On July 18, 2007, AIHL acquired PCC. We sold Darwin on October 20, 2008. Darwin has been reclassified as discontinued operations for the three years ended 2008 and discontinued operations, net of minority interest expense, includes the gain on disposition in 2008.
adverse loss development for events insured by our insurance operating units in either the current year or prior year;
the long-tail and potentially volatile nature of certain casualty lines of business written by our insurance operating units;
Overview. Each of our insurance operating units establishes reserves on its balance sheet for unpaid loss and LAE related to its property and casualty insurance and surety contracts. As of any balance sheet date, historically there have been claims that have not yet been reported, and some claims may not be reported for many years after the date a loss occurs. As a result of this historical pattern, the liability for unpaid loss and LAE includes significant estimates for IBNR. Additionally, reported claims are in various stages of the settlement process. Each claim is settled individually based upon its merits, and certain claims may take years to settle, especially if legal action is
Although we are unable at this time to determine whether additional reserves, which could have a material impact upon our financial condition, results of operations, and cash flows, may be necessary in the future, we believe that the reserves for unpaid loss and LAE established by our insurance operating units are adequate as of December 31, 2010.
Methodologies and Assumptions. Our insurance operating units use a variety of techniques that employ significant judgments and assumptions to establish the liabilities for unpaid loss and LAE recorded at the balance sheet date. These techniques include detailed statistical analyses of past claim reporting, settlement activity, claim frequency, internal loss experience, changes in pricing or coverages and severity data when sufficient information exists to lend statistical credibility to the analyses. More subjective techniques are used when statistical data is insufficient or unavailable. These liabilities also reflect implicit or explicit assumptions regarding the potential effects of future inflation, judicial decisions, changes in laws and recent trends in such factors, as well as a number of actuarial assumptions that vary across our insurance operating units and across lines of business. This data is analyzed by line of business, coverage and accident year, as appropriate.
Each of the above actuarial assumptions may also incorporate data from the insurance industry as a whole, or peer companies writing substantially similar insurance coverages, in the absence of sufficiently credible internally-derived historical information. Data from external sources may be used to set expectations, as well as assumptions regarding loss frequency or severity relative to an exposure unit or claim, among other actuarial parameters. Assumptions regarding the application or composition of peer group or industry reserving parameters require substantial judgment. The use of data from external sources was most significant for PCC as of December 31, 2010.
Sensitivity. Loss frequency and severity are measures of loss activity that are considered in determining the key assumptions described above. Loss frequency is a measure of the number of claims per unit of insured exposure, and loss severity is a measure of the average size of claims. Factors affecting loss frequency include the effectiveness of loss controls and safety programs and changes in economic conditions or weather patterns. Factors affecting loss severity include changes in policy limits, retentions, rate of inflation and judicial interpretations. Another factor affecting estimates of loss frequency and severity is the loss reporting lag, which is the period of time between the occurrence of a loss and the date the loss is reported to our insurance operating units. The length of the loss reporting lag affects our ability to accurately predict loss frequency (loss frequencies are more predictable for lines with short reporting lags), as well as the amount of reserves needed for IBNR. If the actual level of loss frequency and severity is higher or lower than expected, the ultimate losses will be different than management’s estimates. A small percentage change in an estimate can result in a material effect on our reported earnings. The following table reflects the impact of changes, which could be favorable or unfavorable, in frequency and severity on our loss estimates for claims occurring in 2010 (dollars in millions):
Our net reserves for loss and LAE of $1.5 billion as of December 31, 2010 relate to multiple accident years. Therefore, the impact of changes in frequency or severity for more than one accident year could be higher or lower
The more significant prior year adjustments affecting 2010 and 2009 are summarized as follows:
For RSUI, loss and LAE for 2010 reflect a net $33.9 million release of prior accident year casualty loss reserves, compared with a net $38.4 million release of prior accident year casualty loss reserves during 2009. The $33.9 million net release consisted of a $41.4 million reserve release, partially offset by a $7.5 million reserve increase. The $41.4 million reserve release relates primarily to the general liability and professional liability lines of business primarily for the 2003 through 2007 accident years and reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods for such lines of business. Specifically, cumulative losses for such lines of business, which include both loss payments and case reserves, in respect of prior accident years were expected to be higher through the balance sheet date than the actual cumulative losses through that date. The amount of lower cumulative losses, expressed as a percentage of carried loss and LAE reserves at the beginning of the year, was 3.8 percent. Such reduction did not impact the assumptions used in estimating RSUI’s loss and LAE liabilities for its general liability and professional liability lines of business earned in 2010. The $7.5 million reserve increase in loss reserves related to an increase in estimated ultimate 2007 accident year losses for the D&O liability line of business, reflecting, in part, unfavorable loss emergence on certain sub-prime mortgage industry claims. Such increase did not impact the assumptions used in estimating RSUI’s loss and LAE liabilities for its D&O liability line of business earned in 2010. The net $38.4 million release of prior accident year casualty loss reserves during 2009 relates primarily to D&O liability, professional liability and general liability lines of business for the 2003 through 2007 accident years and reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods for such lines of business.
For CATA, loss and LAE for 2010 reflect a net $0.4 million release of prior accident year loss reserves (related primarily to the surety lines of business), compared with a net $10.7 million release of prior accident year loss reserves during 2009 (related primarily to the casualty and surety lines of business). These amounts relate primarily to favorable loss emergence compared with loss emergence patterns assumed in earlier periods. Specifically, cumulative losses for such lines of business, which include both loss payments and case reserves, in respect of prior accident years were expected to be higher through the balance sheet date than the actual cumulative losses through that date. The net $0.4 million release of prior accident year loss reserves did not impact the assumptions used in estimating CATA’s loss and LAE liabilities for business earned in 2010.
For CATA, loss and LAE for 2010 also reflect a $3.5 million reserve release reflecting favorable loss emergence for asbestos and environmental impairment claims that arose from reinsurance assumed by a subsidiary of CATA between 1969 and 1976, based on a reserve study that was completed in the 2010 second quarter.
