Marketplace Conditions and Trends. In general, at the end of 2013, we believe operating conditions continued to be competitive. In most classes of property and casualty business, we experienced mixed pricing, with increases in some casualty classes of business due to the continued low interest rate environment and industry loss development. These positive rate trends have been tempered by relatively high levels of underwriting capacity and competition, particularly in catastrophe exposed property insurance and reinsurance. In our agriculture business, pricing was relatively stable across our portfolio, although the underlying exposure base has varied with commodity price movements. We continued to maintain our adherence to underwriting standards by declining business when pricing, terms and conditions did not meet our underwriting criteria.
The Company’s reinsurance premiums are earned in proportion to the amount of reinsurance protection provided over the applicable risk period established in the reinsurance contract. Reinsurance contracts written on a losses occurring basis cover losses which occur during the term of the reinsurance contract, typically 12 months. Accordingly, the Company earns the premium on a losses occurring reinsurance contract evenly over the reinsurance contract term. Losses occurring reinsurance contracts accounted for approximately 21%, 22%, and 21% of the Company’s gross premiums written during the years ended December 31, 2013, 2012, and 2011, respectively. Reinsurance contracts written on a policies attaching basis cover losses from the underlying insurance policies incepting during the terms of the reinsurance contracts. Losses under a policies attaching reinsurance contract may occur after the end date of the reinsurance contract, so long as they are losses from policies which began during the reinsurance contract period. The Company typically earns the premiums for policies attaching reinsurance contracts over a 24 month period in proportion to the amount of reinsurance protection provided to reflect the extension of the risk period past the term of the contract and the varying levels of reinsurance protection provided during the reinsurance contract period. Policies attaching reinsurance contracts accounted for approximately 24%, 22%, and 19% of the Company’s gross premiums written during the years ended December 31, 2013, 2012, and 2011, respectively.
The Company’s historical experience has shown that estimated premiums from proportional contracts have varied and have been adjusted by up to approximately 7%, although larger variations, both positive and negative, are possible as a result of changes in one or more of the premium assumptions as noted above. A 7% variation in the Company’s proportional premiums receivable, net as of December 31, 2013, after considering the related expected losses and loss expenses, acquisition expenses and taxes, would result in an impact of approximately $1.2 million on the Company’s net income.
The following summarizes the Company’s net proportional premium estimates within premiums receivable, net on the Company’s Audited Consolidated Balance Sheets as of December 31, 2013 and 2012:
As a result of recognizing the estimated gross premium written at the inception of the policy and collecting that premium over an extended period, we include a premiums receivable asset on our balance sheet. We actively monitor our premiums receivable asset to consider whether we need an allowance for doubtful accounts. As part of this process, we consider the credit quality of our cedants and monitor premium receipts versus expectations. At December 31, 2013, the Company has an allowance for estimated uncollectible premiums receivable of $2.3 million (2012 - $3.4 million).
The Company’s loss and loss expense reserves are reviewed regularly, and adjustments, if any, are reflected in earnings in the period in which they become known. The establishment of new loss and loss expense reserves or the adjustment of previously recorded loss and loss expense reserves could result in significant positive or negative changes to the Company’s financial condition for any particular period. While we believe that we have made a reasonable estimate of loss and loss expense reserves, the ultimate loss experience may not be reliably predicted, and it is possible that losses and loss expenses will be higher or lower than the total reserve for losses and loss expenses recorded by the Company.
For the agriculture insurance line of business, loss reserves are established from initial loss notifications that are provided to our independent agents from insureds. Based on the information provided, the Company’s system establishes a loss reserve amount calculated from a formulaic model which includes historical experience, type of crop, and percent of liability. As actual claims are adjusted, outstanding reserves are adjusted to reflect the actual losses incurred.
The information gathered by the Company and the actuarial analyses performed on the gathered information is used to develop individual point estimates of carried loss and loss expense reserves for each of the Company’s business segments and underlying lines of business. These individual point estimates are then aggregated along with the case reserves for actual losses reported to reach the total reserve for losses and loss expenses carried on the Company’s consolidated financial statements. All of the Company’s loss reserving is currently performed on a point estimate basis. The Company does not utilize range estimation in its loss reserving process.
The aspects of the Company’s casualty and professional lines in the Reinsurance and Insurance segments that complicate the process of estimating loss reseves include the lack of long-term historical data for losses of the same type intended to be covered by the policies and contracts written by the Company and the expectation that a portion of losses in excess of the Company’s attachment levels in many of its contracts will be low in frequency and high in severity, limiting the usefulness of claims experience of other insurers and reinsurers for similar claims. In addition, the portion of the Company’s casualty line in its Insurance segment that is underwritten in Bermuda includes policy forms that vary from more traditional policy forms. The primary difference in the casualty policy form used by Endurance Bermuda from more traditional policy forms relates to the coverage being provided on an occurrence reported basis instead of the typical occurrence or claims-made basis used in traditional policy forms. The occurrence reported policy forms typically cover occurrences causing unexpected and unintended personal injury or property damage to third parties arising from events or conditions that commence at or subsequent to an inception date, and prior to the expiration of the policy provided that proper notice is given during the term of the policy or the discovery period.
the diversity of loss development patterns among different types of reinsurance treaties or contracts;
In order to verify the accuracy and completeness of the information provided to the Company by its ceding company counterparties, the Company’s underwriters, actuaries, accounting and claims personnel perform underwriting and claims reviews of the Company’s ceding companies. Findings are communicated as appropriate to the ceding companies and utilized in the establishment or revision of the Company’s case reserves and related IBNR reserves. On occasion, these reviews reveal that the ceding company’s reported losses and loss expenses do not comport with the terms of the contract with the Company. In such events, the Company strives to resolve the outstanding differences in an amicable fashion. The large majority of such differences are resolved in this manner. In the infrequent instance where an amicable solution is not feasible, the Company’s policy is to vigorously defend its position in litigation or arbitration. As of December 31, 2013, the Company was not involved in any material claims litigation or arbitration proceedings.
Due to the large volume of potential transactions that must be recorded in the insurance and reinsurance industry, backlogs in the recording of the Company’s business activities can also impair the accuracy of its loss and loss expense reserve estimates. As of December 31, 2013, there were no significant backlogs related to the processing of policy or contract information in the Company’s Insurance or Reinsurance segments.
new types of injuries caused by new types of injurious activities or exposures; and
The Company considers its ability and intent to hold an equity security in an unrealized loss position for a reasonable period of time to allow for a full recovery. When the Company determines that the decline in value of an equity security is other-than-temporary, the Company reduces the cost of the equity security to its fair value and recognizes the loss in the Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). The new cost basis is not changed for subsequent recoveries in fair value.
At each balance sheet date, management assesses the need to establish a valuation allowance that reduces deferred tax assets when it is more likely than not that all, or some portion, of the deferred tax asset will not be realized. The valuation allowance is based on all available information from each tax-paying component in each tax jurisdiction and available tax planning strategies. Estimates of future taxable income incorporate several assumptions that may differ from actual experience. Differences in our assumptions and resulting estimates could be material and have an adverse impact on our financial results of operations and liquidity. Any such differences are recorded in the period in which they become known. As of December 31, 2013, the Company had a net deferred income tax asset of $51.7 million (2012 - $43.5 million), which includes a valuation allowance of $122.7 million (2012 - $85.8 million).
