(3) Combined ratio: The combined ratio is the sum of the losses and loss adjustment expenses ratio and the expense ratio.
(5) Debt to total capitalization ratio: The debt to total capitalization ratio, is the ratio, expressed as a percentage, of total debt to the sum of total debt and shareholders’ equity. The Company’s total debt consists solely of trust preferred loans payable.
We segregate our business into two segments: insurance operations and other. The insurance operations are further classified into three divisions: E&S, ART and Reinsurance (Assumed Re). E&S consists of seven product lines: environmental, primary casualty, excess, property, surety, healthcare, and professional liability. ART consists of two product lines: specialty programs and fully funded. Reinsurance consists of property and casualty business assumed from unaffiliated specialty insurers and reinsurers. Other includes lines of business that we no longer underwrite (run-off) and other ancillary product lines. Prior year amounts have been reclassified to conform to the current year presentation.
Losses and loss adjustment expenses totaled $171.7 million, or 67.6%, of net earned premiums for the year ended December 31, 2012, compared to $169.4 million and 72.7% in 2011. 2012 results include $9.0 million of development to prior year loss reserves as shown below.
The table below sets forth the prior year reserve development for the years ended December 31, 2012 and 2011 (dollars in millions):
The income tax expense totaled $0.8 million for the year ended December 31, 2012 compared to a tax benefit of $3.4 million for the year ended December 31, 2011. During 2010 and 2011, the RRG was in an NOL position and carrying a valuation allowance and therefore did not provide income tax expense (benefit). During 2012, the RRG generated income before taxes of $1.9 million and tax expense of $0.6 million. The $0.6 million of tax expense for the RRG is included in total tax expense of $0.8 million.
The Company operates through its subsidiaries in the U.S. and Bermuda. Significant differences exist in the regulatory environment in each country. The table below depicts the Company’s operations by geographic location for the years ended December 31, 2012 and 2011 (dollars in thousands):
Net Earnings attributable to American Safety Insurance Holdings, Ltd. Net earnings attributable to American Safety Insurance Holdings, Ltd., from Bermuda operations decreased to $11.8 million for the year ended December 31, 2012, compared to $17.9 million for 2011, due to loss reserve strengthening previously discussed and increased catastrophe losses during 2012. The U.S. operations had net income attributable to American Safety Insurance Holdings, Ltd., of $0.06 million for the year ended December 31, 2012, compared to losses of $7.0 million for 2011, due to higher reserve strengthening in the U.S. during 2011.
Assets. Assets attributable to the Bermuda operations increased to $653.9 million at the end of 2012 compared to $614.9 million at the end of 2011. This increase is primarily due to cash flow from operations and increased market values of investments. Assets attributable to the U.S. operations at the end of 2012 increased to $719.2 million as compared to $671.6 million at the end of 2011 due primarily to increased market values of investments.
The combined ratio for 2011 was 111.8% with an increase in the loss ratio offsetting an improvement in the expense ratio. The 2011 loss ratio increased to 72.7% compared to 59.9% in 2010 while the expense ratio decreased from 40.1% to 39.1% in 2011. The loss ratio increased as a result of prior accident year loss reserve development discussed under “Loss and Loss Adjustment Expenses” and higher than expected property losses in 2011 within the E&S and ART divisions. The reduction in the expense ratio is primarily due to economies of scale associated with the growth in premiums which was partially offset by lower fee income.
Net earned premiums totaled $232.9 in 2011 compared to $200.7 million in 2010, an increase of 16.0%. E&S totaled $119.2 million, a 15.8% increase from $102.9 million the same period in 2010; ART increased to $57.3 million, a 12.9% increase over the 2010 period; Reinsurance totaled $53.0 million, a 20.2% increase from 2010. The increase in earned premium for the E&S lines division was due to increased production across all product lines but driven primarily by excess, professional liability, property, and healthcare product lines. The ART division’s increase in net earned premiums was due primarily to the growth in programs during 2010 and 2011. This growth included a dealer open lot program as well as hospitality programs, some of which have been non-renewed or moved to other carriers in 2012. As a result, 2012 net earned premiums for the ART division are expected to decrease. The Reinsurance division’s increase in net earned premiums was due to continued increased writings in targeted classes of business during 2010 and 2011.
