(6) Per Share Data has been retroactively restated to reflect the TGI’s reverse acquisition transaction with Canopius Holdings Bermuda Limited, which was completed on March 13, 2013. This reverse acquisition resulted in shareholders converting their shares at a 1.1330 conversion ratio.
Tower, through its subsidiaries, offers a range of general commercial, specialty commercial and personal property and casualty insurance products and services to businesses in various industries and to individuals throughout the United States. We provide these products on both an admitted and an excess and surplus (“E&S”) lines basis. Insurance companies writing on an admitted basis are licensed by the states in which they sell policies and are required to offer policies using premium rates and forms that are filed with state insurance regulators. Non-admitted carriers writing in the E&S market are not bound by most of the rate and form regulations imposed on standard market companies, allowing them the flexibility to change the coverage offered and the rate charged without the time constraints and financial costs associated with the filing process.
The third arrangement with Southport Re consisted of two separate reinsurance agreements with TICNY, on its behalf and on behalf of each of its pool participants, and a third reinsurance agreement with Tower Reinsurance, Ltd. (“TRL”). Under the first of the agreements with TICNY, TICNY ceded to Southport Re a 30% quota share of its workers’ compensation and employer’s liability business (the “Southport Quota Share”). The Southport Quota Share covered losses occurring on or after July 1, 2013 for policies in force at June 30, 2013 and policies written or renewed during the term of the agreement. The Southport Quota Share has been accounted for using deposit accounting treatment. Deposit assets of $28.7 million as of December 31, 2013 related to the Southport Quota Share are reflected in Other assets in the consolidated balance sheet. Under the second of these agreements with TICNY, an aggregate excess of loss agreement, Southport Re assumed a portion of the losses incurred by TICNY on its workers’ compensation and employer’s liability business between January 1, 2011 and June 30, 2013, but paid by TICNY on or after June 1, 2013 (the “TICNY/Southport Re ADC”). Finally, TRL, a wholly-owned Bermuda-domiciled reinsurance subsidiary of Tower, also entered into an aggregate excess of loss agreement with Southport Re, in which Southport Re assumed a portion of the losses incurred by TRL on its assumed workers’ compensation and employer’s liability business between January 1, 2011 and June 30, 2013, but paid by TRL on or after June 1, 2013 (the “TRL/Southport Re ADC”, or, collectively, the “Southport Re ADCs”).
The reinsurance agreements with Arch and Hannover resulted in ceded premiums earned, ceding commission revenue and ceded loss and loss adjustment expenses of $76.8 million, $22.3 million, and $41.1 million for the year ended December 31, 2013.
As a result of the announced merger agreement with ACP Re, it was decided that the Southport treaties should be commuted. As a result of a negotiation between the Company and Southport, all of these treaties were commuted effective as of February 19, 2014, with the result of the commutation being that all premiums paid to Southport by the Company were returned to the Company, and all liabilities assumed by Southport were cancelled, and such liabilities became the obligation of the Company. In 2014, the company will record a gain of approximately $6.4 million resulting from the terminations.
On January 2, 2014, Fitch downgraded Tower’s issuer default rating from “B” to “CC” and the insurer strength ratings of its insurance subsidiaries from “BB” to “B”. On October 7, 2013, Fitch downgraded Tower’s issuer default rating to “B” (the sixth highest of 11 such ratings) from “BBB” and the insurer strength ratings of its insurance subsidiaries to “B” (the fifth highest of Fitch Ratings’ nine such ratings) from “A-”. In downgrading such ratings, Fitch stated that it “is concerned that Tower’s competitive position has been materially damaged, negatively impacting the Company’s financial flexibility and ability to write new business” and that “the magnitude of the second quarter charges was large enough to cause several key ratios to fall well outside of previously established ratings downgrade triggers, which resulted in the multi-notch downgrade.” On January 6, 2014, Fitch revised Tower’s rating watch status to “evolving” from “negative” following the ACP Re merger announcement, and stated that “[t]he Evolving Watch reflects that the ratings could go up if the merger closes; however, ratings could be lowered if the merger does not occur and [the Company] is unsuccessful in addressing upcoming debt maturity or if additional reserve deficiencies develop.”
TGI was the obligor under the bank credit facility agreement dated as of February 15, 2012, as amended, with Bank of America, N.A. and other lenders named therein and is the obligor under the $150 million Convertible Senior Notes (“Notes”) due September 15, 2014. The indebtedness of TGI is guaranteed by TGIL and for purposes of the credit facility was also guaranteed by several of TGIL’s non-insurance subsidiaries.
Consequently, there is substantial doubt about the Company’s ability to continue as a going concern. Should the Company no longer continue to support its capital or liquidity needs, or should the Company be unable to successfully execute the above mentioned initiatives, the above items would have a material adverse effect on its business, results of operations and financial position.
Jan R. Van Gorder, who is the lead independent director of the Board and a member of the Board’s Audit Committee, Compensation Committee and Corporate Governance and Nominating Committee, was appointed on February 9, 2014 to succeed Mr. Lee as Chairman of the Board. William W. Fox, Jr., who had served as a member of the Board and of the Board’s Audit Committee and Corporate Governance and Nominating Committee until his resignation from the Board on December 31, 2013, succeeded Mr. Lee as President and Chief Executive Officer of Tower effective as of February 14, 2014.
On August 20, 2012, TGI closed on its previously announced $74.9 million acquisition of a 10.7% stake in Canopius Group. In connection with this acquisition, TGI also entered into an agreement dated April 25, 2012 (the “Master Transaction Agreement”) under which Canopius Group committed to assist TGI with the establishment of a presence at Lloyd’s of London through a
Net premiums earned. Premiums written include all policies produced in an accounting period. Premiums are earned over the term of the related policy. The portion of the premium that relates to the policy term that has not yet expired is included on the
Net investment income and realized gains and losses on investments. We invest our available funds in cash, cash equivalents, securities and investment partnerships. Our investment income includes interest and dividends earned on our invested assets. Realized gains and losses on invested assets are reported separately from net investment income. We earn realized gains when invested assets are sold for an amount greater than their amortized cost, in the case of fixed maturity securities, and cost, in the case of equity securities, and we recognize realized losses when invested assets are written down or sold for an amount less than their amortized cost or actual cost, as applicable.
particular year, regardless of when they are reported, as a percentage of premiums earned during that particular accident year. A calendar year loss ratio measures losses and LAE for insured events occurring during a particular year and the changes in estimates in loss and LAE reserves from prior accident years as a percentage of premiums earned during that particular calendar year.
Operating income (loss). Operating income (loss) excludes realized gains and losses and acquisition-related transaction costs, net of tax. This is a common measurement for property and casualty insurance companies. We believe this presentation enhances the understanding of our results of operations by highlighting the underlying profitability of our insurance business. Additionally, these measures are a key internal management performance standard.
The following table provides a reconciliation of operating income (loss) to net income (loss) attributable to Tower Group International, Ltd. on a GAAP basis. The operating income (loss) is used to calculate operating earnings (loss) per share and operating return on average equity.
Our most critical accounting estimates involve the estimation of reserves for losses (including losses that have occurred but had not been reported by the financial statement date) and LAE, establishing fair value of losses and LAE for acquired businesses, net earned premiums, the reporting of ceding commissions earned, the amount and recoverability of reinsurance recoverable balances, deferred acquisition costs, investment impairments and potential impairments of intangible and long-lived assets.
We segregate our data for estimating loss reserves. The property lines include Fire and Allied Lines, Homeowners-property, Commercial Multi-peril Property, Multi-Family Dwellings, Inland Marine and Automobile Physical Damage. The casualty lines include Homeowners Liability, Commercial Multi-peril Liability, Other Liability, Workers’ Compensation, Commercial Automobile Liability, and Personal Automobile Liability. Commercial Insurance segment reserves are estimated separately from Personal Insurance segment reserves. For the Commercial Insurance segment we analyze reserves by line of business and, where appropriate, by program. Within the Personal Insurance segment, we estimate loss and loss expenses reserves separately for the Reciprocal Exchanges, which we manage, and for our owned companies. We utilize line of business breakdowns and, where appropriate, analyze results separately by state.
We determine ULAE reserves by applying a paid-to-paid ratio to the case and IBNR reserves by line of business. The paid-to-paid ratio is based on ratios of ULAE payments divided by loss and ALAE payments for last three calendar years.
Ceding commissions under a quota share reinsurance agreement are based on the agreed-upon commission rate applied to the amount of ceded premiums written. Ceding commissions are realized in income as ceded premiums written are earned. The ultimate commission rate earned on certain of our quota share reinsurance contracts is determined by the loss ratio on the ceded premiums earned. If the estimated loss ratio decreases from the level currently in effect, the commission rate increases and additional ceding commissions are earned in the period in which the decrease is recognized. If the estimated loss ratio increases, the commission rate decreases, which reduces ceding commissions earned. As a result, the same uncertainties associated with estimating loss and LAE reserves affect the estimates of ceding commissions earned. We monitor the ceded ultimate loss ratio on a quarterly basis to determine the effect on the commission rate of the ceded premiums earned that we accrued during prior accounting periods. The estimated ceding commission income relating to prior years recorded in 2013, 2012, and 2011 was a decrease of $9.8 million, $4.2 million and $2.7 million, respectively. These decreases are attributed to prior year reserve development that was not initially anticipated.
Deferred acquisition costs, net. We defer certain expenses that vary with and are directly related to the successful acquisition of new and renewal insurance business, including commission expense on gross premiums written, premium taxes and certain other costs related to the acquisition of insurance contracts. These costs are capitalized and the resulting asset, DAC, is amortized and charged to expense or income in future periods as gross and ceded premiums written are earned. The method followed in computing deferred acquisition costs, net, limits the amount of such deferred amounts to its estimated realizable value. The ultimate recoverability of deferred acquisition costs is dependent on the continued profitability of our insurance underwriting. We also consider anticipated invested income in determining the recoverability of these costs. If our insurance underwriting becomes unprofitable, we may have to write off a portion of our deferred acquisition costs, resulting in a further charge to income in the period in which the underwriting losses are recognized. The value of business acquired (“VOBA”) is an intangible asset relating to the estimated fair value of the unexpired insurance policies acquired in a business combination. VOBA is determined at the time of a business combination and is reported on the consolidated balance sheet with DAC and is amortized in proportion to the timing of the estimated underwriting profit associated with the in force policies acquired. The cash flow or interest component of VOBA is amortized in proportion to the expected pattern of future cash flows. The Company fully amortized the VOBA in the year ended December 31, 2011 and, accordingly, does not have any VOBA recorded on its balance sheet as of December 31, 2013 or 2012. The Company considers anticipated investment income in determining the recoverability of these costs and believes they are fully recoverable.
the length of time the security’s fair value has been below amortized cost or cost;
Since total unrealized losses are a component of shareholders’ equity, the recognition of OTTI losses has no effect on our comprehensive income or shareholders’ equity.
Identifiable intangible assets with a finite useful life are amortized over the period in which the asset is expected to contribute directly or indirectly to our future cash flows. Identifiable intangible assets with finite useful lives are amortized over their useful lives and tested for recoverability whenever events or changes in circumstances indicate that a carrying amount may not be recoverable. Identifiable intangible assets with indefinite useful lives are not amortized. Rather, they are tested for recoverability at least annually or whenever events or changes in circumstances indicate that a carrying amount may not be recoverable. Management assessed the carrying value of its intangible assets with a finite useful life 2013 and concluded impairment charges of $21.9 million were required to reduce its customer relationship intangible assets to fair value. These charges are reported in Other Operating Expenses in the consolidated statements of operations. No impairment losses were recognized on intangible assets with a finite useful life in 2012 or 2011.
The process of evaluating goodwill for impairment requires judgments and assumptions to be made to determine the fair value of each reporting unit, including discounted cash flow calculations, assumptions that market participants would make in valuing each reporting unit and the level of the Company’s own share price. Fair value estimates utilize both the market approach and income approach. Management considered valuation techniques such as peer company price-to-earnings and price-to-book multiples and an in-depth analysis of projected future cash flows and relevant discount rates, which considered market participant inputs. Other significant assumptions include levels of surplus available for distribution, future business growth and earnings projections for each reporting unit. Estimates of fair value are subject to assumptions that are sensitive to change and represent the Company’s reasonable expectation regarding future developments. Management also considers the implied control premium derived from its market capitalization and the implied fair value of the enterprise.
In conducting the goodwill impairment analysis for the quarter ended September 30, 2013, the Company estimated the Personal Insurance fair values using Tower’s current market capitalization, adjusted for a control premium. Historically, the Company also utilized various market multiple approaches for Personal Insurance reporting unit. However, based upon the significant 2013 events, including A.M. Best’s downgrade to “B” for the insurance subsidiaries, management in its judgment concluded the market capitalization, adjusted for a control premium, was most indicative of a price a market participant would pay for the reporting unit.
