The following selected historical financial information for each of the past five fiscal years has been derived from our audited historical financial statements. This information is only a summary and should be read in conjunction with "
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this annual report. Some of the information contained in this discussion and analysis or included elsewhere in this annual report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and the timing of events could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under "Cautionary Statement Regarding Forward-Looking Statements", "Item 1A. Risk Factors" and elsewhere in this Annual Report on Form 10-K.
Consolidated Results of Operations - for the Years Ended December 31, 2016, 2015, and 2014
We are a multi-faceted insurance group that offers innovative capital release solutions and specialty underwriting capabilities through our network of group companies in Bermuda, the United States, the United Kingdom, Continental Europe, Australia, and other international locations. Our core focus is acquiring and managing insurance and reinsurance companies and portfolios of insurance and reinsurance business in run-off. Since the formation of our Bermuda-based holding company in 2001, we have completed over 75 acquisitions or portfolio transfers.
While our core focus remains acquiring and managing non-life run-off business, in recent years, we expanded our business to include active underwriting through our acquisitions of Atrium and StarStone. We partnered with Trident in the Atrium and StarStone acquisitions, with Enstar owning a 59.0% interest, Trident owning a 39.3% interest, and Dowling owning a 1.7% interest. We also expanded our portfolio of run-off businesses to include closed life and annuities, primarily through our acquisition of Pavonia from HSBC Holdings plc on March 31, 2013, although we have recently entered into an agreement to sell Pavonia.
Our business strategy includes generating growth through acquisitions and reinsurance transactions, particularly in our Non-life Run-off segment. Our non-life run-off reserves were $4.7 billion as at December 31, 2016, including $1.4 billion of reserves acquired or assumed in new transactions during 2016, and we continue to evaluate opportunities for future growth. Most recently, in January and February 2017, we entered into separate agreements to assume net reserves of approximately $1.4 billion from RSA and QBE. We recently agreed to sell Pavonia from our life and annuities segment, which we expect to close during 2017. We will continue to employ a disciplined approach when assessing, acquiring or managing portfolios of risk.
We manage claims in a professional and disciplined manner, drawing on our global team of in-house claims management experts as we aim to proactively manage risks and claims efficiently. We employ an opportunistic commutation strategy in which we negotiate with policyholders and claimants with a goal of commuting or settling existing insurance and reinsurance liabilities at a discount to the ultimate liability and also to avoid unnecessary or expensive legal and other associated run-off fees and expense.
Our strategy is to maintain our disciplined underwriting approach and strong risk management practices, which may result in us writing less premium in certain lines of business than we wrote in 2016. However, we will seek to mitigate these challenging conditions through our diversified book of business, established distribution channels and geographic reach. We will continue to seek growth in certain areas where we have identified opportunities for expansion and the opportunity for increases in premium rates. In addition, our underwriting operations are well-positioned to capture profitable active business from our run-off transactions, where such business is in attractive specialty lines. In both our Atrium and StarStone segments we will maintain our focus on underwriting for profitability. In our StarStone segment we aim to continue reducing our expense base and generating operational efficiencies through ongoing integration into Enstar's operations.
Net investment income is a significant component of our earnings. We are in a period of considerable market uncertainty in which we see fully priced asset valuations across many asset classes compared to historical averages and deteriorating underlying company fundamentals in certain classes. If investment conditions or general economic conditions change during 2017, we may experience further pressure on our investment yields and realized or unrealized losses on investments could materialize. For further discussion of our investments, see "Investable Assets" below.
In the loss ratio, the excluded net premiums earned and net incurred losses and LAE of the holding companies relate to the amortization of our fair value adjustments associated with the liabilities for unearned premiums and losses and LAE acquired on acquisition date. Fair value purchase accounting adjustments established at date of acquisition are recorded by the holding companies.
In Atrium’s other operating expense ratio, the excluded general and administrative expenses relate to amortization of the definite-lived intangible assets in the holding company, and expenses relating to AUL managing agency employee salaries, benefits, bonuses and current year share grant costs. The excluded AUL general and administrative expenses relate to expenses incurred in managing the syndicate, and eliminated items represent Atrium 5’s share of the fees and commissions paid to AUL. We believe it is a more meaningful presentation to exclude the costs in managing the syndicate because they are principally funded by the profit commission fees earned from Syndicate 609, which is a revenue item not included in the insurance ratios.
In StarStone’s other operating expense ratio for 2016, the excluded general and administrative expenses relate to the amortization of the definite-lived intangible assets, recorded at the holding company level. For 2015, the excluded general and administrative expenses relate to the amortization of the definite-lived intangible assets and acquisition-related expenses, in each case as recorded at the holding company level. For 2014, the excluded general and administrative expenses relate to management fee expenses charged by our Non-life Run-off segment primarily related to our costs incurred in managing StarStone, the amortization of the definite-lived intangible assets, and acquisition-related expenses, in each case recorded at the holding company level.
Net earnings from Non-life Run-off and Life and Annuities segments of $206.7 million and $26.5 million, respectively
Net premiums earned of $823.5 million, including $676.6 million and $124.4 million in our StarStone and Atrium segments
Combined ratios of 98.6% and 94.0% for the active underwriting operations within our StarStone and Atrium segments, respectively (refer to "Non-GAAP Financial Measures" above)
2016 versus 2015: We reported consolidated net earnings attributable to Enstar Group Limited shareholders of $264.8 million for the year ended December 31, 2016, an increase of $44.5 million from $220.3 million for the year ended December 31, 2015. Our results were impacted by the loss portfolio transfer reinsurance transactions we completed during 2016 with Allianz, Coca-Cola and Neon. Our results were also impacted by our acquisition activity during 2015, when we acquired Sussex, Wilton Re’s life settlements business, and Alpha, and completed loss portfolio transfer reinsurance transactions with Reciprocal of America, Voya, and Sun Life. The most significant drivers of the change in our financial performance during 2016 as compared to 2015 included:
Net Incurred Losses and LAE in our Non-life Run-off Segment - Net reduction in the liability for net incurred losses and LAE within our Non-life Run-off segment continued to be the predominant driver of our consolidated earnings for the year ended December 31, 2016, improving by $15.1 million from 2015. Net earnings provided by the Non-life Run-off segment increased by $33.5 million in 2016 compared to 2015 primarily due to improved investment results, partially offset by higher expenses and other items;
Life Settlements Business - The life settlements business contributed $11.0 million to earnings in 2016 compared to $16.5 million in 2015;
Noncontrolling Interest - Noncontrolling interest in losses (earnings) is directly attributable to the results from those subsidiary companies in which there are either noncontrolling interests or redeemable noncontrolling interests. For the year ended December 31, 2016, the noncontrolling interest in earnings was $39.6 million as compared to the noncontrolling interest in losses of $10.0 million in 2015.
Noncontrolling Interest - Noncontrolling interest in losses (earnings) is directly attributable to the results from those subsidiary companies in which there are either noncontrolling interests or redeemable noncontrolling interests. For the year ended December 31, 2015, the noncontrolling interest in losses was $10.0 million as compared to the noncontrolling interest in earnings of $13.5 million in 2014.
2016 versus 2015: The increase in net earnings for the year ended December 31, 2016 as compared with the year ended December 31, 2015 was primarily attributable to an increase in net realized and unrealized gains in 2016 compared to net realized and unrealized losses in 2015, an increase in net investment income and a decrease in net incurred losses and LAE, partially offset by a reduction in net premiums earned, an increase in general and administrative expenses and an increase in income taxes.
2016 versus 2015: Our management companies in the Non-life Run-off segment earned fees and commission income of $25.3 million and $21.4 million for the years ended December 31, 2016 and 2015, respectively. The increase in fees is primarily related to services provided to KaylaRe, as described in Note 21 - "Related Party Transactions" in the notes to our consolidated financial statements included within Item 8 of this Annual Report on Form 10-K. These internal fees are predominantly eliminated upon consolidation of our results of operations. While our consulting subsidiaries continue to provide management and consultancy services, claims inspection services and reinsurance collection services to third-party clients in limited circumstances, the core focus of these subsidiaries is providing in-house services to companies within the Enstar group.
2015 versus 2014: Our management companies in the Non-life Run-off segment earned fees and commission income of $21.4 million and $19.3 million for the years ended December 31, 2015 and 2014, respectively. The decrease in fees and commission income related primarily to management fees charged to our StarStone segment.
2015 versus 2014: The net reduction in incurred losses and LAE for the year ended December 31, 2015 of $270.8 million included current period net incurred losses and LAE of $39.9 million related to current period net earned premium of $43.3 million (primarily for the portion of the run-off business acquired with Sussex). Excluding current period net losses and LAE of $39.9 million, net incurred losses and LAE liabilities relating to prior periods were reduced by $310.8 million, which was attributable to a reduction in estimates of net ultimate losses of $227.5 million, a reduction in provisions for bad debts of $25.3 million and a reduction in provision for unallocated LAE of $62.7 million, relating to 2015 run-off activity, partially offset by amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $4.6 million.
