We maintain office facilities in Bermuda, the U.S., Europe, Canada, Singapore, Latin America and the Middle East. We own the property in which our office is located in Dublin, Ireland, and we lease office space in the other countries. We renew and enter into new leases in the ordinary course of business as required. Our global headquarters is located at 92 Pitts Bay Road, AXIS House, Pembroke HM 08, Bermuda. We believe that our office space is sufficient for us to conduct our operations for the foreseeable future.
The following table shows selected consolidated financial information for the last five years. This data should be read in conjunction with
Operating income(1) of $161 million, or $1.92 per diluted common share(1)
Reserve for losses and loss expenses of $12.3 billion and reinsurance recoverable on unpaid and paid losses of $3.8 billion
AXIS Capital Holdings Limited ("AXIS Capital"), through its operating subsidiaries, is a global provider of specialty lines insurance and reinsurance products with operations in Bermuda, the U.S., Europe, Singapore, Canada, Latin America and the Middle East. Our underwriting operations are organized around our global underwriting platforms, AXIS Insurance and AXIS Re.
We provide our clients and distribution partners with a broad range of risk transfer products and services and meaningful capacity, backed by significant financial strength. We manage our portfolio holistically, aiming to construct the optimum consolidated portfolio of funded and unfunded risks, consistent with our risk appetite and development of our franchise. We nurture an ethical, entrepreneurial and disciplined culture that promotes outstanding client service, intelligent risk taking and the achievement of superior risk-adjusted returns for our shareholders. We believe that the achievement of our objectives will position us as a global leader in specialty risks. Our execution of this strategy in 2018 included the following:
continuing to improve in the effectiveness and efficiency of our operating platforms and processes;
We are committed to leadership in specialty insurance risk and global reinsurance, areas where we have depth of talent and expertise and have earned a strong reputation for client service and intelligent risk-taking. As a mid-sized player that is both sophisticated and agile, we believe we are well-positioned to thrive in the rapidly evolving insurance and reinsurance marketplace. Through our hybrid strategy, we have developed substantial platforms in insurance and reinsurance, providing us with both balance and diversification. We believe our market positioning, underwriting expertise, best-in-class claims management capabilities, and strong relationships with our distributors and clients will provide opportunities for profitable growth in 2019 and beyond, with variances among our lines driven by our tactical response to market conditions.
Since late 2017, rates across most insurance lines have generally improved, with catastrophe exposed property insurance lines, U.S. excess casualty and U.K. professional liability experiencing the most upward rate momentum. Market conditions will likely remain competitive in the near term. However, we would expect many specialty segments will experience improved market conditions as carriers assess pricing, portfolio construction and account preferences. In this competitive market environment with mixed market conditions, we are focusing on lines of business and market segments that are adequately priced, and we are trading off growth for profitability in other areas. In addition, our acquisition of Novae increases our leadership and relevance in the London marketplace, and we expect to be well-positioned to capitalize on new opportunities and benefit from improved market conditions emerging through the international specialty insurance market, including Lloyd's.
The reinsurance market is also experiencing increased momentum in rates (stable supply with increasing demand). Given the above average market losses in the last couple of years; we continue to emphasize underwriting discipline to actively manage our portfolios. At the same time, we also see opportunities to support clients in a world of changing exposures, regulation and reinsurance panels. We believe that there is a real opportunity to achieve more relevance by focusing on our clients to produce new streams of income in the future while still defending the quality of our existing portfolio. We are also focused on managing the volatility and capital efficiency of our portfolio by further expanding our already strong group of strategic capital partners. Taken together, we balance short term needs and long term priorities, with the ultimate goal of adding value to our clients and to our communities.
We present our results of operations in a way we believe will be most meaningful and useful to investors, analysts, rating agencies and others who use our financial information to evaluate our performance. Some of the measurements we use are considered non-GAAP financial measures under SEC rules and regulations. In this Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"), we present underwriting-related general and administrative expenses, consolidated underwriting income (loss), operating income (loss) (in total and on a per share basis), operating return on average common equity ("operating ROACE"), amounts presented on a constant currency basis, pre-tax total return on cash and investments excluding foreign exchange movements, ex-PGAAP operating income (loss) (in total and on a per share basis) and ex-PGAAP operating ROACE which are non-GAAP financial measures as defined in Item 10(e) of SEC Regulation S-K. We believe that these non-GAAP financial measures, which may be defined and calculated differently by other companies, better explain and enhance the understanding of our results of operations. However, these measures should not be viewed as a substitute for those determined in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP").
Consolidated underwriting income (loss) is a pre-tax measure of underwriting profitability that takes into account net premiums earned and other insurance related income (losses) as revenues and net losses and loss expenses, acquisition costs and underwriting-related general and administrative expenses as expenses. While this measure is presented in Item 8, Note 4 to the Consolidated Financial Statements 'Segment Information', it is considered a non-GAAP financial measure when presented elsewhere on a consolidated basis.
Amortization of intangibles including VOBA arose from business decisions, the nature and timing of which are not related to the underwriting process, therefore, these expenses are excluded from consolidated underwriting income (loss).
Operating income (loss) represents after-tax operational results exclusive of net realized investment gains (losses), foreign exchange losses (gains), transaction and reorganization expenses, revaluation of net deferred tax asset and bargain purchase gain.
We also present ex-PGAAP operating income (loss) per diluted common share and ex-PGAAP operating ROACE, which are derived from the ex-PGAAP operating income (loss) measure and are reconciled to the most comparable GAAP financial measures, earnings per diluted common share and ROACE, respectively, are also presented in 'Management’s Discussion and Analysis of Financial Condition and Results of Operations - Executive Summary - Results of Operations'.
On October 2, 2017, we acquired Novae. We identified VOBA which represents the present value of the expected underwriting profit within policies that were in-force at the closing date of the transaction. In addition, the allocation of the acquisition price to the assets acquired and liabilities assumed of Novae based on estimated fair values at the acquisition date, resulted in the write-off of the deferred acquisition cost asset on Novae's balance sheet at the acquisition date as the value of policies in-force on that date are considered within VOBA. Consequently, underwriting income (loss) in 2018 and 2017 included the recognition of premium attributable to Novae's balance sheet at the acquisition date without the recognition of the associated acquisition costs.
Tax cost (benefit) of ($11,642), $2,022 and $1,830 for the years ended December 31, 2018, 2017 and 2016, respectively. Tax impact is estimated by applying the statutory rates of applicable jurisdictions, after consideration of other relevant factors including the ability to utilize capital losses.
Tax cost (benefit) of ($4,331), ($7,777) and $2,114 for the years ended December 31, 2018, 2017 and 2016, respectively. Tax impact is estimated by applying the statutory rates of applicable jurisdictions, after consideration of other relevant factors including the tax status of specific foreign exchange transactions.
Refer to Item 8, Note 13 to the Consolidated Financial Statements 'Earnings Per Common Share' for further details on the dilution calculation.
We also present ex-PGAAP operating income (loss), ex-PGAAP operating income (loss) per diluted common share and ex-PGAAP operating ROACE which are derived from the operating income measure and can be reconciled to the most comparable GAAP financial measures as follows:
Tax cost (benefit) of $(35,061), $(10,003) and $nil for the years ended December 31, 2018, 2017 and 2016, respectively. Tax impact is estimated by applying the statutory rates of applicable jurisdictions.
Tax cost (benefit) of $23,839, $6,203 and $nil for the years ended December 31, 2018, 2017 and 2016, respectively. Tax impact is estimated by applying the statutory rates of applicable jurisdictions.
Our reinsurance segment underwriting income increased by $218 million in 2018, compared to 2017. The increase in underwriting income was primarily driven by a decrease in catastrophe and weather-related losses, a decrease in the current accident year loss ratio excluding catastrophe and weather-related losses and an increase in other insurance related income, partially offset by a decrease in net favorable prior year reserve development.
Our reinsurance segment underwriting income decreased by $428 million in 2017, compared to 2016. The decrease in underwriting income was primarily driven by an increase in catastrophe and weather-related losses, a decrease in net favorable prior year reserve development and an increase in the current accident year loss ratio excluding catastrophe and weather-related losses, partially offset by a decrease in general and administrative expenses and acquisition costs.
The variability in net investment income from 2016 through 2018 was largely attributable to the performance of our other investments portfolio. Income from this portfolio decreased by $28 million in 2018, compared to 2017, attributable to lower returns from hedge funds due to lower returns from equity markets and a decrease in our hedge fund holdings, together with lower returns from direct lending funds due to lower returns from credit markets. Comparatively, income from this portfolio increased by $34 million in 2017, compared to 2016, attributable to higher returns from investments in hedge funds and direct lending funds due to the strong performance of global equity and credit markets.
During 2018, net investment losses were $150 million compared to net investment gains of $28 million in 2017 and net investment losses of $61 million in 2016. Net investment losses in 2018 were primarily attributable to net realized investment losses on the sale of agency RMBS, U.S. government and corporate debt securities, and net unrealized investment losses on equity securities of $67 million which were reported in net investment gains (losses) as opposed to other comprehensive income following the adoption of Accounting Standards Update ("ASU") 2016-01 "Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities," in the first quarter of 2018.
Corporate expenses decreased to $108 million in 2018 from $130 million in 2017. The decrease was primarily driven by an increase in the allocation of corporate costs to our insurance and reinsurance segments, together with a decrease in personnel costs, partially offset by an increase in information technology project costs. Corporate expenses also increased to $130 million in 2017 from $120 million in 2016. The increase was primarily driven by higher personnel costs including senior executive transition costs as well as executive retirement costs, and information technology project costs, partially offset by a decrease in performance-related compensation costs.
The foreign exchange gains of $29 million in 2018 were driven primarily by the impact of the strengthening of the U.S. dollar on the re-measurement of net insurance-related liabilities mainly denominated in pound sterling and euro. Foreign exchange losses of $135 million in 2017 were driven primarily by the impact of the weakening of the U.S. dollar on the re-measurement of net insurance-related liabilities mainly denominated in pound sterling and euro, and foreign exchange gains of $121 million in 2016 were driven primarily by the strengthening of the U.S. dollar against the pound sterling.
The tax benefit of $8 million in 2017 was primarily driven by the geographic distribution of pre-tax losses with the benefit being driven by losses in our U.K. and U.S. operations, largely offset by a tax charge of $42 million related to the revaluation of net deferred tax assets associated with the reduction in the U.S. corporate income tax rate from 35% to 21% enacted as part of the U.S. Tax Reform.
The tax expense of $6 million in 2016 was primarily by attributable to the geographic distribution of pre-tax income with the expense being driven by income in our European and partially offset by losses in our U.S. operations.
We expect to achieve annual run-rate pre-tax cost savings of approximately $100 million with effect from 2020. These expense savings will be achieved through the elimination of redundant roles, efficiencies introduced through organizational redesign, operating efficiency improvements, integration of systems and the rationalization of third party contracts and professional fees.
Interest in income (loss) of equity method investments of $1 million in 2018 related to our share of income in an investee.
Interest in loss of equity method investments of $8 million in 2017 included impairment losses of $9 million related to an investment in a U.S. based insurance company, partially offset by income of $1 million related to our share of income of another investee.
Operating ROACE excludes the impact of net investment gains (losses), foreign exchange losses (gains), transaction and reorganization expenses, revaluation of net deferred tax assets, bargain purchase gain and loss on repurchase of preferred shares.
In 2018, our book value per diluted common share decreased by 7%, driven primarily by an increase in net unrealized investment losses reported in other comprehensive income and common dividends declared. The net unrealized investment losses in 2018 reflected a widening of credit spreads which negatively impacted the market values of fixed maturity securities.
The following table provides our underwriting results for the years indicated. Underwriting income is a pre-tax measure of underwriting profitability that takes into account net premiums earned and other insurance related income (loss) as revenues and net losses and loss expenses, acquisition costs and underwriting-related general and administrative expenses as expenses.
Consolidated underwriting income (loss) is a non-GAAP financial measure as defined in Item 10(e) of SEC Regulation S-K. The reconciliation to income (loss) before income taxes and interest in income (loss) of equity investments, the most comparable GAAP measure, is presented in 'Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Summary - Results of Operation'.
2017 versus 2016: Gross premiums written in 2017 increased by $586 million or 12% compared to 2016 due to increases in our insurance and reinsurance segments.
The increase in our insurance segment's gross premiums written of $382 million or 16% compared to 2016 was driven by an increase in gross premiums written of $241 million associated with our acquisition of Novae. In addition, gross premiums written increased by $141 million or 6% ($137 million or 6% on a constant currency basis) primarily attributable to accident and health, liability, professional lines and aviation lines. These increases were partially offset by a decrease in property and marine lines.
Ceded premiums written in 2018 were $2,251 million, or 33% of gross premiums written, compared to $1,529 million, or 28%, in 2017. The increase in the ceded premiums written was attributable to our insurance and reinsurance segments.
In July 2018, we obtained catastrophe protection for our insurance and reinsurance segments through a reinsurance agreement with Northshore. In connection with the reinsurance agreement, Northshore issued notes to unrelated investors in an amount equal to the full $200 million of coverage provided under the reinsurance agreement covering a three year period. At the time of the agreement, we performed an evaluation of Northshore to determine if it meets the definition of a variable interest entity ("VIE"). We concluded that Northshore is a VIE. In addition, we concluded that we do not have a variable interest in the entity, as the variability in results is expected to be absorbed entirely by the investors in Northshore. Accordingly, the results of Northshore are not included in our consolidated financial statements. The premium ceded to Northshore for the year ended December 31, 2018 was $44 million.
In June 2017, we obtained catastrophe protection for our insurance and reinsurance segments through a reinsurance
2018 versus 2017: Net premiums earned in 2018 increased by $643 million or 15% compared to 2017 due to increases in our insurance and reinsurance segments.
Net premiums earned in our insurance segment in 2018 increased by $546 million or 30% compared to 2017. The increase in net premiums earned included $575 million primarily attributable to property, marine, credit and political risk, and professional lines associated with our acquisition of Novae. Excluding the impact of Novae, net premiums earned decreased by $29 million or 2% ($40 million or 2% on a constant currency basis) attributable to property lines, partially offset by an increase in liability lines.
Net premiums earned in our insurance segment in 2017 increased by $282 million or 18%, compared to 2016. The increase in net premiums earned included $162 million attributable to our acquisition of Novae. In addition, net premiums earned increased by $120 million or 8% ($110 million or 7% on a constant currency basis) attributable to accident and health, property and aviation lines.
Other insurance related loss in 2017 of $1 million compared to other insurance related income in 2016 of $7 million, a decrease of $8 million, was primarily driven by our reinsurance segment.
The general and administration expense ratio includes corporate expenses not allocated to underwriting segments of 2.3%, 3.1% and 3.2% for 2018, 2017 and 2016, respectively. These costs are further discussed in the 'Management’s Discussion and Analysis of Financial Condition and Results of Operations - Other Expenses (Revenues), Net' section.
