The principal executive offices of Alleghany, Alleghany Capital and Roundwood are located in leased office space in New York, New York. TransRe leases office space in New York, New York for its headquarters and office space in almost all of its locations around the world. RSUI leases office space in Atlanta, Georgia for its headquarters and office space in Sherman Oaks, California. CapSpecialty leases office space in Middleton, Wisconsin for its headquarters and office space in its other locations throughout the United States. PacificComp leases office space in Westlake Village, California. Bourn & Koch and Kentucky Trailer own their principal offices and manufacturing facilities, which are located in Rockford, Illinois and Louisville, Kentucky, respectively. SORC leases office space in Golden, Colorado for its headquarters and owns facilities, mineral rights and land in other locations in the Midwestern and Southeastern United States. IPS leases office space in Blue Bell, Pennsylvania for its headquarters and office space in its locations around the world. Alleghany Properties leases office space in Sacramento, California. Management considers its facilities suitable and adequate for the current level of operations. See Note 12(c) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional detail on the leases.
(1) On October 31, 2015, we acquired IPS; on August 30, 2013, we acquired Kentucky Trailer; on April 26, 2012, we acquired Bourn & Koch; and on March 6, 2012, we acquired TransRe.
The following is a discussion and analysis of our financial condition and results of operations for the twelve months ended December 31, 2015, 2014 and 2013. This discussion and analysis should be read in conjunction with our audited consolidated financial statements and Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties and that are not historical facts, including statements about our beliefs and expectations. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and particularly under the headings “Risk Factors,” “Business” and “Note on Forward-Looking Statements” contained in Item 1A, Item 1, and Part I of this Form 10-K, respectively.
Throughout this Form 10-K, our analysis of our financial condition and results of operations is based on our consolidated financial statements which have been prepared in accordance with GAAP. Our results of operations have been presented in the way that we believe will be the most meaningful and useful to investors, analysts, rating agencies and others who use financial information in evaluating our performance. This presentation includes the use of underwriting profit, which is a “non-GAAP financial measure,” as such term is defined in Item 10(e) of Regulation S-K promulgated by the SEC. Underwriting profit represents net premiums earned less net loss and LAE and commissions, brokerage and other underwriting expenses, all as determined in accordance with GAAP, and does not include net investment income, net realized capital gains, other than temporary impairment, or “OTTI,” losses, other income, other operating expenses, corporate administration, amortization of intangible assets or interest expense. We consistently use underwriting profit as a supplement to earnings before income taxes, the most comparable GAAP financial measure, to evaluate the performance of our segments and believe that underwriting profit provides useful additional information to investors because it highlights net earnings attributable to a segment’s underwriting performance. Earnings before income taxes may show a profit despite an underlying underwriting loss, and when underwriting losses persist over extended periods, a reinsurance or an insurance company’s ability to continue as an ongoing concern may be at risk. However, underwriting profit is not meant to be considered in isolation or as a substitute for earnings before income taxes or any other measures of operating performance prepared in accordance with GAAP. A reconciliation of underwriting profit to earnings before income taxes is presented within “Consolidated Results of Operations.”
Earnings before income taxes were $757.4 million in 2015, compared with $931.9 million in 2014 and $855.2 million in 2013.
As of December 31, 2015, we had total assets of $22.8 billion and total stockholders’ equity attributable to Alleghany stockholders of $7.6 billion. As of December 31, 2015, we had consolidated total investments of approximately $17.8 billion, of which $13.6 billion was invested in debt securities, $3.0 billion was invested in equity securities, $0.3 billion was invested in short-term investments, $0.2 billion was invested in commercial mortgage loans and $0.7 billion was invested in other invested assets.
(1) Consist of Alleghany Properties, SORC, Bourn & Koch, our investments in Homesite (prior to its sale on December 31, 2013), and ORX and corporate activities at the parent level. In addition, beginning August 30, 2013, July 31, 2014 and October 31, 2015, corporate activities include the operating results of Kentucky Trailer, our investment in Jazwares and the operating results of IPS, respectively. Corporate activities also include interest expense associated with the Senior Notes (as defined on page 115 of this Form 10-K) issued by Alleghany, whereas interest expense associated with the Senior Notes issued by TransRe is included in “total reinsurance and insurance segments.” Information related to the Senior Notes can be found in Note 8 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K.
(1) Total Segments excludes elimination of minor reinsurance activity between segments which is reported in corporate activities.
2015 vs 2014. The increase in gross premiums written in 2015 from 2014 reflects a slight increase at our reinsurance segment, partially offset by a slight decrease at our insurance segment. The increase in gross premiums written at our reinsurance segment primarily reflects $221.6 million of premiums recorded on December 31, 2015 in connection with a large whole account quota share treaty placed as of that date, partially offset by the impact of changes in foreign exchange rates, reduced participation in or non-renewal of certain treaties and reductions in pricing. The decrease in gross premiums written at our insurance segment primarily reflects lower premiums at RSUI, partially offset by continued significant growth in premiums at PacificComp and CapSpecialty.
Net premiums written in 2015 approximated net premiums written from 2014, as a slight decrease at our reinsurance segment was largely offset by an increase at our insurance segment. Net premiums written at our reinsurance segment decreased in 2015 from 2014 as a result of higher ceded premiums written due to an increase in reinsurance coverage purchased by TransRe in 2015.
2015 vs 2014. The decrease in net loss and LAE in 2015 from 2014 reflects a decrease at our reinsurance segment, partially offset by an increase at our insurance segment. The decrease at our reinsurance segment primarily reflects the impact of lower net premiums earned, as discussed above, and, to a lesser extent, lower catastrophe losses and more favorable prior year loss reserve development. The increase at our insurance segment primarily reflects the impact of higher net premiums earned and less favorable prior year loss reserve development overall, partially offset by lower catastrophe losses.
2014 vs 2013. The increase in underwriting profit in 2014 from 2013 primarily reflects lower catastrophe losses at our reinsurance and insurance segments, as discussed above.
Underwriting profits for 2015, 2014 and 2013 are more fully described in the following pages.
2014 vs 2013. The decrease in net investment income in 2014 from 2013 primarily reflects the absence in 2014 of earnings from Homesite (which was sold on December 31, 2013), compared with $42.9 million of earnings from Homesite in 2013 and, to a lesser extent, the impact of changes in foreign currency exchange rates, partially offset by higher interest income from more favorable reinvestment rates for our reinsurance segment and our increased allocation to investment-grade and below investment-grade credit instruments managed through our investment management relationship with Ares Management, L.P., or “Ares.” Absent earnings from Homesite, our net investment income would have increased in 2014.
Corporate administration. Corporate administration expense in 2015 approximated the expense from 2014. The increase in corporate administration expense in 2014 from 2013 primarily reflects the absence of a one-time reduction in expenses of $8.8 million from the freezing of pension benefits at the parent level in 2013.
Interest expense. The increase in interest expense in 2015 from 2014 primarily reflects higher interest expense at the Alleghany parent company arising from the issuance of the 2044 Senior Notes (as defined on page 111 of this Form 10-K) on September 9, 2014, partially offset by lower interest expense at TransRe resulting from the redemption of a portion of the 2015 Senior Notes on October 15, 2014 and the maturity and repayment of the remainder of the 2015 Senior Notes on December 14, 2015. The increase in interest expense in 2014 from 2013 primarily reflects higher interest expense at the Alleghany parent company arising from the issuance of the 2044 Senior Notes on September 9, 2014, partially offset by lower interest expense at TransRe resulting from the partial redemption of the 2015 Senior Notes on October 15, 2014. See Note 8 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for further information on the Senior Notes.
2015 vs 2014. The decrease in income taxes in 2015 from 2014 primarily reflects a decrease in earnings before income taxes, as discussed below. The slight decrease in the effective tax rate in 2015 compared with 2014 primarily reflects lower taxable income in 2015, partially offset by lower interest income arising from municipal bond securities.
2014 vs 2013. The increase in income taxes in 2014 from 2013 primarily reflects an increase in earnings before income taxes, as discussed below. The slightly higher effective tax rate in 2014 compared with 2013 primarily reflects higher taxable income in 2014 relative to a fairly steady level of tax-exempt interest income arising from municipal bond securities.
Property. The decrease in gross premiums written in 2015 from 2014 reflects the impact of changes in foreign exchange rates. Excluding the impact of changes in foreign exchange rates, gross premiums written increased 3.7 percent in 2015 from 2014, primarily reflecting $64.7 million of property-related premiums recorded on December 31, 2015 in connection with a large whole account quota share treaty placed as of that date, partially offset by reduced participation in or non-renewal of certain treaties and reductions in pricing for property reinsurance contracts as the market became increasingly competitive. The decrease in net premiums earned in 2015 from 2014 reflects, in part, the impact of changes in foreign exchange rates. Excluding the impact of changes in foreign exchange rates, net premiums earned decreased 10.0 percent in 2015 from 2014, primarily reflecting a decrease in gross premiums written in recent quarters, and higher ceded premiums earned due to an increase in reinsurance coverage purchased in 2015. There were no net premiums earned in 2015 in connection with the large whole account quota share treaty placed on December 31, 2015.
