The following table sets forth our summary historical statement of operations data and summary balance sheet data as of and for the years ended December 31, 2016, 2015, 2014, 2013 and 2012. Statement of operations data and balance sheet data are derived from our audited consolidated financial statements, which have been prepared in accordance with U.S. GAAP. These historical results are not necessarily indicative of results to be expected from any future period. For further discussion of this risk see Item 1A. “Risk Factors” in this Form 10-K. You should read the following selected financial data in conjunction with the other information contained in this Form 10-K, including
We are a Swiss-based global provider of a diversified portfolio of property and casualty insurance and reinsurance products with operations in Australia, Bermuda, Canada, Europe, Hong Kong, Labuan, Singapore and the United States as well as our Lloyd’s Syndicate 2232. We manage our business through three operating segments: North American Insurance, Global Markets Insurance and Reinsurance. As of December 31, 2016, we had approximately $13.2 billion of total assets, $3.6 billion of total shareholders’ equity and $4.4 billion of total capital, which includes shareholders’ equity, senior notes and other long-term debt.
Our consolidated gross premiums written decreased by $27.2 million, or 0.9%, for the year ended December 31, 2016 compared to the year ended December 31, 2015, driven by the lower gross premiums written in our Reinsurance segment offset by higher premiums written in our North American Insurance and Global Markets Insurance segments. Our net income increased by $171.4 million to $255.3 million compared to the year ended December 31, 2015. The increase was primarily due to higher net investment income and net realized investment gains during the year compared to net realized investment losses during the prior year.
On December 18, 2016, we entered into a merger agreement with Fairfax, whereby Fairfax will acquire all of the outstanding ordinary shares of Allied World Switzerland. Under the terms of the merger agreement, Allied World Switzerland shareholders will receive a combination of Fairfax subordinate voting shares and cash having a value equal to $54.00 per Allied World Switzerland share (based on the closing price of Fairfax's subordinate voting shares on December 16, 2016). The merger agreement has been unanimously approved by both companies' Board of Directors. The acquisition is expected to be consummated following the satisfaction of customary closing conditions. The acquisition is currently anticipated to close in the second quarter of 2017. There can be no assurances that the acquisition will occur.
We reported a net loss of $40.8 million for the three months ended December 31, 2016 compared to net income of $1.7 million for the three months ended December 31, 2015, a decrease of $42.5 million.
Catastrophe-related net losses of $49.9 million during the three months ended December 31, 2016 primarily related to Hurricane Matthew and an earthquake impacting New Zealand. We did not have any catastrophe-related net losses during the three months ended December 31, 2015.
A net favorable change in prior year reserve development of $17.8 million. We recognized net favorable prior year reserve development of $5.3 million during the three months ended December 31, 2016 compared to net unfavorable prior year reserve development of $12.5 million during the three months ended December 31, 2015.
Lower interest expense of $7.7 million due to less principal outstanding on our senior notes due to the repayment of the $500.0 million aggregate principal amount of 7.50% senior notes that matured on August 1, 2016, as well as the currently outstanding senior notes having lower interest rates than the previously held senior notes.
Lower acquisition costs driven by increased outward reinsurance purchases which has increased our ceding commission income.
We have included tangible shareholders' equity, which is total shareholders' equity excluding goodwill and intangible assets, because it represents a more liquid measure of the Company's net assets than total shareholders' equity. We also have included diluted book value per share because it takes into account the effect of dilutive securities; therefore, we believe it is an important measure of calculating shareholder returns.
Annualized return on average shareholders' equity and average tangible shareholders' equity
Annualized return on average shareholders’ equity (“ROAE”) is calculated using average shareholders’ equity, adjusted for other comprehensive income or loss. Annualized return on average tangible shareholders’ equity (“ROATE”) is calculated using average shareholders’ equity, adjusted for other comprehensive income or loss, less goodwill and intangible assets. We present ROAE and ROATE as measures that are commonly recognized as a standard of performance by investors, analysts, rating agencies and other users of our financial information.
We derive our revenues primarily from premiums on our insurance policies and reinsurance contracts, net of any reinsurance or retrocessional coverage purchased. Insurance and reinsurance premiums are a function of the amounts and types of policies and contracts we write, as well as prevailing market prices. Our prices are determined before our ultimate costs, which may extend far into the future, are known. In addition, our revenues include income generated from our investment portfolio, consisting of net investment income and net realized investment gains or losses, and other income related to our non-insurance operations. Investment income is principally derived from interest and dividends earned on investments, as well as undistributed income from equity method investments, partially offset by investment management expenses and fees paid to our custodian bank. Net realized investment gains or losses include gains or losses from the sale of investments, as well as the change in the fair value of investments that we mark-to-market through net income. Other income currently includes revenue from our third-party claims administration services, insurance agency operation, changes in fair value related to insurance and reinsurance contracts accounted for as derivatives, and other non-recurring income.
For additional information related to the reserves for losses and loss expenses, including incurred and paid claim development triangles, see Note 7. "Reserve for Losses and Loss Expenses" to the consolidated financial statements.
estimating the reserve for losses and loss expenses, including IBNR, are predicated on whether the line of business falls into one of the following two categories: short-tail line or long-tail line. In certain lines of business, claims are generally reported and paid within a relatively short period of time (“short-tail lines”) during and following the policy coverage period. For most of the Company’s lines of business, claims may be reported or settled several years after the coverage period has terminated (“long-tail lines”), which increases uncertainties of the reserve estimates in such lines.
