The Company leases office space in Bala Cynwyd, Pennsylvania which holds the Insurance Operations’ principal executive offices and headquarters. In addition, the Company leases additional office space in California, Georgia, Illinois, Maryland and Texas, which serves as office space for field offices. Some of the office space in California also serves as office space for the Company’s claims operations. The Company also leases office space in Hamilton, Bermuda, which is used by the Reinsurance Operations. The Company leases office space in Cavan, Ireland, which is used to support the operating needs of the Insurance and Reinsurance Operations. The Company believes the properties listed are suitable and adequate to meet its needs.
The following table sets forth selected consolidated historical financial data for Global Indemnity and should be read together with the consolidated financial statements and accompanying notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report. No cash dividends were declared on common stock in any year presented in the table.
(1) In 2011 and 2008, “Diluted” shares were the same as “Basic” shares since there was a net loss for that year.
(2) In May 2009, the Company issued 17.2 million A ordinary shares and 11.4 million B ordinary shares in conjunction with the Rights Offering. In computing the basic and diluted weighted share counts, the number of shares outstanding prior to May 5, 2009 (the date that the ordinary shares were issued in conjunction with the Rights Offering) was adjusted by a factor of 1.114 to reflect the impact of a bonus element associated with the Rights Offering in accordance with appropriate accounting guidance. As a result, share counts for the prior periods have been restated.
(4) Results for the year to date 2012 include the impact of an out-of-period adjustment which reduced net income by $1.6 million, or $0.06 per diluted share.
(2) The Company’s 2012 loss and combined ratios were impacted by a $4.4 million increase of net losses and loss adjustment expenses for prior accident years. The Company’s 2011 loss and combined ratios were impacted by a $3.4 million increase of net losses and loss adjustment expenses for prior accident years. The Company’s 2010 loss and combined ratios were impacted by a $54.1 million reduction of net losses and loss adjustment expenses for prior accident years. The Company’s 2009 loss and combined ratios were impacted by a $9.1 million reduction of net losses and loss adjustment expenses for prior accident years. The Company’s 2008 loss and combined ratios were impacted by a $34.9 million increase of net losses and loss adjustment expenses for prior accident years. See “Results of Operations” in
On November 14, 2012, Mary R. Hennessy resigned from the Company’s Board of Directors.
Wind River Reinsurance. Wind River Reinsurance is a Bermuda based treaty reinsurer of excess and surplus lines carriers, specialty property and casualty insurance companies and U.S. regional insurance writers. Wind River Reinsurance conducts business in Bermuda and is focused on using its capital capacity to write catastrophe-oriented placements and other niche or specialty-focused treaties meeting the Company’s risk tolerance and return thresholds. Given the current pricing environment, Wind River Reinsurance continues to cautiously deploy and manage its capital while seeking to position itself as a niche reinsurance solution provider.
The Company’s consolidated financial statements are prepared in conformity with United States of America generally accepted accounting principles (“GAAP”), which requires it to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. See Note 6 of the notes to consolidated financial statements contained in Item 8 of Part II of this report. Actual results could differ from those estimates and assumptions.
The Company believes that of the Company’s significant accounting policies, the following may involve a higher degree of judgment and estimation.
In developing loss and loss adjustment expense (“loss” or “losses”) reserve estimates for the Company’s Insurance Operations, its actuaries perform detailed reserve analyses each quarter. To perform the analysis, the data is organized at a “reserve category” level. A reserve category can be a line of business such as commercial automobile liability, or it can be a particular type of claim such as construction defect. The reserves within a reserve category level are characterized as short-tail through long-tail. For long-tail business, it will generally be several years between the time the business is written and the time when all claims are settled. The Company’s long-tail exposures include general liability, professional liability, products liability, commercial automobile liability, and excess and umbrella. Short-tail exposures include property, commercial automobile physical damage, and equine mortality. To manage its insurance operations, the Company differentiates them by product classifications, which are Penn-America, United National, and Diamond State. For further discussion about the Company’s product classifications, see “General-Business Segments - Insurance Operations” in Item 1 of Part I of this report. Each of the Company’s product classifications contain both long-tail and short-tail exposures. Every reserve category is analyzed by the Company’s actuaries each quarter. The analyses generally include reviews of losses gross of reinsurance and net of reinsurance.
may result in inconsistent payment patterns. Finally, estimating the paid loss pattern subsequent to the most mature point available in the data analyzed often involves considerable uncertainty for long-tail reserve categories.
For many exposures, especially those that can be considered long-tail, a particular accident year may not have a sufficient volume of paid losses to produce a statistically reliable estimate of ultimate losses. In such a case, the Company’s actuaries typically assign more weight to the Incurred Development method than to the Paid
Establishing reserves for A&E and other mass tort claims involves considerably more judgment than other types of claims due to, among other things, inconsistent court decisions, an increase in bankruptcy filings as a result of asbestos-related liabilities, and judicial interpretations that often expand theories of recovery and broaden the scope of coverage. The insurance industry continues to receive a substantial number of asbestos-related bodily injury claims, with an increasing focus being directed toward other parties, including installers of products containing asbestos rather than against asbestos manufacturers. This shift has resulted in significant insurance coverage litigation implicating applicable coverage defenses or determinations, if any, including but not limited to, determinations as to whether or not an asbestos-related bodily injury claim is subject to aggregate limits of liability found in most comprehensive general liability policies. In response to these continuing developments, management increased gross and net A&E reserves during 2008 to reflect its best estimate of A&E exposures. In 2009, one of the Company’s insurance companies was dismissed from a lawsuit seeking coverage from it and other unrelated insurance companies. The suit involved issues related to approximately 3,900 existing asbestos related bodily injury claims and future claims. The dismissal was the result of a settlement of a disputed claim related to accident year 1984. The settlement is conditioned upon certain legal events occurring which may trigger financial obligations by the insurance company.
The detailed reserve analyses that the Company’s internal and external actuaries complete use a variety of generally accepted actuarial methods and techniques to produce a number of estimates of ultimate loss. The Company determines its best estimate of ultimate loss by reviewing the various estimates and assigning weight to each estimate given the characteristics of the reserve category being reviewed. The reserve estimate is the
difference between the estimated ultimate loss and the losses paid to date. The difference between the estimated ultimate loss and the case incurred loss (paid loss plus case reserve) is considered to be IBNR. IBNR calculated as such includes a provision for development on known cases (supplemental development) as well as a provision for claims that have occurred but have not yet been reported (pure IBNR).
In light of the many uncertainties associated with establishing the estimates and making the assumptions necessary to establish reserve levels, the Company reviews its reserve estimates on a regular basis and makes adjustments in the period that the need for such adjustments is determined. The anticipated future loss emergence continues to be reflective of historical patterns, and the selected development patterns have not changed significantly from those underlying the Company’s most recent analyses.
For an analysis of the Company’s securities with gross unrealized losses as of December 31, 2012 and 2011, and for other than temporary impairment losses that the Company recorded for the years ended December 31, 2012, 2011, and 2010, please see Note 7 of the notes to the consolidated financial statements in Item 8 of Part II of this report.
The Company categorizes its assets that are accounted for at fair value in the consolidated statements into a fair value hierarchy. The fair value hierarchy is directly related to the amount of subjectivity associated with the inputs utilized to determine the fair value of these assets. See Note 8 of the notes to the consolidated financial statements in Item 8 of Part II of this report for further information about the fair value hierarchy and the Company’s assets that are accounted for at fair value.
The Company tests for impairment of goodwill at least annually and more frequently as circumstances warrant in accordance with applicable accounting guidance. Recent accounting guidance allows for the testing of goodwill for impairment using both qualitative and quantitative factors. Impairment of goodwill is recognized only if the carrying amount of the business unit, including goodwill, exceeds the fair value of the reporting unit. The amount of the impairment loss would be equal to the excess carrying value of the goodwill over the implied fair value of the reporting unit goodwill. Based on the analysis performed in 2012, there was no impairment of goodwill as of December 31, 2012.
As of December 31, 2012, the Company’s deferred acquisition costs were $0.5 million lower than they would have been due to premium deficiencies. As of December 31, 2011, the Company’s deferred acquisition costs were $4.8 million lower than they would have been and loss and loss adjustment expense reserves were $4.1 million higher than they would have been due to premium deficiencies.
