In the Insurance segment, the Company writes agriculture, casualty and other specialty, professional lines, and property insurance. In the Reinsurance segment, the Company writes catastrophe, property, casualty, and other specialty reinsurance.
If factors such as those described in the “Risk Factors” section in this Form 10-K cause actual events or results to differ materially from management’s underlying assumptions or estimates, there could be a material adverse effect on the Company’s results of operations, financial condition and liquidity.
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 which 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, we monitor the underlying insured values and record additional or return premiums in the period in which amounts are reasonably determinable. For our agriculture 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 56%, 60%, and 54% of the Company’s gross premiums written during the years ended December 31, 2012, 2011, and 2010, respectively.
The Company’s reinsurance premiums are earned in proportion to the amount of reinsurance protection provided over the applicable risk period established in the reinsurance contract. Reinsurance contracts written on a losses occurring basis cover losses which occur during the term of the reinsurance contract, typically 12 months. Accordingly, the Company earns the premium on a losses occurring reinsurance contract evenly over the reinsurance contract term. Losses occurring reinsurance contracts accounted for approximately 22%, 21%, and 25% of the Company’s gross premiums written during the years ended December 31, 2012, 2011, and 2010, respectively. Reinsurance contracts written on a policies attaching basis cover losses from the underlying insurance policies incepting during the terms of the reinsurance contracts. Losses under a policies attaching reinsurance contract may occur after the end date of the reinsurance contract, so long as they are losses from policies which began during the reinsurance contract period. The Company typically earns the premiums for policies attaching reinsurance contracts over a 24 month period in proportion to the amount of reinsurance protection provided to reflect the extension of the risk period past the term of the contract and the varying levels of reinsurance protection provided during the reinsurance contract period. Policies attaching reinsurance contracts accounted for approximately 22%, 19%, and 21% of the Company’s gross premiums written during the years ended December 31, 2012, 2011, and 2010, 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 24%, 21%, and 24% of the Company’s gross premiums written during the years ended December 31, 2012, 2011, and 2010, 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 also utilizes its judgment in establishing proportional reinsurance contract premium estimates after considering the following factors:
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 changes in one or more of the premium assumptions as noted above. A 7% variation in the Company’s proportional premiums receivable, net as of December 31, 2012, after considering the related expected losses and loss expenses, acquisition expenses and taxes, would result in an impact of approximately $0.8 million on the Company’s net income.
Under U.S. GAAP, the Company is not permitted to establish loss reserves until the occurrence of an actual loss event. Once such an event occurs, the Company establishes reserves based upon estimates of total losses incurred by the ceding companies or insureds as a result of the event, its estimate of the potential losses incurred, and its estimate of the portion of such loss the Company has insured or reinsured. As a result, only loss reserves applicable to losses incurred up to the financial statement date may be recorded, with no allowance for the provision of a contingency reserve to account for expected future losses. See ‘‘Reserve for Losses and Loss Expenses’’ below for further discussion.
Since inception, the Company has used reserving methods that are commonly applied when limited loss development experience exists. As the Company has accumulated its own loss reserve history, it has determined it is more appropriate to incorporate the Company’s actual loss experience. As of 2006, the Company determined that its own loss development history in relation to its agriculture, property, catastrophe, and other specialty lines of business had 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. As such, the Company’s actual reporting patterns were considered when determining the reserve for losses and loss expenses in the agriculture and property lines of business in its Insurance segment and the catastrophe, property and other specialty lines of business in its Reinsurance segment for the year ended December 31, 2012. 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, 2012 to estimate the reserve for losses and loss expenses within the Company’s Insurance and Reinsurance segments are as follows:
The aspects of the Company’s casualty line in the Reinsurance segment and the casualty and professional lines in the Insurance segment that complicate the process of estimating loss reseves include the lack of long-term historical data for losses of the same type intended to be covered by the policies and contracts written by the Company and the expectation that a portion of losses in excess of the Company’s attachment levels in many of its contracts will be low in frequency and high in severity, limiting the usefulness of claims experience of other insurers and reinsurers for similar claims. In addition, the portion of the Company’s casualty line in its Insurance segment which is underwritten in Bermuda includes policy forms that vary from more traditional policy forms. The primary difference in the casualty policy form used by Endurance Bermuda from more traditional policy forms relates to the coverage being provided on an occurrence reported basis instead of the typical occurrence or claims-made basis used in traditional policy forms. The occurrence reported policy forms typically cover occurrences causing unexpected and unintended personal injury or property damage to third parties arising from events or conditions that commence at or subsequent to an inception date, and prior to the expiration of the policy provided that proper notice is given during the term of the policy or the discovery period.
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 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, 2012, the Company was not involved in any material claims litigation or arbitration proceedings.
Other Investments. Other Investments are accounted for using the equity method of accounting whereby the initial investment is recorded at cost. Other Investments consist of alternative funds and specialty funds. Alternative funds include investments in hedge funds and private investment funds that generally invest in senior secured bank debt, high yield debt securities, distressed debt, distressed real estate, derivatives and equity long/short strategies. Specialty funds currently include high yield loan and convertible debt funds. The carrying value 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 certain of the fund managers, valuations of certain alternative funds and specialty 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.
