While management takes into consideration a wide range of factors in planning our business strategy and evaluating results of operations, there are certain factors that management believes are fundamental to understanding how we are managed. First, underwriting profit is consistently emphasized as a primary goal, above premium growth. Management’s assessment of our trends and potential growth in underwriting profit is the dominant factor in its decisions with respect to whether or not to expand a business line, enter into a new niche, product or territory or, conversely, to contract capacity in any business line. In addition, management focuses on controlling the costs of our operations. Management believes that careful monitoring of the costs of existing operations and assessing the costs of potential growth opportunities are important to our profitability. Access to capital also has a significant impact on management’s outlook for our operations. The Insurance Companies’ operations and ability to grow their business and take advantage of market opportunities are constrained by regulatory capital requirements and rating agency assessments of capital adequacy. Similarly, the ability to grow our operations at Lloyd’s is subject to capital and operating requirements of Lloyd’s and the U.K. regulatory authorities.
Management’s decisions are also greatly influenced by access to specialized underwriting and claims expertise in our lines of business. We have chosen to operate in specialty niches with certain common characteristics which we believe provide us with the opportunity to use our technical underwriting expertise in order to realize underwriting profit. As a result, we have focused on underserved markets for businesses characterized by higher severity and lower frequency of loss where we believe our intellectual capital and financial strength bring meaningful value. In contrast, we have avoided niches that we believe have a high frequency of loss activity and/or are subject to a high level of regulatory requirements, such as workers compensation and personal automobile insurance, because we do not believe our technical underwriting expertise is of as much value in these types of businesses. Examples of niches that have the characteristics we look for include offshore energy which provides coverage for physical damage to, for example, high value offshore oil drilling rigs, and Directors and Officers (“D&O”) insurance which covers litigation exposure of a corporation’s directors and officers. These types of exposures require substantial technical expertise. We attempt to mitigate the financial impact of severe claims on our results by conservative and detailed underwriting, prudent use of reinsurance and a balanced portfolio of risks.
For additional information regarding our business, refer to “Business-Overview”, included herein.
For the Insurance Companies, Navigators Insurance Company and Navigators Specialty Insurance Company utilize the financial strength ratings from A.M. Best and S&P for underwriting purposes. Navigators Insurance Company and Navigators Specialty Insurance Company are both rated “A” (Excellent - stable outlook) by A.M. Best and “A” (Strong-negative outlook) by S&P. Syndicate 1221 utilizes the ratings from A.M. Best and S&P for underwriting purposes which apply to all Lloyd’s syndicates. Lloyd’s is rated “A” (Excellent - stable outlook) by A.M. Best and A+ (Strong - stable outlook) by S&P.
The Bornheutter-Ferguson method calculates the IBNR loss reserves as the product of the earned premium, an expected ultimate loss ratio, and a loss development factor that represents the expected percentage of the ultimate losses that have been incurred but not yet reported. The loss development factor equals one hundred percent less the expected percentage of losses that have thus far been reported, which is generally calculated as an average of the percentage of losses reported for comparable reporting periods of prior underwriting years. The expected ultimate loss ratio is generally determined in the same manner as in the loss ratio method.
The reserves for property and casualty are established separately by product with the major product being contractors’ liability insurance. Other products include offshore energy, commercial middle markets, primary casualty, excess casualty and specialty reinsurance. Our actuaries generally utilize two key assumptions in this line of business: first, that our historical loss development patterns are reasonable predictors of future loss patterns and second, that our claims personnel’s assessment of our claims exposures and our underwriters’ assessment of our expected losses are reliable indicators of our loss exposure. However, this line of business includes a number of products where there is insufficient Company historical experience to project loss reserves and/or loss development is sparse or erratic, which makes extrapolation techniques for those products extremely difficult to apply, and in those circumstances we typically rely more on industry data and our underwriters’ input in setting assumptions for our IBNR loss reserves as opposed to historical loss development patterns. In addition, as discussed in more detail below with respect to construction defect reserves, our actuaries may take other market trends or events into account in setting IBNR loss reserves.
