The following table sets forth summarized balance sheet data as of December 31, 2013, 2012, 2011, 2010 and 2009:
The transaction expenses relate to costs incurred in connection with the Company’s proposed acquisition of Transatlantic Holdings, Inc. Transaction expenses are primarily comprised of legal, financial advisory and audit related services.
The combined ratio is calculated by combining the loss and loss expense ratio, the policy acquisition cost ratio and the general and administrative expense ratio.
The Company conducts its operations worldwide through three operating segments which have been determined under U.S. GAAP segment reporting to be Validus Re, AlphaCat and Talbot. Validus Re is a Bermuda-based reinsurance segment focused on short tail lines of reinsurance. AlphaCat is a Bermuda-based investment adviser, managing capital from third parties and the Company in insurance linked securities and other investments in the property catastrophe reinsurance space. Talbot is a specialty insurance segment, primarily operating within the Lloyd's insurance market through Syndicate 1183.
On November 30, 2012, the Company acquired all of the outstanding shares of Flagstone, strengthening the Company's leading property catastrophe reinsurance and short-tail specialty insurance platform. As part of this acquisition, the Company acquired Flagstone Reassurance Suisse, SA, and renamed it Validus Reinsurance (Switzerland) Ltd. ("Validus Re Swiss"). Validus Re Swiss is based in Zurich, Switzerland. Through this local presence, the Company is in a position to closely follow and respond effectively to the changing needs of the various European and Bermuda insurance markets. During October 2013, the Company completed the sale of its wholly owned subsidiary, Flagstone Alliance Insurance and Reinsurance plc.
On April 25, 2013, the Company acquired Longhorn Re, Ltd. (renamed Validus Re Americas, Ltd.), a single contract Bermuda-domiciled crop reinsurer.
We underwrite global property insurance and reinsurance and have large aggregate exposures to natural and man-made disasters. The occurrence of claims from catastrophic events results in substantial volatility, and can have material adverse effects on the Company’s financial condition and results and its ability to write new business. This volatility affects results for the period in which the loss occurs because U.S. accounting principles do not permit reinsurers to reserve for such catastrophic events until they occur. Catastrophic events of significant magnitude historically have been relatively infrequent, although management believes the property catastrophe reinsurance market has experienced a higher level of worldwide catastrophic losses in terms of both frequency and severity in the period from 1992 to the present. We also expect that increases in the values and concentrations of insured property will increase the severity of such occurrences in the future. The Company seeks to reflect these types of trends when pricing contracts.
During the January 2012 renewal season, the Validus Re segment showed rate improvement relative to 2011. This improvement was largely due to the large catastrophe loss activity during 2011. During the first quarter of 2012, Talbot experienced rate increases in loss affected lines without seeing a systemic rise in rates across all lines. During the July 2012 renewal period, the Validus Re segment experienced rate improvements in the U.S. property lines while European and Latin American property rates were unchanged. The Talbot segment experienced a rate increase of approximately 3% against a planned rate movement of 2% across the portfolio, with marine treaty, property and energy related lines outperforming the plan.
During the January 2014 renewal season, the Validus Re and AlphaCat segments underwrote $575.2 million in gross premiums written, a decrease of 3.2% from the prior period, excluding the impact of the agriculture business in both years. This decrease was primarily driven by a challenging rate environment in our U.S. property catastrophe business, which experienced a reduction in rates of approximately 12.5%.
Underwriting income measures the performance of the Company’s core underwriting function, excluding revenues and expenses such as net investment income (loss), other income, finance expenses, net realized and unrealized gains (losses) on investments, foreign exchange gains (losses), gain on bargain purchase, net of expenses and transaction expenses. The Company believes the reporting of underwriting income enhances the understanding of our results by highlighting the underlying profitability of the Company’s core insurance and reinsurance operations. Underwriting income is a non-GAAP financial measure, as described in more detail in the section entitled “Non-GAAP Financial Measures."
Net operating income attributable to Validus is defined as net income excluding net realized and unrealized gains (losses) on investments, income (loss) from investment affiliate, foreign exchange gains (losses), non-recurring items and income (loss) available (attributable) to noncontrolling interest. This measure focuses on the underlying fundamentals of our operations without the influence of gains (losses) from the sale of investments, translation of non-$U.S.currencies and non-recurring items. Net operating income 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 plus accumulated dividends is considered by management to be an even more appropriate measure of our returns to common shareholders than book value per diluted common share, as we believe growth in book value on a diluted basis, plus the dividends that have accumulated, ultimately translates into the return that a shareholder will
receive. Book value per diluted common share plus accumulated dividends increased by $4.21, or 10.6%, from $39.70 at December 31, 2012 to $43.91 at December 31, 2013. Cash dividends per common share are an integral part of the value created for shareholders. The Company paid quarterly cash dividends of $0.30 per common share and common share equivalent in each of the four quarters of 2013 and a special dividend in the amount of $2.00 per common share and $2.00 per common share equivalent for which each outstanding warrant is exercisable, in February 2013. On February 5, 2014, the Company announced a quarterly cash dividend to $0.30 per common share and $0.30 per common share equivalent for which each outstanding warrant is exercisable, payable on March 31, 2014 to holders of record on March 14, 2014. 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.”