Recent Accounting Pronouncements. In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2011-11 “Disclosures About Offsetting Assets and Liabilities” (“ASU 2011-11”). ASU 2011-11 requires additional disclosures about financial instruments and derivative instruments relating to netting arrangements. ASU 2011-11 was effective for interim and annual periods beginning on or after January 1, 2013, with retrospective presentation required. The Company adopted this standard effective January 1, 2013. This standard did not have a material impact on the Company’s Audited Consolidated Financial Statements.
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:
Net premiums written in 2013 increased $19.4 million, or 1.0%, compared to 2012 and increased $69.1 million, or 3.5% compared to 2011. The change in net premiums written for 2013 compared to 2012 and 2011 was driven primarily by the following factors:
An increase in the Reinsurance segment casualty line of business as a result of new international motor and U.S. casualty treaties and improved pricing on renewals partially offset by the non-renewal of business that no longer met profitability targets and a number of negative premium adjustments;
A decline in the catastrophe line of business in the Reinsurance segment reflecting the Company’s selective reduction of its limits on some U.S. business, particularly in Florida, increased retrocessional coverage on business in the current year and pricing declines within a competitive environment. In addition, the level of reinstatement premiums recorded in 2013 was lower than in 2012 and 2011 as a result of a lower incidence of major loss events;
A decline in the property line of business in the Insurance segment compared to 2011 as the Company curtailed the underwriting of several property insurance products in order to reallocate capital to more profitable lines of business.
The components of net investment income for the years ended December 31, 2013, 2012 and 2011 are as follows:
The annualized net earned yield and total return of the investment portfolio for the years ended December 31, 2013, 2012 and 2011 and market yield and portfolio duration as of December 31, 2013, 2012 and 2011 were as follows:
(4) Includes only cash and cash equivalents and fixed income investments managed by the Company’s investment managers.
The Company’s investment portfolio is actively managed on a fair value basis to generate attractive economic returns and income. Movements in financial markets and interest rates influence the timing and recognition of net realized investment gains and losses as the portfolio is adjusted and rebalanced. Proceeds from sales of investments classified as available for sale for the year ended December 31, 2013 were $3,374.0 million compared to $4,143.5 million for the year ended December 31, 2012 and $3,034.9 million for the year ended December 31, 2011. Net realized and unrealized investment gains decreased in the year ended December 31, 2013 compared to 2012 and 2011 due to the impact of the rise in interest rates during 2013.
Net impairment losses recognized in earnings for the years ended December 31, 2013, 2012 and 2011 as a result of other-than-temporarily impaired securities were $1.6 million, $0.8 million and $3.5 million, respectively.
During 2013, 2012 and 2011, the Company’s previously estimated ultimate losses for prior accident years were reduced by $222.4 million, $120.2 million and $180.0 million, respectively, as the loss emergence related to prior accident years was lower than expected. The overall net reduction in the Company’s estimated losses for prior accident years experienced in 2013 emerged across all lines of the Company’s Insurance and Reinsurance segments. Favorable prior year loss reserve development in 2013 was significantly higher than in 2012 due to much lower than expected reported losses in the Reinsurance property and catastrophe lines and from reductions in reserve estimates related to the Thailand flood losses of 2011 ($24.4 million) and Superstorm Sandy losses in 2012 ($24.1 million). Comparatively, 2012 included adverse development on some of the major 2011 loss events impacting the Reinsurance property line of business.
The Company’s acquisition expense ratio in 2013 was consistent with 2012 and increased modestly compared to 2011. Compared to 2012, the acquisition expense ratio increased in 2013 in the Reinsurance segment due to growth in property earned premiums, which incurs higher acquisition expenses, and a decline in the catastrophe line, which incurs lower acquisition expenses. This was offset by a decrease in the Insurance segment acquisition expense ratio compared to 2012, driven by a higher proportion of net earned premiums attributed to the agriculture line, which incurs a lower net acquisition expense rate, and the decline in professional lines premiums compared to 2012, which conversely incurs a higher acquisition expense rate. The change in the 2013 acquisition expense ratio compared to 2011 resulted from growth in the proportion of net premiums earned in the Reinsurance segment, which generally incurs a higher acquisition expense rate.
The Company’s general and administrative expense ratio for 2013 was higher than that of 2012 and 2011, due to an increase in personnel costs related to the addition of new underwriting teams during 2013, current period costs associated with the Company’s Chief Executive Officer transition, severance costs, and increased annual incentive costs associated with improved corporate operating results in 2013. The prior year also benefited from a lower 2012 payout of the Company’s 2011 annual incentive compensation than was previously accrued. Compared to 2011, the increase in 2013 general and administrative expenses resulting in a higher expense ratio was partially offset by an increase in third party commissions and expense reimbursement offsets in the Insurance segment’s agriculture line of business. At December 31, 2013, the Company had a total of 920 employees as compared to 881 employees at December 31, 2012 and 844 employees at December 31, 2011.
Premiums. Net premiums written in the Insurance segment decreased in 2013 by 1.0% compared to 2012 and decreased 7.3% compared to 2011. Gross and net premiums written for each line of business in the Insurance segment for the years ended December 31, 2013, 2012 and 2011 were as follows:
A decrease in the professional line of business driven by the non-renewal of a large program relationship in late 2012 and higher cessions to third parties;
A decline in the property line of business in 2013 as the Company continued to curtail the underwriting of several property insurance products in order to reallocate capital to more profitable lines of business; and
An increase in the casualty and other specialty line of business driven primarily by the addition of new underwriting teams and products.
Net premiums earned by the Company in 2013 in the Insurance segment decreased compared to net premiums earned in 2012 and 2011 due to a decline in net premiums written over the prior two years in the property and professional lines of business, partially offset by growth in the agriculture and casualty and other specialty lines of business.
General and Administrative Expenses. The Company’s general and administrative expense ratio in the Insurance segment for 2013 increased compared to both 2012 and 2011. The increase in 2013 was due to higher personnel costs resulting from the addition of new underwriting teams, higher annual incentive costs, and increased levels of allocated expenses primarily from increased personnel expenses associated with the Company’s Chief Executive Officer transition. Compared to 2011, the overall increase in expenses was partially offset by higher third party commissions and expense reimbursements in the current year.
The following table summarizes the underwriting results and associated ratios for the Company’s Reinsurance segment for the years ended December 31, 2013, 2012 and 2011:
Premiums. Net premiums written in the Reinsurance segment increased in 2013 by 2.7% over 2012 and 14.6% over 2011, respectively. Gross and net premiums written for each line of business in the Reinsurance segment for the years ended December 31, 2013, 2012 and 2011 were as follows:
A decline in the catastrophe line of business reflecting the impact of reduced pricing in a more competitive market and the selective reduction by the Company of its limits on some U.S. business, particularly in Florida, as well as the purchase by the Company of increased retrocessional coverage on business in the current year. In addition, the level of reinstatement premiums recorded in 2013 was lower than in the previous years as a result of a lower incidence of major loss events; and
Ceded premiums written by the Company in the Reinsurance segment amounted to $73.4 million in 2013 as compared to $32.0 million and $23.0 million in 2012 and 2011, respectively. Ceded premium increased in 2013 compared to 2012 and 2011 as the Company has purchased increased levels of protection in the catastrophe and property lines of business.
Net premiums earned increased in 2013 compared to 2012 and 2011 primarily due to the overall increase in premiums written during 2013.
