We maintain office facilities in Bermuda, the U.S., Canada, Europe, Australia, Singapore, Latin America and the Middle East. We own the property in which our offices are located in Dublin, Ireland, and we lease office space in the other countries. We renew and enter into new leases in the ordinary course of business as required. Our global headquarters is located at 92 Pitts Bay Road, AXIS House, Pembroke HM 08, Bermuda. We believe that our office space is sufficient for us to conduct our operations for the foreseeable future.
The following is a discussion and analysis of our results of operations for the years ended December 31, 2016, 2015 and 2014 and our financial condition at December 31, 2016 and 2015. This should be read in conjunction with the Consolidated Financial Statements and related notes included in Item 8 of this report. Tabular dollars are in thousands, except per share amounts. Amounts in tables may not reconcile due to rounding differences.
Net income available to common shareholders of $465 million, or $5.13 per common share and $5.08 per diluted common share
Estimated pre-tax catastrophe and weather-related net losses, net of reinstatement premiums, of $204 million compared to $100 million for 2015
Total cash and investments of $14.7 billion; fixed maturities, cash and short-term securities comprise 87% of total cash and investments and have an average credit rating of AA-
Reserve for losses and loss expenses of $9.7 billion and reinsurance recoverable of $2.3 billion
Total debt of $993 million and a debt to total capital ratio of 13.7%
Total common shares repurchased were 10.5 million, consisting of 9.1 million of common shares repurchased for $512 million and 1.4 million common shares acquired under an Accelerated Share Repurchase agreement, which terminated on January 15, 2016
continued implementation of a more focused distribution strategy and increased our scale and relevance in key markets;
continued rebalancing of our portfolio towards less-volatile lines of business that carry attractive rates;
broadened our risk-funding sources and developed vehicles that utilize third-party capital:
our investment in Harrington Reinsurance Holdings Limited ("Harrington"), the parent company of Harrington Re Ltd. ("Harrington Re"), an independent reinsurance company jointly sponsored by AXIS Capital and The Blackstone Group L.P. ("Blackstone"). Harrington Re’s strategy is to combine a multi-line reinsurance portfolio with a diversified allocation to alternative investment strategies to earn attractive risk-adjusted returns. Harrington has developed a portfolio that optimizes the risk-reward characteristics of both assets and liabilities, leveraging the respective strengths of AXIS Capital and Blackstone while deploying a disciplined and fully integrated approach to both underwriting and investing; and
On January 27, 2016 we redeemed the remaining $3 million of our 7.50% Series B preferred shares. In addition, on November 7, 2016 we issued $550 million of 5.50% Series E preferred shares and used a portion of the net proceeds to repurchase $49 million of our 6.875% Series C preferred shares. The Company intends to redeem or repurchase the remaining $351 million of its Series C preferred shares outstanding using a portion of the remaining net proceeds from the Series E offering. The execution of these transactions will reduce the weighted average annual dividend rate on our preferred equity capital base by 88 basis points to 5.50%, with a minimal impact on our financial leverage.
On November 28, 2016, the Company announced that it has agreed to acquire general aviation insurance and reinsurance leader Aviabel, increasing the Company's scale and relevance in the global aviation market while extending its physical presence into Brussels and Amsterdam. The transaction is expected to close in the first half of 2017, subject to regulatory approval and customary closing conditions.
The reinsurance segment underwriting income decreased by $19 million during 2016 compared to 2015. The decrease in underwriting income was primarily driven by an increase in catastrophe and weather-related losses and a higher acquisition cost ratio partially offset by an increase in net favorable prior year loss reserve development, other insurance-related income and lower general and administrative expenses.
The reinsurance segment underwriting income decreased by $122 million during 2015 compared to 2014. The decrease in underwriting income was primarily driven by the increase in the current accident year loss ratio. An increase in the acquisition cost ratio and the impact of lower net earned premiums also contributed to the overall decrease. Partially offsetting these decreases was an increase in net favorable prior year loss reserve development.
The variability in net investment income from 2014 through 2016 was largely attributable to the performance of other investments. Income from this portfolio increased by $22 million in 2016 compared to 2015, as a result of higher returns from
investments in equity tranches of collateralized loan obligations ("CLO-Equities") which increased in value along with other risk assets. Comparatively, income from this portfolio decreased by $37 million in 2015 compared to 2014, driven by lower returns from our hedge funds and a decline in value of CLO-Equities which declined in value along with other risk assets during 2015.
Excluding income from other investments, net investment income increased $26 million compared to both 2015 and 2014. The increase was primarily attributable to contributions from fixed income as a result of longer duration assets and income from commercial mortgage loans as a result of an increased allocation to this asset class during 2016.
Tax expense increased to $6 million in 2016, compared to $3 million in 2015. The effective tax rate can vary between periods depending on the distribution of net income amongst tax jurisdictions, as well as other factors. The increase was driven primarily by an increase in comparative European pre-tax income, offset partially by a decrease in comparative pre-tax income in the U.S. Tax expense decreased to $3 million in 2015, compared to $26 million in 2014. The primary factor in the decrease in the effective tax rate from 2014 to 2015 was the geographical distribution of our net income. While we generated consolidated pre-tax net income in 2015, the majority of our operating income as well as the PartnerRe merger termination fees received were recognized in Bermuda. The tax expense was further impacted by realized losses on investments in our European entities during 2015.
During 2015, the Company announced that we had accepted a request from PartnerRe to terminate the Amalgamation Agreement with the Company. PartnerRe paid the Company $315 million to immediately terminate the Amalgamation Agreement, the amount was comprised of a termination fee of $280 million and a reimbursement of merger-related expenses of $35 million.
During 2015, the Company implemented a number of profitability enhancement initiatives which resulted in a recognition of reorganization and related expenses of $46 million and additional corporate expenses of $5 million in the Consolidated Statement of Operations. Refer to Item 8, Note 4 to the Consolidated Financial Statements 'Goodwill and Intangibles' and to Note 18 'Reorganization and Related Expenses' for additional information.
Interest in loss of equity method investments represents the Company's aggregate share of losses related to investments in which the Company has significant influence over the operating and financial policies of the investee.
Competitive conditions continue to impact worldwide insurance markets with the greatest pressures impacting catastrophe exposed property and certain global specialty lines of business. We also observed greater competitiveness for large accounts compared to smaller risks. These competitive pressures have led to price reductions across most lines of business, with decreases in international markets generally more severe than those observed in the U.S. We expect this trend to continue in the short-term but believe that there are still attractive risks in the market. In this challenging market environment, we are focusing on lines and markets that remain adequately priced or continue to deliver price increases and those that provide opportunities for profitable growth. Where necessary we also continue to shift our business mix toward smaller, less volatile risk accounts which we believe will enable us to achieve a better, more stable attritional loss experience with lower severity.
The reinsurance markets' trading environment remains challenging in many lines of business and geographical regions. The market continues to be influenced by excess capacity, strong balance sheets of established market participants and a consolidation of reinsurance purchasing. Despite these conditions we have observed recent favorable trends which we expect to positively impact trends in our business including many cedants reducing the size of their reinsurer panels, some moderation of pricing pressures, increased resistance to demands for greater commission rates as well as an expansion of terms and conditions, an increase in the number of cedants looking to buy more reinsurance protection and Solvency II and other regulatory or governmental driven opportunities. These factors, combined with AXIS' customer-centric approach, and opportunities in specific lines of business and geographies allow us to execute on our targeted growth strategy. We continue to address the difficult market conditions by taking actions to protect the quality and profitability of our existing book, targeting larger shares of the more attractive treaties, managing the overall volatility of our reinsurance book, and expanding our already strong group of strategic capital partners with whom to share our risks.
The increase in non-GAAP operating ROACE in 2016, compared to 2015, was primarily driven by an increase in net investment income, partially offset by a decrease in underwriting income and higher corporate expenses.
In addition to the items noted above for non-GAAP operating ROACE, ROACE is also impacted by net realized investment gains (losses), foreign exchange losses (gains), termination fee received, reorganization and related expenses and the loss on repurchase of preferred shares.
The decrease in ROACE in 2015, compared to 2014, was primarily driven the adverse impacts of net realized investment losses, a decrease in underwriting income and net investment income together with reorganization and related expenses incurred in 2015 partially offset by the termination fee received from PartnerRe in 2015, a decrease in corporate expenses and lower interest expense and financing costs.
We consider diluted book value per common share to be an appropriate measure of our returns to common shareholders, as we believe growth in our book value on a diluted basis will ultimately translate into appreciation of our stock price.
During 2016 and 2015, our diluted book value per common share appreciated by 8% and 7%, respectively, driven primarily by $465 million and $602 million in net income available to common shareholders, respectively. This was partially offset by common dividends declared.
The decrease in unrealized losses in 2016 reflected a tightening of credit spreads on non-government bonds and strong equity market returns, while the increase in unrealized losses in 2015 reflected an increase in the U.S. interest rates, the widening of credit spreads on non-government bonds and foreign exchange volatility.
In 2016, our net income and a decrease in unrealized losses on investments included in other comprehensive income, drove an increase in DBV per common share adjusted for dividends. In 2015 and 2014, our net income, which was partially offset by unrealized losses on investments included in other comprehensive income, drove an increase in DBV per common share adjusted for dividends.
Underwriting-related general and administrative expenses is a non-GAAP measure as defined in SEC Regulation G. Our total general and administrative expenses also included $120,016, $109,910 and $135,675 of corporate expenses for 2016, 2015 and 2014, respectively. Refer to 'Other Expenses (Revenues), Net' for additional information related to these corporate expenses. Also, refer to 'Non-GAAP Financial Measures' for further information.
2015 versus 2014: Gross premiums written in 2015 decreased by $108 million or 2% (comparable to 2014 on a constant currency basis) due to decreases in the reinsurance segment, partially offset by increases in the insurance segment.
The insurance segment's gross written premium increased by $48 million or 2% compared to 2014. The increase was driven by new business in our accident and health lines, growth in our professional and liability lines, increased deal premium in our credit and political risk lines compared to prior year, and certain new initiatives providing growth in our professional lines. These increases were partially offset by the strength of the U.S. dollar as well as certain profitability enhancement initiatives announced during the third quarter of 2015, as well as reductions in our property lines.
The ceded ratio increased by 4 points in 2016 compared to 2015, driven by increases in both segments. The increase in the ceded ratio in the reinsurance segment was due to a new retrocessional cover entered into with Harrington Re, which increased premiums ceded in our liability and professional lines, together with new retrocessional treaties that increased ceded premiums in our catastrophe and property business. The increase in the ceded ratio in the insurance segment was driven by increased cessions in our professional and liability lines.
The decrease in net premiums earned in the insurance segment in 2016 compared to 2015, was primarily driven by an increase in premiums ceded in our professional lines, partially offset by an increase in gross premiums earned driven by an increase in premiums written in recent periods.
The general and administration expense ratio includes corporate expenses not allocated to underwriting segments of 3.2%, 3.0% and 3.5% for 2016, 2015 and 2014, respectively. These costs are further discussed in the ‘Other Expenses (Revenues), Net’ section.