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 assets will not be realized. A valuation allowance would be based on all available information including the Company’s assessment of uncertain tax positions and projections of future taxable income from each tax-paying component in each jurisdiction, principally derived from business plans and available tax planning strategies. There are no valuation allowances as of December 31, 2012. The deferred tax asset balance is analyzed regularly by management. Based on these analyses, the Company has determined that its deferred tax asset is recoverable. Projections of future taxable income incorporate several assumptions of future business and operations that are apt to differ from actual experience. If, in the future, the Company’s assumptions and estimates that resulted in the forecast of future taxable income for each tax-paying component prove to be incorrect, a valuation allowance may be required. This could have a material adverse effect on the Company’s financial condition, results of operations, and liquidity.
The Company applies a more likely than not recognition threshold for all tax uncertainties, only allowing the recognition of those tax benefits that have a greater than 50% likelihood of being sustained upon examination by the taxing authorities. Please see Note 11of the notes to the consolidated financial statements in Item 8 of Part II of this report for a discussion of the Company’s tax uncertainties.
The Company evaluates the performance of its Insurance Operations and Reinsurance Operations segments based on gross and net premiums written, revenues in the form of net premiums earned, and expenses in the form of (1) net losses and loss adjustment expenses, (2) acquisition costs, and (3) other underwriting expenses.
The following table sets forth an analysis of financial data for the Company’s segments during the periods indicated:
(2) Excludes corporate and other operating expenses and interest expense, which are not allocated to the Company’s segments.
Gross premiums written, which represents the amount received or to be received for insurance policies written without reduction for reinsurance costs or other deductions, was $201.8 million for 2012, compared with $229.1 million for 2011, a decrease of $27.4 million or 11.9%. In the second half of 2011 the Company began exiting certain unprofitable classes of business which contributed to the decrease in 2012. This was partially offset by increases in the Company’s small business class, property brokerage class, and commercial auto class, which is included in “Other” in the table below.
Net premiums written, which equals gross premiums written less ceded premiums written, was $177.8 million for 2012, compared with $202.3 million for 2011, a decrease of $24.5 million or 12.1%. The decrease was primarily due to the decrease in gross premiums written noted above. The ratio of net premiums written to gross premiums written was 88.1% for 2012 and 88.3% for 2011, a decrease of 0.2 points.
The loss ratio for the Company’s Insurance Operations was 66.1% for 2012 compared with 86.9% for 2011. The loss ratio is a non-GAAP financial measure that is generally viewed in the insurance industry as an indicator of underwriting profitability and is calculated by dividing net losses and loss adjustment expenses by net premiums earned.
The current accident year loss ratio decreased 22.9 points to 68.5% in 2012 from 91.4% in 2011:
The non-catastrophe loss ratio decreased 6.4 points from 56.4% in 2011 to 50.0% in 2012. Non-catastrophe losses were $47.4 million and $55.1 million for the years ended December 31, 2012 and 2011, respectively.
The current accident year casualty loss ratio decreased 30.5 points from 102.9% in 2011 to 72.4% in 2012 primarily due to the Company exiting certain unprofitable classes of business in the second half of 2011.
The prior accident year loss ratio increased by 2.1 points resulting from a decrease of net losses and loss adjustment expenses for prior accident years of $4.2 million in 2012 compared to a decrease of net losses and loss adjustment expenses for prior accident years of $9.7 million in 2011. When analyzing loss reserves and prior year development, the Company considers many factors, including the frequency and severity of claims, loss credit trends, case reserve settlements that may have resulted in significant development, and any other additional or pertinent factors that may impact reserve estimates.
General Liability: A $12.9 million reduction in general liability lines primarily consisted of net reductions of $25.5 million in accident years 2008 and prior due to continued favorable emergence. Incurred losses for these years have developed at a rate lower than the Company’s historical averages. The Company also decreased its reinsurance allowance by $1.3 million in this line due to changes in reinsurance exposure on specifically identified claims and general decreases in ceded reserves. Offsetting these decreases were increases of $13.9 million in accident years 2009 and 2010 primarily driven by loss emergence as well as revised exposure estimates for construction defect liability. Increased estimates for construction defect were primarily the result of a methodology change during the year, with some increases in recent years due to a slight increase in claim frequency in one of the reviewed segments. The Company has addressed profitability concerns by exiting certain classes of business within this line.
Acquisition costs and other underwriting expenses were $79.9 million for 2012, compared with $94.7 million for 2011, a decrease of $14.8 million or 15.6%. The decrease is primarily due to a decrease in commissions related to the decrease in net earned premiums and a decrease in property and office costs.
Gross premiums written, which represents the amount received or to be received for reinsurance agreements written without reduction for reinsurance costs or other deductions, was $42.3 million for 2012, compared with $78.8 million for 2011, a decrease of $36.5 million or 46.3%. The decrease was primarily due to the cancellation of several unprofitable treaties in 2012, partially offset by $6.0 million in new premium related to reinsurance treaties written in 2009 and 2010 which was contractually due as a result of losses incurred on these treaties. This income is non-recurring. Wind River only writes primarily property treaties at the current time.
The Company recognized a loss of $0.7 million for 2012 compared with income of $0.4 million for 2011. Other income or loss is comprised of exchange gains and losses related to business written in foreign currencies.
The current accident year loss ratio decreased 45.7 points from 95.0% in 2011 to 49.3% in 2012.
Automobile Liability: A $3.1 million increase in auto liability lines primarily related to accident year 2010 resulting from further unexpected development on non-standard auto treaties which were not renewed in 2011.
Acquisition costs and other underwriting expenses were $15.5 million for 2012, compared with $26.8 million for 2011, a decrease of $11.3 million or 42.2%. The decrease is primarily due to a decrease in commissions as a result of the decrease in net earned premiums.
The expense ratio for the Company’s Reinsurance Operations was 25.9% for 2012, compared with 33.0% for 2011. The expense ratio is a non-GAAP financial measure that is calculated by dividing the sum of acquisition costs and other underwriting expenses by net premiums earned. The decrease in the expense ratio is primarily due to changes in mix of business as a result of cancelling several unprofitable treaties in 2011 and 2012, partially offset by an increase in contingent commissions due to the profitability of business in 2012.
The factors described above resulted in income from underwriting for the Company’s Reinsurance Operations of $8.4 million in 2012, compared to a loss from underwriting of $35.4 million in 2011, an increase of $43.8 million.
Gross investment income, which excludes realized gains and losses, was $52.0 million for 2012, compared with $57.8 million for 2011, a decrease of $5.8 million or 10.1%. The decrease was primarily due to a reduction in the Company’s fixed maturities portfolio related to funding the share repurchase program, repayment of debt and negative operating cash flow. This decrease was offset by investment income of $4.8 million generated from distributions from two limited partnership investments. There was no investment income generated by limited partnership investments during 2011. Excluding distributions from limited partnership investments, gross investment income for 2012 decreased $10.6 million or 18.4% compared to 2011.
As of December 31, 2012, the Company held mortgage-backed securities with a book value of $189.9 million. Excluding the mortgage-backed securities, the average duration of the Company’s fixed maturities portfolio was 2.2 years as of December 31, 2012, compared with 2.0 years as of December 31, 2011. Including cash and short-term investments, the average duration of the Company’s fixed maturities portfolio, excluding mortgage-backed securities, as of December 31, 2012 was 2.0 years compared with 1.7 years as of December 31, 2011. Changes in interest rates can cause principal payments on certain investments to extend or shorten which can impact duration. At December 31, 2012, the Company’s embedded book yield on its fixed maturities, not including cash, was 3.1% compared with 3.6% at December 31, 2011. As of December 31, 2012, the Company’s investment portfolio held $201.1 million in municipal bonds with an embedded book yield of 3.0% compared with an embedded book yield of 3.6% on $206.1 million in municipal bonds as of December 31, 2011.
See Note 7 of the notes to the consolidated financial statements in Item 8 of Part II of this report for an analysis of total investment return on a pre-tax basis for the years ended December 31, 2012 and 2011.
