We lease office space in Bala Cynwyd, Pennsylvania which holds our Insurance Operations’ principle executive offices and headquarters. In addition, we lease additional office space in California, Georgia, Illinois, Maryland and Texas which serves as office space for our field offices. Some of the office space in California also serves as office space for our claims operations. We also lease office space in Hamilton, Bermuda, which is used by our Reinsurance Operations. We lease office space in Cavan, Ireland which is used to support the operating needs of our Insurance and Reinsurance Operations. We believe the properties listed are suitable and adequate to meet our needs.
(2) In May 2009, we issued 17.2 million Class A ordinary shares and 11.4 million Class B ordinary shares in conjunction with the Rights Offering. In computing the basic and diluted weighted share counts, the number of shares outstanding prior to May 5, 2009 (the date that the ordinary shares were issued in conjunction with the Rights Offering) was adjusted by a factor of 1.114 to reflect the impact of a bonus element associated with the Rights Offering in accordance with appropriate accounting guidance. As a result, share counts for the prior periods have been restated.
(1) Our insurance operating ratios are non-GAAP financial measures that are generally viewed in the insurance industry as indicators of underwriting profitability. The loss ratio is the ratio of net losses and loss adjustment expenses to net premiums earned. The expense ratio is the ratio of acquisition costs and other underwriting expenses to net premiums earned. The combined ratio is the sum of the loss and expense ratios. The ratios presented here represent the consolidated results of both our Insurance Operations and Reinsurance Operations.
Our Insurance Operations distribute property and casualty insurance products through a group of approximately 100 professional general agencies that have limited quoting and binding authority, as well as a number of wholesale insurance brokers who in turn sell our insurance products to insureds through retail insurance brokers. We operate predominantly in the excess and surplus lines marketplace. To manage our operations, we differentiate them by product classification. These product classifications are: 1) Penn-America, which includes property and general liability products for small commercial businesses distributed through a select network of wholesale general agents with specific binding authority; 2) United National, which includes property, general liability, and professional lines products distributed through program administrators with specific binding authority; and 3) Diamond State, which includes property, casualty, and professional lines products distributed through wholesale brokers and program administrators with specific binding authority.
We derive our revenues primarily from premiums paid on insurance policies that we write and from income generated by our investment portfolio, net of fees paid for investment management services. The amount of insurance premiums that we receive is a function of the amount and type of policies we write, as well as of prevailing market prices.
Our expenses include losses and loss adjustment expenses, acquisition costs and other underwriting expenses, corporate and other operating expenses, interest, other investment expenses, and income taxes. Losses and loss adjustment expenses are estimated by management and reflect our best estimate of ultimate losses and costs arising during the reporting period and revisions of prior period estimates. We record losses and loss adjustment expenses based on an actuarial analysis of the estimated losses we expect to incur on the insurance policies we write. The ultimate losses and loss adjustment expenses will depend on the actual costs to resolve claims. Acquisition costs consist principally of commissions that are typically a percentage of the premiums on the insurance policies we write, net of ceding commissions earned from reinsurers and allocated internal costs. Other underwriting expenses consist primarily of personnel expenses and general operating expenses. Corporate and other operating expenses are comprised primarily of outside legal fees, other professional fees, including accounting fees, directors’ fees, management fees, salaries and benefits for company personnel whose services relate to the support of corporate activities, and capital duty taxes incurred. Interest expense consists primarily of interest on senior notes payable, junior subordinated debentures, and funds held on behalf of others.
In developing loss and loss adjustment expense (“loss” or “losses”) reserve estimates for our Insurance Operations, our actuaries perform detailed reserve analyses each quarter. To perform the analysis, the data is organized at a “reserve category” level. A reserve category can be a line of business such as commercial automobile liability, or it can be a particular type of claim such as construction defect. The reserves within a reserve category level are characterized as short-tail through long-tail. Most of our business can be characterized as medium to long-tail. For long-tail business, it will generally be several years between the time the business is written and the time when all claims are settled. Our long-tail exposures include general liability, professional liability, products liability, commercial automobile liability, and excess and umbrella. Short-tail exposures include property, commercial automobile physical damage, and equine mortality. To manage our insurance operations, we differentiate them by product classifications, which are Penn-America, United National, and Diamond State. For further discussion about our product classifications, see “General-Our Insurance Operations” in Item 1 of Part I of this report. Each of our product classifications contain both long-tail and short-tail exposures. Every reserve category is analyzed by our actuaries each quarter. The analyses generally include reviews of losses gross of reinsurance and net of reinsurance.
In addition to our internal reserve analysis, independent external actuaries perform a full, detailed review of our Insurance Operations’ reserves during the second and fourth quarters of each fiscal year. Our independent external actuaries also perform a full, detailed review of our Reinsurance Operations’ reserves on a quarterly basis. We do not rely upon the review by the independent actuaries to develop our reserves; however, the data is used to corroborate the analysis performed by the in-house actuarial staff.
The Bornhuetter-Ferguson method using premiums and paid losses is a combination of the Paid Development method and the Expected Loss Ratio method. This method normally determines expected loss ratios similar to the method used for the Expected Loss Ratio method and requires analysis of the same factors described above.
The method assumes that only future losses will develop at the expected loss ratio level. The percent of paid loss to ultimate loss implied from the Paid Development method is used to determine what percentage of ultimate loss is yet to be paid. The use of the pattern from the Paid Development method requires consideration of all factors listed in the description of the Paid Development method. The estimate of losses yet to be paid is added to current paid losses to estimate the ultimate loss for each year. This method will react very slowly if actual ultimate loss ratios are different from expectations due to changes not accounted for by the expected loss ratio calculation.
For many exposures, especially those that can be considered long-tail, a particular accident year may not have a sufficient volume of paid losses to produce a statistically reliable estimate of ultimate losses. In such a case, our actuaries typically assign more weight to the Incurred Development method than to the Paid Development method. As claims continue to settle and the volume of paid losses increases, the actuaries may assign additional weight to the Paid Development method. For most of our reserve categories, even the incurred losses for accident years that are early in the claim settlement process will not be of sufficient volume to produce a reliable estimate of ultimate losses. In these cases, we will not assign any weight to the Paid and Incurred Development methods and will use the Bornhuetter-Ferguson and Expected Loss Ratio methods. For short-tail exposures, the Paid and Incurred Development methods can often be relied on sooner primarily because our history includes a sufficient number of years to cover the entire period over which paid and incurred losses are expected to change. However, we may also use the Expected Loss Ratio, Bornhuetter-Ferguson and Average Loss methods for short-tail exposures.
Reserve analyses performed by our internal and external actuaries result in actuarial point estimates. The results of the detailed reserve reviews were summarized and discussed with our senior management to determine the best estimate of reserves. This group considered many factors in making this decision. The factors included, but were not limited to, the historical pattern and volatility of the actuarial indications, the sensitivity of the actuarial indications to changes in paid and incurred loss patterns, the consistency of claims handling processes, the consistency of case reserving practices, changes in our pricing and underwriting, and overall pricing and underwriting trends in the insurance market.
Management’s best estimate at December 31, 2011 was recorded as the loss reserve. Management’s best estimate is as of a particular point in time and is based upon known facts, our actuarial analyses, current law, and our judgment. This resulted in carried gross and net reserves of $971.4 million and $687.7 million, respectively, as of December 31, 2011. A breakout of our gross and net reserves, excluding the effects of our intercompany pooling arrangements and intercompany stop loss and quota share reinsurance agreements, as of December 31, 2011 is as follows:
We continually review these estimates and, based on new developments and information, we include adjustments of the estimated ultimate liability in the operating results for the periods in which the adjustments are made. The establishment of loss and loss adjustment expense reserves makes no provision for the possible broadening of coverage by legislative action or judicial interpretation, or the emergence of new types of losses not sufficiently represented in our historical experience or that cannot yet be quantified or estimated. We regularly analyze our reserves and review pricing and reserving methodologies so that future adjustments to prior year reserves can be minimized. However, given the complexity of this process, reserves require continual updates and the ultimate liability may be higher or lower than previously indicated. Changes in estimates for loss and loss adjustment expense reserves are recorded in the period that the change in these estimates is made. See Note 11 to the consolidated financial statements in Item 8 of Part II of this report for details concerning the changes in the estimate for incurred loss and loss adjustment expenses related to prior accident years.
The detailed reserve analyses that our internal and external actuaries complete use a variety of generally accepted actuarial methods and techniques to produce a number of estimates of ultimate loss. We determine our best estimate of ultimate loss by reviewing the various estimates and assigning weight to each estimate given the characteristics of the reserve category being reviewed. The reserve estimate is the difference between the estimated ultimate loss and the losses paid to date. The difference between the estimated ultimate loss and the case incurred loss (paid loss plus case reserve) is considered to be IBNR. IBNR calculated as such includes a provision for development on known cases (supplemental development) as well as a provision for claims that have occurred but have not yet been reported (pure IBNR).
