We believe that this office space is sufficient for us to conduct our current operations for the foreseeable future, although in connection with future acquisitions from time to time, we may expand to different locations or increase space to support any such growth.
risks relating to our acquisitions, including our ability to successfully price acquisitions, evaluate opportunities and address operational challenges;
The factors listed above should be not construed as exhaustive and should be read in conjunction with the Risk Factors that are included in Item 1A above. We undertake no obligation to publicly update or review any forward looking statement, whether to reflect any change in our expectations with regard thereto, or as a result of new information, future developments or otherwise, except as required by law.
Since our formation in August 2001, we have acquired 36 insurance and reinsurance companies and 21 portfolios of insurance and reinsurance business and are now administering those businesses in run-off.
We operate our business internationally through our insurance and reinsurance subsidiaries and our consulting subsidiaries in Bermuda, the United States, the United Kingdom, Australia and Europe. We had a total of 383 employees as at December 31, 2012.
The financial measure that we believe is most meaningful in analyzing our performance and assessing whether we are achieving our objectives is growth in book value per share. As of December 31, 2012 and 2011, book value per share and diluted book value per share were as follows:
providing expert run-off management services for a fixed and/or incentive-based fee in cases where vendors are not ready or able to dispose of their run-off operations, but require third-party services to stabilize the business and, where possible, add value to the core business.
During the year ended December 31, 2012, our book value per share on a basic and diluted basis increased by 11.5% and 12.5%, respectively. The increase in both basic and diluted book value per share was principally due to our net earnings for the year.
Our insurance-related earnings comprise primarily reductions, or potential increases, of net ultimate loss and loss adjustment expense liabilities. These liabilities are comprised of outstanding loss or case reserves (or OLR), losses incurred but not reported (or IBNR) and unallocated loss adjustment expenses (or ULAE) reserves.
Our net investment income is a function of the average invested assets and the average yield that we earn on those invested assets. The investment yield on our fixed maturity investments is a function of market interest rates as well as the credit quality and duration of our fixed maturities portfolio. Our net realized and unrealized gains or losses on investments includes realized gains and losses on our fixed maturity securities and changes in fair value of our trading securities and other investments. We recognize realized gains and losses at the time of sale, and these gains and losses, along with the changes in fair value of our trading securities, reflect the results of changing market conditions, including changes in market interest rates and changes in the market’s perception of the credit quality of our fixed maturity holdings. The change in fair value of other investments is principally a function of the success of the funds in which we are invested, which depends on, among other things, the underlying strategies of the funds, the ability of the fund managers to execute the fund strategies and general economic and investment market conditions.
We generate consulting fees based on a combination of fixed and success-based fee arrangements. Consulting income will vary from period to period depending on the timing of completion of success-based fee arrangements. Success-based fees are recorded when targets related to overall project completion or profitability goals are achieved.
We have operations in multiple jurisdictions where our subsidiaries are subject to taxation. Income tax expense is generated through our foreign operations outside of Bermuda. Our income tax expense will fluctuate depending on the geographic distribution of pre-tax net income.
Net earnings attributable to noncontrolling interest relates to the share of earnings of seven of our subsidiaries that is not attributable to us because a third party has an interest in such subsidiaries.
We believe the following accounting policies affect the more significant judgments and estimates used in the preparation of our financial statements.
The following table provides a breakdown of loss and loss adjustment expense reserves (net of reinsurance balances recoverable) by type of exposure as of December 31, 2012 and 2011:
As of December 31, 2012, the IBNR reserves (net of reinsurance balances recoverable) accounted for $939.7 million, or 33.7%, of our total net loss reserves. The reserve for IBNR (net of reinsurance balance recoverable) accounted for $1,038.9 million, or 35.8%, of our total net loss reserves at December 31, 2011.
Because a significant amount of time can lapse between the assumption of risk, the occurrence of a loss event, the reporting of the event to an insurance or reinsurance company and the ultimate payment of the claim on the loss event, the liability for unpaid losses and loss adjustment expenses is based largely upon estimates.
Our management must use considerable judgment in the process of developing these estimates. The liability for unpaid losses and loss adjustment expenses for property and casualty business includes amounts determined from loss reports on individual cases and amounts for IBNR reserves. Such reserves, including IBNR reserves, are estimated by management based upon loss reports received from ceding companies, supplemented by our own estimates of losses for which no ceding company loss reports have yet been received and the results of annual independent actuarial studies.
Where we provide reinsurance or retrocession reinsurance protection, the process of claim advice from the direct insurer to the reinsurers and/or retrocessionaires naturally involves more levels of communication, which inevitably creates delays or lags in the receipt of loss advice by the reinsurers/retrocessionaires relative to the date of first advice to the direct insurer. Certain types of exposure, typically latent health exposures such as asbestos-related claims, have inherently long reporting delays, in some cases many years, from the date a loss occurred to the manifestation and reporting of a claim and ultimately until the final settlement of the claim. For asbestos and environmental exposures, our actuaries apply explicit time lag assumptions in their reserving methodologies. This time lag varies by portfolio from one to five years depending on the relative mix of domicile, percentages of product mix of insurance, reinsurance and retrocessional reinsurance, primary insurance, excess reinsurance, reinsurance of direct and reinsurance of reinsurance within any given exposure category. Exposure portfolios written from a non-US domicile are assumed to have a greater time lag than portfolios written from a US-domicile. Portfolios with a larger proportion of reinsurance exposures are assumed to have a greater time-lag than portfolios with a larger proportion of insurance exposures.
2. Onsite claims audits are often supplemented by further reviews by our internal and external legal advisors to determine the reasonableness of advised case reserves and, if considered necessary, an adjustment to the reported case reserve will be recorded.
We strive to apply the highest standards of discipline and professionalism to our claims adjusting, processing and settlement and disputes with cedants are rare. However, we are from time to time involved in various disputes and legal proceedings in the ordinary course of our claims adjusting process. The majority of the losses ceded to us are from the subscription insurance market (where there are often many insurers and reinsurers underwriting each policy), and we often are involved in disputes commenced by other co-insurers who act in unison with any litigation or dispute resolution controlled by the lead underwriter. Coverage disputes arise when the insured/reinsured and insurer/reinsurer cannot reach agreement as to the interpretation of the policy and/or application of the policy to a claim. Most insurance and reinsurance policies contain dispute resolution clauses requiring arbitration or mediation. In the absence of a contractual dispute resolution process, civil litigation would be commenced. We aim to reach a commercially acceptable resolution to any dispute, using arbitration or litigation as a last resort. We regularly monitor and provide internal reports on disputes involving arbitration and litigation and engage external legal counsel to provide professional advice and assist with case management.
Within the annual loss reserve studies produced by our independent actuaries, exposures for each subsidiary are separated into homogeneous reserving categories for the purpose of estimating IBNR. Each reserving category contains either direct insurance or assumed reinsurance reserves and groups relatively similar types of risks and exposures (for example, asbestos, environmental, casualty, property) and lines of business written (for example, marine, aviation, non-marine). Based on the exposure characteristics and the nature of available data for each individual reserving category, a number of methodologies are applied. Recorded reserves for each category are selected from the indications produced by the various methodologies after consideration of exposure characteristics, data limitations and strengths and weaknesses of each method applied. This approach to estimating IBNR has been consistently adopted in the annual loss reserve studies for each period presented.
When establishing loss reserves we have an expectation that, in the absence of commutations and significant favorable or unfavorable non-commuted loss development compared to expectations, loss reserves will not exceed the high, or be less than the low, end of the following ranges of gross loss and loss adjustment expense reserves implied by the various methodologies used by each of our insurance subsidiaries as of December 31, 2012.
The ranges of gross loss and loss adjustment expense reserves implied by the various methodologies used by each of our insurance and reinsurance subsidiaries as of December 31, 2012 were:
The estimation of unpaid claim liabilities is subject to a high degree of uncertainty for a number of reasons. First, unpaid claim liabilities for property and casualty exposures in general are impacted by changes in the legal environment, jury awards, medical cost trends and general inflation. Moreover, for latent exposures in particular, developed case law and adequate claim history do not exist. There is significant coverage litigation related to
As of December 31, 2012, we employed approximately 27 full-time equivalent employees, including attorneys, actuaries, and experienced claims-handlers, to directly administer our A&E liabilities.