Corporate and other operating expenses consist of outside legal fees, other professional fees, directors’ fees, management fees, salaries and benefits for holding company personnel, development costs for new products, and taxes incurred which are not directly related to operations. Corporate and other operating expenses were $9.7 million for 2012, compared with $14.0 million for 2011, a decrease of $4.3 million or 30.6%. The decrease is primarily due to a decrease in outside legal and other professional fees.
Income tax expense was a benefit of $5.9 million for 2012, compared with expense of $2.8 million for 2011. See Note 11 of the notes to the consolidated financial statements in Item 8 of Part II of this report for an analysis of income tax expense between periods.
Equity in net income of partnerships, net of tax was $0.05 million for 2011. There was no equity in net income of partnerships during 2012.
The loss ratio for the Company’s Insurance Operations was 86.9% for 2011 compared with 36.6% for 2010. The loss ratio is a non-GAAP financial measure that is generally viewed in the insurance industry as an indicator of underwriting profitability and is calculated by dividing net losses and loss adjustment expenses by net premiums earned.
The catastrophe loss ratio increased 17.3 points from 3.8% in 2010 to 21.1% in 2011. The increase in the catastrophe loss ratio is primarily due to tornado and severe weather related losses in the Midwest, Alabama and North Carolina, as well as the impact of Hurricane Irene and Tropical Storm Lee. Catastrophe losses were $20.6 million and $2.8 million for the years ended December 31, 2011 and 2010, respectively.
The current accident year casualty loss ratio increased 34.0 points from 68.9% in 2010 to 102.9% in 2011 primarily due to a professional lines loss in a class of business that the Company is exiting, loss emergence in the Company’s general liability line and an increase to losses related to premium deficiencies. The Company increased the current accident year expected loss ratio for certain classes within its general liability line to 208.6% during 2011, which had a 19.1 point impact on the casualty lines loss ratio during the quarter. On a pro forma basis, excluding the impact of the increase to losses related to premium deficiencies and the general liability line increase noted above, the current year casualty loss ratio increased 11.2 points from 69.2% in 2010 to 80.4% in 2011. The Company is addressing profitability concerns by exiting certain classes of business within the general liability line.
The prior accident year loss ratio increased by 24.8 points resulting from a decrease of net losses and loss adjustment expenses for prior accident years of $9.7 million in 2011 compared to a decrease of net losses and
loss adjustment expenses for prior accident years of $56.8 million in 2010. When analyzing loss reserves and prior year development, the Company considers many factors, including the frequency and severity of claims, loss credit trends, case reserve settlements that may have resulted in significant development, and any other additional or pertinent factors that may impact reserve estimates.
General Liability: A $43.7 million reduction in general liability lines primarily consisted of reductions of $45.4 million related to accident years 2002 through 2009 due to lower than anticipated frequency and severity. Incurred losses for these years have developed at a rate lower than the Company’s historical averages. The Company also reduced its allowance for uncollectible reinsurance by $0.2 million primarily due to the decrease in the amount of carried reinsurance receivables. These reductions were partially offset by net increases of $1.8 million related to accident years 2001 and prior as a result of increases in loss and loss adjustment expense estimates related to construction defect claims.
Umbrella: A $5.4 million reduction in umbrella lines related to all accident years 2009 and prior due to lower than anticipated severity. As these accident years have matured, more weight has been given to experience based methods which continue to develop favorably compared to initial indications.
Net losses and loss adjustment expenses were $188.4 million for 2011, compared with $71.2 million for 2010, an increase of $117.2 million or 164.6%. Excluding the impact of prior accident year adjustments, the current accident year net losses and loss adjustment expenses were $198.0 million and $128.0 million for 2011 and 2010, respectively. This increase is primarily attributable to an increase to losses related to a premium deficiency in the current year, the impact of an increase in current accident year loss reserves related to the Company’s general liability lines, the increase in net premiums earned, and the increase in current accident year severity as described above.
Acquisition costs and other underwriting expenses were $94.7 million for 2011, compared with $91.5 million for 2010, an increase of $3.2 million or 3.5%. The increase is due to a write down of deferred acquisition costs related to premium deficiencies, an increase in commissions and premium taxes resulting mainly from an increase in net earned premiums and a decrease in ceding commissions resulting from an increase in retained business. As of December 31, 2011, deferred acquisition costs were $1.9 million lower than they would have been as a result of premium deficiencies. This was partially offset by an overall decrease in employee compensation related to the Profit Enhancement Initiative as well as a decrease in share-based compensation related to the forfeiture of unvested restricted shares and options.
The expense ratio for the Company’s Insurance Operations was 43.7% for 2011, compared with 47.1% for 2010. The expense ratio is a non-GAAP financial measure that is calculated by dividing the sum of acquisition costs and other underwriting expenses by net premiums earned. The decrease in the expense ratio is primarily due to a decrease in contingent commissions recorded in the current period compared to the same period last year, a decrease in employee compensation costs related to the Profit Enhancement Initiative, and a decrease in share-based compensation related to the forfeiture of unvested restricted shares and options, partially offset by a write down of deferred acquisition costs related to premium deficiencies. Excluding the impact of the write down of deferred acquisition costs, the expense ratio for the Company’s Insurance Operations was 42.8% for the year ended December 31, 2011.
The factors described above resulted in a loss from underwriting for the Company’s Insurance Operations of $54.3 million for 2011, compared with income from underwriting of $32.1 million for 2010, a decrease of $86.5 million.
The components of income from the Company’s Reinsurance Operations segment and corresponding underwriting ratios are as follows:
Gross premiums written, which represents the amount received or to be received for reinsurance agreements written without reduction for reinsurance costs or other deductions, was $78.8 million for 2011, compared with $100.3 million for 2010, a decrease of $21.5 million or 21.5%. The decrease was primarily due to the sale of a company that elected not to renew its treaty with Wind River Reinsurance post-acquisition and non-renewing treaties that did not meet the Company’s return hurdles.
Net premiums written, which equals gross premiums written less ceded premiums written, was $78.3 million for 2011, compared with $100.4 million for 2010, a decrease of $22.2 million or 22.1%. The decrease was primarily due to the decrease in gross premiums written as described above.
The loss ratio for the Company’s Reinsurance Operations was 111.1% for 2011 compared with 63.9% for 2010. The loss ratio is a non-GAAP financial measure that is generally viewed in the insurance industry as an indicator of underwriting profitability and is calculated by dividing net losses and loss adjustment expenses by net premiums earned.
The current accident year loss ratio increased 34.0 points from 61.0% in 2010 to 95.0% in 2011.
The casualty lines loss ratio was 95.5% in 2011 compared to 75.1% in 2010. This increase was primarily due to higher than expected losses on general liability treaties.
In 2010, the Company increased its prior accident year loss reserves by $2.7 million, which primarily consisted of the following:
Automobile Liability: A $2.6 million increase in automobile liability lines primarily due to higher frequency in accident year 2009 from a non-standard auto treaty.
Workers’ Compensation: A $0.5 million increase in workers’ compensation lines related to an accident year 2009 structured excess of loss treaty where the Company increased its loss estimates based on industry workers’ compensation results.
Net losses and loss adjustment expenses were $90.3 million for 2011, compared with $59.2 million for 2010, an increase of $31.1 million or 52.6%. Excluding the impact of prior accident year adjustments, the current accident year net losses and loss adjustment expenses were $77.3 million and $56.5 million for 2011 and 2010, respectively. This increase is primarily attributable to large catastrophe losses incurred in 2011 as discussed above.
Acquisition costs and other underwriting expenses were $26.8 million for 2011, compared with $26.7 million for 2010, an increase of $0.1 million or 0.4%. The increase is due to an increase in compensation related to the hiring of new employees within this business unit and a write down of deferred acquisition costs related to premium deficiencies. As of December 31, 2011, deferred acquisition costs were $2.9 million lower than they would have been as a result of premium deficiencies. This was offset by a decrease in contingent commissions resulting from higher than expected current and prior accident year losses discussed above.
The factors described above resulted in a loss from underwriting for the Company’s Reinsurance Operations of $35.4 million in 2011, compared to income from underwriting of $6.4 million in 2010, a decrease of $41.7 million.
