(b) During 2012 we incurred a $102.8 million net catastrophe loss (not including the benefit of reinstatement premiums, which we record as revenues) from windstorm Sandy. During 2011 we incurred $409.0 million in net losses (not including the benefit of reinstatement premiums) associated with several catastrophic events, including earthquakes in New Zealand and Japan, and Thailand floods. During 2010 we incurred $135.9 million in net losses (not including the benefit of reinstatement premiums) associated with earthquakes in Chile and New Zealand. The magnitude of these catastrophic events significantly impacted our expenses in those years.
The following is a discussion and analysis of our results of operations for the years ended December 31, 2013, 2012 and 2011 and our financial condition as of December 31, 2013 and 2012. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes thereto included elsewhere in this report.
We ended 2012 with a FCBVPCS of $26.14, an increase of 17.0% for the year after taking into account dividends declared on Common Shares during the period. The increase in our FCBVPCS during 2012 was primarily the result of strong underwriting and investment results. Our comprehensive income for 2012 was $228.4 million and our GAAP combined ratio was 81.0%.
We ended 2011 with a FCBVPCS of $22.71, a decrease of 6.1% for the year after taking into account dividends declared on Common Shares during the period. The decrease in our FCBVPCS during 2011 resulted from significant natural catastrophe underwriting losses, which were partially offset by modest investment results. Our comprehensive loss for 2011 was $113.1 million and our GAAP combined ratio was 131.1%.
The following table presents our computations of book value per Common Share (“BVPCS”) and FCBVPCS as of December 31, 2013, 2012 and 2011:
Our computations of FCBVPCS and the increase in FCBVPCS are non-GAAP measures which we believe are important to our investors, analysts and other interested parties who benefit from having an objective and consistent basis for comparison with other companies within our industry.
We provide customized and innovative insurance and reinsurance solutions to the global market through our underwriting platforms in Bermuda, the U.K. and the U.S. Through our affiliates in Bermuda, we also provide institutional and retail investors with the opportunity to directly invest in global property catastrophe reinsurance risks.
In addition, the launch of BCRH on the New York Stock Exchange in November and the growth experienced by the BCGR Listed Fund (in terms of both capital raised and earnings on capital deployed) further expanded our presence in the collateralized reinsurance market. Our total capital under management now exceeds $600 million, enabling us to provide a broader product mix and increased line sizes for select clients.
Despite the competitive market conditions we currently face, through our efforts thus far in 2014, we believe that we have: (i) achieved preferred signings; (ii) strengthened our relationships with key business partners; and (iii) expanded our product mix. As a result, with our strong balance sheet, disciplined underwriting and specialist approach, we are positioned to perform well into 2014 and beyond. Further, at current risk exposure levels, we believe we have retained the ability to quickly adapt and respond to new market opportunities while continuing our strategic focus on property, marine and other short-tail lines.
These treaty limits are a snapshot of our exposure as of January 1, 2014. As of that date, Mid-Atlantic hurricane represented our largest concentration of net reinsurance treaty limits among the selected zones. The relative comparison between zones and the absolute level of exposure may change materially at any time due to changes in the composition of our portfolio and changes in our ceded reinsurance program.
For certain defined natural catastrophe region and peril combinations, we assess the probability and likely magnitude of losses using a combination of industry third-party models, CATM® and underwriting judgment. We attempt to model the projected net impact from a single event, taking into account contributions from property catastrophe reinsurance (including retrocessional business), property pro-rata reinsurance, workers compensation catastrophe reinsurance, event-linked derivative securities and individual risk business, offset by the net benefit of any reinsurance or derivative protections we purchase and the benefit of reinstatement premiums.
The table below details the projected net impact from single event losses as of January 1, 2014 for selected zones at selected return period levels using AIR Worldwide Corporation’s CLASIC/2 model version 15.0, one of several industry-recognized third-party vendor models. It is important to note that each catastrophe model contains its own assumptions as to the frequency and severity of loss events, and results may vary significantly from model to model.
As of January 1, 2014, our three largest modeled exposures to a single event loss at a 250-year return period were U.S. Hurricane, U.S. Earthquake and European Windstorm.
The activities of the Company, certain of its intermediate holding and service companies and intercompany eliminations relating to inter-segment reinsurance and support services, collectively referred to as “Corporate and Other,” are also presented herein.
Gross premiums written by Montpelier Bermuda during 2013 totaled $429.4 million, a decrease of $51.1 million, or 11%, as compared to 2012. This decrease was mainly driven by the Property Catastrophe - Treaty line of business, where pricing deterioration led to the non-renewal by Montpelier Bermuda of certain contracts as well as reduced premiums on certain renewals. Also contributing to the decrease in Montpelier Bermuda’s Property Catastrophe - Treaty gross premiums written was a reduction in reinstatement premiums written due to the low level of catastrophe losses experienced in 2013.
Gross premiums written by Montpelier Bermuda during 2012 totaled $480.5 million, an increase of $34.0 million, or 8%, as compared to 2011. This increase was driven by the Property Catastrophe - Treaty line of business, which experienced improved pricing in 2012 versus that experienced in 2011. This improvement led to both additional property catastrophe writings and increased premiums on renewal business.