Existence of currently undiscovered polluted sites eligible for clean-up under the Comprehensive Environmental Response, Compensation, and Liability Act (or CERCLA) and related legislation.
subsidiaries, payment and reporting pattern acceleration due to large “wholesale” settlements (e.g., policy buy-backs and commutations) pursued by us, and lists of individual risks remaining and general trends within the legal and tort environments.
1. $65 Billion Ultimate Industry Asbestos Losses - This level of industry-wide losses and its comparison to industry-wide paid, incurred and outstanding case reserves is the base benchmarking assumption applied to Paid Market Share, Reserve-to-Paid, IBNR:Case Ratio and the Ultimate-to-Incurred asbestos reserving methodologies.
increased slightly from 2.6 years to 2.8 years and the average selected lag for environmental has decreased slightly from 2.3 years to 2.2 years. The changes to the selected lags arose largely as a result of the changes in the relative sizes of the various underlying asbestos and environmental portfolios during 2012.
Historically, asbestos claims have been presented as “products liability” claims brought against manufacturers and distributors of asbestos-containing products. For a given manufacturer, distributor, or other entity involved in asbestos litigation, multiple claims are filed by numerous individuals. There is typically an allocation of the settlement costs for asbestos claims over time based on exposure to asbestos by the injured claimants. Many asbestos claims will aggregate within each individual policy period to exhaust the annual aggregate policy limits that exist within policies sold to cover products liability claims.
not be subject to the aggregate limits of products liability claims. Instead, the policyholder would assert that each individual bodily injury claim should be treated as a separate occurrence under the “premises/operations” section of their policies. Under such presentation, individual claim or occurrence limits apply separately to each claim and there is no aggregate limit for the amount of “premises” or “non-products” claims within a particular policy.
As stated above, the trend of asbestos losses shifting from products to non-products is not a new phenomenon. As our assumed reinsurance entities have not received any material reporting of non-products claims to date and their assumed reinsurance exposures generally cover layers of insurance not impacted by non-products asbestos losses, management does not expect any material future liability in respect of non-products asbestos claims.
In late 2012, one commonly-referenced benchmark increased its estimate of ultimate industry asbestos losses from $75 billion to $85 billion. Little reasoning was given to explain the increase other than the fact that the industry has reported ultimate losses of $74 billion as of year-end 2011, and that the industry has been increasing its estimate of ultimate losses by approximately $2 billion per year over recent years. Based on the lack of reasoning presented, it is unclear to what extent the phenomena of asbestos losses presenting as “non-products” has influenced the most recent increase.
asbestos reserve survival ratio at year-end 2011 is 9.7. Using an ultimate loss estimate of $85 billion (as opposed to $74 billion based on industry reserves carried at year-end 2011) produces a survival ratio of 14.4. Our carried-reserve survival ratio at year-end 2012 is 14.0. It should be noted that this is consistent with the industry three-year survival ratio when lagged by 2.8 years.
In summary, estimates of ultimate asbestos losses for the insurance industry have increased in recent years, however, our recent history of favorable settlements on commutations and policy buybacks and of lower incurred loss emergence relative to expectations does not support an increase to our asbestos loss reserve levels. Finally, our carried reserve level compares favorably with the industry carried reserve level - even under an $85 billion ultimate loss scenario - using the well-accepted three-year average paid survival ratio.
4. Bornhuetter-Ferguson Expected Loss Projection Reported and Paid Methods. The Bornhuetter-Ferguson Expected Loss Projection Method based on reported loss data relies on the assumption that remaining unreported losses are a function of the total expected losses rather than a function of currently reported losses. The expected losses used in this analysis are based on initial selected ultimate loss ratios by year. The expected losses are multiplied by the unreported percentage to produce expected unreported losses. The unreported percentage is calculated as one minus the reciprocal of the selected cumulative incurred LDFs. Finally, the expected unreported losses are added to the current reported losses to produce ultimate losses. The calculations underlying the Bornhuetter-Ferguson Expected Loss Projection Method based on paid loss data are similar to the Bornhuetter-Ferguson calculations based on reported losses, with the exception that paid losses and unpaid percentages replace reported losses and unreported percentages. The Bornhuetter-Ferguson method is most useful as an alternative to other models for immature years. For these immature years, the amounts reported or paid may be small and unstable and therefore not predictive of future development. Therefore, future development is
In addition to an in-depth annual review, we also perform quarterly reserve reviews. This is done by examining quarterly paid and incurred loss development to determine whether it is consistent with reserves
Provisions for unallocated loss adjustment expense liabilities are estimated by management by determining the future annual costs to be incurred by us, comprising staff costs, consultancy and professional fees and overheads, in managing the run-off of claims liabilities for each of our insurance and reinsurance entities and is increased with outstanding losses and loss expenses. The provision is reviewed quarterly and adjusted in accordance with the related costs incurred each period.
Level 3 - Model-derived valuations in which one or more significant inputs or significant value drivers are unobservable.
When the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Thus, a Level 3 fair value measurement may include inputs that are observable (Level 1 and 2) and unobservable (Level 3).
Fixed maturity investments are subject to fluctuations in fair value due to changes in interest rates, changes in issuer specific circumstances such as credit rating and changes in industry specific circumstances such as movements in credit spreads based on the market’s perception of industry risks. As a result of these potential fluctuations, it is possible to have significant unrealized gains or losses on a security. At maturity, absent any credit loss, fixed maturity investments amortized cost will equal their fair value and no realized gain or loss will be recognized in income. If, due to an unforeseen change in loss payment patterns, we need to sell any available-for-sale investments before maturity, we could realize significant gains or losses in any period, which could result in a meaningful effect on reported net income for such period.
We perform regular reviews of our available-for-sale fixed maturities portfolios and utilize a process that considers numerous indicators in order to identify investments that are showing signs of potential other than temporary impairment losses. These indicators include the length of time and extent of the unrealized loss, any specific adverse conditions, historic and implied volatility of the security, failure of the issuer of the security to make scheduled interest payments, significant rating changes and recoveries or additional declines in fair value subsequent to the balance sheet date. The consideration of these indicators and the estimation of credit losses involve significant management judgment.
markets. For determining the fair value of investments that are not actively traded, in general, pricing services use “matrix pricing” in which the independent pricing service uses observable market inputs including, but not limited to, reported trades, benchmark yields, broker-dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value. In addition, pricing services use valuation models, using observable data, such as an Option Adjusted Spread model, to develop prepayment and interest rate scenarios. The Option Adjusted Spread model is commonly used to estimate fair value for investments such as mortgage-backed and asset-backed investments.
Our other investments are comprised of private equity, fixed income, fixed income hedge, equity and real estate debt funds. Investments in the funds are carried at their net asset values, which approximate fair value. We believe the reported net asset value represents the fair value market participants would apply to an interest in the fund. The fund managers value their underlying investments at fair value in accordance with policies established by each fund, as described in each of their financial statements and offering memoranda. The change in fair value is included in net realized and unrealized gains on investments and recognized in net earnings. These investments are stated at fair value, which ordinarily will be the most recently reported net asset value as advised by the fund manager or administrator.
(iii) an increase in net investment income of $9.1 million primarily as a result of higher average cash and fixed maturities balances for 2012 as a result of the Clarendon National Insurance Company acquisition, which was partially offset by a decrease in yields due to declining yields in the global fixed maturities markets; partially offset by
(iv) a lower net reduction in ultimate loss and loss adjustment expense liabilities of $53.7 million;
(v) an increase in income taxes of $19.0 million due to increased tax liabilities recorded on the results of our taxable subsidiaries;
(viii) a decrease in consulting fee income of $9.3 million due to lower revenue from incentive-based fee arrangements.
