We lease office space in Bermuda, where our principal executive offices are located. Argo Group US leases office space in San Antonio, Texas, for its United States headquarters, its Commercial Specialty subsidiary company, and for certain support functions associated with Argonaut Insurance Company. We also lease space in the following locations:
For the year ended December 31, 2011, we reported net loss of $82.4 million, or ($3.03) per fully diluted share. For the year ended December 31, 2010, we reported net income of $82.6 million, or $2.76 per fully diluted share. For the year ended December 31, 2009, we reported net income of $117.5 million, or $3.81 per fully diluted share.
Consolidated net investment income decreased for the year ended December 31, 2011 as compared to the same periods ended 2010 and 2009 due to lower investment yields and continued declining invested asset balances. Total invested assets at December 31, 2011 were $3,985.0 million, net of $162.5 million of invested assets attributable to the trade capital providers. Total invested assets at December 31, 2010 were $4,045.0 million, net of $170.4 million of invested assets attributable to Argo International’s trade capital providers. Total invested assets at December 31, 2009 were $4,099.0 million, net of $235.3 million of invested assets attributable to the trade capital providers.
Consolidated gross realized gains were $74.2 million for the year ended December 31, 2011, as compared to $47.3 million and $47.4 million in 2010 and 2009, respectively. Consolidated gross realized losses were $25.0 million, $10.5 million and $64.1 million for the years ended December 31, 2011, 2010 and 2009, respectively. Included in consolidated gross realized losses for the years ended December 31, 2011, 2010 and 2009 were write downs of approximately $1.2 million, $0.8 million and $45.5 million, respectively, from the recognition of other-than-temporary impairments on certain investment securities.
During 2011, we purchased foreign currency 90 day forward contracts to manage currency exposure on losses related to the New Zealand and Japan earthquakes and Australian and Thai floods. The term of these contracts gives us flexibility to adjust the notional amount of the contracts based on payments made and changes in estimates of future losses. We do not apply hedge accounting to these contracts, and as a result, all gains (losses) are recognized in net realized investment and other gains. For the year ended December 31, 2011 we recognized $4.3 million in foreign currency exchange losses related to the loss reserves recorded for these events which were offset by $4.6 million in realized gains from the currency forward contracts. The foreign currency exchange (gains) losses related to these loss reserves and the realized gains (losses) from the currency forward contracts are reported under the Corporate and Other segment.
Included in consolidated losses and loss adjustment expenses for the 2010 accident year was $77.3 million in catastrophe losses resulting from earthquakes in Haiti, Chile and New Zealand, U.S. Storm losses, the Deepwater Horizon incident and Queensland flooding. Also included in losses and loss adjustment expenses was $43.1 million in net favorable loss reserve development on prior accident years. The Excess and Surplus Lines segment had $19.0 million in net favorable loss reserve development primarily in the casualty and professional liability lines of business. The Commercial Specialty segment had $9.8 million of net favorable loss reserve development primarily within the workers compensation lines of business and in an assumed directors and officers program. The International Specialty segment had net favorable loss reserve development of $16.8 million primarily attributable to short-tail non-catastrophe losses. The Syndicate 1200 segment had net unfavorable loss reserve development of $4.4 million attributable to $14.2 million of unfavorable loss reserve development in the liability lines of business and $9.8 million of favorable loss reserve development in the property lines of business. The Run-off Lines segment had net favorable loss reserve development of $1.9 million due to $8.0 million of favorable loss reserve development related to risk management run-off reserves, $2.6 million of favorable loss reserve development on legacy PXRE claims, $0.8 million of favorable loss reserve development related to unallocated loss adjustment reserves, partially offset by $9.5 million of unfavorable loss reserve development in the general liability lines resulting from asbestos and environmental exposure.
The following table summarizes the above referenced loss reserve development as respects to prior year loss reserves by line of business for the year ended December 31, 2011:
In determining appropriate reserve levels for the year ended December 31, 2011, we maintained the same general processes and disciplines that were used to set reserves at prior reporting dates. No significant changes in methodologies were made to estimate the reserves since the last reporting date; however at each reporting date we reassess the actuarial estimate of the reserve for loss and loss adjustment expenses and record our best estimate. Consistent with prior reserve valuations, as claims data becomes more mature for prior accident years, actuarial estimates were refined to weigh certain actuarial methods more heavily in order to respond to any emerging trends in the paid and reported loss data. These modifications to the analysis varied depending on whether the line of business was short-tailed or long-tailed and also varied by accident year. While prior accident years’ net reserves for losses and loss adjustment expenses for some lines of business have developed favorably in recent years, this does not infer that more recent accident years’ reserves also will develop favorably; pricing, reinsurance costs, the legal environment, general economic conditions including changes in inflation and many other factors impact management’s ultimate loss estimates.