Net Losses and Loss Expenses. The net loss ratio in the Company’s Reinsurance segment for 2013 decreased compared to 2012 and 2011 as a result of higher levels of favorable prior year loss reserve development and lower levels of catastrophe related activity in 2013. The following table shows the net losses after adjustment for reinstatement premiums and other loss sensitive accruals recorded by the Company in connection with catastrophes in the Reinsurance segment for the years ended December 31, 2013, 2012 and 2011.
For 2013, catastrophe related losses added 7.4 percentage points to the Reinsurance segment’s net loss ratio after adjustment for reinstatement premiums and other loss sensitive accruals compared to 17.3 percentage points in 2012 and 49.9 percentage points in 2011.
The Company experienced higher favorable prior year loss reserve development in its Reinsurance segment in 2013 compared to 2012 and 2011. The 2013 favorable prior year loss reserve development emerged across all business lines in the segment. During 2013, 2012 and 2011, the Company’s previously estimated ultimate losses for the Reinsurance segment for prior accident years were reduced by $188.5 million, $74.0 million and $109.2 million, respectively. Favorable prior year loss reserve development resulted as claims have not materialized as originally estimated by the Company. During 2013, the majority of the favorable loss reserve development emanated from the property and catastrophe lines, driven by reductions in the Thailand flood losses of 2011 and Superstorm Sandy losses in 2012, and from lower than expected attritional losses.
General and Administrative Expenses. The general and administrative expense ratio experienced by the Reinsurance segment in 2013, as compared to 2012 and 2011 increased due to an increase in allocated costs associated with higher annual incentive costs and the Company’s Chief Executive Officer transition, partially offset by the impact of higher earned premiums.
The Company’s investment portfolio was valued at $6.5 billion as of December 31, 2013. The Company’s investment portfolio is comprised of cash and cash equivalents, fixed maturity investments, short-term investments, equity securities and other investments, comprised of alternative funds and specialty funds. Alternative funds include investments in hedge funds and private investment funds that generally invest in senior secured bank debt, high yield debt securities, distressed debt, distressed real estate, derivatives, and equity long/short strategies. Specialty funds currently include high yield loan and convertible debt funds.
The following tables set forth the types of securities, amortized costs, fair values and related gross unrealized gains and losses of our fixed maturity, short-term and equity investment portfolios as of December 31, 2013 and 2012:
U.S. State and Municipal Securities. U.S. State and Municipal Securities are debt securities issued by a state, municipality, or county, in order to finance its capital expenditures. Most municipal bonds are exempt from federal taxes and from most state and local taxes.
Corporate Securities. Corporate securities are comprised of bonds issued by corporations, primarily rated A-/A3 or higher and are diversified across a wide range of issuers and industries. Corporate securities also include high yield securities comprised of bonds issued by corporations rated below BBB-. The principal risk of corporate securities is the potential loss of income and potential realized and unrealized principal losses due to insolvencies or deteriorating credit. The largest corporate security in our portfolio represented approximately 1% of our fixed income investments at December 31, 2013.
(2) Includes agency mortgage-backed securities of $1,165.9 million and $1,223.5 million at December 31, 2013 and 2012, respectively.
The Company’s other investments are comprised of (i) hedge funds and private investment funds that generally invest in senior secured bank debt, high yield debt securities, distressed debt, distressed real estate, derivatives, and equity long/short strategies (“alternative funds”) and (ii) high yield loan and convertible debt funds (“specialty funds”) are recorded on the Company’s balance sheet as “other investments.” As of December 31, 2013, our Board of Directors had approved investments in alternative funds at the time of commitment of capital of up to the lesser of (x) 20% of total shareholders’ equity, or (y) $600 million. This restriction does not apply to investments in specialty funds that are typically long only structures. As of December 31, 2013, the Company’s other investments totaled $617.5 million and represented 9.5% of the Company’s investment portfolio. As of December 31, 2013, the Company had invested, net of capital returned, a total of $440.9 million in alternative funds and specialty funds. As of December 31, 2013, the market value of alternative funds represented $461.1 million or approximately 74.7% of other investments, and specialty funds represented $156.3 million or approximately 25.3% of other investments.
During 2013, 2012 and 2011, the Company identified available for sale securities that were considered to be other-than-temporarily impaired. In identifying such securities, the Company initially considered whether it intended to sell or would be more likely than not required to sell the securities in an unrealized loss position at the end of the applicable period. To the extent that the Company did not identify securities meeting these criteria, the Company then performed various analyses and reviews to determine whether the investments in an unrealized loss position were other-than-temporarily impaired as a result of credit factors or non-credit related factors. As such, the Company recorded total other than temporary impairments of $1.6 million (2012 - $0.8 million; 2011 - $3.5 million) related to credit factors and recognized in earnings.
The Company’s diversified portfolio of investments includes exposures to the debt of various European countries. The Company continuously monitors its exposures through review of its portfolio and has established investment guidelines that restrict the amount of investment exposure to any one issuer or country to depending on specific ratings of such issuer or country as stated by
credit rating agencies. The Company has remained relatively consistent in its aggregate direct exposure to the indebtedness and equity securities of those countries whose currency is the Euro or whose sovereign debt rating is below AAA (except the U.S.), with $463.4 million of exposure at December 31, 2013 (2012 - $198.5 million). The increase in exposures as of December 31, 2013 compared to the prior year is mainly due to Moody’s downgrade of the United Kingdom from “Aaa” to “Aa1” in February 2013.
The following table shows the fair value as of December 31, 2013 based on the ratings of the securities held by country of risk in those countries whose currency is the Euro or whose sovereign debt rating is below AAA (except the U.S.) by any of the recognized rating agencies at December 31, 2013:
In addition to the direct exposures above, the Company has indirect exposure to sovereign and non-sovereign investments held within certain alternative funds in its other investments. The Company has one investment in the other investments category in a hedge fund with a primary focus on European indebtedness, principally focused on the declining value of European sovereign indebtedness.
Endurance U.S. Reinsurance, Endurance American, Endurance American Specialty and Endurance Risk Solutions are subject to regulation by the State of Delaware Department of Insurance and American Agri-Business is subject to regulation by the Texas Department of Insurance. Dividends for each U.S. operating subsidiary are limited to the greater of 10% of policyholders’ surplus or statutory net income, excluding realized capital gains. In addition, dividends may only be declared or distributed out of earned surplus. At December 31, 2013, Endurance U.S. Reinsurance, Endurance American, Endurance Risk Solutions, and Endurance American Specialty did not have earned surplus; therefore, these companies are precluded from declaring or distributing dividends during 2014 without the prior approval of the applicable insurance regulator. At December 31, 2013, American Agri-Business (with notice to the Texas Department of Insurance) could pay dividends of $3.9 million without prior regulatory approval from the applicable regulators. In addition, any dividends paid by Endurance American, Endurance American Specialty and Endurance Risk Solutions would be subject to the dividend limitation of their respective parent insurance companies.
As of December 31, 2013 and 2012, the Company had pledged cash and cash equivalents and fixed maturity investments of $146.1 million and $224.4 million, respectively, in favor of certain ceding companies to collateralize obligations. As of December 31, 2013 and 2012, the Company had also pledged $302.7 million and $380.0 million of its cash and fixed maturity investments to meet collateral obligations for $260.3 million and $320.4 million in secured letters of credit outstanding under its credit facility, respectively. In addition, at December 31, 2013 and 2012, cash and fixed maturity investments with fair values of $273.7 million and $280.0 million were on deposit with U.S. state regulators, respectively.