2016 versus 2015: The current accident year loss ratio increased to 67.4% in 2016 from 65.6% in 2015. The increase was primarily due to an increase in catastrophe and weather-related losses. During 2016 we incurred pre-tax catastrophe and weather-related net losses (net of reinstatement premiums) of $204 million or 5.6 points, attributable to U.S. weather-related events, Hurricane Matthew, Fort McMurray wildfires, the Japanese, Ecuadorian and South Island earthquakes, North Calgary hailstorm and European floods. Comparatively, in 2015 we incurred $100 million or 2.7 points of losses attributable to catastrophe and weather-related events.
After adjusting for the impact of the catastrophe and weather-related losses, our current accident year loss ratio decreased from 62.9% in 2015 to 61.8% in 2016. The decrease in the current accident year loss ratio after adjusting for the impact of the catastrophe and weather-related losses was driven by a decrease in mid-size loss experience in our insurance marine and property lines and a decrease in loss experience in our reinsurance credit and surety lines, partially offset by the ongoing adverse impact of rate and trend, and an increase in loss experience in our insurance credit and political risk and reinsurance agriculture lines.
2015 versus 2014: The current accident year loss ratio increased to 65.6% in 2015 from 63.2% in 2014. The increase in 2015 was primarily due to changes in business mix, primarily reflecting the reduction in catastrophe exposures; the impact of lower rates; an increase in the insurance marine and liability and reinsurance credit and surety loss experience; as well as an increased level of catastrophe and weather-related losses. In 2015, we recorded $100 million of such aggregate pre-tax losses compared to $93 million of pre-tax catastrophe and weather-related losses in 2014. The increases in the current accident year loss ratio were partially offset by improvement in loss experience across both segments' property and other reserving lines and the insurance professional lines.
Our long-tail business consists primarily of liability and motor reserve classes. In 2016, 2015 and 2014, our motor and reinsurance liability reserve classes contributed net favorable prior year reserve development of $99 million, $82 million and $40 million, respectively. The net favorable prior year reserve development for the motor reserve class related to favorable loss emergence trends on several classes of business spanning multiple accident years. The net favorable prior year reserve development for our reinsurance liability reserve class primarily reflected the progressively increased weight given by management to experience based indications on older accident years, which has generally been favorable.This favorable development was partially offset by adverse development in our insurance liability reserve class of $8 million, $27 million and $23 million in 2016, 2015 and 2014, respectively, related primarily to an increase in loss estimates for specific individual claim reserves as well as a higher frequency of large auto liability claims which impacted the adverse reserve development in 2015.
$35 million of net favorable prior year reserve development on property and other business, driven by better than expected loss emergence primarily related to accident years 2012 through 2014.
$9 million of net favorable prior year reserve development on aviation business, spanning a number of accident years and largely related to better than expected loss emergence.
$44 million of net favorable prior year reserve development on liability business, primarily related to the 2006 through 2011 accident years, for reasons discussed in the overview.
$37 million of net favorable prior year reserve development on motor business, predominantly related to non-proportional business and driven by better than expected loss emergence on accident years 2007 through 2013, partially offset by reserve strengthening on accident year 2014.
$21 million of net favorable prior year reserve development on liability business related to accident years 2008 and prior, for the reasons discussed in the overview. This favorable development was partially offset by strengthening of the reserves related to the 2009 through 2013 accident years.
Acquisition Cost Ratio: The increase in the acquisition cost ratio to 20.2% in 2016 from 19.5% in 2015 was driven by an increase in our reinsurance segment. The increase in the reinsurance segment's acquisition cost ratio was primarily due to the impact of retrocessional contracts, adjustments related to loss-sensitive features in underlying contracts, and higher acquisition costs in certain lines of business due to the increase in the amount of business being written on a proportional basis. This increase was partially offset by a decrease in the insurance segment's acquisition cost ratio driven by higher ceding commissions following increased cessions in our professional lines, partially offset by higher variable acquisition costs paid on certain lines of business and favorable federal excise tax adjustment which benefitted 2015.
General and Administrative Expense Ratio: The general and administrative expense was consistent in 2016 compared to 2015 at 16.2%. An increase in personnel expenses including transition and severance costs was offset by the benefits of arrangements with our strategic capital partners and an increase in net premiums earned.
The increase in the general and administrative expense ratio to 16.2% in 2015 from 16.1% in 2014 was primarily driven by lower net earned premiums and was largely offset by lower general administrative expenses primarily due to: adjustments to senior leadership executive stock-compensation awards, a reduction in performance-based incentive compensation, a decrease in severance expenses, lower costs related to operational excellence initiatives and the favorable impact of foreign exchange. These reductions were partially offset by reorganization related corporate expenses incurred in the third quarter of 2015.
2016 versus 2015: Gross premiums written in 2016 increased by $137 million or 5% compared to 2015. In 2016, gross premiums written were negatively impacted by our exit from retail insurance operations in Australia and foreign exchange movements. After adjusting for our exit from retail insurance operations in Australia and foreign exchange movements, gross premium written increased by $200 million primarily attributable to new business in our accident and health, property, professional, and liability lines. These increases were partially offset by decreases in our marine, and credit and political risk lines. Our marine lines decreased principally due to reduced new business opportunities, lower rates and timing differences. The decrease in our credit and political risk line was driven by timing differences.
2015 versus 2014: Gross premiums written in 2015 increased by $48 million or 2% compared to 2014. The 2015 gross premiums written were negatively impacted by foreign exchange movements, as well as the impact of our exit from retail insurance operations in Australia, together reducing premiums by approximately $78 million. The $126 million increase, after adjusting for foreign exchange and our exit from retail insurance operations in Australia was primarily driven by new business in our accident and health line, growth in our lawyers' liability program in the U.S and cyber liability initiatives in our professional lines, growth in the U.S. primary and excess casualty markets within our liability line and increased deal premiums compared to the prior year in our credit and political risk line. These increases were partially offset by a reduction in our property lines, reflecting competitive market conditions.
2015 versus 2014: Premiums ceded in 2015 were $824 million, or 32%, of gross premiums written, compared to $756 million, or 30%, in 2014. The increase in premiums ceded and the related ceded ratio was due to an increase in reinsurance protection purchased primarily in our professional lines and a change in the business mix.
2015 versus 2014: Net premiums earned in 2015 decreased by $32 million or 2% ($11 million or 1% decrease on a constant currency basis) compared to 2014. The decrease in net premiums earned was driven by the growth in our ceded reinsurance programs primarily covering our professional lines. Gross premiums earned increased in 2015 compared to 2014, driven by growth in the liability and marine lines gross premiums written in recent periods, partially offset by decreases in gross premiums written mainly in the professional lines.
Acquisition Cost Ratio: The decrease in the acquisition cost ratio to 14.1% in 2016 from 14.5% in 2015 primarily reflected an increase in ceding commissions following increased cessions in our professional lines, partially offset by higher variable acquisition costs paid on certain lines of business, and favorable federal excise tax adjustment which benefitted 2015.
The decrease in the acquisition cost ratio in 2015 relative to 2014, primarily reflected changes in the mix of business, higher ceded commissions received, following increases in our ceded reinsurance programs, and a federal excise tax adjustment. These decreases were partially offset by higher commissions paid on certain lines of business.
General and Administrative Expense Ratio: The increase in the general and administrative expense ratio to 19.5% in 2016 from 19.1% in 2015, was primarily driven by the decrease in net earned premium, an increase in personnel expenses as well as transition and severance costs associated with the closure of four U.S. retail business units.
2016 versus 2015: Gross premiums written in 2016 increased by $229 million or 11% compared to 2015. The increase in gross written premiums was impacted by an increase in the level of premiums written on a multi-year basis in 2016 compared to 2015. This increase in multi-year contracts increased the amount of premium recorded in the current year relating to future years compared to 2015, most notably in the credit and surety and liability lines. On a comparative basis the impact of the multi-year premiums resulted in an increase in gross premiums written of $110 million in 2016 compared to 2015. The increase in gross premiums written was partially offset by foreign exchange movements as the strengthening of the U.S. dollar drove comparative premium decreases in the treaties denominated in foreign currencies, resulting in a decrease of $52 million in gross premiums written in 2016 compared to 2015.
2015 versus 2014: Net premiums earned in 2015 decreased by $152 million or 7% ($105 million or 5% decrease on a constant currency basis) compared to 2014. The decrease was primarily driven by reductions in the business written in the catastrophe, agriculture, professional and credit & surety lines in recent periods, as well as an increase in the premiums ceded reflecting increased retrocessional covers purchased primarily in the catastrophe lines. These decreases were partially offset by growth in the motor lines.
2015 versus 2014: The current accident year loss ratio increased to 65.7% in 2015 from 61.3% in 2014. The increase was primarily due to changes in business mix, an increase in losses due to catastrophic and weather-related events where during 2015 we incurred pre-tax losses related to catastrophe and weather-related losses of $46 million compared to $27 million of weather-related events in 2014 and increased loss experience in our credit and surety lines also contributed to the increase. The increases in the current accident year loss ratio were partially offset by improved loss experience in our property lines which include our agriculture and engineering business.
The increase in the acquisition cost ratio to 24.2% in 2015 from 22.5% in 2014 was primarily impacted by higher acquisition costs paid in certain lines of business, the impact of loss-sensitive feature adjustments, primarily due to prior year reserve releases, and changes in the business mix.
General and Administrative Expense Ratio: The decrease in the general and administrative expense ratio to 7.0% in 2016 from 7.7% in 2015, was primarily driven by an increase in net premiums earned, benefits of arrangements with our strategic capital partners, and lower professional fees, partially offset by higher personnel costs.
The increase in the general and administrative expense ratio to 7.7% in 2015 from 7.1% in 2014, was attributable to the impact of decreased net earned premiums and increased costs associated with new growth initiatives. These were partially offset by a reduction in the allocations of certain corporate expenses.
Interest Expense and Financing Costs: Interest expense and financing costs, primarily related to interest due on our senior notes, were consistent in 2016 compared to 2015 as there were no significant changes to our debt and financing arrangements. The decrease in 2015 compared to 2014 was a result of the repayment of $500 million of our 5.75% senior unsecured notes which matured on December 1, 2014.
The tax rate in 2016 increased compared to 2015. The increase was driven primarily by an increase in comparative European pre-tax income, offset partially by a decrease in comparative pre-tax income in the U.S.
The decreased tax rate in 2015 as compared to 2014 was primarily driven by the geographic distribution of underwriting income and investment gains (losses). While we generated consolidated pre-tax net income in 2015, the majority of our operating income as well as the PartnerRe merger termination fees received were recognized in Bermuda. The tax expense was further impacted by realized losses on investments in our European entities during 2015.
The following table provides a breakdown of net investment income from other investments:
The pre-tax return on other investments is non-annualized and calculated by dividing total net investment income from other investments by the average month-end fair value balances held for the periods indicated.
2015 versus 2014: Net realized investment losses during 2015 primarily reflect foreign exchange losses on non-U.S. denominated fixed maturities, as a result of the strengthening of the U.S. dollar during 2015. Lower net realized gains on the sale of equities reflect lower returns in the global equity markets during 2015.