For the Run-off Lines segment, in determining appropriate reserve levels, we maintained the same general processes and disciplines that were used to set reserves at prior reporting dates. No changes in key assumptions were made to estimate the reserves since the last reporting date.
Consolidated loss reserves were $3,291.1 million (including $196.6 million of reserves attributable to Argo International’s trade capital providers), $3,152.2 million (including $185.3 million of reserves attributable to the trade capital providers) and $3,203.2 million (including $227.9 million of reserves attributable to the trade capital providers) as of December 31, 2011, 2010 and 2009, respectively. Management has recorded its best estimate of loss reserves at each date based on current known facts and circumstances. Due to the significant uncertainties inherent in the estimation of loss reserves, there can be no assurance that future loss development, favorable or unfavorable, will not occur.
In 2011, we entered into two reinsurance transactions with a special purpose reinsurance company which provided the coverage through the issuance of two catastrophe bond transactions. The reinsurance transactions provide coverage for selected events. In accordance with generally accepted accounting principles in the United States (“GAAP”), we are accounting for these covers as derivatives, and as such, present the financial statement impact in a separate line item - “Other reinsurance-related expense”-in the Consolidated Statements of (Loss) Income. Other reinsurance-related expense totaled $5.9 million for the year ended December 31, 2011. As management views these coverage as reinsurance protection, we treat the financial statement effects of these covers as ceded premium for the purposes of calculating our loss, expense and combined ratios.
Consolidated interest expense was $22.1 million, $22.9 million and $25.7 million for the years ended December 31, 2011, 2010 and 2009, respectively. The decrease in interest expense was due to reduced interest rates and the repayment of outstanding balances on our revolving line of credit during 2009.
We are primarily engaged in writing property and casualty insurance and reinsurance. We have four ongoing reporting segments: Excess and Surplus Lines, Commercial Specialty, International Specialty (formerly Reinsurance) and Syndicate 1200 (formerly International Specialty). Additionally, we have a Run-off Lines segment for products that we no longer underwrite.
The declines in gross written and earned premiums were primarily due to market conditions. The excess and surplus lines marketplace continues to experience increased competition from both other excess and surplus lines carriers as well as the standard markets, which has led to lower rates and business shifting to the standard markets. Competition within the excess and surplus lines marketplace remains intense, resulting in continued downward pressure on average rate per exposure and the current economic conditions are forcing insureds to reduce coverage or in some cases, cease operations. In addition, insureds in this segment are often the result of new business formations, which have been limited due to the current economic environment.
The Excess and Surplus Lines segment has experienced a shift in both product and policyholder mix, resulting in reduced premium writings.
Included in losses and loss adjustment expenses for the year ended December 31, 2011 was $7.6 million in catastrophe losses for storm activity in the United States, including the Alabama and Joplin, Missouri tornados and Hurricane Irene. Offsetting these catastrophe losses was $33.8 million of net favorable loss reserve development on prior accident years primarily resulting from $30.2 million of favorable development in the general and products liability lines of business. The remaining net favorable development was attributable to the automobile liability, professional liability and property lines of business.
Included in losses and loss adjustment expenses for the year ended December 31, 2010 was $19.0 million in favorable loss reserve development on prior accident years within the casualty, professional liability and property lines. Included in losses and loss adjustment expenses was $4.5 million of storm losses for the 2010 accident year. Included in losses and loss adjustment expenses was $15.4 million in favorable loss reserve development on prior accident years within the casualty, professional liability and property lines.
The decline in earned premiums for the years ended December 31, 2011 and 2010 as compared to the same period in 2009 was primarily attributable to the discontinued hotel/motel, religious institution, and First Insurance Company of Hawaii (“FICOH”) programs and underwriting actions in the grocery and restaurant programs within the Argo Insurance U.S. Retail business unit which began in 2009. Earned premiums of $90.8 million at Argo Insurance were $20.1 million less than 2010 following the termination of the above mentioned programs and $2.3 million of property catastrophe reinstatement premiums assessed after April 2011 tornados in Alabama. Partially offsetting these declines were increases in gross written and earned premiums for our coal mining and surety products. Earned premiums at Rockwood increased $5.1 million to $66.7 million for 2011 as increased demand for coal and natural gas increased workers compensation payrolls on mining and energy-related accounts. Earned premiums for our surety products increased $2.4 million to $12.9 million for 2011 due to expanded new business opportunities resulting from a revised reinsurance structure that expanded capacity.