(iii) a lower net reduction in ultimate loss and loss adjustment expense liabilities of $16.4 million;
(iv) a decrease in consulting fee income of $5.2 million due to lower revenue from incentive-based fee arrangements;
(v) an increase in salaries and benefits costs of $3.2 million due primarily to our increased overall headcount from 335 at December 31, 2010 to 412 at December 31, 2011, which was offset by a reduction in salary costs related to our discretionary bonus plan as a result of decreased net earnings for the year;
(vi) an increase in general and administrative expenses of $12.6 million due primarily to an increase in loan structure fees and letter of credit fees that were paid in 2011, along with an overall increase in other professional fees due primarily to legal fees and settlement costs associated with certain litigation; and
(vii) a decrease of $10.7 million in our share of net earnings of our equity method investee; partially offset by
(x) a decrease in interest expense of $1.7 million due primarily to lower interest rates on the loan facilities outstanding during 2011.
We recorded noncontrolling interest in earnings of $54.8 million and $41.6 million for the years ended December 31, 2011 and 2010, respectively. Net earnings attributable to Enstar Group Limited decreased from $174.1 million for the year ended December 31, 2010 to $153.7 million for the year ended December 31, 2011.
Net investment income for the year ended December 31, 2012 increased by $9.1 million to $77.8 million, as compared to $68.7 million for the year ended December 31, 2011. The increase was primarily a result of higher than average cash and fixed maturities for 2012 as a result of the 2011 acquisition of Clarendon National Insurance Company, or Clarendon. In 2012, we had a full year of net investment income from Clarendon as opposed to net investment income for approximately six months in 2011 from the date of acquisition. Lower absolute yields obtained on cash and fixed maturities due to declining yields in global fixed maturities markets offset part of this increase.
(i) an increase of $12.8 million in net realized gains on our fixed maturities and short-term investments mostly due to increased trading in those asset classes;
(ii) an increase of $19.6 million in unrealized gains on trading securities as a result of increases in the value of our investments in equities and fixed maturities in line with increases in the global markets; and
The average annualized return on the cash and fixed maturities (inclusive of net realized and unrealized gains, but excluding net investment income and net realized and unrealized gains related to our other investments and equities) for the year ended December 31, 2012 was 2.3% as compared to the average return of 1.7% for the year ended December 31, 2011. The average credit rating of our fixed maturities at December 31, 2012 and December 31, 2011 was AA-. The average annualized return on our other investments and equities (inclusive of net realized and unrealized gains) for the year ended December 31, 2012 was 11.8% as compared to the average return of 1.7% for the year ended December 31, 2011.
(i) a decrease of $7.1 million in interest income from cash and fixed maturities (net of amortization of bond premiums and discounts) as a result of lower yields earned driven by lower interest rates in developed economies, primarily the United States;
(ii) a decrease of $2.1 million in our income from other investments;
The average annualized return on the cash and fixed maturities (inclusive of net realized and unrealized gains, but excluding net investment income and net realized and unrealized gains related to our other investments and equities) for the year ended December 31, 2011 was 1.7% as compared to the average return of 2.2% for the year ended December 31, 2010. The average annualized return on our other investments (inclusive of net realized and unrealized gains) for the year ended December 31, 2011 was 1.7% as compared to the average return of 14.7% for the year ended December 31, 2010.
(i) a decrease of $17.5 million in realized and unrealized gains on our other investments, largely related to net losses recorded on our private equity investments in 2011 (whereas net gains were recorded in 2010);
The following table shows the components of the movement in the net reduction in ultimate loss and loss adjustment expense liabilities for the years ended December 31, 2012, 2011 and 2010:
Net reduction in case and LAE reserves comprises the movement during the year in specific case reserve liabilities as a result of claims settlements or changes advised to us by our policyholders and attorneys, less changes in case reserves recoverable advised by us to our reinsurers as a result of the settlement or movement of assumed claims. Net reduction in IBNR reserves represents the change in our actuarial estimates of losses incurred but not reported, less amounts recoverable.
The net reduction in ultimate loss and loss adjustment expense liabilities for the year ended December 31, 2012 of $241.8 million was attributable to a reduction in estimates of net ultimate losses of $221.9 million, a reduction in aggregate provisions for bad debt of $3.1 million and a reduction in estimates of unallocated loss adjustment expense liabilities of $39.3 million, relating to 2012 run-off activity, partially offset by the amortization, over the estimated payout period, of fair value adjustments relating to companies acquired amounting to $22.6 million.
The aggregate reduction in net IBNR reserves of $215.0 million 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 101 commutations, to estimate loss reserves required to cover liabilities for unpaid losses and loss adjustment expenses relating to non-commuted exposures. The prior period estimate of aggregate net IBNR reserves was reduced as a result of the combined impact on all classes of business of loss development activity during 2012, including commutations and the favorable trend of loss development related to non-commuted policies compared to prior forecasts. The net incurred favorable loss development, excluding the allocation of $52.4 million from net IBNR reserves to specific net case and LAE reserves, of $6.9 million, resulting from settlement of net advised case and LAE reserves of $317.6 million for net paid losses of $310.7 million, related to the settlement of non-commuted losses in the year and 101 commutations of assumed and ceded exposures. Net incurred liabilities settled by way of commutation during the year ended December 31, 2012 amounted to $26.6 million (comprising $163.1 million of assumed incurred liabilities partially offset by $136.5 million of ceded incurred reinsurance recoverables) compared to the net aggregate reduction in advised case reserves during the same period of $317.6 million (excluding the allocation of $52.4 million from net IBNR reserves to specific net case and LAE reserves).
IBNR reserves of $224.8 million 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 113 commutations (including three commutations completed shortly after December 31, 2011), to estimate loss reserves required to cover liabilities for unpaid losses and loss adjustment expenses relating to non-commuted exposures.
(iii) increased staff costs due to an increase in our average headcount from 378 in 2011 to 392 in 2012, attributable to staff acquired on completion of the Clarendon acquisition in July 2011, partially offset by reductions in headcount in both our U.K. and Australian subsidiaries.
(iii) the reduction in the discretionary bonus accrual of $8.1 million due to the release back to earnings in 2011 of approximately $4.0 million relating to the unallocated portion of the 2010 year-end bonus accrual provision and the reduction in net earnings for the year ended December 31, 2011 as compared to 2010.
(i) a decrease in legal and professional fees of $10.9 million due largely to higher 2011 legal fees and settlement costs associated with certain litigation that did not recur in 2012 along with reductions in audit, actuarial and consulting fees of approximately $4.0 million; and
For 2013, we expect general and administrative expenses to increase over 2012 levels due primarily to the recently completed SeaBright acquisition and the pending acquisition of the HSBC Insurance Companies.
General and administrative expenses increased by $12.6 million from $59.2 million to $71.8 million during the year ended December 31, 2011, as compared to the year ended December 31, 2010. The increased expenses in 2011 related primarily to:
(i) increased bank costs of $5.2 million primarily associated with the costs of establishing and maintaining our letters of credit, along with the arrangement and agency fees paid in relation to the establishment of both our Clarendon and revolving credit facilities;
For 2013, we expect interest expense increase over 2012 levels due primarily to the increase in loans payable as a result of the borrowings under the SeaBright Facility on February 5, 2013 in connection with our acquisition of SeaBright along with additional borrowings in respect of the planned acquisition of the HSBC Insurance Companies.
Income tax expense is generated through our foreign operations outside of Bermuda, principally in the United States, Europe and Australia. The effective tax rate was 18.8% for the year ended December 31, 2012 compared with 10.8% in the year ended December 31, 2011. Our effective income tax rate may fluctuate significantly from period to period depending on the geographic distribution of pre-tax net income in any given period between different jurisdictions with different tax rates. Our tax expense increased by $19.0 million for the year ended December 31, 2012 due principally to increased taxable earnings from our U.K.-based subsidiaries.
We recorded income tax expense of $25.3 million and $87.1 million for the years ended December 31, 2011 and 2010, respectively.