Goodwill. The Company is required to make an annual assessment as to whether the value of the Company’s goodwill asset is impaired. Impairment, which can be either partial or full, 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 $90.9 million as of December 31, 2012.
At each balance sheet date, management assesses the need to establish a valuation allowance that reduces deferred tax assets when it is more likely than not that all, or some portion, of the deferred tax asset will not be realized. The valuation allowance is based on all available information from each tax-paying component in each tax jurisdiction and available tax planning strategies. Estimates of future taxable income incorporate several assumptions that may differ from actual experience. Differences in our assumptions and resulting estimates could be material and have an adverse impact on our financial results of operations and liquidity. Any such differences are recorded in the period in which they become known. As of December 31, 2012, the Company had a net deferred income tax asset of $43.5 million (2011-$33.4 million), which includes a valuation allowance of $85.8 million (2011-$31.4 million).
Recent Accounting Pronouncements. In July 2012, the Financial Accounting Standards Board (the “FASB”) issued ASU 2012-02 “Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment” (“ASU 2012-02”). Under ASU 2012-02, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. In addition, an entity has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing a quantitative impairment test.
The following is a discussion and analysis of the Company’s consolidated results of operations for the years ended December 31, 2012, 2011 and 2010:
Growth in the Reinsurance segment where property premiums were higher due to new premiums and growth in renewals, particularly from the Company’s U.S., Zurich and Singapore offices;
Premiums in the agriculture line of the Insurance segment were higher compared to 2010 as a result of higher commodity prices and growth in policy count. Premiums declined modestly in 2012 compared to 2011 where the impact of lower commodity prices was partially offset by a higher policy count;
Net premiums earned in 2012 increased compared to 2011 and 2010 principally due to growth in net premiums written experienced over the last two years.
(1) 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.
During 2012, the yield on the benchmark three year U.S. Treasury bond fluctuated within a 66 basis point range, with a high of 1.20% and a low of 0.54%. Trading activity in the Company’s portfolio in 2012 included reductions in short term investments, U.S. government and agencies securities, government guaranteed corporate securities, and U.S. state and municipal securities, and increased allocations to residential mortgage-backed securities, foreign government bonds, corporate securities, commercial mortgage-backed securities, asset-backed securities, equity securities and Other Investments. The duration of the fixed maturity portfolio held at December 31, 2012 increased from 2.39 years at December 31, 2011 and 2010 to 2.49 years at December 31, 2012.
The Company’s investment portfolio is 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 investment 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, 2012 were $4,143.5 million compared to $3,034.9 million for the year ended December 31, 2011 and $3,422.5 million for the year ended December 31, 2010. Net realized investment gains increased in the year ended December 31, 2012 compared to 2011 and 2010 as the Company realized gains as a result of selling securities in order to reposition the portfolio to meet revised benchmarks for performance measurement and to fund accounts with new external investment managers. Realized investment gains and losses and the change in the fair value of derivative financial instruments for the years ended December 31, 2012, 2011 and 2010 were as follows:
The following table details the impact of the catastrophe related activity for the years ended December 31, 2012, 2011 and 2010.
During 2012, 2011 and 2010, the Company’s previously estimated ultimate losses for prior accident years were reduced by $120.2 million, $180.0 million and $126.8 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 2012 emerged across all lines of the Company’s Insurance segment and the catastrophe, casualty and other specialty lines of the Reinsurance segment.
The Company’s acquisition expense ratio increased in 2012 as compared to 2011 and was consistent with 2010. The change in acquisition expense ratio compared to 2011 resulted from the Reinsurance segment, which generally incurs a higher acquisition expense rate, accounting for a higher proportion of net premiums earned in 2012. In 2010 the Reinsurance segment accounted for a similar proportion of total net premiums earned as the current year resulting in a similar acquisition expense ratio.
Premiums. Net premiums written in the Insurance segment decreased in 2012 by 6.3% compared to 2011 and increased 13.6% compared to 2010, respectively. Gross and net premiums written for each line of business in the Insurance segment for the years ended December 31, 2012, 2011 and 2010 were as follows:
The change in the Insurance business segment net premiums written in 2012 compared to 2011 and 2010 was driven by the following factors:
Premiums in the agriculture line were higher compared to 2010 as a result of comparatively higher commodity prices and growth in policy count. Premiums declined modestly in 2012 compared to 2011 due to lower commodity prices, partially offset by a higher policy count;
Decreased professional lines premiums in the Insurance segment compared to 2010 due to the non-renewal of a large program relationship; and
Net premiums earned by the Company in the Insurance segment decreased in 2012 compared to 2011 and increased compared to 2010. The decrease against the prior year was primarily due to the decrease in net premiums written in the agriculture and property lines in the current year. The increase in 2012 over 2010 was primarily due to growth in net premiums written in the agriculture line compared to 2010.
General and Administrative Expenses. The Company’s general and administrative expense ratio in the Insurance segment for 2012 decreased compared to both 2011 and 2010. This was due to a decrease in annual incentive expense. In addition, the Company experienced higher third party commissions and expense reimbursement offsets during 2012.