OTTI losses in 2016 were $26 million compared to $73 million in 2015, a decrease of $47 million. The decrease in 2016 compared to 2015 was mainly due to higher losses recorded on high yield corporate debt securities in 2015 as a result of the widening of credit spreads in 2015. The current year OTTI losses included impairments on non-U.S. denominated securities as a result of the decline in foreign exchange rates against the U.S. dollar, corporate debt securities that have declined significantly in value, and ETFs which are unlikely to recover in the near term.
Change in net unrealized gain (losses) is calculated by taking net unrealized gain (losses) at year end less net unrealized gain (losses) at the prior year end.
Includes restricted cash and cash equivalents of $202 million and $187 million for 2016 and 2015, respectively.
At December 31, 2016, fixed maturities had a weighted average credit rating of AA- (2015: AA-), a book yield of 2.6% (2015: 2.5%) and an average duration of 3.5 years (2015: 3.3 years). At December 31, 2016, the weighted average credit rating was AA- (2015: AA-) and duration was 3.2 years (2015: 3.0 years) when short-term investments and cash and cash equivalents were included in the calculations (i.e. total investments of $12.7 billion).
To calculate the weighted average credit rating for fixed maturities, we assign points to each rating with 29 points for the highest rating (AAA) and 2 points for the lowest rating (D) and then calculate the weighted average based on the fair values of the individual securities. Securities that are not rated by S&P, Moody’s or Fitch are excluded from weighted average calculations. At December 31, 2016, the fair value of fixed maturities not rated was $42.8 million (2015: $3.6 million).
In light of global concerns during recent years over the creditworthiness of certain sovereign debt within the eurozone, we have actively managed our exposure to these countries. Our current non-U.S. government holdings include exposures to the Netherlands and Germany, both of which have a weighted average credit rating of AAA. At December 31, 2016, we held no sovereign debt issued by the peripheral European countries of Greece, Ireland, Italy, Portugal and Spain.
We also have an indirect eurozone exposure through our investment in exchange traded funds, which are classified as equities. At December 31, 2016 our exposure was $59 million (2015: $21 million).
"Other" is mainly local currency emerging market sovereign debt and were reduced during the year. At December 31, 2016, this portfolio had a weighted average credit rating of BBB+ (2015: BBB+), a duration of 5.3 years (2015: 4.8 years) and a yield-to-worst of 7.6% (2015: 8.6%).
At December 31, 2016, our non-U.S. government debt had net unrealized losses of $47 million (2015: $70 million) which included gross unrealized foreign exchange losses of $51 million (2015: $65 million), mainly on U.K. government bonds.
Corporate debt securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The composition of our corporate debt securities by sector was as follows:
ABS include mostly investment-grade bonds backed by pools of loans with a variety of underlying collateral, including automobile loan receivables, student loans, credit card receivables, and CLO Debt originated by a variety of financial institutions.The following table provides a breakdown of the fair value of our ABS by underlying collateral and credit rating:
The average duration and weighted average life of our ABS portfolio at December 31, 2016 was 0.6 years (2015: 0.5 years) and 2.8 years (2015: 3.2 years), respectively.
G.O. bonds are backed by the full faith and credit of the authority that issued the debt and are secured by the taxing powers of those authorities. Revenue bonds are backed by the revenue stream generated by the services provided by the issuer (e.g. sewer, water or utility projects). As issuers of revenue bonds do not have the ability to draw from tax revenues or levy taxes to fund obligations, revenue bonds may carry a greater risk of default than G.O. bonds. At December 31, 2016, 71% of our municipals are taxable with the remainder tax exempt.
The following table provides information on the severity of the unrealized loss position as a percentage of amortized cost for all non-investment grade fixed maturities in an unrealized loss position at December 31, 2016 and 2015:
During 2016, we increased our investment in commercial mortgage loans to $350 million from $206 million, an increase of $144 million. Our commercial mortgage loans are high quality and collateralized by a variety of commercial properties and are diversified both geographically throughout the U.S., and by property type, to reduce the risk of concentration. At December 31, 2016, there were no credit losses associated with our commercial mortgage loans portfolio.
The fair value of our total hedge funds decreased by $159 million in 2016 driven by $165 million of net redemptions offset by $6 million of price appreciation. Certain of these funds may be subject to restrictions on redemptions which may limit our ability to liquidate these investments in the short term. See Item 8, Note 5(c) to the Consolidated Financial Statements 'Investments' for further details on these restrictions and details on unfunded commitments relating to our other investment portfolio.
The Company also has investments in other equity method investments with a carrying value of $8 million.
Refer to Item 8, Note 5 (g) to the Consolidated Financial Statements 'Investments'.
permissible distributions, such as returns of capital, from its subsidiaries. The ability to pay such dividends and/or distributions is limited by the applicable laws and regulations of the various countries and states in which AXIS Capital’s subsidiaries operate (refer to Item 8, Note 21 to the Consolidated Financial Statements 'Statutory Financial Information' for further information), as well as the need to maintain capital levels to adequately support (re)insurance operations and to preserve financial strength ratings issued by independent rating agencies. During 2016, AXIS Capital received $550 million (2015: $420 million; 2014: $1,221 million) of distributions from its subsidiaries. AXIS Capital’s primary uses of funds are dividend payments to both common and preferred shareholders, share repurchases, interest and principal payments on debt, capital investments in subsidiaries and payment of corporate operating expenses. We believe the dividend/distribution capacity of AXIS Capital’s subsidiaries, which was $1.6 billion at December 31, 2016, will provide AXIS Capital with sufficient liquidity for the foreseeable future.
Net cash provided by operating activities was $407 million in 2016, compared to $791 million in 2015 and $862 million in 2014. The Company's insurance and reinsurance operations typically receive principal cash inflows from premiums, net of policy acquisition costs, and reinsurance recoverables. Our principal cash outflows are for the payment of claims and loss adjustment expenses, premium payments to reinsurers and operating expenses. Cash provided by operating activities can fluctuate due to timing differences in the collection of premium receivable and reinsurance recoverables and the payment of losses and ceded premiums payable. The reductions in operating cash flows in 2016 were primarily attributable to the the termination fee received from PartnerRe in 2015, increased purchases of reinsurance and retrocession covers and an increase in losses paid, primarily in our liability and accident and health lines, partially offset by an increase in premium collection which was driven by higher gross premiums written in 2016. The reductions in operating cash flows in 2015 compared to 2014 were primarily driven by an increase in net paid losses as we settled losses incurred in prior years. In 2015 operating cash flows were also reduced by increased purchases of reinsurance protection and retrocessional coverage, the settlement of reorganization expenses as well as an increase in general and administrative expenses paid, partially offset by the termination fee received by PartnerRe and increased reinsurance recoveries related to the increase in claims paid.
Our diversified underwriting portfolio has demonstrated an ability to withstand catastrophic losses. Since 2003, we have generated positive cash flows, notwithstanding the impacts of the global financial crisis and the recognition of significant natural catastrophe-related losses during the period: our net losses and loss expenses, gross of reinstatement premiums, included $266 million for Hurricanes Charley, Frances, Ivan and Jeanne in 2004; $1,019 million for Hurricanes Katrina, Rita and Wilma in 2005; $408 million for Hurricanes Gustav and Ike in 2008; $256 million for the Chilean and New Zealand earthquakes in 2010; $944 million for numerous natural catastrophe and weather events in 2011; and $331 million for Storm Sandy in 2012. There remains significant uncertainty associated with our estimates of net losses for certain of these events (see ‘Underwriting Results - Group - Underwriting Expenses’ for further details), as well as the timing of the associated cash outflows.
In addition to common equity, we have utilized other external sources of financing, including debt, preferred shares and credit facilities to support our business operations. We believe that we hold sufficient capital to allow us to take advantage of market opportunities and to maintain our financial strength ratings, as well as to comply with various local statutory regulations. We monitor our capital adequacy on a regular basis and will seek to adjust our capital base (up or down) according to the needs of our business (refer to ‘Risk and Capital Management’ in Item 1).
Our consolidated balance sheet for December 31, 2016 reflects the redemption of $3 million of Series B preferred shares, the issuance of $550 million in Series E preferred shares and the repurchase of $49 million of Series C preferred shares. The increase of $498 million in preferred equity reflected in the table above was attributable to the recognition of these transactions. The Company intends to use a portion of the remaining net proceeds from the Series E preferred share offering to redeem or repurchase the remaining $351 million of our Series C preferred shares outstanding. As a result, $351 million of the $498 million increase in preferred equity is expected to be temporary. We believe that our financial flexibility remains strong.
Preferred Shares: During 2005, we issued $250 million of 7.50% Series B non-cumulative preferred shares. During April 2012, we closed a cash tender offer for any and all of our outstanding Series B preferred shares at a price of $102.81 per share. As a result, we repurchased 2,471,570 Series B Preferred shares, for $254 million. At December 31, 2015, 28,430 Series B preferred shares, representing $3 million in aggregate liquidation preference, remained outstanding.
During October and November 2016, we repurchased 1,957,045 Series C preferred shares at an average purchase price of $25.67 per share for $50 million. At December 31, 2016, 14,042,955 Series C preferred shares, representing $351 million in aggregate liquidation preference, remain outstanding.
During May 2013, we issued 9 million of 5.50% Series D preferred shares with a liquidation preference of $25.00 per share for gross proceeds of $225 million. Dividends on the Series D preferred shares are non-cumulative.To the extent declared, dividends will accumulate, with respect to each dividend period, in an amount per share equal to 5.50% of the liquidation preference per annum. We may redeem these shares on or after June 1, 2018 at a redemption price of $25.00 per share.
During November 2016, we issued 220 thousand shares of the Company's 5.50% Series E preferred shares, with a liquidation preference of $2,500 per Series E preferred share, which series E preferred shares were deposited against delivery of
Each of our existing facilities is described further below; refer to Item 8, Note 10(b) of the Consolidated Financial Statements 'Debt and Financing Arrangements' for additional information.
Maintenance of an A.M. Best financial strength rating of at least B++ for each of AXIS Capital’s material insurance/reinsurance subsidiaries that are party to the Credit Facility.
At December 31, 2016, we had $340 million and $nil letters of credit outstanding under the LOC Facility and the Credit Facility, respectively. The remaining available capacity under these facilities was $410 million, before taking into consideration the $150 million potential increase in the amount available under the Credit Facility. There was no debt outstanding under the Credit Facility. We were in compliance with all covenants of the facilities at December 31, 2016.
As part of our capital management strategy, our Board of Directors authorizes common share repurchase programs. On December 9, 2016, our Board of Directors authorized a new share repurchase plan for up to $1 billion of our common shares through December 31, 2017. The new share repurchase authorization, effective January 1, 2017, replaced the previous plan which had $252 million available until December 31, 2016 (refer to Item 5 ‘Market for Registrant’s Common Equity, Related Stockholder Matters and Issue Purchases of Equity Securities’ ). At February 24, 2017, we had $963 million of remaining authorization under this common share repurchase program. As noted above, repurchases under this program are entirely
discretionary; the timing and amount of the additional repurchase transactions will depend on a variety of factors including, but not limited to, global (re)insurance and financial market conditions and opportunities, capital management and regulatory considerations.
On November 22, 2016, we filed an unallocated universal shelf registration statement with the SEC, which became effective upon filing. Pursuant to the shelf registration, we may issue an unlimited amount of equity, debt, warrants, purchase contracts or a combination of those securities. Our intent and ability to issue securities pursuant to this registration statement will depend on market conditions at the time of any proposed offering.