The professional liability policies mainly provide coverage on a claims-made basis mostly for a one-year period. The reserves for professional liability are analyzed separately by product. The major products are D&O liability coverage and E&O liability coverage for lawyers and other professionals.
Reserves for the Company’s Lloyd’s Operations are reviewed separately for the marine, property and casualty, and professional liability lines by product. The major marine products are marine liability, transport, marine energy liability, offshore energy, cargo, specie and marine reinsurance. The major property and casualty products are offshore energy, engineering, onshore energy and operational engineering. The major products for professional liability are international D&O and international E&O.
The process for establishing the IBNR loss reserves for the marine and professional liability lines of the Lloyd’s Operations, and the assumptions used as part of this process, are similar in nature to the process employed by the Insurance Companies.
(2) - Calculated using average diluted shares of 14,327,820 for the year ended December 31, 2012.
The day to day management of our investment portfolio is outsourced to third party investment managers. While these investment managers may, at a given point in time, believe that the preferred course of action is to hold securities with unrealized losses that are considered temporary until such losses are recovered, the dynamic nature of the portfolio management may result in a subsequent decision to sell the security and realize the loss based upon a change in the market and other factors described above. Investment managers are required to notify management of rating agency downgrades of securities in their portfolios as well as any potential investment valuation issues at the end of each quarter. Investment managers are also required to notify management, and receive approval, prior to the execution of a transaction or series of related transactions that may result in a realized loss above a certain threshold. Additionally, management monitors the execution of a transaction or series of related transactions that may result in any realized loss up until a certain period beyond the close of a quarterly accounting period.
Net income for the year ended December 31, 2011 was $25.6 million or $1.69 per diluted share compared to net income of $69.6 million or $4.24 per diluted share for the year ended December 31, 2010. Operating earnings for the year ended December 31, 2011 were $19.1 million or $1.26 per diluted share compared to $43.4 million or $2.65 per diluted share for the comparable period in 2010. In comparison to net income, operating earnings excludes after-tax net realized gains of $7.8 million and $26.9 million and after-tax OTTI losses of $1.3 million and $0.7 million for the years ended December 31, 2011 and 2010, respectively. The decrease in our operating earnings was largely attributable to unfavorable underwriting results related to large loss activity from our energy business, including losses arising from the Deepwater Horizon oil drilling platform, and significant current year loss emergence from our Professional Liability division, and to a lesser extent a decrease in net investment income.
Cash flow from operations for the year ended December 31, 2012 was $96.7 million compared to approximately $118 million for the years ended December 31, 2011 and 2010. The decrease in cash flow from operations was primarily due to an increase in claim payments, partially offset by improved collections on reinsurance recoverables as well as premiums receivables.
Current accident year loss emergence of $14.5 million from our Agriculture business that was driven by significant drought related crop losses across the U.S.
In addition to the above, the increase in our pre-tax underwriting profit in 2012 was affected by the mix of business and loss trends.
The combined ratio for the year ended December 31, 2011 was 104.7% compared to 100.7% for the comparable period in 2010. Our pre-tax underwriting loss increased by $27.7 million to $32.6 million for the year ended December 31, 2011 compared to a $4.9 million loss for the same period in 2010. Our pre-tax underwriting profit for 2011 includes the following:
2011 accident year energy losses with a net loss of $25.6 million, inclusive of $8.2 million in RRPs, related to drilling operations in the North Sea, Gulf of Mexico and Russia, as well as an onshore industrial site.
An increase in our RRP accrual of $5.2 million. This accrual was driven by the recognition of the effect of a shift in our Marine reinsurance protections to an excess of loss program from a quota share program. As a result of this shift and the increased frequency of severity losses in recent periods, a greater portion of our IBNR was attributable to marine and energy losses that are or will be ceded to our Marine Excess-of-Loss Reinsurance program and such cession will trigger additional reinstatement premiums.