Net investment income decreased 2.5% to $31.3 million for the year ended December 31, 2011, compared to $32.1 million for 2010 due to lower yields on increased average invested assets. Yield compression during 2011 impacted investment income as cash flow and portfolio maturities were reinvested at lower rates. Average invested assets increased to $850.8 million as of December 31, 2011, from $784.4 million as of December 31, 2010. The average pre-tax investment yield was 4.1% for 2011.
Also during 2011, the Company’s loss ratio included adjustments to the current accident year of $20.2 million. The ART division accounted for $11.5 million due to increased loss activity primarily in one program and Reinsurance accounted for $7.4 million due to catastrophes.
Acquisition expenses are commissions paid to our producers, offset by ceding commissions we receive from our reinsurers. Acquisition expenses also include premium taxes paid to states in which we are admitted to conduct business. Acquisition expenses increased to $52.1 million for the year ended December 31, 2011, as compared to $43.5 million for the same period of 2010. The increase year over year is the result of growth in gross written premiums in 2011 of $298.5 million as compared to $277.6 million in 2010. As a percentage of net earned premiums acquisition costs were constant for both years at approximately 22%.
Net Earnings attributable to American Safety Insurance Holdings, Ltd. Net earnings attributable to American Safety Insurance Holdings, Ltd., from Bermuda operations decreased to $17.9 million for the year ended December 31, 2011, compared to $29.6 million for 2010, due to loss reserve strengthening previously discussed and increased catastrophe losses during 2011. The U.S. operations net loss attributable to American Safety Insurance Holdings, Ltd., of $7.0 million for the year ended December 31, 2011, compared to earnings of $0.9 million for 2010.
Assets. Assets attributable to the Bermuda operations increased to $614.9 million at the end of 2011 compared to $569.1 million at the end of 2010. This increase is primarily due to cash flow from operations and increased market values of investments. Assets attributable to the U.S. operations at the end of 2011 increased to $671.6 million as compared to $652.1 million at the end of 2010 due primarily to increased market values of investments.
As management is ultimately responsible for determining the fair value measurements for all securities, we selectively validate prices received by comparing the fair value estimates to our knowledge of the current market and investigate prices deemed not to be representative of fair value. See Note 6 to the Company’s consolidated financial statements for additional information regarding the Company’s fair value measurements. Assets measured at fair value on a recurring basis are summarized below:
Our contractual obligations (in thousands of dollars) as of December 31, 2012, were:
(1) The above table includes all interest payments through the expiration of debt instruments. All amounts are reflected based on final maturity dates. Variable rate interest obligations are estimated based on current interest rates. As a result of applying interest rates based on the current LIBOR rate plus the contractual spread for each capital trust, the interest rates were 4.5%, 4.4% and 3.8% for American Safety Capital Trust, American Safety Capital Trust II and American Safety Capital Trust III, respectively as of December 31, 2012. These rates are used to calculate the variable interest rate obligations through maturity.
(2) The above table includes the expected settlement of our gross loss reserves. The Company relies on reinsurance to reduce current risk exposures. The expected payout of gross loss reserves net of reinsurance recoverables is as follows: total $539.6 million; $99.0 million less than a year; $146.9 million 1-3 years, $77.4 million; 3-5 years and $216.3 million; more than 5 years. More information about our unpaid loss and loss adjustment expenses appears in Note 13 to our consolidated financial statements.
Investments. We routinely review our investments that have experienced declines in fair value to determine if the decline is other than temporary. These reviews are performed with consideration of the facts and circumstances of an issuer in accordance with the Securities and Exchange Commission (“SEC”), Accounting for Non-Current Marketable Equity Securities; ASC 320-10-05, Accounting for Certain Investments in Debt and Equity Securities; and Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments; and related guidance. The identification of distressed investments and the assessment of whether a decline is other than temporary involve significant management judgment and require evaluation of factors including but not limited to:
• percentage decline in value and the length of time during which the decline has occurred;
• adverse changes in the issuer’s economic, regulatory or political environment.
The Company routinely monitors and evaluates the difference between the cost and fair value of its investments. Additionally, credit analysis and/or credit rating issues related to specific investments may trigger more intensive monitoring to determine if a decline in market value is other than temporary (“OTTI”). For investments with a market value below cost, the process includes evaluating the length of time and the extent to which cost exceeds market value, the prospects and financial condition of the issuer, and evaluation for a potential recovery in market value, among other factors. This process is not exact and further requires consideration of risks such as credit risk and interest rate risk. Therefore, if an investment’s cost exceeds its market value solely due to changes in interest rates, impairment may not be appropriate.