Montpelier Bermuda’s gross and net premiums written during the periods presented include amounts assumed from Montpelier at Lloyd’s as part of an inter-segment excess-of loss reinsurance agreement. See “Corporate and Other” under this Item 7.
Reinsurance premiums ceded by Montpelier Bermuda in 2013, 2012 and 2011 were $75.8 million, $99.8 million and $78.4 million, respectively. Over the past few years, Montpelier Bermuda has established several private underwriting partnerships (in the form of property catastrophe quota share reinsurance treaties) with various third parties. These underwriting partnerships allow Montpelier Bermuda to: (i) write larger property catastrophe lines with preferred clients; (ii) recover a portion of its losses from events of all sizes, not just from those events that exceed a specified loss amount; and (iii) reduce its net acquisition costs. As a result of these private underwriting partnerships, any increases or decreases in Montpelier Bermuda’s gross Property-Catastrophe writings directly impact the amount of reinsurance premiums it cedes to third-parties pursuant to these arrangements.
Net premiums earned by Montpelier Bermuda in 2013, 2012 and 2011 were $359.2 million, $369.5 million and $378.0 million, respectively. Net premiums earned are primarily a function of the amount and timing of net premiums previously written.
The following tables summarize Montpelier Bermuda’s loss and LAE reserve movements for the years ended December 31, 2013, 2012 and 2011, and the composition of its gross loss and LAE reserves at December 31, 2013 and 2012:
Our best estimates of Montpelier Bermuda’s ending gross loss and LAE reserves at December 31, 2013 and 2012, were $520.9 million and $728.2 million, respectively. Montpelier Bermuda’s gross IBNR reserves, as a percentage of its total gross reserves, amounted to 64% and 59% as of December 31, 2013 and 2012, respectively.
We estimated Montpelier Bermuda’s gross and net loss and LAE reserves using the methodology outlined in our “Summary of Critical Accounting Policies and Estimates” contained in Item 7 herein. We did not make any significant changes in the assumptions or methodology used in Montpelier Bermuda’s reserving process during the year ended December 31, 2013.
During 2011 Montpelier Bermuda incurred $421.8 million in current year net losses and LAE. The individually significant known loss events impacting Montpelier Bermuda during 2011 included the following:
· IBNR reductions associated with medical malpractice business ($7.3 million decrease),
The remaining net favorable development on prior year loss reserves recognized during 2013, 2012 and 2011 related to several smaller adjustments made across multiple classes of business.
The following table summarizes Montpelier Bermuda’s underwriting expenses during the years ended December 31, 2013, 2012 and 2011:
Profit commissions, which are accrued based on the estimated results of the subject contract, change as Montpelier Bermuda’s estimates of loss and LAE fluctuate. Montpelier Bermuda pays profit commissions on certain assumed reinsurance contracts, and receives profit commissions on certain ceded reinsurance contracts. Only a few of Montpelier Bermuda’s assumed and ceded reinsurance contracts contain profit commission clauses, and the terms of these profit commissions are specific to the individual contracts and vary as a percentage of the contract results.
During 2013 and 2012, profit commissions earned by Montpelier Bermuda in connection with its ceded reinsurance contracts exceeded profit commissions incurred in connection with its assumed reinsurance contracts by $9.0 million and $4.0 million, respectively. Net profit commissions incurred during 2011 were not significant.
Incentive compensation expenses recorded at Montpelier Bermuda consist of two independent components. The first component represents amounts that are not, or are no longer, dependent on Company performance and consist of: (i) Fixed RSUs (as defined on page 82 of this report) and Variable RSUs granted in prior years that have been effectively converted to Fixed RSUs because the performance goal has been formally achieved at a level that permits payout; and (ii) the portion of annual employee cash bonuses that is based on individual employee performance goals. The second component represents amounts that are entirely dependent on Company performance and consist of: (i) Variable RSUs in the Initial RSU Period; and (ii) the portion of annual employee cash bonuses that is based on Company performance.
Reinsurance premiums ceded by Montpelier at Lloyd’s in 2013, 2012 and 2011 were $23.0 million, $15.9 million and $29.5 million, respectively. Montpelier at Lloyd’s purchases reinsurance in the normal course of its business in order to manage its exposures. The amount and type of reinsurance that Montpelier at Lloyd’s purchases is dependent on a variety of factors, including the cost of a particular reinsurance cover and the nature of its gross exposures assumed during a particular period. Other factors affect Montpelier at Lloyds’ appetite and capacity to write and retain risk. These include the impact of changes in frequency and severity assumptions used in our models and the corresponding pricing required to meet our return targets, evolving industry-wide capital requirements, increased competition, market conditions and other considerations.
Net premiums earned by Montpelier at Lloyd’s in 2013, 2012 and 2011 were $213.7 million, $217.3 million and $194.5 million, respectively. Net premiums earned are primarily a function of the amount and timing of net premiums previously written.
The following tables summarize Montpelier at Lloyds’ loss and LAE reserve movements for the years ended December 31, 2013, 2012 and 2011, and the composition of its gross loss and LAE reserves at December 31, 2013 and 2012:
(1) Montpelier at Lloyds’ ending reinsurance recoverable at December 31, 2013 and 2012 includes a recoverable from Montpelier Bermuda pursuant to an inter-segment reinsurance contract of $8.4 million and $13.3 million, respectively. The effects of these inter-segment reinsurance contracts are eliminated in consolidation.