Our December 31, 2018 net reserve for losses and loss expenses includes estimated amounts for numerous catastrophe events. We caution that the magnitude and/or complexity of losses arising from these events, in particular California Wildfires, Hurricanes Michael and Florence which occurred in 2018 as well as Hurricanes Harvey, Irma and Maria and the two earthquakes in Mexico which occurred in 2017 inherently increase the level of uncertainty and, therefore, the level of management judgment involved in arriving at our estimated net reserve for losses and loss expenses. As a result, our actual losses for these events may ultimately differ materially from our current estimates.
Our estimated net losses in relation to the catastrophe events described above were derived from ground-up assessments of our in-force contracts and treaties providing coverage in the affected regions. These assessments take into account the latest information available from clients, brokers and loss adjusters. In addition, we consider industry insured loss estimates, market share analyses and catastrophe modeling analyses, when appropriate. Our estimates remain subject to change as additional loss data becomes available.
Short-tail business includes the underlying exposures in the property and other, marine and aviation reserve classes within our insurance segment and the property and other reserve class within our reinsurance segment.
These reserve classes contributed net favorable prior year development of $86 million in 2018 primarily reflecting the recognition of overall better than expected loss emergence related to the 2017 catastrophe events. These reserve classes contributed net favorable prior year reserve development of $60 million and $148 million in 2017 and 2016, respectively, reflecting the recognition of better than expected loss emergence.
Our insurance professional reserve class recorded net favorable prior year development of $32 million, $26 million and $14 million in 2018, 2017 and 2016, respectively. Our reinsurance professional reserve class recognized $21 million, $44 million and $30 million of net favorable prior year development in 2018, 2017 and 2016, respectively. The net favorable prior year
loss development on these reserve classes continued to reflect the generally favorable experience on older accident years as we continued to transition to more experience based methods.
Long-tail business consists primarily of our insurance and reinsurance liability reserve classes and our reinsurance motor reserve class.
Our reinsurance motor reserve class contributed net favorable prior year reserve development of $23 million, $1 million and $55 million in 2018, 2017 and 2016, respectively. The net favorable prior year reserve development on our motor reserve class in 2018 was primarily attributable to non proportional treaty business on older accident years. Net favorable prior year development in 2017 was adversely impacted by the decrease in the discount rate used to calculate lump sum awards in U.K. bodily injury cases, known as the Ogden Rate, which changed from plus 2.5% to minus 0.75% effective March 20, 2017. The net favorable prior year reserve development on the motor reserve class in 2016 related to favorable loss emergence trends on several classes of business spanning multiple accident years.
At the acquisition date, the fair value of reserves for losses and loss expenses for Syndicate 2007 was established giving weight to the observable value of these reserves based on a Reinsurance to Close ("RITC") transaction of the Syndicate’s 2015 and prior years of account, which was completed prior to the allocation of purchase price. Management made no change to the initial estimate when establishing its best estimate of reserves for losses and loss expenses at December 31, 2017 (refer to 'Critical Accounting Estimates - Reserve for Losses and Loss Expenses' for further details).
We caution that conditions and trends that impacted the development of our reserve for losses and loss expenses in the past may not recur in the future.
The following tables map our lines of business to reserve classes and the expected claim tails:
$18 million of net favorable prior year reserve development on marine business primarily due to better than expected loss emergence on more recent accident years.
In 2017, we recognized $60 million of net favorable prior year reserve development, the principal components of which were:
$26 million of net favorable prior year reserve development on professional lines business due to the recognition of better the expected emerging loss experience, particularly on the 2013 and 2014 accident years.
$8 million of net adverse prior year reserve development on liability business due to reserve strengthening on several large claims within our run-off Bermuda excess casualty book of business and limited reserve strengthening within our U.S. excess casualty book of business.
In 2016, we recognized $49 million of net favorable prior year reserve development, the principal components of which were:
$28 million of net favorable prior year reserve development on property and other business driven by better than expected loss emergence primarily related to accident years 2012 through 2015.
$14 million of net favorable prior year reserve development on professional lines business driven by better than expected development related to various accident years, partially offset by reserve strengthening relating to updated information on specific claims impacting accident years 2010 and 2011.
$33 million of net favorable prior year reserve development on credit and surety business primarily due to generally better than expected loss emergence, primarily related to accident years 2013 and 2014.
$23 million of net favorable prior year reserve development on liability business due to progressively increased weight given by management to experience based indications on older accident years.
$21 million of net favorable prior year reserve development on professional lines business reflecting the generally favorable experience on older accident years as we continue to transition to more experience based methods.
$33 million of net favorable prior year reserve development on credit and surety business, due to better than expected loss emergence, primarily related to accident years 2012 through 2015.
$19 million of net favorable prior year development on property and other business due to overall better than expected loss emergence across multiple accident years, partially offset by reserve strengthening related to accident year 2016.
$1 million of net favorable prior year reserve development on motor business, due to better than expected loss emergence spanning multiple accident years, largely offset by the impact of the change in Ogden rate.
$105 million of net favorable prior year development on property and other business, primarily related to the 2010 through 2015 accident years driven by better than expected loss emergence.
The decrease in the general and administrative expense ratio to 14.0% in 2017 from 16.2% in 2016 was primarily driven by a decrease in performance-related compensation costs and an increase in fees from strategic capital partners.
2018 versus 2017: Gross premiums written in 2018 increased by $983 million or 35% compared to 2017. The increase in gross premiums written included $923 million attributable to property, marine, professional lines and credit and political risk lines associated with our acquisition of Novae. In addition, gross premiums written increased by $60 million or 2% ($45 million or 2% on a constant currency basis) primarily attributable to professional lines and liability lines driven by new business opportunities, partially offset by a decrease in property, marine and accident and health lines. The decrease in property lines was due to our exit from onshore energy business in the fourth quarter of 2017 together with our exit from some U.S. retail insurance operations in the fourth quarter of 2016. The decrease in marine lines was due to non-renewals. The decrease in accident and health lines was due to the cancellation of certain program business.
2017 versus 2016: Gross premiums written in 2017 increased by $382 million or 16% compared to 2016. In 2017, the increase in gross premiums written included $241 million attributable to property, professional lines, marine as well as credit and political risk lines associated with our acquisition of Novae. In addition, gross premium written increased by $141 million or 6% ($137 million or 6% on a constant currency basis) primarily attributable to new business opportunities in accident and health, liability, and professional lines together with an increase in aviation lines associated with our acquisition of Aviabel. These increases were partially offset by a decrease in property lines following our exit from U.S. retail insurance operations last year and a decrease in marine lines largely driven by timing differences.
The decrease was driven by an increase in ceded premiums earned in our liability and property lines, together with a decrease in gross premiums earned in property, partially offset by an increase in gross premiums earned in our liability lines.
2018 versus 2017: The current accident year loss ratio decreased to 67.2% in 2018 from 84.0% in 2017. The decrease was primarily due to a decrease in catastrophe and weather-related losses. During 2018, we incurred pre-tax catastrophe and weather-related net losses of $204 million, or 8.7 points attributable to Hurricanes Michael and Florence, the California Wildfires as well as U.S. and European weather-related events. Comparatively, in 2017 we incurred $412 million, or 22.7 points of losses attributable to catastrophe and weather-related events.
After adjusting for the impact of the catastrophe and weather-related losses, our current accident year loss ratio decreased to 58.5% in 2018 from 61.3% in 2017. The decrease in the current accident year loss ratio after adjusting for the impact of the catastrophe and weather-related losses was principally due to favorable changes in business mix predominantly related to the acquisition of Novae together with favorable impact of rate and trend.
2017 versus 2016: The current accident year loss ratio increased to 84.0% in 2017 from 66.9% in 2016. The increase was primarily due to an increase in catastrophe and weather-related losses. During 2017 we incurred pre-tax catastrophe and weather-related net losses of $412 million, or 22.7% points attributable to Hurricanes Harvey, Irma and Maria, the two earthquakes in Mexico, the wildfires in Northern and Southern California and other U.S. weather-related events. Comparatively, in 2016 we incurred $121 million, or 7.9 points of losses attributable to catastrophe and weather-related events.
After adjusting for the impact of the catastrophe and weather-related losses, our current accident year loss ratio increased to 61.3% in 2017 from 59.0% in 2016. The increase in the current accident year loss ratio after adjusting for the impact of the catastrophe and weather-related losses was principally due to an increase in attritional loss experience in property lines together with the adverse impact of rate and trend, partially offset by a decrease in mid-size loss experience in marine and credit and political risk lines and favorable changes in business mix (refer to 'Underwriting Results - Consolidated - Prior Year Reserve Development' for further details).
The increase in the acquisition cost ratio to 16.9% in 2018 from 14.9% in 2017 was primarily due to business mix attributable to the acquisition of Novae.
The decrease in the general and administrative expense ratio to 16.8% in 2018 from 17.9% in 2017, was primarily driven by to an increase in net premiums earned, a decrease in personnel costs and professional fees, partially offset by an increase in general and administrative expenses associated with the acquisition of Novae and in increase in the allocation of corporate costs to the segment.
The decrease in the general and administrative expense ratio to 17.9% in 2017 from 21.3% in 2016 was primarily driven by a decrease in performance-related compensation costs and an increase in net earned premium, partially offset by general and administrative expenses associated with the acquisition of Novae.
The increase in catastrophe and property lines was driven by new business spread across several cedants. Favorable premium adjustments and reinstatement premiums also contributed to the increase in premiums written in catastrophe, property and agriculture lines. The increase in motor lines was driven by new business and favorable premium adjustments, partially offset by the impact of foreign exchange movements and a lower level of premiums written on a multi-year basis during 2017, compared to 2016. The decrease in credit and surety lines was primarily due to a lower level of premiums written on a multi-year basis.
2018 versus 2017: Ceded premiums written in 2018 were $778 million, or 25%, of gross premiums written, compared to $490 million, or 18%, in 2017. The increase in ceded premiums written included $29 million primarily attributable to catastrophe, marine and aviation lines associated with the acquisition of Novae. In addition, ceded premiums written increased by $259 million, or 53% attributable to accident and health, credit and surety, and liability lines primarily due to an increase in premiums ceded to a new quota share retrocessional treaty which covers these lines of business. The increase in catastrophe lines was due to an increase in premiums ceded to our strategic capital partners and costs associated with purchasing catastrophe bond protection.
2017 versus 2016: Net premiums earned in 2017 increased by $161 million or 7% compared to 2016. The increase in net premiums earned was driven by an increase in gross premiums earned attributable to new business written in property and motor lines, as well as favorable premium adjustments impacting agriculture, motor and property lines, partially offset by decrease in gross premiums earned in professional lines.
The increase in gross premiums earned was partially offset by an increase in ceded premium earned reflecting the impact of the retrocessions to Harrington Reinsurance Ltd. ("Harrington Re") on professional lines and increased retrocessions in agriculture and property lines.
2017 versus 2016: The current accident year loss ratio increased to 84.1% in 2017 from 67.7% in 2016. The increase was primarily due to an increase in catastrophe and weather-related losses. During 2017, we incurred pre-tax catastrophe and weather-related losses, net of reinstatement premiums, of $422 million, or 18.5 points attributable to the Hurricanes Harvey, Irma and Maria, the two earthquakes in Mexico, the wildfires in Northern and Southern California and other U.S. weather-related events. Comparatively, in 2016 we incurred $83 million or 3.9 points of net losses attributable to catastrophe and weather-related events.
After adjusting for the impact of the catastrophe and weather-related losses, our current accident year loss ratio increased to 65.6% in 2017 from 63.8% in 2016. The increase in the current accident year loss ratio after adjusting for the impact of the catastrophe and weather-related losses was principally due to a large risk loss in property lines, the impact of the Ogden Rate change in motor lines and adverse impact of rate and trend (refer to 'Underwriting Results - Consolidated - Prior Year Reserve Development' for further details).
The acquisition cost ratio of 23.5% in 2018 was comparable to 23.7% in 2017.
The decrease in the acquisition cost ratio to 23.7% in 2017 from 24.9% in 2016 was primarily attributable to changes in business mix, together with a decrease in adjustments related to loss-sensitive features, the impact of favorable reinstatement premium adjustments, partially offset by the impact of retrocessional contracts with lower acquisition costs.
The following table provides a summary of our other expenses (revenues), net:
The increase in corporate expenses during 2017 compared to 2016 was primarily driven by higher personnel costs including senior executive transition costs as well as executive retirement costs, and information technology project costs, partially offset by a decrease in performance-related compensation costs.
Some of our business is written in currencies other than the U.S. dollar. Foreign exchange gains in 2018 were driven primarily by the impact of the strengthening of the U.S. dollar on the re-measurement of net insurance-related liabilities mainly denominated in pound sterling and euro.
Interest expense and financing costs are related to interest due on 5.875% Senior Notes issued in 2010, 2.65% Senior Notes and the 5.15% Senior Notes issued in 2014, and 4.0% Senior Notes issued in the fourth quarter of 2017. Interest expense and
financing costs increased by $12 million in 2018 compared to 2017, primarily attributable to costs associated with the 4.0% Senior Notes which were executed to refinance the 2.65% Senior Notes that will mature and be repaid in 2019.
The tax benefit of $8 million in 2017 was primarily attributable to the geographic distribution of pre-tax losses with the benefit being driven by losses in our U.S. and U.K. operations, share based compensation excess tax benefits which were recognized in the year, a tax adjustment related to the bargain purchase gain recognized in connection with the acquisition of Aviabel, largely offset by a tax charge of $42 million related to the revaluation of net deferred tax assets associated with the reduction in the U.S. corporate income tax rate from 35% to 21% enacted as part of the U.S. Tax Reform.
The following table provides details of income earned from our cash and investment portfolio by major asset class:
2018 versus 2017: Pre-tax return on other investments decreased to 6.4% in 2018 compared to 9.6% in 2017. The decrease was due to lower returns from hedge funds reflective of lower returns from equity markets and a decrease in our hedge fund holdings, together with lower returns from direct lending funds reflective of lower returns from credit markets.
2017 versus 2016: Net investment gains in 2017 were $28 million compared to net investment losses of $61 million in 2016. Net investment gains reported in 2017 primarily reflected net realized investment gains on the sale of ETFs, as a result of the strong performance of global equity markets. This was partially offset by foreign exchange losses on non-U.S. denominated fixed maturities, as a result of the strengthening of the U.S. dollar during 2017.
Generally, sales of individual securities occur when there are changes in the relative value, credit quality, or duration of a particular issue. We may also sell to re-balance our investment portfolio in order to change exposure to particular asset classes or sectors.
The following table provides details of the OTTI charge (refer to 'Critical Accounting Estimates - OTTI' for details of our impairment review process) recognized in net income by asset class:
2017 versus 2016: OTTI losses in 2017 were $14 million compared to $26 million in 2016, a decrease of $12 million. The decrease in 2017 compared to 2016 was mainly due to higher losses related to non-U.S. denominated securities as a result of the decline in foreign exchange rates against the U.S. dollar in 2016. The current year OTTI losses included impairments on
non-U.S. denominated securities as a result of foreign exchange losses and non-investment grade corporate debt securities that have had a significant decline in value.
During 2018, our foreign exchange hedges resulted in $3 million of net gains which related primarily to securities denominated in euro and pound sterling as each of these currencies experienced volatility during 2018. We also recorded net gains of $2 million related to interest rate swaps.
