We currently occupy our office space in Grand Cayman, Cayman Islands under operating lease agreements which will expire on June 30, 2018 unless we renew the leases for an additional five year term. In addition, during 2011, GRIL entered into an operating lease agreement for office space in Dublin, Ireland which expires in 2031 but provides us an option to terminate the lease in 2016 or 2021 without any penalty. We believe that for the foreseeable future the office spaces in the Cayman Islands and Ireland will be sufficient for conducting our operations.
We believe the reinsurance industry in general has been, and for the foreseeable future will remain, over-capitalized. An influx of new capital, particularly for peak zone catastrophe risk, from alternative capital market participants such as hedge funds, pension funds and other fixed income bond managers has contributed to the over-capitalization. Additionally, we believe that the slowdown in global economic activity continues to weaken the overall demand for property and casualty insurance and, accordingly, reinsurance. However, the over-capitalization of the market is not uniform across all insurers and reinsurers and there are many insurers and reinsurers, including those that are deemed with lower financial security profiles, that have and will continue to suffer disproportionately. We believe the value proposition of our reinsurance offering and our differentiated underwriting strategy, together with our “A (Excellent)” rating by A.M.Best, positions us well to compete for new business.
The reinsurance industry has recently experienced several announcements of mergers and acquisitions ("M&A") between large reinsurance companies. We believe there is likely to be further consolidation in the industry. However, this consolidation will not likely result in a significant reduction in total capital within the industry, but simply a concentration of capital in fewer, larger participants. Due to the reduction in the number of competitors in the industry, we believe pricing may partially stabilize. We also believe that while some business may be further restricted to only the largest reinsurance companies in the industry, this consolidation may create an opportunity for us as more capacity may be made available to other reinsurers.
Premium Revenues and Risk Transfer. Our property and casualty reinsurance premiums are recorded as premiums written based upon contract terms and information received from ceding companies and their brokers. For excess of loss reinsurance contracts, premiums are typically stated as a percentage of the subject premiums written by the client, subject to a minimum and deposit premium. The minimum and deposit premium is typically based on an estimate of subject premiums expected to be written by the client during the contract term. The minimum and deposit premium is reported initially as premiums written and adjusted, if necessary, in subsequent periods once the actual subject premium is known. For catastrophe contracts that contractually require the payment of a reinstatement premium equal to or greater than the original premium upon the occurrence of a full limit loss, the reinstatement premiums are earned over the original contract period. Reinstatement premiums that are contractually calculated on a pro-rata basis of the original premiums are earned over the remaining coverage period.
We account for reinsurance contracts in accordance with U.S. GAAP. Assessing whether or not a reinsurance contract meets the conditions for risk transfer requires judgment. The determination of risk transfer is critical to reporting premiums written and is based, in part, on the use of actuarial and pricing models and assumptions. If we determine that a reinsurance contract does not transfer sufficient risk, or if a contract provides retroactive reinsurance coverage, we use deposit accounting. Any losses on such contracts are charged to earnings immediately and recorded in the consolidated statements of income as other expense. Any gains relating to such contracts are deferred and amortized over the estimated remaining settlement period. All such deferred gains are included in reinsurance balances payable in the consolidated balance sheets. Amortized gains are recorded in the consolidated statements of income as other income.
case reserves resulting from claims notified to us by our clients;
We establish reserves for contracts based on estimates of the ultimate cost of all losses including IBNR. These estimated ultimate reserves are based on our own actuarial estimates derived from reports received from ceding companies, industry data and historical experience. These estimates are periodically reviewed by the Company on a contract by contract basis and adjusted when necessary. Since reserves are estimates, the setting of appropriate reserves is an inherently uncertain process. Our
For all non-natural peril business, we initially reserve every individual contract to the expected loss and loss expense ratio that we calculated when we originally priced the business. In our pricing analysis, we typically utilize a significant amount of information both from the individual client and from industry data. Where practical, we compare historic reserving data that we receive from our client, if any, to publicly available financial statements of the client in an effort to identify, confirm and monitor the accuracy and completeness of the data. We require each of our clients to provide loss information for each reporting period, which, depending on the contract, could be monthly or quarterly. The loss information required depends on the terms and conditions of each contract and may include many years of history. Depending on the type of business underwritten, we are entitled to receive client and industry information on historical paid losses, incurred losses, number of open claims, number of closed claims, number of total claims, listings of individual large losses, earned premiums, policy count, policy limits underwritten, exposure information and rate change information. We may also receive information by class or subclass of business. If the reserving data is not available from a client, we rely on industry data, as well as the judgment and experience of our underwriters and actuaries.