The combined ratio for the year ended December 31, 2010 was 100.7% and the pre-tax loss was $4.9 million mostly driven by a combined $22.5 million in RRPs related to the Deepwater Horizon and West Atlas losses, respectively. The RRPs were partially offset by net prior period reserve redundancies of $13.8 million. The net prior period reserve redundancies were driven by significant redundancies from our Property Casualty business partially offset by loss emergence from our Professional Liability business.
Gross written premiums increased $121.0 million, or 12.3%, to $1.11 billion for the year ended December 31, 2011 compared to $987.2 million for the same period in 2010. The increase in gross written premiums were primarily attributed growth in our Property Casualty business, which includes $101.5 million related to our newly established Assumed Reinsurance division which writes Accident & Health, Agriculture and Latin American reinsurance lines of business. The increase within Property Casualty is also attributable to the growth of our Excess Casualty, Environmental Liability and Primary Casualty divisions of $34.2 million, $11.5 million and $10.6 million, respectively, resulting from strong production, partially offset by the run-off of our middle market commercial package business. The increase in gross written premiums was offset by a $22.2 million decrease in our Professional Liability business attributable to our Directors and Officer Liability lines. This decrease reflects a change in our underwriting strategy that focuses on a planned shift toward underwriting excess layers.
We record an estimate of the expected RRPs for losses ceded to excess-of-loss agreements where this feature applies.
Net written premiums increased 10.6% for the year ended December 31, 2012 compared to the same period in 2011. The increase is due to higher gross written premiums and the mix of business driven by our assumed reinsurance business written by NavRe, partially offset by higher premium cessions on our NavTech business and the additional RRPs recognized in our Marine business as discussed above. Net written premiums increased 15.3% for the year ended December 31, 2011 compared to the same period in 2010, due to the impact of higher gross written premiums, a reduction in RRP’s in comparison to those recorded in 2010, and to a lesser extent lower premium cessions, as discussed above.
Net OTTI losses for the year ended December 31, 2012 primarily consists of $0.8 million for three equity securities which were previously impaired.
The ratio of net losses and LAE to net earned premiums (“loss ratios”) for the years ended December 31, 2012, 2011 and 2010 is presented in the following table:
The net loss and LAE ratio for the year ended December 31, 2012 decreased 5.4 percentage points to 63.6% from 69.0% for the year ended December 31, 2011. The decrease in the loss ratio reflects improved loss experience due to net prior year reserve redundancies of $47.2 million, or 6 loss ratio points, from our Lloyd’s Operations and loss ratio trends driven by mix of business. The improvement in the loss ratio was partially offset by $14.5 million, or 1.9 loss ratio points of current year loss emergence from our Agriculture reinsurance business, and specific large loss events that occurred in the current year. The current year loss ratio includes a net loss of $12.1 million, exclusive of RRPs, or 1.5 loss ratio points, related to Superstorm Sandy and net losses of $2.8 million, exclusive of RRPs, or 0.4 loss ratio points, related to several large losses from our Marine business, including the grounding of the cruise ship Costa Concordia off the coast of Italy.
The net loss and LAE ratio for the year ended December 31, 2011 increased 5.2 percentage points to 69.0% from 63.8% for the year December 31, 2010. The increase for the year ended December 31, 2011 was primarily due to 2011 accident year loss emergence of approximately $11.0 million related to our Professional Liability business of which approximately $8.0 million was specific to our D&O liability insurance for both publicly and privately held corporations. The remaining $3.0 million was specific to our small lawyers and miscellaneous professional liability coverages. In addition, the increase for the year ended December 31, 2011 included net losses of $17.4 million related to four energy events compared to net losses of $11.0 million in 2010 related to Deepwater Horizon and West Atlas.
The segment and line of business breakdowns of prior period net reserve deficiencies (redundancies) for the years ended December 31, 2012, 2011 and 2010 are as follows:
The following is a discussion of relevant factors related to the $45.3 million prior period net reserve redundancies recorded for the year ended December 31, 2012:
an IBNR adjustment of 4.0 million to reflect the actual emergence of claims for underwriting year “(UY)” 2010, which was more favorable than the expected emergence.