We purchase reinsurance and retrocessional protection for our insurance and reinsurance lines of business. The minimum premiums are contractually due in advance on a quarterly basis.
We have $401 million of unfunded investment commitments related to our investments in hedge, direct-lending, real estate, private equity and bank revolver opportunity funds, which are callable by our investment managers. For further details, refer to Item 8, Note 5(c) to the Consolidated Financial Statements 'Investments'. In addition, we have a $2 million commitment to purchase commercial mortgage loans.
The estimation of IBNR is necessary due to the time lags between when a loss event occurs and when it is actually reported to us, referred to as the reporting lag. Reporting lags may arise from a number of factors, including but not limited to the nature of the loss, the use of intermediaries and complexities in the claims adjusting process. By definition, we do not have specific information on IBNR so it must be estimated. IBNR is calculated by deducting incurred losses (i.e. paid losses and case reserves) from management’s best estimate of ultimate losses. In contrast to case reserves, which are established at the contract level, IBNR reserves are generally estimated at an aggregate level and cannot be identified as reserves for a particular loss event or contract. Refer to the ‘Reserving For Significant Catastrophic Events’ section below for additional information on reserving for such events.
An important and distinguishing feature of many of these contracts, though, is our contractual right, subsequent to payment of a claim to our insured, to be subrogated to, or otherwise have an interest in, the insured’s rights of recovery under an insured loan or facility agreement. These estimated recoveries are recorded as an offset to our credit and political risk loss reserves. The lag between the date of a claim payment and our ultimate recovery from the corresponding security can result in negative case reserves at a point in time (as was the case at December 31, 2016 and 2015). The nature of the underlying collateral is specific to each transaction and we also estimate the value of this collateral on a contract-by-contract basis. This valuation process is inherently subjective and involves the application of management’s judgment because active markets for the collateral often do not exist. Our estimates of value are based on numerous inputs, including information provided by our insureds, as well as third party sources including rating agencies, asset valuation specialists and other publicly available information. We also assess any post-event circumstances, including restructurings, liquidations and possession of asset proposals/agreements.
Our results of operations for each of 2016, 2015 and 2014 were impacted by natural catastrophe activity. See Item 7 ‘Underwriting Results - Group, Underwriting Expenses’ for a discussion of these events and the remaining associated uncertainties.
The overall increase in our gross loss reserves during 2016 was driven by incurred loss activity in the property and other, liability, motor, professional and marine reserve classes, partially offset by favorable prior year development across the reinsurance segment's reserve classes and the insurance property and other, professional lines and marine reserve classes as well as the impact of foreign exchange.
Our medium-tail business primarily consists of professional lines (re)insurance and trade credit and surety reinsurance business. Certain other classes of business, including aviation hull and engineering reinsurance, are also considered to have a medium-tail. Claim reporting and settlement periods on these classes are generally longer than those of our short-tail reserving classes. We also consider our credit and political risk insurance business to have a medium tail, due to the complex nature of claims and the potential additional time that may be required to realize our subrogation assets.
For our trade credit and surety reinsurance business, our initial and most recent underwriting year loss projections are generally based on the ELR method, with consideration given to qualitative factors. Given that there is a quicker and more stable reporting pattern for trade credit business, we generally commence the transition to experience-based methods sooner than for the surety business.
Commencing with our fourth quarter 2012 reserving process, we began to give weight to actuarial methods that reflect our actual experience for liability business as we believed that our oldest accident years were at a stage of expected development where such methods would produce meaningful actuarial indications. In 2016, we continued to give weight to experience-based methods on the earlier years for the liability line of business leading to the recognition of some favorable experience on the reinsurance classes.
The following tables show the effect on our estimate of gross loss reserves of reasonably likely changes in the two key assumptions used to estimate our gross loss reserves at December 31, 2016.
The results show the cumulative increase (decrease) in our loss reserves across all accident years. For example, if our assumed loss development pattern for our property and other insurance business was three months shorter with no accompanying change in our ELR assumption, our loss reserves may decrease by approximately $48 million. Each of the impacts set forth in the tables is estimated individually, without consideration for any correlation among key assumptions or among reserving classes. Therefore, it would be inappropriate to take each of the amounts and add them together in an attempt to estimate total volatility. While we believe the variations in the expected loss ratios and loss development patterns presented could be reasonably expected, our own historical data regarding variability is generally limited and actual variations may be greater or less than these amounts. It is also important to note that the variations are not meant to be a “best-case” or “worst-case” series of scenarios and, therefore, it is possible that future variations in our loss reserves may be
We apply case-specific provisions against certain recoveries that we deem unlikely to be collected in full. In addition, we use a default analysis to estimate our provision for uncollectible amounts on the remainder of the balance. The principal components of the default analysis are reinsurance recoverable by reinsurer and default factors applied to estimate uncollectible amounts based on our reinsurers’ credit ratings. The default factors are based on a model developed by a major rating agency. The provision recorded against reinsurance recoverable was $20 million and $18 million at December 31, 2016 and 2015, respectively. We have not written off any significant reinsurance recoverable balances in the last three years. At December 31, 2016, the use of different assumptions within our approach could have a material effect on our provision for uncollectible reinsurance recoverable. To the extent the creditworthiness of our 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 our provision. Given the various considerations used to estimate our uncollectible provision, we cannot precisely quantify the effect a specific industry event may have on our provision.
For the majority of our insurance business, we receive a fixed premium which is identified in the policy and recorded as unearned premium on the inception date of the contract. This premium is adjusted only if underlying insured values ultimately differ. We actively monitor underlying insured values and record adjustment premiums in the period in which amounts are reasonably determinable. Gross premiums written on a fixed premium basis accounted for approximately 85%, 87% and 91% of the segment’s total for the years ended December 31, 2016, 2015 and 2014, respectively. A portion of this business is written through MGAs, third parties granted authority to bind risks on our behalf in accordance with our underwriting guidelines. For this business, we record premiums based on monthly statements received from the MGAs. Due to inherent reporting delays, we generally record premiums written by MGAs one month in arrears. In the event that a significant individual statement is not received, we record our best estimate based upon our historical experience.
A limited portion of our insurance business is written on a line slip or proportional basis, under which we assume a fixed percentage of the premiums and losses on a particular risk or group of risks along with numerous other unrelated insurers. Although premiums on this business are not contractually stated, we recognize gross premiums written based on estimates provided by clients through brokers. For further details on the estimation process, see the discussion provided for the reinsurance segment below. We review these estimates on a quarterly basis and record significant adjustments in premium estimates when identified. Gross premiums written on a line slip/proportional basis comprised 15%, 13% and 9% of the segment’s total for the years ended December 31, 2016, 2015 and 2014, respectively, and therefore the associated impact of these estimates on our pre-tax net income was immaterial. The increases in 2016 compared to 2015 and in 2015 compared to 2014 were driven by an increase in the amount of proportional business written in our accident and health lines.
Our excess of loss reinsurance contracts with cedants typically include provisions for a deposit or minimum premiums payable to us, which are generally considered to be the best estimate of the excess of loss reinsurance written premium at inception. The minimum/deposit premium is normally adjusted at the end of the contract period to reflect changes in the underlying risks in force during the contract period. We record adjustments to the deposit/minimum premiums in the period during which they become determinable. Excess of loss contracts accounted for 38% of our reinsurance segment’s total gross premiums written for each of the years ended December 31, 2016, 2015 and 2014, respectively.
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 could be material to gross premiums written and the resulting adjustments may directly and significantly impact net premiums earned favorably or unfavorably in the period they are determined because the adjustment may be substantially or fully earned. Gross premiums written for proportional contracts, including amounts related to the adjustment of premium estimates established in prior years, accounted for 62% of our reinsurance segment’s gross premiums written for each of the years ended December 31, 2016, 2015 and 2014, respectively.
Our historical experience has shown that cumulative adjustments to our annual initial premium estimates on proportional reinsurance contracts have ranged from 0% to 5% over the last 5 years. Giving more weight to recent years where premium volume was comparable to current levels, we believe that a reasonably likely change in our 2016 proportional reinsurance gross premiums written estimate would be 5% in either direction. Such a change would result in a variance in our gross premiums written of approximately $67 million and an immaterial impact on our pre-tax net income. However, larger variations, both positive and negative, are possible.
Fair value is defined as the price to sell an asset or transfer a liability (i.e. the “exit price”) in an orderly transaction between market participants. U.S. GAAP prescribes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. The level in the hierarchy within which a given fair value measurement falls is determined based on the lowest level input that is significant to the measurement. The hierarchy is broken down into three levels as follows:
At December 31, 2016 and 2015, we have not adjusted any pricing provided by independent pricing services (see ‘Management Pricing Validation’ below). Additionally, our total Level 3 fixed maturities and equities amounted to $96 million (2015: $49 million), less than 1% of total fixed maturities and equities. Refer Item 8, Note 6 to the Consolidated Financial Statements 'Fair Value Measurements' for further information.
While we obtain pricing from pricing services and/or broker-dealers, management is ultimately responsible for determining the fair value measurements for all securities. To ensure fair value measurement is applied consistently and in accordance with U.S. GAAP, we annually update our understanding of the pricing methodologies used by the pricing services and broker-dealers.
The fair values of hedge funds, direct lending funds, private equity funds and real estate funds are estimated using net asset values (NAVs) as advised by external fund managers or third party administrators. Refer Item 8, Note 6 to the Consolidated Financial Statements 'Fair Value Measurements' for further information.
Our available-for-sale ("AFS") investment portfolio is the largest component of our consolidated assets and it is a multiple of our shareholders’ equity. As a result, an OTTI charge could be material to our financial condition and operating results particularly during periods of dislocation in financial markets. During 2016, we recorded an OTTI charge in earnings of $26 million (2015: $73 million; 2014: $31 million). Refer to the ‘Net Investment Income and Net Realized Investment Gains (Losses)’ section above for further details.
A security is “impaired” if fair value is below amortized cost for fixed maturities or cost for equities. On a quarterly basis, we review all impaired AFS securities to determine if impairments are other-than-temporary. The OTTI assessment is inherently judgmental, especially where securities have experienced severe declines in fair value over a short period. Our review process begins with a quantitative analysis to identify securities to be further evaluated for potential OTTI. For all identified securities, further fundamental analysis is performed that considers the following quantitative and qualitative factors:
The following discussion provides further details regarding our processes for identification of impairments that are other-than-temporary for AFS fixed maturities and equity securities and the recognition of the related OTTI charges in earnings.
For the first two criteria above, the OTTI charge is the entire difference between the security’s fair value and its amortized cost and the full amount of the impairment is charged to earnings and is included in net realized investment gains (losses). If the impairment arises due to an anticipated credit loss on the security (third criterion above), we recognize only the credit loss component (i.e. the amount representing the decease in cash flows expected to be collected) of the OTTI charge in earnings with a corresponding adjustment to amortized cost (new cost basis) of the security. The non-credit component (e.g. interest rates, market conditions, etc.) of the OTTI charge is recognized in other comprehensive income in shareholders’ equity.