Property. The decrease in net loss and LAE in 2015 from 2014 primarily reflects the impact of lower net premiums earned, lower claims in the current accident year and lower catastrophe losses. Catastrophe losses for 2015 relate to the chemical explosion in Tianjin, China in August 2015. Catastrophe losses for 2014 reflect losses from severe snowstorms across northeast Japan in February 2014 and from wind and hailstorm Ela, which struck Europe in June 2014.
The increase in net loss and LAE in 2014 from 2013 primarily reflects less favorable prior accident year development on loss reserves and higher non-catastrophe losses incurred, partially offset by lower catastrophe losses. Catastrophe losses for 2014 reflect losses from the severe Japanese snowstorms and from wind and hailstorm Ela, discussed above. Catastrophe losses in 2013 primarily reflect net losses from flooding in Germany in May 2013, flooding in Central Europe and Canada in June 2013, hurricanes in Mexico in September 2013 and hailstorms in Germany and Canada in July 2013.
(5) Reflects favorable prior accident year development on loss reserves primarily related to the 2012 accident year and, to a lesser extent, the 2011 accident year.
Casualty & other. The decrease in net loss and LAE in 2015 from 2014 primarily reflects the impact of lower net premiums earned and more favorable prior accident year development on loss reserves, partially offset by higher catastrophe losses in 2015. Catastrophe losses for 2015 relate to the chemical explosion in Tianjin, China in August 2015. The decrease in net loss and LAE in 2014 from 2013 primarily reflects more favorable prior accident year development on loss reserves in 2014 and lower claims for the current accident year.
(1) Represents certain medical malpractice treaties pursuant to which the increased underwriting profits created by the favorable prior accident year development on loss reserves are retained by the cedants, or the “Malpractice Treaties.” As a result, TransRe records an offsetting increase in profit commission expense incurred when such favorable prior accident year development occurs.
(3) Generally reflects favorable prior accident year development on loss reserves in a variety of casualty & other lines of business primarily from the 2005 through 2014 accident years, including ($30.7) million of favorable prior accident year development related to French medical malpractice loss reserves commuted in the fourth quarter of 2015 with a European cedant, partially offset by unfavorable prior accident year development from the 2004 and prior accident years.
(5) Generally reflects favorable prior accident year development on loss reserves in a variety of casualty & other lines of business.
The favorable prior accident year development on loss reserves in 2015, 2014 and 2013 reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods. The favorable prior accident year development on loss reserves in 2015 did not impact assumptions used in estimating TransRe’s loss and LAE liabilities for business earned in 2015.
Casualty & other. The increase in commissions, brokerage and other underwriting expenses in 2015 from 2014 primarily reflects an increase in commission rates being required by cedants, partially offset by the impact of lower net premiums earned. The increase in commissions, brokerage and other underwriting expenses in 2014 from 2013 primarily reflects an increase in commission rates being demanded by cedants in 2014, partially offset by a decrease in profit commissions related to the Malpractice Treaties, as described above. In addition, 2013 reflects the favorable impact of deferred acquisition costs being written off in 2012 under the acquisition method of accounting for the merger with TransRe.
Casualty & other. The decrease in underwriting profit in 2015 from 2014 primarily reflects lower net premiums earned, the presence of catastrophe losses in 2015 and higher commission rates in 2015, partially offset by more favorable prior accident year development on loss reserves, all as discussed above. The underwriting profit in 2014 compared with the underwriting loss in 2013 reflects a decrease in net loss and LAE, partially offset by a decrease in net premiums earned and an increase in commissions, brokerage and other underwriting expenses, all as discussed above.
(1) Underwriting profit (loss) represents net premiums earned less net loss and LAE and commissions, brokerage and other underwriting expenses, all as determined in accordance with GAAP, and does not include net investment income, net realized capital gains, OTTI losses, other income, other operating expenses, corporate administration, amortization of intangible assets or interest expense. Underwriting profit is a non-GAAP financial measure and does not replace earnings before income taxes determined in accordance with GAAP as a measure of profitability. See “Comment on Non-GAAP Financial Measures” herein for additional detail on the presentation of our results of operations.
(4) The combined ratio is the sum of the loss ratio and the expense ratio, all as determined in accordance with GAAP. The combined ratio represents the percentage of each premium dollar a reinsurance or an insurance company has to spend on net loss and LAE, and commissions, brokerage and other underwriting expenses.
CapSpecialty. The increase in gross premiums written in 2015 from 2014 primarily reflects strong growth in the professional lines of business, partially offset by declines in other property and casualty lines of business and the surety line of business. The increase in gross premiums written in 2014 from 2013 reflects growth in the property and casualty lines of business, including strong growth in the professional lines of business.
PacificComp. The increases in gross premiums written and net premiums earned in 2015 from 2014 primarily reflect PacificComp’s distribution initiatives and the identification of desirable segments of the California workers’
compensation market. The increases in gross premiums written and net premiums earned in 2014 from 2013 primarily reflect PacificComp’s distribution initiatives and increased market acceptance of PacificComp’s product offerings.
(1) Primarily reflects favorable prior accident year development on loss reserves in the umbrella/excess, general liability and professional liability lines of business related to the 2006 through 2011 accident years, partially offset by unfavorable prior accident year development in the directors’ and officers’ liability line of business related to the 2011 through 2014 accident years.
(2) Primarily reflects favorable prior accident year development on loss reserves in the professional liability, general liability and umbrella/excess lines of business, and primarily related to the 2006 through 2010 accident years, partially offset by unfavorable prior accident year development on loss reserves in the directors’ and officers’ liability line of business in the 2011 and 2012 accident years.
(3) Primarily reflects favorable prior accident year development on loss reserves in the umbrella/excess liability and professional liability lines of business, and primarily related to the 2005 through 2010 accident years.
CapSpecialty. The increase in net loss and LAE in 2015 from 2014 primarily reflects the impact of higher net premiums earned, substantially higher unfavorable prior accident year development on loss reserves and higher surety losses in the current accident year, partially offset by lower property losses. Higher surety losses relate to a few large claims that were incurred in 2015 related to the discontinued large construction contract class of business. Lower property losses arose from lower fire and weather-related losses in 2015. The decrease in net loss and LAE in 2014 from 2013 primarily reflects substantially less unfavorable prior accident year development on loss reserves in 2014, partially offset by the impact of higher net premiums earned and higher property losses. Higher property losses in 2014 arose from fire and weather-related losses.
(3) Primarily reflects unfavorable prior accident year development on loss reserves from workers’ compensation and certain other casualty lines of business, and related primarily to unfavorable loss emergence on a few individual claims, partially offset by favorable prior accident year development on loss reserves on surety and property lines of business.
The unfavorable prior accident year development on loss reserves in 2015, 2014 and 2013 reflects unfavorable loss emergence compared with loss emergence patterns assumed in earlier periods. The unfavorable prior accident year development on loss reserves in 2015 did not impact assumptions used in estimating CapSpecialty’s loss and LAE liabilities for business earned in 2015.
PacificComp. The increase in net loss and LAE in 2015 from 2014 primarily reflects the impact of higher net premiums earned, partially offset by unfavorable prior accident year development on loss reserves in 2014. The increase in net loss and LAE in 2014 from 2013 primarily reflects the impact of higher net premiums earned. The unfavorable prior accident year development on loss reserves in 2014 and 2013 related primarily to the 2009 and prior accident years, and reflects unfavorable loss emergence compared with loss emergence patterns assumed in earlier periods.
RSUI. The slight increase in commissions, brokerage and other underwriting expenses in 2015 from 2014 primarily reflects higher commissions and higher employee-related benefit and compensation costs, partially offset by the impact of lower net premiums earned. Higher commissions reflect the fact that RSUI’s binding authority line of business, which incurs a higher commission rate than RSUI’s other lines of business, is a higher portion of RSUI’s overall book of business in 2015. The increase in commissions, brokerage and other underwriting expenses in 2014 from 2013 is due primarily to the impact of higher net premiums earned.
The following table summarizes the investment results for our reinsurance and insurance segments.
The increase in net investment income for the reinsurance and insurance segments in 2014 from 2013 is due primarily to more favorable reinvestment rates at TransRe as well as an increased allocation of our debt securities portfolio to higher yielding securities, partially offset by the impact of changes in foreign currency exchange rates. The higher yielding securities relate primarily to an increased allocation to investment-grade and below investment-grade credit instruments managed through our investment management relationship with Ares.
