(1) - Office leases are in force at December 21, 2016, however, service operations will not commence until 2017.
(3) - Calculated as stockholders’ equity divided by actual shares outstanding as of the date indicated.
Throughout this Annual Report, we present our operations in the way we believe will be most meaningful, useful and transparent to anyone using this financial information to evaluate our performance. In addition to the GAAP presentation of Net income, we show certain non-GAAP financial measures that we believe are valuable in managing our business and drawing comparisons to our peers. These measures are Underwriting profit (loss), Combined ratio, Net operating earnings, Net losses and LAE reserves and Book value and Book value per share.
Underwriting profit (loss) represents one measure of the pretax profitability of our insurance operations and is derived by subtracting Net losses and LAE, Commission expenses, Other operating expenses and Other underwriting income (expense) from Net earned premiums. This information is available in total and by segment in Note 2 - Segment Information in the Notes to Consolidated Financial Statements. The nearest comparable GAAP measure is Income before income taxes which, in addition to Underwriting profit (loss), includes Net investment income, Other than temporary impairment (“OTTI”) loss, Net realized gains (losses) on investments, Interest expense and Other income (loss).
The Combined ratio is a common insurance industry measure of profitability for any underwriting operation and is calculated in two components. First, the loss ratio is Net losses and LAE divided by Net earned premiums. The second component, the expense ratio, reflects the sum of Commission expenses, insurance operating expenses and Other underwriting income (expense), divided by Net earned premiums. All items included in these components of the Combined ratio are presented in our GAAP Consolidated Financial Statements. The sum of the loss and expense ratios is the Combined ratio. The difference between the Combined ratio and 100 percent reflects the rate of Underwriting profit (loss). For example, a Combined ratio of 85 percent implies that for every $100 of premium we earn, we record $15 of Underwriting profit.
Reserve for losses and LAE, as shown in the liabilities section of our Consolidated Balance Sheets, represents the total obligations to claimants for both estimates of known claims and estimates for IBNR claims. The related asset item, Reinsurance balances recoverable on unpaid losses and LAE, is the estimate of both known claims and IBNR that we expect to recover from reinsurers. The net of these two items is generally referred to as Net losses and LAE reserves and is commonly used in our disclosures regarding the process of establishing these various estimated amounts.
We are an international insurance company with a long-standing area of specialization in Marine insurance. Our P&C insurance business primarily offers General Liability coverage and Umbrella & Excess Liability coverage to commercial enterprises through our Primary and Excess Casualty divisions. We have also developed niches in Professional Liability insurance, through our D&O and E&O divisions. Beginning in 2010, we added reinsurance products through our GlobalRe reporting segment.
In May 2016, our Company received authorization from the PRA and the FCA for a new U.K. based insurance company, NIIC, which is a wholly-owned direct subsidiary of our Parent Company. Our Company has been fully capitalized in compliance with the terms of the authorization from the PRA and has been granted a financial strength rating of “A” by Standard & Poor’s. In light of the result of the U.K. referendum held on June 23, 2016 in favor of the U.K. leaving the E.U., the operational and start up plans for NIIC were re-evaluated. It is now anticipated that NIIC will begin writing business in the first quarter of 2017 and through the course of 2017 will write business both in the U.K. and through our European branches. While the precise timing and nature of the U.K’s exit from membership of the E.U. remains uncertain, we have developed contingency plans in order to maintain the required regulatory approvals and licenses in the countries of the E.U. in which we wish to do business.
As a result of the U.K. referendum vote in favor of exiting the E.U., for the twelve months ended December 31, 2016, the Great British pound (“GBP”) exchange rate experienced a significant decline in value against the USD. As a result, we have recorded realized and unrealized foreign exchange gains in Other income primarily due to a net GBP monetary liability in our foreign, U.S. functional currency subsidiaries. Additionally, we recorded a foreign currency translation loss in accumulated other comprehensive income (“AOCI”), primarily due to our GBP portfolio investments in NIIC, a GBP functional currency subsidiary. These assets are also the principal driver of the foreign exchange effect in our cash accounts.
Our revenue is primarily comprised of premiums and investment income. Cash flow is generated from premiums collected and investment income received less paid losses and loss expenses, Commission expenses and administrative expenses as well as the timing of reinsurance receipts and payments. Our products are distributed through multiple channels, utilizing global, national and regional retail and wholesale insurance brokers.
