We maintain office facilities in the United States, Bermuda, Europe, Canada, Australia, Singapore and Latin America. We own the property in which our offices are located in Dublin, Ireland, and we lease office space in the other countries. We renew and enter into new leases in the ordinary course of business as required. Our global headquarters is located at 92 Pitts Bay Road, Pembroke, Bermuda. We believe that our office space is sufficient for us to conduct our operations for the foreseeable future.
Results by Segment: Years ended December 31, 2013, 2012 and 2011
Estimated aggregate natural catastrophe and weather-related pre-tax net losses (net of related reinstatement premiums)
Total cash and investments of $14.8 billion; fixed maturities, cash and short-term securities comprise 88% of total cash and investments and have an average credit rating of AA-
Repurchased 10.8 million common shares for total cost of $472 million; remaining authorization under the repurchase program approved by our Board of Directors of $723 million at February 20, 2014
Common shareholders’ equity of $5.2 billion; diluted book value per common share of $45.80
continued expansion of our accident and health line, which launched in 2010 and is focused on specialty accident and health products;
the expansion of the Company’s global underwriting platform, facilitated through the establishment of a new syndicate at Lloyd's which commenced operations on January 1, 2014 and provides us with access to Lloyd’s worldwide licenses and an extensive distribution network; and
In addition, we issued $225 million of 5.50% Series D preferred shares and used a portion of the net proceeds to redeem the $100 million of 7.25% Series A preferred shares outstanding. The execution of these transactions reduced the weighted average annual dividend rate on our preferred equity capital base by 57 basis points to 6.385%, with a minimal impact on our financial leverage.
During September 2013, A.M. Best upgraded the financial strength rating of each of our principal operating insurance and reinsurance subsidiaries to a financial strength rating of A+ (Stable) (see 'Liquidity and Capital Resources - Financial Strength Ratings' for more detail).
2013 versus 2012: The $165 million improvement in our underwriting result during 2013 was primarily due to a reduction in the frequency and severity of natural catastrophe and weather-related losses. 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 2012 U.S. weather events. Comparatively, in 2013, we recognized pre-tax net aggregate losses (net of related reinstatement premiums) of $198 million related to worldwide natural catastrophe and weather-related events. Growth in net premiums earned across both segments also contributed favorably. These improvements were partially offset by increases in the current accident year loss ratios, exclusive of the natural catastrophe and weather-related losses, for both segments and a $25 million reduction in net favorable prior year reserve development.
The improvement in the reinsurance segment's underwriting result of $560 million was primarily attributable to the significantly lower level of natural catastrophe and weather-related losses. The segment's underwriting loss for 2011 included aggregate pre-tax natural catastrophe and weather-related net losses (net of related reinstatement premiums) of $774 million for the 2011 events noted above. Comparatively, in 2012, we recognized pre-tax natural catastrophe and weather-related net losses (net of related reinstatement premiums) of $214 million. An improvement in the current accident year loss ratio, exclusive of these catastrophe and weather-related losses, further contributed to the improvement in 2012. Partially offsetting these improvements was a $32 million reduction in net favorable prior year reserve development, a reduction in net premiums earned and increases in acquisition costs and general and administrative expenses.
Excluding income from our other investments, net investment income decreased by $13 million and $37 million in 2013 and 2012, respectively. These decreases were largely attributable to our fixed maturity portfolio, where lower reinvestment yields drove reductions in income despite higher investment balances.
During each period presented, we realized net investment gains. During 2013, sales of equities were the largest contributor to the net realized gains while sales of fixed maturities were the primary driver in 2012 and 2011. Other-than-temporary impairment ("OTTI") charges were $9 million, $24 million and $16 million in 2013, 2012 and 2011, respectively.
Appreciation in the euro and the Sterling against the U.S. dollar drove foreign exchange losses of $26 million and $30 million in 2013 and 2012, related to the remeasurement of our foreign-denominated net insurance-related liabilities. The 2013 loss was partially offset by the depreciation in the Australian dollar. In 2011, depreciation in the euro and the Sterling resulted in foreign exchange gains of $45 million.
Excluding these foreign exchange-related amounts, other expenses were $159 million, $195 million and $155 million in 2013, 2012 and 2011 respectively. A $53 million increase in corporate expenses impacted other expenses in 2012. Separation payments and accelerated and incremental share-based compensation costs related to our second quarter 2012 senior leadership transition totaled $34 million and were the primary driver of this increase. Partially offsetting the increase in corporate expenses was a $12 million reduction in tax expense, as the impact of Storm Sandy led to minimal taxable income in the U.S. for 2012.
Management expects gross premiums written to increase across both of our segments in 2014 with a continued focus on diversification and pursuit of opportunities to expand our reach in areas where we believe returns are most attractive.
In the primary insurance market we observed a slowdown in the favorable pricing momentum observed in the recent years. Despite the reduction in pricing trends, we continue to observe good fundamentals in many of our insurance lines and markets. Noting variations between different lines of business, we believe that the United States market will continue to provide opportunities for growth, with the international markets coming under increasing pricing pressures.
We believe that the global reinsurance market is currently showing signs of a supply and demand imbalance with an increase in new alternative capacity entering the market, coupled with strong capital positions of established reinsurers having a negative impact on both pricing and terms and conditions. While we believe that established insurers maintain an advantage in the access to attractively-priced business, it will be the focus on targeted lines of business such as agriculture that will provide the key drivers for premium growth. Management expects the competitive market conditions to remain for the rest of the year.
Return on average common equity (“ROACE”) is calculated by dividing net income available to common shareholders for the period by the average shareholders’ equity determined by using the common shareholders’ equity balances at the beginning and end of the period.
Our underwriting loss, driven by natural catastrophe and weather-related losses, was the primary driver of the negative operating ROACE for 2011. Our combined net realized investment gains and foreign exchange gains for 2011 were sufficient for us to recognize net income for the period; as such, our ROACE for the year was marginally positive.
We believe in returning excess capital to our shareholders by way of dividends (as well as share repurchases) and, accordingly, our dividend policy is an integral part of the value we create for our shareholders. Our cumulatively strong earnings have permitted our Board of Directors to approve ten successive annual increases in quarterly common share dividends.
Underwriting-related general and administrative expenses is a non-GAAP measure as defined in SEC Regulation G. Our total general and administrative expenses also included $90,256, $129,660 and $77,089 of corporate expenses for 2013, 2012 and 2011, respectively; refer to 'Other Expenses, Net' for additional information related to these corporate expenses. Also, refer to 'Non-GAAP Financial Measures' for further information.
2013 versus 2012: Gross premiums written growth of 13% was driven by increases in both segments. Increase of 11% in the insurance segment was driven by the accident & health, liability and professional lines. The accident & health line continued to reflect new business expansion. Liability growth was driven by select new business opportunities and, to a lesser extent, rate increases in the U.S wholesale excess casualty market. Growth in the professional lines was largely due to new business as we continue our global expansion.