Our expected loss ratios for short-tail lines change from year to year. As our losses from short-tail lines of business are reported relatively quickly, we select our expected loss ratios for the most recent years based upon our actual loss ratios for our older years adjusted for rate changes, inflation, cost of reinsurance and average storm activity. For the short-tail lines, we initially used benchmarks for reported and paid loss emergence patterns. We continue to supplement those benchmark patterns with our actual patterns as appropriate. For the long-tail lines, we continue to use benchmark patterns, although we supplement the benchmark patterns with internal company data as appropriate.
For short-tail lines, the primary assumption that changed during both 2016 as compared to 2015 and 2015 as compared to 2014 as it relates to prior year losses was that actual paid and reported loss emergence patterns were generally less severe than estimated for each year due to lower frequency and severity of reported losses. As a result of this change, we recognized net favorable prior year reserve development in both 2016 and 2015.
Our overall change in the loss reserve estimates related to prior years decreased as a percentage of total carried reserves during 2016. During 2016, we had a net decrease of $98.3 million, or 2.0%, on an opening carried reserve base of $4,976.2 million, net of reinsurance recoverables. During 2015, we had a net decrease of $81.6 million, or 1.8%, on an opening carried reserve base of $4,540.9 million, net of reinsurance recoverables. We believe that these changes are reasonable given the long-tail nature of our business.
There is potential for significant variation in the development of loss reserves, particularly for the casualty lines of business due to their long-tail nature and high attachment points. The maturing of our casualty insurance and reinsurance loss reserves have caused us to reduce what we believe is the reasonably possible variance in the expected loss ratios for older loss years. As of December 31, 2016 and 2015, we believe the reasonably possible variances in our expected loss ratio in percentage points for our loss years are as follows:
In terms of liquidity, our contractual obligations for reserves for losses and loss expenses would also increase or decrease by approximately $835.2 million after reinsurance recoverables. If our obligations were to increase, we believe we currently have sufficient cash and investments to meet those obligations.
The following tables provide our ranges of loss and loss expense reserve estimates by business segment as of December 31, 2016:
Our selection of the actual carried reserves has typically been above the midpoint of the range. As of December 31, 2016, we were 2.5% above the midpoint of the consolidated net loss reserve range. We believe that we should be prudent in our reserving practices due to the lengthy reporting patterns and relatively large limits of net liability for any one risk of our direct excess casualty business and of our casualty reinsurance business. Thus, due to this uncertainty regarding estimates for reserve for losses and loss expenses, we have carried our consolidated reserve for losses and loss expenses, net of reinsurance recoverable, above the midpoint of the low and high estimates for the consolidated net losses and loss expenses. We believe that relying on the more prudent actuarial indications is appropriate for these lines of business.
We cede insurance to external reinsurers in order to limit our maximum loss, to protect against concentration of risk within our portfolio and to manage our exposure to catastrophic events. Because the ceding of insurance does not discharge us from our primary obligation to the insureds, we remain liable to the extent that our reinsurers do not meet their obligations under the reinsurance agreements. Therefore, we regularly evaluate the financial condition of our reinsurers and monitor concentration of credit risk. No material provision has been made for unrecoverable reinsurance as of December 31, 2016 and 2015 as we believe that nearly all reinsurance balances will be recovered.
The examples below illustrate the types of treaty reinsurance arrangements in force at December 31, 2016:
Professional Liability: For professional liability policies, including healthcare, our reinsurance varied by writing office and by policy type. We utilize both excess-of-loss and quota share reinsurance across our offices. During 2016, we changed the structure of the reinsurance treaty that renewed from an excess-of-loss treaty to a quota share treaty, and as such we have increased ceded premiums and ceding commission income compared to the prior period.
Specialty: We purchased both quota share and excess-of-loss reinsurance protection for our various specialty classes of business in our North American Insurance and Global Market Insurance segments.
The following table illustrates our reinsurance recoverable as of December 31, 2016 and 2015:
As noted above, we remain obligated for amounts ceded in the event our reinsurers do not meet their obligations. Accordingly, we have evaluated the reinsurers that are providing reinsurance protection to us and will continue to monitor their
The following table shows our reinsurance recoverables by operating segment as of December 31, 2016 and 2015:
Total premiums estimated on quota share reinsurance contracts for the years ended December 31, 2016, 2015 and 2014 represented approximately 11%, 12% and 15%, respectively, of consolidated gross premiums written.
Other insurance and reinsurance policies can require that the premium be adjusted at the expiry of a policy to reflect the risk assumed by us. Premiums resulting from such adjustments are estimated and accrued based on available information.
In accordance with U.S. GAAP, we are required to recognize certain assets at their fair value in our consolidated balance sheets. This includes our fixed maturity investments, equity securities and “other invested assets”. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. There is a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement date, with quoted market prices being the highest level (Level 1) and unobservable inputs being the lowest level (Level 3). A fair value measurement will fall within the level of the hierarchy based on the input that is significant to determining such measurement. The three levels are defined as follows:
At each measurement date, we estimate the fair value of the financial instruments using various valuation techniques. We utilize, to the extent available, quoted market prices in active markets or observable market inputs in estimating the fair value of our financial instruments. When quoted market prices or observable market inputs are not available, we utilize valuation techniques that rely on unobservable inputs to estimate the fair value of financial instruments. The following describes the valuation techniques we used to determine the fair value of financial assets held as of December 31, 2016 and the level within the U.S. GAAP fair value hierarchy that valuation technique resides.