The following items are not allocated to the Company’s Insurance Operations or Reinsurance Operations segments:
Gross investment income, which excludes realized gains and losses, was $57.8 million for 2011, compared with $62.6 million for 2010, a decrease of $4.8 million or 7.6%. The decrease was primarily due to lower yields on fixed maturities when compared to the corresponding period in 2010 as well as a reduction in cash and invested assets.
As of December 31, 2011, the Company held mortgage-backed securities with a book value of $239.4 million. Excluding the mortgage-backed securities, the average duration of the Company’s fixed maturities portfolio was 2.0 years as of December 31, 2011, compared with 2.3 years as of December 31, 2010. Including cash and short-term investments, the average duration of the Company’s fixed maturities portfolio, excluding mortgage-backed securities, as of December 31, 2011 was 1.7 years compared with 2.1 years as of December 31, 2010. Changes in interest rates can cause principal payments on certain investments to extend or shorten which can impact duration. At December 31, 2011, the Company’s embedded book yield on its fixed maturities, not including cash, was 3.6% compared with 3.9% at December 31, 2010. As of December 31, 2011, the Company’s investment portfolio held $206.1 million in municipal bonds with a book yield of 3.6% compared with an embedded book yield of 3.5% on $245.0 million in municipal bonds as of December 31, 2010.
Net realized investment gains were $21.5 million for 2011, compared with $26.4 million for 2010. The net realized investment gains for 2011 consist primarily of net gains of $14.2 million relative to the Company’s fixed maturities and $14.7 million relative to its equity securities, offset by mutual fund losses of $0.8 million and other than temporary impairment losses of $6.6 million. The net realized investment gains for 2010 consist primarily of net gains of $17.4 million relative to the Company’s fixed maturities and $9.5 million relative to its equity securities, offset by other than temporary impairment losses of $0.5 million.
Corporate and other operating expenses consist of outside legal fees, other professional fees, directors’ fees, management fees, salaries and benefits for holding company personnel, development costs for new products and taxes incurred which are not directly related to operations. Corporate and other operating expenses were $14.0 million for 2011, compared with $20.8 million for 2010, a decrease of $6.8 million or 32.7%. The decrease is primarily due to cost savings resulting from the Company’s previously disclosed Profit Enhancement Initiative and a decrease in share-based compensation related to the forfeiture of unvested restricted shares and options, offset partially by an increase in outside legal fees.
The factors described above resulted in a net loss of $38.3 million in 2011, compared with net income of $84.9 million in 2010, a decrease of $123.2 million.
The principal source of cash that Global Indemnity needs to meet its short term and long term liquidity needs, including the payment of corporate expenses and share repurchases, includes dividends, other permitted disbursements from its direct and indirect subsidiaries, reimbursement for equity awards granted to employees and intercompany borrowings. The principal sources of funds at these direct and indirect subsidiaries include underwriting operations, investment income, and proceeds from sales and redemptions of investments. Funds are used principally by these operating subsidiaries to pay claims and operating expenses, to make debt payments, to purchase investments, and to make dividend payments. The future liquidity of Global Indemnity is dependent on the ability of its subsidiaries to pay dividends. Global Indemnity has no planned capital expenditures that could have a material impact on its short-term or long-term liquidity needs.
Global Indemnity’s U.S. insurance companies are restricted by statute as to the amount of dividends that they may pay without the prior approval of regulatory authorities. The dividend limitations imposed by state laws are based on the statutory financial results of each insurance company within the Insurance Operations that are determined by using statutory accounting practices that differ in various respects from accounting principles used in financial statements prepared in conformity with GAAP. See “Regulation-Statutory Accounting Principles.” Key differences relate to, among other items, deferred acquisition costs, limitations on deferred income taxes, reserve calculation assumptions and surplus notes.
Under Indiana law, Diamond State Insurance Company and United National Casualty Insurance Company may not pay any dividend or make any distribution of cash or other property, the fair market value of which, together with that of any other dividends or distributions made within the 12 consecutive months ending on the date on which the proposed dividend or distribution is scheduled to be made, exceeds the greater of (1) 10% of its surplus as of the 31st day of December of the last preceding year, or (2) its net income for the 12 month period ending on the 31st day of December of the last preceding year, unless the commissioner approves the proposed payment or fails to disapprove such payment within 30 days after receiving notice of such payment. An additional limitation is that Indiana does not permit a domestic insurer to declare or pay a dividend except out of earned surplus unless otherwise approved by the commissioner before the dividend is paid.
Under Wisconsin law, United National Specialty Insurance Company may not pay any dividend or make any distribution of cash or other property, other than a proportional distribution of its stock, the fair market value of which, together with that of other dividends paid or credited and distributions made within the preceding 12 months, exceeds the lesser of (1) 10% of its surplus as of the preceding 31st day of December, or (2) the greater of (a) its net income for the calendar year preceding the date of the dividend or distribution, minus realized capital gains for that calendar year or (b) the aggregate of its net income for the three calendar years preceding the date of the dividend or distribution, minus realized capital gains for those calendar years and minus dividends paid or credited and distributions made within the first two of the preceding three calendar years, unless it reports the extraordinary dividend to the commissioner at least 30 days before payment and the commissioner does not disapprove the extraordinary dividend within that period. Additionally, under Wisconsin law, all authorizations of distributions to shareholders, other than stock dividends, shall be reported to the commissioner in writing and no payment may be made until at least 30 days after such report.
The Company’s reconciliation of net income to cash provided from operations is generally influenced by the following:
In 2012, the decrease in operating cash flows of approximately $27.3 million from the prior year was primarily a net result of the following items:
In 2011, the decrease in operating cash flows of approximately $6.7 million from the prior year was primarily a net result of the following items:
Currently, Global Indemnity believes each company in its Insurance Operations and Reinsurance Operations maintains sufficient liquidity to pay claims through cash generated by operations and investments in liquid investments. The holding companies also maintain sufficient liquidity to meet their obligations. At December 31, 2012, the Company had cash and cash equivalents of $104.5 million.
Included in the share repurchases above, on May 9, 2012, the Company announced a self-tender offer pursuant to which it could repurchase up to $61.0 million of its A ordinary shares. On June 14, 2012, the Company accepted for purchase 2,913,464 of its A ordinary shares at a price of $21.75 per share for a total cost of $63.4 million, excluding fees and expenses related to the tender offer. The Company funded the purchase of the shares using cash on hand. Included within the A ordinary shares accepted for purchase were 122,578 A ordinary shares that Global Indemnity elected to purchase pursuant to its option to increase the size of the tender offer by up to 2.0% of the outstanding A ordinary shares.
The Company’s U.S. insurance companies participate in quota share reinsurance agreements with Wind River Reinsurance whereby 50% of the net retained business of the U.S. insurance companies is ceded to Wind River Reinsurance. These agreements exclude named storms. Wind River Reinsurance is an unauthorized reinsurer. As a result, any losses and unearned premiums that are ceded to Wind River Reinsurance by the U.S. insurance companies must be collateralized. To satisfy this requirement, Wind River Reinsurance has set up custodial trust accounts on behalf of the U.S. insurance companies.
Wind River also has established trust accounts to collateralize exposure it has to third party ceding companies. The Company invests the funds in securities that have durations that closely match the expected duration of the liabilities assumed. The Company believes that Wind River Reinsurance will have sufficient liquidity to pay claims prospectively.
Global Indemnity’s U.S. insurance companies participate in an intercompany pooling arrangement whereby premiums, losses, and expenses are shared pro rata amongst the U.S. insurance companies. United National Insurance Company is not an authorized reinsurer in all states. As a result, any losses and unearned premiums that are ceded to United National Insurance Company are collateralized. The state insurance departments that regulate the parties to the intercompany pooling agreements require United National Insurance Company to place assets on deposit subject to trust agreements for the protection of the other members of the U.S. insurance companies.
In 2012, the Company expects that, in the aggregate, the Insurance Operations and Reinsurance Operations will have sufficient liquidity to pay claims. The Company monitors its portfolios to assure liability and investment durations are closely matched.