Included in losses and loss adjustment expenses for the year ended December 31, 2011 was $21.0 million in catastrophe losses from storm activity in the United States, including Hurricane Irene and the Alabama and Joplin, Missouri tornados. The Commercial Specialty segment had net unfavorable loss reserve development on prior accident years of $8.4 million primarily
driven by $16.3 million of unfavorable development in general liability due to increases in claim severity and $2.0 million of unfavorable development in short-tail lines. Partially offsetting the unfavorable reserve development was $5.9 million of favorable development in workers compensation and $3.7 million of favorable development in an assumed Directors and Officers program.
Gross written and earned premiums increased for the year ended December 31, 2011 in comparison to the same periods in 2010 and 2009 as a result of the continued growth of the excess casualty and professional lines unit and an increase in property catastrophe reinstatement premium. Partially offsetting this was a decrease in premium generated by our “Other Assumed” program. Earned premiums for the property catastrophe reinsurance unit were $84.7 million for the year ended December 31, 2011 and $83.7 million for the same period in 2010. The excess casualty and professional lines unit contributed earned
premiums of $16.4 million for the year ended December 31, 2011 compared with $13.7 million for the same period in 2010. Earned premiums for the Other Assumed unit was $0.1 million for the year ended December 31, 2011 and $2.8 million for the same period in 2010. Earned premiums for the year ended December 31, 2010 increased in comparison to 2009 as a result of continued growth in the excess casualty and professional lines unit.
Losses and loss adjustment expenses for the year ended December 31, 2011 included $118.1 million in catastrophe losses including $75.3 million resulting from the Japan and New Zealand earthquakes, $24.9 million from the Thailand and Australia floods and the Danish cloudburst and $17.9 million from storms in the United States including the Alabama and Joplin, Missouri tornados and Hurricane Irene and aggregate reinsurance covers losses of $9.3 million. Partially offsetting these 2011 accident year losses was $4.6 million of net favorable reserve development on prior accident year’s loss reserves. Favorable development consisted of $7.0 million attributable to short-tail non-catastrophe losses and $1.0 million related to 2005 Hurricanes Ike and Gustav. Partially offsetting this favorable development was $1.4 million of unfavorable development attributable to the 2010 New Zealand earthquake and $2.5 million of unfavorable development in long-tail lines primarily due to the 2010 Deepwater Horizon incident.
Losses and loss adjustment expenses for the year ended December 31, 2010 reflect $32.2 million in catastrophe losses resulting primarily from earthquake activity and the Deepwater Horizon incident. Included in losses and loss adjustment expenses for the year ended December 31, 2010 was $16.8 million of favorable prior year loss reserve development. The prior year development was primarily the result of $14.5 million of favorable loss reserve development in non-catastrophe property due to favorable reported loss activity and $1.1 million of favorable loss reserve development on 2008 hurricane reserves. By comparison, 2009 had no major loss events and $3.6 million in favorable loss reserve development for the 2008 accident year due to the hurricane losses developing more favorably than original estimates, plus $4.4 million of favorable development as a result of favorable reported loss activity on non-catastrophe property reserves.
The decline in earned premiums in 2011 as compared to 2010 was primarily attributable to the reduction in gross written premiums beginning in 2010 and continuing into 2011, partially offset by the new aerospace and specialty divisions.
Fee income represents fees and profit commission derived from the management of third party capital for our underwriting syndicate at Lloyd’s. The decreased fee income for the year ended December 31, 2011 was primarily due to a reduction in estimated profit commission in the same periods ending December 31, 2010. Fee income for the year ended December 31, 2010 was greater than the same period in 2009 due to a reduction in fee income receivable from the third party trade capital providers.
Earned premiums for the years ended December 31, 2011, 2010 and 2009 were primarily attributable to adjustments resulting from final audits, reinstatement premiums and other adjustments on policies previously written.
