Weighted average common shares outstanding includes the impact of unvested restricted shares as well as the impact of repurchases of Class A common shares made under the Company's share repurchase authorization.
Common shares outstanding includes the impact of unvested restricted shares and also the impact of repurchases of Class A common shares made under the Company's share repurchase authorization.
Our combined ratio was 97.5% for the year ended December 31, 2012, compared to 92.1% for the year ended December 31, 2011. The increase in the combined ratio for the year ended December 31, 2012 was primarily due to the impact of hurricane Sandy in the year ended December 31, 2012. Favorable loss reserve development for our consolidated insurance operations was $7.4 million, or 0.7 points, in 2012 compared to $29.8 million, or 2.9 points, for the prior year. The favorable reserve development for the year ended December 31, 2012 was primarily in the workers' compensation, multiple peril liability and general liability lines. This favorable development was offset somewhat by adverse development on a few excess property claims. Catastrophe losses were $47.7 million, or 4.2 points, for the year ended December 31, 2012, due primarily to the impact of hurricane Sandy. The year ended December 31, 2011 included $36.7 million, or 3.6 points, of catastrophe losses primarily related to hurricane Irene, tornados in the southeastern and midwestern United States as well as storms and freezing weather in the northeastern and southwestern United States. Total net written premiums increased 11.0% in the year ended December 31, 2012 to $1,179.2 million, compared to $1,062.7 million for the prior year, due to the growth from both our Specialty Products
Our combined ratio for the year ended December 31, 2011 decreased to 92.1% from 96.0% for the year ended December 31, 2010. The loss and LAE ratio decreased by 3.8 points to 54.2% while the expense ratio decreased by 0.1 points to 37.9%. The decrease in the loss and LAE ratio was primarily due to a decrease in current accident year non-catastrophe losses. We experienced a number of large losses in our property and inland marine business within Specialty Industries during the year ended December 31, 2010. The year ended December 31, 2011 included $29.8 million or 2.9 points of favorable loss reserve development, as compared to $36.0 million or 3.0 points of favorable loss reserve development in the year ended December 31, 2010. During the year ended December 31, 2011, the favorable loss reserve development in continuing operations was primarily related to lower than expected severity on non-catastrophe losses related to professional liability lines, multiple peril liability lines and other general liability lines. Catastrophe losses were 0.6 points higher than the prior year. The year ended December 31, 2011 included $36.7 million or 3.6 points of catastrophe losses, as compared to $35.1 million or 3.0 points of catastrophe losses in the year ended December 31, 2010. The slight decrease in the expense ratio reflects lower other underwriting expense.
We are an exempted Bermuda limited liability company. Our operating companies are U.S.-based property and casualty insurance writers, most of which operate in a multi-company pool. Pooling arrangements permit the participating companies to rely on the capacity of the entire pool's capital and surplus rather than just on its own capital and surplus. Under such arrangements, the members share substantially all insurance business that is written, and allocate the combined premiums, losses and expenses. During the fourth quarter of 2012, we restructured our internal pooling arrangement as part of the Runoff Transaction, as further described below. The internal pool restructuring did not have an effect on our consolidated results. We provide a wide range of specialty insurance products and services through independent agencies, regional and national brokers, wholesalers and managing general agencies. In the year ended December 31, 2012, our net written premiums totaled $1.2 billion and we had total assets of approximately $5.4 billion and total OneBeacon's common shareholders' equity of $1.0 billion at December 31, 2012.
Previously, we reported our insurance operations through a Specialty Insurance Operations segment and an Other Insurance Operations segment. The former Specialty Insurance Operations segment was comprised of twelve underwriting operating segments that were aggregated into a single reportable segment, with supplemental disclosures of three major underwriting units for financial reporting: MGA Business, Specialty Industries and Specialty Products. The former Other Insurance Operations segment consisted of substantially all operations classified as discontinued operations as of December 31, 2012, including AutoOne, other run-off business, and certain purchase accounting adjustments relating to the run-off business and the OneBeacon Acquisition. Prior periods have been reclassified to conform to the current presentation.
See Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations-Significant Transactions-Dispositions" below.
Historically, we have offered a range of specialty, commercial and personal products and services, however, as a result of recent transactions we are now focused exclusively on specialty business. In addition, the transactions freed up significant capital, increased our financial flexibility and reduced our catastrophe exposure.
Runoff Business. On October 17, 2012, one of OneBeacon's indirect wholly-owned subsidiaries, OneBeacon Insurance Group LLC, entered into a definitive agreement (the Stock Purchase Agreement) with Trebuchet US Holdings, Inc. (Trebuchet), a wholly-owned subsidiary of Armour Group Holdings Limited (together with Trebuchet, Armour), to sell its run-off business. OneBeacon's run-off business includes the results of OneBeacon's remaining non-specialty commercial lines business and certain other run-off business, including the vast majority of asbestos and environmental reserves, as well as certain purchase accounting adjustments related to the OneBeacon Acquisition (the Runoff Business, the sale of which is referred to as the Runoff Transaction). During 2012, OneBeacon recorded a $91.5 million after tax estimated loss on sale of the Runoff Business and $24.0 million in after tax losses from discontinued operations, which included $9.0 million of after tax incurred loss and loss adjustment expenses relating to an adjustment to the workers compensation discount rate applied to the loss reserves being transferred, as well as $6.5 million of after tax underwriting losses primarily related to adverse prior year loss reserve development related to a legacy assumed reinsurance treaty.