Accordingly, the Company performed a Step 2 impairment test on the Personal Insurance reporting unit. Based on the results, the Company recorded a non-cash goodwill impairment charge of $55.5 million to write-down all of the goodwill in the Personal Insurance reporting unit as of September 30, 2013. As of December 31, 2013, the Company had no goodwill reported on its consolidated balance sheet.
Long-lived tangible assets that an entity will continue to hold and use should be reviewed for impairment, which includes two steps. The first step in the impairment test is to determine whether the long-lived assets are recoverable as measured by comparing net carrying value of the asset or asset group to the undiscounted net cash flows to be generated from the use and eventual disposition of that asset or asset group. In performing this step, management concluded that the sum of the undiscounted cash flows was less than the carrying value of the asset group. Accordingly, the Company performed an impairment analysis in which the implied fair value of the fixed assets was determined to be lower than the carrying value.
See “Note 7 - Goodwill, Intangible and Fixed Asset Impairments” in the notes to consolidated financial statements. Also see “Item 9A. Controls and Procedures” for a discussion on the companies material weakness over financial reporting as it relates to the impairment process of assessing long-lived tangible and intangible assets.
Total revenues. Total revenues decreased by 9.4% for the year ended December 31, 2013 as compared to 2012. This decrease is attributable to lower net premiums earned and net investment income offset by increases in ceding commission.
Net realized investment gains (losses) for the year ended December 31, 2013 and 2012 were $25.0 million and $25.5 million, respectively. These gains and losses are a function of individual securities selected for sale when cash needs arise in the ordinary course of business or when market dictates disposals pursuant to our investment policy.
Loss and loss adjustment expenses. The consolidated net loss ratio, which includes the Reciprocal Exchanges, was 100.5% and 73.4% for the years ended December 31, 2013 and 2012, respectively. Excluding the Reciprocal Exchanges, the net loss ratio was 103.9% and 74.1% for the years ended December 31, 2013 and 2012, respectively. The Reciprocal Exchanges’ net loss ratio was 71.3% and 66.7% for the years ended December 31, 2013 and 2012, respectively.
Incurred losses and LAE for the year ended December 31, 2013 attributable to insured events of prior years were $538.1 million. Excluding the Reciprocal Exchanges, the incurred losses and LAE from prior accident years were $533.0 million. These prior accident year losses include unfavorable development of $539.8 million in the Commercial Insurance segment, favorable loss development of $5.4 million in the Assumed Reinsurance segment and unfavorable loss development of $3.7 million in the Personal Insurance segment for the year ended December 31, 2013. The favorable development of $5.4 million in the Assumed Reinsurance segment includes $19.1 million of favorable development resulting from the release of reserve risk premium. The Reciprocal Exchanges reported $5.1 million of unfavorable loss development for the year ended December 31, 2013.
Interest expense. Interest expense increased by $1.0 million for the year ended December 31, 2013 compared to 2012. The increase is mainly due to a combination of higher interest rates on our floating rate debt instruments and the accelerated recognition of accrued debt issuance costs that resulted with the termination of the $220 million Bank Facility on December 13, 2013, and the Letter of Credit Facility on December 5, 2013.
Goodwill and Fixed Asset Impairment. For the year ended December 31, 2013, the Company recorded $271.4 million to impair goodwill and $125.8 million to impair fixed assets. The impairment charges were the result of the significant reserve development and rating agency downgrades in 2013 and their effects on the estimated fair value of each of the reporting units and fixed asset valuations.
Other. On August 19, 2013, Tower terminated an agreement to acquire American Safety Reinsurance, Ltd. (“ASRe”). Tower previously announced entering into an agreement to acquire ASRe, the Bermuda-based reinsurance subsidiary of American Safety Insurance Holdings, Ltd. from Fairfax Financial Holdings Limited. Tower received $5 million in exchange for the termination of such agreements.
For the year ended December 31, 2013, Tower, excluding the Reciprocal Exchanges, had pre-tax losses of $901.4 million. These losses resulted in net operating loss carryforwards of $161.9 million as of December 31, 2013. In addition, Tower had net deferred tax assets, before any valuation allowances, of $265.0 million.
Management, in its judgment, concluded that a full valuation allowance was required for the net deferred tax assets after its consideration of the cumulative three-year pre-tax loss in its U.S. taxed subsidiaries resulting from certain 2013 events and the 2012 pre-tax loss of $61.3 million. In 2013, Tower had $325.6 million of prior year adverse reserve development, of which $149.7 million was recorded in Tower’s U.S. taxed subsidiaries. Management believes that the negative evidence associated with the realizability of its net deferred tax asset (including the cumulative three-year pre-tax loss, the prior year adverse reserve development, and the effects of Hurricane Irene in 2011 and Superstorm Sandy in 2012) outweighed the positive evidence that the deferred tax assets, including the net operating carryforward would be realized, and subsequently recorded the full valuation allowance.
Net income (loss) and return on average equity. Net income (loss) and annualized return on average equity attributable to Tower Group International, Ltd. were ($942.6) million and (157.2%) for the year ended December 31, 2013 compared to ($34.2) million and (3.4%) for the year ended December 31, 2012. The return on average equity is calculated by dividing net income (loss) by average shareholders’ equity. Average shareholders’ equity was $599.5 million and $1,001.7 million at December 31, 2013 and 2012, respectively. The increase in net loss and decrease in annualized return on equity for the years ended December 31, 2013 compared to the prior year is primarily due to the prior year loss reserve development and a $397.2 million goodwill and fixed asset impairment change, as discussed above.
Premiums earned. Net premiums earned for the years ended December 31, 2012 and 2011 were $1.7 billion and $1.6 billion respectively. The increase of 8.0% for the year ended December 31, 2012 is primarily a result of increased premiums from Tower’s assumed reinsurance business, offset by an increase in ceded premiums in 2012. Ceded premiums increased in 2012 due primarily to the reinstatement premium on the Company’s catastrophe reinsurance program as a result of Superstorm Sandy
Commission and fee income. Commission and fee income, comprised of ceding commission revenue, insurance services revenue and policy billing fees, increased by $2.3 million for the year ended December 31, 2012, compared to the prior year. The increase is due to additional policy billing fees and an increase in fees earned by our managing general agencies.
Excluding the Reciprocal Exchanges, there was a reserve increase of $88.1 million for the year ended December 31, 2012 comprised of a reserve increase in Personal Insurance of $4.0 million and a reserve increase in Commercial Insurance of $86.6 million and a reserve decrease in Assumed Reinsurance of $2.5 million.
Operating expenses. Operating expenses, which include direct and ceding commission expenses and other operating expenses, were $676.8 million for year ended December 31, 2012, compared to $594.7 million for the year ended December 31, 2011 representing an increase of 13.8%. This increase is primarily due to: (i) increased business production, including more assumed premiums written which have a higher commission rate compared to direct premiums written, (ii) the Company’s ongoing efforts to build-out our information technology infrastructure to support our policy administration and claims processing needs, and (iii) a $2.9 million after-tax charge attributable to a legal settlement with Munich Reinsurance America, Inc. (“Munich Re”).
Net income (loss) and return on average equity. Net income (loss) and annualized return on average equity attributable to Tower Group, International, Ltd., were ($34.2) million and (3.4%) for the year ended December 31, 2012 compared to $44.4 million and 4.3% for the year ended December 31, 2011. The return on average equity is calculated by dividing net income (loss) by average shareholders’ equity. Average shareholders’ equity was $1,001.7 million and $1,029.9 million at December 31, 2012 and 2011, respectively.
Premiums. Net premiums written for the year ended December 31, 2013 decreased 325.5 million and net premiums earned for the year ended December 31, 2013 decreased $172.9 million compared to 2012. These declines are attributed to a decline in direct written premiums in the fourth quarter of 2013 as a result of the A.M. Best rating downgrades. In addition, ceded premiums increased as a direct result of the Arch and Hannover treaties entered into July 1, 2013 for in force, new and renewal business which accounted for $143.1 million of ceded written premium and $76.8 million of ceded earned premium.
Reserve increases arose primarily from accident years 2008 through 2012 within the workers’ compensation, CMP liability, and other liability lines of business partially offset by a modest amount of favorable loss development from more recent years within the short tail property lines of business. During the second, third and fourth quarters of 2013, the Company recognized that the higher than expected reported loss development it had been experiencing had become a trend. In response to this recognition, the Company continued to update its internal reserve study to respond to higher than expected reported losses and to update the actuarial assumptions within the study. In conjunction with its comprehensive internal reviews, the Company also retained its consulting actuary to perform independent reserve studies.
Ceding commission revenue. Ceding commission revenue decreased for the year ended December 31, 2012 by $7.1 million compared 2011. This was primarily due to a change in loss ratio on a prior year’s quota share treaty which reduced ceding commission revenue by $4.2 million during the year ended December 31, 2012 compared to the prior year and also as a result of the non-renewal of our liability quota share contract.
Net loss and loss adjustment expenses. The net calendar year loss ratios were 77.8% and 70.4% for the years ended December 31, 2012 and 2011, respectively. The accident year loss ratios for the years ended December 31, 2012 and 2011 were 70% and 63.9%, respectively.
Management’s estimates of prior years’ loss and loss expenses increased $86.6 million for the year ended December 31, 2012. This increase in prior accident year loss and loss expense was the result of a comprehensive review of its loss reserves completed in the second quarter of 2012 and an updated analysis during the third quarter as well as recent loss emergence that occurred during the fourth quarter.
Underwriting expenses. Underwriting expenses, which include direct commissions and other underwriting expenses, increased by $35.7 million, or 10.1%, for the year ended December 31, 2012, respectively, compared to 2011. The net underwriting expense ratio increased 2.3 percentage points for year ended December 31, 2012 compared to 2011.
The gross underwriting expense ratio for the year ended December 31, 2012 was 31.9% compared to 30.5% in 2011. The commission portion of the gross underwriting expense ratio, which is expressed as a percentage of gross premiums earned, was
Underwriting expenses. Underwriting expenses, which include assumed commissions and other underwriting expenses, increased by $13.4 million, or 30.3%, for the year ended December 31, 2013, compared to 2012. The net underwriting expense ratio increased 12.6 percentage points for the year ended December 31, 2013 from the prior year.
Underwriting expenses. Underwriting expenses, which include assumed commissions and other underwriting expenses, increased by $32.3 million and 272.1%, for the year ended December 31, 2012, respectively, compared to 2011. The net underwriting expense ratio increased 3.7 percentage points for the year ended December 31, 2012 from the prior year. The increases in the underwriting expenses are directly attributable to the Tower management’s efforts to actively increase its participation in the assumed reinsurance market in 2012.
Personal lines renewal retention rate was 86.9% and 89.3% for the years ended December 31, 2013 and 2012, respectively. Written premiums on renewed business increased by 4.5% and 0.1% for the years ended December 31, 2013 and 2012, respectively. Policies-in-force increased 2.4% as of December 31, 2013 compared to December 31, 2012.
Net loss and loss adjustment expenses. For Personal Insurance, including the Reciprocal Exchanges, the net calendar year loss ratios were 63.0% and 70.6% for the years ended December 31, 2013 and 2012, respectively. The accident year loss ratios for the years ended December 31, 2013 and 2012 were 62.2% and 71.6%, respectively. Estimates of prior accident year loss and loss expenses increased by $3.7 million for the year ended December 31, 2013, and decreased by $4.9 million for the year ended December 31, 2012.
The Reciprocal Exchanges’ net calendar year loss ratios were 71.3% and 66.7% for the years ended December 31, 2013 and 2012, respectively. The accident year loss ratios for the years ended December 31, 2013 and 2012 were 68.1% and 72.2%, respectively. Estimates of prior accident year loss and loss adjustment expenses increased by $5.1 million for the year ended December 31, 2013, and decreased by $8.9 million for the year ended December 31, 2012.
Underwriting profit (loss) and combined ratio. Underwriting loss decreased $30.5 million and the combined ratio improved 5.8 percentage points for the year ended December 31, 2013 compared to the year ended December 31, 2012. The improvements in underwriting loss and combined ratio are due to the 2012 results being impacted by Superstorm Sandy, which occurred in the fourth quarter of 2012. There was no significant hurricane or tropical storm in 2013.
Premiums. Net premiums written for the year ended December 31, 2012 increased $27.5 million and net premiums earned for the year ended December 31, 2012 decreased $8.6 million, compared to the year ended December 31, 2012.