In light of the many uncertainties associated with establishing the estimates and making the assumptions necessary to establish reserve levels, we review our reserve estimates on a regular basis and make adjustments in the period that the need for such adjustments is determined. The anticipated future loss emergence continues to be reflective of historical patterns, and the selected development patterns have not changed significantly from those underlying our most recent analyses.
of variability around our best estimate based on our historical loss experience and management’s judgment, reflects the impact of changes (which could be favorable or unfavorable) in frequency and severity on our current accident year net loss estimate of $275.3 million for claims occurring during the year ended December 31, 2011:
See Note 9 of the notes to consolidated financial statements in Item 8 of Part II of this report for further information surrounding our reinsurance receivable balances and collectability as of December 31, 2011 and 2010. For a listing of the ten reinsurers for which we have the largest reinsurance asset amounts as of December 31, 2011, see “Reinsurance of Underwriting Risk” in Item 1 of Part I of this report.
For an analysis of our securities with gross unrealized losses as of December 31, 2011 and 2010, and for other than temporary impairment losses that we recorded for the years ended December 31, 2011, 2010, and 2009, please see Note 6 of the notes to the consolidated financial statements in Item 8 of Part II of this report.
We categorize our assets that are accounted for at fair value in the consolidated statements into a fair value hierarchy. The fair value hierarchy is directly related to the amount of subjectivity associated with the inputs utilized to determine the fair value of these assets. See Note 7 of the notes to the consolidated financial statements in Item 8 of Part II of this report for further information.
Impairment of intangible assets with an indefinite useful life is tested at least annually and more frequently as circumstances warrant in accordance with applicable accounting guidance. Impairment of indefinite lived intangible assets is recognized only if the carrying amount of the intangible assets exceeds the fair value of said assets. The amount of the impairment loss would be equal to the excess carrying value of the assets over the fair value of said assets. Based on the analysis performed in 2011, there were no impairments of indefinite lived intangible assets as of December 31, 2011.
The costs of acquiring new and renewal insurance and reinsurance contracts include commissions, premium taxes and certain other costs that vary with and are primarily related to the acquisition of new and renewal insurance and reinsurance contracts. The excess of the Company’s costs of acquiring new and renewal insurance and reinsurance contracts over the related ceding commissions earned from reinsurers is capitalized as deferred acquisition costs and amortized over the period in which the related premiums are earned.
At each balance sheet date, management assesses the need to establish a valuation allowance that reduces deferred tax assets when it is more likely than not that all, or some portion, of the deferred tax assets will not be realized. A valuation allowance would be based on all available information including our assessment of uncertain tax positions and projections of future taxable income from each tax-paying component in each jurisdiction, principally derived from business plans and available tax planning strategies. There are no valuation allowances as of December 31, 2011. The deferred tax asset balance is analyzed regularly by management. Based on these analyses, we have determined that our deferred tax asset is recoverable. Projections of future taxable income incorporate several assumptions of future business and operations that are apt to differ from actual experience. If, in the future, our assumptions and estimates that resulted in our forecast of future taxable income for each tax-paying component prove to be incorrect, a valuation allowance may be required. This could have a material adverse effect on our financial condition, results of operations, and liquidity.
We manage our business through two business segments: Insurance Operations and Reinsurance Operations.
(2) Excludes corporate and other operating expenses and interest expense, which are not allocated to our segments.
The components of income (loss) from underwriting and underwriting ratios of our Insurance Operations segment are as follows:
(1) Includes excise tax of $1,060 and $1,021 related to cessions from our U.S. Insurance Companies to Wind River Reinsurance for 2011 and 2010, respectively.
The ratio of net premiums written to gross premiums written was 88.3% for 2011 and 79.9% for 2010, an increase of 8.4 points, which was primarily due to changes in our reinsurance structure on our property business noted above.
Net premiums earned were $216.5 million for 2011, compared with $194.2 million for 2010, an increase of $22.4 million or 11.5%. The increase was primarily due the increases in net premiums written within the previous year. Property net premiums earned for 2011 and 2010 were $97.6 million and $75.2 million, respectively. Casualty net premiums earned for 2011 and 2010 were $118.9 million and $119.0 million, respectively.
The current accident year loss ratio increased 25.5 points in 2011 due to increases in both the property and casualty loss ratios:
The current accident year casualty loss ratio increased 34.0 points from 68.9% in 2010 to 102.9% in 2011 primarily due to a professional lines loss in a class of business that we are exiting, loss emergence in our general liability line and an increase to losses related to premium deficiencies. We increased the current accident year expected loss ratio for certain Diamond State classes within our general liability line to 208.6% during 2011, which had a 19.1 point impact on the casualty lines loss ratio during the quarter. On a pro forma basis, excluding the impact of the increase to losses related to premium deficiencies and the general liability line increase noted above, the current year casualty loss ratio increased 11.2 points from 69.2% in 2010 to 80.4% in 2011. We are addressing profitability concerns by exiting certain classes of business within the general liability line. Casualty net premiums earned for the year ended December 31, 2011 and 2010 were $118.9 million and $119.0 million, respectively.
consider many factors, including the frequency and severity of claims, loss credit trends, case reserve settlements that may have resulted in significant development, and any other additional or pertinent factors that may impact reserve estimates.
In 2011, we decreased our prior accident year loss reserves by $8.4 million and decreased our allowance for uncollectible reinsurance by $1.3 million. The reduction of our prior accident year loss reserves primarily consisted of a $11.6 million reduction in our general liability lines, a $2.5 million reduction in our property lines, and a $1.7 million reduction in our umbrella lines, offset partially by a $5.7 million increase in our professional liability lines and a $1.8 million increase in our auto liability lines:
General Liability: The reduction in the general liability lines primarily consisted of net reductions of $25.5 million in accident years 2008 and prior due to continued favorable emergence. Incurred losses for these years have developed at a rate lower than the Company’s historical averages. We also decreased our reinsurance allowance by $1.3 million in this line due to changes in our reinsurance exposure on specifically identified claims and general decreases in ceded reserves. Offsetting these decreases were increases of $13.9 million in accident years 2009 and 2010 primarily driven by loss emergence primarily within our Diamond State product as well as revised exposure estimates for construction defect liability. Increased estimates for construction defect were primarily the result of a methodology change during the year, with some increases in recent years due to a slight increase in claim frequency in one of our review segments. We are addressing profitability concerns by exiting certain classes of business within this line.
Property: The reduction in the property lines primarily related to accident years 2009 and 2010 related to anticipated subrogation on a large equine mortality claim as well as favorable development on prior year catastrophe claims.
Auto Liability: The increase in the auto liability lines is primarily related to accident year 2010 due to higher than expected severity.
The reduction in our allowance for uncollectible reinsurance is primarily due to due to write-offs of receivables deemed to be uncollectible and a decrease in the amount of carried reinsurance receivables.
General Liability: The reduction in the general liability lines primarily consisted of reductions of $45.4 million related to accident years 2002 through 2009 due to lower than anticipated frequency and severity. Incurred losses for these years have developed at a rate lower than the Company’s historical averages. This reduction was partially offset by net increases of $1.8 million related to accident years 2001 and prior where the Company increased the loss and loss adjustment expense estimates related to construction defect claims.
Umbrella: The $5.4 million reduction in the umbrella lines related to all accident years 2009 and prior due to less than anticipated severity. As these accident years have matured, more weight has been given to experience based methods which continue to develop favorably compared to our initial indications.
Property: The reduction in the property lines primarily consisted of reductions of $2.9 million related to accident years 2002 and 2004 through 2008 driven by lower than anticipated severity, partially offset by increases of $0.9 million primarily related to accident year 2009 where the Company experienced higher than expected claim frequency and severity.
Acquisition costs and other underwriting expenses were $96.7 million for 2011, compared with $91.5 million for 2010, an increase of $5.2 million or 5.7%. The increase is due to an $8.6 million increase in acquisition costs offset partially by a $3.4 million decrease in other underwriting expenses.
The decrease in other underwriting expenses is primarily due to an overall decrease in employee compensation related to the Profit Enhancement Initiative as well as a decrease in share-based compensation related to the forfeiture of unvested restricted shares and options.
The factors described above resulted in a loss from underwriting for our Insurance Operations of $56.3 million for 2011, compared with income from underwriting of $32.2 million for 2010, a decrease of $88.5 million.
Gross premiums written, which represents the amount received or to be received for reinsurance agreements written without reduction for reinsurance costs or other deductions, was $78.8 million for 2011, compared with $100.3 million for 2010, a decrease of $21.5 million or 21.5%. The decrease was primarily due to the sale of a company that elected not to renew its treaty with Wind River Reinsurance post-acquisition and non-renewing treaties that did not meet our return hurdles.
Net premiums earned were $81.3 million for 2011, compared with $92.6 million for 2010, a decrease of $11.3 million or 12.2%. The decrease was primarily due to the non-renewal of certain treaties that did not meet our return hurdles throughout 2011. Property net premiums earned for 2011 and 2010 were $32.8 million and $35.3 million, respectively. Casualty net premiums earned for 2011 and 2010 were $48.5 million and $57.3 million, respectively.
The loss ratio for our Reinsurance Operations was 111.1% for 2011 compared with 63.9% for 2010. The loss ratio is a non-GAAP financial measure that is generally viewed in the insurance industry as an indicator of underwriting profitability and is calculated by dividing net losses and loss adjustment expenses by net premiums earned.