(1) - We completed a two-for-one stock split on January 20, 2017. All per share data has been retroactively restated on a post-split basis
Underwriting profit was $35.9 million for the year ended December 31, 2016, which decreased by $22.2 million from the same period in 2015, driven by $26.8 million of catastrophic events (“CAT”) plus related reinsurance reinstatement premiums (“RRPs”) of $1.8 million, $35.7 million of net additional current accident year (“AY”) reserve development due to large loss activity in our Int’l Insurance segment, and an increase in Other operating expense as we continue to invest in our European expansion and GlobalRe reporting segment. These items were partially offset by $28.5 million of favorable loss emergence on prior AY’s and increased production.
Underwriting profit was $58.1 million for the year ended December 31, 2015, which decreased by $10.8 million from the same period in 2014, mostly driven by Hurricane Joaquin CAT losses, which resulted in a $10.0 million net loss and $4.0 million of related RRPs, partially offset by increased production and favorable loss emergence on prior accident years (“AY”). Additionally, operating expenses increased due to our European expansion.
For the year ended December 31, 2016, we recorded $28.5 million of net prior AY reserve releases including $25.0 million, $2.2 million and $1.3 million of reserve releases from our Int’l Insurance, GlobalRe and U.S. Insurance reporting segments, respectively, all due to favorable loss emergence. This was offset by $62.5 million of additional net current AY reserve development, of which $26.8 million was due to CAT losses, including $11.7 million related to the Alberta Wildfires, $7.1 million due to Hurricane Matthew, $3.8 million due to the Ecuador earthquake and $3.3 million due to the Taiwan earthquake. Additionally, we incurred $35.7 million of non-CAT net current AY development, mostly due to large losses in our Int’l Insurance Marine and Int’l Insurance P&C operating segments, and $2.0 million of net RRPs primarily related to the CATs noted above.
For the year ended December 31, 2014, we recorded $55.8 million of net prior AY reserve releases primarily driven by $38.3 million, $15.4 million and $2.1 million of reserve releases from our Int’l Insurance, U.S. Insurance and GlobalRe reporting segments, respectively, all due to favorable loss emergence. This was partially offset by $16.8 million of additional net current AY reserve development related to large loss activity and $4.4 million of RRPs.
The increase in total Net investment income for all years presented as compared to the prior years was primarily due to growth of invested assets coupled with an increase in pretax yields, which was driven in part by an increased allocation to higher yielding preferred stocks. The annualized pre-tax yields, excluding Net realized gains and losses and OTTI losses recognized in earnings, on a consolidated basis were 2.6%, 2.4% and 2.3%, respectively, for the years ended December 31, 2016, 2015 and 2014.
Net realized gains and losses, excluding OTTI losses recognized in earnings, for the periods indicated were as follows:
Other income (loss) for the years ended December 31, 2016, 2015 and 2014 was $8.6 million, ($0.6) million and $10.1 million, respectively. Other income (loss) primarily consists of realized and unrealized foreign exchange gains and losses mostly driven by the strengthening of the USD against the GBP and CAD. 2016 included $10.2 million of unrealized foreign exchange gain and ($1.6) million of realized foreign exchange loss. 2015 included $0.3 million of realized foreign exchange gain and ($0.9) million of unrealized foreign exchange loss. 2014 was impacted by a $10.0 million foreign currency translation gain in connection with a change in the functional currency of the Syndicate that took place in the first quarter of 2014. See Note 1 - Organizations & Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements, included herein for additional information regarding the foreign currency adjustment.
The following tables summarize our Consolidated Financial Results by reporting segment for the years ended December 31, 2016, 2015 and 2014:
The following tables summarize our financial results by operating segment for our U.S. Insurance reporting segment for the years ended December 31, 2016, 2015 and 2014:
Ceded written premiums decreased $32.9 million for the year ended December 31, 2016 compared to the same period in 2015, mostly due to the reduction in proportional reinsurance coverage that supports our Excess Casualty and Environmental risks within our P&C operating segment, the nonrenewal of our E&O proportional reinsurance treaty in the fourth quarter of 2015 within our Professional Liability segment, and the year over year effect of RRPs. For the year ended December 31, 2016, RRPs decreased $4.6 million to $0.8 million as compared to $5.4 million in the prior year, primarily due to the reduction in large loss activity within our Marine operating segment. These items were partially offset by increases in our proportional reinsurance coverage within our Marine operating segment.
For the year ended December 31, 2015, RRPs of $5.4 million increased $3.6 million as compared to prior year of $1.8 million, primarily due to large loss activity within our Marine operating segment.
increase in our Professional Liability reserve for uncollectible reinsurance. The loss ratio was also unfavorably impacted by $2.9 million of net current AY loss from our Marine and P&C operating segments as well as $0.8 million of RRPs, which were primarily within our Marine operating segment.