Asbestos and Environmental Impairment Reserves. Our reserve for unpaid loss and LAE includes $14.1 million and $14.0 million of gross and net reserves, respectively, at December 31, 2010, for asbestos and environmental impairment claims that arose from reinsurance of certain general liability and commercial multiple peril coverages assumed by Capitol Indemnity between 1969 and 1976. Reserves for asbestos and environmental impairment claims cannot be estimated with traditional loss reserving techniques because of uncertainties that are greater than those associated with other types of claims. Factors contributing to these uncertainties include a lack of historical data, the significant periods of time that often elapse between the occurrence of an insured loss and the reporting of that loss to the ceding company and the reinsurer, uncertainty as to
Reinsurance. Receivables recorded with respect to claims ceded by our insurance operating units to reinsurers under reinsurance contracts are predicated in large part on the estimates for unpaid losses and, therefore, are also subject to a significant degree of uncertainty. In addition to the factors cited above, reinsurance receivables may prove uncollectible if the reinsurer is unable to perform under the contract. Reinsurance contracts purchased by our insurance operating units do not relieve them of their obligations to their own policyholders. Additional information regarding the use of, and risks related to, the use of reinsurance by our insurance operating units can be found on pages 22 through 24 and pages 31 and 32 of this Form 10-K Report.
the duration of time and the relative magnitude to which fair value of the investment has been below cost;
extraordinary events, including negative news releases and rating agency downgrades, with respect to the issuer of the investment;
our ability and intent to hold an equity security for a period of time sufficient to allow for any anticipated recovery; and
A debt security is deemed impaired if it is probable that we will not be able to collect all amounts due under the security’s contractual terms. An equity security is deemed impaired if, among other things, its decline in estimated
fair value has existed for twelve months or more or if its decline in estimated fair value from its cost is greater than 50 percent, absent compelling evidence to the contrary. Further, for securities expected to be sold, an other-than-temporary impairment loss is recognized if we do not expect the fair value of a security to recover its cost prior to the expected date of sale. If that judgment changes in the future, we may ultimately record a realized loss after having originally concluded that the decline in value was temporary. Risks and uncertainties are inherent in the methodology we use to assess other-than-temporary declines in value. Risks and uncertainties could include, but are not limited to, incorrect assumptions about financial condition, liquidity or future prospects, inadequacy of any underlying collateral, and unfavorable changes in economic or social conditions, interest rates or credit ratings.
Our consolidated balance sheet as of December 31, 2010 includes goodwill and other intangible assets, net of amortization, of $142.3 million. This amount has been recorded as a result of business acquisitions. Other intangible assets that are not deemed to have an indefinite useful life are amortized over their estimated useful lives. Goodwill and other intangible assets deemed to have an indefinite useful life are tested annually in the fourth quarter of every calendar year for impairment and at such other times upon the occurrence of certain events. We also evaluate goodwill and other intangible assets whenever events and changes in circumstances suggest that the carrying amount may not be recoverable. A significant amount of judgment is required in performing goodwill and other intangible asset impairment tests. These tests include estimating the fair value of our operating units and other intangible assets. With respect to goodwill, as required by GAAP, we compare the estimated fair value of our operating units with their respective carrying amounts including goodwill. Under GAAP, fair value refers to the amount for which the entire operating unit may be bought or sold. Our methods for estimating operating unit values include asset and liability fair values and other valuation techniques, such as discounted cash flows and multiples of earnings or revenues. All of these methods involve significant estimates and assumptions.
In connection with impairment testing of our goodwill and other intangible assets in the fourth quarter of 2008, we also determined that the $48.7 million of goodwill associated with our acquisition of PCC was impaired in its entirety. As a result, at December 31, 2008, we recorded a non-cash charge of $48.7 million, which is classified as a net realized capital loss in our consolidated statement of earnings for the year ended December 31, 2008 and represents the entire PCC goodwill balance at such date. Our estimation of PCC’s fair value was based primarily on observing the stock market-based valuations of other publicly-traded insurance carriers. The factors that contributed to our determination that the PCC goodwill was impaired included unfavorable conditions in the U.S. economy and California workers’ compensation insurance market, combined with PCC’s poor results during 2008. There was no resulting impact to our tax balances as a result of this charge.
See Note 4 to the Consolidated Financial Statements set forth in Item 8 of this Form 10-K Report for additional information on our goodwill and other intangible assets.
The profitability of our insurance operating units, and as a result, our profitability, is primarily impacted by the adequacy of premium rates, level of catastrophe losses, investment returns, intensity of competition and the cost of reinsurance. The adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural disasters, regulatory measures and court decisions that define and expand the extent of coverage, and the effects of economic inflation on the amount of compensation due for injuries or losses. The ultimate adequacy of premium rates is not known with certainty at the time property and casualty insurance policies are issued because premiums are determined before claims are reported.
The profitability of our insurance operating units is also impacted by competition generally and price competition in particular. Historically, the performance of the property and casualty insurance industry has tended to fluctuate in cyclical periods of price competition and excess underwriting capacity followed by periods of high premium rates and shortages of underwriting capacity. Although an individual insurance company’s performance is dependent on its own specific business characteristics, the profitability of most property and casualty insurance companies tends to follow this cyclical market pattern. In the past few years, our insurance operating units have faced increasing competition as a result of an increased flow of capital into the insurance industry, with both new entrants and existing insurers seeking to gain market share. This has resulted in decreased premium rates and less favorable contract terms and conditions. In particular, RSUI and CATA’s specialty lines of business increasingly encounter competition from standard market companies seeking to increase market share. We expect to continue to face strong competition in these and the other lines of business of our insurance operating units, and our insurance operating units may continue to experience decreases in premium rates and/or premium volume and less favorable contract terms and conditions.
Discontinued operations consist of the operations of Darwin, net of minority interest expense and the gain on disposition in 2008. Additional information regarding the results of discontinued operations can be found in Note 2 to the Notes to the Consolidated Financial Statements set forth in Item 8 of this 10-K Report.
Corporate activities consist of Alleghany Properties, our investments in Homesite and ORX and corporate activities at the parent level.
Our earnings from continuing operations before income taxes in 2009 increased substantially from 2008, primarily reflecting higher net realized capital gains, lower other-than-temporary impairment losses and a decrease in loss and LAE, partially offset by lower net premiums earned. The increase in net realized capital gains was due primarily to larger gains on the sales of equity securities, including our holdings of Burlington Northern, as well as certain holdings within our energy portfolio. In addition, 2009 net realized capital gains include a non-cash charge of $11.2 million related to an impairment of assets associated with our acquisition of PCC, compared with $48.7 million of such non-cash charges in 2008. The decrease in other-than-temporary impairment losses was due in part to comparatively improved equity market conditions in 2009 compared with 2008. The decrease in loss and LAE primarily reflects $6.7 million of catastrophe losses at RSUI in 2009, compared with $97.9 million of net catastrophe losses at RSUI in 2008 related in large part to Hurricanes Ike, Gustav and Dolly. The significant decrease in net premiums earned primarily reflects the impact of continuing competition at our insurance operating units.
The decrease in commissions, brokerage and other underwriting expenses in 2010 compared with 2009, as well as 2009 compared with 2008, primarily reflects the net effect of lower premium volumes described above, which caused premium taxes, commissions and related acquisition costs to decline.
The decrease in RSUI’s underwriting profit in 2010 from 2009 primarily reflects a decrease in net premiums earned, partially offset by the decrease in loss and LAE. The increase in RSUI’s underwriting profit in 2009 from 2008 primarily reflects a decrease in loss and LAE, partially offset by the decrease in net premiums earned.