Our best estimates of Montpelier at Lloyds’ ending gross loss and LAE reserves at December 31, 2013 and 2012, were $337.3 million and $354.0 million, respectively. Montpelier at Lloyds’ gross IBNR reserves, as a percentage of its total gross reserves, amounted to 59% and 53% as of December 31, 2013 and 2012, respectively.
The following table presents Montpelier at Lloyds’ net loss and LAE ratios for the years ended December 31, 2013, 2012 and 2011:
During 2013 Montpelier at Lloyd’s incurred $145.0 million of current year net losses and LAE. There were no individually significant known loss events affecting Montpelier at Lloyd’s during 2013.
During 2012 Montpelier at Lloyd’s experienced $41.0 million in net favorable development on prior year loss and LAE reserves, which included loss reserve movements associated with:
· 2011 catastrophe losses relating to Thai floods and other events ($16.9 million decrease), and
During 2011 Montpelier at Lloyd’s experienced $38.3 million in net favorable development on prior year loss and LAE reserves, which included loss reserve movements associated with:
Montpelier at Lloyds’ acquisition costs and acquisition cost ratios have increased from 2011 to 2013, primarily as a result of changes in the mix of the business it writes. Montpelier at Lloyds’ marine, pro-rata engineering and casualty writings, which have also increased during such periods, are subject to higher acquisition cost ratios than most of the other business it writes. The changes in profit commissions noted above also contributed to the increase in the acquisition cost ratio from 2012 to 2013, and partially offset the increase from 2011 to 2012.
The following table summarizes Montpelier at Lloyds’ general and administrative expenses during the years ended December 31, 2013, 2012 and 2011:
Montpelier at Lloyds’ operating expenses incurred during 2013 decreased, versus those incurred during 2012, due primarily to a non-recurring third-party management fee recorded in 2012. Montpelier at Lloyds’ 2012 operating expenses were higher than those incurred in 2011, due to: (i) the 2012 non-recurring management fee; and (ii) ongoing increases in consulting and other professional services associated with Solvency II and other initiatives.
The increase in Montpelier at Lloyds’ incentive compensation expenses during 2013, versus those of 2012, was primarily the result of additional incentive costs associated with new personnel which more than offset the benefit of its 2013 accruals being provided at a lower projected payout level than that of the prior year. The increase in Montpelier at Lloyds’ incentive compensation expenses during 2012, versus those of 2011, was the result of a significant improvement in the Company’s performance during 2012.
Gross premiums written by the Collateralized Reinsurance segment totaled $39.8 million and $2.4 million during the years ended December 31, 2013 and 2012, respectively. The increase in gross premiums written during 2013, as compared to those written in 2012, reflects the additional capital deployed into Blue Water Re by the BCGR Listed Fund and the BCAP Cell. BCRH and its subsidiaries, which commenced their operations in November 2013, did not write any reinsurance premiums during 2013.
All premiums written within the Collateralized Reinsurance segment relate to the Property Catastrophe - Treaty line of business.
Losses and LAE incurred and paid by the Collateralized Reinsurance segment totaled $2.2 million and $1.6 million, respectively, during the year ended December 31, 2013, all of which related to U.S. weather events that occurred during 2013. Gross and net unpaid loss and LAE reserves totaled $0.6 million at December 31, 2013. The Collateralized Reinsurance segment did not incur or pay any losses during 2012.
Acquisition costs include commissions, profit commissions, brokerage costs and excise taxes, when applicable.
The Collateralized Reinsurance segment incurred $3.5 million and $1.7 million of general and administrative expenses during 2013 and 2012, respectively. The Collateralized Reinsurance segment’s general and administrative expenses have consisted primarily of third-party legal and consulting costs, as well as internal personnel costs.
During 2013 and 2012 Montpelier Re assumed $0.5 million and $2.5 million of MUSIC’s premium writings, respectively, which represented: (i) policies bound by MUSIC in 2012 with an effective date on or prior to December 31, 2011; and (ii) additional audit premiums relating to policies written on or prior to December 31, 2011. During 2011, MUSIC wrote $59.7 million of gross premiums on a direct basis.
Montpelier Re may be required to assume additional MUSIC premium writings in future periods, but we do not expect such additional writings to be significant.
As of December 31, 2013 and 2012, we had no remaining unearned premiums associated with the MUSIC Sale.
Our best estimates of MUSIC Run-Off’s ending gross loss and LAE reserves at December 31, 2013 and 2012, were $31.2 million and $43.5 million, respectively. We estimated the MUSIC Run-Off segment’s loss and LAE reserves using the methodology outlined in our “Summary of Critical Accounting Policies and Estimates” contained in Item 7 herein. We did not make any significant changes in the assumptions or methodology used in the MUSIC Run-Off segment’s reserving process during the year ended December 31, 2013.
MUSIC experienced $3.0 million of favorable prior year loss reserve development during 2011, which related primarily to MUSIC’s casualty classes of business. The MUSIC Run-Off segment did not experience a significant amount of prior year loss reserve development during 2013 or 2012.