During 2017, our foreign exchange hedges resulted in $7 million of net losses which related primarily to securities denominated in the Japanese yen, euro and pound sterling as each of these currencies experienced volatility during 2017. We also recorded net losses of $1 million related to interest rate swaps.
Change in net unrealized investment gains (losses) on fixed maturities is calculated by taking net unrealized investment gains (losses) at period end less net unrealized investment gains (losses) at the prior period end.
Includes restricted cash and cash equivalents of $597 million and $415 million for 2018 and 2017, respectively.
The fair value of total investments decreased by $1.6 billion in 2018, driven by the settlement of the RITC agreement of the 2015 and prior years of account of Syndicate 2007, funding of operating activities and the decline in market value of fixed maturities due to the widening of credit spreads and the rise in U.S. Treasury rates.
The following provides further analysis on our investment portfolio by asset class:
Our methodology for assigning credit ratings to our fixed maturities is in line with the methodology used for the Barclays U.S. Aggregate Bond index. This methodology uses the middle of Standard & Poor's (S&P), Moody's and Fitch ratings. When ratings from only two of these agencies are available, the lower rating is used. When only one agency rates a security, that rating is used.
To calculate the weighted average credit rating for fixed maturities, we assign points to each rating with 29 points for the highest rating (AAA) and 2 points for the lowest rating (D) and then calculate the weighted average based on the fair values of the individual securities. Securities that are not rated by S&P, Moody’s or Fitch are excluded from weighted average calculations. At December 31, 2018, the fair value of fixed maturities not rated was $55.9 million (2017: $53.1 million).
In addition to managing our credit risk exposure within our fixed maturities portfolio we also monitor the aggregation of country risk exposure on a group-wide basis (refer to Item 1 'Risk and Capital Management' for further details). Country risk exposure is the risk that events within a country, such as currency crises, regulatory changes and other political events, will adversely affect the ability of obligors within the country to honor their obligations. For corporate debt and structured
Non-U.S. government securities include bonds issued by non-U.S. governments and their agencies along with supranational organizations (collectively also known as sovereign debt securities). The table below provides details of our exposures to governments in the eurozone and other non-U.S. government concentrations by fair value:
Non-Agency RMBS include mostly investment-grade bonds originated by non-agencies. At December 31, 2018, our non-agency RMBS had an average duration and weighted average life of 0.8 years (2017: 0.8 years) and 4.0 years (2017: 4.2 years), respectively.
At December 31, 2018, the average duration and weighted average life of our ABS portfolio was 0.7 years (2017: 0.7 years) and 3.6 years (2017: 3.8 years), respectively.
During 2017, we recorded an impairment charge of $9 million, related to a U.S. based insurance company, which reduced the carrying value of the investment to $nil. This charge is included in interest in loss of equity method investments in the consolidated statement of operations.
Refer to Item 8, Note 6(g) to the Consolidated Financial Statements 'Investments'.
AXIS Capital’s operating subsidiaries primarily derive cash from the net inflow of premiums less claim payments related to underwriting activities and from net investment income. Historically, these cash receipts have been sufficient to fund the operating expenses of these subsidiaries, as well as to fund dividend payments to AXIS Capital. The subsidiaries’ remaining cash flows are generally reinvested in our investment portfolio or used to fund acquisitions, and they have also been used to fund common share repurchases in recent periods.
The table below provides details of our consolidated cash flows from operating, investing and financing activities in the last three years:
Net cash provided by operating activities was $11 million in 2018, compared to $259 million in 2017 and $407 million in 2016. Our insurance and reinsurance operations typically receive cash inflows from premiums, net of policy acquisition costs, and reinsurance recoverables. Our cash outflows are principally for the payment of claims and loss adjustment expenses, premium payments to reinsurers and operating expenses. Cash provided by operating activities can fluctuate due to timing differences in the collection of premium receivable and reinsurance recoverables and the payment of losses and ceded premiums payable.
Operating cash flows decreased in 2018 compared to 2017, primarily attributable to losses paid on short-tail lines of business related to the 2017 and 2018 catastrophe events, consideration paid for the RITC transaction of the 2015 and prior years of account of Syndicate 2007, the quota share retrocessional agreement with Harrington Re, (refer to Item 8, Note 9 to the Consolidated Financial Statements 'Reserve for Losses and Loss Expenses' for further details) and increased purchases of traditional reinsurance and retrocession covers, partially offset by an increase in premium collected due to higher gross premiums written in 2018, together with an increase in reinsurance recoveries, and an increase in interest and dividends received.
The decrease in operating cash flows in 2017 compared to 2016 was primarily attributable to increased purchases of reinsurance and retrocession covers, together with an increase in losses paid primarily in our property, catastrophe, marine as well as our accident and health lines, partially offset by an increase in premium collected due to higher gross premiums written in 2017, together with an increase in reinsurance recoveries.
Investing cash inflows in 2018 principally related to the net proceeds from the sale and redemption of fixed maturities of $364 million (2017: $300 million, 2016: $221 million), net proceeds from the sale of equity securities of $173 million (2017: $342 million, 2016: $3 million) and the net proceeds from the sale of other investments of $181 million (2017: $108 million, 2016: $25 million).
In 2018, we also fully redeemed the Dekania Notes at par (refer to Item 8, Note 11(b) to the Consolidated Financial Statements 'Debt and Financing Arrangements' for further details).
In 2017, we redeemed our remaining Series C preferred shares, which resulted in a cash outflow of $351 million and issued senior notes, which resulted in cash inflows of $346 million (refer to Item 8, Note 11(a) to the Consolidated Financial Statements 'Debt and Financing Arrangements' for further details).We used a portion of the proceeds from the issuance of the senior notes to repay a Novae term loan of $67 million.
Our net losses and loss expenses, gross of reinstatement premiums, included $327 million for Hurricanes Michael and Florence, the California Wildfires, and Typhoon Jebi in 2018; $744 million for Hurricanes Harvey, Irma and Maria, and the two earthquakes in Mexico and the wildfires in Northern and Southern California in 2017; $331 million for Super Storm Sandy in 2012; $944 million for numerous natural catastrophe and weather events in 2011; $256 million for the Chilean and New Zealand earthquakes in 2010; $408 million for Hurricanes Gustav and Ike in 2008; $1,019 million for Hurricanes Katrina, Rita and Wilma in 2005 and $266 million for Hurricanes Charley, Frances, Ivan and Jeanne in 2004. There remains significant uncertainty associated with our estimates of net losses for certain of these events (refer to 'Underwriting Results - Consolidated - Current Accident Year Loss Ratio' for further details), as well as the timing of the associated cash outflows.
We continue to expect that cash flows generated from our operations, combined with the liquidity provided by our investment portfolio, will be sufficient to cover our required cash outflows and other contractual commitments through the foreseeable future. For further details about the anticipated amounts and timing of our contractual obligation and commitments (refer to 'Contractual Obligations and Commitments' below).
In addition to common equity, we have utilized other external sources of financing, including debt, preferred shares and credit facilities to support our business operations. We believe that we hold sufficient capital to allow us to take advantage of market opportunities and to maintain our financial strength ratings, as well as to comply with various local statutory regulations. We monitor our capital adequacy on a regular basis and will seek to adjust our capital base (up or down) according to the needs of our business (refer to Item 1 'Risk and Capital Management' for further details).
We finance our operations with a combination of debt and equity capital. Our debt to total capital and debt and preferred equity to total capital ratios provide an indication of our capital structure, along with some insight into our financial strength.
Debt represents the 5.875% Senior Notes issued in 2010, which will mature in 2020, the 2.65% Senior Notes and the 5.15% Senior Notes issued in 2014, which will mature in 2019 and 2045, and the 4.0% Senior Notes issued in 2017, which will mature in 2027 (refer to Item 8, Note 11(a) of the Consolidated Financial Statements 'Debt and Financing Arrangements' for further details). The 4.0% Senior Notes issued in 2017 were executed to refinance the 2.65% Senior Notes that will mature and be repaid in 2019.
During October and November 2016, we repurchased 1,957,045 Series C preferred shares at an average purchase price of $25.67 per share for $50 million. On April 17, 2017, we redeemed the remaining $351 million of 6.875% Series C preferred shares.
On November 7, 2016, we issued $550 million of 5.50% Series E preferred shares. Dividends on the Series E preferred shares are non-cumulative. To the extent declared, dividends will accumulate, with respect to each dividend period, in an amount per share equal to 5.50% of the liquidation preference per annum. We may redeem these shares on or after November 7, 2021 at a redemption price of $2,500 per Series E preferred share.
Underlying movements in the value of our common equity over the past two years are outlined in the following table:
We routinely enter into agreements with financial institutions to obtain secured and unsecured credit and letter of credit facilities. These facilities are primarily used for the issuance of letters of credit, in the normal course of operations, to certain (re)insurance operations that purchase reinsurance protection from us. These letters of credit allow those operations to take credit, under local insurance regulations, for reinsurance obtained in jurisdictions where AXIS Capital’s subsidiaries are not licensed or otherwise admitted as an insurer. The value of our letters of credit outstanding is driven by, among other factors, the amount of unearned premium, loss development on existing reserves, the payment patterns of existing reserves, the expansion of our business and the loss experience of that business. A portion of these facilities may also be used for liquidity purposes.
Each of our existing facilities is described further below (refer to Item 8, Note 11(c) of the Consolidated Financial Statements 'Debt and Financing Arrangements' for further details).
Letters of credit issued under the $750 Million Facility will principally be used to support the reinsurance obligations of the Participating Subsidiaries. The Participating Subsidiaries are subject to certain covenants, including the requirement to maintain sufficient collateral to cover the obligations outstanding under the $750 Million Facility. In the event of default, Citibank may exercise certain remedies, including the exercise of control over pledged collateral and the termination of the availability of the $750 Million Facility to any or all of the Participating Subsidiaries.
Financial strength ratings represent the opinions of the rating agencies on the overall financial strength of a company and its capacity to meet the obligations of its (re)insurance contracts. Independent ratings are one of the important factors that establish our competitive position in (re)insurance markets. The rating agencies consider many factors in determining the financial strength rating of an insurance company, including the relative level of statutory surplus necessary to support the business operations of the company. These ratings are based upon factors considered by the rating agencies to be relevant to policyholders, agents and intermediaries and are not directed toward the protection of investors. Ratings are not recommendations to buy, sell or hold securities.
(1) On July 6, 2017, following the offer to acquire Novae, Standard & Poor's revised its outlook from stable to negative. The change in outlook reflects its concerns about the level of capital redundancy at the 'AAA' level on a pro-forma consolidated basis. On December 12, 2018, Standard & Poor's revised its outlook from negative to stable, which reflects their expectation that the Company's capital redundancy at the 'AAA' level will be restored by year-end 2019.
within the underlying contracts. The total amount in the table above reflects our best estimate of our reserve for losses and loss expenses. Actual amounts and timing may differ materially from our best estimate. Refer to ‘Critical Accounting Estimates - Reserve for Losses and Loss Expenses’ for further details. We have not taken into account corresponding reinsurance recoverable amounts that would be due to us.
The Company believes that the material items requiring such subjective and complex estimates are:
Loss reserves are not an exact calculation of the liability but instead, are complex estimates. The process of estimating loss reserves involves a number of variables (refer to 'Selection of Reported Reserves - Management's Best Estimate' below for further details). We review our estimate of loss reserves each reporting period and consider all significant facts and circumstances then known. As additional experience and other data become available and/or laws and legal interpretations change, we may adjust our previous estimates of loss reserves. Adjustments are recognized in the period in which they are determined therefore they can impact that period's underwriting results either favorably (indicating that our current estimates are lower than our previous estimates) or adversely (indicating that our current estimates are higher than our previous estimates).
With respect to our insurance business, we are generally notified of losses by our insureds and/or their brokers. Based on this information, our claims personnel estimate our ultimate losses arising from the claim, including the cost of administering the claims settlement process. These estimates reflect the judgment of our claims personnel based on general reserving practices, the experience and knowledge of such personnel regarding the nature of the specific claim and, where appropriate, the advice of legal counsel, loss adjusters and other relevant consultants.
Our quarterly reserving process begins with the collection and analysis of paid and incurred claim data for each of our segments. The segmental data is disaggregated by reserve class and further disaggregated by underwriting year and accident year. We use underwriting year information to analyze our business and subsequently allocate reserves to the respective accident years. Our reserve classes are selected to ensure that the underlying contracts have homogeneous loss development characteristics, while remaining large enough to make the estimation of trends credible. We review our reserve classes on a regular basis and adjust them over time as our business evolves. The paid and incurred claim data, in addition to industry benchmarks, serves as a key input to many of the methods employed by our actuaries. The relative weights assigned to our own historical loss data versus industry data vary according to the length of the development profile for the reserve class being evaluated (refer to 'Claim Tail Analysis' below for further details).
Expected Loss Ratio Method ("ELR Method"): This method estimates ultimate losses for an accident year or underwriting year by applying an expected loss ratio to the earned or written premium for that year. Generally, expected
Loss Development Method (also referred to as the "Chain Ladder Method" or "Link Ratio Method"): This method assumes that the losses incurred/paid for each accident year or underwriting year at a particular development stage follow a relatively similar pattern. It assumes that on average, every accident year or underwriting year will display the same percentage of ultimate losses incurred/paid at the same point in time after the inception of that year. The percentages incurred/paid are established for each development stage (e.g. 12 months, 24 months, etc.) after examining historical averages from historical loss development data and/or external industry benchmark information. Ultimate losses are then estimated by multiplying the actual incurred/paid losses by the reciprocal of the established incurred/paid percentage. The strengths of this method are that it reacts to loss emergence/payments and that it makes full use of historical claim emergence/payment experience. However, this method has weaknesses when the underlying assumption of stable loss development/payment patterns is not valid. This could be the consequence of changes in business mix, claim inflation trends or claim reporting practices and/or the presence of large claims, among other things. Furthermore, this method tends to produce volatile estimates of ultimate losses where there is volatility in the underlying incurred/paid patterns. In particular, where the expected percentage of incurred/paid losses is low, small deviations between actual and expected claims can lead to very volatile estimates of ultimate losses. As a result, this method is often unsuitable at early development stages for an accident year or underwriting year.
In order to capture the key dynamics of our loss reserve development and potential volatility, our reserve classes should be considered according to their potential expected length of loss emergence and settlement, generally referred to as the "tail". We consider our business to consist of three claim tail classes: short-tail, medium-tail and long-tail. Favorable development on prior accident year reserves indicates that our current estimates are lower than our previous estimates, while adverse development indicates that our current estimates are higher than our previous estimates. Below is a discussion of the specifics of our loss reserve process as they apply to each claim tail class, as well as commentary on the factors contributing to our historical loss reserve development for each class.
The key actuarial assumptions for our short-tail business in our early accident years were primarily developed with reference to industry benchmarks for both expected loss ratios and loss development patterns. As our own historical loss experience amassed, it gained credibility and became relevant for consideration in establishing these key actuarial assumptions. As a
result, we gradually increased the weighting assigned to our own historical experience in selecting the expected loss ratios and loss development patterns utilized to establish our estimates of ultimate losses for an accident year.
