The summary Consolidated Statements of Comprehensive Income data for the years ended December 31, 2013, December 31, 2012, December 31, 2011, December 31, 2010 and December 31, 2009 and the summary Consolidated Balance Sheet data as of December 31, 2013, December 31, 2012, December 31, 2011, December 31, 2010 and December 31, 2009 are derived from our audited Consolidated Financial Statements. The Company was formed on October 19, 2005 and completed the acquisitions of Talbot, IPC and Flagstone on July 2, 2007, September 4, 2009 and November 30, 2012, respectively. IPC is included in the Company’s consolidated results for the four months ended December 31, 2009 and for subsequent fiscal year ends. Flagstone is included in the Company's consolidated results for the one month ended December 31, 2012 and for the subsequent fiscal year end.
The gain on bargain purchase, net of expenses, arose from the acquisitions of Flagstone on November 30, 2012 and IPC on September 4, 2009 and is net of transaction related expenses.
Book value per common share is defined as total shareholders’ equity available to Validus divided by the number of common shares outstanding as at the end of the period, giving no effect to dilutive securities.
The following is a discussion and analysis of the Company’s consolidated results of operations for the years ended December 31, 2013, 2012 and 2011 and the Company’s consolidated financial condition, liquidity and capital resources at December 31, 2013 and 2012. This discussion and analysis should be read in conjunction with the Company’s audited Consolidated Financial Statements and related notes thereto included elsewhere within this filing.
The Company’s strategy is to concentrate primarily on short-tail risks, which has been an area where management believes prices and terms provide an attractive risk-adjusted return and the management team has proven expertise. The Company’s profitability in any given period is based upon premium and investment revenues, less net losses and loss expenses, acquisition expenses and operating expenses. Financial results in the insurance and reinsurance industry are influenced by the frequency and/or severity of claims and losses, including as a result of catastrophic events, changes in interest rates, financial markets and general economic conditions, the supply of insurance and reinsurance capacity and changes in legal, regulatory and judicial environments.
On April 2, 2012, the Company capitalized PaCRe, a Class 4 Bermuda reinsurer formed for the purpose of writing high excess property catastrophe reinsurance. PaCRe was funded with $500.0 million of contributed capital, of which the Company invested $50.0 million in PaCRe's common equity. On May 1, 2013, PaCRe was funded with an additional $58.5 million in contributed capital from a third party investor and $6.5 million from the Company. The Company underwrites business for PaCRe, for which it is paid a profit commission based on PaCRe's underwriting results. As the Company holds a majority of PaCRe's outstanding voting rights, the financial statements of PaCRe are included in the Consolidated Financial Statements of the Company and its results are reported within the AlphaCat segment. The portion of PaCRe's earnings attributable to third party investors is recorded in the consolidated Statements of Comprehensive Income as "Net (income) loss attributable to noncontrolling interest."
Property and other reinsurance premiums have historically risen in the aftermath of significant catastrophic losses. As loss reserves are established, industry surplus is depleted and the industry’s capacity to write new business diminishes. At the same time, management believes that there is a heightened awareness of exposure to natural catastrophes on the part of cedants, rating agencies and catastrophe modeling firms, resulting in an increase in the demand for reinsurance protection. The global property and casualty insurance and reinsurance industry has historically been highly cyclical. Since 2007, increased capital provided by new entrants or by the commitment of capital by existing insurers and reinsurers increased the supply of insurance and reinsurance which resulted in a softening of rates on most lines. During 2010 and 2011, there was an increased level of catastrophe activity, principally the Chilean earthquake, Deepwater Horizon, Tohoku and Christchurch earthquake events, but the Company continues to see increased competition and decreased premium rates in most classes of business.
During the January 2013 renewal season, the Validus Re and AlphaCat segments underwrote $655.7 million in gross premiums written, an increase of 12.7% from the prior year period. This increase was driven primarily by an increase in gross premiums written in the specialty lines. This renewal data does not include Talbot’s operations as its business is distributed relatively evenly throughout the year. During the mid-year 2013 renewal period, the Validus Re segment experienced rate softening across U.S. and international property lines. The Talbot segment experienced relatively flat rate price movements in the year ended December 31, 2013 with increases being generated by the onshore energy, marine treaty and marine liability accounts offset by decreases generated by aviation accounts and the remainder of the treaty portfolio.
Book value per diluted common share is considered by management to be an appropriate measure of our returns to common shareholders, as we believe growth in book value on a diluted basis ultimately translates into growth in stock price. Book value per diluted common share after dividends paid, increased by $1.01, or 2.9%, from $35.22 at December 31, 2012 to $36.23 at December 31, 2013. The increase was primarily due to net income available to Validus, offset by the special dividend of $2.00 per share and quarterly dividends of $0.30 per share which were paid during the year ended December 31, 2013. Book value per diluted common share is calculated based on total shareholders’ equity plus the assumed proceeds from the exercise of outstanding options and warrants, divided by the sum of common shares, unvested restricted shares and options and warrants outstanding (assuming their exercise). Book value per diluted common share is a non-GAAP financial measure, as described in more detail in the section entitled “Non-GAAP Financial Measures.”