The Commission expense ratio increased 1.2 percentage points for the year ended December 31, 2016 compared to the same period in 2015, primarily due to less ceded proportional reinsurance and related ceding commission benefit within our Professional Liability and P&C operating segments, partially offset by the implementation of new proportional reinsurance programs within our Marine operating segment.
The Commission expense ratio increased 0.2 percentage points for the year ended December 31, 2015 compared to the same period in 2014, primarily due to less ceded proportional reinsurance and related ceding commission benefit within our P&C operating segment as a result of the change in the proportional reinsurance program previously discussed partially offset by a decrease in commission expense ratio in the Professional Liability operating segment, and to a lesser extent, our Marine operating segment, due to the implementation of new proportional reinsurance programs.
Other operating expenses decreased $3.3 million for the year ended December 31, 2016 compared to the same period in 2015 due to decreases in non-recurring project specific information technology and professional fee expenditures.
Other operating expenses increased $15.6 million for the year ended December 31, 2015 compared to the same period in 2014, primarily driven by continued investment in our underwriting teams, support staff and infrastructure as well as an increase in our professional service fees and information technology expenses to support business growth and initiatives.
Gross written premiums increased $72.5 million for the year ended December 31, 2016 compared to the same period in 2015, primarily due to increases in our P&C and Professional Liability operating segments of $50.4 million and $22.6 million, respectively. Our P&C operating segment benefitted from $24.6 million growth in our Property division, mostly driven by our expanded coverage for international exposures, as well as growth of $10.9 million and $6.9 million from our Energy & Engineering and Casualty divisions, and the commencement of the PV&T product in 2016. The increase in our Professional Liability operating segment was due to new business production across all divisions.
Ceded written premiums increased $4.5 million for the year ended December 31, 2016 compared to the same period in 2015, driven by our Marine and P&C operating segments of $3.6 million and $1.9 million, respectively, mostly due to the year on year effect of RRPs. For the year ended December 31, 2016, RRPs of $2.9 million were incurred, compared to a release of $4.0 million in RRPs in 2015 resulting in a $6.9 million increase. This was partially offset by decreases in proportional reinsurance coverages in our P&C and Professional Liability operating segments.
For the year ended December 31, 2015, RRPs releases of $4.0 million decreased by $10.6 million as compared to the same period in 2014 when RRPs of $6.6 million were incurred. 2015 benefited from RRP releases of $4.0 million, which included releases due to reductions in Superstorm Sandy related losses.
For the year ended December 31, 2016, Other operating expenses increased $10.5 million as compared to the same period in 2015, due to the growth of our P&C business, specifically our International Property and PV&T businesses. We also incurred higher Lloyd’s charges due to increased volumes of European business attracting higher foreign levies. Increased costs also arose relating to additional support staff, costs associated with authorization of NIIC and related startup of operations, offset by favorable foreign exchange rates applied to GBP expenses incurred.
Gross written premiums decreased $24.6 million for the year ended December 31, 2015 compared to the same period in 2014, primarily due to the nonrenewal of a significant multiple peril crop quota share treaty within our Agriculture product and to a lesser extent nonrenewals in our Marine product and lower assumed RRPs in our P&C and Marine products. The decline in Gross written premiums was partially offset by an increase in renewal premiums in our A&H and P&C products.
Ceded written premiums increased $1.5 million for the year ended December 31, 2016 compared to the same period in 2015, primarily due to an increase in ceded RRPs in our Marine product and an increase in excess of loss costs in our P&C product.
Ceded written premiums increased $1.6 million for the year ended December 31, 2015 compared to the same period in 2014, primarily due to two additional retrocessional treaties written in 2015 for our Surety product, as well as increased renewal cost for a retrocessional treaty, which covers our P&C product.
The following table presents the changes in reserves and RRPs on our Net losses and LAE ratio for the years ended December 31, 2016, 2015 and 2014:
For the year ended December 31, 2016, our GlobalRe reporting segment recorded additional net current AY reserve development of $3.9 million, of which $9.3 million was due to CAT losses including $5.1 million related to the Alberta Wildfires, $2.7 million due to the Ecuador Earthquake and $0.9 million due to the Taiwan Earthquake, partially offset by $5.4 million of favorable loss emergence on the current AY, mostly driven by our A&H product. In addition, we recorded $2.2 million of net prior AY reserve release driven by favorable loss emergence mostly from our A&H product and $1.6 million of net RRP benefit primarily from our P&C and Marine products.
