The following table sets forth our selected historical financial information for the periods ended and as of the dates indicated. The summary income statement data for the twelve months ended December 31, 2018, 2017, 2016, 2015 and 2014 and the balance sheet data as of December 31, 2018, 2017, 2016, 2015 and 2014 are derived from our audited consolidated financial statements. The consolidated financial statements as of December 31, 2018, and for each of the twelve months ended December 31, 2018, 2017 and 2016, and the report thereon of KPMG LLP, an independent registered public accounting firm, are included elsewhere in this report. These historical results, including the ratios presented below, are not necessarily indicative of results to be expected from any future period. You should read the following selected consolidated financial information along with the information contained in this report, including Item 8, “Financial Statements and Supplementary Data” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited consolidated financial statements and related notes included elsewhere in this report.
Total cash and investments include cash, cash equivalents, fixed income securities, equities, bank loans, other investments, short-term investments and catastrophe bonds.
The following is a discussion and analysis of our financial condition and results of operations for the twelve months ended December 31, 2018, 2017 and 2016. This discussion and analysis should be read in conjunction with our audited consolidated financial statements and related Notes contained in this report. This discussion contains forward-looking statements that involve risks and uncertainties and that are not historical facts, including statements about our beliefs and expectations. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and particularly under the headings “Risk Factors,” “Business” and “Cautionary Statement Regarding Forward-Looking Statements” contained in Item 1A, Item 1, and Part I of this report, respectively.
Pursuant to the Merger Agreement, at the effective time of the Merger, each ordinary share of the Company issued and outstanding immediately prior to such time (other than ordinary shares owned by Aspen as treasury shares, owned by any subsidiary of the Company or owned by Highlands, Merger Sub or any of their respective subsidiaries, which will be canceled as set forth in the Merger Agreement) will be converted into the right to receive $42.75 in cash, without interest and less any required withholding taxes. At the effective time of the Merger, each of the Company’s issued and outstanding 5.95% Fixed-to-Floating Rate Perpetual Non-Cumulative Preference Shares and 5.625% Perpetual Non-Cumulative Preference Shares (collectively, the “Preference Shares”) will remain issued and outstanding. The Merger Agreement restricts the Company from declaring or paying any dividends other than the quarterly dividends on Aspen’s ordinary shares that were previously declared and publicly announced prior to the date of the Merger Agreement and periodic cash dividends on the Preference Shares in accordance with the terms of the applicable certificate of designation.
For further details on the Merger, refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Aspen’s Year In Review” and Note 19(d) of our consolidated financial statements, “Commitments and Contingencies - Contingent Liabilities.”
Effectiveness and Efficiency Program. We launched the Effectiveness and Efficiency Program in October 2017 to allow us to be a more nimble organization with faster decision-making ability and a more competitive expense ratio. We exceeded our target to achieve run rate savings of $30 million in 2018 and we continue to expect to achieve approximately $55 million of run rate savings in 2019. We recognized $37.5 million of expenses associated with the Effectiveness and Efficiency Program in 2018 (2017 - $15.2 million).
As part of the Effectiveness and Efficiency Program, Aspen UK Services, Aspen U.S. Services and Aspen Bermuda entered into an outsourcing agreement, dated April 1, 2018, with Genpact (UK) Limited, a company registered in England and Wales. Under the outsourcing agreement, Genpact provides Aspen with a range of operational business processes, primarily from their offshore service center in Gurgaon, India. In addition, Aspen UK Services, Aspen U.S. Services and Aspen Bermuda entered into an outsourcing agreement with Cognizant Worldwide Limited, a company registered in England, on August 31, 2018 for the provision of information technology services.
Business Portfolio Optimization. In 2018, we reduced our net retentions through the purchase of additional reinsurance for both of our business segments as part of our strategy to reduce volatility and our exposures to 1-in-100 and 1-in-250 cat events relative to total shareholders’ equity. Total ceded written premiums in 2018 increased by $216.5 million compared to 2017 due to
an increase in the proportion of business ceded to our casualty, financial institutions and property quota share programs. In addition, we increased ceded reinsurance for our property catastrophe business lines where business previously ceded to Silverton, a consolidated entity, is now ceded to Peregrine, a non-consolidated entity.
Capital Management. We continue to focus on capital management and maintain our capital at an appropriate level. On June 18, 2018, we elected to redeem $125.0 million in aggregate principal amount of the $250 million 6.00% Senior Notes due 2020, the only material debt issued by Aspen Holdings currently outstanding. The redemption resulted in a realized loss, or make-whole payment, of $8.6 million.