Net Realized Capital Gains. The increase in net realized capital gains in 2015 from 2014 primarily reflects higher gains from the equity securities portfolio, partially offset by lower gains for the debt securities portfolio. Realized capital gains in 2015 include the sales of certain equity securities resulting from a modification of our equity investment strategy and the sales of certain equity securities which had their cost basis reduced in earlier periods for the recognition of OTTI losses. Realized capital gains in 2014 include a realized capital gain of $34.0 million from the sales of long-dated U.S. Treasury Strip debt securities in April 2014, some additional realized capital gains taken on debt securities and a $9.4 million realized capital loss on the early redemption of $300 million par value of the 2015 Senior Notes.
The increase in net realized capital gains in 2014 from 2013 primarily reflects higher gains for the debt securities portfolio, partially offset by lower gains for the equity securities portfolio and a $9.4 million realized capital loss on the early redemption of $300 million par value of the 2015 Senior Notes. In addition, net realized capital gains in 2013 includes a realized capital loss of $5.0 million relating to a non-cash impairment charge for certain finite-lived intangible assets at CapSpecialty.
Other Than Temporary Impairment Losses. OTTI losses in 2015 reflect $125.5 million of unrealized losses that were deemed to be other than temporary and, as such, were required to be charged against earnings. Upon the ultimate disposition of the securities for which OTTI losses have been recorded, a portion of the loss may be recoverable depending on market conditions at the time of disposition. Of the $125.5 million, $107.2 million related to equity securities, primarily in the energy, pharmaceutical, gaming and airline sectors, and $18.3 million related to debt securities, primarily in the energy and finance sectors. The determination that unrealized losses on equity and debt securities were other than temporary was primarily based on the fact that we lacked the intent to hold the securities for a period of time sufficient to allow for an anticipated recovery and, to a lesser extent, the duration of the decline in the fair value of equity securities relative to their costs.
See Note 4 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional detail on gross unrealized investment losses for debt and equity securities as of December 31, 2015.
Other income and Other operating expenses. The increase in other income in 2015 from 2014 primarily reflects the acquisition of IPS on October 31, 2015 and, to a lesser extent, growth at Kentucky Trailer. The increase in other operating expenses in 2015 from 2014 primarily reflects the acquisition of IPS and, to a lesser extent, increased expenses at Kentucky Trailer and SORC. The increases in other income and other operating expenses in 2014 from 2013 primarily reflect the acquisition of Kentucky Trailer on August 30, 2013 and, to a lesser extent, increased expenses at SORC.
Net realized capital gains. Net realized capital losses in 2015 reflect a $25.8 million realized capital loss related to a non-cash impairment charge related to a write-off of our investment in ORX and, to a lesser extent, the sale of equity securities at a loss. Net realized capital gains in 2014 primarily reflect gains from the sale of equity securities. Net realized capital gains in 2013 primarily reflect the sale of Homesite on December 31, 2013, partially offset by sales of equity securities at a realized capital loss.
Corporate administration. Corporate administration expense in 2015 approximated corporate administration expense from 2014. The increase in corporate administration expense in 2014 from 2013 primarily reflects the absence of a one-time reduction in expenses from the freezing of pension benefits at the parent company level. On July 16, 2013, our Board of Directors decided to: (i) freeze the benefits associated with our unfunded, noncontributory defined benefit pension plan for parent company level executives, effective December 31, 2013; and (ii) terminate our two retiree health plans for parent company level executives and employees, effective September 30, 2013. As a result of these decisions, we recorded a pre-tax $8.8 million reduction to corporate administration expense in the third quarter of 2013.
Interest expense. The increase in interest expense in 2015 from 2014 and in 2014 from 2013 is due to the issuance of the 2044 Senior Notes (as defined on page 111 of this Form 10-K) on September 9, 2014.
As of December 31, 2015, our reinsurance and insurance subsidiaries had total reinsurance recoverables of $1,249.9 million, consisting of $1,169.3 million of ceded outstanding loss and LAE and $80.6 million of recoverables on paid losses. See Part I, Item 1, “Business - Reinsurance Protection” of this Form 10-K for additional information on the reinsurance purchased by our reinsurance and insurance subsidiaries.
(2) Represents the A.M. Best financial strength rating for the applicable reinsurance subsidiary or subsidiaries from which the reinsurance recoverable is due.
(4) Approximately 95 percent of our reinsurance recoverables balance as of December 31, 2015 was due from reinsurers having an A.M. Best financial strength rating of A (Excellent) or higher.
(5) Represents reinsurance recoverables secured by funds held, trust agreements and letters of credit.
We had no allowance for uncollectible reinsurance as of December 31, 2015.
We believe our most critical accounting estimates are those with respect to the liability for unpaid loss and LAE reserves, fair value measurements of certain financial assets, OTTI losses on investments, goodwill and other intangible assets and reinsurance premium revenues, as they require management’s most significant exercise of judgment on both a quantitative and qualitative basis. The accounting estimates that result require the use of assumptions about certain matters that are highly uncertain at the time of estimation. To the extent actual experience differs from the assumptions used, our financial condition, results of operations and cash flows would be affected, possibly materially.
While the reserving process is difficult for insurance business, the inherent uncertainties of estimating loss reserves are even greater for reinsurance business, due primarily to the longer-tailed nature of much of the reinsurance business, the diversity of development patterns among different types of reinsurance contracts, the necessary reliance on the ceding companies for information regarding reported claims and differing reserving practices among ceding companies, which can be subject to change without notice. TransRe writes a significant amount of non-proportional assumed casualty reinsurance as well as proportional assumed reinsurance of excess liability business for classes such as medical malpractice, directors’ and officers’ liability, errors and omissions liability and general liability. Claims from such classes can exhibit greater volatility over time than most other classes due to their low frequency, high severity nature and loss cost trends that are more difficult to predict.
Expected loss ratios represent management’s expectation of losses, in relation to earned premium, at the time business is written, before any actual claims experience has emerged. This expectation is a significant determinant of the estimate of loss reserves for recently written business where there is little paid or incurred loss data to consider. Expected loss ratios are generally derived from historical loss ratios adjusted for the impact of rate changes, loss cost trends and known changes in the type of risks underwritten. For certain longer-tailed reinsurance business that are typically lower frequency, high severity classes, expected loss ratios are often used for the last several accident years or underwriting years, as appropriate.
Our net reserves for loss and LAE of $9.6 billion as of December 31, 2015 relate to multiple accident years. Therefore, the impact of changes in frequency or severity for more than one accident year could be higher or lower than the amounts reflected above. We believe the above analysis provides a reasonable benchmark for sensitivity as we believe it is within historical variation for our reserves. Currently, none of the scenarios is believed to be more likely than the other. See Note 1(k) and Note 6 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on our loss and LAE.
(9) Generally reflects favorable prior accident year development on loss reserves in a variety of casualty & other lines of business primarily from the 2005 through 2014 accident years, including ($30.7) million of favorable prior accident year development related to French medical malpractice loss reserves commuted in the fourth quarter of 2015 with a European cedant, partially offset by unfavorable prior accident year development from the 2004 and prior accident years.
(18) Primarily reflects unfavorable prior accident year development on loss reserves related to the casualty lines of business from the 2011 through 2013 accident years.
(20) Represents certain specialty classes of business written through a program administrator in connection with a terminated program related to the 2010 and 2009 accident years and reflects (favorable) unfavorable loss emergence compared with loss emergence patterns assumed in earlier periods for such business.
Reinsurance. Our reinsurance and insurance subsidiaries reinsure portions of the risks they underwrite in order to reduce the effect of individual or aggregate exposure to losses, manage capacity, protect capital resources, reduce volatility in specific lines of business, improve risk-adjusted portfolio returns and enable them to increase gross premium writings and risk capacity without requiring additional capital. Our reinsurance and insurance subsidiaries purchase reinsurance and retrocessional coverages from highly-rated third-party reinsurers. If the assuming reinsurers are unable or unwilling to meet the obligations assumed under the applicable reinsurance agreements, our reinsurance and insurance subsidiaries would remain liable for such reinsurance portion not paid by these reinsurers. Recoverables recorded with respect to claims ceded to reinsurers under reinsurance contracts are predicated in large part on the estimates for unpaid losses and, therefore, are also
A three-tiered hierarchy for inputs is used in management’s determination of fair value of financial instruments that emphasizes the use of observable inputs over the use of unobservable inputs by requiring that the observable inputs be used when available. Assets classified as Level 3 principally include certain residential mortgage-backed securities, or “RMBS,” commercial mortgage-backed securities, or “CMBS,” other asset-backed securities, U.S. corporate bonds, partnership investments and non-marketable equity investments. The valuation of Level 3 assets requires the greatest degree of judgment, as these valuations are based on techniques that use significant inputs that are unobservable. These measurements may be made under circumstances in which there is little, if any, market activity for the asset. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment. In making the assessment, we consider factors specific to the asset.
