We lease approximately 10,300 square feet of office space in Hamilton, Bermuda, where our principal executive office is located. We also lease office space in a number of U.S. states, the United Kingdom (including in London and Guildford), Australia, Ireland and Sweden. We renew and enter into leases in the ordinary course of our business.
This annual report and the documents incorporated by reference contain statements that constitute “forward-looking statements” within the meaning of Section 21E of the Exchange Act, with respect to our financial condition, results of operations, business strategies, operating efficiencies, competitive positions, growth opportunities, plans and objectives of our management, as well as the markets for our ordinary shares and the insurance and reinsurance sectors in general. Statements that include words such as “estimate,” “project,” “plan,” “intend,” “expect,” “anticipate,” “believe,” “would,” “should,” “could,” “seek,” “may” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise. All forward-looking statements are necessarily estimates or expectations, and not statements of historical fact, reflecting the best judgment of our management and involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. These forward looking statements should, therefore, be considered in light of various important factors, including those set forth in this annual report and the documents incorporated by reference.
continued availability of exit and finality opportunities provided by solvent schemes of arrangement;
risks relating to our ability to obtain regulatory approvals, including the timing, terms and conditions of any such approvals, and to satisfy other closing conditions in connection with our acquisition agreements, which could affect our ability to complete acquisitions;
changes in tax laws or regulations applicable to us or our subsidiaries, or the risk that we or one of our non-U.S. subsidiaries become subject to significant, or significantly increased, income taxes in the United States or elsewhere;
changes in Bermuda law or regulation or the political stability of Bermuda; and
We are a Bermuda-based company that acquires and manages insurance and reinsurance companies in run-off and portfolios of insurance and reinsurance business in run-off, and provides management, consulting and other services to the insurance and reinsurance industry.
Our principal business consists of acquiring and managing property and casualty insurance and reinsurance companies that have ceased underwriting new business - meaning they are in “run-off.” We believe growth in our net book value is driven primarily by growth in our net earnings, which is in turn driven in large part by successfully completing new acquisitions and effectively managing companies and portfolios of business that we previously acquired. We generate our earnings in the following ways:
generating investment income on the cash and investment portfolios of acquired businesses;
in some cases, purchasing companies at a discount to the fair value of the assets acquired, which has resulted in the recording of gains on bargain purchases; and
Net ultimate loss and loss adjustment expense liabilities established by management utilizing analysis performed by independent actuaries prepared on an annual basis are reviewed by our management each quarter. Reserves reflect management’s best estimate of the remaining unpaid portion of these liabilities. Prior period estimates of net ultimate loss and loss adjustment expense liabilities may change as our management considers the combined impact of commutations, policy buy-backs, settlement of losses on carried reserves and the trend of incurred loss development compared to prior forecasts. Net reductions in ultimate loss and loss adjustment expense liabilities are reported as negative expenses by us. For more information on how the reserves are calculated, see “- Critical Accounting Policies - Loss and Loss Adjustment Expenses” on page 54.
We are a service-based company and, as such, employee salaries and benefits are our largest expense. We have experienced significant increases in our salaries and benefits expenses as we have grown our operations, and we expect that trend to continue if we are able to expand our operations successfully.
The most significant liability of an acquired company is typically the liability for loss and loss adjustment expenses, and the most significant asset is typically the asset related to any reinsurance recoverable on these liabilities that may be contractually due to the acquired entity. The market for acquisition of run-off companies is not sufficiently active and transparent to enable us to identify reliable, market exit values for acquired assets and liabilities. Accordingly, consistent with provisions of U.S. GAAP, we have developed internal models that we believe allow us to determine fair values that are reasonable proxies for market exit values. We are familiar with the major participants in the acquisition run-off market and believe that the key assumptions we make in valuing acquired assets and liabilities are consistent with the kinds of assumptions made by such market participants. Furthermore, in our negotiation of purchase price with sellers, it is frequently clear to us that other bidders in the market are using models and assumptions similar in nature to ours during the competitive bid process. The majority of acquisitions are completed following a public tender process whereby the seller invites market participants to provide bids for the target acquisition.
The key assumptions used by us and, we believe, by other run-off market participants in the fair valuation of acquired companies are (i) the projected payout, timing and amounts of claims liabilities; (ii) the related projected timing and amount of reinsurance collections; (iii) a risk-free discount rate, which is applied to determine the present value of the future cash flows; (iv) the estimated unallocated loss adjustment expenses to be incurred over the life of the run-off; (v) the impact of any accelerated run-off strategy; and (vi) an appropriate risk margin.
The probability-weighted projected cash flows of the acquired company are based on projected claims payouts provided by the seller predominantly in the form of the seller’s most recent independent actuarial reserve report. In the absence of the seller’s actuarial reserve report, our independent actuaries will determine the estimated claims payout.
With respect to our U.K., Bermudian and Australian insurance and reinsurance subsidiaries, we are able to pursue strategies to achieve complete finality and conclude the run-off of a company by promoting solvent schemes of arrangement. Solvent schemes of arrangement are a popular means of achieving financial certainty and finality for insurance and reinsurance companies incorporated or managed in the U.K., Bermuda and Australia by making a one-time full and final settlement of an insurance and reinsurance company’s liabilities to policyholders. On acquisition of a U.K., Bermudian or Australian company, the claims payout projection is weighted according to management’s estimated probability of being able to complete a solvent scheme of arrangement. To the extent that solvent schemes of arrangement are not available to an acquired company, no weighting is applied to the projected claims payout.
On acquisition, we make a provision for unallocated loss adjustment expense liabilities. This provision considers the adequacy of the provision maintained and recorded by the seller in light of our run-off strategy and estimated unallocated loss adjustment expenses to be incurred over the life of the acquired run-off as projected by the seller’s actuaries or, in their absence, our actuaries. To the extent that our estimate of the total unallocated loss adjustment expense provision is different from the seller’s, an adjustment will be made. While it is our objective to accelerate the run-off by completing commutations of assumed and ceded business (which would have the effect of shortening the life, and therefore the cost, of the run-off), the success of this strategy is far from certain. Therefore, the estimates of unallocated loss adjustment expenses are based on running off the liabilities and assets over the actuarially projected life of the run-off. In those domiciles where solvent schemes of arrangement are available, management’s estimates of the total unallocated loss adjustment expenses are probability-weighted in accordance with the estimated time that a solvent scheme of arrangement could be completed, which has the effect of reducing the period of the run-off and the related unallocated loss adjustment expenses. For those acquisitions in domiciles where solvent schemes of arrangement are not available, the unallocated loss adjustment expenses are estimated over the projected life of the run-off.
The difference between the original carrying value of reinsurance liabilities and reinsurance assets acquired at the date of acquisition and the fair value is recorded as an intangible asset or other liability, which we refer to as the Fair Value Adjustment, or FVA. The FVA is amortized over the estimated payout period and adjusted for accelerations on commutation settlements or any other new information or subsequent change in circumstances after the date of acquisition. To the extent the actual payout experience after the acquisition is materially faster or slower than anticipated at the time of the acquisition, there is an adjustment to the estimated ultimate loss reserves, or there are changes in bad debt provisions or in estimates of future run-off costs following accelerated payouts, then the amortization of the FVA is accelerated or decelerated, as the case may be, to reflect such changes. The FVA is tested annually for impairment.
By adopting either of the above run-off strategies, we would expect that over the targeted life of the run-off, acquired ultimate loss reserves would settle below their recorded fair value, resulting in reductions in ultimate loss and loss adjustment expense liabilities. There can be no assurance, however, that we will successfully implement our strategy.
The following table provides a breakdown of gross loss and loss adjustment expense reserves by type of exposure as of December 31, 2012 and 2011:
Loss advices or reports from ceding companies are generally provided via the placing broker and comprise treaty statements, individual claims files, electronic messages and large loss advices or cash calls. Large loss advices and cash calls are provided to us as soon as practicable after an individual loss or claim is made or settled by the insured. The remaining broker advices are issued monthly, quarterly or annually depending on the provisions of the individual policies or the ceding company’s practice. For certain direct insurance policies where the claims are managed by Third Party Administrators (TPA’s) and Managing General Agents (MGA’s), loss bordereaux are received either monthly or quarterly depending on the arrangement with the TPA and MGA.
1. We closely monitor cedant loss reporting and, for those cedants identified as providing inadequate, untimely or unusual reporting of losses, we conduct, in accordance with the provisions of the insurance and reinsurance contracts, detailed claims audits at the insured’s or reinsured’s premises. Such claims audits have the benefit of validating advised claims, determining whether the cedant’s loss reserving practices and reporting are adequate and identifying potential loss reserving issues of which our actuaries need to be made aware. Any required adjustments to advised claims reserves reported by cedants identified during the claims audits will be recorded as an adjustment to the advised case reserve.
3. Our actuaries project expected paid and incurred loss development for each class of business, which is monitored on a quarterly basis. Should actual paid and incurred development differ significantly from the expected paid and incurred development, we will investigate the cause and, in conjunction with our actuaries, consider whether any adjustment to ultimate loss reserves is required.
Nearly all of our unpaid claims liabilities are considered to have a long claims payout tail. Gross loss reserves relate primarily to casualty exposures, including latent claims, of which approximately 18% relate to asbestos and environmental, or A&E, exposures.
Our asbestos claims are primarily products liability claims submitted by a variety of insureds who operated in different parts of the asbestos distribution chain. While most such claims arise from asbestos mining and primary asbestos manufacturers, we have also been receiving claims from tertiary defendants such as smaller manufacturers, and the industry has seen an emerging trend of non-products claims arising from premises exposures. Unlike products claims, primary policies generally do not contain aggregate policy limits for premises claims, which, accordingly, remain at the primary layer and, thus, rarely impact excess insurance policies. As the vast majority of our policies are excess policies, this trend has had only a marginal effect on our asbestos exposures thus far.
Costs imposed due to joint and several liability if not all potentially reliable parties (or PRPs) are capable of paying their share.
1. Paid Survival Ratio Method. In this method, our expected annual average payment amount is multiplied by an expected future number of payment years to get an indicated reserve. Our historical calendar year payments are examined to determine an expected future annual average payment amount. This amount is multiplied by an expected number of future payment years to estimate a reserve. Trends in calendar year payment activity are considered when selecting an expected future annual average payment amount. Accepted industry benchmarks are used in determining an expected number of future payment years. Each year, annual payments data is updated, trends in payments are re-evaluated and changes to benchmark future payment years are reviewed. Advantages of this method are of ease of application and simplicity of assumptions. A potential disadvantage of the method is that results could be misleading for portfolios of high excess exposures where significant payment activity has not yet begun.