On April 25, 2018, Kendall Re issued $225.0 million Series 2018-1 Class A Principal At-Risk Variable Rate Notes due May 6, 2021 under a variable rate note program from which the proceeds will be used to provide Aspen Bermuda with fully-collateralized retrocessional reinsurance protections against losses from a range of international perils, including U.S. named storms, U.S. and Canada earthquakes, U.S. severe thunderstorms, U.S. wildfires, U.S. winter storms and European windstorms. The results and balance sheet of Kendall Re are not included within our condensed consolidated financial statements because we do not hold variable or voting interest in Kendall Re.
We did not repurchase any ordinary shares in 2018 under the $250.0 million share repurchase program which expired on February 8, 2019 and was not renewed. As set forth in the Merger Agreement, we are prohibited from redeeming, purchasing or otherwise acquiring any outstanding ordinary shares unless Highlands consents in writing.
The following overview of our 2018, 2017 and 2016 operating results and financial condition is intended to identify important themes and should be read in conjunction with the more detailed discussion further below.
Combined ratio of 110.0% for 2018, including $262.9 million, or 12.1 percentage points of pre-tax catastrophe losses, net of reinsurance and reinstatements, compared with 125.7% for 2017, which included $561.9 million or 24.6 percentage points of pre-tax catastrophe losses, net of reinsurance and reinstatements, and 98.5% for 2016, which included $164.4 million, or 6.3 percentage points of pre-tax catastrophe losses, net of reinsurance and reinstatements.
Net favorable development on prior year loss reserves of $111.1 million, or 5.0 combined ratio points, for 2018 compared with $105.4 million, or 4.6 combined ratio points, for 2017 and $129.3 million, or 4.9 combined ratio points, for 2016.
The combined ratio for 2017 increased by 27.2 percentage points compared to 2016 due mainly to the increase in the loss ratio as a result of a $409.6 million increase in catastrophe losses, a $59.7 million increase in large losses, a $23.9 million decrease prior year reserve releases, an increase in attritional losses in our insurance segment and a $330.7 million decrease in net earned premiums. The expense ratio for 2017 increased by 0.5 percentage points due to a reduction in net earned premiums and an increase in general, administrative and corporate expenses, partially offset by a decrease in policy acquisition expenses due to over-rider commissions associated with the increase in ceded reinsurance.
Overall reserve releases in 2018 increased by $5.7 million compared to 2017 due to a $19.1 million increase in net reserve releases in our insurance segment offsetting a $13.4 million reduction in net reserve releases in our reinsurance segment. Overall reserve releases in 2017 decreased by $23.9 million compared to 2016 due an $18.7 million decrease in net reserve releases in our insurance segment and a $5.2 million decrease in reserve releases in our reinsurance segment. Further information relating to the release of reserves can be found below under “- Reserves for Losses and Loss Adjustment Expenses - Prior Year Loss Reserves.”
Amortization of deferred policy acquisition costs decreased in 2018 compared to 2017 and in 2017 compared to 2016 due to an increase in over-rider commissions associated with the increase in ceded reinsurance.
Net investment income. We generated net investment income of $198.2 million in 2018, an increase of 4.9% compared to the prior year (2017 - $189.0 million; 2016 - $187.1 million) primarily due to increased income from our fixed income portfolio. The increase in investment income in 2017 compared to 2016 was also primarily due to the increase in the book yield of the fixed income portfolio.
Taxes. We recognized an income tax benefit for the twelve months ended December 31, 2018 of $10.2 million compared to a benefit of $15.4 million and an expense of $6.1 million in 2017 and 2016, respectively. The effective tax rate for the twelve months ended December 31, 2018 on our loss before tax was 6.5% (2017 - 5.5%; 2016 - 2.9%).
The effective tax rate is subject to revision in future periods if circumstances change and depends on the relative profitability of the business underwritten in Bermuda (where the rate of tax on corporate profits is zero), the United Kingdom (where the corporation tax rate is 19% and will be reduced to 17% effective April 1, 2020) and the United States (where the federal income tax rate was previously 34% and was reduced to 21% effective January 1, 2018). The tax in each of the years is representative of the geographic spread of our business between taxable and non-taxable jurisdictions in such years.
Other comprehensive income. Total other comprehensive income decreased by $66.0 million (2017 - $50.8 million decrease), net of taxes, for the twelve months ended December 31, 2018. The decrease in total other comprehensive income includes a net unrealized loss of $81.0 million in the available for sale investment portfolio (2017 - $9.2 million net unrealized loss) largely attributable to the impact of rising interest rates on our bond portfolios, a $4.5 million reclassification of net realized loss to net income (2017 - $3.6 million reclassified realized gains), a $1.8 million unrealized loss (2017 - $2.6 million unrealized gain) on the hedged derivative contracts and an unrealized gain in foreign currency translation of $12.3 million (2017 -$40.6 million unrealized loss) largely attributable to the impact from the continued strengthening of the U.S. dollar.
Dividends. Dividends paid on our ordinary shares in 2018 were $42.9 million (2017 - $56.2 million; 2016 - $52.7 million). The decrease in dividends on our ordinary shares in 2018 was because, effective August 27, 2018, we are restricted from declaring or paying any dividends on our ordinary shares under the Merger Agreement.