The following table summarizes the underwriting results and associated ratios for the Company’s Reinsurance segment for the years ended December 31, 2012, 2011 and 2010:
Premiums. Net premiums written in the Reinsurance segment increased in 2012 by 11.6% over 2011 and 16.4% over 2010, respectively. Gross and net premiums written for each line of business in the Reinsurance segment for the years ended December 31, 2012, 2011 and 2010 were as follows:
The change in the Reinsurance business segment net premiums written during 2012 compared to 2011 and 2010 was driven by the following factors:
Increased catastrophe premiums as a result of improved pricing together with reinstatement premiums recorded in relation to the catastrophe loss events experienced in 2011 and 2012.
Net premiums earned increased in 2012 compared to 2011 and 2010 primarily due to the growth in gross premiums written.
For 2012, catastrophe related losses added 17.3 percentage points to the Reinsurance segment’s net loss ratio after adjustment for reinstatement premiums and other loss sensitive accruals compared to 49.9 percentage points in 2011.
The Company experienced lower favorable loss reserve development in its Reinsurance segment in 2012 compared to 2011 and 2010. The 2012 favorable loss reserve development emerged from the segment’s catastrophe, casualty and other specialty lines of business. During 2012, 2011 and 2010, the Company’s previously estimated ultimate losses for the Reinsurance segment for prior accident years were reduced by $74.0 million, $109.2 million and $79.9 million, respectively. Favorable prior year loss reserve development resulted as claims have not materialized as originally estimated by the Company.
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, 2012 and 2011:
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 our portfolio represented less than 0.86% of the fixed income investments at December 31, 2012. We had minimal realized credit related losses during 2012.
The investment ratings (provided by major rating agencies) for the fixed income investments held as of December 31, 2012 and 2011 and the percentage of our fixed income investments they represented at such date were as follows:
(2) Includes agency mortgage-backed securities of $1,223.5 million and $993.8 million at December 31, 2012 and 2011, respectively.
During 2012, the Company adjusted the composition of the investment portfolio as it sought to optimize risk adjusted return potential. As a result, the Company reduced its investment holdings in U.S. government and agencies securities, government guaranteed corporates, and U.S. state and municipal securities and increased its holdings in corporates and residential and commercial mortgage-backed securities.
Other Investments are accounted for under the equity method of accounting. Adjustments to the carrying value of these investments are made based upon the net valuation criteria established by the managers of the Other Investments, which in turn are established based upon the valuation criteria in the governing documents of the Other Investments. Such valuations may differ significantly from the values that would have been used had liquid markets existed for the shares or partnership interests of the Other Investments. Due to a delay in the valuations reported by certain of the fund managers, valuations of certain alternative funds and specialty 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. Many of the Other Investments are subject to restrictions on redemptions and sale that limit our ability to liquidate these investments in the short-term. Interest income, income distributions and realized and unrealized gains and losses on our investments in the Other Investments are included in net investment income and totaled $49.1 million of gains, $0.7 million of losses and $40.3 million of gains for the years ended 2012, 2011 and 2010, respectively.
During 2012, 2011 and 2010, the Company identified available for sale securities that were considered to be other-than-temporarily impaired. In identifying such securities, the Company initially considered whether it intended to sell or would be more likely than not required to sell the securities in an unrealized loss position at the end of the applicable period. To the extent that the Company did not identify securities meeting these criteria, the Company then performed various analyses and reviews to determine whether the investments in an unrealized loss position were other-than-temporarily impaired as a result of credit factors or non-credit related factors. As such, the Company recorded total other than temporary impairments of $0.8 million (2011-$3.5 million; 2010-$3.9 million) related to credit factors and recognized in earnings.
The Company participated in a securities lending program until July of 2011. Under this program, fixed maturity investments were loaned by the Company to third parties, primarily major brokerage firms and commercial banks. The borrowers of the Company’s securities provided the Company with collateral, typically cash, which the Company separately maintained. The Company typically invested such cash collateral in overnight repurchase agreements. All securities on loan were issued on a term or overnight basis and were subject to daily recall at the Company’s discretion. Upon termination of the securities lending program in July of 2011, the Company recalled all securities on loan and refunded all collateral previously held as part of the program.
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, 2012. The amortized cost basis of these investments was not significantly different from their fair value at December 31, 2012. 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. The Company does not have any direct exposure to sovereign debt issued by Ireland, Greece or Portugal.
Under the jurisdiction of the United Kingdom’s Financial Services Authority (“FSA”), Endurance U.K. must maintain a margin of solvency at all times, which is determined based on the type and amount of insurance business written. The FSA 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 FSA 28 days prior to any proposed dividend payment. Dividends may only be distributed from profits available for distributions. At December 31, 2012, Endurance U.K. did not have retained profits available for distributions.
Cash flows provided by investing activities. During the twelve months ended December 31, 2012, cash flows provided by investing activities were $56.9 million, compared to $238.1 million for 2011 and $6.2 million in 2010. 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 provided by investing activities in 2012 were lower than in 2011 due to a decrease in net proceeds from available for sale investments and an absence of positive cash flows from securities lending collateral received, partially offset by a decrease in net purchases of Other Investments. Net cash flows provided by investing activities were higher in 2012 compared to 2010 due to an increase in net proceeds from available for sale investments partially offset by higher net purchases of Other Investments.
Contractual Obligations. At December 31, 2012, letters of credit totaling $320.4 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.