Our Lloyd’s Operations recorded $47.2 million of net prior period reserve redundancies across all businesses and divisions. In connection with the Company’s implementation of the Solvency II technical provisions in its Lloyd’s operation, the Company’s actuaries undertook a comprehensive review during 2012 of the historical claims emergence patterns for all lines of business underwritten through Syndicate 1221. As a result of this review, the Company updated the loss emergence patterns used to project ultimate losses for all such lines of business, aligning these loss emergence factors with the historical median. This caused a reduction in ultimate loss estimates for all Lloyd’s segments other than certain lines of business in Property Casualty segment, which increased. The Lloyd’s Operation also experienced significant reserve redundancies in several large claims. The amount of reserve redundancies attributable to these settlements was $5.0 million, consisting of $4.1 million from the Lloyd’s Marine business and $0.9 million from Lloyd’s Professional Liability business. A summary of the resulting prior period redundancies for each business within our Lloyd’s Operations by prior UY is set forth below:
Our Insurance Companies Professional Liability business had overall adverse development of $17.6 million, which consisted of adverse development of $14.5 million and $3.1 million from Management Liability and Errors and Omissions, respectively. The Management Liability development was primarily driven by liability coverage of Public Company directors and officers for accident years 2009 and 2010. The Errors and Omissions development was driven by Small Lawyers Professional Liability and Miscellaneous Professional Liability classes for accident year 2010.
Our Lloyd’s operations experienced $10.0 million of favorable development. This was driven by favorable development of $10.3 million and $5.5 million from the Marine and NavTech divisions respectively, which was partially offset by $5.8 million of unfavorable development from Professional Liability. The favorable development in Marine was primarily from the Cargo, Liability and Specie classes for accident years 2008 and prior. The favorable development in NavTech was from Offshore Energy primarily in accident years 2007 to 2009. The adverse development in Professional Liability was mostly from Errors and Omissions in accident years 2006 to 2008.
The Insurance Companies recorded $4.2 million of net prior year favorable development for the marine business, of which $2.6 million arose in the marine liability business due to favorable loss emergence relative to our expectations and $1.4 million in Hull as we eliminated IBNR in older underwriting years where we determined the year had been fully reported and saw case reserve reductions on a number of claims.
• $2.9 million of favorable development on our offshore energy (NavTech) book due to favorable claims trends across a number of prior underwriting years.
The net loss in connection with Superstorm Sandy was $20.4 million, or 2.6 points on our combined ratio, inclusive of $8.3 million in RRPs. Excluding the impact of RRPs, the gross and net loss was $66.7 million and $12.1 million, respectively.
The following table sets forth our gross and net loss and LAE reserves, incurred loss and LAE, and payments for Superstorm Sandy for the year ended December 31, 2012:
The reduction in incurred loss and LAE shown for the 2008 Hurricanes was due to the release of IBNR on Hurricane Ike during the first quarter 2012. The takedown of IBNR on this loss event was a result of an evaluation of the reported losses over 2010 and 2011. The result of this review was a reduction to Hurricane Ike IBNR as the Company determined that the IBNR reserves for this loss event should be reduced to be in line with our ultimate loss expectations on this event.
The reserves for asbestos exposures as of December 31, 2012 are for: (i) one large settled claim for excess insurance policy limits exposed to a class action suit against an insured involved in the manufacturing or distribution of asbestos products being paid over several years (two other large settled claims were fully paid in 2007); (ii) other insureds not directly involved in the manufacturing or distribution of asbestos products, but that have more than incidental asbestos exposure for their purchase or use of products that contained asbestos; and (iii) attritional asbestos claims that could be expected to occur over time. Substantially all of our asbestos liability reserves are included in our marine loss reserves.