The Company’s business trust subsidiaries have issued floating rate capital and floating rate common securities (“Trust Preferred Securities”). A summary of the terms related to these securities is as follows:
AIS through its wholly owned subsidiary United National Group Capital Trust I (“UNG Trust I”)
AIS through its wholly owned subsidiary United National Group Capital Statutory Trust II (“UNG Trust II”)
The Company has commitments in the form of operating leases, a revolving line of credit, senior notes payable, junior subordinated debentures and unpaid losses and loss expense obligations. As of December 31, 2012, contractual obligations related to Global Indemnity’s commitments, including any principal and interest payments, were as follows:
(4) These amounts represent the gross future amounts needed to pay losses and related loss adjustment expenses and do not reflect amounts that are expected to be recovered from the Company’s reinsurers. See discussion in “Liability for Unpaid Losses and Loss Adjustment Expenses” for more details.
Some of the statements under “Business,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report may include forward-looking statements that reflect the Company’s current views with respect to future events and financial performance that are intended to be covered by the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that are not historical facts. These statements can be identified by the use of forward-looking terminology such as “believe,” “expect,” “may,” “will,” “should,” “project,” “plan,” “seek,” “intend,” or “anticipate” or the negative thereof or comparable terminology, and include discussions of strategy, financial projections and estimates and their underlying assumptions, statements regarding plans, objectives, expectations or consequences of identified transactions or natural disasters, and statements about the future performance, operations, products and services of the companies.
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Global Indemnity, plc. and its subsidiaries at December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in “Management’s Report on Internal Control over Financial Reporting” appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As discussed in Note 2 to the consolidated financial statements, as of January 1, 2012, the Company retrospectively adopted a new accounting standard that amends the accounting for costs incurred by insurance companies that can be capitalized in connection with acquiring or renewing insurance contracts.
The Company offers property and casualty insurance products in the excess and surplus lines marketplace through its Insurance Operations and provides third party treaty reinsurance for writers of excess and surplus and specialty lines of property and casualty insurance through its Reinsurance Operations. The Company manages its Insurance Operations by differentiating them into three product classifications: Penn-America, which markets to small commercial businesses through a select network of wholesale general agents with specific binding authority; United National, which markets insurance products for targeted insured segments, including specialty products, such as property, general liability, and professional lines through program administrators with specific binding authority; and Diamond State, which markets property, casualty, and professional lines products, which are developed by the Company’s underwriting department by individuals with expertise in those lines of business, through wholesale brokers and also markets through program administrators having specific binding authority. These product classifications comprise the Company’s Insurance Operations business segment and are not considered individual business segments because each product has similar economic characteristics, distribution, and coverage. Collectively, the Company’s U.S. insurance subsidiaries are licensed in all 50 states and the District of Columbia. The Company’s Reinsurance Operations consist solely of the operations of its Bermuda-based wholly-owned subsidiary, Wind River Reinsurance. Wind River Reinsurance provides reinsurance solutions through brokers, primary writers, including regional insurance companies, and program managers and is focused on using its capital capacity to write catastrophe-oriented placements and other niche or specialty-focused treaties meeting the Company’s risk tolerance and return thresholds.
The consolidated financial statements have been prepared in conformity with United States of America generally accepted accounting principles (“GAAP”), which differ in certain respects from those followed in reports to insurance regulatory authorities. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The Company’s wholly-owned business trust subsidiaries, United National Group Capital Trust I (“UNG Trust I”), United National Group Capital Statutory Trust II (“UNG Trust II”), are not consolidated pursuant to the
Financial Accounting Standards Board (“FASB”) Accounting Standards Codification. The Company’s business trust subsidiaries have issued $30.0 million in floating rate capital securities (“Trust Preferred Securities”) and $0.9 million of floating rate common securities. The sole assets of the Company’s business trust subsidiaries are $30.9 million of junior subordinated debentures issued by the Company, which have the same terms with respect to maturity, payments, and distributions as the Trust Preferred Securities and the floating rate common securities.
During the year ended December 31, 2011, the Company recorded $13.3 million of premium deficiency charges, comprised of reductions to deferred acquisition costs of $8.2 million and increases to unpaid loss and loss adjustment expenses of $5.1 million. As of December 31, 2011, $4.1 million of premium deficiency reserves were included in unpaid losses and loss adjustment expenses.
The $13.3 million of premium deficiency charges recorded during the year ended December 31, 2011 consisted of $8.1 million recorded in Insurance Operations and $5.2 million recorded in Reinsurance Operations. The $8.1 million recorded in Insurance Operations related primarily to casualty and professional lines products distributed through wholesale brokers and consisted of $3.7 million of reductions to deferred acquisition costs and $4.4 million of increases to unpaid loss and loss adjustment expenses. The $5.2 million recorded in Reinsurance Operations related primarily to marine lines and consisted of $4.5 million of reductions to deferred acquisition costs and $0.7 million of increases to unpaid loss and loss adjustment expenses.
The $8.9 million net impact during the year ended December 31, 2011 consisted of $5.3 million recorded in Insurance Operations and $3.6 million recorded in Reinsurance Operations. The $5.3 million net impact recorded in Insurance Operations consisted of $1.9 million of reductions to deferred acquisition costs and $3.4 million of increases to loss and loss adjustment expense reserves. The $3.6 million net impact recorded in Reinsurance Operations consisted of $2.9 million of reductions to deferred acquisition costs and $0.7 million of increases to loss and loss adjustment expense reserves.
There was no impact to the Company’s financial condition resulting from premium deficiencies during the year ended December 31, 2010.
The total cost of implementing this initiative was recorded in the Company’s consolidated statements of operations within its Insurance Operations segment in the fourth quarter of 2010. Components of the initiative included: (1) employee termination and severance charges of $1.71 million; (2) expenses of $1.53 million relating to discontinuing use of leased office space, net of expected sub-lease income; (3) restructuring expenses of $0.63 million for related asset and leasehold improvement impairments; and (4) expenses of $2.91 million relating to the curtailment of the Company’s workers’ compensation product initiative, consisting of a minimum
The following table summarizes charges incurred by expense type and the remaining liability as of December 31, 2012, 2011 and 2010:
The following table summarizes the charges incurred within the Company’s consolidated statement of operations for the years ended December 31, 2012, 2011 and 2010:
As of December 31, 2012 and 2011, the Company held $130.0 million and $195.9 million in corporate loans, respectively. Corporate loans are primarily investments in senior secured floating rate loans that banks have made to corporations. The loans are generally priced at an interest rate spread over LIBOR which resets periodically, typically at intervals between one month and one year. The Company’s investments in corporate loans are purchased in secondary markets for the purpose of being held as investments. They are carried at fair value with any change in the difference between amortized cost and fair value, net of the effect of deferred income taxes, reflected in accumulated other comprehensive income in shareholders’ equity. These investments are typically below investment grade.
The Company’s investments in other invested assets were valued at $3.1 million and $6.6 million as of December 31, 2012 and 2011, respectively. Both of these amounts relate to investments in limited partnerships who have invested primarily in publicly traded companies. However, not all of the partnerships’ investments are publicly traded, nor does the Company have access to daily valuations, therefore the estimated fair values of these limited partnerships are measured utilizing net asset value as a practical expedient for the limited partnerships. Material assumptions and factors utilized in pricing these securities include future cash flows, constant default rates, recovery rates, and any market clearing activity that may have occurred since the prior month-end pricing period.
contractually due. Securities for which the Company determines that a credit loss is likely are subjected to further analysis through discounted cash flow testing to estimate the credit loss to be recognized in earnings, if any. The specific methodologies and significant assumptions used by asset class are discussed below. Upon identification of such securities and periodically thereafter, a detailed review is performed to determine whether the decline is considered other than temporary. This review includes an analysis of several factors, including but not limited to, the credit ratings and cash flows of the securities and the magnitude and length of time that the fair value of such securities is below cost.
For an analysis of other than temporary losses that were recorded for the years ended December 31, 2012, 2011, and 2010, please see Note 7 below.
The Company evaluates the collectability of accounts receivable based on a combination of factors. In circumstances in which the Company is aware of a specific circumstance where a party may be unable to meet its financial obligations to the Company, a specific allowance for bad debts against amounts due is recorded to reduce the net receivable to the amount reasonably believed by management to be collectible. For all remaining balances, allowances are recognized for bad debts based on the length of time the receivables are past due. The allowance for bad debts was $1.3 million and $1.5 million as of December 31, 2012 and 2011, respectively.