We recorded a noncontrolling interest in earnings of $23.5 million and $54.8 million for the years ended December 31, 2012 and 2011, respectively. The decrease for the year ended December 31, 2012 was due primarily to the decrease in earnings for those companies where there exists a noncontrolling interest. In addition, on January 1, 2012, S2008 transferred the assets and liabilities relating to its 2009 and prior underwriting years of account into its 2010 underwriting year of account by means of an RITC transaction. Following the transfer, the existing noncontrolling interest held by JCF FPK and JCF II ceased, resulting in us now providing 100% of the underwriting capacity for S2008. The number of subsidiaries with a noncontrolling interest decreased from 8 as at December 31, 2011 to 7 as at December 31, 2012.
We believe that restrictions on liquidity resulting from restrictions on the payments of dividends by our subsidiary companies will not have a material impact on our ability to meet our cash obligations. Retained earnings of our insurance and reinsurance subsidiaries are not currently restricted as minimum capital solvency margins are covered by share capital and additional paid-in-capital.
Our acquired insurance and reinsurance subsidiaries, prior to acquisition by us, used retrocessional agreements to reduce their exposure to the risk of reinsurance assumed. 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. Provisions are made for amounts considered potentially uncollectible.
We expect the net operating cash flows for us, to expiry, to be negative as we pay out cash in claims payments and operational expenses in excess of cash generated via investment income and consulting fees.
(i) a decrease of $675.1 million in loss and loss adjustment expense liabilities in 2011 compared to an increase of $150.0 million in 2010;
(iii) a decrease in funds held by reinsurance companies of $167.0 million in 2011 compared to an increase of $206.0 million in 2010.
(ii) a decrease of $91.1 million in the sales and maturities of available-for-sale securities between 2012 and 2011; and
(iii) an increase of $173.0 million in the funding of other investments between 2012 and 2011 due to the increased allocation to other investments during 2012; partially offset by
Net cash provided by investing activities was $691.9 million during the year ended December 31, 2011 compared to $253.5 million during the year ended December 31, 2010. This $438.5 million increase in investing cash flows between 2011 and 2010 was due primarily to the following:
(iv) the use of $88.5 million in net cash for acquisitions during 2011, compared to net cash provided by acquisitions of $173.7 million during 2010.
(i) $287.4 million in net proceeds from the private placement of shares in 2011 to affiliates of Goldman, Sachs & Co. compared to $nil in 2012; and
(ii) an increase of $112.8 million in cash received attributable to bank loans between 2011 and 2010 largely due to increased acquisition-funding requirements, partially offset by an increase of $51.2 million in the repayment of bank loans; and
Our strategy of commuting our liabilities has the potential to accelerate the natural payout of losses. Therefore, we maintain a relatively short-duration investment portfolio in order to provide liquidity for commutation opportunities and avoid having to liquidate longer dated investments. Accordingly, the majority of our investment portfolio consists of highly rated fixed maturities, including U.S. government and agency
At December 31, 2012, we had $319.1 million of short-term investments (2011: $410.3 million). Short-term investments are managed as part of our investment portfolio and have a maturity of one year or less when purchased. Short-term investments are carried at fair value.
The value of our fixed maturity investments will fluctuate with changes in the interest rate environment and when changes occur in the overall investment market and in overall economic conditions.
Our fixed maturity portfolio is managed by our Chief Investment Officer and outside investment advisors with oversight from our Investment Committee.
As at December 31, 2012 and 2011, no investments were considered other-than-temporarily impaired. At December 31, 2012, our gross unrealized losses on available-for-sale investments totaled $0.7 million. At December 31, 2012, we held 23 available-for-sale investments that were in an unrealized loss position for longer than twelve months.
The table below shows the fair value of our portfolio of other investments held at December 31, 2012 and 2011:
We have committed capital to other investments of $87.6 million as at December 31, 2012 and $77.5 million as at December 31, 2011. In the future, we may enter into additional commitments in respect of private equity partnerships or individual portfolio company investment opportunities.
As of December 31, 2012 and 2011, we had $127.7 million and $107.4 million, respectively, of other investments recorded in private equity funds, which represented 3.8% and 3.2% of total investments, respectively.
This class is comprised of a number of positions in diversified fixed income funds that are managed by third party managers. Underlying investments vary from high grade corporate bonds to below investment grade senior secured loans and bonds, but are generally invested in liquid fixed income markets. These funds have regularly published prices. The funds have liquidity terms that vary from daily to monthly.
This class is comprised of an equity fund that invests in a diversified portfolio of international publicly-traded equity investments. The manager of the fund seeks to maximize the intrinsic value of the portfolio by focusing on price and quality.
On June 14, 2011, we, as borrower, and certain of our subsidiaries, as guarantors, entered into a Revolving Credit Facility Agreement with NAB and Barclays, as bookrunners and mandated lead arrangers, certain financial institutions, as lenders, and NAB as agent, or the EGL Revolving Credit Facility. The EGL Revolving Credit Facility provides for a three-year revolving credit facility pursuant to which we are permitted to borrow up to an aggregate of $250.0 million, which is available to prepay certain existing credit facilities of ours and certain of our subsidiaries, to fund permitted acquisitions and for general corporate purposes. Our ability to draw on the EGL Revolving Credit Facility is subject to customary conditions.
During the existence of any payment default, the interest rate is increased by 1.0%. During the existence of any event of default (as specified in the EGL Revolving Credit Facility), the agent may cancel the commitments of the lenders, declare all or a portion of outstanding amounts immediately due and payable, declare all or a portion of outstanding amounts payable upon demand or proceed against the security. The EGL Revolving Credit Facility terminates and all amounts borrowed must be repaid on June 14, 2014, the third anniversary of the facility.
On October 21, 2011 and December 30, 2011, we repaid $25.0 million and $26.8 million, respectively, of the outstanding principal balance of the EGL Revolving Credit Facility. On June 29, 2012, we repaid $115.9 million of the outstanding principal balance and $2.1 million of accrued interest on the facility. As of December 31, 2012, the outstanding EGL Revolving Credit Facility loan balance, inclusive of accrued interest, was $nil. On February 5, 2013, we borrowed $56.0 million under the EGL Revolving Credit Facility.
On March 4, 2011, we, through Clarendon Holdings, Inc., entered into a $106.5 million term facility agreement, or the Clarendon Facility, with NAB. The Clarendon Facility provides a four-year term loan facility, which was fully drawn upon on July 12, 2011 to fund 50% of the purchase price of Clarendon. As of December 31, 2012, the outstanding Clarendon Facility principal balance was $106.5 million.
The following table shows our aggregate contractual obligations and commitments by time period remaining to due date as at December 31, 2012. The table does not reflect certain acquisition-related payments potentially due in the future.
The reserves for loss and loss adjustment expenses represent management’s estimate of the ultimate cost of settling losses. As more fully discussed in“- Critical Accounting Policies - Loss and Loss Adjustment Expenses” above, the estimation of losses is based on various complex and subjective judgments. Actual losses paid may differ, perhaps significantly, from the reserve estimates reflected in our financial statements. Similarly, the timing of payment of our estimated losses is not fixed and there may be significant changes in actual payment activity. The assumptions used in estimating the likely payments due by period are based on our historical claims payment experience and industry payment patterns, but due to the inherent uncertainty in the process of estimating the timing of such payments, there is a risk that the amounts paid in any such period can be significantly different from the amounts disclosed above.
We have audited the accompanying consolidated balance sheet of Enstar Group Limited and subsidiaries (the “Company”) as of December 31, 2012, and the related consolidated statements of earnings, comprehensive income, changes in shareholders’ equity and cash flows for the year ended December 31, 2012. In connection with our audit of the consolidated financial statements, we also have audited financial statement schedule II as of, and for the period ended, December 31, 2012. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audit.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2012, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 28, 2013 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
The consolidated financial statements include the assets, liabilities and results of operations of the Company as of December 31, 2012 and 2011 and for the years ended December 31, 2012, 2011 and 2010. Results of operations for subsidiaries acquired are included from the dates of their acquisition by the Company. Intercompany transactions are eliminated on consolidation.
valuation of certain fixed maturities and other investments that are measured using significant unobservable inputs; and
Short-term investments comprise investments with a maturity greater than 3 months but less than one year from the date of purchase. Fixed maturities comprise investments with a maturity of one year and greater from the date of purchase.