Acquisition costs for the Non-life Run-off segment were $4.2 million for the year ended December 31, 2016, compared to $8.9 million for 2015. Acquisition costs for the years ended December 31, 2016 and 2015 primarily related to net premiums earned on the portion of Sussex business that was placed into run-off. The $8.4 million in acquisition costs in 2014 primarily related to StarStone.
2016 versus 2015: General and administrative expenses for the Non-life Run-off segment increased by $36.2 million, from $239.0 million in the year ended December 31, 2015 to $275.2 million in the year ended December 31, 2016. The increase in expenses in 2016 related primarily to:
2015 versus 2014: General and administrative expenses for the Non-life Run-off segment increased by $40.9 million, from $198.1 million in the year ended December 31, 2014 to $239.0 million in the year ended December 31, 2015. The increase in expenses in 2015 related primarily to:
2015 versus 2014: We recorded net foreign exchange losses of $4.4 million and $8.0 million for the Non-life Run-off segment for the years ended December 31, 2015 and 2014, respectively. The net foreign exchange losses for the years ended December 31, 2015 and 2014 arose primarily as a result of the holding of surplus Euro and British pound assets at a time when the U.S. dollar appreciated against these currencies. The Non-life Run-off segment also recorded net foreign exchange gains (losses) of ($5.9) million and ($6.4) million in currency translation adjustment in the consolidated statement of comprehensive income, net of noncontrolling interest, for the years ended December 31, 2015 and 2014, respectively. For the years ended December 31, 2015 and 2014, the currency translation adjustments related primarily to our Australian-based subsidiaries whose functional currency is the Australian dollar.
2016 versus 2015: We recorded income tax expenses for our Non-life Run-off segment of $28.6 million and $12.6 million for the years ended December 31, 2016 and 2015, respectively. The effective tax rate was 11.3% for the year ended December 31, 2016 compared with 8.3% for the year ended December 31, 2015 due to having proportionately higher net income in our tax paying subsidiaries in 2016 than in 2015 as well as an increase in the valuation allowance on our deferred tax assets in the U.S. Income tax expense is primarily generated through our foreign operations outside of Bermuda, principally in the United States, the United Kingdom, Continental Europe and Australia. The effective tax rate, which is calculated as income tax expense or benefit divided by income before tax, is driven primarily by the geographic distribution of pre-tax net income between jurisdictions with comparatively higher tax rates and those with comparatively lower income tax rates and as a result may fluctuate significantly from period to period.
2015 versus 2014: We recorded a noncontrolling interest in losses (earnings) of our Non-life Run-off segment of $33.7 million and $(9.8) million for the years ended December 31, 2015 and 2014, respectively. The increase in losses associated with the noncontrolling interests for the year ended December 31, 2015 was due primarily to the decrease in earnings for those companies where there is a noncontrolling interest. The number of subsidiaries in this segment with a noncontrolling interest decreased from 7 as at December 31, 2014 to 2 as at December 31, 2015.
The decrease in the AUL result from $8.1 million in 2015 to $2.8 million in 2016 reflects decreased profit commission earned from the results of Syndicate 609.
Holding Company and Enstar Specific Expenses are discussed below under General and Administrative Expenses and Interest Expenses, respectively.
(1) Terrorism previously included war-related premiums which have been reclassified to marine and aviation lines. For the twelve months ended December 31, 2015, gross premiums written of $2.1 million and $5.3 million were reclassified to the marine and aviation lines, respectively.
The following table provides net premiums earned by line of business for the Atrium segment for the years ended December 31, 2016, 2015 and 2014:
(1) Terrorism previously included war-related premiums which have been reclassified to marine and aviation lines. For the twelve months ended December 31, 2015, net premiums earned of $2.0 million and $2.3 million were reclassified to the marine and aviation lines, respectively.
2016 versus 2015: Net premiums earned for the Atrium segment were $124.4 million and $134.7 million for the years ended December 31, 2016 and 2015, respectively. The decrease in net premiums earned was due to underwriting discipline to non-renew certain business that no longer met our underwriting standards, particularly in the marine, reinsurance and upstream energy lines. We are seeing continued pressure on premium rates and terms and conditions due to overcapacity in many markets for insurable risks. We continue to focus on risk selection and underwriting for profitability. These premium decreases were partially offset by the increase in the property and casualty binding authority line, which reflects the continued success of AU Gold, our proprietary online underwriting platform.
2015 versus 2014: Net premiums earned for the Atrium segment were $134.7 million and 135.9 million for the years ended December 31, 2015 and 2014, respectively. Net premiums earned for the 2015 year reflect the execution of Atrium’s underwriting strategies combined with the impact of softened market conditions across the industry. Market conditions particularly impacted the upstream energy line, although this was partially offset by the increase in the property and casualty binding authorities line. The syndicate commenced writing marine excess-of-loss business during 2015.
2016 versus 2015: Fees and commission income was $18.2 million and $28.4 million for the years ended December 31, 2016 and 2015, respectively. The fees represent management and profit commission fees earned by us in relation to AUL’s management of Syndicate 609 and other underwriting consortiums. The decrease was due primarily to profit commission on lower syndicate profits in 2016 as compared with 2015.
2015 versus 2014: Fees and commission income was $28.4 million and $26.2 million for the years ended December 31, 2015 and 2014, respectively. The fees represent management and profit commission fees earned by us in relation to AUL’s management of Syndicate 609 and other underwriting consortiums. The increase was due primarily to profit commission on higher syndicate profits in 2015 as compared with 2014.
2016 versus 2015: Acquisition costs were $44.7 million and $45.5 million for the years ended December 31, 2016 and 2015, respectively. The Atrium 5 acquisition cost ratios for the years ended December 31, 2016 and 2015 were 35.9% and 34.4%, an increase of 1.5%. The increase in the ratio was primarily due to less premium written in lines of business with lower acquisition ratios.
2016 versus 2015: General and administrative expenses for the Atrium segment were $25.1 million and $31.6 million for the years ended December 31, 2016 and 2015, respectively. The decrease of $6.5 million primarily relates to lower bonus accruals resulting from lower net earnings in 2016 compared to 2015 as well as the impact of the stronger U.S. dollar in 2016 compared with 2015.
2015 versus 2014: General and administrative expenses for the Atrium segment were $31.6 million and $34.9 million for the years ended December 31, 2015 and 2014, respectively. The decrease of $3.3 million was primarily due to more compensation costs being retained in Syndicate 609 versus AUL.
2016 versus 2015: Interest expense was $0.2 million and $4.3 million for the years ended December 31, 2016 and 2015, respectively. The 2015 interest expense was in respect of borrowings under the Enstar revolving credit facility, which is an Enstar Specific Expense, as compared to no interest relating to this facility in 2016.
2015 versus 2014: Noncontrolling interest in earnings of the Atrium segment was $14.3 million and $11.0 million for the years ended December 31, 2015 and 2014, respectively. As of December 31, 2015, Trident and Dowling had a combined 40.39% noncontrolling interest in the Atrium segment, although their share of net earnings was higher due primarily to the interest expense recorded in the segment, which is an Enstar Specific Expense.
2015 versus 2014: Income tax expense was $6.0 million and $5.1 million for the years ended December 31, 2015 and 2014, respectively. Income tax expense is associated with the operations of Atrium 5 and AUL in the United Kingdom. The effective tax rates for the Atrium segment for the years ended December 31, 2015 and 2014 were 16.2% and 19.2%, respectively.
The results of our StarStone segment include the results of StarStone Insurance Bermuda Limited and its subsidiaries ("StarStone") and StarStone Specialty Holdings Limited ("Holding Company"), which was formerly known as Bayshore Holdings Limited. StarStone results represent the active underwriting operations. The Holding Company's results include the amortization of fair value adjustments such as for intangible assets that were fair valued upon acquisition, and other expenses incurred.
Refer to "Non-GAAP Financial Measures" for a description of how these ratios are calculated. The ratios are based upon the following amounts for StarStone, which exclude Holding Company amounts, for the years ended December 31, 2016 and 2015, respectively: net premiums earned of $676,244 and $577,071, net incurred losses and LAE of $403,488 and $331,219, acquisition costs of $138,822 and $109,347, and other operating expenses of $124,239 and $128,544.
The combined ratio remained flat between 2016 and 2015, primarily due to a reduction in the other operating expense ratio, which was driven by an increase in net premiums earned whilst maintaining a relatively stable expense base. This was partially offset by an increase in the loss ratio, primarily due to an increase in workers compensation premiums written which has a higher loss ratio and lower acquisition cost ratio than most other lines of business. The acquisition cost ratio increased partly as a result of business mix and partly as a result of increasing market rates in some lines of business.
2016 versus 2015: Net incurred losses and LAE for the year ended December 31, 2016 were $401.6 million as compared with $327.7 million for the year ended December 31, 2015. Net favorable prior year loss development for the year ended December 31, 2016 was $14.2 million compared to net favorable prior year loss development of $39.4 million for the year ended December 31, 2015. Net favorable prior year loss development in 2016 primarily related to marine liability, offshore and terrorism. Net favorable prior year loss development in 2015 related to construction, general property and terrorism. Excluding net prior year loss development, net incurred losses and LAE for the year ended December 31, 2016 were $415.8 million compared to $367.0 million for the year ended December 31, 2015.