Cash flows used in financing activities. The Company’s cash flows used in financing activities for the twelve months ended December 31, 2013 were $74.4 million, compared to $97.6 million and $234.1 million in 2012 and 2011, respectively. The 2013 cash flows used in financing activities decreased compared to 2012 due to proceeds from the issuance of ordinary shares. Compared to 2011, cash flows used in financing activities in 2013 decreased due to the decrease in ordinary share repurchase activity and absence of negative cash flows from securities lending payables partially offset by a decrease in proceeds from share issuances.
During 2013, the Company used its capital to repurchase 318,252 of its ordinary shares in the open market for $14.6 million at an average price per share of $45.83. During 2012, the Company repurchased $1.0 million of its 6.15% Senior Notes due October 15, 2015 (2013: nil; 2011: $0.5 million). On January 28, 2011, the Company repurchased 7,143,056 ordinary shares and options to purchase 10,000 ordinary shares from two affiliated funds of Perry Corp., a founding shareholder of Endurance. The aggregate repurchase price for the shares and the options was $321.5 million. The ordinary shares acquired by the Company represented approximately 15% of its ordinary shares outstanding at December 31, 2010. Endurance Holdings funded the repurchase primarily from calling an outstanding loan between Endurance Holdings and Endurance Bermuda. Endurance Bermuda funded the settlement of the loan from its existing cash and investments.
The Company’s contractual obligations as of December 31, 2013 are summarized as follows:
(1) The Company entered into investment agreements to invest additional amounts in other investments.
Dividends on the Series A Preferred Shares and Series B Preferred Shares, when, as and if declared by the Board of Directors of Endurance Holdings or a duly authorized committee of the Board, accrue and are payable on the liquidation preference amount from the original issue date, quarterly in arrears on each dividend payment date, at an annual rate of 7.75% in the case of the Series A Preferred Shares and an annual rate of 7.5% in the case of the Series B Preferred Shares. Dividends on the Series A Preferred Shares and Series B Preferred Shares are not cumulative.
The Company’s functional currencies are U.S. dollars for its U.S. and Bermuda operations and British Sterling for its U.K. operations. The reporting currency for all entities is U.S. dollars. The Company maintains a portion of its investments and liabilities in currencies other than the U.S. dollar. The Company has made a significant investment in the capitalization of Endurance U.K which was valued at £296.4 million as of December 31, 2013 ($490.9 million in U.S. dollars). Endurance U.K. is subject to the United Kingdom’s Prudential Regulation Authority rules concerning the matching of the currency of its assets to the currency of its liabilities. Depending on the profile of Endurance U.K.‘s liabilities, it may be required to hold some of its assets in currencies corresponding to the currencies of its liabilities. The Company may, from time to time, experience losses resulting from fluctuations in the values of foreign currencies, which could have a material adverse effect on the Company’s results of operations.
For the year ended December 31, 2013, 15% of the Company’s gross premiums were written in currencies other than the U.S. dollar. The portions of our cash and cash equivalents, investments, net premium receivable and insurance and reinsurance balances receivable, and reserves for loss and loss expenses denominated in non-U.S. currencies at December 31, 2013 were approximately 45%, 5%, 21%, and 15%, respectively. As of December 31, 2013, the Company’s principal foreign currency exposures are denominated in British Sterling and Euros. The Company measures and manages its exposure in these currencies, among others, by monitoring its estimated gross and net asset positions. In order to estimate such exposures, the Company considers currency specific investments, cash and cash equivalents, premiums receivable, reserve for losses and loss expenses, and unearned premiums. The total estimated gross and net asset balances denominated in Euros were $281.0 million and $48.0 million, respectively. The total estimated gross and net asset balances denominated in British Sterling were $277.9 million and $155.9 million, respectively. Assuming all other variables are held constant and disregarding any tax effects, a 10% change in the U.S. dollar relative to these currencies could result in a $20.4 million increase or decrease in the net assets held by the Company at December 31, 2013.
Differences between actual reported losses and expected losses are anticipated to occur in any individual period and such deviations may influence future initial expected loss ratios and/or expected loss reporting patterns as recent actual experience becomes part of the historical data utilized as part of the ongoing reserve estimation process. The Company has demonstrated the impact of changes in the speed of loss reporting patterns, as well as changes in expected loss ratios, within the table under the heading “Potential Variability in Reserves for Losses and Loss Expenses” below.
For the year ended December 31, 2013, as part of the Company’s periodic review of key parameters and in order to recognize accumulated historical experience and other relevant industry information, the Company adjusted the initial expected loss ratios for a number of business units within the Insurance and Reinsurance segments. Within the Insurance segment, initial expected loss ratios were lowered for historical years for the casualty and other specialty and professional lines of business, and raised for the workers’ compensation line of business that is included in the casualty and other specialty line of business. Within the Reinsurance segment, initial expected loss ratios were lowered for historical years for the catastrophe line of business.
Current and prior year incurred losses and loss expenses by segment and line of business for the year ended December 31, 2012 were as follows:
For the year ended December 31, 2012, the Company did not materially alter the two key inputs it utilizes to establish its reserve for losses and loss expenses, initial expected loss ratios or loss reporting patterns, for business related to prior years for the insurance and reinsurance reserve categories as the variances in reported losses in 2012 for those reserve categories were within the range of possible results anticipated by the Company.
Catastrophe. The Company recorded favorable loss emergence within the catastrophe line of business during 2013 and 2012 primarily due to lower than expected claims activity. During 2013, the favorable loss reserve development was driven by reductions in the Thailand flood losses of 2011 and Superstorm Sandy losses in 2012, and from lower than expected attritional losses.
Casualty. The Company recorded favorable prior period development within the casualty line of business during 2013 and 2012 primarily due to lower than expected claims reported.
Other specialty. The Company recorded favorable loss emergence within the other specialty line of business during 2013 and 2012 due to lower than expected claims reported.
Selected quarterly activity in the reserve for losses and loss expenses for the years ended December 31, 2013 and 2012 is summarized as follows:
The following table represents the development of the GAAP balance sheet reserve for losses and loss expenses, net of losses and loss expenses recoverable, for 2003 through December 31, 2013. This table does not present accident or policy year development data. The top line of the table shows the gross and net reserve for losses and loss expenses at the balance sheet date for each of the indicated years. This represents the estimated amounts of gross and net losses and loss expenses arising in the current year and all prior years that are unpaid at the balance sheet date, including IBNR reserves. The table also shows the re-estimated amount of the previously recorded reserve based on experience as of the end of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. The “cumulative redundancy” represents the aggregate change to date from the original estimate.
The table also shows the cumulative paid amounts as of successive years with respect to the reserve liability. All paid loss amounts reflect the conversion from the original currency of the underlying business if not initially denominated in U.S. dollars. The data in the cumulative paid losses table has been restated using the rate of exchange to U.S. dollars as of December 31, 2013. Information presented herein may differ materially from that reported in the Company’s financial statements due to differences in foreign currency exchange rates.
The following table reconciles cumulative paid losses per the table above to the cumulative paid losses reported in the Company’s audited financial statements.
The Company’s intangible assets and goodwill are tested at least annually for impairment and more often if a triggering event is deemed to have occurred. Impairment testing is performed based upon estimates of the fair value of the “reporting unit” to which the goodwill relates. The reporting unit is the operating segment or a business one level below that operating segment if discrete financial information is prepared and regularly reviewed by management at that level. The Company’s reporting units identified include the agriculture line of business in the Insurance segment, the remaining Insurance segment lines of business, and the Reinsurance segment. The fair value of the reporting unit is impacted by the performance of the business. The Company uses discounted cash flow analyses to estimate fair value. There have been no significant changes in the Company’s methodologies from the prior year. If it is determined that the goodwill has been impaired, the Company must write down the goodwill by the amount of the impairment, with a corresponding charge to net income.