Return on average equity represents the return generated on common shareholders’ capital during the period. Return on average equity is calculated by dividing the net income available to Validus for the period by the average shareholders’ equity available to Validus during the period. Average shareholders’ equity is the average of the beginning, ending and intervening quarter end shareholders’ equity balances. The Company’s objective is to generate superior returns on capital that appropriately reward shareholders for the risks assumed. The increase in return on average equity was driven by an increase in net income available to Validus for the year ended December 31, 2013 and a reduction in shareholders' equity as a result of share repurchases during the year. Net income available to Validus for the year ended December 31, 2013 increased by $124.2 million, compared to the year ended December 31, 2012 due primarily to the decreased impact of notable loss events for the year ended December 31, 2013 as compared to the year ended December 31, 2012.
Net investment income for the three months ended December 31, 2013 was $24.2 million compared to $28.8 million for the three months ended December 31, 2012, a decrease of $4.6 million, or 16.0%.
Net operating income available to Validus for the three months ended December 31, 2013 was $96.4 million compared to net operating loss attributable to Validus of ($100.8) million for the three months ended December 31, 2012, an increase of $197.2 million, or 195.6%.
Losses and loss expenses from notable loss events for the three months ended December 31, 2013 was $nil compared to $361.0 million for the three months ended December 31, 2012, a decrease of $361.0 million.
Investment yield for the three months ended December 31, 2013 was 1.31% compared to 1.53% for the three months ended December 31, 2012.
Annualized return on average equity and annualized net operating return on average equity for the three months ended December 31, 2013 were 10.2% and 10.3%, respectively, compared to (9.5)% and (10.5)% for the three months ended December 31, 2012.
During the quarter there was unfavorable loss reserve development on both the 2010 and 2011 New Zealand earthquakes of $40.3 million and $30.6 million, respectively. The remaining Reserve for Development on 2011 Notable Loss Events of $29.0 million was fully allocated to the 2011 New Zealand earthquake, resulting in net unfavorable loss reserve development of $41.9 million. The consolidated current period loss ratio, excluding notable losses and loss reserve development on prior accident years, for the three months ended December 31, 2013 was 48.7% compared to 31.0% for the three months ended December 31, 2012. This increase is largely attributable to a number of non-notable loss events that were below the $30.0 million notable loss threshold.
The AlphaCat segment's non-consolidated affiliates incurred loss and loss expenses of $8.4 million related to Hurricane Sandy for the three months ended December 31, 2012. These losses are not included in the table above as the entities are accounted for as investments in operating affiliates.
Net income available to Validus for the year ended December 31, 2013 was $532.7 million, or $4.94 per diluted common share compared to $408.4 million or $3.99 per diluted common share for the year ended December 31, 2012.
Losses and loss expenses from notable loss events for the year ended December 31, 2013 was $60.8 million compared to $500.6 million for the year ended December 31, 2012, a decrease of $439.7 million.
Return on average equity and net operating return on average equity for the year ended December 31, 2013 were 14.0% and 15.2%, respectively compared to 11.3% and 9.2% for the year ended December 31, 2012.
Overview of the Results of Operations for Years Ended December 31, 2013 and December 31, 2012 compared to the Years Ended December 31, 2012 and December 31, 2011, respectively.
Notable loss for the year ended December 31, 2013 was the European Floods. Notable losses for the year ended December 31, 2012 were Costa Concordia, Cat 67, U.S. drought, Hurricane Isaac and Hurricane Sandy. Notable losses for the year ended December 31, 2011 were Tohoku Earthquake, Gryphon Alpha, Christchurch Earthquake, Brisbane Floods, CNRL Horizon, Cat 46, Cat 48, Jupiter 1, Danish Floods, Hurricane Irene and the Thailand Floods.
Net operating income available to Validus for the year ended December 31, 2013 was $578.7 million compared to $333.8 million for the year ended December 31, 2012, an increase of $244.8 million. The primary factors driving the increase were:
An increase in underwriting income of $356.2 million due primarily to:
A $205.5 million decrease in losses and loss expenses, driven by a significantly lower level of notable losses, offset by losses on the new agricultural business written by Validus Re;
A $51.6 million increase in general and administrative expenses, due primarily to costs associated with the run-off of the former Flagstone business and an increase in average headcount; and
•Decreases in investment income of $11.9 million and other income of $14.1 million.
The Year Ended December 31, 2012 compared to the Year Ended December 31, 2011
A $245.0 million decrease in losses and loss expenses, driven by a lower level of notable losses; and
A $71.1 million increase in net premiums earned, primarily due to expansion of the marine book at both Validus Re and Talbot;
A $66.2 million increase in general and administrative expenses, due primarily to an increase in headcount and a higher level of performance bonus, partially offset by $7.6 million decrease in share compensation expenses; and
A $20.5 million increase in policy acquisition costs, reflecting the higher level of net premiums earned.
A $20.4 million decrease in net operating income attributable to noncontrolling interest; and
Increases in other income of $16.7 million and income from operating affiliates of $12.6 million.
Management has determined that the Company operates in three reportable segments - Validus Re, AlphaCat and Talbot. For segmental reporting purposes, the results of Flagstone’s operations since November 30, 2012 have been included within the Validus Re segment in the Consolidated Financial Statements.