4. IBNR:Case Ratio Method. In this method, the ratio of estimated industry IBNR reserves to industry case reserves is multiplied by our case reserves to estimate our IBNR reserves. Specific considerations in the application of this method include the presence of policies reserved at policy limits, changes in overall industry case reserve adequacy and recent loss reporting history. Each year, our case reserves are updated, industry reserves are updated and the applicability of the industry IBNR:Case Ratio is reviewed. This method has the advantage that it incorporates the most recent estimates of amounts needed to settle open cases included in current case reserves. A potential disadvantage is that results could be misleading where our case reserve adequacy differs significantly from overall industry case reserve adequacy.
5. Ultimate-to-Incurred Method. In this method, the ratio of estimated industry ultimate losses to industry incurred-to-date losses is applied to our incurred-to-date losses to estimate our IBNR reserves. Specific considerations in the application of this method include the completeness of our incurred-to-date loss information, the potential acceleration or deceleration in our incurred losses (relative to the industry) due to our claims handling practices and the impact of large individual settlements. Each year incurred-to-date loss information is updated (for both us and the industry) and updates to industry estimated ultimate losses are reviewed. This method has the advantage that it incorporates both paid and case reserve information in projecting
As of December 31, 2012, we had 30 separate insurance and/or reinsurance subsidiaries whose reserves are categorized into approximately 311 reserve categories in total, including 38 distinct asbestos reserving categories and 25 distinct environmental reserving categories.
The following key assumptions were used to estimate A&E reserves at December 31, 2012:
2. $38.5 Billion Ultimate Industry Environmental Losses - This level of industry-wide losses and its comparison to industry-wide paid, incurred and outstanding case reserves is the base benchmarking assumption applied to Paid Market Share, Reserve-to-Paid, IBNR:Case Ratio and the Ultimate-to-Incurred environmental reserving methodologies.
The assumptions above as to Ultimate Industry Asbestos and Environmental losses have not changed from the immediately preceding period. For our company as a whole, the average selected lag for asbestos has
The following tables provide a summary of the impact of changes in industry ultimate losses, from the selected $65 billion for asbestos and $38.5 billion for environmental, and changes in the time-lag, from the selected averages of 2.8 years for asbestos and 2.2 years for environmental, for us behind industry development that it is assumed relates to our insurance and reinsurance companies. Please note that the table below demonstrates sensitivity to changes to key assumptions using methodologies selected for determining loss and allocated loss adjustment expenses, or ALAE, at December 31, 2012 and differs from the table on page 58, which demonstrates the range of outcomes produced by the various methodologies.
Beginning in the mid-1990’s, a trend began to emerge whereby certain policyholders began to assert that their asbestos claims should not fall within the “products liability” section of their policies and, therefore, should
Our exposure to asbestos losses arises largely from direct excess policies and assumed reinsurance policies written through the London market. With respect to direct excess policies, our companies typically participated on policies whereby liability would only attach in excess of primary and umbrella policy limits. As non-products asbestos losses are not aggregated and are generally confined to the limits of the primary and other lower layer insurance policies, we believe we have very little exposure to non-products asbestos losses through direct insurance policies issued by our subsidiary companies. To date, we have seen no material reporting of non-products asbestos claims on direct insurance policies. The trend of asbestos losses shifting from products to non-products is not a new phenomenon. As our insurance entities have not received any material reporting of non-products claims to date and their direct insurance exposures are generally in excess of the layers of insurance impacted by non-products asbestos losses, we do not expect any material future liability in respect of non-products asbestos claims.
One key measure of reserve strength for asbestos reserves is the three-year average paid survival ratio. This measure compares the asbestos carried-reserve amount with the average of the most recent three calendar years of asbestos loss payment activity. The most recent available information indicates that the insurance industry’s
As the basis for our environmental reserving, we had, for a number of years and based on advice supplied by our independent consulting actuaries, selected an estimate of $35 billion ultimate industry environmental losses. Based on the most recent information available, industry reported incurred losses have now exceeded $35 billion. In addition, a notable industry publication has recently published a revised estimate of ultimate industry environmental losses of $42 billion. In light of these facts, in 2011, we increased our estimate of ultimate environmental industry losses from $35 billion to $38.5 billion as the basis for our environmental loss reserving. This change of assumption had no material impact on our consolidated financial statements. We continue to experience only moderate incurred loss development on our own portfolios of environmental exposures, and believe our carried reserve level for environmental exposures is appropriate based on the analysis conducted by both our internal and our external independent actuaries.
1. Cumulative Reported and Paid Loss Development Methods. The Cumulative Reported (Case Incurred) Loss Development method relies on the assumption that, at any given state of maturity, ultimate losses can be
predicted by multiplying cumulative reported losses (paid losses plus case reserves) by a cumulative development factor. The validity of the results of this method depends on the stability of claim reporting and settlement rates, as well as the consistency of case reserve levels. Case reserves do not have to be adequately stated for this method to be effective; they only need to have a fairly consistent level of adequacy at all stages of maturity. Historical “age-to-age” loss development factors (or LDFs) are calculated to measure the relative development of an accident year from one maturity point to the next. Age-to-age LDFs are then selected based on these historical factors. The selected age-to-age LDFs are used to project the ultimate losses. The Cumulative Paid Loss Development Method is mechanically identical to the Cumulative Reported Loss Development Method described above, but the paid method does not rely on case reserves or claim reporting patterns in making projections. The validity of the results from using a cumulative loss development approach can be affected by many conditions, such as internal claim department processing changes, a shift between single and multiple payments per claim, legal changes, or variations in a company’s mix of business from year to year. Typically, the most appropriate circumstances in which to apply a cumulative loss development method are those in which the exposure is mature, full loss development data is available, and the historical observed loss development is relatively stable.
2. Incremental Reported and Paid Loss Development Methods. Incremental incurred and paid analyses are performed in cases where cumulative data is not available. The concept of the incremental loss development methods is similar to the cumulative loss development methods described above, in that the pattern of historical paid or incurred losses is used to project the remaining future development. The difference between the cumulative and incremental methods is that the incremental methods rely on only incremental incurred or paid loss data from a given point in time forward, and do not require full loss history. These incremental loss development methods are therefore helpful when data limitations apply. While this versatility in the incremental methods is a strength, the methods are sensitive to fluctuations in loss development, so care must be taken in applying them.
assumed to follow an expected pattern that is supported by more stable historical data or by emerging trends. This method is also useful when changing reporting patterns or payment patterns distort historical development of losses. Similar to the loss development methods, the Bornhuetter-Ferguson method may be applied to loss and ALAE on a combined or separate basis. The Bornhuetter-Ferguson method may not be appropriate in circumstances where the liabilities being analyzed are very mature, as it is not sensitive to the remaining amount of case reserves outstanding, or the actual development to date.
Our independent actuaries select the appropriate loss development extrapolation methods to apply to each company and each class of exposure, and then apply these methods to calculate an estimate of ultimate losses. Our management, which is responsible for the final estimate of ultimate losses, reviews the calculations of our independent actuaries, considers whether the appropriate method was applied, and adjusts the estimate of ultimate losses as it deems necessary. Historically, we have not deviated from the recommendations of our independent actuaries. Paid-to-date losses are then deducted from the estimate of ultimate losses to arrive at an estimated total loss reserve, and reported outstanding case reserves are then deducted from estimated total loss reserves to calculate the estimated IBNR reserve.
The change in our estimated total loss reserves for both latent and all other exposures compared to that of the previous period, less net losses paid during the period, is recorded as a reduction in net ultimate losses on our statement of earnings for the period. Our estimated total loss reserve at December 31, 2012 was determined by estimating the ultimate losses and deducting paid-to-date losses. The estimated ultimate losses, for both latent and all other (non-latent) liabilities, were determined by the amount of advised case reserves and the application of the actuarial methodologies described above to estimate IBNR reserves. Future changes in our estimates of ultimate losses are likely to have a significant impact on future operating results. Our operating objective is to commute our loss exposures and manage non-commuted loss development in a disciplined manner such that future incurred loss development will be less than expected. A combination of future commutations and better-than-expected incurred loss development of non-commuted exposures could improve the trend of loss development and, after the application of actuarial methodologies to the improved trend, reduce the December 31, 2012 estimates of ultimate losses with a positive impact on our future results. However, it is not possible to project future commutation settlements or whether incurred loss development will be better than expected, and it is possible that ultimate loss reserves could increase based on the factors discussed herein.
Quarterly loss development is expected to be fairly erratic for the types of exposure insured and reinsured by us. Several quarters of low incurred loss development can be followed by spikes of relatively large incurred losses. This is characteristic of latent claims and other insurance losses that are reported and settled many years after the inception of the policy. Given the high degree of statistical uncertainty, and potential volatility, it would be unusual to adjust reserves on the basis of one, or even several, quarters of loss development activity. As a result, unless the incurred loss activity in any one quarter is of such significance that management is able to quantify the impact on the ultimate liability for loss and loss adjustment expenses, reductions or increases in loss and loss adjustment expense liabilities are carried out in the fourth quarter based on the annual reserve review described above.
As described above, our management regularly reviews and updates reserve estimates using the most current information available and employing various actuarial methods. Adjustments resulting from changes in our estimates are recorded in the period when such adjustments are determined. The ultimate liability for loss and loss adjustment expenses is likely to differ from the original estimate due to a number of factors, primarily consisting of the overall claims activity occurring during any period, including the completion of commutations of assumed liabilities and ceded reinsurance receivables, policy buy-backs and general incurred claims activity.
We invest in a trading portfolio of fixed maturity investments and equities and an available-for-sale portfolio of fixed maturity investments. We record both the trading and available-for-sale portfolios at fair value on our balance sheet. For our trading portfolio, the unrealized gain or loss associated with the difference between the fair value and the amortized cost of the investments is recorded in net earnings. For our available-for-sale portfolio, the unrealized gain or loss (other than credit losses) is recorded in accumulated other comprehensive income in the shareholders’ equity section of our consolidated balance sheet.
We measure fair value in accordance with Accounting Standards Codification (or ASC) 820, Fair Value Measurements. The guidance dictates a framework for measuring fair value and a fair value hierarchy based on the quality of inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
Any other-than-temporary impairment loss, or OTTI, related to a credit loss would be recognized in earnings, and the amount of the OTTI related to other factors (e.g. interest rates, market conditions, etc.) is recorded as a component of other comprehensive income. If no credit loss exists but either we have the intent to sell the fixed maturity investment or it is more likely than not that we will be required to sell the fixed maturity investment before its anticipated recovery, then the entire unrealized loss is recognized in earnings.
For the years ended December 31, 2012, 2011 and 2010, we did not recognize any other than temporary impairment charges through earnings.