AutoOne. On August 30, 2011, we entered into the AutoOne Purchase Agreement to sell AutoOne to Interboro. AutoOne offers products and services to assigned risk markets primarily in New York and New Jersey. AutoOne has been presented as discontinued operations in the statements of operations with the prior periods reclassified to conform to the current presentation. Pursuant to the terms of the AutoOne Purchase Agreement, at closing OneBeacon transferred to Interboro all of the issued and outstanding shares of common stock of AutoOne Insurance Company (AOIC) and AutoOne Select Insurance Company (AOSIC), through which substantially all of the AutoOne business is written on a direct basis. At closing, OneBeacon transferred the assets, liabilities (including loss reserves and unearned premiums) and capital of the business as well as substantially all of the AutoOne infrastructure including systems and office space as well as certain staff. The AutoOne Transaction included the execution of a reinsurance agreement with certain subsidiaries of the Company pursuant to which we cede, on a 100% quota share basis, AutoOne business not directly written by AOIC and AOSIC. The AutoOne Transaction, which was subject to regulatory approvals, closed in 2012 and we recorded post-closing adjustments, which resulted in recording an after tax net charge of $0.3 million relating to underwriting activity and an after tax net gain of $0.5 million to true up the estimated loss on sale. During the year ended December 31, 2011, we recorded an after tax net charge of approximately $19.2 million reflecting the estimated loss on sale of the AutoOne business.
As consideration, based upon the carrying value of the traditional personal lines business as of July 1, 2010, we received $166.6 million. The consideration represented the statutory surplus in the reciprocals (as consideration for surplus notes issued by the reciprocals), the combined GAAP equity in the insurance companies and attorneys-in-fact being sold, plus $32.5 million. During the year ended December 31, 2010, we recorded a total after tax net gain on the sale of $24.6 million that is comprised of $8.5 million included in net other revenues and $16.1 million included in the tax provision. During the second quarter of
2011, OneBeacon and Tower reached agreement on post-closing adjustments resulting in no material change to the $24.6 million after tax net gain on sale that OneBeacon had recorded during 2010.
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies. Our ability to collect our reinsurance recoverables is subject to the solvency of the reinsurers with whom we have entered into reinsurance contracts. We are selective in regard to our reinsurers, principally placing reinsurance with those reinsurers with strong financial condition, reputation, industry ratings and underwriting ability. Management monitors the financial condition and ratings of our reinsurers on an ongoing basis.
Our executive compensation policies are designed with one goal in mind, namely, the maximization of shareholder value over long periods of time. We believe that this goal is best pursued by utilizing a pay-for-performance program that serves to
In February 2007, the Compensation Committee approved the principal performance share goal of the OneBeacon Long-Term Incentive Plan to be growth in its intrinsic business value per share (GIBVPS), which was defined by the Compensation Committee with respect to each award cycle.
2010-2012 Performance Share Plan. In February 2010, the Compensation Committee granted performance shares with a goal of growth in book value per share for the 2010-2012 performance cycle. As of December 31, 2012, 238,658 performance shares were outstanding with respect to the 2010-2012 performance cycle.
2012-2014 Performance Share Plan. In February 2012, the Compensation Committee granted performance shares with a goal of growth in book value per share for the 2012-2014 performance cycle. As of December 31, 2012, 181,290 performance shares were outstanding with respect to the 2012-2014 performance cycle.
In connection with OneBeacon's initial public offering, options were issued to certain key employees as a one-time incentive. The options did not include a mechanism to reflect the contribution to total return from the regular quarterly
On March 1, 2012, OneBeacon issued 300,000 shares of restricted stock to certain employees that vest in equal installments on February 28, 2014 and 2015. On May 25, 2011, OneBeacon issued 630,000 shares of restricted stock to its CEO that vest in equal installments on February 22, 2014, 2015, 2016 and 2017. Concurrently with the 2011 grant of restricted stock, 35,000 performance shares issued to the CEO for the 2011-2013 performance share cycle were forfeited. Performance share awards to the CEO for each of the next five years are being reduced by 35,000 shares. The restricted shares contain dividend participation features, and therefore, are considered participating securities. At December 31, 2012 and 2011, the Company had unvested restricted shares outstanding of 927,000 and 630,000, respectively.
The income tax expense related to pre-tax income from continuing operations for the years ended December 31, 2012, 2011 and 2010 represented net effective tax rates of 7.9%, 12.4% and 14.3%, respectively. Our effective tax rate for the years ended December 31, 2012 and 2011 were lower than the U.S. statutory rate of 35% due to income generated in jurisdictions other than the United States, principally representing interest income taxed in a jurisdiction with a lower effective tax rate. Our effective tax rate for the year ended December 31, 2010 was lower than the U.S. statutory rate of 35% due to income generated in jurisdictions other than the United States, principally representing interest income taxed in a jurisdiction with a lower effective tax rate, and recognition of a deferred tax asset for a higher tax basis and deconsolidation of the companies sold as part of the Personal Lines Transaction, partially offset by an increase in the valuation allowance for insurance reciprocals. For the years ended December 31, 2012, 2011 and 2010, the effective tax rate on non-U.S. income was 0.6%, 0.3% and 0.5%, respectively, and the effective rate on U.S. income was 26.1%, 31.6% and 25.2%, respectively.
In November 2012, OneBeacon U.S. Holdings, Inc. issued $275.0 million face value of senior unsecured debt through a public offering, at an issue price of 99.9% (2012 Senior Notes), which bear an annual interest rate of 4.60%. The net proceeds from the issuance of the 2012 Senior Notes were used to repurchase the outstanding balance on OBH's senior unsecured debt issued in May 2003, which had an annual interest rate of 5.875%. OneBeacon Insurance Group, Ltd provides an irrevocable and unconditional guarantee as to the payment of principal and interest on the 2012 Senior Notes. See Note 6-"Debt" of the accompanying consolidated financial statements. In conjunction with the repurchase of the 2003 Senior Notes, we recognized a loss of $6.3 million.
On October 17, 2012, we entered into the Stock Purchase Agreement with respect to the sale of our Runoff Business to Armour. Pursuant to the terms of the Stock Purchase Agreement, at closing, OneBeacon will transfer to Armour all of the issued and outstanding shares of common stock of certain legal entities that will contain the assets, liabilities (including gross and ceded loss reserves) and capital supporting the Runoff Business as well as certain elements of the Runoff Business infrastructure, including staff and office space. Additionally, as part of the Runoff Transaction, OneBeacon may provide financing in the form of surplus notes. The Runoff Transaction is expected to close in the second half of 2013. During 2012, we recorded a $91.5 million after tax estimated loss on sale of the Runoff Business and $24.0 million in after tax losses from discontinued operations, which included $9.0 million of after tax incurred loss and loss adjustment expenses relating to an adjustment to the workers compensation discount rate applied to the loss reserves being transferred, as well as $6.5 million of after tax underwriting losses primarily related to adverse prior year loss reserve development related to a legacy assumed reinsurance treaty.