Net investment income for the three months ended December 31, 2013 was $19.6 million compared to $23.8 million for the three months ended December 31, 2012, a decrease of $4.2 million, or 17.8%.
Other operating income and expenses, net, consists of net investment income, other income, finance expenses and taxes.
The decrease in gross premiums written in the property lines of $27.0 million was due to a reduction in reinstatement premiums of $38.6 million, primarily relating to Hurricane Sandy, a decrease in per risk excess of loss treaties of $22.4 million, primarily due to non-renewals of business on a number of accounts and prior year business being renewed under specialty lines in 2013, a decrease of $7.2 million due to downward premium adjustments and a decrease of $6.4 million in renewals of business written by Flagstone in 2012. These decreases were offset by an increase of $50.2 million in catastrophe excess of loss treaties primarily relating to new business written and increased shares on renewals. The decrease in gross premiums written of $63.5 million in the marine lines was due to a $32.0 million decrease in reinstatement premiums compared to the prior year, primarily relating to the Costa Concordia event. In addition, there was a $25.0 million decrease in proportional treaties due to reductions in shares and the non-renewal of business on a number of accounts that no longer met the Company's underwriting threshold. In addition, $8.6 million of business historically written in marine lines was renewed in specialty lines. The increase in gross premiums written of $201.0 million in the specialty lines was due primarily to an increase in proportional agriculture treaties of $179.4 million. This was as a result of hiring two experienced underwriters at the beginning of the year to target growth in this
class. In addition, $23.8 million of business historically written in the property and marine lines was renewed in specialty lines. Offsetting these increases were downward premium adjustments of $5.6 million.
The mix of business has remained fairly consistent with the exception of the increase in specialty lines relating to the targeted growth in the agriculture business in the first quarter of 2013, as discussed above.
The property ratio has decreased 7.1% reflecting the restructuring of the property retrocessional coverage and the specialty ratio has decreased 12.0% due to the reinsurance coverage purchased for new agriculture business, whereas almost all other specialty business is fully retained.
Marine lines did not incur any notable losses during the year ended December 31, 2013. In comparison, Validus Re marine lines incurred $102.5 million of losses from notable loss events during the year ended December 31, 2012, primarily Costa Concordia, which represented 40.3 percentage points of the marine lines loss ratio.
Specialty lines experienced $11.2 million lower favorable loss reserve development, primarily related to an increase in the loss estimate for the U.S. drought. The current period loss ratio, excluding the impact of notable losses, was significantly higher due to the impact of agricultural business, which typically has a higher attritional loss ratio than Validus Re's other specialty business.
The underwriting results of an insurance or reinsurance company are often measured by reference to its combined ratio, which is the sum of the loss and loss expense ratio and the expense ratio. The loss and loss expense ratio is calculated by dividing losses and loss expenses incurred (including estimates for incurred but not reported losses) by net premiums earned. The expense ratio is calculated by dividing acquisition costs combined with general and administrative expenses by net premiums earned. The following table presents the loss and loss expense ratio, policy acquisition cost ratio, general and administrative expense ratio, expense ratio and combined ratio for the years ended December 31, 2013, 2012 and 2011.
The decrease in the combined ratio for the year ended December 31, 2013 of 15.6 percentage points compared to the year ended December 31, 2012 is due to the movement in the underlying ratios as discussed above.
The decrease in net investment income for the year ended December 31, 2013 was $7.4 million or 8.3% mainly due to falling yields on fixed maturity investments.
The increase in finance expenses of $7.2 million for the year ended December 31, 2013 was due primarily to the interest on the Flagstone junior subordinated deferrable debentures, as the 2012 finance expenses only included interest from the November 30, 2012 acquisition date.
Managed gross premiums written, including our non-consolidated affiliates, for the three months ended December 31, 2013 were ($1.0) million compared to $nil for the three months ended December 31, 2012, a decrease of $1.0 million.
Income from operating affiliates for the three months ended December 31, 2013 was $5.5 million compared to a loss from operating affiliates of ($0.6) million for the three months ended December 31, 2012, an increase of $6.1 million.
Net operating income available to AlphaCat for the three months ended December 31, 2013 was $11.8 million compared to $1.1 million for the three months ended December 31, 2012, an increase of $10.7 million.
The increase in gross premiums written in the property lines of $125.4 million was due primarily to the renewal of business through AlphaCat Re, which is fully consolidated and which wrote business on behalf of AlphaCat 2013 and the AlphaCat ILS funds. The comparable business was included within AlphaCat Re 2011 and AlphaCat Re 2012 which were not consolidated in 2012 and were accounted for as operating affiliates under the equity method of accounting. The 2012 premiums are included in managed gross premiums below, which is a comparable measure. In addition, $4.0 million of the increase relates to PaCRe as this company started writing business in June 2012, therefore, current year to date results includes business for the full year.
Managed gross premiums written, which includes gross premiums written by our non-consolidated affiliates, AlphaCat Re 2011 and AlphaCat Re 2012, for the year ended December 31, 2013 were $143.1 million compared to $148.1 million for the year ended December 31, 2012, a decrease of $4.9 million or 3.3%. A reconciliation of managed gross premiums written to gross premiums written, the most comparable U.S. GAAP financial measure, is presented in the section entitled "Non-GAAP Financial Measures."