Dividends paid on our outstanding Preference Shares in 2018 were $30.5 million (2017 - $36.2 million; 2016 - $41.8 million). The reduction in dividends in 2018 and 2017 was due to the redemption of the 7.401% Preference Shares and 7.250% Preference Shares on January 3, 2017 and July 3, 2017, respectively. Under the Merger Agreement, we continue to be able to pay periodic cash dividends on the Preference Shares in accordance with the terms of the applicable certificate of designation.
a reduction of $66.0 million in other comprehensive income which included a $76.5 million net unrealized loss on available for sale investments, a $12.3 million gain in foreign currency translation and a $1.8 million net loss in the value of hedged foreign exchange contracts.
As at December 31, 2018 and 2017, our total shareholders’ equity included Preference Shares with a total value as measured by their respective liquidation preferences of $525.0 million less issue costs of $13.1 million.
the total debt and the liquidation preference of our Preference Shares to total capital which was 30.4% as at December 31, 2018 (2017 - 30.5%). The Preference Shares are classified in our balance sheet as equity but may receive a different treatment in some cases under the capital adequacy assessments made by certain rating agencies.
Results for the (re)insurance market were once again dominated by catastrophe losses in 2018. Losses from natural catastrophes in 2018 are estimated to be the fourth highest on record for the (re)insurance industry. In addition, there remains an abundance of capital across all products and geographies which continues to place pressure on (re)insurance price increases.
We continue to seek to balance our underwriting portfolio and to target the best risk-adjusted returns. In connection with this objective, we anticipate reducing our total purchase of ceded and retrocessional reinsurance in 2019 as we purchase less proportional reinsurance protection and more excess of loss protection compared to 2018. As a result of these actions, we expect our net written premium to gross written premium ratio to increase from 60% in 2018 to approximately 75% in 2019.
Refer to Part I, Item 1A, “Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements” included in this report.
Our consolidated financial statements contain certain amounts that are inherently subjective in nature and require management to make assumptions and best estimates to determine the reported values. We believe that the following critical accounting policies affect the more significant estimates used in the preparation of our consolidated financial statements. A statement of all the significant accounting policies we use to prepare our financial statements is included in the Notes to the consolidated financial statements. If factors such as those described in Part I, Item 1A, “Risk Factors” cause actual events to differ from the assumptions used in applying the accounting policies and calculating financial results, there could be a material adverse effect on our operating results, financial condition and liquidity.
Written premiums comprise the estimated premiums on contracts of insurance and reinsurance entered into in the reporting period, except in the case of proportional reinsurance contracts, where written premiums relate only to our estimated proportional share of premiums due on contracts entered into by the ceding company prior to the end of the reporting period.
The reported gross written premiums for treaty pro rata business include estimates of premiums due to us but not yet reported by the cedant because of time delays between contracts being written by our cedants and their submission of treaty statements to us. This additional premium is normally described as pipeline premium. Treaty statements disclose information on the underlying contracts of insurance written by our cedants and are generally submitted on a monthly or quarterly basis, from 30 to 90 days in arrears. In order to report all risks incepting prior to a period end, we estimate the premiums written between the last submitted treaty statement and the period end. Treaty pro rata premiums are written predominantly in our other property, specialty and casualty reinsurance lines of business.
Property treaty pro rata contributed significantly to our reinsurance segment where we wrote $182.0 million in gross written premium in 2018 (2017 - $242.5 million), or 12.2% of the gross written premiums in our reinsurance segment, of which $106.1 million was estimated (2017 - $76.6 million) and $75.9 million was reported by the cedants (2017 - $165.9 million). Excluding the impact of costs, such as reinsurance premiums and operating expenses, we estimate that the impact of a $1.0 million increase/decrease in our estimated gross written premiums in our property treaty pro rata business would increase/decrease net income before tax by approximately $0.1 million for the year ended December 31, 2018 (2017 - $0.3 million increase/decrease).
changes in renewal rate or rate of new business acceptances by cedant insurance companies leading to lower or greater volumes of ceded premiums than our estimate, which could result from changes in the relevant primary market that could affect more than one of our cedants or could be a consequence of changes in marketing strategy or risk appetite by a particular cedant;
Earned premiums. Premiums are recognized as earned over the policy exposure periods. The premium related to the unexpired portion of each policy at the end of the reporting period is included in the balance sheet as unearned premiums.
IBNR reserves to cover the anticipated cost of claims incurred but not reported. Within this, we also include the potential development of reported claims; and
Sources of Information. Claims information received typically includes the loss date, details of the claim, the recommended reserve and reports from the loss adjusters dealing with the claim. In respect of pro rata treaties and any business written through managing general agents, we receive regular statements (bordereaux) which provide paid and outstanding claims information, often with large losses separately identified. Following widely reported loss events, such as catastrophes, we adopt a proactive approach to establish our likely exposure to claims by reviewing policy listings and contacting brokers and policyholders as appropriate.