Our fixed maturity portfolio is managed by our Chief Investment Officer and outside investment advisors with oversight from our Investment Committee. Fair value prices for all investments in the fixed maturity portfolios are independently provided by the investment custodian, investment accounting service provider and investment managers, each of which utilize internationally recognized independent pricing services. Interactive Data Corporation is, however, the main pricing service utilized to estimate the fair value measurements for our fixed maturity investments. We record the unadjusted price provided by the investment custodian, investment accounting service provider or the investment manager and validate this price through a process that includes, but is not limited to: (i) comparison of prices against alternative pricing sources; (ii) quantitative analysis (e.g. comparing the quarterly return for each managed portfolio to its target benchmark); (iii) evaluation of methodologies used by external parties to estimate fair value, including a review of the inputs used for pricing; and (iv) comparing the price to our knowledge of the current investment market. Our internal price validation procedures and review of fair value methodology documentation provided by independent pricing services have not historically resulted in adjustment in the prices obtained from the pricing service.
The independent pricing services used by the investment custodian, investment accounting service provider and investment managers obtain actual transaction prices for investments that have quoted prices in active
We have ongoing due diligence processes with respect to funds in which we invest and their managers. These processes are designed to assist us in assessing the quality of information provided by, or on behalf of, each fund and in determining whether such information continues to be reliable or whether further review is warranted. Certain funds do not provide full transparency of their underlying holdings; however, we obtain the audited financial statements for funds annually, and regularly review and discuss the fund performance with the fund managers to corroborate the reasonableness of the reported net asset values. The use of net asset value as an estimate of the fair value for investments in certain entities that calculate net asset value is a permitted practical expedient. While reported net asset value is the primary input to the review, when the net asset value is deemed not to be indicative of fair value, we may incorporate adjustments to the reported net asset value (and not use the permitted practical expedient) on an investment by investment basis. These adjustments may involve significant management judgment.
The fixed income funds and equity fund in which we invest have been classified as Level 2 investments because their fair value is estimated using the net asset value provided regularly and because the fixed income funds and equity fund are highly liquid.
Our remaining other investments are valued based on the latest available capital statements and have been classified as Level 3.
As at December 31, 2012, none of our funds included in other investments were subject to gates or had side-pockets.
The following table sets forth our selected consolidated statements of earnings data for each of the periods indicated:
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this annual report. Some of the information contained in this discussion and analysis or included elsewhere in this annual report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and the timing of events could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under “Risk Factors,” “Cautionary Statement Regarding Forward-Looking Statements” and elsewhere in this annual report.
(i) an increase in net realized and unrealized gains of $64.4 million due primarily to: (a) mark-to-market changes in the market value of our equity securities; (b) increases in realized gains on our fixed maturities; and (c) increased returns from our other investments;
Noncontrolling interest in earnings decreased by $31.3 million to $23.5 million primarily as a result of lower earnings in those companies in which there are noncontrolling interests. Net earnings attributable to Enstar Group Limited increased from $153.7 million for the year ended December 31, 2011 to $168.0 million for the year ended December 31, 2012.
(i) a decrease in net investment income of $12.6 million primarily as a result of a decrease, in 2011, in net investment income due primarily to lower yields earned on our fixed maturity investments;
(ii) a decrease in net realized and unrealized gains of $22.6 million due primarily to a decrease in our realized and unrealized gains on our other investments along with a decrease in net realized gains on our fixed maturities and equities as a result of conditions in the U.S. equity markets;
(viii) a gain on bargain purchase of $13.1 million in 2011, which arose in relation to our acquisition of Laguna Life Limited;
(ix) a decrease in income taxes of $61.8 million due to decreased tax liabilities recorded on the results of our taxable subsidiaries and an additional tax liability of $30.3 million provided for in 2010 arising in our Australian subsidiary from the formation of an Australian tax consolidated group that did not recur in 2011; and
Our consulting companies earned fees of approximately $8.6 million and $17.9 million for the years ended December 31, 2012 and 2011, respectively. The decrease in consulting fees of $9.3 million related to the decrease in management fees earned from incentive-based engagements. Consulting fee income as a percentage of net earnings has declined in recent periods, and we would expect it to remain at or around current levels in future periods, excluding the impact of any one-time incentive based fees that we might receive. While we intend to continue to provide management and consultancy services, claims inspection services and reinsurance collection services to third-party clients in limited circumstances, our core focus continues to be acquiring and managing insurance and reinsurance companies and portfolios of business in run-off.
Our consulting companies earned fees of approximately $17.9 million and $23.0 million for the years ended December 31, 2011 and 2010, respectively. The decrease in consulting fees of $5.2 million related to the decrease in management fees earned from incentive-based engagements.
Net realized and unrealized gains for the years ended December 31, 2012 and 2011 were $73.6 million and $9.2 million, respectively. The increase of $64.4 million was primarily attributable to a combination of the following:
Net investment income for the year ended December 31, 2011 decreased by $12.6 million to $68.7 million, as compared to $81.3 million for the year ended December 31, 2010. The decrease was primarily attributable to a combination of the following:
(iii) a decrease of $2.0 million in our other income; and
(iv) an increase of $1.8 million in our investment expenses due to the hiring of additional third-party investment managers in 2011.
Net realized and unrealized gains for the years ended December 31, 2011 and 2010 were $9.2 million and $31.8 million, respectively. The decrease of $22.6 million was primarily attributable to a combination of the following:
(ii) a decrease of $3.8 million in net realized gains on our fixed maturities and equities mostly related to lower realized gains from our equities as a result of conditions in the U.S. equity markets; and
The average credit rating of our fixed maturities at December 31, 2011 was AA- (2010: AA-). During 2011, the rating agency Standard & Poors downgraded the U.S. sovereign debt from AAA to AA+. This, combined with the assets we acquired upon the acquisition of Clarendon, which had a lower proportion of investments with AAA credit ratings, has resulted in us having a lower percentage of AAA-rated investments than we had as at December 31, 2010.
Gain on bargain purchase of $13.1 million was recorded for the year ended December 31, 2011. The gain on bargain purchase was earned in connection with our acquisition of Laguna Life Limited, or Laguna, and represents the excess of the cumulative fair value of net assets acquired of $34.3 million over the cost of $21.2 million. This excess was, in accordance with the provisions of the Business Combinations topic of the FASB ASC, recognized as income for the year ended December 31, 2011. The gain on bargain purchase arose mainly as a result of our reassessment, upon acquisition, of the total required estimated costs to manage the business to expiry. Our assessment of costs was lower than the acquired costs recorded by the vendor in the financial statements of Laguna.
The reduction in estimates of net ultimate losses of $221.9 million comprised net incurred loss development of $45.5 million and reductions in net IBNR reserves of $267.4 million. During the three months ended December 31, 2012, one of our insurance entities, following an exposure-based review of all advised claims, allocated $52.4 million of net IBNR reserves to specific net case and LAE reserves. Excluding this allocation, net incurred loss development for the year ended December 31, 2012 was a favorable $6.9 million and reductions in net IBNR reserves amounted to $215.0 million. The decrease in the aggregate estimate of net IBNR reserves of $215.0 million, excluding the allocation of $52.4 million from net IBNR reserves to specific net case and LAE reserves (compared to $224.8 million during the year ended December 31, 2011), was comprised of $36.4 million relating to asbestos liabilities (compared to $57.9 million in 2011), $2.6 million relating to environmental liabilities (compared to $2.8 million in 2011), $96.3 million relating to general casualty liabilities (compared to $91.6 million in 2011) and $79.7 million relating to all other remaining liabilities (compared to $72.5 million in 2011).
Commutations provide an opportunity for us to exit exposures to entire policies with insureds and reinsureds at a discount to the previous estimated ultimate liability. As a result of exiting all exposures to such policies, all advised case reserves and net IBNR reserves relating to that insured or reinsured are eliminated. This often results in a net gain irrespective of whether the settlement exceeds the advised case reserves. We adopt a disciplined approach to the review and settlement of non-commuted claims through claims adjusting and the inspection of underlying policyholder records such that settlements of assumed exposures may often be achieved below the level of the originally advised loss, and settlements of ceded receivables may often be achieved at levels above carried balances.
The net reduction in ultimate loss and loss adjustment expense liabilities for the year ended December 31, 2011 of $295.4 million was attributable to a reduction in estimates of net ultimate losses of $250.2 million, a reduction in aggregate provisions for bad debt of $42.8 million and a reduction in estimates of unallocated loss adjustment expense liabilities of $45.1 million, relating to 2011 run-off activity, partially offset by the amortization, over the estimated payout period, of fair value adjustments relating to companies acquired amounting to $42.7 million.
The reduction in estimates of net ultimate losses of $250.2 million comprised net incurred favorable loss development of $25.4 million and reductions in net IBNR reserves of $224.8 million. The aggregate reduction in net
Of the 113 commutations completed during 2011, nine related to our top ten insured and/or reinsured exposures and two related to our top ten ceded reinsurance assets, including three commutations completed shortly after December 31, 2011 whereby the related reduction in net IBNR reserves was recorded in the reduction in net ultimate losses for the year. The remaining 102 commutations, of which approximately 46% were completed during the three months ended December 31, 2011, were of a smaller size, consistent with our approach of targeting significant numbers of cedant and reinsurer relationships, as well as targeting significant individual cedant and reinsurer relationships. The combination of the claims settlement activity in 2011, including commutations, and the actuarial estimation of net IBNR reserves required for the remaining non-commuted exposures (which took into account the favorable trend of loss development in 2011 related to such exposures compared to prior forecasts), resulted in our management concluding that the loss development activity that occurred subsequent to the prior reporting period provided sufficient new information to warrant a reduction in net IBNR reserves of $224.8 million in 2011.
The table below provides a reconciliation of the beginning and ending reserves for losses and loss adjustment expenses for the years ended December 31, 2012, 2011, and 2010. Losses incurred and paid are reflected net of reinsurance recoverables.
Salaries and benefits, which include expenses relating to our discretionary bonus and employee share plans, were $100.5 million and $89.8 million for the years ended December 31, 2012 and 2011, respectively.
(i) an increase in the discretionary bonus provision of $3.0 million due to the increase in net earnings for the year ended December 31, 2012 as compared to 2011. Expenses relating to our discretionary bonus plan will be variable and are dependent on our overall profitability;
For 2013, we expect costs related to salaries and benefits to increase over 2012 levels due primarily to the expected increase in headcount within our U.S. operations as a result of the recently completed SeaBright acquisition and the pending acquisition of the HSBC Insurance Companies, which is expected to close by the end of the first quarter of 2013.