(2) The Company leases office space and office equipment under various operating leases.
Credit Facility. As of December 31, 2012 and 2011, the Company had $320.4 million and $447.3 million, respectively, of letters of credit outstanding under the Credit Facility and no revolving loans outstanding. The Company was in compliance with all covenants contained in the Credit Facility as of December 31, 2012.
At December 31, 2012, the carrying value of the Senior Notes stood at $527.2 million while the fair value as determined by quoted market valuation was $592.7 million. The Company was in compliance with all covenants contained within the indentures governing the Senior Notes as of December 31, 2012.
For the year ended December 31, 2012, as part of the Company’s periodic review of key parameters and in order to recognize accumulated historical experience and other relevant industry information, the Company adjusted the initial expected loss ratios for a number of business units within the Insurance and Reinsurance segments. Within the Insurance segment, initial expected loss ratios were lowered for historical years for the casualty and other specialty and professional lines of business, and raised for the workers’ compensation line of business that is included in the casualty and other specialty line of business. Within the Reinsurance segment, initial expected loss ratios were lowered for historical years for the catastrophe line of business.
Current and prior year incurred losses and loss expenses by segment and line of business for the year ended December 31, 2011 were as follows:
Losses and loss expenses for the year ended December 31, 2011 include $180.0 million in favorable development of reserves relating to prior accident years. The favorable loss reserve development experienced during the 2011 year benefited the Company’s 2011 reported loss ratio by approximately 9.3 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.
For the year ended December 31, 2011, the Company did not materially alter the two key inputs it utilizes to establish its reserve for losses and loss expenses, initial expected loss ratios or loss reporting patterns, for business related to prior years for the insurance and reinsurance reserve categories as the variances in reported losses in 2011 for those reserve categories were within the range of possible results anticipated by the Company.
Agriculture. The favorable loss emergence within the agriculture insurance line of business during 2012 and 2011 resulted from lower than anticipated agriculture claims settlements for the 2011 and 2010 crop years, respectively.
Casualty and other specialty. The favorable loss emergence within the casualty and other specialty insurance line of business during 2012 and 2011 was primarily due to lower than expected claims activity within the healthcare liability line of business. This favorable loss emergence was partially offset by adverse development within the workers’ compensation line of business for 2012 and the casualty and workers’ compensation lines of business in 2011. The Company exited the workers’ compensation line of business in 2009.
Property. The favorable loss emergence within the property line of business during 2012 and 2011 was primarily due to lower than expected reported claim emergence.
Catastrophe. The Company recorded favorable loss emergence within the catastrophe line of business during 2012 and 2011 primarily due to lower than expected claims activity.
Other specialty. The Company recorded favorable loss emergence within the other specialty line of business during 2012 and 2011 due to lower than expected claims reported.
Case and IBNR reserves for losses and loss expenses by segment and line of business were as follows at December 31, 2012:
Case and IBNR reserves for losses and loss expenses by segment and line of business were as follows at December 31, 2011:
The following table represents the development of GAAP balance sheet reserve for losses and loss expenses, net of losses and loss expenses recoverable, for 2002 through December 31, 2012. This table does not present accident or policy year development data. The top line of the table shows the gross and net reserve for losses and loss expenses at the balance sheet date for each of the indicated years. This represents the estimated amounts of gross and net losses and loss expenses arising in the current year and all prior years that are unpaid at the balance sheet date, including IBNR reserves. The table also shows the re-estimated amount of the previously recorded reserve based on experience as of the end of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. The “cumulative redundancy (deficiency)” 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. All amounts reflect the conversion from the original currency of the underlying business if not initially denominated in U.S. dollars. The data in the table has been restated using the rate of exchange to U.S. dollars as of December 31, 2012. Information presented herein may differ materially from that reported in the Company’s financial statements due to differences in foreign currency exchange rates.
(1) Reporting pattern changes are not applicable to the agricultural business as it is typically settled at an established time each year.
During the fourth quarter of 2012, 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 primarily 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 impairment testing, no write-downs were deemed necessary at December 31, 2012 and 2011.
The Company’s income tax (expense) benefit was as follows for the years ended December 31, 2012, 2011 and 2010, respectively:
Income tax paid in 2012 totaled $1.6 million. The Company received refunds and paid income taxes totaling $15.7 million and $24.3 million for the years ended December 31, 2011 and 2010, respectively. Net operating loss carryforwards in the amount of $161.4 million, $25.5 million, $39.0 million, and $28.9 million are available for application against future taxable income in the United States, United Kingdom, Singapore and Switzerland respectively. These net operating loss carry forwards have no expiration date in the United Kingdom and Singapore. In Switzerland and the United States the net operating loss carry forwards expire through 2019 and 2032, respectively.
Pre-tax income (loss) for our non-U.S. operations was favorable compared to U.S. operations for the year ending December 31, 2012 and 2011 because our U.S. operations were impacted by losses resulting from severe drought conditions within our agriculture line of business which is underwritten by ARMtech. Pre-tax income for our non-U.S. operations was higher compared to our U.S. operations for the year ending December 31, 2010 primarily as a result of the more volatile catastrophe business underwritten in our non-U.S. operations during 2010 being relatively free of losses and thus generating higher levels of net underwriting income than our U.S. operations, which underwrite less volatile business and as a result produce lower levels of net underwriting income in benign loss years. In addition, our non-U.S. operations hold a substantial amount of our invested assets and thus a larger portion of the Company’s investment income is earned in our non-U.S. operations as compared to our U.S. operations.