Losses and loss adjustment expenses for the year ended December 31, 2009 included $1.6 million in net favorable loss reserve development on prior accident years. The favorable development included $7.6 million of favorable loss reserve development for PXRE non-catastrophe lines and $3.2 million of favorable development related to PXRE’s 2005 hurricane losses. Partially offsetting the favorable development was $6.1 million in unfavorable reserve development resulting from the settlement of one large asbestos claim in the first quarter of 2009 and $3.0 million due to the unwinding of the workers compensation reserve discount.
Underwriting expenses for the year ended December 31, 2011 decreased as compared to 2010 and 2009 due to reduced administrative expenses. Bad debt expense, net of recoveries, on uncollectible reinsurance recoverable balances of $3.4 million, $6.0 million and $4.8 million were included for the years ended December 31, 2011, 2010 and 2009, respectively.
Argonaut Insurance Company also assumed risk as a reinsurer, primarily for the period from 1970 to 1975, a portion of which was assumed from the London market. Argonaut Insurance Company also reinsured risks on policies written by domestic carriers. Such reinsurance typically provided coverage for limits attaching at a relatively high level, which are payable only after other layers of reinsurance are exhausted. Some of the claims now being filed on policies reinsured by Argonaut Insurance Company are on behalf of claimants who may have been exposed at some time to asbestos incorporated into buildings they occupied, but have no apparent medical problems resulting from such exposure. Additionally, lawsuits are being brought against businesses that were not directly involved in the manufacture or installation of materials containing asbestos. We believe that a significant portion of claims generated out of this population of claimants may result in incurred losses generally lower than the asbestos claims filed over the past decade and could be below the attachment level of Argonaut Insurance Company.
The following table represents a reconciliation of total gross and net reserves for the Run-off Lines for each of the years in the three-year period ended December 31, 2011. Amounts in the net column are reduced by reinsurance recoverables.
that review to determine their best estimate of the asbestos and environmental loss and loss adjustment expense reserves. Management primarily relied on a method that projects future reported claims and severities, with some weight given to other methods. This method relies most heavily on our historical claims and severity information, whereas other methods rely more heavily on industry information. The method produces an estimate of losses that have been incurred but not yet reported based on projections of future claims and the average severity for those future claims. The severities were calculated based on our specific data and in management’s opinion best reflect our liabilities based upon the insurance policies issued.
The number of claims opened during the three years ended December 31, 2011 were as follows:
Because of the types of coverages within the Run-off Lines of business still being serviced by Argonaut Insurance Company, a significant amount of subjectivity and uncertainty exists in establishing the reserves for losses and loss adjustment expenses. Factors that increase these uncertainties are: (1) lack of historical data, (2) inapplicability of standard actuarial projection techniques, (3) uncertainties regarding ultimate claim costs, (4) coverage interpretations, and (5) the judicial, statutory and regulatory environments under which these claims may ultimately be resolved. Significant uncertainty remains as to our ultimate liability due to the potentially long waiting period between exposure and emergence of any bodily injury or property damage and the resulting potential for involvement of multiple policy periods for individual claims. Due to these uncertainties, the current trends may not be indicative of future results. Although management has determined and recorded its best estimate of the reserves for losses and loss adjustment expenses for Run-off Lines, current judicial and legislative decisions continue to broaden liability, expand policy scopes and increase the severity of claims payments. As a result of these and other recent developments, the uncertainties inherent in estimating ultimate loss reserves are heightened, further complicating the already complex process of determining loss reserves. The industry as a whole is involved in extensive litigation over these coverages and liability issues, and must contend with the continuing uncertainty in its effort to quantify these exposures.
The primary sources of cash flow for Argo Group and its subsidiaries are premiums, reinsurance recoverables, proceeds from sales and redemptions of investments and investment income. The primary cash outflows are claim payments, loss adjustment expenses, reinsurance costs and operating expenses. The nature of insurance is that cash collected for premiums written is invested, interest and dividends are earned thereon, and loss and settlement expenses are paid out over a period of years. This period of time varies by line of business and by the circumstances surrounding each claim. A substantial portion of our loss and loss expenses are paid out over more than one year. Additional cash outflow occurs through payments of underwriting and acquisition costs such as commissions, taxes, payroll and general overhead expenses. Management believes that cash receipts from premiums, proceeds from investment sales and redemptions and investment income are sufficient to cover cash outflows in the foreseeable future. Should the need for additional cash arise, we believe we have access to additional sources of liquidity.