Reinsurance segment gross premiums written grew by 17% reflecting increases across most lines of business and these increases were most pronounced in agriculture, professional and property lines. The increase in the agriculture line reflected the continuing initiative to grow this line of business and related primarily to growth on the proportional U.S. business with a contribution from global excess of loss business. The professional lines increase primarily reflected new business opportunities. The property line increased primarily due to new business and the expansion of worldwide client relationships.
2012 versus 2011: Growth in net premiums earned for our insurance segment was primarily driven by growth in gross premiums written in our accident & health line. Growth in our professional lines business also contributed, although this was tempered by an increase in premiums ceded. The reduction in catastrophe gross premiums written during 2012 was the primary driver of the decline in net premiums earned for our reinsurance segment.
After adjusting for the impact of the natural catastrophe and weather-related losses noted above, the current accident year loss ratio increased in 2013 driven primarily by a change in the mix of business written. In addition, during the second half of 2013 we experienced an increased level of loss activity in our insurance professional lines which led to an associated strengthening of the professional lines' current year loss ratio. The strengthening in our professional lines was largely driven by the loss experience in certain parts of our D&O business written in the United States. An increase in the level of losses in our reinsurance agriculture line also contributed to the current year ratio increase.
Exclusive of the impact of the natural catastrophe and weather-related losses noted above, the current accident year loss ratio improved during 2012 driven by improvements in both segments:
Reduced exposure and loss experience related to aggregate property reinsurance of regional insurance companies in the U.S. drove an improvement in the reinsurance segment, though this was partially offset by a higher ratio for the trade credit and bond reinsurance business and business mix changes; and
A lower level of loss activity in our property and marine lines of business and a reduction in the ratio for our credit and political risk business were the primary drivers of the improvement in our insurance segment.
In the first quarter of 2013, we began to give weight to actuarial methods that reflect our actual experience for liability reinsurance business, as we believe that our older accident years are now at a stage of expected development where such methods will produce meaningful actuarial indications. During 2013, we recognized $85 million of net favorable prior year development, primarily reflecting the greater weight management is giving to experience based indications and our experience which has been favorable for the 2004 through 2008 accident years.
Our professional lines business recognized $29 million of net adverse development in 2013. This increase in the reserves was due to a $51 million adverse development in the insurance segment, reflecting worse than expected loss experience for the 2011-2012 accident years, due to worse than expected loss experience on certain parts of our U.S. D&O business, and the 2008-2009 accident years, due to developments on certain global financial crisis-related claims. Comparably in 2012 and 2011 professional lines contributed net favorable prior year reserve developments of $54 million and $105 million, respectively. The 2012 and 2011 favorable prior year reserve developments were driven by increased weight being given to experience-based actuarial methods in selecting our ultimate loss estimates for accident years 2009 and prior. During 2013, the transition to the experience-based actuarial methods had a favorable impact on 2010 and prior years, which partially offset the adverse development discussed above.
$64 million of net favorable prior year reserve development on our property and other business, the majority of which related to the 2009 through 2011 accident years ($42 million) and the 2008 accident year ($17 million). While development was primarily driven by better than expected loss emergence, $7 million of the 2008 accident year amount was due to the final settlement of two Hurricane Ike claims.
$19 million of net favorable prior year reserve development on professional lines business, primarily related to the 2006 through 2008 accident years for the reasons discussed in the overview.
$56 million of net favorable prior year reserve development on our property and other business, the majority of which related to the 2010 ($27 million), 2009 ($9 million) and 2008 ($10 million) accident years. While the 2010 and 2009 amounts primarily related to better than expected loss emergence, the 2008 amount largely related to updated information from a client with respect to one large loss event.
$10 million of net favorable prior year reserve development on aviation business, spanning a number of accident years and driven by better than expected loss emergence.
$22 million of net favorable prior year reserve development on professional lines reinsurance business, primarily related to the 2007 through 2009 accident years and driven by better than expected loss emergence, for the reasons discussed in the overview.
$8 million in net favorable prior year reserve development on engineering business, primarily related to the 2007 through 2009 accident years and due to better than expected loss emergence.
Acquisition Cost Ratio: Our acquisition cost ratio decreased from 18.4% in 2012 to 17.9% during 2013, driven by decreases in both segments. In the insurance segment a reduction in acquisition cost ratio is generated by a reduction in the business written through MGAs and higher ceding commissions earned partially offset by a change in business mix. For the reinsurance segment the decrease is driven by variances in accruals for loss-sensitive features in underlying contracts, partially offset by higher acquisition costs paid on certain lines of business. The increase in the ratio in 2012 compared to 2011 was primarily driven by changes in the business mix.
General and Administrative Expense Ratio: The general and administrative expenses increase during 2013 was primarily due to an increase in headcount and the costs related to various growth initiatives across the Company and was partially offset by senior leadership transition costs incurred during 2012. The impact of the increase in general and administrative expenses during 2013 was more than offset by the growth in net premiums earned reducing the overall general and administrative cost ratio. The general and administrative expense ratio increase in 2012 compared to 2011, reflected the senior leadership transition costs noted above, as well as an increase in performance-based compensation expenses and staff increases.
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 business written through MGAs.
2013 versus 2012: Premiums ceded in 2013 were $746 million, or 29%, of gross premiums written, compared to $787 million, or 34%, in 2012. The year on year reductions in the premiums ceded and the related ceded ratio primarily related to changes in our reinsurance purchasing and business mix changes. Reductions related to changes in our reinsurance purchasing included excess of loss treaty reductions driven by both retention and rate, and proportional changes related to reductions in the cession rates on our professional lines and liability programs on renewal during 2013. Changes in business mix related to growth in our accident & health business for which we did not purchase significant reinsurance.
2013 versus 2012: Our accident & health line was the primary contributor to the year on year increase, commensurate with gross premiums written growth discussed above, and accounted for 53% of the overall growth in net premiums earned. Our property, liability and professional lines also contributed to the increase following growth in the gross premiums written and the reductions in premiums ceded discussed above.
After adjusting for these natural catastrophe and weather-related losses, our 2013 current accident year loss ratio increased relative to 2012 primarily due to:
strengthening in our professional lines, relating to certain parts of our D&O business written in the United States, following recent loss experience; and
Acquisition Cost Ratio: The current year acquisition cost ratio decreased from 14.6% in 2012 to 14.1% in 2013. The majority of the variance is being generated by property and marine lines and is due to the aforementioned MGA reductions. Higher ceding commissions earned relative to 2012 also contributed. This was partially offset by a change in the business mix with the accident & health business incurring a higher acquisition cost ratio. The change in the business mix was the primary driver of the increase in the 2012 acquisition cost ratio compared to 2011.
General and Administrative Expense Ratio: The general and administrative expense ratio was comparable at 20.1% in 2013 versus 20.2% in 2012. The increase in general and administrative costs was driven by increased salaries and related costs following an increase in staff compared to last year, as we continue to build-out the segment's global platform. The impact on the general and administrative expense ratio was fully offset by the growth in net premiums earned. The increase in the
general and administrative expense ratio in 2012 compared to 2011, was driven by performance-based compensation expenses and staff increases.
