The summary Consolidated Statements of Comprehensive Income data for the years ended December 31, 2014, December 31, 2013, December 31, 2012, December 31, 2011 and December 31, 2010 and the summary Consolidated Balance Sheet data as of December 31, 2014, December 31, 2013, December 31, 2012, December 31, 2011 and December 31, 2010 are derived from our audited Consolidated Financial Statements. The Company was formed on October 19, 2005 and completed the acquisitions of Talbot, IPC, Flagstone and Western World on July 2, 2007, September 4, 2009, November 30, 2012 and October 2, 2014, respectively. Flagstone is included in the Company's consolidated results for the one month ended December 31, 2012 and for subsequent fiscal year ends. Western World is included in the Company's consolidated results from the October 2, 2014 date of acquisition.
The losses and loss expenses ratio is calculated by dividing losses and loss expenses by net premiums earned.
The policy acquisition costs ratio is calculated by dividing policy acquisition costs by net premiums earned.
The general and administrative expenses ratio is calculated by dividing the sum of general and administrative expenses and share compensation expenses by net premiums earned.
Return on average equity is calculated by dividing the net income available to Validus for the period by the average of the beginning, ending and intervening quarter end shareholders’ equity available to Validus balances.
Property and other reinsurance premiums have historically risen in the aftermath of significant catastrophic losses. As loss reserves are established, industry surplus is depleted and the industry’s capacity to write new business diminishes. At the same time, management believes that there is a heightened awareness of exposure to natural catastrophes on the part of cedants, rating agencies and catastrophe modeling firms, resulting in an increase in the demand for reinsurance protection. The global property and casualty insurance and reinsurance industry has historically been highly cyclical. Since 2007, increased capital provided by new entrants or by the commitment of capital by existing insurers and reinsurers increased the supply of insurance and reinsurance which resulted in a softening of rates on most lines. During 2010 and 2011, there was an increased level of catastrophe activity, principally the Chilean earthquake, Deepwater Horizon, Tohoku and New Zealand earthquake events, but the Company continues to see increased competition and decreased premium rates in most classes of business.
During the January 2015 renewal season, the Validus Re and AlphaCat segments underwrote $540.9 million in gross premiums written (net of intercompany eliminations between Validus Re and AlphaCat), a decrease of 6.0% from the prior period. This decrease was primarily driven by a challenging rate environment in the Company's U.S. and European property catastrophe business, which experienced a reduction in rates of approximately 10-15%.
dividends is calculated based on total shareholders’ equity plus the assumed proceeds from the exercise of outstanding options and warrants, divided by the sum of common shares, unvested restricted shares and options and warrants outstanding (assuming their exercise), plus accumulated dividends. Book value per diluted common share plus accumulated dividends is a non-GAAP financial measure, as described in more detail in the section entitled “Non-GAAP Financial Measures.”
Book value per diluted common share is considered by management to be a measure of returns to common shareholders, as we believe growth in book value on a diluted basis ultimately translates into growth in stock price. Book value per diluted common share after dividends paid increased by $3.43, or 9.5%, from $36.23 at December 31, 2013 to $39.66 at December 31, 2014. Growth in book value per diluted common share inclusive of dividends was 12.8% for the year ended December 31, 2014. Book value per diluted common share is a non-GAAP financial measure, as described in more detail in the section entitled “Non-GAAP Financial Measures.”
Annualized return on average equity represents the return generated on common shareholders’ capital during the period. Return on average equity is calculated by dividing the net income available to Validus for the period by the average shareholders’ equity available to Validus during the period. Average shareholders’ equity is the average of the beginning, ending and intervening quarter end shareholders’ equity balances. The Company’s objective is to generate superior returns on capital that appropriately reward shareholders for the risks assumed. The annualized return on average equity for the years ended December 31, 2014 and 2013 was 13.1% and 14.0%, respectively.
Gross premiums written for the three months ended December 31, 2014 were $336.6 million compared to $237.3 million for the three months ended December 31, 2013, an increase of $99.4 million, or 41.9%.
Net premiums earned for the three months ended December 31, 2014 were $558.7 million compared to $492.2 million for the three months ended December 31, 2013, an increase of $66.5 million, or 13.5%.
Loss ratio for the three months ended December 31, 2014 was 40.5% compared to 41.9% for the three months ended December 31, 2013.
Losses and loss expenses from notable loss events for the three months ended December 31, 2014 was $6.8 million compared to ($1.9) million for the three months ended December 31, 2013, an increase of $8.7 million.
Net investment income for the three months ended December 31, 2014 was $30.2 million compared to $24.2 million for the three months ended December 31, 2013, an increase of $6.0 million, or 24.6%.
Net operating income available to Validus for the three months ended December 31, 2014 was $129.0 million compared to $100.1 million for the three months ended December 31, 2013, an increase of $29.0 million, or 29.0%.
Gross premiums written increased $99.4 million for the three months ended December 31, 2014 compared to the three months ended December 31, 2013. This increase primarily relates to the acquisition of Western World. Gross premiums written by Western World were $65.2 million for the three months ended December 31, 2014. In addition, gross premiums written by Validus Re and Talbot increased by $22.5 million and $11.1 million, respectively, during the three months ended December 31, 2014. These increases were primarily due to premium adjustments and additional premium signings, respectively.
Net premiums earned increased $66.5 million for the three months ended December 31, 2014 compared to the three months ended December 31, 2013. This increase primarily relates to the acquisition of Western World. Net premiums earned for the Western World segment were $73.0 million for the three months ended December 31, 2014.
The current period loss ratio, excluding notable and non-notable loss events, for the three months ended December 31, 2014 was 52.7% compared to 49.1% for the three months ended December 31, 2013.
Full Year 2014 Summarized Consolidated Results of Operations and Financial Condition
Gross premiums written for the year ended December 31, 2014 were $2.363 billion compared to $2.401 billion for the year ended December 31, 2013, a decrease of $37.8 million, or 1.6%.
Loss ratio for the year ended December 31, 2014 was 38.6% compared to 37.8% for the year ended December 31, 2013.
Net income available to Validus for the year ended December 31, 2014 was $481.3 million, or $5.08 per diluted common share compared to $532.7 million or $4.94 per diluted common share for the year ended December 31, 2013.