Corporate and Other, which collectively represents the Company, certain intermediate holding and service companies and inter-segment eliminations relating to inter-segment reinsurance and service charges, is not considered to be an operating segment of our business. The underwriting losses generated by Corporate and Other principally reflect general and administrative expenses incurred in support of the Company’s various operating companies.
The gross premiums written and ceded reinsurance premiums presented within Corporate and Other represent the elimination of inter-segment excess-of-loss reinsurance arrangements between Montpelier Bermuda and Montpelier at Lloyd’s and, for 2011, between MUSIC Run-Off and Montpelier at Lloyd’s.
The following table summarizes the general and administrative expenses of Corporate and Other during the years ended December 31, 2013, 2012 and 2011:
The increase in Corporate and Other’s incentive compensation expenses during 2013, versus those of 2012, was due to: (i) a greater number of outstanding RSUs attributable to Corporate and Other activities due, in part, to Mr. Harris’ revised Service Agreement; and (ii) the acceleration of the vesting of Mr. Busher’s outstanding RSUs awards in connection with his retirement. See Note 9 of the Notes to Consolidated Financial Statements. These items more than offset the impact of the 2013 incentives being provided at a lower projected payout level than that of the prior year. The increase in Corporate and Other’s incentive compensation expenses during 2012, versus those of 2011, was the result of a significant improvement in the Company’s performance during 2012.
The following table summarizes our consolidated net investment income and total return on cash and investments for the years ended December 31, 2013, 2012 and 2011:
Our total return on cash and investments for 2013 was significantly lower than that of 2012, due primarily to net realized and unrealized investment losses and investment-related derivative losses experienced in 2013, versus net gains experienced in 2012. Our total return on cash and investments for 2012 was higher than that of 2011, due primarily to higher net realized and unrealized investment gains experienced in 2012.
Investment expenses incurred during 2013 were higher than those incurred during 2012 due to changes in the allocation of invested balances among investment managers. Investment expenses incurred during 2012 were higher than those incurred during 2011 due to: (i) an increase in the weighted average value of the portfolio; and (ii) changes in the allocation of invested balances among investment managers.
Certain of our investment managers have entered into derivative contracts for investment purposes. Our total net losses from investment-related derivative instruments during 2013, 2012 and 2011 were $13.6 million, $1.9 million and $8.2 million, respectively. Each of our derivative instruments, as well as the income and loss derived therefrom, are described in Note 7 of the Notes to Consolidated Financial Statements.
The following table summarizes the components of our consolidated net foreign currency gains (losses) for the years ended December 31, 2013, 2012 and 2011:
The net foreign currency transaction gains (losses) we experienced in connection with our other activities represent net foreign currency gains and losses resulting from: (i) Montpelier Bermuda’s premiums receivable that are denominated in currencies other than the U.S. dollar (Montpelier Bermuda’s functional currency); and (ii) Montpelier at Lloyds’ assets and liabilities that are denominated in currencies other than the British pound (Montpelier at Lloyds’ functional currency), including those denominated in U.S. dollars. These net transaction gains and losses do not include: (i) fluctuations associated with Montpelier Bermuda’s and Montpelier at Lloyds’ losses and LAE, which we record as favorable or unfavorable loss reserve development; (ii) the income or loss associated with those Foreign Exchange Contracts we enter into in order to mitigate the financial effects of certain foreign currency exchange rate fluctuations, see “Net Income (Loss) From Derivative Instruments”; and (iii) any offsetting foreign currency translation gains and losses we recognize through our comprehensive income or loss associated with Montpelier at Lloyds’ assets and liabilities that are denominated in U.S. dollars.
On December 31, 2011, we completed the MUSIC Sale, received total proceeds of $54.9 million therefrom and recorded a gain on the sale of $11.1 million, which is net of $1.0 million in expenses related to the transaction.
In connection with the sale of PUAL, we received a note from the buyer in which the repayment of principal and interest was contingent on the future performance of that company. Due to the contingencies surrounding the note at the time of sale in 2012, we assigned no value to it and recognized a loss on the sale of PUAL of $0.5 million. Based on the performance of the note to-date, as well as our outlook for the future performance of the note, we recognized the full value of the note during 2013 and recorded a $0.4 million gain on the sale of PUAL.
The following table summarizes our consolidated interest and other financing expenses for the years ended December 31, 2013, 2012 and 2011:
In 2012 we incurred $1.2 million of incremental interest expense during the one-month period in which both debt issuances were outstanding (which constituted the redemption notice period we were required to provide to holders of the 2013 Senior Notes).
Excluding the incremental interest associated with the issuance of the 2022 Senior Notes described above, our interest and other financing expenses decreased during 2012, as compared to 2011. This reduction was mainly due to: (i) the interest rate on our $100.0 million of capital securities (the “Trust Preferred Securities”) moving from an 8.55% per annum fixed rate to a floating rate, effective March 30, 2011 (see Note 6 of the Notes to Consolidated Financial Statements); and (ii) continual reductions in letter of credit fees experienced since 2010 as a result of the Reinsurance Trust replacing letter of credit facilities that we allowed to expire in accordance with their terms.