(i) increased staff costs due to an increase in staff numbers from 335 for the year ended December 31, 2010 to 415 for the year ended December 31, 2011 attributable to staff acquired on completion of the Clarendon Acquisition in July 2011;
(ii) increased U.S. dollar costs of our U.K.-based staff following an increase in the average British pound exchange rate from approximately 1.5458 for the year ended December 31, 2010 to 1.6041 for the year ended December 31, 2011. Approximately 61% and 67% of the average staff numbers for the years ended December 31, 2011 and 2010, respectively, had their salaries paid in British pounds; partially offset by
General and administrative expenses decreased by $15.2 million from $71.8 million to $56.6 million during the year ended December 31, 2012, as compared to the year ended December 31, 2011. The decrease in expenses in 2012 related primarily to:
(ii) additional general and administrative expenses of $4.1 million incurred in relation to both new acquisitions and significant new business that we completed in 2011;
(iii) increased legal expenses of approximately $9.7 million due primarily to legal fees and settlement costs associated with certain litigation and legal fees associated with ongoing due diligence projects; and
(iv) an increase in actuarial consulting fees of approximately $2.9 million due to costs associated with ongoing and completed due diligence projects; partially offset by
Interest expense of $8.5 million and $10.5 million was recorded for the years ended December 31, 2011 and 2010, respectively. The decrease in interest expense was attributable primarily to the lower interest rates on the loan facilities outstanding during the year ended December 31, 2011 as compared to the same period in 2010.
We recorded income tax expense of $44.3 million and $25.3 million for the years ended December 31, 2012 and 2011, respectively.
(i) lower overall net earnings in our tax paying subsidiaries for the year ended December 31, 2011 as compared to those earned in the same period in 2010; and
(ii) during 2010, in order to mitigate the tax impacts of inter-group transactions, the boards of our Australian group of companies elected to form a consolidated tax group. The impact of this tax consolidation resulted in resetting the cost basis of certain assets, which resulted in us recording a tax charge in 2010 of approximately $30.3 million.
For the year ended December 31, 2010, we recorded $10.7 million as our share of net earnings of our equity method investee. During 2010, we disposed of our 44.4% indirect interest in Stonewall Insurance Company and we acquired a 100% interest in Seaton Insurance Company.
Our future cash flows depend upon the availability of dividends or other statutorily permissible payments from our subsidiaries. The ability to pay dividends and make other distributions is limited by the applicable laws and regulations of the jurisdictions in which our insurance and reinsurance subsidiaries operate, including Bermuda, the United Kingdom, the United States, Australia and Europe, which subject these subsidiaries to significant regulatory restrictions. These laws and regulations require, among other things, certain of our insurance and reinsurance subsidiaries to maintain minimum capital resources requirements and limit the amount of dividends and other payments that these subsidiaries can pay to us, which in turn may limit our ability to pay dividends and make other payments. For more information on these laws and regulations, see “Business - Regulation” beginning on page 20.
As of December 31, 2012 and 2011, all of our insurance and reinsurance subsidiaries’ capital resources levels were in excess of the minimum levels required, with the exception of one of our U.S. insurance companies that was acquired whilst under supervision and is not in compliance with its minimum risk-based capital level. We do not believe this company’s non-compliance will have an impact on our ability to meet our cash obligations. In addition, our subsidiaries’ ability to pay dividends and make other forms of distributions may be further limited by repayment obligations in certain of our outstanding loan facility agreements.
Our sources of funds primarily consist of the cash and investment portfolios acquired on the completion of the acquisition of an insurance or reinsurance company in run-off. These acquired cash and investment balances are classified as cash provided by investing activities. We expect to use these funds acquired, together with collections from reinsurance debtors, consulting income, investment income and proceeds from sales and redemptions of investments, to meet expected claims payments and operational expenses with the remainder used for acquisitions and additional investments. We expect a net use of cash from operations as total net claim payments and operating expenses will generally be in excess of investment income earned. We expect our operating cash flows, together with our existing capital base and cash and investments acquired on the acquisition of our insurance and reinsurance subsidiaries, to be sufficient to meet cash requirements and to operate our business. We currently do not intend to pay dividends on our ordinary shares.
At December 31, 2012, we had total cash and cash equivalents, restricted cash and cash equivalents and investments of $4.31 billion, compared to $4.56 billion at December 31, 2011. Our cash and cash equivalent portfolio is comprised mainly of cash, high-grade fixed deposits, commercial paper with maturities of less than three months and money market funds.
As of December 31, 2012 and 2011, we had total reinsurance balances recoverable of $1.12 billion and $1.79 billion, respectively. The decrease of $666.7 million in total reinsurance balances recoverable was primarily a result of commutations, cash collections and a reduction in estimated ultimate losses in the year ended December 31, 2012. At December 31, 2012 and 2011, the provision for uncollectible reinsurance recoverable relating to total reinsurance balances recoverable was $343.9 million and $341.1 million, respectively. To estimate the provision for uncollectible reinsurance recoverable, the reinsurance balances recoverable are first allocated to applicable reinsurers. As part of this process, ceded IBNR reserves are allocated by reinsurer. The ratio of the provision for uncollectible reinsurance recoverable to total reinsurance balances recoverable (excluding provision for uncollectible reinsurance recoverable) as of December 31, 2012 increased to 23.4% as compared to 16.0% as of December 31, 2011. This was primarily as a result of commutations and the collection of reinsurance balances recoverable against which there were minimal provisions for uncollectible reinsurance recoverable.
See “Item 8. Financial Statements and Supplementary Data - Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010” for further information.
(ii) a decrease in reinsurance balances recoverable of $666.8 million in 2012 compared to a decrease of $238.8 million in 2011;
(iii) an increase of $460.8 million in purchases of trading securities between 2011 and 2012; and
Net cash used in our operating activities for the year ended December 31, 2011 was $909.9 million compared to $609.2 million for the year ended December 31, 2010. This $300.7 million increase in cash used in operating activities was due primarily to the following:
(ii) a decrease in reinsurance balances recoverable of $238.8 million in 2011 compared to an increase of $13.9 million in 2010; and
Investing cash flows consist primarily of cash acquired net of acquisitions along with net proceeds on the sale and purchase of available-for-sale securities and other investments. Net cash provided by investing activities was $228.6 million during the year ended December 31, 2012 compared to $691.9 million during the year ended December 31, 2011. This $463.3 million decrease in investing cash flows was due primarily to the following:
(i) a decrease of $73.2 million in restricted cash and cash equivalents during 2012, compared to a decrease of $290.2 million in 2011;
(iv) a decrease of $88.5 million in net cash used for acquisitions between 2012 and 2011.
Net cash provided by (used in) financing activities was $259.8 million during the year ended December 31, 2011 compared to $(124.7) million during the year ended December 31, 2010. This $384.5 million increase in cash provided by financing activities was primarily attributable to the following:
(i) an increase of $287.4 million in net proceeds from the private placement of shares in 2011 to affiliates of Goldman, Sachs & Co. compared to $nil in 2010; and
The table below shows the aggregate amounts of our investments as of December 31, 2012 and 2011:
As at December 31, 2012, we held investments totaling $3.35 billion, compared to $3.34 billion at December 31, 2011, with net unrealized appreciation included in accumulated other comprehensive income of $5.7 million compared to $16.8 million at December 31, 2011. As at December 31, 2012, we had approximately $1.0 billion of restricted assets compared to approximately $1.2 billion at December 31, 2011.
We strive to structure our investments in a manner that recognizes our liquidity needs for future liabilities. In that regard, we attempt to correlate the maturity and duration of our investment portfolio to our general liability profile. If our liquidity needs or general liability profile unexpectedly change, we may adjust the structure of our investment portfolio to meet new business needs.
investments, highly rated sovereign and supranational investments, high-grade corporate investments, and mortgage-backed and asset-backed investments. We allocate a portion of our investment portfolio to other investments, including private equity funds, fixed income funds, fixed income hedge funds, an equity fund and a real estate debt fund. At December 31, 2012, these other investments totaled $414.8 million, or 12.4%, of our total investments (2011: $192.3 million or 5.8%). The trend of increased allocation to our other investments is likely to continue in the future because we have not fully funded all existing investment commitments in this asset class.
Our investment guidelines govern the types of investments we make, including with respect to credit quality ratings.
The maturity distribution for our fixed maturity investments held as of December 31, 2012 and 2011 was as follows:
As at December 31, 2012 and 2011, our fixed maturity investments and short-term investment portfolio had an average credit quality rating of AA-. At December 31, 2012 and 2011, our fixed maturity investments rated BBB or lower comprised 11.3% and 11.5% of our total investment portfolio, respectively.
The following table summarizes the composition of the amortized cost and fair value of our fixed maturity investments, short term investments and other investments at the date indicated by ratings as assigned by major rating agencies.
The following table presents the fair value, unfunded commitments and redemption frequency for all of our other investments. These investments are all valued at net asset value as at December 31, 2012.
This class is comprised of several private equity funds that invest primarily in the financial services industry. All of our investments in private equity funds are subject to restrictions on redemptions and sales that are determined by the governing documents and limit our ability to liquidate those investments. These restrictions have been in place since the dates the initial investments were made.
This class is comprised of hedge funds that invest in a diversified portfolio of debt investments. The advisor of the funds intends to seek attractive risk-adjusted total returns for the funds’ investors by acquiring, originating, and actively managing a diversified portfolio of debt investments, with a focus on various forms of mortgage-backed investments and loans. The funds focus on investments that the advisor believes to be fundamentally undervalued with current market prices that are believed to be compelling relative to intrinsic value. The hedge funds are not currently eligible for redemption due to imposed lock-up periods of three years from the time of our initial investment. Once eligible, redemptions will be permitted quarterly with 90 days’ notice. The first eligible redemption is March 2014.
This class is comprised primarily of a fund that provides loans to educational institutions throughout the U.S. and its territories. Through this investment we participate in the performance of the underlying loans. This investment matures when the loans are paid down.
At December 31, 2012, we did not own any investments in fixed maturity investments (which includes bonds that are classified as cash and cash equivalents) and fixed income funds issued by the sovereign governments of Portugal, Italy, Ireland, Greece or Spain. Our fixed maturity investments and fixed income funds exposures to Eurozone Governments (which includes regional and municipal governments including guaranteed agencies) by rating are highlighted in the following tables:
Investments issued by companies located in the United Kingdom and Switzerland are not included in the tables.
None of the investments we owned at December 31, 2012 were considered impaired and we do not expect to incur any significant losses on these investments.
For the years ended December 31, 2012, 2011 and 2010, we incurred interest expense of $8.4 million, $8.5 million and $10.3 million, respectively, on our loan facilities and loans related to the share repurchase agreements. All of our currently outstanding loan facilities are floating rate loans, and the fair values of these loans approximate their book values.