In anticipation of the Runoff Transaction, and as means to separate the Runoff Business from the ongoing specialty business, we sought and received various regulatory approvals to terminate, incept or amend various intercompany reinsurance agreements which took effect on October 1, 2012.
On February 22, 2012, OneBeacon completed the sale of its AutoOne Insurance business (AutoOne) to Interboro Holdings, Inc. (Interboro) (the AutoOne Transaction). AutoOne had offered products and services to assigned risk markets primarily in New York and New Jersey. AutoOne has been presented as discontinued operations in the statements of operations and cash flows with the prior periods reclassified to conform to the current presentation. The AutoOne disposal group excludes investing and financing activities from amounts classified as discontinued operations. OneBeacon's investing and financing operations are conducted on an overall consolidated level and, accordingly, there are no separately identifiable investing or financing cash flows associated with AutoOne. Pursuant to the terms of the AutoOne Transaction, at closing, the legal entities included in the sale held an agreed upon level of invested assets and capital. The assets and liabilities associated with the AutoOne business as of December 31, 2011 have been presented in the balance sheet as held for sale assuming the investing and financing steps required to effect the sale were completed as of December 31, 2011.
Certain amounts in the prior period consolidated results have been reclassified to conform to the current presentation.
A summary of our consolidated financial results for the years ended December 31, 2012, 2011 and 2010, is as follows:
The following table provides our consolidated underwriting ratios for the years ended December 31, 2012, 2011 and 2010:
(1) The amount for 2010 includes operations associated with personal lines business that we sold in 2010. Excluding results from the personal lines business which would have increased (decreased) the loss and LAE, expense and combined ratios presented above by (2.9) points, 0.4 points and (2.5) points, respectively.
Consolidated Results-Year ended December 31, 2012 versus year ended December 31, 2011
Our comprehensive loss attributable to OneBeacon's common shareholders was $22.1 million for the year ended December 31, 2012, compared to comprehensive income attributable to OneBeacon's common shareholders of $43.9 million in the year ended December 31, 2011. Net loss attributable to OneBeacon's common shareholders was $19.2 million for the year ended December 31, 2012, compared to net income attributable to OneBeacon's common shareholders of $55.1 million for the year ended December 31, 2011. The decrease in results for the year ended December 31, 2012 as compared to the prior year was primarily due to charges associated with the Runoff Transaction and $28.2 million after-tax of ($43.4 million pre-tax) catastrophe losses and reinstatement premiums resulting from the impact of hurricane Sandy, which made landfall in the mid-Atlantic and northeastern regions of the United States in October 2012. Change in other comprehensive income (loss) items in the year ended December 31, 2012 included the impact of a $2.9 million after tax decrease in the over-funded status of our qualified pension primarily related to an increase in the plan's projected benefit obligation, as compared to an $11.2 million after tax decrease in our pension plans in the prior year driven by a decline in the value of the investment results.
Our combined ratio was 97.5% for the year ended December 31, 2012, compared to 92.1% for the year ended December 31, 2011. The increase in the combined ratio for the year ended December 31, 2012 was primarily due to the impact of hurricane Sandy in the year ended December 31, 2012, as well as a 2.2 point decrease in favorable loss reserve development compared to the year ended December 31, 2011. Favorable loss reserve development for our consolidated insurance operations was $7.4 million, or 0.7 points, in 2012 compared to $29.8 million, or 2.9 points, for the prior year period. The favorable loss reserve development for the year ended December 31, 2012 was primarily in the workers' compensation, multiple peril liability and general liability lines. This favorable development was offset somewhat by adverse loss reserve development on a few excess property claims. Catastrophe losses were $47.7 million, or 4.2, points for the year ended December 31, 2012, due primarily to the impact of hurricane Sandy. The year ended December 31, 2011 included $36.7 million, 3.6 points, of catastrophe losses primarily related to hurricane Irene, tornados in the southeastern and midwestern United States as well as storms and freezing weather in the northeastern and southwestern United States. Total net written premiums increased 11.0% in the year ended December 31, 2012 to $1,179.2 million, compared to $1,062.7 million for the prior year, due to the growth from both our Specialty Products and Specialty Industries segments. The expense ratio increased 2.2 points, primarily due to our investment in new businesses and costs associated with actions taken to migrate certain corporate functions to Minnesota in the year ended December 31, 2012.
Our comprehensive income attributable to OneBeacon's common shareholders was $43.9 million in the year ended December 31, 2011, compared to $124.8 million in the year ended December 31, 2010. Change in other comprehensive income and loss items in the year ended December 31, 2011 included the impact of an $11.2 million after tax decrease in our pension plans primarily related to a decrease in the over-funded status of our qualified pension plan driven by a decline in the value of the investment results, as compared to a $5.8 million after tax increase in our pension plans in 2010 also driven by investment assets in the plan. Net income attributable to OneBeacon's common shareholders was $55.1 million in the year ended December 31, 2011, compared to $118.3 million in the year ended December 31, 2010.
Our total revenues decreased 20.0% to $1,081.8 million in the year ended December 31, 2011, compared to $1,351.7 million in the year ended December 31, 2010, due primarily to decreases in earned premiums, as well as decreases in net realized and change in unrealized investment gains and net investment income. Earned premiums decreased $168.9 million, primarily due to a decrease in earned premiums of $201.9 million resulting from the Personal Lines Transaction. Net realized and change in unrealized investment gains decreased 85.8% to $10.6 million, compared to $74.6 million in the year ended
December 31, 2010. Net investment income decreased 26.1% to $71.4 million in the year ended December 31, 2011, primarily due to an 18.5% decline in average invested assets, including invested assets of $111.8 million reclassified to assets held for sale as of December 31, 2011 as part of the AutoOne Transaction. The decline in average invested assets since December 31, 2010 was driven by the Personal Lines Transaction, return of capital to shareholders and repurchases of debt and the Commercial Lines Transaction, including the impact of claim payments related to non-specialty commercial lines reserves. Net other revenues (expenses) increased $11.8 million to $(12.4) million in the year ended December 31, 2011, compared to $(0.6) million in the year ended December 31, 2010. The year ended December 31, 2011 included a $12.0 million loss related to the purchase of a portion of our 2003 Senior Notes, whereas the year ended December 31, 2010 included a $10.8 million loss related to the purchase of a portion of our 2003 Senior Notes.