The increase in loss and LAE in 2010 from 2009 primarily reflects a lower amount of prior year reserve releases in 2010 compared with 2009, and, to a lesser extent, higher property and workers’ compensation claims. During 2010, CATA had a net prior year reserve release of $3.9 million, compared with a net prior year reserve release of $10.7 million in 2009. Of the $3.9 million reserve release, $3.5 million reflects favorable loss emergence for asbestos and environmental impairment claims based on a reserve study that was completed in the 2010 second quarter. The remaining $0.4 million of the $3.9 million reserve release primarily relates to a net prior year reserve release in 2010 in the surety lines of business, reflecting favorable loss emergence compared with loss emergence patterns assumed in earlier periods for such lines of business. The $10.7 million reserve release in 2009 primarily reflects favorable emergence in the casualty and surety lines of business.
PCC reported an underwriting loss of $30.5 million in 2010, primarily reflecting a substantial decrease in net premiums earned from 2009 for the reasons described above. PCC’s underwriting loss of $30.5 million for 2010 also reflects a $12.5 million increase of prior accident year workers’ compensation net loss reserves, related primarily to a decrease in ceded loss and LAE based on a fourth quarter 2010 review of reinsurance coverage estimates, and to a lesser extent, an increase in unallocated LAE reserves. The review of reinsurance coverage estimates also resulted in a $5.0 million decrease in ceded premiums earned which increased net premiums earned.
PCC reported an underwriting loss of $70.7 million for 2009, primarily reflecting a substantial decrease in net premiums earned from 2008 for the reasons described above, and a $34.5 million reserve increase in the 2009 second quarter. Of the $34.5 million reserve increase, $26.5 million related to prior accident years and $8.0 million related to the 2009 accident year. In addition, PCC also recorded a pre-tax non-cash impairment charge of $11.2 million in the 2009 second quarter, which was classified as a net realized capital loss in its consolidated statement of earnings.
PCC reported an underwriting loss of $60.9 million for 2008, primarily reflecting a reserve increase of $35.9 million and a decrease in net premiums earned. In addition, in connection with impairment testing of goodwill and other intangible assets as of December 31, 2008, we determined that the $48.7 million of goodwill associated with our acquisition of PCC was impaired. As a result, as of December 31, 2008, we recorded a non-cash charge of $48.7 million, which is classified as a net realized capital loss in our consolidated statement of earnings for the year ended December 31, 2008 and represents the entire PCC goodwill balance at such date. The estimation of PCC’s fair value was based primarily on observing the stock market-based valuations of other publicly-traded insurance carriers. The factors that contributed to our determination that the PCC goodwill was impaired included the recent unfavorable conditions in the U.S. economy and California workers’ compensation insurance market, combined with PCC’s poor results during 2008. There was no resulting impact to our tax balances as a result of this charge.
The California Department of Insurance, or the “CDI,” is responsible for periodic financial and market conduct examinations of California-domiciled insurance companies. In September 2010, the CDI issued a financial examination report of PCIC for the period from July 1, 2004 through December 31, 2008. As part of its work for such financial examination report, the CDI produced an actuarial report, or the “Actuarial Report,” for the years ended December 31, 2009 and 2008. The Actuarial Report included an estimate of loss and LAE reserves on a statutory basis of accounting that was higher than that recorded by PCIC at such dates. We believe that PCIC’s reserves for unpaid loss and LAE are adequate, and the CDI did not require PCIC to currently or retroactively increase its carried reserves to the estimates included in the Actuarial Report. AIHL did, however, contribute $40.0 million of capital to PCC on September 27, 2010, and these funds were used by PCIC to increase its workers’ compensation deposit, which is required to be maintained by PCIC under California workers’ compensation regulations, to a level consistent with the estimated loss and LAE reserves included in the Actuarial Report. To the extent that PCIC’s actual loss experience is less than the CDI’s final estimate of PCIC’s loss and LAE reserves, over time such additional workers’ compensation deposit funds will be released back to PCIC.
Additional information regarding PCC’s reserve increases can be found on pages 43 and 44 of this Form 10-K Report.
Excludes non-cash impairment charges in 2009 and 2008 related to the intangible assets associated with our acquisition of PCC which were classified as a net realized capital loss in our consolidated statements of earnings (see Note 4(a) to the Notes to the Consolidated Financial Statements set forth in Item 8 of this Form 10-K Report).
Approximate yields of AIHL’s debt securities for 2010, 2009 and 2008 are as follows (in millions, except for percentages):
After investment expenses, excluding net realized gains and other-than-temporary impairment losses.
Net Realized Capital Gains. Net realized capital gains in 2010, 2009 and 2008 relate primarily to sales of equity securities in the energy sector, some of which had their cost basis reduced in earlier periods for the recognition of unrealized losses through other-than-temporary impairment losses, particularly in 2009.
the absence of compelling evidence that would cause us to call into question the financial condition or near-term prospects of the issuer of the investment; and
Corporate activities reported a loss from continuing operations before income taxes in 2010 compared with earnings from continuing operations before income taxes in 2009, primarily reflecting lower net realized capital gains which were not sufficient to offset corporate administration, interest and other expenses. The lower net realized capital gains primarily reflects the absence of sales of common stock of Burlington Northern in 2010, which were significant in 2009.
Net investment income includes ($2.0) million, ($21.9) million and $1.5 million of our equity in (losses) earnings of ORX for 2010, 2009 and 2008, respectively. The 2009 losses were due primarily to asset impairment charges incurred as of December 31, 2008, but finalized in the 2009 third quarter, arising from relatively low energy prices as of December 31, 2008. Net investment income also includes ($3.2) million, ($1.1) million and $0.3 million of our equity in (losses) earnings of Homesite for 2010, 2009 and 2008, respectively. Homesite losses in 2010 and 2009 primarily reflect the impact of increased homeowners insurance claims from severe weather and ongoing purchase accounting adjustments.
Interest expense in 2010 includes interest on our $300.0 million of Senior Notes, which were issued on September 20, 2010 (see Note 7 to the Notes to the Consolidated Financial Statements set forth in Item 8 of this Form 10-K Report for further details).
Primarily consists of loss and LAE reserves for terminated lines of business and loss reserves acquired in connection with prior acquisitions for which the sellers provided loss reserve guarantees. The loss and LAE reserves are ceded 100 percent to the sellers. Additional information regarding the loss reserve guarantees can be found in Note 5(c) to the Notes to the Consolidated Financial Statements set forth in Item 8 of this 10-K Report.
prior years. The decrease in workers’ compensation gross loss and LAE reserves primarily reflects the impact of PCC’s decision in June 2009 to cease soliciting new or renewal business on a direct basis commencing August 1, 2009.
Gross Reserves. Gross loss and LAE reserves at December 31, 2009 decreased slightly from December 31, 2008 due to reserve decreases in property and certain other lines of business, largely offset by increases in casualty and, to a lesser extent, workers’ compensation lines of business. The decrease in property gross loss and LAE reserves is mainly due to loss payments made by RSUI on hurricane related losses incurred in prior years. The increase in casualty gross loss and LAE reserves primarily reflects anticipated loss reserves on current accident year gross premiums earned and limited gross paid loss activity for the current and prior accident years at RSUI, partially offset by RSUI’s release of prior accident year reserves for D&O liability, professional liability, and general liability lines of business. The increase in workers’ compensation gross loss and LAE reserves primarily reflects an increase by PCC of current and prior accident year reserves during 2009, partially offset by the impact of PCC’s decision to cease soliciting new or renewal business on a direct basis commencing August 1, 2009.