Amounts of loans payable outstanding, and accrued interest, as of December 31, 2012 and 2011 totaled $107.4 million and $242.7 million, respectively, and were comprised of:
On December 21, 2012, we, through AML Acquisition, entered into a Term Facility Agreement with NAB and Barclays, or the SeaBright Facility. The SeaBright Facility provides a four-year term loan facility, which AML Acquisition fully drew down on February 5, 2013 in an amount of $111.0 million to partially fund our acquisition of SeaBright. We acquired SeaBright on February 7, 2013 by way of a merger of AML Acquisition with and into SeaBright, or the Merger, with SeaBright surviving the Merger as our indirect, wholly-owned subsidiary.
From the date of the SeaBright Facility until the draw down on February 5, 2013, the undrawn and uncancelled amount of the SeaBright Facility incurred a fee of 1% per annum. Interest on amounts borrowed under the SeaBright Facility is payable at the end of each interest period chosen by the borrower or, at the latest,
On October 1, 2010, we entered into repurchase agreements to repurchase an aggregate of 800,000 of our ordinary shares at a price of $70.00 per share from three of our executives and certain trusts and a corporation affiliated with the executives. The aggregate purchase price of $56.0 million was payable through promissory notes to the selling shareholders. The annual interest rate on the promissory notes was fixed at 3.5%, and the notes were repayable in three equal installments on December 31, 2010, December 1, 2011 and December 1, 2012. On December 1, 2012, we fully repaid the outstanding amount of $19.3 million under the promissory notes, inclusive of accrued interest, relating to the share repurchase.
On April 20, 2011, we entered into an Investment Agreement with GSCP VI AIV Navi, Ltd., GSCP VI Offshore Navi, Ltd., GSCP VI Parallel AIV Navi, Ltd., GSCP VI Employee Navi, Ltd., and GSCP VI GmbH Navi, L.P., or collectively, the Purchasers, each of which is an affiliate of Goldman, Sachs & Co. Under the Investment Agreement, we agreed to issue and sell, and the Purchasers agreed to purchase, at three different closings that occurred during 2011, securities representing 19.9% of our outstanding share capital pro forma for all the issuances, with the right to acquire an additional 2.0% on a fully diluted basis pro forma for all the issuances through the exercise of warrants as described below, although the Purchasers’ voting interest purchased pursuant to the Investment Agreement is less than 4.9%. The total investment made by the Purchasers was $291.6 million, and we received net proceeds (after transaction costs) of approximately $287.4 million.
The amounts in the above table represent our estimates of known liabilities as of December 31, 2012 and do not take into account corresponding reinsurance recoverable amounts that would be due to us. Furthermore, reserves for loss and loss adjustment expenses recorded in the audited consolidated financial statements as of December 31, 2012 are computed on a fair value basis, whereas the expected payments by period in the table above are the estimated payments at a future time and do not reflect the fair value adjustment in the amount payable.
The following table provides a summary of our outstanding unfunded investment commitments for the years ended December 31, 2012 and 2011:
As at December 31, 2012 and 2011, we had, in total, parental guarantees supporting Fitzwilliam’s obligations in the amount of $213.3 million and $219.9 million, respectively.
We have entered into definitive agreements with respect to: (i) the Reciprocal of America loss portfolio transfer, which is expected to close in the second quarter of 2013; (ii) the American Physicians Assurance Corporation assignment and assumption agreement, which is expected to close in the second quarter of 2013; and (iii) the purchase of the HSBC Insurance Companies, which is expected to close by the end of the first quarter of 2013. All three agreements are described in “Business - Recent Transactions - 2013/2012 Acquisitions and Portfolio Transfers” beginning on page 6.
Consolidated Statements of Earnings for the years ended December 31, 2012, 2011 and
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Enstar Group Limited and subsidiaries as of December 31, 2012, and the results of their operations and their cash flows for the year ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule as of, and for the period ended, December 31, 2012, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We have audited the accompanying consolidated balance sheet of Enstar Group Limited and subsidiaries (the “Company”) as of December 31, 2011, and the related consolidated statements of earnings, comprehensive income, changes in shareholders’ equity and cash flows for each of the two years ended December 31, 2011 and 2010. Our audits also included the financial statement schedule as of, and for the year ended, December 31, 2011 listed in the Index at Item 15. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Enstar Group Limited and subsidiaries as of December 31, 2011, and the results of their operations and their cash flows for each of the two years ended December 31, 2011 and 2010 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule as of and for the year ended December 31, 2011, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
Enstar Group Limited (“Enstar” or the “Company”) was formed in August 2001 under the laws of Bermuda to acquire and manage insurance and reinsurance companies in run-off and portfolios of insurance and reinsurance business in run-off, and to provide management, consulting and other services to the insurance and reinsurance industry.
Fixed maturity investments classified as available-for-sale are carried at fair value, with unrealized gains and losses excluded from net earnings and reported as a separate component of accumulated other comprehensive income. Realized gains and loss on sales of investments classified as available-for-sale are recognized in the consolidated statements of earnings. Amortization of premium or discount is recognized using the effective yield method and included in net investment income. For mortgage-backed and asset-backed investments, and any other holdings for which there is a prepayment risk, prepayment assumptions are evaluated and revised on a regular basis.
Short-term investments and fixed maturities classified as trading are carried at fair value, with realized and unrealized holding gains and losses included in net earnings and reported as net realized and unrealized gains and losses. Investment purchases and sales are recorded on a trade-date basis. Realized gains and losses on the sale of investments are based upon specific identification of the cost of investments.
Fixed maturity investments classified as available-for-sale are reviewed quarterly to determine if they have sustained an impairment of value that is, based on management’s judgement, considered to be other than temporary. The process includes reviewing each fixed maturity investment that is below cost and: (1) determining if the Company has the intent to sell the fixed maturity investment; (2) determining if it is more likely than not that the Company will be required to sell the fixed maturity investment before its anticipated recovery; and (3) assessing whether a credit loss exists, that is, whether the Company expects that the present value of the cash flows expected to be collected from the fixed maturity investment is less than the amortized cost basis of the investment. In evaluating credit losses, the Company considers a variety of factors in the assessment of a fixed maturity investment including: (1) the time period during which there has been a significant decline below cost; (2) the extent of the decline below cost and par; (3) the potential for the investment to recover in value; (4) an analysis of the financial condition of the issuer; (5) the rating of the issuer; and (6) failure of the issuer of the investment to make scheduled interest or principal payments. If management concludes an investment is other-than-temporarily impaired (“OTTI”) then the difference between the fair value and the amortized cost of the investment is presented as an OTTI charge in the consolidated statements of earnings, with an offset for any noncredit-related loss component of the OTTI charge to be recognized in other comprehensive income. Accordingly, only the credit loss component of the OTTI amount will have an impact on the Company’s earnings.
Amounts billed to, and due from, reinsurers result from paid movements in the underlying assumed business and are calculated in accordance with the terms of the individual reinsurance contracts.
The Company’s reinsurance balances recoverable are presented net of a provision for uncollectible amounts, reflecting the amount deemed not collectible due to credit quality, collection problems due to location of the reinsurer, contractual disputes with reinsurers over individual contentious claims, contract language or coverage or for some other reason.
Fixed fee income is recognized in accordance with the term of the Company’s third-party management agreements. Time-based fees are recognized as services are provided. Success-based fees are recognized when all of the contractual requirements specified in the agreement are met.
The Company uses the purchase method in accounting for acquisitions. The difference between the fair value of net assets acquired and purchase price is recorded as goodwill.
Goodwill represents the excess of the purchase price over the fair value of the net assets acquired. The Company performed an initial valuation of its goodwill assets and updates this analysis on an annual basis. If, as a result of the assessment, the Company determines the value of its goodwill asset is impaired, goodwill is written down in the period in which the determination is made. An annual impairment valuation has concluded that there is no impairment to the value of the Company’s goodwill asset.
Certain subsidiaries and branches of the Company operate in jurisdictions where they are subject to taxation. Current and deferred income taxes are charged or credited to net income, or, in certain cases, to accumulated other comprehensive income, based upon enacted tax laws and rates applicable in the relevant jurisdiction in the period in which the tax becomes accruable or realizable. Deferred income taxes are provided for all temporary differences between the bases of assets and liabilities used in the financial statements and those used in the various jurisdictional tax returns. When management’s assessment indicates that it is more likely than not that deferred income tax assets will not be realized, a valuation allowance is recorded against the deferred tax assets.
The Company recognizes a tax benefit relating to uncertain tax positions only where the position is more likely than not to be sustained assuming examination by tax authorities. A liability is recognized for any tax benefit (along with any interest and penalty, if applicable) claimed in a tax return in excess of the amount allowed to be recognized in the financial statements under U.S. GAAP. Any changes in amounts recognized are recorded in the period in which they are determined.
Effective January 1, 2012, the Company adopted new guidance issued by FASB related to disclosure requirements for presentation of comprehensive income. This guidance requires presentation of total comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The implementation of this amended accounting guidance had no impact on the consolidated financial statements.
In September 2011, FASB issued amendments that simplify the two-step goodwill impairment test previously required, by permitting entities to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, it would then perform the first step of the goodwill impairment test; otherwise, no further impairment test would be required. The Company adopted the amended guidance as of December 31, 2011. The adoption of the amended guidance did not have a material impact on the consolidated financial statements.
In December 2011, FASB issued new disclosure requirements regarding the nature of an entity’s rights of setoff and related arrangements associated with its financial instruments and derivative instruments. The new disclosures are designed to make financial statements that are prepared under U.S. GAAP more comparable to those prepared under IFRS. The new disclosure requirements are effective retrospectively for annual and interim reporting periods beginning on or after January 1, 2013. The Company is currently evaluating the impact of adopting these revised disclosure requirements on the consolidated financial statements.
from the operation of the business prior to closing. The Company expects to finance the purchase price through a combination of cash on hand and a drawing under its Revolving Credit Facility with NAB and Barclays. The Company is a party to the acquisition agreement and has guaranteed the performance by Pavonia of its obligations thereunder. Completion of the transaction is conditioned on, among other things, governmental and regulatory approvals and satisfaction of various customary closing conditions. The transaction is expected to close by the end of the first quarter of 2013.
On July 12, 2011, the Company, through its wholly-owned subsidiary, Clarendon Holdings, Inc., completed the acquisition of 100% of the shares of Clarendon National Insurance Company (“Clarendon”) from Clarendon Insurance Group, Inc., an affiliate of Hannover Re (“Hannover”). Clarendon is a New Jersey-domiciled insurer that is in run-off. Clarendon owns three other insurers, two domiciled in New Jersey and one domiciled in Florida, that are also in run-off. The aggregate cash purchase price was $219.1 million and was financed in part by $106.5 million under a four-year term loan facility provided by NAB.