The current accident year property loss ratio was 94.3% in 2011 compared to 38.2% in 2010. This increase was primarily due to catastrophe losses related to the Japan earthquake and tsunami, New Zealand earthquakes, Australian floods, Alabama tornadoes, Hurricane Irene, Tropical Storm Lee and other U.S. catastrophe events. Current accident year property losses for the year ended December 31, 2011 and 2010 were $31.0 million and $13.5 million, respectively.
In 2011, we increased our prior accident year loss reserves by $13.1 million. The increase in our prior accident year loss reserves primarily consisted of a $8.7 million increase in general liability lines, a $3.1 million increase in our automobile liability lines, a $1.5 million increase in property lines, and a $1.0 million increase in our workers’ compensation lines, offset partially by a decrease of $1.3 million in our professional liability lines:
General Liability: The increase in our general liability lines was primarily related to accident years 2009 and 2010 due to loss estimates that were greater than expected.
Automobile Liability: The increase in the automobile liability lines was primarily related to accident year 2010 resulting from further unexpected development on non-standard auto treaties which were not renewed in 2011.
Automobile Liability: The increase in the automobile liability lines was primarily due to increases of $2.5 million related to higher frequency within accident year 2009 from a non-standard auto treaty.
Net losses and loss adjustment expenses were $90.3 million for 2011, compared with $59.2 million for 2010, an increase of $31.1 million or 52.6%. Excluding the $13.1 million increase of net losses and loss adjustment expenses for prior accident years in 2011 and the $2.7 million increase of net losses and loss adjustment expenses for prior accident years in 2010, the current accident year net losses and loss adjustment expenses were $77.3 million and $56.5 million for 2011 and 2010, respectively. This increase is primarily attributable to large catastrophe losses incurred during the first nine months of 2011 as discussed above.
The factors described above resulted in a loss from underwriting for our Reinsurance Operations of $35.8 million in 2011, compared to income from underwriting of $6.7 million in 2010, a decrease of $42.5 million.
Net investment income, which is gross investment income less investment expenses, was $53.1 million for 2011, compared with $56.6 million for 2010, a decrease of $3.5 million or 6.2%.
The average duration of our fixed maturities portfolio was 1.8 years as of December 31, 2011, compared with 2.2 years as of December 31, 2010. Including cash and short-term investments, the average duration of our fixed maturities portfolio as of December 31, 2011 was 1.6 years compared with 2.1 years as of December 31, 2010. Changes in interest rates can cause principal payments on certain investments to extend or shorten which can impact duration. At December 31, 2011, our book yield on our fixed maturities, not including cash, was 3.58% compared with 3.92% at December 31, 2010. As of December 31, 2011, our investment portfolio held $152.5 million in tax-exempt municipals with a book yield of 3.69% and $53.7 million in taxable municipals with a book yield of 3.31%.
Net realized investment gains were $21.5 million for 2011, compared with $26.4 million for 2010. The net realized investment gains for 2011 consist primarily of net gains of $14.2 million relative to our fixed maturities and $14.7 million relative to our equity securities, offset by mutual fund losses of $0.8 million and other than
See Note 6 of the notes to the consolidated financial statements in Item 8 of Part II of this report for an analysis of total investment return on an after-tax basis for the years ended December 31, 2011 and 2010.
Interest expense was $6.5 million and $7.0 million for 2011 and 2010, respectively. This reduction was primarily due to a principal payment of $18.0 million on our senior notes payable made during July, 2011. See Note 12 of the notes to the consolidated financial statements in Item 8 of Part II of this report for details on our debt.
Gross premiums written, which represents the amount received or to be received for insurance policies written without reduction for reinsurance costs or other deductions, was $245.5 million for 2010, compared with $268.0 million for 2009, a decrease of $22.5 million or 8.4%. The decrease was primarily due to declines in the Penn-America book of business and price decreases in the aggregate of 3.0%, offset partially by growth in our brokerage operations.
The ratio of net premiums written to gross premiums written was 79.9% for 2010 and 81.4% for 2009, a decline of 1.5 points, which was primarily due to increased reinsurance costs and the minimum premium charge noted above. Without the impact of the premium charge, the ratio of net premiums written to gross premiums written was 80.5% in 2010.
Net premiums earned were $194.2 million for 2010, compared with $250.4 million for 2009, a decrease of $56.2 million or 22.5%. The decrease was primarily due to the reductions in net premiums written in recent years. Property net premiums earned for 2010 and 2009 were $75.2 million and $103.5 million, respectively. Casualty net premiums earned for 2010 and 2009 were $119.0 million and $146.9 million, respectively.
The loss ratio for our Insurance Operations was 36.6% for 2010 compared with 58.4% for 2009. The loss ratio is a non-GAAP financial measure that is generally viewed in the insurance industry as an indicator of underwriting profitability and is calculated by dividing net losses and loss adjustment expenses by net premiums earned.
Property: The reduction in the property lines primarily consisted of reductions related to accident year 2006 through 2008 due to better than expected loss emergence in Diamond State brokerage.
General Liability: The reduction in the general liability lines primarily consisted of net reductions of $13.5 million related to accident years 2006 and prior due to loss emergence that had been consistently lower than expected during those years, partially offset by increases of $10.6 million related to accident years 2007 and 2008 that were driven by a large claim and an increase in our construction defect provisions.
Professional Liability: The increase to the professional liability lines primarily consisted of increases of $10.1 million related to accident years 2007 and 2008 due to an increase in severity, partially offset by net reductions of $5.4 million primarily related to accident years 2006 and prior.
The current accident year loss ratio increased 3.9 points in 2010 due to increases in both the property and casualty loss ratios:
The current accident year casualty loss ratio increased 2.1 points from 66.8% in 2009 to 68.9% in 2010 primarily due to rate decreases of approximately 2.7% and higher reinsurance costs in 2010. Casualty net premiums earned for 2010 and 2009 were $119.0 million and $146.9 million, respectively.
The decrease in acquisition costs is primarily due to a decrease in commissions resulting from a decrease in net premiums earned. The increase in acquisition costs related to prior accident years is primarily due to an increase in contingent commissions related to the prior accident year loss reserve releases noted above.
The decrease in other underwriting expenses is primarily due to decreases in compensation related expenses and decreases in legal fees, partially offset by one-time charges of $3.9 million related to the Profit Enhancement Initiative. See Note 4 of the notes to the consolidated financial statements in Item 8 of Part II of this report for a discussion on the Profit Enhancement Initiative.
The expense ratio for our Insurance Operations was 47.1% for 2010, compared with 42.4% for 2009. The current accident year expense ratio was 45.7% for 2010, compared with 42.1% for 2009. The expense ratio is a non-GAAP financial measure that is calculated by dividing the sum of acquisition costs and other underwriting expenses by net premiums earned. The increase in the expense ratio is primarily due to the decrease in net premiums earned noted above, as well as one-time charges related to the Profit Enhancement Initiative of 1.5% or $3.9 million.
The combined ratio for our Insurance Operations was 83.7% for 2010, compared with 100.8% for 2009. The combined ratio is a non-GAAP financial measure and is the sum of our loss and expense ratios. Excluding the impact of prior accident year adjustments, the combined ratio increased from 104.2% in 2009 to 111.6% in 2010. See discussion of loss ratio included in “Net Losses and Loss Adjustment Expenses” above and discussion of expense ratio in preceding paragraph above for an explanation of this increase.
Net premiums written, which equals gross premiums written less ceded premiums written, was $100.4 million for 2010, compared with $72.7 million for 2009, an increase of $27.7 million or 38.1%. The increase was primarily due to the increase in gross premiums written as described above.
The ratio of net premiums written to gross premiums written was 100.2% for 2010 and 99.6% for 2009.
In 2010, we increased our prior accident year loss reserves by $2.7 million. The increase in our prior accident year loss reserves primarily consisted of a $2.6 million increase in our automobile liability lines, a $0.5 million increase in our workers’ compensation lines, offset partially by a decrease of $0.5 million in our property lines:
Property: The reduction in the property lines primarily consisted of reductions of $0.7 million related to accident year 2009, partially offset by increases of $0.2 million related to accident year 2008. These changes are due to continuing emergence of loss trends on our catastrophe treaty.
In 2009, we increased our prior accident year loss reserves by $0.03 million, which primarily consisted of increases in our general liability lines. The increase to the general liability lines was related to accident years 2007 and 2008.
Net losses and loss adjustment expenses were $59.2 million for 2010, compared with $23.2 million for 2009, an increase of $36.0 million or 155.3%. Excluding the $2.7 million increase of net losses and loss adjustment expenses for prior accident years in 2010 and the $0.03 million increase of net losses and loss adjustment expenses for prior accident years in 2009, the current accident year net losses and loss adjustment expenses were $56.5 million and $23.2 million for 2010 and 2009, respectively. This increase is primarily attributable to an increase in net premiums earned and the factors that caused an increased current accident year loss ratio, as described above.