At December 31, 2010, AIHL had total reinsurance recoverables of $873.3 million, consisting of $847.4 million of ceded outstanding loss and LAE and $25.9 million of recoverables on paid losses. RSUI’s reinsurance recoverables totaled $752.6 million of AIHL’s $873.3 million. The reinsurance purchased by AIHL’s insurance operating units does not relieve them from their obligations to their policyholders, and therefore, the financial strength of their reinsurers is important. Approximately 89.9 percent of AIHL’s reinsurance recoverables balance at December 31, 2010 was due from reinsurers having an A.M. Best financial strength rating of A (Excellent) or higher. AIHL’s Reinsurance Security Committee, which includes certain of our officers and the chief financial officer of each of AIHL’s operating units and which manages the use of reinsurance by such operating
units, has determined that reinsurers with a rating of A (Excellent) or higher have an ability to meet their ongoing obligations at a level that is acceptable to us.
Stockholders’ equity increased to approximately $2.9 billion as of December 31, 2010, compared with approximately $2.7 billion as of December 31, 2009, representing an increase of 7.0 percent. The increase in stockholders’ equity primarily reflects net earnings in 2010, and a net increase in net unrealized appreciation in our investment portfolio during 2010, partially offset by the repurchase of our common stock pursuant to our repurchase program described below.
of (i) a secured credit facility, or “Tranche A,” subject to a borrowing base as set forth in the Credit Agreement, in an aggregate principal amount of up to $50.0 million and (ii) an unsecured credit facility, or “Tranche B,” in an aggregate principal amount of up to $50.0 million. The Commitments under the Credit Agreement are scheduled to terminate on September 9, 2013, or the “Maturity Date,” unless earlier terminated. Borrowings under the Credit Agreement will be available for working capital and general corporate purposes.
The Credit Agreement contains representations, warranties and covenants customary for bank loan facilities of this nature. In this regard, the Credit Agreement requires us to, among other things, (i) maintain a consolidated net worth of not less than the sum of (x) approximately $2.0 billion plus (y) 50 percent of our cumulative consolidated net income earned in each fiscal quarter (if positive) commencing on September 30, 2010 and (ii) maintain a ratio of consolidated total indebtedness to consolidated capital as of the end of each fiscal quarter of not greater than 0.25 to 1.0. Additionally, the Credit Agreement contains various negative covenants with which we must comply, including, but not limited to, limitations respecting the creation of liens on any property or asset; the incurrence of indebtedness; mergers, consolidations, liquidations and dissolutions; change of business; sales of assets; transactions with affiliates; and other provisions customary in similar types of agreements. In addition, at any time when a default has occurred and is continuing or would result therefrom, the Credit Agreement proscribes our ability to declare or pay, or permit certain of our subsidiaries to declare or pay, any dividend on, or make any payment on account of, or set apart assets for a sinking or other analogous fund for, the purchase, redemption, defeasance, retirement or acquisition of, any of our stock or any such subsidiaries.
Under the Credit Agreement, an Event of Default is defined as (i) a failure to pay any principal or interest on any of the loans or any fee or any other amount payable under the Credit Agreement or any other loan document within designated time periods; (ii) a breach of any representation or warranty made in the Credit Agreement or any other loan document; (iii) a failure to comply with certain specified covenants, conditions or agreements in the Credit Agreement; (iv) a failure to comply with any other conditions, covenants or agreements in the Credit Agreement or any other loan document within thirty days after knowledge or written notice of such failure; (v) a failure by us or any subsidiary to pay any indebtedness, other than loans under the Credit Agreement, or any obligation in respect of our or any subsidiary’s hedging agreements in an aggregate amount exceeding $25.0 million, or “Material Indebtedness,” when due or payable; (vi) any event or condition occurs that results in the acceleration of the maturity of Material Indebtedness or which enables or permits the holder of such Material Indebtedness to cause the acceleration of such indebtedness, except for secured indebtedness that becomes due as a result of the voluntary sale or transfer of the property or assets securing such indebtedness; (vii) the occurrence of certain involuntary or voluntary bankruptcy, insolvency or reorganization events relating to us or any of our material subsidiaries; (viii) the rendering of certain money judgments against us or any of our subsidiaries in an aggregate amount in excess of $25.0 million; (ix) a failure by us or certain affiliates to pay any material amounts to the Pension Benefit Guaranty Corporation or to an employee pension benefit plan or the institution of an enforcement proceeding under ERISA (as defined in the Credit Agreement), the occurrence of certain ERISA events which would reasonably be expected to have a material adverse effect, or the occurrence of certain material events under ERISA covered plans; (x) the failure of any lien created by any of the security documents to constitute an enforceable first priority perfected lien on all of the collateral encumbered thereby; or (xi) the occurrence of certain events constituting a Change of Control relating to us.
Preferred Stock. On June 23, 2006, we completed an offering of 1,132,000 shares of 5.75% Mandatory Convertible Preferred Stock, or the “Preferred Stock,” at a public offering price of $264.60 per share, resulting in net proceeds of $290.4 million. On June 15, 2009, all outstanding shares of Preferred Stock were mandatorily converted into shares of our common stock. Each outstanding share of Preferred Stock was automatically converted into 1.0139 shares of our common stock based on the arithmetic average of the daily volume-weighted average price per share of our common stock for each of the 20 consecutive trading days ending on June 10, 2009, or $260.9733 per share. We issued 698,009 shares of our common stock for the 688,621 shares of Preferred Stock that were outstanding at the date of the mandatory conversion. All of the foregoing per share data has not been adjusted for subsequent Alleghany common stock dividends.
Capital Contributions. From time to time, we make capital contributions to our subsidiaries when third-party financing may not be attractive or available. In 2010, we made a capital contribution of $40.0 million to provide capital support to PCIC in connection with an increase in its workers’ compensation deposit, which is required to be maintained by PCIC under California workers’ compensation regulations. In 2007, we made a capital contribution of $50.0 million to provide additional capital support to PCC in connection with AIHL’s acquisition of PCC. We expect that we will continue to make capital contributions to our subsidiaries from time to time in the future for similar or other purposes.
During 2010, we repurchased an aggregate of 285,056 shares of our common stock in the open market for $83.1 million, at an average price per share of $291.64. During 2009, we repurchased an aggregate of 295,463 shares of our common stock in the open market for $75.9 million, at an average price per share of $256.73. Prior to the mandatory conversion date of June 15, 2009, we repurchased an aggregate of 442,998 shares of Preferred Stock in the open market for $117.4 million, at an average price per share of $264.92. During 2008, we repurchased an aggregate of 78,817 shares of our common stock in the open market for $25.1 million, at an average price per share of $318.05. All of the foregoing per share and average price data has not been adjusted for subsequent Alleghany common stock dividends.