Management’s assessment of equity securities initially involves an evaluation of all securities that are in an unrealized loss position, regardless of the duration or severity of the loss, as of the applicable balance sheet date. Such initial review consists primarily of assessing whether: (i) there has been a negative credit or news event with respect to the issuer that could indicate the existence of an OTTI; and (ii) we have the ability and intent to hold an equity security for a period of time sufficient to allow for an anticipated recovery (generally considered to be one year from the balance sheet date).
To the extent that an equity security in an unrealized loss position is not impaired based on the initial review described above, we then further evaluate such equity security and deem it to be other than temporarily impaired if it has been in an unrealized loss position for 12 months or more or if its unrealized loss position is greater than 50 percent of its cost, absent compelling evidence to the contrary.
In developing the cash flow analyses for debt securities, we consider various factors for the different categories of debt securities. For municipal bonds, we take into account the taxing power of the issuer, source of revenue, credit risk and credit enhancements and pre-refunding. For mortgage and asset-backed securities, we discount our best estimate of future cash flows at an effective rate equal to the original effective yield of the security or, in the case of floating rate securities, at the current coupon. Our models include assumptions about prepayment speeds, default and delinquency rates and underlying collateral (if any), as well as credit ratings, credit enhancements and other observable market data. For corporate bonds, we review business prospects, credit ratings and available information from asset managers and rating agencies for individual securities.
With respect to goodwill, a qualitative assessment is first made to determine whether it is necessary to perform quantitative testing. This initial assessment includes, among other factors, consideration of: (i) past, current and projected future earnings and equity; (ii) recent trends and market conditions; and (iii) valuation metrics involving similar companies that are publicly-traded and acquisitions of similar companies, if available. If this initial qualitative assessment indicates that the fair value of an operating subsidiary of ours may be less than its respective carrying amount, a second step is taken, involving a comparison between the estimated fair values of our operating subsidiary with its respective carrying amount including goodwill. Under GAAP, fair value refers to the amount for which the entire operating subsidiary may be bought or sold. The methods for estimating operating subsidiary values include asset and liability fair values and other valuation techniques, such as discounted cash flows and multiples of earnings or revenues. All of these methods involve significant estimates and assumptions. If the carrying value exceeds estimated fair value, there is an indication of potential impairment, and a third step is performed to measure the amount of impairment. The third step involves calculating an implied fair value of goodwill by measuring the excess of the estimated fair value of the operating subsidiary over the aggregate estimated fair values of the individual assets less liabilities. If the carrying value of goodwill exceeds the implied fair value of goodwill, an impairment charge is recorded for the excess.
On October 15, 2014, TransRe redeemed $300.0 million aggregate principal amount of its 2015 Senior Notes for $324.4 million, consisting of the $300.0 million aggregate principal amount redeemed, $18.6 million of redemption premium and $5.8 million of accrued and unpaid interest to the date of redemption. Of the $324.4 million redemption amount, $297.3 million was funded by a capital contribution from Alleghany primarily using the $294.3 million of net proceeds from Alleghany’s issuance of the 2044 Senior Notes. As a result of this early extinguishment of debt, TransRe recorded a realized loss, before tax, of $9.4 million in 2014. On December 14, 2015, the remaining $367.0 million outstanding aggregate principal amount of TransRe’s 2015 Senior Notes matured and was repaid.
On April 13, 2015, S&P upgraded Alleghany’s issuer credit rating to “BBB+” from “BBB,” and on January 27, 2016, Moody’s upgraded Alleghany’s issuer credit ratings to Baa1 from Baa2.
In 2015, we borrowed and repaid $60.0 million under the Credit Agreement. As of December 31, 2015, there were no outstanding borrowings under the Credit Agreement.
The ability of our reinsurance and insurance subsidiaries to pay dividends or other distributions is subject to the laws and regulations applicable to each subsidiary, as well as each subsidiary’s need to maintain capital requirements adequate to maintain its operations and financial strength ratings issued by independent rating agencies.
A summary of dividends paid to Alleghany by its reinsurance and insurance subsidiaries in 2015, 2014 and 2013 follows:
(1) In 2015, TRC paid dividends of $400.0 million to the TransRe holding company, of which $250.0 million was in turn paid to Alleghany. In 2014, TRC paid dividends of $400.0 million to the TransRe holding company, of which $300.0 million was in turn paid to Alleghany. In 2013, TRC paid dividends of $200.0 million to the TransRe holding company, of which $150.0 million was in turn paid to Alleghany.
Common Stock Repurchases. In October 2012, our Board of Directors authorized a program to repurchase of shares of our common stock, at such times and at prices as management determines to be advisable, up to an aggregate of $300.0 million, or the “2012 Repurchase Program.” In July 2014, our Board of Directors authorized, upon the completion of the 2012 Repurchase Program, the repurchase of additional shares of common stock, at such times and at prices as management determines to be advisable, up to an aggregate of $350.0 million, or the “2014 Repurchase Program.” In the fourth quarter of 2014, we completed the 2012 Repurchase Program and subsequent repurchases have been made pursuant to the 2014 Repurchase Program. In November 2015, our Board of Directors authorized, upon the completion of the 2014 Repurchase Program, the repurchase of additional shares of common stock, at such times and at prices as management determines to be advisable, up to an aggregate of $400.0 million.
Contractual Obligations. We have certain obligations to make future payments under contracts and credit-related financial instruments and commitments. As of December 31, 2015, certain long-term aggregate contractual obligations and credit-related financial commitments were as follows:
The obligations and cash outflow of our reinsurance and insurance subsidiaries include claim settlements, commission expenses, administrative expenses, purchases of investments, and interest and principal payments on the 2015 Senior Notes and TransRe’s 8.00% senior notes due on November 30, 2039. In addition to premium collections, cash inflow is obtained from interest and dividend income and maturities and sales of investments. Because cash inflow from premiums is received in advance of cash outflow required to settle claims, our reinsurance and insurance operating units accumulate funds which they invest pending the need for liquidity. As the cash needs of a reinsurance or an insurance company can be unpredictable due to the uncertainty of the claims settlement process, the portfolios of our reinsurance and insurance subsidiaries consist primarily of debt securities and short-term investments to ensure the availability of funds and maintain a sufficient amount of liquid securities.
With respect to our non-insurance operating subsidiaries, SORC has almost entirely depended on Alleghany to support its growth. From formation in 2011 through December 31, 2015, we have invested $243.9 million in SORC. The $243.9 million includes $45.2 million for SORC’s January 2015 acquisition of the Teapot Dome Oilfield, known officially as Naval Petroleum Reserve Number 3, located in the State of Wyoming.
On a consolidated basis, our invested assets decreased to approximately $17.8 billion as of December 31, 2015 from approximately $18.8 billion as of December 31, 2014, primarily reflecting the impact of a decrease in unrealized appreciation on our equity and debt securities portfolio, repurchases of our common stock, the maturity of the 2015 Senior Notes, amounts paid by TransRe related to commutations in the fourth quarter of 2015 with certain cedants and capital contributions to SORC, partially offset by cash flows from operating activities. The decrease in unrealized appreciation on our debt securities portfolio is due to a modest increase in longer-term interest rates and credit spreads that occurred in 2015.
Fair Value. The carrying values and estimated fair values of our consolidated financial instruments as of December 31, 2015 and 2014 were as follows:
Since Level 3 valuations are based on techniques that use significant inputs that are unobservable with little or no market activity, the fair values under the market approach for Level 3 securities are less credible than under the income approach, however, the market approach, where feasible, is used to corroborate the fair values determined by the income approach. The market approach primarily relies on the securities’ relationships to quoted transaction prices for similarly structured instruments. To the extent that transaction prices for similarly structured instruments are not available for a particular security, other market approaches are used to corroborate the fair values determined by the income approach, including option adjusted spread analyses.
The impact of prepayment speeds on fair value is dependent on a number of variables including whether the securities were purchased at a premium or discount. A decrease in interest rates generally increases the assumed rate of prepayments, and an increase in interest rates generally decreases the assumed speed of prepayments. Increased prepayments increase the yield on securities purchased at a discount, and reduce the yield on securities purchased at a premium. In a decreasing prepayment environment, yields on securities purchased at a discount are reduced but are increased for securities purchased at a premium. Changes in default assumptions on underlying collateral are generally accompanied by directionally similar changes in other collateral performance factors, but generally result in a directionally opposite change in prepayment assumptions.