The Company’s balance sheet at December 31, 2012 contains a net deferred tax asset in the amount of $43.5 million (2011-$33.4 million deferred tax asset). The current year net deferred tax asset consists of gross deferred tax assets of $188.3 million, gross deferred tax liabilities of $59.0 million and a valuation allowance against certain operating loss carryforwards of $85.8 million (2011-$31.4 million). Of the Company’s gross deferred tax assets, $72.5 million (2011-$41.6 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 2019 and 2032, respectively.
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, 2012 and 2011, and the related consolidated statements of income (loss) and comprehensive income (loss), changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2012 and our report dated February 28, 2013 expressed an unqualified opinion thereon.
Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) for the years ended December 31, 2012, 2011 and 2010
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2012, 2011 and
Notes to the Consolidated Financial Statements for the years ended December 31, 2012, 2011 and
We have audited the accompanying consolidated balance sheets of Endurance Specialty Holdings Ltd. as of December 31, 2012 and 2011, and the related consolidated statements of income (loss) and comprehensive income (loss), changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
The Company’s reinsurance premiums are earned in proportion to the amount of reinsurance protection provided over the applicable risk period established in the reinsurance contract. Reinsurance contracts written on a losses occurring basis cover losses which occur during the term of the reinsurance contract, typically 12 months. Accordingly, the Company earns the premium on a losses occurring reinsurance contract evenly over the reinsurance contract term. Reinsurance contracts written on a policies attaching basis cover losses from the underlying insurance policies incepting during the terms of the reinsurance contracts. Losses under a policies attaching reinsurance contract may occur after the end date of the reinsurance contract, so long as they are losses from policies which began during the reinsurance contract period. The Company typically earns the premiums for policies attaching reinsurance contracts over a 24-month period in proportion to the amount of reinsurance protection provided to reflect the extension of the risk period past the term of the contract and the varying levels of reinsurance protection provided during the reinsurance contract period.
The Company currently classifies its fixed maturity investments, short-term investments and equity securities as “available for sale” and, accordingly, they 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 available-for-sale 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:
If the Company has the intent to sell an available for sale security or it is more likely than not that the Company will be required to sell the security, the Company deems the security to be other-than-temporarily impaired and writes down the value to fair value, thereby establishing a new cost basis. The amount of the write-down is recognized in earnings as an other-than-temporary impairment (“OTTI”) loss.
For equity securities in an unrealized loss position for which a decision to sell has not been made and it is not more likely than not that the Company will be required to sell the equity security, the Company considers its ability and intent to hold the 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 (Loss) and Comprehensive Income (Loss). The new cost basis is not changed for subsequent recoveries in fair value.
The Company participated in a securities lending program until July 2011. Under this program fixed maturity investments were loaned by the Company to third parties, primarily major brokerage firms and commercial banks. The Company retained all economic interest in the securities it lent, retained the earnings and cash flows associated with the loaned securities and received a fee from the borrower for the temporary use of the securities. The borrowers of the Company’s securities provided the Company with collateral, typically cash, which the Company separately maintained. The Company typically invested such collateral in overnight repurchase agreements. All securities on loan were issued on a term or overnight basis and were subject to daily recall at the Company’s discretion. Upon the termination of the securities lending program, the Company recalled all securities on loan and refunded all collateral previously held as part of the program.
Cash equivalents include highly liquid short-term deposits and securities with maturities of ninety days or less at the time of purchase. Cash equivalents are valued at amortized cost, which approximates fair value due to the short-term, liquid nature of these securities.
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 to manage exposure to interest rate and currency risk, to enhance the efficiency of the investment portfolio, to economically hedge certain risks, and as part of its weather risk management business. These contracts do not qualify, and are not designated, as hedges. Thus, changes in fair value and any realized gains (losses) are recognized in net realized and unrealized gains, net foreign exchange gains, or other underwriting loss in the Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). 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 are generally netted by the counterparty and are reported accordingly in other assets and other liabilities in the Consolidated Balance Sheets.
Basic earnings (losses) per common share are calculated by dividing net income (loss) available (attributable) 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.
Certain comparative information has been reclassified to conform to current year presentation. The Company identified immaterial mis-classifications of certain tax and foreign exchange effects on the Company’s investment portfolio in the 2008 and 2009 financial statements. The Company reclassified these tax and foreign exchange effects on the investment portfolio between accumulated other comprehensive income and retained earnings within the Condensed Consolidated Balance Sheet for the year ended December 31, 2011. The reclassifications had no impact on earnings or total shareholders’ equity for the year ended December 31, 2011.
ASU 2012-02 was effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The Company adopted this standard prospectively on October 1, 2012. This standard did not have a material impact on the Company’s consolidated financial statements.
The following table summarizes the composition by investment rating of the fixed maturity and short-term investments at December 31, 2012 and 2011. In some cases, where bonds are unrated, the rating of the issuer has been applied.