The Company regularly reviews the collectability of reinsurance receivables. An allowance for uncollectible reinsurance receivable is recognized based on the financial strength of the reinsurers and the length of time any balances are past due. Any changes in the allowance resulting from this review are included in income during the period in which the determination is made. During 2012, the Company decreased its uncollectible reinsurance reserve by $1.0 million due to write-offs of receivables deemed to be uncollectible and a decrease in the amount of carried reinsurance receivables. During 2011, the Company decreased its uncollectible reinsurance reserve by $2.7 million due to write-offs of receivables deemed to be uncollectible and a decrease in the amount of carried reinsurance receivables.
these commissions, which is stated separately on the face of the consolidated balance sheet as contingent commissions, was $9.9 million and $7.5 million as of December 31, 2012 and 2011, respectively.
The Company has corrected this error in its consolidated financial statements as of and for the year ended December 31, 2012 by increasing the “Unpaid losses and loss adjustment expenses” line item on the consolidated balance sheet and the “Net losses and loss adjustment expenses” line item on the consolidated statement of operations by $1.6 million, or $0.06 per diluted share, the cumulative effect of the error. The Company does not believe that that these adjustments are material to any prior years’ consolidated financial statements. As a result, the Company has not restated or adjusted any prior period amounts for this error.
Excluding U.S. treasuries and agency bonds, the Company did not hold any debt or equity investments in a single issuer that was in excess of 3% and 4% of shareholders’ equity at December 31, 2012 or 2011, respectively.
The following table contains an analysis of the Company’s securities with gross unrealized losses, categorized by the period that the securities were in a continuous loss position as of December 31, 2012:
The following table contains an analysis of the Company’s securities with gross unrealized losses, categorized by the period that the securities were in a continuous loss position as of December 31, 2011:
Obligations of states and political subdivisions-As of December 31, 2012, gross unrealized losses related to obligations of states and political subdivisions were $0.132 million. All unrealized losses have been in an unrealized loss position for less than twelve months. These securities are rated A- or better. The Company’s investment manager considers all factors that influence performance of the municipal bond market, including investor expectations, supply and demand patterns, and current versus historical yield and spread relationships. The manager relies on the output of its fixed income credit analysts, including dedicated municipal bond
Mortgage-backed securities (“MBS”)-As of December 31, 2012, gross unrealized losses related to mortgage-backed securities were $0.189 million. Of this amount, $0.017 million has been in an unrealized loss position for twelve months or greater and are rated investment grade. The Company’s investment manager models each mortgage-backed security to project principal losses under downside, base, and upside scenarios for the economy and home prices. The primary assumption that drives the security and loan level modeling is the Home Price Index (“HPI”) projection. The Company’s investment manager first projects HPI at the national level, then at the zip-code level based on the historical relationship between the individual zip code HPI and the national HPI, using inputs from its macroeconomic team, mortgage portfolio management team, and structured analyst team. The model utilizes loan level data and borrower characteristics including FICO score, geographic location, original and current loan size, loan age, mortgage rate and type (fixed rate / interest-only / adjustable rate mortgage), issuer / originator, residential type (owner occupied / investor property), dwelling type (single family / multi-family), loan purpose, level of documentation, and delinquency status as inputs. The model also includes the explicit treatment of silent second liens, utilization of loan modification history, and the application of roll rate adjustments.
Asset backed securities (“ABS”)-As of December 31, 2012, gross unrealized losses related to asset backed securities were $0.009 million. Of this amount, $0.006 million has been in an unrealized loss position for twelve months or greater and are rated A- or better. The weighted average credit enhancement for the Company’s asset backed portfolio is 34.1. The Company’s investment manager analyzes every ABS transaction on a stand-alone basis. This analysis involves a thorough review of the collateral, prepayment, and structural risk in each transaction. Additionally, their analysis includes an in-depth credit analysis of the originator and servicer of the collateral. The Company’s investment manager projects an expected loss for a deal given a set of assumptions specific to the asset type. These assumptions are used to calculate at what level of losses that the deal will incur a dollar of loss. The major assumptions used to calculate this ratio are loss severities, recovery lags, and no advances on principal and interest.
Commercial mortgage-backed securities (“CMBS”)-As of December 31, 2012, gross unrealized losses related to the CMBS portfolio were $0.013 million. All unrealized losses have been in an unrealized loss position for less than twelve months and are rated AAA. The weighted average credit enhancement for the Company’s CMBS portfolio is 26.3. This represents the percentage of pool losses that can occur before a mortgage-backed security will incur its first dollar of principal losses. For the Company’s CMBS portfolio, a loan level analysis is utilized where every underlying CMBS loan is re-underwritten based on the Company’s investment manager’s internally generated set of assumptions that reflect their expectation for the future path of the economy. In the analysis, the focus is centered on stressing the significant variables that influence commercial loan defaults and collateral losses in CMBS deals. These variables include: (1) occupancies are projected to drop; (2) capitalization rates vary by property type and are forecasted to return to more normalized levels as the capital markets repair and capital begins to flow again; and (3) property value was stressed by using projected property performance and projected capitalization rates. Term risk is triggered if projected debt service coverage rate falls below 1x. Balloon risk is triggered if a property’s projected performance does not satisfy new, tighter mortgage standards.
Corporate bonds and loans-As of December 31, 2012, gross unrealized losses related to corporate bonds and loans were $0.428 million. Of this amount, $0.154 million has been in an unrealized loss position for twelve months or greater. The Company’s investment manager’s analysis for this sector includes maintaining detailed financial models that include a projection of each issuer’s future financial performance, including prospective debt servicing capabilities, capital structure composition, and the value of the collateral. The analysis
Foreign bonds-As of December 31, 2012, the Company did not have any gross unrealized losses related to foreign bonds. The Company’s investment manager maintains financial models for its bond issuers. These models include a projection of each issuer’s future financial performance including prospective debt servicing capabilities and capital structure composition. The analysis incorporates the macroeconomic environment, industry conditions in which the issuer operates, issuer’s current competitive position, vulnerability to changes in the competitive environment, regulatory environment, issuer liquidity, issuer commitment to bondholders, issuer creditworthiness, and asset protection.
Common stocks-As of December 31, 2012, gross unrealized losses related to common stock were $2.951 million. Of this amount, $0.667 million has been in an unrealized loss position for twelve months or greater. To determine if other than temporary impairment of an equity security has occurred, the Company considers, among other things, the severity and duration of the decline in fair value of the equity security. The Company also examines other factors to determine if the equity security could recover its value in a reasonable period of time.
The Company recorded the following other than temporary impairments (“OTTI”) on its investment portfolio for the years ended December 31, 2012, 2011, and 2010:
The following table is an analysis of the credit losses recognized in earnings on debt securities held by the Company as of December 31, 2012, 2011 and 2010 for which a portion of the OTTI loss was recognized in other comprehensive income (loss).
Accumulated other comprehensive income as of December 31, 2012 and 2011 was as follows:
The components of net realized investment gains on the sale of investments and other than temporary impairment losses for the years ended December 31, 2012, 2011, and 2010 were as follows:
The proceeds from sales of available for sale securities resulting in net realized investment gains for the years ended December 31, 2012, 2011, and 2010 were as follows:
The sources of net investment income for the years ended December 31, 2012, 2011, and 2010 were as follows:
In addition to the $42.1 million of insurance enhanced municipal bonds, the Company also held insurance enhanced asset-backed and credit securities with a market value of approximately $21.1 million, which represented approximately 1.4% of the Company’s total invested assets, net of receivable/payable for securities purchased and sold. The financial guarantors of the Company’s $21.1 million of insurance enhanced asset-backed and credit securities include Financial Guaranty Insurance Company ($0.4 million), Municipal Bond Insurance Association ($4.6 million), Ambac ($2.1 million), Assured Guaranty Corporation ($8.7 million), and Other ($5.3 million).
Both observable and unobservable inputs may be used to determine the fair value of positions that the Company has classified within the Level 3 category. As a result, the unrealized gains and losses for invested assets within the Level 3 category presented in the tables below may include changes in fair value that are attributed to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long-dated volatilities) inputs.
The securities classified as Level 1 in the above table consist of U.S. treasuries and equity securities actively traded on an exchange.