Gross premiums written for the year ended December 31, 2012 were $643.2 million as compared to $585.6 million in 2011 for an increase of $57.6 million. This increase is attributed to the acquisition of personal lines renewal rights resulting in $28.8 million of written premium and an increase in homeowners business offset by a decline in mono line automobile policies. Gross premiums earned increased to $621.7 million for the year ended December 31, 2012 from $611.2 million for the year ended December 31, 2011. This increase is due primarily to the renewal rights premiums and increase in homeowners business discussed above offset by a decline in mono line automobile policies.
Net loss and loss adjustment expenses. For Personal Insurance, the net calendar year loss ratios were 70.6% and 63.0% for the years ended December 31, 2012 and 2011, respectively. The accident year loss ratios for the years ended December 31, 2012 and 2011 were 71.6% and 76.2%, respectively. Estimates of prior accident year loss and loss expenses decreased by $4.9 million for the year ended December 31, 2012.
The Reciprocal Exchanges’ net calendar year loss ratios were 66.7% and 55.8% for the years ended December 31, 2012 and 2011, respectively. The accident year loss ratios for the years ended December 31, 2012 and 2011 were 72.2% and 76.0%, respectively. Estimates of prior accident year loss and loss adjustment expenses decreased by $8.9 million for the year ended December 31, 2012. For the year ended December 31, 2012, the Reciprocal Exchanges recorded $9.0 million of losses relating to Superstorm Sandy.
The OUE ratio, including BB&T, was 17.7% for the year ended December 31, 2012 compared 15.6% for 2011.
Underwriting profit and combined ratio. Underwriting profit decreased $44.4 million and the net combined ratio increased 8.9 percentage points for the year ended December 31, 2012 compared to the year ended December 31, 2011. The increase in the combined ratio for the twelve months ended December 31, 2012 resulted primarily from Superstorm Sandy losses in the fourth quarter of 2012. Such losses aggregated $42.8 million and increased the calendar year loss ratio by 12.8 points. These losses were partially offset by favorable prior year loss development of $4.9 million in 2012. For the year ended December 31, 2011, the Company also recorded catastrophe and other severe storm losses. In 2011, such losses aggregated $42.8 million and increased the calendar year loss ratio by 13.4 points. In addition, as discussed above, the expense ratio increased by 1.3 percentage points from 2011 to 2012.
The following table shows the composition of our fixed maturity portfolio by remaining time to maturity at December 31, 2013 and 2012. For securities that are redeemable at the option of the issuer and have a market price that is greater than redemption value, the maturity used for the table below is the earliest redemption date. For securities that are redeemable at the option of the issuer and have a market price that is less than redemption value, the maturity used for the table below is the final maturity date:
At December 31, 2013, securities with a fair value of $43.6 million included in other invested assets and 1 private convertible bond with a fair value of $3.4 million included in fixed maturity investments were priced in Level 3.
“Note 6 - Fair Value Measurements” to the consolidated financial statements provides a description of the valuation methodology utilized to value Level 3 assets, how the valuation methodology is validated and an analysis of the change in fair value of Level 3 assets. As of December 31, 2013, the fair value of Tower Level 3 assets as a percentage of Tower’s total assets carried at fair value was as follows (the Reciprocal Exchanges had no Level 3 assets):
For those fixed-maturity investments deemed not to be in an OTTI position, we believe that the gross unrealized investment loss was primarily caused by a spread widening in the capital markets. We expect cash flows from operations and investment maturities to be sufficient to meet our liquidity requirements and, therefore, we do not intend to sell these fixed maturity securities and we do not believe that we will be required to sell these securities before recovering their cost basis. For equity securities not considered OTTI, we believe we have the ability to hold these investments until a recovery of fair value to our cost basis. A substantial portion of the unrealized loss relating to the mortgage-backed securities is the result of a spread widening in the market that we believe to be temporary.
The following table shows the number of securities, fair value, unrealized loss amount and percentage below amortized cost and the ratio of fair value by security rating as of December 31, 2013:
Net cash flows provided by investing activities were $701.3 million for the year ended December 31, 2013 compared to net cash flows used in investing activities of $100.7 million for the year ended December 31, 2012. The change in investing cash flows is attributed to the following items: (i) cash from investing activities increased $133.3 million on March 13, 2013 relating to the Canopius Merger Transaction; (ii) in 2013 the Company increased its sale of investment securities to fund the settlement of loss and LAE claims attributable to Superstorm Sandy; (iii) the Company sold securities in the third and fourth quarter of 2013 to generate cash which was paid to reinsurers pursuant to the third and fourth quarter reinsurance agreements; (iv) a $70 million cash inflow for the sale of Tower’s 10.7% investment in Canopius Group in 2013 (Tower had a cash outflow of $75 million in 2012 relating to its acquisition of the Canopius Group investment); and (v) an increase of $97.6 million for the Company’s restricted cash balances relating primarily to “Funds at Lloyd’s” collateral balances for its assumed reinsurance programs.
The net cash flows used in financing activities for the year ended December 31, 2013 are primarily the result of the settlement of the Company’s credit facility for $70 million. In addition, the Company paid dividends of $26 million in 2013. In 2012, the Company had uses of cash for the repurchase of common stock and dividend payments of $21.0 million and $29.1 million, respectively, offset by net cash inflows of $20 million from a drawdown on our credit facility.
Cash flow needs at the holding company level are primarily for dividends to our shareholders, interest and principal payments on our outstanding debt and payments under the credit facility.
operations and financial condition. In addition, the NYDFS has placed limitations on payments and transactions outside the ordinary course of business and material changes in the insurance subsidiaries’ management and related matters. Tower’s management and Board of Directors have held discussions with the NYDFS, and Tower has been complying with the orders and oversight.
On April 21, 2014, the NYDFS issued additional orders for two of Tower’s insurance subsidiaries instructing them to provide plans to address weaknesses in such insurance subsidiaries’ risk based capital levels as shown in their statutory annual financial statements, and imposing further enhanced reporting and prior approval requirements and limitations on writings of new business. On the same date, the NYDFS issued a letter pertaining to one of Tower’s insurance subsidiaries requiring the submission of a plan to address weaknesses in risk based capital levels.
The Maine Bureau of Insurance entered a Corrective Order imposing certain conditions on Maine domestic insurers York Insurance Company of Maine (“YICM”) and North East Insurance Company (“NEIC”). The Corrective Order imposes increased reporting obligations on YICM and NEIC with respect to business operations and financial condition and imposes restrictions on payments or other transfers of assets from YICM and NEIC outside the ordinary course of business.
competitive position has been materially damaged, negatively impacting the Company’s financial flexibility and ability to write new business” and that “the magnitude of the second quarter charges was large enough to cause several key ratios to fall well outside of previously established ratings downgrade triggers, which resulted in the multi-notch downgrade.” On January 6, 2014, Fitch revised Tower’s rating watch status to “evolving” from “negative” following the ACP Re merger announcement, and stated that “[t]he Evolving Watch reflects that the ratings could go up if the merger closes; however, ratings could be lowered if the merger does not occur and [the Company] is unsuccessful in addressing upcoming debt maturity or if additional reserve deficiencies develop.”
TGI was the obligor under the bank credit facility and is the obligor under the $150 million Convertible Senior Notes (“Notes”) due September 15, 2014. The indebtedness of TGI was (and the Notes are) guaranteed by Tower Group International, Ltd. (“TGIL”) and for purposes of the credit facility was also guaranteed by several of TGIL’s non-insurance subsidiaries.
Using primarily proceeds from the sale, Tower’s wholly-owned subsidiary, Tower Group, Inc., has paid in full the $70.0 million outstanding on its credit facility led by Bank of America, N.A., and the credit facility has been terminated as of December 13, 2013.
The Company’s plan to repay the Notes is related to the closing of the ACP Re Merger Agreement with ACP Re. In the event that the ACP Re Merger Agreement does not close, the Company would evaluate a combination of using proceeds from the sale of assets held at TGI, including but not limited to, renewal rights on its commercial and personal lines of business and certain of its insurance companies to pay down the principal of the Notes. The Company can provide no assurance that it will be successful in finalizing the liquidation of the assets held at TGI or selling certain of its operating assets to satisfy repayment of the Notes.
As of December 31, 2013, there were $235.1 million of subordinated debentures outstanding. The subordinated debentures do not have financial covenants that would cause an acceleration of their stated maturities. The earliest stated maturity date is on a $10 million debenture, with a stated maturity in May 2033. The Company has the ability to defer interest payments on its subordinated debentures for up to twenty quarters.
See the Liquidity section in “Note 1 - Nature of Business” to the consolidated financial statements for further discussion on Liquidity and Capital Resources.
Book value per common share represents Tower Group International, Ltd. shareholders’ equity divided by the number of common shares outstanding. Book value per common share is impacted by, among other factors, our underwriting results, investment returns and share repurchase activity, which has an accretive or dilutive impact on book value per common share depending on the purchase price. (Historical share counts prior to March 13, 2013 have been adjusted for 1.1330 share conversion ratio, as discussed more fully in “Note 3 - Canopius Merger Transaction”.) The decline in book value per common share from December 31, 2012 to December 31, 2013 is primarily a result of the significant loss reserve development, the goodwill and fixed assets impairment charges recorded in the second and third quarters of 2013, and, to a lesser extent, to an immediate reduction from the sale of common stock to third-party investors in connection with the Canopius Merger Transaction. In addition, the decline in the fair value of the Company’s investment portfolio due to changes in interest rates had an unfavorable impact on book value per common share.
We do not consolidate the statutory business trusts for which we hold 100% of the common trust securities because we are not the primary beneficiary of the trusts. Our $7.1 million investment in the common trust securities of the statutory business trusts is reported in Other Assets. We report as a liability the outstanding subordinated debentures issued to the statutory business trusts.
our failure to comply with the covenants or other provisions of the indentures or the subordinated debentures; or
In October 2010, TGI effected interest rate swap contracts with $190 million notional on the subordinated debentures. Certain of these subordinated debentures are currently paying a variable interest rate and other subordinated debentures will convert to variable rates over the next year. The interest rate swaps will fix the variable interest payments on the subordinated debentures to rates from 5.1% to 5.9%. The interest rate swaps mature in 2015.
On December 13, 2013, TGI paid in full the $70.0 million outstanding on the bank credit facility and the bank credit facility has been terminated. The $70.0 million was provided, primarily, from the sale of Tower’s 10.7% ownership in Canopius Group on December 13, 2013.
The gross loss reserve payments due by period in the table above are based upon the loss and loss expense reserves estimates as of December 31, 2013 and actuarial estimates of expected payout patterns by line of business. As a result, our calculation of loss reserve payments due by period is subject to the same uncertainties associated with determining the level of reserves and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. The projected gross loss payments presented do not include the estimated amounts recoverable from reinsurers that amounted to $570.9 million, which are estimated to be recovered as follows: less than one year, $237.7 million; one to three years, $300 million; four to five years, $26.4 million; and after five years, $6.9 million. The interest on the subordinated debentures is calculated using interest rates in effect at December 31, 2013 for variable rate debentures.
For a discussion of our loss and LAE reserving process, see “Critical Accounting Policies-Loss and LAE Reserves.” Actual payments of losses and loss adjustment expenses by period will vary, perhaps materially, from the above table to the extent that current estimates of loss reserves vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns. See “Risk Factors-Risks Related to Our Business - If our actual loss and loss adjustment expense reserves
Our capital resources consist of funds deployed or available to be deployed to support our business operations. At December 31, 2013 and 2012, our capital resources were as follows:
The Company’s total capitalization declined $921.5 million, or 65.8%, from December 31, 2012 to December 31, 2013. This decline is primarily a result of the significant loss reserve development and the goodwill and fixed asset impairment charges recorded in the second and third quarters of 2013 offset by the sale of common stock to third-party investors in connection with the Canopius Merger Transaction. As a consequence, the Company’s ratings have been downgraded by the rating agencies, Tower has seen a significant decline in its production of new and renewal business and various state insurance departments have placed limitations on the activities of the subsidiary insurance companies. See Loss Reserve Increase, Goodwill impairment and deferred tax valuation allowance discussion in the Overview Section of “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further detail.
The Company has entered into the ACP Re Merger Agreement to address the reduction in capital. In the event that the ACP Re Merger Agreement does not close, Tower’s production of new and renewal business will continue to be unfavorably impacted. See “Proposed Merger with ACP Re” discussion in the Overview section of “Item 1. Business” for further detail.
Substantial future increases in inflation could also result in future increases in interest rates, which in turn are likely to result in a decline in the market value of the investment portfolio and cause unrealized losses or reductions in shareholders’ equity.