Acquisition costs and other underwriting expenses were $26.7 million for 2010, compared with $13.6 million for 2009, an increase of $13.1 million or 96.0%. We incurred $1.5 million in acquisition costs related to prior accident years in 2010, while we did not make any adjustments to prior accident year acquisition costs in 2009. The entire increase in acquisition costs and other underwriting expenses is due to increases in commissions resulting from the increase in net premiums earned. The increase in acquisition costs related to prior accident years is primarily due to timing of contingent commission expenses incurred.
The combined ratio for our Reinsurance Operations was 92.7% for 2010, compared with 71.8% for 2009. The combined ratio is a non-GAAP financial measure and is the sum of our loss and expense ratios. Excluding the impact of prior accident year adjustments, the combined ratio increased from 71.8% in 2009 to 88.2% in 2010. See discussion of loss ratio included in “Net Losses and Loss Adjustment Expenses” above and discussion of expense ratio in preceding paragraph above for an explanation of this increase.
The following items are not allocated to our Insurance Operations or Reinsurance Operations segments:
Net investment income, which is gross investment income less investment expenses, was $56.6 million for 2010, compared with $70.2 million for 2009, a decrease of $13.6 million or 19.4%.
Cash and invested assets, net of payable for securities purchased, increased to $1,712.4 million as of December 31, 2010 from $1,694.1 million as of December 31, 2009, an increase of $18.3 million or 1.1%. This increase was primarily due to timing of purchases and sales of securities.
Investment expenses were $6.0 million for 2010, compared with $4.7 million for 2009, an increase of $1.3 million or 28.2%. The increase was primarily due to additional fees related to our investments in corporate loans.
Corporate and other operating expenses consist of outside legal fees, other professional fees, development costs, directors’ fees, management fees, salaries and benefits for holding company personnel, and taxes incurred which are not directly related to operations. Corporate and other operating expenses were $21.1 million for 2010, compared with $16.8 million for 2009, an increase of $4.4 million or 26.1%. This increase was primarily due to one-time charges related to the Profit Enhancement Initiative and infrastructure costs related to IT upgrades, offset by decreases in professional service fees.
The factors described above resulted in net income of $84.9 million in 2010, compared with $75.4 million in 2009, an increase of $9.5 million.
In May 2009, we received gross proceeds of $100.1 million from the issuance of 17.2 million and 11.4 million of our Class A and Class B ordinary shares, respectively, in conjunction with the Rights Offering that was announced in March 2009. The net proceeds of $91.8 million were used to support strategic initiatives, enhance liquidity and financial flexibility, and for other general corporate purposes. See Note 13 to the consolidated financial statements in Item 8 of Part II of this report for details concerning the Rights Offering.
Under Pennsylvania law, United National Insurance Company, Penn-America Insurance Company, and Penn-Star Insurance Company may not pay any dividend or make any distribution that, together with other dividends or distributions made within the preceding 12 consecutive months, exceeds the greater of (1) 10% of its surplus as shown on its last annual statement on file with the commissioner or (2) its net income for the period covered by such statement, not including pro rata distributions of any class of its own securities, unless the commissioner has received notice from the insurer of the declaration of the dividend and the commissioner approves the proposed payment or fails to disapprove such payment within 30 days after receiving notice of such payment. An additional limitation is that Pennsylvania does not permit a domestic insurer to declare or pay a dividend except out of unassigned funds (surplus) unless otherwise approved by the commissioner before the dividend is paid. Furthermore, no dividend or other distribution may be declared or paid by a Pennsylvania insurance company that would reduce its total capital and surplus to an amount that is less than the amount required by the Insurance Department for the kind or kinds of business that it is authorized to transact.
Under Wisconsin law, United National Specialty Insurance Company may not pay any dividend or make any distribution of cash or other property, other than a proportional distribution of its stock, the fair market value of which, together with that of other dividends paid or credited and distributions made within the preceding 12 months, exceeds the lesser of (1) 10% of its surplus as of the preceding 31st day of December, or (2) the greater of (a) its net income for the calendar year preceding the date of the dividend or distribution, minus realized capital gains for that calendar year or (b) the aggregate of its net income for the three calendar years preceding the date of the dividend or distribution, minus realized capital gains for those calendar years and minus dividends paid or credited and distributions made within the first two of the preceding three calendar years, unless it reports the extraordinary dividend to the commissioner at least 30 days before payment and the commissioner does not
disapprove the extraordinary dividend within that period. Additionally, under Wisconsin law, all authorizations of distributions to shareholders, other than stock dividends, shall be reported to the commissioner in writing and no payment may be made until at least 30 days after such report.
the fact that we collect premiums, net of commission, in advance of losses paid;
Net cash was used for operating activities in 2011, 2010, and 2009 was $7.7 million, $1.0 million and $52.6 million, respectively.
See the consolidated statement of cash flows in the financial statements in Item 8 of Part II of this report for details concerning our investing and financing activities.
Currently, we believe each company in our Insurance Operations and Reinsurance Operations maintains sufficient liquidity to pay claims through cash generated by operations and investments in liquid investments. Our holding companies also maintain sufficient liquidity to meet their obligations. At December 31, 2011, Global Indemnity had cash and cash equivalents of $175.9 million.
Prospectively, as fixed income investments mature and new cash is obtained, the cash available to invest will be invested in accordance with our investment policy. Our investment policy allows us to invest in taxable and tax-exempt fixed income investments as well as publicly traded and private equity investments. With respect to bonds, our credit exposure limit for each issuer varies with the issuer’s credit quality. The allocation between taxable and tax-exempt bonds is determined based on market conditions and tax considerations. During 2011, we decreased the average duration on our investment portfolio in order to defensively position ourselves during the current low interest rate environment.
We have access to various capital sources including dividends from insurance subsidiaries, invested assets in our Non-U.S. Subsidiaries, and access to the debt and equity capital markets. We believe we have sufficient liquidity to meet our capital needs. See Note 19 of the notes to the consolidated financial statements in Item 8 of Part II of this report for a discussion of our dividend capacity.
On November 12, 2007, Wind River Reinsurance issued a $50.0 million demand line of credit to United America Indemnity, Ltd. which bears interest at 5.25%. The proceeds of the line were used to fund the purchases of our Class A ordinary shares as part of two $50.0 million share buyback programs that were initiated in November 2007 and February 2008, respectively. On February 13, 2008, the demand line of credit was amended. The interest rate was decreased to 3.75% per annum, and the loan amount was increased to $100.0 million. In June 2008, Wind River Reinsurance declared and paid a dividend of $50.0 million to United America Indemnity, Ltd. United America Indemnity, Ltd. used proceeds from the dividend to repay a portion of the line of credit. In February, 2010 the line of credit was converted to a non-interest bearing note payable for the full amount of principle and accrued interest to date. As of December 31, 2011, there was $53.0 million outstanding on the note payable.
In November, 2011, U.A.I. (Luxembourg) Investment S.à.r.l. issued a $100.0 million demand line of credit to Global Indemnity (Cayman) Ltd. which bears interest at 1.2%. The proceeds of the line are being loaned from Global Indemnity (Cayman) Ltd. to Global Indemnity plc, bearing interest at 1.2%, to fund purchases of our Class A ordinary shares as part of our $100.0 million share repurchase program announced in September, 2011. As of December 31, 2011, there was $39.1 million outstanding on the line of credit, with accrued interest of $0.03 million.
AIS through its wholly owned subsidiary United National Group Capital Statutory Trust II
We have the ability to call these floating rate capital and floating rate common securities on a quarterly basis anytime between now and maturity.
Our wholly owned business trust subsidiaries, UNG Trust I and UNG Trust II, are not consolidated pursuant to applicable accounting guidance. Our business trust subsidiaries have issued $30.0 million in floating rate capital securities and $0.9 million of floating rate common securities. The sole assets of the business trust subsidiaries are $30.9 million of our junior subordinated debentures, which have the same terms with respect to maturity, payments, and distributions as the floating rate capital securities and the floating rate common securities.
We have commitments in the form of operating leases, a revolving line of credit, senior notes payable, junior subordinated debentures and unpaid losses and loss expense obligations. As of December 31, 2011, contractual obligations related to Global Indemnity’s commitments, including any principal and interest payments, were as follows:
(2) On July 20, 2005, we sold $90.0 million of guaranteed senior notes, due July 20, 2015. These notes have an interest rate of 6.22%, payable semi-annually. In accordance with the agreement, on July 20, 2011, we prepaid $18.0 million of the principle amount of the guaranteed senior notes. On July 20, 2012 and on each anniversary thereafter to and including July 20, 2014, we are required to prepay $18.0 million of the principal amount. On July 20, 2015, we are required to pay any remaining outstanding principal amount on the notes. The notes are guaranteed by Global Indemnity (Cayman), Ltd. Proceeds from the notes were used to prepay $72.8 million in principal together with related interest due as of July 20, 2005 under senior notes issued by Wind River to the Ball family trusts in September 2003.
(4) These amounts represent the gross future amounts needed to pay losses and related loss adjustment expenses and do not reflect amounts that are expected to be recovered from our reinsurers. See discussion in “Liability for Unpaid Losses and Loss Adjustment Expenses” for more details.
We have no off balance sheet arrangements other than the Trust Preferred Securities and floating rate common securities discussed in the “Capital Resources” section of “Liquidity and Capital Resources.”
