You should read the following selected consolidated financial information along with the information contained in this Form 10-K, including
Through its operating subsidiaries based in Bermuda, the United States and the United Kingdom, the Company focuses on underwriting specialty lines of personal and commercial property and casualty insurance and reinsurance on a global basis. The Company’s portfolio of specialty lines of business is organized into two business segments - Insurance and Reinsurance.
In the Insurance segment, the Company writes agriculture, casualty and other specialty, professional lines, and property, marine and energy insurance. In the Reinsurance segment, the Company writes catastrophe, property, casualty, professional lines, and specialty reinsurance.
accounting. In accordance with generally accepted accounting principles in the United States (“U.S. GAAP”), the available for sale investments are carried at fair market value and unrealized gains and losses on the Company’s investments are generally excluded from earnings. These unrealized gains and losses are included on the Company’s balance sheet in accumulated other comprehensive income as a separate component of shareholders’ equity. If unrealized losses are considered to be other-than-temporary due to the Company’s intent to sell or requirement to sell such securities, or credit related factors, such losses are included in earnings as net impairment losses recognized in earnings. For other investments, the Company increases or decreases the value of these investments for the Company’s share of income or loss, less dividends, which is included in net investment income.
Marketplace Conditions and Trends. In general, at the end of 2014, management believes operating conditions continued to be competitive. In most classes of property and casualty business, the Company experienced mixed pricing, with increases in some casualty classes of business due to the continued low interest rate environment and industry loss development. These positive rate trends have been tempered by relatively high levels of underwriting capacity and competition, particularly in catastrophe exposed property insurance and reinsurance where rates have declined. In the Company's agriculture insurance business, pricing was relatively stable across the portfolio, although the underlying exposure base has varied with commodity price movements. The Company continued to adhere to its underwriting standards by declining business when pricing, terms and conditions did not meet the Company's underwriting criteria.
Premiums and Related Expenses. The Company’s insurance premiums are earned pro rata over the terms of the applicable risk period specified in the insurance policy. The Company’s insurance policies cover losses occurring or claims made during the term of the policy. Generally, the Company receives a fixed premium that is identified in the policy and is recorded on the inception date of the contract or when premiums are determinable and earned evenly over the policy term. This premium will generally only adjust if the underlying insured values adjust. Accordingly, the Company monitors the underlying insured values and records additional or return premiums in the period in which amounts are reasonably determinable. For the Company's agriculture insurance line, premiums are determined based on estimated acreage planted combined with the base commodity price for the insured crops. Adjustments are made to the agriculture premium estimates as acreage reporting and claims adjusting occurs. Insurance premiums written accounted for 59%, 55%, and 56% of the Company’s gross premiums written during the years ended December 31, 2014, 2013, and 2012, respectively.
In addition to the applicable risk period, the Company’s estimate of its reinsurance premiums written is based on the type of reinsurance contracts underwritten. For excess of loss reinsurance contracts, the deposit premium, as defined in the contract, is generally considered to be the best estimate of the reinsurance contract’s written premium at inception. The Company earns reinstatement premiums upon the occurrence of a loss under the reinsurance contract. Reinstatement premiums are calculated in accordance with the contract terms based upon the ultimate loss estimate associated with each contract. Excess of loss reinsurance contracts accounted for approximately 19%, 22%, and 24% of the Company’s gross premiums written during the years ended December 31, 2014, 2013, and 2012, respectively. For proportional reinsurance contracts, the Company estimates premiums, commissions and related expenses based on broker and ceding company estimates. In addition to broker and ceding company estimates, the Company's management also utilizes its judgment in establishing proportional reinsurance contract premium estimates after considering the following factors:
Proportional reinsurance contracts accounted for approximately 22%, 23%, and 20% of the Company’s gross premiums written during the years ended December 31, 2014, 2013, and 2012, respectively.
The Company’s historical experience has shown that estimated premiums from proportional contracts have varied and have been adjusted by up to approximately 7%, although larger variations, both positive and negative, are possible as a result of
The following summarizes the Company’s net proportional premium estimates within premiums receivable, net on the Company’s Audited Consolidated Balance Sheets as of December 31, 2014 and 2013:
accident year). Another actuarial method used by the Company is known as the Bornhuetter-Ferguson method. The Bornhuetter-Ferguson method uses an initial loss estimate (expected loss technique) for each accident year by business line and type of contract. Under this method, IBNR is set equal to the initial loss estimate multiplied by the expected percent of loss yet to be reported at each valuation date. In a given quarter, if reported losses are less than expected, then the difference would result in a decrease in estimated ultimate losses. If losses for the quarter are greater than expected, then the difference would result in an increase in estimated ultimate losses. A third actuarial method used by the Company to estimate reserves for losses and loss expenses is known as the loss development method. The loss development method extrapolates the current value of reported losses to ultimate expected losses by using selected reporting patterns of losses over time. The selected reporting patterns are based on historical information (organized into loss development triangles) and are adjusted to reflect the changing characteristics of the book of business written by the Company. Management uses these multiple actuarial methods, supplemented with its own professional judgment, to establish its best estimate of reserves for losses and loss expenses.
The Company uses reserving methods that are commonly applied when limited loss development experience exists. As the Company has accumulated its own loss reserve history, it has incorporated the Company’s actual loss experience for certain lines of business that have reached a level of maturity sufficient to provide a credible basis on which to estimate its reserve for losses and loss expenses related to these lines of business. The Company continues to utilize industry loss and development patterns in the establishment of loss and loss expense reserves where appropriate.
Significant Assumptions Employed in the Estimation of Loss and Loss Expense Reserves. The most significant assumptions used as of December 31, 2014 to estimate the reserve for losses and loss expenses within the Company’s Insurance and Reinsurance segments are as follows:
The above five assumptions most significantly influence the Company’s determination of initial expected loss ratios and expected loss reporting patterns that are the key inputs which impact potential variability in the estimate of the reserve for losses and loss expenses and are applicable to each of the Company’s business segments. While there can be no assurance that any of the above assumptions will prove to be correct, we believe that these assumptions represent a realistic and appropriate basis for estimating the reserve for losses and loss expenses.
In order to verify the accuracy and completeness of the information provided to the Company by its ceding company counterparties, the Company’s underwriters, actuaries, accounting and claims personnel perform underwriting and claims reviews of the Company’s ceding companies. Findings are communicated as appropriate to the ceding companies and are utilized in the establishment or revision of the Company’s case reserves and related IBNR reserves. On occasion, these reviews reveal that the ceding company’s reported losses and loss expenses do not comport with the terms of the contract with the Company. In such events, the Company strives to resolve the outstanding differences in an amicable fashion. The large majority of such differences are resolved in this manner. In the infrequent instance where an amicable solution is not feasible, the Company’s policy is to vigorously defend its position in litigation or arbitration. As of December 31, 2014, the Company was not involved in any material claims litigation or arbitration proceedings.