Cash provided (used) by operating activities can fluctuate due to timing difference in the collection of premiums and reinsurance recoverables and the payment of losses and expenses. For the years ended December 31, 2011 and 2010, net cash used by operating activities was $17.7 million and $3.1 million, respectively, compared to net cash provided of $301.8 million for the year ended December 31, 2009. The decrease in cash flows from operations in 2011 compared to 2010 was primarily due to increased claim payments due to the 2011 catastrophe activity, partially offset by increased premium writings in the latter half of 2011. The decrease in cash flows from operations in 2010 compared to 2009 was primarily due to decreased written premiums which were slightly offset by reduced claim payments.
For the year ended December 31, 2011, net cash provided by investing activities was $100.3 million as compared to $183.9 million and net cash used by investing activities for the years ended December 31, 2010 and 2009 of $240.8 million, respectively. In 2010, cash was provided by maturities and the proceeds from the sale of investments which were used to repurchase our common stock and to pay dividends. In 2009, cash was primarily used to acquire fixed maturity securities. As of December 31, 2011, 2010 and 2009, $296.4 million, $375.3 million, and $439.3 million, respectively, of the investment portfolio were invested in short-term investments.
During 2011, Argonaut Insurance Company may be permitted to pay dividends of up to $37.3 million in cash without approval from the Illinois Department of Insurance, based on the state of domicile’s ordinary dividend calculation. Colony may be permitted to pay dividends of up to $161.3 million in cash without approval from the Virginia Bureau of Insurance, based on the state of domicile’s ordinary dividend calculation. Rockwood may be permitted to pay dividends of up to $17.5 million in cash without approval from the Pennsylvania Department of Insurance, based on the state of domicile’s ordinary dividend calculation. Business and regulatory considerations may impact the amount of dividends actually paid, and prior approval of dividend payments may be required.
The Credit Agreement contains customary events of default. If an event of default occurs and is continuing, the Borrowers could be required to repay all amounts outstanding under the Credit Agreement. Lenders holding more than 51% of the loans and commitments under the Credit Agreement may elect to accelerate the maturity of the loans under the Credit Agreement upon the occurrence and during the continuation of an event of default. No defaults or events of defaults have occurred as of the date of this filing.
We have two additional LOC facilities totaling $500.0 million that allow us to provide LOCs to our ceding companies if such LOC is required under the terms of the contract and to Lloyd’s to be filed on behalf of Argo (No. 604) Limited, our corporate member at Lloyd’s. All of the facilities require us to provide collateral in the form of fixed maturity securities or cash to the issuing bank as security for the outstanding LOCs. We also have an LOC facility that has been terminated under which we still have outstanding LOCs. We no longer have the ability to issue new LOCs from this facility. We must transfer eligible assets to collateral accounts prior to each respective bank issuing an LOC. Since eligible assets include fixed income investments, such securities need not be sold in order to qualify as eligible collateral. At December 31, 2011, we have pledged assets with a fair value of $199.8 million to support outstanding letters of credit.
We assumed debt through the acquisition of Argo International. These notes are unsecured. All are redeemable subject to certain terms and conditions at a price up to 100% of the principal plus accrued and unpaid interest. Interest on the U.S. Dollar and Euro notes is due semiannually and quarterly, respectively. A summary of the notes outstanding at December 31, 2011 is presented below:
Throughout 2011, 2010 and 2009, we had no preferred shares outstanding.
On February 15, 2012, our Board of Directors declared a quarterly cash dividend in the amount of $0.12 on each share of common stock outstanding. The dividend will be paid on March 15, 2012 to shareholders of record on March 1, 2012.
On February 18, 2011, our Board of Directors authorized the repurchase of up to $150.0 million of our common shares. The 2011 Repurchase Authorization supersedes the November 13, 2007 repurchase authorization which also had authorized the repurchase of up to $150.0 million of our common shares. From January 1, 2011 through February 16, 2012, the last trading day of the Rule 10b5-1 repurchase plan that was initiated on December 14, 2011, we have repurchased 1,792,056 shares of our common stock for a total cost of $54.7 million. Since the inception of the repurchase authorizations through February 16, 2012, we have repurchased 5,155,616 shares of our common stock at an average price of $32.26 for a total cost of $166.3 million. These shares are being held as treasury shares in accordance with the provisions of the Bermuda Companies Act 1981. As of February 16, 2012, availability under the 2011 Repurchase Authorization for future repurchases of our common shares was $110.1 million.
We maintain a comprehensive reinsurance program at levels management considers adequate to diversify risk and safeguard our financial position. The costs of this program, to the extent not passed on to customers through increased rates may have a negative impact on liquidity.