Our total expenses decreased 18.2% in the year ended December 31, 2011 to $962.1 million, compared to $1,176.3 million in the year ended December 31, 2010. Loss and LAE decreased 20.0% to $548.3 million in the year ended December 31, 2011, reflective of the decrease in our book of business resulting from the Personal Lines Transaction, partially offset by favorable loss reserve development in our specialty businesses. Policy acquisition expenses decreased 12.3% to $221.2 million and other underwriting expenses decreased 17.2% to $162.3 million in the year ended December 31, 2011, reflective of the shrink in our book of business resulting from the Personal Lines Transaction. Interest expense decreased 30.7% to $20.5 million in the year ended December 31, 2011, reflective of actions taken to reduce outstanding debt. General and administrative expenses decreased 24.0% to $9.8 million.
Our income tax expense related to pre-tax income from continuing operations for the years ended December 31, 2011 and 2010 represented net effective tax rates of 12.4% and 14.3%, respectively. The effective tax rate for the year ended December 31, 2011 was lower than the U.S. statutory rate of 35% due to income generated in jurisdictions other than the United States, principally representing interest income taxed in a jurisdiction with a lower effective tax rate. The effective tax rate for the year ended December 31, 2010 was lower than the U.S. statutory rate of 35% due to income generated in jurisdictions other than the United States, principally representing interest income taxed in a jurisdiction with a lower effective tax rate, and recognition of a deferred tax asset for a higher tax basis and deconsolidation of the companies sold as part of the Personal Lines Transaction, partially offset by an increase in the valuation allowance for insurance reciprocals. For the years ended December 31, 2011 and 2010, the effective tax rate on non-U.S. income was 0.3% and 0.5%, respectively, and the effective rate on U.S. income was 31.6% and 25.2%, respectively. See Note 7-"Income Taxes" of the accompanying consolidated financial statements.
The Specialty Products segment is comprised of seven underwriting operating segments representing an aggregation based on those that offer distinct products and tailored coverages and services to a broad customer base across the United States. The Specialty Industries segment is comprised of six underwriting operating segments representing an aggregation based on those that focus on solving the unique needs of a particular customer or industry group. The Investing, Financing and Corporate segment includes the investing and financing activities for OneBeacon on a consolidated basis, and certain other activities conducted through the Company and our intermediate subsidiaries, as well as operations associated with personal lines business that we sold in 2010 (see Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations-Overview").
The following table provides underwriting ratios for Specialty Products for the years ended December 31, 2012, 2011 and 2010:
Specialty Products-Year ended December 31, 2011 versus year ended December 31, 2010
Net written premiums for Specialty Products increased 2.6% to $571.2 million in the year ended December 31, 2011 from $556.8 million in the year ended December 31, 2010. The increase was primarily due to increases in net written premiums of $13.3 million from our Collector Cars and Boats underwriting operating segment, $3.5 million from Excess and Surplus which we began writing in 2011, $2.5 million from Specialty Property, and $0.9 million from Tuition Reimbursement, partially offset by a decrease in net written premiums of $5.8 million from Professional Insurance primarily related to the medical excess line.
Financial results for our Specialty Industries reportable segment for the years ended December 31, 2012, 2011 and 2010 were as follows:
The following table provides underwriting ratios for Specialty Industries for the years ended December 31, 2012, 2011 and 2010:
Specialty Industries-Year ended December 31, 2012 versus year ended December 31, 2011
Net written premiums for Specialty Industries increased 11.6% to $548.3 million in the year ended December 31, 2012 from $491.5 million in the year ended December 31, 2011. The increase compared to the prior year was due to increases in net written premiums of $26.7 million from our Technology underwriting operating segment, $15.2 million from Accident, $13.5 million from Government Risks, $11.1 million from Energy, and a $10.2 million from Entertainment. These increases were primarily due to new business as well as solid retention levels despite competition in the marketplace. These increases were partially offset by a $19.9 million decrease in net written premiums from IMU, reflecting a revised underwriting strategy.
The Specialty Industries combined ratio for the year ended December 31, 2012 increased to 97.1% from 96.0% for the year ended December 31, 2011. The loss and LAE ratio was unchanged at 57.7% while the expense ratio increased by 1.1 points to 39.4%. The year ended December 31, 2012 included 1.1 points of favorable loss reserve development primarily related to Technology, compared to 2.8 points of favorable loss reserve development primarily related to Technology in the prior year. This 1.7 point decrease in favorable loss reserve development was offset by a 1.7 point decrease in current accident year losses, compared to the year ended December 31, 2011. The year ended December 31, 2012 included 4.7 points of catastrophe losses, primarily related to hurricane Sandy and thunderstorms in the midwestern, mid-Atlantic, and northeastern United States, which primarily impacted IMU, as compared to 6.8 points of catastrophe losses in 2011, primarily related to hurricane Irene, storms and freezing weather in the northeastern and southwestern United States impacting primarily IMU, and tornados in the southeastern and midwestern United States most notably impacting IMU and Technology. The increase in the expense ratio was due to a 2.2 point increase in other underwriting expenses primarily for Entertainment and Technology, partially offset by a 1.1 point decrease in policy acquisition expenses primarily related to Entertainment.