Consolidated Statements of Operations for the years ended December 31, 2013, 2012, and
Consolidated Statements of Comprehensive Income for the years ended December 31, 2013, 2012, and
Tower Group International, Ltd. (the “TGIL”, the Company” or “Tower”) offers a range of commercial, assumed reinsurance and personal property and casualty insurance products and services through its subsidiaries to businesses and to individuals. On March 13, 2013, the Company and Tower Group, Inc. (“TGI”) completed a merger transaction under which the Company, formerly known as Canopius Holdings Bermuda Limited (“Canopius Bermuda”), was re-named Tower Group International, Ltd. and became the ultimate parent company (the “Canopius Merger Transaction”). The Company’s Common Shares (as defined below) are publicly traded on the NASDAQ Global Select Market under the symbol “TWGP”, which was also the symbol of TGI common shares on that exchange prior to the Canopius Merger Transaction. See “Note 3 - Canopius Merger Transaction” for further discussion of the Canopius Merger Transaction and the Company’s succession to TGI as registrant. As stated above, the registrant is deemed to be the successor to Tower Group, Inc. pursuant to Rule 12g-3(a) under the Exchange Act and, following the consummation of the merger described above by the registrant and Tower Group, Inc., the consolidated financial statements of Tower Group, Inc. for the periods through March 13, 2013, closing date of the merger, became the registrant’s consolidated statements for the same periods. Accordingly, as used herein, unless the context requires otherwise, references to “Tower”, the “Company”, “we”, “us”, or “our” (i) with respect to any period, event or occurrence prior to March 13, 2013, are to Tower Group, Inc. and (ii) with respect to any subsequent period, event or occurrence, are to Tower Group International, Ltd., and, in each case include the Company’s insurance subsidiaries, managing general agencies and management companies.
Concurrently with the execution of the ACP Re Merger Agreement, several subsidiaries of Tower have entered into two Cut-Through Reinsurance Agreements, pursuant to which a subsidiary of AmTrust and a subsidiary of NGHC will provide 100% quota share reinsurance and a cut-through endorsement to cover all eligible new and renewal commercial and personal lines business, respectively, and at their option, losses incurred on or after January 1, 2014 on not less than 60% of the in-force business. Tower received confirmation on January 16, 2014 from AmTrust and NGHC that they would exercise such option to reinsure on a cut-through basis losses incurred on or after January 1, 2014 under in-force policies with respect to (1) in the case of AmTrust, approximately 65.7% of Tower’s unearned premium reserves as of December 31, 2013 with respect to its ongoing commercial lines business, and (2) in the case of NGHC, 100% of Tower’s unearned premium reserves as of December 31, 2013 with respect to its personal lines segment business. Tower will receive a 20% ceding commission from AmTrust or NGHC on all Tower unearned premiums that are subject to the Cut-Through Reinsurance Agreements and a 22% ceding commission on 2014 ceded premiums.
Concurrently with the execution of the ACP Re Merger Agreement, the controlling shareholder of ACP Re has provided to Tower a guarantee for the payment of the merger consideration, effective upon the closing of the merger.
Michael H. Lee, the former Chairman, President and Chief Executive Officer of Tower, who beneficially owns approximately 4.2% of the issued and outstanding common stock of Tower as of January 3, 2014, has entered into a support agreement pursuant to which he has agreed to vote his shares in favor of the merger.
Loss and loss adjustment expenses for the twelve months ended December 31, 2013 recorded in the statement of operations included an increase of $533.0 million, excluding the Reciprocal Exchanges relating to reserve increases associated with losses from prior accident years. This unfavorable loss development arose primarily from accident years 2008-2012 within the workers’ compensation, commercial multi-peril liability (“CMP”), other liability and commercial auto liability lines of business partially offset by a modest amount of favorable development from more recent years within the short tail property lines of business. The Company performed comprehensive updates to its internal reserve study in response to continued observance in the second, third quarters and fourth of 2013 of higher than expected reported loss development. In conjunction with its comprehensive internal reviews, the Company also retained a consulting actuary to perform an independent reserve study in the fourth quarter of 2013 covering lines of business comprising over 98% of the Company’s loss reserves. Since 2010, the Company has changed the mix of business by reducing the amount of program and middle market workers’ compensation and liability business that it underwrites.
In the third quarter of 2013, Tower entered into agreements with three reinsurers, Arch Reinsurance Ltd. (“Arch”), Hannover Re (Ireland) Plc. (“Hannover”) and Southport Re (Cayman), Ltd. (“Southport Re”). These agreements provided for surplus enhancement and improved certain financial leverage ratios, while increasing the Company’s financial flexibility. The agreements with Arch and Hannover each consisted of one reinsurance agreement while the arrangement with Southport Re consisted of several agreements. Each of these is described below.
The first agreement was between Tower Insurance Company of New York (“TICNY”), on its behalf and on behalf of each of its pool participants, and Arch. Under this multi-line quota share agreement, TICNY ceded 17.5% on a quota share of certain
outside of previously established ratings downgrade triggers, which resulted in the multi-notch downgrade.” On January 6, 2014, Fitch revised Tower’s rating watch status to “evolving” from “negative” following the ACP Re merger announcement, and stated that “[t]he Evolving Watch reflects that the ratings could go up if the merger closes; however, ratings could be lowered if the merger does not occur and [the Company] is unsuccessful in addressing upcoming debt maturity or if additional reserve deficiencies develop.”
In January 2014, Tower’s Board of Directors approved Tower’s merger with ACP Re. In light of the adverse ratings actions, concurrent with entering into its merger agreement with ACP Re, Tower entered into cut-through reinsurance treaties with affiliates of ACP Re. As a result of this merger, and the execution of the cut-through reinsurance treaties, Tower believes its insurance subsidiaries will retain significant portions of their business. (See “Note 9 - Reinsurance” for a discussion of the cut-through reinsurance treaties).
As of December 31, 2013, TRL and CastlePoint Re had capital and surplus that did not meet the minimum solvency requirements of the BMA. Management has discussed the ACP Re Merger Agreement and provided 2014 solvency forecasts to the BMA.
On February 6, 2014, Tower and Michael H. Lee entered into a Separation and Release Agreement in connection with the resignation of Mr. Lee from his positions as Chairman of the Board of Directors, President and Chief Executive Officer, effective as of February 6, 2014. Mr. Lee’s employment with the Company was terminated effective as of February 6, 2014. In connection with his resignation, Mr. Lee received on March 31. 2014 a severance payment of approximately $3.3 million calculated pursuant to terms of his employment agreement.
The Company and certain of its current and former senior officers have been named as defendants in several class action lawsuits instituted against them by certain shareholders. In addition, the Company and certain of its current and former directors, along with certain other parties, have been named as defendants in a putative class action lawsuit instituted against them by another purported shareholder. See “Note 17 - Contingences” for additional detail on such litigation.
The accompanying consolidated financial statements included in this report have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). All intercompany transactions have been eliminated in consolidation.
In 2013, the Company changed the presentation of its business results by allocating its assumed reinsurance previously reported in the Commercial Insurance segment to a new Assumed Reinsurance segment. In addition, the Company redefined the Personal Insurance segment to include its management companies, which provide certain services to the Reciprocal Exchanges for a management fee. The Reciprocal Exchanges continue to be included in the Personal Insurance segment and transactions between the management companies and the Reciprocal Exchanges have been eliminated. The management companies were previously reported in the Insurance Services segment. The Company will no longer present an Insurance Services segment. These changes in presentation reflected the way management organized the Company for operating decisions and assessing profitability in the second quarter of 2013, subsequent to the Canopius Merger Transaction and the significant business developments and risks and uncertainties that occurred in 2013.
Following the changes in presentation the Company now operates in three business segments: Commercial Insurance, Assumed Reinsurance and Personal Insurance:
Personal Insurance (“Personal”) segment offers a broad range of personal lines property and casualty insurance products to individuals distributed through a network of retail and wholesale agents. Also included in the Personal Insurance segment are the results of the Reciprocal Exchanges.
See “Note 21 - Segment Information” for further information on the composition of the Company’s operating and reportable segments.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
In the first quarter 2012, Tower transferred a licensed insurance subsidiary shell to the Reciprocal Exchanges and received cash for its statutory book value. At the date of the transfer, Tower’s GAAP carrying basis in this subsidiary exceeded the statutory book value and the transfer resulted in a loss to Tower of $1.8 million. Since this was a non-recurring transaction between entities
under common control, assets are transferred at historical book value. Any difference in the consideration paid and the book value of the assets transferred is treated as an adjustment to equity. This transaction had no effect on consolidated shareholders’ equity.
The table below reflects the previously reported and revised shareholders’ equity accounts resulting from the Canopius Merger Transaction:
Revision to the 2012 Consolidated Balance Sheet and 2012 and 2011 Consolidated Statements of Cash Flows
Management is revising the Company’s 2012 consolidated balance sheet and 2012 and 2011 consolidated statements of cash flows to properly reflect the changes in restricted cash as change in cash flows from investing activities. In its Amendment No. 2 to Form 10-K for the year ended December 31, 2012, the Company previously recorded $9.1 million and $7.0 million of restricted cash within the “cash and cash equivalents” caption on the consolidated balance sheet as of December 31, 2012 and 2011, respectively. These amounts should have been recorded within “other assets,” and management has properly corrected those amounts out of the “cash and cash equivalent” balances in the 2012 and 2011 financial statements contained herein. In addition, in the 2012 consolidated balance sheet, management also corrected the classification of $9.4 million of “receivable for securities” that was originally reported within “cash and cash equivalents” to “other assets.” Also, in the 2012 consolidated balance sheet, management previously reported $0.9 million of receivables from reinsurance within “reinsurance balances payable.” The Company has properly reflected the $0.9 million as a receivable reported within “other assets.” These adjustments had no impact on shareholders’ equity or net income (loss). Management has concluded these corrections were not material to the 2012 consolidated balance sheet.
The liability for loss and LAE represents management’s best estimate of the ultimate cost and expense of all reported and unreported losses that are unpaid as of the balance sheet date. The liability for loss and LAE is recorded net of a tabular reserve discount for workers’ compensation and excess workers’ compensation claims in the amount of $5.5 million (net of reinsurance basis) and $8.4 million at December 31, 2013 and 2012, respectively. The 2013 discount relates to $244.7 million of total net reserves for workers’ compensation. The projection of future claims payments and reporting is based on an analysis of the Company’s historical experience, supplemented by analyses of industry loss data. Management believes that the liability for loss and LAE is an adequate reasonable provision to cover the ultimate cost of losses and claims to date; however, because of the uncertainty from various sources, including changes in reporting patterns, claims settlement patterns, judicial decisions, legislation, and economic conditions, actual loss experience may not conform to the assumptions used in determining the estimated amounts for such liability at the balance sheet date. As adjustments to these estimates become necessary, such adjustments are reflected in expense for the period in which the estimates are changed.
The Company uses reinsurance to limit its exposure to certain risks. Management has evaluated its reinsurance arrangements and determined that significant insurance risk is transferred to the reinsurers. Reinsurance agreements have been determined to be short-duration prospective and retrospective contracts. For prospective contracts, the costs of reinsurance are recognized over the life of the contracts in a manner consistent with the earning of premiums on the underlying policies subject to the reinsurance contract. For retroactive reinsurance agreements, when incurred losses and loss reserves exceed consideration paid for the retroactive reinsurance agreement, a gain results. The gain is deferred and amortized over the estimated remaining settlement period.
Restricted cash balances relate primarily to “Funds at Lloyd’s” collateral balances for its assumed reinsurance programs. The Company also has restricted cash collateralizing its interest rate swap contracts. Restricted cash balances are reported in “Other Assets” on the accompanying consolidated balance sheets. As of December 31, 2013 and 2012, these assets were approximately $134.1 million and $44.2 million, respectively. Certain amounts in prior years have been reclassified to conform to the current year presentation. These reclassifications had no effect on net income or equity.
The Company’s fixed-maturity and equity securities are classified as available-for-sale and carried at fair value. The Company may sell its available-for-sale securities in response to changes in interest rates, risk/reward characteristics, liquidity needs or other factors.
The Company’s other invested assets consist of investments in limited partnerships accounted for using the equity method of accounting, real estate and certain securities for which the Company has elected the fair value option. In accounting for the partnerships, management uses the financial information provided by the general partners, which is on a three-month lag. As of December 31, 2013, the Company had future funding commitments of $45.3 million to these limited partnerships. For securities in which the Company has elected the fair value option, interest and dividends are reported in net investment income with the remaining change in overall fair value reported in other net realized investment gains (losses).
Premiums receivable represent amounts due from insureds and reinsureds for insurance coverage and are presented net of an allowance for doubtful accounts of $17.6 million and $16.5 million at December 31, 2013 and 2012, respectively. The allowance for uncollectible amounts is based on an analysis of amounts receivable giving consideration to historical loss experience and current economic conditions and reflects an amount that, in management’s judgment, is adequate. Uncollectible premiums receivable of $12.1 million, $4.8 million and $3.0 million were written off in 2013, 2012 and 2011, respectively.