Total cash and cash equivalents, restricted cash and investments less assets held in trust on behalf of operating affiliates, catastrophe bonds and non-controlling interest as at December 31, 2014 was $7.1 billion compared to $7.1 billion as at December 31, 2013.
Overview of the Results of Operations for Years Ended December 31, 2014 and December 31, 2013 compared to the Years Ended December 31, 2013 and December 31, 2012, respectively.
The change in net operating income available to Validus for the years ended December 31, 2014 and December, 31 2013 as compared to the years ended December 31, 2013 and December 31, 2012, respectively, is described in the following table:
The results of operations for Flagstone are consolidated from the November 30, 2012 date of acquisition.
Net operating income available to Validus for the year ended December 31, 2014 was $486.5 million compared to $589.4 million for the year ended December 31, 2013, a decrease of $103.0 million. The primary factors driving the decrease in net operating income available to Validus were:
An increase in income attributable to operating affiliate investors of $40.6 million; offset by,
An increase in general and administrative expenses of $51.6 million, due primarily to costs associated with the run-off of the former Flagstone business and an increase in average headcount;
Management has determined that the Company operates in four reportable segments Validus Re, AlphaCat, Talbot and Western World. For segmental reporting purposes, the results of Flagstone’s operations since November 30, 2012 have been included within the Validus Re segment in the Consolidated Financial Statements. The results of Western World have been included in the consolidated results from the October 2, 2014 date of acquisition.
Gross premiums written for the three months ended December 31, 2014 were $32.7 million compared to $10.3 million for the three months ended December 31, 2013, an increase of $22.5 million, or 219.4%. Gross premiums written for the three months ended December 31, 2014 included $14.0 million of property premiums, $15.3 million of marine premiums and $3.5 million of specialty premiums; compared to $17.2 million of property premiums and $nil of marine premiums, offset by ($6.9) million of specialty premiums for the three months ended December 31, 2013.
Underwriting income for the three months ended December 31, 2014 was $112.3 million compared to income of $77.1 million for the three months ended December 31, 2013, an increase of $35.2 million, or 45.7%.
The loss ratio for the three months ended December 31, 2014 was 25.8% compared to 44.2% for the three months ended December 31, 2013, a decrease of 18.4 percentage points. The loss ratio for the three months ended December 31, 2014 included favorable loss reserve development on prior accident years of $30.8 million, decreasing the loss ratio by 13.3 percentage points. The loss ratio for the three months ended December 31, 2013 included unfavorable loss reserve development on prior accident years of $3.4 million, increasing the loss ratio by 1.3 percentage points.
Losses and loss expenses from a notable loss event for the three months ended December 31, 2014 was $6.8 million compared to $nil for the three months ended December 31, 2013.
Net investment income for the three months ended December 31, 2014 was $18.3 million compared to $19.6 million for the three months ended December 31, 2013, a decrease of $1.3 million, or 6.4%.
The change in net operating income for the years ended December 31, 2014 and December, 31 2013 as compared to the years ended December 31, 2013 and December 31, 2012, respectively, is described in the following table:
Other underwriting deductions consist of policy acquisition costs, general & administration expenses and share compensation expenses.
Other operating income and expenses, net, consists of net investment income, other insurance related income, finance expenses and taxes.
Losses and loss expenses from notable loss events for the year ended December 31, 2014 was $22.5 million from a single notable loss event, Tripoli Airport, which represented 2.4 percentage points of the loss ratio. Net of $3.0 million of reinstatement premiums, the effect of this event on net operating income was a reduction of $19.5 million. Losses and loss expenses from notable loss events for the year ended December 31, 2013 was $55.3 million also from a single notable loss event, the European Floods, which represented 4.9 percentage points of the loss ratio. Net of $4.8 million of reinstatement premiums, the effect of this event on net operating income was a $50.5 million reduction.
The marine lines current year loss ratio, excluding the impact of notable and non-notable loss events, decreased by 2.1 percentage points as a result of lower attritional losses in the current year. The favorable development of $6.8 million, on prior accident years for the year ended December 31, 2014, was primarily due to lower claims emergence on attritional losses; whereas, the unfavorable development of $26.7 million, on prior accident years for the year ended December 31, 2013, was primarily due to adverse development on both Costa Concordia and Deepwater Horizon.
During the year ended December 31, 2014, the specialty lines incurred $22.4 million of losses and loss expenses from a single notable loss event, Tripoli Airport, which represented 8.0 percentage points of the specialty lines loss ratio. Net of $3.0 million of reinstatement premiums, the effect of this event on net operating income was a reduction of $19.4 million. In comparison, the specialty lines incurred no losses and loss expenses from notable loss events during the year ended December 31, 2013.
The specialty lines current year loss ratio, excluding the impact of notable and non-notable loss events, decreased by 3.9 percentage points as a result of lower attritional losses in the current year.
The underwriting results of an insurance or reinsurance company are often measured by reference to its combined ratio, which is the sum of the losses and loss expenses ratio and the expense ratio. The losses and loss expenses ratio is calculated by dividing losses and loss expenses incurred (including estimates for incurred but not reported losses) by net premiums earned. The expense ratio is calculated by dividing acquisition costs combined with general and administrative expenses by net premiums earned. The following table presents the losses and loss expenses ratio, policy acquisition costs ratio, general and administrative expenses ratio, expense ratio and combined ratio for the years ended December 31, 2014, 2013 and 2012.
The results of operations from Flagstone are consolidated from the November 30, 2012 date of acquisition.
Finance expenses for the year ended December 31, 2014 and 2013 were comparable.
Gross premiums written from our consolidated entities, including PaCRe, for the three months ended December 31, 2014 were $0.1 million compared to $0.3 million for the three months ended December 31, 2013, a decrease of $0.1 million.
Other insurance related income for the three months ended December 31, 2014 was $5.6 million compared to $9.0 million for the three months ended December 31, 2013, a decrease of $3.3 million.
Income attributable to operating affiliate investors for the three months ended December 31, 2014 and 2013 was $26.6 million.
The change in net operating income available to Validus for the years ended December 31, 2014 and December, 31 2013 as compared to the years ended December 31, 2013 and December 31, 2012, respectively, is described in the following table.
Other operating income and expenses, net, consists of net investment income, other insurance related income, finance expenses, taxes and income (loss) from operating affiliates.