For impaired securities held within our high yield portfolios (i.e. managed under a mandate to invest primarily in non-investment grade securities), we have established separate parameters for our credit loss assessment. Due to the additional volatility inherent in high yield securities relative to investment-grade securities, we focus on the severity of the impairment and work closely with our external high yield investment managers to identify securities with significant potential credit losses.
The credit loss component of OTTI recognized in earnings is calculated based on the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to the impairment. The significant inputs and the methodology used to estimate credit losses are disclosed in Item 8, Note 5(f) to the Consolidated Financial Statements 'Investments'.
At December 31, 2016, the Company is not party to any off-balance sheet arrangements, as defined by Item 303(a)(4) of Regulation S-K to which an entity unconsolidated with the Company is a party that management believes is reasonably likely to have a current or future effect on its financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that the Company believes is material to investors.
In this report, we present non-GAAP operating income, non-GAAP operating ROACE, consolidated underwriting income and underwriting-related general and administrative expenses and amounts presented on a constant currency basis which are “non-GAAP financial measures” as defined in Regulation G.
Consolidated underwriting income is a pre-tax measure of underwriting profitability that takes into account net premiums earned and other insurance related income (loss) as revenues and net losses and loss expenses, acquisition costs and underwriting-related general and administrative costs as expenses. Underwriting-related general and administrative expenses include those general and administrative expenses that are incremental and/or directly attributable to our individual underwriting operations. While these measures are presented in Item 8, Note 3 to the Consolidated Financial Statements 'Segment Information', they are considered non-GAAP financial measures when presented elsewhere on a consolidated basis.
Non-GAAP operating income, diluted non-GAAP operating income per common share and non-GAAP operating ROACE can be reconciled to the nearest GAAP financial measures as follows:
Foreign exchange losses (gains) in our Consolidated Statements of Operations are primarily driven by the impact of foreign exchange rate movements on net insurance related-liabilities. However, this movement is only one element of the overall impact of foreign exchange rate fluctuations on our financial position. In addition, we recognize unrealized foreign exchange losses (gains) on our available-for-sale investments in other comprehensive income and foreign exchange losses (gains) realized upon the sale of these investments in net realized investments gains (losses). These unrealized and realized foreign exchange rate movements generally offset a large portion of the foreign exchange losses (gains) reported separately in earnings, thereby minimizing the impact of foreign exchange rate movements on total shareholders’ equity. As such, the Statements of Operations foreign exchange losses (gains) in isolation are not a fair representation of the performance of our business.
In this regard, certain users of our financial statements evaluate earnings excluding after-tax net realized investment gains (losses), foreign exchange losses (gains), termination fee received, reorganization and related expenses and losses on repurchase of preferred shares to understand the profitability of recurring sources of income.
As noted above, foreign exchange losses (gains) in our Consolidated Statement of Operations primarily relate to our net insurance-related liabilities. However, we manage our investment portfolio in such a way that unrealized and realized foreign exchange losses (gains) on our investment portfolio generally offset a large portion of the foreign exchange losses (gains) arising from our underwriting portfolio. As a result, we believe that foreign exchange losses (gains) are not a meaningful contributor to our underwriting performance and, therefore, exclude them from consolidated underwriting income.
The termination fee received represents the break-up fee received on the cancellation of the Amalgamation Agreement between PartnerRe Ltd. and AXIS Capital and should be excluded from consolidated underwriting income since it is not related to underwriting operations.
Reorganization and related expenses are driven by business decisions, the nature and timing of which are unrelated to the underwriting process and for this reason they are excluded from consolidated underwriting income.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
The Company is the primary beneficiary of a VIE if it has a controlling financial interest in the VIE, if it has both (a) the power to direct the activities of the VIE that most significantly impact the economic performance of the VIE, and (b) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE.
To facilitate comparison of information across periods, certain reclassifications have been made to prior year amounts to conform to the current year's presentation. These reclassifications did not impact our results of operations, financial condition or liquidity.
impairment in earnings, with the remaining non-credit related balance of the impairment (i.e. related to interest rates, market conditions, etc.) recognized in AOCI.
Mortgage loans held-for-investment are stated at amortized cost calculated as the unpaid principal balance, adjusted for any unamortized premium or discount, deferred fees or expenses, and are net of valuation allowances. Interest income and prepayment fees are recognized when earned. Interest income is recognized using an effective yield method giving effect to the amortization of premiums and accretion of discounts.
Cash equivalents include money-market funds,fixed interest deposits and reverse repurchase agreements placed with a maturity of under 90 days when purchased. Cash and cash equivalents are recorded at amortized cost, which approximates fair value due to the short-term, liquid nature of these securities. Our restricted cash balance primarily relates to funds held in trust in support of our obligations in regulatory jurisdictions where we operate as a non-admitted carrier.
inception of the contract based on management’s best estimate of total premiums to be received. However, premiums are normally recognized on an annual basis for multi-year contracts where the cedant has the ability to unilaterally commute or cancel coverage within the term of the policy. The remaining annual premiums are included as written at each successive anniversary date within the multi-year term.
(Re)insurance premiums are earned evenly over the period during which we are exposed to the underlying risk, which is generally one to two years with the exception of multi-year contracts. Unearned premiums represent the portion of premiums written which is applicable to the unexpired risks under contracts in force.
The estimates of our reinsurance recoverable and the associated provision require management’s judgment and are reviewed in detail on a quarterly basis. Any adjustments to amounts recognized in prior periods are reported in our net losses and loss expenses in the consolidated statements of operations for the period when the adjustments were identified.
The Company’s reporting currency is the U.S. dollar. In translating the financial statements of our subsidiaries or branches where the functional currency is other than the U.S. dollar, assets and liabilities are converted into U.S. dollars using the rates of exchange in effect at the balance sheet dates and revenues and expenses are converted using the weighted average foreign exchange rates for the period. The effect of translation adjustments is reported as a separate component of AOCI in shareholders’ equity.
In recording foreign currency transactions, revenue and expense items are converted to the relevant functional currency at the exchange rate prevailing at the transaction date. Assets and liabilities originating in currencies other than the functional currency are remeasured to the functional currency at the rates of exchange in effect at the balance sheet date. The resulting foreign currency gains or losses are recognized in the Consolidated Statements of Operations, with the exception of those related to foreign-denominated available for sale investments. For these investments, exchange rate fluctuations represent an unrealized appreciation/depreciation in the value of the securities and are included in the related component of AOCI.
The Company is authorized to issue restricted stock awards and units, stock options and other equity-based awards to its employees and directors. Our plan includes both equity and cash-settled awards comprising of service and performance based awards. The fair value of equity service-based awards is measured at the grant date, with the associated expense recognized on a straight-line basis over the service period. The fair value of equity performance-based awards ("PSUs") is measured at the grant date based on pre-established targets relating to certain performance based measures achieved by the Company, with the associated expense recognized on a straight-line basis over the applicable performance and vesting period. The compensation expense for PSUs is subject to a periodic review and adjustment taking into account actual performance of the Company. The fair value of the liability associated with service and performance based cash-settled awards is re-measured at each balance sheet date, with the effects recognized as an increase or decrease to share-based compensation expense for the period. Forfeiture benefits are estimated at the time of grant and incorporated in the determination of share-based compensation expense.
We measure all derivative instruments at fair value (see Note 6 'Fair Value Measurements') and recognize them as either assets or liabilities in the Consolidated Balance Sheets. Subsequent changes in fair value and any realized gains or losses are recognized in the Consolidated Statements of Operations.
We amortize intangible assets with finite lives over their estimated useful lives in proportion to the estimated economic benefits of the intangible assets. We also test these assets for impairment if circumstances indicate that the carrying value may not be fully recoverable. Such circumstances may include an economic downturn in a geographic market or a change in the assessment of future operations. If, as a result of such an evaluation, we determine that the carrying value of the finite-lived intangible assets is not recoverable, the value of the assets will be reduced to fair value with the difference being expensed in the Consolidated Statements of Operations.
Effective January 1, 2016, the Company adopted the ASU 2014-12, "Compensation -Stock Compensation (Topic 718) - Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could be Achieved after the Requisite Service Period" issued by FASB. This guidance was issued to address a divergence in accounting practice and it resolves if, and when a performance target is achieved. ASU 2014-12 requires compensation costs to be recognized in the period in which it becomes probable that a performance target will be achieved and to represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The adoption of ASU 2014-12 did not impact our results of operations, financial condition or liquidity.
Effective January 1, 2016, the Company adopted ASU 2015-07, "Fair Value Measurement (Topic 820) - Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or its Equivalent)" issued by the FASB. This guidance eliminates the requirement to categorize investments for which fair value is measured using the net asset value per share ("NAV") practical expedient within the fair value hierarchy. As this new guidance relates solely to disclosures, the adoption of ASU 2015-07 did not impact our results of operations, financial condition or liquidity. The updated disclosures have been provided in Note 6 'Fair Value Measurements'.
Effective December 31, 2016, the Company adopted ASU 2015-09 "Financial Services - Insurance (Topic 944) - Disclosures About Short-Duration Contracts" issued by the FASB. ASU 2015-09 requires insurance entities to disclose for annual reporting periods additional information about the liability for unpaid claims and claim adjustment expenses, including: (1) incurred and paid claims development information by accident year, on a net basis, for the number of years for which claims incurred typically remain outstanding, not exceeding 10 years; (2) a reconciliation of incurred and paid claims development information to the aggregate carrying amount of the liability for claims and claim adjustment expenses, with separate disclosure of reinsurance recoverable on unpaid claims for each period presented in the statement of financial position; (3) for each accident year presented of incurred claims development information, the total of incurred but not reported liabilities plus expected development on reported claims including the liability for unpaid claims and claim adjustment expenses, accompanied by a description of the reserving methodologies; (4) for each accident year presented of incurred claims development information, quantitative information about claim frequency (unless impracticable) accompanied by a qualitative description of methodologies used for determining claim frequency information; and (5) for all claims, the average annual percentage payout of incurred claims by age for all accident years presented. ASU 2015-09 also requires insurance entities to disclose information about significant changes in methodologies and assumptions used to calculate the liability for unpaid claims and claim adjustment expenses, including the reasons for the change and the effects on the financial statements.
In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)". This guidance affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example, insurance contracts are not in scope of the new guidance). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB delayed the effective date by one year through the issuance of ASU 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date". This guidance is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted for interim and annual reporting periods beginning after December 15, 2016. As accounting for insurance contracts is outside the scope of ASU 2014-09, the Company does not expect the adoption of this guidance to have a material impact on our results of operations, financial condition and liquidity.
In January 2016, the FASB issued ASU 2016-01 "Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities" which requires equity investments (except those accounted for under the equity method of accounting, investments that are consolidated or those that meet a practicability exception) to be measured at fair value with changes in fair value recognized in net income, simplifies the impairment assessment of equity investments without readily determinable values by requiring a qualitative assessment to identify impairment, eliminates the
requirement to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost, requires the use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes, requires separate presentation in other comprehensive income of the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the organization has elected to measure the liabilities in accordance with the fair value option, requires the separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and clarifies that the reporting organization should evaluate the need for a valuation allowance
In March 2016, the FASB issued ASU 2016-09, "Compensation-Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting" which simplifies several aspects of the accounting for share-based payments to employees including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The guidance requires all excess tax benefits and tax deficiencies to be recognized in the income statement with the tax effects of exercised or vested awards to be treated as discrete items in the reporting period in which they occur. Excess tax benefits should be classified along with other income tax cash flows as an operating activity on the statement of cash flows. In addition, companies will be required to make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur. The guidance allows withholding up to the maximum statutory tax rates in the applicable jurisdictions to cover income taxes on share-based compensation awards without requiring liability classification. Cash paid by an employer when directly withholding shares for tax withholding purposes should be classified as a financing activity.This guidance is effective for annual periods beginning after December 15, 2016, and interim periods within those fiscal years with early adoption permitted. The adoption of this guidance is not expected to have a material impact on our results of operations, financial condition and liquidity.