Non-U.S. government and government agencies: Comprised of fixed income obligations of non-U.S. governmental entities. The fair values of these securities are based on prices obtained from international indices and are included in the Level 2 fair value hierarchy.
Corporate debt: Comprised of bonds issued by or loan obligations of corporations that are diversified across a wide range of issuers and industries. The fair values of corporate debt that pay a floating rate coupon are priced using the spread above the London Interbank Offered Rate yield curve and the fair values of corporate bonds that are long term are priced using the spread above the risk-free yield curve. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price corporate bonds are observable market inputs, the fair values of corporate debt are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the corporate debt securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.
Other invested assets: Comprised of funds invested in a range of diversified strategies. In accordance with U.S. GAAP, the fair values of the funds are based on the NAV of the funds as reported by the fund manager. We do not measure our investments that are accounted for using the equity method of accounting at fair value, unless an other-than-temporary impairment is recorded.
The following summarizes the valuation techniques used by each of our major pricing sources for the current period:
Barclays indices: We use Barclays indices to price our U.S. and non-U.S. government, U.S. and non-U.S. government agencies, municipalities and political subdivisions securities, corporate debt, agency mortgage-backed and asset-backed securities. There are several observable inputs that the Barclays indices use in determining its prices which include among others, treasury yields, new issuance and secondary trades, information provided by broker-dealers, security cash flows and structures, sector and issuer level spreads, credit rating, underlying collateral and prepayment speeds. For U.S. government securities, traders that act as market makers are the primary source of pricing; as such, for U.S. government securities we believe the Barclays indices reflect quoted prices (unadjusted) for identical securities in active markets.
International indices: We use international indices, which include the FTSE, and the Iboxx, to price our non-U.S. government and government agencies securities, and corporate debt. The observable inputs used by international indices to determine their prices are based on new issuance and secondary trades and information provided by broker-dealers.
We utilize independent pricing sources to obtain market quotations for securities that have quoted prices in active markets. In general, the independent pricing sources use observable market inputs, including, but not limited to, investment yields, credit risks and spreads, benchmarking of like securities, non-binding broker-dealer quotes, reported trades and sector groupings to determine the fair value. For a majority of the portfolio, we obtained two or more prices per security as of December 31, 2016. When multiple prices are obtained, a price source hierarchy is utilized to determine which price source is
the best estimate of the fair value of the security. The price source hierarchy emphasizes more weighting to significant observable inputs such as index pricing and less weighting towards non-binding broker quotes. We investigate any material differences between the multiple sources and determine which price best reflects the fair value of the individual security. There were no material differences between the prices from the independent pricing sources and the prices obtained from our investment portfolio managers and other sources as of December 31, 2016.
Related to the acquisitions of the Hong Kong, Singapore and Labuan operations of Royal & Sun Alliance Insurance plc (“RSA”).
Related to the acquisition of Allied World National Assurance Company and Allied World Assurance Company (U.S.) Inc.
Events affecting a reporting unit such as a change in the composition, or carrying amount of its net assets or a more-likely-than-not expectation of selling or disposing all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit; and
For indefinite lived intangible assets, such as insurance licenses, we do not amortize the intangible asset but test these intangible assets for impairment by comparing the fair value of the assets to their carrying values on an annual basis or more frequently if circumstances warrant. We determine the fair value of the insurance licenses by obtaining the amount paid for similar insurance licenses in recent transactions. We assessed whether any of the significant inputs used to determine the fair value of the indefinite lived intangible assets are impaired considering the factors noted above. As a result of our evaluation, we determined that there was no impairment to the carrying value of our indefinite lived intangible assets for the year ended December 31, 2016.
We have determined that the goodwill arising from the acquisition of AW Underwriters and the claims administration services company should be allocated to the U.S. insurance operations reporting unit of the North American Insurance segment as the assets employed and the liabilities relate to the U.S. insurance operations. All of the insurance operations of AW Underwriters and the claims administration services company are included in the North American Insurance segment.
We have determined that the goodwill arising from the acquisition of the Hong Kong, Singapore and Labuan operations of RSA should be allocated to the Asia insurance operations reporting unit of the Global Markets Insurance segment because the assets employed and the liabilities relate to the Asia insurance operations. All of the insurance operations of the acquired RSA branches are included in the Global Markets Insurance segment.
the reporting unit’s projected earnings or book value. We select the weighting of the models utilized to determine the fair value of the reporting units based on judgment, considering such factors as the reliability of the cash flow projections and the entities included in the market multiples.
During 2016, we elected to bypass the qualitative assessment and performed the first step of the goodwill impairment test.
The process of determining whether or not an asset, such as goodwill, is impaired or recoverable relies on projections of future cash flows, operating results and market conditions. Such projections are inherently uncertain and, accordingly, actual future cash flows may differ materially from projected cash flows. In evaluating the recoverability of goodwill, we perform a discounted cash flow analysis. The discounted cash value may be different from the fair value that would result from an actual transaction between a willing buyer and a willing seller. Such analyses are particularly sensitive to changes in discount rates, growth rates, projected losses, mix of business and investment rates. Changes to these assumptions might result in material changes in the valuation and determination of the recoverability of goodwill. For example, an increase in the rate used to discount cash flows will decrease the discounted cash flow value.