(1) The credit rating for each asset reflected above was determined based on the rating assigned to the individual security by Standard & Poor’s Financial Services LLC (“Standard & Poor’s”). If a rating is not supplied by Standard & Poor’s, the equivalent rating supplied by either Moody’s Investors Service, Inc. (“Moody’s”) or Fitch Ratings is used.
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 82% of the hedge fund portfolio, with the remainder over the following two years.
Private investment funds - The Company generally has no right to redeem its interest in any of these private investment partnerships in advance of dissolution of the applicable partnership. Instead, the nature of these investments is that distributions are received by the Company in connection with the liquidation of the underlying assets of the applicable limited partnership. It is estimated that the majority of the underlying assets of the limited partnerships would liquidate over 5 to 10 years from inception of the limited partnership.
High yield loan funds - There are generally no restrictions on the Company’s right to redeem its interest in high yield loan funds with the exception of certain redemption frequency and notice requirements. The redemption frequency of these funds ranges from monthly to quarterly with notice periods from 30 to 90 days.
Realized and unrealized investment gains and losses are recognized in earnings (losses) using the first in and first out method. The analysis of net realized and unrealized investment gains for the years ended December 31, 2012, 2011 and 2010 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, 2012 and 2011 are as follows:
The following tables summarize, for all available for sale securities in an unrealized loss position at December 31, 2012 and 2011, the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position.
The Company is involved in the normal course of business with VIEs primarily as a passive investor in residential and commercial mortgage-backed securities and through its interests in various other investments that are structured as limited partnerships considered to be third party VIEs. The Company determined that it was not the primary beneficiary for any of these investments as of December 31, 2012 and 2011. The Company believes its exposure to loss with respect to these investments is generally limited to the investment carrying amounts reported in the Company’s consolidated balance sheet and any unfunded investment commitments.
The Company determines the fair value of the fixed maturity investments, short-term investments, equity securities, other investments, debt, and other assets and liabilities 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 Company determines the estimated fair value of each individual security utilizing the highest level inputs available. Valuation inputs by security type may include the following:
Corporate fixed maturity securities - These securities are generally priced by pricing services or index providers. The pricing services or index providers typically use discounted cash flow models that incorporate benchmark curves for treasury, swap and high issuance credits. Credit spreads are developed from current market observations for like or similar securities. The Company generally classifies the fair values of its corporate securities in Level 2.
Other assets and liabilities - These securities consist of a variety of derivative instruments used to enhance the efficiency of the investment portfolio and economically hedge certain risks. These instruments are generally priced by pricing services, broker/dealers and/or recent trading activity. The market value approach valuation technique is used to estimate the fair value for these derivatives based on significant observable market inputs. Certain derivative instruments are priced by pricing services based on quoted market prices in active markets. These derivative instruments are generally classified in Level 1. Other derivative instruments are priced using industry valuation models and are considered Level 2, as the inputs to the valuation model are based on observable market inputs. Also included in this line item are proprietary, non-exchange traded derivative-based risk management products primarily used to address weather and energy risks. The trading market for these weather derivatives are generally linked to energy and agriculture commodities, weather and other natural phenomena. In instances where market prices are not available, the Company uses industry or internally developed valuation techniques such as spread option, Black Scholes, quanto and simulation modeling to determine fair value and classifies these in Level 3. These models may reference prices for similar instruments.
Other investments - Other investments are comprised of alternative funds and specialty funds, are generally priced on net asset values (“NAV”) received from the fund managers or administrators. Due to the timing of the delivery of the final NAV by certain of the fund managers, valuations of certain alternative funds and specialty funds are estimated based on the most recently available information, including period end NAVs, period end estimates, or, in some cases, prior month or prior quarter NAVs. As this valuation technique incorporates both observable and significant unobservable inputs, the Company generally classifies the fair value of its other investments in Level 3.
During 2012, fixed maturity investments were transferred from Level 3 to Level 2. The reclassifications were largely related to collateralized debt obligation securities. During the year, the market activity for these securities increased and observable inputs became available. In addition, the Company purchased asset-backed securities, which are classified as Level 3 securities, as no observable price was available. The Company used pricing models with significant unobservable inputs in order to determine the fair value of these securities.
During 2012, the Company wrote derivative-based risk management products used to address weather and energy risks. The trading market for these weather derivatives are generally linked to energy and agriculture commodities, weather and other natural phenomena. In instances where market prices are not available, the Company uses industry or internally developed valuation techniques to determine fair value, and therefore these products were classified in Level 3.
Level 3 assets represented 9.55% and 0.21% of the Company’s total available for sale investments, other investments and derivative instruments at December 31, 2012 and 2011, respectively. Level 3 securities are primarily comprised of non-agency commercial mortgage-backed securities, asset-backed securities, investments in alternative and specialty funds, and weather derivatives. The NAV used to fair value the Company’s other investments are generally derived from the underlying investments held within the funds. Although the Company does not have direct access to detailed financial information related to the underlying investments of the funds, the Company obtains and reviews fund financial statements, internal control review reports, and industry benchmarking reports to determine the reasonability of the NAV of the funds.
The effects of reinsurance on premiums earned and written during the years ended December 31, 2012, 2011 and 2010 are as follows:
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, 2012.
Interest Rate Futures, Swaps, Swaptions and Options-to manage exposure to interest rate risk, which can include increasing or decreasing its exposure to this risk through modification of the portfolio composition and duration.