The following tables set forth our gross and net loss and LAE reserves, incurred loss and LAE, and payments for our asbestos exposures for the periods indicated:
Commission expenses paid to brokers and agents are generally based on a percentage of gross written premiums and are partially offset by ceding commissions we may receive on ceded written premiums. Commissions are generally deferred and recorded as deferred policy acquisition costs to the extent that they relate to unearned premium. The percentage of commission expenses to net earned premiums (“commission expense ratio”) for the years ended December 31, 2012, 2011 and 2010 was 15.5% 16.0% and 16.5%, respectively. The decrease in commission expense for the year ended December 31, 2012 compared to the same period in 2011 can be attributed to changes in the mix of business and to a lesser extent an increase in the ceding commission on the new quota share program for our offshore energy business, partially offset by additional RRPs in 2012 in connection with loss events from our Marine business. The slight decrease in the commission expense ratio for the year ended December 31, 2011 when compared to the same period in 2010 can be attributed to the impact of RRPs recorded in 2010, which reduced net earned premiums and in turn increased the commission expense ratio in 2010.
Other operating expenses increased to $159.1 million for the year ended December 31, 2012 from $138.0 million for the same period in 2011 primarily due to continued investments in new underwriting teams closely aligned with business growth and an increase in incentive compensation, which is largely impacted by a reversal of stock grants expense recorded for 2011 related to performance based awards that were not expected to vest, and to a lesser extent the issuance of additional performance and non-performance restricted stock grants in 2012. Refer to Note 15, Stock Option Plans, Stock Grants, Stock Appreciation Rights and Employee Stock Purchase Plan, in the Notes to Consolidated Financial Statements for additional information regarding our expense for restricted stock grants.
The Company has not provided for U.S. income taxes on approximately $17.9 million of undistributed earnings of its non-U.S. subsidiaries since it is intended that those earnings will be reinvested indefinitely in those subsidiaries. If a future determination is made that those earnings no longer are intended to be reinvested indefinitely in those subsidiaries, U.S. income taxes of approximately $1.8 million, assuming all foreign tax credits are realized, would be included in the tax provision at that time and would be payable if those earnings were distributed to the Company.
We evaluate the performance of each segment based on its underwriting and GAAP results. The underwriting results of the Insurance Companies and the Lloyd’s Operations are measured by taking into account net earned premium, net loss and LAE, commission expenses, other operating expenses and other income (expense). Each segment also maintains its own investments, on which it earns income and realizes capital gains or losses. Our underwriting performance is evaluated separately from the performance of our investment portfolios.
The Insurance Companies consist of Navigators Insurance Company, including its U.K. Branch, and its wholly-owned subsidiary, Navigators Specialty. They are primarily engaged in underwriting marine insurance and related lines of business, specialty insurance lines of business, including contractors general liability insurance, commercial umbrella and primary and excess casualty businesses, specialty assumed reinsurance business, and professional liability insurance. Navigators Specialty underwrites specialty and professional liability insurance on an excess and surplus lines basis. Navigators Specialty is 100% reinsured by Navigators Insurance Company.
Our Insurance Companies reported net income of $33.5 million, $27.2 million and $66.3 million for the years ended December 31, 2012, 2011 and 2010, respectively. The increase in net income for the year ended December 31, 2012 as compared to the same period in 2011 was largely related to an increase in net realized gains on our investment portfolio, partially offset by a decrease in investment income driven by lower yields and unfavorable underwriting results. The decrease in net income for the year ended December 31, 2011 as compared to the same period in 2010 was largely attributable to an increase in our underwriting loss and a reduction in net realized gains.
Our Insurance Companies’ combined ratio for the year ended December 31, 2011 was 106.5% compared to 101.2% for the same period in 2010. Our Insurance Companies’ pre-tax underwriting loss increased by $25.6 million to $30.9 million as of December 31 2011 compared to $5.3 million for the same period 2010. The Insurance Companies’ pre-tax underwriting loss in 2011 includes the following:
• 2011 accident year loss emergence of approximately $11.0 million related to our Professional liability business, of which approximately $8.0 million was specific to our Directors and Officers liability insurance for both publicly and privately held corporations. The remaining $3.0 million of emergence was specific to our small lawyers and miscellaneous professional liability coverages.