Gross premiums written for the three months ended December 31, 2013 were $237.3 million compared to $311.8 million for the three months ended December 31, 2012, a decrease of $74.6 million, or 23.9%.
Underwriting income for the three months ended December 31, 2013 was $110.4 million compared to an underwriting loss of ($113.1) million for the three months ended December 31, 2012, an increase of $223.4 million, or 197.6%.
Loss ratio for the three months ended December 31, 2013 was 41.9% compared to 91.8% for the three months ended December 31, 2012.
Net income available to Validus for the three months ended December 31, 2013 was $95.3 million, or $0.93 per diluted common share compared to a loss of ($90.7) million or ($0.94) per diluted common share for the three months ended December 31, 2012.
Gross premiums written decreased $74.6 million for the three months ended December 31, 2013 compared to the three months ended December 31, 2012. This decrease primarily relates to reinstatement premiums attributable to Hurricane Sandy of $36.4 million in the fourth quarter of 2012 and downward premium estimate adjustments for certain classes during the fourth quarter of 2013.
These notable loss event amounts are based on management’s estimates following a review of the Company’s potential exposure and discussions with certain clients and brokers. Given the magnitude and recent occurrence of these events in relation to the corresponding period end date, and other uncertainties inherent in loss estimation, meaningful uncertainty exists at the relevant reporting date regarding losses from these events and the Company’s actual ultimate net losses from these events can vary materially from these estimates.
Net of reinsurance but not of reinstatement premiums. Total reinstatement premiums were $0.0 million and $30.8 million for the three months ended December 31, 2013 and December 31, 2012, respectively.
The Company increased the threshold for disclosure of notable losses effective January 1, 2013 from $15.0 million to $30.0 million.
Full Year 2013 Summarized Consolidated Results of Operations and Financial Condition
Gross premiums written for the year ended December 31, 2013 were $2.4 billion compared to $2.2 billion for the year ended December 31, 2012, an increase of $234.7 million, or 10.8%.
Underwriting income for the year ended December 31, 2013 was $604.9 million compared to $248.7 million for the year ended December 31, 2012, an increase of $356.2 million, or 143.2%.
Combined ratio for the year ended December 31, 2013 was 71.2%, which included $205.4 million of favorable loss reserve development on prior accident years, benefiting the loss ratio by 9.8 percentage points, compared to 86.8%, which included $175.0 million of favorable loss reserve development on prior accident years, benefiting the loss ratio by 9.3 percentage points, for the year ended December 31, 2012.
Loss ratio for the year ended December 31, 2013 was 37.8% compared to 53.4% for the year ended December 31, 2012.
Net operating income available to Validus for the year ended December 31, 2013 was $578.7 million, or $5.38 per diluted common share compared to $333.8 million or $3.26 per diluted common share for the year ended December 31, 2012.
Investment yield for the year ended December 31, 2013 was 1.30% compared to 1.65% for the year ended December 31, 2012.
Total cash and investments as at December 31, 2013 was $8.0 billion compared to $8.0 billion as at December 31, 2012.
The change in net operating income available to Validus for the years ended December 31, 2013 and December, 31 2012 as compared to the years ended December 31, 2012 and December 31, 2011, respectively, is described in the following table:
Other operating income and expenses, net, consists of net investment income, other income, finance expenses, taxes and income (loss) from operating affiliates.
A $228.8 million increase in net premiums earned, primarily due to new agriculture business written by Validus Re and business written in consolidated AlphaCat subsidiaries; and
A $25.6 million increase in policy acquisition costs, reflecting the higher level of net premiums earned.
Net operating income available to Validus for the year ended December 31, 2012 was $333.8 million compared to $52.3 million for the year ended December 31, 2011, an increase of $281.5 million. The primary factors driving the increase were:
Fourth Quarter 2013 Summarized Results of Operations - Validus Re Segment
Gross premiums written for the three months ended December 31, 2013 were $10.3 million compared to $79.2 million for the three months ended December 31, 2012, a decrease of $69.0 million, or 87.1%. Gross premiums written for the three months ended December 31, 2013 included $17.2 million of property premiums and $nil of marine premiums, offset by ($6.9) million of specialty premiums, compared to $54.9 million of property premiums, $8.6 million of marine premiums and $15.7 million of specialty premiums for the three months ended December 31, 2012.
Net premiums earned for the three months ended December 31, 2013 were $250.3 million compared to $285.3 million for the three months ended December 31, 2012, a decrease of $35.0 million, or 12.3%.
Underwriting income for the three months ended December 31, 2013 was $77.1 million compared to a loss of ($103.1) million for the three months ended December 31, 2012, an increase of $180.2 million, or 174.7%.
Combined ratio for the three months ended December 31, 2013 was 69.1% compared to 136.2% for the three months ended December 31, 2012.