Some of the statements under “Business,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this report may include forward-looking statements that reflect our current views with respect to future events and financial performance that are intended to be covered by the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that are not historical facts. These statements can be identified by the use of forward-looking terminology such as “believe,” “expect,” “may,” “will,” “should,” “project,” “plan,” “seek,” “intend,” or “anticipate” or the negative thereof or comparable terminology, and include discussions of strategy, financial projections and estimates and their underlying assumptions, statements regarding plans, objectives, expectations or consequences of identified transactions, and statements about the future performance, operations, products and services of the companies, including statements regarding projected annual savings and costs resulting from the Profit Enhancement Initiative.
Our business and operations are and will be subject to a variety of risks, uncertainties and other factors. Consequently, actual results and experience may materially differ from those contained in any forward-looking statements. Such risks, uncertainties and other factors that could cause actual results and experience to differ from those projected include, but are not limited to, the following: (1) the ineffectiveness of our business strategy due to changes in current or future market conditions; (2) the effects of competitors’ pricing policies, and of changes in laws and regulations on competition, including industry consolidation and development of competing financial products; (3) greater frequency or severity of claims and loss activity than our underwriting, reserving or investment practices have anticipated; (4) decreased level of demand for our insurance products or increased competition due to an increase in capacity of property and casualty insurers; (5) risks inherent in establishing loss and loss adjustment expense reserves; (6) uncertainties relating to the financial ratings of our insurance subsidiaries; (7) uncertainties arising from the cyclical nature of our business; (8) changes in our relationships with, and the capacity of, our general agents, brokers, insurance companies and reinsurance companies from which we derive our business; (9) the risk that our reinsurers may not be able to fulfill obligations; (10) investment performance and credit risk; (11) risks associated with our completed re-domestication to Ireland, which may include encountering difficulties moving jurisdictions and opening new offices and functions, tax and financial expectations and advantages not materializing or changing, our stock price could decline, and Irish corporate governance and regulatory schemes could prove different or more challenging than currently expected; (12) new tax legislation or interpretations that could lead to an increase in our tax burden; (13) uncertainties relating to governmental and regulatory policies, both domestically and internationally; (14) foreign currency fluctuations; (15) impact of catastrophic events; (16) estimates of the projected annual savings and costs for the Profit Enhancement Initiative, which we made based on information available at the time the charges were recorded; (17) our subsidiaries’ ability to pay dividends; (18) risks and uncertainties relating to our share repurchase program; and (19) uncertainties relating to ongoing or future litigation matters.
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Global Indemnity plc and its subsidiaries at December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in “Management’s Report on Internal Control over Financial Reporting” appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
(3) For the year ended December 31, 2011, “diluted” loss per share is the same as “basic” loss per share since there was a net loss for each period.
business trust subsidiaries are $30.9 million of junior subordinated debentures issued by the Company, which have the same terms with respect to maturity, payments, and distributions as the Trust Preferred Securities and the floating rate common securities. The registration of the Company’s wholly owned business trust subsidiary, Penn-America Statutory Trust II (“Penn Trust II”), was cancelled effective February 2, 2009 as a result of the redemption of its $15.0 million issued and outstanding notes on May 15, 2008.
The $13.3 million of premium deficiency charges recorded during the year ended December 31, 2011 consisted of $8.1 million recorded in our Insurance Operations and $5.2 million recorded in our Reinsurance Operations. The $8.1 million recorded in our Insurance Operations related primarily to casualty and professional lines products distributed through wholesale brokers and consisted of $3.7 million of reductions to deferred acquisition costs and $4.4 million of increases to unpaid loss and loss adjustment expenses. The $5.2 million recorded in our Reinsurance Operations related primarily to our marine lines and consisted of $4.5 million of reductions to deferred acquisition costs and $0.7 million of increases to unpaid loss and loss adjustment expenses.
For the year ended December 31, 2011, the Company’s results of operations reflect acquisition and loss and loss adjustment expenses that were $8.9 million higher, or $0.24 per diluted share, than they otherwise would have been as a result of the premium deficiency charges. Total premium deficiency charges recorded during 2011 were $13.3 million, however $4.4 million would have been expensed regardless as a result of amortization of deferred acquisition costs and recognition of loss and loss adjustment expenses incurred.
The $8.9 million net impact during the year ended December 31, 2011 consisted of $5.3 million recorded in our Insurance Operations and $3.6 million recorded in our Reinsurance Operations. The $5.3 million net impact recorded in our Insurance Operations consisted of $1.9 million of reductions to deferred acquisition costs and $3.4 million of increases to loss and loss adjustment expense reserves. The $3.6 million net impact recorded in our Reinsurance Operations consisted of $2.9 million of reductions to deferred acquisition costs and $0.7 million of increases to loss and loss adjustment expense reserves.
Indemnity, Ltd. ordinary shares would be cancelled and all holders of such shares would receive ordinary shares of Global Indemnity plc, a newly formed Irish company that was incorporated on March 9, 2010, on a one-for-two basis (two United America Indemnity, Ltd. shares exchanged for one Global Indemnity plc share). The re-domestication transaction was completed on July 2, 2010, following approval from the Grand Court of the Cayman Islands, at which time Global Indemnity plc replaced United America Indemnity, Ltd. as the ultimate parent company, and United America Indemnity, Ltd. became a wholly-owned subsidiary of Global Indemnity plc. Shares of United America Indemnity, Ltd. previously traded on the NASDAQ Global Select Market under the symbol “INDM.” Shares of the Irish company, Global Indemnity plc, began trading on the NASDAQ Global Select Market on July 6, 2010 under the symbol “GBLI.”
The Company regularly performs various analytical valuation procedures with respect to its investments, including reviewing each fixed maturity security in an unrealized loss position to assess whether the security is a candidate for credit loss. Specifically, the Company considers credit rating, market price, and issuer specific financial information, among other factors, to assess the likelihood of collection of all principal and interest as contractually due. Securities for which the Company determines that a credit loss is likely are subjected to further analysis through discounted cash flow testing to estimate the credit loss to be recognized in earnings, if any. The specific methodologies and significant assumptions used by asset class are discussed below. Upon identification of such securities and periodically thereafter, a detailed review is performed to determine whether the decline is considered other than temporary. This review includes an analysis of several factors, including but not limited to, the credit ratings and cash flows of the securities and the magnitude and length of time that the fair value of such securities is below cost.
According to accounting guidance, for debt securities in an unrealized loss position, the Company is required to assess whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before the anticipated recovery. If either of these conditions is met the Company must recognize an other than temporary impairment with the entire unrealized loss being recorded through earnings. For debt securities in an unrealized loss position not meeting these conditions, the Company assesses whether the impairment of a security is other than temporary. If the impairment is deemed to be other than temporary, the Company must separate the other than temporary impairment into two components: the amount representing the credit loss and the amount related to all other factors, such as changes in interest rates. The credit loss represents the portion of the amortized book value in excess of the net present value of the projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. The credit loss component of the other than temporary impairment is recorded through earnings, whereas the amount relating to factors other than credit losses are recorded in other comprehensive income, net of taxes.
(2) the value of the investment has been 20% or more below cost for six continuous months or more.
At December 31, 2011, the Company had approximately $136.4 million of cash and cash equivalents that was invested in a diversified portfolio of high quality short-term debt securities.
The Company evaluates the collectability of accounts receivable based on a combination of factors. In circumstances in which the Company is aware of a specific circumstance where a party may be unable to meet its financial obligations to the Company, a specific allowance for bad debts against amounts due is recorded to reduce the net receivable to the amount reasonably believed by the Company’s management to be collectible. For all remaining balances, allowances are recognized for bad debts based on the length of time the receivables are past due. The allowance for bad debts was $1.5 million and $1.2 million as of December 31, 2011 and 2010, respectively.
The amortization of deferred acquisition costs for the years ended December 31, 2011, 2010, and 2009 was $92.8 million, $85.3 million, and $84.1 million, respectively. For the year ended December 31, 2011, the Company’s results of operations reflect acquisition costs and loss and loss adjustment expenses which were $4.8 million and $4.1 million higher, respectively, than they otherwise would have been as a result of premium deficiencies. Deferred acquisition costs were deemed to be fully recoverable as of December 31, 2010. For additional information surrounding premium deficiencies, see Note 2.
We maintain investments and cash accounts in foreign currencies related to the operations of our business. At period-end, we re-measure non-U.S. currency financial assets to their current U.S. dollar equivalent with the resulting gain or loss reflected in income during the period. Financial liabilities, if any, are generally adjusted within the reserving process. However, for known losses on claims to be paid in foreign currencies, we re-measure the liabilities to their current U.S. dollar equivalent each period end with the resulting gain or loss reflected in income during the period. Net transaction gains were $0.4 million for both of the years ended December 31, 2011 and 2009. Net transaction losses were $0.4 million for the year ended December 31, 2010.
The Company has corrected this error in its consolidated financial statements as of and for the year ended December 31, 2009 by decreasing the “Cash and cash equivalents” and the “Unpaid losses and loss adjustment expenses” line items on the consolidated balance sheet and the “Unpaid losses and loss adjustment expenses” line item on the consolidated statement of cash flows by $18.6 million, the cumulative net effect of the error. The Company does not believe that that these adjustments are material to the consolidated financial statements for the year ended December 31, 2009 or to any prior years’ consolidated financial statements. As a result, the Company did not restate any prior period amounts.