The Specialty Industries combined ratio for the year ended December 31, 2011 decreased to 96.0% from 102.9% for the year ended December 31, 2010. The loss and LAE ratio decreased by 3.4 points to 57.7% while the expense ratio decreased by 3.5 points to 38.3%. The decrease in the loss and LAE ratio was primarily due to the impact of favorable loss reserve development. The year ended December 31, 2011 included 2.8 points of favorable loss reserve development primarily related to Technology, compared to 0.5 points of adverse loss reserve development primarily related to Entertainment and Accident in the prior year. Current accident year losses decreased 0.1 points, compared with the year ended December 31, 2010. The year ended December 31, 2011 included 6.8 points of catastrophe losses, primarily related to hurricane Irene, storms and freezing weather in the northeastern and southwestern United States impacting primarily IMU, and tornados in the southeastern and
midwestern United States most notably impacting IMU and Technology, as compared to 4.1 points of catastrophe losses in 2010, primarily related to severe wind and rainstorms in the northeastern United States impacting IMU. The decrease in the expense ratio was due to a 2.4 point decrease in other underwriting expenses, as well as a 1.1 point decrease in policy acquisition expenses primarily related to Entertainment.
A summary of results from our Investing, Financing and Corporate reportable segment for the years ended December 31, 2012, 2011 and 2010 is as follows:
The underwriting loss for 2010 includes operations associated with personal lines business that we sold in 2010.
Investing, Financing and Corporate reported pre-tax income from continuing operations of $40.4 million in the year ended December 31, 2011, compared to $111.7 million in the year ended December 31, 2010. The decrease was primarily related to a decrease in net realized and change in unrealized investment gains and net investment income. As further described below, net realized and change in unrealized investment gains decreased to $10.6 million in the year ended December 31, 2011, compared to $74.6 million in the prior year period, and net investment income decreased to $71.4 million in the year ended December 31, 2011, compared to $96.6 million in the prior year period. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Summary of Investment Results". The decrease in interest expense reflects actions taken to reduce outstanding debt. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Financing." Further, net other expenses increased mainly due to a $12.0 million loss related to the purchase of a portion of our 2003 Senior Notes in the year ended December 31, 2011, compared to a $10.8 million loss in the prior year period. General and administrative expenses decreased to $8.1 million as compared with $10.6 million.
In connection with purchase accounting for the OneBeacon Acquisition, we were required to adjust to fair value our loss and LAE reserves and the related reinsurance recoverables. As of December 31, 2012, $150.1 million of this adjustment remains, which is included in assets held for sale and liabilities held for sale on the Consolidated Balance Sheet.
A summary of our consolidated pre-tax investment results for the years ended December 31, 2012, 2011 and 2010 is as follows:
Our total pre-tax investment results were $82.0 million, a return of 3.0% for the year ended December 31, 2011, compared to $171.2 million, a return of 4.9% for the year ended December 31, 2010. Net investment income in the year ended December 31, 2011 was $71.4 million, a decrease of $25.2 million, compared to $96.6 million in the year ended December 31, 2010. The decrease was principally due to lower investment yields, a reduction in invested assets as a result of the Personal Lines Transaction, return of capital to shareholders, repurchases of debt and the Commercial Lines Transaction, including the impact of claim payments related to non-specialty commercial lines reserves. Net realized investment gains were $56.8 million in the year ended December 31, 2011, a decrease of $25.1 million compared to $81.9 million in the year ended December 31, 2010. The change in net unrealized investment gains (losses) was a decrease of $46.2 million in the year ended December 31, 2011, compared to a decrease in net unrealized investment gains (losses) of $7.3 million in the year ended December 31, 2010.
Our total common equity securities, convertible fixed maturity and other investments portfolio returned 1.1% for the year ended December 31, 2011, compared to 13.2% for the year ended December 31, 2010. Our total common equity securities and convertible fixed maturity investments portfolio returned (1.5)% and 16.4% for the years ended December 31, 2011 and 2010, respectively, or 360 basis points worse and 130 basis points better, respectively, than the S&P 500 Index benchmark. Our total common equity securities and convertible fixed maturity investments portfolio has overweight positions in the gold mining sector compared to the S&P 500 Index and also contains convertible fixed maturity investments whose returns were hurt by rising credit spreads on the fixed maturity component of the instrument. In addition, other investments, which are composed principally of hedge funds and private equities, outperformed the S&P 500 Index by 490 basis points for the year ended December 31, 2011 and underperformed by 910 basis points for the year ended December 31, 2011.
The breakdown of our fixed maturity portfolio, including convertible fixed maturity investments, at December 31, 2012 by credit class, based upon issue credit ratings provided by Standard & Poor's, or if unrated by Standard & Poor's, long-term obligation ratings provided by Moody's, is as follows:
Represents publicly traded mortgage-backed securities which carry the full faith and credit guaranty of the U.S. government (i.e., GNMA) or are guaranteed by a government sponsored entity (i.e., FNMA, FHLMC).
The classification of the underlying collateral quality and the tranche levels of our non-agency RMBS securities are as follows as of December 31, 2012:
At issuance, Super Senior were rated AAA by Standard & Poor's or Aaa by Moody's and were senior to other AAA or Aaa bonds.
The amount of fixed and floating rate securities and their tranche levels are as follows as of December 31, 2012:
At issuance, Senior were rated AAA by Standard & Poor's or Aaa by Moody's and were senior to non-AAA or non-Aaa bonds.
Holding company level. The primary sources of cash for OneBeacon Insurance Group, Ltd. and certain of our intermediate holding companies are expected to be distributions and tax sharing payments received from our insurance operating subsidiaries, capital raising activities, net investment income, and proceeds from sales and maturities of holding company investments. The primary uses of cash are expected to be interest payments on our debt obligations, repurchases and
retirements of our debt obligations, dividend payments on our common shares, common share repurchases, purchases of investments, payments made to tax authorities, contributions to our operating subsidiaries, and holding company operating expenses.
Operating subsidiary level. The primary sources of cash for our operating subsidiaries are expected to be premium collections, net investment income, capital raising activities, contributions from our holding companies, and proceeds from sales and maturities of investments. The primary uses of cash are expected to be claim payments, policy acquisition and other underwriting expenses, interest payments on internal debt obligations, repurchases and retirements of debt obligations, purchases of investments, and distributions and tax sharing payments made to parent holding companies.