The loss ratio for the three months ended December 31, 2013 was 44.2% compared to 116.1% for the three months ended December 31, 2012, a decrease of 71.9 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. The loss ratio for the three months ended December 31, 2012 included favorable loss reserve development on prior accident years of $19.8 million, benefiting the loss ratio by 6.9 percentage points.
Net operating income for the three months ended December 31, 2013 of $88.4 million compared to a loss of ($80.9) million for the three months ended December 31, 2012, an increase of $169.4 million.
General and administrative expenses for the three months ended December 31, 2013 were $21.6 million compared to $14.7 million for the three months ended December 31, 2012, an increase of $6.9 million, or 46.9%. General and administrative expenses associated with the run-off from the Flagstone acquisition were $3.7 million for the three months ended December 31, 2013.
Losses from notable loss events for the three months ended December 31, 2013 was $nil compared to $282.6 million for the three months ended December 31, 2012.
The change in net operating income for the years ended December 31, 2013 and December, 31 2012 as compared to the years ended December 31, 2012 and December 31, 2011, respectively, is described in the following table:
The increase in Validus Re net premiums written was driven by factors highlighted above in respect of gross premiums written and reinsurance premiums ceded.
The increase in net premiums earned is consistent with the pattern of net premiums written, except for the earning out during the year ended December 31, 2013 of property business assumed through the Flagstone acquisition.
Notable losses incurred in the year ended December 31, 2013 of $55.3 million were 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 income was a decrease of $50.5 million. In comparison, for the year ended December 31, 2012, losses from notable loss events were $402.7 million, primarily from Hurricane Sandy, which represented 39.4 percentage points of the loss ratio. Net of $60.8 million of reinstatement premiums, the effect of these events on net income was a decrease of $342.0 million.
Property lines incurred $55.3 million of losses from a single notable loss event, the European Floods, which represented 8.2 percentage points of the property lines loss ratio. Net of $4.8 million in reinstatement premiums, the effect of this event on net income was a decrease of $50.5 million. In comparison, for the year ended December 31, 2012, Validus Re property lines incurred $277.1 million of losses from notable loss events, primarily Hurricane Sandy, which represented 41.1 percentage points of the property lines loss ratio.
Property lines experienced $35.9 million higher favorable loss reserve development, primarily related to lower claims emergence on attritional losses incurred, partially offset by unfavorable development on New Zealand earthquake losses.
Marine lines experienced $38.0 million higher unfavorable loss reserve development due primarily to an increase in the ultimate loss estimate on Costa Concordia.
Specialty lines did not incur any notable losses during the year ended December 31, 2013. In comparison, for the year ended December 31, 2012, Validus Re specialty lines incurred $23.2 million of losses from notable loss event, the U.S. drought, which represented 24.3 percentage points of the loss ratio.
The acquisition cost ratio for the property lines has increased by 1.6% primarily as a result of a decrease in reinstatement premiums compared to the year ended December 31, 2012, as these premiums typically attract little or no policy acquisition costs. The acquisition cost ratio on the specialty lines has decreased by 1.8% percentage points due to the effect of the agriculture business, which typically has a lower acquisition cost ratio than most other specialty lines written by Validus Re.
Other income primarily reflects the gain recorded on the redemption of part of Validus Re's investment in the AlphaCat ILS funds.
a) The results of operations from Flagstone are consolidated from the November 30, 2012 date of acquisition.
Underwriting income for the three months ended December 31, 2013 was $28.0 million compared to $3.2 million for the three months ended December 31, 2012, an increase of $24.8 million.
Income attributable to operating affiliate investors for the three months ended December 31, 2013 was $26.6 million compared to $nil for the three months ended December 31, 2012, an increase of $26.6 million.
The combined ratio for the three months ended December 31, 2013 was 25.6% compared to 45.6% for the three months ended December 31, 2012, a decrease of 20.0 percentage points.
The loss ratio for the three months ended December 31, 2013 was 1.7% compared to 0.0% for the three months ended December 31, 2012, an increase of 1.7 percentage points.
Net investment income for the three months ended December 31, 2013 was $1.0 million compared to $1.1 million for the three months ended December 31, 2012.
The following table presents results of operations for the years ended December 31, 2013, 2012 and 2011:
The change in net operating income available to Validus for the years ended December 31, 2013 and December, 31 2012 as compared to the years ended December 31, 2012 and December 31, 2011, respectively, is described in the following table.
Notable loss for the year ended December 31, 2013 was the European Floods.
AlphaCat reinsurance premiums ceded for the year ended December 31, 2013 were $0.5 million compared to $nil for the year ended December 31, 2012. The reinsurance was purchased as a hedge to balance portfolio risk.
The increase in AlphaCat net premiums written was driven by the factors highlighted above in respect of gross premiums written. The ratios of net premiums written to gross premiums written were 99.6% and 100.0% for the years ended December, 31 2013 and 2012, respectively.
The increase in net premiums earned is consistent with the pattern of net premiums written influencing the earned premiums for the year ended December 31, 2013 compared to the year ended December 31, 2012.
AlphaCat losses and loss expenses included $16.8 million of current year losses, excluding notable losses, in comparison to $nil for the year ended December 31, 2012. AlphaCat typically writes high excess and aggregate stop loss contracts, therefore losses can be triggered by a combination of loss events incurred by the cedant.