Acquisition costs represent the costs of writing business that vary with, and are primarily related to, the successful production of insurance business (principally commissions, premium taxes and certain underwriting costs). Policy acquisition costs are deferred and recognized as expense as related premiums are earned. Deferred acquisition costs (“DAC”) presented in the balance sheet are net of deferred ceding commission revenue.
The second and third quarter reserve increases were viewed by the Company as events or circumstances that required the Company to perform a detailed quantitative analysis of whether its recorded goodwill was impaired. After performing the quantitative analysis in the second quarter of 2013, it was determined that $214.0 million of goodwill, which represents all of the goodwill allocated to the Commercial Insurance reporting unit, was impaired. In the third quarter of 2013, management in its judgment impaired the remaining $55.5 million of goodwill, all of which was allocated to the Personal Insurance reporting unit. See “Note 7 - Goodwill, Intangible and Fixed Asset Impairments” for additional detail on the Goodwill impairment.
Tower’s other assets balances are comprised primarily of fixed assets, restricted cash, deposit assets, receivables for securities sold, receivables for the participation in involuntary pools and current tax receivables.
Furniture, leasehold improvements, computer equipment, and software, including internally developed software, are reported at cost less accumulated depreciation and amortization. We periodically evaluate our long-lived assets to be held and used. Our judgments regarding the existence of impairment indicators are based on factors such as operational performance, market conditions and legal factors. Any adverse changes in these factors could cause an impairment in our assets. For long-lived assets to be held and used, if an impairment indicator exists, we compare the expected future undiscounted cash flows against the carrying amount of that asset. If the sum of the estimated undiscounted cash flows is less than the carrying amount of the asset, we record an impairment loss for the carrying amount in excess of the estimated fair value, if any, of the asset. Gross fixed assets and accumulated depreciation were $194.0 million and $54.7 million, as of December 31, 2013, and 2012, respectively. As a
Management in its judgment concluded that a full valuation allowance was required for the net deferred tax assets after its consideration of the cumulative three-year pre-tax loss in its U.S. taxed subsidiaries resulting from certain 2013 events and the 2012 pre-tax loss of $61.0 million. In 2013, Tower had $325.6 million of prior year adverse reserve development, of which $149.7 million was recorded in Tower’s U.S. taxed subsidiaries. Management believes that the negative evidence associated with the realizability of its net deferred tax asset (including the cumulative three-year pre-tax loss, the prior year adverse reserve development, and the effects of Hurricane Irene in 2011 and Superstorm Sandy in 2012) outweighed the positive evidence that the deferred tax assets, including the net operating loss carryforward would be realized, and subsequently recorded the full valuation allowance.
The Company accounts for the treasury stock at the repurchase price as a reduction to shareholders’ equity as it does not currently intend to retire the treasury stock held at December 31, 2013.
Financial instruments that potentially subject the Company to concentration and credit risk are primarily cash and cash equivalents, investments, interest rate swaps, premiums receivable and reinsurance recoverables. Investments are diversified through many industries and geographic regions through the use of money managers who employ different investment strategies. The Company limits the amount of credit exposure with any one financial institution and believes that no significant concentration of credit risk exists with respect to cash and investments. The interest rate swap contracts contain credit support annex agreements with collateral posting provisions which reduces counterparty non-performance risk. The premiums receivable balances are generally diversified due to the number of entities comprising the Company’s distribution network and its customer base, which is largely concentrated in the Northeast, Florida, Texas and California. To reduce credit risk, the Company performs ongoing evaluations of its distribution network’s and customers’ financial condition. The Company also has receivables from its reinsurers. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company periodically evaluates the financial condition of its reinsurers and, in certain cases, requires collateral from its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. As of December 31, 2013, the largest uncollateralized reinsurance recoverable balance from any one reinsurer was $56.4 million representing 6.8% of the Company’s total reinsurance recoverable balance. Management’s policy is to review all outstanding receivables at period end as well as the bad debt write-offs experienced in the past and establish an allowance for doubtful accounts, if deemed necessary.
Our largest agent accounted for 9.7%, 7.5% and 10%, respectively, of the insurance subsidiaries’ premiums receivable balances at December 31, 2013, 2012 and 2011. Our largest agent accounted for 9%, 7% and 7% of the insurance subsidiaries’ direct premiums written in 2013, 2012 and 2011, respectively.
In July 2012, the Financial Accounting Standards Board (FASB) issued an accounting standard that allows a company, as a first step in an impairment review, to assess qualitatively whether it is more likely than not that an indefinite-lived intangible asset is impaired. We are not required to calculate the fair value of an indefinite-lived intangible asset and perform a quantitative impairment test unless we determine, based on the results of the qualitative assessment, that it is more likely than not the asset is impaired. The standard became effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. We adopted the standard on its required effective date of January 1, 2013. (See Note 7 for a discussion of Goodwill, Intangible and Fixed Asset Impairments in 2013).
Under this standard, the entire amount of the cumulative translation adjustment associated with the foreign entity should be released into earnings when there has been: (i) a sale of a subsidiary or group of net assets within a foreign entity and the sale represents a complete or substantially complete liquidation of the foreign entity in which the subsidiary or the net assets had resided; (ii) a loss of a controlling financial interest in an investment in a foreign entity; or (iii) a change in accounting method from applying the equity method to an investment in a foreign entity to consolidating the foreign entity. The standard is effective for fiscal years and interim periods beginning after December 15, 2013, and will be applied prospectively. We plan to adopt the standard on its required effective date of January 1, 2014 and do not expect the adoption of the standard to have a material effect on our consolidated financial condition, results of operations or cash flows.
In July 2013, the FASB clarified the applicable guidance for the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward as long as it is available, at the reporting date under the tax law of the applicable jurisdiction, to settle any additional income taxes that would result from the disallowance of a tax position (with certain exceptions). The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. This ASC update is effective for annual and interim periods beginning after December 15, 2013, with early adoption permitted, and is to be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The Company does not expect the adoption of this standard to have a material impact on its financial position or results of operations.
In July 2013, the FASB issued an accounting standard that permits the Federal Funds Effective Swap Rate (or Overnight Index Swap Rate) to be used as a U.S. benchmark interest rate for hedge accounting purposes in addition to U.S. Treasury rates and LIBOR. The standard also removes the prohibition on the use of differing benchmark rates when entering into similar hedging relationships. The standard became effective on a prospective basis for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013 to the extent the Federal Funds Effective Swap Rate is used as a U.S. benchmark interest rate for hedge accounting purposes. The Company will consider this guidance if and when it enters into any new hedging relationships.
On August 20, 2012, TGI closed on its previously announced $74.9 million acquisition of a 10.7% stake in Canopius Group. In connection with this acquisition, TGI also entered into an agreement dated April 25, 2012 (the “Master Transaction Agreement”) under which Canopius Group committed to assist TGI with the establishment of a presence at Lloyd’s of London through a special purpose syndicate (“SPS Transaction Right and Acquisition Right”) (subject to required approvals) and granted TGI an option (the “Merger Option”) to combine with Canopius Bermuda. On July 30, 2012, TGI announced that it had exercised the Merger Option and executed an Agreement and Plan of Merger (the “Original Merger Agreement”) with Canopius Bermuda pursuant to which a wholly-owned subsidiary of Canopius Bermuda would acquire all of TGI’s common stock. TGI paid Canopius Group a fee of $1,000,000 to exercise the Merger Option. On November 8, 2012, the Original Merger Agreement was amended by Amendment No. 1 to the Agreement and Plan of Merger to reflect changes to the merger consideration to be received by TGI shareholders (the Original Merger Agreement as so amended, the “Merger Agreement”).
Immediately after giving effect to the issuance of Common Shares to the former TGI shareholders in the Canopius Merger Transaction, approximately 57,432,150 Common Shares were outstanding, of which 76% were held by the former TGI shareholders. The remaining 24% of Common Shares outstanding immediately after giving effect to the Canopius Merger Transaction were held by third party investors. TGIL, succeeding to the attributes of TGI as registrant, including TGI’s SEC file number, TGIL’s Common Shares trade on the same exchange, the NASDAQ Global Select Market, and under the same trading symbol, “TWGP,” that the shares of TGI common stock traded on and under prior to the Canopius Merger Transaction.
With proceeds from the sale, Tower has paid in full the $70.0 million outstanding on its credit facility led by Bank of America, N.A., and the credit facility has been terminated.
The purchase consideration was determined based on the total consideration received by Canopius Group for its sale of 100% of its equity ownership of Canopius Bermuda, and the proceeds received for the issuance and exercise of the Merger Option from TGI.
Direct costs of the acquisition were expensed as incurred. During the year ended December 31, 2013, the Company recognized approximately $20.3 million of such costs, all of which have been classified within “acquisition-related transaction costs” on the consolidated statement of operations. Such costs included $11.6 million in compensation expense (of which accelerated vesting of restricted stock was $10.3 million) and $8.7 million in legal and accounting fees.
The resulting goodwill recognized in connection with the Canopius Merger Transaction was mainly derived from the synergies and economies of scale expected to result from the combined operations of the Company. This goodwill was fully impaired in the second quarter of 2013. See “Note 7 - Goodwill, Intangible and Fixed Asset Impairments” for the allocation of the Canopius Merger Transaction goodwill by segment and discussion on the non-cash impairment charge.
The fair value of loss and loss adjustment expenses includes $19.1 million of reserves for risk premiums (“risk premiums”). The risk premium was determined using a cash flow model. This model used an estimate of net nominal future cash flows related to liabilities for losses and loss adjustment expenses that a market participant would expect as of the date of the transaction. These future cash flows were adjusted for the time value of money at a risk free rate and a risk margin to compensate an acquirer for bearing the risk associated with the liabilities. The risk premium was fully amortized in the third quarter of 2013 in connection with the September 30, 2013 commutation and novation of the Syndicate 4444 YOA 2012 and YOA 2011 and prior years assumed reinsurance and retrocession agreements.
Since the effective date of the Canopius Merger Transaction on March 13, 2013 through December 31, 2013, the operations of the acquired business accounted for approximately $53.5 million and $(11.8) million of the Company’s consolidated revenues and net income (loss), respectively.
The cost or amortized cost and fair value of the Company’s investments in fixed maturity and equity securities, gross unrealized gains and losses, and other-than-temporary impairment losses as of December 31, 2013 and December 31, 2012 are summarized as follows:
In addition, the Company had $248.9 million and $481.5 million of investments as of December 31, 2013 and 2012, respectively, held by counterparties as collateral or in trusts to support letters of credit issued on Tower’s behalf, reinsurance liabilities on certain assumed reinsurance treaties and obligations under certain leases.
Proceeds from the sale of fixed-maturity securities were $1.7 billion, $1.8 billion and $2.0 billion for the years ended December 31, 2013, 2012 and 2011, respectively. Proceeds from the sale of equity securities were $1.3 billion, $1.4 billion and $793.9 million for the years ended December 31, 2013, 2012 and 2011, respectively.
The evaluation of equity securities includes management’s intent and ability to hold the security to recovery. Management will record OTTI in those situations where it does not intend to hold the security to recovery or if the security is not expected to recover in value in the near term.
The following table shows the amount of fixed-maturity and equity securities that were OTTI for the years ended December 31, 2013, 2012 and 2011. This resulted in recording impairment write-downs included in net realized investment gains (losses), and reduced the unrealized loss in other comprehensive net income:
There are 511 securities at December 31, 2013, including fixed maturities and equity securities, which account for the gross unrealized loss, none of which is deemed by management to be OTTI. Temporary losses on corporate and other bonds result from purchases made in a lower interest rate environment or lower yield spread environment. In addition, there have been some ratings
For all fixed-maturity securities in an unrealized loss position at December 31, 2013, the Company has received all contractual interest payments (and principal if applicable). Based on the continuing receipt of cash flow and the foregoing analyses, management expects continued timely payments of principal and interest and considers the losses to be temporary.
The unrealized loss position associated with the fixed-maturity portfolio was $23.6 million as of December 31, 2013, consisting primarily of municipal bonds, corporate and other bonds and U.S. Treasury securities of $19.9 million. The total fixed-maturity portfolio of gross unrealized losses included 490 securities which were, in aggregate, approximately 3.0% below amortized cost. Of the 490 fixed maturity investments identified, 68 have been in an unrealized loss position for more than 12 months. The total unrealized loss on these investments at December 31, 2013 was $4.2 million. Management does not consider these investments to be other-than-temporarily impaired.
For common stocks, there were 20 securities in a loss position at December 31, 2013 totaling $2.6 million. Management evaluated the financial condition of the common stock issuers, the severity and duration of the impairment, and our ability and intent to hold to recovery and determined these securities are not OTTI. The evaluation consisted of a detailed review, including but not limited to some or all of the following factors for each security: the current S&P rating, analysts’ reports, past earnings trends and analysts’ earnings expectations for the next 12 months, liquidity, near-term financing risk, and whether the company was currently paying dividends on its equity securities. Management does not consider these investments to be other-than-temporarily impaired.