The Year Ended December 31, 2013 compared to the Year Ended December 31, 2012
The increase in general and administrative expenses of $11.2 million, or 149.1%, primarily reflects additional ILS funds under management, for the year ended December 31, 2013. In addition, an increased share of corporate costs has been allocated to the AlphaCat segment, reflecting the general growth in the size of the segment.
The following table presents the loss and loss expense ratio, policy acquisition cost ratio, general and administrative expense ratio, expense ratio and combined ratio for the years ended December 31, 2013, 2012 and 2011.
Net investment income for the years ended December 31, 2013 and 2012 were comparable.
The increase in finance expenses of $2.7 million for the year ended December 31, 2013 was due to fees on additional capital raised.
For details of voting and equity ownership interests of the above entities, refer to Note 9 to the Consolidated Financial Statements in Part II, Item 8. The increase for the year ended December 31, 2013 reflects the ILS fund that commenced operations in 2013.
Income attributable to operating affiliate investors for the year ended December 31, 2013 was $68.8 million compared to $nil for the year ended December 31, 2012. This represents the transfer of investors' economic interest in the non-consolidated affiliated entities and includes both the Company's and third-party investors' share.
Gross premiums written for the three months ended December 31, 2013 were $236.4 million compared to $241.1 million for the three months ended December 31, 2012, a decrease of $4.7 million, or 2.0%. Gross premiums written for the three months ended December 31, 2013 included $60.9 million of property premiums, $75.1 million of marine premiums and $100.4 million of specialty premiums compared to $62.3 million of property premiums, $81.5 million of marine premiums and $97.3 million of specialty premiums for the three months ended December 31, 2012.
Net premiums earned for the three months ended December 31, 2013 were $204.3 million compared to $208.1 million for the three months ended December 31, 2012, a decrease of $3.8 million, or 1.8%.
Underwriting income for the three months ended December 31, 2013 was $27.1 million compared to $4.4 million for the three months ended December 31, 2012, an increase of $22.7 million.
Combined ratio for the three months ended December 31, 2013 was 86.8% compared to 97.9% for the three months ended December 31, 2012.
The loss ratio for the three months ended December 31, 2013 was 46.4% compared to 61.1% for the three months ended December 31, 2012, a decrease of 14.7 percentage points. The loss ratio for the three months ended December 31, 2013 included favorable loss reserve development on prior accident years of $37.0 million, benefiting the loss ratio by 18.1 percentage points. The loss ratio for the three months ended December 31, 2012 included favorable loss reserve development on prior accident years of $37.4 million, benefiting the loss ratio by 18.0 percentage points.
Net investment income for the three months ended December 31, 2013 was $4.6 million compared to $4.8 million for the three months ended December 31, 2012, a decrease of $0.3 million, or 5.6%.
Notable loss for the year ended December 31, 2013 was the European Floods. Notable losses for the year ended December 31, 2012 were Costa Concordia, Cat 67, Hurricane Isaac and Hurricane Sandy. Notable losses for the year ended December 31, 2011 were Tohoku Earthquake, Gryphon Alpha, Christchurch Earthquake, Brisbane Floods, CNRL Horizon, Cat 46, Cat 48, Jupiter 1, Danish Floods, Hurricane Irene and the Thailand Floods.
The increase in gross premiums written in the property lines of $20.9 million was due primarily to an increase in direct property lines of $14.3 million which was mainly driven by new business as a result of the hiring of an additional experienced property underwriter. In addition, there was an increase in construction lines of $7.1 million, driven by new business and premium adjustments on prior period policies. The decrease in gross premiums written in the marine lines of $15.0 million was due primarily to a reassessment of commission costs on underwriting years 2007 and prior, in the year ended December 31, 2012. This resulted in an additional $14.8 million of gross premiums written and earned premium in the prior year, offset by an equal increase to policy acquisition costs, resulting in no net impact. In addition, the decrease was as a result of $4.8 million of downward premium adjustments in hull lines. These decreases were offset by $8.1 million of new business written and premium increases on renewals in cargo lines. The increase in gross premiums written in the specialty lines of $7.3 million was due primarily to new business written of $11.3 million, mainly
The decrease in reinsurance premiums ceded in the marine lines of $6.3 million was due primarily to a decrease in reinstatement premiums ceded, with higher reinstatement premiums being ceded in the year ended December 31, 2012 related to Hurricane Sandy losses.
The increase in Talbot net premiums written was driven by the factors highlighted above in respect of gross premiums written and reinsurance premiums ceded.
The increase in the retention of property business primarily reflects the fact that the majority of the new property business written in the year ended December 31, 2013 has been retained. The lower retention of marine business in the year ended December 31, 2012 reflects a reduction in reinstatement premiums.