Investments. The Company currently classifies its fixed maturity investments, short-term investments and equity securities, as “available for sale” and, accordingly, these investments are carried at estimated fair value, with related net unrealized gains or losses excluded from earnings and included in shareholders’ equity as a component of accumulated other comprehensive income. The Company determines the fair value of its fixed maturity, short-term and equity investments in accordance with current accounting guidance, which defines fair value and establishes a fair value hierarchy based on inputs to the various valuation techniques used for each fair value measurement. The use of valuation techniques for any given investment requires a significant amount of judgment and consideration of factors specific to the underlying investment. Fair value measurements determined by the Company seek to maximize observable inputs and minimize the use of unobservable inputs. Current accounting guidance establishes three levels as follows:
Level 2: Quoted prices for similar assets in markets that are active, quoted prices for identical or similar assets in markets that are not active or inputs that are observable either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities other than quoted prices in Level 1; quoted prices in markets that are not active; or other inputs that are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.
quantitative analysis (consisting of comparing the quarterly return for each managed portfolio to its target benchmark, with significant differences identified and investigated);
If the amortized cost of the Company’s fixed maturity or short-term investments is, based upon the judgment of management, unlikely to be recovered, the Company writes down the investment by the amount representing the credit related portion of the decline in value, thereby establishing a new cost basis. The amount of the write-down is recognized in earnings as an OTTI loss. The new cost basis is not changed for subsequent recoveries in fair value.
To the extent the Company determines that the amortized cost of the Company’s fixed maturity or short-term investments is likely to be recovered and related to non-credit factors (such as interest rates, market conditions, etc.) and not due to credit related factors, that remaining non-credit portion of the unrealized loss is recorded as a part of accumulated other comprehensive income in the shareholders’ equity section of the Company’s balance sheet.
The Company considers its ability and intent to hold an equity security in an unrealized loss position for a reasonable period of time to allow for a full recovery. When the Company determines that the decline in value of an equity security is other-than-temporary, the Company reduces the cost of the equity security to its fair value and recognizes the loss in the Consolidated Statements of Income and Comprehensive Income. The new cost basis is not changed for subsequent recoveries in fair value.
Goodwill and Intangible Assets. The Company is required to make an annual assessment as to whether the value of the Company’s goodwill and intangible assets are impaired. Impairment of these assets can be either partial or full. For goodwill,
impairment is based on a fair value analysis by individual reporting unit. Based upon the Company’s assessment at the reporting unit level, there was no impairment of its goodwill asset of $91.2 million as of December 31, 2014.
The following is a discussion and analysis of the Company’s consolidated results of operations for the years ended December 31, 2014, 2013 and 2012:
An increase in gross premiums written in the Insurance segment's casualty and other specialty, property, marine and energy, and professional lines of business, including excess casualty, marine, energy,
An increase in gross premiums written in the specialty line of business in the Reinsurance segment as a result of new trade credit, surety and international agriculture business written, partially offset by non-renewal of business that no longer met profitability targets and increased ceding company retentions in the aviation and space business;
An increase in gross premiums written in the professional line of business in the Reinsurance segment, due primarily to new business generated by underwriting teams that joined the Company in late 2013, partially offset by non-renewal of contracts that no longer met profitability targets; and
Net premiums written in 2014 decreased $114.7 million, or 5.6%, compared to 2013 and decreased $95.3 million, or 4.7% compared to 2012. The change in net premiums written for 2014 compared to 2013 and 2012 was driven primarily by an increase in ceded premiums written by the Company for the year ended December 31, 2014 across both the Insurance and Reinsurance segments. Ceded premiums written increased across all lines of business in the Insurance segment primarily due to a new whole account quota share treaty providing protection for all of the Insurance segment’s book of business for 2014. In addition, the Company purchased excess of loss reinsurance covering the Insurance segment’s agriculture line of business at a lower attachment point compared to 2013, resulting in increased ceded premiums written. In the Reinsurance segment, ceded premium written increased as the Company purchased increased levels of retrocessional protection within the catastrophe and specialty lines of business, including an aggregate all perils excess of loss treaty and increased proportional retrocession.
Net premiums earned in 2014 decreased $152.5 million, or 7.6% compared to 2013 and decreased $149.9 million, or 7.4% compared to 2012 principally due to the increase in ceded premiums written.
The actual net earned income from the investment portfolio after adjusting for expenses and accretion of discount and amortization of premium from the purchase price divided by the average book value of assets.
The Company’s investment portfolio is actively managed on a fair value basis to generate attractive economic returns and income. Movements in financial markets and interest rates influence the timing and recognition of net realized gains and losses as the portfolio is adjusted and rebalanced. Proceeds from sales of investments classified as available for sale for the year ended December 31, 2014 were $3,557.5 million compared to $3,374.0 million for the year ended December 31, 2013 and $4,143.5 million for the year ended December 31, 2012. Net realized and unrealized gains decreased in the year ended December 31, 2014 compared to 2013 and 2012 due to the impact of the rise in interest rates during 2013 and from an intangible asset impairment loss recorded in 2014.
Realized investment gains and losses, intangible asset impairment loss, and the change in the fair value of investment-related derivative financial instruments for the years ended December 31, 2014, 2013 and 2012 were as follows:
Net investment impairment losses recognized in earnings for the years ended December 31, 2014, 2013 and 2012 as a result of other-than-temporarily impaired securities were $0.6 million, $1.6 million and $0.8 million, respectively.
During 2014, the Company remeasured its monetary assets and liabilities denominated in foreign currencies, which resulted in net foreign exchange losses of $3.8 million compared to losses of $14.2 million for 2013 and gains of $15.9 million for 2012. The modest loss recorded in the current period resulted from offsetting exposures across the Company as the U.S. dollar weakened generally in the first half of the year before strengthening against the major currencies in the second half. In 2013, the net foreign exchange loss resulted from the U.S. dollar strengthening in particular against the Japanese Yen and Australian dollar, which caused the Company's net asset positions in those currencies to be revalued lower. In contrast, in 2012 the Company was in a net liability position particularly related to the Japanese Yen as the U.S. dollar strengthened against the Yen over the period resulting in foreign exchange gains. In addition, foreign exchange gains were recognized in income as revaluations on investments recorded in other comprehensive income (loss) were realized in 2012.
During 2014, 2013 and 2012, the Company’s previously estimated ultimate losses for prior accident years were reduced by $233.8 million, $222.4 million and $120.2 million, respectively, as the loss emergence related to prior accident years was lower than expected. The overall net reduction in the Company’s estimated losses for prior accident years experienced in 2014 emerged across all lines of the Company’s Insurance and Reinsurance segments. Favorable prior year loss reserve development in 2014 was higher than in 2013 in the Insurance segment due to lower than expected reported losses in the casualty and other specialty and professional lines of business. Favorable prior year loss reserve development in 2014 was lower than in 2013 in the Reinsurance segment in the catastrophe and property lines of business as 2013 included significant reductions in reserve estimates related to the Thailand flood losses of 2011 ($24.4 million) and Superstorm Sandy losses in 2012 ($24.1 million). Comparatively, 2012 included adverse development on some of the major 2011 loss events impacting the Reinsurance property line of business.
The Company participates in lines of business where claims may not be reported for many years. Accordingly, management does not believe that reported claims are the only valid means for estimating ultimate obligations. Ultimate losses and loss expenses may differ materially from the amounts recorded in the Company’s consolidated financial statements. These
The Company’s acquisition expense ratio in 2014 was higher than 2013 and 2012 primarily due to growth in net premiums earned in the specialty and professional lines of business in the Reinsurance segment, which incur a higher than average net acquisition expense rate, and a decline in net premiums earned in the agriculture line of business in the Insurance segment and the catastrophe line of business in the Reinsurance segment, which incur lower than average acquisition expenses.
The Company generated net income of $348.5 million in 2014 compared to net income of $311.9 million in 2013 and $162.5 million in 2012. The increase in 2014 net income compared to 2013 and 2012 was primarily due to a reduction in losses incurred, which was partially offset by reduced net premiums earned, reduced investment income, and higher acquisition and general administrative expenses.