2012 versus 2011: The decrease in gross premiums written was primarily driven by reduction in catastrophe business. We repositioned our catastrophe portfolio throughout 2012, reducing exposure in certain zones; this was partially offset by exposure increases in selected other areas, where we believe risk and return characteristics are more attractive. The decline in property premiums was driven by reductions in reinsurance purchasing by certain of our clients, as well as our evaluation of risk/return characteristics. Our trade credit and bond reinsurance premiums also decreased, driven by management of our European exposure base in light of existing economic conditions and changes in contract terms. While motor premiums were down slightly for the year, there was an underlying shift in business mix; we reduced our participation in certain excess of loss business in light of recent settlement trends, which was partially offset by an increase in proportional business.
Exclusive of these natural catastrophe and weather-related losses, the 2012 current accident year loss ratio improved relative to 2011 largely due to reduced exposure and loss experience related to aggregate property reinsurance of regional insurance companies in the U.S. This was partially offset by a higher loss ratio for our trade credit and bond reinsurance business and business mix changes.
Corporate Expenses: Our corporate expenses include holding company costs necessary to support our worldwide insurance and reinsurance operations and costs associated with operating as a publicly-traded company. As a percentage of net premiums earned, corporate expenses were 2.4%, 3.8% and 2.4% for 2013, 2012 and 2011, respectively. The increase in corporate expenses during 2012 was reflective of costs associated with our second quarter 2012 senior leadership transition; these costs included accelerated and incremental share-based compensation expenses of $20 million and separation payments of $14 million. Excluding these senior leadership transition amounts, corporate expenses were 2.8% of net premiums earned for 2012.
Foreign Exchange Losses (Gains): Some of our business is written in currencies other than the U.S. dollar. The foreign exchange losses (gains) for all periods presented were largely driven by the re-measurement of net insurance related liabilities. Appreciation in the euro and Sterling against the U.S. dollar resulted in foreign exchange losses during 2013 and 2012, with depreciation in the Australian dollar partially offsetting the 2013 loss. Depreciation in the euro and Sterling had the opposite effect in 2011.
Income Tax Expense: Income tax expense primarily results from income generated by our foreign operations in the United States and Europe. Our effective tax rate, which is calculated as income tax expense divided by income before tax, was 1.0%, 0.6% and 24.8% in 2013, 2012 and 2011, respectively. This effective rate can vary between periods depending on the distribution of net income (loss) amongst tax jurisdictions, as well as other factors.
The majority of the higher tax rate in 2013 compared to 2012 is attributable to an increase in pre-tax income in the U.S. A significant portion of our losses and loss expenses for Storm Sandy in 2012 related to insurance risks written by our U.S. subsidiaries, driving a low effective tax rate. 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.
Further increasing income tax expense for 2011 was the establishment of a $13 million valuation allowance related to 2011 operating loss tax-carryforwards generated from branch operations in Singapore and Australia. Partially offsetting these increases was a further $10 million reduction in income tax expense due to the elimination of the remaining valuation allowance associated with our U.S. capital loss carryforwards. During 2011, we concluded an allowance was no longer required, as there were sufficient net unrealized gains that could be realized in order to generate capital gains in the remaining carryforward period.
2013 versus 2012: The improvement in the pre-tax return on our other investments portfolio was primarily driven by the returns generated by our hedge funds as a result of the continued strong performance of both global equities and bank loans. Our direct investments in CLO Equities provided strong returns again in 2013, driven by lower than anticipated default rates and higher than anticipated recovery rates for the underlying collateral (refer to the ‘Critical Accounting Estimates - Fair Value Measurements’ for further details on the fair value measurement). The decline in income from CLO Equities in dollar terms was primarily due to a reduction in our direct investments as two holdings have entered the liquidation phase of their investment cycle and have begun returning capital to equity tranche holders.
2012 versus 2011: The improvement in the pre-tax return on our other investments portfolio was primarily driven by the rally in global equity markets and its impact on our hedge funds. Although CLO Equities provided less income in 2012, their continued strong performance was still a significant positive contributor to 2012 performance. The increase in fair value of our CLO Equities was driven primarily by lower than anticipated default rates and higher than anticipated recovery rates for the underlying collateral.
2012 versus 2011: The improvements in global equity markets throughout 2012 enabled us to realize some net gains on our equity holdings during 2012. The primary sources of the net realized gains on fixed maturities in 2012 were investment-grade corporate debt, agency MBS and non-U.S. governments compared to the primary sources of investment-grade corporate debt, agency MBS and U.S. government and agencies in 2011.
Excluding the impact of foreign currencies due to matching with foreign denominated insurance liabilities, the total return would be 1.6% for 2013 (2012: 4.9%, 2011: 3.7%).
The fair value of our total investments increased $233 million from December 31, 2012, primarily due to net contributions to our fixed maturities and other investments as well as the strong performance of global equity markets during 2013 which led to improved valuations for our equities and other investments. The increases attributable to these factors were partially offset by lower valuations on our fixed maturities as a result of the upward shift in sovereign yield curves.
In light of global concerns during recent years over the creditworthiness of certain countries, particularly within the eurozone, we have actively managed our exposure to sovereign debt issued by these countries. 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, 2013, we held no sovereign debt issued by the peripheral European countries of Greece, Ireland, Italy, Portugal and Spain.
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, 2013 and 2012:
During 2013, proceeds from sales of certain investment grade corporate holdings were reinvested primarily in ABS and municipal debt securities. The increase in non-investment grade holdings is due to additional funds being allocated to our short duration high yield strategy during 2013. At December 31, 2013, our short duration high yield portfolio had a fair value of $916 million (2012: $793 million), a weighted average credit rating of B+ (2012: B+) and duration of 1.6 years (2012: 1.7 years). At December 31, 2013, our total corporate debt portfolio, including short duration high yield securities, had a duration of 2.4 years (2012: 2.9 years).
Our RMBS portfolio consists primarily of AAA-rated U.S. agency issues and is supported by loans that are diversified across geographical areas. Due to a change in prepayment speed assumptions caused by rising interest rates, the duration of our agency MBS holdings expanded from 2.6 years at December 31, 2012 to 4.9 years at December 31, 2013.
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, 2013, the top three revenue streams related to transportation (25%), school (11%) and power (11%) (2012: transportation (22%), school (12%) and power (11%)).
Additionally, certain of our holdings in municipal debt are insured by financial guarantee companies. At December 31, 2013, we held insurance enhanced municipal bonds in the amount of $150 million (2012: $202 million), with a weighted average credit rating of AA- (2012: AA-). In the event the financial guarantors are unable to make good on their guarantee on a defaulted security, we would then be exposed to the credit loss. Excluding the insurance benefit from the financial guarantee companies, the weighted average credit quality of our insured bond holdings would be AA- (2012: AA-). At December 31, 2013, our largest exposures to financial guarantors were Assured Guaranty Corp. for $65 million (2012: $90 million) and National Public Finance Guarantee Corporation for $43 million (2012: $58 million). We had no direct investments in either of these companies at December 31, 2013 and 2012.
At December 31, 2013, the gross unrealized losses on our fixed maturities portfolio were $180 million (2012: $18 million).