Bornhuetter-Ferguson (“BF”) method: The BF method uses as a starting point an assumed IELR and blends in the loss ratio, which is implied by the claims experience to date using benchmark loss development patterns on paid claims data (“Paid BF”) or reported claims data (“Reported BF”). Although the method tends to provide less volatile indications at early stages of development and reflects changes in the external environment, it can be slow to react to emerging loss development and can, if the IELR proves to be inaccurate, produce loss estimates which take longer to converge with the final settlement value of loss.
Selection of Reported Gross Reserves. Management, through its Reserve Committees, reviews the actuarial stochastic distribution and any other evidence before selecting its management best estimate of reserves for each line of business. Management selects the “management best estimate” by considering all the information provided to them and the risks and uncertainties associated with the actuarial mean best estimate. Management has to date selected its best estimate above that of the actuarial mean best estimate and within the range of the actuarial stochastic distribution. The management mean best estimate provides the basis for management’s recommendation to the Audit Committee and the Board regarding the reserve amounts and related disclosures to be recorded in our financial statements.
Given many of the coverages underwritten involve claims that may not be ultimately settled for many years after they are incurred, subjective judgments as to the ultimate exposure to losses are an integral and necessary component of the loss reserving process. We review our reserves regularly, using a variety of statistical and actuarial techniques to analyze current claims costs, frequency and severity data, and prevailing economic, social and legal factors. Reserves established in prior periods are adjusted as claims experience develops and new information becomes available.
Total ceded written premiums in 2018 increased by $216.5 million compared to 2017. The changes in our reinsurance program reduced our retention ratio, which is defined as net written premiums as a percentage of gross written premiums, from 65.8% in 2017 to 60.4% in 2018. Ceded reinsurance premiums increased for our insurance segment primarily due to an increase in the proportion of business ceded to our casualty, financial institutions and property quota share programs. Ceded reinsurance premiums increased for our reinsurance segment due to increased ceded reinsurance for our property catastrophe business lines where business previously ceded to Silverton, a consolidated entity, is now ceded to Peregrine, a non-consolidated entity. Ceded reinsurance premiums for our reinsurance segment also increased as a result of the transitional arrangements following the sale of AgriLogic in December 2017.
Losses and loss adjustment expenses. The loss ratio for 2018 of 71.0% improved by 15.5 percentage points compared to 2017 and losses and loss adjustment expenses decreased from $1,994.7 million in 2017 to $1,573.0 million in 2018. The improvement in the loss ratio was largely due to a $301.3 million decrease in catastrophe losses and a $38.7 million decrease in large losses which offset the impact from a $91.9 million decrease in net earned premiums. Net losses from catastrophes decreased from $576.0 million in 2017 to $274.7 million in 2018. Large losses in 2018 included $39.7 million of fire-related losses, $19.6 million credit and surety losses, and $9.9 million in relation to a dam construction.
The loss ratio for 2017 of 86.5% increased by 26.7 percentage points compared to 2016 and losses and loss adjustment expenses increased from $1,576.1 million in 2016 to $1,994.7 million in 2017. The increase in the loss ratio was largely due to a $409.6 million increase in catastrophe losses, a $59.7 million increase in large losses, a $23.9 million decrease in prior year losses and a $330.7 million decrease in net earned premiums. Net losses from catastrophes increased from $166.4 million in 2016 to $576.0 million in 2017. Large losses in 2017 included $64.0 million of fire-related losses, a $12.6 million surety loss, an $11.1 million loss related to cyber and terrorism and a $4.8 million loss from a refinery explosion.
In the reinsurance segment, the loss ratio for 2018 was 73.8% compared to 92.6% in 2017 largely due to a $245.1 million decrease in catastrophe losses which offset the impact from a $24.3 million increase in large losses and a $13.4 million decrease in reserve releases. In 2018, there were $222.2 million of catastrophe losses, net of reinsurance recoveries, associated with Hurricanes Florence and Michael in the U.S., Typhoon Jebi in Japan, Winter Storm Friederike in Europe, wildfires in California, U.K. winter storms and other U.S. and Asian weather-related events. In 2017, we experienced $467.3 million of catastrophe losses, net of reinsurance recoveries, associated with Hurricanes Harvey, Irma and Maria, wildfires in California, earthquakes in Mexico and other weather-related events in the U.S. and Australia.