Premiums. Gross premiums written in 2014 increased $240.7 million, or 16.3%, compared to 2013 and increased $286.2 million, or 20.0% compared to 2012. Net premiums written in the Insurance segment decreased in 2014 by 7.7% compared to 2013 and decreased 8.7% compared to 2012. Gross and net premiums written for each line of business in the Insurance segment for the years ended December 31, 2014, 2013 and 2012 were as follows:
The change in the Insurance business segment gross premiums written in 2014 compared to 2013 and 2012 was driven by the following factors:
A decline in gross premiums written in the agriculture line of business due to declines in commodity prices on spring crops, partially offset by growth in policy counts.
Net premiums written in the Insurance segment decreased as a result of increased ceded premiums written by the Company during 2014 as compared to 2013 and 2012. Ceded premiums written increased across all lines of business primarily due to a new whole account quota share treaty providing protection for all of the Insurance segment’s book of business for 2014 combined with additional quota share covers or increases in coverage in 2014 compared to 2013. In addition, the Company purchased an excess of loss treaty covering the agriculture line of business at a lower attachment point compared to 2013, resulting in increased ceded premiums written.
Net Losses and Loss Expenses. The decrease in the net loss ratio in the Company’s Insurance segment for the year ended December 31, 2014 compared to 2013 and 2012 resulted primarily from a lower current accident year loss ratio and increased levels of favorable loss reserve development. The current accident year loss ratio improved for 2014 versus 2013 due primarily to lower losses incurred in the casualty and other specialty line of business driven by the strategic re-underwriting and re-balancing of the portfolio. Prior year loss reserves were reduced in 2014 by $80.6 million as compared to reductions of $33.9 million and $46.2 million for the years ended December 31, 2013 and 2012. The Company’s Insurance segment experienced net reductions in the Company’s estimated losses for prior accident years in 2014 as claims have not materialized as originally estimated by the Company, primarily in the casualty and other specialty line of business.
Acquisition Expenses. The Company’s acquisition expense ratio in the Insurance segment for the year ended December 31, 2014 increased compared to 2013 and was similar to 2012. The increase in acquisition expense ratio over 2013 was due to the decrease in net earned premiums in the agriculture line of business, which incurs a lower than average net acquisition expense rate.
The following table summarizes the underwriting results and associated ratios for the Company’s Reinsurance segment for the years ended December 31, 2014, 2013 and 2012:
Premiums. Gross premiums written in 2014 decreased $11.9 million, or 1.0%, compared to 2013 and increased $58.9 million, or 5.3% compared to 2012. Net premiums written in the Reinsurance segment decreased in 2014 by 3.8% over 2013 and 1.2% over 2012, respectively. Gross and net premiums written for each line of business in the Reinsurance segment for the years ended December 31, 2014, 2013 and 2012 were as follows:
An increase in net premiums written in the professional line of business due primarily to new business generated by underwriting teams that joined the Company in late 2013, partially offset by non-renewal of contracts that no longer met profitability targets;
A decline in net premiums written in the catastrophe line of business due to reductions in signed lines on renewed contracts and non-renewals due to rate declines, and an increase in ceded premiums due to increased retrocessional protection purchased on this line of business; and
A decline in net premiums written in the property line of business due to non-renewal of business that no longer met profitability targets and increased ceding company retentions, partially offset by new business.
Net premiums earned by the Company in the Reinsurance segment decreased in 2014 compared to 2013 and 2012 primarily due to the overall increase in ceded premiums written during 2014.
For 2014 the current accident year loss ratio decreased as compared to 2013 and 2012 from the strategic re-underwriting and re-balancing of the Company's underwriting portfolios, driven in part by the impact of underwriting teams added during the past two years.
The following tables set forth the types of securities, amortized costs, fair values and related gross unrealized gains and losses of our fixed maturity, short-term and equity investment portfolios as of December 31, 2014 and 2013:
Corporate Securities. Corporate securities are comprised of bonds issued by corporations, primarily rated A-/A3 or higher and are diversified across a wide range of issuers and industries. Corporate securities also include high yield securities comprised of bonds issued by corporations rated below BBB-. The principal risk of corporate securities is the potential loss of income and potential realized and unrealized principal losses due to insolvencies or deteriorating credit. The largest corporate security in the Company's portfolio represented approximately 1% of our fixed income investments at December 31, 2014.
Short-term investments are investments that mature within no more than one year or no less than 90 days at the time of purchase. The Company’s short-term investments generally consist of U.S. government and agencies securities.
The investment ratings (provided by major rating agencies) for the fixed income investments held as of December 31, 2014 and 2013 and the percentage of our fixed income investments they represented at such date were as follows:
The credit rating for each security reflected above was determined based on the rating assigned to the individual security by Standard & Poor’s Financial Services LLC ("S&P"). If a rating is not supplied by S&P, the equivalent rating supplied by Moody’s Investors Service, Inc. ("Moody's"), Fitch Ratings, Inc., or DBRS, Inc. is used.
Includes agency mortgage-backed securities of $1,133.1 million and $1,155.8 million at December 31, 2014 and 2013, respectively.
The contractual maturity distribution for our fixed maturity portfolio held as of December 31, 2014 and 2013 was as follows:
Our investment returns for the years ended December 31, 2014, 2013 and 2012 were as follows:
The following table shows the fair value of the Company’s investments exposed to all countries whose currency is the Euro or whose sovereign debt rating is below AAA (except the U.S.) by any of the recognized rating agencies at December 31, 2014. The amortized cost basis of these investments was not significantly different from their fair value at December 31, 2014. The Company determined the underlying exposure of the investment by reference to the risk country or parent risk country as published by a third party pricing service.
Structured securities includes residential non-agency mortgage-backed securities, commercial non-agency mortgage-backed securities, and asset-backed securities.
European Supranational securities are issued by entities formed by two or more central governments to promote economic development for the member countries, such as the World Bank, the European Bank for Reconstruction and Development and the European Investment Bank.
The following table shows the fair value as of December 31, 2014 based on the ratings of the securities held by country of risk in those countries whose currency is the Euro or whose sovereign debt rating is below AAA (except the U.S.) by any of the recognized rating agencies at December 31, 2014:
Endurance Holdings is a holding company that does not have any significant operations or assets other than its ownership of the shares of its direct and indirect subsidiaries. Endurance Holdings relies primarily on dividends and other permitted distributions from its subsidiaries to pay its operating expenses, interest on debt and dividends, if any, on its ordinary shares, its 7.75% Non-Cumulative Preferred Shares, Series A (“Series A Preferred Shares”) and its 7.5% Non-Cumulative Preferred Shares, Series B (“Series B Preferred Shares”). There are restrictions on the payment of dividends by the Company’s operating subsidiaries to Endurance Holdings, which are described in more detail below.
Ability of Subsidiaries to Pay Dividends. The ability of Endurance Bermuda to pay dividends is dependent on its ability to meet the requirements of applicable Bermuda law and regulations. Under Bermuda law, Endurance Bermuda may not declare or pay a dividend if there are reasonable grounds for believing that Endurance Bermuda is, or would after the payment be, unable to pay its liabilities as they become due, or the realizable value of Endurance Bermuda’s assets would thereby be less than the aggregate of its liabilities and its issued share capital and share premium accounts. Further, Endurance Bermuda, as a regulated insurance company in Bermuda, is subject to additional regulatory restrictions on the payment of dividends or distributions. As of December 31, 2014, Endurance Bermuda could pay a dividend or return additional paid-in capital totaling approximately $719.2 million without prior regulatory approval based upon the Bermuda insurance and corporate regulations. In 2011, Endurance Holdings loaned Endurance Bermuda $200.0 million, which remains outstanding and is callable on demand.