The Company held a mortgage-backed security (“MBS”) issued by Government National Mortgage Association (“GNMA”) which represented approximately 2% and 8% of shareholders’ equity as of December 31, 2011 and 2010, respectively. Excluding U.S. treasuries, agency bonds, and the MBS issued by GNMA, the Company did not hold any debt or equity investments in a single issuer that was in excess of 4% and 2% of shareholders’ equity at December 31, 2011 or 2010, respectively.
The amortized cost and estimated fair value of the Company’s fixed maturities portfolio classified as available for sale at December 31, 2011, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Subject to the risks and uncertainties in evaluating the potential impairment of a security’s value, the impairment evaluation conducted by the Company as of December 31, 2011, concluded the unrealized losses discussed above are not other than temporary impairments. The impairment evaluation process is discussed in the “Investment” section of Note 5 (“Summary of Significant Accounting Policies”).
Obligations of states and political subdivisions-As of December 31, 2011, gross unrealized losses related to obligations of states and political subdivisions were $0.06 million. All unrealized losses have been in an unrealized loss position for twelve months or longer. These securities are rated A- or better. The Company’s investment manager considers all factors that influence performance of the municipal bond market, including investor expectations, supply and demand patterns, and current versus historical yield and spread relationships. The manager relies on the output of its fixed income credit analysts, including dedicated municipal bond
Commercial mortgage-backed securities (“CMBS”)-As of December 31, 2011, gross unrealized losses related to the CMBS portfolio were $0.07 million. Of this amount, $0.03 million has been in an unrealized loss position for twelve months or greater and are rated AAA. The weighted average credit enhancement for the Company’s CMBS portfolio is 29.2. This represents the percentage of pool losses that can occur before a mortgage-backed security will incur its first dollar of principle losses. For the Company’s CMBS portfolio, a loan level analysis is utilized where every underlying CMBS loan is re-underwritten based on the Company’s investment manager’s internally generated set of assumptions that reflect their expectation for the future path of the economy. In the analysis, the focus is centered on stressing the significant variables that influence commercial loan defaults and collateral losses in CMBS deals. These variables include: (1) occupancies are projected to drop; (2) capitalization rates vary by property type and are forecasted to return to more normalized levels as the capital markets repair and capital begins to flow again; and (3) property value was stressed by using projected property performance and projected capitalization rates. Term risk is triggered if projected debt service coverage rate falls below 1x. Balloon risk is triggered if a property’s projected performance does not satisfy new, tighter mortgage standards.
Corporate bonds and loans-As of December 31, 2011, gross unrealized losses related to corporate bonds and loans were $3.7 million. Of this amount, $0.4 million has been in an unrealized loss position for twelve months or greater and 95% of these securities are rated A-. The Company’s investment manager’s analysis for this sector includes maintaining detailed financial models that include a projection of each issuer’s future financial performance, including prospective debt servicing capabilities, capital structure composition, and the value of the collateral. The analysis incorporates the macroeconomic environment, industry conditions in which the issuer
Common stocks-As of December 31, 2011, gross unrealized losses related to common stock were $6.5 million. Of this amount, $0.06 million has been in an unrealized loss position for twelve months or greater. To determine if other than temporary impairment of an equity security has occurred, the Company considers, among other things, the severity and duration of the decline in fair value of the equity security. The Company also examines other factors to determine if the equity security could recover its value in a reasonable period of time.
Accumulated other comprehensive income as of December 31, 2011 and 2010 was as follows:
The Company’s total investment return on an after-tax basis for 2011, 2010, and 2009 were as follows:
As of December 31, 2011, the Company held insurance enhanced municipal bonds of approximately $85.9 million, which represented approximately 5.2% of the Company’s total cash and invested assets including $1.5 million in net receivables for securities purchased and sold. These securities had an average rating of “AA.” Approximately $32.4 million of these bonds are pre-refunded with U.S. treasury securities, of which $22.5 million are backed by financial guarantors, meaning that funds have been set aside in escrow to satisfy the future interest and principal obligations of the bond. Of the remaining $53.5 million of insurance enhanced municipal bonds, $19.9 million would have carried a lower credit rating had they not been insured. The following table provides a breakdown of the ratings for these municipal bonds with and without insurance.
In addition to the $85.9 million of insurance enhanced municipal bonds, the Company also held insurance enhanced asset-backed and credit securities with a market value of approximately $29.4 million, which represented approximately 1.8% of the Company’s total invested assets including $1.5 million in net receivables for securities purchased and sold. The financial guarantors of the Company’s $29.4 million of insurance enhanced asset-backed and credit securities include Financial Guaranty Insurance Company ($0.6 million), Municipal Bond Insurance Association ($10.0 million), Ambac ($2.6 million), Assured Guaranty Corporation ($10.8 million), and Other ($5.4 million).
Certain cash balances, cash equivalents, and bonds available for sale were deposited with various governmental authorities in accordance with statutory requirements or were held in trust pursuant to intercompany reinsurance agreements. The estimated fair values of bonds available for sale and on deposit or held in trust were as follows as of December 31, 2011 and 2010:
These gains (losses) are reflected on the consolidated statement of operations as equity in net income (loss) of partnerships, net of taxes.
Level 2-inputs utilize other than quoted prices included in Level 1 that are observable for the similar assets, either directly or indirectly.
There were no significant transfers between Level 1 and Level 2 during the twelve or three months ended December 31, 2011.
The investments classified as Level 3 in the above table consist of $5.4 million related to investments in limited partnerships. This entire amount was comprised of investments for which there is no readily available independent market price. The estimated fair value of these limited partnerships is measured utilizing the Company’s net asset value as a practical expedient for each limited partnership. Material assumptions and factors utilized in pricing these securities include future cash flows, constant default rates, recovery rates, and any market clearing activity that may have occurred since the previous pricing period. Of our investments in limited partnerships, $1.1 million was related to a limited partnership which holds convertible preferred securities of a privately held company. These securities were subject to an appraisal action in Delaware State Court. In February, 2011, the Company’s remaining interest of $1.1 million was liquidated.
The investments classified as Level 3 in the above table consist of $8.0 million related to the Company’s limited partnerships investments. This entire amount was comprised of investments for which there is no readily available independent market price. The estimated fair value of these limited partnerships is measured utilizing
Agencies are individually evaluated on an option adjusted spread basis or a nominal spread for non-callable issues.
For CMOs, which are categorized with mortgage-backed securities in the tables listed above, volatility-driven and ratings based multi-dimensional spread tables or an option-adjusted spread model and prepayment model is used. For ABSs, a multi-dimensional, collateral specific spread / prepayment speed tables is utilized. For both asset classes, evaluations utilize standard inputs plus new issue data, monthly payment information, and collateral performance. The evaluated pricing models incorporate security set-up, prepayment speeds, cash flows, and treasury swap curves and spread adjustments.
U.S. Treasuries are priced on the bid side by a market maker.
The 2010 acquisition resulted in goodwill of $4.8 million, the excess purchase price over the Company’s best estimate of the fair value of the assets acquired. The impairment testing performed in 2011 did not result in impairment of the goodwill acquired in 2010.
The following table presents details of the Company’s intangible assets as of December 31, 2010:
As of December 31, 2011 and 2010, indefinite lived intangible assets, which are comprised of trade names, trademarks, and state insurance licenses, were $14.0 million. In assessing fair value for the 2011 and 2010 impairment testing, state insurance licenses related to the merger with Penn-America Group, Inc. were valued by estimating demand for such licenses by evaluating the growth of competitors and analyzing overall property and casualty market conditions. Trade names related to the merger with Penn-America Group, Inc. and trademarks related to the 2010 acquisition were valued by analyzing discounted cash flow projections as well as reviewing prior independent valuations. Impairment testing performed in 2011 and 2010 indicated that there was no impairment of these assets.
As of December 31, 2011 and 2010, definite lived intangible assets were $4.7 million and $5.1 million, net of accumulated amortization, and were comprised of customer relationships and non-compete agreements. In assessing fair value for the 2011 and 2010 impairment testing, customer relationships and non-compete agreements related to the 2010 acquisition were valued by analyzing financial results of the acquired business unit, evaluating overall property and casualty market conditions and reviewing prior independent valuations. Impairment testing performed in 2011 and 2010 indicated that there was no impairment of these assets.
At December 31, 2011 and 2010, the Company carried reinsurance receivables of $288.0 million and $422.8 million, respectively. These amounts are net of a purchase accounting adjustment and an allowance for uncollectible reinsurance receivables. The purchase accounting adjustment is related to discounting the loss reserves to their present value and applying a risk margin to the discounted reserves. This adjustment was $10.0 million and $12.0 million at December 31, 2011 and 2010, respectively. The allowance for uncollectible reinsurance receivables was $10.0 million and $12.7 million at December 31, 2011 and 2010, respectively. The change is primarily due to write-offs of receivables deemed to be uncollectible and a decrease in the amount of carried reinsurance receivables.