In the insurance segment, the loss ratio for 2018 was 67.4% compared to 79.8% in 2017 largely due to a $56.2 million decrease in catastrophe losses, a $47.6 million decrease in large losses and a $19.1 million increase in reserve releases which more than offset the impact from a $142.2 million decrease in net earned premiums. In 2018, there were $52.5 million of catastrophe losses associated with Hurricanes Florence and Michael, wildfires in California, U.K. winter storms and other U.S. and Asian weather-related events. The loss ratio for 2017 was 79.8% compared to 63.1% for 2016 mainly due to a $57.1 million increase in catastrophe losses, a $34.4 million increase in large losses, an $18.7 million decrease in reserve releases and a $354.9 million decrease in net earned premiums. In 2017, our insurance segment experienced $108.7 million of catastrophe losses associated with Hurricanes Harvey, Irma and Maria, wildfires in California and U.S. weather-related events.
Overall, prior year reserve releases in 2017 decreased by $23.9 million from $129.3 million in 2016 to $105.4 million. Reserve releases in the reinsurance segment in 2017 were across all business lines, totaling $81.8 million. Reserve releases in the insurance segment in 2017 were $23.6 million compared to $42.3 million in 2016 and came principally from marine, energy and aviation insurance.
The slight reduction in the gross policy acquisition expense ratio from 18.9% in 2016 to 18.6% in 2017 was due to a decrease in profit commission accruals in the insurance segment partially offset by an increase in the acquisition ratio in the reinsurance segment due to an increase in profit commission accruals and the prior year benefiting from Federal Excise Tax (“FET”) refunds.
General, administrative and corporate expenses increased by $12.1 million from $490.1 million in 2016 to $502.2 million in 2017 due to $15.2 million of costs associated with the Effectiveness and Efficiency Program, and increased costs associated with growth in our insurance business, partially offset by lower provisions for performance-related remuneration.
Net investment income. In 2018, we generated net investment income of $198.2 million, an increase of 4.9% from the prior year (2017 - $189.0 million, 2016 - $187.1 million) primarily due to an increase in the book yield of the fixed income portfolio. The increase in investment income in 2017 compared with 2016 was also primarily due to the increase in the book yield of the fixed income portfolio despite a reduction in dividend income following the sale of a portion of our equity portfolio in the third quarter of 2017.
Income before tax. In the twelve months ended December 31, 2018, loss before tax was $156.0 million (2017 -loss of $281.8 million; 2016 - income of $209.5 million), consisting of the amounts set out in the table below:
Realized and unrealized investment gains. In 2018, we recorded a reduction in net gross realized and unrealized gains and losses in the statement of operations of $64.7 million (2017 - $120.5 million gains) driven primarily by mark to market losses in our fixed income portfolios. For more details, refer to Note 6 of our consolidated financial statements, “Investments.”
Realized loss on debt extinguishment. On June 18, 2018, we redeemed $125.0 million of our 2020 Senior Notes resulting in a realized loss, or make-whole payment, of $8.6 million.
Net income after tax. In 2018, we had a net loss after tax of $145.8 million, equivalent to $2.97 basic loss per ordinary share adjusted for the $30.5 million preference share dividends and $1.0 million non-controlling interest. In 2017, we had net loss after tax of $266.4 million, equivalent to $5.22 basic loss per ordinary share adjusted for the $36.2 million preference share dividends, $8.0 million of preference share redemption costs and $1.3 million non-controlling interest. In 2016, we had net income after tax of $203.4 million, equivalent to fully diluted earnings per ordinary share of $2.61. For a more detailed description of basic and diluted earnings per ordinary share, see Note 4 of our consolidated financial statements, “Earnings per Ordinary Share.”
We are organized into two business segments, namely reinsurance and insurance. We have determined our reportable segments, Aspen Insurance and Aspen Re, by taking into account the manner in which management makes operating decisions and assesses
Management measures segment results on the basis of the combined ratio, which is obtained by dividing the sum of the losses and loss expenses, amortization of deferred policy acquisition costs and operating and administrative expenses by net premiums earned. Other than corporate expenses, indirect operating and administrative expenses are allocated to business segments predominantly based on each segment’s proportional share of gross earned premiums.
We do not allocate our assets by business segment as we evaluate underwriting results of each segment separately from the results of our investment portfolio. Segment profit or loss for each of our business segments is measured by underwriting profit or loss. Refer to Note 5 of our consolidated financial statements, “Segment Reporting” for information on gross and net premiums written and earned, underwriting results, and combined ratios and reserves for each of our business segments.
non-consolidated entity, which business had previously been ceded to Silverton, a consolidated entity. The decrease in ceded written premiums in specialty reinsurance was due to a reduction in retrocession costs for our agriculture business.
Net premiums earned. Net premiums earned increased by $50.3 million, or 4.2%, in 2018 compared to 2017 largely due to increased gross earned premiums from credit and surety business written in our specialty reinsurance business line, partially offset by increased ceded costs. Net premiums earned increased by $24.2 million, or 2.0%, in 2017 compared to 2016 largely due to increased business written in specialty reinsurance and inwards reinstatement premiums associated with catastrophe losses, partially offset by increased ceded costs.