The Insurance Companies Marine gross written premiums for the year ended December 31, 2012 decreased 12.4% compared to the same period in 2011 primarily due to the transfer of underwriting responsibility of our Transport business, which in the table above is included in Other Marine, to our Lloyd’s Operations. The aforementioned decreases were slightly offset by growth across multiple products driven by an overall increase in renewal rates of 4.4%.
The Insurance Companies Property Casualty gross written premiums for the year ended December 31, 2012 increased 32.7% compared to the same period in 2011. The increases were primarily driven by our assumed reinsurance business written by NavRe as the division continues to achieve successful growth since its establishment in late 2010. Additionally, we experienced growth in our Excess Casualty division resulting from strong production attributable to the expansion of our underwriting team and dislocation of certain competitors.
The Insurance Companies Professional Liability gross written premiums for the year ended December 31, 2012 increased 13.8% compared to the same period in 2011. The increase is related to our E&O division and is driven by growth from the real estate product, which produced $19.3 million in gross written premiums in 2012. Additionally, E&O reported an overall 5.7% increase in renewal rates for the year ended December 31, 2012.
Other operating expenses for the Insurance Companies decreased to $101.5 million for the year ended December 31, 2011 from $106.6 million for the same period in 2010. The decrease was primarily due to a reduction in allocated expenses from NMC and NHUK due in part to a decrease in stock grant expense related to performance based awards that are not expected to vest, partially offset by increased expenses for continued investments in new underwriting teams.
Our Lloyd’s Operations reported net income of $34.8 million, $3.4 million and $7.7 million for the years ended December 31, 2012, 2011 and 2010, respectively. The increase in net income for the year ended December 31, 2012 as compared to the same period in 2011 was largely attributable to stronger underwriting results and to a lesser extent an increase in net realized gains on investments. The decrease in net income for the year ended December 31, 2011 as compared to the same period in 2010 was largely attributable to adverse underwriting activity and current year net realized losses on investments.
• Net loss of $7.6 million, inclusive of $2.0 million in RRPs, related to Superstorm Sandy. Gross of reinsurance our Lloyd’s Operations loss related to Superstorm Sandy was approximately $21.5 million.
• Net losses of $4.0 million, inclusive of $1.9 million in RRPs, related to several large losses from our Marine business, including the grounding of the cruise ship Costa Concordia off the coast of Italy.
• Sliding scale commission adjustments of $3.3 million related to large loss activity that has reduced our ceding commission benefit on a large loss quota share treaty.
The Lloyd’s Operations combined ratio for the year ended December 31, 2010 was 99.8% and the pre-tax underwriting profit was $0.4 million and included $9.4 million of net losses related to the Deepwater Horizon and West Atlas events.
Marine Premiums. The gross written premiums for our Marine business for the years ended December 31, 2012, 2011 and 2010 consisted of the following:
The Lloyd’s Operations Marine gross written premiums for the year ended December 31, 2012 increased 16.0% compared to the same period in 2011. The increase in Lloyd’s Marine is primarily related to growth within Cargo and the transfer of the Transport business to the Lloyd’s Operations from the U.K. Branch.
The Lloyd’s Operations Property Casualty gross written premiums for the year ended December 31, 2012 increased 10.3% compared to the same period in 2011. The increase is primarily due to growth within the Offshore Energy book due to new business opportunities. In addition, Property Casualty benefited from increases in average renewal rates of 7.4%.
The Lloyd’s Operations Professional Liability gross written premiums for the year ended December 31, 2012 increased 17.8% compared to the same period in 2011 primarily as a result of new business in both lines.
The 2011 Lloyd’s Operations Professional Liability gross written premiums decreased 16.0% compared to the same period in 2010, due to restructuring the E&O and D&O businesses. E&O gross written premium declined 31.3% from the prior year due to exiting areas of business that were deemed unprofitable as well as reducing our number of underwriters. We had also restructured the D&O business by reducing our exposure to certain areas and non-renewing business that no longer fit our underwriting strategy. The 2011 average renewal premium rates for the Professional Liability division decreased approximately 1.8% compared to the same periods in 2010.