During 2013 we recorded a $0.6 million provision for future expense associated with the Loss Development Cover.
We are domiciled in Bermuda and have subsidiaries that are domiciled in the U.K. and the U.S. At the present time, no income taxes are levied in Bermuda and the Company and its Bermuda-domiciled subsidiaries have received an assurance from the Bermuda Minister of Finance exempting them from all Bermuda-imposed income, withholding and capital gains taxes until March 31, 2035.
During 2013, 2012 and 2011, our Bermuda operations generated income (loss) before income taxes of $205.3 million, $232.2 million and $(105.5) million, respectively.
The following table summarizes the net income attributable to non-controlling interests during 2013:
During 2013 and 2012 we declared $13.3 million in cash dividends on our Preferred Shares. During 2011 we declared $9.1 million in cash dividends on our Preferred Shares for the interim period during which the Preferred Shares were outstanding for that year.
As of December 31, 2013, our sources of immediate and unencumbered liquidity consisted of: (i) $336.9 million of cash and cash equivalents; (ii) $181.5 million of highly liquid fixed maturity investments which currently trade at a very narrow bid-ask spread and whose proceeds are available within two business days; and (iii) $124.4 million of liquid fixed maturity investments which currently trade at a narrow bid-ask spread and whose proceeds are available within four business days. Further, we believe that we have significant sources of additional liquidity within our fixed maturity investment portfolio, although the bid-ask spreads associated with such investment securities would likely be broader, perhaps significantly, than those with respect to the securities referred to above, particularly if a large individual investment were required to be liquidated in an expeditious manner. We also believe that we have additional liquidity within our portfolio of equity securities, whose proceeds are available within four business days.
The following table summarizes our capital structure as of December 31, 2013 and 2012:
The Trust Preferred Securities mature on March 30, 2036, but are redeemable at our option at par. The Trust Preferred Securities bear interest at a floating rate of 3-month LIBOR plus 380 basis points, reset quarterly. We currently have no intention of redeeming the Trust Preferred Securities.
The Preferred Shares have no stated maturity, and are not subject to any sinking fund or mandatory redemption and are not convertible into any other securities. Except in certain limited circumstances, the Preferred Shares are not redeemable prior to May 10, 2016. After that date, we may redeem the Preferred Shares at our option, in whole or in part, at a price of $25.00 per share plus any declared and unpaid dividends.
None of the 2022 Senior Notes, the Trust Preferred Securities or the Preferred Shares contain any covenants regarding financial ratios or specified levels of net worth or liquidity to which we must adhere.
The agreements governing our letter of credit facilities contain covenants that limit our ability, among other things, to grant liens on our assets, sell our assets, merge or consolidate, incur debt and enter into certain agreements. In addition, the secured facilities require us to maintain a debt to capital ratio of no greater than 30% and for Montpelier Re to maintain an A.M. Best financial strength rating of no less than “B++.” If we were to fail to comply with these covenants or fail to meet these financial ratios, the lenders could revoke these facilities and exercise remedies against our collateral. As of December 31, 2013 and December 31, 2012, our debt to capital ratio (which, as defined in such agreements, is the amount of our senior unsecured debt outstanding divided by the sum of: (i) the amount of our senior unsecured debt outstanding; and (ii) the amount of our total shareholders’ equity available to the Company, expressed as a percentage) was 15.4% and 15.5%, respectively, and Montpelier Re’s A.M. Best financial strength rating was “A” (with a stable outlook) as of both dates.
We established the Reinsurance Trust as a means of providing statutory credit to Montpelier Re’s cedants and the Lloyd’s Capital Trust as a means of satisfying Lloyd’s capital requirements. As a result of these, and other, trust arrangements we currently utilize, our ongoing reliance on letter of credit facilities has been significantly reduced. See Note 6 of the Notes to Consolidated Financial Statements.
Our letter of credit facilities are cancellable upon one-years’ notice and are assumed to have been cancelled on December 31, 2013.
Our non-cancellable operating lease obligations presented represent the actual terms of those arrangements.
Our investment activities provided (used) net cash and cash equivalents of $70.0 million, $(128.9) million and $(84.2) million during 2013, 2012 and 2011, respectively. The cash and cash equivalents provided from our investment activities during 2013 resulted primarily from net sales of investment securities, whose proceeds were used to pay loss and LAE reserves and to fund repurchases of Common Shares. The cash and cash equivalents used for our investment activities during 2012 resulted primarily from net purchases of investment securities, representing the initial deployment of the net proceeds raised from the issuance of the 2022 Senior Notes and a lower level of Common Share repurchases. The cash and cash equivalents used for our investment activities during 2011 resulted primarily from net purchases of investment securities representing the initial deployment of the proceeds from the issuance of the Preferred Shares.
Detailed information regarding our cash flows for the years ended December 31, 2013, 2012 and 2011, follows:
· we received $137.2 million from net sales and maturities of fixed maturity investments,
· we paid $18.1 million in settlements of investment-related derivative instruments,
Our cash flows provided from financing activities totaled $29.9 million, resulting from the following:
· we received $238.8 million in net third-party investments in non-controlling interests, and
· we paid $37.5 million in dividends to holders of Common Shares and Preferred Shares.