Our medium-tail business primarily consists of insurance and reinsurance professional lines, reinsurance credit and surety and discontinued lines - Novae within our insurance segment. Certain other classes of business, including aviation hull are also considered to have a medium-tail. Claim reporting and settlement periods on these classes are generally longer than those of our short-tail reserve classes. We also consider our insurance credit and political risk business to have a medium tail, due to the complex nature of claims and the potential additional time that may be required to realize our subrogation assets.
For our professional lines business and discontinued lines - Novae, claim payment and reporting patterns are typically medium to long-tail in nature. The underlying business is predominantly written on a claims-made basis. With respect to our key actuarial assumptions, we are progressively giving more weight to our own experience when establishing our expected loss ratios and our selected loss development patterns, though we continue to consider industry benchmarks.
Loss reporting patterns for professional lines business tend to be volatile, causing instability in actuarial indications based on incurred loss data until an accident year matures. Consequently, our initial loss reserves for an accident year or underwriting year are generally based upon an ELR method and the consideration of relevant qualitative factors. As accident years and underwriting years mature, we increasingly give more weight to methods that reflect our actual experience until our selections are based almost exclusively on experience-based methods. We evaluate the appropriateness of the transition to experience-based methods at the reserve class level, commencing this transition when we believe that our incurred loss development is sufficient to produce meaningful actuarial indications. The rate at which we transition fully to sole reliance on experience-based methods can vary by reserve class and by year, depending on our assessment of the stability and relevance of such indications. For some professional lines in our insurance segment, we also rely upon the evaluation of the open claim inventory in addition to the commonly employed actuarial methods when establishing reserves.
Our transition from the ELR method to experience-based methods began in 2008, when we commenced gradual transition for the 2004 and prior accident years. As our loss history continued to develop, the transition was expanded to include additional accident years. With the exception of the experience in our insurance professional lines during 2014 and 2015, our actual loss experience has generally been more favorable than or broadly in line with initial expectations and the transition has generally led to the recognition of net favorable prior year reserve
development in recent years. During 2014, management continued to rely upon experience-based methods, an evaluation of the open claims inventory and other qualitative factors in establishing the ultimate loss estimates for our insurance professional lines reserve class. During 2015, updated actuarial assumptions in our Australian book of business impacting accident years 2010 to 2014 resulted in strengthening of our insurance professional lines reserve class, partially offset by favorable development in certain U.S. professional lines business. Refer to 'Underwriting Results - Consolidated - Prior Year Development' for a discussion of the development recognized during the last three years.
For our reinsurance credit and surety business, our initial and most recent underwriting year loss projections are generally based on the ELR method, with consideration given to qualitative factors. Given that there is a quicker and more stable reporting pattern for trade credit business, we generally commence the transition to experience-based methods sooner than for the surety business.
Refer to 'Reserving for Credit and Political Risk Business' below for a discussion of specific loss reserve issues related to this business. When considering prior year reserve development for this line of business, it is important to note that the multi-year nature of the credit business distorts loss ratios when a single accident year is considered in isolation. In recent years, the average term of these contracts has been four to five years. The premiums we receive are generally earned evenly over the contract term, thus spanning multiple accident years. In contrast, losses incurred on these contracts, which can be characterized as low in frequency and high in severity, are reflected in a single accident year.
more significant weight given to industry benchmarks in forming our key actuarial assumptions;
While we consider industry benchmarks that we believe reflect the nature and coverage of our business, our actual loss experience may differ from the benchmarks based on industry averages.
Commencing with the fourth quarter 2012 reserving process, we began to give weight to actuarial methods that reflect our actual experience for liability business as we believed that our oldest accident years were at a stage of expected development where such methods would produce meaningful actuarial indications. In 2018, we continued to give weight to experience-based methods on the earlier years for our liability line of business leading to the recognition of some favorable experience on our reinsurance classes.
An important and distinguishing feature of many of these contracts is our contractual right, subsequent to payment of a claim to our insured, to be subrogated to, or otherwise have an interest in, the insured’s rights of recovery under an insured loan or facility agreement. These estimated recoveries are recorded as an offset to our credit and political risk loss reserves. The lag between the date of a claim payment and our ultimate recovery from the corresponding security can result in negative case reserves at a point in time (as was the case at December 31, 2018 and 2017). The nature of the underlying collateral is specific to each transaction and we also estimate the value of this collateral on a contract-by-contract basis. This valuation process is inherently subjective and involves the application of management’s judgment because active markets for the collateral often do not exist. Our estimates of values are based on numerous inputs, including information provided by our insureds, as well as third party sources including rating agencies, asset valuation specialists and other publicly available information. We also assess any post-event circumstances, including restructurings, liquidations and possession of asset proposals/agreements.
We cannot estimate losses from widespread catastrophic events, such as hurricanes and earthquakes, using the traditional actuarial methods described above. Loss reserves for such events are estimated by management after a catastrophe occurs by completing an in-depth analysis of individual contracts which may potentially have been impacted by the catastrophic event. This in-depth analysis may rely on several sources of information including:
discussions of the impact of the event with our customers and brokers; and
We generally use a blend of these information sources to arrive at our aggregate estimate of the ultimate losses arising from the catastrophic event. In subsequent reporting periods, we review changes in paid and incurred losses in relation to each significant catastrophe and adjust our estimates of ultimate losses for each event if there are developments that are different from our previous expectations. Adjustments are recorded in the period in which they are identified.
There are additional risks affecting our ability to accurately estimate ultimate losses for catastrophic events. For example, the estimates of loss reserves related to hurricanes and earthquakes can be affected by factors including, but not limited to: the inability to access portions of impacted areas, infrastructure disruptions, the complexity of factors contributing to losses, legal and regulatory uncertainties, complexities involved in estimating business interruption losses and additional living expenses, the impact of demand surge, fraud and the limited nature of information available. For hurricanes, additional complex coverage factors may include determining whether damage was caused by flooding or wind, evaluating general liability and pollution exposures, and mold damage. The timing of a catastrophe, for example, near the end of a reporting period, can also affect the level of information available to us to estimate loss reserves for that reporting period.
Beginning in 2013, we significantly enhanced the capabilities and resources dedicated to the actuarial reserving function. Consequently, from the first quarter of 2014, management began to rely upon its internal actuarial reserving function for the quarterly reserve evaluation process rather than utilizing the services of an independent actuarial firm. On an annual basis, we use an independent actuarial firm to provide an actuarial opinion on the reasonableness of our loss reserves for each of our operating subsidiaries and statutory reporting entities: such actuarial opinions are required to meet various insurance regulatory requirements. The actuarial firm also discusses its conclusions from the annual review with management and presents its findings to our Board of Directors.
While we believe that our loss reserves at December 31, 2018 are adequate, new information, events or circumstances may result in ultimate losses that are materially greater or less than provided for in our loss reserves. As previously noted, there are many factors that may cause our reserves to increase or decrease, particularly those related to catastrophe losses and long-tail lines of business.
Our expected loss ratios are a key assumption in our estimate of ultimate losses for business at an early stage of development. All else remaining equal, a higher expected loss ratio would result in a higher ultimate loss estimate, and vice versa. Our assumed loss development patterns are another significant assumption in estimating our loss reserves. All else remaining equal, accelerating a loss reporting pattern (i.e. shortening the claim tail) would result in lower ultimate losses, as the estimated proportion of losses already incurred would be higher. The uncertainty in the timing of the emergence of claims (i.e. the length of the development pattern) is generally greater for a company like ours with a relatively limited operating history which, therefore, must rely on industry benchmarks to a certain extent when establishing loss reserve estimates.
In the normal course of business, we purchase reinsurance protection to limit our ultimate losses from catastrophic events and to reduce our loss aggregation risk. To the extent that reinsurers do not meet their obligations under the reinsurance agreements, we remain liable. Consequently, we are exposed to credit risk associated with reinsurance recoverable on unpaid and paid losses to the extent that any of our reinsurers are unable or unwilling to pay our claims.
The following table shows the composition of reinsurance recoverable on unpaid losses for each of our reportable segments, segregated between reinsurance recoverable on unpaid losses related to case reserves and reinsurance recoverable on unpaid losses related to IBNR and by line of business:
At December 31, 2018, reinsurance recoverable on unpaid losses as a percentage of reserves for losses and loss expenses was 29% (2017: 24%). At December 31, 2018 and 2017, 89.5% and 88.8%, respectively, of our reinsurance recoverable on unpaid and paid losses (excluding the provision for uncollectible amounts) were collectible from reinsurers rated A- or better by A.M. Best. Refer to Item 8, Note 12 to the Consolidated Financial Statements 'Commitments and Contingencies' for an analysis of the credit risk associated with reinsurance recoverable on unpaid and paid losses at December 31, 2018.
The recognition of reinsurance recoverable on unpaid losses requires two key estimates. The first estimate is the amount of reserves for losses and loss expenses to be ceded to our reinsurers. This amount consists of two elements, amounts related to case reserves and amounts related to IBNR.
Reinsurance recoverable related to case reserves is estimated on a case-by-case basis by applying the terms of any applicable reinsurance cover to individual case reserve estimates. Reinsurance recoverable related to IBNR is generally developed as part of our loss reserving process, therefore, its estimation is subject to similar risks and uncertainties as the estimation of IBNR. Estimates of amounts to be ceded under non-proportional reinsurance contracts also take into account pricing information for those contracts and require greater judgment than estimates for proportional contracts.
A limited amount of our insurance business is written on a line slip or proportional basis, under which we assume a fixed percentage of the premiums and losses on a particular risk or group of risks along with numerous other unrelated insurers. Although premiums on this business are not contractually stated, we recognize gross premiums written based on estimates provided by clients through brokers (refer to 'Reinsurance Segment' below for further details). We review these premium estimates on a quarterly basis and recognize any adjustments to estimates in gross premium written in the period in which they are determined. Gross premiums written on a line slip/proportional basis comprised 12%, 12% and 11% of the segment’s gross premiums written for the years ended December 31, 2018, 2017 and 2016, respectively, therefore the impact of these premium estimates on our pre-tax net income was immaterial.
Reinsurance premiums are recorded at the inception of the contract and are estimated based on information received from ceding companies.
Our reinsurance segment provides cover to cedants (i.e. insurance companies) on an excess of loss and proportional basis. In most cases, cedants seek protection from us for business that they have not yet written at the time they enter into agreements with us, therefore, cedants must estimate their underlying premiums when purchasing reinsurance cover from us.
Our premiums estimates for proportional reinsurance contracts incepting during the year were as follows:
Our fixed premium insurance and excess of loss reinsurance contracts are generally written on a "losses occurring" or "claims made" basis over the term of the contract. Consequently, we earn the premium evenly over the contract term, which is generally 12 months.
Our estimated fair value of a financial instrument may differ from the amount that could be realized if the security was sold in an immediate sale, e.g., a forced transaction. In addition, the valuation of financial instruments is more subjective when markets are less liquid due to the lack of available market based inputs, as was the case during the global financial market crisis in late 2008 and early 2009. This may lead us to change the selection of our valuation technique (from market to cash flow approach) or may cause us to use multiple valuation techniques to estimate the fair value of a financial instrument. This circumstance may require significant management judgment and could cause a financial instrument to be reclassified between levels of the fair value hierarchy.
At December 31, 2018, the fair value of 92% (2017: 93%) of total fixed maturities and equity securities was based on prices provided by globally recognized independent pricing services where we have a current and detailed understanding of how their prices were derived. The remaining securities were priced by either non-binding broker quotes or internal valuation models.
At December 31, 2018 and 2017, we have not adjusted any pricing provided by independent pricing services (refer to 'Management Pricing Validation' below). In addition, our total Level 3 fixed maturities and equity securities amounted to $87 million (2017: $53 million), less than 1% of total fixed maturities and equity securities (refer to Item 8, Note 7 to the Consolidated Financial Statements 'Fair Value Measurements' for further information).
Hedge Funds, Direct Lending Funds, Private Equity Funds and Real Estate Funds
At December 31, 2018 and 2017 we had invested indirectly (through a fund structure) in CLO-Equities, also known as "cash flow CLOs" in the industry. During 2018, the CLO-Equity market continued to be relatively inactive with only a small number of transactions being observed, particularly as it related to transactions involving our CLO-Equities. Our indirect investments in CLO-Equities are valued using a discounted cash flow model prepared by an external manager. At December 31, 2018 and 2017, the estimated fair value for indirect CLO-Equities was $21 million (2017: $29 million).
At December 31, 2017 we had also invested directly in CLO-Equities. Given that all of our direct investments in CLO-Equities were past their reinvestment period, there was uncertainty over the remaining time until maturity, therefore, fair values of our direct investments in CLO-Equities were estimated using a liquidation valuation. At December 31, 2017, the estimated fair value for direct CLO-Equities was $2 million.
Other privately held securities include convertible preferred shares, convertible notes and notes payable. These securities are initially valued at cost which approximates fair value. In subsequent measurement periods, the fair values of these securities are determined using an income approach valuation technique, specifically an internally developed discounted cash flow model.
A fixed maturity or equity security is impaired if the fair value of the investment is below amortized cost. On a quarterly basis, we review all impaired securities to determine if impairments are other-than-temporary. The OTTI assessment is inherently judgmental, especially when securities have experienced severe declines in fair value over a short period. Our impairment review process begins with a quantitative analysis to identify securities to be evaluated for potential OTTI. For identified securities, fundamental analysis is performed that considers the following quantitative and qualitative factors:
If a fixed maturity is impaired and we intend to sell the security or it is more likely than not that we will be required to sell the security before its anticipated recovery, the full amount of the impairment (i.e. the difference between the security’s fair value and its amortized cost) is charged to net income and is included in net investment gains (losses) in our consolidated statements of operations. In instances where the Company intends to hold the impaired fixed maturity, and we do not anticipate to recover fully the amortized cost based on projected cash flows to be collected (i.e. a credit loss exists), we recognize the credit loss component (i.e. the amount representing the decrease in cash flows we expected to collect) of the OTTI charge in net income with a corresponding adjustment to amortized cost (new cost basis) of the security. The new cost basis is adjusted for subsequent increases in fair value where the difference between the new cost basis and the expected cash flows is accreted on a quarterly basis to net investment income over the remaining life of the fixed maturity. The non-credit component (e.g. interest rates, market conditions, etc.) of the OTTI charge is recognized in other comprehensive income.
From time to time, we may sell fixed maturities subsequent to the balance sheet date that we did not intend to sell at the balance sheet date. Conversely, we may not sell fixed maturities that we intended to sell at the balance sheet date. Such changes in intent may arise due to events occurring subsequent to the balance sheet date. The types of events that may result in a change in intent include, but are not limited to, significant changes in the economic facts and circumstances related to the specific issuer, changes in liquidity needs, or changes in tax laws or the regulatory environment.
For impaired investment-grade securities (i.e. rated BBB- or above) that we do not intend to sell and it is more likely than not that we will not be required to sell, we have established some parameters for identifying securities with potential credit losses. Our parameters focus primarily on the duration and the extent of the decline, including but not limited to:
For impaired securities in our high yield portfolios, we have established separate parameters for our credit loss assessment. Due to the additional volatility inherent in high yield securities relative to investment-grade securities, we focus on the severity of the impairment and work closely with our external high yield investment managers to identify securities with significant potential credit losses.