Property lines experienced $19.4 million higher favorable loss reserve development, primarily related to favorable development on the Tohuku earthquake, Thailand floods and Hurricane Sandy, combined with lower than expected attritional claims development
Marine lines incurred $2.0 million of losses from a notable loss event, the European Floods, which represented 0.6 percentage points of the marine lines loss ratio. In comparison, for the year ended December 31, 2012, Talbot’s marine lines incurred $43.3 million of losses from notable loss events, primarily Costa Concordia and Hurricane Sandy, which represented 12.2 percentage points of the marine lines loss ratio.
Marine lines experienced $6.0 million higher favorable loss reserve development, primarily related to lower than expected development on attritional claims during the period, as well as a lower emergence of events. This was partially offset by unfavorable reserve development of $7.5 million on Costa Concordia. The current period loss ratio, excluding the impact of notable losses, was higher by 5.8 percentage points, representing higher attritional claims and larger, non-notable events.
The increase in property acquisition costs was due to increases in rates due to current market conditions and the changes in the onshore energy managing agent general commission arrangements. The decrease in the marine rates are a result of the impact of the reassessment of commission costs in calendar year 2012, which was offset by an equal increase on gross written and earned premium resulting in no net impact. The impact on the marine policy acquisition cost ratio for the year ended December 31, 2012 was an additional 3.2 percentage points.
Corporate general and administrative expenses for the year ended December 31, 2013, net of eliminations related to the operating segments, were $68.8 million compared to $59.8 million for the year ended December 31, 2012, an increase of $9.0 million or 15.0%. General and administrative expenses have increased primarily due to higher performance bonus expense and headcount, from 155 employees at December 31, 2012 to 169 employees at December 31, 2013. Corporate general and administrative expenses are comprised of executive and board expenses, internal and external audit expenses and other costs relating to the Company as a whole.
The unfavorable movement on fixed maturity and short term investments was primarily as a result of a shift in the yield curve and a widening of corporate bond spreads, especially during the second quarter of 2013. The favorable movement on other investments was primarily due to an improved performance of the Paulson & Co. hedge fund investments held by PaCRe.
The Company currently hedges foreign currency exposure by balancing assets (primarily cash and premium receivables) with liabilities (primarily case reserves and event IBNR) for certain major non-U.S. dollar currencies, or by entering into forward foreign currency contracts. Consequently, the Company aims to have a limited exposure to foreign exchange fluctuations.
For the year ended December 31, 2013, net income attributable to noncontrolling interest was $9.7 million, which was comprised of operating income of $11.6 million, as discussed in the AlphaCat Segment Results of Operations, and a non-operating loss of $1.9 million, primarily on the investment portfolio within PaCRe.
The operating results of an insurance or reinsurance company are also often measured by reference to its net operating income, which is a non-GAAP financial measure. Net operating income, as set out in the table below, is reconciled to net income (the most directly comparable GAAP financial measure) by the addition or subtraction of certain Consolidated Statement of Comprehensive Income (Loss) line items, as illustrated below.
Operating income indicates the performance of the Company’s core underwriting function, excluding revenues and expenses such as the reconciling items in the table above. The Company believes the reporting of operating income enhances the understanding of our results by highlighting the underlying profitability of the Company’s core insurance and reinsurance business. This profitability is influenced significantly by earned premium growth, adequacy of the Company’s pricing and loss frequency and severity. Over time it is also influenced by the Company’s underwriting discipline, which seeks to manage exposure to loss through favorable risk selection and diversification, its management of claims, its use of reinsurance and its ability to manage its expense ratio, which it accomplishes through its management of acquisition costs and other underwriting expenses.
The Company also uses underwriting income as a primary measure of underwriting results in its analysis of historical financial information and when performing its budgeting and forecasting processes. Analysts, investors and rating agencies who follow the Company request this non-GAAP financial information on a regular basis. In addition, underwriting income is one of the factors considered by the compensation committee of our Board of Directors in determining the total annual incentive compensation.
be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP.
Managed gross premiums written represents gross premiums written by the Company and its operating affiliates. Managed gross premiums written differs from total gross premiums written, which the Company believes is the most directly comparable GAAP measure, due to the inclusion of premiums written on behalf of the Company's operating affiliates, AlphaCat Re 2011 and AlphaCat Re 2012, which are accounted for under the equity method of accounting. A reconciliation of managed gross premiums written to gross premiums written, the most comparable U.S. GAAP financial measure, for the years ended December 31, 2013 and December 31, 2012 is presented in the table below.
The following tables present reconciliations of book value per diluted common share to book value per common share, the most comparable U.S. GAAP financial measure, at December 31, 2013 and December 31, 2012.
The Company also has an allocation to other investments, primarily hedge funds. At December 31, 2013, these other investments, excluding noncontrolling interests, totaled $128.9 million, or 1.9%, of our total investments (2012 - $131.7 million or 1.9%). For further details related to our investment portfolio, including the extent of investments with fair values measured using unobservable inputs, see notes 7 and 8 to the Consolidated Financial Statements in Part II, Item 8.
The estimated fair value of investments at December 31, 2013 and 2012 were as follows:
Included in the short-term investments balance are investments held by consolidated AlphaCat ILS funds, where the Company has an equity interest of less than 100% and the remaining is held by third party investors.