Endurance U.S. Reinsurance, Endurance American, Endurance American Specialty and Endurance Risk Solutions are subject to regulation by the State of Delaware Department of Insurance and American Agri-Business is subject to regulation by the Texas Department of Insurance. Dividends for each U.S. operating subsidiary are limited to the greater of 10% of policyholders’ surplus or statutory net income, excluding realized capital gains. In addition, dividends may only be declared or distributed out of earned surplus. At December 31, 2014, Endurance U.S. Reinsurance, Endurance American, Endurance Risk Solutions, and Endurance American Specialty did not have earned surplus; therefore, these companies are precluded from declaring or distributing dividends during 2015 without the prior approval of the applicable insurance regulator. At December 31, 2014, American Agri-Business (with notice to the Texas Department of Insurance) could pay dividends of $3.7 million without prior regulatory approval from the applicable regulators. In addition, any dividends paid by Endurance American, Endurance American Specialty and Endurance Risk Solutions would be subject to the dividend limitation of their respective parent insurance companies.
As of December 31, 2014 and 2013, the Company had pledged cash and cash equivalents and fixed maturity investments of $130.6 million and $146.1 million, respectively, in favor of certain ceding companies to collateralize obligations. As of December 31, 2014 and 2013, the Company had also pledged $240.0 million and $302.7 million of its cash and fixed maturity investments to meet collateral obligations for $209.9 million and $260.3 million in secured letters of credit outstanding under its credit facilities, respectively. In addition, at December 31, 2014 and 2013, cash and fixed maturity investments with fair values of $205.2 million and $273.7 million were on deposit with U.S. state regulators, respectively.
Cash flows provided by operating activities. Cash flows provided by operating activities for the year ended December 31, 2014 were $266.3 million compared to $157.9 million for the year ended December 31, 2013 and $283.5 million for the year ended December 31, 2012. The increase in cash flows provided by operating activities in 2014 compared to 2013 was primarily due to lower net claims payments, partially offset by higher ceded premium payments. The decrease in cash flows provided by operating activities in 2014 compared to 2012 was primarily due to an increase in ceded premium payments.
Cash flows (used in) provided by investing activities. During the twelve months ended December 31, 2014, cash flows used in investing activities were $236.9 million, compared to cash flows used in investing activities of $347.8 million for 2013 and cash flows provided by investing activities of $46.3 million in 2012. The Company actively manages its investment portfolio on a fair value basis to generate attractive economic returns and income. Movements in financial markets and interest rates influence the timing of investment sales and purchases. The cash flows used in investing activities in 2014 were lower than in 2013 due to an increase in the redemption of other investments and proceeds from settlements of other assets. The cash
flows used in investing activities in 2014 was higher than 2012 due to increased net purchases of available for sale investments in 2014.
Credit Facilities. On April 19, 2012 the Company and certain designated subsidiaries of the Company entered into a $700.0 million four-year revolving credit facility with JPMorgan Chase Bank, N.A. (“JPMorgan”) as administrative agent (“Credit Facility”). Upon entering into the Credit Facility, the Company terminated its existing $1,175.0 million amended and restated credit agreement dated May 8, 2007 with JPMorgan as administrative agent. As of December 31, 2014 and 2013, there were no borrowings under the Credit Facility and letters of credit outstanding under the Credit Facility were $204.0 million (2013 - $260.3 million).
(December 31, 2013 - nil) under the LOC Agreement. For letters of credit issued under the LOC Agreement, the Company is required to pay a fee that is negotiated at the time of issuance of the letter of credit. Letters of credit issued under the LOC Agreement are required to be collateralized with cash or investments.
Contractual Obligations. At December 31, 2014, letters of credit totaling $209.9 million were outstanding, $198.5 million face value of 6.15% Senior Notes due October 15, 2015 (the “6.15% Senior Notes”) were outstanding and $335.0 million face value of 7% Senior Notes due July 15, 2034 (the “7% Senior Notes”) were outstanding.
The Company’s contractual obligations as of December 31, 2014 are summarized as follows:
The Company expects to fund these estimated obligations noted in the table above through operating cash flows and existing cash and investments.
The following table summarizes the components of our capital resources at December 31, 2014 and 2013:
Preferred Shares. On October 10, 2005, Endurance Holdings issued 8,000,000 shares of its Series A Preferred Shares and on June 1, 2011, Endurance Holdings issued 9,200,000 shares of its Series B Preferred Shares. The Series A Preferred Shares and Series B Preferred Shares sold were registered under the Securities Act of 1933, as amended, and are traded on the New York Stock Exchange. The Series A Preferred Shares and Series B Preferred Shares were both issued at a price to the public of $25.00 per share. Endurance Holdings received net proceeds of $193.5 million from its offering of Series A Preferred Shares and $224.0 million from its offering of Series B Preferred Shares, in each case after expenses and underwriting discounts. The proceeds from both offerings were used to provide additional capital to Endurance Holdings’ subsidiaries and for other general corporate purposes.
Upon any voluntary or involuntary liquidation, dissolution or winding-up of Endurance Holdings, holders of the Series A Preferred Shares, Series B Preferred Shares and any parity shares are entitled to receive out of Endurance Holdings’ assets available for distribution to shareholders, before any distribution is made to holders of Endurance Holdings’ common equity securities, a liquidating distribution in the amount of $25.00 per Series A Preferred Share and per Series B Preferred Share, plus
The Company’s functional currencies are U.S. dollars for its U.S. and Bermuda operations and British Sterling for its U.K. operations. The reporting currency for all entities is U.S. dollars. The Company maintains a portion of its investments and liabilities in currencies other than the U.S. dollar. The Company has made a significant investment in the capitalization of Endurance U.K. which was valued at £367.0 million as of December 31, 2014 ($572.3 million in U.S. dollars). Endurance U.K. is subject to the United Kingdom’s Prudential Regulation Authority rules concerning the matching of the currency of its assets to the currency of its liabilities. Depending on the profile of Endurance U.K.‘s liabilities, it may be required to hold some of its assets in currencies corresponding to the currencies of its liabilities. The Company may, from time to time, experience losses resulting from fluctuations in the values of foreign currencies, which could have a material adverse effect on the Company’s results of operations.
For the year ended December 31, 2014, 16.2% of the Company’s gross premiums were written in currencies other than the U.S. dollar. The portions of the Company's cash and cash equivalents, investments, net premium receivable and insurance and reinsurance balances receivable, and reserves for loss and loss expenses denominated in non-U.S. currencies at December 31, 2014 were approximately 38.4%, 5.7%, 23.9%, and 13.6%, respectively. As of December 31, 2014, the Company’s principal foreign currency exposures are denominated in British Sterling and Euros. The Company measures and manages its exposure in these currencies, among others, by monitoring its estimated gross and net asset positions. In order to estimate such exposures, the Company considers currency specific investments, cash and cash equivalents, premiums receivable, reserve for losses and loss expenses, and unearned premiums. The total estimated gross and net asset balances denominated in Euros were $261.2 million and $61.2 million, respectively. The total estimated gross and net asset balances denominated in British Sterling were $329.7 million and $200.5 million, respectively. Assuming all other variables are held constant and disregarding any tax effects, a 10% change in the U.S. dollar relative to these currencies could result in a $26.2 million increase or decrease in the net assets held by the Company at December 31, 2014.