For the year ended December 31, 2015, our GlobalRe reporting segment recorded $9.1 million of net prior AY reserve releases primarily driven by $5.2 million, $2.8 million and $2.0 million of reserve releases from our Marine, P&C and A&H products, respectively, due to lower than expected loss activity. In addition, $0.8 million of RRPs received reduced our Net losses and LAE ratio, primarily driven by our Marine product. The prior AY reserve releases were partially offset by $2.8 million current year strengthening in our Marine product, related to two large losses in 2015.
The Commission expense ratio increased 1.4 percentage points for the year ended December 31, 2015 compared to the same period in 2014, resulting from an increase in profit commission expenses in our A&H and P&C products.
Other operating expenses increased $0.5 million for the year ended December 31, 2015, compared to the same period in 2014, due to continued investment in our underwriting teams and support staff, as well as an increase in our professional service fees and information technology expenses to support business growth and initiatives.
Our capital resources consist of funds deployed or available to be deployed to support our business operations. As of December 31, 2016 and 2015, our capital resources were as follows:
As part of our capital management program, we may seek to raise additional capital or may seek to return capital to our stockholders through share repurchases, cash dividends or other methods (or a combination of such methods). Any such determination will be at the discretion of our Parent Company’s Board of Directors and will be dependent upon our profits, financial requirements and other factors, including legal restrictions, rating agency requirements, credit facility limitations and such other factors as our Board of Directors deems relevant.
The Bilateral Facility is a non-committed facility which has an applicable fee rate ranging from 0.85% to 1.20% per annum based upon our Company’s S&P rating. For the Club Facility the applicable fee rate payable ranges from 0.95% to 1.60% per annum based on a tiered schedule that is based on our then-current financial strength ratings issued by S&P and A.M. Best and the amount of our own collateral utilized to fund our participation in the Syndicate. If any letters of credit remain outstanding under these facilities after December 31, 2018, we would be required to post additional collateral to secure the remaining letters of credit. As of December 31, 2016, letters of credit with an aggregate face amount of $125.0 million and £60.0 million were outstanding under the Club Facility and we had an aggregate of $1.1 million of cash collateral posted. As of December 31, 2016 there were no letters of credit outstanding under the Bilateral Facility.
The Bilateral and Club Facilities contain customary covenants for facilities of this type, including restrictions on indebtedness and liens, limitations on mergers, dividends and the sale of assets, and requirements as to maintaining certain consolidated tangible net worth, statutory surplus and other financial ratios. These credit facilities also provide for customary events of default, including failure to pay principal, interest or fees when due, failure to comply with covenants, any representation or warranty made by our Company being false in any material respect, default under certain other indebtedness, certain insolvency or receivership events affecting our Company and our subsidiaries, the occurrence of certain material judgments, or a change in control of our Company. As of December 31, 2016, our Company was in compliance with all covenants.
Net cash provided by operating activities was $224.2 million for the year ended December 31, 2016 compared to $227.6 million for the same period in 2015. The decrease in cash flow from operations was due to increased claims and operating expense payments which marginally exceeded higher premium collections and investment income driven by overall growth in our business.
U.S. insurance companies, NIC and NSIC, utilize the financial strength ratings from A.M. Best and S&P for underwriting purposes. NIC and NSIC are both rated “A” (Excellent - stable outlook) by A.M. Best and “A” (Strong - stable outlook) by S&P. The Syndicate utilizes the ratings from A.M. Best and S&P for underwriting purposes, which apply to all Lloyd’s syndicates. Lloyd’s is rated “A” (Excellent - positive outlook) by A.M. Best and A+ (Strong - stable outlook) by S&P.
We have no material off-balance sheet transactions with the exception of our letter of credit facilities.
The amounts determined are estimates which are subject to a high degree of variation and uncertainty, and are not subject to any specific payment schedule since the timing of these obligations are not set contractually. The amounts in the above table exclude reinsurance recoveries of $779.3 million. See “Business - Loss Reserves” included herein.
Our investment portfolio is invested primarily in publicly traded, investment grade, fixed income securities with an average credit quality of AA-/Aa3 as rated by S&P or Moody’s Investors Service (“Moody’s”). As of December 31, 2016, our portfolio had a duration of 3.7 years. Management periodically projects cash flow of the investment portfolio and other sources in order to maintain the appropriate levels of liquidity in an effort to ensure our ability to satisfy claims. As of December 31, 2016 and December 31, 2015, all fixed maturities and equity securities held by us were classified as available-for-sale.
Our portfolio is externally managed by independent, professional investment managers and is broadly diversified across geographies, sectors, and issuers. The primary objectives are to maximize total investment return in the context of preserving and enhancing stockholder value and the statutory surplus of our regulated insurance companies. As part of our overall investment strategy, we seek to build a tax efficient investment portfolio by maintaining an allocation to tax exempt municipal bonds. As of December 31, 2016, the tax-exempt portion of our fixed maturities portfolio was approximately 17.1%. Additionally, substantially all of our equity portfolio is invested in tax efficient securities which qualify for the dividends received deduction. Our investments are subject to the oversight of the respective insurance companies’ Boards of Directors and the Finance Committee of the Parent Company’s Board of Directors.