Other investments include investments in limited partnerships and limited liability companies (collectively “private equities”) and fixed income, hedge, equity and real estate debt funds (collectively “funds”) that carry their investments at fair value. These funds are stated at fair value, which ordinarily will be the most recently reported net asset value as advised by the fund manager or administrator. Many of the Company’s fund investments publish net asset values on a daily basis and provide daily liquidity, others report on a monthly basis. Private equities typically report quarterly. The Company believes the reported net asset value represents the fair
value market participants would apply to an interest in the various private equities or funds. The change in fair value is included in net realized and unrealized gains on investments and recognized in net earnings.
The Company recognizes all derivatives as either assets or liabilities in the consolidated balance sheets and carries them at the fair value of the instrument. The Company participates in derivative instruments for purposes of its overall foreign currency risk management strategy. Changes in fair value and realized gains or losses on derivative instruments are recorded in net foreign exchange gains and losses.
The liability for losses and loss adjustment expenses includes an amount determined from reported claims and an amount, based on historical loss experience and industry statistics, for losses incurred but not reported determined using a variety of actuarial methods. These estimates are continually reviewed and are necessarily subject to the impact of future changes in factors such as claim severity and frequency, changes in economic conditions including the impact of inflation, legal developments and changes in social attitudes. While management believes that the amount is adequate, the ultimate liability may be significantly in excess of, or less than, the amounts provided. Adjustments will be reflected as part of net increase or reduction in losses and loss adjustment expense liabilities in the periods in which they become known. Premium and commission adjustments may be triggered by incurred losses and any amounts are reflected in net loss and loss adjustment expense liabilities at the same time the related incurred loss is recognized.
Consideration received for business assumed by way of novation and premiums on retroactive reinsurance is recorded in the balance sheet. The difference between the consideration received and liabilities assumed is presented as an intangible asset. The intangible asset is amortized into earnings over the settlement period of liabilities assumed.
The reporting currency of the Company is the U.S. dollar. Assets and liabilities of entities whose functional currency is not the U.S. dollar are translated at period end exchange rates. Revenue and expenses of such foreign entities are translated at average exchange rates during the year. The effect of the currency translation adjustments for foreign entities is included in accumulated other comprehensive income.
Other foreign currency assets and liabilities that are considered monetary items are translated at exchange rates in effect at the balance sheet date. Foreign currency revenues and expenses are translated at transaction date exchange rates. These exchange gains and losses are included in the determination of net earnings.
Basic earnings per share is based on the weighted average number of ordinary shares outstanding and excludes any dilutive effects of warrants, options and convertible securities. Diluted earnings per share is based on the weighted average number of ordinary and ordinary share equivalents outstanding calculated using the treasury stock method for all potentially dilutive securities. When the effect of dilutive securities would be anti-dilutive, these securities are excluded from the calculation of diluted earnings per share.
materially faster or slower than anticipated at the time of the acquisition, there is an adjustment to the estimated ultimate loss reserves, or there are changes in bad debt provisions or in estimates of future run-off costs following accelerated payouts, then the amortization of the FVA is accelerated or decelerated, as the case may be, to reflect such changes. The FVA is tested annually for impairment.
On February 7, 2013, the Company completed its acquisition of SeaBright Holdings, Inc. (“SeaBright”), through the merger of its indirect, wholly-owned subsidiary, AML Acquisition, Corp. (“AML Acquisition”), with and into SeaBright (the “Merger”), with SeaBright surviving the Merger as the Company’s indirect, wholly-owned subsidiary. SeaBright owns SeaBright Insurance Company, an Illinois-domiciled insurer that is commercially domiciled in California, which wrote workers compensation business. The aggregate cash purchase price paid by the Company for all equity securities of SeaBright was approximately $252.1 million, which was funded in part with $111.0 million borrowed under a four-year term loan facility provided by National Australia Bank (“NAB”) and Barclays Bank PLC (“Barclays”). This business combination will be accounted for by the Company as an acquisition under U.S. GAAP purchase accounting requirements.
The base purchase price of approximately $181.0 million will be adjusted under the terms of the stock purchase agreement based upon changes to the capital and surplus of the HSBC Insurance Companies arising
On March 25, 2011, the Company, through its wholly-owned subsidiary, Kenmare Holdings Ltd. (“Kenmare”), completed the acquisition of Laguna Life Limited, formerly known as CitiLife Financial Limited (“Laguna”), from Citigroup Insurance Holding Corporation (“Citigroup”), an affiliate of Citigroup Inc. Laguna is an Ireland-based life insurer that is in run-off. The aggregate cash purchase price was 15.0 million (approximately $21.2 million). The originally disclosed purchase price of 30.0 million (approximately $42.4 million) was reduced, prior to completion of the acquisition, after Citigroup received approval from Laguna’s regulator to distribute 15.0 million (approximately $21.2 million) to its shareholders.
The purchase price and fair value of the net assets acquired in the Laguna acquisition were as follows:
On December 31, 2010, the Company, through its wholly-owned subsidiary, CLIC Holdings, Inc., completed the acquisition of Claremont Liability Insurance Company (“Claremont”), for an aggregate cash purchase price of $13.9 million. Claremont is a California-domiciled insurer that is in run-off.
On July 20, 2010, the Company, through its wholly-owned subsidiary, PWAC Holdings, Inc., completed the acquisition of PW Acquisition Company (“PWAC”) for an aggregate purchase price of $25.0 million. PWAC owns the entire share capital of Providence Washington Insurance Company. Providence Washington Insurance Company and its two subsidiaries are Rhode Island-domiciled insurers that are in run-off. The purchase price was financed by a term facility provided by a London-based bank (the “EGL Facility”), which was fully repaid on September 13, 2010.
approximately £28.8 million (approximately $44.0 million). Knapton is a U.K.-domiciled reinsurer that is in run-off. In April 2010, Knapton Holdings entered into a term facility agreement with a London-based bank (the “Knapton Facility”). On April 20, 2010, Knapton Holdings drew down $21.4 million from the Knapton Facility. On June 30, 2011, the Knapton Facility was fully repaid.
On June 30, 2012, the Company, through the Danish branch of its wholly-owned subsidiary, Marlon Insurance Company Limited (“Marlon”), acquired, by way of loss portfolio transfer under Danish law, a portfolio of reinsurance and professional disability business from the Danish branch of Zurich Insurance Company (“Zurich”). After reflecting the final balances reported by Zurich, Marlon received total assets and assumed liabilities of approximately $60.0 million.
Effective December 31, 2012, S2008 entered into a 100% quota share reinsurance agreement with another Lloyd’s syndicate in respect of its 2009 and prior underwriting years of account, under which S2008 assumed total gross insurance reserves of approximately £193.0 million (approximately $313.3 million) for consideration of an equal amount. The consideration received has been recorded as funds withheld in the Company’s consolidated balance sheet for the year ended December 31, 2012.
Australian Federal Court approved scheme. Gordian received total assets and assumed total net reinsurance liabilities of approximately 9.7 million Australian dollars (approximately $10.0 million).
In February 2011, S2008 entered into RITC agreements with two Lloyd’s syndicates assuming total gross insurance reserves of approximately $129.6 million for consideration of an equal amount.