If a security meets one of the above parameters, we perform a fundamental analysis that considers the quantitative and qualitative factors noted above to determine whether an impairment charge should be recognized in the period under review.
The credit loss component of an OTTI charge recognized in net income is calculated based on the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to the impairment. The significant inputs and the methodology used to estimate credit losses are disclosed in Item 8, Note 6 (f) to the Consolidated Financial Statements 'Investments'.
Equity securities are recognized at fair value. Prior to the adoption of ASU 2016-01, the change in the fair values (net unrealized investment gains (losses)) of equity securities, net of tax were recognized in AOCI in the consolidated statement of changes in shareholders’ equity.
An equity security is impaired if the fair value of the investment was below cost. On a quarterly basis, the Company assessed whether unrealized losses on equity securities represented impairments that are other-than-temporary and recognized impairments on equity securities in an unrealized loss position when the Company did not have the ability and intent to hold the security for a reasonable period of time to allow for a full recovery. The full amount of the impairment was charged to net income and was included in net realized investment gains (losses) in the consolidated statements of operations. Upon recognition of an other-than-temporary impairment ("OTTI") charge, the new cost basis for the security was the cost for an equity security less the OTTI charge recognized in net income. The new cost basis was not adjusted for subsequent recoveries in fair value.
From time to time, we may have sold our equity securities subsequent to the balance sheet date that were considered temporarily impaired at the balance sheet date. This would have occurred due to events occurring subsequent to the balance sheet date that resulted in a change in our intent or ability to hold an equity security. Such subsequent events that would have resulted in a sale included significant deterioration in the financial condition of the issuer, significant unforeseen changes in our liquidity needs, or changes in tax laws or the regulatory environment.
Refer to Item 8, Note 2(m) to the Consolidated Financial Statements 'Basis of Presentation and Significant Accounting Policies' for a discussion of recently issued accounting pronouncements that the Company has not yet adopted.
At December 31, 2018, the Company is not party to any off-balance sheet arrangements, as defined by Item 303(a)(4) of Regulation S-K to which an entity unconsolidated with the Company is a party that management believes is reasonably likely to have a current or future effect on its financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that the Company believes is material to investors.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2019 expressed an unqualified opinion on the Company's internal control over financial reporting.
AXIS Capital Holdings Limited ("AXIS Capital" and together with its wholly owned subsidiaries the "Company"), was incorporated on December 9, 2002, under the laws of Bermuda. The Company provides a broad range of (re)insurance products on a worldwide basis. The Company's principal operating subsidiaries, located in Bermuda, the United States (U.S.), Europe, Singapore and Canada are described below:
AXIS Specialty Limited ("AXIS Specialty Bermuda"), a Bermuda domiciled company is licensed to provide specialty insurance and treaty reinsurance products on a worldwide basis. In addition, AXIS Specialty Bermuda conducts (re)insurance business through its branch in Singapore, AXIS Specialty Limited (Singapore Branch).
AXIS Insurance Company, domiciled in Illinois and AXIS Reinsurance Company, domiciled in New York, together with AXIS Reinsurance Company (Canadian branch) are licensed to offer a range of specialty insurance and treaty reinsurance products to a variety of niche markets on a worldwide basis. AXIS Surplus Insurance Company, domiciled in the state of Illinois is eligible to write insurance on a surplus lines basis.
AXIS Ventures Limited ("AXIS Ventures"), regulated by the BMA as an insurance manager, generates fee income from services provided to strategic capital partners. AXIS Ventures Reinsurance Limited ("Ventures Re") is a Bermuda domiciled insurer and is a registered segregated accounts company under the Bermuda Segregated Accounts Companies Act 2000, as amended. Ventures Re manages capital for investors interested in deploying funds directly into the property-catastrophe and other short-tail business.
During the three months ended March 31, 2018, the Company realigned its accident and health business by integrating this business and its operations into the Company's insurance and reinsurance segments. Through this realignment, the Company's accident and health business benefited from the greater scale and market presence of the Company's property and casualty insurance and reinsurance businesses and operations. Financial results relating to the Company's accident and health lines of business were previously included in the Company's insurance segment. Effective January 1, 2018, accident and health results are included in the results of both the insurance and reinsurance segments of the Company. As a result of the realignment, gross premiums written for the year ended December 31, 2017 of $313 million (2016: $288 million) and underwriting income for the year ended December 31, 2017 of $14 million (2016: $15 million) were reclassified from the Company's insurance segment to the Company's reinsurance segment.
Fixed maturities classified as available-for-sale are reported at fair value (refer to Note 7 'Fair Value Measurements'). The change in fair values (net unrealized investment gains (losses)) of fixed maturities, net of tax is recognized in accumulated other comprehensive income (loss) ("AOCI") in the consolidated statement of change shareholders’ equity.
A fixed maturity is impaired if the fair value of the investment is below amortized cost. On a quarterly basis, the Company assesses whether unrealized investment losses on fixed maturities represent impairments that are other-than-temporary. The Company's impairment review process begins with a quantitative analysis to identify securities to be evaluated for potential OTTI. For identified securities, fundamental analysis is performed that considers the following quantitative and qualitative factors:
(iii) the historical and implied future volatility of the fair value; and
In instances where the Company intends to hold the impaired fixed maturity, the Company estimates the anticipated credit loss on the security and recognizes this component of the impairment in net income with a corresponding adjustment to amortized cost (new cost basis) of the security. The new cost basis is adjusted for subsequent increases in fair value where the difference between the new cost basis and the expected cash flows is accreted on a quarterly basis to net investment income over the remaining life of the fixed maturity.
Following the adoption of Accounting Standards Update ("ASU") 2016-01 "Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities," (refer to 'New Accounting Standards Adopted in 2018' below)
Net investment income includes dividend income and is presented net of investment expenses. Investment income is recognized when earned. Purchases and sales of equity securities are recorded on a trade-date basis and realized investment gains (losses) on sales of equity securities are determined based on the specific identification method. Realized investment gains (losses) on equity securities are included in net investments gains (losses) in the consolidated statements of operations.
Equity securities are reported at fair value. Prior to the adoption of ASU 2016-01, the change in the fair values (net unrealized investment gains (losses)) of equity securities, net of tax was recognized in AOCI in the consolidated statement of changes in shareholders’ equity. An equity security is impaired if the fair value of the investment is below cost. On a quarterly basis, the Company assessed whether unrealized investment losses on equity securities represented impairments that are other-than-temporary and recognized impairments on equity securities in an unrealized loss position when the Company did not have the ability and intent to hold the security for a reasonable period of time to allow for a full recovery. The full amount of the impairment was charged to net income and was included in net realized investment gains (losses) in the consolidated statements of operations. Upon recognition of an other-than-temporary impairment ("OTTI") charge, the new cost basis for the equity security was the cost for an equity security less the OTTI charge recognized in net income. The new cost basis was not adjusted for subsequent increases in fair value.
Other investments are recorded at fair value (refer to Note 7 'Fair Value Measurements'), with both changes in fair value and realized investment gains (losses) reported in net investment income in the consolidated statements of operations.
Cash equivalents include money-market funds, fixed interest deposits and reverse repurchase agreements with a maturity of under 90 days when purchased. Cash and cash equivalents are recorded at amortized cost, which approximates fair value due to the short-term, liquid nature of these securities. Restricted cash primarily relates to funds held in trust to support of obligations in regulatory jurisdictions where the Company operates as a non-admitted carrier and to support the underwriting activities of Syndicate 1686 and Syndicate 2007 at Lloyd's.
(Re)insurance premiums are earned evenly over the period during which the Company is exposed to the underlying risk, which is generally one to two years with the exception of multi-year contracts. Unearned premiums represent the portion of premiums written which relates to the unexpired risks under contracts in force.
Reinstatement premiums are recognized and earned at the time a loss event occurs, where the coverage limits for the remaining life of the contract are reinstated under pre-defined contract terms. The accrual of reinstatement premiums is based on estimates of losses and loss adjustment expenses, which reflects management’s judgment, as described in Note 2(d) 'Losses and Loss Expenses' below.
The Company reviews its reserve for losses and loss expenses on a quarterly basis. Case reserves are primarily established based on amounts reported from insureds and/or their brokers. Management estimates IBNR after reviewing detailed actuarial analyses and applying informed judgment regarding qualitative factors that may not be fully captured in the actuarial estimates. A variety of actuarial methods are utilized in this process, including the Expected Loss Ratio, Chain Ladder and Bornhuetter Ferguson methods. The estimate is highly dependent on management’s judgment as to which method(s) are most appropriate for a particular accident year and line of business. Historical claims data is often supplemented with industry benchmarks when applying these methodologies.
Any adjustments to reserve for losses and loss expenses estimates are recognized in the period in which they are determined. While the Company believes that its reserves for losses and loss expenses are adequate, this estimate requires significant judgment and new information, events or circumstances may result in ultimate losses that are materially greater or less than provided for in the consolidated balance sheets.
Retroactive reinsurance reimburses a ceding company for liabilities incurred as a result of past insurable events covered under contracts subject to the reinsurance. In certain instances, reinsurance contracts cover losses both on a prospective basis and on a retroactive basis and where practical the Company bifurcates the prospective and retrospective elements of these reinsurance contracts and accounts for each element separately. Initial gains in connection with retroactive reinsurance contracts are deferred and amortized into income over the settlement period while losses are recognized immediately. When changes in the estimated amount recoverable from the reinsurer or in the timing of receipts related to that amount occur, a
cumulative amortization adjustment is recognized in net income in the period of the change so that the deferred gain reflects the balance that would have existed had the revised estimate been available at the inception of the reinsurance transaction.
The functional currency of the Company and the majority of its subsidiaries is the U.S. dollar. All foreign currency transactions are initially measured and recorded in the Company’s functional currency using the rates of exchange prevailing at the transaction date.
Monetary assets and liabilities denominated in foreign currency are remeasured to functional currency at the rates of exchange in effect at the balance sheet date with the resulting foreign currency gains (losses) generally being recognized in the consolidated statements of operations. Foreign currency gains (losses) related to available-for-sale investments denominated in foreign currency represent an unrealized appreciation (depreciation) in the market value of the securities and are included in the relevant component of AOCI. Non-monetary assets and liabilities denominated in foreign currency are not subsequently remeasured.
The fair value cash-settled service and performance based awards is also based on the fair market value of Company's common shares at the grant date and is expensed over the requisite service period. In addition, the fair value of the cash-settled service and performance based awards is recognized as a liability in the consolidated balance sheet and is remeasured at the end of each reporting period.
For the purposes of evaluating goodwill and indefinite lived intangible assets for impairment, the Company has an unconditional option to bypass the qualitative assessment in any period and proceed directly to performing the quantitative impairment test. The Company may resume performing the qualitative assessment in any subsequent period.
If goodwill or an intangible asset is impaired, the carrying value of the asset is reduced to fair value and a corresponding expense is recorded in the consolidated statements of operations.
Common shares repurchased by the Company and not subsequently canceled are classified as treasury shares and are recorded at cost. This results in a reduction of shareholders’ equity in the consolidated balance sheets. When shares are reissued from treasury, the Company uses the average cost method to determine the cost of the reissued shares.
Fixed maturities and equity securities are reported at fair value at the balance sheet date (refer to Note 7 'Fair Value Measurements'). Effective January 1, 2018, the Company adopted ASU 2016-01 "Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities," which:
requires the use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes;
requires separate presentation in other comprehensive income of the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the organization has elected to measure the liabilities in accordance with the fair value option;
clarifies that the reporting organization should evaluate the need for a valuation allowance on a deferred tax asset related to available for sale securities in combination with the organization’s other deferred tax assets.
Effective January 1, 2018, the Company adopted ASU 2016-15, "Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments," which addresses diversity in practice in how eight specific cash receipts and cash payments should be presented and classified on the statement of cash flows. The adoption of this guidance did not impact the Company's results of operations, financial condition and liquidity.
Effective January 1, 2018, the Company adopted ASU 2016-18, "Statement of Cash Flows (Topic 230) - Restricted Cash," which addresses diversity in practice in the classification and presentation of changes in restricted cash on the statement of cash flows. This guidance requires a statement of cash flows to explain the change during the period in the total of cash, cash equivalents, restricted cash and restricted cash equivalents. Transfers between cash and cash equivalents and restricted cash and restricted cash equivalents will no longer be presented on the statement of cash flows. To facilitate comparison of the Company's consolidated statements of cash flows, the Company adopted this guidance utilizing the full retrospective approach for all periods presented in the Company's consolidated financial statements. As a result, the Company's consolidated statements of cash flows now explains the change during the period in the total of cash, cash equivalents, and restricted cash. Therefore, restricted cash is now included with cash and cash equivalents in the reconciliation of the beginning of period and end of period total amounts shown on the statement of cash flows. The adoption of this guidance did not impact the Company's results of operations, financial condition and liquidity.
The current disclosure requirements in Topic 718 apply regardless of whether an entity is required to apply modification accounting under the amendments in this Update. The adoption of this guidance did not impact the Company's results of operations, financial condition and liquidity.
Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018 ("U.S. Tax Reform"), which was enacted on December 22, 2017.
U.S. GAAP currently requires deferred tax liabilities and assets to be adjusted for the effect of a change in tax laws or rates with the effect included in income from continuing operations in the reporting period that includes the enactment date. This guidance is applicable even in situations in which the related income tax effects of items in accumulated other comprehensive income were originally recognized in other comprehensive income rather than in income from continuing operations. As the adjustment of deferred taxes due to the reduction of the historical corporate income tax rate to the newly enacted corporate income tax rate is required to be included in income from continuing operations, the tax effects of items within accumulated other comprehensive income (referred to as stranded tax effects for purposes of this Update) do not reflect the appropriate tax rate.
The amendments in this Update allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from U.S. Tax Reform. Consequently, the amendments eliminate the stranded tax effects resulting from U.S. Tax Reform and will improve the usefulness of information reported to financial statement users. However, because the amendments only relate to the reclassification of the income tax effects of U.S. Tax Reform, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected.
Effective October 1, 2018, the Company adopted ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment" that eliminates the requirement to calculate the implied fair value of goodwill (i.e., Step 2 of the current goodwill impairment test) to measure a goodwill impairment charge. Instead, an impairment charge will be based on the excess of a reporting unit's carrying amount over its fair value (i.e., measure the charge based on Step 1 of the current goodwill impairment test). The adoption of this guidance did not impact the Company's results of operations, financial condition and liquidity.
In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)" which provided a new comprehensive model for lease accounting. Topic 842 will require a lessee to recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term.
The Company will adopt Topic 842 effective January 1, 2019, by electing the additional transition method provided in ASU 2018-11. The Company will also elect the package of practical expedients permitted under the transition guidance of Topic 842, which must be elected as a package and applied consistently to all leases. The package of practical expedients permits the Company not to reassess the following:
The purchase price was allocated to the assets acquired and liabilities assumed of Novae based on estimated fair values at the closing date and the Company recognized goodwill of $54 million. The allocation of the purchase price was based on information included in Novae's audited financial statements at October 2, 2017.
