon's common shares.
During 2015, we declared and paid 80.0 million of regular quarterly cash dividends to holders of OneBeacon's common shares.
During 2014, we repurchased and retired 106,366 common shares for $1.8 million to satisfy employee income tax withholding, pursuant to employee benefit plans that do not fall under the board authorization.
Refer to Note 5-"Investment Securities" for discussion regarding assets measured at fair value using unobservable inputs.
Assets carried at fair value include fixed maturity investments, common equity securities, surplus notes, and interests in hedge funds and private equity funds. Valuation of assets measured at fair value requires us to make estimates and apply judgment to matters that may carry a significant degree of uncertainty. In determining our estimates of fair value, we use a variety of valuation approaches and inputs. Whenever possible, we estimate fair value using valuation methods that maximize the use of observable prices and other inputs.
We use brokers and outside pricing services to assist in determining fair values. For investments in active markets, we use the quoted market prices provided by outside pricing services to determine fair value. The outside pricing services we use have indicated that if no observable inputs are available for the security, they will not provide a price. In such circumstances, where quoted market prices are unavailable or are not considered reasonable, we estimate fair value using industry standard pricing methodologies and observable inputs such as benchmark yields, reported trades, broker-dealer quotes, issuer spreads, benchmark securities, bids, offers, credit spreads, prepayment speeds reference data including research publications and other relevant inputs. Given that many fixed maturity investments do not trade on a daily basis, the outside pricing services evaluate a wide range of fixed maturity investments by regularly drawing parallels from recent trades and quotes of comparable securities with similar features. The characteristics used to identify comparable fixed maturity investments vary by asset type and take into account market convention.
The valuation process above is generally applicable to all of OneBeacon’s fixed maturity investments. The techniques and inputs specific to asset classes within OneBeacon's fixed maturity investments for Level 2 securities that use observable inputs are as follows:
Debt securities issued by corporations: The fair value of debt securities issued by corporations is determined from a pricing evaluation technique that uses information from market sources and integrates relative credit information, observed market movements, and sector news. Key inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including sector, coupon, quality ratings, duration, credit enhancements, early redemption features and market research publications.
The fair value of the surplus notes provided in conjunction with the financing of the Runoff Transaction is determined based on a discounted expected cash flow model using information as of the measurement date, and is classified as a Level 3 measurement. OneBeacon’s other investments also include an investment in a community reinvestment vehicle, which is accounted for at fair value, and a tax advantaged federal affordable housing development fund, which is accounted for under the proportional amortization method.
Hedge funds and private equity funds are measured at fair value for which NAV is generally the practical expedient and are no longer classified within the fair value hierarchy. We employ a number of procedures to assess the reasonableness of the NAV reported by the fund, including obtaining and reviewing periodic and audited financial statements and discussing each
In the fourth quarter of 2014, in conjunction with the Runoff Transaction, OneBeacon provided financing in the form of surplus notes having a par value of $101.0 million, which had a fair value of $64.9 million on the date of sale and $71.9 million and $51.5 million as of December 31, 2016 and 2015, respectively. The surplus notes, issued by one of the transferred entities, Bedivere (Issuer), were in the form of both seller priority and pari passu notes.
Represents the value of the surplus notes, at current market yields on comparable publicly traded debt, and assuming issuer is allowed to make principal and interest payments when its financial capacity is available, as measured by statutory capital in excess of a 250% RBC score under the NAIC's risk-based capital standards for property and casualty companies. The favorable year-over-year change in impact is due principally to the narrowing of non-investment grade credit spreads as well as the time value of money benefit from moving one year closer to modeled cash receipts.
Represents impact of liquidity spread to account for OneBeacon's sole ownership of the notes, lack of a trading market, and unique nature of the ongoing regulatory approval process. The unfavorable year-over-year change in impact is due largely to the increased fair value of the notes as well as a higher effective duration resulting from a lower overall yield to maturity; there was no change in the magnitude of the liquidity spread in 2016.
The increase in the fair value of the surplus notes during the year ended December 31, 2016 was driven primarily by the narrowing of non-investment grade credit spreads, partially offset by the impact of a change in estimates and assumptions regarding the timing of regulatory approval of principal and interest payments on the notes.
The internal valuation model used to estimate the fair value of the surplus notes is based on a discounted expected cash flow model using information as of the measurement date. The estimated fair value of the surplus notes is sensitive to changes in public debt credit spreads, as well as changes in estimates with respect to other variables, including a discount to reflect the private nature of the notes (and the related lack of liquidity), the credit quality of the notes, based on the financial performance of the Issuer relative to expectations, and the timing, amount, and likelihood of interest and principal payments on the notes, which are subject to regulatory approval and therefore may vary from the contractual terms. Anticipating a change in the assumed timeline, amounts, and process necessary to obtain regulatory approval, the Company made a change in its estimate as of December 31, 2016 with regard to the timing of regulatory approval of principal and interest payments on the notes. For the purpose of estimating fair value, the Company has currently assumed that all accrued unpaid interest on the seller priority note since the date of issuance is paid in 2020, with regular annual interest payments on both the seller priority note and pari passu note beginning thereafter, all accrued but unpaid interest on the pari passu note since the date of issuance is paid in 2025, and principal repayments begin on a graduated basis in 2030 for the seller priority note and 2035 for the pari passu note. Previously, including as of December 31, 2015, the Company had assumed for the purpose of estimating fair value that interest payouts, including all accrued but unpaid amounts, began in 2020 for both notes and that principal repayments began on a graduated basis in 2025 for the seller priority note and 2030 for the pari passu note.