Despite increasing our allocation to our short duration high yield strategy during 2013, both the amount and severity of gross unrealized losses on our non-investment grade fixed maturities declined, primarily due to significant tightening of credit spreads.
In order to support our obligations in regulatory jurisdictions where we operate as a non-admitted carrier, we provide collateral in the form of assets held in trust and, to a lesser extent, letters of credit. Refer to Item 8, Note 10(b) to our Consolidated Financial Statements for further information on our collateral requirements upon issuance of certain letters of credit. The fair value of our restricted investments primarily relates to these items, as noted in the table below. Our restricted investments primarily consist of high-quality fixed maturity and short-term investment securities. During 2013, we established AXIS Syndicate to write insurance and reinsurance business. The collateral pledged in connection with this new Lloyd's syndicate was the main driver of the year-over-year increase in total restricted investments.
Liquidity is a measure of a company’s ability to generate cash flows sufficient to meet the short-term and long-term cash requirements of its business operations. We manage our liquidity at both the holding company and operating subsidiary level.
As a holding company, AXIS Capital has no operations of its own and its assets consist primarily of investments in its subsidiaries. Accordingly, AXIS Capital’s future cash flows depend on the availability of dividends or other statutorily permissible distributions, such as returns of capital, from its subsidiaries. The ability to pay such dividends and/or distributions is limited by the applicable laws and regulations of the various countries and states in which AXIS Capital’s subsidiaries operate (refer to Item 8, Note 20, to the Consolidated Financial Statements for further information), as well as the need to maintain capital levels to adequately support (re)insurance operations and to preserve financial strength ratings issued by independent rating agencies. During 2013, AXIS Capital received $566 million (2012: $525 million; 2011: $385 million) of distributions from its subsidiaries. AXIS Capital’s primary uses of funds are dividend payments to both common and preferred shareholders, share repurchases, interest and principal payments on debt, capital investments in subsidiaries and payment of corporate operating expenses. We believe the dividend/distribution capacity of AXIS Capital’s subsidiaries, which was over $1 billion at December 31, 2013, will provide AXIS Capital with sufficient liquidity for the foreseeable future.
Net cash provided by operating activities was $1.1 billion in 2013 and 2012 compared to $1.2 billion in 2011. The Company's insurance and reinsurance operations typically receive principal cash inflows from premiums and reinsurance recoverables. Our principal cash outflows are for the payment of claims and loss adjustment expenses, premium payments to reinsurers, policy acquisition costs and operating expenses. Cash provided by operating activities can fluctuate due to timing differences in the collection of premium receivable and reinsurance recoverables and the payment of losses and premiums payable. The small reductions in cash flows in 2013 and 2012 were driven by an
increase in net paid losses as we continued to settle losses related to prior years' natural catastrophe and weather-related events, partially offset by an increase in premium receipts driven by growth in net written premiums.
The cash outflows from investing activities for 2013 related principally to the net purchase of fixed maturities of $0.6 billion (2012: $0.9 billion, 2011: $0.3 billion). This was a result of reinvesting net investment income across a variety of fixed income asset classes. The decrease in the investing cash flows compared to prior years relates to an increased allocation to cash and cash equivalents during the year. During 2012, fixed income purchases included increased allocations to TIPS, short duration high yield corporate debt and CMBS. 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.
Dividends paid to common and preferred shareholders are the primary source of recurring cash flows used in financial activities and totaled $158 million in 2013 (2012: $159 million, 2011: $243 million); this amount was higher for 2011 relative to the succeeding years largely due to the payment of deferred dividends to certain warrant holders upon exercise (refer to Item 8, Note 13 to our Consolidated Financial Statements). Financing cash outflows also included common share repurchases totaling $472 million, $318 million and $66 million in 2013, 2012 and 2011, respectively. We note that market share repurchases are completely 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 (see ‘Capital Resources - Share Repurchases’ below). During 2013 and 2012, financing cash flows also included a net $118 million inflow and $11 million outflow, respectively, related to the preferred share transactions discussed under 'Capital Resources - Preferred Shares' below. During 2013, cash outflows were partially offset by a $50 million third party investment in shares issued by Ventures Re (See noncontrolling interests discussion in Item 8, Note 14 of the Consolidated Financial Statements).
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 with 2009 being adversely impacted by claims arising from the global financial crisis. Besides 2009, these positive cash flows were generated notwithstanding the impacts of the global financial crisis on other financial years 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 and New Zealand earthquakes 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.
Should claim payment obligations accelerate beyond our ability to fund payments from operating cash flows, we would utilize our cash and cash equivalent balances and/or liquidate a portion of our investment portfolio. Our investment portfolio is heavily weighted towards conservative, high quality and highly liquid securities. We expect that, if necessary, approximately $13.1 billion of cash and invested assets at December 31, 2013 could be available in one to three business days under normal market conditions; of this amount, $3.1 billion relates to restricted assets, which primarily support our obligations in regulatory jurisdictions where we operate as a non-admitted carrier (see Item 8, Note 5(e) to the Consolidated Financial Statements for further details). For context, our largest 1-in-250 year return period, single occurrence, single-zone modeled probable maximum loss (Southeast U.S. Hurricane) is approximately $887 million, net of reinsurance; our claim payments pertaining to such an event would be paid out over a period spanning many months. Our internal risk tolerance framework aims to limit both the loss of capital due to a single event, and the loss of capital that would occur from multiple but perhaps smaller events, in any year. Refer to the ‘Risk and Capital Management’ section of Item 1 for further information.
During April 2012, we closed a cash tender offer for any and all of our outstanding Series B preferred shares at a price of $102.81 per share. As a result, we repurchased 2,471,570 Series B Preferred shares, for $254 million. At December 31, 2012, 28,430 Series B preferred shares, representing $3 million in aggregate liquidation preference, remained outstanding. We may redeem these shares on or after December 1, 2015, at a redemption price of $100.00 per share.
During May 2013, we issued 9 million newly designated 5.50% Series D preferred shares with a liquidation preference of $25.00 per share for gross proceeds of $225 million. Dividends on the Series D preferred shares are non-cumulative; to the extent declared, dividends will accumulate, with respect to each dividend period, in an amount per share equal to 5.50% of the liquidation preference per annum. We may redeem these shares on or after June 1, 2018 at a redemption price of $25.00 per share.
We maintain a secured $750 million letter of credit facility (the “LOC Facility”). This facility is subject to certain covenants, including the requirement to maintain sufficient collateral to cover all of our obligations under the facility. Such obligations include contingent reimbursement obligations for outstanding letters of credit and fees payable to the lender. In the event of default, the lender may exercise certain remedies, including the exercise of control over pledged collateral and the termination of the availability of the facility to any or all of the participating operating subsidiaries.