During 2013, the Company received partial returns of investment from AlphaCat Re 2011 and AlphaCat Re 2012 of $54.9 million and $31.7 million, respectively. Offsetting these returns were contributions of capital to AlphaCat 2014 and Aquiline of $22.0 million and $14.5 million, respectively. The Company expects to receive further returns of investment in 2014 from AlphaCat Re 2011 and AlphaCat Re 2012.
At December 31, 2013 and 2012, gross and net reserves for losses and loss expenses were estimated using the methodology as outlined in the Critical Accounting Policies and Estimates section below. The following tables indicate the breakdown of gross and net reserves for losses and loss expenses between lines of business and between case reserves and IBNR.
The management of insurance and reinsurance companies use significant judgment in the estimation of reserves for losses and loss expenses. Given the magnitude of some notable loss events and other uncertainties inherent in loss estimation, meaningful uncertainty remains regarding the estimation for these events. The Company's actual ultimate net loss may vary materially from these estimates. Ultimate losses for notable loss events are estimated through detailed review of contracts which are identified by the Company as potentially exposed to the specific notable loss event. However, there can be no assurance that the ultimate loss amount estimated for a specific contract will be accurate, or that all contracts with exposure to a specific notable loss event will be identified in a timely manner. Potential losses in excess of the estimated ultimate loss assigned to a contract on the basis of a specific review, or loss amounts from contracts not specifically included in the detailed review may be reserved for in the reserve for potential development on notable loss events. Any reserve for potential development on notable loss events (or “RDE”) is included as part of the Company's overall reserve as defined and disclosed in the Critical Accounting Policies and Estimates section.
Notable losses for the year ended December 31, 2011 were Tohoku earthquake, Gryphon Alpha mooring failure, Christchurch earthquake, Brisbane floods, CNRL Horizon, Cat 46, Cat 48, Jupiter 1, Danish floods, Hurricane Irene and Thailand floods.
Notable losses for the year ended December 31, 2012 were Costa Concordia, Cat 67, U.S. drought, Hurricane Isaac and Hurricane Sandy.
The RDE is included as part of the Company's overall reserve requirement as defined and disclosed in the Critical Accounting Policies and Estimates section.
The following table details the capital of the Company’s more significant subsidiaries on an unconsolidated basis:
There are three main sources of cash flows for the Company: operating activities, investing activities and financing activities. The movement in net cash provided by or used in operating, investing and financing activities and the effect of foreign currency rate changes on cash and cash equivalents for the years ended December 31, 2013, 2012 and 2011 is shown in the following table.
Cash flow from investing activities is derived primarily from the receipt of net proceeds on the Company’s investment portfolio. As at December 31, 2013, the Company’s portfolio was composed of fixed income investments, short-term and other investments amounting to $6,912.4 million or 86.7% of total cash and investments. For further details related to investments pledged as collateral, see note 7 (d) to the Consolidated Financial Statements in Part II, Item 8.
Net cash used in investing activities during 2013 was ($157.9) million compared to ($268.9) million for 2012, a favorable movement of $111.0 million. This favorable movement was driven primarily by the returns on investment from AlphaCat Re 2011 and AlphaCat Re 2012 totaling $86.6 million during 2013, offset by an additional investment of $22.0 million in AlphaCat 2014. This is compared to the cost of purchasing shares in AlphaCat Re 2012, AlphaCat 2013 and the ILS funds totaling $91.5 million during 2012.
The following table details the Company's overall capital position as at December 31, 2013, 2012 and 2011.
(c) As part of the acquisition of Flagstone Reinsurance Holdings, S.A., the Company assumed $137.2 million of junior subordinated deferrable interest debentures due 2036 (the “Flagstone 2006 Junior Subordinated Deferrable Debentures”). The Flagstone 2006 Junior Subordinated Deferrable Debentures mature on September 15, 2036 and have been redeemable at the Company's option at par since September 15, 2011. In addition, the Company assumed $113.7 million of junior subordinated deferrable interest debentures due 2037 (the “Flagstone 2007 Junior Subordinated Deferrable Debentures”). $88.8 million of the Flagstone 2007 Junior Subordinated Deferrable Debentures mature on July 30, 2037 and have been redeemable at the Company's option at par since July 30, 2012. $25.0 million of the Flagstone 2007 Junior Subordinated Deferrable Debentures mature on September 15, 2037 and have been redeemable at the Company's option at par since September 15, 2012.
(e) Total capitalization available to Validus equals total capitalization less noncontrolling interests.
(f) The Company does not include notes payable to operating affiliate investors within total capitalization, since these are issued to some of the Company's operating affiliates specifically for the purpose of purchasing capital market products and writing collateralized reinsurance.
Shareholders' equity available to Validus at December 31, 2013 was $3,704.1 million.
On February 5, 2014, the Company announced a quarterly cash dividend of $0.30 per common share and $0.30 per common share equivalent for which each outstanding warrant is exercisable, which is payable on March 31, 2014 to shareholders and warrant holders of record on March 14, 2014. The timing and amount of any future cash dividends, however, will be at the discretion of the
Board and will depend upon our results of operations and cash flows, our financial position and capital requirements, general business conditions, legal, tax, regulatory, rating agency and contractual constraints or restrictions and any other factors that the Board deems relevant.