The estimated fair values of our financial instruments measured at fair value and the level of the fair value hierarchy of inputs used as of December 31, 2015 and 2014 were as follows:
Natural disasters such as hurricanes, other windstorms, earthquakes and other catastrophes have the potential to materially and adversely affect our operating results. Other risks, such as an outbreak of a pandemic disease, a major terrorist event, the bankruptcy of a major company or a marine and/or aviation disaster, could also have a material adverse effect on our operating results.
Projections of potential catastrophe losses are typically expressed in terms of the probable maximum loss, or “PML.” We define PML as our anticipated maximum loss (taking into account contract limits) caused by a single catastrophe event at a specified estimated return period affecting a broad contiguous area. These modeled losses are estimated based upon contracts in force at January 1, 2016 for TransRe, December 1, 2015 for RSUI and January 1, 2016 for PacificComp. Modeled results also reflect losses arising from certain of our invested assets that have specific catastrophe exposures.
“Florida, Wind” has the highest modeled after-tax net catastrophe costs for both a 100 and 250 year return period. These costs would represent approximately 7 percent and 10 percent, respectively, of stockholders’ equity attributable to Alleghany as of December 31, 2015. If multiple severe catastrophe events occur in any one year, or a single catastrophe event affects more than one geographic area, the potential economic cost to us could be materially higher than any one of the amounts shown above.
In April 2014, the FASB issued guidance that changed the criteria for reporting discontinued operations. Under the new guidance, only disposals that represent a strategic shift in operations qualify as discontinued operations. In addition, the new guidance requires expanded disclosure about discontinued operations. This guidance was effective in the first quarter of 2015. We adopted this guidance in the first quarter of 2015 and the implementation did not have an impact on our results of operations and financial condition.
Although Alleghany’s primary sources of revenues and earnings are its reinsurance and insurance operations and investments, Alleghany also manages, sources, executes and monitors certain private capital investments primarily through its wholly-owned subsidiary Alleghany Capital Corporation (“Alleghany Capital”). Alleghany Capital’s private capital investments are included in corporate activities for segment reporting purposes and include: (i) Stranded Oil Resources Corporation (“SORC”), an exploration and production company focused on enhanced oil recovery, headquartered in Golden, Colorado; (ii) Bourn & Koch, Inc. (“Bourn & Koch”), a manufacturer and remanufacturer/retrofitter of precision machine tools and supplier of replacement parts, headquartered in Rockford, Illinois; (iii) R.C. Tway Company, LLC (“Kentucky Trailer”), a manufacturer of custom trailers and truck bodies for the moving and storage industry and other markets, headquartered in Louisville, Kentucky; (iv) IPS-Integrated Project Services, LLC (“IPS”), a technical service provider focused on the global pharmaceutical and biotechnology industries, headquartered in Blue Bell, Pennsylvania, acquired on October 31, 2015 for $106.3 million; (v) an approximately 40 percent equity interest in ORX Exploration, Inc. (“ORX”), a regional oil and gas exploration and production company, headquartered in New Orleans, Louisiana; and (vi) a 30 percent equity interest in Jazwares, LLC (“Jazwares”), a toy and consumer electronics company, headquartered in Sunrise, Florida, which interest was acquired on July 31, 2014. ORX and Jazwares are accounted for under the equity method of accounting. In addition, Alleghany owns and manages properties in the Sacramento, California region through its wholly-owned subsidiary Alleghany Properties Holdings LLC (“Alleghany Properties”).
The portion of stockholders’ equity, net earnings and accumulated other comprehensive income that is not attributable to Alleghany stockholders is presented on the Consolidated Balance Sheets, the Consolidated Statements of Earnings and Comprehensive Income and the Consolidated Statements of Changes in Stockholders’ Equity as noncontrolling interest. Because all noncontrolling interests have the option to sell their interests to Alleghany in the future (generally from 2016 through 2023), the portion of stockholders’ equity that is not attributable to Alleghany stockholders is presented on the Consolidated Balance Sheets as redeemable noncontrolling interest for all periods presented. Bourn & Koch and Kentucky Trailer each had approximately 20 percent noncontrolling interests outstanding during 2015 and IPS had approximately 16 percent noncontrolling interests outstanding from its October 31, 2015 acquisition date through December 31, 2015. Noncontrolling interests for Bourn & Koch was reduced to approximately 12 percent outstanding as of December 31, 2015 as a result of a purchase by Bourn & Koch’s parent company from certain noncontrolling interests.
Investments consist of debt securities, equity securities, short-term investments, commercial mortgage loans and other invested assets. Alleghany considers all of its marketable equity securities, debt securities and short-term investments as available-for-sale (“AFS”). Debt securities consist of securities with an initial fixed maturity of more than one year. Debt securities typically take the form of bonds. Equity securities generally consist of securities that represent ownership interests in an enterprise. Equity securities typically take the form of common stock. Mutual funds are also classified as equity securities, including funds that invest mostly in debt securities. Short-term investments include commercial paper, certificates of deposit, money market instruments and any fixed maturity investment with an initial maturity of one year or less.
Other invested assets include invested assets not identified above, primarily related to: (i) equity investments in operating companies where Alleghany has significant influence; (ii) partnership investments (including hedge funds and private equity funds); and (iii) non-marketable equity investments. Equity investments in operating companies where Alleghany has significant influence (an aggregate common stock position held at or above 20 percent is presumed to convey significant influence) are accounted for using the equity method. Partnership investments are accounted for as either AFS, or using the equity method where Alleghany has significant influence. Non-marketable equity investments are accounted for as AFS securities.
Level 2: Valuations are based on direct and indirect observable inputs other than quoted market prices included in Level 1. Level 2 inputs include quoted prices for similar assets in active markets and inputs other than quoted prices that are observable for the asset, such as the terms of the security and market-based inputs. Terms of the security include coupon, maturity date and any special provisions that may, for example, enable the investor, at its election, to redeem the security prior to its scheduled maturity date (such provisions may apply to all debt securities except U.S. Government obligations). Market-based inputs include interest rates and yield curves that are observable at commonly quoted intervals and current credit rating(s) of the security. Market-based inputs may also include credit spreads of all debt securities except U.S. Government obligations, and currency rates for certain foreign government obligations and foreign corporate bonds denominated in foreign currencies. Fair values are determined using a market approach that relies on the securities’ relationships to quoted prices for similar assets in active markets, as well as the other inputs described above. In determining the fair values for the vast majority of commercial mortgage-backed securities (“CMBS”) and other asset-backed securities, as well as a small portion of residential mortgage-backed securities (“RMBS”), an income approach is used to corroborate and further support the fair values determined by the market approach. The income approach primarily involves developing a discounted cash flow model using the future projected cash flows of the underlying collateral, and the terms of the security. Level 2 assets generally include short-term investments and most debt securities. Alleghany’s Level 2 liabilities consist of the senior notes.
Reinsurance is used to mitigate the exposure to losses, manage capacity and protect capital resources. Reinsuring loss exposures does not relieve a ceding entity from its obligations to policyholders and cedants. Reinsurance recoverables (including amounts related to claims incurred but not reported) and ceded unearned premiums are reported as assets. To minimize exposure to losses from a reinsurer’s inability to pay, the financial condition of such reinsurer is evaluated initially upon placement of the reinsurance and periodically thereafter. In addition to considering the financial condition of a reinsurer, the collectability of the reinsurance recoverables is evaluated (and where appropriate, whether an allowance for estimated uncollectible reinsurance recoverables is to be established) based upon a number of other factors. Such factors include the amounts outstanding, length of collection periods, disputes, any collateral or letters of credit held and other relevant factors. To the extent that an allowance for uncollectible reinsurance recoverable is established, amounts deemed to be uncollectible are written off against the allowance for estimated uncollectible reinsurance recoverables. Alleghany currently has no allowance for uncollectible reinsurance recoverables.
Goodwill and other intangible assets deemed to have an indefinite useful life are tested annually in the fourth quarter of every year for impairment. Goodwill and other intangible assets are also tested whenever events and changes in circumstances suggest that the carrying amount may not be recoverable. A significant amount of judgment is required in performing goodwill and other intangible asset impairment tests. These tests may include estimating the fair value of Alleghany’s operating subsidiaries and other intangible assets. If it is determined that an asset has been impaired, the asset is written down by the amount of the impairment, with a corresponding charge to net earnings. Subsequent reversal of any impairment charge is not permitted.