The increase in other income of $3.2 million, or 13.8%, is primarily due to increased management and performance fees that the AlphaCat segment earns from managing the business written in its reinsurance subsidiaries and affiliates and the investments made in its ILS funds.
For the year ended December 31, 2013, the net operating income attributable to noncontrolling interest was $11.6 million, which comprised $6.7 million relating to 90% of the net operating income in PaCRe for the year and $4.9 million of net operating income relating to the consolidated AlphaCat ILS funds.
Net operating income available to Talbot for the three months ended December 31, 2013 was $33.4 million compared to $7.6 million for the three months ended December 31, 2012, an increase of $25.8 million.
Non-GAAP Financial Measures. In presenting the Company’s results, management has included and discussed underwriting income 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. Reconciliations of these measures to the most comparable U.S. GAAP financial measure, are presented in the section below entitled “Non-Operating Income and Expenses.”
from the political risk lines and $6.0 million upward premium adjustments in political violence lines. These increases were offset by a downward premium adjustment of $11.6 million which was mainly driven by decreases on the war lines.
The changes in mix of business are consistent with the reasons for changes in gross premiums written discussed above.
The increase in property lines and decrease in marine lines net premiums earned are consistent with the pattern of net premiums written influencing the earned premiums for the year ended December 31, 2013 compared to the year ended December 31, 2012. The decrease in the specialty lines net premiums earned is due primarily to the timing of premiums written during the year compared to the prior year, with the increase in net premiums written having occurred in the second half of 2013 compared to the first half of 2012.
Notable losses incurred in the year ended December 31, 2013 of $4.7 million were 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 income was a decrease of $4.4 million. In comparison, for the year ended December 31, 2012, losses from notable loss events were $97.8 million, primarily relating to Hurricane Sandy, which represented 11.8 percentage points of the loss ratio. Net of ($3.3) million of reinstatement premiums, the effect of the 2012 events on net income was a decrease of $101.1 million.
Details of Talbot loss ratios by line of business and period of occurrence are provided below.
Property lines incurred $2.7 million of losses from a notable loss event, the European Floods, which represented 1.4 percentage points of the property lines loss ratio. In comparison, for the year ended December 31, 2012, Talbot’s property lines incurred $47.5 million of losses from notable loss events, primarily Hurricane Sandy, which represented 27.2 percentage points of the property lines loss ratio.
during the year. The current period loss ratio, excluding the impact of notable losses, was higher by 6.5 percentage points, representing a higher level of attritional claims experienced during the year.
Specialty lines did not incur any notable losses for the year ended December 31, 2013. In comparison, for the year ended December 31, 2012, Talbot’s specialty lines incurred $7.1 million of losses from a notable loss event, Hurricane Sandy, which represented 2.3 percentage points of the specialty lines loss ratio.
Specialty lines experienced $18.3 million higher favorable loss reserve development, primarily related to lower than expected development on attritional claims during the period, as well as a lower emergence of events. The current period loss ratio, excluding the impact of notable losses, was higher by 9.1 percentage points, representing an increase in attritional claims experienced during the period.
General and administrative and share compensation expenses have increased primarily as a result of a higher overall headcount, from 285 employees at December 31, 2012 to 306 employees at December 31, 2013, and a new grant issue.
Net investment income for the year ended December 31, 2013 decreased by $3.2 million or 15.2% due to falling yields on fixed maturity investments.
Corporate share compensation expenses for the year ended December 31, 2013 were $9.9 million compared to $10.9 million for the year ended December 31, 2012, a decrease of $1.0 million or 9.2%.
Corporate finance expenses for the year ended December 31, 2013 were $42.1 million compared to $41.7 million for the year ended December 31, 2012, an increase of $0.4 million or 0.9%.
The change in net realized and unrealized losses on fixed maturity and short term investments of ($91.0) million was due to an unfavorable movement in net realized and unrealized losses on fixed maturity and short term investments of ($109.6) million, offset by a favorable movement in net realized and unrealized gains on other investments of $18.6 million.
Income from investment affiliate for the year ended December 31, 2013 was $5.8 million higher than for the year ended December 31, 2012. The income from investment affiliate relates to the income earned from the Company's investment in the Aquiline Financial Services Fund II L.P. and therefore reflects the underlying performance of that fund for the period.
Our reporting currency is the U.S. dollar. As a significant portion of our operations are transacted in currencies other than the U.S. dollar, fluctuations in foreign exchange rates may affect period-to-period comparisons. The Company's largest foreign currency fluctuation exposure is to the following currencies, with the movement in each currency against the U.S. dollar for the years ended December 31, 2013, 2012 and 2011 shown in the table below:
Foreign exchange gains for the year ended December 31, 2013 were $2.3 million, or 47.8% lower than for the year ended December 31, 2012. The lower gain was primarily due to the fact that the Company holds non-U.S. dollar currency deposits, most notably in Australian dollars, which weakened significantly against the U.S. dollar during the year.