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments" which replaces the "incurred loss" impairment methodology with an approach based on "expected losses" to estimate credit losses on certain types of financial instruments and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The guidance requires financial assets measured at amortized cost to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost of the financial asset to present the net carrying value at the amount expected to be collected on the financial asset. Credit losses relating to available-for-sale debt securities will be recorded through an allowance for credit losses. The guidance also provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. This guidance is effective for interim and annual periods beginning after December 15, 2019. Early adoption is permitted for interim and annual periods beginning after December 15, 2018. The Company is currently evaluating the impact of this guidance on our results of operations, financial condition and liquidity.
In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments" which addresses diversity in practice in how eight specific cash receipts and cash payments should be presented and classified on the statement of cash flows. This guidance is effective for interim and annual periods beginning after December 15, 2017, with early adoption permitted. The adoption of this guidance is not expected to impact our results of operations, financial condition or liquidity.
In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment" that eliminates the requirement to calculate the implied fair value of goodwill (i.e., Step 2 of the current goodwill impairment test) to measure a goodwill impairment charge. Instead, an impairment charge will be based on the excess of a reporting unit's carrying amount over its fair value (i.e., measure the charge based on Step 1 of the current goodwill impairment test). This guidance is effective for annual and interim impairment tests performed in periods beginning after December 15, 2019, with early adoption permitted for annual and interim goodwill impairment testing dates after January 1, 2017. The guidance will be adopted on a prospective basis.
Our reinsurance segment provides non-life treaty reinsurance to insurance companies on a worldwide basis. The product lines in this segment are catastrophe, property, professional lines, credit and surety, motor, liability, agriculture, engineering and marine and other. The reinsurance segment also writes derivative based risk management products designed to address weather and commodity price risks.
Intangible assets with an indefinite life consist primarily of U.S. state licenses that provide a legal right to transact business indefinitely. Our impairment reviews for goodwill and indefinite lived intangibles did not result in the recognition of impairment losses for the years ended December 31, 2016, 2015 and 2014.
In the normal course of investing activities, we actively manage allocations to non-controlling tranches of structured securities (variable interests) issued by VIEs. These structured securities include RMBS, CMBS and ABS and are included in the above table. Additionally, within our other investments portfolio, we also invest in limited partnerships (hedge funds, direct lending funds, real estate funds and private equity funds) and CLO equity tranched securities, which are all variable interests issued by VIEs (see Note 5(c)). For these variable interests, we do not have the power to direct the activities that are most significant to the economic performance of the VIEs therefore we are not the primary beneficiary for any of these VIEs. Our maximum exposure to loss on these interests is limited to the amount of our investment. We have not provided financial or other support with respect to these structured securities other than our original investment.
At December 31, 2016, 1,881 fixed maturities (2015: 2,314) were in an unrealized loss position of $197 million (2015: $230 million) of which $15 million (2015: $39 million) was related to securities below investment grade or not rated.
The following tables provide a breakdown of our investments in hedge funds, direct lending funds, private equity funds, real estate funds, CLO-Equities and other privately held investments, together with additional information relating to the liquidity of each category:
Two common redemption restrictions which may impact our ability to redeem our hedge funds are gates and lockups. A gate is a suspension of redemptions which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the fund’s net assets which may otherwise hinder the general partner or investment manager’s ability to liquidate holdings in an orderly fashion in order to generate the cash necessary to fund extraordinarily large redemption payouts. A lockup period is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. During 2016 and 2015, neither of these restrictions impacted our redemption requests. At December 31, 2016, $60 million (2015: $66 million), representing 12% (2015: 10%) of our total hedge funds, relate to holdings where we are still within the lockup period. The expiry of these lockup periods range from September, 2017 to March, 2019.
At December 31, 2016, we had $176 million (2015: $222 million) of unfunded commitments within our other investments portfolio relating to our future investments in direct lending funds. Once the full amount of committed capital has been called by the General Partner of each of these funds, the assets will not be fully returned until the completion of the fund's investment term. These funds have investment terms ranging from 5-10 years and the General Partners of certain funds have the option to extend the term by up to three years.
At December 31, 2016, we had $140 million (2015: $95 million) of unfunded commitments as a limited partner in funds which invest in real estate and real estate securities and businesses. These funds are subject to a three year commitment period and a total fund life of 6-8 years during which time we are not eligible to redeem our investment.
During 2016, we paid $108 million including direct transaction costs to acquire 19% of the common equity of Harrington Reinsurance Holdings Limited ("Harrington"), the parent company of Harrington Re Ltd. ("Harrington Re"), an independent reinsurance company jointly sponsored by AXIS Capital and The Blackstone Group L.P. ("Blackstone"). Through long-term service agreements, AXIS Capital will serve as Harrington Re's reinsurance underwriting manager and Blackstone will serve as exclusive investment management service provider. As an investor, we expect to benefit from underwriting profit generated by Harrington Re and the income and capital appreciation Blackstone seeks to deliver through its investment management services. In addition, we have entered into an arrangement with Blackstone under which underwriting and investment related fees will be shared equally. Harrington is not a variable interest entity.Given that we exercise significant influence over the operating and financial policies of this investee we account for our ownership in Harrington under the equity method of accounting. The Company's proportionate share of the underlying equity in net assets resulted in a basis difference of $5 million which represents initial transactions costs.
The following table provides a roll forward of credit losses (“credit loss table”), before income taxes, for which a portion of the OTTI charge was recognized in AOCI:
Non-U.S. government obligations are evaluated for credit loss primarily through qualitative assessments of the likelihood of credit loss using information such as duration and severity of unrealized losses, as well as credit ratings and price volatility. At December 31, 2016, our holdings in sovereign debt, including $28 million (2015: $21 million) relating to the eurozone countries, were substantially all investment-grade securities. The gross unrealized losses of $50 million at December 31, 2016 were mainly due to pricing and foreign exchange losses on emerging market debt. Based on our analysis, we do not anticipate any credit losses on our non-U.S. government fixed maturities held at December 31, 2016. In 2016, the OTTI charges on non-U.S. government fixed maturities mainly related to unrealized foreign exchange losses on certain securities where forecasted recovery was uncertain.
To estimate credit losses for corporate debt securities, our projected cash flows are primarily driven by our assumptions regarding the probability of default and the severity associated with those defaults. Our default and loss severity rates are based on credit rating, credit analysis, industry analyst reports and forecasts, Moody’s historical default data and any other data relevant to the recoverability of the security. In 2016, the OTTI charges on corporate debt securities were mainly related to significant loss severity, unrealized foreign exchange losses on certain securities where forecasted recovery was uncertain, as well as our intent to sell.
Our investments in CMBS are diversified and primarily rated AA or better, with a weighted average estimated subordination percentage of 36% at December 31, 2016 (2015: 32%). Based on discounted cash flows at December 31, 2016, the current level of subordination is sufficient to cover the estimated loan losses on the underlying collateral of the CMBS.
For non-agency RMBS, our projected cash flows incorporated underlying data from widely accepted third-party data sources along with certain internal assumptions and judgments regarding the future performance of the security. These assumptions included the following: default, delinquency, loss severity and prepayment rates. The assumptions used to calculate the credit losses in 2016 have not changed significantly since December 31, 2015. At December 31, 2016, the fair value of our non-agency RMBS was $57 million (2015: $101 million), consisting primarily of $40 million (2015: $82 million) of Prime and $10 million (2015: $13 million) of Alt-A MBS. We have concluded there are no credit losses anticipated for any of our non-agency RMBS at December 31, 2016, other than those already recorded.
Our investments in ABS at December 31, 2016 consist mainly of CLO debt tranched securities (“CLO Debt”) purchased primarily as new issues during 2013 through 2015. Of these new issues all had credit ratings of AA or better. We utilize a scenario-based approach to reviewing our CLO Debt portfolio based on the current asset market price. We also review subordination levels of our securities to determine their ability to absorb credit losses of underlying collateral. If losses are forecast to be below the subordination level for the tranche held by us, the security is determined not to be impaired. We have concluded there are no credit losses anticipated for any of our CLO Debt at December 31, 2016.
The valuation techniques, including significant inputs and assumptions generally used to determine the fair values of our financial instruments as well as the classification of the fair values of our financial instruments in the fair value hierarchy are described in detail below.
Corporate debt securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As the yields for the risk-free yield curve and the spreads are observable market inputs, the fair values of corporate debt securities are classified as Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, the fair values of these securities are classified as Level 3.
Indirect investments in CLO-Equities are classified as Level 3 as the fair values of these securities are estimated using an income approach valuation technique (discounted cash flow model) due to the lack of observable and relevant trades in secondary markets. Direct investments in CLO-Equities are also classified as Level 3 as these securities are valued at the lower of liquidation value and fair value based on an internally developed discounted cash flow model is used.
Short-term investments primarily comprise highly liquid securities with maturities greater than three months but less than one year from the date of purchase. These securities are classified as Level 2 as these securities are not typically actively traded due to their approaching maturity, and, as such, their amortized cost approximates fair value.
Cash settled awards comprise restricted stock units that form part of our compensation program. Although the fair values of these awards are determined using observable quoted market prices in active markets, the stock units themselves are not actively traded. Accordingly, the fair values of these liabilities are classified as Level 2.
The liquidation valuation is based on the fair values of the net underlying collateral which is determined by applying market discount margins by credit quality bucket. An increase (decrease) in the market discount margin would result in a decrease (increase) in value of our CLO-Equities.
Weather derivatives relate to non-exchange traded risk management products addressing weather risks. The fair values of these derivatives are determined using market inputs and unobservable inputs in combination with industry or internally-developed valuation and forecasting techniques. The models may reference market price information for similar instruments. The pricing models are internally reviewed by Risk Management personnel prior to implementation and are reviewed periodically thereafter.
Observable inputs: market prices for similar instruments, notional price, option strike, term to expiry, contractual limits;
In general, weather curves are the most significant input contributing to the determination of fair value estimates. Changes in this variable can result in higher or lower fair values depending on the underlying position. In addition, changes in any or all of the unobservable inputs identified above may contribute positively or negatively to overall portfolio value. The correlation input will quantify the interrelationship, if any, amongst the other variables.
The transfers into Level 2 from Level 3 made during 2016 were primarily due to the availability of observable market inputs and quotes from pricing vendors on certain fixed maturities.
If there is a reporting lag between the current period end and reporting date of the latest available fund valuation for any hedge fund, we estimate fair values by starting with the most recently available fund valuation and adjusting for return estimates as well as any subscriptions, redemptions and distributions that took place during the current period. Return estimates are obtained from the relevant fund managers. Accordingly, we do not typically have a reporting lag in fair value measurements of these funds. Historically, our valuation estimates incorporating these return estimates have not significantly diverged from the subsequently received NAVs.