Non-GAAP Financial Measures. In presenting the Company’s results, management has included and discussed underwriting and operating income that are not calculated under standards or rules that comprise U.S. GAAP. Such measures are referred to as non-GAAP. Non-GAAP measures may be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. Further discussion of these measures is presented in the section entitled “Non-GAAP Financial Measures.”
AlphaCat reinsurance premiums ceded for the year ended December 31, 2014 were $4.3 million compared to $0.5 million for the year ended December 31, 2013. The reinsurance was purchased due to the availability of attractively priced coverage.
The decrease in net premiums earned in the property lines was due to lower mid-year renewals in 2014 compared to 2013.
The increase in general and administrative expenses of $0.8 million or 4.4% was due primarily to an increase in professional fees relating to PaCRe.
The decrease in finance expenses of $2.2 million or 38.2% was primarily due to non-recurring finance costs incurred of $1.9 million during the year ended December 31, 2013.
For details of voting and equity ownership interests of the above entities, refer to Note 9 to the Consolidated Financial Statements in Part II, Item 8. The increase in income from operating affiliates for the year ended December 31, 2014 was primarily due to the deconsolidation of one of the AlphaCat ILS funds in the first quarter of 2014.
Income attributable to operating affiliate investors was $40.6 million higher, reflecting the increased transfer of economics as a result of the deconsolidation of one of the AlphaCat ILS funds in the first quarter of 2014. This balance represents the transfer of investors' economic interest in the non-consolidated affiliated entities and includes both the Company's and third-party investors' share.
For the year ended December 31, 2014, the net operating income attributable to noncontrolling interest was $6.8 million, which comprised $3.2 million relating to 90% of the net operating income in PaCRe for the year and $3.6 million of net operating income relating to the consolidated AlphaCat ILS funds.
Gross premiums written for the three months ended December 31, 2014 were $247.4 million compared to $236.4 million for the three months ended December 31, 2013, an increase of $11.1 million, or 4.7%. Gross premiums written for the three months ended December 31, 2014 included $76.1 million of property premiums, $72.9 million of marine premiums and $98.4 million of specialty premiums compared to $60.9 million of property premiums, $75.1 million of marine premiums and $100.4 million of specialty premiums for the three months ended December 31, 2013.
Net premiums earned for the three months ended December 31, 2014 were $221.2 million compared to $204.3 million for the three months ended December 31, 2013, an increase of $16.9 million, or 8.3%.
Combined ratio for the three months ended December 31, 2014 was 96.8% compared to 86.8% for the three months ended December 31, 2013.
The loss ratio for the three months ended December 31, 2014 was 53.6% compared to 46.4% for the three months ended December 31, 2013, an increase of 7.2 percentage points. The loss ratio for the three months ended December 31, 2014 included favorable loss reserve development on prior accident years of $42.0 million, benefiting the loss ratio by 19.0 percentage points. The loss ratio for the three months ended December 31, 2013 included favorable loss reserve development on prior accident years of $37.0 million, benefiting the loss ratio by 18.1 percentage points.
Net investment income for the three months ended December 31, 2014 was $6.3 million compared to $4.6 million for the three months ended December 31, 2013, an increase of $1.7 million, or 37.0%.
The following table presents results of operations for the years ended December 31, 2014, 2013 and 2012:
The change in net operating income for the years ended December 31, 2014 and December 31, 2013 as compared to the years ended December 31, 2013 and December 31, 2012, respectively, is described in the following table:
Non-GAAP Financial Measures. In presenting the Company’s results, management has included and discussed underwriting income and operating income that is not calculated under standards or rules that comprise U.S. GAAP. Such measures are referred to as non-GAAP. Non-GAAP measures may be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. Further discussion of the measures is presented in the section entitled “Non-GAAP Financial Measures.”
The decrease in gross premiums written in the property lines of $8.6 million was primarily due to a net decrease in the property treaty lines of $33.9 million, of which $28.2 million related to the Latin American business now being written directly through Validus Re Swiss. This business was previously written by Talbot and ceded to Validus Re. This decrease was partially offset by an increase in the direct property and construction lines of $20.4 million and $5.2 million, respectively, due to new business and premium adjustments. The increase in gross premiums written in the marine lines of $11.5 million was due primarily to an increase in the cargo lines of $11.2 million as a result of additional premium signings. The increase in gross premiums written in the specialty lines of $7.0 million was partially due to an increase on political risk lines of $6.3 million. In particular, the political risk lines increase was in part due to the expanding crisis management book and the employment of two new underwriters.
The decrease in reinsurance premiums ceded in the property lines of $30.0 million was due primarily to a decrease in the property treaty lines of $22.7 million due to lower quota share premiums as a result of underlying Latin American business now being written directly through Validus Re Swiss. This business was previously written by Talbot and ceded to Validus Re. Also contributing to the decrease was a reduction in the energy onshore lines of $6.0 million due to changes in the excess of loss program and structure. The decrease in the specialty lines of $4.4 million was primarily due to a decrease in the aviation direct lines of $4.3 million.
The property ratio increased by 7.8 percentage points due to the Latin American business being written directly through Validus Re Swiss. This business was previously written through Talbot and ceded to Validus Re.
The changes in the net premiums earned were consistent with the pattern of net premiums written influencing the earned premiums for the year ended December 31, 2014 compared to the year ended December 31, 2013.
Losses and loss expenses from notable loss events for the year ended December 31, 2014 was $12.5 million from a single notable loss event, Tripoli Airport, which represented 1.4 percentage points of the loss ratio. Net of $0.8 million of reinstatement premiums, the effect of this event on net operating income was a reduction of $11.7 million. Losses and loss expenses from notable loss events for the year ended December 31, 2013 was $4.7 million also from a single notable loss event, the European Floods, which represented 0.6 percentage points of the loss ratio. Net of $0.3 million of reinstatement premiums, the effect of this event on net operating income was a $4.4 million reduction.
The property lines incurred no losses and loss expenses from notable loss events during the year ended December 31, 2014. In comparison, for the year ended December 31, 2013 the property lines incurred $3.7 million of losses and loss expenses from a single notable loss event, the European Floods, which represented 1.9 percentage points of the property lines loss ratio. Net of $0.3 million of reinstatement premiums, the effect of this event on net operating income was a reduction of $3.4 million.