For the year ended December 31, 2012, net loss attributable to noncontrolling interest was $15.8 million, which was comprised of operating income of $1.4 million, as discussed in the AlphaCat Segment Results of Operations, and a non-operating loss of $17.2 million, primarily on the investment portfolio within PaCRe.
(a) Total gross premiums written for the year ended December 31, 2011 included $60.0 million of gross premiums written from AlphaCat Re 2011, which was a consolidated subsidiary from formation until December 31, 2011.
At December 31, 2013, the Company held investments totaling $6,912.4 million, compared to $6,764.0 million at December 31, 2012, an increase of $148.3 million, or 2.2%. A significant portion of (re)insurance contracts written by the Company provides short-tail reinsurance coverage for losses resulting mainly from natural and man-made catastrophes, which could result in payment of a substantial amount of losses at short notice. Accordingly, the Company’s investment portfolio is primarily structured to provide liquidity, which means the investment portfolio contains a significant amount of relatively short-term fixed maturity investments, such as government and government agency securities, corporate debt securities, bank loans and mortgage-backed and asset-backed securities. At December 31, 2013, the average duration of the Company’s fixed maturity and short term investment portfolio was 1.60 years (December 31, 2012: 1.34 years). This duration is reviewed regularly based on changes in the duration of our liabilities and in general market conditions.
The Company’s investment portfolio is also structured to preserve capital. With the exception of the Company's bank loan portfolio, the Company’s investment guidelines require that investments be rated BBB- or higher at the time of purchase. At December 31, 2013, the Company’s fixed maturity portfolio had an average credit quality rating of AA- (2012 - AA-) and an effective yield of 1.30% (2012 - 1.65%) for the year then ended. The estimated fair value of investment grade fixed maturities was $4,762.1 million, or 85.9% of the fixed maturity portfolio, compared to $4,349.5 million, or 85.5%, an increase of $412.6 million, or 9.5%. The estimated fair value of non-investment grade fixed maturities, excluding bank loans, as at December 31, 2013 was $63.0 million compared to $62.4 million as at December 31, 2012, an increase of $0.6 million, or 1.0%.
The value of the Company’s fixed maturity portfolio will fluctuate with, among other factors, changes in the interest rate environment and in overall economic conditions. Additionally, the structure of the investment portfolio exposes the Company to other risks, including insolvency or reduced credit quality of corporate debt securities, and prepayment, default and structural risks on asset-backed securities, mortgage-backed securities and bank loans.
Included in the other investments balance are investments held by PaCRe in which the Company has an equity interest of 10%. The remaining 90% interest is held by third party investors.
The Company manages its corporate debt securities by limiting its exposure to any single issuer, excluding government and agency securities, to 3% or less of its total investments and cash. At December 31, 2013, the Company did not have an aggregate exposure to any single issuer of more than 1.0%, other than with respect to government and government agency securities. The top ten exposures to fixed income corporate issuers at December 31, 2013 are as follows:
Ratings used are the lower of Standard & Poor's (S&P) and Moody's. When Moody's ratings are used, they are presented in S&P's equivalent rating.
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, 2013.
The amount of recorded reserves represents management’s best estimate of expected losses and loss expenses on premiums earned. For the year ended December 31, 2013, favorable loss reserve development on prior accident years was $205.4 million, of which $59.3 million related to the Validus Re segment and $146.2 million related to the Talbot segment. Current year incurred losses included $60.8 million of losses from notable loss events, of which $55.3 million related to the Validus Re segment, $0.8 million related to the AlphaCat segment and $4.7 million related to the Talbot segment.
As at December 31, 2012, the reserve for potential development on 2011 notable loss events was $42.2 million. During the year ended December 31, 2013, the Company allocated the full $42.2 million to the Christchurch earthquake and Gryphon Alpha mooring failure. Contract complexity, the nature and number of perils arising from these events, limits and sub limits exposed, the quality, flow and timing of information received by the Company, information regarding retrocessional covers, assumptions, both explicit and implicit, regarding future paid and reported loss development patterns, frequency and severity trends, claims settlement practices and potential changes in the legal environment led to complexity and volatility in the ultimate loss estimates for these events. As at December 31, 2012, the reserve for potential development on 2010 notable loss events had been fully allocated. No RDE has been established for 2012 or 2013 notable losses and therefore as at December 31, 2013 the Company had no remaining reserve for potential development on notable loss events.
For disclosure purposes, only those notable loss events which had an initial ultimate loss estimate above a defined threshold 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.
The reserve for notable loss events table below does not disclose 2010 notable loss events. Deepwater Horizon and the Christchurch earthquake, both 2010 events, had closing reserves as at December 31, 2013, of $82.2 million and $90.1 million, respectively.
(d) Closing Reserve for the period equals Closing Estimate for the period less cumulative Paid Losses (Recovery).
During the year ended December 31, 2011, $14.8 million was allocated to Deepwater Horizon from the 2010 reserve for development on notable loss events. During the same period, $29.8 million was allocated to the Tohoku earthquake and $20.2 million was allocated to the Christchurch earthquake from the 2011 reserve for development on notable loss events.