Other operating expenses for our Lloyd’s Operations increased to $45.5 million for the year ended December 31, 2012 from $36.5 million for the same period in 2011 primarily due to an increase in direct expenses, as well as allocated expenses from NMC, mostly driven by an increase in incentive compensation. The increase in incentive compensation is largely impacted by a reversal of stock grants expense recorded in 2011 related to performance based awards that were not expected to vest, and to a lesser extent the issuance of additional performance and non-performance restricted stock grants in 2012. As a percentage of net earned premiums, Lloyd’s operating expenses for 2012 were higher at 21.5% as compared to 16.9% for the same period in 2011 due in part to additional RRP’s in 2012 in connection with loss events from our Lloyd’s Marine business as well as the increase in allocated expenses from NMC.
Our capital resources consist of funds deployed or available to be deployed to support our business operations. As of December 31, 2012 and 2011, our capital resources were as follows:
Navigators Insurance Company may pay dividends to the Parent Company out of its statutory earned surplus pursuant to statutory restrictions imposed under the New York insurance law. As of December 31, 2012, the maximum amount available for the payment of dividends by Navigators Insurance Company in 2013 without prior regulatory approval is $68.3 million. Navigators Insurance Company paid $15.0 million, $45.0 million and $40.0 million in dividends to the Parent Company in 2012, 2011 and 2010, respectively.
Refer to Note 14, Dividends and Statutory Financial Information, in the Notes to Consolidated Financial Statements for additional information regarding dividends, including dividend restrictions and net assets available for dividend distribution.
Condensed Parent Company balance sheets as of December 31, 2012 and 2011 are shown in the table below:
On November 22, 2012, we entered into a $165 million credit facility agreement with ING Bank N.V., London Branch, individually and as Administrative Agent, and a syndicate of lenders. The new credit facility amended and restated a $165 million letter of credit facility entered into by the parties on March 28, 2011. The credit facility, which is denominated in U.S. dollars, is utilized to fund our participation in Syndicate 1221 through letters of credit for the 2013 and 2014 underwriting years, as well as open prior years. The letters of credit issued under the facility are denominated in British pounds and their aggregate face amount will fluctuate based on exchange rates. If any letters of credit remain outstanding under the facility after December 31, 2014, we would be required to post additional collateral to secure the remaining letters of credit. As of December 31, 2012, letters of credit with an aggregate face amount of $145.2 million were outstanding under the credit facility and we have $0.8 million of cash collateral posted.
This credit facility contains customary covenants for facilities of this type, including restrictions on indebtedness and liens, limitations on mergers, dividends and the sale of assets, and requirements as to maintaining certain consolidated tangible net worth, statutory surplus and other financial ratios. The credit facility also provides for customary events of default, including failure to pay principal, interest or fees when due, failure to comply with covenants, any representation or warranty made by the Company being false in any material respect, default under certain other indebtedness, certain insolvency or receivership events affecting the Company and its subsidiaries, the occurrence of certain material judgments, or a change in control of the Company. The letter of credit facility is secured by a pledge of the stock of certain insurance subsidiaries of the Company. To the extent the aggregate face amount issued under the credit facility exceeds the commitment amount, we are required to post collateral with the lead bank of the consortium. We were in compliance with all covenants under the credit facility as of December 31, 2012.
Time lags do occur in the normal course of business between the time gross loss reserves are paid by the Company and the time such gross paid losses are billed and collected from reinsurers. Reinsurance recoverable amounts related to gross loss reserves as of December 31, 2012 are anticipated to be billed and collected over the next several years as the gross loss reserves are paid by the Company.
Net cash provided by operating activities for the year ended December 31, 2012 was $96.7 million compared to approximately $118 million for the years ended December 31, 2011, and 2010, respectively. The decrease in cash flow from operations was due to an increase in claims payments, partially offset by improved collections on reinsurance recoverables as well as premiums receivables.