On December 3, 2010, the Company, through Kenmare, completed the acquisition of New Castle Reinsurance Company Ltd. (“New Castle”), for an aggregate cash purchase price of $22.0 million. New Castle is a Bermuda-domiciled insurer that is in run-off.
The purchase price and fair value of the assets acquired in the New Castle acquisition were as follows:
On November 2, 2010, the Company acquired the 49.9% of the shares of Hillcot Holdings Ltd. (“Hillcot”) from Shinsei Bank, Ltd. (“Shinsei”) that it did not previously own for an aggregate purchase price of $38.0 million, resulting in the Company owning 100% of Hillcot. At the time of acquisition, Hillcot owned 100% of the shares of Brampton Insurance Company of Europe Limited (“Brampton”). Brampton is a London-domiciled insurer that is in run-off. The fair value of the assets acquired that the Company did not previously own was $34.9 million. The excess of the purchase price over the fair value of assets acquired in the amount of $3.1 million was recorded as a charge to additional paid-in capital.
On August 3, 2010, the Company, through its wholly-owned subsidiary, Virginia Holdings Ltd. (“Virginia”), acquired 55.6% of the shares of Seaton Insurance Company (“Seaton”) for a $nil purchase price. Seaton is a Rhode Island-domiciled insurer that is in run-off and, at that time, was the subsidiary of Stonewall Acquisition Corporation (“Stonewall”). At the time of the acquisition, Virginia held 44.4% of the outstanding capital stock of Stonewall and, therefore, indirectly owned 44.4% of Seaton through its holdings. The acquisition of the 55.6% of the Seaton shares that it previously did not own was a result of the distribution by Stonewall to Virginia of proceeds and certain other assets following its sale of another subsidiary, Stonewall Insurance Company, to Columbia Insurance Company, an affiliate of National Indemnity Company (an indirect subsidiary of Berkshire Hathaway, Inc.). The distribution resulted in Virginia owning 100% of Seaton following the distribution. The fair value of the assets acquired in the Seaton acquisition was $nil.
On July 6, 2012, the Company, through PWIC, entered into a definitive loss portfolio transfer reinsurance agreement with Reciprocal of America (in Receivership) and its Deputy Receiver relating to a portfolio of workers compensation business. The estimated liabilities to be assumed are approximately $174.0 million with an equivalent amount of assets to be received as consideration. Completion of the transaction is conditioned upon, among other things, regulatory approvals and satisfaction of customary closing conditions. The transaction is expected to close in the second quarter of 2013.
The Company, through its wholly-owned U.K.-based subsidiary, Shelbourne Group Limited (“Shelbourne”), invests in RITC transactions (the transferring of liabilities from one Lloyd’s syndicate to another) with Lloyd’s of London insurance and reinsurance syndicates in run-off. Shelbourne was originally formed in December 2007 in conjunction with a newly-hired executive management team and JCF FPK I L.P. (“JCF FPK”) (a joint investment program between Fox-Pitt, Kelton, Cochran, Caronia & Waller (USA) LLC and J.C. Flowers II L.P., which is a private investment fund affiliated with J. Christopher Flowers, who was formerly affiliated with the Company). Shelbourne owns 100% of Shelbourne Syndicate Services Limited, the Managing Agency for Lloyd’s Syndicate 2008 (“S2008”), a syndicate approved by Lloyd’s of London on December 16, 2007 to undertake RITC transactions with Lloyd’s syndicates in run-off. On January 1, 2012, S2008 transferred the assets and liabilities relating to its 2009 and prior underwriting years of account into its 2010 underwriting year of account by means of an RITC transaction. Following the transfer, the existing noncontrolling interest held by JCF FPK ceased, resulting in the Company now providing 100% of the underwriting capacity for S2008, represented by the total Funds at Lloyd’s capital commitment of £71.7 million (approximately $116.5 million). The capital commitment was financed from available cash on hand.
On January 1, 2013, S2008 transferred the assets and liabilities relating to its 2010 and prior underwriting years of account into its 2011 underwriting year of account by means of an RITC transaction.
On September 20, 2011, the Company, through its wholly-owned subsidiary, Gordian Run-off Limited (“Gordian”), acquired an inwards reinsurance portfolio from Insurance Australia Group Limited via an
On October 1, 2011, the Company, through its wholly-owned subsidiary, Brampton Insurance Company Limited (“Brampton”), completed the portfolio transfer of certain run-off agency business from International Insurance Company of Hannover (“IICH”), under part VII of the U.K. Financial Services and Markets Act 2000. The transferred business was previously reinsured by Fitzwilliam pursuant to a 100% quota share reinsurance agreement with IICH, which was entered into on December 3, 2010, and under which Fitzwilliam had received total assets and assumed total net reinsurance reserves of approximately $137.1 million. In addition, the Company provided a parental guarantee supporting Fitzwilliam’s obligations initially in the amount of approximately $118.7 million. The amount of the guarantee will decrease over time in line with relevant independent actuarial assessments. This 100% quota share reinsurance, along with the associated guarantee, was novated in favor of Brampton as part of the portfolio transfer from IICH. As of December 31, 2012, the total amount of the parental guarantee was approximately $15.5 million.
In May 2010, a specific portfolio of business in run-off underwritten by Mitsui Sumitomo Insurance Co., Ltd. of Japan (“Mitsui”), was transferred to the Company’s 50.1% owned subsidiary, Bosworth Run-off Limited (“Bosworth”). This transfer, which occurred under Part VII of the U.K. Financial Services and Markets Act 2000, was approved by the U.K. Court and took effect on May 31, 2010. As a result of the transfer, Bosworth received total assets and assumed net reinsurance reserves of approximately $117.5 million.
In February 2010, Fitzwilliam, entered into a 100% quota share reinsurance agreement with Allianz Global Corporate & Specialty AG (UK) Branch (“Allianz”), with respect to a specific portfolio of run-off business of Allianz. Fitzwilliam received total assets and assumed total gross reinsurance reserves of approximately $112.6 million.
Included within the residential and commercial mortgaged-backed securities as at December 31, 2012 are securities issued by U.S. governmental agencies with a fair value of $3,500 (as at December 31, 2011: $4,624).
This class is comprised of several private equity funds that invest primarily in the financial services industry. All of the Company’s investments in private equity funds are subject to restrictions on redemptions and sales that are determined by the governing documents and limit the Company’s ability to liquidate those investments. These restrictions have been in place since the dates the initial investments were made by the Company.
This class is comprised of a number of positions in diversified fixed income funds that are managed by third party managers. Underlying investments vary from high grade corporate bonds to non-investment grade senior secured loans and bonds, but are generally invested in liquid fixed income markets. These funds have regularly published prices. The funds have liquidity terms that vary from daily to monthly.
This class is comprised of an equity fund that invests in a diversified portfolio of international publicly-traded equity securities. The manager of the fund seeks to maximize the intrinsic value of the portfolio by focusing on price and quality.
This class is comprised of a real estate debt fund that invests primarily in U.S. commercial real estate loans and securities. A redemption request for this fund can be made 10 days after the date of any monthly valuation; the fund states that it will make commercially reasonable efforts to redeem the investment within the next monthly period.
At December 31, 2012 and 2011, the Company had no investments subject to gates or side-pockets.
The following table presents the fair value, unfunded commitments and redemption frequency for all other investments. These investments are all valued at net asset value as at December 31, 2012:
Level 2 - Valuations based on quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or for which significant inputs are observable (e.g. interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.
The Company’s fixed maturity portfolio is managed by the Company’s Chief Investment Officer and outside investment advisors with oversight from the Company’s Investment Committee. Fair values for all securities in the fixed maturities portfolio are independently provided by the investment custodian, investment accounting service provider and investment managers, each of which utilize internationally recognized independent pricing services. Interactive Data Corporation is, however, the main pricing service utilized to estimate the fair value measurements for the Company’s fixed maturity investments. The Company records the unadjusted price provided by the investment custodian, investment accounting service provider or the investment manager and validates this price through a process that includes, but is not limited to: (i) comparison of prices against alternative pricing sources; (ii) quantitative analysis (e.g. comparing the quarterly return for each
managed portfolio to its target benchmark); (iii) evaluation of methodologies used by external parties to estimate fair value, including a review of the inputs used for pricing; and (iv) comparing the price to the Company’s knowledge of the current investment market. The Company’s internal price validation procedures and review of fair value methodology documentation provided by independent pricing services have not historically resulted in adjustment in the prices obtained from the pricing service.
U.S. government and agency securities consist of securities issued by the U.S. Treasury and mortgage pass-through agencies such as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and other agencies. The significant inputs used to determine the fair value of these securities include the spread above the risk-free yield curve, reported trades and broker-dealer quotes. These are considered to be observable market inputs and, therefore, the fair values of these securities are classified within Level 2.
Corporate securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The fair values of these securities are determined using the spread above the risk-free yield curve, reported trades, broker-dealer quotes, benchmark yields, and industry and market indicators. These are considered observable market inputs and, therefore, the fair values of these securities are classified within Level 2. Where pricing is unavailable from pricing services, the Company obtains non-binding quotes from broker-dealers. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, securities are classified within Level 3. As at December 31, 2012, the Company had one corporate security classified as Level 3.
Asset-backed securities consist primarily of investment-grade bonds backed by pools of loans with a variety of underlying collateral. The significant inputs used to determine the fair value of these securities include the spread above the risk-free yield curve, reported trades, benchmark yields, broker-dealer quotes, prepayment speeds and default rates. These are considered observable market inputs and, therefore, the fair values of these securities are classified within Level 2.
Residential and commercial mortgage-backed securities include both agency and non-agency originated securities. The significant inputs used to determine the fair value of these securities include the spread above the risk-free yield curve, reported trades, benchmark yields, broker-dealer quotes, prepayment speeds and default rates. These are considered observable market inputs and, therefore, the fair values of these securities are classified within Level 2. Where pricing is unavailable from pricing services, the Company obtains non-binding quotes from broker-dealers. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, securities are classified within Level 3. As at December 31, 2012, the Company had no residential or commercial mortgage-backed securities classified as Level 3.
The fixed income funds and equity fund in which the Company invests have been classified as Level 2 investments because their fair value is estimated using the published net asset value and because the fixed income funds and equity fund are highly liquid.
The amount of net gains/(losses) for the year included in earnings attributable to the fair value of changes in assets still held at December 31, 2012 was $18.2 million. All of this amount was included in net realized and unrealized gains.