During 2013, we entered into a $170 million secured letter of credit facility (the "Lloyd's LOC Facility") pursuant to a Letter of Credit Facility Agreement and Security Agreement (collectively, the "Lloyd's Facility Documents"). The Lloyd's LOC Facility is fully utilized and meets the Funds at Lloyd's requirements for the Company's subsidiary, AXIS Corporate Capital UK Limited to support the underwriting capacity of the Company's Lloyd's syndicate, AXIS Syndicate 1686, for the 2014 underwriting year of account. The Letter of Credit issued under the Lloyd's LOC Facility will expire no later than July 31, 2018. The Lloyd's Facility Documents contain customary covenants with which the Company must comply, including a requirement to maintain sufficient collateral to fully secure any issued Letter of Credit. In case of an event of default under
At December 31, 2013, this facility required a minimum consolidated net worth of $4.019 billion and our actual consolidated net worth, as calculated under the provisions of the Credit Facility, was $5.693 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, 2013, we had $501 million, $170 million and $nil letters of credit outstanding under the LOC Facility, Lloyd's LOC Facility and Credit Facility, respectively. The remaining available capacity under these three facilities was $499 million, not taking into consideration the $150 million potential increase in the amount available under the Credit Facility. There was no debt outstanding under the Credit Facility. We were in compliance with all covenants of the facilities at December 31, 2013.
As part of our capital management strategy, our Board of Directors authorizes common share repurchase programs. On December 9, 2013, 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 2014. At February 20, 2014, the remaining authorization under the program was $723 million (see to Item 5 ‘Market for Registrant’s Common Equity, Related Stockholder Matters and Issue Purchases of Equity Securities’ ). 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 ten 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, 2013 by period due:
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, see Item 8, Note 5(b) to the Consolidated Financial Statements.
Nevertheless, other significant accounting policies are important to understanding our Consolidated Financial Statements. See Item 8, Note 2 ‘Significant Accounting Policies’ to the Consolidated Financial Statements for further information.
We believe the most significant accounting judgment we make is the estimate of our reserve for losses and loss expenses (“loss reserves”). Our loss reserves represent management’s estimate of the unpaid portion of our ultimate liability for losses and loss expenses (“ultimate losses”) for (re)insured events that have occurred at or before the balance sheet date. Our loss reserves reflect both claims that have been reported to us (“case reserves”) and claims that have been incurred but not yet reported to us (“IBNR”). Our loss reserves represent our best estimate of what the ultimate settlement and administration of claims will cost, based on our assessment of facts and circumstances known at that particular point in time.
Our results of operations for each of 2013, 2012 and 2011 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.
The overall increase in our gross loss reserves during 2013 was driven by growth in our business and the continued accumulation of reserves for medium and longer-tailed lines.
Our medium-tail business primarily consists of professional lines (re)insurance and trade credit and surety reinsurance business. Certain other classes of business, including aviation hull and offshore energy insurance and engineering reinsurance, are also considered to have a medium-tail. Claim reporting and settlement periods on these classes are generally longer than those of our short-tail reserving classes. We also consider our credit and political risk insurance business to have a medium tail, due to the complex nature of claims and the potential additional time that may be required to realize our subrogation assets.
Loss reporting patterns for professional lines business tend to be volatile, causing instability in actuarial indications based on incurred loss data until an accident year matures for a number of years. Consequently, our initial loss reserves for an accident year are generally based upon an ELR method and the consideration of relevant qualitative factors. As accident years mature, we increasingly give more weight to methods that reflect our actual experience until our selections are based almost exclusively on experience-based methods. We evaluate the appropriateness of the transition to experience-based methods at the reserving class level, commencing this transition when we believe that our incurred loss development is sufficient to produce meaningful actuarial indications. The rate at which we transition fully to sole reliance on experience-based methods can vary by reserving class and by accident year, depending on our assessment of the stability and relevance of such indications. For professional lines in our insurance segment, we also rely upon the evaluation of the open claim inventory in addition to the commonly employed actuarial methods when establishing reserves.
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 recognition of adverse development in some instances. Prior to the fourth quarter of 2012 (see additional details below), we
In addition, during 2011, we recognized net adverse development on our motor reinsurance business, mainly as a result of a change in our assumptions surrounding U.K. settlement practices. Specifically, we increased our assumptions relating to the frequency and cost of claims that are expected to settle using Periodic Payment Orders ("PPOs"), which are annuities designed to cover items such as the ongoing cost of care and loss of earnings for injured claimants. We do not discount our loss reserves in order to adjust for the time value of money associated with such annuity awards.
While we believe that our loss reserves at December 31, 2013 are adequate, new information, events or circumstances may result in ultimate losses that are materially greater or less than provided for in our loss reserves. As previously noted, there are many factors that may cause our reserves to increase or decrease, particularly those related to catastrophe losses and long-tail lines of business.
The second estimate is the amount of reinsurance recoverable on unpaid and paid losses that we will ultimately be unable to recover from reinsurers. The majority of our reinsurance recoverable on unpaid losses will not be due for collection until some point in the future. As a result, the amount we ultimately collect may differ from our estimate due to the ability and willingness of reinsurers to pay our claims, which may be negatively impacted by factors such as insolvency, contractual disputes over contract language or coverage and/or other reasons. Additionally, over the period of time before the amounts become due to us, economic conditions and/or operational performance of a particular reinsurer may deteriorate and this could also affect the willingness and ability of a reinsurer to meet their contractual obligations to us. Accordingly, we review
In our credit and political risk line of business, we write certain policies on a multi-year basis with premiums generally payable in installments. We record premiums at the inception of the policy based on our best estimate of total premiums, including assumptions relating to prepayments/refinancings. Furthermore, certain contracts within this line of business meet the U.S. GAAP definition of a financial guarantee insurance contract. Premiums for such contracts are recognized as the present value of the contractual premiums due or expected to be collected using a discount rate that reflects the risk-free rate at the inception of contract. Due to the scope exemption for insurance contracts that are similar to financial guarantee insurance contracts, the determination of whether certain of our credit and political risk contracts fall within the scope of the U.S. GAAP definition for financial guarantee contracts requires significant management judgment. For the years ended December 31, 2013 and 2012, our total premiums from financial guarantee insurance contracts were immaterial in the context of total gross premiums written for the segment. At December 31, 2013, the average duration of the outstanding unearned premiums written for our credit and political risk line of business was 4.4 years (2012: 4.0 years).
Our excess of loss reinsurance contracts with cedants typically include provisions for a deposit or minimum premiums payable to us, which are generally considered to be the best estimate of the excess of loss reinsurance written premium at inception. The minimum/deposit premium is normally adjusted at the end of the contract period to reflect changes in the underlying risks in force during the contract period. We record adjustments to the deposit/minimum premiums in the period during which they become determinable. Excess of loss contracts accounted for 42%, 47% and 53% of our reinsurance segment’s total gross premiums written for the years ended December 31, 2013, 2012 and 2011, respectively. The decrease during 2013 and 2012, when compared to 2011, was primarily driven by the growth in our agriculture line and repositioning of our catastrophe portfolio.
As a result of this review process, any adjustments to estimates are recognized in gross premiums written during the period they are determined. Such changes in premium estimates could be material to gross premiums written and the resulting adjustments may directly and significantly impact net premiums earned favorably or unfavorably in the period they are determined because the adjustment may be substantially or fully earned. Gross premiums written for proportional contracts, including amounts related to the adjustment of premium estimates established in prior years, accounted for 58%, 53% and 47% of our reinsurance segment’s gross premiums written for the years ended December 31, 2013, 2012 and 2011, respectively.