With respect to goodwill, a qualitative assessment is first made to determine whether it is necessary to perform quantitative testing. This initial assessment includes, among other factors, consideration of: (i) past, current and projected future earnings and equity; (ii) recent trends and market conditions; and (iii) valuation metrics involving similar companies that are publicly-traded and acquisitions of similar companies, if available. If this initial qualitative assessment indicates that the fair value of an operating subsidiary may be less than its respective carrying amount, a second step is taken, involving a comparison between the estimated fair values of the operating subsidiary with its respective carrying amount including goodwill. Under GAAP, fair value refers to the amount for which the entire operating subsidiary may be bought or sold. The methods for estimating operating subsidiary values include asset and liability fair values and other valuation techniques, such as discounted cash flows and multiples of earnings or revenues. All of these methods involve significant estimates and assumptions. If the carrying value exceeds estimated fair value, there is an indication of potential impairment, and a third step is performed to measure the amount of impairment. The third step involves
calculating an implied fair value of goodwill by measuring the excess of the estimated fair value of the operating subsidiary over the aggregate estimated fair values of the individual assets less liabilities. If the carrying value of goodwill exceeds the implied fair value of goodwill, an impairment charge is recorded for the excess.
The reserves for loss and LAE include but are not limited to: (i) reports and individual case estimates received from ceding companies with respect to assumed reinsurance business; (ii) the accumulation of individual estimates for claims reported with respect to direct insurance business; (iii) estimates for incurred but not reported claims based on past experience, modified for current trends and industry data; and (iv) estimates of expenses for investigating and settling claims based on past experience. The methods used to determine such estimates and to establish the resulting reserves are continually reviewed and updated. Any adjustments are reflected in current income. Net loss and LAE incurred consists of the estimated ultimate cost of settling claims incurred within the reporting period (net of related reinsurance recoverable), including incurred but not reported claims, plus changes in estimates of prior period losses.
See Notes 6 and 12(d) for additional information on loss reserves.
(l) Earnings Per Share of Common Stock Attributable to Alleghany Stockholders
Basic earnings per share of common stock is based on the average number of shares of common stock, par value $1.00 per share, of Alleghany (“Common Stock”) outstanding during the period, retroactively adjusted for stock dividends where applicable. Diluted earnings per share of Common Stock are based on those shares used to calculate basic earnings per share of Common Stock plus the dilutive effect of stock-based compensation awards, retroactively adjusted for stock dividends where applicable.
Debt consists of senior notes issued by Alleghany (the “Alleghany Senior Notes”) and senior notes issued by TransRe (the “TransRe Senior Notes,” and collectively with the Alleghany Senior Notes, the “Senior Notes”). The Senior Notes are carried at unpaid principal balance including any unamortized premium or discount.
Certain prior year amounts have been reclassified to conform to the 2015 presentation of the financial statements.
In May 2014, the FASB, together with the International Accounting Standards Board, issued guidance on the recognition of revenue from contracts with customers. Under the new guidance, revenue is recognized as the transfer of goods and services to customers takes place, and in amounts that reflect the payment or payments that are expected to be received from the customers for those goods and services. The new guidance also requires new disclosures about revenue. Revenues related to insurance and reinsurance are not impacted by this guidance. In
In February 2015, the FASB issued guidance that amended the analysis that must be performed to determine whether an entity should consolidate certain types of legal entities. Under the new guidance, the evaluation of whether limited partnerships and similar entities are variable interest entities or voting interest entities is modified, the presumption that general partners should consolidate limited partnerships is eliminated and the process to determine the primary beneficiary of a variable interest entity is modified. This guidance is effective in the first quarter of 2016 for public entities, with early adoption permitted. Alleghany will adopt this guidance in the first quarter of 2016 and does not currently believe that the implementation will have a material impact on its results of operations and financial condition.
In April 2015, the FASB issued guidance that requires debt issuance costs related to debt liabilities be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, which is consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected. This guidance is effective in the first quarter of 2016 for public entities, with early adoption permitted. Alleghany will adopt this guidance in the first quarter of 2016 and does not currently believe that the implementation will have an impact on its results of operations and financial condition.
In May 2015, the FASB issued guidance that requires disclosures related to short-duration insurance contracts. The guidance applies to property and casualty insurance and reinsurance entities, among others, and requires the following annual disclosure related to the liability for loss and LAE: (i) net incurred and paid claims development information by accident year for up to ten years; (ii) a reconciliation of incurred and paid claims development information to the aggregate carrying amount of the liability for loss and LAE; (iii) incurred-but-not-reported liabilities by accident year and in total; (iv) a description of reserving methodologies (as well as any changes to those methodologies); (v) quantitative information about claim frequency by accident year; and (vi) the average annual percentage payout of incurred claims by age by accident year. In addition, the guidance requires insurance entities to disclose for annual and interim reporting periods a roll-forward of the liability for loss and LAE. This guidance is effective for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016, with early adoption permitted. Alleghany will adopt this guidance as of December 31, 2016 and does not currently believe that the implementation will have an impact on its results of operations and financial condition.
In January 2016, the FASB issued guidance that changes the recognition and measurement of certain financial instruments. The new guidance requires investments in equity securities (except those accounted for under the equity method of accounting) to be measured at fair value with changes in fair value recognized in net income. For equity securities that do not have readily determinable fair values, measurement may be at cost, adjusted for any impairment and changes resulting from observable price changes for a similar investment of the same issuer. The new guidance also changes the presentation and disclosure of financial instruments by: (i) requiring that financial instrument disclosures of fair value use the exit price notion; (ii) requiring separate presentation of financial assets and financial liabilities by measurement category and form, either on the balance sheet or the accompanying notes to the financial statements; (iii) requiring separate presentation in other comprehensive income for the portion of the change in a liability’s fair value resulting from instrument-specific credit risk when an election has been made to measure the liability at fair value; and (iv) eliminating the requirement to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet. The new guidance is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Except for the change in presentation for instrument-specific credit risk, the new guidance does not permit early adoption. Alleghany will adopt this guidance in the first quarter of 2018. As of January 1, 2018, unrealized gains or losses of equity securities, net of deferred taxes, will be reclassified from accumulated other comprehensive income to retained earnings. Subsequently, all changes in unrealized gains or losses of equity securities, net of deferred taxes, will be presented in the consolidated statement of earnings, rather than the consolidated statement of comprehensive income. Alleghany does not currently believe that the implementation will have a material impact on its financial condition.
The carrying values and estimated fair values of Alleghany’s consolidated financial instruments as of December 31, 2015 and 2014 were as follows:
(2) See Note 8 for additional information on the Senior Notes.
Alleghany’s financial instruments measured at fair value and the level of the fair value hierarchy of inputs used as of December 31, 2015 and 2014 were as follows:
In 2015, there were transfers of $19.9 million of securities into Level 3 that were principally due to a decrease in observable inputs related to the valuation of such assets. Of the $19.9 million of transfers, $14.2 million related to U.S. corporate bonds, $5.0 million related to other invested assets and $0.7 million related to foreign corporate bonds. There were no other transfers between Levels 1, 2 or 3 in 2015.
In 2014, there were transfers of $253.8 million of invested assets out of Level 3. Of the $253.8 million, $232.9 million related to a conversion of an equity interest held by AIHL in the second quarter of 2014. As further described in Note 4(h), AIHL’s investment in Ares Management LLC (“Ares”) converted to limited partner interests in certain Ares subsidiaries during the second quarter of 2014, at which time the investment ceased to qualify as a financial instrument measured at fair value. No gain or loss was recognized upon the conversion. The remaining transfers of $20.9 million of invested assets out of Level 3 were principally due to an increase in observable inputs related to the valuation of such assets.
(2) There were no OTTI losses recorded in net earnings related to Level 3 instruments still held as of December 31, 2015 and 2014.
Net unrealized losses related to Level 3 investments as of December 31, 2015 and 2014 were not material.
The amortized cost or cost and the fair value of AFS securities as of December 31, 2015 and 2014 are summarized as follows:
The amortized cost and estimated fair value of debt securities as of December 31, 2015 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Net investment income for 2015, 2014 and 2013 was as follows:
(1) See Note 4(h) for discussion of the Pillar Investments and the investment in Ares as defined in Note 3.
As of December 31, 2015, non-income producing invested assets were insignificant.
The proceeds from sales of AFS securities were $9.6 billion, $6.6 billion and $8.6 billion in 2015, 2014 and 2013, respectively.
Realized capital gains and losses in 2015, 2014 and 2013 generally reflect sales of equity securities. In addition, realized capital gains from equity securities in 2015 include the sales of certain equity securities resulting from a modification of Alleghany’s equity investment strategy, the sales of certain equity securities
which had their cost basis reduced in earlier periods for the recognition of OTTI losses, and a $25.8 million realized capital loss related to a non-cash impairment charge related to a write-off of Alleghany’s investment in ORX. Net realized capital gains in 2014 also include a realized capital gain of $34.0 million from the sales of long-dated U.S. Treasury Strip debt securities in April 2014, some additional realized capital gains taken on debt securities and a $9.4 million realized capital loss on the early redemption of $300 million par value of TransRe’s 5.75% senior notes due on December 14, 2015 (the “2015 Senior Notes”). See Note 8(b) for additional information on the early redemption of the 2015 Senior Notes. Realized capital gains for 2013 included a $46.8 million gain on the sale of Homesite, and a $5.0 million non-cash impairment charge related to certain finite-lived intangible assets at CapSpecialty.