Our insurance operating units have obligations to make certain payments for loss and LAE pursuant to insurance policies they issue. These future payments are reflected as reserves on our consolidated financial statements. With respect to loss and LAE, there is typically no minimum contractual commitment associated with insurance contracts, and the timing and ultimate amount of actual claims related to these reserves is uncertain. Additional information regarding reserves for loss and LAE, including information regarding the timing of payments of these expenses, can be found on pages 19 through 21, pages 29 and 30, pages 40 through 45 and pages 57 and 58 of this Form 10-K Report.
Alleghany Properties. As of December 31, 2010, Alleghany Properties held properties having a total book value of $19.9 million, compared with $19.8 million as of December 31, 2009 and $19.5 million as of December 31, 2008. These properties and loans had a total book value of $90.1 million as of October 31, 1994, the date Alleghany Properties purchased the assets. The capital needs of Alleghany Properties consist primarily of various development costs relating to its owned properties and corporate administration. Adequate funds to provide for the currently foreseeable needs of its business are expected to be generated by sales and, if needed, capital contributions by us.
Statements set forth in Item 8 of this Form 10-K Report for further details concerning the contractual maturities of our consolidated debt securities portfolio. We may modestly increase the proportion of our debt securities portfolio held in securities with maturities of more than five years should the yields of these securities provide, in our judgment, sufficient compensation for their increased risk. We do not believe that this strategy would reduce our ability, as necessary, to meet ongoing claim payments or to respond to significant catastrophe losses.
GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are not adjusted for transaction costs. In addition, GAAP has a three tiered hierarchy for inputs used in management’s determination of fair value of financial instruments that emphasizes the use of observable inputs over the use of unobservable inputs by requiring that the observable inputs be used when available. Observable inputs are market participant assumptions based on market data obtained from sources independent of the reporting entity. Unobservable inputs are the reporting entity’s own assumptions about market participant assumptions based on the best information
available under the circumstances. In assessing the appropriateness of using observable inputs in making our fair value determinations, we consider whether the market for a particular security is “active” or not based on all the relevant facts and circumstances. For example, we may consider a market to be inactive if there are relatively few recent transactions or if there is a significant decrease in market volume. Furthermore, we consider whether observable transactions are “orderly” or not. We do not consider a transaction to be orderly if there is evidence of a forced liquidation or other distressed condition, and as such, little or no weight is given to that transaction as an indicator of fair value.
“Level 1” - Valuations are based on unadjusted quoted prices in active markets for identical, unrestricted assets. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these assets does not involve any meaningful degree of judgment. An active market is defined as a market where transactions for the financial instrument occur with sufficient frequency and volume to provide pricing information on an ongoing basis. Our Level 1 assets generally include publicly traded common stocks and debt securities issued directly by the U.S. Government, where our valuations are based on quoted market prices.
The estimated fair values of our financial instruments as of December 31, 2010 and December 31, 2009 allocated among the three levels set forth above were as follows (in millions):
Level 3 securities consist of partnership investments. The carrying value of partnership investments of $24.8 million decreased by $10.4 million from the December 31, 2009 carrying value of $35.2 million,
“FNMA” refers to the Federal National Mortgage Association, and “FHLMC” refers to the Federal Home Loan Mortgage Corporation.
All of our mortgage- and asset-backed securities are current as to principal and interest. Additional information regarding our holdings of securities backed by sub-prime and Alt-A collateral at December 31, 2010 is as follows (in millions):
Municipal Bonds. The following table details the top five state exposures of our municipal bond portfolio (in millions):
In June 2009, the Financial Accounting Standards Board, or “FASB,” issued guidance that establishes the FASB Accounting Standards Codification, or the “ASC,” as the single source of authoritative accounting principles in the preparation of financial statements in conformity with GAAP. The ASC was effective for interim and annual
periods ending after September 15, 2009. We adopted the ASC in the 2009 third quarter, and the implementation did not have any impact on our results of operations and financial condition.
In September 2009, FASB issued guidance that allows investors to use net asset value as a practical expedient to estimate the fair value of investments in investment companies (and like entities) that do not have readily determinable fair values. This guidance does not apply to investments accounted for using the equity method. This guidance was effective for interim and annual periods ending after December 15, 2009, with early application permitted. We adopted this guidance in the fourth quarter of 2009, and the implementation did not have any impact on our results of operations and financial condition. Our partnership investments that are accounted for as available-for-sale are subject to this guidance. Net asset value quotes from the third-party general partner of the entity in which such investments are held, which will often be based on unobservable market inputs, constitute the primary input in our determination of the fair value of such investments. The fair value of our available-for-sale partnership investments was $24.8 million at December 31, 2010 and $35.2 million at December 31, 2009.
In January 2010, FASB issued guidance that provides for additional financial statement disclosure regarding fair value measurements, including how fair values are measured. This guidance was effective for interim and annual periods ending after December 15, 2009. We adopted this guidance in the 2010 first quarter, and the implementation did not have any impact on our results of operations and financial condition.
At December 31, 2010 and 2009, available-for-sale securities are recorded at fair value. Unrealized gains and losses during the year, net of the related tax effect applicable to available-for-sale securities, are excluded from earnings and reflected in comprehensive income and the cumulative effect is reported as a separate component of stockholders’ equity until realized. If the decline in fair value is deemed to be other than temporary, it is written down to the carrying value of the investment and recorded as an other-than-temporary impairment loss on the statement of earnings. In addition, any portion of such decline that relates to debt securities that is believed to arise from factors other than credit is to be recorded as a component of other comprehensive income.
AIHL’s insurance operating units reinsure a significant portion of the risks they underwrite in order to mitigate their exposure to losses, manage capacity and protect capital resources. Reinsuring loss exposures does not relieve AIHL’s insurance operating units from their obligations to policyholders. AIHL’s insurance operating units remain liable to their policyholders for the portion reinsured to the extent that any reinsurer does not meet the obligations assumed under the reinsurance agreements. To minimize their exposure to losses from a reinsurer’s inability to pay, AIHL’s insurance operating units evaluate the financial condition of their reinsurers upon placement of the reinsurance and periodically thereafter. In addition to considering the financial condition of their reinsurers, Alleghany and AIHL’s insurance operating units evaluate the collectibility of their reinsurance recoverables (and where appropriate, establish an allowance for estimated uncollectible reinsurance recoverables), based upon a number of factors. Such factors include the amounts outstanding, length of collection periods, disputes, any collateral or letters of credit held by AIHL’s insurance operating units and other relevant factors. Amounts deemed to be uncollectible are written off against the allowance for estimated uncollectible reinsurance recoverables. As of
December 31, 2010 and December 31, 2009, Alleghany did not record an allowance for estimated uncollectible reinsurance recoverables.