On December 31, 2010, the Company, through Fitzwilliam, entered into a 100% reinsurance agreement, administrative services agreement, and related transaction documents with three affiliates of Cigna Corporation (“Cigna affiliates”), pursuant to which Fitzwilliam reinsured all of the run-off workers compensation and personal accident reinsurance business of those Cigna affiliates. Pursuant to the transaction documents, the Cigna affiliates have transferred assets into three reinsurance collateral trusts securing the obligations of Fitzwilliam under the reinsurance agreement and administrative services agreement. Fitzwilliam received total assets and assumed total net reinsurance reserves of approximately $190.5 million. Fitzwilliam transferred approximately $50.0 million of additional funds to the trusts to further support these obligations. The Company funded the contribution to the trusts through a draw on a $115.0 million credit facility entered into with Barclays Bank PLC on December 29, 2010, which was fully repaid on June 30, 2011.
In addition to the trusts, the Company has provided a limited parental guarantee supporting certain obligations of Fitzwilliam initially in the amount of $79.7 million. The amount of the guarantee will increase or decrease over time under certain circumstances, but will always be subject to an overall maximum cap with respect to reinsurance liabilities. As of December 31, 2012, the amount of the parental guarantee was $106.5 million.
In July 2010, following the acquisition of the entire issued share capital of Glacier Insurance AG by Torus Insurance (Bermuda) Limited (“Torus”), Fitzwilliam entered into two quota share reinsurance agreements with Torus protecting the prior year reserve development of two portfolios of business reinsured by them: (i) a 79% quota share of Torus’ 95% quota share reinsurance of Glacier Insurance AG, and (ii) a 75% quota share of Torus’ 100% quota share reinsurance of Glacier Reinsurance AG. Fitzwilliam received total assets and assumed total gross reinsurance reserves of approximately $105.0 million.
During 2010, S2008 entered into RITC agreements with three Lloyd’s syndicates with total gross insurance reserves assumed of approximately $192.6 million for consideration of an equal amount.
As at December 31, 2012 and 2011, the number of securities classified as available-for-sale in an unrealized loss position was 30 and 107, respectively, with a fair value of $29.0 million and $156.5 million, respectively. Of these securities, the number of securities that had been in an unrealized loss position for twelve months or longer was 23 and 59, respectively. As of December 31, 2012, none of these securities were considered to be other than temporarily impaired.
The contractual maturities of the Company’s fixed maturity securities classified as available-for-sale are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The following tables set forth certain information regarding the credit ratings (provided by major rating agencies) of the Company’s fixed maturity securities classified as available-for-sale:
The Company assesses whether declines in the fair value of its fixed maturity investments classified as available-for-sale represent impairment losses that are other-than-temporary and whether a credit loss exists in accordance with its accounting policies. The Company had no planned sales of its fixed maturity investments classified as available-for-sale as at December 31, 2012. In assessing whether it is more likely than not that the Company will be required to sell a fixed maturity investment before its anticipated recovery, the Company considers various factors including its future cash flow requirements, legal and regulatory requirements, the level of its cash, cash equivalents, short-term investments and fixed maturity investments available-for-sale in an unrealized gain position, and other relevant factors. For the twelve months ended December 31, 2012, the Company did not recognize any other-than-temporary impairments/losses due to required sales. The Company determined that, as at December 31, 2012, no credit losses existed.
As of December 31, 2012 and 2011, the Company had $127.7 million and $107.4 million, respectively, of other investments recorded in private equity funds, which represented 3.0% and 2.4% of total investments, cash and cash equivalents and restricted cash and cash equivalents at December 31, 2012 and 2011, respectively. Due to a lag in the valuations reported by the managers, the Company records changes in the investment value with up to a three-month lag. Management regularly reviews and discusses fund performance with their fund managers to corroborate the reasonableness of the reported net asset values and to assess whether any events have occurred within the lag period that would affect the valuation of the investments.
This class is comprised of hedge funds that invest in a diversified portfolio of debt securities. The hedge funds are not currently eligible for redemption due to imposed lock-up periods of three years from the time of the Company’s initial investment. Once eligible, redemptions will be permitted quarterly with 90 days’ notice. The first investment in the funds will be eligible for redemption in March 2014.
This class is comprised of primarily a fund that provides loans to educational institutions throughout the U.S. and its territories. Through these investments, the Company participates in the performance of the underlying loans. This investment matures when the loans are paid down and cannot be redeemed before maturity.
Certain funds included in other investments may be allowed to invest a portion of their assets in illiquid securities, such as private equity or convertible debt. In such cases, a common mechanism used is a “side-pocket”, whereby the illiquid security is assigned to a separate memorandum capital account or designated account. Typically, the investor loses its redemption rights in the designated account. Only when the illiquid security is sold, or is otherwise deemed liquid by the fund, may investors redeem their interest in the side-pocket.
Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement. The unobservable inputs reflect the Company’s own judgment about assumptions that market participants might use.
The following is a summary of valuation techniques the Company uses to measure fair value by asset and liability classes.
The independent pricing services used by the investment custodian, investment accounting service provider and investment managers obtain actual transaction prices for securities that have quoted prices in active markets. For determining the fair value of securities that are not actively traded, in general, pricing services use “matrix pricing” in which the independent pricing service uses observable market inputs including, but not limited to, reported trades, benchmark yields, broker-dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value. In addition, pricing services use valuation models, using observable data, such as an Option Adjusted Spread model, to develop prepayment and interest rate scenarios. The Option Adjusted Spread model is commonly used to estimate fair value for securities such as mortgage-backed and asset-backed securities.
The Company has categorized all of its investments in equities as Level 1 investments because the fair values of these investments are based on quoted prices in active markets for identical assets or liabilities. Because their fair value estimates are based on observable market data, the Company has categorized its investments in preferred stock as Level 2, with the exception of one investment in preferred stock that has been categorized as Level 3.
The Company has ongoing due diligence processes with respect to funds in which it invests and their managers. These processes are designed to assist the Company in assessing the quality of information provided by, or on behalf of, each fund and in determining whether such information continues to be reliable or whether further review is warranted. Certain funds do not provide full transparency of their underlying holdings; however, the Company obtains the audited financial statements for funds annually, and regularly reviews and discusses the fund performance with the fund managers to corroborate the reasonableness of the reported net asset values. The use of net asset value as an estimate of the fair value for investments in certain entities that calculate net asset value is a permitted practical expedient. While reported net asset value is the primary input to the review, when the net asset value is deemed not to be indicative of fair value, the Company may incorporate adjustments to the reported net asset value (and not use the permitted practical expedient) on an investment by investment basis. These adjustments may involve significant management judgment.
For its investments in private equity funds, the Company measures fair value by obtaining the most recently provided capital statement from the external fund manager or third-party administrator. The funds calculate net asset value on a fair value basis. For all publicly-traded companies within these funds, the Company adjusts the reported net asset value based on the latest share price as of the Company’s reporting date. The Company has classified its investments in private equity funds as Level 3.
The real estate debt fund in which the Company invests has been valued based on the most recent published net asset value. This investment has been classified as Level 3.
The following table presents a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs during the year ended December 31, 2012:
The following table presents a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs during the year ended December 31, 2011:
The Company uses foreign currency forward contracts as part of its overall foreign currency risk management strategy or to obtain exposure to a particular financial market and for yield enhancement. These derivatives were not designated as hedging investments.
The fair value adjustments, determined on acquisition of reinsurance subsidiaries, are based on the estimated timing of loss and loss adjustment expense recoveries and an assumed interest rate equivalent to a risk free rate for securities with similar duration to the reinsurance recoverables acquired plus 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.
At December 31, 2012 and 2011, the Company’s top ten reinsurers accounted for 63.1% and 70.0%, respectively, of reinsurance recoverables (which includes loss reserves recoverable and recoverables on paid losses) and included $194.5 million and $451.3 million, respectively, of IBNR reserves recoverable. With the exception of one BBB+ rated reinsurer from which $37.7 million was recoverable (December 31, 2011: $55.2 million), the other top ten reinsurers, as at December 31, 2012 and 2011, were all rated A- or better. Reinsurance recoverables by reinsurer were as follows:
There can be no assurance that the reserves established by the Company will be adequate or will not be adversely affected by the development of other latent exposures. The Company’s liability for unpaid losses and loss adjustment expenses as of December 31, 2012 and 2011 included $557.6 million and $621.5 million, respectively, that represented an estimate of its net ultimate liability for asbestos and environmental claims. The gross liability for such claims as at December 31, 2012 and 2011 was $628.7 million and $702.8 million, respectively.