Losses and loss expenses for the year ended December 31, 2014 include $233.8 million in favorable development of reserves relating to prior accident years. The favorable loss reserve development experienced during 2014 benefited the Company’s 2014 reported loss ratio by approximately 12.5 percentage points. The net reduction in estimated losses for prior accident years reflects lower than expected loss emergence in each of the Company’s reserve categories within both the Insurance and Reinsurance segments.
Professional lines. The favorable loss emergence within the professional liability line of business during 2014 was primarily due to lower than expected claims activity. During 2013, the Company recorded modest favorable loss emergence within this line of business, primarily due to lower than expected claims activity, partially offset by higher than expected reported claims activity in the U.S. based environmental and miscellaneous errors and omissions businesses.
Property, marine and energy. The favorable loss emergence within the property, marine and energy line of business during 2014 and 2013 was primarily due to lower than expected reported claim emergence within the property business.
Professional lines. The favorable loss emergence within this line of business during 2014 was primarily due to lower than expected claims emergence for accident years 2010-2011. The favorable loss emergence within this line of business during 2013 was primarily due to lower than expected claims emergence for accident years 2009-2011.
Specialty. The Company recorded favorable loss emergence within this line of business during 2014 due to lower than expected claims emergence in the aerospace business. The Company recorded favorable loss emergence within this line of business during 2013 due to lower than expected claims emergence in the agriculture reinsurance and aerospace businesses.
Case and IBNR reserves for losses and loss expenses by segment and line of business were as follows at December 31, 2014:
“cumulative redundancy” represents the aggregate change to date from the original estimate. The table also shows the cumulative paid amounts as of successive years with respect to the reserve liability. Development in each column is shown relative to the GAAP reserves held at the original year end with all subsequent loss amounts (reserves for losses and loss expenses and paid losses) converted to the foreign exchange rate in effect at that original year end. Therefore, information presented herein may differ materially from that reported in the Company’s financial statements due to differences in foreign currency exchange rates.
Reporting pattern changes are not applicable to the agricultural business as it is typically settled at an established time each year.
Each of the impacts set forth in the tables above is estimated individually, without consideration for any correlation among key assumptions or among lines of business. Therefore, it would be inappropriate to take each of the amounts set forth above and add them together in an attempt to estimate volatility for the Company’s loss and loss expense reserves in total. The Company believes the assumed variations in loss and loss expense reserves set forth in the tables above represents a reasonable estimate of the possible loss and loss expense reserve variations that may occur in the future. It is important to note that the variations set forth in the tables above are not meant to be a “best-case” or “worst-case” series of scenarios, and therefore, it is possible that future variations may be more or less than the amounts set forth above.
During the fourth quarter of 2014, the Company performed its annual impairment testing of goodwill. The Company has two primary sources of goodwill - goodwill obtained from a renewal rights transaction completed in 2003 with HartRe and goodwill obtained from the Company’s acquisition of ARMtech in 2007. The Company determined that the appropriate reporting units for evaluation were the Reinsurance segment in relation to HartRe goodwill and the agriculture line of business of the Insurance segment in relation to the ARMtech goodwill. The Company used a discounted cash flow approach to estimate the fair value of these reporting units. The fair value determined was in excess of the carrying value including goodwill for both
reporting units noted. As a result of the goodwill impairment testing, no write-downs of goodwill were deemed necessary at December 31, 2014 and 2013.
During the fourth quarter of 2014, the Company performed its annual impairment testing of its intangible assets with indefinite useful lives. The Company's intangible assets with indefinite lives are its U.S. insurance licenses in five legal entities. The Company obtained a third party valuation appraisal to estimate the fair value of the insurance licenses held by these legal entities. The carrying value for the excess and surplus lines licenses held by one of the Company's legal entities was in excess of the fair value of these licenses as estimated by the third party valuation appraisal. Therefore, an impairment loss of $5.5 million was included within the net realized and unrealized gains line item in the Consolidated Statements of Income and Comprehensive Income at December 31, 2014 (2013 - nil).
The Company’s balance sheet at December 31, 2014 contains a net deferred tax asset in the amount of $49.0 million (2013 - $51.7 million). The current year net deferred tax asset consists of gross deferred tax assets of $219.6 million, gross deferred tax liabilities of $49.2 million and a valuation allowance against certain operating loss carryforwards of $121.4 million (2013 - $122.7 million). Of the Company’s gross deferred tax assets, $93.2 million (2013 - $106.1 million) relates to net operating loss carryforwards that are available to offset future taxable income generated by the Company’s subsidiaries. The Company’s net operating losses may be carried forward indefinitely in the United Kingdom and Singapore. In Switzerland and the United States the net operating loss carryforwards expire in 2021 and 2033, respectively.
The 2014 and 2013 valuation allowances were established against net operating loss carryforwards in the Company’s United States subsidiaries, United Kingdom subsidiary and non-U.S. branches. The increase in the valuation allowance was charged to the Company’s income tax expense during 2014. Management believes the net deferred tax assets, less the valuation allowance noted, are more likely than not to be fully realized in corresponding future periods, and the Company’s net deferred tax asset has been fairly stated as at December 31, 2014. In the event that management determines in the future that it is more likely than not that the net deferred tax assets will not be fully realized in the near term and prior to their expiration, the Company will reassess the valuation allowance against the net deferred tax assets and record any changes to income tax expense in the period determined.
We have audited Endurance Specialty Holdings Ltd.‘s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (the COSO criteria). Endurance Specialty Holdings Ltd.‘s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
In our opinion, Endurance Specialty Holdings Ltd. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Endurance Specialty Holdings Ltd. as of December 31, 2014 and 2013, and the related consolidated statements of income and comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2014 of Endurance Specialty Holdings Ltd. and our report dated February 27, 2015 expressed an unqualified opinion thereon.
Consolidated Statements of Cash Flows for the years ended December 31, 2014, 2013 and 2012
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Endurance Specialty Holdings Ltd.‘s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) and our report dated February 27, 2015 expressed an unqualified opinion thereon.
The consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States (“U.S. GAAP”) and include the accounts of Endurance Holdings and its wholly-owned subsidiaries, which are collectively referred to herein as the “Company.” All intercompany transactions and balances have been eliminated in consolidation. The following are significant accounting and reporting policies adopted by the Company:
The Company’s reserve for losses and loss expenses includes case reserves and reserves for losses incurred but not reported (referred to as “IBNR reserves”). Case reserves are established for losses that have been reported, but not yet paid. IBNR reserves represent a provision for claims that have been incurred but not yet reported to the Company, as well as future loss development on losses already reported, in excess of the case reserves. Case reserves and IBNR reserves are established by management based on reports from reinsurance intermediaries, ceding companies and insureds, and consultations with independent legal counsel. In addition, reserves for IBNR losses and loss expenses are established by management based on reported losses and loss expenses, and actuarially determined estimates of ultimate losses and loss expenses.
Reinsurance recoverable on paid and unpaid losses represent estimates of losses and loss expenses that will be recovered from reinsurers. Amounts recoverable from reinsurers are estimated in a manner consistent with the provisions of the reinsurance agreements and consistent with the establishment of the Company’s reserve for losses and loss expenses. Ceding commissions earned on ceded business are classified as an offset to acquisition and general and administrative expenses.