Reinsurance contracts that do not result in a reasonable possibility that the reinsurer may realize a significant loss from the insurance risk assumed and that do not provide for the transfer of significant insurance risk generally do not meet the conditions for reinsurance accounting and are accounted for as deposits. Alleghany currently does not have any reinsurance contracts that qualify for deposit accounting. See Note 5.
Property and equipment is recorded at cost, net of accumulated depreciation and amortization. Depreciation of buildings and equipment is principally calculated using the straight-line method over the estimated useful life of the respective assets. Estimated useful lives for such assets range from 3 to 20 years. Amortization of leasehold improvements is principally calculated using the straight-line method over the estimated useful life of the leasehold improvement or the life of the lease, whichever is less. Rental expense on operating leases is recorded on a straight-line basis over the term of the lease, regardless of the timing of actual lease payments. See Note 16(c).
Certain prior year amounts have been reclassified to conform to the 2010 presentation.
In June 2009, the Financial Accounting Standards Board (“FASB”) issued guidance that establishes the FASB Accounting Standards Codification (the “ASC”) as the single source of authoritative accounting principles in the preparation of financial statements in conformity with GAAP. The ASC was effective for interim and annual periods ending after September 15, 2009. Alleghany adopted the ASC in the 2009 third quarter, and the implementation did not have any impact on its results of operations and financial condition.
In January 2010, FASB issued guidance that provides for additional financial statement disclosure regarding fair value measurements, including how fair values are measured. This guidance was effective for interim and annual periods ending after December 15, 2009. Alleghany adopted this guidance in the 2010 first quarter, and the implementation did not have any impact on its results of operations and financial condition.
In July 2010, FASB issued guidance that provides for additional financial statement disclosure regarding financing receivables, including the credit quality and allowance for credit losses associated with such assets. This guidance is generally effective for interim and annual periods beginning after December 15, 2010, with certain disclosures effective for interim and annual periods ending on or after December 31, 2010. Alleghany will fully adopt this guidance in the 2011 first quarter, and Alleghany does not currently believe that the implementation will have any impact on its results of operations and financial condition.
Alleghany’s insurance operating units, domiciled principally in the States of California, New Hampshire, Delaware, Wisconsin, Oklahoma and Nebraska, prepare statutory financial statements in accordance with the accounting practices prescribed or permitted by the insurance departments of the states of domicile. Prescribed statutory accounting practices are those practices that are incorporated directly or by reference in state laws, regulations and general administrative rules applicable to all insurance enterprises domiciled in a particular state. Permitted statutory accounting practices include practices not prescribed by the domiciliary state, but allowed by the domiciliary state regulatory authority. The impact of any permitted accounting practices on statutory surplus of Alleghany is not material. See Note 9(c).
Historical information related to the results of operations of the discontinued operations of Darwin, as included in Alleghany’s consolidated financial statements, is set forth in the following table (in millions):
Represents the portion of Darwin’s earnings attributable to common stockholders other than Alleghany, as well as parent capital gains taxes incurred. These expense accruals were made at the AIHL level.
The amortized cost and estimated fair value of debt securities at December 31, 2010 by contractual maturity are shown below (in millions). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
inadequacy of any underlying collateral, and unfavorable changes in economic or social conditions, interest rates or credit ratings.
the absence of compelling evidence that would cause Alleghany to call into question the financial condition or near-term prospects of the issuer of the investment; and
Alleghany’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery.
At December 31, 2010 and 2009, investments carried at fair value totaling $322.1 million and $286.2 million, respectively, were on deposit with various states or governmental agencies to comply with state insurance regulations. The $322.1 million amount at December 31, 2010 includes $40.0 million that was contributed by AIHL to PCC on September 27, 2010, and these funds were used by PCIC to increase its workers’ compensation deposit.
On July 18, 2008, Alleghany acquired a minority voting interest in ORX, a regional oil and gas exploration and production company, through a purchase of $50.0 million of preferred stock, which currently represents an approximately 38 percent ownership of ORX.
ORX is reported as a component of other invested assets. Alleghany’s interest in ORX is included in corporate activities for segment reporting purposes and is accounted for under the equity method of accounting.
The economic useful lives of intangible assets are as follows: agency relationships - 15 years; state insurance licenses - indefinite; trade names - indefinite; brokerage and reinsurance relationships - 15 years and renewal and distribution rights - between 5 and 10 years. Accumulated amortization expense as of December 31, 2010 was $51.0 million, consisting of $6.0 million for agency relationships, $16.9 million for brokerage and reinsurance relationships, $24.0 million for renewal and distribution rights, and $4.1 million of other intangible assets. Accumulated amortization expense as of December 31, 2009 was $47.6 million, consisting of $5.0 million for agency relationships, $14.6 million for brokerage and reinsurance relationships, $23.9 million for renewal and distribution rights and $4.1 million of other intangible assets.
CATA. CATA uses reinsurance to protect against severity losses. In 2010, CATA reinsured individual property and casualty and contract surety risks in excess of $1.5 million with various reinsurers. As of December 1, 2010, the commercial surety line was reinsured for individual losses above $1.5 million. In addition, CATA purchases facultative reinsurance coverage for risks in excess of $6.0 million on property and casualty and $15.0 million on commercial surety.
The following table indicates property and casualty premiums written and earned for the years ended December 31, 2010, 2009 and 2008 (in millions):
Activity in liability for loss and LAE in 2010, 2009 and 2008 is summarized as follows (in millions):
Gross loss and LAE reserves at December 31, 2010 decreased $192.3 million from December 31, 2009 due primarily to reserve decreases in property lines of business of $99.0 million and reserve decreases in workers’ compensation lines of business of $59.2 million. The decrease in property gross loss and LAE reserves is mainly due
The above reserve changes included increases (decreases) to prior year net reserves, which are summarized as follows (in millions):
For RSUI, loss and LAE for 2010 reflect a net $33.9 million release of prior accident year casualty loss reserves, compared with a net $38.4 million release of prior accident year casualty loss reserves during 2009. The $33.9 million net release consisted of a $41.4 million reserve release, partially offset by a $7.5 million reserve increase. The $41.4 million reserve release relates primarily to the general liability and professional liability lines of business primarily for the 2003 through 2007 accident years and reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods for such lines of business. Specifically, cumulative losses for such lines of business, which include both loss payments and case reserves, in respect of prior accident years were expected to be higher through the balance sheet date than the actual cumulative losses through that date. The amount of lower cumulative losses, expressed as a percentage of carried loss and LAE reserves at the beginning of the year, was 3.8 percent. Such reduction did not impact the assumptions used in estimating RSUI’s loss and LAE liabilities for its general liability and professional liability lines of business earned in 2010. The $7.5 million reserve increase in loss reserves related to an increase in estimated ultimate 2007 accident year losses for the D&O liability
line of business, reflecting, in part, unfavorable loss emergence on certain sub-prime mortgage industry claims. Such increase did not impact the assumptions used in estimating RSUI’s loss and LAE liabilities for its D&O liability line of business earned in 2010. The net $38.4 million release of prior accident year casualty loss reserves during 2009 relates primarily to D&O liability, professional liability and general liability lines of business for the 2003 through 2007 accident years and reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods for such lines of business.