North American Insurance: Gross premiums written in our North American Insurance segment increased by $41.0 million, or 2.3%, for the year ended December 31, 2016 compared to 2015. The increase in gross premiums written was primarily due to growth in our programs line of business and certain other specialty lines of business, such as environmental and construction. This was partially offset by the non-renewal of business that did not meet our underwriting requirements, particularly in our casualty and property lines of business;
Global Markets Insurance: Gross premiums written in our Global Markets Insurance segment increased by $27.0 million, or 5.7%, for the year ended December 31, 2016 compared to 2015. The increase was primarily due to gross premiums written from the Asian operations in Hong Kong, Singapore and Labuan acquired from RSA, which were included in our results for the full twelve months of the current year, whereas the results from those operations were included starting only in April during the year ended December 31, 2015; and
treaties across all lines of business, due either to poor terms and conditions, including rate decreases, or cedents retaining more of their own business. The non-renewal of treaties was partially offset by new business written for each line of business.
Net premiums written decreased by $192.2 million, or 7.9%, for the year ended December 31, 2016 compared to the year ended December 31, 2015. The decrease in net premiums written was due to the overall decrease in gross premiums written and an increase in ceded premiums written, primarily in our North American Insurance segment, partially offset by lower cost of our current year property catastrophe reinsurance treaty. The cost of our current year property catastrophe reinsurance treaty, which was effective May 1, 2016, was lower than the prior coverage given our overall reduction in property catastrophe exposures. We ceded 26.4% and 20.9% of gross premiums written for the years ended December 31, 2016 and 2015, respectively.
The following table illustrates the mix of our business on both a gross premiums written and net premiums earned basis.
The total return of our investment portfolio, which combines net investment income and realized investment gains or losses, was 2.5% and 0.6% for the years ended December 31, 2016 and 2015, respectively. The increase in total return was primarily due to lower overall interest rates and tightening credit spreads during the current year that caused lower mark-to-market losses on our fixed maturity investments, despite increased market volatility in the fourth quarter, compared to higher interest rates and widening credit spreads which caused mark-to-market losses during the year ended ended December 31, 2015.
During the year ended December 31, 2016, we incurred $75.7 million in property catastrophe losses, which included $38.1 million of net losses from Hurricane Matthew, $15.9 million of net losses from the April hailstorm in Texas, $15.6 million of net losses from the New Zealand earthquake in November and $6.1 million of net losses from the Fort McMurray wildfires. During the fourth quarter of 2016, we decreased our net incurred losses from the Fort McMurray wildfires by $4.3 million. The total property catastrophe losses for our North American Insurance segment, Global Markets Insurance segment and Reinsurance segment were $22.7 million, $10.1 million and $42.9 million, respectively.
For the year ended December 31, 2016, we recorded net favorable prior year reserve development in each of our operating segments, primarily due to actual loss emergence being lower than initially expected. The net favorable prior year reserve development in the North American Insurance segment was primarily related to the professional liability line of business. The net favorable reserve development in the Global Markets Insurance segment was primarily related to the casualty and property lines of business, partially offset by unfavorable reserve development in the professional liability and other specialty lines of business. The net favorable prior year reserve development in the Reinsurance segment was primarily related to our property reinsurance and specialty reinsurance lines of business, partially offset by net unfavorable prior year reserve development in our casualty reinsurance line of business.
The amortization and impairment of intangible assets increased by $0.9 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 due to an impairment of $0.9 million recorded related to the customer renewal intangibles from the acquisition of LAU. The trade credit business that is underwritten by LAU underperformed during the current year due to increased frequency of reported losses and as a result the customer renewal intangible asset was impaired. As a result of this impairment, the carrying value of the customer renewal intangible asset was zero.
We recorded a foreign exchange gain of $4.1 million for the year ended December 31, 2016 compared to a foreign exchange loss of $11.3 million for the year ended December 31, 2015, for a change of $15.4 million. The change was primarily due to a loss recorded in the prior year related to the close out of the foreign currency forward contract we entered into to economically hedge a portion of our foreign currency exposure related to the consideration paid for the Hong Kong and Singapore operations of RSA. The change was also attributable to the strengthening of the U.S. dollar relative to other major currencies during the current year.
Corporate income tax expense or benefit is generated through our various operating subsidiaries. Our income tax expense or benefit may fluctuate significantly from year to year depending on the geographic distribution of pre-tax net income or loss in any given year between different jurisdictions with different tax rates. The geographic distribution of pre-tax net income or loss can vary significantly between years principally due to the geographic location of the business written, the mix of business and the profitability of such business; the geographic location of investment income; the geographic location of net losses and loss expenses incurred; and the amount of inter-company reinsurance utilized for rating agency purposes.
Gross premiums written increased by $157.6 million, or 5.4%, for the year ended December 31, 2015 compared to the year ended December 31, 2014. The overall increase in gross premiums written was primarily the result of the following:
Global Markets Insurance: Gross premiums written in our Global Markets Insurance segment increased by $195.8 million, or 69.8%, for the year ended December 31, 2015 compared to 2014. The increase was primarily due to
The table below illustrates our gross premiums written by underwriting location for each of the years indicated.