Our estimates of fair value for financial assets and financial liabilities are based on the framework established in U.S. GAAP. This framework is based on the inputs used in valuation and gives the highest priority to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect our significant market assumptions. The three levels of the hierarchy are as follows:
We measure the fair value for hedge, direct lending and CLO equity funds by obtaining the net asset value (NAV) as advised by our external fund manager or third party administrator. For any funds for which we did not receive a December 31, 2013 net asset value, we have recorded an estimate of the change in fair value for the latest period based on return estimates obtained from the fund managers. Accordingly, we do not typically have a reporting lag in our fair value measurements for these funds. Historically, our estimated NAVs have not significantly diverged from the subsequent final audited NAVs. Where
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 2013, we recorded a total OTTI charge in earnings of $9 million (2012: $24 million; 2011: $16 million). Refer to the ‘Net Investment Income and Net Realized Investment Gains/Losses’ section above for further details.
For the first two criteria above, the OTTI charge is the entire difference between the security’s fair value and its amortized cost. However, if the impairment arises due to an anticipated credit loss on the security (third criterion above), we recognize only the credit loss component of the OTTI amount in earnings with a corresponding adjustment to amortized cost (new cost basis). The non-credit component (e.g. interest rates, market conditions, etc.) of the OTTI amount is recognized in other comprehensive income in our shareholders’ equity.
From time to time, we may sell fixed maturities subsequent to the balance sheet date that we did not intend to sell at the balance sheet date. Conversely, we may not sell fixed maturities that we previously asserted that we intended to sell at the balance sheet date. Such changes in intent may arise due to events occurring subsequent to the balance sheet date. The types of events that may result in a change in intent include, but are not limited to, significant changes in the economic facts and circumstances related to the specific issuer, changes in liquidity needs, or changes in tax laws or the regulatory environment.
If a security meets one of the above criteria, we then perform a fundamental analysis by considering the qualitative factors noted above. Our OTTI review process for credit impairment excludes all fixed maturities guaranteed by the U.S. government and its agencies because we anticipate these securities will not be settled below amortized costs. However, these securities are still evaluated for intention to sell at a loss.
The credit loss component of OTTI recognized in earnings is calculated based on the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to the impairment. The significant inputs and the methodology used to estimate the credit losses are disclosed in Item 8, Note 5(d) to the Consolidated Financial Statements.
Operating income (loss) represents after-tax operational results without consideration of after-tax net realized investment gains (losses), foreign exchange losses (gains) and losses on repurchase of preferred shares. We also present diluted operating income (loss) per common share and operating return on average common equity (“operating ROACE”), which are derived from the non-GAAP operating income (loss) measure.
Tax benefit (cost) of $2,459, $1,148 and ($976) for 2013, 2012 and 2011, 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.
We evaluate our underwriting results separately from the performance of our investment portfolio. As such, we believe it appropriate to exclude net investment income and net realized investment gains (losses) from our underwriting profitability measure.
As noted above, foreign exchange losses (gains) in our Consolidated Statement of Operations primarily relate to our net insurance-related liabilities. However, we manage our investment portfolio in such a way that unrealized and realized foreign exchange rate gains (losses) on our investment portfolio generally offset a large portion of the foreign exchange losses (gains) arising from our underwriting portfolio. As a result, we believe that foreign exchange losses (gains) are not a meaningful contributor to our underwriting performance and, therefore, exclude them from consolidated underwriting income (loss).
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2013, 2012 and 2011
AXIS Capital Holdings Limited (“AXIS Capital”) is the Bermuda-based holding company for the AXIS group of companies, collectively the “Company”. AXIS Capital was incorporated on December 9, 2002, under the laws of Bermuda. Through its subsidiaries and branches organized in Bermuda, the United States, Europe, Singapore, Canada, Australia and Latin America, AXIS Capital provides a broad range of (re)insurance products on a worldwide basis under two distinct global underwriting platforms, AXIS Insurance and AXIS Reinsurance. In these notes, the terms “we,” “us,” “our,” or the “Company” refer to AXIS Capital and its direct and indirect subsidiaries.
Tabular dollar and share amounts are in thousands, with the exception of per share amounts. All amounts are reported in U.S. dollars. To facilitate comparison of information across periods, certain reclassifications have been made to prior year amounts to conform to the current year's presentation.
Reinstatement premiums are recognized and earned at the time a loss event occurs, where the coverage limits for the remaining life of the contract are reinstated under pre-defined contract terms. The accrual of reinstatement premiums is based on our estimate of losses and loss adjustment expenses, which reflects management’s judgment, as described in Note 2(d) - Losses and Loss Expenses below.
Premiums receivable balances are reviewed for impairment at least quarterly and an allowance is established for amounts considered uncollectible. The need for charge-off of any amounts previously reserved as uncollectible is assessed on a quarterly basis.
Common shares repurchased by the Company and not subsequently cancelled are classified as treasury shares and are recorded at cost. This results in a reduction of shareholders’ equity in the Consolidated Balance Sheets. When shares are reissued from treasury, we use the average cost method to determine the cost of the reissued shares. Gains on sales/reissuances of treasury shares are credited to additional paid-in capital, while losses are charged to additional paid-in capital to the extent that previous net gains from reissued treasury shares were included therein; otherwise losses are charged to retained earnings.
Effective January 1, 2013, we adopted FASB guidance requiring additional disclosures about reclassification adjustments from AOCI. As this guidance is disclosure-related only and did not amend existing guidance on the reporting of net income available to common shareholders or other comprehensive income, adoption did not impact our results of operations, financial condition or liquidity. The additional disclosures are provided in Note 19 - Other Comprehensive Income (Loss).
We estimate that the annual amortization expense for our total intangible assets with a finite life will be approximately $2 million from 2014 to 2018. The estimated remaining useful lives of these assets range from six to twenty-five years.
securities as well as the remaining securities in an unrealized loss position in the above table were temporarily depressed at December 31, 2013, and were expected to recover in value as the securities approach maturity. Further, at December 31, 2013, we did not intend to sell these securities in an unrealized loss position and it is more likely than not that we will not be required to sell these securities before the anticipated recovery of their amortized costs.
At December 31, 2013, 63 securities (2012: 106) were in an unrealized loss position of $6 million (2012: $7 million).
At December 31, 2013, 9 (2012: 17) securities had been in a continuous unrealized loss position for 12 months or greater and had a fair value of $3 million (2012: $12 million). Based on our impairment review process and our ability and intent to hold these securities for a reasonable period of time sufficient for a full recovery, we concluded that the above equities in an unrealized loss position were temporarily impaired at December 31, 2013 and 2012.
Two common redemption restrictions which may impact our ability to redeem our hedge 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 2013 and 2012, neither of these restrictions impacted our redemption requests. At December 31, 2013, $99 million (2012: $38 million), representing 10% (2012: 5%) of our total hedge funds, relate to holdings where we are still within the lockup period. The expiry of this lockup periods range from April, 2014 to April, 2016.