For PCC, loss and LAE for 2010 reflect a $12.5 million increase of prior accident year workers’ compensation net loss reserves, compared with a $26.5 million reserve increase of prior accident year workers’ compensation loss reserves during 2009. The $12.5 million increase relates primarily to a decrease in ceded loss and LAE based on a fourth quarter 2010 review of reinsurance coverage estimates, and to a lesser extent, an increase in unallocated LAE reserves. Such increase did not impact the assumptions used in estimating PCC’s loss and LAE liabilities for business earned in 2010. The review of reinsurance coverage estimates also resulted in a $5.0 million decrease in ceded premiums earned, which increased net premiums earned. The $26.5 million increase in 2009 primarily reflects a significant acceleration in claims emergence and higher than anticipated increases in industry-wide severity. In addition, the $26.5 million increase in 2009 also reflects the estimated impact of judicial decisions by the Workers’ Compensation Appeals Board, or the “WCAB.” Such WCAB decisions related to permanent disability determinations that have materially weakened prior workers’ compensation reforms instrumental in reducing medical and disability costs in earlier years. These decisions are in the process of being appealed to the California appellate courts but will continue in effect during the appeals process. With respect to the $26.5 million increase for prior accident years, $17.7 million primarily reflected higher than expected paid losses and $8.8 million reflected the estimated impact of the WCAB decisions. Such increases impacted the assumptions used in estimating PCC’s loss and LAE liabilities for business earned in 2009, causing an increase of current accident year
reserves of $8.0 million in 2009. Of the $8.0 million, $6.2 million primarily reflected higher than expected paid losses and the remainder reflected the estimated impact of the WCAB decisions.
Alleghany’s income tax returns are not currently under examination by the Internal Revenue Service. Alleghany’s 2009, 2008 and 2007 income tax returns remain open to examination.
On June 23, 2006, Alleghany completed an offering of 1,132,000 shares of its 5.75% mandatory convertible preferred stock (the “Preferred Stock”) at a public offering price of $264.60 per share, resulting in net proceeds of $290.4 million. On June 15, 2009, all outstanding shares of Preferred Stock were mandatorily converted into shares
In February 2008, Alleghany announced that its Board of Directors had authorized the repurchase of shares of Common Stock, at such times and at prices as management determined advisable, up to an aggregate of $300.0 million. In November 2008, the authorization to repurchase Common Stock was expanded to include repurchases of Preferred Stock. As of December 31, 2010, this program had been fully utilized. In anticipation of the full utilization of such program, in July 2010, Alleghany’s Board of Directors authorized the repurchase of additional shares of Common Stock, at such times and at prices as management may determine advisable, up to an aggregate of $300.0 million upon such full utilization.
As of December 31, 2010, Alleghany had stock-based payment plans for parent-level employees and directors. As described in more detail below, parent-level, stock-based payments to current employees do not include stock options but consist only of restricted stock awards, including restricted stock units, and performance share awards. Parent-level, stock-based payments to non-employee directors consist of annual awards of stock options and restricted stock, including restricted stock units. In addition, as of December 31, 2010, RSUI and PCC had their own stock-based payment plans, which are described below.
Alleghany’s 2005 Directors’ Stock Plan, which expired on December 31, 2009, provided for the automatic grant of nonqualified options to purchase 500 shares of Common Stock, as well as an automatic grant of 250 shares of restricted Common Stock or, under certain circumstances, restricted stock units, to each non-employee director on an annual basis. In 2010, Alleghany established the 2010 Directors’ Stock Plan which provides for the same automatic grants to directors as the 2005 Directors’ Stock Plan. In 2010 and 2009, Alleghany awarded a total of 2,500 restricted shares and units, and 2,295 restricted shares and units, respectively, which vest over a one year period.
A summary of option activity under the above plans as of December 31, 2010 and changes during the year then ended is presented below:
The weighted-average grant-date fair value of options granted during the years 2010, 2009 and 2008, was $133, $100 and $131, respectively. The total intrinsic value of options exercised during the years ended December 31, 2010, 2009 and 2008, was $1.6 million, $1.1 million and $2.1 million, respectively.
During 2010, PCC granted non-qualified stock options (the “Options”) to two senior PCC executives. The Options vest over two years and expire in five years. Under the terms of the grants, the executives may purchase from AIHL common stock of PCC representing an aggregate of approximately 5 percent of PCC common stock outstanding, at a price based on grant-date book value of PCC. Once the Options are exercised, the PCC common stock held by each executive may be converted to cash at either AIHL’s election or the executive’s election, based on PCC’s book value. The compensation expense recorded by PCC in 2010 was immaterial.
The executive plan currently provides for designated employees (including all of Alleghany’s current executive officers) retirement benefits in the form of an annuity for the joint lives of the participant and his or her spouse or, alternatively, actuarially equivalent forms of benefits, including a lump sum. Under the executive plan, a participant must have completed five years of service with Alleghany before he or she is vested in, and thus has a right to receive, any retirement benefits following his or her termination of employment. The annual retirement benefit under the executive plan, if paid in the form of a joint and survivor life annuity to a participant who retires on reaching age 65 with 15 or more years of service, is equal to 67 percent of the participant’s highest average annual base salary award over a consecutive three-year period during the last ten years or, if shorter, the full calendar years of employment. The plan does not take other payments or benefits, such as payouts of long-term incentives, into account in computing retirement benefits. In December 2010, Alleghany’s Board of Directors approved an amendment to the executive plan, whereby only salary (and not the related annual incentive award) is to be taken account in computing future retirement benefits. This amendment resulted in an increase in Alleghany’s other comprehensive income in 2010, and will modestly reduce Alleghany’s pension expenses beginning in 2011. During 2004, the plan was amended and changed from a funded to an unfunded plan resulting in the distribution of all accrued benefits to vested participants.
With respect to the smaller, non-contributory defined benefit pension plan for employees, Alleghany’s policy is to contribute annually the amount necessary to satisfy the Internal Revenue Service’s funding requirements. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future.
The measurement date used to determine pension benefit plans is December 31, 2010.
Alleghany has two unfunded retiree health plans, one for executives and one for employees. To be eligible for benefits, participants must be age 55 or older. In addition, non-executive employees must have completed at least 10 years of service. Under both plans, participants must pay a portion of the premiums charged by the medical insurance provider. All benefits cease upon the death of the retiree. RSUI also has an unfunded retiree health plan for its employees. As of December 31, 2010 and December 31, 2009, the liability for all of these plans was $5.5 million and $3.1 million, respectively, representing the entire accumulated post-retirement benefit obligation as of that date. Assumptions used with respect to the accounting for these plans are comparable to those cited above for the Alleghany pension plans. Future benefit payments associated with these plans are not expected to be material to Alleghany.