Credit Default Swaps-to manage market exposures. The Company may assume or economically hedge credit risk through credit default swaps to replicate or hedge investment positions. The original term of these credit default swaps is generally five years or less.
To-Be-Announced Mortgage-backed Securities (“TBAs”)-to enhance investment performance and as part of overall investment strategy. TBAs represent commitments to purchase or sell a future issuance of agency mortgage-backed securities. For the period between purchase of a TBA and issuance of the underlying securities, the Company’s position is accounted for as a derivative.
The gains and losses on the Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) for derivatives for the years ended December 31, 2012 and 2011 were as follows:
Reinsurance - This segment is comprised of four lines of business: catastrophe, casualty, property, and other specialty. Catastrophe coverages include reinsurance for catastrophic perils on a treaty basis. The casualty line of business is comprised of third party liability exposures, clash and workers’ compensation coverages. The property line of business includes proportional and excess of loss reinsurance of personal and commercial exposures. The other specialty line coverages include 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 and agriculture coverages for weather related perils as well as protection from yield and price risks.
Management measures segment results on the basis of the combined ratio, which is obtained by dividing the sum of the net losses and loss expenses, acquisition expenses and general and administrative expenses by net premiums earned. When purchased across multiple lines of business, ceded reinsurance and recoveries are allocated to the lines of business in proportion to the related risks assumed. The Company does not manage its assets by segment; accordingly, investment income and total assets are not allocated to the individual business segments. General and administrative expenses incurred by segments are allocated directly. Remaining general and administrative expenses not directly incurred by the segments are allocated primarily based on estimated consumption and other variables deemed relevant to the allocation of such expenses.
Concentrations of credit risk. The areas where significant concentrations of credit risk may exist include loss recoverables, investments and cash and cash equivalents. The Company’s reinsurance recoverables at December 31, 2012 and 2011 amounted to $774.9 million and $666.9 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, 2012, $341.5 million of losses recoverable (2011 - $299.7 million) was due from reinsurers rated A- or better by A.M. Best or Standard & Poor’s. An additional $423.8 million (2011 - $364.8 million) of losses recoverable was due from a U.S. government sponsored reinsurance program as of December 31, 2012.
Major production sources. The following table shows the percentage of net premiums written generated through the Company’s largest brokers for the years ended December 31, 2012, 2011 and 2010:
Investment commitments. As of December 31, 2012 and 2011, the Company had pledged cash and cash equivalents and fixed maturity investments of $224.4 million and $171.4 million, respectively, in favor of certain ceding companies to collateralize obligations. As of December 31, 2012 and 2011, the Company had also pledged $380.0 million and $517.2 million of its cash and fixed maturity investments as required to meet collateral obligations for $320.4 million and $447.3 million in secured letters of credit outstanding under its credit facility, respectively. In addition, at December 31, 2012 and 2011, cash and fixed maturity investments with fair values of $280.0 million and $370.4 million were on deposit with U.S. state regulators, respectively, and cash and fixed maturity investments with fair values of nil and $7.6 million were on deposit with Canadian regulators, respectively.
Total lease expense under operating leases for the year ended December 31, 2012 was $15.2 million (2011 - $12.2 million; 2010 - $11.1 million).
The following table sets forth the computation of basic and diluted earnings (losses) per share for the years ended December 31, 2012, 2011 and 2010:
Pyramis Global Advisors, a subsidiary of FMR, LLC (“Fidelity”), provides investment management services to the Company. Fidelity and its affiliates owned 2.6 million or 6.0% of Endurance Holdings’ ordinary shares outstanding at December 31, 2012 and were therefore considered a related party. The Company incurred investment management fees totaling $1.4 million (2011-$1.5 million; 2010-$2.0 million) to this investment manager of which $0.3 million was accrued at December 31, 2012 (2011-$0.4 million).
On February 28, 2011, the Company entered into an agreement with Robert A. Spass, a member of the Board of Directors of the Company, to purchase from Mr. Spass warrants exercisable for 90,000 ordinary shares of the Company having an exercise price on the date of the agreement of $12.87 per ordinary share (the “Warrant Purchase Agreement”). The Warrant Purchase Agreement provided that the Company would purchase the warrants from Mr. Spass at a purchase price of $36.72 per warrant, which represented the closing price for the Company’s ordinary shares on the New York Stock Exchange on February 28, 2011, less the exercise price of the warrants. The transactions contemplated bye the Warrant Purchase Agreement closed on March 1, 2011.
Under the terms of the 2007 Plan as amended, and after the consolidation of the Company’s previous plans, a total of 2,100,000 ordinary shares were reserved for issuance. At a meeting on February 11, 2010, the Company’s Board of Directors adopted a resolution to add 1,795,000 ordinary shares to the 2007 Plan. The addition of 1,795,000 ordinary shares to the 2007 Plan was approved by the Company’s shareholders at the Annual General Meeting of Shareholders held on May 13, 2010. After the approval of the additional shares, a total of 3,895,000 ordinary shares were reserved for issuance. The Company issues new ordinary shares upon the issuance of share based equity incentives, such as restricted shares, or the exercise or settlement of outstanding derivative equity incentives, such as options or restricted share units. As of December 31, 2012, 2,339,707 (2011-2,592,134) ordinary shares remained available for issuance under the 2007 and prior Plans.