At December 31, 2013, $11 million (2012: $29 million) was invested in hedge funds that are not accepting redemption requests. Of this amount, substantially all relates to a leveraged bank loan fund in a period of planned principal distributions. Based on market conditions and payments made to date, management's current expectation is that the distribution process will be completed in 2014. 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.
During 2013, we made a $60 million commitment as a limited partner in a multi-strategy hedge fund. Once the full amount of committed capital has been called by the General Partner, the assets will not be fully returned until the completion of the fund's investment term which ends in December, 2018. The General Partner then has the option to extend the term by up to three years. At December 31, 2013, $54 million of our commitment remains unfunded and the current fair value of the funds called to date are included in the multi-strategy funds line of the table above.
Includes $37 million of gains in 2012 and $11 million of losses in 2011 relating to previously unrealized foreign exchange currency amounts on the hedged fixed maturity portfolios. The hedged portfolio was sold and all associated foreign exchange contracts were fully settled during 2012 so there is no impact on the 2013 figures.
Non-U.S. government obligations are evaluated for credit loss primarily through qualitative assessments of the likelihood of credit loss using information such as duration and severity of unrealized losses, as well as credit ratings and price volatility. At December 31, 2013, our holdings in sovereign debt, including $161 million (2012: $217 million) relating to the eurozone countries, were substantially all investment-grade securities. The gross unrealized losses of $50 million at December 31, 2013 were mainly due to pricing and foreign exchange losses on emerging market debt. Based on our analysis, we do not anticipate any credit losses on our non-U.S. government fixed maturities at December 31, 2013.
To estimate credit losses for corporate debt securities, our projected cash flows are primarily driven by our assumptions regarding the probability of default and the severity associated with those defaults. Our default and loss severity rates are based on credit rating, credit analysis, industry analyst reports and forecasts, Moody’s historical default data and any other data relevant to the recoverability of the security. In 2013, the OTTI charges on corporate debt securities were related to our intent to sell, as well as unrealized foreign exchange losses on certain securities where forecasted recovery was uncertain.
Our investments in CMBS are diversified and highly rated, with a weighted average estimated subordination percentage of 30% at December 31, 2013 (2012: 30%). Based on discounted cash flows at December 31, 2013, the current level of subordination is sufficient to cover the estimated loan losses on the underlying collateral of the CMBS.
For non-agency RMBS, our projected cash flows incorporated underlying data from widely accepted third-party data sources along with certain internal assumptions and judgments regarding the future performance of the security. These assumptions included the following: default, delinquency, loss severity and prepayment rates. The assumptions used to calculate the credit losses in 2013 have not changed significantly since December 31, 2012. At December 31, 2013, the fair value of our non-agency RMBS was $68 million (2012: $95 million), consisting primarily of $41 million (2012: $65 million) of Prime and $19 million (2012: $22 million) of Alt-A MBS. We have concluded there are no credit losses anticipated for any of our non-agency RMBS at December 31, 2013, other than those already recorded.
In order to support our obligations in regulatory jurisdictions where we operate as a non-admitted carrier, we provide collateral in the form of assets held in trust and, to a lesser extent, letters of credit. Refer to Note 10(b) for further information on our collateral requirements upon issuance of certain letters of credit. The fair value of our restricted investments primarily relates to these items, as noted in the table below. Our restricted investments primarily consist of high-quality fixed maturity and short-term investment securities.
Corporate debt securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As these spreads and the yields for the risk-free yield curve are observable market inputs, the fair values of our corporate debt securities are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, securities are classified within Level 3.
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 spreads to determine the appropriate average life of the MBS. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As the significant inputs used to price MBS are observable market inputs, the fair values of the MBS are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers 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 classified within Level 3.
ABS include mostly investment-grade bonds 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. Similarly to MBS, 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.
with U.S. GAAP. For any funds for which we have not yet received a NAV concurrent with our period end date, we record an estimate of the change in fair value for the period subsequent to the most recent NAV. Such estimates are based on return estimates for the period between the most recently issued NAV and the period end date; these estimates are obtained from the relevant fund managers. Accordingly, we do not typically have a reporting lag in our fair value measurements for these funds. Historically, our valuation estimates incorporating these return estimates have not significantly diverged from the subsequent NAVs.
Within the hedge fund, direct lending fund and CLO 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).
Our foreign currency forward contracts and interest rate swaps are customized to our economic hedging strategies and trade in the over-the-counter derivative market. We use the market approach valuation technique to estimate the fair value for these derivatives based on significant observable market inputs from third party pricing vendors, non-binding broker-dealer quotes and/or recent trading activity. Accordingly, we classified these derivatives within Level 2.
Our CLO Debt represent holdings of investment-grade debt tranches within collateralized loan obligations with underlying collateral of loans originated primarily by U.S. corporations. The CLO Debt in the table represent securities where broker-dealer quotes are unavailable so we estimate fair value through the use of a discounted cash flow model (income approach). This model estimates fair values by discounting the estimated cash flows based on current credit spreads for similar securities, derived from observable offer prices. As these securities are thinly traded in the secondary market, we apply an illiquidity discount to these discounted cash flows in developing our estimate of fair value. Significant increases (decreases) in either of the significant unobservable inputs (credit spread, illiquidity discount) in isolation would result in lower (higher) fair value estimates for our CLO Debt. The interrelationship between these inputs is insignificant. These inputs are updated on a quarterly basis and the reasonableness of the resulting prices is assessed through a comparison to observable offer prices for similar securities.
The CLO - Equities market continues to be mostly inactive with only a small number of transactions being observed in the market and fewer still involving transactions in our CLO - Equities. Accordingly, we continue to rely on the use of our internal discounted cash flow model (income approach) to estimate fair value of our direct investments in CLO - Equities. Of the significant inputs into this model, the default and loss severity rates are the most judgmental unobservable market inputs
The transfers from Level 3 to Level 2 made during 2013 were primarily due to the availability of observable market inputs and multiple quotes from pricing vendors and broker-dealers. The transfer from Level 3 to Level 2 in 2012 related to certain hedge funds where we had the ability to liquidate holdings at the reported NAV in the near term due to the expiry of lockup provisions.
Our derivative instruments are generally traded under International Swaps and Derivatives Association master netting agreements, which establish terms that apply to all transactions. In the event of a bankruptcy or other stipulated event, master netting agreements provide that individual positions be replaced with a new amount, usually referred to as the termination amount, determined by taking into account market prices and converting into a single currency. Effectively, this contractual close-out netting reduces credit exposure from gross to net exposure. The table below presents a reconciliation of our gross derivative assets and liabilities to the net amounts presented in our Consolidated Balance Sheets, with the difference being attributable to the impact of master netting agreements.
Net asset and liability derivatives are classified within other assets and other liabilities on the Consolidated Balance Sheets.
Overall, the majority of the net favorable prior year reserve development related to short-tail lines of business. Net favorable prior year reserve development for liability reinsurance also contributed significantly in 2013 with professional lines contributing notably in 2012 and 2011. Favorable development in 2013 was partially offset by adverse development in the insurance professional lines.