Components of net realized and unrealized gains (losses) for the years ended December 31, 2012, 2011 and 2010 were as follows:
As of December 31, 2012 and 2011, $212.0 million and $225.9 million, respectively, of cash and cash equivalents and investments were on deposit with various regulatory authorities to support the Company’s insurance and reinsurance operations. The investments on deposit are available to settle insurance and reinsurance liabilities. The Company also utilizes trust accounts to collateralize business with its insurance and reinsurance counterparties. As at December 31, 2012 and 2011, $570.4 million and $798.3 million, respectively, of cash and cash equivalents and investments were used for collateral in trust for third-party agreements. The Company also has issued secured letters of credit collateralized against the Company’s investment portfolio. As of December 31, 2012 and 2011, $246.6 million and $179.9 million, respectively, of cash and cash equivalents and investments were pledged as security in favor of letters of credit issued.
The following table sets out the foreign currency forward contracts outstanding during the periods ended December 31, 2012, 2011 and 2010 and the estimated fair value of derivative instruments recorded on the balance sheet:
The Company’s acquired reinsurance subsidiaries, prior to acquisition, used retrocessional agreements to reduce their exposure to the risk of insurance and reinsurance assumed. The Company’s reinsurance subsidiaries remain liable to the extent that retrocessionaires do not meet their obligations under these agreements, and therefore, the Company evaluates and monitors concentration of credit risk among its reinsurers. Provisions are made for amounts considered potentially uncollectible.
In establishing the reserves for losses and loss adjustment expenses related to asbestos and environmental claims, management considers facts currently known and the current state of the law and coverage litigation. Liabilities are recognized for known claims (including the cost of related litigation) when sufficient information has been developed to indicate the involvement of a specific insurance policy, and management can reasonably estimate its liability. In addition, reserves have been established to cover additional exposures on both known and unasserted claims. Estimates of the reserves are reviewed and updated continually. Developed case law and
adequate claim history do not exist for such claims, especially because significant uncertainty exists about the outcome of coverage litigation and whether past claim experience will be representative of future claim experience.
In view of the changes in the legal and tort environment that affect the development of such claims, the uncertainties inherent in valuing asbestos and environmental claims are not likely to be resolved in the near future. Ultimate values for such claims cannot be estimated using traditional reserving techniques and there are significant uncertainties in estimating the amount of the Company’s potential losses for these claims.
The table below provides a reconciliation of the beginning and ending reserves for losses and loss adjustment expenses for the years ended December 31, 2012, 2011 and 2010. Losses incurred and paid are reflected net of reinsurance recoverables.
The net reduction in ultimate loss and loss adjustment expense liabilities for the years ended December 31, 2012, 2011 and 2010 was due to the following:
The reduction in estimates of net ultimate losses of $221.9 million comprised net incurred loss development of $45.5 million and reductions in net IBNR reserves of $267.4 million. During the three months ended December 31, 2012, one of the Company’s insurance entities, following an exposure-based review of all advised claims, allocated $52.4 million of net IBNR reserves to specific net case and LAE reserves. Excluding this allocation, net incurred loss development for the year ended December 31, 2012 was a favorable $6.9 million and reductions in net IBNR reserves amounted to $215.0 million. The decrease in the aggregate estimate of net IBNR reserves of $215.0 million, excluding the allocation of $52.4 million from net IBNR reserves to specific net case and LAE reserves (compared to $224.8 million during the year ended December 31, 2011), was comprised of $36.4 million relating to asbestos liabilities (compared to $57.9 million in 2011), $2.6 million relating to environmental liabilities (compared to $2.8 million in 2011), $96.3 million relating to general casualty liabilities (compared to $91.6 million in 2011), and $79.7 million relating to all other remaining liabilities (compared to $72.5 million in 2011).
The reduction in estimates of net ultimate losses of $250.2 million comprised net incurred favorable loss development of $25.4 million and reductions in net IBNR reserves of $224.8 million. The decrease in the aggregate estimate of net IBNR reserves of $224.8 million (compared to $236.9 million during the year ended December 31, 2010) was comprised of $57.9 million relating to asbestos liabilities (compared to $67.8 million in 2010), $2.8 million relating to environmental liabilities (compared to $4.2 million in 2010) and $164.1 million relating to all other remaining liabilities (compared to $164.9 million in 2010). The aggregate reduction in net IBNR reserves of $224.8 million was a result of the application, on a basis consistent with the assumptions applied in the prior period, of the Company’s actuarial methodologies to revised historical loss development data, following 113 commutations (including three commutations completed shortly after December 31, 2011), to estimate loss reserves required to cover liabilities for unpaid losses and loss adjustment expenses relating to non-commuted exposures. The prior period estimate of aggregate net IBNR reserves was reduced as a result of the combined impact on all classes of business of loss development activity during 2011, including commutations and the favorable trend of loss development related to non-commuted policies compared to prior forecasts.
The net incurred favorable loss development of $25.4 million, resulting from settlement of net advised case and LAE reserves of $310.0 million for net paid losses of $284.6 million, related to the settlement of non-commuted losses in the year and approximately 110 commutations of assumed and ceded exposures, excluding the three commutations completed subsequent to December 31, 2011. Net incurred liabilities settled by way of commutation during the year ended December 31, 2011 (excluding the three commutations completed subsequent to December 31, 2011) amounted to $71.5 million compared to the net reduction in advised case reserves during the same period of $310.0 million.
The EGL Revolving Credit Facility is secured by a first priority lien on the stock of certain of the Company’s subsidiaries and certain bank accounts held with Barclays in the name of the Company and into which amounts received in respect of any capital release from certain of the Company’s subsidiaries are required to be paid. Interest is payable at the end of each interest period chosen by the Company or, at the latest, each six months. The interest rate is LIBOR plus 2.75%, plus an incremental amount tied to certain regulatory costs, if any, that may be incurred by the lenders. Any unused portion of the EGL Revolving Credit Facility is subject to a commitment fee of 1.10%. The EGL Revolving Credit Facility is subject to various financial and business covenants applicable to the Company, the guarantors and certain other material subsidiaries, including limitations on mergers and consolidations, acquisitions, indebtedness and guarantees, restrictions as to dispositions of stock and dividends, and limitations on liens on stock. As of December 31, 2012, all of the covenants relating to the EGL Revolving Credit Facility were met.
On March 4, 2011, the Company, through Clarendon Holdings, Inc., entered into a $106.5 million term facility agreement (the “Clarendon Facility”) with NAB. The Clarendon Facility provides a four-year term loan facility, which was fully drawn upon on July 12, 2011 to fund 50% of the purchase price of Clarendon. As of December 31, 2012, the outstanding Clarendon Facility principal balance was $106.5 million.
As at December 31, 2012 and 2011, the authorized share capital was 156,000,000 ordinary shares and non-voting convertible ordinary shares, each par value $1.00 per share. The following tables are a summary of changes in ordinary shares and non-voting convertible ordinary shares issued and outstanding:
Issued and fully paid Series B, C and D non-voting convertible ordinary shares of par value $1.00 each:
Goldman, Sachs & Co. Under the Investment Agreement, the Company agreed to issue and sell, and the Purchasers agreed to purchase, at three different closings that occurred during 2011, securities representing 19.9% of the Company’s outstanding share capital pro forma for all the issuances, with the right to acquire an additional 2.0% on a fully diluted basis pro forma for all the issuances through the exercise of warrants as described below, although the Purchasers’ voting interest in the Company purchased pursuant to the Investment Agreement is less than 4.9%.
Following all three closings, the Purchasers total investment and shares/warrants owned were as follows:
For the years ended December 31, 2012, 2011 and 2010, 191, 16,328 and 78,664 shares, respectively, were awarded to directors, officers and employees under the 2006 Equity Incentive Plan. The total value of the awards for the year ended December 31, 2012 was $0.1 million and was charged against the Enstar Group Limited 2011-2015 Annual Incentive Compensation Program (the “2011 Program”) accrual established for the year ended December 31, 2011. For the years ended December 31, 2011 and 2010, the total value of the awards was $1.5 million and $5.4 million, respectively, and was charged against the Enstar Group Limited 2006-2010 Annual Incentive Compensation Program (“2006 Program”) accruals established for the years ended December 31, 2011 and 2010, respectively. The 2006 Program ended effective December 31, 2010. On February 23, 2011, the Company adopted the 2011 Program.
As at December 31, 2012, 2011 and 2010, 5,442, 5,208 and 5,871 shares have been issued to employees under the Amended and Restated Enstar Group Limited Employee Share Purchase Plan. Compensation costs of less than $0.1 million relating to the shares issued have been recognized in the Company’s statement of earnings for the years ended December 31, 2012, 2011 and 2010.
For the years ended December 31, 2012, 2011 and 2010, 3,029, 4,193 and 6,463 restricted share units, respectively, were credited to the accounts of non-employee directors under the Enstar Group Limited Deferred Compensation and Ordinary Share Plan for Non-Employee Directors (the “Deferred Compensation Plan”). The Company recorded expenses related to the restricted share units for the years ended December 31, 2012, 2011 and 2010 of $0.3 million, $0.4 million and $0.5 million, respectively.
The Company acquired, as part of the acquisition of PWAC, a noncontributory defined benefit pension plan (the “PWAC Plan”) that covers substantially all PWAC employees hired before April 1, 2003 and provides pension and certain death benefits. Effective April 1, 2004, PWAC froze the PWAC Plan. During 2012, an actuarial review was performed of the PWAC Plan, which determined that the PWAC Plan’s unfunded liability, as at December 31, 2012, was $13.9 million as compared to $12.4 million as at December 31, 2011. As at December 31, 2012, PWAC had an accrued liability of $13.9 million for the unfunded PWAC Plan liability.
Following several private transactions occurring from May 2012 to July 2012, Trident V, L.P. and certain of its affiliates (“Trident”) acquired approximately 9.7% of the Company’s ordinary shares. The Company has investments in two funds affiliated with entities owned by Trident. As of December 31, 2012, the fair value of the investments in the two funds was $58.9 million.
As of December 31, 2012 and December 31, 2011, the Company included $187.4 million and $221.8 million, respectively, as part of noncontrolling interest on its balance sheet relating to five companies acquired in 2008 in which J.C. Flowers II L.P., a private investment fund, co-invested.
The Company earned management fees for advisory services provided to J.C. Flowers II L.P. for the years ended December 31, 2012, 2011 and 2010 of $0.5 million, $0.5 million and $0.3 million.