Management’s assessment of equity securities initially involves an evaluation of all securities that are in an unrealized loss position, regardless of the duration or severity of the loss, as of the applicable balance sheet date. Such initial review consists primarily of assessing whether: (i) there has been a negative credit or news event with respect to the issuer that could indicate the existence of an OTTI; and (ii) Alleghany has the ability and intent to hold an equity security for a period of time sufficient to allow for an anticipated recovery (generally considered to be one year from the balance sheet date).
Alleghany then evaluates those equity securities where the unrealized loss is at least 20 percent of cost as of the balance sheet date or which have been in an unrealized loss position continuously for six months or more preceding the balance sheet date. This evaluation takes into account quantitative and qualitative factors in determining whether such securities are other than temporarily impaired including: (i) market valuation metrics associated with the equity security (such as dividend yield and price-to-earnings ratio); (ii) current views on the equity security, as expressed by either Alleghany’s internal stock analysts and/or by third-party stock analysts or rating agencies; and (iii) credit or news events associated with a specific issuer, such as negative news releases and rating agency downgrades with respect to the issuer of the investment.
OTTI losses in 2015 reflect $133.9 million of unrealized losses that were deemed to be other than temporary and, as such, were required to be charged against earnings. Upon the ultimate disposition of the securities for which OTTI losses have been recorded, a portion of the loss may be recoverable depending on market conditions at the time of disposition. Of the $133.9 million of OTTI losses, $115.6 million related to equity securities, primarily in the energy, pharmaceutical, gaming and airline sectors, and $18.3 million related to debt securities, primarily in the energy and finance sectors. The determination that unrealized losses on equity and debt securities were other than temporary was primarily due to the fact that Alleghany lacked the intent to hold the securities for a period of time sufficient to allow for an anticipated recovery and, to a lesser extent, based on the duration of the decline in the fair value of equity securities relative to their costs.
After adjusting the cost basis of securities for the recognition of OTTI losses, the remaining gross unrealized investment losses for debt and equity securities as of December 31, 2015 were deemed to be temporary, based on, among other factors: (i) the duration of time and the relative magnitude to which the fair value of these investments had been below cost were not indicative of an OTTI loss (for example, no equity security was in a continuous unrealized loss position for 12 months or more as of December 31, 2015); (ii) the absence of compelling evidence that would cause Alleghany to call into question the financial condition or near-term business prospects of the issuer of the investment; and (iii) Alleghany’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery.
As of December 31, 2015 and 2014, gross unrealized losses and related fair values for equity securities and debt securities, grouped by duration of time in a continuous unrealized loss position, were as follows:
extensive reinsurance and capital market experience of the principals of Pillar Holdings. Alleghany has concluded that both Pillar Holdings and the Funds (collectively, the “Pillar Investments”) represent variable interest entities and that Alleghany is not the primary beneficiary, as it does not have the ability to direct the activities that most significantly impact each entity’s economic performance. Therefore, the Pillar Investments are not consolidated and are accounted for under the equity method of accounting. Alleghany’s potential maximum loss in the Pillar Investments is limited to its cumulative net investment. As of December 31, 2015, Alleghany’s carrying value in the Pillar Investments, as determined under the equity method of accounting, was $238.8 million, which is net of returns of capital received from the Pillar Investments.
In 2015, Alleghany invested in certain commercial mortgage loans. As of December 31, 2015, the carrying value of the commercial loan portfolio was $177.9 million, representing the unpaid principal balance on the loans. As of December 31, 2015, there was no allowance for loan losses. The commercial loan portfolio consists primarily of high quality fixed- and floating-rate loans with terms of 2-10 years, backed by high-quality commercial properties in the U.S.
Alleghany’s reinsurance and insurance subsidiaries reinsure portions of the risks they underwrite in order to reduce the effect of individual or aggregate exposure to losses, manage capacity, protect capital resources, reduce volatility in specific lines of business, improve risk-adjusted portfolio returns and enable them to increase gross premium writings and risk capacity without requiring additional capital. Alleghany’s reinsurance and insurance subsidiaries purchase reinsurance and retrocessional coverages from highly-rated third-party reinsurers. If the assuming reinsurers are unable or unwilling to meet the obligations assumed under the applicable reinsurance agreements, Alleghany’s reinsurance and insurance subsidiaries would remain liable for such reinsurance portion not paid by these reinsurers. As such, funds, trust agreements and letters of credit are held to collateralize a portion of Alleghany’s reinsurance and insurance subsidiaries’ reinsurance recoverables, and Alleghany’s reinsurance and insurance subsidiaries reinsure portions of the risks they underwrite or assume with multiple reinsurance programs.
Amounts recoverable from reinsurers are recognized in a manner consistent with the claims liabilities associated with the reinsurance placement and presented on the balance sheet as reinsurance recoverables. Such balances as of December 31, 2015 and 2014 consist of the following:
Reinsured loss and LAE ceded included in Alleghany’s consolidated statements of earnings were $309.6 million, $250.3 million and $263.0 million for 2015, 2014 and 2013, respectively.
RSUI’s catastrophe reinsurance program covers catastrophe risks including, among others, windstorms and earthquakes. Portions of the catastrophe reinsurance program include multi-year terms, some of which were entered into in 2014. As of December 31, 2015, the catastrophe reinsurance program consisted of three layers, with the first two layers placed on May 1, 2015 and the third layer placed on May 1, 2014. The catastrophe reinsurance program provides coverage for $600.0 million of losses in excess of a $200.0 million net retention after application of surplus share treaties and facultative reinsurance. The first layer provides coverage for $300.0 million of losses, subject to a 5.0 percent co-participation by RSUI in excess of $200.0 million, the second layer provides coverage for $100.0 million of losses in excess of $500.0 million, with no co-participation by RSUI, and the third layer provides coverage for $200.0 million of losses in excess of $600.0 million, with no co-participation by RSUI. The first and second layers of coverage include expiration terms as follows: 34.0 percent of coverage limits will expire on April 30, 2016; 33.0 percent of coverage limits will expire on April 30, 2017; and 33.0 percent of coverage limits will expire on April 30, 2018. The third layer of coverage will expire on April 30, 2017.
In addition, RSUI’s property per risk reinsurance program runs on an annual basis from May 1 to the following April 30 and thus expired on April 30, 2015. On May 1, 2015, the property per risk program was renewed and will expire on April 30, 2016. For the 2015 to 2016 period, RSUI’s property per risk reinsurance program provides coverage for $90.0 million of losses, subject to a 10.0 percent co-participation by RSUI, in excess of a $10.0 million net retention per risk after application of surplus share treaties and facultative reinsurance.
In the third quarter of 2015, AIHL Re and CapSpecialty (specifically, the insurance subsidiaries of CapSpecialty) entered into an intercompany reinsurance contract, effective July 1, 2015, pursuant to which AIHL Re will provide CapSpecialty with coverage primarily for adverse development on net loss and allocated LAE for accident years 2014 and prior in excess of its carried reserves at June 30, 2015. AIHL Re’s commitments are intended to cover the statutory collateral requirements at CapSpecialty, if and when necessary, and AIHL Re’s obligations are subject to an aggregate limit of $50.0 million. In connection with such intercompany reinsurance agreement, Alleghany and AIHL Re entered into a contract whereby Alleghany will guarantee the recoverable balances owed to CapSpecialty from AIHL Re up to $50.0 million. The above agreements had no impact on Alleghany’s consolidated results of operations and financial condition.
(7) Represents certain medical malpractice treaties pursuant to which the increased underwriting profits created by the favorable prior accident year development on loss reserves are retained by the cedants (the “Malpractice Treaties”). As a result, TransRe records an offsetting increase in profit commission expense incurred when such favorable prior accident year development occurs.
(8) Represents unfavorable prior accident year development on loss reserves related to a commutation and release agreement entered into on November 30, 2015 by TransRe with AIG Property Casualty, Inc., National Indemnity Company and Resolute Management, Inc. with respect to certain reinsurance contracts (the “Commutation Agreement”), including contracts covering asbestos-related illness and environmental impairment liabilities for 1986 and prior years (the “Commuted A&E Liabilities”).