2015 versus 2014: Net incurred losses and LAE for the year ended December 31, 2015 were $327.7 million as compared with $218.4 million for the nine-month period ended December 31, 2014. Net favorable prior year loss development for the year ended December 31, 2015 was $39.4 million compared to net favorable prior year loss development of $11.1 million for the nine-month period ended December 31, 2014. Net favorable prior year loss development in 2015 primarily related to construction, excess casualty and terrorism. Net favorable prior year loss development in 2014 related to general property and terrorism. Excluding net prior year loss development, incurred losses and LAE for the year ended December 31, 2015 were $367.0 million compared to $229.5 million for the nine-month period ended December 31, 2014.
2016 versus 2015: Acquisition costs of the StarStone segment increased to $138.8 million for the year ended December 31, 2016 from $109.3 million for the year ended December 31, 2015, primarily due to an increase in net premiums earned. The acquisition cost ratios for the year ended December 31, 2016 and 2015 were 20.5% and 18.9%, respectively. The ratio increased by 1.6% in the year ended December 31, 2016 as compared with the year ended December 31, 2015 primarily due to higher gross premiums written in property and marine, which have higher acquisition cost ratios, partially offset by writing less aerospace, which has lower acquisition cost ratios.
2016 versus 2015: General and administrative expenses for the year ended December 31, 2016 and 2015 were $125.3 million and $126.1 million, respectively. The expense base has been kept at a relatively consistent level with prior year. The 2016 amount includes the realization of savings from favorable foreign exchange rates arising from our expenses in the United Kingdom and Continental Europe translating into fewer United States dollars than the prior year, offset by an increase in valuation of stock appreciation right awards outstanding in 2016 as a result of the increase in the share price.
2015 versus 2014: General and administrative expenses for the year and nine-month period ended December 31, 2015 and 2014 were $126.1 million and $113.3 million, respectively. The 2014 period only included nine months compared to a full year in 2015. The 2015 amount reflects the realization of savings from our ongoing expense management initiatives, partially offset by non-recurring costs incurred to close our operations in India, along with restructuring costs in the United Kingdom and Europe. Our expense management initiatives contributing to a decrease in general and administrative expenses included reducing the number of employees and contractors.
2016 versus 2015: We recorded a tax expense of $3.7 million in the year ended December 31, 2016 as compared with a tax benefit of $5.9 million for 2015. The 2016 tax expense related to our U.S. insurance entities offset by group relief with the Atrium segment in the United Kingdom, while the tax benefit in 2015 related to a reduction in the valuation allowance against our deferred tax asset largely related to the utilization of net operating losses carried forward.
The following is a discussion and analysis of our results of operations for our Life and Annuities segment for the years ended December 31, 2016, 2015 and 2014, which are summarized below.
The main driver of earnings from continuing operations in this segment was our life settlements business. For the years ended December 31, 2016, 2015 and 2014, the contribution to earnings from our life settlements business was $11.0 million, $16.5 million and $nil, respectively. Net earnings of $11.0 million in the year ended December 31, 2016 was comprised of net investment income of $13.0 million from policy maturity events, offset by expenses of $2.0 million. Net earnings of $16.5 million in the year ended December 31, 2015 was comprised of net investment income of $20.1 million from policy maturity events, offset by expenses of $3.6 million.
The components of Pavonia's net earnings of $12.0 million, classified as discontinuing operations, are included in Note 5 - "Held-For-Sale Business" in the Consolidated Financial Statements within Item 8 of this Form10-K.
Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2016
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Enstar Group Limited’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 (COSO), and our report dated February 27, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
StarStone - StarStone is a global specialty insurer that underwrites a diverse range of property, casualty and specialty insurance through its operations in Bermuda, the United States, the United Kingdom, and Continental Europe. Certain run-off business of StarStone is recorded in our Non-life Run-off segment.
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The consolidated financial statements include our assets, liabilities and results of operations as of December 31, 2016 and 2015 and for the years ended December 31, 2016, 2015 and 2014. Results of operations for acquired subsidiaries are included from the date of acquisition. All significant intercompany transactions and balances have been eliminated. Certain prior period amounts have been reclassified to conform to the current period presentation. These reclassifications had no impact on net earnings.
The reserves for losses and LAE in the Atrium and StarStone segments include reserves for unpaid reported losses and for IBNR loss reserves. The reserves for unpaid reported losses and loss expenses are established by management based on reports from brokers, ceding companies and insureds and represent the estimated ultimate cost of events or conditions that have been reported to or specifically identified by us. The reserve for IBNR losses is established by us based on actuarially determined estimates of ultimate losses and loss expenses. Inherent in the estimate of ultimate losses and loss expenses are expected trends in claim severity and frequency and other factors
Since the development of the policy benefits is based upon projections of future cash flows, we are required to make assumptions for mortality, longevity and morbidity rates, lapse rates, expenses and investment income. The assumptions used to determine policy benefits are determined at the inception of the contracts, reviewed and adjusted at the point of acquisition, as required, and are locked-in throughout the life of the contract unless a premium deficiency develops. These locked-in assumptions are based on a best estimate view of experience at the time they are established and may include a provision for adverse deviation. Assumptions are established based upon a combination of historical and industry experience, when available, and management judgment. Actual results could differ from these estimates.
comprehensive income. Realized gains and losses on sales of investments classified as available-for-sale are recognized in the consolidated statements of earnings.
The difference between the fair value of net assets acquired and purchase price is recorded as a goodwill asset or as a gain on bargain purchase in the consolidated statements of earnings. Goodwill is established initially upon acquisition and assessed at least annually for impairment. If the goodwill asset is determined to be impaired it is written down in the period in which the determination is made.
Intangible assets represent the fair value adjustments related to unpaid losses and LAE, reinsurance balances recoverable and policy benefits for life and annuity contracts along with the intangible assets arising from the acquisitions of Atrium and StarStone. Definite-lived intangible assets are amortized over their useful lives. Amortization of intangible assets is recognized in the consolidated statement of earnings. Indefinite-lived intangible assets are not subject to amortization. The carrying values of intangible assets are reviewed for indicators of impairment at least annually. Impairment is recognized if the carrying values of the intangible assets are not recoverable from their undiscounted cash flows and are measured as the difference between the carrying value and the fair value.
In our Non-life Run-off and StarStone segments we have ceded business to KaylaRe Ltd., an affiliated reinsurer, as described in Note 21 - "Related Party Transactions". The reinsurance ceded by StarStone to KaylaRe Ltd. during the year ended December 31, 2016 was mostly recognized as retroactive reinsurance, except for the unearned ceded premium as at December 31, 2016 which is recognized as prospective reinsurance. The reinsurance ceded by StarStone to KaylaRe Ltd. from January 1, 2017 will be recognized as prospective reinsurance.
Accounting Standards Update ("ASU") 2016-18, Statement of Cash Flows - Restricted Cash
In November 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-18, which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. We have early adopted this guidance and applied it retrospectively to all periods presented on our consolidated financial statements.
In October 2016, the FASB issued ASU 2016-17, which amends the consolidation guidance on how a reporting entity that is the single decision maker of a variable interest entity (“VIE”) should treat indirect interests in the entity held through related parties that are under common control with the reporting entity when determining whether it is the primary beneficiary of that VIE. The adoption of this guidance did not have a material impact on our consolidated financial statements and disclosures.
In May 2015, the FASB issued ASU 2015-07, which eliminates the requirement to categorize investments in the fair value hierarchy if their fair value is measured at the net asset value ("NAV") per share (or its equivalent) using the practical expedient in the FASB’s fair value measurement guidance. Instead, an entity is required to include those investments as a reconciling line item so that the total fair value amount of investments in the disclosure is consistent with the amount on the balance sheet. In addition, the scope of current disclosure requirements for investments eligible to be measured at NAV is limited to investments for which the practical expedient is applied. While the adoption of this guidance impacted our disclosures, it did not have an impact on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, which simplifies the accounting for goodwill impairments by eliminating Step 2 from the goodwill impairment test. Instead, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. The ASU is effective for any interim and annual impairment tests for periods beginning after December 15, 2019. Early adoption is permitted for any interim and annual impairment tests occurring after January 1, 2017. We intend to adopt this new guidance for our annual impairment tests occurring after January 1, 2017 and do not expect the adoption to have a material impact on our consolidated financial statements.
We expect to adopt the new guidance on January 1, 2020 and upon adoption the OTTI approach we currently use for our available for sale securities whereby any credit losses are presented as write-downs on individual securities will be replaced by an approach whereby any credit losses are instead presented as an allowance against each security. This revised approach records the full effect of reversals of any credit losses in current period earnings, compared to current U.S. GAAP which amortizes the reversal of credit losses over the lifetime of the security. The length of time an available for sale security has been in an unrealized loss position will no longer be considered in determining whether to record a credit loss. In addition, the historical and implied volatility of the fair value of an available for sale security and recoveries or declines in fair value after the balance sheet date will no longer be considered when making a determination of whether a credit loss exists. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements and disclosures.
In March 2016, the FASB issued ASU 2016-09, which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The ASU is effective for interim and annual reporting periods beginning after December 15, 2016. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements and disclosures.
We expect to adopt the new standard on January 1, 2019 and will recognize and measure our leasing arrangements at the beginning of the earliest period presented using the modified retrospective approach permitted by the ASU. The modified retrospective approach includes a number of specific optional practical expedients which we intend to elect on adoption of the ASU, relating to, (1) the identification and classification of leases that commenced before the effective date, (2) initial direct costs for leases that commenced before the effective date, and (3) the ability to use hindsight in evaluating lessee options to extend or terminate a lease. The election of these practical expedients will allow us to in effect, continue to account for leases that commence before the effective date in accordance with the previous GAAP unless the lease is modified. The only exception would be that we will be required to recognize a right-of-use asset and a lease liability for all our existing operating leases at each reporting date based on the present value of the remaining minimum lease rental payments that we are disclosing under current U.S. GAAP. We are continuing to review all our operating lease arrangements to quantify the right-of-use asset and the offsetting lease liability to be recorded on our Consolidated Balance Sheet upon adoption of this guidance.
We are required to adopt ASU 2016-08, ASU 2016-10 and ASU 2016-12 together with ASU 2014-09, which is effective for interim and annual reporting periods beginning after December 15, 2017.We expect to adopt this guidance on January 1, 2018. The two permitted transition methods under the new revenue standard are the full retrospective method, in which case the guidance would be applied to each prior reporting period presented, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of initial adoption. We expect to adopt the guidance using the modified retrospective method. While we are still in the process of completing our analysis of the impact this guidance will have on our consolidated financial statements and related disclosures, we do not expect the impact to be material, as the majority of our revenues are within the scope of other FASB topics, primarily ASC 944, Insurance.
On December 30, 2016, we completed the acquisition of Dana Companies, LLC ("Dana Companies") from Dana Incorporated ("Dana"). Dana Companies holds liabilities associated with personal injury asbestos claims and environmental claims arising from its legacy manufacturing operations. Dana Companies’ assets include, amongst others, insurance rights related to coverage against these liabilities and marketable securities.
The following table summarizes the fair values of the assets acquired and liabilities assumed at the acquisition date, recorded in our Non-life Run-off segment.
The total consideration for the transaction was €32.8 million (or $35.2 million).
The total consideration for the transaction was $173.1 million, paid in two installments. The first installment of $89.1 million was paid on closing. The second installment of $83.9 million was paid on the first anniversary of closing. The companies are operating as part of the Life and Annuities segment.
Canada Pension Plan Investment Board ("CPPIB"), together with management of Wilton Re, owns 100% of the common stock of Wilton Re. Subsequent to the closing of our transaction with Wilton Re, CPPIB separately acquired certain of our voting and non-voting ordinary shares in several third party transactions during 2015 and 2016, as described in "Note 21 - Related Party Transactions."
The net unearned premiums acquired included a decrease of $34.6 million to adjust net unearned premiums to fair value. This fair value adjustment is included within unearned premiums on the consolidated balance sheet. As at December 31, 2016, $16.1 million has been amortized to acquisition costs and $15.7 million has been amortized to net premiums earned in the consolidated statements of earnings and comprehensive income. As at December 31, 2016, the remaining balance of the fair value adjustment was $2.7 million, which will be amortized to net premiums earned over the remaining terms of the underlying policies.
The following unaudited pro forma condensed combined statement of earnings for the years ended December 31, 2015 and 2014 combines our historical consolidated statements of earnings with those of Sussex, Alpha and Wilton Re, giving effect to the business combinations and related transactions as if they had occurred on January 1, 2014 and 2015. For the year ended December 31, 2015, the operating results of Sussex, Alpha and Wilton Re have been included in the consolidated financial statements from each of their respective dates of acquisition. The unaudited pro forma financial information presented below is for informational purposes only and is not necessarily indicative of the results of operations that would have been achieved if the acquisitions of Sussex, Alpha and Wilton Re and related transactions had taken place at the beginning of each period presented, nor is it indicative of future results.
Summary of the Pro Forma Adjustments to the Pro Forma Condensed Consolidated Statement of Earnings for the Twelve Months Ended December 31, 2015 (Unaudited):
As a shareholder of StarStone, FR XI Offshore AIV, L.P., First Reserve Fund XII, L.P., FR XII A Parallel Vehicle L.P. and FR Torus Co-Investment, L.P. (collectively, "First Reserve") received 1,501,211 Voting Ordinary Shares, 714,015 Non-Voting Preferred Shares and cash consideration in the transaction. Following the approval of our shareholders of an amendment to our bye-laws on June 10, 2014, First Reserve’s Non-Voting Preferred Shares converted on a share-for-share basis into 714,015 shares of newly created Series E Non-Voting Convertible Common Shares (the "Series E Non-Voting Ordinary Shares"). Corsair Specialty Investors, L.P. ("Corsair") received 397,115 Voting Ordinary Shares and cash consideration in the transaction. The remaining StarStone shareholders received all cash.
Prior to acquisition, StarStone ceased underwriting certain lines of business in order to focus on core property, casualty and specialty lines. The results of the discontinued lines of business that were placed into run-off are included within our Non-life Run-off segment.
The fair value of the Lloyd’s syndicate capacity was estimated using the multi-period excess-earnings method, a form of the income approach. Lloyd’s syndicate capacity represents StarStone’s authorized premium income limit to write insurance business in the Lloyd’s market. The capacity is renewed annually at no cost to us but may be freely purchased or sold, subject to Lloyd’s approval. The ability to write insurance business within the syndicate capacity is indefinite, with the premium income limit being set annually by StarStone, subject to Lloyd’s approval.
On December 23, 2015, we completed a corporate reorganization of certain of our subsidiary holding companies. Following the reorganization, StarStone Holdings and Northshore are owned by a common parent, North Bay Holdings Limited ("North Bay"), as described in Note 16 - "Noncontrolling Interests".
On February 7, 2017, we entered into an agreement to reinsure U.K. employers' liability legacy business of RSA Insurance Group PLC ("RSA"). Pursuant to the transaction, our subsidiary will assume gross insurance reserves of approximately £957 million (approximately $1.2 billion), relating to 2005 and prior year business. Net insurance reserves are approximately £834 million (approximately $1.0 billion) and the reinsurance premium payable to Enstar’s subsidiary is £799 million (approximately $1.0 billion). The transaction is subject to finalizing and effecting certain security arrangements.
On January 11, 2017, we announced the closing of a transaction to reinsure multi-line property and casualty business of QBE Insurance Group Limited ("QBE"). Our subsidiary assumed gross reinsurance reserves of approximately $919.0 million (net reserves of $444.0 million) relating to the portfolio, which primarily includes workers' compensation, construction defect, and general liability discontinued lines of business. In addition our subsidiary has pledged a portion of the premium as collateral to a subsidiary of QBE, and we have provided additional collateral and a limited parental guarantee.
On February 17, 2016, we entered into a reinsurance agreement with Allianz SE ("Allianz") to reinsure portfolios of Allianz's run-off business. Pursuant to the reinsurance agreement, our subsidiary reinsured 50% of certain portfolios of workers' compensation, construction defect, and asbestos, pollution, and toxic tort business originally held by Fireman's Fund Insurance Company, and in the process assumed net reinsurance reserves of $1.1 billion. Affiliates of Allianz retained $1.1 billion of reinsurance premium as funds withheld collateral for the obligations of our subsidiary under the reinsurance agreement and we transferred $110.0 million to a reinsurance trust to further support our subsidiary's obligations. We have also provided a limited parental guarantee, which is subject to a maximum cap. The combined monetary total of the support offered by us through the trust and parental guarantee was initially be capped at $270.0 million.
On September 30, 2015, we entered into two 100% reinsurance agreements and a related administration services agreement with Sun Life pursuant to which we reinsured all of the run-off workers' compensation carve-out and occupational accident business of Sun Life. We assumed reinsurance reserves of $128.3 million, received total assets of $122.5 million and recorded a deferred charge of $5.8 million, included in other assets. We transferred $30.6 million of additional funds into trust to further support our obligations under the reinsurance agreements. We provided limited parental guarantees, subject to an overall maximum of $36.8 million.
On January 1, 2014, we entered into a RITC of the 2011 and prior underwriting years of account of a Lloyd’s syndicate, under which we assumed total net insurance reserves of £17.0 million ($28.1 million) for cash consideration of an equal amount.
Pavonia is a substantial portion of the Life and Annuities segment. We have classified the assets and liabilities of the businesses to be sold as held-for-sale. The following table summarizes the components of assets and liabilities held-for-sale on our consolidated balance sheet as at December 31, 2016 and 2015:
Included within residential and commercial mortgage-backed securities as at December 31, 2016 were securities issued by U.S. governmental agencies with a fair value of $362.9 million (as at December 31, 2015: $355.4 million). Included within corporate securities as at December 31, 2016 were senior secured loans of $90.7 million (as at December 31, 2015: $94.4 million).
As at December 31, 2016 and December 31, 2015, the number of securities classified as available-for-sale in an unrealized loss position was 156 and 332, respectively. Of these securities, the number of securities that had been in an unrealized loss position for twelve months or longer was 41 and 124, respectively.
The following table sets forth the credit ratings of our fixed maturity and short-term investments as of December 31, 2016:
Real estate debt fund invests primarily in U.S. commercial real estate loans and securities. A redemption request for this fund can be made 10 days after the date of any monthly valuation. The fund was fully redeemed during the year ended December 31, 2016.
CLO equity funds comprise two funds that invest primarily in the equity tranches of term-financed securitizations of diversified pools of corporate bank loans. One of the funds has a fair value of $4.1 million, part of a self-liquidating structure which is expected to pay out over one to five years. The other fund has a fair value of $11.3 million and is eligible for redemption in 2018.
Investments of $0.5 million in fixed income hedge funds were subject to gates or side-pockets, where redemptions are subject to the sale of underlying investments. A gate is the ability to deny or delay a redemption request, whereas a side-pocket is a designated account for which the investor loses its redemption rights.
As at December 31, 2016, we had unfunded commitments to private equity funds of $144.0 million.
Components of net realized and unrealized gains (losses) for the years ended December 31, 2016, 2015 and 2014 were as follows:
The gross realized gains and losses on available-for-sale securities included in the table above resulted from sales of $41.3 million, $95.1 million and $90.7 million for the years ended December 31, 2016, 2015 and 2014, respectively.
The carrying values of assets and liabilities underlying the funds held - directly managed account as at December 31, 2016 were as follows:
Net Realized Gains (Losses) and Change in Fair Value of Embedded Derivative
Major categories of net investment income underlying the funds held - directly managed for the year ended December 31, 2016 are summarized as follows:
Municipal securities consist primarily of bonds issued by U.S.-domiciled state and municipal entities. The fair values of these securities are determined using the spread above the risk-free yield curve, reported
trades, broker-dealer quotes and benchmark yields. These are considered observable market inputs and, therefore, the fair values of these securities are classified as Level 2.
We have categorized all of our investments in equities other than preferred stock as Level 1 investments because the fair values of these investments are based on unadjusted quoted prices in active markets for identical assets or liabilities. The fair value estimates of our investments in preferred stock are based on observable market data and, as a result, have been categorized as Level 2.
As of December 31, 2016 and 2015, investments in life settlement contracts were carried at cost of $131.7 million and $133.1 million, respectively, and their fair values were $129.5 million and $130.3 million, respectively.
The following table presents the gross notional amounts, estimated fair values recorded within other assets and liabilities and the amounts of the net gains deferred in the currency translation adjustment account which is a component of accumulated other comprehensive income (loss) ("AOCI"), in shareholders' equity, related to our foreign currency forward exchange rate contracts as at December 31, 2016.
We use equity call option instruments either to obtain exposure to a particular equity instrument or for yield enhancement, in non-qualifying hedging relationships.
The following table provides the total reinsurance balances recoverable as at December 31, 2016 and, 2015:
The fair value adjustments, determined on acquisition of insurance and reinsurance subsidiaries, are based on the estimated timing of loss and LAE recoveries and an assumed discount rate equivalent to an interest rate for securities with similar duration to the reinsurance recoverables acquired including a spread to reflect credit risk, and are amortized over the estimated recovery period, as adjusted for accelerations in timing of payments as a result of commutation settlements.
recoverable of $241.7 million and $154.7 million, respectively, related to KaylaRe Ltd. and Lloyd’s syndicates, both of which represent 10% or more of total reinsurance balances recoverable. Lloyd’s is rated ‘A+’ by Standard & Poor’s and ‘A’ by A.M. Best. KaylaRe Ltd. is not rated but is an affiliated company partly owned by Enstar, as described in Note 21 - "Related Party Transactions", and security is provided in the form of funds withheld. As at December 31, 2015, reinsurance balances recoverable with a carrying value of $165.6 million related to Lloyd's syndicates and represented 10% or more of total reinsurance balances recoverable.
We remain liable to the extent that retrocessionaires do not meet their obligations under these agreements, and therefore, we evaluate and monitor concentration of credit risk among our reinsurers. Provisions are made for amounts considered potentially uncollectible.
The liability for losses and LAE, also referred to as loss reserves, represents our gross estimates before reinsurance for unpaid reported losses and losses that have been incurred but not reported ("IBNR") for our Non-life Run-off, Atrium and StarStone segments. We recognize an asset for the portion of the liability that we expect to recover from reinsurers. LAE reserves include allocated loss adjustment expenses ("ALAE"), and unallocated loss adjustment expenses ("ULAE"). ALAE are linked to the settlement of an individual claim or loss, whereas ULAE are based on our estimates of future costs to administer the claims. IBNR represents reserves for loss and LAE that have been incurred but not yet reported to us. This includes amounts for unreported claims, development on known claims and reopened claims.
The table below provides a consolidated reconciliation of the beginning and ending liability for losses and LAE for the years ended December 31, 2016, 2015 and 2014:
IBNR reserves are established by management based on actuarially determined estimates of ultimate losses and loss expenses. We use generally accepted actuarial methodologies to estimate ultimate losses and LAE and those estimates are reviewed by our management. In addition, the routine settlement of claims, at either below or above the carried advised loss reserve, updates historical loss development information to which actuarial methodologies are applied often, resulting in revised estimates of ultimate liabilities. On an annual basis, independent actuarial firms are retained by management to provide their estimates of ultimate losses and to review the estimates developed by our actuaries.
The table below provides a reconciliation of the beginning and ending reserves for losses and LAE for the years ended December 31, 2016, 2015 and 2014 for the Non-life Run-off segment:
Net incurred losses and LAE in the Non-life Run-off segment for the years ended December 31, 2016, 2015 and 2014 were as follows:
The net reduction in incurred losses and LAE for the year ended December 31, 2016 of $285.9 million included net incurred losses and LAE of $5.8 million related to current period net earned premium of $7.1 million (primarily for the portion of the run-off business acquired with Sussex). Excluding current period net incurred losses and LAE of $5.8 million, net incurred losses and LAE liabilities relating to prior periods were reduced by $291.7 million, which was attributable to a reduction in estimates of net ultimate losses of $259.1 million, a reduction in provisions for bad debt of $13.8 million and a reduction in provisions for unallocated LAE of $44.2 million, relating to 2016 run-off activity, partially offset by amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $25.4 million.
policy buy-backs, to estimate loss reserves required to cover liabilities for unpaid losses and LAE relating to non-commuted exposures. The prior period estimate of net IBNR reserves was reduced as a result of the combined impact on all classes of business of loss development activity during 2015, including commutations and the favorable trend of loss development related to non-commuted policies compared to prior forecasts. The net incurred loss development resulting from settlement of net advised case and LAE reserves of $366.3 million for net paid losses of $501.2 million related to the settlement of non-commuted losses in the year and 79 commutations and policy buy-backs of assumed and ceded exposures (including the commutation of two of our top ten assumed exposures and one of our top ten ceded recoverables as at January 1, 2014). Net advised case and LAE reserves settled by way of commutation and policy buy-back during the year ended December 31, 2015 amounted to $56.6 million (comprising $140.3 million of assumed case reserves and LAE reserves partially offset by $83.7 million of ceded incurred reinsurance recoverable case reserves).
The reduction in net IBNR reserves of $262.4 million relating to prior periods was a result of the application, on a basis consistent with the assumptions applied in the prior period, of our actuarial methodologies to revised historical loss development data, following 98 commutations and policy buy-backs, to estimate loss reserves required to cover liabilities for unpaid losses and LAE relating to non-commuted exposures. The prior period estimate of net IBNR reserves was reduced as a result of the combined impact on all classes of business of loss development activity during 2014, including commutations and the favorable trend of loss development related to non-commuted policies compared to prior forecasts. The net incurred loss development resulting from settlement of net advised case and LAE reserves of $285.8 million for net paid losses of $312.4 million related to the settlement of non-commuted losses in the year and 98 commutations and policy buy-backs of assumed and ceded exposures (including the commutation of one of our top ten assumed exposures and one of our top ten ceded recoverables as at January 1, 2013). Net advised case and LAE reserves settled by way of commutation and policy buy-back during the year ended December 31, 2014 amounted to $29.1 million (comprising $99.5 million of assumed case reserves and LAE reserves partially offset by $70.4 million of ceded incurred reinsurance recoverable case reserves).
As noted in the table above, the significant categories within this segment include asbestos, general casualty and workers’ compensation, which collectively comprised approximately 80% and 77% of the total gross and net reserves as at December 31, 2016. Separate claims development tables have been provided for the workers’ compensation and general casualty categories as set forth below. The asbestos category is wholly comprised of losses with accident years before 2007 and therefore accident year claims development tables are excluded from these disclosures. The exposures included in the other category includes losses with several different development patterns that are not individually sufficiently significant to be disclosed in separate claims development tables.
Our non-life run-off segment is unique within the insurance industry. Legacy reserves are continuously being acquired into this segment through company acquisition or through loss portfolio transfer reinsurance. The loss development tables in this segment include actual loss development as well as the effects of assimilating newly acquired reserves. Accordingly, it would not be appropriate to extrapolate redundancies or deficiencies into the future or to infer actual historical accident year development information from the tables provided below. Acquired reserves for company acquisitions are shown on a full retrospective basis. Assumed reserves for loss portfolio reinsurance transactions are shown as follows: (i) unpaid reported claims are shown on a full retrospective basis and (ii) assumed IBNR is shown on a prospective basis as historical IBNR is generally not available to us in these transactions. For further information, we have disclosed additional development tables for reported claims, for IBNR, and for IBNR acquired in loss portfolio reinsurance transactions.
The following tables set forth information about incurred and paid loss development information related to our general casualty category within the Non-life Run-off segment as at December 31, 2016. The information related to incurred and paid loss development for the years ended December 31, 2007 through 2015 is presented as supplementary information and is unaudited.
The reconciliation of incurred and paid loss development to the liability for unpaid losses and LAE as presented in the tables above for the year ended December 31, 2016 is set forth below:
Information about total IBNR liabilities and cumulative loss frequency as at December 31, 2016, including expected development on reported claims included within the net incurred losses and allocated LAE amounts for the Non-life Run-off segment for workers' compensation, are set forth in the table below:
The table below provides a reconciliation of the beginning and ending liability for losses and LAE for the years ended December 31, 2016, 2015 and 2014:
Net incurred losses and LAE in the Atrium segment for the years ended December 31, 2016, 2015 and 2014 were as follows:
The Atrium segment comprises only 3.5% of the consolidated liability for losses and LAE as at December 31, 2016 and therefore has not been disaggregated further for the purposes of presenting the accident year disclosures below.
The reconciliation of incurred and paid loss development to the liability for unpaid losses and LAE as presented in the tables above for the Atrium segment for the year ended December 31, 2016 is set forth below:
The table below provides a reconciliation of the beginning and ending liability for losses and LAE for the years ended December 31, 2016 , 2015 and 2014:
Net incurred losses and LAE for the years ended December 31, 2016 and 2015 were as follows:
The StarStone segment comprises 18% of the consolidated liability for losses and LAE as at December 31, 2016 and therefore has not been disaggregated further for the purposes of presenting the accident year disclosures below.
The following tables set forth information about incurred and paid loss development information for the StarStone segment as at December 31, 2016. The information related to incurred and paid loss development for the years ended December 31, 2014 through 2015 is presented as supplementary information and is unaudited. This business was acquired on April 1, 2014, as described in Note 3 - "Acquisitions". The information in the incurred and paid loss development tables below is presented on a prospective basis from the date of our acquisition of StarStone; as providing pre-acquisition incurred losses by accident year for years prior to 2014 was determined to be impracticable.
The following tables provide a summary of net premiums written and earned in our Non-life Run-off, Atrium, StarStone and Life and Annuities segments for the years ended December 31, 2016, 2015 and 2014:
Intangible assets with a definite life - Other includes the distribution channel, Lloyd’s capacity, technology and brand related to our acquisitions of Atrium and StarStone. These assets are amortized on a straight-line basis over a period ranging from four to fifteen years. Intangible asset amortization for the years ended December 31, 2016, 2015 and 2014 was $6.4 million, $9.8 million and $6.0 million, respectively. Amortization for the year ended December 31, 2015 included an impairment charge of $4.0 million for the Torus brand in relation to the StarStone rebranding exercise.
The gross carrying value, accumulated amortization and net carrying value of intangible assets by type and deferred charge at December 31, 2016 and 2015 were as follows:
The table above excludes fair value adjustments of $46.5 million and $53.6 million as at December 31, 2016 and 2015, respectively, relating to policy benefits for life and annuity contracts relating to our Pavonia operations which are classified as held-for-sale. Amortization of fair value adjustments relating to Pavonia was $7.0 million and $7.9 million during the years ended December 31, 2016 and 2015, respectively.
The estimated amortization expense for each of the five succeeding fiscal years related to our intangible assets with a definite life is as follows:
Financial and business covenants imposed on Sussex include limitations on mergers and consolidations, acquisitions, indebtedness and guarantees, restrictions as to dispositions of stock and assets (except for certain permitted dispositions), restrictions on dividends, and limitations on liens. Generally, the financial covenants require Sussex to (i) maintain statutory surplus of at least 1.1 times the authorized control level under the NAIC's risk-based capital calculation and at least 2 times the outstanding loan balance; and (ii) maintain certain characteristics of its investment portfolio relating to average credit quality and concentration. We are in compliance with the covenants of the Sussex Facility.
On November 18, 2016, we entered into and fully utilized a three-year $75.0 million unsecured term loan (the "EGL Term Loan Facility").
Redeemable noncontrolling interest ("RNCI") as of December 31, 2016 comprises the ownership interest held by Trident (39.32%) and Dowling (1.71%) in North Bay Holdings Limited ("North Bay"). On December 23, 2015, we completed a corporate reorganization of certain of our subsidiary holding companies. Following the reorganization, StarStone Holdings and Northshore are owned by a common parent, North Bay. Northshore owns 100% of Atrium and Arden. StarStone Holdings owns 100% of StarStone and all of the interests in a segregated cell of one of our non-life run-off subsidiaries that reinsured all of StarStone’s non-life run-off reserves with effect from January 1, 2014.
The following is a reconciliation of the beginning and ending carrying amount of the equity attributable to the RNCI for the years ended December 31, 2016 and 2015:
We have carried the RNCI at its estimated redemption value, which is fair value, as of December 31, 2016. The decrease was primarily attributable to a decrease in comparable company market valuations.
On September 3, 2015, we entered into a Sale and Purchase Agreement with Shinsei Bank, Limited ("Shinsei"), pursuant to which we purchased all of the Class B shares of Comox Holdings Ltd., which represents all of the NCI owned directly by Shinsei in our subsidiaries, for an aggregate price of $10.4 million. Immediately prior to the repurchase, the book value of Shinsei’s NCI was $12.5 million. The transaction closed on September 8, 2015.
The Voting Ordinary Shares are listed and trade on the NASDAQ Global Select Market. Each Voting Ordinary Share entitles the holder thereof to one vote. In accordance with the bye-laws, any U.S. shareholder or direct foreign shareholder group whose shares constitute 9.5% or more of the voting power of the Voting Ordinary Shares is entitled to less than one vote for each Voting Ordinary Share held by it.
The Non-Voting Ordinary Shares are comprised of several different series as of December 31, 2016:
As of December 31, 2016, there were warrants outstanding to acquire 175,901 Series C Non-Voting Ordinary Shares for an exercise price of $115.00 per share, subject to certain adjustments (the "Warrants"). The Warrants were issued in April 2011 and expire in April 2021. The Warrant holder may, at its election, satisfy the exercise price of the Warrants on a cashless basis by surrender of shares otherwise issuable upon exercise of the Warrants in accordance with a formula set forth in the Warrants. During December 2016, 164,919 Warrants were exercised on a cashless basis, resulting in the issuance of 66,520 Series C Non-Voting Ordinary Shares. In a series of transactions that took place subsequent to December 31, 2016, 192,485 Series C Non-Voting Ordinary Shares converted into Voting Ordinary Shares in a widely dispersed offering by their registered holders.
As of December 31, 2016, there were 388,571 Series C Participating Non-Voting Perpetual Preferred Stock ("Series C Preferred Shares") issued and held by one of our wholly-owned subsidiaries. The Series C Preferred Shares were issued in June 2016 in an internal reorganization transaction that resulted in the cancellation of all of the Series A Shares, which had an equivalent value and were also previously held by our wholly-owned subsidiary. The Series C Preferred Shares (i) upon liquidation, dissolution or winding up of the Company, entitle their holders to a preference over holders of our ordinary voting and non-voting shares of an amount equal to $0.001 per share with respect to surplus assets and (ii) are non-voting except in certain limited circumstances. The Series C Preferred shares have dividend rights equal to those of the ordinary voting shares, subject to certain limitations and in an amount determined by a "participation rate" that is generally reflective of the reduction in the number of Series C Preferred Shares issued
in exchange for the previously outstanding Series A Shares. The Series C Preferred Shares otherwise rank on parity with the ordinary voting and non-voting shares, and they rank senior to each other class or series of share capital, unless the terms of any such class or series shall expressly provide otherwise.
There were 714,015 Series B Convertible Participating Non-Voting Perpetual Preferred Stock, par value 1.00 per share (the “Non-Voting Preferred Shares”) issued and converted into Series E shares during 2014 in connection with our acquisition of StarStone.
The following table sets forth the computation of basic and diluted earnings per share for the years ended December 31, 2016, 2015 and 2014:
Compensation costs of $3.0 million, $6.1 million and $3.9 million relating to these share awards were recognized in our statement of earnings for the years ended December 31, 2016, 2015 and 2014, respectively. The unrecognized compensation cost related to our non-vested share awards as at December 31, 2016 was $8.4 million. This cost is expected to be recognized over the next 2.0 years, which is the weighted average contractual life of the awards.
The following table summarizes the activity related to SARs during 2016:
(1) The aggregate intrinsic value is calculated as the pre-tax difference between the exercise price of the underlying share awards and the closing price per share of our ordinary shares of $197.70 on December 31, 2016.
Compensation expense for SARs is based on the estimated fair value on the date of grant using the Black-Scholes valuation model, which requires the use of subjective assumptions related to the expected stock price volatility, expected term, expected dividend yield and risk-free interest rate. SARs are liability-classified awards for which compensation expense and the liability are re-measured using the then-current Black Scholes assumptions at each interim reporting date based upon the portion of the requisite service period rendered. Compensation costs of $35.6 million and $8.9 million relating to these share awards were recognized in our statement of earnings for the years ended December 31, 2016 and 2015, respectively. The unrecognized compensation cost related to our SARs as at December 31, 2016 was $10.1 million. This cost is expected to be recognized over the next 0.53 years, which is the weighted-average remaining vesting term of the awards.
The following table sets forth the assumptions used to estimate the fair value of the SARs using the Black-Scholes option valuation model as at December 31, 2016 and 2015:
Subsequent to December 31, 2016, we granted 34,775 PSU's with a grant date fair value of $6.9 million. The PSU's are share-settled and vest on the third anniversary of the grant date. The number of shares to vest will be determined by a performance adjustment based on the change in fully diluted book value per share ("FDBVPS") over three years. An increase of 30% to 40% or more in FDBVPS results in a settlement of 100% to a maximum of 150% of the units granted, respectively. An increase of 20% to 30% in FDBVPS results in a settlement of 50% to 100% of the units granted, respectively. Straight-line interpolation applies within these ranges and no settlement occurs if the increase in FDBVPS is less than 20%.
Our subsidiary, Northshore, has long-term incentive plans that award time-based restricted shares of Northshore to certain Atrium employees. Shares generally vest over two to three years. These share awards have been classified as liability awards. For the years ended December 31, 2016, 2015, and 2014, compensation costs of $2.8 million, $3.9 million and $5.2 million relating to the long-term incentive plans were recorded in our consolidated statement of earnings. The unrecognized compensation cost related to the Northshore incentive plan at December 31, 2016 was $3.7 million. This cost is expected to be recognized over the next 1.76 years, which is the weighted average contractual life of the awards.
For the years ended December 31, 2016, 2015 and 2014, compensation costs relating to the shares issued under the Amended and Restated Enstar Group Limited Employee Share Purchase Plan ("Share Plan") of $0.3 million, $0.3 million and $0.1 million, respectively, were recorded as salaries and benefits in our consolidated statement of earnings. For the years ended December 31, 2016, 2015 and 2014, 12,234, 11,998 and 6,031 shares, respectively, were issued to employees under the Share Plan.
Pension expense relating to defined contribution plans for the years ended December 31, 2016, 2015 and 2014 was $10.8 million, $10.3 million and $9.2 million, respectively. Pension expense can be affected by changes in our employee headcount as a result of our acquisitions described in Note 3 - "Acquisitions."
Enstar Group Limited's Parent Company is incorporated under the laws of Bermuda and under Bermuda law is not required to pay taxes in Bermuda based upon income or capital gains. The Company, under the Exempted Undertakings Tax Protection Act of 1966, is protected against any legislation that may be enacted in Bermuda which would impose any tax on profits, income, or gain until March 31, 2035.
The following table presents earnings before income taxes by jurisdiction from continuing operations:
The following table presents our current and deferred income tax expense (benefit) from continuing operations by jurisdiction:
The actual income tax rate differs from the amount computed by applying the effective rate of 0% under Bermuda law to earnings from continuing operations before income taxes as shown in the following reconciliation:
As of December 31, 2016 and 2015, we had deferred tax asset valuation allowances of $290.9 million and $291.3 million, respectively, related to foreign subsidiaries.
The realization of deferred tax assets is dependent on generating sufficient taxable income in future periods in which the tax benefits are deductible or creditable. Taxes are determined and assessed jurisdictionally by legal entity or by filing group. Certain jurisdictions require or allow combined or consolidated tax filings. We have estimated future taxable income of our foreign subsidiaries and provided a valuation allowance in respect of those assets where we do not expect to realize a benefit. We have considered all available evidence using a “more likely than not” standard in determining the amount of the valuation allowance. Our assessment weighs both positive and negative evidence and considers the extent to which the evidence can be objectively verified. When negative evidence outweighs positive evidence then it can be difficult to support a conclusion that a valuation allowance is not needed. We consider the following evidence: (i) net earnings or losses in recent years; (ii) the future sustainability and likelihood of positive net earnings of our subsidiaries; (iii) the carryforward periods of tax losses including the effect of reversing temporary differences; and (iv) tax planning strategies.
The decrease of $0.4 million in our continuing operations for 2016 related to the utilization of deferred tax assets for which we previously carried a valuation allowance, offset by additional valuation allowance for deferred tax assets management assessed as unable to meet the more-likely-than-not standard for utilization.
Our operating subsidiaries may be subject to audit by various tax authorities and may have different statutes of limitations expiration dates. Tax authorities may propose adjustments to our income taxes. Listed below are the tax years that remain subject to examination by a major tax jurisdiction as of December 31, 2016:
In addition, we have entered into certain agreements with Trident with respect to Trident’s co-investments in the Atrium, Arden, and StarStone acquisitions. These include investors’ agreements and shareholders’ agreements, which provide for, among other things: (i) our right to redeem Trident’s equity interest in the Atrium/Arden and StarStone transactions in cash at fair market value within the 90 days following the fifth anniversary of the Arden and StarStone closings, respectively, and at any time following the seventh anniversary of the Arden and StarStone closings, respectively; and (ii) Trident’s right to have its equity co-investment interests in the Atrium/Arden and StarStone transactions redeemed by us at fair market value (which we may satisfy in either cash or our ordinary shares) following the seventh anniversaries of the Arden closing and StarStone closing, respectively. As of December 31, 2016, we have included $454.5 million (December 31, 2015: $417.7 million) as RNCI on our balance sheet relating to these Trident co-investment transactions. Pursuant to the terms of the shareholders’ agreements, Mr. Carey serves as a Trident representative on the boards of the holding companies established in connection with the Atrium/Arden and StarStone co-investment transactions. Trident also has a second representative on these boards who is a Stone Point employee.
We also have separate accounts, with a balance of $215.0 million and $157.8 million as at December 31, 2016 and 2015, respectively, managed by Eagle Point Credit Management and PRIMA Capital Advisors, which are affiliates of entities owned by Trident, with respect to which we incurred approximately $0.5 million and $0.4 million in management fees for the years ended December 31, 2016 and 2015, respectively.
31, 2016 and 2015, we recognized interest income of $6.7 million and $3.4 million, respectively, in respect of these investments.
We have a separate account managed by Sound Point Capital, with a balance of $61.2 million and $53.5 million as at December 31, 2016 and December 31, 2015, respectively, with respect to which we incurred approximately $0.3 million and $0.1 million in management fees for the years ended December 31, 2016 and 2015, respectively.
As of December 31, 2016 and December 31, 2015, we had investments in funds (carried within other investments) affiliated with entities owned by Goldman Sachs, which had a fair value of $19.3 million and $39.6 million, respectively. The decrease was primarily due to a sale of one of the fund investments during the year ended December 31, 2016. As of December 31, 2016 and December 31, 2015, we had an indirect investment in non-voting interests of two companies affiliated with Hastings Insurance Group Limited which had a fair value of $49.9 million and $44.6 million, respectively. Goldman Sachs affiliates have an approximately 38% interest in the Hastings companies, and Mr. Rajpal serves as a director of the entities in which we have invested. For the years ended December 31, 2016 and 2015, we recognized net realized and unrealized gains of $20.6 million and $24.1 million and interest income of $1.7 million and $nil, respectively, in respect of the Goldman Sachs-affiliated investments.
In addition, approximately 4.6% of our voting shares (constituting an aggregate economic interest of approximately 3.8%) are held indirectly by CPPIB through CPPIB Epsilon Ontario Limited Partnership ("CPPIB LP"). CPPIB is the sole limited partner of CPPIB LP, and CPPIB Epsilon Ontario Trust ("CPPIB Trust") is the general partner. CPPIB's director representative is a trustee of CPPIB Trust.
On December 15, 2016, our equity method investee, KaylaRe Holdings Ltd. ("KaylaRe") completed an initial capital raise of $620.0 million. We own approximately 48.4% of KaylaRe's common shares. We also have a warrant
In connection with our investment in KaylaRe, we entered into a Shareholders Agreement with the other shareholders in KaylaRe, including the Trident funds and HH KaylaRe Holdings, Ltd., an affiliate of Hillhouse Capital Management (“Hillhouse”). The Shareholders Agreement (i) provides us with the right to appoint one member to the KaylaRe Board of Directors until the date that we own less than 1,250,000 common shares, (ii) includes a five year lock-up period on common shares of KaylaRe (unless KaylaRe completes an initial public offering before the expiry of this five year lock-up period), (iii) provides customary tag-along rights and rights of first refusal in the case of certain proposed transfers by any other shareholder and customary preemptive rights in the event of a proposed new issuance of equity securities by KaylaRe. In the event that KaylaRe has not consummated an initial public offering by March 31, 2021, the Trident funds have the right to require us and Hillhouse to purchase on a pro rata basis all of their common shares in KaylaRe at the then-current fair market value.