In 2010, in order to mitigate the tax impacts of inter-group transactions, the board of directors of the Company’s Australian subsidiaries elected to form a consolidated tax group. The impact of this tax consolidation resulted in the resetting of the cost basis of certain assets of our Australian subsidiaries which resulted in an additional tax liability of approximately $30.3 million.
As of December 31, 2012 and 2011, U.K. insurance subsidiaries and branch operations had tax loss carryforwards, which do not expire, and deductions available for tax purposes of approximately $346.9 million and $382.8 million, respectively. Certain of the Company’s U.K. insurance and reinsurance subsidiaries have tax loss carryforwards that arose prior to acquisition. Under U.K. tax law, these tax loss carryforwards are available to offset future taxable income generated by the acquired company without time limit.
As of December 31, 2012 and 2011, U.S. subsidiaries had deductible losses for tax purposes of approximately $234.5 million and $221.9 million, respectively. Under U.S. tax law, these tax losses can be carried forward and could be available to offset future taxable income of the companies that experienced the losses.
Included in the balances for each of the years ended December 31, 2012, 2011 and 2010 was $4.4 million of tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of the shorter deductibility period would not affect the annual effective tax rate but could accelerate the payment of cash to the taxing authority to an earlier period.
It is reasonably possible that the amount of unrecognized tax benefits with respect to certain of the unrecognized tax positions could decrease by up to approximately $3.7 million within the next 12 months if the statute of limitations expires on certain tax periods.
The Company’s operating subsidiaries in specific countries may be subject to audit by various tax authorities and may have different statutes of limitations expiration dates. With limited exceptions, the Company’s major subsidiaries that operate in the United States, United Kingdom and Australia are no longer subject to tax examinations for years before 2006, 2009 and 2006, respectively.
The Company’s ability to pay dividends to its shareholders is dependent upon the ability of its insurance and reinsurance subsidiaries to distribute capital and pay dividends to it. The Company’s insurance and reinsurance subsidiaries are subject to certain regulatory restrictions on the distribution of capital and payment of dividends in the jurisdictions in which they operate as more fully described below. The restrictions are generally based on net income or levels of capital and surplus as determined in accordance with the relevant statutory accounting practices. Failure of these subsidiaries to meet their applicable regulatory requirements could result in restrictions on any distributions of capital or retained earnings and/or stricter regulatory oversight of the subsidiaries. In addition, the Company’s ability to pay dividends and make other forms of distributions is further limited by repayment obligations in the Company’s outstanding loan facility agreements.
As at December 31, 2012, the amount of consolidated retained earnings of the Company that was free of restrictions and therefore potentially available to be distributed to the Company’s ordinary shareholders was $972.9 million (2011: $689.0 million). This amount is held primarily within our insurance and reinsurance subsidiaries and represents retained earnings held in those companies in excess of their minimum regulatory requirements. Although these amounts are in excess of statutory minimums, regulators may nonetheless further restrict distributions, and therefore actual amounts available for distribution to shareholders are likely to be significantly less. In addition, the Company does not intend to pay dividends on its ordinary shares, as it intends instead to reinvest any distributions from its subsidiaries back into the Company, primarily as a means to fund future acquisitions.
The statutory capital and surplus amounts for the years ended December 31, 2012 and 2011 and statutory net income (loss) amounts for the years ended December 31, 2012, 2011 and 2010 for the Company’s insurance and reinsurance subsidiaries based in Bermuda, the United Kingdom, Australia, the United States and Europe are as follows:
The Company’s Bermuda-based insurance and reinsurance subsidiaries are registered under the Insurance Act 1978 of Bermuda and related regulations, as amended (the “Insurance Act”). The Insurance Act requires that the Company’s Bermuda-based insurance and reinsurance subsidiaries maintain certain solvency and liquidity standards. These are determined as a percentage of either net reserves for losses and loss expenses or premiums and, for some of our subsidiaries, pursuant to a risk-based capital measure.
Each of the Company’s regulated Bermuda insurance and reinsurance subsidiaries would be prohibited from declaring or paying any dividends if it is in breach of its minimum solvency margin (which is a function of outstanding losses) or liquidity ratio (which is a function of relevant assets) or if the declaration or payment of such dividends would cause it to fail to meet such margin or ratio. In addition, each of the Company’s regulated Bermuda insurance and reinsurance subsidiaries is prohibited, without the prior approval of the Bermuda regulator, from reducing by 15% or more its total statutory capital as set out in its previous year’s statutory financial statements.
As of December 31, 2012 and 2011, all of the Company’s Bermuda-based insurance and reinsurance subsidiaries exceeded their respective minimum solvency and liquidity requirements. The Bermuda insurance and reinsurance subsidiaries in aggregate exceeded minimum solvency requirements by $534.7 million as of December 31, 2012 (2011: $537.3 million) and exceeded minimum liquidity requirements by $369.4 million as of December 31, 2012 (2011: $433.7 million).
The Company’s U.K. based insurance subsidiaries are regulated by the U.K. Financial Services Authority (the “FSA”) and are required to maintain adequate financial resources, the rules for which are set out in the General Prudential Sourcebook (“GENPRU”) and the Prudential Sourcebook for Insurers (“INSPRU”) of the FSA’s Handbook of Rules and Guidance.
In addition, the FSA’s Individual Capital Adequacy Standards (“ICAS”) framework requires insurance companies to carry out various capital modeling and risk management exercises in order to calculate a company-specific Individual Capital Assessment (“ICA”) amount, which is the company’s internal calculation of its capital requirements under the ICAS framework. The basis for this calculation is prescribed in GENPRU and is intended to ensure a company holds sufficient capital such that there is no material risk that its liabilities cannot be met as they fall due. In 2009, the European Parliament approved the Solvency II framework directive. Solvency II was due to take effect January 1, 2014, but is now expected to be delayed until January 2016. Solvency II will set out new, strengthened EU-wide requirements on capital adequacy and risk management for insurers with the aim of increasing policyholder protection, instilling greater risk awareness and improving the international competitiveness of EU insurers.
The FSA’s rules require the Company’s U.K. insurance subsidiaries to obtain FSA approval for any proposed or actual payment of a dividend. The FSA uses the ICA and the estimated capital requirement for Solvency II purposes when assessing requests to make distributions and therefore dividends approved by the FSA will often significantly differ from any surplus capital above the entity’s minimum capital resources requirements.
to cover its insurance liabilities to a 99.5% level of sufficiency of capital before APRA will consent to a capital release or dividend.
The U.S. subsidiaries are required to file annual statements with insurance regulatory authorities prepared on a statutory basis prescribed or permitted by such authorities. Statutory accounting principles differ from U.S. GAAP in the treatment of various items, including treatment of deferred acquisition costs, deferred income taxes, required investment reserves, reserve calculation assumptions and surplus notes. For the Company’s U.S. insurance and reinsurance subsidiaries, there are no prescribed or permitted statutory accounting practices that differ significantly from the statutory accounting principles established by the NAIC. The U.S. insurance and reinsurance subsidiaries are also required to maintain minimum levels of solvency and liquidity as determined by law, and to comply with risk-based capital requirements and licensing rules.
The Company’s Swiss insurance subsidiary is regulated by the Swiss Financial Market Supervisory Authority (“FINMA”) pursuant to the Insurance Supervisory Act 2004. This subsidiary is obligated to maintain a minimum solvency margin based on the Solvency I and Swiss Solvency Test regulations (“SST”) as stipulated by the Insurance Supervisory Act. As of December 31, 2012 and 2011, this subsidiary exceeded the Solvency I requirements by $103.9 million (2011: $107.7 million) and exceeded the SST requirements by $44.9 million (2011: $32.6 million).The amount of dividends that this subsidiary is permitted to distribute is restricted to freely distributable reserves, which consist of retained earnings, the current year profit and legal reserves. Any dividend exceeding the current year profit requires FINMA’s approval. The solvency and capital requirements must continue to be met following any distribution.
The Company’s investments are held by 21 different custodians. These custodians are all large financial institutions that are highly regulated. These institutions have controls over their investment processes that are certified annually. The largest concentration of fixed maturities investments, by fair value, at a single custodian was $1.8 billion and $2.1 billion as of December 31, 2012 and 2011, respectively.
The Company leases office space under operating leases expiring in various years through 2018. The leases are renewable at the option of the lessee under certain circumstances. The following is a schedule of future minimum rental payments on non-cancellable leases as of December 31, 2012:
As at December 31, 2012 and 2011, the Company had, in total, parental guarantees supporting Fitzwilliam’s obligations in the amount of $213.3 million and $219.9 million, respectively.
The Company has entered into definitive agreements with respect to: (i) the Reciprocal of America loss portfolio transfer, which is expected to close in the second quarter of 2013; (ii) the American Physicians Assurance Corporation assignment and assumption agreement, which is expected to close in the second quarter of 2013; and (iii) the purchase of the HSBC Insurance Companies, which is expected to close by the end of the first quarter of 2013. The HSBC agreement is described in Note 2 - “Acquisitions,” and the Reciprocal of America and American Physicians Assurance Corporation agreements are described in Note 3 - “Significant New Business.”
In connection with the Company’s acquisition of SeaBright, two purported class action lawsuits were filed against SeaBright, the members of its board of directors, AML Acquisition, and, in one of the cases, the Company. The first suit was filed September 13, 2012 in the Superior Court of the State of Washington and the second suit was filed September 20, 2012 in the Court of Chancery of the State of Delaware. The lawsuits allege, among other things, that SeaBright’s directors breached their fiduciary duties when negotiating, approving and seeking stockholder approval of the Merger, and that SeaBright and the Company or its merger subsidiary aided and abetted the alleged breaches of fiduciary duties. In the suits, plaintiffs sought to enjoin defendants from taking any action to consummate the transactions contemplated by the Merger Agreement, as well as monetary damages, including attorneys’ fees and expenses. The Company believes these suits are without merit. Nevertheless, in order to avoid the potential cost and distraction of continued litigation and to eliminate any risk of delay to the closing of the Merger, the Company, SeaBright and the SeaBright director defendants agreed in principle to settle the two lawsuits, without admitting any liability or wrongdoing. The settlement required SeaBright to make supplemental information available to its stockholders through a filing of a Current Report on Form 8-K with the U.S. Securities and Exchange Commission. The settlement did not change the amount of the consideration that the Company paid to SeaBright’s stockholders in any way, nor did it alter any deal terms. The settlement is subject to execution and delivery of definitive documentation, approval by the Washington court of the settlement and approval by the Delaware court of the dismissal of the Delaware suit. If the settlement becomes effective, both lawsuits will be dismissed.
We have audited Enstar Group Limited’s internal control over financial reporting as of December 31, 2012, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Enstar Group Limited’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, included in the accompanying Form 10-K under Item 9A, “Controls and Procedures”. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.