The fair value of the assets acquired and liabilities assumed and the allocation of the purchase price on the acquisition date are summarized in the following table:
Prepaid reinsurance premiums: To reflect adjustments to align premium recognition accounting policies;
VOBA: To establish the fair value of VOBA identifiable intangible asset related to the acquisition of Novae;
Goodwill: To establish the fair value of goodwill related to the acquisition of Novae;
Indefinite lived and finite lived intangible assets: To establish the fair value of identifiable intangible assets related to the acquisition of Novae and to eliminate Novae's pre-existing intangible assets;
Unearned premiums: To reflect adjustments to align premium recognition accounting policies; and
Identifiable intangible assets at the acquisition date are included in intangible assets in the consolidated balance sheets and are shown in the following table:
MGA contract: MGA contract was valued using the Multi-Period Excess Earnings Method, an application of the Income Approach. Key inputs used in the valuation model used for this intangible asset included SPA 6129's stamp capacity with Lloyd's, return on stamp capacity, fee income and profit commission associated with the managing agent contract for SPA 6129, profit margins, contributory asset charges which represent the required return on and of intangibles assets utilized to generate future revenue and operating income, and an appropriate discount rate.
The following selected audited information is a summary of the results of Novae that has been included in the consolidated financial statements for the year ended December 31, 2017.
In addition to the fair value adjustments and recognition of goodwill and identifiable intangible assets, other material pro forma adjustments directly attributable to the acquisition of Novae primarily included adjustments to recognize transaction and integration related expenses, to align accounting policies, to amortize identifiable indefinite lived intangible assets and to recognize related tax impacts.
On September 6, 2017 (the "closing date"), the Company acquired a 100% ownership interest in Contessa Limited ("Contessa"). Contessa is a Managing General Agent that manages, underwrites, services and administers small and medium
sized commercial property and casualty business on behalf of the Company. The purchase price was allocated to the assets acquired and liabilities assumed of Contessa based on estimated fair values on the closing date. Consequently, the Company recognized goodwill of $1 million.
In connection with the acquisition of Contessa, the Company recognized goodwill of $1 million.
The Company's impairment review of goodwill and indefinite lived intangibles resulted in the recognition of an impairment loss of $4 million for the year ended December 31, 2018, related to the termination of the MGA contract intangible asset identified in connection with the acquisition of Novae. The Company's impairment reviews of goodwill and indefinite lived intangibles did not result in the recognition of impairment losses for the years ended December 31, 2017 and 2016.
The cost and fair values of the Company's equity securities were as follows:
In the normal course of investing activities, the Company actively manages allocations to non-controlling tranches of structured securities which are variable interests issued by Variable Interest Entities ("VIEs"). These structured securities include RMBS, CMBS and ABS. The Company also invests in limited partnerships including hedge funds, direct lending funds, private equity funds and real estate funds as well as CLO equity tranched securities, which are all variable interests issued by VIEs (refer to Note 6(c) 'Other Investments'). The Company does not have the power to direct the activities that are most significant to the economic performance of the VIEs therefore the Company is not the primary beneficiary of any of these VIEs. The maximum exposure to loss on these interests is limited to the amount of investment made by the Company. The Company has not provided financial or other support with respect to these structured securities other than the original investment.
Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The contractual maturities of fixed maturities are shown below:
The following table summarizes fixed maturities and equity securities in an unrealized loss position and the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position:
At December 31, 2018, 3,599 fixed maturities (2017: 2,424) were in an unrealized loss position of $215 million (2017: $91 million) of which $49 million (2017: $7 million) was related to securities below investment grade or not rated.
The Company has a high quality mortgage loan portfolio with weighted average debt service coverage ratios in excess of 2.2x and weighted average loan-to-value ratios of less than 60%. At December 31, 2018 and 2017, there were no credit losses or past due amounts associated with the commercial mortgage loans held by the Company.
The following tables provide a summary of the Company's other investments, together with additional information relating to the liquidity of each category:
Two common redemption restrictions which may impact the Company's ability to redeem hedge funds are gates and lockups. A gate is a suspension of redemptions which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the fund’s net assets which may otherwise hinder the general partner or investment manager’s ability to liquidate holdings in an orderly fashion in order to generate the cash necessary to fund extraordinarily large redemption payouts. A lockup period is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. During 2018 and 2017, neither of these restrictions impacted the Company's redemption requests. At December 31, 2018, $27 million (2017: $38 million), representing 14% (2017: 11%) of total hedge funds, relate to holdings where the Company is still within the lockup period. The expiration of these lockup periods range from March 2019 to March 2021.
At December 31, 2018, the Company had $210 million (2017: $137 million) of unfunded commitments as a limited partner in direct lending funds. Once the full amount of committed capital has been called by the General Partner of each of these funds, the assets will not be fully returned until the completion of the fund's investment term. These funds have investment terms ranging from five to ten years and the General Partners of certain funds have the option to extend the term by up to three years.
At December 31, 2018, the Company had $84 million (2017: $16 million) of unfunded commitments as a limited partner in multi-strategy hedge funds. Once the full amount of committed capital has been called by the General Partner of each of these funds, the assets will not be fully returned until after the completion of the funds' investment term. These funds have investment terms ranging from two years to the dissolution of the underlying fund.
At December 31, 2018, the Company had $16 million (2017: $21 million) of unfunded commitments as a limited partner in a private equity fund. The life of the fund is subject to the dissolution of the underlying funds. The Company expects the overall holding period to be over ten years.
During 2015, the Company made a $50 million commitment as a limited partner of a bank revolver opportunity fund. The fund has an investment term of seven years and the General Partners have the option to extend the term by up to two years. At December 31, 2018, this commitment remains unfunded. It is not anticipated that the full amount of this fund will be drawn.
For the year ended December 31, 2017, the Company recorded an impairment charge of $9 million, related to a U.S. based insurance company, which reduced the carrying value of the investment to $nil. This charge was included in interest in income (loss) of equity method investments in the consolidated statement of operations.
Unrealized losses on securities issued or backed (either explicitly or implicitly) by the U.S. government are not analyzed for OTTI. The Company has concluded that the possibility of a credit losses on these securities is highly unlikely due to the explicit U.S. government guarantee on certain securities (e.g. GNMA issuances) and the implicit guarantee on other securities that has been validated by past actions (e.g. U.S. government bailout of FNMA and FHLMC during the 2008 credit crisis). Although these securities are not analyzed for credit losses, they are still evaluated for intention to sell and likely requirement to sell.
Non-U.S. government securities are evaluated for credit losses primarily through qualitative assessment of the likelihood of credit losses using information such as duration and severity of unrealized losses, as well as credit ratings and price volatility. At December 31, 2018, the Company's holdings in sovereign debt, including $29 million (2017: $185 million) relating to the eurozone countries, were substantially all investment-grade securities. At December 31, 2018, the gross unrealized investment losses of $16 million were mainly due to foreign exchange losses. Based on analysis performed, the Company does not anticipate any credit losses on non-U.S. government fixed maturities held at December 31, 2018. In 2018, the OTTI charge on non-U.S. government fixed maturities mainly related to unrealized foreign exchange losses on certain securities where forecasted recovery was uncertain.
To estimate credit losses for corporate debt securities, the company's projected cash flows are primarily driven by assumptions regarding the probability of default and the severity associated with those defaults. The company's default and loss severity rates are based on credit rating, credit analysis, industry analyst reports and forecasts, Moody’s historical default data and any other data relevant to the recoverability of the security. In 2018, the OTTI charge on corporate debt securities mainly related to significant loss severity, unrealized foreign exchange losses on certain securities where forecasted recovery was uncertain, as well as the Company's intent to sell.
The Company's investments in CMBS are diversified and primarily rated AA or better. At December 31, 2018, CMBS had a weighted average estimated subordination percentage of 31% (2017: 29%). Based on discounted cash flows at December 31, 2018, the current level of subordination is sufficient to cover the estimated loan losses on the underlying collateral of the CMBS.
For non-agency RMBS, the Company's projected cash flows incorporated underlying data from widely accepted third-party data sources along with certain internal assumptions and judgments regarding the future performance of the security. These assumptions included default, delinquency, loss severity and prepayment rates. The assumptions used to calculate the credit losses in 2018 have not changed significantly since December 31, 2017.
In order to support the Company's obligations in regulatory jurisdictions where it operates as a non-admitted carrier, the Company provides collateral in the form of assets held in trust and, to a lesser extent, letters of credit (refer to Note 11(c) 'Debt and Financing Arrangements').
The capital provided to support underwriting, or Funds at Lloyd’s ("FAL"), may be satisfied by cash, certain investments and letters of credit provided by approved banks (refer to Note 12 'Commitments and Contingencies' and Note 20 'Statutory Financial Information').
At December 31, 2018 collateral in trust for third party agreements included $403 million (2017: $1,120 million) of fixed maturities and equity securities, and cash of $39 million (2017: $55 million) held on deposit to support the underwriting activities of Syndicate 2007. At December 31, 2018 collateral in trust for third party agreements included cash of $154 million (2017: $140 million) held on deposit to support the underwriting activities of Syndicate 1686.
The Company's restricted investments and cash primarily consist of high-quality fixed maturity and short-term investment securities. The fair value of the Company's restricted investments and cash primarily relates to these items, as noted in the table below.
Level 1 - Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.
The availability of observable inputs can vary from financial instrument to financial instrument and is affected by a wide variety of factors including, for example, the type of financial instrument, whether the financial instrument is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment.
Accordingly, the degree of judgment exercised by management in determining fair value is greatest for financial instruments categorized in Level 3. In periods of market dislocation, the observability of prices and inputs may be reduced for many financial instruments. This may lead the Company to change the selection of valuation technique (from market to cash flow approach) or may cause the Company to use multiple valuation techniques to estimate the fair value of a financial instrument. This circumstance could cause an instrument to be reclassified between levels within the fair value hierarchy.
Non-U.S. government securities include bonds issued by non-U.S. governments and their agencies along with supranational organizations (collectively also known as sovereign debt securities). The fair values of these securities are based on prices obtained from international indices or valuation models that include inputs such as interest rate yield curves, cross-currency basis index spreads and country credit spreads for structures similar to the sovereign bond in terms of issuer, maturity and
seniority. As the significant inputs used to price these securities are observable market inputs, the fair values of non-U.S. government securities are classified as Level 2.
Non-Agency RMBS include mostly investment-grade bonds originated by non-agencies. The fair values of these securities are determined using an option adjusted spread model or other relevant models, which use inputs including available trade information or broker quotes, prepayment and default projections based on historical statistics of the underlying collateral and current market data. As the significant inputs used to price these securities are observable market inputs, the fair values of Non-Agency RMBS are generally classified as Level 2. Where pricing is unavailable from pricing services, the Company obtains non-binding quotes from broker-dealers to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, the fair values of these securities are classified as Level 3.
ABS include mostly investment-grade bonds backed by pools of loans with a variety of underlying collateral, including auto loans, student loans, credit card receivables, CDOs and CLO debt originated by a variety of financial institutions. The fair values of these securities are determined using a model which uses prepayment speeds and spreads sourced primarily from the new issue market. As the significant inputs used to price these securities are observable market inputs, the fair values of ABS are generally classified as Level 2. Where pricing is unavailable from pricing services, the Company obtains non-
Equity securities include common stocks, exchange-traded funds and bond mutual funds. As the fair values of common stocks and exchange-traded funds are based on unadjusted quoted market prices in active markets, the fair value of these securities are classified as Level 1. As bond mutual funds have daily liquidity with redemptions based on the net asset values per share ("NAV") of the funds, the fair values of these securities are classified as Level 2.
Other privately held securities include convertible preferred shares, convertible notes and notes payable. These securities are initially valued at cost which approximates fair value. In subsequent measurement periods, the fair values of these securities are determined using an income approach valuation technique, specifically an internally developed discounted cash flow model. As the significant inputs used to price these securities are unobservable, the fair values of other investments are classified as Level 3.
Overseas deposits include investments in private funds held by Syndicate 2007 where the underlying investments are primarily U.S. government, non-U.S. government and corporate debt securities. The funds do not trade on an exchange therefore are not included within available for sale investments. As the significant inputs used to price the underlying investments are observable market inputs, the fair values of overseas deposits are classified as Level 2.
Short-term investments primarily comprise highly liquid securities with maturities greater than three months but less than one year from the date of purchase. The fair values of these securities are classified as Level 2 because these securities are typically not actively traded due to their approaching maturity and, as such, their amortized cost approximates fair value.
Other underwriting-related derivatives include insurance and reinsurance contracts that are accounted for as derivatives. These derivative contracts are initially valued at cost which approximates fair value. In subsequent measurement periods, the fair values of these derivatives are determined using an income approach valuation technique, specifically internally developed discounted cash flow models. As the significant inputs used to price these derivatives are unobservable, the fair values of these contracts are classified as Level 3.
Note: Fixed maturities and insurance-linked securities that are classified as Level 3 are excluded from the above table as these securities are priced using broker-dealer quotes.
The CLO-Equities market continues to be relatively inactive with only a small number of transactions being observed, particularly as it relates to transactions involving CLO-Equities held by the Company. Accordingly, the fair value of the Company's indirect investment in CLO-Equities is determined using a discounted cash flow model prepared by an external investment manager.
Other privately held securities are initially valued at cost which approximates fair value. In subsequent measurement periods, the fair values of these securities are determined using internally developed discounted cash flow models. These models include inputs that are specific to each investment. The inputs used in the fair value measurements include dividend or interest rates and appropriate discount rates. The selection of an appropriate discount rate is judgmental and is the most significant unobservable input used in the valuation of these securities. A significant increase (decrease) in this input in isolation could result in significantly lower (higher) fair value measurement for other privately held securities. Where relevant, the Company also considers the contractual agreements which stipulate methodologies for calculating the dividend rate to be paid upon liquidation, conversion or redemption. In order to assess the reasonableness of the inputs the Company uses in the discounted cash flow models, the Company maintains an understanding of current market conditions, historical results, as well as investee specific information that may impact future cash flows.
The following table presents changes in Level 3 for financial instruments measured at fair value on a recurring basis for the periods indicated:
Realized investment gains (losses) on fixed maturities, and realized and unrealized gains (losses) on other assets and other liabilities included in net income are included in net investment gains (losses). Realized and unrealized gains (losses) on other investments included in net income are included in net investment income.
Change in unrealized investment gains (losses) relating to assets held at the reporting date.
The transfers into Level 3 from Level 2 made during 2018 and 2017 were primarily due to the lack of observable market inputs and multiple quotes from pricing vendors and broker-dealers for certain fixed maturities.
The fair values of hedge funds, direct lending funds, private equity funds and real estate funds are estimated using NAVs as advised by external fund managers or third party administrators. For these funds, NAVs are based on the manager's or administrator's valuation of the underlying holdings in accordance with the fund's governing documents and in accordance with U.S. GAAP.