The Company often does not have access to financial information relating to the underlying securities held within the funds, therefore management is unable to corroborate the fair values placed on the securities underlying the asset valuations provided by fund managers or fund administrators. In order to assess the reasonableness of the NAVs, we perform a number of monitoring procedures on a quarterly basis, to assess the quality of the information provided by fund managers and funds administrators. These procedures include, but are not limited to, regular review and discussion of each fund's performance with its manager, regular evaluation of fund performance against applicable benchmarks and the backtesting of our fair value estimates against subsequently received NAVs. Backtesting involves comparing our previously reported fair values for each
fund against NAVs per audited financial statements (for year-end values) and final NAVs from fund managers and fund administrators (for interim values).
The carrying values of cash and cash equivalents (including restricted amounts), accrued investment income, receivable for investments sold, certain other assets, payable for investments purchased and certain other liabilities approximated their fair values at December 31, 2016, due to their respective short maturities. As these financial instruments are not actively traded, their fair values are classified as Level 2.
The carrying value of mortgage loans held-for-investment approximated their fair value at December 31, 2016. The fair values of mortgage loans are primarily determined by estimating expected future cash flows and discounting them using current interest rates for similar mortgage loans with similar credit risk, or are determined from pricing for similar loans. As mortgage loans are not actively traded their fair values are classified as Level 3.
Our (re)insurance subsidiaries and branches operate in various foreign countries. Consequently, some of our business is written in currencies other than the U.S. dollar and, therefore, our underwriting portfolio is exposed to significant foreign currency risk. We manage foreign currency risk by seeking to match our foreign-denominated net liabilities under (re)insurance contracts with cash and investments that are denominated in such currencies. We may also use derivative instruments, specifically forward contracts and currency options, to economically hedge foreign currency exposures.
The following tables reconcile reserving classes to the lines of business categories and the expected claim tails:
Expected Loss Ratio Method (“ELR Method”): This method estimates ultimate losses for an accident year or underwriting year by applying an expected loss ratio to the earned or written premium for that year. Generally, expected loss ratios are based on one or more of (a) an analysis of historical loss experience to date, (b) pricing information and (c) industry data, adjusted as appropriate, to reflect changes in rates and terms and conditions. This method is insensitive to actual incurred losses for the accident year or underwriting year in question and is, therefore, often useful in the early stages of development when very few losses have been incurred. Conversely, the lack of sensitivity to incurred/paid losses for the accident year or underwriting year in question means that this method is usually inappropriate in later stages of an accident year or underwriting year’s development.
Our medium-tail business generally has claim reporting and settlement periods longer than those of our short-tail reserving classes. For our earliest accident and underwriting years, our initial key actuarial expected loss ratio and loss development assumptions were established utilizing industry benchmarks. Due to the longer claim tail, the length of time required to develop our own credible loss history for use in the reserving process is greater for our medium-tail business than for our short-tail business. As a result, the number of years where we relied heavily on industry benchmarks to establish our key actuarial assumptions is greater for our medium-tail business.
Our reserving process involves the collaboration of our underwriting, claims, actuarial, legal, ceded reinsurance and finance departments, includes various segmental committee meetings and culminates with the approval of a single point best estimate by our Group Reserving Committee, which comprises senior management. In selecting this best estimate, management considers actuarial estimates and applies informed judgment regarding qualitative factors that may not be fully captured in these actuarial estimates. Such factors include, but are not limited to: the timing of the emergence of claims, volume and complexity of claims, social and judicial trends, potential severity of individual claims and the extent of internal historical loss data versus industry information. While these qualitative factors are considered in arriving at the point estimate, no specific provisions for qualitative factors are established.
Our gross reserve for losses and loss expenses comprise the following:
We write business with loss experience generally characterized as low frequency and high severity in nature, which can result in volatility in our financial results. During 2016, 2015 and 2014, respectively, we recognized aggregate net losses and loss expenses, net of reinstatement premiums of $204 million, $100 million and $93 million in relation to catastrophe and weather-related events.
During April 2016, the Company entered into a quota share and adverse development cover reinsurance agreement, a retroactive contract which was deemed to have met the established criteria for retroactive reinsurance accounting. Foreign exchange and other includes reinsurance recoverables of $150 million related to this reinsurance agreement.
Our medium-tail business consists primarily of professional insurance and reinsurance reserve classes, credit and political risk insurance reserve class, and credit and surety reinsurance reserve class. Our reinsurance professional reserve class business recognized $30 million, $38 million and $33 million of net favorable prior year development in 2016, 2015 and 2014, respectively. The 2016, 2015 and 2014 favorable loss developments on these reserve classes continued to reflect the generally favorable experience on earlier accident years as we continued to transition to more experience based methods. As our loss experience has generally been better than expected, this resulted in the recognition of net favorable prior year reserve development. In 2016, the insurance professional lines recorded $14 million of net favorable prior year development driven by overall better than expected development. In 2015, the insurance professional lines recorded adverse prior year reserve development of $14 million which was primarily the result of strengthening our Australian book of business during the third quarter of 2015. Our credit and surety lines recorded net favorable prior year reserve development of $10 million and $27 million in 2016 and 2015, respectively. This net favorable prior year reserve development reflected the recognition of generally better than expected loss emergence. In 2015, net adverse development of $15 million was recognized in our in credit and political risk insurance lines relating primarily to an increase in loss estimates for one specific claim.
Our long-tail business consists primarily of liability and motor reserve classes. In 2016, 2015 and 2014, our motor and reinsurance liability reserve classes contributed net favorable prior year reserve development of $99 million, $82 million and $40 million, respectively. The net favorable prior year reserve development for the motor reserve class related to favorable loss emergence trends on several classes of business spanning multiple accident years. The net favorable prior year reserve
The following tables present net incurred and paid claims development by accident year, total incurred-but-not-reported liabilities plus expected development on reported claims, cumulative reported claims frequency and claims duration for each reserve class. The development triangles are presented on an accident year basis for both our Insurance and Reinsurance segments. We do not discount our unpaid losses and loss expense reserves.
There are many considerations in establishing loss reserves and an attempt to evaluate our loss reserves using solely the data presented in these tables could be misleading. We caution against mechanical application of standard actuarial methodologies to project ultimate losses using data presented in this disclosure.
This reserve class comprises our professional line of business and provides coverage for directors’ and officers’ liability, errors and omissions liability, employment practices liability, fiduciary liability, crime, professional indemnity, medical malpractice and other financial insurance related coverages for commercial enterprises, financial institutions and not-for-profit organizations. This business is predominantly written on a claims-made basis. Typically this reserve class is anticipated to exhibit medium to long tail claim reporting and settlement patterns.
With respect to our key actuarial assumptions, we are progressively giving more weight to our own experience when establishing our expected loss ratios and our selected loss development patterns, though we continue to consider industry benchmarks. Loss reporting patterns for professional lines business tend to be volatile, causing instability in actuarial indications based on incurred loss data until an accident year matures for a number of years. Consequently, our initial loss reserves for an accident year are generally based upon an ELR method and the consideration of relevant qualitative factors. As accident years mature, we increasingly give more weight to methods that reflect our actual experience until our selections are based almost exclusively on experience-based methods. We evaluate the appropriateness of the transition to experience-based methods at the reserving class level, commencing this transition when we believe that our incurred loss development is sufficient to produce meaningful actuarial indications. The rate at which we transition fully to sole reliance on experience-based methods can vary, depending on our assessment of the stability and relevance of such indications. For some professional lines in our insurance segment, we also
rely upon the evaluation of the open claim inventory in addition to the commonly employed actuarial methods when establishing reserves.
This reserve class is comprised of our credit and surety line of business and consists of reinsurance of trade credit insurance products and includes both proportional and excess of loss structures. The underlying insurance indemnifies sellers of goods and services in the event of a payment default by the buyer of those goods and services. The Company provides credit insurance coverage to mortgage guaranty insurers and government sponsored entities. Also included in this line of business is coverage for losses arising from a broad array of surety bonds issued by insurers to satisfy regulatory demands or contract obligations in a variety of jurisdictions around the world.
The motor non-proportional business consists of standard excess of loss contracts written for cedants in several European countries with the two major markets, U.K. and France, generally accounting for the majority of the premium volume. From 2009/2010 onwards increasing numbers of large bodily injury settlements in the U.K. market were settled using indexed annuities (Periodical Payment Orders "PPOs"). This led to a materially longer development tail on the older accident years for the U.K. non-proportional motor book. This also resulted in a move towards generally lower treaty attachment points and the inclusion of capitalization clauses on a number of U.K. motor treaties partly helping to mitigate the lengthening of the development tail on more recent accident years. Despite the trend toward a greater number of claims settlements using PPOs, we note that there has been a trend towards generally quicker and more adequate reporting of losses in recent years.
This reserve class is comprised of our liability line of business and provides coverage to insurers of standard casualty business, excess and surplus casualty business and specialty casualty programs. The primary focus of the underlying business is general liability, although workers' compensation and auto liability are also written. Claim payment and reporting patterns are typically long tail in nature and, therefore, also subject to increased uncertainty surrounding future loss development. In particular, claims can be subject to inflation from a number of sources including, but not limited to, economic and medical inflation, judicial inflation and changing social trends.
Non-U.S. dollar denominated loss data is converted to U.S dollar at the rates of exchange in effect at the balance sheet date for material underlying currencies. Fluctuations in currency exchange rates cause material shifts in loss development. Reserves for losses and loss expenses, disclosed on our consolidated balance sheets, are also revalued using the exchange rate at the balance sheet date.
Our provision for unrecoverable reinsurance was $20 million at December 31, 2016 (2015: $18 million). At December 31, 2016, 96.7% (2015: 96.2%) of our gross reinsurance recoverables were collectible from reinsurers rated A- or better by A.M. Best.
On November 15, 2004, AXIS Capital issued $500 million aggregate principal amount of 5.75% senior unsecured debt (the ''5.75% Senior Notes'') at an issue price of 99.785%. The net proceeds of the issuance, after consideration of the offering discount and underwriting expenses and commissions, totaled approximately $496 million. Interest on the 5.75% Senior Notes was payable semi-annually in arrears on June 1 and December 1 of each year, beginning on June 1, 2005. AXIS Capital repaid the full $500 million of its outstanding 5.75% Senior Notes upon their scheduled maturity of December 1, 2014.
Effective February 10, 2014, AXIS Specialty Finance PLC was added as a guarantor to the Credit Facility.
We monitor and manage the aggregation of credit risk on a group-wide basis allowing us to consider exposure management strategies for individual companies, countries, regions, sectors and any other relevant inter-dependencies. Our credit exposures are aggregated based on the origin of risk. As part of our credit aggregation framework, we also assign aggregate credit limits by single counterparty (a group of companies or country). These limits are based and adjusted on a variety of factors including the prevailing economic environment and the nature of the underlying credit exposures. Our credit aggregation measurement and reporting process is facilitated by our credit risk exposure database, which contains relevant information on counterparty details and credit risk exposures. We also license third party tools to provide credit risk assessments.