During the year ended December 31, 2014, the marine lines incurred $0.2 million of losses and loss expenses from a single notable loss event, Tripoli Airport, which represented 0.1 percentage point of the marine lines loss ratio. In comparison, for the year ended December 31, 2013 the marine lines incurred $1.0 million of losses and loss expenses from a single notable loss event, the European Floods, which represented 0.3% percentage points of the marine lines loss ratio.
During the year ended December 31, 2014, the specialty lines incurred $12.3 million of losses and loss expenses from a single notable loss event, Tripoli Airport, which represented 4.0 percentage points of the specialty lines loss ratio. Net of $0.8 million of reinstatement premiums, the effect of this event on net operating income was a reduction of $11.5 million. In comparison, the specialty lines incurred no losses and loss expenses from notable loss events during the year ended December 31, 2013.
General and administrative expenses increased by $14.4 million due to salary increases, an increase in overall headcount from 306 employees at December 31, 2013 to 317 employees at December 31, 2014 and a strengthening of the British pound against the U.S. dollar compared to the prior year. The increase in share compensation expenses of $1.7 million or 18.0% was primarily due to a higher level of awards being issued in 2013 compared to earlier years.
Net investment income for the year ended December 31, 2014 increased by $2.5 million or 13.9% as a result of enhancements to our asset allocation strategy.
The liability lines consists largely of commercial package liability, program and other liability business. Western World discontinued writing binding authority commercial auto business during the three months ended December 31, 2014.
The Western World reinsurance program includes various treaties: a binding authority excess of loss, brokerage casualty, brokerage professional, property per risk excess of loss and property catastrophe excess of loss.
Net premiums written and the net retention ratio were driven by the factors highlighted above in respect of gross premiums written and reinsurance premiums ceded.
Upon closing the acquisition, an adjustment of $15,586 was made to increase net reserves to reflect fair value. This adjustment was amortized to income through a reduction in losses and loss expenses of $4,607 during the year ended December 31, 2014, benefiting the loss ratio by 6.3% points. The remaining fair value adjustment will be amortized in 2015.
Upon closing the acquisition, an adjustment of $15,586 was made to increase net reserves to reflect fair value. This adjustment was amortized to income through a reduction in losses and loss expenses of $4,607 during the year ended December 31, 2014. The remaining fair value adjustment will be amortized in 2015.
There were no notable loss events for the year ended December 31, 2014.
Upon closing the acquisition, an adjustment of $409 was made to decrease net reserves to reflect fair value. This adjustment was amortized to income through an increase in losses and loss expenses of $121 during the year ended December 31, 2014, increasing the loss ratio by 1.1% points. The remaining fair value adjustment will be amortized in 2015.
Upon closing the acquisition, an adjustment of $409 was made to decrease net reserves to reflect fair value. This adjustment was amortized to income through an increase in losses and loss expenses of $121 during the year ended December 31, 2014. The remaining fair value adjustment will be amortized in 2015.
The property lines current year loss ratio, excluding the impact of notable and non-notable loss events, was 69.8 percentage points, representing attritional claims experienced during the year. The property lines experienced adverse loss reserve development of $1.0 million during the year ended December 31, 2014.
Upon closing the acquisition, an adjustment of $15,995 was made to increase net reserves to reflect fair value. This adjustment was amortized to income through a reduction in losses and loss expenses of $4,728 during the year ended December 31, 2014, benefiting the loss ratio by 7.7% points. The remaining fair value adjustment will be amortized in 2015.
Upon closing the acquisition, an adjustment of $15,995 was made to increase net reserves to reflect fair value. This adjustment was amortized to income through a reduction in losses and loss expenses of $4,728 during the year ended December 31, 2014. The remaining fair value adjustment will be amortized in 2015.
The liability lines current year loss ratio, excluding the impact of notable and non-notable loss events, was 88.2 percentage points, representing attritional claims experienced during the year. The liability lines experienced favorable loss reserve development of $12.3 million during the year ended December 31, 2014 primarily due to lower than expected development on attritional losses and loss expenses in several liability lines.
The property acquisition cost ratio for the year ended December 31, 2014 was 5.4% and the liability acquisition cost ratio for the year ended December 31, 2014 was 4.1%.
The following non-operating income and expense items are discussed on a consolidated basis, since management does not include these items when assessing the results of its operating segments.
The movement in the net realized and change in net unrealized (losses) gains on investments of $20.3 million was due to a favorable movement in net realized and unrealized (losses) gains on fixed maturity and short term investments of $64.2 million and an unfavorable movement in net realized and unrealized (losses) gains on other investments of ($43.9) million.
For the year ended December 31, 2014, net loss attributable to noncontrolling interest was $35.5 million, which was comprised of operating income of $6.8 million, as discussed in the AlphaCat Segment Results of Operations, and non-operating loss of $42.3 million, primarily on the investment portfolio within PaCRe.
Operating income indicates the performance of the Company’s core underwriting function, excluding revenues and expenses such as the reconciling items in the table above. The Company believes the reporting of operating income enhances the understanding of results by highlighting the underlying profitability of the Company’s core insurance and reinsurance business. This profitability is influenced significantly by earned premium growth, adequacy of the Company’s pricing and loss frequency and severity. Over time it is also influenced by the Company’s underwriting discipline, which seeks to manage exposure to loss through favorable risk selection and diversification, its management of claims, its use of reinsurance and its ability to manage its expense ratio, which it accomplishes through its management of acquisition costs and other underwriting expenses.
The Company excludes the U.S. GAAP measures noted above, in particular net realized and unrealized gains and losses on investments, from its calculation of operating income because the amount of these gains and losses is heavily influenced by, and fluctuates in part, according to availability of investment market opportunities. The Company believes these amounts are largely independent of its core underwriting activities and including them distorts the analysis of trends in its operations. In addition to presenting net income determined in accordance with U.S. GAAP, the Company believes that showing operating income provides investors with a valuable measure of profitability and enables investors, analysts, rating agencies and other users of its financial information to more easily analyze the Company’s results of operations in a manner similar to how management analyzes the Company’s underlying business performance.