Our general and administrative expenses decreased by $38.8 million from $157.3 million in 2017 to $118.5 million in 2018. Our general and administrative expense ratio was 9.4% in 2018 compared to 13.0% in 2017 due primarily to a reduction in administration costs following the sale of AgriLogic and lower provisions for performance-related remuneration. Our general and administrative expense ratio of 13.0% in 2017 decreased from 15.1% in 2016 due to a lower provision for performance-related remuneration.
The decrease in gross written premiums in 2017 compared to 2016 in property and casualty insurance was largely attributable to reductions in primary global casualty and program business as a result of a change in our appetite for this type of business, partially offset by growth in our U.K. regional and excess casualty business lines. The decrease in gross written premiums in marine, aviation and energy insurance was largely attributable to continued challenging market conditions in marine and energy liability and aviation business lines. The increase in gross written premiums in financial and professional lines insurance was largely attributable to growth in our management liability, surety, cyber and accident and health business lines.
Ceded reinsurance for 2017 was $849.9 million, an increase of $440.6 million from 2016. Ceded reinsurance increased as a result of the impact from restructuring our ceded reinsurance arrangements in the second half of 2016 and in particular through the use of significant quota share reinsurance arrangements which aim to reduce earnings volatility and benefit the expense ratio through an increase in over-rider commissions. Ceded written premiums also increased across all lines of business due to the purchase of a whole account quota share contract and due to the recognition of ceded costs to reinstate cover following catastrophe losses.
Policy acquisition, general and administrative expenses. Amortization of deferred policy acquisition costs were $110.7 million in 2018, equivalent to 11.6% of net premiums earned (2017 - $165.0 million or 15.0% of net premiums earned; 2016 - $302.5 million or 20.8% of net earned premium). The decrease in the acquisition expense ratio in 2018 compared with 2017 was largely due to an increase in over-rider commissions associated with an increase in ceded reinsurance. The decrease in the acquisition expense ratio in 2017 compared with 2016 was due to lower profit commission accruals and an increase in over-rider commissions.
Our general and administrative expenses decreased by $14.7 million to $239.2 million in 2018 from $253.9 million in 2017. Our general and administrative expense ratio was 25.0% in 2018 compared to 23.1% in 2017 as although there was a reduction in direct costs including accruals for performance-related pay this was less significant than the reduction in net earned premiums due to the increase in ceded costs. General and administrative expenses of $253.9 million in 2017 increased from $228.4 million in 2016 largely due to costs associated with growth in the business.
As of December 31, 2018, our investments consisted of a diversified portfolio of fixed income securities including U.S. Dollar BBB Emerging Market Debt and money market funds. Our overall portfolio strategy remains focused on high quality fixed income investments. In the first quarter of 2018, we took advantage of rising equity markets and sold our remaining equity portfolio. Proceeds from the sales were reinvested into a core fixed income strategy. As at December 31, 2018, the Company had a 4.5% position in BBB Emerging Market Debt and a 1.3% position in a real estate fund representing in total 5.8% of our Managed Portfolio. As at December 31, 2017 the Company had a 5.8% position in equities, a 4.0% position in U.S. Dollar BBB Emerging Market Debt and a 0.2% in risk asset portfolio cash representing in total 10.0% of our Managed Portfolio.
Book yield for the year ended December 31, 2018 on the fixed income portfolio was 2.69%, an increase of 13 basis points from 2.56% at December 31, 2017, as a result of rising interest rates. Our fixed income portfolio duration as at December 31, 2018 was 3.54 years compared to 3.90 as at December 31, 2017. As at December 31, 2018, the average credit quality of our fixed income portfolio was “AA-,” with 88.3% of the portfolio being rated “A” or higher. The average rating of our mortgage-backed securities was AA+. As at December 31, 2017, the average credit quality of our fixed income portfolio was “AA-,” with 88.9% of the portfolio being rated “A” or higher. Where the credit ratings were split between the two main rating agencies, S&P and Moody’s, the lowest rating was used.
Unrealized losses in the available for sale investment portfolio, net of taxes, were $66.8 million as at December 31, 2018, a reduction of $76.5 million from the net $9.7 million unrealized gain as at December 31, 2017.
As at December 31, 2018, we had investments in four entities classified as other investments, equity method: a micro-insurance incubator (“MVI”), Bene Assicurazioni (“Bene”), Digital Risk Resources, LLC (“Digital Re”) and Crop Re Services LLC (“Crop Re”). For further information regarding these investments, see Note 6 of our consolidated financial statements, “Investments.” On December 20, 2017, the Company committed to, and during 2018 invested $100.0 million as a limited partner to a real estate fund, classified as other investments. The investment objective of the fund is to achieve attractive risk-adjusted returns through
the acquisition of income producing, high quality assets in gateway cities located in the U.S. and Canada in the office, retail, industrial and multifamily sectors of the real estate market. On May 1, 2018, the Company received a demand for an initial capital call of $86.2 million and paid the capital call on May 10, 2018. On September 19, 2018, the Company received a demand for the final capital call of $13.8 million and paid the capital on September 28, 2018.