The securities classified as Level 2 in the above table consist primarily of fixed maturity securities. Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, security prices are derived through recent reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information. If there are no recent reported trades, matrix or model processes are used to develop a security price where future cash flow expectations are developed based upon collateral performance and discounted at an estimated market rate. Included in the pricing of asset-backed securities, collateralized mortgage obligations, and mortgage-backed securities are estimates of the rate of future prepayments of principal over the remaining life of the securities. Such estimates are derived based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral. For corporate loans, price quotes from multiple dealers along with recent reported trades for identical or similar securities are used to develop prices.
There were no transfers between Level 1 and Level 2 during the year ended December 31, 2012.
The following tables present the changes in Level 3 investments measured at fair value on a recurring basis for 2012, 2011 and 2010:
Of the Company’s investments in limited partnerships, as of December 31, 2010, $1.1 million was related to a limited partnership which holds convertible preferred securities of a privately held company. These securities were subject to an appraisal action in Delaware State Court. In February, 2011, the Company’s remaining interest of $1.1 million was liquidated.
Included in “Other invested assets” in the fair value hierarchy at December 31, 2012 and 2011 are limited liability partnerships measured at fair value. The following table provides the fair value and future funding commitments related to these investments at December 31, 2012 and 2011.
The following table presents details of the Company’s intangible assets as of December 31, 2011:
The reinsurance receivables above are net of a purchase accounting adjustment related to discounting acquired loss reserves to their present value and applying a risk margin to the discounted reserves. This adjustment was $8.0 million and $10.0 million at December 31, 2012 and 2011, respectively.
The Company regularly evaluates retention levels to ensure that the ultimate reinsurance cessions are aligned with corporate risk tolerance and capital levels. The Company’s Insurance Operations’ primary reinsurance treaties are as follows:
Property Catastrophe Excess of Loss-The Company’s current property writings create exposure to catastrophic events. To protect against these exposures, the Company purchases a property catastrophe treaty. Effective June 1, 2012, the Company renewed its property catastrophe excess of loss treaty which provides occurrence coverage for losses of $80.0 million in excess of $20.0 million. At this renewal, the Company retained 50% of the $20 million in excess of $20 million layer, and 20% of the $50 million in excess of $40 million layer. This treaty provides for one full reinstatement of coverage at 100% additional premium as to time and pro rata as to amount of limit reinstated. This replaces the treaty that expired on May 31, 2012, which provided occurrence coverage for 100% of losses of $80.0 million in excess of $20.0 million.
Property Per Risk Excess of Loss-Effective January 1, 2013, the Company renewed its property per risk excess of loss treaty which provides coverage of 50% of $13.0 million per risk in excess of $2.0 million per risk. This replaces the treaty that expired December 31, 2012, which provided 100% of $13.0 million per risk in excess of $2.0 million per risk. The renewal treaty provides coverage in two layers: $3.0 million per risk in excess of
$2.0 million per risk, and $10.0 million per risk in excess of $5.0 million per risk. The first layer is subject to a $6.0 million limit of liability for all risks involved in one loss occurrence, and the second layer is subject to a $10.0 million limit for all risks involved in one loss occurrence.
Casualty and Professional Liability Excess of Loss-Effective May 1, 2012, the Company renewed its casualty and professional liability excess of loss treaty. The casualty section provides coverage for $2.0 million per occurrence in excess of $1.0 million per occurrence for general liability and auto liability. The professional liability section provides coverage of $4.0 million per policy/occurrence in excess of $1.0 million per policy/occurrence. For both sections, allocated loss adjustment expenses are included within limits. The casualty and professional liability treaty that expired April 30, 2012 provided identical coverage.
Casualty Clash Excess of Loss-Effective May 1, 2012, the Company renewed its casualty clash excess of loss treaty which provides coverage of $10.0 million per occurrence in excess of $3.0 million per occurrence, subject to a $20.0 million limit for all loss occurrences. The casualty clash treaty that expired April 30, 2012 provided identical coverage.
The weighted average expected tax provision has been calculated using income (loss) before income taxes in each jurisdiction multiplied by that jurisdiction’s applicable statutory tax rate.
The Company had an alternative minimum tax (“AMT”) credit carryforward of $9.2 million and $6.0 million as of December 31, 2012 and 2011, respectively, which can be carried forward indefinitely.
The Company and some of its subsidiaries file income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. The Company is no longer subject to U.S. federal tax examinations by tax authorities for tax years before 2009.
The Company classifies all interest and penalties related to uncertain tax positions as income tax expense. As of December 31, 2012, the Company did not record any liabilities for tax-related interest and penalties on its consolidated balance sheet.
During 2010, the Company reduced its prior accident year loss reserves by $54.1 million, which consisted of a $56.8 million decrease related to Insurance Operations and a $2.7 million increase related to Reinsurance Operations.
Workers’ Compensation: A $0.5 million increase in workers’ compensation lines is related to an accident year 2009 structured excess of loss treaty where the Company increased its loss estimates based on industry workers’ compensation results.
Prior to 2001, the Company underwrote multi-peril business insuring general contractors, developers, and sub-contractors primarily involved in residential construction that has resulted in significant exposure to construction defect (“CD”) claims. The Company’s reserves for CD claims ($74.8 million and $68.8 million as of December 31, 2012 and 2011, net of reinsurance, respectively) are established based upon management’s best estimate in consideration of known facts, existing case law and generally accepted actuarial methodologies. However, due to the inherent uncertainty concerning this type of business, the ultimate exposure for these claims may vary significantly from the amounts currently recorded.
and coverage litigation. Liabilities are recognized for known claims (including the cost of related litigation) when sufficient information has been developed to indicate the involvement of a specific insurance policy, and management can reasonably estimate its liability. In addition, liabilities have been established to cover additional exposures on both known and unasserted claims. Estimates of the liabilities are reviewed and updated regularly. Case law continues to evolve for such claims, and significant uncertainty exists about the outcome of coverage litigation and whether past claim experience will be representative of future claim experience. Included in net unpaid losses and loss adjustment expenses as of December 31, 2012, 2011, and 2010 were IBNR reserves of $14.6 million, $26.2 million, and $20.2 million, respectively, and case reserves of approximately $5.5 million, $3.6 million, and $10.1 million, respectively, for known A&E-related claims.
Establishing reserves for A&E and other mass tort claims involves more judgment than other types of claims due to, among other things, inconsistent court decisions, an increase in bankruptcy filings as a result of asbestos-related liabilities, and judicial interpretations that often expand theories of recovery and broaden the scope of coverage. The insurance industry continues to receive a substantial number of asbestos-related bodily injury claims, with an increasing focus being directed toward other parties, including installers of products containing asbestos rather than against asbestos manufacturers. This shift has resulted in significant insurance coverage litigation implicating applicable coverage defenses or determinations, if any, including but not limited to, determinations as to whether or not an asbestos-related bodily injury claim is subject to aggregate limits of liability found in most comprehensive general liability policies. In 2009, one of the Company’s insurance companies was dismissed from a lawsuit seeking coverage from it and other unrelated insurance companies. The suit involved issues related to approximately 3,900 existing asbestos-related bodily injury claims and future claims. The dismissal was the result of a settlement of a disputed claim related to accident year 1984. The settlement is conditioned upon certain legal events occurring which may trigger financial obligations by the insurance company.
On October 9, 2012, The United States District Court for the Northern District of California (District Court) issued an order confirming an amended plan of reorganization (Plan) for a named insured that included an injunction under 11 U.S.C. Section 524(g) (US bankruptcy code) related to the suit above. The injunction, also called a “channeling injunction,” precludes, inter alia, non-settling insurers from asserting claims against one of the Company’s insurance companies and asbestos related claims by third parties against one of the Company’s insurance companies that are related to the named insured. An appeal from the District Court order has been filed with the 9th Circuit Court of Appeals. A motion for stay to prevent the Plan and the channeling injunction from taking effect has been denied by the District Court. Management will continue to monitor the developments of the litigation to determine if any additional financial exposure is present.
In 2003, trusts formed and owned by the Company issued a total of $30.0 million of trust preferred securities. The funds were used to purchase junior subordinated interest notes and to support the business growth in the
Distributions on the above securities can be deferred up to five years, but in the event of such deferral, the Company may not declare or pay cash dividends on the common stock of the applicable subsidiary.