At December 31, 2011 and 2010, the Company held collateral securing its reinsurance receivables of $169.0 million and $289.2 million, respectively. Prepaid reinsurance premiums were $6.6 million and $11.1 million at December 31, 2011 and 2010, respectively. Reinsurance receivables, net of collateral held, were $119.0 million and $133.6 million at December 31, 2011 and 2010, respectively.
Property Catastrophe Excess of Loss-The Company’s current property writings create exposure to catastrophic events. To protect against these exposures, the Company purchases a property catastrophe treaty. Effective June 1, 2011, the Company renewed its property catastrophe excess of loss treaty which provides occurrence coverage for losses of $80.0 million in excess of $20.0 million. This treaty provides for one full reinstatement of coverage at 100% additional premium as to time and pro rata as to amount of limit reinstated. This replaces the treaty that expired on May 31, 2011, which provided occurrence coverage for losses of $75.0 million in excess of $15.0 million.
Casualty and Professional Liability Excess of Loss-Effective May 1, 2011, the Company renewed its casualty excess of loss treaty and added the professional liability exposure as a separate section to the treaty. The casualty section provides coverage for $2.0 million per occurrence in excess of $1.0 million per occurrence for general liability and auto liability. Allocated loss adjustment expenses are included within limits. The stand-alone casualty treaty that expired April 30, 2011 provided identical coverage. The professional liability section provides coverage of $4.0 million per policy/occurrence in excess of $1.0 million per policy/occurrence.
Property Quota Share-Effective January 1, 2010, the Company renewed its 40% quota share treaty related to the Penn-America property line of business. This treaty covers premiums earned in 2010 on policies written in 2009 and 2010. During 2010, the Company ceded $14.1 million of earned premium. This treaty expired on December 31, 2010 and was not renewed.
Marine Excess of Loss-Effective May 24, 2010, the Company entered into a marine excess of loss treaty which provides coverage in three layers for $13.0 million per occurrence in excess of $2.0 million per occurrence. The first layer of $3.0 million in excess of $2.0 million, and the second layer of $5.0 million in excess of $5.0 million, provides for two full reinstatements of coverage at 100% additional premium. The third layer of $5.0 million in excess of $10.0 million provides for one full reinstatement of coverage at 100% additional premium. This treaty expired on November 30, 2011 and was not renewed.
To the extent that there may be an increase or decrease in catastrophe or casualty clash exposure in the future, the Company may increase or decrease its reinsurance protection for these exposures commensurately.
The Company had an alternative minimum tax (“AMT”) credit carryforward of $6.0 million and $6.5 million as of December 31, 2011 and 2010, respectively, which can be carried forward indefinitely.
The Company and some of its subsidiaries file income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. The Company is no longer subject to U.S. federal tax examinations by tax authorities for tax years before 2008.
Should the Company’s subsidiaries that are subject to income taxes imposed by the U.S. authorities pay a dividend to their foreign affiliates, withholding taxes would apply. However, the Company has not recorded deferred taxes for potential withholding tax on undistributed earnings as all U.S. earnings have been permanently reinvested in the U.S.
The Company applies a more-likely-than-not recognition threshold for all tax uncertainties whereby it only recognizes those tax benefits that have a greater than 50% likelihood of being sustained upon examination by the taxing authorities. The Company’s unrecognized tax benefits were $0.3 million and $0.7 million as of December 31, 2011 and 2010, respectively.
During 2011, the Company increased its prior accident year loss reserves by $4.7 million and reduced its allowance for uncollectible reinsurance by $1.3 million, which primarily consisted of a $4.9 million increase in auto liability lines, a $4.4 million increase in professional liability lines, and a $1.1 million increase in workers’ compensation lines, offset partially by a $2.9 million reduction in general liability lines, a $1.7 million reduction in umbrella lines, and a $1.1 million reduction in property lines:
Professional Liability: The $4.4 million increase primarily related to our Insurance Operations and consisted of increases of $19.0 million related to accident years 1998, 2009 and 2010, offset partially by decreases of $13.2 million related to all other accident years. In 2011, we exited certain professional liability classes where the volume of premium was low and loss volatility was high. We are focused on writing business where we expect to realize profit that meets our return on investment thresholds. The net increase in our Insurance Operations was offset partially by a decrease in our Reinsurance Operations of $1.3 million primarily related to accident years 2009 and 2010 and is the result of better than expected development on certain treaties.
Property: The reduction in the property lines primarily consisted of reductions of $2.5 million in our Insurance Operations primarily related to accident years 2009 and 2010 related to anticipated subrogation on a large equine mortality claim as well as favorable development on prior year catastrophe claims. These reductions were offset partially by an increase of $1.5 million in our Reinsurance Operations primarily related to accident year 2010 due to loss emergence on a worldwide catastrophe treaty.
In 2009, the Company reduced its prior accident year loss reserves by $8.4 million and reduced its allowance for uncollectible reinsurance by $0.7 million. The reduction of prior accident year loss reserves primarily consisted of a $5.5 million reduction in property lines, a $2.9 million reduction in general liability lines, and a $4.7 million reduction in umbrella lines, partially offset by a $4.7 million increase in professional liability lines:
General liability: The $2.9 million reduction primarily consisted of reductions of $13.5 million related to accident years 2006 and prior due to loss emergence that had been consistently lower than expected during the year, partially offset by increases of $10.6 million related to accident years 2007 and 2008 that were driven by a large claim and an increase in our construction defect provisions.
As of December 31, 2011, 2010, and 2009, the survival ratio on a gross basis for the Company’s open A&E claims was 9.4 years, 5.5 years, and 5.1 years, respectively. As of December 31, 2011, 2010, and 2009, the survival ratio on a net basis for the Company’s open A&E claims was 7.7 years, 6.0 years, and 5.7 years, respectively. The survival ratio, which is the ratio of gross or net reserves to the 3-year average of annual paid claims, is a financial measure that indicates how long the current amount of gross or net reserves are expected to last based on the current rate of paid claims.
With the exception of the Rights Offering discussion below, all share amounts reported prior to July 2, 2010 have been adjusted to reflect the one-for-two stock exchange of Global Indemnity plc shares for United America Indemnity, Ltd. shares as part of the re-domestication to Ireland. See Note 3 above for more information regarding the re-domestication.
The Rights Offering allowed holders of the Company’s Class A ordinary shares to subscribe to a new offering of Class A ordinary shares and the holders of the Company’s Class B ordinary shares to subscribe to a new offering of Class B ordinary shares. One non-transferable Class A Right for each Class A ordinary share held, and one non-transferable Class B Right for each Class B ordinary share held, was distributed to the respective Class A and B share holders for each share owned at 5:00 PM EST on March 16, 2009, the record date for the Rights Offering. Each Right entitled the holder to purchase either 0.9013 Class A shares or 0.9013 Class B shares, depending on the class of shares owned on the record date of the offering, at the subscription price of $3.50 per share. The Rights Offering expired April 6, 2009.
As a result of the Rights Offering, 17.2 million Class A ordinary shares and 11.4 million Class B ordinary shares were purchased, resulting in gross proceeds of $100.1 million. After deducting expenses associated with the Rights Offering, the Company’s equity increased $91.8 million. Approximately 66% of the Class A common shareholders had exercised their subscription right. Excluding those Class A ordinary shares that are owned by Fox Paine & Company and affiliated entities, approximately 72% of the Class A common shareholders had exercised their subscription right. Fox Paine & Company and affiliated entities purchased 5.9 million Class A ordinary shares and all Class B ordinary shares for $60.7 million.
The Company allows employees to surrender the Company’s Class A ordinary shares as payment for the tax liability incurred upon the vesting of restricted stock that was issued under the Company’s Share Incentive Plan. During 2011, the Company purchased an aggregate of 8,347 of surrendered Class A ordinary shares from its employees for $0.2 million. During 2010, the Company purchased an aggregate of 12,088 of surrendered Class A ordinary shares from its employees for $0.2 million. All Class A ordinary shares purchased from employees by the Company are held as treasury stock and recorded at cost.
The following table provides information with respect to the Class A ordinary shares that were surrendered or repurchased in 2011:
As of December 31, 2011, Fox Paine & Company beneficially owns shares having approximately 90.5% of the Company’s total outstanding voting power. Fox Paine & Company can nominate a certain number of our Directors, dependent on Fox Paine & Company’s percentage ownership of voting shares in the Company, for so long as Fox Paine & Company holds an aggregate of 25% or more of the voting power in the Company. Fox Paine & Company controls the election of all of our Directors due to its controlling share ownership. The Company’s Chairman is a member of Fox Paine & Company. The Company relies on Fox Paine & Company to provide management services and other services related to the operations of the Company.
On July 2, 2010, United America Indemnity, Ltd. entered into an agreement to indemnify the affected indirect owners of the affiliates of Fox Paine & Company that were shareholders of United America Indemnity, Ltd. immediately prior to the effective date of our re-domestication to Ireland (See Note 3 for details). The agreement indemnifies them for any tax cost (including interest on tax and penalties, if any) of any triggering event and such affected indirect owners will pay us an amount equal to any tax benefits, if any, realized by them as a result of a triggering event for which they were indemnified, provided that the indirect owners will not be required to pay any amount of tax benefits in excess of the tax costs for which we have indemnified them. A sale or other disposition by these indirect owners of our ordinary shares will not constitute a triggering event for this purpose. In addition, the indemnification agreement provides that, under certain circumstances, in the event the conversion of Global Indemnity plc’s Class B ordinary shares to Class A ordinary shares or a sale or other disposition of Global Indemnity plc’s Class B ordinary shares is subject to Irish stamp duty, we will indemnify such affiliates of Fox Paine & Company and their transferees against such Irish stamp duty.