In presenting the Company's results, management has also included and discussed certain schedules containing book value per diluted common share and book value per diluted common share plus accumulated dividends that are not calculated under standards or rules that comprise U.S. GAAP. Such measures are referred to as non-GAAP and may be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP.
with our overall enterprise-risk framework. At December 31, 2014, the Company’s total investment portfolio had an average credit quality rating of AA- (December 31, 2013: AA-) and an effective yield of 1.53% for the year then ended (December 31, 2013: 1.38%). The estimated fair value of investment grade fixed maturities, as at December 31, 2014 was $4.9 billion, or 89.2% of the fixed maturity portfolio, compared to $4.8 billion as at December 31, 2013, or 86.0%, an increase of $0.2 billion, or 3.6%. The estimated fair value of non-investment grade fixed maturities as at December 31, 2014 was $599.0 million compared to $777.7 million as at December 31, 2013, a decrease of $178.7 million, or 23.0%.
The Company manages its corporate debt securities by limiting its exposure to any single issuer, excluding government and agency securities, based on credit rating, ranging from 3.5% to 0.5% of total cash and investments. At December 31, 2014, the Company did not have an aggregate exposure to any single issuer of more than 1.0% other than with respect to government and agency securities. The top ten exposures to fixed income corporate issuers at December 31, 2014 are as follows:
Investment ratings are the median of Moody's, Standard & Poor's and Fitch, presented in Standard & Poor's equivalent rating. For investments where three ratings are unavailable, the lower of the ratings shall apply, presented in Standard & Poor's equivalent rating.
During 2014, the Company received partial returns of investment from AlphaCat Re 2011, AlphaCat Re 2012, AlphaCat 2013 and the AlphaCat ILS funds of $5.8 million, $1.5 million, $52.8 million and $12.4 million, respectively. Offsetting these returns were contributions of capital to AlphaCat 2015, the AlphaCat ILS funds and Aquiline of $25.6 million, $12.0 million and $12.5 million, respectively. The Company expects to receive further returns of investment in 2015 from AlphaCat Re 2011, AlphaCat Re 2012, AlphaCat 2013 and AlphaCat 2014.
At December 31, 2014, gross and net reserves for losses and loss expenses were estimated using the methodology as outlined in the Critical Accounting Policies and Estimates section below. The following tables indicate the breakdown of gross and net reserves for losses and loss expenses between lines of business and between case reserves and IBNR.
The following table sets forth a reconciliation of gross and net reserves for losses and loss expenses by segment for the year ended December 31, 2014.
The management of insurance and reinsurance companies use significant judgment in the estimation of reserves for losses and loss expenses. Given the magnitude of some notable loss events and other uncertainties inherent in loss estimation, meaningful uncertainty remains regarding the estimation for these events. The Company's actual ultimate net loss may vary materially from these estimates. Ultimate losses for notable loss events are estimated through detailed review of contracts which are identified by the Company as potentially exposed to the specific notable loss event. However, there can be no assurance that the ultimate loss
For disclosure purposes, only those notable loss events which had an initial ultimate loss estimate above $30.0 million are disclosed separately and included in the reserves for notable loss event roll forward table below. To the extent that there are increased complexity and volatility factors relating to notable loss events in the aggregate, additions to the RDE may be established for a specific accident year. The Company increased the threshold for disclosure for notable loss events effective January 1, 2011, from $5.0 million to $15.0 million and further increased the threshold effective January 1, 2013 from $15.0 million to $30.0 million. Non-notable losses events which aggregate to more than $15.0 million but less than $30.0 million on a consolidated basis have been disclosed from January 1, 2013.
The reserves for notable loss events table below does not disclose 2010 or 2011 notable loss events. Deepwater Horizon, a 2010 event, had closing reserves of $63.4 million at December 31, 2014, excluding reserves assumed as part of the Flagstone acquisition. The New Zealand earthquakes of 2010 and 2011, had total closing reserves of $95.2 million at December 31, 2014, excluding reserves assumed as part of the Flagstone acquisition.
As at September 30, 2014, the initial estimate for Tripoli Airport was below the $30.0 notable loss event threshold; however, during the fourth quarter of 2014 adverse development caused this event to exceed the notable loss event threshold.
During the year ended December 31, 2012, $18.6 million was allocated to Deepwater Horizon from the 2010 reserve for development on notable loss events. During the same period, $16.3 million was allocated to the Tohoku earthquake, $20.1 million was allocated to the New Zealand earthquake, $7.7 million was allocated to the Danish flood and $14.3 million was allocated to the Thailand floods and $5.4 million was allocated to the Gryphon Alpha mooring failure from the 2011 reserve for development on notable loss events.
Notable loss events for the year ended December 31, 2012 were Costa Concordia, Cat 67, U.S. drought, Hurricane Isaac and Hurricane Sandy.
Notable loss event for the year ended December 31, 2014 was the Tripoli Airport.
During the year ended December 31, 2012, several of the 2011 notable loss events, principally the Tohoku earthquake and the New Zealand earthquake, continued to experience adverse development. Therefore, rather than deteriorate the 2011 RDE proportionately, an additional allocation of $27.9 million was made to the 2011 RDE based on the potential for further adverse development on the 2011 notable loss events.
RDE is included as part of the Company's overall reserve requirement as defined and disclosed in the Critical Accounting Policies and Estimates section.
In addition to relying on premiums received and investment income from the investment portfolio, the Company intends to meet these cash flow demands by carrying a substantial amount of short and medium term investments that would mature, or possibly be sold, prior to the settlement of expected liabilities. The Company cannot provide assurance, however, that it will successfully match the structure of its investments with its liabilities due to uncertainty related to the timing and severity of loss events.
There are three main sources (uses) of cash flows for the Company: operating activities, investing activities and financing activities. The movement in net cash provided by or used in operating, investing and financing activities and the effect of foreign currency rate changes on cash and cash equivalents for the years ended December 31, 2014, 2013 and 2012 is provided in the following table.
Net cash provided by operating activities during the year ended December 31, 2014 was $241.8 million compared to $265.3 million for year ended December 31, 2013, an unfavorable movement of $23.5 million. This unfavorable movement reflects the lower level of business written in the current year and returns on investments made to third party investors in operating affiliates.
Cash flow from investing activities is derived primarily from the receipt of net proceeds on the Company’s investment portfolio. As at December 31, 2014, the Company’s portfolio was composed of fixed income investments, short-term and other investments amounting to $7.4 billion or 90.8% of total cash and investments. For further details related to investments pledged as collateral, see Note 7 (d) to the Consolidated Financial Statements in Part II, Item 8.