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 Christchurch 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.
During the year ended December 31, 2013, $40.2 million was allocated to the Christchurch earthquake and $2.0 million to the Gryphon Alpha mooring failure from the 2011 reserve for potential development on notable loss events.
The 2011 notable loss events, principally the Tohoku earthquake, the Christchurch earthquake and the Thailand floods continued to experience adverse development as shown in the notable loss roll forward table. During the year ended December 31, 2012, based on the potential that one or some of the 2011 notable loss events eligible for potential allocation from the 2011 RDE may experience adverse development, rather than all deteriorating proportionately, an addition to the 2011 RDE of $27.9 million was made.
Validus Holdings, Ltd. is a holding company and conducts no operations of its own. The Company relies primarily on cash dividends and other permitted payments from operating subsidiaries within the Validus Re, AlphaCat and Talbot segments to pay dividends, finance expenses and other holding company expenses. There are restrictions on the payment of dividends from most operating subsidiaries, primarily due to regulatory requirements in the jurisdictions in which the operating subsidiaries are domiciled. Please refer to Part I, Item 1, "Regulation" for further discussion on the regulatory requirements in the jurisdictions in which the Company operates. Please also refer to Part II, Item 5, “Market for Registrants Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities” for further discussion of the Company’s dividend policy. We believe the dividend/distribution capacity of the Company’s subsidiaries will provide the Company with sufficient liquidity for the foreseeable future. We continue to generate substantial cash from operating activities and remain in a strong financial position, with resources available for reinvestment in existing businesses, strategic acquisitions and managing our capital structure to meet short and long-term objectives.
The Company has written certain (re)insurance business that has loss experience generally characterized as having low frequency and high severity. This results in volatility in both results and operational cash flows. The potential for large claims or a series of claims under one or more reinsurance contracts means that substantial and unpredictable payments may be required within relatively short periods of time. As a result, cash flows from operating activities may fluctuate, perhaps significantly, between individual quarters and years. Management believes the Company’s unused credit facility amounts and highly liquid investment portfolio are sufficient to support any potential operating cash flow deficiencies.
Net cash provided by operating activities during 2013 was $265.3 million compared to $543.2 million for 2012, an unfavorable movement of $277.9 million. This unfavorable movement reflected lower underwriting cash flows, mainly due to the increase in losses and loss expense payments of $325.5 million, partially offset by an increase in net premium receipts.
Cash flow from financing activities is derived primarily from the issuance of shares in the Company and its subsidiaries, and notes to operating affiliates.
Net cash used in financing activities during 2013 was ($264.0) million compared to net cash provided by financing activities of $94.7 million during 2012, an unfavorable movement of $358.8 million. This unfavorable movement was driven primarily by the increase of $250.0 million in quarterly dividends and the special dividend during 2013, an increase of $253.5 million in the repurchase of common shares under the share repurchase program and a reduction of $303.2 million in third party capital contributions to consolidated AlphaCat subsidiaries. These movements were offset by receipts from an issuance of notes payable to operating affiliates of $438.9 million.
(a) On January 21, 2010, the Company offered and sold $250,000 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.
(b) $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.
On February 6, 2013, the Company approved a special dividend in the amount of $2.00 per common share and common share equivalent. The dividend was paid on February 26, 2013 to shareholders and warrant holders of record on February 19, 2013. On the same date the Board also approved an increase in the Company's regular quarterly dividend to $0.30 from $0.25 per common share and common share equivalent for which each outstanding warrant is exercisable.
The following table details the Company’s debt and financing arrangements as at December 31, 2013.
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 (Part II, Item 8) for further details.
The reserve for losses and loss expenses represents an estimate, including actuarial and statistical projections at a given point in time of an insurer’s or reinsurer’s expectations of the ultimate settlement and administration costs of claims incurred. As a result, it is likely that the ultimate liability will differ from such estimates, perhaps significantly. Such estimates are not precise in that, among other things, they are based on predictions of future developments and estimates of future trends in loss severity and frequency and other variable factors such as inflation, litigation and tort reform. This uncertainty is heightened by the short time in which the Company has operated, thereby providing limited claims loss emergence patterns specifically for the Company. The lack of historical information for the Company has necessitated the use of industry loss emergence patterns in deriving IBNR. Further, expected losses and loss ratios are typically developed using vendor and proprietary computer models and these expected loss ratios are a material component in the calculation deriving IBNR. Actual loss ratios will deviate from expected loss ratios and ultimate loss ratios will be greater or less than expected loss ratios. During the loss settlement period, it often becomes necessary to refine and adjust the estimates of liability on a claim either upward or downward. Even after such adjustments, ultimate liability will exceed or be less than the revised estimates. The actual payment of the reserve for losses and loss expenses will differ from estimated payouts.
The Company is not party to any off-balance sheet transaction, agreement or other contractual arrangement 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.
For further details related to the Company's variable interest entities, see notes 9 and 10 to the Consolidated Financial Statements in Part II, Item 8.