At December 31, 2018, the carrying values of cash and cash equivalents including restricted amounts, accrued investment income, receivable for investments sold, certain other assets, payable for investments purchased and certain other liabilities approximated their fair values due to their respective short maturities. As these financial instruments are not actively traded, their fair values are classified as Level 2.
At December 31, 2018, the carrying value of mortgage loans held-for-investment approximated their fair value. The fair values of mortgage loans are primarily determined by estimating expected future cash flows and discounting them using current interest rates for similar mortgage loans with similar credit risk, or are determined from pricing for similar loans. As mortgage loans are not actively traded their fair values are classified as Level 3.
During the year ended December 31, 2018, the Company redeemed its notes payable at par. At December 31, 2017, notes payable were recorded at amortized cost with a carrying value of $36 million and a fair value of $36 million. The fair values of the notes payable were primarily determined by estimating expected future cash flows and discounting them using current interest rates for notes payable with similar credit risk. As notes payable were not actively traded their fair values were classified as Level 3.
Asset and liability derivatives are classified within other assets and other liabilities in the consolidated balance sheets.
The total unrealized and realized gains (losses) recognized in net income for derivatives not designated as hedges are shown in the following table:
Short-tail business generally includes exposures for which losses are usually known and paid within a relatively short period of time after the underlying loss event has occurred. The key actuarial assumptions for short-tail business in early accident years were primarily developed with reference to industry benchmarks for expected loss ratios and loss development patterns. As the Company's own historical loss experience amassed, it gained credibility and became relevant for consideration in establishing these key actuarial assumptions. As a result, the Company gradually increased the weighting assigned to its own historical experience in selecting the expected loss ratios and loss development patterns utilized to establish estimates of ultimate losses for an accident year. Due to the relatively short reporting and settlement patterns for short-tail business, more weight is generally placed upon experience-based methods and other qualitative considerations in establishing reserves for recent and more mature accident years. The majority of development for an accident year or underwriting year is expected to be recognized in the subsequent one to three years.
In contrast to short and medium-tail business, the claim tail for long-tail business is expected to be notably longer, as claims are often reported and ultimately paid or settled years, or even decades, after the related loss events occur. As a general rule, estimates of accident year or underwriting year ultimate losses for long-tail business are notably more uncertain than those for short and medium-tail business. To date, key actuarial assumptions for long-tail business have been derived extensively from industry benchmarks supplemented with the Company's own historical experience. Given the Company's relatively short operating history in comparison to the development tail for this business, the Company does not believe that its own historical loss development for long-tail business has amassed an appropriate volume to serve as a fully credible input into the key actuarial assumptions previously outlined. While industry benchmarks that the Company believes reflect the nature and coverage of its business are considered, actual loss experience may differ from the benchmarks based on industry averages. Due to the length of the development tail for this business, reserve estimates for most accident years and underwriting years are predominantly based on the BF Method or ELR Method and the consideration of qualitative factors.
The Company cannot estimate losses from widespread catastrophic events, such as hurricanes and earthquakes, using the traditional actuarial methods described above. Loss reserves for such events are estimated by management after a catastrophe occurs by completing an in-depth analysis of individual contracts which may potentially have been impacted by the catastrophic event. This in-depth analysis may rely on several sources of information including:
a review of modeled loss estimates based on information previously reported by customers and brokers, including exposure data obtained during the underwriting process;
With regard to establishing the fair value of reserves for losses and loss expenses for Novae at the acquisition date, weight was given to the observable value of these reserves based on the RITC transaction which was completed prior to the allocation of purchase price. Management made no change to the initial estimate when establishing its best estimate of reserves for losses and loss expenses at December 31, 2017. This is consistent with the Company's general approach of recognizing all or part of the anticipated cost of third party liability commutations if the transaction has either completed or is considered sufficiently likely to be completed in the near term.
On October 2, 2017, the Company acquired 100% ownership interest in Novae. At December 31, 2017, foreign exchange and other included reserves for losses and loss expenses of $2,126 million and reinsurance recoverables on unpaid and paid losses of $788 million related to this acquisition.
The transfer of the insurance business of AXIS Specialty Australia to a reinsurer was approved by the Irish High Court on February 1, 2017 and the Federal Court of Australia of February 10, 2017. Consequently, the insurance policies, assets and liabilities of AXIS Specialty Australia were transferred to the reinsurer with effect from February 13, 2017. This resulted in the reduction of reserves for losses and loss expenses by $223 million and a reduction in reinsurance recoverables on unpaid and paid losses by $223 million.
Medium-tail business consists primarily of the insurance and reinsurance professional reserve classes, the insurance credit and political risk reserve class and the reinsurance credit and surety reserve class.
For the year ended December 31, 2018, the reinsurance professional reserve class recognized net favorable prior year development of $21 million (2017: $44 million, 2016: $30 million). For the year ended December 31, 2018, the insurance professional reserve class recognized net favorable prior year development of $32 million (2017: $26 million, 2016: $14 million). The net favorable prior year loss development on these reserve classes continued to reflect the generally favorable experience on older accident years as the Company continued to transition to more experienced based methods.
For the year ended December 31, 2018, the reinsurance credit and surety reserve class recorded net favorable prior year reserve development of $33 million (2017: $33 million, 2016: $10 million). The net favorable prior year reserve development was due to the recognition of generally better than expected loss emergence.
For the year ended December 31, 2018, the reinsurance liability reserve classes contributed net favorable prior year development of $23 million (2017: $43 million, 2016: $44 million). For the year ended December 31, 2018, the net favorable prior year development was due to progressively increased weight given by management to experience based indications on older accident years. For the years ended December 31, 2017 and 2016, the net favorable prior year development was primarily due to progressively increased weight given by management to experience based indications on older accident years, which have generally been favorable.
For the year ended December 31, 2018, the insurance liability reserve class recorded net adverse prior year development of $22 million (2017: $8 million, 2016: $8 million). The net adverse prior year reserve development on the insurance liability reserve class in 2018 was primarily related to reserve strengthening within the Company's U.S. excess casualty book of business. The net adverse prior year reserve development in 2017 and 2016 was primarily attributable to reserve strengthening within the Company's run-off Bermuda excess casualty book of business.
For the year ended December 31, 2018, the reinsurance motor reserve class contributed net favorable prior year reserve development of $23 million (2017: $1 million 2016: $55 million). The net favorable prior year reserve development on the motor reserve class in 2018 was primarily attributable to U.K. non proportional treaty business on older accident years. The net favorable prior year development in 2017 was adversely impacted by the decrease in the discount rate used to calculate lump sum awards in U.K. bodily injury cases, known as the Ogden Rate, which changed from plus 2.5% to minus 0.75% effective March 20, 2017. The net favorable prior year reserve development on the motor reserve class in 2016 related to favorable loss emergence trends on several classes of business spanning multiple accident years.
The following tables present net incurred and paid claims development by accident year, total incurred-but-not-reported liabilities plus expected development on reported claims, cumulative reported claims frequency and claims duration for each reserve class. The loss development tables are presented on an accident year basis for the insurance and reinsurance segments. The Company does not discount unpaid losses and loss expense reserves.
At December 31, 2018, the Company included Novae and Aviabel business in the relevant loss development tables retrospectively from the date of acquisition.
To the extent that the Company enters into a disposition, the effects of the disposition are reported on a retrospective basis by removing the balances associated with the disposed of business.
The accident and health line of business includes accidental death, travel insurance and specialty health products for employer and affinity groups. The accident and health line of business contributed net premiums earned of $208 million to this reserve class for the year ended December 31, 2018. A large increase in reported claims related to this line of business was observed from 2012. In particular, an increase in limited benefits medical business written in 2017 has resulted in a significant increase in reported claims observed in that year.
This reserve class includes the marine line of business which provides cover for traditional marine classes, including offshore energy, cargo, liability, recreational marine, fine art, specie, and hull and war. Offshore energy coverage includes physical damage, business interruption, operators extra expense and liability coverage for all aspects of offshore upstream energy, from exploration and construction through the operation and distribution phases. The complex nature of claims arising under marine policies tends to result in reporting and payment patterns that are longer than those of the property and other class. Exposure to natural perils such as windstorm and earthquake can result in volatility.
With respect to key actuarial assumptions, the Company is progressively giving more weight to its own experience when establishing expected loss ratios and selecting loss development patterns, though it continues to consider industry benchmarks. Loss reporting patterns for professional lines business tend to be volatile, causing instability in actuarial indications based on incurred loss data until an accident year matures. Consequently, initial loss reserves for an accident year are generally based upon an ELR Method and the consideration of relevant qualitative factors. As accident years mature, the Company increasingly gives more weight to methods that reflect its actual experience until its selections are based almost exclusively on experience-based methods. The Company evaluates the appropriateness of the transition to experience-based methods at the reserve class level, commencing this transition when it believes that its incurred loss development is sufficient to produce meaningful actuarial indications. The rate at which the Company transitions fully to sole reliance on experience-based methods can vary by reserve
class and by year, depending on its assessment of the stability and relevance of such indications. For some professional lines in the insurance segment, the Company also relies upon the evaluation of the open claim inventory in addition to the commonly employed actuarial methods when establishing reserves.
The property line of business provides protection for property damage and related losses resulting from natural and man-made perils contained in underlying personal and commercial lines insurance policies written by the Company's cedants. The predominant exposure is to property damage, but other risks, including business interruption and other non-property losses, may also be covered when arising from a covered peril. The most significant perils covered by policies in this portfolio include windstorm, tornado and earthquake, but other perils such as freezes, riots, floods, industrial explosions, fires, hail and a number of other loss events are also included. The Company underwrites this business on a proportional and excess of loss basis.
As a result of the realignment of the Company's accident and health business, this reserve class also includes the accident and health line of business specifically specialty health, accidental death, travel, life and disability reinsurance products which are offered on a proportional and catastrophic or per life excess of events loss basis. The accident and health line of business contributed net premiums earned of $300 million to this reserve class for the year ended December 31, 2018.
In general, reporting and payment patterns are relatively short-tailed and can be volatile due to the incidence of catastrophe events such as hurricanes and earthquakes.
This reserve class includes the credit and surety line of business which provides reinsurance of trade credit insurance products and includes proportional and excess of loss structures. The underlying insurance indemnifies sellers of goods and services in the event of a payment default by the buyer of those goods and services. The Company provides credit insurance cover to mortgage guaranty insurers and government sponsored entities. Cover for losses arising from a broad array of surety bonds issued by insurers to satisfy regulatory demands or contract obligations in a variety of jurisdictions around the world is also offered.
Initial and most recent underwriting year loss projections are generally based on the ELR Method, with consideration given to qualitative factors. Given that there is a quicker and more stable reporting pattern for trade credit business, the Company generally commences the transition to experience-based methods sooner for trade credit business than for the surety business.
This reserve class includes the professional line of business which provides cover for directors' and officers' liability, employment practices liability, medical malpractice, professional indemnity, environmental liability and miscellaneous errors and omissions insurance risks. The underlying business is predominantly written on a claims-made basis. The Company underwrites this business on a proportional and excess of loss basis. Typically, this reserve class is anticipated to exhibit medium to long-tail claim reporting and payment patterns.
This reserve class includes the motor line of business which provides cover to insurers for motor liability and motor property damage losses arising from any one occurrence. A loss occurrence can involve one or many claimants where the ceding insurer aggregates the claims from the occurrence. This reserve class also includes discontinued lines - Novae specifically the motor reinsurance line of business that Novae exited or placed into run-off in the first quarter of 2017. The Company offers traditional proportional and non-proportional reinsurance as well as structured solutions predominantly relating to European exposures. The business written on a proportional basis has expanded significantly since 2010 and now represents the majority of the premium written within this line of business. Most of the premium relates to a relatively small number of large United Kingdom ("U.K.") and, to a lesser extent, Greek quota share treaties. The motor proportional class generally has a significantly shorter reported and payment pattern, relative to the motor non-proportional class. In 2017, the U.K. Ministry of Justice announced a decrease in the discount rate to be used to calculate lump sum awards in U.K. bodily injury cases, known as the Ogden Rate. Effective March 20, 2017, the Ogden rate changed from plus 2.5% to minus 0.75%. This resulted in an increase in projected ultimate losses, particularly related to recent accident years.
book. This also resulted in a move towards generally lower treaty attachment points and the inclusion of capitalization clauses on a number of U.K. motor treaties to help mitigate the lengthening of the development tail on more recent accident years. Despite the trend toward a greater number of claims settlements using PPOs, there has been a trend towards generally quicker and more adequate reporting of losses in recent years.
For the year ended December 31, 2018, the Company recognized ceded losses and loss expenses of $1,565 million (2017: $1,010 million; 2016: $556 million).
At December 31, 2018, the Company's provision for uncollectible amounts was $21 million (2017: $17 million; 2016: $20 million).
The Company has the option to redeem the Senior Notes at any time and from time to time, in whole or in part, at a ''make-whole'' redemption price, which is equal to the greater of the aggregate principal amount or the sum of the present values of the remaining scheduled payments of principal and interest. The related indentures contain various covenants, including limitations on liens on the stock of restricted subsidiaries, restrictions as to the disposition of the stock of restricted subsidiaries and limitations on mergers and consolidations. The Company was in compliance with all the covenants contained in the indentures at December 31, 2018.
Interest expense recognized in relation to Senior Notes includes interest payable, amortization of the offering discounts and amortization of debt offering expenses. The offering discounts and debt offering expenses are amortized over the period of time during which the Senior Notes are outstanding. For the year ended December 31, 2018, the Company incurred interest expense of $64 million (2017: $51 million, 2016: $50 million).
The scheduled maturity of the Company's aggregate amount of its debt obligation on its consolidated balance sheet at December 31, 2018 is shown in the following table:
On March 26, 2013, AXIS Capital and certain of its subsidiaries entered into a $250 million credit facility (the "Credit Facility"), which was issued by a syndication of lenders pursuant to a Credit Agreement and other ancillary documents (together, the "Facility Documents") and expired in March 2017. At the request of the Company and subject to the satisfaction of certain conditions, the aggregate commitment available under the Credit Facility could be increased by up to $150 million. Under the terms of the Credit Facility, loans were available for general corporate purposes and letters of credit could have been issued in the ordinary course of business, with total usage not to exceed the aggregate commitment available. Interest on loans issued under the Credit Facility was payable based on underlying market rates at the time of loan issuance. While loans under the Credit Facility were unsecured, the Company had the option to issue letters of credit on a secured basis in order to reduce associated fees. Letters of credit issued under the Credit Facility were principally used to support the (re)insurance obligations of the Company's operating subsidiaries. Each of AXIS Capital, AXIS Specialty Finance LLC, AXIS Specialty Holdings Bermuda Limited and AXIS Specialty Finance PLC guaranteed the obligations of the other parties to the Credit Facility. The Credit Facility was subject to certain non-financial covenants, including limitations on fundamental changes, the incurrence of additional indebtedness and liens and certain transactions with affiliates and investments, as defined in the Facility Documents. The Credit Facility also required compliance with certain financial covenants, including a maximum debt to capital ratio and a minimum consolidated net worth requirement. In addition, each of AXIS Capital’s material (re)insurance subsidiaries party to the Credit Facility had to maintain a minimum A.M. Best financial strength rating. In the event of default, including a breach of these covenants, the lenders had the right to exercise certain remedies, including the termination of the Credit Facility, the declaration of all principal and interest amounts related to Credit Facility loans to be immediately due and the requirement that all outstanding letters of credit be collateralized.