The net reduction in case and loss adjustment expense reserves (“LAE reserves”) comprises the movement during the year in specific case reserve liabilities as a result of claims settlements or changes advised to the Company by its policyholders and attorneys, less changes in case reserves recoverable advised by the Company to its reinsurers as a result of the settlement or movement of assumed claims. Net reduction in IBNR represents the change in the Company’s actuarial estimates of losses incurred but not reported, less amounts recoverable.
The net reduction in ultimate loss and loss adjustment expense liabilities for the year ended December 31, 2012 of $241.8 million was attributable to a reduction in estimates of net ultimate losses of $ 221.9 million, a reduction in aggregate provisions for bad debt of $3.1 million and a reduction in estimates of unallocated loss adjustment expense liabilities of $39.3 million, relating to 2012 run-off activity, partially offset by the amortization, over the estimated payout period, of fair value adjustments relating to companies acquired amounting to $22.6 million.
The aggregate reduction in net IBNR reserves of $215.0 million was a result of the application, on a basis consistent with the assumptions applied in the prior period, of the Company’s actuarial methodologies to revised historical loss development data, following 101 commutations, to estimate loss reserves required to cover liabilities for unpaid losses and loss adjustment expenses relating to non-commuted exposures. The prior period
estimate of aggregate net IBNR reserves was reduced as a result of the combined impact on all classes of business of loss development activity during 2012, including commutations and the favorable trend of loss development related to non-commuted policies compared to prior forecasts. The net incurred favorable loss development, excluding the allocation by one of the Company’s insurance entities of $52.4 million from net IBNR reserves to specific net case and LAE reserves, of $6.9 million, resulting from settlement of net advised case and LAE reserves of $317.6 million for net paid losses of $310.7 million, related to the settlement of non-commuted losses in the year and 101 commutations of assumed and ceded exposures. Net incurred liabilities settled by way of commutation during the year ended December 31, 2012 amounted to $26.6 million (comprising $163.1 million of assumed incurred liabilities partially offset by $136.5 million of ceded incurred reinsurance recoverables) compared to the net aggregate reduction in advised case reserves during the same period of $317.6 million (excluding the allocation of $52.4 million from net IBNR reserves to specific net case and LAE reserves).
The reduction in aggregate provisions for bad debt of $42.8 million was a result of the collection, primarily during the three months ended December 31, 2011, of certain reinsurance recoverables against which bad debt provisions had been provided in earlier periods.
The reduction in aggregate provisions for bad debt of $49.6 million was a result of the collection, primarily during the three months ended December 31, 2010, of certain reinsurance recoverables against which bad debt provisions had been provided in earlier periods.
The Company’s long-term debt consists of loan facilities used to partially finance certain of the Company’s acquisitions or significant new business transactions. The Company draws down on the loan facilities at the time of the acquisition or significant new business transaction, although in some circumstances the Company has made additional draw-downs to refinance existing debt of the acquired company. Until they were fully repaid on December 3, 2012, the Company also had loans outstanding relating to the share repurchase agreements described below.
For the years ended December 31, 2012, 2011 and 2010, the Company incurred interest expense of $8.4 million, $8.5 million and $10.3 million, respectively, on its loan facilities and loans related to the share repurchase agreements. All of the Company’s currently outstanding loan facilities are floating rate loans, and the fair values of these loans approximate their book values.
On June 14, 2011, the Company, as borrower, and certain of its subsidiaries, as guarantors, entered into a Revolving Credit Facility Agreement with NAB and Barclays, as bookrunners and mandated lead arrangers, certain financial institutions, as lenders, and NAB as agent (the “EGL Revolving Credit Facility”). The EGL Revolving Credit Facility provides for a three-year revolving credit facility pursuant to which the Company is permitted to borrow up to an aggregate of $250.0 million, which is available to prepay certain existing credit facilities of the Company and certain of its subsidiaries, to fund permitted acquisitions and for general corporate purposes. The Company’s ability to draw on the EGL Revolving Credit Facility is subject to customary conditions.
On December 21, 2012, the Company, through AML Acquisition, entered into a Term Facility Agreement with NAB and Barclays (the “SeaBright Facility”). The SeaBright Facility provides a $111.0 million four-year term loan facility, which AML Acquisition fully drew down on February 5, 2013 to partially fund the Company’s acquisition of SeaBright. The Company acquired SeaBright on February 7, 2013 by way of a merger of AML Acquisition with and into SeaBright (the “Merger”), with SeaBright surviving the Merger as an indirect, wholly-owned subsidiary of the Company.
Following completion of the Merger, SeaBright (as the survivor of the Merger) became the borrower under the SeaBright Facility and the facility became secured by a security interest in all of the assets of SeaBright, a pledge of the stock of SeaBright by its sole stockholder, a pledge of the stock of SeaBright Insurance Company, Paladin Managed Care Services, Inc., and PointSure Insurance Services, Inc. (which are wholly-owned subsidiaries of SeaBright) by SeaBright, and a security interest in all of the assets of Paladin Managed Care Services, Inc. and PointSure Insurance Services, Inc.
During the existence of any payment default, the interest rate will be increased by 1.0%. During the existence of any event of default (as specified in the SeaBright Facility), the lenders may cancel their commitments, declare all or a portion of outstanding amounts immediately due and payable, declare all or a
portion of borrowed amounts payable upon demand, or proceed against the security. The SeaBright Facility terminates and all amounts borrowed must be repaid on December 21, 2016, the fourth anniversary of the date the facility was put in place.
On October 1, 2010, the Company entered into repurchase agreements to repurchase an aggregate of 800,000 of the Company’s ordinary shares at a price of $70.00 per share from three of its executives and certain trusts and a corporation affiliated with the executives. The aggregate purchase price of $56.0 million was payable through promissory notes to the selling shareholders. The annual interest rate on the promissory notes was fixed at 3.5%, and the notes were repayable in three equal installments on December 31, 2010, December 1, 2011 and December 1, 2012. On December 1, 2012, the Company fully repaid the outstanding amount of $19.3 million under the promissory notes, inclusive of accrued interest, relating to the share repurchase.
Issued and fully paid ordinary shares of par value $1.00 each:
On April 20, 2011, the Company entered into an Investment Agreement (the “Investment Agreement”) with GSCP VI AIV Navi, Ltd., GSCP VI Offshore Navi, Ltd., GSCP VI Parallel AIV Navi, Ltd., GSCP VI Employee Navi, Ltd., and GSCP VI GmbH Navi, L.P. (collectively, the “Purchasers”), each of which is an affiliate of
The first closing occurred on April 20, 2011 and involved an issuance of 531,345 voting ordinary shares (“Voting Common Shares”) and 749,869 newly created Series A convertible non-voting preference shares. The Series A convertible non-voting preference shares were automatically converted into 749,869 non-voting ordinary shares (“Non-Voting Common Shares”) upon the receipt of the approval of the Company’s shareholders at the Annual General Meeting on June 28, 2011. At the first closing, the Company also issued to the Purchasers warrants to acquire Series A convertible non-voting preferred shares, which automatically converted to the right to acquire 340,820 Non-Voting Common Shares upon receipt of shareholder approval, for an exercise price of $115.00 per share, subject to certain adjustments. The warrants expire on April 20, 2021. The second and third closings occurred simultaneously on December 22, 2011 and involved an aggregate issuance of 134,184 Voting Common Shares and 1,975,768 Non-Voting Common Shares. All Voting and Non-Voting Common Shares sold to the Purchasers were at a purchase price of $86.00 per share. The total investment made by the Purchasers for the purchase of the Voting Common Shares, the Non-Voting Common Shares and the warrants was approximately $291.6 million. The Company has accounted for the Purchaser’s investment under the Investment Agreement as equity under the applicable U.S. GAAP.