We also experienced a $1.7 million decrease in the U.S. dollar value of our cash and cash equivalents due to foreign currency rate fluctuations.
We also experienced a $5.4 million increase in the U.S. dollar value of our cash and cash equivalents due to foreign currency rate fluctuations.
· we paid $25.6 million for net purchases of fixed maturity investments,
· we received $145.4 million upon the issuance of the Preferred Shares, and
We also experienced a $1.3 million decrease in the U.S. dollar value of our cash and cash equivalents due to foreign currency rate fluctuations.
Cash and Cash Equivalents Held by Our U.K. and U.S. Subsidiaries
Our Consolidated Financial Statements have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported and disclosed amounts of our assets and liabilities as of the balance sheet dates and the reported amounts of our revenues and expenses during the reporting periods. We believe the items that require the most subjective and complex estimates are: (i) our loss and LAE reserves; (ii) our written and earned insurance and reinsurance premiums; (iii) our ceded reinsurance; and (iv) our share-based compensation accruals.
Our loss and LAE reserves represent estimates of future amounts needed to pay our claims and related expenses (such as claim adjusters’ fees and litigation expenses) for insured losses that have occurred. The process of estimating these reserves involves a considerable degree of judgment and our estimates as of any given date are inherently uncertain.
Our loss and LAE reserves are comprised of case reserves (which are based on claims that have been reported to us) and IBNR reserves (which are based on losses that we believe to have occurred but for which claims have not yet been reported to us and which may include a provision for expected future development on our case reserves).
Our primary focus is on short-tail property treaty reinsurance, written on both an excess-of-loss and proportional basis. We also underwrite direct insurance and facultative reinsurance, as well as specialty casualty risks. The nature and extent of our judgment in the reserving process depends upon the type of business.
Most of our treaty reinsurance contracts comprise business which has both a low frequency of claims occurrence and a high potential severity of loss, such as claims arising from natural catastrophes, terrorism, large individual property risks, and space and aviation risks. Given the high-severity, low-frequency nature of these events, the losses typically generated therefrom do not lend themselves to traditional actuarial reserving methods, such as statistical calculations of a range of estimates surrounding the best point estimate of our loss and LAE reserves. Therefore, our reserving approach for these types of coverages is to estimate the ultimate cost associated with a single loss event rather than analyzing the historical development patterns of past losses as a means of estimating ultimate losses for an entire accident year. We estimate our reserves for these large events on a contract-by-contract basis by means of a review of policies with known or potential exposure to a particular loss event.
As a predominantly broker-market reinsurer for both excess-of-loss and proportional contracts, we must rely on loss information reported to brokers by primary insurers who, in turn, must estimate their own losses at the policy level, often based on incomplete and changing information. The information we receive varies by cedant and may include paid losses, estimated case reserves and an estimated provision for IBNR reserves. Reserving practices and the quality of data reporting varies among ceding companies, which adds further uncertainty to the estimation of our ultimate losses. The nature and extent of information received from ceding companies and brokers also varies widely depending on the type of coverage, the contractual reporting terms (which are affected by market conditions and practices) and other factors. Due to the lack of standardization of the terms and conditions of reinsurance contracts, the wide variability of coverage provided to individual clients and the tendency of those coverages to change rapidly in response to market conditions, the ongoing economic impact of such uncertainties and inconsistencies cannot always be reliably measured. Additional risks to us involved in the reporting of retrocessional contracts include varying reserving methodologies used by the original cedants and an additional reporting lag due to the time required for the retrocedant to aggregate its assumed losses before reporting them to us. Additionally, the number of contractual intermediaries is normally greater for retrocessional business than for insurance and reinsurance business, thereby further increasing the time lag and imprecision associated with loss reporting.
Time lags are inherent in loss reporting, especially in the case of excess-of-loss reinsurance contracts. Also, the combined characteristics of low claim frequency and high claim severity make the available data more volatile and less useful for predicting ultimate losses. In the case of proportional contracts, we rely on an analysis of a contract’s historical experience, industry information and the professional judgment of underwriters in estimating reserves for these contracts. In addition, we utilize ultimate loss ratio forecasts when reported by cedants and brokers, which are normally subject to a quarterly or six month lag for proportional business. Because of the degree of reliance that we necessarily place on ceding companies for claims reporting, our reserve estimates are highly dependent on ceding companies’ management judgment. Furthermore, during the loss settlement period, which may last several years, additional facts regarding individual claims and trends often will become known, and case law may change, all of which can affect ultimate expected losses.