Cash flow from financing activities is derived primarily from the issuance and purchase of shares in the Company and its subsidiaries, and the issuance and repayment of notes to operating affiliates.
On January 21, 2010, the Company offered and sold $250.0 million of Senior Notes due 2040 (the “2010 Senior Notes”) in a registered public offering. The 2010 Senior Notes mature on January 26, 2040, and are redeemable at the Company’s option in whole any time or in part from time to time at a make-whole redemption price. The net proceeds of $244.0 million from the sale of the 2010 Senior Notes, after the deduction of commissions paid to the underwriters in the transaction and other expenses, was used by the Company for general corporate purposes, which included the repurchase of our outstanding capital stock and dividends to our shareholders.
$150.0 million of Junior Subordinated Deferrable Debentures (the "2006 Junior Subordinated Deferrable Debentures") were issued on June 15, 2006, mature on June 15, 2036 and have been redeemable at the Company's option at par since June 15, 2011. $200.0 million of Junior Subordinated Deferrable Debentures ("2007 Junior Subordinated Deferrable Debentures") were issued on June 21, 2007, mature on June 15, 2037 and have been redeemable at the Company's option at par since June 15, 2012. During 2008 and 2009, the Company repurchased $60.2 million principal amount of its 2007 Junior Subordinated Deferrable Debentures due 2037 from an unaffiliated financial institution.
Total capitalization equals total shareholders' equity plus redeemable noncontrolling interest, Senior Notes and Junior Subordinated Deferrable Debentures.
On February 3, 2015, the Company announced a quarterly cash dividend of $0.32 per common share and $0.32 per common share equivalent for which each outstanding warrant is exercisable, which is payable on March 31, 2015 to shareholders and warrant holders of record on March 13, 2015. The timing and amount of any future cash dividends, however, will be at the discretion of the Board and will depend upon results of operations and cash flows, the Company's financial position and capital requirements, general business conditions, legal, tax, regulatory, rating agency and contractual constraints or restrictions and any other factors that the Board deems relevant.
For additional information about our debt, including the terms of our financing arrangements, basis for variable interest rates and debt covenants, Please refer to Note 19 "Debt and financing arrangements" to the Consolidated Financial Statements in Part II, Item 8 for further details.
The Company has also joined with other investors in capitalizing the AlphaCat ILS funds. The AlphaCat ILS funds invest in instruments with returns linked to property catastrophe reinsurance, retrocession and ILS contracts. AlphaCat ILS funds primarily deploy their capital through AlphaCat Master Fund and AlphaCat Re. All of the funds are variable interest entities, with one being consolidated by the Company as the primary beneficiary and the remaining funds being accounted for as equity method investments because the Company holds an equity interest of less than 50% and has significant influence. One of these funds had been consolidated by the Company as the primary beneficiary from its formation through to December 31, 2013. However, on January 1, 2014 the fund received $35,000 in additional third party subscriptions, resulting in a reduction of the Company’s equity interest below 50%. Since the Company retained significant influence, this fund was deconsolidated and accounted for as an equity method investment from January 1, 2014. The fair value of the retained interest, based on the fair value of the underlying instruments in AlphaCat Master Fund and AlphaCat Re, amounted to $113,455 as at January 1, 2014. The deconsolidation resulted in a gain of $1,372 which is included in the Consolidated Statements of Comprehensive Income as other insurance related income for the year ended December 31, 2014. The Company's maximum exposure to any of the funds is the amount of capital invested at any given time.
As at December 31, 2014, the amount of the Company's total capitalization owed to these third parties as redeemable noncontrolling interest or noncontrolling interest was $538.6 million.
Please refer to Note 9 "Investments in affiliates" to the Consolidated Financial Statements in Part II, Item 8 for further details.
The Company’s contractual obligations and commitments as at December 31, 2014 are set out below:
The Flagstone 2006 Junior Subordinated Deferrable Debentures mature on September 15, 2036, are redeemable at the Company's option at par beginning September 15, 2011, and require quarterly interest payments by the Company to the holders of the Flagstone 2006 Junior Subordinated Deferrable Debentures. Interest is payable at a floating rate of three-month LIBOR plus 354 basis points, reset quarterly. The Company has entered into a $120,000 interest rate
swap which fixed the rate of interest on the Flagstone 2006 Junior Subordinated Deferrable Debentures at 6.405%. In addition, the Company has entered into a cross currency interest rate swap which fixed the rate of interest at 6.8625% and the notional at $17,463. The interest payments in the table above reflect the Company's contractual obligations with respect to the swaps.
$88,750 of the Flagstone 2007 Junior Subordinated Deferrable Debentures mature on July 30, 2037, are redeemable at the Company's option at par beginning July 30, 2012, and require quarterly interest payments by the Company to the holders of the Flagstone 2007 Junior Subordinated Deferrable Debentures. Interest is payable at a floating rate of three-month LIBOR plus 300 basis points, reset quarterly. $25,000 of the Flagstone 2007 Junior Subordinated Deferrable Debentures mature on September 15, 2037, are redeemable at the Company's option at par beginning September 15, 2012, and require quarterly interest payments by the Company to the holders of the Flagstone 2007 Junior Subordinated Deferrable Debentures. Interest is payable at a floating rate of three-month LIBOR plus 310 basis points, reset quarterly. The Company has entered into a $100,000 interest rate swap which fixed the rate of interest at 5.9%, and also entered into a $25,000 interest rate swap which fixed the interest rate at 5.9825%. The interest payments in the table above reflect the Company's contractual obligations with respect to the swaps.
Contractual obligations related to the notes payable to operating affiliates, including the timing of any payment, are dependent upon the settlement of the relevant underlying transactions. The notes typically have at least a twelve month duration and do not have any principal amount, since the final amount payable is dependent on the income or loss generated by the transactions. They also do not have any stated maturity date, since full repayment is dependent on the complexity involved in the settlement of the underlying transactions. Please refer to Note 9 to the Consolidated Financial Statements in Part II, Item 8 for further details describing the notes payable.