(10) Generally reflects favorable prior accident year development on loss reserves in a variety of casualty & other lines of business primarily from the 2003 through 2007 and 2010 through 2011 accident years, partially offset by unfavorable prior accident year development on loss reserves from the 2013 accident year and the 2002 and prior accident years.
(14) Primarily reflects favorable prior accident year development on loss reserves in the umbrella/excess liability and professional liability lines of business, and primarily related to the 2005 through 2010 accident years.
A valuation allowance is provided against deferred tax assets when, in the opinion of management, it is more likely than not that a portion of the deferred tax asset will not be realized. As of December 31, 2015 and 2014, Alleghany recognized $17.9 million and $16.6 million, respectively, of deferred tax assets for certain state net operating and capital loss carryovers, and a valuation allowance of $17.9 million and $16.6 million, respectively, has been established against these deferred tax assets as Alleghany does not currently anticipate it will generate sufficient income in these states to absorb such loss carryovers.
Alleghany’s income tax returns are currently under examination by the Internal Revenue Service for the 2012, 2013 and 2014 tax years. TransRe’s income tax returns, which all relate to periods prior to the merger with Alleghany, are currently under examination by the Internal Revenue Service. The following table lists the tax years of Alleghany and TransRe tax returns that remain subject to examination by major tax jurisdictions as of December 31, 2015
Pursuant to the 2014 Repurchase Program and the 2012 Repurchase Program, Alleghany repurchased shares of Common Stock in 2015, 2014 and 2013 as follows:
Reclassifications out of accumulated other comprehensive income attributable to Alleghany stockholders during 2015 and 2014 were as follows:
As of December 31, 2015, approximately $6.2 billion of Alleghany’s total equity of $7.6 billion was unavailable for dividends or advances to Alleghany from its subsidiaries. The remaining $1.4 billion was available for dividends or advances to Alleghany from its subsidiaries, or was retained at the Alleghany parent company level, and as such, was available to pay dividends to Alleghany’s stockholders as of December 31, 2015.
In the United States, Alleghany’s reinsurance and insurance subsidiaries are subject to insurance laws and regulations that restrict the amount and timing of dividends they may pay without the prior approval of regulatory authorities. Under the insurance holding company laws and regulations, Alleghany’s reinsurance and insurance subsidiaries may not pay an “extraordinary” dividend or distribution, or pay a dividend except out of earned surplus, without the approval of state insurance regulators. In general, an “extraordinary” dividend or distribution is defined as a dividend or distribution that, together with other dividends and distributions made within the preceding 12 months, exceeds the greater (or, in some jurisdictions, the lesser) of (i) 10 percent of the insurer’s statutory surplus as of the end of the prior calendar year, and (ii) the adjusted statutory net investment income during the prior calendar year.
77,441, 72,528 and 73,072 contingently issuable shares were potentially available during 2015, 2014 and 2013, respectively, but were not included in the computations of diluted earnings per share because the impact was anti-dilutive to the earnings per share calculation.
On July 14, 2005, Alleghany completed the sale of its world-wide industrial minerals business, World Minerals, Inc. (“World Minerals”), to Imerys USA, Inc. (the “Purchaser”), a wholly-owned subsidiary of Imerys, S.A., pursuant to a Stock Purchase Agreement, dated as of May 19, 2005, by and among the Purchaser, Imerys, S.A. and Alleghany (the “Stock Purchase Agreement”). Pursuant to the Stock Purchase Agreement, Alleghany undertook certain indemnification obligations, including a general indemnification for breaches of representations and warranties set forth in the Stock Purchase Agreement, and a special indemnification related to products liability claims arising from events that occurred during pre-closing periods, including the period of Alleghany ownership (the “Alleghany Period”). Under the terms of the Stock Purchase Agreement, with respect to products liability claims arising in respect of events occurring during the period prior to the Alleghany Period, Alleghany will provide indemnification at a rate of 100.0 percent for the first $100.0 million of losses arising from such claims, and at a rate of 50.0 percent for the next $100.0 million of such losses, so that Alleghany’s maximum indemnification obligation in respect of products liability claims relating to such period of time is $150.0 million. This indemnification obligation will expire on July 31, 2016. The Stock Purchase Agreement provides that Alleghany has no responsibility for products liability claims arising in respect of events occurring after July 14, 2005, and that any products liability claims involving both pre-closing and post-closing periods will be apportioned on an equitable basis.
Loss and LAE include amounts for risks relating to asbestos-related illness and environmental impairment. As of December 31, 2015 and 2014, such gross and net reserves were as follows:
As of December 31, 2015, Alleghany had holdings in energy sector businesses of $551.7 million, comprised of $274.6 million of debt securities, $71.1 million of equity securities and $206.0 million of Alleghany’s equity attributable to SORC.
In addition, corporate activities include interest expense associated with the Alleghany Senior Notes, whereas interest expense associated with the Senior Notes issued by TransRe is included in “Total Segments.” Information related to Alleghany’s and TransRe’s Senior Notes can be found in Note 8.
Foreign gross premiums written in 2015, 2014 and 2013 were approximately $1.6 billion, $1.7 billion and $1.6 billion, respectively.
Included in corporate activities is debt associated with Alleghany Capital’s operating subsidiaries. This includes $36.3 million of borrowings by Kentucky Trailer as of December 31, 2015 related primarily to a mortgage loan, borrowings to finance small acquisitions and borrowings under its available credit facility. None of these liabilities are guaranteed by Alleghany or Alleghany Capital, and they are classified as a component of other liabilities.
Amounts recognized as compensation expense in the consolidated statements of earnings and comprehensive income with respect to long-term compensation awards under plans for parent company level employees and directors were $19.7 million, $21.2 million and $18.7 million in 2015, 2014 and 2013, respectively. The amount of related income tax benefit recognized as income in the consolidated statements of earnings and comprehensive income with respect to these plans was $6.9 million, $7.4 million and $6.5 million in 2015, 2014 and 2013, respectively. In 2015, 2014 and 2013, $4.7 million, $4.5 million and $6.4 million of Common Stock at fair market value, respectively, and $10.9 million, $7.6 million and $16.3 million of cash, respectively, was paid by Alleghany under these plans for parent company level employees and directors. As noted above, as of December 31, 2015 and December 31, 2014, all outstanding awards were accounted for under the fair-value-based method of accounting.
The automatic annual grant to each non-employee director consists of either restricted stock or restricted stock units, at the director’s election. Awards granted to non-employee directors were not material to Alleghany’s results of operations, financial condition or cash flows for the three years ended December 31, 2015.
In February 2012, Alleghany adopted the 2012 Long-Term Incentive Plan (the “2012 LTIP”), which was approved by Alleghany stockholders in April 2012. Awards under the 2012 LTIP may include, but are not limited to, cash and/or shares of Common Stock, rights to receive cash and/or shares of Common Stock and options to purchase shares of Common Stock, including options intended to qualify as incentive stock options under the Internal Revenue Code, and options not intended to so qualify. Under the 2012 LTIP, the following types of awards were outstanding as of December 31, 2015:
Restricted Share Awards - From time to time, Alleghany has awarded to certain management employees restricted shares or restricted stock units of Common Stock. These awards entitle the participants to a specified maximum amount equal to the value of one share of Common Stock for each restricted share issued to them based on the market value on the grant date, subject to certain conditions. The expense is recognized ratably over the performance period, which can be extended under certain circumstances.
Long-term incentive plans exist at certain other subsidiaries for the purpose of providing equity-like incentives to key employees. The awards under such plans were not material to Alleghany’s results of operations, financial condition or cash flows for the three years ended December 31, 2015.
Alleghany and certain of its subsidiaries provide a variety of retirement benefits. Alleghany provides supplemental retirement benefits through deferred compensation programs and profit sharing plans for certain of its parent company level officers and employees. In addition, Alleghany’s subsidiaries sponsor both qualified, defined contribution retirement plans for substantially all employees, including executives, and non-qualified plans only for executives, some of which provide for voluntary salary reduction contributions by employees and matching contributions by each respective subsidiary, subject to specified limitations.
These employee retirement plans are not material to Alleghany’s results of operations, financial condition or cash flows for the three years ended December 31, 2015.
TransRe has an unfunded, noncontributory defined benefit plan and a funded noncontributory defined benefit plan for certain of its employees in the U.S. Benefits under TransRe’s defined benefit plans were frozen as of December 31, 2009. As of December 31, 2015 and 2014, the projected benefit obligation was $63.0 million and $66.2 million, respectively, and the related fair value of plan assets was $46.7 million and $49.2 million, respectively.
Selected quarterly financial data for 2015 and 2014 are presented below:
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Alleghany Corporation and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of earnings and comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015 of Alleghany Corporation and subsidiaries and our report dated February 23, 2016 expressed an unqualified opinion thereon.