Our subsidiary, Enstar Limited, acts as insurance and reinsurance manager to KaylaRe's subsidiary, KaylaRe Ltd. Affiliates of Enstar have also entered into various reinsurance agreements with KaylaRe Ltd., and KaylaRe Ltd. will also have the opportunity to participate in future Enstar legacy transactions. We also provide administrative services to KaylaRe and KaylaRe Ltd.
Through a Quota Share Agreement dated December 15, 2016, (the "KaylaRe-StarStone QS") several of our StarStone affiliates have entered into a Quota Share Treaty with KaylaRe Ltd. pursuant to which KaylaRe Ltd. reinsures 35% of all business written by these StarStone affiliates for risks attaching from January 1, 2016, net of the StarStone affiliates’ reinsurance programs. During the year ended December 31, 2016, StarStone ceded $117.6 million of premium earned, $75.7 million of net incurred losses and LAE and $42.5 million of acquisition costs to KaylaRe Ltd under the KaylaRe-StarStone QS. These amounts were recorded in the aggregate as net incurred losses and LAE of $1.4 million in our consolidated statement of earnings for the year ended December 31, 2016 in accordance with retroactive reinsurance accounting. In addition, certain of our non-life run-off subsidiaries ceded $177.2 million of loss reserves to KaylaRe Ltd. during the year ended December 31, 2016, on a funds held basis.
Our consolidated balance sheet as at December 31, 2016 included the following balances related to transactions between us and KaylaRe and KaylaRe Ltd.: reinsurance recoverable of $242.1 million, prepaid reinsurance premiums of $109.0 million, funds held of $182.3 million recorded in other liabilities, insurance and reinsurance balances payable of $132.6 million, and ceded acquisition costs of $41.2 million recorded as a reduction of deferred acquisition costs.
Investment funds managed by Hillhouse collectively own approximately 2.1% of Enstar’s voting ordinary shares. These funds also own non-voting ordinary shares and warrants to purchase additional non-voting ordinary shares, which together with their voting ordinary shares, represent an approximate 9.8% economic interest in Enstar.
As of December 31, 2016, our equity method investee, KaylaRe, had investments in a fund managed by Hillhouse with a fair value of $350.0 million.
There were no significant restrictions on the Parent Company's ability to pay dividends from retained earnings as at December 31, 2016. Bermuda law permits the payment of dividends if (i) we are not, or would not be after payment, unable to pay our liabilities as the become due and (ii) the realizable value of our assets is in excess of our liabilities after taking such payment into account. Enstar has not historically declared a dividend. Our strategy is to retain earnings and invest distributions from our subsidiaries back into the company. We do not currently expect to pay any dividends on our ordinary shares.
The statutory capital and surplus amounts for the years ended December 31, 2016 and 2015 and statutory net income amounts for the years ended December 31, 2016, 2015 and 2014 for our insurance and reinsurance subsidiaries based in Bermuda, the United Kingdom, Australia, the United States and Continental Europe were as follows:
The Insurance Act requires that our Bermuda-based insurance and reinsurance subsidiaries maintain certain solvency and liquidity standards. The minimum liquidity ratio requires that the value of relevant assets must not be less than 75% of the amount of relevant liabilities. The minimum solvency margin, which varies depending on the class of the insurer, is determined as a percentage of either net reserves for losses and LAE or premiums or pursuant to a risk-based capital measure. Our Bermuda subsidiaries with commercial insurance licenses are required to maintain a minimum statutory capital and surplus (Enhanced Capital Requirement or "ECR") at least equal to the greater of a minimum solvency margin or the Bermuda Solvency Capital Requirement ("BSCR"). The BSCR is calculated based on a standardized risk-based capital model.
Our U.K.-based insurance subsidiaries are required to maintain adequate financial resources in accordance with the requirements of the U.K. Regulator. The calculation of the minimum capital resources requirements in any particular case depends on, among other things, the type and amount of insurance business written and claims paid by the insurance company. As at December 31, 2016 and 2015, all of our U.K. insurance subsidiaries maintained capital in excess of the minimum capital resources requirements and complied with the relevant U.K. Regulator requirements. The U.K.-based insurance subsidiaries, in aggregate, maintained capital in excess of the minimum capital resources requirements by $273.0 million and $567.4 million as of December 31, 2016 and 2015, respectively.
As of December 31, 2016, all of our U.S. non-life insurance and reinsurance subsidiaries exceeded their required levels of risk-based capital. On an aggregate basis, our U.S. non-life insurance and reinsurance subsidiaries exceeded their minimum levels of risk-based capital as of December 31, 2016 by $402.0 million (December 31, 2015: $528.3 million).
Our life and annuities subsidiaries file financial statements with state insurance regulatory authorities and the NAIC in the United States and the Office of Superintendent of Financial Institutions ("OSFI") in Canada (as a result of one of our subsidiaries having a Canadian branch operation). Our life and annuity companies are subject to certain Risk-Based Capital ("RBC") requirements as specified by the NAIC and OSFI. RBC is used to evaluate the adequacy of capital and surplus maintained by our life and annuities companies in relation to risks associated with: (i) asset risk; (ii) insurance risk; (iii) interest rate risk and (iv) business risk. As of December 31, 2016 and 2015, our life and annuities subsidiaries exceeded their minimum RBC requirements by $51.6 million (2015: $80.8 million). These subsidiaries are restricted by state laws and regulations as to the amount of dividends they may pay. Any dividends in excess of limits are deemed "extraordinary" and require approval. As of December 31, 2016 and 2015, the maximum dividend payout which may be made without prior approval is $nil (2015: $0.5 million).
Our Irish and Belgian life insurance subsidiaries file financial statements and returns with the Central Bank of Ireland and the National Bank of Belgium, respectively. These subsidiaries were in compliance with their solvency and capital requirements under Solvency II, and must continue to be met following any distribution.
We are also subject to credit risk in relation to funds held by reinsured companies. Under funds held arrangements, the reinsured company has retained funds that would otherwise have been remitted to our reinsurance subsidiaries. The funds balance is credited with investment income and losses payable are deducted. We are subject to credit risk if the reinsured company is unable to honor the value of the funds held balances, such as in the event of insolvency. However, we generally have the contractual ability to offset any shortfall in the payment of the funds held balances with amounts owed by us to the reinsured for losses payable and other amounts contractually due. We routinely monitor the creditworthiness of reinsured companies with whom we have funds held arrangements. We have a significant concentration of $1.0 billion to one reinsured company which has financial strength credit ratings of A+ from A.M. Best and AA from Standard & Poor's, as well as to KaylaRe as described in Note 21 - "Related Party Transactions".
We lease office space under operating leases expiring in various years through 2026. The leases are renewable at our option under certain circumstances. The following is a schedule of future minimum rental payments on non-cancelable leases as of December 31, 2016:
As at December 31, 2016, we had unfunded commitments to investment funds of $144.0 million.
As at December 31, 2016 and 2015, parental guarantees supporting subsidiaries' insurance obligations were $625.7 million and $334.2 million, respectively. The increase relates to new transactions during 2016 as described in Note 3 - "Acquisitions" and Note 4 - "Significant New Business", and includes $122.0 million for letters of credit issued under a Funds at Lloyd's facility as described in Note 6 - "Investments."
On January 11, 2017 we entered into a reinsurance agreement with QBE. On February 6, 2017, we entered into a reinsurance agreement with RSA. These agreements are described in Note 4 - "Significant New Business."
We have the right to purchase the RNCI interests from the RNCI holders at certain times in the future (each such right, a "call right") and the RNCI holders have the right to sell their RNCI interests to us at certain times in the future (each such right, a "put right"). The RNCI rights held by Trident are described in Note 21 - "Related Party Transactions." Dowling has a right to participate if Trident exercises its put right.
The presentation of the results in our Life and Annuities segment reflect the classification of Pavonia as discontinuing operations and held-for-sale. Following the sale of Pavonia, we will no longer have any annuity products and our continuing life business comprises term life products in Alpha and Laguna, and the life settlements business.
The following table summarizes our gross premiums written for the year ended December 31, 2016 by each of our operating segments by geographic area. Geographic distribution in subsequent years is subject to variation based upon market conditions and business strategies.
The difference in the amount of other investments shown at fair value and the other investments shown in our consolidated balance sheet relates to the fair value of $347.0 million as of December 31, 2016 for our other investments in funds or companies owned by or affiliated with certain related parties. Refer to Note 21 of the notes to the consolidated financial statements.
The table above excludes businesses held for sale. Refer to Note 5 of the notes to the consolidated financial statements.
As at December 31, 2016 and 2015, retained earnings was $1,847.6 million and $1,578.3 million, an increase of $269.2 million. The increase in retained earnings was primarily attributable to net earnings of $264.8 million.