Please refer to Note 22 (f) to the Consolidated Financial Statements in Part II, Item 8 for further details describing the AlphaCat ILS fund commitment. The remaining commitment will be called and deployed throughout 2015, therefore it is included in the less than one year category.
Please refer to Note 22 (g) to the Consolidated Financial Statements in Part II, Item 8 for further details describing the fixed maturity commitment. There is no defined contractual commitment date, therefore it is included in the less than one year category.
Please refer to Note 22 (h) to the Consolidated Financial Statements in Part II, Item 8 for further details describing the other investment commitments. There is no defined contractual commitment date, therefore it is included in the less than one year category.
The A.M. Best ratings were most recently affirmed on February 25, 2014 for Validus Holdings, Ltd, Validus Reinsurance, Ltd and Validus Reinsurance (Switzerland) Ltd. The A.M. Best rating for Lloyd's was most recently affirmed on July 24, 2014. The A.M. Best rating for Talbot Syndicate 1183 was assigned on June 18, 2014. The A.M. Best rating for Western World Insurance Company was downgraded from A+ to A on November 6, 2014.
The S&P ratings were most recently affirmed on August 23, 2012 for Validus Holdings, Ltd and Validus Reinsurance, Ltd. The S&P rating for Validus Reinsurance (Switzerland) Ltd was issued on December 11, 2013. On October 13, 2014, the S&P rating for Lloyd's was affirmed and the outlook was revised from positive to stable.
The Moody’s ratings were most recently affirmed on June 25, 2014 for Validus Holdings, Ltd and Validus Reinsurance, Ltd.
The Fitch ratings were most recently affirmed on August 19, 2014 for Validus Holdings, Ltd. and Validus Reinsurance, Ltd. The Fitch rating for Lloyd's was most recently affirmed on October 14, 2014.
A.M. Best placed the A- rating of PaCRe, Ltd. “under review with negative implications” on January 20, 2015.
Description: We believe that the most significant accounting judgment made by management is our estimate of reserve for losses and loss expenses. The Company establishes its reserve for losses and loss expenses to cover the estimated remaining liability for both reported claims (“case reserves”) and unreported amounts (“incurred but not reported” or “IBNR" reserves). For insurance and reinsurance business, the IBNR reserves include provision for loss incidents that have occurred but have not yet been reported to the Company as well as for future variation in case reserves (where the claim has been reported but the ultimate cost is not yet known). The provision for future variation in current case reserves is generally calculated using actuarial estimates of total IBNR at the aggregated line of business level. Additional individual claim IBNR amounts are sometimes calculated for larger claims within our insurance and reinsurance businesses. Within the reinsurance business, the portion of total IBNR related to future variation on known claims is calculated at the individual claim level in some instances (either as an additional case reserve or individual claim IBNR). Within the insurance business, the provision for future variation in current case reserves is generally calculated using actuarial estimates of total IBNR, while individual claim IBNR amounts are sometimes calculated for larger claims. IBNR is established by the Company separately for certain large or catastrophe losses and smaller “attritional” losses. The Company has procedures in place to aggregate large or catastrophe losses on a consolidated basis for financial reporting and disclosure purposes. Loss events which aggregate to over $30.0 million on a consolidated basis are disclosed separately and included in the reserve for notable loss events and reserve for development on notable loss events tables. In addition, non-notable loss events which aggregate to more than $15.0 million but less than $30.0 million on a consolidated basis are disclosed separately and included in the Company's analysis of losses and loss expenses. Notable and non-notable loss events are first determined at the respective operating segments based on segment thresholds and are then aggregated and only disclosed if it is determined that they reach the respective consolidated threshold for notable and non-notable loss event disclosure.
2.ACR: ACR are established for Validus Re and AlphaCat business by our claims department in cases where we believe the case reserves reported by the cedant requires adjustment. ACR supplement case reserves based on information obtained through ceding company audits or other sources. ACR are not generally used at Talbot or Western World as claim volumes are generally greater and thus the potential for future variation in case reserve estimates on known claims often can be analyzed at an aggregate level using historical data.
b.Attritional losses-IBNR reserves are established using some combination of the actuarial methods described above, including the Chain Ladder method, the Generalized Cape Cod method and the Bornhuetter-Ferguson method. In situations where limited historic development data is available and/or the year being analyzed is more recent (less mature), the expected loss method and the Bornhuetter-Ferguson method are more commonly used. Under all methods used, an ultimate loss amount is established. Paid losses, case reserves and any additional case reserves are then deducted from the ultimate loss to ascertain the attritional IBNR reserves.
For all case reserves, ACR and IBNR, net reserves are estimated by first estimating gross reserves, then estimating reinsurance recoverables.
For insurance business, the Company receives from brokers details of potential claims, on the basis of which the Company’s loss adjusters make estimates of the likely ultimate outcome of the claims. In determining these reserves, the Company takes into account a number of factors including the facts and circumstances of the individual claim, the nature of the coverage and historical information about its experience on similar types of claims. For insurance business where Talbot is not the lead underwriter, the case reserves are established by the lead underwriter and validated centrally by the Lloyd’s market claims bureau, with a sample reviewed by the Company. The sum of the individual claim estimates for lead and follow business constitutes the case reserves.
The Company writes a mix of predominantly short-tail business, both insurance and reinsurance. The combination of low claim frequency and high claim severity that is characteristic of much of this short-tail business makes the available data more volatile and less reliable for predicting ultimate losses. For example, in property lines, there can be additional uncertainty in loss estimation related to large catastrophe events, whether natural or man-made. With wind events, such as hurricanes, the damage assessment process may take more than a year. The cost of claims is also subject to volatility due to supply shortages for construction materials and labor. In the case of earthquakes, the damage assessment process may take longer as buildings are discovered to have structural weaknesses not initially detected.
The Company also writes longer tail insurance lines of business through Talbot and Western World. Talbot's longer tail lines of business predominantly include financial institutions, marine and energy liabilities, aviation products and airports (aviation direct), construction and political risk. Western World's longer tail lines predominantly include liability coverages for contractors, manufacturers and health care related classes. These longer tail lines represent 11.6% of the Company's gross premiums written for the year ended December 31, 2014. In contrast to our short-tail business, the claim tail for our longer tail lines of business is expected to be notably longer as claims are often reported and ultimately paid or settled years after the related loss event occurs. In the intervening period between occurrence, reporting and settlement, additional facts regarding individual claims and trends will often become known and current laws and case law may change, affecting the ultimate value of the claim.