Invested assets increased from December 31, 2015 due to strong operating cash flows. Operating cash flows were primarily directed to Asset-backed securities and Agency mortgage-backed securities as we look to manage duration given the prospects for higher interest rates in the future. Additionally, a portion of our operating cash flows were invested in tax efficient common and preferred equity securities to compensate for lower yields in fixed maturities. The decrease in short term investments is due to the capitalization of NIIC and the subsequent redeployment of funds into our Fixed maturities portfolio.
The following table sets forth the amount of our Fixed maturities as of December 31, 2016 by S&P credit rating or, if an S&P rating is not available, the equivalent Moody’s rating. The total rating is the weighted average quality rating for the fixed maturities portfolio as a whole.
As of December 31, 2016, we own $48.2 million of municipal securities, which are credit enhanced by various financial guarantors which have an average underlying credit rating of AA-.
We analyze our mortgage-backed securities by credit quality of the underlying collateral distinguishing between the securities issued by FNMA, FHLMC and GNMA, which are federal government sponsored entities, and non-FNMA and non-FHLMC securities broken out by prime, Alt-A and subprime collateral. The securities issued by FNMA and FHLMC are the obligations of each respective entity. The U.S. Department of the Treasury has agreed to provide support to FNMA and FHLMC under a Preferred Stock Purchase Agreement by committing to make quarterly payments to these enterprises, if needed, to maintain a zero net worth.
The twelve months or longer unrealized loss of $1.5 million is due to unfavorable foreign exchange movement in our Canadian portfolio.
Our Company utilizes reinsurance principally to reduce the exposure on individual risks, to protect against catastrophic losses and to stabilize loss ratios and underwriting results. Our Company is protected by various treaty and facultative reinsurance agreements. The
The following table sets forth our gross and net losses and LAE reserves, incurred losses and LAE, and payments for Alberta Wildfires for the year ended December 31, 2016 in USD equivalent:
The Alberta Wildfires impacted the second quarter of 2016 with a total estimated net loss for the year of $11.7 million and $1.8 million in additional RRPs.
The following table sets forth our gross and net losses and LAE reserves, incurred losses and LAE, and payments for Hurricane Joaquin for the years ended December 31, 2016 and 2015:
Hurricane Joaquin impacted the fourth quarter of 2015 with a total estimated net loss of $10.0 million and $4.0 million in additional RRPs. At December 31, 2016 the RRP was reduced to $2.6 million.
The exposure to credit risk from any one reinsurer is actively managed through diversification by reinsuring with a number of different reinsurers, principally in the United States and European reinsurance markets. When reinsurance is placed, the standards of acceptability require a reinsurer rating from A.M. Best and/or S&P of “A” or better, or an equivalent financial strength if not rated, plus at least $500 million in policyholders’ surplus. The Reinsurance Security Committee, which is included within the Enterprise Risk Management Finance and Credit Sub-Committee, monitors the financial strength of the reinsurers and the related reinsurance recoverables and periodically reviews the list of acceptable reinsurers.
We believe the items that require the most subjective and complex estimates involve the reporting of:
Reserves for losses and LAE (including losses that have occurred but were not reported to us by the financial reporting date);
The frequency/severity method calculates the IBNR loss reserves by separately projecting claim count and average cost per claim data on either a paid or incurred basis. It estimates the expected ultimate losses as the product of the ultimate number of claims that are expected to be reported and the expected average amount of these claims.
The following table provides a sensitivity analysis of our Net Reserves for Losses and LAE as of December 31, 2016:
A portion of our premium is estimated for unreported premium, mostly for our Marine and Energy & Engineering products written by our Int’l Insurance reporting segment, as well as our A&H product and our LatAm business within our P&C and Surety products written by our GlobalRe reporting segment. Such premium estimates are based on submission data received from brokers and agents and recorded when the insurance policy or reinsurance contract is written or bound. The estimates are regularly reviewed and updated taking into account the premium received to date versus the estimate and the age of the estimate. To the extent that the actual premium varies from the estimates, the difference, along with the related loss reserves and underwriting expenses, is recorded in current operations.
characteristics and relevant transactions in the marketplace. GAAP guidance requires an entity to maximize the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. Refer to Note 4, Fair Value, in the Notes to Consolidated Financial Statements for additional information.