We lease office space under operating leases which expire at various dates. We renew and enter into new leases in the ordinary course of business, as required. During 2016, total rent expense with respect to these operating leases was $25 million (2015: $28 million; 2014: $27 million).
We purchase reinsurance and retrocessional protection for our insurance and reinsurance lines of business. The minimum reinsurance premiums are contractually due in advance on a quarterly basis. Accordingly at December 31, 2016, we have an outstanding reinsurance purchase commitment of $34 million, all of which is due in 2017. Actual payments under the reinsurance contracts will depend on the underlying subject premium and may exceed the minimum premium.
At December 31, 2016, and 2015, our authorized share capital was 800,000,000 common shares, par value of $0.0125 per share.
Amounts in 2016 and 2015 include 1,358,380 and 4,149,378, respectively, of common shares acquired under the accelerated share repurchase program (see below for more detail).
To satisfy withholding tax liabilities upon vesting of restricted stock, restricted stock units, and exercise of stock options. Share repurchases from employees are excluded from the authorized share repurchase plans noted above.
On August 17, 2015, the Company entered into an ASR agreement with Goldman, Sachs & Co. (“Goldman Sachs”) to repurchase an aggregate of $300 million of the Company's ordinary shares under an accelerated share repurchase program.
During August 2015, under the terms of this agreement, the Company paid $300 million to Goldman Sachs and initially repurchased 4,149,378 common shares. The initial shares acquired represented 80% of the $300 million total paid to Goldman Sachs and were calculated using the Company’s stock price at activation of the program. The ASR program is accounted for as an equity transaction. Accordingly, as at December 31, 2015, $240 million of common shares repurchased were included as treasury shares in the Consolidated Balance Sheets with the remaining $60 million included as a reduction to additional paid-in capital.
On January 15, 2016, Goldman Sachs early terminated the ASR agreement and delivered 1,358,380 additional common shares to the Company, resulting in the reduction from additional paid-in capital of $60 million being reclassified to treasury shares. In total, the Company repurchased 5,507,758 common shares under the ASR agreement at an average price of $54.47.
During April 2012, we closed a cash tender offer for any and all of our outstanding 7.50% Series B preferred shares at a purchase price of $102.81 per share. As a result, we purchased 2,471,570 Series B preferred shares for $254 million. In connection with this tender offer, we recognized a $9 million loss on redemption (calculated as the difference between the redemption price and the carrying value), which was recognized as a reduction in determining our net income available to common shareholders.
During March 2012, we issued $400 million of 6.875% Series C preferred shares, par value $0.0125 per share, with a liquidation preference of $25.00 per share. We may redeem the Series C preferred shares on or after April 15, 2017 at a redemption price of $25.00 per share. Dividends on the Series C preferred shares are non-cumulative. Holders of the Series C preferred shares will be entitled to receive, only when, as and if declared by the board of directors, non-cumulative cash dividends, from the original issue date, quarterly in arrears on the fifteenth day of January, April, July and October of each year, commencing on July 15, 2012. To the extent declared, these dividends will accumulate, with respect to each dividend period, in an amount per share equal to 6.875% of the liquidation preference per annum.
In 2016, 2015 and 2014, total dividends declared and paid on Series D preferred shares were $1.3750 per share.
During November 2016, we issued $550 million of 5.50% Series E preferred shares, par value $0.0125 per share, with a liquidation preference of $2,500 per share. We may redeem the Series E preferred shares on or after November 7, 2021 at a redemption price of $2,500 per share. Dividends on the Series E preferred shares are non-cumulative. Holders of the Series E preferred shares will be entitled to receive, only when, as and if declared by the Board of Directors, non-cumulative cash dividends from the original issue date, quarterly in arrears on the fifteenth day of January, April, July and October of each year, commencing on January 17, 2017. To the extent declared, these dividends will accumulate, with respect to each dividend period, in an amount per Series E preferred share equal to 5.50% of the liquidation preference per annum.
In 2016, total dividends declared on Series E preferred shares were $34.3750 per share, which were subsequently paid in January 2017.
In November 2013, the Company formed Ventures Re, a Bermuda domiciled insurer. Ventures Re was formed to write reinsurance on a fully collateralized basis.Ventures Re was considered to be a variable interest entity.
During the second quarter of 2015, the Company early adopted ASU 2015-02. Following the adoption of this amended accounting guidance, the Company concluded that it no longer had a variable interest in Ventures Re and therefore it was no longer required to consolidate the results of operations and the financial position of Ventures Re. The Company adopted this revised accounting guidance using the modified retrospective approach and ceased to consolidate Ventures Re effective as of January 1, 2015. There was no impact from the adoption of ASU 2015-02 on the Company’s cumulative retained earnings.
For eligible U.S. employees, the Company provides a non-qualified deferred compensation plan that enables them to make salary contributions in excess of those permitted under the AXIS 401(k) Plan, to make additional employee contributions from their bonus payments, and to receive discretionary employer contributions.
Between January 1, 2017 and February 24, 2017, a total of 892,574 service-based restricted stock units and 102,558 performance-based restricted stock units were approved for grant. Included in the total restricted stock awards approved for grant subsequent to December 31, 2016 were 420,070 awards which will be settled in cash upon vesting.
(1) Fair value is based on the closing price of our common shares on the New York Stock Exchange on the grant approval date.
The following table provides a reconciliation of the beginning and ending balance of nonvested cash settled restricted stock units for the year ended December 31, 2016:
During 2016, we incurred a compensation cost of $74 million (2015: $59 million; 2014: $73 million) in respect of all restricted stock, restricted stock units, and cash awards, and recorded tax benefits thereon of $16 million (2015: $15 million; 2014: $14 million).
A member of the Company’s Board of Directors, Mr. Charles Davis, is the Chief Executive Officer of Stone Point Capital, LLC ("Stone Point"). In the ordinary course of business, we engage SKY Harbor Capital Management, LLC, an affiliate of Stone Point, for asset management services for certain of our short duration high yield debt portfolios and StoneRiver RegEd, also an affiliate of Stone Point, for broker and adjuster licensing, appointment and compliance services. During 2016, total fees paid to these Stone Point companies were $4 million (2015: $4 million; 2014: $4 million).
We currently have $30 million committed to the NXT Capital Senior Loan Fund II and $30 million committed to NXT Capital Senior Loan Fund III. The manager of these funds is an indirect subsidiary of NXT Capital Holdings, L.P. ("NXT Capital"). Investment funds managed by Stone Point own approximately 45% of NXT Capital. During 2016, fees paid to NXT Capital totaled $1 million (2015: $1 million; 2014: $1 million).
As discussed further in Note 5 ‘Investments’, during the second quarter of 2016, Harrington and Harrington Re commenced operations. AXIS has the ability to exercise significant influence over the operating and financial policies of Harrington. In the normal course of business, the Company entered into certain reinsurance transactions with Harrington Re. During the six months ended December 31, 2016, the Company ceded reinsurance premiums of $128 million to Harrington Re and ceded losses of $27 million. In addition, Harrington Re paid certain acquisition costs and administrative fees to the Company. At December 31, 2016, the amount of reinsurance recoverable on unpaid and paid losses was $38 million and the amount of ceded reinsurance payable included in insurance and reinsurance balances payable was $86 million in the Consolidated balance sheets.
As discussed further in Note 14 'Noncontrolling Interests', during November 2013, the Company formed Ventures Re, a Bermuda domiciled insurer. With effect from January 1, 2015, Ventures Re is no longer consolidated in the financial statements of the Company. All of Ventures Re's directors are employees of the Company. In the normal course of business, the Company enters into certain reinsurance contracts with Ventures Re. During the year ended December 31, 2016, the Company ceded premiums of $40 million to Ventures Re and ceded losses of $10 million. In addition, Ventures Re also paid certain acquisition costs and administrative fees to the Company. We believe that all transactions were conducted at market rates consistent with negotiated arms-length contracts.
Below is a summary of our total operating and capital loss carryforwards and tax credits:
All operating and capital loss carryforwards and tax credits can be carried forward indefinitely with the exception of the U.S. net operating loss which will expire in 2036.
At December 31, 2016 and 2015, we established a full valuation allowance on: (1) operating and capital loss carryforwards relating to operations in Australia and Singapore; (2) unutilized foreign tax credits available in Ireland and (3) certain other deferred tax assets related to branch operations.
Although realization is not assured, management believes it is more likely than not that the tax benefit of the recorded net deferred tax assets will be realized. Other than the items discussed above, the remaining gross deferred tax assets relate substantially to our U.S. operations. In evaluating our ability to recover these tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including historical results, operating loss carryback potential and scheduled reversals of deferred tax liabilities. Our U.S. operations have produced significant taxable income in prior periods and have deferred tax liabilities that will reverse in future periods such that we believe sufficient ordinary taxable income is available to utilize all remaining ordinary deferred tax assets. In 2016 and 2015, there were sufficient net
unrealized gains or capital loss carryback potential to offset remaining impairments, therefore a valuation allowance on such impairments in the U.S., was not considered necessary.
There were no unrecognized tax benefits at December 31, 2016 and 2015.
Our (re)insurance operations are subject to insurance and/or reinsurance laws and regulations in the jurisdictions in which they operate, the most significant of which include Bermuda, Ireland and the U.S. These regulations include certain restrictions on the amount of dividends or other distributions, such as loans or cash advances, available to shareholders without prior approval of the insurance regulatory authorities.
The statutory capital and surplus in each of our most significant regulatory jurisdictions at December 31, 2016 and 2015 was as follows:
Our U.S. operations required statutory capital and surplus is determined using risk based capital tests, which is the threshold that constitutes the authorized control level. If a company falls below the control level, the commissioner is authorized to take whatever regulatory actions may be considered necessary to protect policyholders and creditors. The maximum dividend that may be paid by our U.S. insurance subsidiaries is restricted by the regulatory requirements of the domiciliary states. Generally, the maximum dividend that may be paid by each of our U.S. insurance subsidiaries is limited to unassigned surplus (statutory equivalent of retained earnings) and may also be limited to statutory net income, net investment income or 10% of total statutory capital and surplus. At December 31, 2016, the maximum dividend that our U.S. insurance operations could pay without regulatory approval was approximately $147 million.
Our operating subsidiaries in Bermuda and the U.S. maintain branch offices in Singapore and Canada, respectively. Our Irish operating subsidiaries maintain branch offices in Switzerland, Australia and the U.K. As branch offices are not considered separate entities for regulatory purposes, the required and actual statutory capital and surplus amounts for each jurisdiction in the table above include amounts related to the applicable branch offices. Our branch offices in Singapore, Australia and Canada are subject to additional minimum capital or asset requirements in their countries of domicile. At December 31, 2016 and 2015, the actual capital/assets for each of these branches exceeded the relevant local regulatory requirements.
The transfer of the insurance business of AXIS Specialty Australia to a reinsurer was approved by the Irish High Court on February 1, 2017 and the Federal Court of Australia on February 10, 2017. Consequently, the insurance policies, assets and liabilities of AXIS Specialty Australia have been transferred to the reinsurer with effect from February 13, 2017. AXIS Specialty Australia is now seeking approval from Australia Prudential Regulation Authority to revoke its authorization to carry on insurance business in Australia.