Prior to 2005, the Company issued stock options to employees and non-employee directors, with exercise prices equal to the fair market values of the Company’s ordinary shares on the grant dates. Options generally vested at a rate of 20% per year over a five-year term. Option awards have a 10-year contractual life.
No options were granted, expired or vested during the years ended December 31, 2012, 2011 and 2010. The total intrinsic value of options exercised during the years ended December 31, 2012, 2011 and 2010 was $1.4 million, $32.5 million, and $9.9 million, respectively. The Company received proceeds of $1.5 million from the exercise of options during the year ended December 31, 2012. The Company issued new ordinary shares in connection with the exercise of the above options.
There were no unrecognized stock-based compensation expenses related to unvested stock options at December 31, 2012.
The Company has issued restricted shares and restricted share units to employees and non-employee directors. The fair value of the restricted shares and restricted share units granted was equal to the fair market value of the Company’s ordinary shares on the grant date. Compensation equal to the fair market value of the restricted shares and restricted share units at the measurement date was amortized and charged to income over the vesting period. Restricted shares granted to employees generally vest pro rata over a four-year period. Restricted shares are forfeited upon departure from the Company for any reason prior to the applicable vesting date other than in cases where an employee meets certain retirement eligibility criteria which allow for continuing post-employment vesting of restricted shares, subject to compliance with certain non-competition obligations.
A summary of the restricted share and restricted share unit activity during the year ended December 31, 2012, is presented below:
The Company provides pension benefits to eligible employees through various defined contribution plans sponsored by the Company. Under the Company’s defined contribution plans, the Company makes contributions to its employees’ accounts in amounts ranging from 4% to 12% of its employees’ eligible earnings. In addition, under certain defined contribution plans, employee contributions may be supplemented by matching contributions made by the Company based on the level of employee contribution. Lastly, the Company may provide additional contributions, depending on its annual financial performance. The employee and Company contributions in the defined contribution plans are invested at the election of each employee in one or more of several investment portfolios offered by third party investment advisors. Company contributions for the year ended December 31, 2012 resulted in an expense of $7.4 million being recorded in earnings (2011 - $7.5 million; 2010 - $8.4 million).
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, 2012, Endurance Bermuda can pay dividends of $623.1 million (2011-$605.6 million) to Endurance Holdings without prior approval under Bermuda law.
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 for Endurance’s Delaware domiciled entities. In addition, dividends may only be declared or distributed out of earned surplus. At December 31, 2012, Endurance U.S. Reinsurance, Endurance American, Endurance Risk Solutions, and Endurance American Specialty did not have earned surplus and thus were precluded from declaring or distributing dividends during 2013 without the prior approval of the applicable insurance regulator. If the parent company is also an insurer, as is the case with Endurance American, Endurance American Specialty and Endurance Risk Solutions, the parent company or companies must also meet their own dividend eligibility requirements in order to pass along any dividends received from subsidiary insurance companies. At December 31, 2012, American Agri-Business (with notice to the Texas Department of Insurance) could pay dividends of $4.3 million (2011-$3.9 million) without prior regulatory approval.
The required and actual statutory capital amounts in the “Other” category in the table above include amounts related to Endurance U.K. and Endurance Bermuda’s Singapore branch (“Singapore Branch”). Under the jurisdiction of the United Kingdom’s Financial Services Authority (“FSA”), Endurance U.K. must maintain a margin of solvency at all times, which is determined based on the type and amount of insurance business written. Insurers are required to calculate their required minimum solvency margin and to report it to the FSA. The FSA also mandates calculation of an Enhanced Capital Requirement for Endurance U.K. At December 31, 2012 and 2011, the actual capital for Endurance U.K. exceeded the capital requirements currently promulgated by the FSA.
The required capital noted in the table above as “Other” represents the combined capital requirements for Endurance U.K. and the Singapore Branch.
The FSA 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 FSA 28 days prior to any proposed dividend payment. Dividends may only be distributed from profits available for distribution. At December 31, 2012 Endurance U.K did not have retained profits available for distribution.
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, 2012 and 2011:
Net income taxes paid in 2012 totaled $1.6 million. The Company received net refunds and paid net income taxes totaling $15.7 million and $24.3 million for the years ended December 31, 2011 and 2010, respectively. Net operating loss carryforwards in the amount of $161.4 million, $25.5 million, $39.0 million and $28.9 million are available for application against future taxable income in the United States, United Kingdom, Singapore and Switzerland, respectively. These net operating loss carry forwards have no expiration date in the United Kingdom and Singapore. In Switzerland and the United States the net operating loss carry forwards expire through 2019 and 2032, respectively.
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, 2012, management has established a valuation allowance of $85.8 million (2011 - $31.4 million) against net operating loss carryforwards in the Company’s United States subsidiaries, United Kingdom subsidiary and non-U.S. branches. The valuation allowance in 2011 was established against net operating loss carryforwards in the Company’s United States subsidiaries, United Kingdom subsidiary and non-U.S. branches.
The Company’s income (loss) before income taxes was distributed as follows for the years ended December 31, 2012, 2011 and 2010, respectively: