The table below summarizes the total number of employees we had as at December 31, 2013 by operating segment:
Upon completion of the Torus acquisition, we expect our total number of employees to increase by approximately 600 to 1,339. All of these new employees will be included as part of our active underwriting segment.
Our primary corporate objective is growing our net book value per share. We believe this is driven primarily by growth in our net earnings, which is in turn driven in large part by successfully completing new acquisitions, effectively managing companies and portfolios of business that we have acquired, and executing on our active underwriting strategies. Our growth in book value per share on a fully diluted basis since becoming a public company on January 31, 2007 is set forth in the table below. We have achieved a compounded annual growth rate on our fully diluted book value per share of approximately 18.6% during this time.
During the year ended December 31, 2013, we increased our book value per share on a fully diluted basis by 12.8% to $105.20 per share. We grow our book value primarily in the following ways:
earning premiums in excess of related losses for our life and annuities and active underwriting segments (although during 2013 we also earned premiums in our non-life run-off segment as we implemented the run-off process at SeaBright) (net premiums earned);
earning fees and commission income by providing expert run-off management services for a fixed and/or incentive based fee in our non-life run-off segment, and by providing managing general agency services through Atrium in our active underwriting segment (fees and commission income); and
managing our expenses as we continue to grow our operations (expenses).
Net ultimate losses and loss adjustment expense liabilities established by management utilizing analysis performed by independent actuaries prepared on an annual basis are reviewed by our management each quarter. Reserves reflect management’s best estimate of the remaining unpaid portion of these liabilities. Prior period estimates of net ultimate losses and loss adjustment expense liabilities may change as our management considers the combined impact of commutations, policy buy-backs, settlement of losses on carried reserves and the trend of incurred loss development compared to prior forecasts. Net reductions in ultimate losses and loss adjustment expense liabilities are reported as negative expenses by us. For more information on how the reserves are calculated, see “- Critical Accounting Policies - Losses and Loss Adjustment Expenses” on page 60.
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 maturities 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 and available-for-sale securities and other investments. We recognize realized gains and losses at the time of sale, and they, along with the changes in fair value of our trading and available-for-sale 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 maturities 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.
General and administrative expenses include rent and rent-related costs, professional fees (legal, investment, audit and actuarial) and travel expenses. We have operations in multiple jurisdictions and our employees travel frequently in connection with the search for acquisition opportunities and in the general management of the business.
The most significant liability and asset of an acquired company are typically the liability for losses and loss adjustment expenses and the asset related to any reinsurance balances recoverable on these liabilities that may be contractually due to the acquired entity. The market for acquisition of run-off companies is not sufficiently active and transparent to enable us to identify reliable, market exit values for acquired assets and liabilities. Accordingly, consistent with provisions of U.S. GAAP, we have developed internal models that we believe allow us to determine fair values that are reasonable proxies for market exit values. We are familiar with the major participants in the acquisition run-off market and believe that the key assumptions we make in valuing acquired assets and liabilities are consistent with the kinds of assumptions made by such market participants. Furthermore, in our negotiation of purchase prices with sellers, it is frequently clear to us that other bidders in the market are using models and assumptions similar in nature to ours during the competitive bid process. The majority of acquisitions are completed following a public tender process whereby the seller invites market participants to provide bids for the target acquisition.
We account for acquisitions using the purchase method of accounting, which requires that the acquirer record the assets and liabilities acquired at their estimated fair value. The fair values of each of the insurance and reinsurance assets and liabilities acquired are derived from probability-weighted ranges of the associated projected cash flows, based on actuarially prepared information and management’s run-off strategy. Our run-off strategy, as well as that of other run-off market participants, is expected to be different from the seller’s as generally sellers are not specialized in running off insurance and reinsurance liabilities whereas we and other market participants do specialize in such run-offs.
effect of shortening the life, and therefore the cost, of the run-off), the success of this strategy is far from certain. Therefore, the estimates of unallocated loss adjustment expenses are based on running off the liabilities and assets over the actuarially projected life of the run-off. In those domiciles where solvent schemes of arrangement are available, management’s estimates of the total unallocated loss adjustment expenses are probability-weighted in accordance with the estimated time that a solvent scheme of arrangement could be completed, which has the effect of reducing the period of the run-off and the related unallocated loss adjustment expenses. For those acquisitions in domiciles where solvent schemes of arrangement are not available, the unallocated loss adjustment expenses are estimated over the projected life of the run-off.
The following table provides a breakdown of losses and loss adjustment expense reserves (net of reinsurance balances recoverable) by type of exposure as of December 31, 2013 and 2012:
As of December 31, 2013, the IBNR reserves (net of reinsurance balances receivable) accounted for $962.6 million, or 33.4%, of our total net losses and loss adjustment expenses. The reserve for IBNR (net of reinsurance balance receivable) accounted for $939.7 million, or 33.7%, of our total net loss reserves at December 31, 2012.
Where we provide reinsurance or retrocession reinsurance protection, the process of claims 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-U.S. domicile are assumed to have a greater time lag than portfolios written from a U.S.-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.
The ranges of gross losses and loss adjustment expense reserves implied by the various methodologies used by each of our non-life insurance and reinsurance subsidiaries as of December 31, 2013 were:
Furthermore, because of the reinsurance nature of the claims we manage, we focus on the activities at the reinsured level rather than at the individual claims level. The counterparties with whom we typically interact are generally insurers or large industrial concerns and not individual claimants. Claims do not follow any consistent pattern. They arise from many insureds or locations and in a broad range of circumstances. An insured may present one large claim or hundreds or thousands of small claims. Plaintiffs’ counsel frequently aggregate thousands of claims within one lawsuit. The deductibles to which claims are subject vary from policy to policy and year to year. Often claims data is only available to reinsurers, such as us, on an aggregated basis. Accordingly, we have not found claim count information or average reserve amounts to be reliable indicators of exposure for our reserve estimation process or for management of our liabilities. We have found data
2. Paid Market Share Method. In this method, our estimated market share is applied to the industry estimated unpaid losses or estimate of industry ultimate. The ratio of our historical calendar year payments to industry historical calendar year payments is examined to estimate our market share. This ratio is then applied to the estimate of industry unpaid losses or estimate of industry ultimate. Each year, calendar year payment data is updated (for both us and industry), estimates of industry unpaid losses are reviewed and the selection of our estimated market share is revisited. This method has the advantage that trends in calendar year market share can be incorporated into the selection of company share of remaining market payments. A potential disadvantage of this method is that it is particularly sensitive to assumptions regarding the time-lag between industry payments and our payments.
Under the Paid Survival Ratio Method, the Paid Market Share Method and the Reserve-to-Paid Method, we first determine the estimated total reserve and then deduct the reported outstanding case reserves to arrive at an estimated IBNR reserve. The IBNR:Case Ratio Method first determines an estimated IBNR reserve which is then added to the advised outstanding case reserves to arrive at an estimated total loss reserve. The Ultimate-to-Incurred Method first determines an estimate of the ultimate losses to be paid and then deducts paid-to-date losses to arrive at an estimated total loss reserve and then deducts outstanding case reserves to arrive at the estimated IBNR reserve. In the decay factor method, an initial payment is selected and reserves are estimated directly from the projection of future payments.
As of December 31, 2013, we had 30 separate insurance and/or reinsurance subsidiaries whose reserves are categorized into approximately 259 reserve categories in total, including 33 distinct asbestos reserving categories and 23 distinct environmental reserving categories.
To the extent that data availability allows, the six methodologies described above are applied for each of the 33 asbestos reserving categories and each of the 23 environmental reserving categories. As is common in actuarial practice, no one methodology is exclusively or consistently relied upon when selecting a recorded reserve. Consistent reliance on a single methodology to select a recorded reserve would be inappropriate in light of the dynamic nature of both the A&E liabilities in general, and our actual exposure portfolios in particular.
The following tables provide a summary of the impact of changes in industry ultimate losses, from the selected $74 billion for asbestos and $40 billion for environmental, and changes in the time-lag, from the selected averages of 2.8 years for asbestos and 2.2 years for environmental, for us behind industry development that it is assumed relates to our insurance and reinsurance companies. Please note that the table below demonstrates sensitivity to changes to key assumptions using methodologies selected for determining loss and allocated loss adjustment expenses, or ALAE, at December 31, 2013 and differs from the table on page 64, which demonstrates the range of outcomes produced by the various methodologies.
As with all assumptions, these assumptions are revisited each year. Historically, asbestos and environmental ultimates, as advised by industry publications, were used as the proxy for our industry ultimate. As such, $65.0 billion and $38.5 billion were used in 2012 as the proxy for the industry asbestos and environmental ultimates. Due to the inability of our external actuaries to review the data, methodologies and calculations supporting those industry published estimates, our external actuaries themselves have estimated ultimate industry losses using the techniques described starting on page 67. These techniques allow our external actuaries to better monitor the impact on us of the selected asbestos and environmental ultimate loss assumptions on an annual basis and also allow them to monitor industry payments against expectations. The change in assumptions had no material impact on the estimate of our A&E reserves. The assumption regarding loss reporting lag described on this page has not changed.
5. Reserve Run-off Method. This method first projects the future values of case reserves for all underwriting years to future ages of development. This is done by selecting a run-off pattern of case reserves. The selected case run-off ratios are chosen based on the observed run-off ratios at each age of development. Once the ratios have been selected, they are used to project the future values of case reserves. A paid on reserve factor is selected in a similar way. The ratios of the observed amounts paid during each development period to the respective case reserves at the beginning of the periods are used to estimate how much will be paid on the case reserves during each development period. These paid on reserve factors are then applied to the case reserve amounts that were projected during the first phase of this method. A summation of the resulting paid amounts yields an estimate of the liability. The Reserve Run-off Method works well when the historical run-off patterns are reasonably stable and when case reserves ultimately show a decreasing trend. Another strength of this method is that it only requires case reserves at a given point in time and incremental paid and incurred losses after that point, meaning that it can be applied in cases where full loss history is not available. In cases of volatile data where there is a persistent increasing trend in case reserves, this method will fail to produce a reasonable estimate. In several cases, reliance upon this method was limited due to this weakness.
ultimate losses as it deems necessary. Historically, we have not deviated from the recommendations of our independent actuaries. Paid-to-date losses are then deducted from the estimate of ultimate losses to arrive at an estimated total loss reserve, and reported outstanding case reserves are then deducted from estimated total loss reserves to calculate the estimated IBNR reserve.
Our quarterly paid and incurred loss development is often driven by large, “wholesale” settlements - such as commutations and policy buy-backs - which settle many individual claims in a single transaction. This allows for monitoring of the potential profitability of large settlements, which, in turn, can provide information about the adequacy of reserves on remaining exposures that have not yet been settled. For example, if it were found that large settlements were consistently leading to large negative, or favorable, incurred losses upon settlement, it might be an indication that reserves on remaining exposures are redundant. Conversely, if it were found that large settlements were consistently leading to large positive, or adverse, incurred losses upon settlement, it might be an indication - particularly if the size of the losses were increasing - that certain loss reserves on remaining exposures are deficient. Moreover, removing the loss development resulting from large settlements allows for a review of loss development related only to those contracts that remain exposed to losses. Were this not done, it is possible that savings on large wholesale settlements could mask significant underlying development on remaining exposures.
The following table provides a breakdown of the total liability for losses and loss adjustment expenses by type of exposure for the year ended December 31, 2013 (for the year ended December 31, 2012 we did not have an active underwriting segment).
The reserve for losses and loss expenses is reviewed on a quarterly basis. Each quarter, paid and incurred loss development is reviewed to determine whether it is consistent with expected development. Loss development is examined separately by class of business, and large individual losses or loss events are examined separately from regular attritional development. Discussions are held with appropriate personnel including underwriters, claims adjusters, actuaries, accountants and attorneys to fully understand quarterly loss development and implications for the quarter-end reserve balances. Based on analysis of the loss development data and the associated discussions, management determines whether any adjustment is necessary to quarter-end reserve balances.
Our policy benefits for life and annuity contracts (or policy benefits) are estimated using standard actuarial techniques and cash flow models in accordance with the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 944, Financial Services - Insurance. We establish and maintain our policy benefits at a level that we estimate will, when taken together with future premium payments and investment income expected to be earned on associated premiums, be sufficient to support all future cash flow benefit obligations and third party servicing obligations as they become payable. We review our policy benefits regularly and perform loss recognition testing based upon cash flow projections.
Since the development of the policy benefits is based upon cash flow projection models, we must make estimates and assumptions based on experience and industry mortality tables, longevity and morbidity rates, lapse rates, expenses and investment experience, including a provision for adverse deviation. The assumptions used to determine policy benefits are determined at the inception of the contracts, reviewed and adjusted at the point of acquisition as required, and are locked-in throughout the life of the contract unless a premium deficiency develops. The assumptions are reviewed no less than annually and are unlocked if they would result in a material adverse reserve change. We establish these estimates based upon transaction-specific historical experience, information provided by the ceding company for the assumed business and industry experience. Actual results could differ materially from these estimates. As the experience on the contracts emerges, the assumptions are reviewed by management. We determine whether actual and anticipated experience indicates that existing policy benefits, together with the present value of future gross premiums, are sufficient to cover the present value of future benefits, settlement and maintenance costs and to recover unamortized acquisition costs. If such a review
In addition to the acquired retrocessional agreements, on an annual basis, Atrium purchases a tailored outwards reinsurance program designed to manage its risk profile. The majority of Atrium’s total third party reinsurance cover is with Lloyd’s Syndicates or other reinsurers rated A- or better.
Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
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-
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.
For our investments in fixed income hedge funds, we measure fair value by obtaining the most recently published net asset value as advised by the external fund manager or third-party administrator. The investments in the funds are classified as Level 3.
As at December 31, 2013, five of our funds with a market value of $3.2 million included in other investments were subject to gates or had side-pockets. These investments are all subject to liquidation. There is, however, no significant uncertainty in relation to the valuation of these investments.
Goodwill represents the excess of the purchase price over the fair value of the net assets acquired. We perform an initial valuation of our goodwill assets and assess goodwill for impairment on an annual basis. If, as a result of the assessment, we determine the value of our goodwill asset is impaired, goodwill is written down in the period in which the determination is made. As at December 31, 2013, no impairment has been recorded as a result of our assessment.
Intangible assets represent the fair value adjustments related to unpaid losses and loss expenses, reinsurance balances recoverable and policy benefits for life and annuity contracts along with the fair values of Lloyd’s syndicate capacity, customer relationships, management contract and brand arising from the acquisition of Atrium. Definite-lived intangible assets are amortized over their estimated useful lives. We recognize the amortization of all intangible assets in our consolidated statement of earnings. Indefinite-lived intangible assets are not subject to amortization. The carrying values of intangible assets are reviewed for indicators of impairment on at least an annual basis. Impairment is recognized if the carrying values of the intangible assets are not recoverable from their undiscounted cash flows and are measured as the difference between the carrying value and the fair value.
In connection with the Trident co-investments in our acquisitions of Arden and Atrium, certain subsidiaries have issued shares to a noncontrolling interest (and will issue shares to a noncontrolling interest in connection with the Torus acquisition). These shares are subject to agreements that provide the holder with certain redemption rights. The interests are presented on the balance sheet outside of equity under the caption “redeemable noncontrolling interests” and are carried at fair value. Noncontrolling interests that do not contain such redemption features are presented in equity. We recognize changes in the fair value that exceed the carrying value of redeemable noncontrolling interest through retained earnings as if the balance sheet date were also the redemption date.
Net premiums earned - Combined net premiums earned for our three operating segments were $239.8 million and $3.5 million for the years ended December 31, 2013 and 2012, respectively. The significant increase in 2013 was due to the acquisitions of SeaBright, Pavonia, Arden and Atrium.
Net reduction in ultimate losses and loss adjustment expense liabilities - these are comprised of the results of our non-life run-off and active underwriting segments.
Active underwriting segment results related to losses incurred for Arden and Atrium of $19.4 million and are described in the active underwriting discussion below.
Salaries and benefits - Salaries and benefits were $124.6 million and $100.5 million for the years ended December 31, 2013 and 2012, respectively. The increase of $24.1 million was primarily due to: (i) the salaries and benefits costs associated with the SeaBright, Pavonia and Atrium acquisitions (we did not acquire any employees in the Arden acquisition) and (ii) an increase of $2.5 million in our 2013 bonus accrual of $32.1 million (2012: $29.6 million) relating to increased net earnings for the year ended December 31, 2013 and a bonus accrual rate of 13.3% of pre-bonus net after-tax profits under our annual incentive compensation program (2012: 15%).
Noncontrolling interest - Noncontrolling interest in earnings decreased by $8.3 million to $15.2 million as a result of lower earnings in those companies in which there are either noncontrolling interests or redeemable noncontrolling interests.
Overall, net earnings attributable to Enstar Group Limited increased by $40.6 million, or 24.2%, from $168.0 million for the year ended December 31, 2012 to $208.6 million for the year ended December 31, 2013.
We reported consolidated net earnings, before net earnings attributable to noncontrolling interest, of approximately $191.5 million and $208.5 million for the years ended December 31, 2012 and 2011, respectively. The decrease in earnings of approximately $17.0 million was attributable primarily to the following:
(iv) a lower net reduction in ultimate losses and loss adjustment expense liabilities of $55.5 million;
(vii) an increase in salaries and benefits costs of $10.6 million due primarily to an increase in salary costs for our U.S. operations along with an increase in our discretionary bonus plan as a result of an increase in net earnings for the year; and
(viii) a decrease in fees and commission income of $9.3 million due to lower revenue from incentive-based fee arrangements.
The current operations of one of the Pavonia companies relate solely to the assumption of a closed block of structured settlement, lottery, and other immediate annuities (also known as the periodic payment annuity, or PPA, business). The company no longer writes new business. Reserves relating to the PPA business constitute approximately 80% of the aggregate reserves acquired in the Pavonia acquisition. The contracts within the portfolio are largely structured settlements, although the portfolio also includes a smaller amount of lottery annuities and supplementary contracts.
The PPA business was issued from 1982 to 1995, although the majority of the reserves pertain to the period from 1985 to 1989. The contracts within the portfolio operate pursuant to a variety of different payment features, such as life contingency payments, certain payments (or a combination thereof), one-time lump payments, or payments patterns such as level, compound increase or fixed amount increase payments. Regardless of payment structure, however, the portfolio generally has known and predictable cash flows, which makes the asset liability matching process and the mitigation of interest rate risk a vital component to our management of this portfolio. We have a long duration held-to-maturity investment portfolio designed to manage the cash flow obligations of the PPA business.
The other operations of the acquired Pavonia companies relate to non-annuity portfolios, which include credit life and disability insurance, term life insurance, and corporate owned life insurance and assumed reinsurance of term and ordinary life and accidental death and dismemberment products. This business is significantly shorter in duration than that of the PPA business and, given the premium income associated with these portfolios, the reserves (based upon net present value of future cash flows) remain highly sensitive to lapse rates as well as mortality rates.
Atrium is an underwriting business at Lloyd’s of London, which manages Syndicate 609 and provides approximately 25% of the syndicate’s underwriting capacity and capital (with the balance provided by traditional Lloyd’s Names). Atrium specializes in accident and health, aviation, marine, property, non-marine property, professional liability, property and casualty binding authorities, reinsurance, upstream energy, war and terrorism insurance, cargo and fine art.
(iv) an increase in fees and commission income of $3.5 million;
(vi) a net foreign exchange gain of $5.9 million for the year ended December 31, 2013, which was a $6.6 million increase from the net foreign exchange loss for the same period in 2012; partially offset by
(ix) a decrease in net investment income of $12.8 million; and
We reported consolidated net earnings, before net earnings attributable to noncontrolling interest, of approximately $187.4 million and approximately $191.1 million for the years ended December 31, 2012 and 2011, respectively. The decrease in earnings of approximately $3.7 million was attributable primarily to the factors described in the consolidated results discussion on page 82. All of our results of operations for 2012 and 2011, other than those related to Laguna Life Limited, or Laguna, were reported within our non-life run-off segment. Amounts related to 2012 and 2011 operating results of Laguna have been reclassified to conform to the current period presentation.
Our gross premiums earned totaled $124.3 million from the date of acquisition to December 31, 2013. Ceded reinsurance premiums earned from the date of acquisition to December 31, 2013 were $11.7 million. Accordingly, net non-life run-off premiums earned totaled $112.6 million. With SeaBright no longer generating written premiums, we expect that the remaining unearned premiums of $1.2 million as at December 31, 2013 will be realized and fully earned by the second quarter of 2014. We separately recorded acquisition costs from the date of acquisition to December 31, 2013 of approximately $14.4 million associated with the premiums earned by SeaBright.
Our management companies earned fees and commission income of approximately $9.3 million and $17.9 million for the years ended December 31, 2012 and 2011, respectively. The decrease in fees and commission income of $8.6 million related primarily to the decrease in management fees earned from third-party agreements.
Net investment income for the year ended December 31, 2013 decreased by $12.8 million to $64.0 million, as compared to $76.8 million for the year ended December 31, 2012. The decrease was primarily a result of lower yields obtained on our cash and fixed income portfolios, as securities with higher yields matured and were reinvested at lower yields. This decrease is partially offset by net investment income attributable to higher cash and investment balances due to the SeaBright acquisition, which closed on February 7, 2013.
(ii) An increase of $16.7 million in net unrealized and realized gains due to greater amounts invested in, and improved performance of, our equity portfolios; partially offset by
Net investment income for the year ended December 31, 2012 increased by $10.2 million to $76.8 million, as compared to $66.6 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.
(iii) an increase of $30.2 million in returns from other investments due to increases in global equity and fixed income markets, combined with greater amounts invested in those asset classes in 2012.
The below table presents the annualized investment returns (inclusive of net investment income and net realized and unrealized gains) that we have earned on our average cash and investments for the years ended December 31, 2013, 2012 and 2011:
The net reduction in ultimate losses and loss adjustment expense liabilities for the year ended December 31, 2013 of $183.0 million included current period incurred losses of $74.1 million related to SeaBright. Excluding SeaBright’s current period incurred losses of $74.1 million, ultimate losses and loss adjustment expenses relating to prior periods were reduced by $257.1 million, which was attributable to a reduction in estimates of net ultimate losses of $215.5 million and a reduction in provisions for unallocated loss adjustment expense liabilities of $49.6 million, relating to 2013 run-off activity, partially offset by an increase in provisions for bad debt of
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 $3.1 million, resulting from settlement of net advised case and LAE reserves of $317.6 million for net paid losses of $314.5 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).
Of the 101 commutations completed, three related to our top ten insured and/or reinsured exposures, and one related to our top ten ceded reinsurance assets, all four of which commutations were completed in the three months ended June 30, 2012. The remaining 97 commutations, of which approximately 33% were completed during the three months ended December 31, 2012, were of a smaller size, consistent with our approach of targeting significant numbers of cedant and reinsurer relationships, as well as targeting significant individual cedant and reinsurer relationships. The combination of the claims settlement activity in 2012, including commutations, and the actuarial estimation of net IBNR reserves required for the remaining non-commuted exposures (which took into account the favorable trend of loss development in 2012 related to such exposures compared to prior forecasts), resulted in our management concluding that the loss development activity that occurred subsequent to the prior reporting period provided sufficient new information to warrant a reduction in net IBNR reserves of $215.0 million (excluding the allocation of $52.4 million from net IBNR reserves to specific net case and LAE reserves) in 2012.
The reduction in aggregate provisions for bad debt of $3.1 million was a result of the collection of certain reinsurance recoverables against which bad debt provisions had been provided in earlier periods.
(1) We have reclassified outstanding losses and loss adjustment expense liabilities of $11.0 million and $10.8 million to policy benefits for life and annuity contracts as at January 1, 2013 and 2012, respectively, to conform to the current period presentation. These amounts are associated with Laguna, which now forms part of our life and annuities segment that was established following the acquisition of Pavonia.
(i) increased staff costs due to an increase in our average headcount from 392 in 2012 to 559 in 2013, primarily attributable to staff acquired on completion of the SeaBright acquisition; and
(ii) an increase in our bonus provision of $1.8 million. Expenses relating to our annual incentive compensation program will be variable and are dependent on our overall profitability.
Salaries and benefits, which include expenses relating to our discretionary bonus and employee share plans, were $99.3 million and $89.4 million for the years ended December 31, 2012 and 2011, respectively.
(i) an increase in the discretionary bonus provision of $2.3 million due to the increase in net earnings for the year ended December 31, 2012 as compared to 2011.
General and administrative expenses increased by $12.2 million from $55.7 million to $68.0 million during the year ended December 31, 2013, as compared to the year ended December 31, 2012. The increase in expenses in 2013 related primarily to:
Interest expense of $8.4 million and $8.5 million was recorded for the years ended December 31, 2012 and 2011, respectively. The decrease in interest expense was attributable primarily to the lower interest rates on the loan facilities outstanding during the year ended December 31, 2012 as compared to the same period in 2011.
We recorded income tax expense of $34.2 million and $44.3 million for the years ended December 31, 2013 and 2012, respectively.
The effective tax rate was 13.9% for the year ended December 31, 2013 compared with 18.8% for the year ended December 31, 2012. In 2013, we had proportionately lower net income in our tax paying subsidiaries than in the previous year.
For our life and annuities business, our strategy differs from our non-life run-off and active underwriting businesses, in particular because we are unable to shorten the duration of the liabilities in these businesses through either commutations or policy buy backs. Instead, we will hold the policies associated with the life and annuities business to their natural maturity in order to pay claims as they fall due.
Net investment income for the years ended December 31, 2013 and 2012 was $30.2 million and $0.9 million, respectively. The increase was primarily due to the inclusion of the cash and fixed income securities associated with the acquisition of the Pavonia companies on March 31, 2013.
Life and annuity policy benefits were $78.4 million and ($0.3) million for the years ended December 31, 2013 and 2012, respectively. PPA benefits paid during the year ended December 31, 2013 were $37.5 million, which was an average of approximately $4.2 million per month, offset by a reduction in PPA benefit reserves of $19.3 million. Net ultimate change in life benefit reserves of $60.1 million was comprised of net life claims benefits paid of $64.3 million and amortization of fair value adjustments of $11.3 million, partially offset by net change in life claims benefit reserves of $15.4 million.
Life and annuity policy benefits for 2012 and 2011 related to the Laguna term life business.
For our active underwriting segment, we reported consolidated net earnings attributable to Enstar Group Limited, before net earnings attributable to noncontrolling interest, of approximately $6.8 million from the dates of the acquisitions of Atrium and Arden to December 31, 2013.
(i) net underwriting result of $12.9 million (net premiums earned of $32.2 million less $19.3 million in losses incurred);
Noncontrolling interest in earnings of $3.1 million related to Trident’s 40% interest in the earnings of Atrium and Arden, resulting in net earnings from active underwriting attributable to Enstar Group Limited of $3.7 million for the year ended December 31, 2013.
For 2014, we expect the income and expenses associated with the active underwriting segment to increase over 2013 levels as a result of us having a full year’s results for our recently completed acquisitions of Atrium and Arden, along with a partial year’s results relating to Torus once acquired. Earnings attributable to noncontrolling interest in 2014 will be dependent on the level of combined earnings for Atrium, Arden and Torus. We also expect interest expense to increase in 2014 from 2013, largely due to increased borrowings under our revolving credit facility related to acquisition activity in this segment.
Our future cash flows depend upon the availability of dividends or other statutorily permissible payments from our subsidiaries. The ability to pay dividends and make other distributions is limited by the applicable laws and regulations of the jurisdictions in which our insurance and reinsurance subsidiaries operate, including Bermuda, the United Kingdom, the United States, Australia and Europe, which subject these subsidiaries to significant regulatory restrictions. These laws and regulations require, among other things, certain of our insurance and reinsurance subsidiaries to maintain minimum capital resources requirements and limit the amount of dividends and other payments that these subsidiaries can pay to us, which in turn may limit our ability to pay dividends and make other payments. For more information on these laws and regulations, see “Business - Regulation” beginning on page 24.
We expect to use funds acquired from cash and investment portfolios, collected premiums, collections from reinsurance debtors, fees and commission income, investment income and proceeds from sales and redemptions of investments, to meet expected claims payments and operational expenses with the remainder used for acquisitions and additional investments. We expect a net use of cash from operations as total net claim payments, losses incurred on earned premiums and operating expenses will generally be in excess of investment income earned and collected premiums. We expect our operating cash flows, together with our existing capital base and cash and investments acquired on the acquisition of our insurance and reinsurance subsidiaries, to be sufficient to meet cash requirements and to operate our business. We currently do not intend to pay dividends on our ordinary shares.
At December 31, 2013, we had total cash and cash equivalents, restricted cash and cash equivalents and investments of $6.56 billion, compared to $4.31 billion at December 31, 2012. Our cash and cash equivalent portfolio is comprised mainly of cash, high-grade fixed deposits, commercial paper with maturities of less than three months and money market funds.
Our acquired insurance and reinsurance subsidiaries, prior to acquisition, used retrocessional agreements to reduce their exposure to the risk of insurance and reinsurance assumed. Our insurance and reinsurance subsidiaries remain liable to the extent that retrocessionaires do not meet their obligations under these agreements, and therefore, we evaluate and monitor concentration of credit risk among our reinsurers. Provisions are made for amounts considered potentially uncollectible.
At December 31, 2013 and 2012, the provision for uncollectible reinsurance recoverable relating to reinsurance balances recoverable was $338.6 million and $343.9 million, respectively. To estimate the provision for uncollectible reinsurance recoverable, the balances are first allocated to applicable reinsurers which involves management judgment. As part of this process, ceded IBNR reserves are allocated by reinsurer. The ratio of the provision for uncollectible reinsurance recoverable to total reinsurance balances recoverable (excluding provision for uncollectible reinsurance recoverable) as of December 31, 2013 decreased to 19.9% as compared to 23.4% as of December 31, 2012, primarily as a result of reinsurance balances recoverable of companies acquired during the year requiring minimal provisions for uncollectible reinsurance recoverable.
See “Item 8. Financial Statements and Supplementary Data - Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2012 and 2011” for further information.
Net cash used in our operating activities for the year ended December 31, 2013 was $62.4 million compared to $187.4 million for the year ended December 31, 2012. This $125.0 million decrease in cash used in operating activities was due primarily to the following:
Net cash used in our operating activities for the year ended December 31, 2012 was $187.4 million compared to $909.9 million for the year ended December 31, 2011. This $722.6 million decrease in cash used in operating activities was due primarily to the following:
(iii) an increase of $189.8 million in the purchase of other investments between 2012 and 2011 due to the increased allocation to other investments during 2012; partially offset by
(i) an increase of $369.8 million in cash received attributable to bank loans between 2013 and 2012, and a decrease of $95.0 million in the repayment of bank loans between 2013 and 2012;
Net cash (used in) provided by financing activities was $(233.8) million during the year ended December 31, 2012 compared to $259.8 million during the year ended December 31, 2011. This $493.5 million increase in cash used in financing activities was primarily attributable to the following:
(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
We hold trading portfolios of fixed maturities, short-term investments and equities; available-for-sale portfolios of fixed maturities and short-term investments; and a held-to-maturity portfolio of fixed maturities. Our available-for-sale and trading portfolios are recorded at fair value.
Our held-to-maturity portfolio relates to our PPA business within our life and annuities segment. In an effort to match the expected cash flow requirements of the long-term liabilities associated with the business, we invest a portion of our fixed maturity investments in longer duration securities that we intend to hold to maturity. We classify these securities as held-to-maturity in our consolidated balance sheet. This held-to-maturity portfolio is recorded at amortized cost. As a result, we do not record changes in the fair value of this portfolio, which should reduce the impact on shareholders’ equity of fluctuations in fair value of those investments.
As at December 31, 2013, we held investments on our balance sheet totaling $5.52 billion, compared to $3.35 billion at December 31, 2012, with net unrealized appreciation included in accumulated comprehensive
income of $3.1 million compared to $5.7 million at December 31, 2012. As at December 31, 2013, we had approximately $2.9 billion of restricted assets compared to approximately $1.03 billion at December 31, 2012 due to 2013 acquisition activity.
For our non-life run-off segment, 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 investments, highly rated sovereign and supranational investments, high-grade corporate investments, and mortgage-backed and asset-backed investments. We allocate a portion of our investment portfolio to other investments, including private equity funds, fixed income funds, fixed income hedge funds, equity funds and a real estate debt fund. At December 31, 2013, these other investments totaled $569.3 million, or 10.3%, of our total balance sheet investments (December 31, 2012: $414.8 million or 12.4%).
For our life and annuities segment, we do not commute our policy benefits for life and annuity contracts liabilities and, as a result, we maintain a longer duration investment portfolio that attempts to match the cash flows and duration of our liability profile. Accordingly, the majority of this portfolio consists of highly rated fixed maturity investments, primarily corporate bonds.
Our fixed maturity investments associated with our PPA business are primarily highly rated corporate bonds with which we attempt to match duration and cash flows to the liability profile for this business. As these fixed maturity investments are classified as held-to-maturity, we invest surplus cash flows from maturities into longer dated fixed maturities. As at December 31, 2013, the duration of our fixed maturity investment portfolio associated with our PPA business was shorter than the liabilities, as a significant amount of the liabilities extend beyond 30 years and it is difficult, due to limited investment options, to match duration and cash flows beyond that period.
Our fixed maturity investments associated with our non-PPA life business are primarily highly rated corporate bonds with which we attempt to match duration and cash flows to the liability profile for this business (the non-PPA life business has a short-duration liability profile). These fixed maturity investments are classified as trading, and therefore we may sell existing securities to buy higher yielding securities and funds in the future. As at December 31, 2013, the duration of our fixed maturity investment portfolio associated with our non-PPA life business was shorter than the liabilities, although we have the discretion to change this in the future.
As at December 31, 2013 and 2012, our fixed maturity investments and short-term investment portfolio had an average credit quality rating of A+ and AA-, respectively. At December 31, 2013 and 2012, our fixed maturity investments rated BBB or lower comprised 9.5% and 11.3% of our total investment portfolio, respectively.
At December 31, 2013, we had $313.5 million of short-term investments (December 31, 2012: $319.1 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.
At December 31, 2013 and 2012, our gross unrealized losses on our available-for-sale investments totaled $0.4 million and $0.7 million, respectively. At December 31, 2013 and 2012, we held 2 and 23, respectively, available-for-sale investments that were in an unrealized loss position for longer than twelve months. As at December 31, 2013 and 2012, no investments were considered other-than-temporarily impaired.
As at December 31, 2013 and 2012, we had total unfunded capital commitments related to other investments of $114.2 million and $87.6 million, respectively.
Measuring the Fair Value of Other Investments using Net Asset Valuations
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 materially affect the valuation of the investments.
This class primarily comprises a fund that provides loans to educational institutions throughout the U.S. and its territories. Through these investments, we participate in the performance of the underlying loan pools. This investment matures when the loans are paid down and cannot be redeemed before maturity.
Our fixed maturities exposure to Eurozone Governments (which include regional and municipal governments including guaranteed agencies) by maturity date are highlighted in the following table. Our fixed income fund holdings have daily liquidity and are not included in the maturity table below.
For the years ended December 31, 2013, 2012 and 2011, we incurred interest expense of $12.4 million, $8.4 million and $8.5 million, respectively, on our loan facilities and loans related to the share repurchase agreements. All of our currently outstanding loan facilities are floating rate loans, and the fair values of these loans approximate their book values.
On July 8, 2013, we, and certain of our subsidiaries, as borrowers, as well as certain of our subsidiaries, as guarantors, entered into an amendment and restatement of our existing Revolving Credit Facility Agreement with National Australia Bank Limited, or NAB, and Barclays Bank PLC, or Barclays, as mandated lead arrangers, NAB, Barclays and Royal Bank of Canada, as original lenders, and NAB as agent, or the Restated Credit Agreement. The Restated Credit Agreement provides for a five-year EGL Revolving Credit Facility (expiring in July 2018) pursuant to which we are permitted to borrow up to an aggregate of $375.0 million, which is available to fund permitted acquisitions and for general corporate purposes. The previously existing Revolving Credit Facility Agreement had provided for a three-year $250.0 million facility that was set to terminate in June 2014. Our ability to draw on the EGL Revolving Credit Facility is subject to customary conditions.
The EGL Revolving Credit Facility is secured by a first priority lien on the stock of certain of our subsidiaries and certain bank accounts held with Barclays in our name and into which amounts received in respect of any capital release from certain of our subsidiaries are required to be paid. Interest is payable at the end of each interest period chosen by us or, at the latest, each six months. The interest rate is LIBOR plus 2.75%, plus an incremental amount tied to certain regulatory costs, if any, that may be incurred by the lenders. Any unused portion of the EGL Revolving Credit Facility will be subject to a commitment fee of 1.10%. The EGL Revolving Credit Facility imposes various financial and business covenants on us, the guarantors and certain other material subsidiaries, including limitations on mergers and consolidations, acquisitions, indebtedness and guarantees, restrictions as to dispositions of stock and assets, restrictions on dividends and limitations on liens.
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.
On July 31, 2013, we repaid $27.5 million of the outstanding principal on the Clarendon Facility reducing the outstanding principal as of December 31, 2013 to $79.0 million.
From the date of the SeaBright Facility until the draw down on February 5, 2013, the undrawn and uncancelled amount of the SeaBright Facility incurred a fee of 1% per annum. Interest on amounts borrowed under the SeaBright Facility is payable at the end of each interest period chosen by the borrower or, at the latest, each six months. The interest rate is LIBOR plus 2.75% for the first 18 months from February 5, 2013, and increases to LIBOR plus 3.50% thereafter; the interest rate is subject to increase by an incremental amount tied to certain regulatory costs, if any, that may be incurred by the lenders. The SeaBright Facility imposes various financial and business covenants on SeaBright, including limitations on mergers and consolidations, acquisitions, indebtedness and guarantees, restrictions as to dispositions of stock and assets (except for certain permitted dispositions), restrictions on dividends, and limitations on liens. As at December 31, 2013, all of the financial covenants relating to the SeaBright Facility were met.
The amounts in the above table represent our estimates of known liabilities as of December 31, 2013 and do not take into account corresponding reinsurance recoverable amounts that would be due to us. Furthermore, reserves for losses and loss adjustment expenses recorded in the audited consolidated financial statements as of December 31, 2013 are computed on a fair value basis, whereas the expected payments by period in the table above are the estimated payments at a future time and do not reflect the fair value adjustment in the amount payable.
(2) Policy benefits for life and annuity contracts recorded in our audited consolidated balance sheet as at December 31, 2013 of $1,273.1 million are computed on a discounted basis, whereas the expected payments by period in the table above are the estimated payments at a future time and do not reflect a discount of the amount payable.
(3) The acquisition funding does not include the amount associated with the expected future issuance by us of 2,612,346 shares (which will consist of a combination of voting ordinary shares and Series B convertible non-voting preference shares) in relation to the acquisition of Torus.
Consolidated Statements of Earnings for the years ended December 31, 2013, 2012 and
Schedule I - Summary of Investments Other than in Related Parties
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Enstar Group Limited and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement Schedules, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Enstar Group Limited’s internal control over financial reporting as of December 31, 2013, based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 3, 2014 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
In our opinion, such consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of Enstar Group Limited and subsidiaries for the year ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement Schedule II when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein for the year ended December 31, 2011.
With the Company’s 2013 acquisitions of the closed U.S. life and annuity operations of HSBC Holdings plc (“Pavonia”), Arden Reinsurance Company Ltd. (“Arden”) and Atrium Underwriters Ltd. (“Atrium”), it now measures the results of its operations in three segments: (i) non-life run-off; (ii) life and annuities; and (iii) active underwriting. The Company’s non-life run-off segment comprises the operations and financial results of those subsidiaries acquired for the purpose of running off their property and casualty business, this segment also includes the discontinued business of Arden. The Company’s life and annuities is comprised primarily of Pavonia, which operates a closed block of life and annuity business. The Company’s active underwriting segment is comprised of Atrium and Arden’s reinsurance of Atrium. Atrium is an underwriting business at Lloyd’s of London, which manages Syndicate 609 and provides one quarter of the syndicate’s capital. The syndicate provides insurance and reinsurance on a worldwide basis.
Certain reclassifications have been made to the prior year reported amounts to conform to the current year presentation. These reclassifications had no impact on net earnings previously reported.
The consolidated financial statements include the assets, liabilities and results of operations of the Company as of December 31, 2013 and 2012 and for the years ended December 31, 2013, 2012 and 2011. Results of operations for subsidiaries acquired are included from the dates of their acquisition by the Company. Intercompany transactions are eliminated on consolidation.
Short-term investments comprise investments with a maturity greater than three 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.
Investment purchases and sales are recorded on a trade-date basis. Realized gains and losses on the sale of investments are based upon specific identification of the cost of investments.
recovery; and (3) assessing whether a credit loss exists, that is, whether the Company expects that the present value of the cash flows expected to be collected from the fixed maturity investment is less than the amortized cost basis of the investment. In evaluating credit losses, the Company considers a variety of factors in the assessment of a fixed maturity investment including: (1) the time period during which there has been a significant decline below cost; (2) the extent of the decline below cost and par; (3) the potential for the investment to recover in value; (4) an analysis of the financial condition of the issuer; (5) the rating of the issuer; and (6) failure of the issuer of the investment to make scheduled interest or principal payments. If management concludes an investment is other-than-temporarily impaired (“OTTI”), then the difference between the fair value and the amortized cost of the investment is presented as an OTTI charge in the consolidated statements of earnings, with an offset for any noncredit-related loss component of the OTTI charge to be recognized in other comprehensive income. Accordingly, only the credit loss component of the OTTI amount would have an impact on the Company’s earnings.
To the extent possible, all prior historical loss development that relates to commuted exposures is eliminated to produce revised historical loss development for the remaining non-commuted exposures. The Company’s estimates of IBNR reserves are not determined at the policyholder level but at the aggregate class of business or exposure level. Therefore, the Company does not typically identify a specific amount of IBNR reserves settled with each commutation. Rather, on an annual basis in the fourth quarter, the Company’s actuaries apply their actuarial methodologies to the remaining aggregate exposures and revised historical loss development information to reassess their estimates of gross and net ultimate liabilities and required gross and net IBNR reserves. Should a commutation that the Company considers significant occur in one of the first three quarters, then the Company, in conjunction with its independent actuaries, would estimate the amount of IBNR that would be associated with the policies being commuted. If the financial impact (including release of IBNR) of the commutation is considered significant, the Company would adjust its estimate of ultimate loss and loss adjustment expense liabilities in the quarter that the commutation was concluded. The agreed commutation settlement is recorded in net losses paid.
Commutations of acquired companies’ exposures have the effect of accelerating the payout of claims compared to the probability-weighted ranges of actuarially projected cash flows that the Company applies when estimating the fair values of assets and liabilities at the time of acquisition. Any material acceleration of payout together with the impact of any material loss reserve savings in any period will also accelerate the amortization of fair value adjustments in that period.
The Company’s insurance and reinsurance subsidiaries also establish provisions for loss adjustment expenses relating to run-off costs for the estimated duration of the run-off, which are included in losses and loss adjustment expenses. These provisions are assessed at each reporting date, and provisions relating to future periods are adjusted to reflect any changes in estimates of the periodic run-off costs or the duration of the run-off,
estimates change over time as additional information regarding changes in underlying exposures is obtained. Any subsequent differences arising on such estimates are recorded as premiums written in the period they are determined.
Insurance premiums are recorded at the inception of the policy and are earned on a pro-rata basis over the period of coverage.
Certain contracts that the Company wrote, prior to going into run-off, are retrospectively rated and additional premium will be due should losses exceed pre-determined, contractual thresholds. These required additional premiums are based upon contractual terms and management judgment is involved with respect to the estimate of the amount of losses that the Company expects to be ceded. Additional premiums are recognized at the time loss thresholds specified in the contract are exceeded and are earned over the coverage period, or are earned immediately if the period of risk coverage has passed. Changes in estimates of losses recorded on contracts with additional premium features will result in changes in additional premiums based on contractual terms.
Premiums receivable represent amounts currently due and amounts not yet due on insurance and reinsurance policies. Premiums for insurance policies are generally due at inception. Premiums for reinsurance policies generally become due over the period of coverage based on the policy terms. The Company monitors the credit risk associated with premiums receivable, taking into consideration that credit risk is reduced by the Company’s contractual right to offset loss obligations or unearned premiums against premiums receivable. Amounts deemed uncollectible are charged to net earnings in the period they are determined. Changes in the estimate of premiums written will result in an adjustment to premiums receivable in the period they are determined. Certain contracts are retrospectively rated and provide for a final adjustment to the premium based on the final settlement of all losses. Premiums receivable on such contracts are adjusted based on the estimate of losses the Company expects to incur, and are not considered due until all losses are settled.
In connection with the acquisitions of Arden and Atrium, and with the proposed acquisition of Torus Insurance Holdings Limited (“Torus”), (as described in Note 3, -Acquisitions) certain subsidiaries have issued or will issue shares to a noncontrolling interest. These shares provide certain redemption rights to the holder, which may be settled in the Company’s own shares or cash, at the Company’s option. The Company classifies redeemable noncontrolling interest with redemption features that are not solely within the control of the Company within temporary equity in its consolidated balance sheets and carries them at the redemption value, which is fair value. The Company recognizes changes in the fair value that exceed the carrying value of redeemable noncontrolling interest through retained earnings as if the balance sheet date were also the redemption date. For a description of the redemption rights refer to Note 3 - Acquisitions.
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 these foreign entities is included in accumulated other comprehensive income.
The difference between the original carrying value of reinsurance liabilities and reinsurance assets acquired at the date of acquisition and their fair value is recorded as an intangible asset or other liability, which the Company refers to as the fair value adjustment (“FVA”). The FVA is amortized over the estimated payout period of outstanding losses and loss expenses acquired. To the extent the actual payout experience after the acquisition is 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 adjusted to reflect such changes.
Goodwill represents the excess of the purchase price over the fair value of the net assets acquired. The Company performs an initial valuation of its goodwill assets and assesses goodwill for impairment on an annual basis. If, as a result of the assessment, the Company determines the value of its goodwill asset is impaired, goodwill is written down in the period in which the determination is made. No impairment has been recorded as a result of the assessment.