Securities reported under the fair value option include eight securities for which the Company has elected the fair value option. This election was made to simplify the accounting for these instruments which contain embedded derivatives and other features.
The significant inputs used to determine fair value of these limited partnerships are considered Level 3 pursuant to the fair value hierarchy. See “Note 6 - Fair Value Measurements” below. As of December 31, 2013, the Company and its insurance companies had future funding commitments of $45.3 million including but not limited to the limited partnerships.
The Additional Payment derivative’s fair value was calculated as discussed in “Note 3 - Canopius Merger Transaction.” The significant unobservable inputs included the estimated sales price Bregal could sell Canopius Group to a third party and the probability of such a sale closing. In December 2013, Bregal executed a stock purchase agreement with a third party.
As of December 31, 2013 and 2012, the Company’s financial instruments carried at fair value are allocated among levels as follows:
In 2013, there were no transfers of investments between Level 1 and Level 2 and one investment transfer between Level 2 and Level 3. In 2012, there were no transfers of investments between Level 1 and Level 2 or between Level 2 and Level 3.
At December 31, 2013, management transferred a private convertible bond with a fair value of $3.4 million from Level 2 to Level 3. During the fourth quarter, management used a liquidation pricing methodology to determine the convertible bond’s fair value as of December 31, 2013 and the change in pricing methodology for this security resulted in the Company recording an OTTI loss of $3.6 million, which was reported through realized losses.
Management is responsible for the determination of the value of the investments carried at fair value and the supporting methodologies and assumptions. Management has reviewed the pricing techniques and methodologies of the independent pricing sources and believes that their policies adequately consider market activity, either based on specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. Management monitors security-specific valuation trends and discusses material changes or the absence of expected changes with
The following table summarizes changes in Level 3 assets measured at fair value for the years ended December 31, 2013, 2012 and 2011 for Tower (the Reciprocal Exchanges do not have any Level 3 assets):
(1) All activity for years ended December 31, 2012 and 2011 is comprised of other invested assets
In the third quarter of 2013, the Company re-evaluated the way it presents its results by segment, as described in “Note 1 - Nature of Business”. Following the third quarter 2013 reorganization, based on the information reviewed by the Company’s chief operating decision maker, the Company concluded it had three reporting units corresponding to it each of the business segments: (i) Commercial Insurance, (ii) Assumed Reinsurance and (iii) Personal Insurance. (Each of the reporting units corresponds with the Company’s reporting segments).
each reporting unit and the level of the Company’s own share price. Fair value estimates utilize both the market approach and income approach. Management considered valuation techniques such as peer company price-to-earnings and price-to-book multiples and an in-depth analysis of projected future cash flows and relevant discount rates, which considered market participant inputs. Other significant assumptions include levels of surplus available for distribution, future business growth and earnings projections for each reporting unit. Estimates of fair value are subject to assumptions that are sensitive to change and represent the Company’s reasonable expectation regarding future developments. Management also considers the implied control premium derived from its market capitalization and the implied fair value of the enterprise.
In its 2012 annual impairment test, management determined that a greater risk of future impairment existed for the Commercial Insurance reporting unit. During the second quarter of 2013, management in its judgment concluded a quarterly impairment test was required as a result of the reorganization and significant prior years’ loss reserves incurred (see “Note 10 - Loss and Loss Adjustment Expense”). In the third quarter of 2013, as a result of the additional significant prior years’ loss reserves incurred, management in its judgment concluded a quarterly impairment test was required again as of September 30, 2013 in the preparation of the September 30, 2013 consolidated financial statements.
Step 1 of the impairment test indicated the Commercial Insurance unit’s carrying value exceeded its fair value and the Personal Insurance unit’s fair value exceeded its carrying value.
Step 1 of the impairment test as of September 30, 2013 indicated the Personal Insurance unit’s carrying value exceeded its fair value.
The components of intangible assets and their useful lives, accumulated amortization, and net carrying value as of December 31, 2013 and 2012 are as follows:
The activity in the components of intangible assets for the years ended December 31, 2013 and 2012 consisted of intangible assets acquired from business combinations and amortization expense as shown in the table below:
No impairments were identified during the years ended December 31, 2012 and 2011, respectively.
Furniture, leasehold improvements, computer equipment, and software, including internally developed software, are reported at cost less accumulated depreciation and amortization. As of December 31, 2012, gross fixed assets and capital leases were $194.0 million and accumulated depreciation was $54.7 million (for net fixed assets and capital leases of $139.3 million).
Tower’s 2013 quota share reinsurance program ceded 40.0% of the homeowners business written by the companies obtained in the OBPL transaction in the north east. This coverage had a $250 million per occurrence cap. Tower also ceded 30% of the homeowners business written by the other Tower companies in the north east. This coverage had a $230 million occurrence cap. On November 1, 2013, Tower placed a 35% quota share on the same homeowners subject business. This coverage has an occurrence limit of 135% of the ceded earned premium and will expire on May 31, 2014.
On July 1, 2013, Tower ceded 17.5% of its auto liability, other liability and commercial package brokerage business to Arch. This coverage has an occurrence limit of $25 million and a loss ratio cap of 120% of the ceded reinsurance premium. This coverage expired on December 31, 2013, on a run-off basis. On July 1, 2013, Tower also ceded 14.0% of its auto liability, other liability, workers’ compensation and commercial package brokerage business to Hannover. This coverage had occurrence limits of $10 million for PCS events, $5 million for auto liability, other liability and commercial package liability, $2 million for workers’ compensation and a per risk limit of $5 million for commercial package property, and a loss ratio cap of 110%. This coverage expired on December 31, 2013, on a run-off basis.
Effective July 1, 2013, Tower ceded 30% quota share of its workers’ compensation and employer’s liability business to Southport Re. The agreement covered losses occurring on or after July 1, 2013 for policies in force as of June 30, 2013 and policies written or renewed during the term of the agreement, subject to a maximum liability of $1.5 million per loss occurrence and has been accounted for using deposit accounting treatment. Deposit assets of $28.7 million as of December 31, 2013 are reflected in Other assets in the consolidated balance sheet. Effective July 1, 2013, Tower also purchased from Southport Re an Aggregate Excess of Loss Agreement covering a portion of the losses incurred by Tower on its workers’ compensation and employer’s liability business between January 1, 2011 and May 31, 2013, but paid by on or after June 1, 2013. The coverage was provided in three layers. Each layer provided coverage for varying percentages of losses per underwriting period, not to exceed a specified percentage of the earned premium on the subject business through May 31, 2013, up to caps applicable to each of the layers. The Southport Quota Share and Southport Re ADCs were terminated on February 14, 2014, after determining that such reinsurance agreements were no longer necessary as of result of Tower’s recent rating agency downgrades. In 2014, the company will record a gain of approximately $6.4 million resulting from the terminations.
On January 3, 2014, concurrently with the execution of the ACP Re Merger Agreement, Tower had entered into two Cut-Through Reinsurance Agreements, pursuant to which a subsidiary of AmTrust and a subsidiary of NGHC agreed to provide 100% quota share reinsurance and a cut-through endorsement to cover all eligible new and renewal commercial and personal lines business, respectively, and at their option, losses incurred on or after January 1, 2014 on not less than 60% of the in-force business. Tower received confirmation on January 16, 2014 from AmTrust and NGHC that they would exercise such option to reinsure on a cut -through basis losses incurred on or after January 1, 2014 under in-force policies with respect to (1) in the case of AmTrust, a significant majority of Tower’s unearned premium reserves as of December 31, 2013 with respect to its ongoing commercial lines business, and (2) in the case of NGHC, 100% of Tower’s unearned premium reserves as of December 31, 2013 with respect to its personal lines segment business. Tower received a 20% ceding commission from AmTrust or NGHC on all Tower premiums that are subject to the Cut-Through Reinsurance Agreements.
Under the terms of the excess of loss programs in 2012, Tower was at risk of loss for $5.0 million on property, $3.5 million on workers’ compensation and $2.5 million on umbrella. The Company then had reinsurance coverage up to $30 million for property, $60 million for workers’ compensation, and $5 million for umbrella. In addition, the Company also had “clash coverage” in effect for 2012 for a limit of $5 million in excess of $5 million which applies to the aggregate liability for liability losses from multiple insureds involved in the same occurrence.
Tower’s 2012 quota share reinsurance cedes 35.5% of the homeowners business written by the companies obtained in the OBPL transaction in the north east. This coverage has a $288 million per occurrence cap.
In 2011, Tower was at risk of loss for the first $5.0 million on property, $2.5 million on workers’ compensation and $2.5 million on umbrella. The Company then had reinsurance coverage up to $30 million for property, $50 million for workers’ compensation, and $5 million for umbrella. In addition, the Company also had “clash coverage” in effect for 2012 for a limit of $5 million in excess of $5 million which applies to the aggregate liability for liability losses from multiple insureds involved in the same occurrence. The property catastrophe program renewed on July 1, 2011 had a retention of $75 million per catastrophe, had 60% catastrophe protection for the next $50 million of loss above the $75 million, and 100% percent catastrophe protection for the next $775 million of loss in excess of $125 million.
As of December 31, 2013 and 2012, the Company had $440.4 million and $495.9 million, respectively, of reinsurance recoverables and ceded unearned premiums with reinsurers rated A- or higher by A.M. Best. These represented 53.0% and 91.7%, respectively, of the Company’s total reinsurance recoverables as of those dates. As of December 31, 2013 and 2012, the largest reinsurance recoverable balance with any one reinsurer was approximately 364.2% and 8.6% of the Company’s shareholders’ equity. The largest reinsurance recoverable balance as of December 31, 2013 was due from Southport Re, of which 96.1% was collateralized or in a funds withheld account.
The estimated ultimate loss ratios are the Company’s best estimate based on facts and circumstances known at the end of each period that losses are estimated. The estimation process is complex and involves the use of informed estimates, judgments and actuarial methodologies relative to future claims severity and frequency, the length of time for losses to develop to their ultimate level, possible changes in law and other external factors. The same uncertainties associated with estimating loss and loss adjustment expense reserves affect the estimates of ceding commissions earned. The Company monitors and adjusts the ultimate loss ratio on a quarterly basis to determine the effect on the commission rate and ceding commissions earned. The decrease in estimated ceding commission income relating to prior years recorded in 2013, 2012 and 2011 was $9.8 million, $4.2 million and $0.1 million, respectively.
The components of the liability for loss and LAE expenses and related reinsurance recoverables for the years ended December 31, 2013 and 2012 are as follows:
The following tables provide a reconciliation of the beginning and ending consolidated balances for unpaid losses and LAE for the years ended December 31, 2013, 2012 and 2011:
The consolidated net loss ratio, which includes the Reciprocal Exchanges, was 100.5% and 73.4% for the years ended December 31, 2013 and 2012, respectively. Excluding the Reciprocal Exchanges, the net loss ratio was 103.9% and 74.1% for the years ended December 31, 2013 and 2012, respectively. The Reciprocal Exchanges’ net loss ratio was 71.3% and 66.7% for the years ended December 31, 2013 and 2012, respectively.
Excluding the Reciprocal Exchanges, there was a reserve increase of $533.0 million for the year ended December 31, 2013 comprised of favorable development of $1.4 million in Personal Insurance, favorable development of $5.4 million in Assumed Reinsurance segment and adverse development of $539.8 million in Commercial Insurance.
Incurred losses and LAE for the years ended December 31, 2013 and 2012 included reductions in loss and loss expense reserves pertaining to the amortization of the reserve risk premium on loss reserves recorded in connection with the Company’s acquisitions in prior years. Excluding the Reciprocal Exchanges these reductions in loss reserves were $19.1 million and $7.2 million, respectively, for 2013 and 2012. The Reciprocal Exchanges had reductions in loss reserves of nil for 2013 and $2.5 million for 2012.