Although these variables involve considerable judgment, the Company does not currently expect any resulting changes in the estimated value of the surplus notes to be material to its financial position. Given these significant unobservable inputs, the surplus notes have been classified as Level 3 under the fair value hierarchy. See "Significant Unobservable Inputs" in Note 5-"Investment Securities" of the accompanying consolidated financial statements.
Represents the sensitivity to changes in the estimate of the liquidity spread added to account for OneBeacon's sole ownership of the notes, lack of a liquid trading market, and unique nature of the ongoing regulatory approval process.
Represents the sensitivity to changes in the estimate of the timing of the first principal payment received by OneBeacon. The fair value model assumes a delay in the receipt of principal cash flows as a result of the regulatory approval required before such payments may occur; and assuming repayments are made with a graduated impact on statutory surplus.
Consists of 4 hedge funds as of both December 31, 2016 and 2015.
The fair values as of December 31, 2016 for assets measured using Level 3 inputs are as follows:
Excludes the carrying value of $12.3 million as of December 31, 2016 associated with a tax advantaged federal affordable housing development fund accounted for using the proportional amortization method.
As described in Note 1-"Nature of Operations and Summary of Significant Accounting Policies" investments in hedge funds and private equity funds with a measured fair value of $52.0 million for which NAV is generally the practical expedient are no longer classified within the fair value hierarchy.
uncertainty in loss and LAE, persistent or large variances would indicate that prior assumptions and/or reliance on certain reserving methods may need to be revised going forward.
The process of establishing loss reserves, including amounts incurred but not reported, is complex and imprecise as it must consider many variables that are subject to the outcome of future events. As a result, informed subjective estimates and judgments as to the ultimate exposure to losses are an integral component of the loss reserving process. OneBeacon categorizes and tracks insurance reserves by "line of business", as either property (short-tailed) lines, casualty (long-tailed) lines, or other (accident, surety, and credit) lines. These distinctions follow the characteristics of the underlying reserves such that property lines typically are short-tailed as they payout relatively quickly, while casualty reserves are long-tailed as they pay out over a longer period of time. The other lines category reflects the unique characteristics of the sub-lines within that grouping, which includes credit, accident and surety. These categories are also consistent with considerations by OneBeacon's management with respect to decision making as pertains to capital needs. For example, short-tail lines require less deployed capital than longer-tail lines.
OneBeacon regularly reviews the appropriateness of reserve levels at the line of business level, considering the variety of trends that impact the ultimate settlement of claims for the subsets of claims in each particular line of business.
For loss and allocated LAE reserves, the key assumption as of December 31, 2016 was that the impact of the various reserving factors, as described in Note 3-"Unpaid Loss and Loss Adjustment Expense ("LAE") Reserves," on future paid losses would be similar to the impact of those factors on the historical loss data with the exception of severity trends. Severity trends have been relatively stable over the relevant historical period. The actuarial methods used would project losses assuming continued stability in severity trends. Management has considered a range of assumptions regarding future increases in loss severity trends, including the impact of inflation, in making its reserve selections.
The major causes of material uncertainty (reserving factors) generally will vary for each line, as well as for each separately analyzed component of the line. Also, reserving factors can have offsetting or compounding effects on estimated reserves. For example, in workers compensation, the use of expensive medical procedures that result in medical cost inflation may enable workers to return to work faster, thereby lowering indemnity costs. Thus, in almost all cases, it is impossible to discretely measure the effect of a single reserving factor and construct a meaningful sensitivity expectation. Actual results will likely vary from expectations for each of these assumptions, resulting in an ultimate claim liability that is different from that being estimated currently.
See Note 3-"Unpaid Loss and Loss Adjustment Expense ("LAE") Reserves" for a detailed description of the reserve factors and consideration for each of the major lines.
Professional liability: Recorded loss and allocated LAE reserves, net of reinsurance recoverables, for professional liability were $438 million as of December 31, 2016. A key assumption for professional liability is the implicit loss cost trend, particularly the severity inflation trend component of loss costs. Across the entire reserve base, a 5.0 point change in assumed annual severity trend would have changed the estimated net reserve by approximately $84 million as of December 31, 2016, in either direction.
These statements are based on certain assumptions and analyses made by us in light of our experience and judgments about historical trends, current conditions and expected future developments, as well as other factors believed to be appropriate in the circumstances. However, whether actual results and developments will conform to our expectations is subject to a number of risks, uncertainties or other factors which are described in more detail beginning on page 16 of this Form 10-K, that could cause actual results to differ materially from expectations, including:
recorded loss and LAE reserves subsequently proving to have been inadequate;
our status as a subsidiary of White Mountains, including potential conflicts of interest;