The Company allows employees to surrender A ordinary shares as payment for the tax liability incurred upon the vesting of restricted stock that was issued under the Share Incentive Plan. During 2012, the Company purchased an aggregate of 4,997 of surrendered A ordinary shares from its employees for $0.1 million. During 2011, the Company purchased an aggregate of 8,347 of surrendered A ordinary shares from its employees for $0.2 million. All shares purchased from employees by the Company are held as treasury stock and recorded at cost.
(3) Includes shares surrendered by employees as payment of taxes withheld on the vesting of restricted stock.
The following table provides information with respect to the A ordinary shares that were surrendered or repurchased in 2011:
At December 31, 2012 and 2011, Wind River Reinsurance was a limited partner in the Fox Paine Capital Fund, II, which is managed by Fox Paine & Company. This investment was originally made by United National Insurance Company in June 2000 and pre-dates the September 5, 2003 acquisition by Fox Paine & Company of Wind River Investment Corporation, which was the predecessor holding company for United National Insurance Company. The Company’s investment in this limited partnership was valued at $3.1 million and $6.6 million at December 31, 2012 and 2011, respectively. At December 31, 2012, the Company had an unfunded capital commitment of $2.5 million to the partnership. The Company received a distribution from the limited partnership of $5.4 million, of which $4.3 million was recorded as investment income, during 2012. There were no distributions received during 2011. The Company received a distribution of $0.07 million during 2010.
In 2012 and 2010, the Company incurred $0.2 million for legal services rendered by Cozen O’Connor. Stephen A. Cozen, the chairman of Cozen O’Connor, is a member of the Company’s Board of Directors.
Validus is a participant in a quota share retrocession agreement with Wind River Reinsurance. The Company estimated that the following written premium and losses related to the quota share retrocession agreement have been assumed by Validus from Wind River Reinsurance:
Edward J. Noonan, the chairman and chief executive officer of Validus, was a member of the Company’s Board of Directors until June 1, 2007, when he resigned from the Board. Validus remains a related party since the current quota share retrocession agreement between Validus and Wind River Reinsurance was put in place during the period when Mr. Noonan was a member of the Company’s Board of Directors.
During each of the years ended December 31, 2012, 2011 and 2010, the Company paid $0.2 million in brokerage fees to Crystal & Company, an insurance broker. Prior to October 15, 2012, Crystal & Company was known as Frank Crystal & Company. James W. Crystal, the chairman and chief executive officer of Crystal & Company, is a member of the Company’s Board of Directors.
Total rental expense under operating leases, net of sub-lease income, for the years ended December 31, 2012, 2011, and 2010 were $2.2 million, $4.1 million, and $5.2 million, respectively. As part of its Profit Enhancement Initiative, the Company incurred charges in 2011 and 2010 resulting from future minimum lease commitments related to unused space. Cash payments on leases related to unused space will be paid in future periods and are included in the table below. See Note 5 for additional details. At December 31, 2012, future minimum cash payments under non-cancelable operating leases, net of expected sub-lease income, were as follows:
The Company is, from time to time, involved in various legal proceedings in the ordinary course of business. The Company purchased insurance and reinsurance coverage for risks in amounts that it considers adequate. However, there can be no assurance that the insurance and reinsurance coverage that the Company maintains is sufficient or will be available in adequate amounts or at a reasonable cost. The Company does not believe that the resolution of any currently pending legal proceedings, either individually or taken as a whole, will have a material adverse effect on its business, results of operations, cash flows, or financial condition.
As mentioned in Note 15 above, the Company has a remaining commitment of $2.5 million to the Fox Paine Capital Fund, II.
All share amounts reported prior to July 2, 2010 have been adjusted to reflect the one-for-two stock exchange of Global Indemnity plc shares for United America Indemnity, Ltd. shares as part of the re-domestication to Ireland. See Note 4 above for more information regarding the re-domestication.
The prescribed accounting guidance also requires tax benefits relating to excess stock-based compensation deductions to be prospectively presented in the statement of cash flows as financing cash inflows. Tax expense resulting from stock-based compensation deductions in excess of amounts reported for financial reporting purposes was $0.1 million and $0.2 million for the years ended December 31, 2011 and 2010, respectively. There was no tax expense resulting from stock-based compensation deductions in excess of amounts reported for financial reporting purposes during 2012.
During 2011, the Company granted 400,000 Time-Based Options under the Plan, which consisted of 300,000 Time-Based Options which vest in 33 1/3% increments on December 31, 2012, 2013 and 2014 and 100,000 Time-Based Options which vest in 25% increments on December 31, 2012, 2013, 2014 and 2015. Any unvested options are forfeited upon termination of employment for any reason, and expire 10 years after the grant date.
Option intrinsic values, which are the differences between the fair value of $22.13 at December 31, 2012 and the strike price of the option, are as follows:
The weighted average fair value of options granted under the Plan was $9.52 in 2011 using a Black-Scholes option-pricing model and the following weighted average assumptions. There were no options granted under the Plan in 2012 or 2010.
In addition to stock option awards, the Plan also provides for the issuance of restricted shares to employees and non-employee Directors. The Company recognized compensation expense for restricted stock of $1.8 million, $1.2 million and $2.3 million for 2012, 2011, and 2010, respectively. The total unrecognized compensation expense for the non-vested restricted stock was $1.9 million at December 31, 2012, which will be recognized over a weighted average life of 2.1 years.
(1) Includes 122,603 shares that were purchased by key employees in 2003.
During 2011, the Company granted an aggregate of 65,481 Restricted Shares to key employees of the Company at a weighted average fair value of $21.44 per share and an aggregate of 55,351 fully vested Director Restricted Shares, which are subject to certain restrictions, at a weighted average fair value of $20.74 per share to non-employee Directors of the Company under the Plan. In 2011, the Company granted 17,799 Restricted Shares to key employees and 14,171 fully vested Director Restricted Shares to non-employee Directors of the Company out of shares previously forfeited. Included in the 65,481 are 54,233 Restricted Shares granted by the Company to key executives of the Company. Included in the 54,233 are 38,585 shares that were forfeited in 2011 and 15,648 shares that vest 100% on the first subsequent anniversary date of the award.
Ms. Valko’s terms of employment included two equity components including the granting of 300,000 time-based stock options with a strike price equal to the closing price of the Company’s shares on the trading day preceding the start date, or $17.87 per share, and an annual bonus opportunity of which 50% shall be paid in restricted shares based on the market value of the Company’s shares as of December 31 of the subject bonus year. The time-based options vested 33 1/3% on December 31, 2012 and will vest 33 1/3% on December 31, 2013 and 2014 pending Board approval at the time of vesting. The restricted shares vest 33 1/3% on each anniversary of the subject bonus year. All equity components are subject to accident year true-up of bonus year underwriting results and are subject to Board approval.
The Company maintains a 401(k) defined contribution plan that covers all eligible U.S. employees. Under this plan, the Company matches 100% of the first 6% contributed by an employee. Vesting on contributions made by the Company is immediate. Total expenses for the plan were $1.1 million, $1.1 million, and $1.6 million for the years ended December 31, 2012, 2011, and 2010, respectively.
The following table sets forth the computation of basic and diluted earnings (loss) per share. In 2011, “Diluted” shares were the same as “Basic” shares since there was a net loss for that year.
statements which include, in statutory form, a balance sheet, an income statement, a statement of capital and surplus and notes thereto. The statutory financial statements are not prepared in accordance with GAAP or SAP and are distinct from the financial statements prepared for presentation to Wind River Reinsurance’s shareholders and under the Bermuda Companies Act 1981 (the “Companies Act”), which financial statements will be prepared in accordance with GAAP.
In July, 2012, the FASB issued new accounting guidance surrounding impairment testing for indefinite lived intangible assets. The new guidance allows for an entity to elect first assessing qualitative factors when evaluating for impairment. If qualitative factors indicate that there may be impairment, prior guidance using
An unaudited summary of the Company’s 2012 and 2011 quarterly performance is as follows:
(1) Results for the fourth quarter of 2012 include the impact of an out-of-period adjustment which reduced net income by $1.6 million.