Additionally, we contract with a third-party actuarial firm to perform a quarterly reserve review and to annually opine on the reasonableness and adequacy of our loss reserves. We provide our external actuary with our pricing models, reserving analysis and any other data they may request. Additionally, the actuarial firm may inquire as to the various assumptions and estimates that we may use in our reserving analysis. The external actuarial firm independently creates its own reserving models based on industry loss information, augmented by specific client loss information that we may be asked to provide as well as its own independent assumptions and estimates. Based on various reserving methodologies that the actuarial firm considers appropriate, it creates a reserve estimate for each contract in our portfolio and provides us with an aggregate recommended loss reserve, including IBNR. If there are material differences between our booked reserves and the actuarial firm’s recommended reserves, we review the differences and make any necessary adjustments to the booked reserves. To date there have been no material differences resulting from the external actuary's reviews.
Acquisition Costs. We capitalize brokerage fees, ceding commissions, premium taxes and other direct expenses that relate directly to and vary with the writing of reinsurance contracts. Acquisition costs are deferred subject to ultimate recoverability and amortized over the related period of risk covered. Acquisition costs also include profit commissions. Certain contracts include provisions for profit commissions to be paid to the ceding insurer based upon the ultimate experience of the contracts. The methodology for calculating profit commissions is specific to the individual contracts and varies from contract to contract. Typically profit commissions are calculated and accrued based on the expected ultimate loss experience for such contracts and recorded when the expected loss experience indicates that a profit commission is probable under the contract terms. Profit commission reserves, if any, are included in reinsurance balances payable on the consolidated balance sheets.
Our primary financial goal is to increase the long-term value in fully diluted adjusted book value per share. During the year ended December 31, 2014, the fully diluted adjusted book value per share increased by $2.85 per share, or 10.2%, to $30.76 per share from $27.91 per share at December 31, 2013. For the year ended December 31, 2013, the fully diluted adjusted book value per share increased by $5.90 per share, or 26.8%, to $27.91 per share from $22.01 per share at December 31, 2012.
Details of gross premiums written are provided in the following table:
choosing to retain a larger share on the renewed contracts compared to the expiring contracts. The decrease in frequency gross premiums written was partially offset by a number of new contracts entered into relating to the general liability, specialty health and workers' compensation lines of business.
During 2013, we increased our gross premiums written by $107.9 million, or 25.2%, as we continued to grow our key areas of focus, principally, private passenger automobile insurance and Florida homeowners' insurance.
For the year ended December 31, 2013, the frequency gross premiums written increased by $106.6 million, or 26.3%, primarily as a result of growth in our motor liability and personal property contracts, which increased by $75.5 million, or 42.4%, and $57.9 million, or 73.9%, respectively. The motor liability line includes both commercial motor contracts as well as private passenger automobile contracts (also referred to as non-standard automobile). The increase in motor liability line was primarily driven by an increase of $77.9 million in private passenger automobile premiums written due to an increase in the volume of underlying business written by our clients. The increase in motor liability premiums was partially offset by a decrease of $2.4 million in commercial motor premiums written as we canceled all of our remaining commercial motor related contracts during 2013.
The increases in frequency net premiums earned were offset by decreases in our general liability and workers' compensation premiums earned, which decreased by $27.0 million and $8.0 million, respectively, primarily because during 2013 we commuted a multi-line contract that included coverages for commercial motor, workers' compensation and general liability.
Premiums written relating to severity contracts are earned over the contract period in proportion to the period of protection. For the year ended December 31, 2013, severity net premiums earned decreased $4.1 million, or 18.6%, compared to the same period in 2012. The decrease was primarily due to the reversal of $2.9 million of reinstatement premiums earned in conjunction with the elimination of loss reserves relating to super-storm Sandy. During 2013, we entered into new severity contracts which contributed $11.5 million in earned premiums, which was partially offset by reductions in earned premiums from contracts that expired and were not renewed, and contracts renewed at lower premium amounts due to our participation being at lower risk exposure levels.