Since we rely on ceding company estimates of case and IBNR reserves in the process of establishing our own loss and LAE reserves, we maintain certain procedures designed to mitigate the risk that such information is incomplete or inaccurate. These procedures may include: (i) comparisons of expected premiums to reported premiums, which helps us to identify delinquent client periodic reports; (ii) ceding company audits to facilitate loss reporting and identify inaccurate or incomplete reporting of claims; and (iii) underwriting reviews to ascertain that the losses ceded are covered as provided under the contract terms. We also use catastrophe model outputs and industry market share information to evaluate the reasonableness of reported losses, which are also compared to loss reports received from other cedants and brokers. In addition, each subsequent year of loss experience with a given cedant provides additional insight into the accuracy and timeliness of previously reported information. These procedures are incorporated in our internal controls process on an ongoing basis and are regularly evaluated and amended as market conditions, risk factors, and unanticipated areas of exposure develop. Our claims handling follow-up actions do not permit us to capture data which records the extent to which ceding company claims are subsequently adjusted as a result of these activities, nor do they permit us to determine the extent to which our actions influence the accuracy of subsequent cedant reporting. Nonetheless, we: (i) reserve the right to perform ceding company audits in order to facilitate loss reporting and identify inaccurate or incomplete claims reporting, and (ii) consider unreliable reporting to be a factor which influences an underwriters’ willingness to offer terms to potential cedants. We believe that our diligence in these matters promotes better reporting by cedants and brokers over the long term. In our history, disputes with ceding companies have been rare and those which have not been resolved in negotiation have been resolved through arbitration in accordance with contractual provisions.
Estimating loss reserves for our book of longer-tail casualty reinsurance business, which can be either on an excess-of-loss or proportional basis, involves further uncertainties. In addition to the uncertainties inherent in the reserving process referred to above, casualty business can be subject to longer reporting lags than property business and claims often take several years to settle. During this period additional factors and trends will be revealed and, as they become apparent, we may adjust our reserves. There is also the potential for the emergence of new types of losses within our casualty book. Therefore, any factors that extend the time until claims are settled add uncertainty to the reserving process. At December 31, 2013 and 2012, we recorded gross loss and LAE reserves related to our casualty business of $223.2 million and $243.2 million, respectively.
We do not typically experience significant claims processing backlogs, although such backlogs may occur following a major catastrophic event. At December 31, 2013 and 2012, we did not have a significant backlog in either our insurance or reinsurance claims processing.
The uncertainties inherent in the reserving process, together with the potential for unforeseen developments, including changes in laws and the prevailing interpretation of policy terms, may result in our loss and LAE reserves being materially greater or less than the loss and LAE reserves we initially established. Any adjustments to our loss and LAE reserves are reflected in our financial results during the period in which they are determined. Changes to our prior year loss reserves will impact our current underwriting results by improving our results if the prior year reserves prove to be redundant or impairing our results if the prior year reserves prove to be insufficient.
GAAP does not permit us to record or carry contingency reserves for catastrophe losses that are expected to occur in the future. Therefore, during periods in which significant catastrophe loss events occur, our underwriting results are likely to be adverse and, during periods in which significant catastrophe loss events do not occur, our underwriting results are likely to be favorable.
The portion of our gross loss and LAE reserves at any given time represented by IBNR tends to be lower in periods during which we experience large loss events (such as catastrophes) than those during which we experience loss events of a lower severity. This is because losses from larger events tend to move from IBNR to reported losses much faster than those of a lower severity. At the end of 2013, a year during which we incurred no significant loss events, our gross IBNR reserves represented 63% of our total ending gross loss and LAE reserves. At the end of 2012, a year during which we incurred a significant loss from windstorm Sandy, our gross IBNR reserves represented 58% of our total ending gross loss and LAE reserves.
Favorable development of prior period net losses experienced as a percentage of our opening net loss reserves across all underwriting years was 14.3%, 8.7% and 12.4% for the years ended December 31, 2013, 2012 and 2011, respectively. As of December 31, 2013, we estimate that a 15% change in our net unpaid loss and LAE reserves would result in an increase or decrease in our net income or loss and shareholders’ equity of approximately $122.7 million. The net income or loss and shareholders’ equity impact of the change in net reserves might be partially offset by adjustments to items such as reinstatement premiums, profit commission expense, incentive compensation and income taxes.
Insurance and facultative reinsurance contracts are written based on agreed upon terms and conditions which include a stated premium for coverages provided. The stated premium is then recorded as written premium at the effective date of the policy. In general, if the terms and conditions change during the policy period, either through policyholder request or underwriting audit, the policy would be endorsed to reflect the change in coverage. This endorsement usually generates a change to the policy premium which is then recorded as an adjustment to our written premiums in the period the endorsement becomes effective.
We routinely review the creditworthiness of our cedants on the basis of our market knowledge, the cedant’s current financial strength ratings, the timeliness of cedants’ past payments and the status of current balances owing. Based on our reviews, we established provisions of $3.6 million and $3.8 million for uncollectible insurance and reinsurance premiums receivable as of December 31, 2013 and 2012, respectively, each of which represented less than one percent of our consolidated net insurance and reinsurance premiums earned in those years.
The cost of reinsurance purchased varies based on a number of factors. The initial premium associated with excess-of-loss reinsurance is normally based on the underlying premiums we assume. As these reinsurance contracts are typically purchased prior to the time the assumed risks are written, ceded reinsurance premiums recorded in the period of inception reflect an estimate of the amount that we will ultimately pay. In the majority of cases, the premiums initially recorded are subsequently adjusted to reflect premiums actually assumed by us during the contract period. These adjustments are recorded in the period that they are determined, and to date they have not been significant. In addition,
losses which pierce excess-of-loss reinsurance cover may generate reinstatement premiums ceded, depending on the terms of the contract. Reinstatement premiums ceded are recognized as written and earned when the loss occurs and the reinsurance recovery is estimated and recorded.