In addition, for the years ended December 31, 2012 and 2011, nil and 50,000 restricted shares, respectively, were awarded under the 2006 Equity Incentive Plan. The total unrecognized compensation cost related to the Company’s non-vested share awards as at December 31, 2012 and 2011 was $7.6 million and $10.4 million, respectively. This cost is expected to be recognized evenly over the next 2.8 years. Compensation costs of $2.8 million, $2.7 million and $1.5 million relating to share awards were recognized in the Company’s statement of earnings for the years ended December 31, 2012, 2011 and 2010.
The accrued expense relating to the 2011 Program for the year ended December 31, 2012 was $29.6 million as compared to $26.7 million and $30.7 million, respectively, for the years ended December 31, 2011 and 2010 for the 2006 Program.
The Company provides pension benefits to eligible employees through various plans sponsored by the Company. All pension plans, except as disclosed below, are structured as defined contribution plans. Pension expense for the years ended December 31, 2012, 2011 and 2010 was $4.5 million, $4.9 million and $3.5 million, respectively.
The Company recorded pension expense relating to the PWAC Plan, for the years ended December 31, 2012 and 2011 and for the period from the date of acquisition to December 31, 2010, of $0.8 million, $0.6 million and $0.6 million, respectively.
On January 1, 2012, S2008 transferred the assets and liabilities relating to its 2009 and prior underwriting years of account into its 2010 underwriting year of account by means of a reinsurance to close transaction. Following the transfer, the existing noncontrolling interest held by JCF FPK I L.P. and J.C. Flowers II L.P. ceased, resulting in the Company now providing 100% of the underwriting capacity for S2008. The Company paid JCF FPK I L.P. and J.C. Flowers II L.P. $24.6 million in settlement of their accumulated noncontrolling interest balances. As at December 31, 2012, $1.1 million remained outstanding and was included in the Company’s balance sheet as part of accounts payable and accrued liabilities; the amount was settled on January 9, 2013.
On December 30, 2012, Varadero International Limited (“Varadero”) acquired from an entity affiliated with Mr. Flowers all of that entity’s interest in Varadero. As of the date of the sale, Varadero was no longer affiliated with Mr. Flowers.
During the years ended December 31, 2012, 2011 and 2010, there were certain reductions to unrecognized tax benefits due to the expiration of statutes of limitations of $nil, $0.1 million and $0.3 million, respectively, which were included in net earnings.
The Company recognizes accrued interest and penalties related to unrecognized tax benefits as a part of income tax expense. During the years ended December 31, 2012, 2011 and 2010, the Company recognized a benefit for the reversal of interest and penalties related to unrecognized tax benefits due to the expiration of the statute of limitations in the amount of $nil, $0.1 million and $0.1 million, respectively. The Company had approximately $1.5 million, $1.2 million and $1.0 million accrued for the payment of interest and penalties related to unrecognized tax benefits at December 31, 2012, 2011 and 2010, respectively.
Through its rules, the FSA sets minimum capital resources requirements for its regulated insurance companies. 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, 2012 and 2011, all of the Company’s U.K. insurance subsidiaries maintained capital in excess of the minimum capital resources requirements (or received a waiver from the FSA from the requirement to remedy any shortfall) and complied with the relevant provisions of GENPRU and INSPRU. The U.K.-based insurance subsidiaries, in aggregate, maintained capital in excess of the minimum capital resources requirements by $426.1 million and $477.1 million as of December 31, 2012 and 2011, respectively.
The Company participates in the Lloyd’s market through its interest in S2008. The Company’s Lloyd’s operations are subject to regulation by the FSA and compliance with the Lloyd’s Act(s) and Byelaws. In order to achieve finality and to release their capital (known as Funds at Lloyd’s), Lloyd’s members are usually required to have transferred their liabilities through an approved RITC, such as offered by S2008. The Lloyd’s market is currently in the Solvency II internal model application process under Lloyd’s supervision. Shelbourne will therefore be required to meet Solvency II standards when they come into effect. The Company’s total capital commitment to S2008 required to be in place by February 28, 2013 was £71.7 million (approximately $116.5 million). The capital commitment was financed from available cash on hand.
The Company’s Australian insurance subsidiary is regulated and subject to prudential supervision by the Australian Prudential Regulation Authority (“APRA”). APRA is the primary regulatory body responsible for regulating compliance with the Insurance Act 1973. APRA’s prudential standards require that all insurers maintain and meet prescribed capital adequacy requirements to enable its insurance obligations to be met under a wide range of circumstances. This requires authorized insurers to hold eligible capital in excess of the minimum capital requirement, which may be determined using the Standard method or an internal model based method. The Company’s Australian insurance subsidiary has adopted the Standard method. An insurer must obtain APRA’s written consent prior to making any planned reductions in its capital, including any payment of dividends. The Company’s insurance subsidiary must provide APRA a valuation prepared by an appointed actuary that demonstrates that the tangible assets of the insurer, after the proposed capital reduction, are sufficient
The Company’s U.S. insurance and reinsurance subsidiaries are subject to the insurance laws and regulations of the states in which they are domiciled, licensed and/or approved to conduct business. These laws restrict the amount of dividends the subsidiaries can pay to the Company. The restrictions are generally based on statutory net income and/or certain levels of statutory surplus as determined in accordance with the relevant statutory accounting requirements of the individual domiciliary states or states in which any of the insurance or reinsurance subsidiaries are domiciled. Generally, prior regulatory approval must be obtained before an insurer may pay a dividend or make a distribution above a specified level.
As of December 31, 2012 and 2011, all of the Company’s U.S. insurance and reinsurance subsidiaries exceeded their required levels of risk-based capital, with the exception of one subsidiary that was acquired whilst under supervision. On an aggregate basis, the U.S.-based insurance and reinsurance subsidiaries (excluding the subsidiary under supervision) exceeded their minimum levels of risk-based capital as of December 31, 2012 and 2011 by $407.2 million and $374.9 million, respectively; the subsidiary under regulatory supervision was below its minimum required risk-based capital level by approximately $10.6 million as of December 31, 2012 (2011: $12.3 million). As a consequence of being under regulatory supervision, the subsidiary’s regulator must approve any and all disbursements, new contracts or agreements. The Company does not believe this subsidiary’s non-compliance presents material risk to the Company’s operations or financial condition.
In addition to Switzerland, the Company has insurance and reinsurance subsidiaries located in Belgium, Denmark, Ireland and Sweden. Each insurance and reinsurance subsidiary is subject to the relevant statutory
regulations, provisions and laws in its respective country that require it to maintain certain measures of solvency and restrict dividend payments. As of December 31, 2012 and 2011, the Company’s subsidiaries located in Belgium, Denmark, Ireland and Sweden exceeded their required levels of solvency. These companies, in aggregate, exceeded minimum solvency requirements by $31.5 million and $34.6 million as of December 31, 2012 and 2011, respectively.
As at December 31, 2012, the total amount of net assets of the Company’s consolidated subsidiaries that were restricted was $617.2 million (2011: $767.1 million).
Rent expense for the years ended December 31, 2012, 2011 and 2010 was $3.9 million, $3.0 million and $2.9 million, respectively.
The following table provides a summary of the Company’s outstanding unfunded investment commitments for the years ended December 31, 2012 and 2011:
The Company is, from time to time, involved in various legal proceedings in the ordinary course of business, including litigation regarding claims. The Company does not believe that the resolution of any currently pending legal proceedings, either individually or taken as a whole, will have a material effect on its business, results of operations or financial condition. Nevertheless, the Company cannot assure you that lawsuits, arbitrations or other litigation will not have a material adverse effect on its business, financial condition or results of operations. The Company anticipates that, similar to the rest of the insurance and reinsurance industry, it will continue to be subject to litigation and arbitration proceedings in the ordinary course of business, including litigation generally related to the scope of coverage with respect to asbestos and environmental claims. There can be no assurance that any such future litigation will not have a material adverse effect on the Company’s business, financial condition or results of operations.
In our opinion, Enstar Group Limited maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.