During the fourth quarter of 2013, the Company performed its annual impairment testing of goodwill. The Company has two primary sources of goodwill - goodwill obtained from a renewal rights transaction completed in 2003 with HartRe and goodwill obtained from the Company’s acquisition of ARMtech in 2007. The Company determined that the appropriate reporting units for evaluation were the Reinsurance segment in relation to HartRe goodwill and the agriculture line of business of the Insurance segment in relation to the ARMtech goodwill. The Company used a discounted cash flow approach to estimate the fair value of these reporting units. The fair value determined was in excess of the carrying value including goodwill for both reporting units noted. As a result of the impairment testing, no write-downs were deemed necessary at December 31, 2013 and 2012.
The Company is subject to income taxes on the operations of its subsidiaries and branch offices in the United States, United Kingdom, Switzerland and Singapore. The Company’s Canadian branch office was closed during the fourth quarter of 2012. The Company is not required to pay any income or capital gains taxes on its operations in Bermuda.
The Company’s income tax (expense) benefit was as follows for the years ended December 31, 2013, 2012 and 2011, respectively:
The Company’s income (loss) before income taxes was distributed as follows for the years ended December 31, 2013, 2012 and 2011, respectively:
The Company has operating subsidiaries and branch operations in the United States, United Kingdom, Switzerland and Singapore, which are subject to the relevant taxes in those jurisdictions. During 2013, the Internal Revenue Service conducted audits of income tax returns of the Company’s U.S. subsidiaries. The Canada Revenue Agency and Canadian provinces conducted inquiries of prior year income tax filings of the Company’s former Canadian branch. The audit and inquiry results were immaterial to the operations of the Company. None of the Company’s other operating subsidiaries or branch operations are under an examination in any of the jurisdictions in which they operate. The Company remains subject to examination for tax years 2009 through 2013. As of December 31, 2013 and 2012, the Company had no uncertain tax positions.
The Company is subject to income taxes in certain jurisdictions in which the Company operates; however, since the majority of the Company’s income is currently earned in Bermuda, a jurisdiction with no corporate income tax, the tax impact to the Company’s operations has historically been minimal. In 2013, the Company generated income before income taxes in its subsidiaries, which generated a consolidated 1.8% effective income tax rate. In 2012, certain subsidiaries of the Company in the U.S. generated losses, largely contributing to the Company’s income tax benefit.
We have audited Endurance Specialty Holdings Ltd.‘s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 Framework) (the COSO criteria). Endurance Specialty Holdings Ltd.‘s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2012 and
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Endurance Specialty Holdings Ltd. at December 31, 2013 and 2012, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.
Premiums on the Company’s excess of loss and proportional reinsurance contracts are estimated at the time the business is underwritten. Accordingly, this is the amount the Company records as written premium in the period the reinsurance contract is underwritten. As actual premiums are reported by the ceding companies, management evaluates the appropriateness of the original premium estimates and any adjustments to these estimates are recorded in the period in which they become known.
The Company uses a variety of actuarial methods to estimate the ultimate losses and loss expenses incurred by the Company. One actuarial method used by the Company to estimate reserves for losses and loss expenses is the expected loss ratio approach, which is based on expected results independent of current loss reporting activity. This approach is typically used for immature loss periods (i.e., the current accident year). Another actuarial method used by the Company to estimate reserves for losses and loss expenses is known as the Bornhuetter-Ferguson method. The Bornhuetter-Ferguson method uses an initial loss estimate (expected loss technique) for each accident year by business line and type of contract. Under this method, IBNR is set equal to the initial loss estimate multiplied by the expected percent of loss yet to be reported at each valuation date. In a given quarter, if reported losses are less than expected, then the difference would result in a decrease in estimated ultimate losses. If losses are greater than expected, then the difference would result in an increase in estimated ultimate losses. A third actuarial method used by the Company to estimate reserves for losses and loss expenses is known as the loss development method. The loss development method extrapolates the current value of reported losses to ultimate expected losses by using selected reporting patterns of losses over time. The selected reporting patterns are based on historical information (organized into loss development triangles) and are adjusted to reflect the changing characteristics of the book of business written by the Company. Management uses these multiple actuarial methods, supplemented with professional judgment, to establish the best estimate of reserves for losses and loss expenses.
The Company’s loss and loss expense reserves are reviewed regularly, and adjustments, if any, are reflected in earnings in the period in which they become known. The establishment of new loss and loss expense reserves or the adjustment of previously recorded loss and loss expense reserves could result in significant positive or negative changes to the Company’s financial condition for any particular period. While management believes the Company’s estimate of loss and loss expense reserves is reasonable, the ultimate loss experience may not be reliably predicted, and it is possible losses and loss expenses may be materially different than the total reserve for losses and loss expenses recorded by the Company.
The Company currently classifies its fixed maturity investments, short-term investments and equity securities as “available for sale” and, accordingly, they are carried at estimated fair value, with related net unrealized gains or losses excluded from earnings (losses) and included in shareholders’ equity as a component of accumulated other comprehensive income. Investment transactions are recorded on a trade date basis. The Company determines the fair value of its available for sale investments in accordance with current accounting guidance, which defines fair value and establishes a fair value hierarchy based on inputs to the various valuation techniques used for each fair value measurement. The use of valuation techniques for any given investment requires a significant amount of judgment and consideration of factors specific to the underlying investment. Fair value measurements determined by the Company seek to maximize observable inputs and minimize the use of unobservable inputs. Current accounting guidance establishes three levels as follows:
For equity securities, the Company considers its ability and intent to hold the equity security in an unrealized loss position for a reasonable period of time to allow for a full recovery. When the Company determines that the decline in value of an equity security is other-than-temporary, the Company reduces the cost of the equity security to its fair value and recognizes the loss in the Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). The new cost basis is not changed for subsequent recoveries in fair value.
Other investments within the Company’s investment portfolio, which are comprised of (i) hedge funds and private investment funds that generally invest in senior secured bank debt, high yield debt securities, distressed debt, distressed real estate, derivatives, and equity long/short strategies (“alternative funds”) and (ii) high yield loan and convertible debt funds (“specialty funds”) are accounted for using the equity method of accounting whereby the initial investment is recorded at cost. The carrying values of these investments are increased or decreased to reflect the Company’s share of income or loss, which is included in net investment income, and are decreased for dividends. Due to the timing of the delivery of the final valuations reported by the managers of certain of our alternative and specialty funds, our investments in those funds are estimated based on the most recently available information including period end valuation statements, period end estimates, or, in some cases, prior month or quarter valuation statements.
The two-class method utilized by the Company is an earnings allocation formula that determines earnings (losses) per share for the holders of Endurance Holdings’ ordinary shares (also referred to as “common shares”) and participating common shares, which includes unvested restricted shares that receive cash dividends, according to dividends declared (or accumulated) and participation rights in undistributed earnings. Net income (loss) available (attributable) to common and participating common shareholders is reduced by the amount of dividends declared in the current period and by the contractual amount of dividends that must be paid for the current period related to the Company’s common and participating common shares. Any remaining
Diluted earnings (losses) per common share are based on the weighted average number of common shares and assumes the exercise of all dilutive stock warrants and options and the vesting or conversion of all convertible securities such as unvested restricted shares using the two-class method described above.