Our mortgage-backed portfolio is supported by loans diversified across a number of geographic and economic sectors. The following table summarizes the fair value of our mortgage-backed securities by rating and class as at December 31, 2018:
Valuation of Other Investments. The Company’s other investments represent our investment in a real estate fund. Adjustments to the fair value are made based on the net asset value of the investment. The net valuation criteria established by the manager of such investments are established in accordance with the governing documents and the asset manager’s valuation guidelines, which consider a two part approach: the discounted cash flows approach and the performance multiple approach, which uses a multiple/capitalization rate derived from market metrics from comparable companies or assets to produce operating performance metrics. Alternative valuation methodologies may be employed for investments with unusual characteristics.
Other-than-temporary Impairment of Investments. We review all our available for sale fixed income and equity investments on an individual security basis for potential OTTI each quarter based on criteria including issuer-specific circumstances, credit ratings actions and general macro-economic conditions. There was a $Nil OTTI charge for the twelve months ended December 31, 2018 (2017 -$0.7 million).
The gross reserves may be further analyzed between outstanding claims and IBNR as at December 31, 2018 and 2017 as follows:
Prior year loss reserves. For the twelve months ended December 31, 2018, there was an overall reduction in our estimate of ultimate net claims to be paid in respect of prior accident years. An analysis of this reduction by business segment is as follows for each of the twelve months ended December 31, 2018, 2017 and 2016:
Insurance.Net reserve releases of $23.6 million in 2017 were mainly as a result of favorable development and the recognition of additional prior year ceded recoveries in our marine, aviation and energy business line in respect of an offshore energy-related loss that occurred in Africa. Net reserves were strengthened in property and casualty lines due to adverse development in our casualty lines following the change in the Ogden rate which impacted our U.K. employer’s liability and U.K. public liability business and increases in loss reserves associated with the purchase of an adverse development cover. Financial and professional lines reported an increase in prior year reserves due to adverse development in the management liability account.
Our preference shares are classified in our balance sheet as equity but may receive a different treatment in some cases under the capital adequacy assessments made by certain rating agencies. Such securities are often referred to as “hybrids” as they have certain attributes of both debt and equity. Management monitors the ratio of the total of debt and hybrids to total capital which was 30.4% as of December 31, 2018 (December 31, 2017 - 30.5%). Total capital is defined as being shareholders’ equity plus outstanding debt and excluding loan notes issued by variable interest entities.
Management monitors the ratio of debt to total capital which was 13.8% as at December 31, 2018 (December 31, 2017 - 15.8%).
On June 18, 2018, we redeemed $125.0 million of our 6.00% Senior Notes due 2020 resulting in a realized loss, or make-whole payment, of $8.6 million.
For the twelve months ended December 31, 2017, we acquired and canceled a total of 648,941 ordinary shares in open market repurchases. We paid a total consideration of $30.0 million and an average price of $46.23 per ordinary share for the twelve months ended December 31, 2017. As at December 31, 2017, we had $220.0 million remaining under our then existing $500.0 million share repurchase authorization program.
On April 16, 2018, Kendall Re Ltd. (“Kendall Re”), a Bermuda-exempted company was licensed and registered as a special purpose insurer under the Bermuda Insurance Act 1978 and related regulations, each as amended. On April 25, 2018 Kendall Re issued $225.0 million Series 2018-1 Class A Principal At-Risk Variable Rate Notes due May 6, 2021 under a variable rate note program from which the proceeds have been used to provide Aspen Bermuda Limited with fully-collateralized retrocessional reinsurance protections against losses from a range of international perils, which include: U.S. named storms, U.S. and Canada earthquakes, U.S. severe thunderstorms, U.S. wildfires, U.S. winter storms and European windstorms. The results and balance sheet of Kendall Re is not included within the consolidated financial statements of the Company because the Company holds no variable or voting interest in Kendall Re.
Liquidity is a measure of a company’s ability to generate cash flows sufficient to meet short-term and long-term cash requirements of its business operations. Management monitors the liquidity of Aspen Holdings and of each of its Operating Subsidiaries and arranges credit facilities to enhance short-term liquidity resources on a stand-by basis. As a holding company, Aspen Holdings relies on dividends and other distributions from its Operating Subsidiaries to provide cash flow to meet ongoing cash requirements, including any future debt service payments and other expenses, and to pay dividends, if any, to our preference and ordinary shareholders.
During the year ended December 31, 2018, Aspen Holdings received dividends of $338.2 million (2017 - $360.0 million) from Aspen Bermuda and $2.1 million (2017 - $Nil) from Aspen Managing Agency Limited.