The OTTI is split between a credit loss portion and a portion due to other factors like liquidity and market interest rate changes. The credit portion of the OTTI is the difference between the amortized cost of the debt security and the present value of the estimated cash flows to be received from the security and is charged to expense. The non-credit portion is recorded in a new category of other comprehensive income (“OCI”), net of applicable deferred taxes, separately from unrealized gains and losses on available-for-sale (“AFS”) securities.
Reserves. Claims made policies provide coverage for claims that are incurred and reported during the policy period. Insurance policies and reinsurance treaties can be occurrence based and therefore may be subject to claims brought years after an incident has occurred or the policy period has ended. We are required to maintain reserves to cover the unpaid portion of our ultimate liability for losses and loss adjustment expenses with respect to (i) reported claims and (ii) incurred but not reported (IBNR) claims. An actuarial analysis is performed quarterly to estimate all of our unpaid losses and loss adjustment expenses under the terms of our contracts and agreements. In evaluating whether the reserves are adequate for unpaid losses and loss adjustment expenses, it is necessary to project future losses and loss adjustment expenses payments. It is probable that the actual future losses and loss adjustment expenses will not develop exactly as projected and may, in fact, vary materially from the projections.
Short-tail business is generally characterized by the industry as business for which claims are received and settled within one year. Our total net reserves for short tail business as generally defined by the industry, as of December 31, 2012, were approximately 2.2% of total net reserves. In the aggregate, our primary long-tail lines are construction, where we offer general liability insurance to construction contractors and environmental where we offer general liability and professional liability insurance to environmental contractors and consultants.
As part of our year-end process, the Company has an external actuarial firm perform an independent analysis and issues an actuarial opinion on the insurance operating companies’ carried loss and loss adjustment expense reserves.
Environmental exposures may involve bodily injury and property damage claims. These claims tend to be reported sooner but take longer to settle because often times multiple parties are involved in a claim. The loss development patterns and the expected loss ratios are estimated based on our internal loss history.
A number of assumptions were made in the determination of the best reserve estimates for each line of business at December 31, 2012. The key assumptions among them were the expected loss ratios and loss development patterns. If the actual future losses and loss adjustment expenses develop materially differently from those key assumptions, there could be a potential for significant variation in the development of loss reserves. The effect of any specific assumptions can vary by accident year and line of business. We performed sensitivity analyses that tested the effects on the loss reserve position of using alternative expected loss ratios and loss development patterns. The tests addressed each major line of business for which a material deviation to the overall reserve position is possible and used what we believed was a reasonably likely range of potential deviation for each line of business. If our net carried reserves were to decrease from our best estimate, this would increase our net earnings, while an increase in our net carried reserves would decrease our earnings.
Acquisition Costs. We defer commissions and premium taxes that are related to the acquisition of insurance contracts. These costs are capitalized and charged to expense in proportion to premium revenue recognized. The method followed in computing deferred acquisition costs limits the amount of such deferred costs to their estimated realizable value. This would also give effect to the premiums to be earned and anticipated losses and settlement expenses as well as certain other costs expected to be incurred as the premiums are earned. Judgments as to the ultimate recoverability of such deferred costs are highly dependent upon estimated future loss costs associated with the written premiums as well as investment income.
Deferred Income Taxes. The majority of our deferred taxes associated with our premium writings will be realized over the policy period and payout of related claims. We believe it is more likely than not that we will realize the full benefit of our deferred tax assets. See Note 5 to the Company’s consolidated financial statements for additional information on deferred tax assets.
This report contains forward-looking statements. These forward-looking statements reflect the Company’s current views with respect to future events and financial performance, including insurance market conditions, premium growth, acquisitions and new products and the impact of new accounting standards. Forward-looking statements involve risks and uncertainties which may cause actual results to differ materially, including competitive conditions in the insurance industry, levels of new and renewal insurance business, developments in loss trends, adequacy and changes in loss reserves and actuarial assumptions, timing or collectability of reinsurance recoverables, market acceptance of new coverages and enhancements, changes in reinsurance costs and availability, potential adverse decisions in court and arbitration proceedings, the integration and other challenges attendant to acquisitions, and changes in levels of general business activity and economic conditions.