In February 2013, the FASB issued ASU 2013-02 “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” (“ASU 2013-02”). ASU 2013-02 requires entities to report, in one location, information about reclassifications out of accumulated other comprehensive income (“AOCI”). ASU 2013-02 also requires companies to report changes in AOCI balances. For significant items reclassified out of AOCI into net income in their entirety in the same reporting period, reporting (either on the face of the statement where net income is presented or in the notes to the financial statements) is required about the effect of the reclassifications on the respective line items in the statement where net income is presented. For items that are not reclassified into net income in their entirety in the same reporting period, a cross reference to other disclosures currently required under US GAAP is required in the notes. The above information must be presented in one place (parenthetically on the face of the financial statements by income statement line item or in a note to the financial statements). ASU 2013-02 was effective for fiscal years and interim periods beginning after December 15, 2012. The Company adopted this standard prospectively on January 1, 2013. This standard resulted in additional disclosure in Note 12 to the consolidated financial statements, “Shareholders’ equity”.
The following table summarizes the composition of the investment portfolio by investment type at December 31, 2013 and 2012:
The following table summarizes the composition by investment rating of the fixed maturity and short-term investments at December 31, 2013 and 2012. In some cases, where bonds are unrated, the rating of the issuer has been applied.
Hedge funds - The redemption frequency of the hedge funds range from monthly to biennially with notice periods from 30 to 90 days. Over one year, it is estimated that the Company can liquidate approximately 88% of the hedge fund portfolio, with the remainder over the following two years.
Realized and unrealized investment gains and losses are recognized in earnings (losses) using the first in, first out method. The analysis of net realized and unrealized investment gains and the change in the fair value of investment-related derivative financial instruments for the years ended December 31, 2013, 2012 and 2011 are as follows:
The Company classifies its investments in fixed maturity investments, short-term investments and equities as available for sale. The amortized cost, fair value and related gross unrealized gains and losses and non-credit OTTI losses on the Company’s securities classified as available for sale at December 31, 2013 and 2012 are as follows:
(2) Represents total OTTI recognized in accumulated other comprehensive income. It does not include the change in fair value subsequent to the impairment measurement date. At December 31, 2012, the gross unrealized loss related to fixed income investments for which a non-credit OTTI was recognized in accumulated other comprehensive income was $0.4 million.
The following tables summarize, for all available for sale securities in an unrealized loss position at December 31, 2013 and 2012, the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position.
(1) Gross unrealized losses include unrealized losses on non-OTTI and non-credit OTTI securities recognized in accumulated other comprehensive income at December 31, 2012.
As of December 31, 2012, 403 available for sale securities were in an unrealized loss position aggregating $6.9 million. Of those, 55 securities with aggregated unrealized losses of $2.1 million at December 31, 2012 had been in a continuous unrealized loss position for twelve months or greater.
The Company is involved in the normal course of business with VIEs primarily as a passive investor in residential and commercial mortgage-backed securities and through its interests in various other investments that are structured as limited partnerships considered to be third party VIEs. The Company determined that it was not the primary beneficiary for any of these investments as of December 31, 2013 and 2012. The Company believes its exposure to loss with respect to these investments is generally limited to the investment carrying amounts reported in the Company’s Consolidated Balance Sheets and any unfunded investment commitments.
The carrying values of cash and cash equivalents, accrued investment income, net receivable on sales of investments, net payable on purchases of investments, and other financial instruments not described above approximated their fair values at December 31, 2013 and 2012.
The following table sets forth the Company’s available for sale investments, other investments, other assets and liabilities and debt categorized by the level within the hierarchy in which the fair value measurements fall at December 31, 2013:
During 2013, there were no transfers into Level 1; however, the Company purchased current issue U.S. government securities and exchange traded equity securities, which are classified as Level 1 securities. U.S. government securities were transferred from Level 1 to Level 2 as they no longer qualified as on the run U.S. treasury securities.
During 2013, certain fixed maturity investments were transferred from Level 3 to Level 2. The reclassifications were largely related to asset-backed and commercial mortgage-backed securities. During the year, the market activity for these securities increased and observable inputs became available. In addition, the Company purchased asset-backed securities, which are classified as Level 3 securities, as no observable price was available. The Company used pricing models with significant unobservable inputs in order to determine the fair value of these securities.
Level 3 assets represented 10.9% and 9.5% of the Company’s total available for sale investments, other investments and derivative instruments at December 31, 2013 and 2012, respectively. Level 3 securities are primarily comprised of non-agency commercial mortgage-backed securities, asset-backed securities, investments in alternative and specialty funds, and weather derivatives. The NAV used to measure the fair value the Company’s other investments are generally derived from the underlying investments held within the funds. Although the Company does not have direct access to detailed financial information related to the underlying investments of the funds, the Company obtains and reviews fund financial statements, internal control review reports, and industry benchmarking reports to determine the reasonability of the NAV of the funds. There were no material changes in the Company’s valuation techniques for the year ended December 31, 2013.
Observable and unobservable inputs to these valuation techniques vary by contract requirements and commodity type, are validated using market-based or independently sourced parameters where applicable and may typically include the following, if applicable, dependent on contract requirements and commodity type:
The range of each unobservable input could vary based on the specific commodity, including, but not limited to natural gas, electricity, crude, liquids, temperature or precipitation. Due to the diversity of the portfolio, the range of unobservable inputs could be wide-spread as reflected in the below table on quantitative information.
If a trade has one or more significant valuation inputs that are unobservable, such trades are initially valued at the transaction price, which is considered to be the best initial estimate of fair value. Subsequent to the initial valuation, the Company updates market observable inputs to reflect observable market changes. The unobservable inputs are validated at each reporting period and are only changed when corroborated by evidence such as similar market transactions, third-party pricing services and/or broker or dealer quotations or other empirical market data.
There were no impairment losses on Level 3 securities recognized in earnings for the year ended December 31, 2013. Impairment losses of $0.1 million were recognized for the year ended December 31, 2012.
The following tables present a reconciliation of the beginning and ending balances for all available for sale investments, other investments and derivative instruments measured at fair value on a recurring basis using Level 3 inputs during the years ended December 31, 2013 and 2012.
(1) As required by ASU 2011-04, the fair value of the Company’s other investments was transferred into Level 3 at March 31, 2012.
During 2013, the Company’s estimated ultimate losses for prior accident years were reduced by $222.4 million (2012 - $120.2 million; 2011 - $180.0 million) due to lower claims emergence than originally estimated by the Company. During 2013, the Company experienced favorable development in the Reinsurance segment of $188.5 million in the catastrophe, property, casualty, professional lines and other specialty lines of business. In the Insurance segment, the Company experienced $33.9 million of favorable development across the agriculture, casualty and other specialty, professional lines, and property lines of business. During 2012, the Company experienced favorable development in the Reinsurance segment of $74.0 million in the catastrophe, casualty, professional lines and other specialty lines of business. In the Insurance segment, the Company experienced $46.2 million of favorable development across the agriculture, casualty and other specialty, professional lines, and property lines of business. During 2011, the Company experienced favorable development in the Reinsurance segment of $109.2 million in the catastrophe, property, casualty, professional lines and other specialty lines of business. In the Insurance segment, the Company experienced $70.8 million of favorable development across the agriculture, casualty and other specialty, professional lines, and property lines of business during 2011.