The cost of pro-rata reinsurance is initially based on our estimated gross premiums written related to the specific lines of business covered by the reinsurance contract. As gross premiums are written during the period of coverage, reinsurance premiums ceded are adjusted in accordance with the terms of the reinsurance agreement.
Reinsurance recoverable on paid losses represents amounts currently due from reinsurers. Reinsurance recoverable on unpaid losses represents amounts that will be collectible from reinsurers once the losses are paid. The recognition of reinsurance recoverable requires two key judgments. In determining our ceded IBNR, the first judgment involves the estimation of the amount of gross IBNR to be ceded to reinsurers. Ceded IBNR is developed as part of our loss reserving process, and consequently, the estimate is subject to risks and uncertainties similar to the estimation of gross IBNR. The second judgment relates to the amount of the reinsurance recoverable balance that ultimately will not be collected from reinsurers due to insolvency, contractual dispute or other reasons.
As of December 31, 2013 and 2012, we recorded $3.6 million and $6.7 million in reinsurance recoverable on paid losses, respectively, and $63.6 million and $102.7 million in reinsurance recoverable on unpaid losses, respectively. We record provisions for uncollectible reinsurance recoverable when collection becomes unlikely due to the reinsurer’s inability to pay. Based on a review of the financial condition of the reinsurers and other factors, we have determined that a reserve for uncollectible reinsurance recoverable on paid and unpaid loss and LAE was not considered necessary as of December 31, 2013 and 2012.
RSUs are phantom (as opposed to actual) Common Shares which, depending on the individual award, vest in equal tranches over a one to five-year period, subject to the recipient maintaining a continuous relationship with Montpelier through the applicable vesting date. RSUs are payable in Common Shares upon vesting (the amount of which may be reduced by applicable statutory income tax withholdings at the recipient’s option). RSUs do not require the payment of an exercise price and are not entitled to voting rights, but they are entitled to receive payments equivalent to any dividends and distributions declared on the Common Shares underlying the RSUs.
For 2013, the number of Variable RSUs expected to be formally awarded to employees was based on our 2013 increase in FCBVPCS. FCBVPCS is computed by dividing the common shareholders’ equity available to the Company by the sum of its ending Common Shares and unvested RSUs outstanding. Our calculation of the increase in our FCBVPCS represents the growth in our FCBVPCS during the Initial RSU Period, after taking into account dividends on Common Shares declared during such period.
We also use fixed RSUs (“Fixed RSUs”) as a supplemental component of our ongoing long-term incentive compensation for certain of our employees and non-employee directors. Unlike Variable RSUs, the number of Fixed RSUs is fixed on the grant date. Fixed RSUs are typically granted for the following purposes: (i) to induce individuals to join Montpelier; (ii) to retain certain key employees; (iii) to reward employees for exhibiting outstanding individual performance; and (iv) as remuneration to non-management members of the boards of directors of both the Company and MAL. Additionally, when the actual number of Variable RSUs to be awarded in any given year has been formally determined, they are effectively converted into Fixed RSUs.
For the 2013-2016 Variable RSU award cycle, the targeted performance metric was based on a 2013 increase in FCBVPCS of 9.76%, which would have generated a grant of approximately 530,000 Variable RSUs to participants. The payout range for that year was from a threshold of 2.76% (generating no RSUs) to a maximum of 16.76% (generating approximately 1,060,000 Variable RSUs). Throughout the Initial RSU Period for this cycle, our quarterly Variable RSU accrual for this cycle varied in response to actual year-to-date results achieved and ranged from as many as 900,800 RSUs (as recorded at December 31, 2013) to as few as 498,954 RSUs (as recorded at March 31, 2013). Because we determined our achieved increase in FCBVPCS for 2013 to be 14.3%, the preliminary number of Variable RSUs expected to be granted for the 2013-2016 Variable RSU award cycle was determined to be 900,800 at December 31, 2013. The final number of Variable RSUs granted for the 2013-2016 Variable RSU award cycle will be formally determined by the Compensation Committee in February 2014 and any adjustments required to be made will be recorded in our consolidated financial statements in the first quarter of 2014.
For the 2011-2014 Variable RSU award cycle, the targeted performance metric was based on a 2011 ROE of 9.01%, which would have generated a grant of approximately 590,000 Variable RSUs to participants. The payout range for that year was from a threshold of 3.01% (generating no RSUs) to a maximum of 19.01% (generating approximately 1,180,000 Variable RSUs). Throughout the Initial RSU Period for this cycle, our quarterly Variable RSU accrual for this cycle remained at zero. Based on our actual ROE achieved for 2011 of negative 7.4%, the final number of Variable RSUs granted for the 2011-2014 Variable RSU award cycle was formally determined to be zero by the Compensation Committee in February 2012.
During 2013, 2012 and 2011, we also granted 35,000, 50,700 and 100,000 Fixed RSUs, respectively, to certain of our employees and non-management directors.
The financial statements and supplementary data have been filed as a part of this Report on Form 10-K as indicated in the Index to Consolidated Financial Statements and Financial Statement Schedules appearing on page 95 of this report.