Insurance companies typically collect premiums on policies that they write prior to paying claims made under those policies. During periods of premium growth, insurance companies typically experience positive cash flow from operations, as premium receipts typically exceed claim payments. When this happens, positive cash flow from operations is usually offset by negative cash flow from investing activities, as the positive operating cash flow is used to purchase investments. Conversely, during periods of premium decline, insurance companies typically experience negative cash flow from operations, even during periods in which they report net income, as the claims that they pay exceed the premiums that they collect. When this happens, negative cash flow from operations is typically offset by positive cash flow from investing activities, as invested assets are sold to fund current claim payments. For businesses that are in run-off, cash flow should be neutral as held investments are used to pay claims, loss adjusting, and other operating expenses.
As disclosed in Note 2-"Acquisitions and Dispositions" of the accompanying consolidated financial statements, during the fourth quarter of 2012, OneBeacon executed various intercompany reinsurance agreements which, along with other internal capital transactions among our insurance operating subsidiaries, resulted in ASIC becoming the lead insurance company for the ongoing specialty business and OBIC becoming the lead insurance company for the Runoff Business. As a result of the internal restructuring transactions, OBIC's 2012 statutory net income was significantly higher than that of our consolidated combined statutory net income as statutory net losses at lower-tiered subsidiaries more than offset the income recorded at OBIC. Notwithstanding these restructuring transactions, OneBeacon continues to manage its statutory capital on a combined basis. Although OBIC remains a top tier regulated insurance operating subsidiary and maintains sufficient statutory capital to support the Runoff Business, the majority of the group's statutory capital is now included in ASIC to support the ongoing specialty business.
structure noted above, ASIC will likely require prior approval by regulatory authorities in order to pay dividends until it builds up a historical net investment income stream and earned surplus balance under its new structure. At December 31, 2012, ASIC had negative earned surplus and $0.7 billion of statutory surplus.
During 2012, our unregulated insurance operating subsidiaries paid $4.9 million of dividends to their immediate parent. At December 31, 2012, OneBeacon's unregulated insurance operating subsidiaries had $28.6 million of net unrestricted cash, short-term investments and fixed maturity investments.
During 2012, OneBeacon Ltd. paid $80.1 million of regular quarterly dividends to its common shareholders. At December 31, 2012, OneBeacon Ltd. and its intermediate holding companies had $272.4 million of net unrestricted cash, short-term investments and fixed maturity investments and $33.3 million of common equity securities and convertible fixed maturity investments outside of its regulated and unregulated insurance operating subsidiaries.
The following table illustrates our consolidated insurance float position and four operational leverage ratios based on insurance float and net invested assets as of December 31, 2012 and 2011.
Based on December 31, 2012 balances, insurance float is expected to decrease by approximately $338.1 million as a result of the sale of the Runoff business. During the year ended December 31, 2012, insurance float decreased by $110.5 million, due to the sale of AutoOne.
The following table summarizes our debt to capital ratio at December 31, 2012 and 2011:
On March 24, 2011, OBH commenced a cash tender offer for up to $150.0 million in aggregate principal amount of the 2003 Senior Notes at a price of $1,045 per $1,000 principal amount. The cash tender offer, which was not subject to the tender of any minimum principal amount of 2003 Senior Notes, expired on April 20, 2011. OBH accepted and retired $150.0 million aggregate principal amount of the Senior Notes for $161.6 million, which resulted in a $12.0 million pre-tax loss in 2011, including transaction fees.
The balances included in the table above regarding our long-term incentive compensation plans include amounts payable for performance shares and units, as well as deferred compensation balances. Exact amounts to be paid cannot be predicted with certainty as the ultimate amounts of these liabilities are based on future performance. The estimated payments reflected in the table are based on current accrual factors (common share price and pay-out percentage) and assume that all outstanding balances were 100% vested as of December 31, 2012.
There are no provisions within our operating lease agreements that would trigger acceleration of future lease payments. As of December 31, 2012, we have accrued $0.1 million net of anticipated sub-lease income for leased space which we have ceased using. The capital lease entered into in conjunction with the sale-leaseback of certain of OneBeacon's fixed assets and capitalized software contains provisions that could trigger an event of default including a failure to pay when due payments under the capital lease. If an event of default were to occur, the lessor would have a number of remedies available including the acceleration of future lease payments or the possession of the property covered under the lease agreement.
On August 22, 2007, our Board authorized us to repurchase up to $200.0 million of OneBeacon's Class A common shares from time to time, subject to market conditions. Shares may be repurchased on the open market or through privately negotiated transactions. This authorization does not have a stated expiration date. Since the inception of this authorization, the Company has repurchased and retired 5.6 million of its Class A common shares. During the years ended December 31, 2012 and December 31, 2011, no shares were repurchased. During the year ended December 31, 2010, 0.7 million Class A common shares under this authorization were repurchased for $10.5 million and retired.
Detailed information concerning our cash flows during the years ended December 31, 2012, 2011 and 2010 follows:
Net cash flows (used for) provided from operations were $(53.7) million, $(118.5) million, and $22.4 million, respectively, for the years ended December 31, 2012, 2011 and 2010. Net cash flows for operations in the years ended December 31, 2012, 2011 and 2010 were reduced by the run-off of reserves related to the Commercial Lines Transaction. Net cash flows for operations in the years ended December 31, 2012, 2011 and 2010 were reduced by declining net investment income, primarily due to lower overall portfolio yields, shifts in portfolio mix to lower risk, lower yield investments and a decrease in the overall invested asset base. In addition, cash flows from operations for the year ended December 31, 2010 reflects the impact of the Personal Lines Transaction.
During 2011, OBH repurchased and retired a portion of the 2003 Senior Notes for $161.6 million in a cash tender offer, including transaction fees.
During 2010, we repurchased and retired 0.7 million of our Class A common shares for $10.5 million under our share repurchase authorization.
During 2010, OBIC purchased a portion of the 2003 Senior Notes for $1.1 million.
During 2010, OBH repurchased and retired a portion of the 2003 Senior Notes for $30.8 million.
During 2010, we received $10.2 million of additional consideration related to the Commercial Lines Transaction.
Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements. The consolidated financial statements presented herein include all adjustments considered necessary by management to fairly present our financial position, results of operations and cash flows.
We measure certain assets at estimated fair value in our consolidated financial statements, with changes therein recognized in current period earnings. In addition, we disclose estimated fair value for certain assets and liabilities measured at historical or amortized cost. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an exit price). Fair value measurements are categorized into a hierarchy that distinguishes between inputs based on market data from independent sources (observable inputs) and a reporting entity's internal assumptions based upon the best information available when external market data is limited or unavailable (unobservable inputs). Quoted prices in active markets for identical assets or liabilities have the highest priority (Level 1), followed by observable inputs other than quoted prices, including prices for similar but not identical assets or liabilities (Level 2) and unobservable inputs, including the reporting entity's estimates of the assumptions that market participants would use, having the lowest priority (Level 3).
As of December 31, 2012 and 2011, approximately 92% and 93%, respectively, of the investment portfolio recorded at fair value was priced based upon quoted market prices or other observable inputs. Investments valued using Level 1 inputs include fixed maturity investments, primarily investments in U.S. Treasuries, common equities and short-term investments, which include U.S. Treasury Bills. Investments valued using Level 2 inputs comprise fixed maturity investments including corporate debt, state and other governmental debt, convertible fixed maturity investments and mortgage and asset-backed securities. Fair value estimates for investments that trade infrequently and have few or no observable market prices are classified as Level 3 measurements. Level 3 fair value estimates based upon unobservable inputs include our investments in hedge funds and private equity funds, as well as certain investments in debt and equity securities, including asset-backed securities, where quoted market prices are unavailable.
Our process to assess the reasonableness of the market prices obtained from the outside pricing sources covers substantially all of our fixed maturity investments and includes, but is not limited to, evaluation of model pricing methodologies, review of the pricing services' quality control processes and procedures on at least an annual basis, comparison of market prices to prices obtained from different independent pricing vendors on at least an annual basis, monthly analytical reviews of certain prices and review of assumptions utilized by the pricing service for selected measurements on an ad hoc basis throughout the year. We also perform back-testing of selected purchases and sales activity to determine whether there are any significant differences between the market price used to value the security prior to purchase or sale and the actual purchase or sale price on at least an annual basis. Prices provided by the pricing services that vary by more than 5% and $1.0 million from the expected price based on the procedures are considered outliers. In circumstances where the results of our review process does not appear to support the market price provided by the pricing services, we challenge the price. If we cannot gain satisfactory evidence to support the challenged price, we rely upon our own pricing methodologies to estimate the fair value of the security in question.
The fair value measurements at December 31, 2012 and 2011 for assets recorded in accordance with ASC 825 and any related Level 3 inputs are as follows:
At December 31, 2012 and 2011, we held one private preferred stock that represented approximately 84% and 85%, respectively, of our preferred stock portfolio. We used quoted market prices for similar securities that were adjusted to reflect management's best estimate of fair value; this security is classified as a Level 3 measurement.
the liabilities included in the $36.9 million were classified as Level 1 measurements. These liabilities were no longer held at December 31, 2012 as the partnership was sold.
The changes in Level 3 fair value measurements for the year ended December 31, 2012 are as follows:
Excludes the carrying value of $21.1 million associated with a tax advantaged federal affordable housing development fund accounted for using the equity method.
Expected loss ratio methods: These methods are based on the assumption that ultimate losses vary proportionately with premiums. Expected loss ratios are typically developed based upon the information used in pricing, and are multiplied by the total amount of premiums written to calculate ultimate losses. Expected
We perform an actuarial review of our recorded reserves each quarter. Our actuaries compare the previous quarter's estimates of paid loss and LAE, case reserves and IBNR to amounts indicated by actual experience. Differences between previous estimates and actual experience are evaluated to determine whether a given actuarial method for estimating loss and LAE should be relied upon to a greater or lesser extent than it had been in the past. While some variance is expected each quarter due to the inherent uncertainty in loss and LAE, persistent or large variances would indicate that prior assumptions and/or reliance on certain reserving methods may need to be revised going forward.
Upon completion of each quarterly review, our actuaries select indicated reserve levels based on the results of the actuarial methods described previously, which are the primary consideration in determining management's best estimate of required reserves. However, in making its best estimate, management also considers other qualitative factors that may lead to a difference between held reserves and actuarially recommended levels in the future. Typically, these factors exist when management and our actuaries conclude that there is insufficient historical incurred and paid loss information or that trends included in the historical incurred and paid loss information are unlikely to repeat in the future. Such factors include, among others, recent entry into new markets or new products, improvements in the claims department that are expected to lessen future ultimate loss costs and legal and regulatory developments. At December 31, 2012 and 2011, total carried reserves, including reserves that are presented as liabilities held for sale in the December 31, 2012 balance sheet related to the Runoff Business, were 6% and 10%, respectively, above the actuarial point estimate.
We also incurred A&E losses via our participation in industry pools and associations. The most significant of these pools was Excess Casualty Reinsurance Association, or ECRA, which provided excess liability reinsurance to U.S. insurers from 1950 until the early 1980s. ECRA incurred significant liabilities for A&E, of which we bear approximately a 4.6% and 4.7% share, respectively, at December 31, 2012 and 2011, or $66.9 million and $77.1 million, respectively, at December 31, 2012 and 2011, which is fully reflected in our loss and LAE reserves.
During 2011, we completed a study of our legacy A&E exposures. Reasonable estimates of potential adverse scenarios continue to be within the $2.5 billion reinsurance cover issued by NICO. Based on the results of the study, we increased the point estimate of incurred losses ceded to NICO from $2.2 billion to $2.3 billion, an increase of $121.9 million, net of underlying reinsurance. Due to the NICO Cover, there was no impact to income or equity from the change in the estimate.