Net investment income increased by $5.2 million, or 2.9%, for the year ended December 31, 2015 compared to the year ended December 31, 2014. The increase was primarily due to higher interest income in the current year from our fixed maturity investments and higher returns from our hedge fund and private equity investments. These increases were partially offset by lower income from our other private securities due to an other-than-temporary impairment of $6.3 million related to one of our
General and administrative expenses increased by $40.6 million, or 11.1%, for the year ended December 31, 2015 compared to the year ended December 31, 2014. The increase in general and administrative expenses was the result of costs related to the acquired Asian operations of $34.6 million, higher salary-related costs due to higher headcount and higher building-related costs. These increases were partially offset by lower performance-based compensation. Our general and
Other expense is comprised of the expenses from our third-party claims administration services of $2.7 million that are included in our North American Insurance segment, transaction-related costs of $2.5 million incurred for the acquisition of the Hong Kong and Singapore operations of RSA included in our Global Markets Insurance segment and an unrealized loss of $1.0 million recorded on an ILW derivative in our Reinsurance segment.
The amortization and impairment of intangible assets increased by $7.3 million for the year ended December 31, 2015 compared to the year ended December 31, 2014. The increase was due to the intangible assets acquired during 2015 related to the RSA and LAU acquisitions, as well as an impairment of $1.4 million recorded related to the customer renewal intangibles from the acquisition of LAU. The trade credit business that is underwritten by LAU underperformed during the current year due to increased frequency of reported losses and as a result the customer renewal intangible asset was impaired.
Interest expense increased by $3.6 million, or 6.2%, for the year ended December 31, 2015 compared to the year ended December 31, 2014. The increase in interest expense was due to the accrued interest related to the senior notes issued in October 2015.
Global Markets Insurance Segment. The Global Markets Insurance segment includes our direct specialty insurance operations in Europe and Asia Pacific, which includes offices in Dublin, Hong Kong, Labuan, London, Singapore, Sydney and Zug, as well as our insurance agency operation. This segment provides both property and casualty insurance primarily to non-North American domiciled accounts.
The following table summarizes the underwriting results and associated ratios for the North American Insurance segment for each of the years ended December 31, 2016, 2015 and 2014.
(2) Includes our medical malpractice line of business. The healthcare management liability line of business previously included in the healthcare line of business is included in the professional liability line of business, as we reorganized the management responsibility for this line of business. The comparative period was updated to reflect the current presentation.
Net premiums earned decreased by $34.5 million, or 2.7%, for the year ended December 31, 2016 compared to 2015. The decrease was due to the reduction in net premiums written during the current year.
The decrease in the current year non-catastrophe losses and loss expenses and the related ratio was primarily due to lower non-catastrophe property losses in the current period compared to the same period last year partially offset by higher loss ratio assumptions in certain lines of business. The lower non-catastrophe property losses decreased the losses and loss expense ratio by 1.6 percentage points.
During the year ended December 31, 2016, we incurred $18.1 million related to Hurricane Matthew and $4.6 million in property catastrophe losses from the April hailstorm in Texas. During the year ended December 31, 2015, we incurred $2.5 million of property catastrophe losses related to explosions in the port of Tianjin, China.
For the year ended December 31, 2016, the net unfavorable prior year reserve development in the casualty line of business for the 2011 through 2014 loss years was primarily due to adverse case reserve development and higher than expected reported claims. This line of business also experienced lower than expected development of reported claims for loss years 2010 and prior. The net favorable prior year reserve development in the professional liability line of business for loss years 2010 and prior was due to lower than expected claims development. The net unfavorable prior year reserve development for the 2013 loss year in the professional liability line of business was due to adverse development on several claims above our previous expectations.
Acquisition costs. Acquisition costs decreased by $7.5 million, or 5.4%, for the year ended December 31, 2016 compared to the year ended December 31, 2015. The decrease was primarily due to higher ceding commission income due to the restructuring of some of our underlying reinsurance programs, partially offset by an increase in average broker commissions during the current period compared to the prior period. The acquisition cost ratio decreased to 10.4% for the year ended December 31, 2016 from 10.7% for 2015 due to the lower ceding commission income.
General and administrative expenses. General and administrative expenses decreased by $1.4 million, or 0.6%, for the year ended December 31, 2016 compared to the year ended December 31, 2015. The decrease was due to expense-control initiatives implemented during the current year, partially offset by higher salary-related costs, including stock-based compensation. The general and administrative expense ratio increased to 17.6% for the year ended December 31, 2016 from 17.3% in 2015, as the decrease in net premiums earned outpaced the reduction in expenses.
Other insurance-related income and expense. The net increase in other insurance-related income and expense was primarily due to a net unrealized gain recorded of $3.4 million for insurance and reinsurance contracts we account for as derivatives.
Premiums. Gross premiums written increased by $99.0 million, or 5.8%, for the year ended December 31, 2015 compared to 2014. The increase in gross premiums written was primarily due to growth in our casualty, professional liability and programs lines of business due to increased premiums on renewals and new business, and growth in our specialty lines of business due to new business. This growth was partially offset by the non-renewal of business that did not meet our underwriting requirements, particularly in certain classes within our healthcare and property lines of business, and decreased premiums on renewal.
The increase in the current year non-catastrophe losses and loss expenses, and the related increase in the losses and loss expenses ratio, was primarily due to growth, mix of the business, higher net loss ratios in our casualty and healthcare lines of business and higher non-catastrophe property losses in the current period compared to the prior period.
Net losses and loss expenses. Net losses and loss expenses increased by $29.2 million, or 12.2%, for the year ended December 31, 2016 compared to the year ended December 31, 2015. The following is a breakdown of the loss and loss expense ratio for the years ended December 31, 2016 and 2015:
The increase in the current year non-catastrophe losses and loss expenses and related ratio was primarily due to the growth in net premiums earned in the current year compared to the prior year.