At December 31, 2013 and 2012, the Company held collateral of $14.2 million and $11.5 million, respectively, related to its ceded reinsurance agreements.
On October 17, 2005, Endurance Holdings issued $200.0 million principal amount of 6.15% Senior Notes due 2015 (the “6.15% Senior Notes”). The 6.15% Senior Notes were offered by the underwriters at a price of 99.639% of their principal amount, providing an effective yield to investors of 6.199%, and, unless previously redeemed, will mature on October 15, 2015. Endurance Holdings used the net proceeds from the offering to repay the $143.5 million then outstanding under Endurance Holdings’ revolving credit facility as well as to provide additional capital to its subsidiaries and for other general corporate purposes.
In 2004, prior to the issuance of the 7% Senior Notes, the Company entered into an interest rate lock on a notional amount of $125.0 million to protect against interest rate increases before the anticipated issuance of the Senior Notes. The objective of the interest rate lock was to protect 50% of the forecasted receipt of proceeds from the issuance of the 7% Senior Notes offering, which was subject to change prior to issuance due to fluctuations in the benchmark 30 year U.S. Treasury rate. Upon issuance of the 7% Senior Notes, the interest rate lock was settled through payment by the Company of $2.7 million. The interest rate lock agreement was designated as a “cash flow hedge” under the current accounting guidance and accordingly, the fair value of the derivative was recorded in other comprehensive (loss) income and is being recognized as a component of interest expense in the Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) as the interest expense related to the 7% Senior Notes affects earnings. The net income effect of the interest rate lock was not material.
None of the Company’s derivatives are designated as hedges under current accounting guidance, with the exception of the interest rate lock. The Company invests a portion of its fixed maturity assets with a third party investment manager with investment guidelines that permit the use of derivative instruments. The Company may enter derivative transactions directly or as part of strategies employed by its external investment managers. The Company’s objectives for holding these derivatives are as follows:
On January 1, 2013, the Company adopted new guidance that requires disclosure of financial instruments subject to a master netting agreement. At December 31, 2013, derivative assets of $14.5 million and liabilities of $21.2 million were traded under International Swaps and Derivatives Association Master Agreements (“ISDAs”) which provide for the ability to settle the derivative asset and liability with each counterparty on a net basis. TBAs and interest rate futures are not subject to ISDAs. At December 31, 2013 and 2012, none of the Company’s derivative instruments were netted. See Note 11 for information on collateral pledged.
Reinsurance - This segment is comprised of five lines of business: catastrophe, property, casualty, professional lines, and other specialty. The catastrophe line of business includes reinsurance for catastrophic perils on a treaty basis. The property line of business includes proportional and excess of loss reinsurance of personal and commercial exposures. The casualty line of business is comprised of third party liability exposures, clash and workers’ compensation coverages. The professional line of business includes directors’ and officers’ liability, errors and omissions, employment practices liability, environmental liability and pension trust liability reinsurance. The other specialty line of business includes the reinsurance of aviation and space business and proportional and non-proportional reinsurance of hull and cargo insurance business, and proportional and excess of loss coverages of contract and commercial surety business, personal accident coverages, political risk coverages, weather risk management products and agriculture coverages for weather related perils as well as protection from yield and price risks.
Management measures segment results on the basis of the combined ratio, which is obtained by dividing the sum of the net losses and loss expenses, acquisition expenses and general and administrative expenses by net premiums earned. When purchased within a single line of business, ceded reinsurance and recoveries are accounted for within that line of business. When purchased across multiple lines of business, ceded reinsurance and recoveries are allocated to the lines of business in proportion to the related risks assumed. The Company does not manage its assets by segment; accordingly, investment income and total assets are not allocated to the individual business segments. General and administrative expenses incurred by segments are allocated directly. Remaining general and administrative expenses not directly incurred by the segments are allocated primarily based on estimated consumption, headcount and other variables deemed relevant to the allocation of such expenses.
The following table reconciles total segment results to income (loss) before income taxes for the years ended December 31, 2013, 2012 and 2011:
The following table provides the geographic distribution of gross premiums written for the years ended December 31, 2013, 2012 and 2011:
The following table shows an analysis of goodwill and intangible assets for the years ended December 31, 2013 and 2012:
As of December 31, 2013, substantially all the Company’s cash and investments were held by three custodians.
Letters of credit. As of December 31, 2013, the Company had issued letters of credit of $260.3 million (2012 - $320.4 million) under its credit facility in favor of certain ceding companies to collateralize obligations.
Investment commitments. As of December 31, 2013 and 2012, the Company had pledged cash and cash equivalents and fixed maturity investments of $146.1 million and $224.4 million, respectively, in favor of certain ceding companies to collateralize obligations. As of December 31, 2013 and 2012, the Company had also pledged $302.7 million and $380.0 million of its cash and fixed maturity investments as required to meet collateral obligations for $260.3 million and $320.4 million in secured letters of credit outstanding under its credit facility, respectively. In addition, at December 31, 2013 and 2012, cash and fixed maturity investments with fair values of $273.7 million and $280.0 million were on deposit with U.S. state regulators, respectively.
The Company is subject to certain commitments with respect to other investments at December 31, 2013 and 2012. See Note 3.
During 2013, the Company issued restricted shares under its equity compensation plans (Note 15). The common shares issued, outstanding and fully paid for at December 31, 2013 includes 1,260,845 restricted shares.
On November 9, 2011, the Company’s Board of Directors authorized for repurchase up to 7.0 million ordinary shares or share equivalents through November 30, 2013. This authorization superseded previous authorizations. During 2013 and 2012, under programs authorized by the Company’s Board of Directors, the Company repurchased 318,252 and 251,309 of its ordinary shares and share equivalents in open market and privately negotiated transactions at an average price of $45.83 and $39.81 per share, respectively. Common shares repurchased by the Company are not cancelled and are classified as treasury shares. The Company’s treasury shares are recorded at cost as a reduction in common shares and additional paid-in capital within shareholders’ equity. There were no authorized repurchases remaining at December 31, 2013 (2012 - 6,748,691).
At December 31, 2013, 2012 and 2011, no warrants were outstanding. During 2011, the Company repurchased 90,000 outstanding warrants at an average price of $36.72, net of the average warrant strike price of $12.87 per warrant. During 2011, 2,895,527 warrants with an exercise price of $11.97 were exercised for the purchase of the Company’s ordinary shares at an average price of $36.44. The holders of 2,308,482 warrants elected the net settlement option, and thus the Company delivered 2,143,396 ordinary shares in settlement of all exercises.
The following table presents the changes in accumulated other comprehensive income balances by component for the year ended December 31, 2013:
The following table sets forth the computation of basic and diluted earnings (losses) per share for the years ended December 31, 2013, 2012 and 2011:
The following table sets forth dividends declared in the years ended December 31, 2013, 2012 and 2011, respectively:
On February 28, 2011, the Company entered into an agreement with Robert A. Spass, a member of the Board of Directors of the Company, to purchase from Mr. Spass warrants exercisable for 90,000 ordinary shares of the Company having an exercise price on the date of the agreement of $12.87 per ordinary share (the “Warrant Purchase Agreement”). The Warrant Purchase Agreement provided that the Company would purchase the warrants from Mr. Spass at a purchase price of $36.72 per warrant, which represented the closing price for the Company’s ordinary shares on the New York Stock Exchange on February 28, 2011, less the exercise price of the warrants. The transactions contemplated by the Warrant Purchase Agreement closed on March 1, 2011.