As noted above, we have ceded estimated incurred losses of approximately $2.3 billion to the NICO Cover at December 31, 2012. Since entering into the NICO Cover, approximately 9% of the $2.3 billion of utilized coverage relates to uncollectible Third-Party Recoverables and settlements on Third-Party Recoverables through December 31, 2012. Net losses paid totaled $1.5 billion as of December 31, 2012. To the extent that actual experience differs from our estimate of incurred A&E losses and Third-Party Recoverables, future losses could exceed the $198.3 million of protection remaining under the NICO Cover.
medical and clean-up cost increases and industry settlement practices, limit our ability to accurately estimate ultimate liability and we may be subject to A&E losses beyond currently estimated amounts. In addition, we remain liable for risks reinsured in the event that a reinsurer does not honor its obligations under reinsurance contracts. See Note 3-"Reserves for Unpaid Loss and LAE-Asbestos and environmental loss and LAE reserve activity" of the accompanying consolidated financial statements for more information regarding our A&E reserves.
Our A&E claims activity, substantially all of which relates to Runoff Business, the operations of which have been included in discontinued operations and the loss and LAE reserves of which are included in liabilities held for sale on the December 31, 2012 consolidated balance sheet, is illustrated in the table below:
Workers compensation covers an employer's liability for injuries, disability or death of employees, without regard to fault, as prescribed by state workers compensation law and other statutes. Workers compensation is generally considered a long-tail coverage, as it takes a relatively long period of time to finalize claims from a given accident year. While certain payments such as initial medical treatment or temporary wage replacement for the injured worker are made quickly, some other payments are made over the course of several years, such as awards for permanent partial injuries. In addition, some payments can run as long as the injured worker's life, such as permanent disability benefits and ongoing medical care. Despite the possibility of long payment tails, the reporting lags are generally short, settlements are generally not complex, and most of the liability can be considered high frequency with moderate severity. The largest reserve risk generally comes from the low frequency, high severity claims providing lifetime coverage for medical expense arising from a worker's injury.
Examples of common reserving factors that can change and, thus, affect the estimated workers compensation reserves include:
Mortality trends of injured workers with lifetime benefits and medical treatment or dependents entitled to survivor benefits
reserving risk for this line is dominated by the liability coverage portion of this product, except occasionally in the event of catastrophic or large single losses.
During the year ended December 31, 2012, OneBeacon experienced $7.4 million of favorable loss and LAE reserve development on prior accident year reserves. During 2010, management began separately reviewing loss reserves for some business which had been previously managed as a part of OneBeacon's former commercial lines underwriting unit. As of December 31, 2011, the reserves for these businesses had been selected based on expected emergence which was based in large part on the historic loss development of the former commercial lines underwriting unit. The favorable reserve development was primarily due to emergence which continued to be lower than expected for these businesses, particularly in the workers' compensation, multiple peril liability and general liability lines. This favorable development was offset somewhat by adverse development on a few excess property claims.
During 2010, management began separately reviewing loss reserves for some business which had been previously managed as a part of OneBeacon's former commercial lines underwriting unit. As of December 31, 2010, the reserves for these businesses had been selected based on expected emergence which was based on the historic loss development of the former commercial lines underwriting unit. However, during 2011 the actual emerged experience for these businesses was significantly lower than the expected emergence. As a result of this favorable emergence, management lowered the loss reserves for these businesses by $14.0 million, which also affect the Specialty Industries and Specialty Products segments.
Specifically, at December 31, 2009, management had revised its expectations downward with respect to future loss emergence in the professional liability business, which had initially been based on market analysis when this business was initiated in 2002 and 2003. However, during the year ended December 31, 2010, losses continued to be significantly lower than these revised expectations. As a result, management lowered its selected reserves on the earliest years which affected more recent years as total loss expectations for those years are based in part on prior years' results. The impact of this revised estimate was a decrease to professional liability reserves of $19.3 million.
Unpaid loss and LAE reserves, net of reinsurance recoverable on unpaid losses, at December 31, 2012 and 2011 were as follows:
Amounts included in Runoff Business as of December 31, 2012 include case and IBNR reserves that have been reclassified to liabilities held for sale in the December 31, 2012 consolidated balance sheet.
In selecting its best estimate, management continues to monitor the impact of future increases in inflation, including adverse changes in tort liability. These types of changes could result in deterioration in the loss reserves. During 2012, inflation continued to emerge in the loss data for some lines of business which increased the actuarial indications and related estimated range of outcomes. Since these changes in inflation assumptions are now being partially reflected in the actuarial methods, management does not need to select reserves as high in the range of actuarial indications. This has had some impact on most lines but has a particular impact on general liability - claims made and medical malpractice within both OneBeacon's Ongoing Business and its Runoff Business. Additionally, as OneBeacon continues to pay down the obligations associated with its Runoff
The percentages shown in the following table represent the linear interpolation of where our recorded loss and LAE reserves on our Ongoing Business, net of reinsurance recoverable on unpaid losses, are within the range of reserves estimates by line of business at December 31, 2012 and 2011. Similar to the preceding table, the low end of the range equals zero, the middle of the range equals 50% and the high end of the range equals 100%.
Professional liability: Recorded loss and allocated loss adjustment expense reserves, net of reinsurance recoverables, for professional liability were $409.5 million at December 31, 2012. A key assumption for professional liability is the implicit loss cost trend, particularly the severity inflation trend component of loss costs. Across the entire reserve base, a 5.0 point change in assumed annual severity would have changed the estimated net reserve by approximately $68 million at December 31, 2012, in either direction.
Multiple peril liability: Recorded loss and LAE reserves for the Ongoing and Runoff Businesses, net of reinsurance recoverables excluding the GRC Cover, for multiple peril were $142.3 million at December 31, 2012. Reported loss development patterns are a key assumption for these lines of business, particularly for more mature accident years. Historically, assumptions on reported loss development patterns have been impacted by, among other things, emergence of new types of claims (e.g. construction defect claims) or a shift in the mixture between smaller, more routine claims and larger, more complex claims. If case reserve adequacy for multiple peril claims changed by 10.0 points this would have changed the estimated net reserve by approximately $14 million at December 31, 2012, in either direction.
changes in domestic or foreign laws or regulations, or their interpretation, applicable to us, our competitors, our agents or our customers;
an economic downturn or other economic conditions adversely affecting our financial position including stock market volatility;