Overall, our Global Markets Insurance segment recorded net favorable reserve development of $9.8 million during the year ended December 31, 2016 compared to net favorable reserve development of $24.8 million for the year ended December 31, 2015, as shown in the tables below.
For the year ended December 31, 2016, the unfavorable development for the 2014 loss year in the other specialty line of business was primarily related to higher than expected reported losses in our trade credit and aviation classes of business. The net favorable prior year development in our casualty and property lines of business was due to lower than expected loss emergence.
For the year ended December 31, 2015, the favorable prior year reserve development in our property, professional liability and casualty lines of business was due to lower than expected loss emergence. The unfavorable prior year reserve development for the other specialty line of business in the 2013 loss year primarily related to the trade credit line of business due to higher frequency of reported claims above our expectations.
expenses was due to the inclusion of the acquired Asian operations results for the twelve months in the current year compared to only being included from April during the year ended December 31, 2015. The general and administrative expense ratios for the years ended December 31, 2016 and 2015 were 32.7% and 29.5%, respectively.
Net premiums written increased by $136.1 million, or 72.4%, for the year ended December 31, 2015 compared to the year ended December 31, 2014. The increase in net premiums written was primarily due to the higher gross premiums written from the acquired Asian operations. We ceded to reinsurers 32.0% of gross premiums written for the year ended December 31, 2015 compared to 33.0% for the year ended December 31, 2014. The decrease was due to retaining more of our gross premiums written in our professional liability, general casualty and healthcare lines of business in the current period than in the prior period.
During the year ended December 31, 2015, we incurred $4.0 million in property catastrophe losses related to windstorms that occurred in the New South Wales region of Australia and $0.3 million related to explosions in the port of Tianjin, China. During the year ended December 31, 2014, we incurred $11.0 million of catastrophe-related losses from Hurricane Odile.
Overall, our Global Markets Insurance segment recorded net favorable reserve development of $24.8 million during the year ended December 31, 2015 compared to net favorable reserve development of $53.6 million for the year ended December 31, 2014, as shown in the tables below.
For the year ended December 31, 2015, the favorable prior year reserve development in our property, professional liability and casualty lines of business was due to lower than expected loss emergence. The unfavorable prior year reserve development for the other specialty line of business in the 2013 and 2014 loss years primarily related to the trade credit line of business due to higher frequency of reported claims above our expectations.
Acquisition costs. Acquisition costs increased by $52.7 million for the year ended December 31, 2015 compared to the year ended December 31, 2014. The increase in acquisition costs was due to higher acquisition costs from the acquired Asian operations and the additional amortization of the insurance-related intangible asset recorded from the acquisitions of the RSA operations. The acquisition cost ratio was 19.3% for the year ended December 31, 2015 and 11.2% for the year ended December 31, 2014. The increase in the acquisition cost ratio was due to the factors noted above.
Other insurance-related income and expense. The other insurance-related expenses incurred represent the transaction-related costs incurred for our acquisition of RSA's Hong Kong and Singapore operations.
Net premiums earned decreased by $120.8 million, or 14.7%, for the year ended December 31, 2016 compared to the year ended December 31, 2015. The decrease was primarily the result of the decrease in net premiums written during the previous years.
The decrease in the current year non-catastrophe losses and loss expenses was primarily due to the decrease in net premiums earned. The increase in the current year non-catastrophe losses and loss expenses ratio was due to higher loss ratio assumptions and higher non-catastrophe property losses in the current year. These increases were partially offset by a higher reduction in IBNR loss reserves for current year property losses than in the prior period. The higher non-catastrophe property losses in the current year increased the current year non-catastrophe loss ratio by 1.5 percentage points.
During the year ended December 31, 2016, we incurred $42.9 million in property catastrophe losses, which included catastrophe losses from a New Zealand earthquake ($13.5 million), Hurricane Matthew ($12.0 million), hailstorms in Texas in April 2016 ($11.3 million) and Fort McMurray wildfires ($6.1 million). During the fourth quarter of 2016, we decreased our net incurred losses from the Fort McMurray wildfires by $4.3 million. During the year ended December 31, 2015, we incurred property catastrophe losses and loss expenses of $32.5 million related to explosions in the port of Tianjin, China and $21.0 million in property catastrophe losses related to windstorms that occurred in the New South Wales region of Australia.
Overall, our Reinsurance segment recorded net favorable reserve development of $55.5 million during the year ended December 31, 2016 compared to net favorable reserve development of $58.5 million for the year ended December 31, 2015, as shown in the tables below.
For the year ended December 31, 2016, the net favorable reserve development in the 2015 loss year was due to favorable reserve development in the property reinsurance line of business due to benign reported loss activity. The net unfavorable reserve development for the 2012 to 2014 loss years in the casualty reinsurance line of business was due to higher than expected reported claims.
Acquisition costs. Acquisition costs decreased by $23.6 million, or 14.3%, for the year ended December 31, 2016 compared to the year ended December 31, 2015. The decrease was primarily due to the decrease in net premiums earned. The acquisition cost ratio was 20.2% for the year ended December 31, 2016 compared to 20.1% for the year ended December 31, 2015.
The decrease in the current year non-catastrophe losses and loss expenses, and related the losses and loss expense ratio, was primarily due to lower than expected property losses during the year ended December 31, 2015 compared to the same
period in 2014. These decreases in the current year non-catastrophe losses and loss expenses were partially offset by higher loss ratio assumptions in our non-property reinsurance lines of business.