To the extent the Company determines that the amortized cost of the Company’s fixed maturity and short-term investments is likely to be recovered and the decline in value is related to non-credit factors (such as interest rates, market conditions, etc.) and not due to credit related factors, that remaining non-credit portion of the unrealized loss is recorded as a part of accumulated other comprehensive income in the shareholders’ equity section of the Company’s Consolidated Balance Sheets.
Other investments within the Company’s investment portfolio are comprised of (i) hedge funds and private investment funds that generally invest in senior secured bank debt, high yield credit securities, distressed debt, macro strategies, multi-strategy, equity long/short strategies, distressed real estate, and energy sector private equity (“alternative funds”) and (ii) high yield loan funds (“specialty funds”). During 2014, the Company's investment in convertible debt funds previously classified as other investments was merged by the investment manager into a new fund that is classified as an available for sale equity security. Other investments are accounted for using the equity method of accounting whereby the initial investment is recorded at cost. The carrying values of these investments are increased or decreased to reflect the Company’s share of income or loss, which is included in net investment income, and are decreased for dividends. Due to the timing of the delivery of the final valuations reported by the managers of certain of our alternative and specialty funds, our investments in those funds are estimated based on the most recently available information including period end valuation statements, period end estimates, or, in some cases, prior month or quarter valuation statements.
Assumptions underlying these valuations include forecasts of discounted future cash flows and future profits in addition to an analysis of the Company’s stock price relative to both its book value and its net income.
The Company may use various derivative instruments such as foreign exchange forward, future and option contracts; interest rate futures, swaps, swaptions, and options; credit default swaps; commodity futures and options; weather swaps and options; and to-be-announced mortgage-backed securities. Except for a cash flow hedge entered into in 2004 as disclosed in Note 8, these derivative instruments are used to manage exposure to interest rate and currency risk, to enhance the efficiency of the Company’s investment portfolio, to economically hedge certain risks, and as part of its weather risk management business. These derivative instruments do not qualify, and are not designated, as hedges. Thus, changes in fair value and any realized gains or losses are recognized in net realized and unrealized gains, net foreign exchange losses (gains), or other underwriting loss in the Consolidated Statements of Income and Comprehensive Income. Margin balances required of counterparties are included in cash and cash equivalents. Where the Company has entered into master netting agreements with counterparties, or the Company has the legal and contractual right to offset positions, the derivative positions may be netted by the counterparty.
The two-class method utilized by the Company is an earnings allocation formula that determines earnings per share for the holders of Endurance Holdings’ ordinary shares (also referred to as “common shares”) and participating common shares, which includes unvested restricted shares that receive cash dividends, according to dividends declared (or accumulated) and participation rights in undistributed earnings. Net income available to common and participating common shareholders is reduced by the amount of dividends declared in the current period and by the contractual amount of dividends that must be paid for the current period related to the Company’s common and participating common shares. Any remaining undistributed earnings are allocated to the common and participating common shareholders to the extent that each security may share in earnings as if all of the earnings for the period had been distributed. In periods of loss, no losses are allocated to participating common shareholders. Instead, all such losses are allocated solely to the common shareholders.
Basic earnings per common share are calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding. The weighted average number of common shares excludes any dilutive effect of outstanding warrants, options and convertible securities such as unvested restricted shares.
Diluted earnings per common share are based on the weighted average number of common shares and assumes the exercise of all dilutive stock warrants and options and the vesting or conversion of all convertible securities such as unvested restricted shares using the two-class method described above.
Entities that do not have sufficient equity at risk to allow the entity to finance its activities without additional financial support or in which the equity investors, as a group, do not have the characteristic of a controlling financial interest are referred to as variable interest entities (“VIE”). A VIE is consolidated by the variable interest holder that is determined to have the controlling financial interest (primary beneficiary) as a result of having both the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and the obligation to absorb losses or right to receive benefits from the VIE that could potentially be significant to the VIE. The Company determines whether it is the primary beneficiary of an entity subject to consolidation based on a qualitative assessment of the VIE’s capital structure, contractual terms, nature of the VIE’s operations and purpose and the Company’s relative exposure to the related risks of the VIE on the date it becomes initially involved in the VIE. The Company reassesses its VIE determination with respect to an entity on an ongoing basis. See also Note 3.
In July 2013, the FASB issued ASU 2013-11 “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” (“ASU 2013-11”). ASU 2013-11 provides guidance on the presentation of unrecognized tax benefits to better reflect the manner in which an entity would settle at the reporting date any additional income taxes that would result from the disallowance of a tax position when net operating loss carryforwards, similar tax losses, or tax credit carryforwards exist. ASU 2013-11 was effective for annual and interim reporting periods beginning after December 15, 2013, with both early adoption and retrospective application permitted. The Company adopted this standard effective January 1, 2014. This standard did not have a material impact on the Company’s consolidated financial statements.
The following table summarizes the composition of the investment portfolio by investment type at December 31, 2014 and 2013:
The credit rating for each security reflected above was determined based on the rating assigned to the individual security by Standard & Poor’s Financial Services LLC (“S&P”). If a rating is not supplied by S&P, the equivalent rating supplied by Moody’s Investors Service, Inc. (“Moody’s”), Fitch Ratings, Inc., or DBRS, Inc. is used.
In addition to the Company’s fixed maturity, short-term and equity investments, the Company invests in (i) hedge funds and private investment funds that generally invest in senior secured bank debt, high yield credit securities, distressed debt, macro strategies, multi-strategy, equity long/short strategies, distressed real estate, and energy sector private equity (“alternative funds”) and (ii) high yield loan funds (“specialty funds”). During 2014, the Company's investment in convertible debt funds previously classified as other investments was merged by the investment manager into a new fund that is classified as an available for sale equity security. The Company’s alternative funds and specialty funds are recorded on the Company’s balance sheet as “other investments”. At December 31, 2014 and 2013, the Company had invested, net of capital returned, a total of $387.2 million and $440.9 million, respectively, in other investments. At December 31, 2014 and 2013, the carrying value of other investments was $541.5 million and $617.5 million, respectively. The following table summarizes the composition and redemption restrictions of other investments as of December 31, 2014 and 2013:
Hedge funds - The redemption frequency of the hedge funds range from monthly to biennially with notice periods from 30 to 90 days. Over one year, it is estimated that the Company can liquidate approximately 97.4% of the hedge fund portfolio, with the remainder over the following two years.
Realized and unrealized gains and losses are recognized in earnings using the first in, first out method. The analysis of net realized and unrealized gains and losses, intangible asset impairment loss, and the change in the fair value of investment-related derivative financial instruments for the years ended December 31, 2014, 2013 and 2012 are as follows:
The Company classifies its investments in fixed maturity investments, short-term investments and equities as available for sale. The amortized cost, fair value and related gross unrealized gains and losses and non-credit OTTI losses on the Company’s securities classified as available for sale at December 31, 2014 and 2013 are as follows:
Represents total OTTI recognized in accumulated other comprehensive income. It does not include the change in fair value subsequent to the impairment measurement date. At December 31, 2014, the gross unrealized loss related to fixed income investments for which a non-credit OTTI was recognized in accumulated other comprehensive income was nil.
The following tables summarize, for all available for sale securities in an unrealized loss position at December 31, 2014 and 2013, the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position.