Alleghany provides supplemental retirement benefits through deferred compensation programs and profit sharing plans for certain of its officers and employees. In addition, Alleghany’s subsidiaries sponsor both qualified, defined contribution retirement plans for substantially all employees, including executives, and non-qualified plans
Alleghany has endorsement split-dollar life insurance policies for its officers that are effective during employment as well as retirement. Premiums are paid by Alleghany, and death benefits are split between Alleghany and the beneficiaries of the officers. Death benefits for current employees that inure to the beneficiaries are generally equal to four times the annual salary at the time of an officer’s death. After retirement, death benefits that inure to the beneficiaries are generally equal to the annual ending salary of the officer at the date of retirement.
AIHL’s reserve for unpaid loss and LAE includes $14.1 million of gross reserves and $14.0 million of net reserves at December 31, 2010, and $18.9 million of gross reserves and $18.8 million of net reserves at December 31, 2009, for asbestos and environmental impairment claims that arose from reinsurance assumed by a subsidiary of CATA between 1969 and 1976. This subsidiary exited this business in 1976. CATA released $3.5 million of such net reserves at June 30, 2010 based on a reserve study that was completed in the 2010 second quarter. Reserves for asbestos and environmental impairment claims cannot be estimated with traditional loss reserving techniques because of uncertainties that are greater than those associated with other types of claims. Factors contributing to those uncertainties include a lack of historical data, the significant periods of time that often elapse between the occurrence of an insured loss and the reporting of that loss to the ceding company and the reinsurer, uncertainty as to the number and identity of insured parties with potential exposure to such risks, unresolved legal issues regarding policy coverage, and the extent and timing of any such contractual liability. Loss reserve estimates for such environmental impairment and asbestos exposures include case reserves, which also reflect reserves for legal and other LAE and IBNR reserves. IBNR reserves are determined based upon historic general liability exposure base and policy language, previous environmental loss experience and the assessment of current trends of environmental law, environmental cleanup costs, asbestos liability law, and judicial settlements of asbestos liabilities.
precautionary claims notices and, based upon current information, assesses the likelihood of loss to CATA. Such assessment is one of the factors used in determining the adequacy of the recorded asbestos and environmental impairment reserves.
On July 14, 2005, Alleghany completed the sale of its world-wide industrial minerals business, World Minerals, Inc. (“World Minerals”), to Imerys USA, Inc. (the “Purchaser”), a wholly-owned subsidiary of Imerys, S.A., pursuant to a Stock Purchase Agreement, dated as of May 19, 2005, by and among the Purchaser, Imerys, S.A. and Alleghany (the “Stock Purchase Agreement”). Pursuant to the Stock Purchase Agreement, Alleghany undertook certain indemnification obligations, including a general indemnification for breaches of representations and warranties set forth in the Stock Purchase Agreement (the “Contract Indemnification”) and a special indemnification (the “Products Liability Indemnification”) related to products liability claims arising from events that occurred during pre-closing periods, including the period of Alleghany ownership (the “Alleghany Period”).
“Level 2” - Valuations are based on quoted market prices where such markets are not deemed to be sufficiently “active.” In such circumstances, additional valuation metrics will be used which involve direct or indirect observable market inputs. Alleghany’s Level 2 assets generally include preferred stocks and debt securities other than debt issued directly by the U.S. Government. Alleghany’s Level 2 liabilities include the Senior Notes. Substantially all of the determinations of value in this category are based on a single quote from third-party dealers and pricing services. As Alleghany generally does not make any adjustments thereto, such quote typically constitutes the sole input in its determination of the fair value of these types of securities. In developing a quote, such third parties will use the terms of the security and market-based inputs. Terms of the security include coupon, maturity date, and any special provisions that may, for example, enable the investor, at its election, to redeem the security prior to its scheduled maturity date. Market-based inputs include the level of interest rates applicable to comparable securities in the market place and current credit rating(s) of the security. Such quotes are generally non-binding.
Alleghany validates the reasonableness of its fair value determinations for Level 2 securities by testing the methodology of the relevant third-party dealer or pricing service that provides the quotes upon which the fair value determinations are made. Alleghany tests the methodology by comparing such quotes with prices from executed market trades when such trades occur. Alleghany discusses with the relevant third-party dealer or pricing service any identified material discrepancy between the quote derived from its methodology and the executed market trade in order to resolve the discrepancy. Alleghany uses the quote from the third-party dealer or pricing service unless Alleghany determines that the methodology used to produce such quote is not in compliance with GAAP. In addition to such procedures, Alleghany also compares the aggregate amount of the fair value for such Level 2 securities with the aggregate fair value provided by a third-party financial institution. Furthermore, Alleghany reviews the reasonableness of its classification of securities within the three-tiered hierarchy to ensure that the classification is consistent with GAAP.
Of the $1,500.7 million of fair value at December 31, 2010, $1,004.8 million related to certain energy sector businesses. Of the $624.5 million of fair value at December 31, 2009, $399.2 million related to certain energy sector businesses.
at December 31, 2009, $685.7 million related to RMBS, $75.5 million related to CMBS and $197.6 million related to other asset-backed securities.
Level 3 securities consist of partnership investments. The carrying value of partnership investments of $24.8 million decreased by $10.4 million from the December 31, 2009 carrying value of $35.2 million, due primarily to sales of $13.9 million (which generated a realized capital gain of $5.1 million), partially offset by an increase in estimated fair value during the period of $3.5 million. Level 3 securities, consisting of mortgage- and asset-backed securities totaling $1.6 million, were acquired during the 2010 third quarter and sold during the 2010 fourth quarter.
The primary components of “Corporate activities” are Alleghany Properties, Alleghany’s investments in Homesite and ORX and strategic investments and other activities at the parent level.
Includes $(3.2) million, $(1.1) million and $0.3 million of Alleghany’s equity in (losses) earnings of Homesite for 2010, 2009 and 2008, respectively. Also includes $(2.0) million, $(21.9) million and $1.5 million of Alleghany’s equity in (losses) earnings of ORX for 2010, 2009 and 2008, respectively. See Note 4(b) and 4(c).
Other invested assets shown in Alleghany’s consolidated balance sheets include the following amounts at December 31, 2010 and 2009 (in millions):
Equity method partnership investments were dissolved during the third quarter of 2010, and thus were not outstanding at December 31, 2010.
Property and equipment, net of accumulated depreciation and amortization, at December 31, 2010 and 2009, were as follows (in millions):
Selected quarterly financial data for 2010 and 2009 are presented below (in millions, except per share amounts):
We have audited the accompanying consolidated balance sheets of Alleghany Corporation and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of earnings and comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Alleghany Corporation and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Alleghany Corporation’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 23, 2011 expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
We have audited Alleghany Corporation’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Alleghany Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, including the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
In our opinion, Alleghany Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).