We establish reserves for each contract based on estimates of the ultimate cost of all losses including losses incurred but not reported. These estimated ultimate reserves are based on reports received from ceding companies, industry data and historical experience as well as our own actuarial estimates. Quarterly, we review these estimates on a contract by contract basis and adjust as we deem appropriate to reflect our best estimates based on updated information and our internal actuarial estimates. We expect losses incurred on our severity business to be volatile depending on the number and magnitude of catastrophic events from year to year.
For the years ended December 31, 2014 and 2013, the loss ratios for our severity business were 16.1% and (48.1)%, respectively. During the year ended December 31, 2014 our severity business was not impacted by any major catastrophe events. The net losses incurred on severity contracts of $3.8 million for the year ended December 31, 2014, primarily related to attritional loss reserves on certain excess of loss contracts. The negative loss ratio of (48.1)% for the comparable year ended December 31, 2013, was due to the reversal of loss reserves relating to super-storm Sandy. Excluding the effect of that loss reserve reversal (and the corresponding reversal of reinstatement premiums), the severity loss ratio for the year ended December 31, 2013 was 29.9% which included a $4.0 million increase in loss reserves on a casualty clash contract.
For the year ended December 31, 2013, the net losses incurred on frequency contracts increased by $3.1 million, or 0.9%. This increase is the net result of the 19.2% increase in earned premiums, partially offset by the decrease in loss reserves primarily related to commercial motor contracts currently in run off. For the year ended December 31, 2013, the incurred losses relating to commercial motor contracts were negative $2.1 million compared to $53.2 million in 2012. During 2012, we had increased the loss reserves relating to these contracts based on loss data, which had indicated adverse loss development due to several large losses and overall higher settlement amounts expected on open claims. For the year ended December 31, 2013, the incurred losses on these contracts decreased as we reversed some of the loss reserves due to favorable loss development and due to commutation of a multi-line contract during 2013. The commuted multi-line contract also included coverage for general liability and workers' compensation which also contributed to the decrease in loss reserves.
For the years ended December 31, 2013 and 2012, the loss ratios for our severity business were (48.1)% and 101.2%, respectively. The net losses incurred on severity contracts of $(8.7) million for the year ended December 31, 2013, included $(15.0) million of loss reserves reversed during 2013 relating to super-storm Sandy. During 2012, the estimated loss from super-storm Sandy was reserved at the full limit of the excess of loss contract. However, during the first quarter of 2013, we received additional information from our client that indicated that the losses would not exceed the threshold of the layer of coverage provided under our contract. Excluding the effect of the super-storm Sandy related contract, the severity loss ratio for the year ended December 31, 2013 was 29.9% compared to 45.2% for the year ended December 31, 2012. The 2013 losses incurred on severity contracts included a $4.0 million increase in loss reserves on a casualty clash contract based on updated information from the client indicating higher estimated ground up losses which in turn would increase the losses in the layer covered by us. By comparison, the 2012 loss ratio included $9.0 million of loss reserves relating to the 2010 New Zealand earthquake. To a lesser extent, the severity loss ratio for the year ended December 31, 2013 included attritional loss reserves recorded on new severity contracts entered into during 2013.
For the years ended December 31, 2014 and 2013, the acquisition cost ratios for frequency business were 31.2% and 31.7%, respectively. For the year ended December 31, 2014, the slightly lower frequency acquisition cost ratio was related to a combination of decreases in specialty health, professional liability and workers' compensation lines, partially offset by increases in general liability and personal property lines. Acquisition cost ratio for the motor line remained unchanged due to the lower ceding commissions on the in-force private passenger contracts being entirely offset by an increase in sliding scale commission adjustments from the favorable loss development on prior period private passenger contracts.
For the years ended December 31, 2013 and 2012, the severity acquisition cost ratios were 20.8% and 14.0%, respectively. For the year ended December 31, 2013, the higher severity acquisition cost ratio was partially related to the impact of the reinstatement premiums reversed during 2013 relating to super-storm Sandy with no corresponding reversal of commissions. Excluding the impact of this reversal, the 2013 acquisition cost ratio was 18.0%. Additionally, the higher acquisition cost ratio also related to higher commissions on new severity contracts written during 2013. Additionally, the 2012 acquisition cost ratio was lower as a result of the reinstatement premiums earned relating to super-storm Sandy.
Investment returns relating to our investment portfolio managed by DME Advisors are calculated monthly and compounded to calculate the quarterly and annual returns. The resulting actual investment income may vary depending on cash flows into or out of the investment account.