Under the terms of the 2007 Plan as amended, and after the consolidation of the Company’s previous plans, a total of 2,100,000 ordinary shares were reserved for issuance. At a meeting on February 11, 2010, the Company’s Board of Directors adopted a resolution to add 1,795,000 ordinary shares to the 2007 Plan, which was subsequently approved by the Company’s shareholders at the Annual General Meeting of Shareholders held on May 13, 2010. After the approval of the additional shares, a total of 3,895,000 ordinary shares were reserved for issuance. The Company issues new ordinary shares upon the issuance of share based equity incentives, such as restricted shares, or the exercise or settlement of outstanding derivative equity incentives, such as options or restricted share units. As of December 31, 2013, 2,107,889 (2012 - 2,339,707) ordinary shares remained available for issuance under the 2007 and prior Plans.
The 800,000 options awarded to Mr. Charman will vest annually, in five equal tranches commencing on May 28, 2013, subject to Mr. Charman’s continued employment, or in the event of certain terminations of employment and other events. Mr. Charman’s options have a 10-year contractual life.
During the year ended December 31, 2013, 800,000 options were granted with a weighted average grant date fair value of $10.2 million. No options were granted during the years ended December 31, 2012 and 2011. The Company uses the Black-Scholes-Merton formula to estimate the value of stock options granted. No options expired during the years ended December 31, 2013, 2012 and 2011. During the year ended December 31, 2013, 175,000 options vested. No options vested during the years ended December 31, 2012 and 2011. The total intrinsic value of options exercised during the years ended December 31, 2013, 2012 and 2011 was $0.5 million, $1.4 million, and $32.5 million, respectively. The Company received proceeds of $0.6 million from the exercise of options during the year ended December 31, 2013. The Company issued new ordinary shares in connection with the exercise of the above options.
The Company has issued restricted shares and restricted share units to employees and non-employee directors. The fair value of the restricted shares and restricted share units granted was equal to the fair market value of the Company’s ordinary shares on the grant date. Compensation equal to the fair market value of the restricted shares and restricted share units at the measurement date is amortized and charged to income over the vesting period. Restricted shares granted to employees generally vest pro rata over a four-year period. Restricted shares are forfeited upon departure from the Company for any reason prior to the applicable vesting date other than in cases where an employee meets certain retirement eligibility criteria which allow for continuing post-employment vesting of restricted shares, subject to compliance with certain non-competition obligations.
The Company generally withholds an amount sufficient to satisfy any federal, state or local withholding tax requirements associated with the vesting of the restricted shares and the restricted share units held by employees.
A summary of the restricted share and restricted share unit activity during the year ended December 31, 2013, is presented below:
During the years ended December 31, 2013, 2012 and 2011, the Company granted an aggregate of 1,211,987, 437,284 and 305,806 restricted shares and restricted share units with weighted average grant date fair values of $58.1 million, $16.8 million and $14.8 million, respectively. During the years ended December 31, 2013, 2012 and 2011, the aggregate fair value of restricted shares and restricted share units that vested was $17.1 million, $11.7 million and $14.4 million, respectively.
Total expenses related to this plan for the year ended December 31, 2013 was approximately $167,000 (2012 - $165,000; 2011- $200,000).
The Company provides pension benefits to eligible employees through various defined contribution plans sponsored by the Company. Under the Company’s defined contribution plans, the Company makes contributions to its employees’ accounts in amounts ranging from 4% to 12% of its employees’ eligible earnings. In addition, under certain defined contribution plans, employee contributions may be supplemented by matching contributions made by the Company based on the level of employee contribution. Lastly, the Company may provide additional contributions, depending on its annual financial performance. The employee and Company contributions in the defined contribution plans are invested at the election of each employee in one or more of several investment portfolios offered by third party investment advisors. Company contributions for the year ended December 31, 2013 resulted in an expense of $10.8 million being recorded in earnings (2012 - $7.4 million; 2011 - $7.5 million).
As a Bermuda holding company, Endurance Holdings is subject to the Companies Act 1981, which limits the Company’s ability to pay dividends and make distributions to its shareholders. The Company’s retained earnings are unrestricted; however, the Company is not permitted to declare or pay a dividend, or make a distribution out of contributed surplus, if it is, or would after the payment be, unable to pay its liabilities as they come due, or if the realizable value of its assets would be less than its liabilities. Endurance Holdings had, as of December 31, 2013, $2.2 billion in retained earnings, $0.1 billion in accumulated other comprehensive income and an additional $0.6 billion in contributed surplus available to declare or pay a dividend, or make a distribution out of contributed surplus, so long as Endurance Holdings remained in compliance with the Companies Act 1981 following such dividend or distribution. Endurance Holdings relies on dividends from Endurance Bermuda to provide cash flow required for debt service and dividends to shareholders.
The required and actual statutory capital amounts in the “Other” category in the table above include amounts related to Endurance U.K. and Endurance Bermuda’s Singapore branch (“Singapore Branch”). Under the jurisdiction of the United Kingdom’s Prudential Regulation Authority (“PRA”), Endurance U.K. must maintain a margin of solvency at all times, which is determined based on the type and amount of insurance business written. Insurers are required to calculate their required minimum solvency margin and to report it to the PRA. The PRA also mandates calculation of an Enhanced Capital Requirement for Endurance U.K. At December 31, 2013 and 2012, the actual capital for Endurance U.K. exceeded the capital requirements currently promulgated by the PRA.
The PRA regulatory requirements impose no explicit restrictions on Endurance U.K.’s ability to pay a dividend, but Endurance U.K. would have to notify the PRA 28 days prior to any proposed dividend payment. Dividends may only be distributed from profits available for distribution. At December 31, 2013 Endurance U.K did not have retained profits available for distribution.
The Company has operating subsidiaries and branch operations in the United States, United Kingdom, Switzerland and Singapore, which are subject to the relevant taxes in those jurisdictions. During 2013, the Internal Revenue Service conducted audits and inquiries of income tax returns of the Company’s U.S. subsidiaries. The Canada Revenue Agency and Canadian provinces conducted inquiries of prior year income tax filings of the Company’s former Canadian branch. The audit and inquiry results were immaterial to the operations of the Company. None of the Company’s other operating subsidiaries or branch operations were under examination in any of the jurisdictions in which they operate. The Company remains subject to examination for tax years 2009 through 2013.
The income tax (expense) benefit was as follows for the years ended December 31, 2013, 2012 and 2011, respectively:
Of the 2013 current income tax (expense) benefit, $(3.1) million related to taxes incurred in the United States (2012 - $(4.6) million; 2011 - $12.7 million). Of the deferred income tax (expense) benefit, $(2.8) million related to deferred income tax expense in the United States (2012 - $1.6 million; 2011 - $9.6 million). A full valuation allowance has been recorded against the net asset position of Endurance Bermuda’s foreign branches and Endurance U.K.
Deferred income taxes represent the tax effect of the differences between the book and tax bases of assets and liabilities. Net deferred income tax assets and liabilities consisted of the following as of December 31, 2013 and 2012:
A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. At December 31, 2013, management has established a valuation allowance of $122.7 million (2012 - $85.8 million) against net operating loss carryforwards in the Company’s United States subsidiaries, United Kingdom subsidiary and non-U.S. branches.
(1) The Company’s non-U.S. (foreign) operating subsidiaries write business that is exposed to risks originating in the United States.
As of December 31, 2013 and 2012, the Company had no uncertain tax positions.