The Company expects the purchases under its share repurchase program to be made from time to time in the open market or in privately negotiated transactions. The timing, form and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, the Company's capital position relative to internal and rating agency targets, legal requirements and other factors. The repurchase program may be modified, extended or terminated by the Board of Directors at any time.
On April 2, 2012, the Company joined with other investors in capitalizing PaCRe, a Class 4 Bermuda reinsurer formed for the purpose of writing high excess property catastrophe reinsurance. The total capital invested was $500.0 million, of which the Company has an equity interest of 10% and the remaining 90% interest is held by third party investors.
The Company has also joined with other investors in capitalizing three AlphaCat ILS funds, which invest in instruments with returns linked to property catastrophe reinsurance, retrocession and insurance linked securities contracts. Two of the three funds are variable interest entities and are consolidated by the Company as the primary beneficiary, with the economics not attributable to the Company being shown as noncontrolling interest.
As at December 31, 2013, the amount of the Company's total capitalization owed to these third parties as redeemable noncontrolling interest or noncontrolling interest was $584.2 million.
The Company’s contractual obligations and commitments as at December 31, 2013 are set out below:
The Flagstone 2006 Junior Subordinated Deferrable Debentures mature on September 15, 2036, are redeemable at the Company's option at par beginning September 15, 2011, and require quarterly interest payments by the Company to the holders of the Flagstone 2006 Junior Subordinated Deferrable Debentures. Interest is payable at a floating rate of three-month LIBOR plus 354 basis points, reset quarterly. During 2013, the Company entered into a $120,000 interest rate swap which fixed the rate of interest on the Flagstone 2006 Junior Subordinated Deferrable Debentures at 6.405%. Also in 2013, the Company entered into a cross currency interest rate swap which fixed the rate of interest at 6.8625% and the notional at $17,463. The interest payments in the table above reflect the Company's contractual obligations with respect to the swaps.
$88,750 of the Flagstone 2007 Junior Subordinated Deferrable Debentures mature on July 30, 2037, are redeemable at the Company's option at par beginning July 30, 2012, and require quarterly interest payments by the Company to the holders of the Flagstone 2007 Junior Subordinated Deferrable Debentures. Interest is payable at a floating rate of three-month LIBOR plus 300 basis points, reset quarterly. $25,000 of the Flagstone 2007 Junior Subordinated Deferrable Debentures mature on September 15, 2037, are redeemable at the Company's option at par beginning September 15, 2012, and require quarterly interest payments by the Company to the holders of the Flagstone 2007 Junior Subordinated Deferrable Debentures. Interest is payable at a floating rate of three-month LIBOR plus 310 basis points, reset quarterly. During 2013, the Company entered into a $100,000 interest rate swap which fixed the rate of interest at 5.9%, and also entered into a $25,000 interest rate swap which fixed the interest rate at 5.9825%. The interest payments in the table above reflect the Company's contractual obligations with respect to the swaps.
Please refer to Note 20 (f) to the Consolidated Financial Statements (Part II, Item 8) for further details describing the Aquiline commitment. While the commitment expires on July 2, 2015, it does not have a defined contractual commitment date and therefore it is included in the less than one year category.
The Company has performed an impairment analysis of its carried goodwill and indefinite lived intangible assets as required by U.S. GAAP. Based on this analysis, management has concluded that an impairment valuation is not required against the carried goodwill and carried indefinite lived intangible assets.
The following table summarizes the financial strength ratings of the Company and its principal reinsurance and insurance subsidiaries from internationally recognized rating agencies as of February 18, 2014:
The A.M. Best ratings were most recently affirmed on February 7, 2013.
The S&P ratings were most recently affirmed on August 30, 2012. The S&P rating for Validus Reinsurance (Switzerland), Ltd. was issued on December 11, 2013.
Description: We believe that the most significant accounting judgment made by management is our estimate of reserve for losses and loss expenses. The Company establishes its reserve for losses and loss expenses to cover the estimated remaining liability for both reported claims (“case reserves”) and unreported amounts (“incurred but not reported” or “IBNR" reserves). For insurance and reinsurance business, the IBNR reserves include provision for loss incidents that have occurred but have not yet been reported to the Company as well as for future variation in case reserves (where the claim has been reported but the ultimate cost is not yet known). The provision for future variation in current case reserves is generally calculated using actuarial estimates of total IBNR at the aggregated line of business level. Additional individual claim IBNR amounts are sometimes calculated for larger claims within our insurance and reinsurance businesses. Within the reinsurance business, the portion of total IBNR related to future variation on known claims is calculated at the individual claim level in some instances (either as an additional case reserve or individual claim IBNR). Within the insurance business, the provision for future variation in current case reserves is generally calculated using actuarial estimates of total IBNR, while individual claim IBNR amounts are sometimes calculated for larger claims. IBNR is established by the Company separately for certain large or catastrophe losses and smaller “attritional” losses. The Company has procedures in place to aggregate large or catastrophe losses on a consolidated basis for financial reporting and disclosure purposes. For disclosure purposes, only those loss events which aggregate to over $30.0 million on a consolidated basis are disclosed separately and included in the reserve for notable loss events and reserve for development on notable loss events tables. Notable loss events are first determined at the respective operating segments based on segment thresholds and are then aggregated and disclosed if it is determined that they reach the consolidated threshold for notable loss disclosure.