On November 20, 2013, certain of AXIS Capital’s operating subsidiaries (the "Participating Subsidiaries") entered into an amendment to extend the term of the Company's secured $750 million letter of credit facility (the "LOC Facility") with Citibank Europe plc ("Citibank") pursuant to a Master Reimbursement Agreement and other ancillary documents (together, the "LOC Facility Documents"). Under the terms of the LOC Facility, letters of credit to a maximum aggregate amount of $750 million are available for issuance on behalf of the Participating Subsidiaries. These letters of credit will principally be used to support the reinsurance obligations of the Participating Subsidiaries. The LOC Facility is subject to certain covenants, including the requirement to maintain sufficient collateral, as defined in the LOC Facility Documents, to cover all of the obligations under the LOC Facility. Such obligations include contingent reimbursement obligations for outstanding letters of credit and fees payable to Citibank. In the event of default, Citibank may exercise certain remedies, including the exercise of control over pledged collateral and the termination of the availability of the LOC Facility to any or all of the Participating Subsidiaries.
On March 28, 2018, the Participating Subsidiaries amended their existing $250 million secured letter of credit facility with Citibank Europe plc (the "$250 Million Facility") under their aggregate $750 million secured letter of credit facility with Citibank Europe plc (the "$750 million Facility") to extend the expiration date to March 31, 2019.
On December 29, 2017, the term loan was repaid and the letter of credit and revolving credit facility were terminated. For the year ended December 31, 2017, the Company recognized $1 million of interest expense in relation to the syndicated bank financing facility.
At December 31, 2018, the Company was in compliance with these limits.
The Company is exposed to the credit risk associated with reinsurance recoverable on unpaid and paid losses to the extent that any of its reinsurers fail to meet their obligations under reinsurance contracts. To help mitigate this risk, the Company's purchase of reinsurance is subject to financial security requirements specified by its Reinsurance Security Committee. This Committee maintains a list of approved reinsurers, performs credit risk assessments for potential new reinsurers, regularly monitors approved reinsurers with consideration for events which may have a material impact on their creditworthiness, recommends counterparty tolerance levels for different types of ceded business and monitors concentrations of credit risk. This assessment considers a wide range of individual attributes, including a review of the counterparty’s financial strength, industry position and other qualitative factors. Generally, the Committee requires that reinsurers who do not meet specified requirements provide collateral.
At December 31, 2018, the three largest balances by reinsurer accounted for 13%, 10% and 10% (2017: 12%, 11% and 7%) of reinsurance recoverable on unpaid and paid losses.
The diversity of the Company's client base limits the credit risk associated with its insurance and reinsurance premium balances receivable. In addition, for insurance contracts the Company has contractual rights to cancel cover for non-payment of premiums and for reinsurance contracts the Company has contractual rights to offset premium balances receivable against corresponding payments for losses and loss expenses.
The Company produces its business through brokers and direct relationships with insurance companies. For the year ended December 31, 2018, three brokers accounted for 43% (2017: 49%; 2016: 52%) of gross premiums written.
Marsh & McLennan Companies Inc. accounted for 17% (2017: 20%; 2016: 21%), Aon plc accounted for 17% (2017: 17%; 2016: 19%), and Willis Tower Watson PLC accounted for 9% (2017: 12%; 2016: 12%).
The Company operates in the Lloyd’s market through its corporate member AXIS Corporate Capital UK Limited, which represents its participation in Syndicate 1686 and Novae Corporate Underwriting Limited, the sole corporate member of Syndicate 2007. Lloyd’s sets capital requirements for corporate members annually through the application of a capital model that is based on regulatory rules pursuant to Solvency II.
At December 31, 2018, investments and cash of $1.3 billion (2017: $1.2 billion) were restricted to satisfy the Company's FAL requirements (refer to Note 6 'Investments' and Note 20 'Statutory Financial Information').
The following table presents changes in common shares issued and outstanding, excluding restricted stock units related to the Company's share-based compensation plans (refer to Note 16 'Share-Based Compensation'):
The following table presents common shares repurchased from shares held in treasury:
On November 23, 2005, the Company issued $250 million of 7.50% Series B preferred shares, par value $0.0125 per share, with a liquidation preference of $100.00 per share. The Company could redeem the Series B preferred shares on or after December 1, 2015 at a redemption price of $100.00 per share. Dividends on the Series B preferred shares were non-
cumulative. Holders of Series B preferred shares were entitled to receive, only when, as and if declared by the board of directors, non-cumulative cash dividends, from the original issue date, quarterly in arrears on the first day of March, June, September and December of each year, commencing on March 1, 2006, up to but not including January 27, 2016. To the extent declared, these dividends accumulated, with respect to each dividend period, in an amount per share equal to 7.50% of the liquidation preference per annum.
During April 2012, the Company closed a cash tender offer for any and all of the outstanding 7.50% Series B preferred shares at a purchase price of $102.81 per share. As a result, the Company purchased 2,471,570 Series B preferred shares for $254 million. In connection with this tender offer, a loss on redemption of $9 million was recognized in determining net income available to common shareholders.
In 2017, the total dividends declared and paid on Series C preferred shares were $0.4297 per share. In 2016, the total dividends declared and paid on Series C preferred shares were $1.7188 per share.
On November 7, 2016, the Company issued $550 million of 5.50% Series E preferred shares, par value $0.0125 per share, with a liquidation preference of $2,500 per share. The Company may redeem the Series E preferred shares on or after November 7, 2021 at a redemption price of $2,500 per share. Dividends on the Series E preferred shares are non-cumulative. Holders of the Series E preferred shares will be entitled to receive, only when, as and if declared by the board of directors, non-cumulative cash dividends from the original issue date, quarterly in arrears on the fifteenth day of January, April, July and October of each year, commencing on January 15, 2017. To the extent declared, these dividends will accumulate, with respect to each dividend period, in an amount per Series E preferred share equal to 5.50% of the liquidation preference per annum.
The following table provides an activity summary of the Company's share-settled RSUs:
(2) Share-settled restricted stock units that vested during the year ended December 31, 2017 included 313,391 service based restricted stock units which were granted in 2014 and were subject to a three year cliff vesting period.
In addition, the Company has invested $50 million in the Freedom Consumer Credit Fund, LLC Series B. The manager of this fund is Freedom Financial Asset Management, LLC ("Freedom") which is an indirect subsidiary of Pantheon Partners, LLC ("Pantheon"). Investment funds managed by Stone Point own approximately 14.5% of Pantheon. For the year ended December 31, 2018, fees paid to Freedom were $2 million (2017: $1 million).
The Company's Chairman, Mr. Butt received consulting fees for the year ended December 31, 2018 of $0.5 million (2017: $0.5 million; 2016: $0.6 million) pursuant to the terms of a consulting agreement by and between Mr. Butt and the Company dated May 3, 2012, as amended. The consulting agreement was further amended on December 5, 2018 to extend the term of the agreement to the Company's 2019 Annual General Meeting for an annual fee of $0.5 million.
The Company's investment portfolio includes certain investments where it is considered to have the ability to exercise significant influence over the operating and financial policies of the investee. Significant influence is generally deemed to exist where the Company has an investment of 20% or more in the common stock of a corporation or an investment of 3% or more in closed end funds, limited partnerships, LLCs or similar investment vehicles. At December 31, 2018, the Company has $450 million (2017: $451 million) of investments where it is deemed to have the ability to exercise such significant influence. The Company generally pays management and performance fees to the investment managers of these investments. The Company considers all fees paid to the investment managers to be at market rates consistent with negotiated arms-length contracts.
On November 5, 2013, the Company formed Ventures Re, a Bermuda domiciled insurer. With effect from January 1, 2015, Ventures Re is no longer consolidated in the financial statements of the Company. All of Ventures Re's directors are employees of the Company. In the normal course of business, the Company enters into certain reinsurance contracts with Ventures Re. For the year ended December 31, 2018, the Company ceded premiums of $182 million (2017: $107 million) and ceded losses of $138 million (2017: $126 million) to Ventures Re. In addition, Ventures Re paid certain acquisition costs and administrative fees to the Company. At December 31, 2018, the amount of reinsurance recoverable on unpaid and paid losses was $186 million (2017: $131 million) and the amount of ceded reinsurance payable included in insurance and reinsurance balances payable was $67 million (2017: $17 million) in the consolidated balance sheets. All transactions were conducted at market rates consistent with negotiated arms-length contracts.
Under current Bermuda law, the Company's Bermuda domiciled subsidiaries are not required to pay any taxes in Bermuda on income or capital gains. The Company has received an assurance from the Minister of Finance in Bermuda that, in the event of any taxes being imposed, it will be exempt from taxation in Bermuda until March 2035. The Company's primary Bermuda subsidiary has an operating branch in Singapore, which is subject to the relevant taxes in that jurisdiction. The branch is not under examination in this tax jurisdiction, but remains subject to examination for tax years 2015 through 2018.
In Canada, the Company's U.S. reinsurance company operates through a branch and its U.S. service company has an unlimited liability company subsidiary based in Canada. These Canadian operations are subject to the relevant taxes in that jurisdiction and remain subject to examination for tax years 2014 through 2018.
The Company also has subsidiaries in Ireland, the U.K., Belgium, the Netherlands, Luxembourg, Brazil and Dubai. In 2017, the Company ceased operations in Australia. These subsidiaries and their branches, are not under examination, but remain subject to examination in all applicable jurisdictions for tax years 2014 through 2018.
In the U.K., the Company has Lloyd’s syndicates whose income is subject to tax in the U.K. payable by its corporate members. The income from operations at Lloyd’s is also subject to taxes in other jurisdictions in which Lloyd's operates, including the U.S. Under a Closing Agreement between Lloyd’s and the IRS, Lloyd’s Members pay U.S. income tax on U.S. connected income written by Lloyd’s syndicates. To the extent that the Lloyd’s syndicates suffer taxes outside the U.K. they may claim a credit for foreign taxes suffered, limited to the U.K. equivalent tax on the same income.
Deferred income taxes reflect the tax impact of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. The significant components of deferred tax assets and liabilities were as follows:
On December 22, 2017, H.R.1, An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018 ("U.S. Tax Reform") was signed into law. U.S. Tax Reform, among other things, reduced the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018. Consequently, the Company reduced its net deferred tax assets at December 31, 2017 by $41.6 million.
As a result of U.S. tax reform, all alternative minimum tax credits will be refunded by tax year 2021.
At December 31, 2018 and 2017, the Company established a full valuation allowance on: (1) operating and capital loss carryforwards relating to operations in Singapore; (2) un-utilized foreign tax credits available in Ireland and (3) certain other deferred tax assets related to branch operations. At December 31, 2018, the Company established a valuation allowance on certain unrealized investment losses. In 2017, the valuation allowance was released on the Australian operating loss carryforwards, capital loss carryforwards, and other deferred tax assets upon the cessation of operations. The valuation allowance was reduced by a net $1.2 million for items unrelated to the Australian operations.
Although realization is not assured, management believes it is more likely than not that the tax benefit of the recorded net deferred tax assets will be realized. In evaluating the Company's ability to recover these tax assets within the jurisdiction from which they arise, it considered all available positive and negative evidence, including historical results, operating loss carry-back potential and scheduled reversals of deferred tax liabilities. The Company believes its U.S. and U.K. operations will produce significant taxable income in future periods and have deferred tax liabilities that will reverse in future periods, such that the Company believes sufficient ordinary taxable income is available to utilize all remaining ordinary deferred tax assets.
At December 31, 2018 and 2017, there were no unrecognized tax benefits.
At December 31, 2018 and 2017, the statutory capital and surplus in each of the Company's most significant regulatory jurisdictions are shown in the following table:
The Company's Irish subsidiaries may declare dividends subject to meeting their solvency and capital requirements. The maximum dividend is limited to "excess eligible own funds" which is defined as excess Solvency II capital over the SCR and may also be limited to "profits available for distribution'', which is defined as accumulated realized profits less accumulated realized losses and statutory reserves. At December 31, 2018, the maximum dividend the Company's Irish subsidiaries could pay, having met their solvency and capital requirements was approximately $37 million (2017: $52 million).
The Company's U.S. operations required statutory capital and surplus is determined using the risk-based capital formula ("RBC"), which is the National Association of Insurance Commissioners' (the "Commissioner") method of measuring the minimum capital appropriate for U.S. reporting entities to support its overall business operations in consideration of its size and risk profile. If a company falls below the authorized control level as determined under the RBC, the Commissioner is authorized to take whatever regulatory actions may be considered necessary to protect policyholders and creditors. The maximum dividend that may be paid by the Company's U.S. insurance subsidiaries is restricted by the regulatory requirements of the domiciliary states. Generally, the maximum dividend that may be paid by each of the Company's U.S. insurance subsidiaries is limited to unassigned surplus (statutory equivalent of retained earnings) and may also be limited to statutory net income, net investment income or 10% of total statutory capital and surplus. At December 31, 2018, the maximum dividend that the Company's U.S. insurance operations could pay without regulatory approval was approximately $130 million (2017: $115 million).
The capital provided to support underwriting, or FAL is not available for distribution for the payment of dividends or for working capital requirements. Corporate members may also be required to maintain funds under the control of Lloyd’s in excess of their capital requirements and such funds also may not be available for distribution for the payment of dividends. Lloyd’s sets the corporate members’ required capital annually through the application of a capital model that is based on regulatory rules pursuant to Solvency II.
FAL may be satisfied by cash, certain investments and letters of credit provided by approved banks. At December 31, 2018, fixed maturities and short term investments with a fair value of $715 million (2017: $557 million) and cash of $8 million (2017: $12 million), respectively, were restricted to satisfy AXIS Corporate Capital UK Limited FAL requirements. At
Each year, corporate members can apply to Lloyd's to release accumulated funds, whether syndicate profits or interest on FAL, which are in excess of the agreed FAL requirements. At December 31, 2018 and 2017, actual capital and assets exceeded the FAL requirements for Syndicates 1686 and 2007.
During 2018, Syndicate 1686 and 2007 did not apply to release funds for the year ended December 31, 2017. During 2017, the release of funds for Syndicate 1686 for the year ended December 31, 2016 was $1.6 million and the release of funds for Syndicate 2007 for the year ended December 31, 2016 was $41 million.
The Company's operating subsidiaries in Bermuda and the U.S. maintain branch offices in Singapore and Canada, respectively. The Company's Irish operating subsidiaries maintain branch offices in Switzerland and the U.K. In 2017, the Company ceased operations in Australia. As branch offices are not considered separate entities for regulatory purposes, the required and actual statutory capital and surplus amounts for each jurisdiction in the table above include amounts related to the applicable branch offices. The Company's branch offices in Singapore and Canada are subject to additional minimum capital or asset requirements in their countries of domicile. At December 31, 2018 and 2017, the actual capital/assets for each of these branches exceeded the relevant local regulatory requirements.