The underlying exposures in our property, marine and aviation reserving classes within our insurance segment and the property reserving class within our reinsurance segment largely relate to short-tail business. Development from these classes contributed $162 million, $186 million and $178 million of the total net favorable prior year reserve development in 2013, 2012 and 2011, respectively, and primarily reflected the recognition of better than expected loss emergence.
The frequency and severity of natural catastrophe and weather activity was high in recent years and our December 31, 2013 net reserve for losses and loss expenses continues to include estimated amounts for numerous events. We caution that the magnitude and/or complexity of losses arising from certain of these events, in particular Storm Sandy, the Japanese earthquake and tsunami and the three New Zealand earthquakes, inherently increase the level of uncertainty and, therefore, the level of management judgment involved in arriving at our estimated net reserves for losses and loss expenses. As a result, our actual losses for these events may ultimately differ materially from our current estimates.
During the year ended December 31, 2013, we recognized ceded losses and loss expenses of $415 million (2012: $396 million; 2011: $450 million).
Our provision for unrecoverable reinsurance was $18 million at December 31, 2013 (2012: $16 million). At December 31, 2013, 98.8% (2012: 98.8%) of our gross reinsurance recoverables were collectible from reinsurers rated A- or better by A.M. Best.
Interest expense recognized in relation to our Senior Notes includes interest payable, amortization of the offering discounts and amortization of debt offering expenses. The offering discounts and debt offering expenses are amortized over the period of time during which the Senior Notes are outstanding. During 2013, we incurred interest expense of $59 million (2012: $59 million, 2011: $59 million).
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.
On November 6, 2013, AXIS Capital's subsidiary, AXIS Specialty Limited, entered into a $170 million secured letter of credit facility (the "Lloyd's LOC Facility") with ING Bank N.V., London Branch ("ING") pursuant to a Letter of Credit Facility Agreement and Security Agreement (collectively, the "Lloyd's Facility Documents"). The Lloyd's LOC Facility is fully utilized and meets the Funds at Lloyd's requirements for the Company's subsidiary, AXIS Corporate Capital UK Limited to support the underwriting capacity of the Company's Lloyd's syndicate, AXIS Syndicate 1686, for the 2014 underwriting year of account. The Letter of Credit issued under the Lloyd's LOC Facility will expire no later than July 31, 2018. The Lloyd's Facility Documents contain customary covenants with which the Company must comply, including a requirement to maintain sufficient collateral to fully secure any issued Letter of Credit. In case of an event of default under the Lloyd's Facility Documents, ING may exercise certain remedies, including the exercise of sole and exclusive control over pledged collateral.
At December 31, 2013, we had $501 million, $170 million and nil letters of credit outstanding under the LOC Facility, Lloyd's LOC Facility and the Credit Facility, respectively. There was no debt outstanding under the Credit Facility. We were in compliance with all LOC Facility, Lloyd's LOC Facility and Credit Facility covenants at December 31, 2013.
We monitor and control the aggregation of credit risk on a consolidated basis by assigning limits on the maximum credit exposure we are willing to assume by single obligors and groups, industry sector, country, region or other inter-dependencies. Our credit exposures are aggregated based on the origin of risk. Limits are based and adjusted on a variety of factors, including the prevailing economic environment and the nature of the underlying credit exposures. Our credit aggregation measurement and reporting process is facilitated by an exposure database, which contains relevant information on counterparties and credit risk; we also license third party databases to provide credit risk assessments.
Brokers and other intermediaries collect premiums from customers to be paid to us. We have policies and standards in place to manage and monitor credit risk from intermediaries with a focus on day-to-day monitoring of the largest positions.
We lease office space under operating leases which expire at various dates. We renew and enter into new leases in the ordinary course of business, as required. During 2013, total rent expense with respect to these operating leases was $29 million (2012: $29 million; 2011: $24 million).
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, 2013, we have an outstanding reinsurance purchase commitment of $80 million. Actual payments under the reinsurance contracts will depend on the underlying subject premium and may exceed the minimum premium.
The following table sets forth the comparison of basic and diluted earnings per common share:
At December 31, 2013, and 2012, 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. In 2012, concurrent with the issuance of our Series C preferred shares (see below), we redeemed 6,000,000 of the 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.
For 2013, 2012 and 2011, total dividends declared and paid on Series B preferred shares were $7.50 per share.
In conjunction with the formation of Ventures Re, third party investors purchased $50 million of non-voting redeemable preferred share capital issued by this entity. The preferred shares are redeemable at the sole discretion of Ventures Re's Board of Directors, and are expected to be redeemed on or before July 1, 2016.
During 2013, our total pension expenses were $20 million (2012: $20 million and 2011: $20 million) for the above retirement benefits.
At December 31, 2013, 6,310,845 equity-based awards remained available for grant under the 2007 Plan. Between January 1, 2014 and February 10, 2014, a total of 1,890,523 restricted stock units and 91,917 performance-based restricted stock units were approved by the board of directors to be granted on March 1, 2014. Included in the total restricted stock awards granted subsequent to December 31, 2013 were 954,329 awards which will be settled in cash upon vesting.
The total fair value of restricted stock and cash settled awards vested during 2013 was $56 million (2012: $43 million; 2011: $63 million). At December 31, 2013, we had unrecognized compensation costs of $98 million (2012: $89 million) which are expected to be recognized over the weighted average period of 2.4 years (2012: 2.5 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, 2013 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, 2013.
In the ordinary course of business, we engage SKY Harbor Capital Management, LLC for asset management services for certain of our short duration high yield debt portfolios and StoneRiver RegEd for broker and adjuster licensing, appointment and compliance services. During 2013, total fees paid to these Stone Point Group companies were $2 million (2012: $2 million; 2011: nil).
Under current Bermuda law, our Bermuda domiciled companies are not required to pay any taxes in Bermuda on income or capital gains. We have received an assurance from the Minister of Finance in Bermuda that, in the event of any taxes being imposed, we will be exempt from taxation in Bermuda until March 2035. Our primary Bermuda subsidiary has an operating branch in Singapore, which is subject to the relevant taxes in that jurisdiction. The branch is not under examination in this tax jurisdiction, but remains subject to examination for tax years 2010 through 2013.
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 provisions of the U.S. Internal Revenue Code and Regulations. Should the U.S. subsidiaries pay a dividend outside the U.S. group, withholding taxes will apply. Our U.S. subsidiaries are not under examination but remain subject to examination in the U.S. for tax years 2010 through 2013.
At December 31, 2013 and 2012, 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; (2) unutilized foreign tax credits available in Ireland and (3) certain other deferred tax assets related to branch operations.
Reclassifications out of AOCI into net income available to common shareholders were as follows:
Total statutory net income of our operating subsidiaries was $766 million, $697 million, $99 million for 2013, 2012 and 2011, respectively. The differences between statutory financial statements and statements prepared in accordance with U.S. GAAP vary by jurisdiction; however, the primary differences are that statutory financial statements do not reflect deferred acquisition costs, certain net deferred tax assets, goodwill and intangible assets, unrealized appreciation on debt securities or certain unauthorized reinsurance recoverables.