As at December 31, 2018, Aspen Holdings held $59.3 million (December 31, 2017 - $111.4 million) of cash, cash equivalents and investments. Management considers the current cash and cash equivalents, together with dividends declared or expected to be declared by subsidiary companies and our credit facilities, sufficient to appropriately satisfy the liquidity requirements of Aspen Holdings. Aspen Holdings’ liquidity depends on dividends, capital distributions and interest payments from our Operating Subsidiaries. The liquidity requirements of Aspen Holdings have reduced given that, under the Merger Agreement, Aspen is restricted from declaring or paying any dividends other than the quarterly dividends on Aspen’s ordinary shares that were previously declared and publicly announced prior to the date of the Merger Agreement and periodic cash dividends on the Preference Shares in accordance with the terms of the applicable certificate of designation. Aspen Holdings also has recourse to the credit facility described under “Letter of Credit Facilities” below.
insurance losses on our liquidity, refer to Part I, Item 1A, “Risk Factors - Insurance Risks” and Note 15 of our consolidated financial statements, “Statutory Requirements and Dividend Restrictions.”
Where we incur losses in currencies which are not normally held we will convert funds into the appropriate currencies to mitigate our currency risk and also make funds available to settle claims in local currencies as and when they become due. Recent examples of this have been where we have converted funds to Mexican Peso, Chilean Peso and Chinese Yuan to cover earthquake and other losses in these countries. For local regulatory reasons, we hold assets in trusts which limits our liquidity to some degree. The process of matching assets with liabilities in currency means, however, that at any one time we will hold cash and short-term assets in all major currencies which are available to settle claims.
The liquidity of our Operating Subsidiaries is also affected by the terms of our contractual obligations to policyholders and by undertakings to certain regulatory authorities to facilitate the issue of letters of credit or maintain certain balances in trust funds for the benefit of policyholders, or restricted for other reasons. The following table shows the forms of collateral or other security provided in respect of these obligations and undertakings as at December 31, 2018 and December 31, 2017:
Consolidated cash flows for the twelve months ended December 31, 2016. Total net cash flow from operations for the twelve months ended December 31, 2016 was $453.2 million, a decrease of $121.0 million from the equivalent period in 2015. For the twelve months ended December 31, 2016, our cash flows from operations provided us with sufficient liquidity to meet our operating requirements. We paid net claims of $1,222.8 million in 2016, and used $350.9 million in investing and net purchases and sales of equipment during the period. We paid ordinary and preference share dividends of $94.5 million, and $75.0 million was used to repurchase ordinary shares. At December 31, 2016, we had a balance of cash and cash equivalents of $1,273.8 million.
The following table summarizes our contractual obligations (other than our obligations to employees and our Preference Shares) under long-term debt, operating leases (net of subleases) and reserves relating to insurance and reinsurance contracts as at December 31, 2018:
The long-term debt obligations disclosed above do not include the $21.5 million annual interest payments on our outstanding senior notes or dividends payable to holders of our preference shares or the loan notes issued by Silverton in the amount of $4.6 million.
As at December 31, 2018, we were not party to any off-balance sheet arrangements, as defined by Item 303(a)(4) of Regulation S-K, to which an entity unconsolidated with us is a party that management believes is reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that we believe is material to investors.
accounts which were funded by a third party investor. The segregated accounts have not been consolidated as part of the Company’s consolidated financial statements.
Basic book value per ordinary share is calculated by dividing net assets available to holders of Aspen Holdings’ ordinary shares by the number of ordinary shares outstanding. Diluted book value per ordinary share is calculated by dividing net assets available to holders of Aspen Holdings’ ordinary shares by the number of ordinary shares and dilutive potential ordinary shares outstanding using the treasury stock method.
Operating income, a non-U.S. GAAP financial measure, is an internal performance measure used by us in the management of our operations. It represents after-tax operational results excluding, as applicable, after-tax: net realized and unrealized gains or losses on investments, net realized and unrealized foreign exchange gains or losses, changes to the fair value of derivatives and amortization of intangible assets and other non-recurring income or expenses which includes adviser fees associated with the Merger Agreement. In 2018 we also excluded expenses related to the make-whole payment associated with the partial redemption of the 2020 Senior Notes. We exclude after-tax net realized and unrealized capital gains or losses, after-tax net foreign exchange gains or losses and changes in the fair value of derivatives from our calculation of operating income because the amount of these gains or losses is heavily influenced by, and fluctuates in part, according to the availability of market opportunities. We believe these amounts are largely independent of our business and underwriting process and including them distorts the analysis of trends in our operations. In addition to presenting net income determined in accordance with U.S. GAAP, we believe that showing operating income enables investors, analysts, rating agencies and other users of our financial information to more easily analyze our results of operations in a manner similar to how management analyzes our underlying business performance. Operating income should not be viewed as a substitute for U.S. GAAP net income.