For all lines of business, the Company’s reserve for losses and loss expenses and loss reserves recoverable consist of three categories: (1) case reserves, (2) in certain circumstances, additional case reserves ("ACR"), and (3) IBNR reserves. The reserves and recoverables for attritional and large or catastrophe losses are established on an annual and interim basis as follows:
1.Case reserves: Case reserves generally are analyzed and established by each segment’s claims department on all lines, making use of third party input where appropriate (including, for the reinsurance business, reports of losses from ceding companies). For insurance business where Talbot is not the lead underwriter on the business, the case reserves are established by the lead underwriter and validated by the central Lloyd’s market claims bureau, with a sample reviewed by Talbot.
Judgments and Uncertainties: Loss reserve estimates for insurance and reinsurance business are not precise in that they deal with the inherent uncertainty in the outcome of insurance and reinsurance claims made on the Company, many of which have not yet been reported to the Company. Estimating loss reserves requires management to make assumptions, both explicit and implicit, regarding future paid and reported loss development patterns, frequency and severity trends, claims settlement practices, potential changes in the legal environment and other factors. These estimates and judgments are based on numerous factors, and may be revised over time as additional experience or other data becomes available, as new or improved methodologies are developed or as current laws change.
2.The Company uses reinsurance industry information in order to perform consistency checks on the data provided by ceding companies and to identify trends in loss reporting and settlement activity. Where it deems appropriate, the Company incorporates such information in establishing reinsurance reserves; and
In developing estimates for large catastrophe events, the Company considers various sources of information including: specific loss estimates reported by our cedants and policyholders, ceding company and overall insurance industry loss estimates reported by our brokers and by claims reporting services, proprietary and third party vendor models and internal data regarding insured or reinsured exposures related to the geographical location of the event. Use of these various sources enables management to estimate the ultimate loss for known events with a higher degree of accuracy and timeliness than if the Company relied solely on one data source. Indicated ultimate loss estimates for catastrophe events are compiled by a committee of management, and these indicated ultimate losses are incorporated into the process of selecting management’s best estimate of reserves.
Management’s best estimate of the gross reserve for losses and loss expenses and loss reserves recoverable at December 31, 2012 were $3,517.6 million and $440.0 million, respectively. The following table sets forth a breakdown between gross case reserves and gross IBNR by segment at December 31, 2012.
Net reserve for losses and loss expenses at December 31, 2013-Sensitivity to expected loss ratios
Description: For insurance business, written premium estimates are determined from the business plan estimates of premiums by class, the aggregate of underwriters’ estimates on a policy-by-policy basis, and projections of ultimate premiums using generally accepted actuarial methods. In particular, direct insurance premiums are recognized in accordance with the type of contract written. The majority of our insurance premium is accepted on a direct open market or facultative (non-proportional) basis. We receive a premium which is identified in the policy and this premium will typically adjust only if the underlying insured values adjust.
Premium earning: For contracts written on a losses occurring basis or claims made basis, being the majority of our insurance and excess of loss reinsurance business, premium income is generally earned proportionately over the expected risk period, usually 12 months. For contracts written on a risks attaching basis, being primarily our pro-rata reinsurance business, premiums are attached straight line over the period of the policy and generally earned over a 24 month period due to the fact that some of the underlying exposures may attach towards the end of the contract, and such underlying exposures generally have a 12 month coverage period. The portion of the premium related to the unexpired portion of the policy at the end of any reporting period is presented on the consolidated balance sheet as unearned premiums. This is then earned over the period during which we are exposed to the underlying risk. Changes in circumstance subsequent to contract inception can impact the earning period. For example, when the exposure limit for a contract is reached, we fully earn any associated unearned premium.
For business written on a facility basis, although a premium estimate is not contractually stated for the amount of business to be written under any particular facility, an initial estimate of the expected premium written is received from the coverholder via the broker. Our estimate of premium is derived by reference to one or more of the following: the historical premium volume experienced by any facility, historical premium volume of similar facilities, the estimates provided by the broker and industry information on the underlying business. We actively monitor the development of actual reported premium against the estimates made; where actual reported premiums deviate from the estimate, we carry out an analysis to determine the cause and may, if necessary, adjust the estimated premiums.
The Company's ceded unpaid losses and loss expenses consists of two elements, those for reported losses and those for IBNR. Ceded amounts for IBNR are developed as part of our loss reserving process. Consequently, the estimation of ceded unpaid losses and loss expenses is subject to similar risks and uncertainties in the estimation of gross IBNR (see “Reserve for Losses and Loss Expenses” above). As at December 31, 2013, ceded IBNR recoverable balances were $196.8 million.
At December 31, 2013, the use of different assumptions within the model could have an effect on the provision for uncollectible reinsurance reflected in the Company’s Consolidated Financial Statements. To the extent the creditworthiness of the Company’s reinsurers was to deteriorate due to an adverse event affecting the reinsurance industry, such as a large number of major catastrophes, actual uncollectible amounts could be significantly greater than the Company’s provision.