General and administrative expenses. General and administrative expenses decreased by $4.7 million, or 6.0%, for the year ended December 31, 2015 compared to the year ended December 31, 2014. The decrease was primarily due to lower
Our total investments and cash were $8.7 billion as of December 31, 2016, the main components of which were investment grade fixed income securities and cash and cash equivalents. As of December 31, 2016, we held $720.9 million of cash and cash equivalents and $808.9 million of fixed income securities with a maturity of less than one year to meet short-term liquidity needs. Our remaining fixed income securities, equity securities and “other invested assets” are available to meet our long-term liquidity needs.
Holdings’ U.S. domiciled operating subsidiaries are subject to significant regulatory restrictions limiting their ability to declare and pay dividends. In particular, payments of dividends by Allied World Assurance Company (U.S.) Inc., Allied World National Assurance Company, Allied World Insurance Company, Allied World Specialty Insurance Company, Allied World Surplus Lines Insurance Company and Vantapro Specialty Insurance Company are subject to restrictions on statutory surplus pursuant to the respective states in which these insurance companies are domiciled. Each state requires prior regulatory
approval of any payment of extraordinary dividends. We have not paid a dividend to any affiliate or parent company outside of the U.S.
Allied World Assurance Company (Europe) dac is subject to regulatory restrictions that effectively limit its ability to declare and pay dividends unless certain conditions are met.
We also have branch operations in Australia, Canada, Hong Kong, Labuan and Singapore, which have regulatory restrictions limiting the ability to declare and pay dividends.
The primary sources of cash inflows from operating activities are premiums received, loss payments from reinsurers, return of funds held balances related to our assumed collateralized property catastrophe reinsurance program through Aeolus Re Ltd. (“Aeolus Re”) and investment income. The primary sources of cash outflows from operating activities are ceded premiums paid to reinsurers, claims paid, contributions of funds held balances related to Aeolus Re, commissions paid, operating expenses, interest expense and income taxes. The primary factor in our ability to generate positive operating cash flow is underwriting profitability. We have generated positive operating cash flow for more than 11 consecutive years.
The $113.5 million decrease in cash flows from operations was primarily due to a decrease in net premiums written and higher net paid losses in the current year compared to the prior year, partially offset by higher net cash receipts from our collateralized property catastrophe reinsurance program through Aeolus Re. During the current year, we received approximately $406.0 million in cash from Aeolus Re and funded approximately $204.0 million for the upcoming underwriting year.
Cash flows used in or provided by financing activities consist primarily of capital raising activities, which include the issuance of common shares or debt, the repurchase of our shares, the payment of dividends and the repayment of debt. The change in cash flows provided by financing activities was primarily due to the repayment at maturity of the $500.0 million aggregate principal amount of 7.50% senior notes on August 1, 2016, while during the year ended December 31, 2015 we received net proceeds of $496.7 million from the 2025 Senior Notes issued during 2015.
Our funds are primarily invested in liquid, high-grade fixed income securities. As of December 31, 2016 and 2015, 91.5% and 90.1%, respectively, of our fixed income portfolio consisted of investment grade securities. The maturity distribution of our fixed income portfolio (on a fair value basis) as of December 31, 2016 and 2015 was as follows:
We have investments in “other invested assets”, comprising interests in hedge funds, private equity funds and other private securities, the carrying value of which was $960.7 million as of December 31, 2016. Some of these funds have redemption notice requirements. For each of our funds, liquidity is allowed after certain defined periods based on the terms of each fund. See Note 4(b) “Investments - Other Invested Assets” to our consolidated financial statements for additional details on our “other invested assets”.
Security arrangements with ceding insurers may subject our assets to security interests or require that a portion of our assets be pledged to, or otherwise held by, third parties. Both of our letter of credit facilities are fully collateralized by assets held in custodial accounts at the Bank of New York Mellon held for the benefit of the banks. Although the investment income derived from our assets while held in trust accrues to our benefit, the investment of these assets is governed by the terms of the letter of credit facilities or the investment regulations of the state or territory of domicile of the ceding insurer, which may be
As of December 31, 2016 and 2015, $2,687.7 million and $2,748.9 million, respectively, of cash and cash equivalents and investments were deposited, pledged or held in escrow accounts in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions and insurance laws.
In addition, as of December 31, 2016 and 2015, a further $587.6 million and $579.3 million, respectively, of cash and cash equivalents and investments were pledged as collateral for our credit facilities.
We do not currently anticipate that the restrictions on liquidity resulting from restrictions on the payment of dividends by our subsidiary companies or from assets committed in trust accounts or to collateralize the letter of credit facilities will have a material impact on our ability to carry out our normal business activities, including interest and dividend payments, respectively, on our senior notes (described below) and common shares.
The table below sets forth the capital structure of the company as of December 31, 2016 and 2015:
On June 18, 2015, we filed a shelf registration statement on Form S-3 with the SEC in which we may offer from time to time common shares of Allied World Switzerland, senior or subordinated debt securities of Allied World Bermuda, guarantees of debt securities of Allied World Bermuda, warrants to purchase common shares of Allied World Switzerland, warrants to purchase debt securities of Allied World Bermuda or units which may consist of any combination of the securities listed above. The registration statement is intended to provide us with additional flexibility to access capital markets for general corporate purposes, subject to market conditions and our capital needs.