The Fitch ratings were most recently affirmed on February 5, 2014 for Validus Holdings, Ltd. and Validus Reinsurance, Ltd. The Fitch ratings for Validus Reinsurance (Switzerland), Ltd. and Talbot were affirmed on October 18, 2013.
a.Large or catastrophe events-IBNR reserves are established for all lines based on each segment’s estimates for known loss events for which not all claims have been reported to the Company. In establishing such IBNR reserves, the Company accumulates loss information from modeling agencies, where possible, publicly available sources and information contained in client reports and estimates. The loss information is applied to the Company’s book of in-force contracts to establish an estimate of the Company’s ultimate exposure to the loss event. For the largest loss events, the Company estimates an ultimate loss expectation for the individual event. Paid losses, case reserves and any additional case reserves are then deducted from the ultimate loss to ascertain the IBNR estimate for these individual large claims or catastrophe events. The size of event for which the Company establishes a separate ultimate loss estimate may vary based on an assessment of the materiality of the event, as well as on other factors.
As predominantly a broker market insurer and reinsurer, the Company must rely on loss information reported to us by brokers from clients, where such information is often incomplete or changing. The quality and type of information received varies by client and by the nature of the business, insurance or reinsurance.
The Company also writes longer tail insurance lines of business, predominantly financial institutions ($38.2 million of gross premiums written on a claims made basis), marine and energy liabilities ($61.5 million of gross premiums substantially written on a losses occurring basis) and aviation products and airport (aviation direct) ($11.9 million of gross premiums substantially written on a loss occurring basis) for the year ended December 31, 2013. These longer tail lines represent 4.6% of the Company's gross premiums written for the year ended December 31, 2013. For marine and energy liability, the time from the occurrence of a claim to its first report to the Company can be years. For marine and energy liability and financial institutions, the subsequent time between reporting of a claim and its settlement can also be years. In these intervening periods between occurrence, reporting and settlement, additional facts regarding individual claims and trends often will become known and current laws and case law may change, affecting the ultimate value of the claim.
For the Company’s reinsurance business, where the Company relies more heavily on information provided by clients in order to assist it in estimating reserves, the Company performs certain processes in order to help assess the completeness and accuracy of such information as follows:
Loss emergence patterns for the business written by Talbot are generally derived from Talbot’s own historic loss development triangulations, supplemented in some instances by Lloyd’s market data. For the business written by Validus Re and AlphaCat, where its own historic loss development triangulations are currently more limited, greater use is made of market data including reinsurance industry data available from organizations such as statistical bureaus and consulting firms, where appropriate. Expected loss ratios are estimated in a variety of ways, largely dependent upon the data available. Wherever it deems appropriate, management incorporates the Company’s own loss experience in establishing initial expected loss ratios and reserves. This is particularly true for the business written by Talbot where a longer reserving history exists and expected losses and loss ratios consider, among other things, rate increases and changes in terms and conditions that have been observed in the market. For reinsurance business, expected losses and loss ratios are typically developed using vendor and proprietary computer models. The information used in these models is collected by underwriters and actuaries during the initial pricing of the business.
During 2010 and 2011, given the complexity and severity of notable loss events, explicit reserves for potential development on 2010 and 2011 notable loss events (RDE) were included within the Company's IBNR reserving process. As uncertainties surrounding initial estimates on notable loss events developed, this reserve has been allocated to specific notable loss events. No RDE was established for 2012 or 2013 notable losses.
The requirement for a reserve for potential development on notable loss events in a quarter is a function of (a) the number of significant events occurring in that quarter and (b) the complexity and volatility of those events. Complexity and volatility factors considered are as follows:
• Quality, timing and flow of information received from each loss;
The Company’s reserving methodology was not changed materially in the year ended December 31, 2013 from the methodology used in the year ended December 31, 2012 for Validus Re, Talbot or AlphaCat. Management’s best estimate of the gross reserve for losses and loss expenses and loss reserves recoverable at December 31, 2013 were $3,030.4 million and $370.2 million, respectively. The following table sets forth a breakdown between gross case reserves and gross IBNR by segment at December 31, 2013.
To the extent insurance and reinsurance industry data is relied upon to aid in establishing reserve estimates, there is a risk that the data may not match the Company’s risk profile or that the industry’s reserving practices overall differ from those of the
Company and its clients. In addition, reserving can prove especially difficult should a significant loss event take place near the end of an accounting period, particularly if it involves a catastrophic event. These factors further contribute to the degree of uncertainty in the reserving process.
Management’s best estimate of the net reserve for losses and loss expenses at December 31, 2013 is $2,660.2 million. The following tables show the effect on estimated net reserves for losses and loss expenses as of December 31, 2013 of a change in two of the most critical assumptions in establishing reserves: (1) loss emergence patterns, accelerated or decelerated by three and six months; and (2) expected loss ratios varied by plus or minus five and ten percent. Management believes that a reasonably likely scenario is represented by such a standard, as used by some professional actuaries as part of their review of an insurer’s or reinsurer’s reserves. Utilizing this standard as a guide, management has selected these variances to determine reasonably likely scenarios of variability in the loss emergence and loss ratio assumptions. These scenarios consider normal levels of catastrophe events. Loss reserves may vary beyond these scenarios in periods of heightened or reduced claim activity. The reserves resulting from the changes in the assumptions are not additive and should be considered separately. The following tables vary the assumptions employed therein independently. In addition, the tables below do not adjust any parameters other than the ones described above. Specifically, reinsurance collectability was not explicitly stressed as part of the calculations below.