The analysis of OTTI for the years ended December 31, 2014, 2013 and 2012 is as follows:
Of the $0.6 million (2013 - $1.6 million; 2012 - $0.8 million) of OTTI losses recognized by the Company for the year ended December 31, 2014, the majority was related to reductions in expected recovery values on mortgage-backed securities during the period, and expected losses on corporate securities following the Company’s decision to liquidate a specific portfolio. The unrealized losses on the Company’s fixed income securities at December 31, 2014 were primarily due to an increase in interest rates and widening of credit spreads, rather than any actual credit losses on these securities. At December 31, 2014, the Company did not have the intent to sell any of the remaining fixed maturity investments in an unrealized loss position and determined that it was unlikely that the Company would be required to sell securities in an unrealized loss position. The Company has the ability and intent to hold its equity securities until recovery, therefore the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2014.
Government guaranteed corporate fixed maturity securities - These securities are generally priced by pricing services or index providers. The pricing service or index providers may use current market trades for securities with similar quality, maturity and coupon. If no such trades are available, the pricing service typically uses analytical spread models which may incorporate inputs from the U.S. treasury curve or LIBOR. The Company generally classifies the fair values of its government guaranteed corporate securities in Level 2.
The carrying values of cash and cash equivalents, accrued investment income, net receivable on sales of investments, net payable on purchases of investments, and other financial instruments not described above approximated their fair values at December 31, 2014 and 2013.
Other assets and other liabilities measured at fair value include assets of $25.6 million (2013 - $14.0 million) and liabilities of $35.4 million (2013 - $19.6 million) related to proprietary, non-exchange traded derivative-based risk management products used in the Company’s weather risk management business, and hedging and trading activities related to these risks. In instances where market prices are not available, the Company may use industry or internally developed valuation techniques such as historical analysis and simulation modeling to determine fair value and are considered Level 3.
The Company's weather curves are determined by taking the average payouts for each transactions within its portfolio utilizing detrended historical weather measurements. The Company's commodity curves are determined using historical market data scaled to currently observed market prices. The range of each unobservable input could vary based on the specific commodity, including, but not limited to natural gas, electricity, crude, liquids, temperature or precipitation. Due to the diversity of the portfolio, the range of unobservable inputs could be wide-spread as reflected in the below table on quantitative information.
Changes in any or all of the unobservable inputs listed above may contribute positively or negatively to the overall portfolio fair value depending upon the underlying position. In general, movements in weather curves are the largest contributing factor that impact fair value.
A significant portion of the Company’s contracts and policies cover excess layers for high severity exposures. Underwriting results and ultimate claims payments for this type of coverage are therefore not typically reported to the Company until later in the contract and policy lives. As a result, the level of losses reported to date is not necessarily indicative of expected future results.
During the year ended December 31, 2014, the Company recorded ceded losses of $575.7 million (2013 - $683.2 million; 2012 - $737.8 million). The balance of reinsurance recoverable on paid and unpaid losses at December 31, 2014 and 2013 was distributed as follows based on the ratings of the reinsurers:
On April 19, 2012, the Company and certain designated subsidiaries of the Company entered into a $700.0 million four-year revolving credit facility with JPMorgan Chase Bank, N.A. (“JPMorgan”) as administrative agent (“Credit Facility”). Upon entering into the Credit Facility, the Company terminated its existing $1,175.0 million amended and restated credit agreement dated May 8, 2007 with JPMorgan as administrative agent. As of December 31, 2014 and 2013, there were no borrowings under the Credit Facility and letters of credit outstanding under the Credit Facility were $204.0 million and $260.3 million, respectively.
On June 25, 2014, the Company entered into the First Amendment (the “Amendment”) to the Credit Facility. The Amendment also amends the Security Agreement, dated as of April 19, 2012 (the “Security Agreement”), among the Company and various designated subsidiaries of the Company, Deutsche Bank Trust Company America, as collateral agent, and JPMorgan. The Amendment contained certain amendments to the Credit Facility and the Security Agreement applicable to the proposed acquisition of Aspen Insurance Holdings Limited (“Aspen”).
On June 2, 2014, the Company entered into a commitment letter with Morgan Stanley Senior Funding, Inc. (the “Commitment Letter”). Pursuant to the Commitment Letter, Morgan Stanley Senior Funding, Inc., as lead arranger, committed to provide to the Company, subject to certain conditions, senior unsecured bank financing of up to $1.0 billion under an unsecured 364-day bridge facility (the “Bridge Facility”), which was to be used to finance a portion of the cash consideration to be paid in connection with the Company’s proposed acquisition of Aspen and related costs and expenses. Upon the termination by the Company of its offer to acquire Aspen on July 30, 2014, the Bridge Facility expired pursuant to its terms.
The indentures governing each of the Senior Notes contain customary covenants and events of default for senior unsecured indebtedness, including events of default for non-payment of principal or interest, breaches of covenants, insolvency of the Company or a default by the Company under other outstanding indebtedness. The Company was in compliance with all covenants contained within the indentures governing the Senior Notes as of December 31, 2014.
In 2004, prior to the issuance of the 7% Senior Notes, the Company entered into an interest rate lock on a notional amount of $125.0 million to protect against interest rate increases before the anticipated issuance of the Senior Notes. The objective of the interest rate lock was to protect 50% of the forecasted receipt of proceeds from the issuance of the 7% Senior Notes offering, which was subject to change prior to issuance due to fluctuations in the benchmark 30 year U.S. Treasury rate. Upon issuance of the 7% Senior Notes, the interest rate lock was settled through payment by the Company of $2.7 million. The interest rate lock agreement was designated as a “cash flow hedge” under current accounting guidance and accordingly, the fair value of the derivative was recorded in other comprehensive income (loss) and is being recognized as a component of interest expense in the Consolidated Statements of Income and Comprehensive Income as the interest expense related to the 7% Senior Notes affects earnings. The net income effect of the interest rate lock was not material.
The fair values and the related notional values of derivatives at December 31, 2014 and 2013 are noted below.
At December 31, 2014, derivative assets of $99.5 million (December 31, 2013 - $14.5 million) and liabilities of $54.3 million (December 31, 2013 - $21.2 million) were subject to master netting agreements, which provide for the ability to settle the derivative asset and liability with each counterparty on a net basis. At December 31, 2014, interest rate futures were not subject to master netting agreements. At December 31, 2013, TBAs and interest rate futures were not subject to master netting agreements. At December 31, 2014 and 2013, none of the Company’s derivative instruments were recorded on a net basis in the Consolidated Balance Sheets.
The gains and losses on the Consolidated Statements of Income and Comprehensive Income for derivatives for the years ended December 31, 2014 and 2013 were as follows:
Reinsurance - This segment is comprised of five lines of business: catastrophe, property, casualty, professional lines, and specialty. The catastrophe line of business includes reinsurance for catastrophic perils on a treaty basis. The property line of business includes proportional and excess of loss reinsurance of personal and commercial exposures. The casualty line of business is comprised of third party liability exposures, clash and workers’ compensation coverages. The professional line of business includes directors’ and officers’ liability, errors and omissions, employment practices liability, environmental liability and pension trust liability reinsurance. The specialty line of business includes the reinsurance of aviation and space business and proportional and non-proportional reinsurance of hull and cargo insurance business, and proportional and excess of loss coverages of contract and commercial surety business, personal accident coverages, political risk coverages, weather risk management products and agriculture coverages for weather related perils as well as protection from yield and price risks.