Loss and loss adjustment expense reserves. The reserving process for loss and LAE reserves provides management’s best estimate at a particular point in time of the ultimate unpaid cost of all losses and LAE incurred, including settlement and administration of losses, and is based on facts and circumstances then known and including losses that have been incurred but not yet reported. The process includes using actuarial methodologies to assist in establishing these estimates, judgments relative to estimates of future claims severity and frequency, the length of time before losses will develop to their ultimate level and the possible changes in the law and other external factors that are often beyond our control. There are various actuarial methods that are appropriate for the different lines of business, and our actuaries’ use of a particular method or weighting of methods depends in part on the maturity of each accident year by line of business, the limits of liability covered under the policies, the presence or absence of large claims in the experience, and other considerations. In general, the various actuarial methods can be grouped into three categories: loss ratio projection, loss development methods, and the Bornhuetter-Ferguson (“B-F”) method. For the most recent accident year, and especially for liability lines of business, the actuarial method given the most weight is usually the loss ratio method, since the percentage of ultimate claims reported to date is expected to be low and the immature reported claims experience is not a reliable indicator of ultimate losses for that accident year. For property lines of business for the most recent accident year, the B-F method is usually given the most weight, because experience typically shows that there is a small percentage of claims reported in the subsequent period due to normal lags in reporting and processing of claims in these lines of business that can be relatively reliably estimated as a percentage of premiums, which is reflected in the B-F method. For each line of business, the actuarial reserving method usually given the most weight shifts from the loss ratio projection to the B-F method to the incurred loss projection as each accident year matures.
This process helps management set carried loss reserves based upon the actuaries’ best estimates, using estimates made by segment, product or line of business, territory, and accident year. The actuaries also separately estimate loss reserves from LAE reserves and within LAE reserves estimates are made for defense and cost containment expenses or Allocated Loss Adjustment Expenses (“ALAE”) and for other claims adjusting expenses or Unallocated Loss Adjustment Expenses (“ULAE”). The amount of loss and LAE reserves for reported claims is a matter of judgment based primarily upon a case-by-case evaluation of coverage, liability, injury severity, and any other information considered pertinent to estimating the exposure presented by the claim. The amounts of loss and LAE reserves for unreported claims are determined using historical information by line of business as adjusted to current conditions. Due to the inherent uncertainty associated with the reserving process, the ultimate liability may differ, perhaps substantially, from the original estimate. Such estimates are regularly reviewed and updated, and any resulting adjustments are included in the current year’s results. Reserves are closely monitored and are recomputed periodically using the most recent information on reported claims and a variety of statistical techniques. Specifically, on at least a quarterly basis, we review, by line of business, existing reserves, new claims, changes to existing case reserves and paid losses with respect to the current and prior years. See “Business-Loss and Loss Adjustment Expense Reserves” for additional information regarding our loss and LAE reserves.
Automobile Liability. Commercial Insurance segment reserves are estimated separately from Personal Insurance segment reserves. For the Commercial Insurance segment we analyze reserves by line of business and, where appropriate, by program. Within the Personal Insurance segment, we estimate loss and loss expenses reserves separately for the Reciprocal Exchanges, which we manage, and for our owned companies. We utilize line of business breakdowns and, where appropriate, analyze results separately by state.
For the years ended December 31, 2013 and 2012, 2,674 and no new common shares, respectively, were issued as the result of employee stock option exercises and 242,626 and 422,176 new common shares, for the same periods, respectively, were issued as the result of restricted stock grants.
For the years ended December 31, 2013 and 2012, 345,946 and 117,377 shares, respectively, of common stock were purchased from employees in connection with the vesting of restricted stock issued under the 2008 Long Term Equity Compensation Plan (the “Plan”). The shares were withheld at the direction of employees as permitted under the Plan in order to pay the expected
amount of tax liability owed by the employees from the vesting of those shares. In addition, for the years ended December 31, 2013 and 2012, 57,080 and 28,513 shares, respectively, of common stock were surrendered as a result of restricted stock forfeitures.
In connection with the Canopius Merger Transaction, all Treasury shares held by TGI as of the effective date of the Canopius Merger Transaction were cancelled. There were 55,471 Treasury shares of the Company held at December 31, 2013.
The Company will not resume paying dividends in the near future even if the necessary financial conditions are met and if sufficient cash is available for distribution.
The Company’s borrowings consisted of the following at December 31, 2013 and 2012:
The fair value of the convertible senior notes are determined utilizing recent transaction prices for these securities between third-party market participants and the fair value of the subordinated debentures are based on discounted cash flow analysis. The significant inputs used for fair value are considered Level 2 in the fair value hierarchy.
non-payment of all or any part of the principal of the subordinated debentures;
our failure to comply with the covenants or other provisions of the indentures or the subordinated debentures;
If an event of default occurs and is continuing, the entire principal and the interest accrued on the affected subordinated debentures and junior subordinated debentures may be declared to be due and payable immediately.
In October 2010, the Company entered into interest rate swap contracts (the “Swaps”) with $190 million notional value to manage interest costs and cash flows associated with the floating rate subordinated debentures. The Swaps have terms of five years. The majority of the Swaps is forward starting and become effective when the respective subordinated debentures change from fixed to floating rates and convert the subordinated debentures to fixed rates ranging from 5.1% to 5.9%. As of December 31, 2013 and 2012, the Swaps had a fair value of $6.1 million and $9.0 million, respectively, in a liability position and are reported in Other Liabilities.
The credit facility contained customary covenants for facilities of this type, including restrictions on indebtedness and liens, limitations on mergers, dividends and the sale of assets, and requirements to maintain certain consolidated net worth, debt to capitalization ratios, minimum risk-based capital and minimum statutory surplus. The credit facility also provided for customary events of default, including failure to pay principal when due, failure to pay interest or fees within three days after becoming due, failure to comply with covenants, any representation or warranty made by TGI or the Company as a guarantor being false in any material respect, default under certain other indebtedness, certain insolvency or receivership events affecting the TGI or the Company as guarantor and its material subsidiaries, the occurrence of certain material judgments, or a change in control of the Company, and upon an event of default, the administrative agent (subject to the consent of the requisite percentage of the lenders) was able to immediately terminate the obligations to make loans and to issue letters of credit, declare the Company’s obligations
under the credit facility to become immediately due and payable, and require the Company to deposit in a collateral account cash collateral with a value equal to the then outstanding amount of the aggregate face amount of any outstanding letters of credit.
The adjusted conversion rate at December 31, 2013 is 41.4269 shares of common stock per $1,000 principal amount of the Notes (equivalent to a conversion price of $24.14 per share), subject to further adjustment upon the occurrence of certain events, including the following: if Tower issues shares of common stock as a dividend or distribution on shares of the common stock, or if Tower effects a share split or share combination; if Tower issues to all or substantially all holders of common stock any rights, options or warrants entitling them, for a period of not more than 45 calendar days after the announcement date of such issuance, to subscribe for or purchase shares of the common stock at a price per share that is less than the average of the last reported sales price of the common stock for the ten consecutive trading day period ending on the date of announcement of such issuance; if Tower distributes shares of its capital stock, other indebtedness, other assets or property of Tower or rights, options or warrants to acquire capital stock or other securities of Tower, to all or substantially all holders of capital stock; if any cash dividend or distribution is made to all or substantially all holders of the common stock, other than a regular quarterly cash dividend that does not exceed $0.110 per share; if Tower makes a payment in respect of a tender offer or exchange offer for common stock, and the cash and value of any other consideration included in the payment per share of common stock exceeds the last reported sale price of the common stock on the trading day next succeeding the last day on which the tenders or exchange may be made.
The proceeds from the issuance of the Notes were allocated to the liability component and the embedded conversion option, or equity component. The equity component was reported as an adjustment to paid-in-capital, net of tax, and is reflected as an original issue discount (“OID”). The OID of $11.5 million and $5.0 million of deferred origination costs relating to the liability component are being amortized into interest expense over the term of the Notes. After considering the contractual interest payments and amortization of the original issue discount, the Notes’ effective interest rate is 7.2%. Transaction costs of $0.4 million associated with the equity component were netted with the equity component in paid-in-capital. Interest expense, including amortization of deferred origination costs, recognized on the Notes was $11.9 million for the year ended December 31, 2013.
The following table shows the amounts recorded for the Notes as of December 31, 2013 and 2012:
In connection with the offering of the Notes, the Company also entered into convertible senior notes hedge transactions (the “Note Hedges” or “purchased call options”) and warrant transactions (the “Warrants”) with respect to its common stock with financial institutions. The Note Hedges and Warrants were intended generally to reduce the potential dilution of the Company’s common stock and to offset potential cash payments in excess of the principal of the Notes upon conversion. The Note Hedges and Warrants were separate transactions, entered into by the Company with the financial institutions, and were not part of the terms of the Notes.
In March 2013, as a result of the Canopius Merger Transaction, the Company terminated the Note Hedges and Warrants. The Company received $2.4 million and paid $1.0 million to terminate the Note Hedges and Warrants, respectively. The effects of the terminations and an associated tax adjustment of $0.8 million were recorded directly to paid-in-capital in shareholders’ equity.
In 2008, the Company’s Board of Directors adopted and its shareholders approved the 2008 LTEP, which amended and revised the 2004 Long-Term Equity Compensation Plan.
The 2008 LTEP provides for the granting of non-qualified stock options, incentive stock options (within the meaning of Section 422 of the Internal Revenue Code), stock appreciation rights (“SARs”), restricted stock and restricted stock unit awards, performance shares and other cash or share-based awards. The maximum amount of share-based awards authorized is 2,325,446 of which 73,441 are available for future grants as of December 31, 2013.
The Compensation Committee of the Board of Directors has established, beginning in 2013 a new Long Term Incentive Plan (the “2013 LTIP”), to replace the Company’s existing 2008 Long Term Equity Compensation Plan. The 2013 LTIP was approved by the shareholders in May 2013. The maximum amount of share-based awards authorized is 2,150,000 of which 2,147,531 are available for future grants as of December 31, 2013.
On March 13, 2013, 525,548 shares vested as a result of the Canopius Merger Transaction.
The following table provides an analysis of stock option activity for the years ended December 31, 2013, 2012 and 2011 (historical share counts and fair values have been adjusted for the 1.1330 share conversion ratio, as discussed more fully in “Note 3 - Canopius Merger Transaction”). As of December 31, 2013, the exercise price for all stock options exceeds the December 31, 2013 common share price.
The following table provides an analysis of stock based compensation expense for the years ended December 31, 2013, 2012 and 2011:
Under current Bermuda Law the Company is not required to pay any taxes on Bermuda based income or capital gains. The Company has received an undertaking from the Minister of Finance in Bermuda that in the event of such taxes being imposed, the Company will be exempted from taxation until the year 2035 pursuant to the Bermuda Exempted Undertakings Tax Protection Act of 1966. The Company’s United States-based subsidiaries are subject to federal, state and local taxes, as applicable, on income and capital gains earned by those subsidiaries.
The Company and TRL, its Bermuda reinsurance subsidiary, are deemed to have permanent establishments in Bermuda. The Bermuda companies have not and do not expect to be engaged in the conduct of a trade or business in the U.S. All transactions between Tower’s U.S.-based subsidiaries and the Bermuda companies are subject to transfer pricing rules. The Company has executed certain reinsurance treaties and service agreements between its U.S.-based subsidiaries and TRL and management believes these arrangements to be conducted at current market rates and in accordance with transfer pricing rules.
The provision for Federal, state and local income taxes consist of the following components for the years ended December 31, 2013, 2012 and 2011:
Deferred tax assets and liabilities are determined using the enacted tax rates applicable to the period the temporary differences are expected to be recovered. Accordingly, the current period income tax provision can be affected by the enactment of new tax rates. The net deferred income taxes on the balance sheet reflect temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and income tax purposes. Significant components of the consolidated deferred tax assets and liabilities are as follows:
At December 31, 2013, a full valuation allowance was recorded against the deferred tax assets. For the year ended December 31, 2013, $240.6 million of the valuation allowance was recorded in income tax expense (benefit) in the statement of operations and $32.5 million was recorded in other comprehensive income as a direct charge to shareholder’s equity ($33.7 million as a component of accumulated other comprehensive income and $(1.2) million as a component of additional paid in capital).
The United States also imposes an excise tax on insurance and reinsurance premiums paid to non-U.S. insurers or reinsurers with respect to risks located in the United States. The rates of tax, unless reduced by an applicable U.S. tax treaty, are four percent for non-life insurance premiums and one percent for life insurance and all reinsurance premiums. The Company incurs federal excise taxes on certain of its reinsurance transactions, including amounts ceded through intercompany transactions. Tower incurred $8.3 million of federal excise tax in 2013.
Section 382 of the Internal Revenue Code (“Section 382”) imposes annual limitations on the ability of a corporation to utilize its net operating tax loss carryforwards (“NOLs”) if the corporation experiences an “ownership change” as defined in Section 382. We will perform a Section 382 limitation calculation to determine whether any changes in ownership during 2013, including changes in ownership resulting from the merger with Canopius, caused an “ownership change” that would result in an annual limitation under Section 382. As of December 31, 2013, the Tower NOL totaled $460.6 million, and the NOLs will expire in years 2019 through 2032.