In 2010 and 2009, the Company incurred $0.2 million and $0.1 million, respectively, for legal services rendered by Cozen O’Connor. Stephen A. Cozen, the chairman of Cozen O’Connor, was a member of the Company’s Board of Directors until he resigned effective December 31, 2010.
Edward J. Noonan, the chairman and chief executive officer of Validus, was a member of the Company’s Board of Directors until June 1, 2007, when he resigned from the Company’s Board. Validus remains a related party since the current quota share retrocession agreement between Validus and Wind River Reinsurance was put in place during the period when Mr. Noonan was a member of the Company’s Board of Directors.
advisory and investment banking services. The Company paid Citi $1.0 million in connection with these services in 2009. Chad A. Leat, Vice Chairman of Global Banking at Citigroup, is a member of the Company’s Board of Directors.
Total rental expense under operating leases, net of sub-lease income, for the years ended December 31, 2011, 2010, and 2009 were $4.1 million, $5.2 million, and $3.5 million, respectively. As part of our Profit Enhancement Initiative, we incurred charges in 2011 and 2010 resulting from future minimum lease commitments related to unused space. Cash payments on leases related to unused space will be paid in future periods and are included in the table below. See Note 4 for additional details. At December 31, 2011, future minimum cash payments under non-cancelable operating leases, net of expected sub-lease income, were as follows:
On December 4, 2008, a federal jury in the U.S. District Court for the Eastern District of Pennsylvania (Philadelphia) returned a $24.0 million verdict in favor of United National Insurance Company (“United National”), an indirect wholly owned subsidiary of the Company, against AON Corp., an insurance and reinsurance broker. On July 24, 2009, a federal judge from the U.S. District Court for the Eastern District of
Pennsylvania (Philadelphia) upheld that jury verdict. In doing so, the U.S. District Judge increased the verdict to $32.2 million by adding more than $8.2 million in prejudgment interest. AON filed its Notice of Appeal and a Bond in the amount of $33.0 million. Oral arguments were heard by the Appellate Court on October 26, 2010. In January, 2011, we settled with AON for $16.3 million. We realized approximately $7.5 million in 2011, net of income taxes and attorney’s fees.
The Company is party to a Management Agreement, as amended, with Fox Paine & Company, LLC, whereby in connection with certain management services provided to it by Fox Paine & Company, LLC, the Company agreed to pay an annual management fee of $1.5 million to Fox Paine & Company, LLC. The most recent annual management fee was paid to Fox Paine & Company, LLC In August, 2011. The next annual management fee payment is payable on September 5, 2012.
The Company maintains the Global Indemnity plc Share Incentive Plan (as so amended, the “Plan”). The purpose of the Plan is to give the Company a competitive advantage in attracting and retaining officers, employees, consultants and non-employee directors by offering stock options, restricted shares and other stock-based awards. As amended and restated on July 2, 2010, the Company may issue up to 5.0 million Class A ordinary shares for issuance pursuant to awards granted under the Plan. Award activity for stock options granted under the Plan and the weighted average exercise price per share are summarized as follows:
On March 31, 2009, 28,037 Option-A Tranche options expired. There was no activity in the Option-A Tranche during 2011 or 2010.
As of December 31, 2011, there were 565,981 outstanding options granted under the Plan. Due to the impact of the forfeitures noted above, we recorded a net favorable adjustment to expense of $1.8 million in 2011. In 2010, the Company recorded $1.2 million of compensation expense for the 330,018 outstanding options granted under the Plan. In 2009, the Company recorded $1.2 million of compensation expense for the 334,018 outstanding options granted under the Plan. The Company did not receive any proceeds from the exercise of options during 2011, 2010, and 2009, respectively. Amortization expense related to options is anticipated to be $1.2 million in 2012, $1.2 million in 2013, $0.9 million in 2014, and $0.2 million in 2015.
NOTE: The intrinsic value of the Exercised Options is the difference between the fair market value at time of exercise and the strike price of the option.
The weighted average fair value of options granted under the Plan was $9.52 and $4.56 in 2011 and 2009, respectively, using a Black-Scholes option-pricing model and the following weighted average assumptions. There were no options granted under the Plan in 2010.
In addition to stock option awards, the Plan also provides for the issuance of Restricted Shares to employees and non-employee Directors. The Company recognized compensation expense for restricted stock of $0.03 million, $1.1 million and $1.8 million for 2011, 2010, and 2009, respectively. The total unrecognized compensation expense for the non-vested restricted stock was $0.2 million at December 31, 2011, which will be recognized over a weighted average life of 1.3 years. The weighted average fair value of the 93,156 Class A ordinary shares, subject to certain restrictions granted to key employees of the Company under the Plan (“Restricted Shares”) that vested during the year ended December 31, 2011 was $20.77 per share.
The following table summarizes the non-vested Restricted Shares activity for the years ended December 31, 2011, 2010, and 2009:
During 2009, the Company granted an aggregate of 65,568 Restricted Shares to key employees of the Company and an aggregate of 101,755 fully vested Director Restricted Shares, at a weighted average fair value of $13.54 per share, to non-employee directors of the Company under the Plan. In 2009, the company granted 29,235 Restricted Shares to key employees out of shares previous forfeited. Included in the 65,568 are 38,681 Restricted Shares granted by the Company to key executives of the Company in exchange for signed employment agreements. Included in the 38,681 are 26,181 shares that were forfeited in 2009 and 7,500 shares that vest 33 1/3% on each subsequent anniversary date of the award for a period of three years, and 5,000 shares that vest 25% on each subsequent anniversary date of the award for a period of four years.
On September 14, 2009, the Company entered into an amended and restated employment agreement with Mr. Frakes, which amended and restated Mr. Frakes’ amended employment agreement that was entered into on February 5, 2008. The amended and restated employment agreement changed and clarified the terms of options granted under the original employment agreement. The Time Based Options vested at 25% on September 14, 2009, and December 31, 2010 and 2011. The Performance Based Options had three vesting opportunities. Each tranche, which represents 25% of the total award, could have initially vested on December 31, 2008, 2009, 2010, and 2011.
The market price of the Company’s Class A ordinary shares was $4.89 per share on March 12, 2009, which was the ex-rights date related to the Rights Offering. Since the $3.50 per share subscription price of the shares issued under the Rights Offering was lower than the $4.89 per share market price on March 12, 2009, the Rights Offering contained a bonus element. In computing the basic and diluted weighted share counts, the number of shares outstanding prior to May 5, 2009 (the date that the ordinary shares were issued in conjunction with the Rights Offering) was adjusted by a factor of 1.114 to reflect the impact of a bonus element associated with the Rights Offering. See Note 13 above for more details concerning the Rights Offering.
The following table sets forth the computation of basic and diluted earnings (loss) per share. In 2011, “Diluted” loss per share is the same as “Basic” loss per share since there was a net loss for that year.
Under SAP, certain assets designated as “Non-admitted assets” (such as prepaid expenses) are charged against surplus.
The Company manages its business through two business segments: Insurance Operations, which includes the operations of the United National Insurance Companies and the Penn-America Insurance Companies, and Reinsurance Operations, which includes the operations of Wind River Reinsurance.
The Insurance Operations segment and the Reinsurance Operations segment follow the same accounting policies used for the Company’s consolidated financial statements. For further disclosure regarding the Company’s accounting policies, please see Note 5.
(3) Includes excise tax of $1,021 related to cessions from U.S. Insurance Companies to Wind River Reinsurance.
(3) Includes excise tax of $1,342 related to cessions from U.S. Insurance Companies to Wind River Reinsurance.
In September, 2011, the FASB issued new accounting guidance surrounding an entity’s goodwill impairment testing. The new guidance allows for an entity to elect assessing qualitative factors when evaluating for goodwill impairment. If qualitative factors indicate that there may be impairment, prior guidance using quantitative factors should still be applied. This guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The Company elected to early adopt this guidance and adoption did not have a material impact on our consolidated financial position and results of operations.
In December, 2011, the FASB issued new accounting guidance requiring additional disclosures surrounding offsetting and related arrangements to enable users of the financial statements to better understand the effect of those arrangements on a company’s financial position. This guidance is effective for interim and annual reporting periods beginning on or after January 1, 2013. The Company is still in the process of evaluating the impact that this guidance will have on our consolidated financial position and results of operations.
Through March 14, 2012, an additional 374,642 shares were repurchased as part of the share repurchase program. Including the 2012 purchases, a total of 1,945,023 shares were repurchased at an average purchase price of $18.87 per share as part of the share repurchase program.
(1) Per share amounts have been restated to reflect the 1-for-2 stock exchange effective July 2, 2010 when the Company completed its re-domestication to Ireland.