3.For both insurance and reinsurance business, the Company supplements the loss information received from clients with loss estimates developed by market share techniques and third party catastrophe models when such information is available.
Although there is normally a lag in receiving reinsurance data from cedants, the Company currently has adequate procedures in place regarding the timeliness related to the processing of assumed reinsurance information and there is no significant backlog. The Company actively manages its relationships with brokers and clients and considers existing disputes with counterparties to be in the normal course of business.
Net reserve for losses and loss expenses at December 31, 2014-Sensitivity to expected loss ratios
The most significant variance in the above scenarios, six month deceleration in loss emergence patterns, would have the effect of increasing losses and loss expenses by $332.2 million.
Management believes that the reserve for losses and loss expenses are sufficient to cover expected claims incurred before the reporting date on the basis of the methodologies and judgments used to support its estimates. However, there can be no assurance that actual payments will not vary significantly from total reserves. The reserve for losses and loss expenses and the methodology of estimating such reserve are regularly reviewed and updated as new information becomes known. Any resulting adjustments are reflected in income in the period in which they become known.
A limited portion of our insurance business is written on a line slip basis or binder, 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 an estimate provided by the client, via the broker.
For reinsurance business, where the assumed reinsurance premium is written on an excess of loss (non-proportional) or on a pro-rata (proportional) basis, reinsurance contracts are generally written prior to the time the underlying direct policies are written by cedants and accordingly cedants must estimate such premiums when purchasing reinsurance coverage. For excess of loss contracts, the deposit premium is defined in the contract. The deposit premium is based on the client’s estimated premiums, and this estimate is the amount recorded as written premium in the period the risk incepts. In the majority of cases, these contracts are adjustable to reflect the changes in underlying risks during the contract period. For pro-rata contracts, an estimate of written premium is recorded in the period in which the risk incepts. The written premiums estimate is based on the pro rata cession percentage, on information provided by ceding companies and on management’s judgment. Management critically evaluates the information provided by ceding companies based on experience with the cedant, broker and the underlying book of business and may modify the initial premium estimates provided by the cedant.
The table below identifies the extent of premiums that were written on a proportional and non-proportional basis:
For business written on a facultative basis, endorsements, based on reports by our clients of changes in the original contractual cover, are recorded in the period in which the client reports are received, which would normally be over the life of the cover or shortly afterwards. Typically, the adjustment to the original premium is an insignificant portion of the total premium written.
For business written on an excess of loss basis, premium adjustments, based on reports by the clients of actual premium, are recorded in the period in which the cedant reports are received, which would normally be within six months to one year subsequent to the expiration of the contract. Typically the adjustment to the deposit premium is an insignificant portion of the total premium written. Many of our excess of loss contracts also include provisions that require an automatic reinstatement of coverage in the event of a loss. Reinstatement premiums are recognized when a triggering loss event occurs and losses are recorded by us. While the reinstatement premium amount is defined by contract terms, our recognition of reinstatement premiums is dependent on our estimate of losses and loss expenses, which reflect management’s best judgment as described above in "Reserve for Losses and Loss Expenses".
Judgments and Uncertainties: For excess of loss business, the amount of reinsurance premium payable is usually contractually documented at inception and management judgment is only necessary in respect of any loss-related elements of the reinsurance premium, for example, reinstatement or adjustment premiums and loss-related commissions. The full reinsurance premium ceded is recorded at inception and if the contract is purchased on a “losses occurring” basis, the reinsurance premium ceded is expensed on a straight line basis over the life of the contract. If the policy is purchased on a “risks attaching” basis, the reinsurance premium ceded is expensed in line with how the inwards gross premium, to which the risk attaching policy relates, is earned. After the contract has expired, a No Claims Bonus may be received for certain policies, and this is recorded as a reinsurance premium adjustment in the period in which it can be reasonably determined.
Paid losses recoverable and loss reserves recoverable balances include amounts owed to us in respect of paid and unpaid ceded losses and loss expenses, respectively. The balances are presented net of a provision for non-recoverability. As at December 31, 2014, loss reserves recoverable balances were $377.5 million and paid losses recoverable balances were $38.1 million. In establishing our reinsurance recoverable balances, significant judgment is exercised by management in determining the amount of unpaid losses and loss expenses to be ceded as well as our ability to cede losses and loss expenses under our reinsurance contracts.
The Company's ceded unpaid losses and loss expenses consists of two elements, those for reported losses and those for IBNR. Ceded amounts for IBNR are developed as part of our loss reserving process. Consequently, the estimation of ceded unpaid losses and loss expenses is subject to similar risks and uncertainties in the estimation of gross IBNR (see “Reserve for Losses and Loss Expenses” above). As at December 31, 2014, ceded IBNR recoverable balances were $231.1 million.
Although our reinsurance recoverable balances are derived from our determination of contractual provisions, the recoverability of such amounts may ultimately differ due to the potential for a reinsurer to become financially impaired or insolvent or for a contractual dispute over contract language or coverage. Consequently, we review our reinsurance recoverable balances on a regular basis to determine if there is a need to establish a provision for non-recoverability. In performing this review, the Company uses judgment in assessing the credit worthiness of our reinsurers and the contractual provisions of our reinsurance agreements. As at December 31, 2014, the Company had a provision for non-recoverability of $4.8 million. In the event that the credit worthiness of our reinsurers were to deteriorate, actual uncollectible amounts could be significantly greater than our provision for non-recoverability.
At December 31, 2014, the use of different assumptions within the model could have an effect on the provision for uncollectible reinsurance reflected in the Company’s Consolidated Financial Statements. To the extent the creditworthiness of the Company’s reinsurers was to deteriorate due to an adverse event affecting the reinsurance industry, such as a large number of major catastrophes, actual uncollectible amounts could be significantly greater than the Company’s provision.
Description: Consistent with U.S. GAAP, the Company recognizes investments at their fair value in the Consolidated Balance Sheets. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. U.S. GAAP also established a three level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement date, with quoted market prices being the highest level (“Level 1”) and unobservable inputs being the lowest level (“Level 3”). Generally, the degree of judgment used in measuring the fair value of financial instruments inversely correlates with the availability of observable inputs.