On April 19, 2016, our shareholders approved a share repurchase program (the “2016 share repurchase program”) in order for us to repurchase up to $500.0 million of our common shares. Under the terms of this share repurchase program, the first three million of common shares repurchased will remain in treasury and will be used by us to satisfy share delivery obligations under our equity-based compensation plans. Any additional common shares will be designated for cancellation at acquisition and will be canceled upon shareholder approval. As of December 31, 2016, approximately $400.4 million remained under this share repurchase authorization. We do not anticipate repurchasing our common shares pending the completion of the Fairfax transaction.
Shares repurchased by the company and not designated for cancellation are classified as “Treasury shares, at cost” on the consolidated balance sheets. The company will issue shares out of treasury principally related to the company’s employee benefit plans. Shares repurchased and designated for cancellation are constructively retired and recorded as a share cancellation.
Allied World Assurance Company, AG entered into a 20-year mortgage commitment with a Swiss bank for the construction of a company-used office building in Zug, Switzerland. The total proceeds received in 2014 under the mortgage are $14.1 million (CHF 14.0 million) with a fixed annual interest rate of 3.2% payable quarterly. An additional $4.0 million (CHF 4.0 million) of proceeds from the mortgage was received in April 2015. The mortgage payments will be $0.3 million (CHF 0.3 million) per year, plus accrued interest, for the first 19 years with the remaining balance payable at the end of the mortgage.
In June 2016, we entered into a Credit Agreement that provides for a $200 million five-year senior unsecured revolving credit facility (the “Facility”) for the making of revolving loans and short-term swingline loans to us. The aggregate commitment of $200 million under the Facility may be increased by up to $150 million upon our request and upon the agreement of one or more Lenders or additional lenders. Borrowings in the form of swingline loans are subject to a sublimit of $25 million included within the $200 million aggregate commitment. Borrowings under the Credit Agreement may be used by us for general corporate purposes. Borrowings under the Credit Agreement bear interest at a rate selected by us and equal to either the Base Rate or LIBOR plus a margin, other than swingline loans, which will only bear interest at the Base Rate plus a margin, as more fully set forth in the Credit Agreement. The Credit Agreement requires that all revolving loans be repaid in full no later than the fifth anniversary of the Closing Date and that any swingline loans be repaid in full no later than the earlier of (i) ten business days after such swingline loan is made and (ii) the fifth anniversary of the Closing Date. The Company and Holdings have unconditionally guaranteed the obligations under the Facility.
We will pay customary arrangement and administration fees under the Credit Agreement. There is an additional fee payable at an annual rate based upon the long-term senior unsecured debt ratings of Holdings and the Company in effect from time to time on the average daily unutilized commitments of the Lenders.
The Credit Agreement contains representations, warranties and covenants customary for similar bank loan facilities, including a covenant to maintain a ratio of Consolidated Indebtedness to Total Capitalization as of the last day of each fiscal quarter or fiscal year of not greater than 0.35 to 1.0 and a covenant that the Consolidated Net Worth of the Company and its subsidiaries, as of the last day of any fiscal quarter or fiscal year, not fall below a minimum amount calculated based on Consolidated Net Worth, as adjusted for increases due to income or issuances of capital stock and decreases due to extraordinary dividend payments and stock repurchases. The Credit Agreement also has customary Events of Default, including (subject to certain materiality thresholds and grace periods): payment defaults; failure to comply with covenants; material inaccuracy of any representation or warranty; cross-defaults to other material debt or hedging obligations; unsatisfied judgments or pension obligations; bankruptcy, liquidation or insolvency proceedings; the issuance of any orders of conservation or supervision with respect to, or certain other matters relating to insurance licenses held by, any Material Insurance Subsidiary; and certain change in control events. We are in compliance with all covenants under the Credit Agreement as of December 31, 2016
The Facility replaced the four-year senior secured credit facility under the Amended and Restated Credit Agreement, dated as of June 7, 2012, by and among us, the lenders party thereto, Citibank, N.A., as syndication agent, and Wells Fargo Bank, National Association, as administrative agent, fronting bank and letters of credit agent (the “2012 Facility”). The aggregate commitment under the 2012 Facility was reduced from $450 million to $150 million effective as of November 17, 2014. The 2012 Facility expired on June 7, 2016 in accordance with its terms. There were no outstanding loans or letters of credit issued under the 2012 Facility as of the expiration date thereof.
As of December 31, 2016, we had a combined unused letters of credit capacity of $458.0 million from the Amended Secured Credit Facility and Citibank Europe plc. We believe that this remaining capacity is sufficient to meet our future letter of credit needs.
In conjunction with the above referenced mortgage commitment, Allied World Assurance Company, AG entered into a three-year credit facility with a Swiss bank that provided us $5.1 million (CHF 5.0 million) for general corporate purposes, however we used the proceeds from the credit facility to fund the purchase of the office building in Zug, Switzerland. The interest rate for the credit facility is 2.5%.
The amounts included for reserve for losses and loss expenses reflect the estimated timing of expected loss payments on known claims and anticipated future claims as of December 31, 2016 and do not take reinsurance recoverables into account. Both the amount and timing of cash flows are uncertain and do not have contractual payout terms. For a discussion of these uncertainties, refer to “- Critical Accounting Policies - Reserve for Losses and Loss Expenses.” Due to the inherent uncertainty in the process of estimating the timing of these payments, there is a risk that the amounts paid in any period will differ significantly from those disclosed. Total estimated obligations will be funded by existing cash and investments.
The reinsurance collateral represents the funding commitment for our collateralized property catastrophe reinsurance program for the upcoming underwriting years. We have no commitment beyond the 2019 underwriting year.
As of December 31, 2016, we did not have any off-balance sheet arrangements.