Net cash provided by financing activities was $1.1 million for the year ended December 31, 2012 compared to net cash used in financing activities of $88.8 million and $50.5 million for the years ended December 31, 2011 and 2010. The significant reduction in the use of cash by financing activities is primarily related to repurchases of the Parent Company’s common stock under our share repurchase program which expired on December 31, 2011 and was not renewed.
As of December 31, 2012, the weighted average rating of our fixed maturity investments was “AA” by S&P and “Aa” by Moody’s. The entire fixed maturity investment portfolio, except for investments with a fair value of $18.6 million, consists of investment grade bonds. As of December 31, 2012, our portfolio had a duration of 3.6 years. Management periodically projects cash flow of the investment portfolio and other sources in order to maintain the appropriate levels of liquidity in an effort to ensure our ability to satisfy claims. As of December 31, 2012 and 2011, all fixed maturity securities and equity securities held by us were classified as available-for-sale.
The total non-credit OTTI on debt securities included in other comprehensive income as of December 31, 2011 was $1.7 million. As of December 31, 2012 due to appreciation in the fair value, the debt securities for which non-credit OTTI was previously recognized are now in an unrealized gain position of twenty thousand.
The fair value of the Company’s investment portfolio may fluctuate significantly in response to various factors such as changes in interest rates, investment quality ratings, equity prices, foreign exchange rates and credit spreads. The Company does not have the intent to sell nor is it more likely than not that it will have to sell debt securities in unrealized loss positions that are not other-than-temporarily impaired before recovery. For structured securities, default probability and severity assumptions differ based on property type, vintage and the stress of the collateral. We do not intend to sell any of these securities and it is more likely than not that we will not be required to sell these securities before the recovery of the amortized cost basis. For equity securities, the Company also considers its intent to hold securities as part of the process of evaluating whether a decline in fair value represents an other-than-temporary decline in value. The Company may realize investment losses to the extent its liquidity needs require the disposition of fixed maturity securities in unfavorable interest rate, liquidity or credit spread environments. Significant changes in the factors the Company considers when evaluating investments for impairment losses could result in a significant change in impairment losses reported in the consolidated financial statements.
The contractual maturity dates for fixed maturity securities categorized by the number of years until maturity as of December 31, 2012 are shown in the following table:
The following table sets forth the composition of the investments categorized as states, municipalities and political subdivisions in our portfolio by generally equivalent S&P and Moody’s ratings (not all securities in our portfolio are rated by both S&P and Moody’s) as of December 31, 2012. The securities that are not rated in the table below are primarily state bonds.
The following table sets forth the municipal bond holdings by sectors as of December 31, 2012 and 2011:
We own $94.6 million of municipal securities which are credit enhanced by various financial guarantors. As of December 31, 2012, the average underlying credit rating for these securities is A+. There has been no material adverse impact to our investment portfolio or results of operations as a result of downgrades of the credit ratings for several of the financial guarantors.
We analyze our mortgage-backed and asset-backed securities by credit quality of the underlying collateral distinguishing between the securities issued by the Federal National Mortgage Association (“FNMA”), the Federal Home Loan Mortgage Corporation (“FHLMC”) and the Government National Mortgage Association (“GNMA”) which are Federal government sponsored entities, and the non-FNMA and non-FHLMC securities broken out by prime, Alternative A-paper (“Alt-A”) and subprime collateral. The securities issued by FNMA and FHLMC are the obligations of each respective entity. Legislation has provided for guarantees by the U.S. Government of up to $100 billion each for FNMA and FHLMC.
The company holds non-sovereign European securities of $83.2 million at fair value and $80.8 million at amortized cost, primarily in the investment portfolio. This represents 3.7% of our total fixed income and equity portfolio. Our largest exposure is in France with a total of $37.4 million followed by the Netherlands with a total of $33.2 million. We have no direct material exposure to Greece, Portugal, Italy or Spain as of December 31, 2012.
As of December 31, 2012 and 2011, the largest single unrealized loss by a non-government backed issuer in the investment portfolio was $0.2 million and $1.4 million, respectively.