The following table reconciles total segment results to income before income taxes for the years ended December 31, 2014, 2013 and 2012:
The following table provides the geographic distribution of gross premiums written for the years ended December 31, 2014, 2013 and 2012:
The following table shows an analysis of goodwill and intangible assets for the years ended December 31, 2014 and 2013:
No impairment of the Company’s goodwill asset was noted following the annual impairment review for the years ended December 31, 2014 and 2013. No changes were made in the methodologies and assumptions used in the Company’s application of its impairment testing. The Company expects the amortization of the intangible assets with finite lives to approximate $6.3 million in each of 2015, 2016 and 2017, $6.2 million in 2018 and 2019, and $19.1 million in all years thereafter.
Concentrations of credit risk. The areas where significant concentrations of credit risk may exist include reinsurance recoverables, investments and cash and cash equivalents. The Company’s reinsurance recoverables on paid and unpaid losses at December 31, 2014 and 2013 amounted to $889.1 million and $758.0 million, respectively, and resulted from reinsurance arrangements entered into in the normal course of operations. A credit exposure exists with respect to reinsurance recoverables as they may become uncollectible. The Company manages its credit risk in its reinsurance relationships by transacting with reinsurers that it considers financially sound and, if necessary, the Company may hold collateral in the form of cash, trust accounts and/or irrevocable letters of credit. This collateral can be drawn on for amounts that remain unpaid beyond specified time periods on an individual reinsurer basis. As of December 31, 2014, $542.5 million of reinsurance recoverable on paid and unpaid losses (2013 - $391.7 million) was due from reinsurers rated A- or better by A.M. Best or S&P. An additional $339.6 million (2013 - $356.0 million) of reinsurance recoverable on paid and unpaid losses was due from a U.S. government sponsored reinsurance program as of December 31, 2014. At December 31, 2014 and 2013, the Company held collateral of $199.7 million and $14.2 million, respectively, related to its ceded reinsurance agreements.
As of December 31, 2014, substantially all the Company’s cash and investments were held by three custodians.
Operating leases. The Company leases office space and office equipment under operating leases. Future minimum lease commitments at December 31, 2014 are as follows:
The following table presents the changes in accumulated other comprehensive income balances by component for the years ended December 31, 2014 and 2013:
The following tables present the significant items reclassified out of accumulated other comprehensive income during the years ended December 31, 2014 and 2013:
At its meeting on February 28, 2007, the Company’s Board of Directors adopted the 2007 Equity Incentive Plan (“2007 Plan”) to allow for the issuance of equity incentives to non-employee directors of the Company and eligible employees of the Company and its subsidiaries. The 2007 Plan was approved by the Company’s shareholders at the Annual General Meeting of Shareholders held on May 9, 2007. At that time, the Company’s existing Amended and Restated 2002 Stock Option Plan and the Amended and Restated 2003 Non-Employee Director Incentive Plan were merged into the new 2007 Plan.
The 2007 Plan allows the Company to grant to employees and non-employee directors restricted shares, restricted share units, stock appreciation rights, share bonuses, options to purchase the Company’s ordinary shares and other forms of equity incentive awards, as determined by the Compensation Committee of the Company’s Board of Directors.
The 800,000 options awarded to Mr. Charman will vest annually, in five equal tranches commencing on May 28, 2013, subject to Mr. Charman’s continued employment, or in the event of certain terminations of employment and other events. Mr. Charman's options have a 10-year contractual life.
No options were granted during the year ended December 31, 2014. During the year ended December 31, 2013, 800,000 options were granted with a weighted average grant date fair value of $10.2 million. No options were granted during the year ended December 31, 2012. The Company uses the Black-Scholes-Merton formula to estimate the value of stock options granted. No options expired during the years ended December 31, 2014, 2013 and 2012. During the years ended December 31, 2014 and 2013, 160,000 and 160,000 options vested, respectively. No options vested during the year ended December 31, 2012. The total intrinsic value of options exercised during the years ended December 31, 2014, 2013 and 2012 was $0.3 million, $0.5 million, and $1.4 million, respectively. The Company received proceeds of $0.5 million from the exercise of options during the year ended December 31, 2014. The Company issued new ordinary shares in connection with the exercise of the above options.
For the years ended December 31, 2014 and 2013, compensation costs recognized in earnings for all options totaled $3.1 million and $4.5 million, respectively (2012 - nil).
The 708,890 restricted shares awarded to Mr. Charman, as discussed above, will vest annually, in five equal tranches commencing on May 28, 2013, subject to Mr. Charman’s continued employment, or in the event of certain terminations of employment and other events.
For the years ended December 31, 2014, 2013 and 2012, compensation costs recognized in earnings for all restricted shares and restricted share units were $27.9 million, $23.5 million, and $11.2 million, respectively. At December 31, 2014, compensation costs not yet recognized related to non-vested awards was $23.3 million (2013 - $29.7 million). This expense is expected to be recognized between 2015 and 2018, with approximately 62.4% expected to be recognized during 2015.
The combined statutory capital and combined statutory net income (loss) for our principal operating subsidiaries in their respective jurisdictions were as follows:
Endurance Bermuda’s ability to pay dividends and make capital distributions is subject to certain regulatory restrictions based on the Enhanced Capital Requirement, limits on the amount of Endurance Bermuda’s premiums written and net reserves for losses and loss expenses and a minimum general capital and surplus requirement of $100.0 million. At December 31, 2014, Endurance Bermuda can pay dividends of $719.2 million (2013 - $654.5 million) to Endurance Holdings without prior approval under Bermuda law.
The Singapore Branch is subject to Fund Solvency and Capital Adequacy requirements by the Monetary Authority of Singapore as a foreign company in Singapore and is regulated by the Monetary Authority of Singapore pursuant to the Insurance Act in Singapore. At December 31, 2014 and 2013, the Singapore Branch complied with the capital requirements promulgated by the Monetary Authority of Singapore.
The PRA regulatory requirements impose no explicit restrictions on Endurance U.K.’s ability to pay a dividend, but Endurance U.K. would have to notify the PRA 28 days prior to any proposed dividend payment. Dividends may only be distributed from profits available for distribution. At December 31, 2014 Endurance U.K did not have retained profits available for distribution.
The Company has operating subsidiaries and branch operations in the United States, United Kingdom, Switzerland and Singapore, which are subject to the relevant taxes in those jurisdictions. During 2014, the Internal Revenue Service completed its audit of the income tax returns of the Company’s U.S. subsidiaries for 2009, 2010 and 2011. The audit results were immaterial to the operations of the Company. As of December 31, 2014, none of the Company’s operating subsidiaries or branch operations were under examination in any of the jurisdictions in which they operate. The Company remains subject to examination for tax years 2010 through 2014.
The income tax expense was as follows for the years ended December 31, 2014, 2013 and 2012, respectively:
The actual income tax expense attributable to income for the years ended December 31, 2014, 2013 and 2012 differed from the amount computed by applying the combined effective rate of 0% under Bermuda law to income before income taxes, as a result of the following:
Deferred income taxes represent the tax effect of the differences between the book and tax bases of assets and liabilities. Net deferred income tax assets and liabilities consisted of the following as of December 31, 2014 and 2013:
A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. At December 31, 2014, management has established a valuation allowance of $121.4 million (2013 - $122.7 million) against net deferred tax assets in the Company’s United States subsidiaries, United Kingdom subsidiary and non-U.S. branches.
The Company’s non-U.S. (foreign) operating subsidiaries write business that is exposed to risks originating in the United States.
The following is a summary of the unaudited quarterly data for the year ended December 31, 2014: