The following is a discussion and analysis of our results of operations for the years ended December 31, 2012, 2011 and 2010 and our financial condition at December 31, 2012 and 2011. This should be read in conjunction with the Consolidated Financial Statements and related notes included in Item 8 of this report. Tabular dollars are in thousands, except per share amounts. Amounts in tables may not reconcile due to rounding differences.
Results by Segment: Years ended December 31, 2012, 2011 and 2010
Total cash and investments of $14.4 billion; fixed maturities, cash and short-term securities comprise 90% of total cash and investments and have an average credit rating of AA-
We are a Bermuda-based global provider of specialty lines insurance and treaty reinsurance products with operations in Bermuda, the United States, Europe, Singapore, Canada, Australia and Latin America. Our underwriting operations are organized around our two global underwriting platforms, AXIS Insurance and AXIS Reinsurance.
the continuing growth of our new accident & health line, focused on specialty accident and health products; and
2012 versus 2011: The $590 million improvement in our underwriting result during 2012 was largely due to a reduction in the frequency and severity of natural catastrophe and weather-related losses. During 2011, we recognized aggregate pre-tax net losses (net of related reinstatement premiums) of $931 million for numerous catastrophe and weather events, including: the February Christchurch, New Zealand earthquake ("New Zealand II"), the Japanese earthquake and tsunami, the series of severe U.S. storms and tornadoes in April/May, first quarter Australian weather events (January floods and Cyclone Yasi), the Thai floods, the June Christchurch aftershock ("New Zealand III"), the Danish floods, Hurricane Irene and Tropical Storm Lee; these events impacted our reinsurance segment to a greater extent. Comparatively, in 2012, we recognized pre-tax net losses (net of related reinstatement premiums) of $331 million for Storm Sandy and an aggregate $105 million for the impact
of severe drought conditions on U.S. crops, Hurricane Isaac and first and second quarter U.S. weather events. Growth in net premiums earned in our insurance segment and improvements in the current accident year loss ratios exclusive of the catastrophe and weather-related losses for both segments further contributed to the improvement in 2012; this was partially offset by a $13 million reduction in net favorable prior year reserve development and growth in general and administrative expenses.
2011 versus 2010: The significantly high frequency and severity of natural catastrophe activity in 2011, described above, was the primary driver of the deterioration in underwriting results in that year. However, natural catastrophe activity also impacted underwriting results for 2010. In comparison to the $931 million for 2011 noted above, during 2010 we recognized aggregate pre-tax net losses (net of related reinstatement premiums) of $248 million for the September New Zealand earthquake (“New Zealand I”) and the Chilean earthquake, with substantially all of this emanating from our reinsurance segment. Further contributing to the reduction in underwriting income was a $56 million decrease in net favorable prior year reserve development.
The variability in our net investment income for 2010 through 2012 was largely attributable to our alternative investment portfolio ("other investments"). Income from this portfolio increased by $56 million in 2012, driven by improved performance for our hedge funds (reflective of global equity market performance) and credit funds (driven by pricing improvement in underlying bank loans). Comparatively, income from these investments decreased $33 million in 2011, reflective of the underperformance of both global equities and bank loans during in that year.
We believe that the following financial indicators are important in evaluating our performance and measuring the overall growth in value generated for our common shareholders:
Value creation represents the change in diluted book value per common share and dividends declared during the period.
2011 versus 2010: Our underwriting loss, driven by catastrophe and weather-related losses, was the primary driver of the negative operating ROACE for 2011; reductions in net favorable prior year reserve development and net investment income also contributed to a lower return when compared to 2010.
The previously described impact of catastrophe and weather-related losses on our 2011 net income available to common shareholders was the primary driver of the 3% reduction in our diluted book value per common share for the 2011 fiscal year. During 2012, our diluted book value per common share appreciated by 13%, driven by $495 million in net income available
Group (or consolidated) underwriting income (loss) is a non-GAAP financial measure as defined in SEC Regulation G. Refer to Item 8, Note 3 to the Consolidated Financial Statements, for a reconciliation of consolidated underwriting income (loss) to the nearest GAAP financial measures (income before income taxes) for the periods indicated above. Also, refer to 'Non-GAAP Financial Measures' for additional information related to the presentation of consolidated underwriting income (loss).
Changes in net premiums earned reflect period to period changes in net premiums written and business mix, together with normal variability in premium earning patterns.
2012 versus 2011: A lower level of natural catastrophe and weather-related losses in 2012 was the primary driver of the 20.0 point reduction in our current accident year loss ratio, though the ratios for both years were significantly impacted by natural catastrophe events.
Comparatively, numerous notable natural catastrophe and significant weather events impacted our results in 2011, namely: New Zealand II, the Japanese earthquake and tsunami, the series of severe U.S. storms and tornadoes in April and May, first quarter Australian weather events, the Thai floods, New Zealand III, the Danish floods, Hurricane Irene and Tropical Storm Lee. In aggregate, we recognized pre-tax net losses (net of related reinstatement premiums) of of $931 million in relation to
2011 versus 2010: The level of natural catastrophe and weather-related losses was also the primary driver of the variance in the current accident year loss ratios for these years. In comparison to the 2011 catastrophe and weather-related losses noted above, we recognized pre-tax net losses (net of related reinstatement premiums) of $138 million for New Zealand I and $110 million for the February earthquake in Chile during 2010. In addition, there were a number of other weather-related loss events during 2010, including Australian and U.S. storms and European Windstorm Xynthia in the first quarter and further Australian storms and flooding and U.S. storms in the fourth quarter. The 2010 events principally impacted our reinsurance segment.
Rate reductions, changes in business mix and an increased level of property and marine loss activity contributed to an increase in our insurance segment; and
We continue to monitor paid and incurred loss development for catastrophe events of prior years and update our estimates of ultimate losses accordingly. While there was no material change in our aggregate estimate for the events of 2011 and 2010 during 2012, updated information received during the year resulted in revisions to our estimated ultimate losses for each of the three New Zealand earthquakes; our estimate for the 2010 accident year event (New Zealand I) decreased and our combined estimate for the 2011 accident year events (New Zealand II/III) increased.
Refer to the ‘Critical Accounting Estimate - Reserve for Losses and Loss Expenses’ section for further details. We caution that conditions and trends that impacted the development of our reserve for losses and loss expenses in the past may not recur in the future.
The following sections provide further details on prior year reserve development by segment, reserving class and accident year.
$19 million of net favorable prior year reserve development on professional lines business, primarily related to the 2006 through 2008 accident years and for the reasons discussed in the overview.
$14 million of net adverse prior year reserve development on credit and political risk business, primarily driven by $21 million in adverse development on the 2009 accident year as we reduced our recovery estimates based on the latest available information. Partially offsetting this amount was $8 million in net favorable development on the 2007 and 2008 accident years.
$50 million of net favorable prior year reserve development on professional lines business. We recognized a total of $60 million of net favorable development for 2004 through 2007 accident years, largely due to the reasons discussed in the overview. This amount included $19 million reallocated from the 2007 accident year to the 2008 accident year, recognized after consideration of our claims history and other available information and data for accident years impacted by the global financial crisis; in the aggregate, our estimate for global financial crisis remained unchanged. Partially offsetting this was the recognition of $8 million of net adverse development on the 2010 accident year.
$18 million of net adverse prior year reserve development on credit and political risk business. This balance consisted of net adverse development of $54 million on the 2009 accident year, as we finalized settlements for certain loss events and reduced our recovery estimates for the latest available information. Partially offsetting this amount was $36 million in net favorable prior year reserve development on the 2006 through 2008 accident years, in recognition of better than anticipated loss emergence on our CEND and credit business.
$7 million of net adverse development on liability business, primarily related to the 2007 through 2009 accident years and reflecting earlier than expected loss emergence on our U.S. excess and surplus lines umbrella business for those accident years during 2010.
$80 million of net favorable prior year reserve development on property and other business, consisting largely of:
$63 million of net favorable prior year reserve development on catastrophe and property business. Net favorable development was evident across all accident years, with the exception of 2011, and was largely due to better than expected loss emergence. We recognized net adverse development of $18 million on the 2011 accident year, driven by the revision in our estimates for New Zealand II/III as noted under 'Estimates for Significant Catastrophe Events' above.
$34 million of net favorable prior year reserve development on professional lines reinsurance business, primarily related to the 2007, and to a lesser extent 2006, accident years for the reasons discussed in the overview.
In 2011, we recognized $154 million of net favorable prior year reserve development, the principal components of which were:
$11 million of net favorable prior year reserve development on crop business, largely related to the 2010 accident year and due to better than expected loss emergence.
$32 million of net adverse prior year reserve development on motor reinsurance business, primarily related to 2008 through 2010 accident year non-proportional business and due to changes in assumptions relating to settlement practices in the U.K. motor market (namely, Periodic Payment Orders, or “PPOs”).
In 2010, we recognized $195 million of net favorable prior year reserve development, the principal components of which were:
$75 million of net favorable prior year reserve development on property and catastrophe business, largely consisting of net favorable development on the 2009 ($39 million), 2007 ($14 million) and 2005 ($28 million) accident years and partially offset by net adverse development of $17 million on the 2008 accident year. Development on the 2009 and 2007 accident years was driven by better than expected loss emergence, while development on the 2005 accident year was driven by a favorable court judgment associated with one claim and a reduction in our reserve for another claim following the receipt of updated information. The net adverse development on the 2008 accident year largely related to updated information with respect to Hurricane Ike losses.
$38 million of net favorable prior year reserve development on trade credit and bond reinsurance lines of business, largely related to the 2009 accident year and, to a lesser extent the 2007 and 2008 accident years, in recognition of better than expected loss emergence and updated information from our cedants.
$60 million of net favorable prior year reserve development on professional lines reinsurance business, primarily on the 2006 accident year and, to a lesser extent the 2007, 2005 and 2004 accident years, for the reasons discussed in the overview.
2012 versus 2011: Growth in gross premiums written was evident in the majority of our lines of business, with professional lines, liability and accident & health contributing most significantly. Geographic expansion (including our European operations) and newer initiatives were the primary drivers of the growth in professional lines; an improving rate environment also contributed. Liability growth was attributable to select new business opportunities and, to a lesser extent, rate increases in our U.S. excess and surplus lines umbrella business. Our recently established accident & health line continued to generate new business. Property premiums were also up, as growth driven by rate increases and new business opportunities more than offset a reduction due to the non-renewal of certain catastrophe-exposed business written through MGAs.
2011 versus 2010: Our accident & health line, launched in 2010, led the 11% growth in gross premiums written. A large portion of this growth was due to accident & health reinsurance business assumed.
Comparatively, during 2011, we recognized estimated pre-tax net losses (inclusive of related premiums to reinstate our reinsurance protection) for the following natural catastrophe and weather related events:
a reduction in the ratio for our credit & political risk line of business (loss experience on this business was notably less in 2012, driving a 22 percentage point reduction in the ratio from 60% to 38%).
Natural catastrophe and weather-related losses were the primary driver of the 14.5 point increase. While the 2011 current accident year loss ratio was impacted by the events noted above, catastrophe-related pre-tax net losses were insignificant in 2010. Exclusive of these items, rate reductions, changes in business mix and a higher level of loss activity in our property and marine lines of business also contributed to a higher ratio in 2011.
General and Administrative Expense Ratio: General and administrative expenses increased in 2012, driven by performance-based compensation expenses and staff increases. From a general and administrative expense ratio perspective, commensurate growth in net premiums earned muted the impact on the 2012 ratio.
2011 versus 2010: The 8% growth in gross premiums written was primarily driven by our motor reinsurance line of business, driven by a higher volume of European proportional business; both increases on renewal and new business contributed. Gross premiums written for our trade credit and bond reinsurance business also increased, with both premium adjustments on prior year treaties and an increase in Latin American surety business contributing.
While natural catastrophe and weather-related losses contributed to the current accident year loss ratios for both periods, the impact was less significant in 2012.
$74 million in relation to the first quarter Australian weather events;
an aggregate $63 million in relation to New Zealand III, the Danish floods and Hurricane Irene.
Foreign Exchange Losses (Gains): Some of our business is written in currencies other than the U.S. dollar. Movements in the rates of exchange for the euro and Sterling against the U.S. dollar were the primary drivers of the amounts in each period presented. Appreciation in these currencies against the U.S. dollar resulted in foreign exchange losses on the remeasurement of our net insurance-related liabilities during 2012, whereas depreciation had the opposite effect in 2011 and 2010.
A significant portion of our losses and loss expenses for Storm Sandy related to insurance risks written by our U.S. subsidiaries, driving a low effective tax rate for 2012. Comparatively, a large proportion of the 2011 catastrophe and weather-related losses previously described arose from reinsurance risks written in Bermuda; these losses reduced income before tax without a corresponding tax benefit. Our U.S. and European operations generated taxable income in 2011, thus resulting in a notably higher effective tax rate for the year in comparison to 2010.
2012 versus 2011: The 10% reduction in investment income from fixed maturities reflected lower reinvestment yields throughout much of 2012 due to downward shifts in U.S. and European risk-free yield curves. Spread tightening, primarily on investment-grade and high yield corporate debt, also contributed to lower reinvestment yields. These declines were partially offset by growth of 6% on our average fixed maturities balances during 2012 as additional investments in fixed maturities were funded primarily by reinvestment of net investment income.
Other investments include hedge funds, fund of hedge funds, credit funds and CLO equity tranched securities (“CLO Equities”). These investments are recorded at fair value, with the change in fair value reported in net investment income. Consequently, the pre-tax return on other investments may vary materially period over period, particularly during volatile credit and equity markets.
The following table provides a breakdown of net realized investment gains:
We entered into foreign exchange forward contracts to hedge the foreign currency exposure of certain available for sale fixed maturity portfolios denominated in euros. The hedges were designated and qualified as fair value hedges, resulting in the net impact of the hedges recognized in net realized investment gains (losses). During 2012, we sold all available for sale fixed maturities in the portfolios that qualified for hedge accounting and settled all of the associated foreign exchange forward contracts.
Excluding the impact of foreign currencies due to matching with foreign denominated insurance liabilities, the total return would be 4.9% for 2012 (2011: 3.7%, 2010: 5.3%).
The cost of our total investments increased by $731 million from December 31, 2011, primarily due to investing a portion of our operating cash flows generated in 2012, investing cash on hand and reinvesting net investment income and proceeds from sales in 2012. In addition to these cash contributions, significant contributors to the increase in the fair value of our total investments from December 31, 2011 include improved valuations for our fixed maturities and equities and, to a lesser degree, movements in foreign exchange rates, mainly the euro strengthening against the U.S. dollar. The strong rally in global equity markets during 2012 combined with new and incremental hedge fund investments contributed to the increase in fair value of our other investments.
Our methodology for assigning credit ratings to our fixed maturities is in line with the methodology used for the Barclay's U.S. Aggregate Bond index. This methodology uses the middle of Standard & Poor's (S&P), Moody's and Fitch ratings. When ratings from only two of these agencies are available, the lower rating is used. When a rating from only one agency is available, it is used. Previously, we used S&P's ratings; in the absence of a rating from S&P, we used the lower of the ratings established by Moody's and Fitch.
As part of our ongoing risk management process, in addition to managing our credit risk exposure within our fixed maturity portfolio we also monitor the aggregation of country risk exposure on a group-wide basis (refer to Item 1 ‘Risk and Capital Management’ for further details). Country risk exposure is the risk that events within a country, such as currency crises, regulatory changes and other political events, will adversely affect the ability of obligors within the country to honor their obligations to us. For foreign corporate debt securities and structured securities, we measure the country risk exposure based
In light of global concerns over the creditworthiness of certain countries within the eurozone, we have actively managed our exposure to sovereign debt issued by these countries. During 2012, we sold all remaining sovereign debt holdings in France, Spain and Belgium. Our current non-U.S. government holdings include exposure to only three countries within the eurozone - Germany, Netherlands and Austria, all of which are rated AAA. At December 31, 2012, we held no sovereign debt issued by the peripheral European countries of Greece, Ireland, Italy, Portugal and Spain.
The increase was mainly due to an allocation to Treasury Inflation-Protected Securities ("TIPS") which are expected to reduce the impact of rising rates on the portfolio caused by higher than expected inflation.
Our holdings in non-U.S. government securities consisted of fixed income obligations of non-U.S. sovereigns, including government agencies, local governments and supranationals. The table below summarizes our aggregate fixed maturity exposures to governments in the eurozone and other non-U.S. government concentrations by fair value at December 31, 2012 and 2011:
The increase in corporate debt holdings during 2012 was mainly due to the increase in our allocation to short duration high yield corporate debt securities. At December 31, 2012, our short duration high yield portfolio had a fair value of $793 million (2011: $499 million), a weighted-average credit rating of B+ (2011: BB-) and duration of 1.7 years (2011: 1.3 years). The primary sector exposures for this high yield portfolio are consumer cyclical, communications, industrials, consumer non-cyclicals and energy. These five sectors comprise 75% (2011: 76%) of the total fair value of this portfolio.
During 2012, our holdings of non-agency RMBS declined mainly due to paydowns. At December 31, 2012, the average duration and weighted average life was 0.3 years (2011: 0.1 years) and 3.5 years (2011: 5.8 years), respectively, for non-agency RMBS.
During 2012, we continued to add municipal debt securities primarily to our taxable U.S. portfolios due to the attractive relative value of this asset class.
G.O. bonds are backed by the full faith and credit of the authority that issued the debt and are secured by the taxing powers of those authorities. Revenue bonds are backed by the revenue stream generated by the services provided by the issuer (e.g. sewer, water or utility projects). As issuers of revenue bonds do not have the ability to draw from tax revenues or levy taxes to fund obligations, revenue bonds may carry a greater risk of default than G.O. bonds. At December 31, 2012, the top three revenue streams related to transportation (22%), school (12%) and power (11%) (2011: transportation (20%), power (15%) and school (14%)).
The improvement in investment-grade pricing is primarily due to significant credit spread tightening. Lower risk-free rates on European issues also had a meaningful impact on the reduction in total gross unrealized losses compared to 2011.
Despite significantly increasing our allocation to high yield corporate debt during 2012, both the amount and severity of gross unrealized losses on our non-investment grade fixed maturities declined, primarily due to significant tightening of high yield credit spreads.
During 2012, we decreased our allocation to global equities, mainly due to sales of exchange traded funds (“ETFs”) which were originally introduced to our portfolio in 2011 to provide highly liquid and cost efficient exposure to the global equity markets. The proceeds from these sales were reinvested in high yield corporate debt and hedge funds.
At December 31, 2012, our equities portfolio had net unrealized gains of $58 million (2011: $22 million net unrealized losses) of which most relate to our managed portfolios. The $80 million change in net unrealized gains/losses was caused primarily by the strong rally in the equity markets during 2012.
The $148 million increase in the fair value of our total hedge and credit funds in 2012 was driven by $92 million of net subscriptions as well as $56 million of increased valuations during the year as our hedge and credit funds tracked the rally in the global equity and credit markets. Certain of these funds may be subject to restrictions on redemptions which may limit our ability to liquidate these investments in the short term. Refer to Item 8, Note 5(b) of our Consolidated Financial Statements for further details.
See Consolidated Statements of Cash Flows included in Item 8, ‘Financial Statements and Supplementary Data’, of this report for additional information.
While our 2011 cash flows from operating activities were comparable to 2010, there were certain notable underlying movements; net premium-related cash receipts increased but were partially offset by an increase in net paid losses. Premium receipts increased due to growth in gross premiums written, as well as changes in reinsurance purchasing effected in the second quarter of 2010. The high frequency and severity of natural catastrophe and weather-related events in 2010 and 2011 drove an increase in net paid losses, though this was partially offset by a continued reduction in payments related to lines of business impacted by the global financial crisis. The slight reduction in operating cash flows in 2012 was driven by an increase in net paid losses, as we continued to pay claims related to 2010 and 2011
events. Partially offsetting this was an increase in net premium receipts, driven by growth in gross premiums written; this growth was partially muted in the second half of 2012 due to the previously discussed changes in reinsurance purchasing in the second quarter.
During 2011, we increased our allocation to global equities and hedge funds, driving combined net purchases of equities and other investments of $0.5 billion. Our remaining cash outflows for 2011, and the majority for 2012 and 2010, largely related to the net purchase of fixed maturities (2012: $0.9 billion, 2011: $0.3 billion, 2010: $0.6 billion). Fixed income purchases for 2012 included the previously discussed increased allocations to TIPS, short duration high yield corporate debt and CMBS, a portion of which was funded from cash on hand at the end of 2011. Refer to the ‘Cash and Investments’ section for further details.
Our diversified underwriting portfolio has demonstrated an ability to withstand catastrophic losses. Since 2003, with the only exception being 2009, our annual cash flows from operations were in excess of $1 billion; operating cash flows of $850 billion for 2009 were adversely impacted by claims arising amidst the global financial crisis and a non-recurring payment of $200 million to settle our insurance derivative contract. These positive cash flows were generated notwithstanding the impacts of the global financial crisis and the recognition of significant natural catastrophe-related losses during the period: our net losses and loss expenses included $266 million for Hurricanes Charley, Frances, Ivan and Jeanne in 2004; $1,019 million for Hurricanes Katrina, Rita and Wilma in 2005; $408 million for Hurricanes Gustav and Ike in 2008; $256 million for the Chilean earthquake and New Zealand I in 2010; $944 million for numerous natural catastrophe and weather events in 2011; and $331 million for Storm Sandy in 2012. There remains significant uncertainty associated with our estimates of net losses for certain of these events (see ‘Underwriting Results - Group - Underwriting Expenses’ for further details), as well as the timing of the associated cash outflows.
During 2005, we issued $250 million of 7.25% Series A and $250 million of 7.50% Series B non-cumulative preferred shares.
Maintenance of a minimum consolidated net worth, with the minimum being equal to the sum of $3.689 billion plus 25% of consolidated net income (if positive) for each semi-annual fiscal period ending on or after December 31, 2010 plus 25% of the net cash proceeds received by AXIS Capital from the issuance of its capital stock during each such semi-annual fiscal period. For the purposes of this covenant, consolidated net worth excludes unrealized appreciation (depreciation) on our available for sale investments.
At December 31, 2012, this facility required a minimum consolidated net worth of $4.038 billion and our actual consolidated net worth, as calculated under the provisions of the Credit Facility, was $5.431 billion. We had a consolidated debt to total capital ratio, calculated in accordance with the Credit Facility provisions, of 0.15 to 1 and each of our material insurance/reinsurance subsidiaries party to the agreement had an A.M. Best financial strength rating of A.
At December 31, 2012, we had $423 million of letters of credit outstanding under the LOC Facility. There were no letters of credit or borrowings outstanding under the Credit Facility. Thus, remaining available capacity under these two facilities was $827 million, not taking into consideration the $250 million potential increase in the amount available under the Credit Facility. We were in compliance with all covenants of both facilities at December 31, 2012. We are currently evaluating alternatives in advance of the scheduled expirations of the LOC Facility and the Credit Facility and believe that we will be able to continue to meet the collateral requirements of our clients and adequately preserve our liquidity.
As part of our capital management strategy, our Board of Directors authorizes common share repurchase programs. On December 17, 2012, our Board of Directors authorized a new $750 million share common share repurchase plan, which replaced the existing plan set to expire at the end of 2012. At February 21, 2013, the remaining authorization under the program was $634 million (refer to Item 5 ‘Market for Registrant’s Common Equity, Related Stockholder Matters and Issue Purchases of Equity Securities’ and Item 8, Note 20 to the Consolidated Financial Statements for additional information). As noted above, repurchases under this program are entirely discretionary; the timing and amount of the additional repurchase transactions will depend on a variety of factors including, but not limited to, global (re)insurance and financial market conditions and opportunities, capital management and regulatory considerations.
The ‘A’ grouping is the third highest out of nine major rating categories. The first seven major rating categories may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories.
The following table provides a breakdown of our contractual obligations and commitments at December 31, 2012 by period due:
We are obligated to pay claims for specified loss events covered by the (re)insurance contracts we write. Such loss payments represent our most significant future payment obligation. In contrast to our other contractual obligations, our cash payments are not determinable from the terms specified within the underlying contracts. The total amount in the table above reflects our best estimate of our reserve for losses and loss expenses. However, the actual amounts and timing may differ materially; refer to the ‘Critical Accounting Estimates - Reserve for Losses and Loss Expenses’ for further information. We have not taken into account corresponding reinsurance recoverable amounts that would be due to us. Given the limited loss development pattern information specific to our experience, we have generally estimated the timing of payment by applying industry benchmark payout patterns to each underlying reserving class.
We have unfunded investment commitments related to our investments in hedge and credit funds, which are callable by our investment managers. We have assumed that such investments will be called in the next year but such funding may occur over a longer period of time, due to market conditions and other factors. For further details, refer to Item 8, Note 5(b) to the Consolidated Financial Statements.
For further details on the terms of our senior unsecured debt, refer to Item 8, Note 10(a) to the Consolidated Financial Statements.
Our quarterly reserving process begins with the collection and analysis of paid and incurred claim data for each of our segments. The segmental data is disaggregated by reserving class and further disaggregated by accident year (i.e. the year in which the loss event occurred). We use underwriting year information (i.e. the year in which the contract incepted) to analyze some of our proportional reinsurance business and subsequently allocate reserves to the respective accident years. Our reserving classes are selected to ensure that the underlying contracts have homogeneous loss development characteristics, while remaining large enough to make the estimation of trends credible. We review our reserving classes on a regular basis and adjust them over time as our business evolves. This data, in addition to industry benchmarks, serves as a key input to many of the methods employed by our actuaries. The relative weights assigned to our own historical loss data versus industry data vary according to the length of the development profile for the reserving class being evaluated. At present, we generally give more weight to our own experience (and, correspondingly, less weight to industry data) for reserving classes with short and medium claim tails; the converse is true for reserving classes with longer claim tails. (See ‘Claim Tail Analysis’ below for more detailed information by claim tail class.)
Our results of operations for each of 2012, 2011 and 2010 were significantly impacted by natural catastrophe activity. See Item 7 ‘Underwriting Results - Group, Underwriting Expenses’ for a discussion of these events and the remaining associated uncertainties.
Due to the relatively short reporting and settlement patterns for our short-tail business, we generally place more weight upon experience-based methods and other qualitative considerations in establishing reserves for our most recent accident years. Our estimates for more mature accident years are generally based on actuarial methods that are more responsive to actual
experience, such as the Loss Development Method. As our experience developed more favorably than our initial expectations, we recognized favorable prior year development on short-tail business in recent years. See 'Underwriting Results - Group - Prior Year Reserve Development' for a discussion of the net favorable reserve development recognized when re-estimating our ultimate losses for short-tail business during the past three years.
Although our estimates of ultimate losses for our short-tail business are inherently less uncertain than for our medium and long-tail business, significant judgment is still required. For example, because much of our excess insurance and excess of loss reinsurance business has high attachment points, it is often difficult to estimate whether claims will exceed those attachment points. Also, the inherent uncertainties relating to catastrophe events previously discussed, together with our typically large line sizes, further add to the complexity of estimating our potential exposure. In addition, we use MGAs and other producers for certain business within our insurance segment; this can delay the reporting of loss information to us. We expect that the majority of development for an accident year will be recognized in the subsequent one to three years.
For our earliest accident years, our initial key actuarial expected loss ratio and loss development assumptions were established utilizing industry benchmarks. Due to the longer claim tail, the length of time required to develop our own credible loss history for use in the reserving process is greater for our medium-tail business than for our short-tail business. As a result, the number of accident years where we relied heavily on industry benchmarks to establish our key actuarial assumptions is greater for our medium-tail business. Our reserving approach for medium-tail business is tailored by line of business, with our significant lines being specifically addressed below.
Our transition from the ELR method to experience-based methods began during 2008, when we commenced gradual transition for the 2004 and prior accident years. As our loss history continued to develop, the transition was expanded to include additional accident years. At the end of 2012, the transition had begun for the 2009 and prior accident years for certain underlying reserve classes. As our actual loss experience has generally been more favorable than initial expectations, this transition led to the recognition of net favorable prior year reserve development in recent years; see 'Underwriting Results - Group - Prior Year Development' for a discussion of the development recognized during the last three years.
We believe that there continues to be relatively high uncertainty around ultimate losses for the 2007 through 2009 accident years, resulting from the global financial crisis. This is attributable to both a higher than average volume of reported claims for these years and a higher proportion of open claims, relative to earlier accident years at the same stage of development. Given the significance of the global financial crisis, we believe that development patterns for the 2007 through 2009 accident
years may ultimately differ from other years. In light of this, we separately evaluate the latest available claims information for each reserving class impacted by this 'event' when establishing loss reserves, in addition to considering actuarial indications. Given our expectation of longer development patterns for these accident years, we are exercising a greater degree of caution in recognizing potential favorable loss emergence.
As previously described, the estimation of the value of our recoveries on credit and political risk business requires significant management judgment. At December 31, 2012, our total estimated recoveries on credit insurance business were $106 million, of which $82 million related to contracts where we had already paid losses and $24 million related to contracts where case reserves were recognized. Comparatively, at December 31, 2011, our estimated recoveries were $158 million, with $109 million and $49 million, respectively, relating to paid losses and case reserves. The reduction in 2012 largely reflected the reduction in recovery estimates for two claims based on updated information and the settlement of one claim.
Due to the length of the development tail for this business, our reserve estimates for all accident years are predominantly based on the ELR method and the consideration of qualitative factors. As part of our quarterly reserving process, we monitor actual paid and incurred loss emergence relative to expected loss emergence based on industry-benchmark loss development patterns. The drivers of any unfavorable loss emergence are investigated and, as a result, have led to an immediate
Our expected loss ratios are a key assumption in our estimate of ultimate losses for business at an early stage of development. All else remaining equal, a higher expected loss ratio would result in a higher ultimate loss estimate, and vice versa. Our assumed loss development patterns are another significant assumption in estimating our loss reserves. All else remaining equal, accelerating a loss reporting pattern (i.e. shortening the claim tail) would result in lower ultimate losses, as the estimated proportion of losses already incurred would be higher. The uncertainty in the timing of the emergence of claims (i.e. the length of the development pattern) is generally greater for a company like ours with a limited operating history which, therefore, must rely on industry benchmarks to a certain extent when establishing loss reserve estimates.
For the majority of our insurance business, we receive a fixed premium which is identified in the policy and recorded as unearned premium on the inception date of the contract. This premium will be adjusted only if the underlying insured values ultimately differ. Accordingly, we actively monitor underlying insured values and record adjustment premiums in the period in which amounts are reasonably determinable. Gross premiums written on a fixed premium basis accounted for approximately 93%, 92% and 97% of the segment’s total for the years ended December 31, 2012, 2011 and 2010, respectively. A portion of this business is written through MGAs, third parties granted authority to bind risks on our behalf in accordance with our underwriting guidelines. For this business, we record premiums based on monthly statements received from the MGAs. Due to inherent reporting delays, we generally record premiums written via MGAs one month in arrears. In the event that a significant individual statement is not received, we record our best estimate based upon our historical experience.
Since 2009, significant liquidity has returned to the financial markets, resulting in an increase in observable market prices for our financial instruments. At December 31, 2012, the fair value for 96% (2011: 95%) of our total fixed maturities and equities was based on prices provided by globally recognized independent pricing services where we have a current and detailed understanding of how their prices were derived. The remaining securities were priced by either non-binding broker quotes or internal valuation models.
Generally, we obtain quotes directly from broker-dealers who are active in the corresponding markets when prices are unavailable from independent pricing services. This may also be the case if the pricing from pricing services is not reflective of current market levels, as detected by our pricing control tolerance procedures. Generally, broker-dealers value securities through their trading desks based on observable market inputs. Their pricing methodologies include mapping securities based on trade data, bids or offers, observed spreads and performance on newly issued securities. They may also establish pricing through observing secondary trading of similar securities.
We have also invested in CLO Equities, also known as “cash flow CLOs” in the industry. In 2012, the CLO - Equity market continues to be mostly inactive with only a small number of transactions being observed in the market and even fewer still involving deals we hold. Accordingly, we continue to rely on the use of our internal discounted cash flow model (income approach) to estimate the fair value of CLO - Equities. At December 31, 2012, the estimated fair value for CLO - Equities was $62 million (2011: $67 million), based on the following significant inputs used in our valuation model.
Because our available-for-sale ("AFS") investment portfolio is the largest component of our consolidated assets and a multiple of shareholders’ equity, OTTI could be material to our financial condition and operating results particularly during periods of dislocation in the financial markets. During 2012, we recorded a total OTTI charge in earnings of $24 million (2011: $16 million; 2010: $18 million). Refer to the ‘Net Investment Income and Net Realized Investment Gains/Losses’ section above for further details.
declines in value greater than 5% and rated less than BBB (i.e. downgraded to non-investment grade since its original purchase).
In light of the volatile global equity markets we have experienced in recent years, we generally impair any equities for which we do not forecast a recovery to cost within three years. Further, we generally impair an equity security if its value has declined by more than 30% for nine consecutive months or by more than 20% for twelve consecutive months. We have also established parameters for identifying potential impaired equity securities for fundamental analysis based on the severity, in either percentage or absolute dollar terms, of the unrealized loss position.
See Item 8, Note 2(m) to the Consolidated Financial Statements for a discussion of recently issued accounting pronouncements that we have not yet adopted.
At December 31, 2012, we have not entered into any off-balance sheet arrangements, as defined by Item 303(a)(4) of Regulation S-K.
Consolidated underwriting income (loss) is a pre-tax measure of underwriting profitability that takes into account net premiums earned and other insurance related income as revenues and net losses and loss expenses, acquisition costs and underwriting-related general and administrative costs as expenses. Underwriting-related general and administrative expenses include those general and administrative expenses that are incremental and/or directly attributable to our individual underwriting operations. While these measures are presented in Item 8, Note 3 to our Consolidated Financial Statements, they are considered non-GAAP financial measures when presented elsewhere on a consolidated basis.
Operating income (loss), diluted operating income (loss) per common share and operating ROACE can be reconciled to the nearest GAAP financial measures as follows:
Tax cost of $11,615, $1,703 and $1,974 for 2012, 2011 and 2010, respectively. Tax impact is estimated by applying the statutory rates of applicable jurisdictions, after consideration of other relevant factors including the ability to utilize capital losses.
Tax benefit (cost) of $1,148, ($976) and ($153) for 2012, 2011 and 2010, respectively. Tax impact is estimated by applying the statutory rates of applicable jurisdictions, after consideration of other relevant factors including the tax status of specific foreign exchange transactions.
For operating loss per share purposes, we have excluded the impact of otherwise anti-dilutive securities.
We present our results of operations in the way we believe will be most meaningful and useful to investors, analysts, rating agencies and others who use our financial information to evaluate our performance. This includes the presentation of “operating income (loss)” (in total and on a per share basis), “annualized operating return on average common equity” (which is based on the “operating income (loss)” measure) and "consolidated underwriting income (loss)", which incorporates "underwriting-related general and administrative expenses".
Corporate expenses include holding company costs necessary to support our worldwide (re)insurance operations and costs associated with operating as a publicly-traded company. As these costs are not incremental and/or directly attributable to our individual underwriting operations, we exclude them from underwriting-related general and administrative expenses and, therefore, consolidated underwriting income (loss). Interest expense and financing costs primarily relate to interest payable on our senior notes and are excluded from consolidated underwriting income (loss) for the same reason.
We believe that presentation of underwriting-related general and administrative expenses and consolidated underwriting income (loss) provides investors with an enhanced understanding of our results of operations, by highlighting the underlying pre-tax profitability of our underwriting activities.
We have audited the accompanying consolidated balance sheets of AXIS Capital Holdings Limited and subsidiaries (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’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 and our report dated February 22, 2013 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Insurance premiums written are recorded in accordance with the terms of the underlying policies. For multi-year policies where premiums are payable in annual installments, premiums are recorded at the inception of the policy based on management’s best estimate of total premiums to be received. However, this excludes premiums for the period during which the client has the ability to unilaterally commute or cancel coverage. Reinsurance premiums are recorded at the inception of the policy and are estimated based upon information received from ceding companies. Any subsequent differences arising on insurance and reinsurance premium estimates are recorded in the period they are determined.
In the normal course of business, we purchase reinsurance protection to limit our ultimate losses from catastrophic events and to reduce our loss aggregation risk. The premiums paid to our reinsurers (i.e. premiums ceded) are expensed over the coverage period. Prepaid reinsurance premiums represent the portion of premiums ceded applicable to the unexpired term of the contracts in force. Reinstatement-related premiums ceded are recorded at the time a loss event occurs and our coverage limits for the remaining life of a contract are reinstated under pre-defined contract terms; such premiums are expensed over the remaining risk period.
In recording foreign currency transactions, revenue and expense items are converted to the relevant functional currency at the exchange rate prevailing at the transaction date. Assets and liabilities originating in currencies other than the functional currency are translated into the functional currency at the rates of exchange in effect at the balance sheet date. The resulting foreign currency gains or losses are recognized in the Consolidated Statements of Operations, with the exception of those
related to foreign-denominated available for sale investments. For these investments, exchange rate fluctuations represent an unrealized appreciation/depreciation in the value of the securities and are included in the related component of AOCI.
Our intangible assets with indefinite lives include licenses held by certain subsidiaries in various jurisdictions that allow such subsidiaries to write insurance and/or reinsurance business. These intangible assets are carried at or below estimated fair value and are tested annually for impairment, either qualitatively or quantitatively, and between annual tests if events or changes in circumstances indicate that it is more likely than not that the asset is impaired.
Effective January 1, 2012, we prospectively adopted FASB guidance providing entities with the option to perform a qualitative assessment prior to calculating the estimated fair value of a reporting unit, the first step of the required annual goodwill impairment test. Entities able to qualitatively conclude that the fair value of a reporting unit more likely than not (a likelihood of more than 50%) exceeds its carrying amount can bypass the existing requirement to perform the quantitative annual impairment test. The adoption of this guidance did not impact our results of operations, financial condition or liquidity.
address the fair value measurement of instruments with offsetting market or counterparty credit risks,
The adoption of this amended guidance did not impact our results of operations, financial condition or liquidity. The additional disclosures are provided in Note 6 - Fair Value Measurements.
In December 2011, the FASB issued new guidance requiring additional disclosures about financial instruments and derivative instruments that are either: (1) offset for balance sheet presentation purposes or (2) subject to an enforceable master netting arrangement or similar arrangement, regardless of whether they are offset for balance sheet presentation purposes. This guidance will be effective at January 1, 2013, with retrospective presentation of the new disclosures required. In January 2013, the FASB issued a related scope clarification, limiting the applicability of the requirements to derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing/lending transactions. As this new guidance is disclosure-related only and does not amend existing balance sheet offsetting guidance, adoption will not impact our results of operations, financial condition or liquidity.
In February 2013, the FASB issued new guidance requiring additional disclosures about reclassification adjustments from AOCI. This guidance will be effective prospectively at January 1, 2013. As this new guidance is disclosure-related only and does not amend existing guidance on the reporting net income available to common shareholders or other comprehensive income, adoption will not impact our results of operations, financial condition or liquidity.
Our reinsurance segment provides non-life treaty reinsurance to insurance companies on a worldwide basis. The product lines in this segment are catastrophe, property, professional lines, credit and bond, motor, liability, engineering and other.
We estimate that the annual amortization expense for our total intangible assets with a finite life will be approximately $2 million from 2013 to 2017. The estimated remaining useful lives of these assets range from seven to twenty-six years.
Intangible assets with an indefinite life consist primarily of U.S. state licenses that provide a legal right to transact business indefinitely. Our impairment reviews for goodwill and indefinite lived intangibles did not result in the recognition of impairment losses for the years ended December 31, 2012, 2011 and 2010.
At December 31, 2012, 106 securities (2011: 128) were in an unrealized loss position of $7 million (2011: $47 million).
Long/short equity funds: Seek to achieve attractive returns by executing an equity trading strategy involving both long and short investments in publicly-traded equities.
Leveraged bank loan funds: Seek to achieve attractive returns by investing primarily in bank loan collateral that has limited duration exposure.
Two common redemption restrictions which may impact our ability to redeem our hedge and credit funds are gates and lockups. A gate is a suspension of redemptions which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the fund’s net assets which may otherwise hinder the general partner or investment manager’s ability to liquidate holdings in an orderly fashion in order to generate the cash necessary to fund extraordinarily large redemption payouts. A lockup period is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. During 2012 and 2011, neither of these restrictions impacted our redemption requests.
At December 31, 2012, $38 million (2011: $90 million) of our long/short equity funds, representing 4% (2011: 13%) of our total other investments, relate to a holding where we are still within the lockup period. The expiry of this lockup period is September, 2014. No other category contains investments currently subject to lockup.
At December 31, 2012, $29 million (2011: $45 million) of our hedge and credit fund investments were invested in funds that are not accepting redemption requests. Of this amount, 92% relates to a leveraged bank loan fund in a period of planned principal distributions which has a target completion date in late 2013 and, based on current market conditions and payments made to date, management expects this target date to be met. The remainder primarily relates to funds that entered liquidation or had their assets side pocketed as a result of the global financial crisis which began in late 2008. For these funds, management is currently unable to estimate when those funds will be distributed.
Non-U.S. government obligations are evaluated for credit loss primarily through qualitative assessments of the likelihood of credit loss using information such as credit ratings and yield. At December 31, 2012, our holdings in sovereign debt, including $217 million (2011: $634 million) relating to the eurozone countries, were all highly rated securities. The gross unrealized losses of $2 million at December 31, 2012 were due to foreign exchange losses, mainly on euro-denominated securities. We have concluded there were no credit losses anticipated for these securities at December 31, 2012.
The majority of the unrealized losses on ABS at December 31, 2012, and 2011, were related to CLO debt tranched securities (“CLO Debt”) with a carrying value of $53 million (2011: $48 million). We used the following significant inputs to estimate the credit loss for these securities:
Our assumptions on default and loss severity rates are established based on an assessment of actual experience to date for each CLO Debt and review of recent credit rating agencies’ default and loss severity forecasts. Based on the underlying collateral values and our projected cash flows at December 31, 2012, our CLO Debt had sufficient credit protection levels to receive all contractually obligated principal and interest payments.
The OTTI losses on common stocks in 2012 and 2011 are primarily due to the severity and duration of their unrealized loss positions, for which we concluded the forecasted recovery period was uncertain. The recognition of such losses does not necessarily indicate that sales will occur or that sales are imminent or planned. During 2012, we recorded $9 million of OTTI
losses on our exchange-traded funds as we no longer had the intent to hold these underwater securities through full recovery of cost. At December 31, 2012, the fair value of our equities was $667 million (2011: $678 million), which included $7 million (2011: $47 million) of gross unrealized losses.
Level 1 - Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access.
Level 2 - Valuations based on quoted prices in active markets for similar assets or liabilities, quoted prices for identical 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.
Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This may lead us to change the selection of our valuation technique (from market to cash flow approach) or may
cause us to use multiple valuation techniques to estimate the fair value of a financial instrument. This circumstance could cause an instrument to be reclassified between levels within the fair value hierarchy.
At each valuation date, we use the market approach valuation technique to estimate the fair value of our fixed maturities portfolio, when possible. This market approach includes, but is not limited to, prices obtained from third party pricing services for identical or comparable securities and the use of “pricing matrix models” using observable market inputs such as yield curves, credit risks and spreads, measures of volatility, and prepayment speeds. Pricing from third party pricing services is sourced from multiple vendors, when available, and we maintain a vendor hierarchy by asset type based on historical pricing experience and vendor expertise. When prices are unavailable from pricing services, we obtain non-binding quotes from broker-dealers who are active in the corresponding markets.
Our portfolio of RMBS and CMBS are originated by both agencies and non-agencies. The fair values of these securities are determined through the use of a pricing model (including Option Adjusted Spread) which uses prepayment speeds and
ABS include mostly investment-grade debt securities backed by pools of loans with a variety of underlying collateral, including automobile loan receivables, student loans, credit card receivables, and CLO Debt originated by a variety of financial institutions. The fair values of ABS are priced through the use of a model which uses prepayment speeds and spreads sourced primarily from the new issue market. As the significant inputs used to price ABS are observable market inputs, the fair values of ABS are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers or use a discounted cash flow model to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. These securities are priced within Level 3.
Equity securities include U.S. and non-U.S. common stocks, exchange-traded funds, and non-U.S. bond mutual funds. For common stocks and exchange-traded funds, we classified these within Level 1 as their fair values are based on unadjusted market prices in active markets. Our investments in non-U.S. bond mutual funds have daily liquidity, with redemption based on the net asset value (NAV) of the funds. Accordingly, we have classified these investments as Level 2.
Within the hedge and credit fund industries, there is a general lack of transparency necessary to facilitate a detailed independent assessment of the values placed on the securities underlying the NAV provided by the fund manager or fund administrator. To address this, on a quarterly basis, we perform a number of monitoring procedures designed to assist us in the assessment of the quality of the information provided by managers and administrators. These procedures include, but are not limited to, regular review and discussion of each fund's performance with its manager, regular evaluation of fund performance against applicable benchmarks and the backtesting of our fair value estimates against subsequently received NAVs. Backtesting involves comparing our previously reported values for each individual fund against NAVs per audited financial statements (for year-end values) and final NAVs from fund managers and fund administrators (for interim values).
At December 31, 2012, the CLO - Equities were classified within Level 3 as we estimated the fair value for these securities using an income approach valuation technique (discounted cash flow model) due to the lack of observable and relevant trades in the secondary markets.
During 2012 and 2011, we had no transfers between Levels 1 and 2.
On a quarterly basis, our valuation processes for both CLO Debt and CLO - Equities include a review of the underlying cash flows and key assumptions used in the discounted cash flow models. We review and update the above significant unobservable inputs based on information obtained from secondary markets, including from the managers of the CLOs we hold. These inputs are the responsibility of management and, in order to ensure fair value measurement is applied consistently and in accordance with U.S. GAAP, we update our assumptions through regular communication with industry participants and ongoing monitoring of the deals in which we participate (e.g. default and loss severity rate trends), we
The following tables present changes in Level 3 for financial instruments measured at fair value on a recurring basis for the periods indicated:
Gains and losses included in earnings on fixed maturities are included in net realized investment gains (losses). Gains and (losses) included in earnings on other investments are included in net investment income.
The transfers to Level 3 from Level 2 made in 2012 and 2011 were due to a reduction in the availability of observable market inputs or a lack of sufficient quotes available from pricing vendors and broker-dealers. None of the transfers were as a result of changes in valuation methodology that we made.
During 2011, the transfer of fixed maturities from Level 3 to Level 2 relates to non-agency RMBS for which observable market inputs and multiple quotes from pricing vendors and broker-dealers became available during the year as a result of the return of liquidity in this asset class. We also transferred certain hedge and credit funds (included in “other investments”) from Level 3 to Level 2 during 2012 and 2011 as we have the ability to liquidate these holdings at the reported NAV in the near term.
The carrying values of cash equivalents (including restricted amounts), accrued investment income, receivable for investments sold, certain other assets, payable for investments purchased and certain other liabilities approximated their fair values at December 31, 2012, due to their respective short maturities. As these financial instruments are not actively traded, their respective fair values are classified within Level 2.
Our (re)insurance subsidiaries and branches operate in various foreign countries. Consequently, some of our business is written in currencies other than the U.S. dollar and, therefore, our underwriting portfolio is exposed to significant foreign currency risk. We manage foreign currency risk by seeking to match our foreign-denominated net liabilities under (re)insurance contracts with cash and investments denominated in such currencies. We may also use derivative instruments, specifically forward contracts and currency options, to economically hedge foreign currency exposures.
The decrease in the notional amount of underwriting related derivatives since 2011 was primarily due to settlement of certain foreign denominated liabilities relating to the catastrophe losses incurred from the New Zealand and Japanese earthquakes.
Overall, the majority of the net favorable prior year reserve development related to short-tail lines of business, with our professional lines business also contributing notably.
Our professional lines insurance and reinsurance business contributed further net favorable prior year reserve development of $54 million, $105 million and $117 million, respectively, in 2012, 2011 and 2010. This prior year reserve development was driven by increased weight being given to experience-based actuarial methods in selecting our ultimate loss estimates for accident years 2009 and prior. As our loss experience has generally been better than expected, this resulted in the recognition of favorable prior year reserve development. Given the significance of the global financial crisis, we expect that loss development patterns for the 2007 through 2009 accident years may ultimately differ from other years; as a result, we are exercising a greater degree of caution in recognizing potential favorable loss emergence for these years.
During the year ended December 31, 2012, we recognized ceded losses and loss expenses of $396 million (2011: $450 million; 2010: $425 million).
On March 23, 2010, AXIS Specialty Finance LLC (“AXIS Specialty Finance”), a 100% owned finance subsidiary, issued $500 million aggregate principal amount of 5.875% senior unsecured debt (the “5.875% Senior Notes” and, together with the 5.75% Senior Notes, the “Senior Notes”) at an issue price of 99.624%. The net proceeds of the issuance, after consideration of the offering discount and underwriting expenses and commissions, totaled approximately $495 million. Interest on the 5.875% Senior Notes is payable semi-annually in arrears on June 1 and December 1 of each year, beginning on June 1, 2010. Unless previously redeemed, the 5.875% Senior Notes will mature on June 1, 2020. The 5.875% Senior Notes are ranked as unsecured senior obligations of AXIS Specialty Finance. AXIS Capital has fully and unconditionally guaranteed all obligations of AXIS Specialty Finance under the 5.875% Senior Notes. AXIS Capital’s obligations under this guarantee are unsecured and senior and rank equally with all other senior obligations of AXIS Capital.
We have the option to redeem the Senior Notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price, which is equal to the greater of the aggregate principal amount or the sum of the present values of the remaining scheduled payments of principal and interest. The related indentures contain various covenants, including limitations on liens on the stock of restricted subsidiaries, restrictions as to the disposition of the stock of restricted subsidiaries and limitations on mergers and consolidations. We were in compliance with all the covenants contained in the indentures at December 31, 2012.
On August 24, 2010, AXIS Capital and certain of its operating subsidiaries entered into a three-year revolving $500 million credit facility (the “Credit Facility”) with a syndication of lenders pursuant to a Credit Agreement and other ancillary documents (together, the “Credit Facility Documents”). Subject to certain conditions and at the request of AXIS Capital, the aggregate commitment under the Credit Facility may be increased by up to $250 million. Under the terms of the Credit Facility, loans are available for general corporate purposes and letters of credit may be issued in the ordinary course of business, with total usage not to exceed the aggregate amount of the Credit Facility. Interest on loans issued under the Credit Facility is payable based on underlying market rates at the time of loan issuance. While loans under the Credit Facility are unsecured, we have the option to issue letters of credit on a secured basis in order to reduce associated fees. The letters of
credit will principally be used to support the reinsurance obligations of the operating subsidiaries. Under the Credit Facility, AXIS Capital guarantees the obligations of the operating subsidiaries and each of AXIS Specialty Finance and AXIS Specialty Holdings Bermuda Limited guarantees the obligations of AXIS Capital and the operating subsidiaries. The Credit Facility is subject to certain non-financial covenants, including limitations on fundamental changes, the incurrence of additional indebtedness and liens and certain transactions with affiliates and investments, as defined in the Credit Facility Documents. The Credit Facility also requires compliance with certain financial covenants, including a maximum debt to capital ratio and a minimum consolidated net worth requirement. In addition, each of AXIS Capital’s material (re)insurance subsidiaries party to the Credit Facility must maintain a minimum A.M. Best Company, Inc. financial strength rating. In the event of default, including a breach of these covenants, the lenders may exercise certain remedies including the termination of the Credit Facility, the declaration of all principal and interest amounts related to Credit Facility loans to be immediately due and the requirement that all outstanding letters of credit be collateralized.
At December 31, 2012, we had $423 million and nil letters of credit outstanding under the LOC Facility and the Credit Facility, respectively. There was no debt outstanding under the Credit Facility. We were in compliance with all LOC Facility and Credit Facility covenants at December 31, 2012.
These contractual rights contribute to the mitigation of credit risk, as does our monitoring of aged receivable balances. In light of these mitigating factors, and considering that a significant portion of our premiums receivable are not currently due based on the terms of the underlying contracts, we do not utilize specific credit quality indicators to monitor our premiums receivable balance. At December 31, 2012, we recorded an allowance for estimated uncollectible premiums receivable of $2 million (2011: $4 million). The corresponding bad debts expense charges for 2012, 2011 and 2010 were insignificant.
We purchase reinsurance coverage for our insurance lines of business. The minimum reinsurance premiums are contractually due in advance on a quarterly basis. Accordingly at December 31, 2012, we have an outstanding reinsurance purchase commitment of $54 million. Actual payments under the reinsurance contracts will depend on the underlying subject premium and may exceed the minimum premium.
From time to time, we are subject to routine legal proceedings, including arbitrations, arising in the ordinary course of business. These legal proceedings generally relate to claims asserted by or against us in the ordinary course of insurance or reinsurance operations; estimated amounts payable under such proceedings are included in the reserve for losses and loss expenses in our Consolidated Balance Sheets.
Except as noted below, we are not a party to any material legal proceedings arising outside the ordinary course of business.
an agreement in principle with plaintiffs during the first quarter of 2011 to settle all claims and causes of action in this matter for an immaterial amount. On March 30, 2012, the District Court issued the final settlement order, and this matter is now closed.
The following table provides a computation of basic and diluted earnings per common share:
At December 31, 2012, and 2011, our authorized share capital was 800,000,000 common shares, par value of $0.0125 per share.
During October 2005, we issued $250 million of 7.25% Series A preferred shares, par value $0.0125 per share, with a liquidation preference of $25.00 per share. We may redeem the shares at a redemption price of $25.00 per share. Dividends on the Series A preferred shares are non-cumulative. Consequently, if the board of directors does not authorize and declare a dividend for any dividend period, holders of the Series A preferred shares will not be entitled to receive a dividend for such period, and such undeclared dividend will not accumulate and be payable. Holders of Series A preferred shares will be entitled to receive, only when, as and if declared by the board of directors, non-cumulative cash dividends from the original issue date, quarterly in arrears on the fifteenth day of January, April, July and October of each year, commencing on January 15, 2006, without accumulation of any undeclared dividends. To the extent declared, these dividends will accumulate, with respect to each dividend period, in an amount per share equal to 7.25% of the liquidation preference per annum. For 2012 and 2011, the total dividends declared and paid on Series A preferred shares was $1.8125 per share.
Concurrent with the issuance of our Series C preferred shares (see below), we redeemed 6,000,000 of our 7.25% Series A preferred shares, representing $150 million in aggregate liquidation preference, without accumulation of any undeclared dividends. In connection with this redemption, we recognized a $5 million loss on redemption (calculated as the difference between the redemption price and the carrying value), which was recognized as a reduction in determining our net income
available to common shareholders. Following this redemption, 4,000,000 Series A preferred shares, representing $100 million in aggregate liquidation preference, remain outstanding.
During November 2005, we issued $250 million of 7.50% Series B preferred shares, par value $0.0125 per share, with a liquidation preference of $100.00 per share. We may redeem the shares on or after December 1, 2015 at a redemption price of $100 per share. Dividends on the Series B preferred shares if, as and when declared by our board of directors will be payable initially at a fixed rate per annum equal to 7.50% of the liquidation preference on the first day of March, June, September and December of each year, commencing on March 1, 2006, up to but not including December 1, 2015. Commencing on March 1, 2016, the dividend rate on the Series B preferred shares will be payable at a floating rate. During a floating rate period, the floating rate per annum will be reset quarterly at a rate equal to 3.4525% plus the 3 month LIBOR Rate. Dividends on the Series B preferred shares are non-cumulative. For 2012 and 2011, the total dividends declared and paid on Series B preferred shares was $7.50 per share.
During 2012, our total pension expenses were $20 million (2011: $20 million and 2010: $15 million) for the above retirement benefits.
We currently issue restricted stock and restricted stock units to our employees with service conditions, vesting generally over a period of 4 years with 25% of the award vesting annually. During 2012, we also granted a performance-based stock award to a key employee in order to promote long-term growth and profitability. The award represents the right to receive a specified number of common shares in the future, based upon the achievement of established performance criteria during the applicable performance period, which is the period ending on the third anniversary of the grant date. At December 31, 2012, we anticipate that the established performance based criterion for this award is likely to be achieved.
The following table provides a reconciliation of the beginning and ending balance of nonvested restricted stock (including restricted stock units) for the year ended December 31, 2012:
(1) Fair value is based on the closing price of our common shares on the New York Stock Exchange on the day of the grant.
The total fair value of shares vested during 2012 was $43 million (2011: $63 million; 2010: $56 million). At December 31, 2012, we had unrecognized compensation costs of $89 million (2011: $86 million) which are expected to be recognized over the weighted average period of 2.5 years (2011: 2.6 years).
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between our closing stock price at December 31, 2012 and the exercisable price, multiplied by the number of in-the-money-options) that would have been received by the stock option holder had all stock option holders exercised their stock options on December 31, 2012.
Our U.S. subsidiaries are subject to federal, state and local corporate income taxes and other taxes applicable to U.S. corporations. The provision for federal income taxes has been determined under the principles of the consolidated tax
In Canada, our U.S. reinsurance company operates through a branch and our U.S. service company has an unlimited liability company subsidiary based in Canada. Prior to 2011, our U.S. service company operated in Canada via a Canadian branch. These Canadian operations are subject to the relevant taxes in that jurisdiction and generally remain subject to examination for tax years 2008 through 2012. Our Canadian reinsurance branch is currently under audit by the Canada Revenue Agency for income taxes for tax years 2009 and 2010.
We also have subsidiaries in Ireland, the United Kingdom (U.K.), Australia and Brazil. Our Ireland insurance subsidiary with branch operations in the U.K. and Australia was subject to a compliance review of the U.K. branch for 2009, by H.M. Revenue and Customs, which resulted in no significant adjustments. These subsidiaries and their branches, other than the U.K. branch, are not under examination, but generally remain subject to examination in all applicable jurisdictions for tax years 2008 through 2012.
At December 31, 2012 and 2011, we established a full valuation allowance on: (1) operating loss carryforwards relating to branch operations in Australia and Singapore due to cumulative losses in recent years and (2) unutilized foreign tax credits available in Ireland. Although realization is not assured, management believes it is more likely than not that the tax benefit of the recorded net deferred tax assets will be realized.
Outside of the items for which we have established a valuation allowance as described above, our gross deferred tax assets relate substantially to our U.S. operations. In evaluating our ability to recover these tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including historical results, operating loss carryback potential and scheduled reversals of deferred tax liabilities. Our U.S. operations have produced significant taxable income in prior periods and have deferred tax liabilities that will reverse in future periods such that we believe sufficient ordinary taxable income is available to utilize all remaining ordinary deferred tax assets. In 2012, there were sufficient net unrealized gains to offset remaining impairments, therefore a valuation allowance on such impairments in the U.S., was not considered necessary. In 2011, we concluded that a valuation allowance on U.S. capital loss carryforwards and impairments was not needed as there were sufficient net unrealized capital gains that would, if necessary, be recognized to generate sufficient capital gains within the carryforward period.
Our Irish subsidiaries, AXIS Specialty Europe SE and AXIS Re SE, are required to maintain minimum levels of statutory and capital surplus. At December 31, our subsidiaries were in compliance with these requirements. Our Irish subsidiaries may declare dividends out of retained earnings subject to meeting their solvency and capital requirements. At December 31, 2012, the maximum dividend our Irish subsidiaries could pay out of retained earnings, subject to regulatory approval, was approximately $142 million.
Our U.S. operations required statutory capital and surplus is determined using risk based capital tests, which is the threshold that constitutes the authorized control level. If a company falls below the control level, the commissioner is authorized to take whatever regulatory actions may be considered necessary to protect policyholders and creditors. The maximum dividend that may be paid by our U.S. insurance subsidiaries is restricted by the regulatory requirements of the domiciliary states. Generally, the maximum dividend that may be paid by each of our U.S. insurance subsidiaries is limited to unassigned surplus (statutory equivalent of retained earnings) and may also be limited to statutory net income, net investment income or 10% of total statutory capital and surplus. At December 31, 2012, the maximum dividend that our U.S. insurance operations could pay without regulatory approval was approximately $130 million.
Subsequent to December 31, 2012, we privately negotiated with Trident II, L.P. and affiliated entities to repurchase 3 million common shares at an average price of $38.70 per share, for a total cost of $116 million. At February 21, 2013 we have $634 million of remaining authorization under the common share repurchase program approved by our Board of Directors, which will expire on December 31, 2014.