For the year ended December 31, 2014, investment income, net of all fees and expenses, resulted in a gain of 8.7% on our investment portfolio. This compares to a gain of 19.6% and a gain of 7.1% reported for the years ended December 31, 2013 and 2012, respectively.
Our investment advisor, DME Advisors, and its affiliates manage and expect to manage other client accounts besides ours, some of which have investment objectives similar to ours. To comply with Regulation FD, our investment returns are posted on our website on a monthly basis. Additionally, our website (www.greenlightre.ky) provides the names of the largest disclosed long positions in our investment portfolio as of the last business day of the month of the relevant posting, as well as
information on our long and short exposures. Although DME Advisors discloses all investment positions to us, it may choose not to disclose certain positions to its clients in order to protect its investment strategy. Therefore, we present on our website the largest long positions and exposure information as disclosed by DME Advisors or its affiliates to their other clients.
We are not obligated to pay taxes in the Cayman Islands on either income or capital gains. We have been granted an exemption by the Governor-In-Cabinet from any income taxes that may be imposed in the Cayman Islands for a period of 20 years, expiring on February 1, 2025.
The acquisition cost ratio is calculated by dividing net acquisition costs by net premiums earned. This ratio demonstrates the higher acquisition costs incurred for our frequency business than for our severity business.
Our investment portfolio, including any derivatives, is valued at fair value and any unrealized gains or losses are reflected in net investment income in the consolidated statements of income. As of December 31, 2014, 83.9% (2013: 85.9%) of our investment portfolio (excluding restricted and unrestricted cash and cash equivalents) was comprised of investments valued based on quoted prices in actively traded markets (Level 1), 14.5% (2013: 12.3%) was comprised of securities valued based on observable inputs other than quoted prices (Level 2) and 1.6% (2013: 1.8%) was comprised of securities valued based on non-observable inputs (Level 3).
As of December 31, 2014, our securities sold, not yet purchased decreased by $21.0 million, or 1.9%, to $1,090.7 million from $1,111.7 million at December 31, 2013, as we reduced the number and size of short positions and decreased the short exposure in our portfolio from 69.8% to 66.9%. As of December 31, 2014, the restricted cash included $1,090.7 million relating to collateral for securities sold, not yet purchased compared to $1,111.7 million as of December 31, 2013.
Sudden unexpected changes in the underlying business model of the issuer;
Given the various scenarios under which a loss may occur on a short sale, it is not possible to quantify the risk and uncertainty of loss relating to short sales. However, DME Advisors typically performs a detailed analysis prior to entering into a short sale. Thereafter, the investment is routinely monitored by DME Advisors. As of December 31, 2014, Greenlight Re's investment guidelines limit any single investment from constituting more than 20% of the portfolio (10% for GRIL's portfolio) at any given time, hence limiting the potential adverse impact on our results of operations and financial position.
The decrease in frequency loss reserves as of December 31, 2014 was partially due to the decrease in premiums earned for the year ended December 31, 2014 and partially due to losses paid on contracts currently in run-off. See "Note 7. Loss and Loss Adjustment Expense Reserves" for a summary of changes in outstanding loss and loss adjustment expense reserves. The decrease in severity loss reserves as of December 31, 2014, was principally a result of losses paid during the 2014 year for which loss reserves had been established in the prior year.
Our severity business includes contracts that contain or may contain natural peril loss exposure. As of January 1, 2015, our maximum aggregate loss exposure to any series of natural peril events was $216.2 million. For purposes of the preceding sentence, aggregate loss exposure is net of any retrocession and is equal to the difference between the aggregate limits available in the contracts that contain natural peril exposure minus estimated reinstatement or additional premiums, if any, for the same contracts. We categorize peak zones as: United States, Canada and the Caribbean, Europe, Japan and the rest of the world. The following table provides any single event loss exposure and aggregate loss exposure information for the peak zones of our natural peril coverage as of the date of this filing:
As of December 31, 2014, Greenlight Re and GRIL were each rated "A (Excellent)" with a stable outlook by A.M. Best. The ratings reflect A.M. Best’s opinion of our reinsurance subsidiaries’ financial strength, operating performance and ability to meet obligations and it is not an evaluation directed toward the protection of investors or a recommendation to buy, sell or hold our Class A ordinary shares. If A.M. Best downgrades our ratings below "A- (Excellent)" or withdraws our rating, we could be severely limited or prevented from writing any new reinsurance contracts, which would significantly and negatively affect our business. Insurer financial strength ratings are based upon factors relevant to policyholders and are not directed toward the protection of investors. Our A.M. Best ratings may be revised or revoked at the sole discretion of the rating agency.
Our sources of funds consist primarily of premium receipts (net of brokerage and ceding commissions), investment income (net of advisory compensation and investment expenses), including realized gains, and other income. We use cash from our operations to pay losses and loss adjustment expenses, profit commissions and general and administrative expenses. Substantially all of our funds, including shareholders’ capital, net of funds required for cash liquidity purposes, are invested by DME Advisors in accordance with our investment guidelines. As of December 31, 2014, approximately 92% (December 31, 2013: 89%) of our long investments were comprised of publicly-traded equity securities and gold bullion which can be readily liquidated to meet current and future liabilities. As of December 31, 2014, the majority of our investments were valued based on quoted prices in active markets for identical assets (Level 1). Given our value-oriented long and short investment strategy, if markets are distressed we would expect the liability of the short portfolio to decline. Any reduction in the liability would cause our need for restricted cash to decrease and thereby free up cash to be used for any purpose. Additionally, since the majority of our invested assets are liquid, even in distressed markets, we believe securities can be sold or covered to generate cash to pay claims. Since we classify our investments as "trading," we book all gains and losses (including unrealized gains and losses) on all our investments (including derivatives) as net investment income in our consolidated statements of income for each reporting period.
As of December 31, 2014, we believe we have sufficient cash flow from operating and investing activities to meet our foreseeable liquidity requirements. We believe that our future operational needs for liquidity can be readily fulfilled from the use of cash, funds generated from underwriting activities and investment income, including realized gains. As of December 31, 2014, we had no plans to issue debt and expect to fund our operations for the next twelve months from operating cash flow. However, we cannot provide assurances that in the future we will not incur indebtedness to implement our business strategy, pay claims or make acquisitions.
Our capital structure currently consists entirely of equity issued in two separate classes of ordinary shares. We expect that the existing capital base and internally generated funds will be sufficient to implement our business strategy for the foreseeable future. Consequently, we do not presently anticipate that we will incur any material indebtedness in the ordinary course of our business other than temporary borrowing directly related to the management of our investment portfolio. However, in order to provide us with flexibility and timely access to public capital markets should we require additional capital for working capital, capital expenditures, acquisitions or other general corporate purposes, we have filed a Form S-3 registration statement, which expires in June 2015 unless renewed. We did not make any significant commitments for capital expenditures during the year ended December 31, 2014.
On April 28, 2010, our shareholders approved an amendment to our stock incentive plan to increase the number of Class A ordinary shares available for issuance from 2.0 million to 3.5 million. As of December 31, 2014, there were 803,558 Class A ordinary shares available for future issuance.
Greenlight Re has entered into lease agreements for office space in the Cayman Islands. The leases expire on June 30, 2018 and Greenlight Re has the option to renew the leases for a further five year term. Under the terms of the lease agreements, Greenlight Re is committed to annual rent payments ranging from $0.3 million at inception to $0.5 million at expiry. The minimum lease payment obligations are included in the above table under operating lease obligations and in Note 8 to the accompanying consolidated financial statements.
The Company has entered into a service agreement with a specialist service provider for the provision of administration and support in developing and maintaining business relationships, reviewing and recommending programs and managing risks relating to certain specialty lines of business. The specialist service provider does not have any authority to bind the Company to any reinsurance contracts. Under the terms of the agreement, the Company has committed to quarterly payments to the specialist service provider. If the agreement is terminated, the Company is obligated to make minimum payments for twelve months starting on September 1 of the year in which the agreement is terminated, to ensure contracts to which the Company is bound are adequately administered by the specialist service provider. The minimum payments are included in the above table under specialist service agreement and in Note 8 to the accompanying consolidated financial statements.
We consider the effects of inflation in our pricing and when estimating loss and loss adjustment expense reserves. The actual effects of inflation on our results of operations cannot be accurately known until claims are ultimately settled. For the years ended December 31, 2014, 2013 and 2012, inflation had no significant impact on our revenues or net income. We do not believe that inflation has had or will have a material effect on our combined results of operations, except insofar as inflation may affect interest rates and the asset values in our investment portfolio.