Net reserve for losses and loss expenses at December 31, 2013-Sensitivity to loss emergence patterns
A limited portion of our insurance business is written on a line slip or treaty (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 an estimate provided by the client, via the broker.
Judgments and Uncertainties: On a quarterly basis, the Company evaluates the appropriateness of premium estimates based on the latest information available, which may include actual reported premium to date, the latest premium estimates as provided by cedants and brokers, historical experience, management’s professional judgment, underlying values as necessary, information obtained during the underwriting renewal process, as well as an assessment of relevant economic conditions. Past experience may not be indicative of how future premium estimates develop.
For business written on a proportional basis, we review premium estimates on a quarterly basis and evaluate their reasonability in light of actual reported premium to date, the latest premium estimates as provided by cedants and brokers, historical experience, management’s professional judgment, information obtained during the underwriting renewal process, as well as an assessment of relevant economic conditions. Factors contributing to changes from the initial premium estimates may include changes in renewal rates, rates of new business or underlying exposures. As a result of this review process, any adjustments to estimates are recognized in gross premiums written during the period they are determined. Such changes in premium estimates may directly impact net premiums earned in the period they are determined because the adjustment may need to be substantially or fully earned.
Credit risk: Management includes an assessment of the creditworthiness of cedants in the review process above, primarily based on market knowledge, reports from rating agencies, the timeliness of cedants’ payments and the status of current balances owing. Based on this assessment, management believes that as at December 31, 2013 no provision for doubtful accounts is necessary for receivables from cedants.
Description: As discussed in Item 1 “Business” the Company primarily uses ceded reinsurance for risk mitigation purposes. Validus Re purchases reinsurance on an excess of loss and a proportional basis together with ILW coverage. Talbot purchases reinsurance on an excess of loss and a proportional basis together with a relatively small amount of facultative reinsurance and ILWs.
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, 2013, loss reserves recoverable balances were $370.2 million and paid losses recoverable balances were $80.1 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.
In addition to internal controls, management relies on the effectiveness of the valuation controls in place at the Company’s external investment accounting service provider (supported by a Statement on Standards for Attestation Engagements No. 16 Report) in conjunction with regular discussion and analysis of the investment portfolio’s structure and performance. To date, management has not noted any issues or discrepancies related to investment valuation.
Other investments consist of hedge funds, a fund of hedge funds, an investment fund, private equity investments and a deferred compensation trust held in mutual funds. The hedge funds were valued at $561.1 million at December 31, 2013. The hedge funds consist of an investment in four Paulson & Co. managed funds and a hedge fund assumed from the Flagstone Acquisition.
The Paulson & Co. Inc. funds' administrator provides monthly reported Net Asset Values ("NAVs") with a one-month delay in its valuation. As a result, the funds' administrator's November 30, 2013 NAV was used as a partial basis for fair value measurement in the Company's December 31, 2013 balance sheet. The fund manager provides an estimate of the NAV at December 31, 2013 based on estimated performance. The Company adjusts fair value to the fund manager's estimated NAV that incorporates relevant valuation sources on a timely basis. As this valuation technique incorporates both observable and significant unobservable inputs, the Paulson hedge funds are classified as Level 3 assets. To determine the reasonableness of the estimated NAV, the Company
assesses the variance between the fund manager's estimated NAV and the fund administrator's NAV. Material variances are recorded in the current reporting period while immaterial variances are recorded in the following reporting period. These managed hedge funds are subject to quarterly liquidity.
The Flagstone hedge funds and private equity investments' monthly reported NAV is provided with a one-month or one-quarter delay in its valuation. As a result, the November 30, 2013 NAV or the September 30, 2013 NAV was used as a basis for fair value measurement in the Company's December 31, 2013 balance sheet. As this valuation technique incorporates both observable and significant unobservable inputs, the investments funds and private equity investments are classified as Level 3 assets.
The fund of hedge funds includes a side pocket valued at $2.3 million at December 31, 2013. While a redemption request has been submitted, the timing of receipt of proceeds on the side pocket is unknown. The fund's administrator provides a monthly reported NAV with a one-month delay in its valuation. As a result, the fund administrator's November 30, 2013 NAV was used as a basis for fair value measurement in the Company's December 31, 2013 balance sheet. As this valuation technique incorporates both observable and significant unobservable inputs, the fund of hedge funds is classified as a Level 3 asset.
The investment fund consists of a pooled investment which is invested in fixed income securities with high credit ratings. The investment fund was valued at $31.6 million at December 31, 2013. The fair value of units in the investment fund is based on the net asset value of the fund as reported by Lloyd's Treasury & Investment Management. As the pricing of the underlying securities are based on quoted prices in active market. The investment fund is classified as a Level 2 asset.