Preserver Group, Inc. (“PGI”), acquired by the Company in 2007, and CastlePoint, acquired by the Company in 2009, had NOLs at the time of the acquisitions of $43.7 million and $17.4 million, respectively. As a result of the acquisitions, those NOLs of PGI and CastlePoint are subject to annual limitations of $2.8 million and $11.1 million, respectively. Any unused annual limitation may be carried over to later years. The PGI and CastlePoint NOLs will expire in years 2025 through 2029.
Additionally, Tower and the Reciprocal Exchanges have an AMT credit of $2.6 million that can be carried over indefinitely.
On January 14, 2014, Derek Wilson, a purported shareholder of Tower, filed a purported class action complaint (the “Wilson Complaint”) against Tower, certain of its current and former directors, ACP Re Ltd. (“ACP Re”), London Acquisition Company Limited (“Merger Sub”), and AmTrust Financial Services, Inc. (“AmTrust”) in the United States District Court for the Southern District of New York. The Wilson Complaint alleges that the members of the Company’s Board of Directors breached their fiduciary duties owed to the shareholders of Tower under Bermuda law by approving Tower’s entry into the ACP Re Merger Agreement and failing to take steps to maximize the value of Tower to its public shareholders, and that Tower, ACP Re, Merger Sub, and AmTrust aided and abetted such breaches of fiduciary duties. The Wilson Complaint also alleges, among other things, that the proposed transaction undervalues Tower, that the process leading up to the ACP Re Merger Agreement was flawed, and that certain provisions of the ACP Re Merger Agreement improperly favor ACP Re and discourage competing offers for the Company. The Wilson Complaint further alleges oppressive conduct against Tower’s shareholders in violation of Bermuda law. The Wilson Complaint seeks, among other things, declaratory and injunctive relief concerning the alleged fiduciary breaches, injunctive relief prohibiting the defendants from consummating the proposed transaction, rescission of the ACP Re Merger Agreement to the extent already implemented, and other forms of equitable relief. On February 27, 2014, the same shareholder filed an amended complaint alleging, in addition, that the defendants disseminated a materially false and misleading preliminary proxy statement regarding the ACP Re Merger Agreement in violation of Sections 14(a) and 20(a) of the Exchange Act and Rule 14a-9 promulgated thereunder (the “Wilson Amended Complaint”).
On March 3, 2014, another purported shareholder filed a purported class action complaint against the Company, certain of its current and former officers and directors, ACP Re, Merger Sub, and AmTrust, also in the United States District Court for the Southern District of New York (the “Raul Complaint”). The Raul Complaint alleges that the defendants disseminated a materially false and misleading preliminary proxy statement regarding the ACP Re Merger Agreement in violation of sections 14(a) and 20(a) of the Exchange Act and Rule 14a-9.
On March 24, 2014, two purported shareholders of the Company filed a purported class action and shareholder derivative complaint against the Company, certain of its current and former officers and directors, and Tower Group, Inc., in the Supreme Court of the State of New York, County of New York (the “Bekkerman Complaint” and, together with the Wilson Amended Complaint and the Raul Complaint, the “Merger Complaints”). The Bekkerman Complaint alleges, among other things, that the members of the Company’s board of directors breached their fiduciary duties owed to the shareholders of the Company by failing to exercise appropriate oversight over the conduct of the Company’s business, awarding Michael Lee excessive compensation, approving the Company’s entry into the ACP Re Merger Agreement, failing to take steps to maximize the value of the Company
to its public shareholders, and misrepresenting or omitting material information in connection with the proposed transaction, and that the Company and Tower Group, Inc., aided and abetted such breaches of fiduciary duties. The Bekkerman Complaint also alleges, among other things, that Lee was unjustly enriched as a result of the compensation he received while allegedly breaching his fiduciary duties and by selling stock while in the possession of material, adverse, non-public information. The Bekkerman Complaint seeks, among other things, an award of money damages, declaratory and injunctive relief concerning the alleged fiduciary breaches, injunctive relief prohibiting the defendants from consummating the proposed transaction, rescission of the ACP Re Merger Agreement to the extent already implemented, and other forms of equitable relief.
Total rental expense was $10.4 million, $9.7 million and $11.1 million in 2013, 2012 and 2011, respectively.
The Company paid $4.9 million, $4.8 million and $5.1 million in 2013, 2012 and 2011, respectively, for its proportional share of the operating expenses of the New York Insurance Department. Property casualty insurance company insolvencies or failures may result in additional security fund assessments to the Company at some future date. At this time the Company is unable to estimate the possible amounts, if any, of such assessments. Accordingly, the Company is unable to determine the impact, if any; such assessments may have on financial position or results of operations of the Company. The Company is permitted to assess premium surcharges on workers’ compensation policies that are based on statutorily enacted rates. Actual assessments have resulted in differences to the original estimates based on permitted surcharges of $1.1 million in 2011. The Company estimates its liability for future assessments based on actual written premiums and historical rates and available information. As of December 31, 2013, the liability for the various workers’ compensation funds, which includes amounts assessed on workers’ compensation policies, was $10.3 million. This amount is expected to be paid over an eighteen month period ending June 30, 2015. As of December 31, 2012 the liability for the various workers’ compensation funds was $7.5 million.
For regulatory purposes, the Company’s U.S.-based insurance subsidiaries, excluding the Reciprocal Exchanges, prepare their statutory basis financial statements in accordance with practices prescribed or permitted by the state they are domiciled in (“statutory basis” or “SAP”). The more significant SAP variances from GAAP are as follows:
For the years ended December 31, 2013, 2012 and 2011, the Company’s insurance subsidiaries had SAP net (loss) income of $(402.4) million, $ (42.3) million and $ 52.0 million, respectively. At December 31, 2013 and 2012 the Company’s insurance subsidiaries had reported SAP capital and surplus of $172.9 million and $594.2 million, respectively, as filed with the insurance regulators.
The Company’s U.S.-based insurance subsidiaries paid zero, $10.2 million and $15.0 million in dividends and or return of capital to TGI in 2013, 2012 and 2011, respectively. As of December 31, 2013, none of the Company’s net statutory assets held at the U.S. insurance subsidiaries were available for distribution or advances to Tower (without prior consent from the insurance regulators).
Based on RBC calculations as of December 31, 2013, six of Tower’s ten U.S. based insurance subsidiaries have capital and surplus below Company Action Level and do not meet the minimum capital and surplus requirements of their respective state regulators. As a result, management has discussed the ACP Re Merger Agreement and the Cut-Through Reinsurance Agreement and provided its 2014 RBC forecasts to the regulators to document the Company’s business plan to bring two of three U.S based insurance subsidiaries’ capital and surplus levels above Company Action Level.
Prepaid expenses and fixed assets have been removed from the statutory balance sheet.
Investments in stocks of subsidiaries are carried as assets on the statutory basis balance sheet. Under GAAP, investments in stocks of subsidiaries are generally consolidated if the investor owns greater than fifty percent or otherwise demonstrates control of the subsidiary.
CastlePoint Re and TRL are also subject to dividend limitations imposed by Bermuda under the Companies Act 1981 of Bermuda, as amended (the “Companies Act”). As of December 31, 2013, CastlePoint Re and TRL were unable to pay dividends to Tower, without BMA approval.
Bermuda based insurance entities minimum capital and surplus requirements are calculated from a solvency formula prescribed by the BMA. As of December 31, 2013, TRL and CastlePoint Re had capital and surplus that did not meet the minimum capital and surplus requirements of the BMA. Management has discussed the ACP Re Merger Agreement and provided 2014 solvency forecasts to the BMA.
The BMA has issued directives for TRL and CastlePoint Re, subjecting them to heightened regulatory oversight and requiring BMA approval before certain transactions can be executed. Tower has been complying with the directives issued by the BMA.
CastlePoint Re paid $22.0 million, $2.5 million and $20.0 million in dividends and/or return of capital to TGI in 2013, 2012 and 2011, respectively. As of December 31, 2013, none of the Company’s net statutory assets held at its Bermuda based insurance subsidiaries were available for distributions or advances to Tower.
The Reciprocal Exchanges prepare their statutory basis financial statements in accordance with SAP. The more significant SAP variances from GAAP are consistent with those discussed above for the U.S.-based insurance subsidiaries.
For the years ended December 31, 2013, 2012 and 2011, the Reciprocal Exchanges had combined SAP net income (loss) of $(8.8) million, $7.4 million and $16.5 million, respectively. At December 31, 2013 and 2012 the Reciprocal Exchanges had combined capital and surplus of $81.2 million and $91.4 million, respectively.
Fixed maturity and equity securities: Fair value disclosures for investments are included in “Note 6-Fair Value Measurements.”
(1) Since the weighted-average shares for the quarters are calculated independently of the weighted-average shares for the year, quarterly earnings (loss) per share may not total to annual earnings per share. Earnings (loss) per share has been calculated using weighted-average shares that have been adjusted for the 1.1330 share conversion ratio resulting from the Canopius Merger Transaction.
(2) Net Income (loss) attributable to Tower Group International, Ltd. and per share amounts have been revised from amounts previously reported to adjust for a correction in income tax expenses by $8.5 million in the second quarter of 2013 and $0.4 million in the third quarter of 2013. The Company adjusted the valuation allowance recorded on its deferred taxes. This correction included an adjustment to increase total liabilities by $8.5 million in second quarter of 2013. This correction resulted in a total increase to liabilities of $8.9 million and cumulative decrease in equity of $8.5 million by the third quarter of 2013. This correction had no impact to cash flows. Management concluded these revisions were not material to the previously reported financial statements.
On January 3, 2014, Tower entered into an Agreement and Plan of Merger (“ACP Re Merger Agreement”) with ACP Re Ltd. (“ACP Re”), and a wholly-owned subsidiary of ACP Re (“Merger Sub”), pursuant to which, subject to the satisfaction or waiver of the conditions therein, Merger Sub would merge with and into Tower, with Tower as the surviving corporation in the merger and a wholly owned subsidiary of ACP Re. The transaction would close in the summer of 2014, subject to the satisfaction or waiver of the closing conditions contained in the ACP Re Merger Agreement. ACP Re is a Bermuda based reinsurance company. The controlling shareholder of ACP Re is a trust established by the founder of AmTrust Financial Services, Inc. (“AmTrust”), National General Holdings Corporation (“NGHC”) and Maiden Holdings, Ltd. Notwithstanding any other statement in this Form 10-K or any other document, many of the conditions for closing the ACP Re Merger Agreement remain outstanding and there can be no assurance that they will be satisfied or that the transaction will be consummated or when it may close.
Pursuant to the terms of the ACP Re Merger Agreement, at the effective time of the merger, each outstanding share of Tower’s common stock, par value $0.01 per share, following the settlement of all outstanding equity awards, will be converted into the right to receive $3.00 in cash, with an aggregate value of approximately $172.1 million.
The ACP Re Merger Agreement was unanimously approved by the respective Boards of Directors of ACP Re and Tower, and is conditioned, among other things, on: (i) the approval of Tower’s shareholders, (ii) receipt of governmental approvals, including antitrust and insurance regulatory approvals (on January 30, 2014, the Company was granted early termination of the Hart-Scott-Rodino waiting period which requires persons contemplating certain mergers or acquisitions to give the Federal Trade Commission and the Assistant Attorney General advanced notice and to wait designated periods before consummation of such plans), (iii) the absence of any law, order or injunction prohibiting the merger, (iv) the accuracy of each party’s representations
and warranties (subject to customary materiality qualifiers), and (v) each party’s compliance with its covenants and agreements contained in the ACP Re Merger Agreement. In addition, ACP Re’s obligation to consummate the merger is subject to the non-occurrence of any material adverse effect on Tower, as well as the absence of any insolvency-related event affecting Tower. The transaction is also conditioned on holders of not more than 15% of Tower’s common stock dissenting to the merger.
There is no financing condition to consummation of the transactions contemplated by the ACP Re Merger Agreement.
In January 2014, Tower’s Board of Directors approved Tower’s merger with ACP Re. In light of the adverse ratings actions, concurrent with entering into its merger agreement with ACP Re, Tower entered into cut-through reinsurance treaties with affiliates of ACP Re. As a result of this merger, if it closes, and the execution of the cut-through reinsurance treaties, Tower believes its insurance subsidiaries will retain significant portions of their business. (See “Note 9 -Reinsurance” for a discussion of the cut-through reinsurance treaties).
Resignation of Tower’s Chairman of the Board, President and Chief Executive Officer and Appointment of new Chairman of the Board and new President and Chief Executive Officer
On February 6, 2014, Tower and Michael H. Lee entered into a Separation and Release Agreement in connection with the resignation of Mr. Lee from his positions as Chairman of the Board of Directors, President and Chief Executive Officer, effective as of February 6, 2014. Mr. Lee’s employment with the Company was terminated effective as of February 6, 2014. In connection with his resignation, Mr. Lee received on March 31, 2014 a severance payment of approximately $3.3 million calculated pursuant to terms of his employment agreement.