Intangible assets represent the fair value adjustments related to unpaid losses and loss expenses, reinsurance balances recoverable and policy benefits for life and annuity contracts along with the fair values of Lloyd’s syndicate capacity, customer relationships, management contract and brand arising from the acquisition of Atrium. Definite-lived intangible assets are amortized over their useful lives. The Company recognizes the amortization of all intangible assets in the consolidated statement of earnings. Indefinite-lived intangible assets are not subject to amortization. The carrying values of intangible assets are reviewed for indicators of impairment on at least an annual basis. Impairment is recognized if the carrying values of the intangible assets are not recoverable from their undiscounted cash flows and are measured as the difference between the carrying value and the fair value.
Share-based payment awards settled in ordinary shares are recorded in additional paid-in capital. The fair value of the award is measured at the grant date and expensed over the vesting period.
ASU 2013-02, Presentation of Items Reclassified from Accumulated Other Comprehensive Income
In February 2013, the FASB issued new disclosure requirements for items reclassified from accumulated other comprehensive income. This guidance requires entities to disclose in a single location (either on the face of the financial statement that reports net earnings or in the notes) the effects of reclassification out of accumulated other comprehensive income. The Company adopted this guidance effective January 1, 2013. The adoption of the guidance did not have a material impact on the consolidated financial statements.
In July 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (“ASU 2013-11”). The objective of ASU 2013-11 is to improve the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. ASU 2013-11 seeks to reduce the diversity in practice by providing guidance on the presentation of unrecognized tax benefits to better reflect the manner in which an entity would settle at the reporting date any additional income taxes that would result from the disallowance of a tax position when net operating loss carryforwards, similar tax losses, or tax credit carryforwards exist. ASU 2013-11 is effective for annual and interim reporting periods beginning after December 15, 2013, with both early adoption and retrospective application permitted. The Company is currently evaluating the impact of this guidance; however, it is not expected to have a material impact on the Company’s consolidated statements of operations and financial position.
The purchase price for the Amalgamation is approximately $692.0 million and will be paid half in cash and half in the Company’s stock. The Company and Kenmare Holdings Ltd. (its wholly-owned subsidiary) (“Kenmare”) will contribute to Bayshore, the parent company of Veranda, approximately $69.2 million in cash and 2,612,346 shares of the Company (which will consist of a combination of voting ordinary shares, par value $1.00 per share (the “Voting Ordinary Shares”) and newly-created Series B convertible non-voting preference shares, par value $1.00 per share (the “Non-Voting Preferred Shares”)) in exchange for a 60% interest in Bayshore. Trident V, L.P., Trident V Parallel Fund, L.P. and Trident V Professionals Fund, L.P. (collectively, “Trident”) will contribute to Bayshore approximately $276.8 million in cash in exchange for a 40% interest in Bayshore. Bayshore will use the contributed funds and shares to pay the purchase price for the Amalgamation.
The number of shares to be issued by the Company is fixed and was determined by reference to an agreed-upon value per share under the Amalgamation Agreement of $132.448, which was the average closing price of the Voting Ordinary Shares over the 20 trading days prior to the date of signing of the Amalgamation Agreement. The final purchase price for the Amalgamation cannot be determined until closing because the overall value of the stock component will be an amount equal to the price of the Company’s Voting Ordinary Shares on the closing date multiplied by the fixed number of shares that will be issued. Following the Amalgamation, the Company and Trident will continue to own, respectively, a 60% and 40% indirect interest in the Amalgamated Company through their ownership of Bayshore.
Completion of the Amalgamation is conditioned on, among other things, governmental and regulatory approvals and satisfaction of various customary closing conditions. The transaction is expected to close in the first quarter of 2014.
FR XI Offshore AIV, L.P., First Reserve Fund XII, L.P., FR XII A Parallel Vehicle L.P. and FR Torus Co-Investment, L.P. (collectively, “First Reserve”) will receive Voting Ordinary Shares, Non-Voting Preferred Shares and cash consideration in the transaction. In the event that the number of Voting Ordinary Shares deliverable to First Reserve at the closing of the Amalgamation would cause First Reserve, as of immediately after such closing, to beneficially own Voting Ordinary Shares that constitute more than 9.5% of the voting power of all shares of the Company, then the Company will issue to First Reserve, at the closing, the total number of shares of Voting Ordinary Shares representing 9.5% of the voting power of all shares of the Company as of immediately after the closing and Non-Voting Preferred Shares representing the remainder of the shares that First Reserve is entitled to under the Amalgamation Agreement. Corsair Specialty Investors, L.P. (“Corsair”) will receive both Voting Ordinary Shares and cash consideration in the transaction. The remaining Torus shareholders will receive all cash. As a result of the Amalgamation, First Reserve will receive approximately 9.5% and 11.5%, respectively, of the Company’s Voting Ordinary Shares and outstanding share capital and Corsair will receive approximately 2.5% and 2.1%, respectively, of the Company’s Voting Ordinary Shares and outstanding share capital.
The Company and First Reserve will enter into a Shareholder Rights Agreement at the closing of the Amalgamation, under which the Company has agreed that First Reserve will have the right to designate one representative to the Company’s Board of Directors. This designation right terminates if First Reserve ceases to beneficially own at least 75% of the total number of Voting Ordinary Shares and Non-Voting Preferred Shares acquired by it under the Amalgamation Agreement.
The Company will also enter into a Registration Rights Agreement with First Reserve and Corsair at the closing of the Amalgamation that provides First Reserve and Corsair with certain rights to cause the Company to register under the Securities Act of 1933, as amended (the “Act”), the Voting Ordinary Shares (including the Voting Ordinary Shares into which the Non-Voting Preferred Shares may convert) issued pursuant to the Amalgamation and any securities issued by the Company in connection with the foregoing by way of a share dividend or share split or in connection with any recapitalization, reclassification or similar reorganization (the foregoing, collectively, “Registrable Securities”). Pursuant to the Registration Rights Agreement, the Company must file a resale shelf registration statement for the Registrable Securities within 20 business days after the closing of the Amalgamation. In addition, at any time following the six-month anniversary of the closing of the Amalgamation, First Reserve will be entitled to make three written requests for the Company to register all or any part of the Registrable Securities under the Act, subject to certain exceptions and conditions set forth in the Registration Rights Agreement. Corsair will have the right to make one such request. First Reserve and Corsair will also be granted “piggyback” registration rights with respect to the Company’s registration of Voting Ordinary Shares for its own account or for the account of one or more of its securityholders.
In connection with the Amalgamation Agreement, the Company, Kenmare and Trident entered into an Investors Agreement on July 8, 2013 governing their investments in Bayshore, and Kenmare and Trident entered into individual equity commitment letters obligating each to fund its respective portion of the purchase price for the Amalgamation noted above. Completion of Kenmare’s and Trident’s funding obligations is conditioned on,
The purchase price was allocated to the acquired assets and liabilities of Atrium based on estimated fair values at the acquisition date. The Company recognized goodwill of $38.8 million, all of which was recorded
The following table summarizes the provisional fair values of the assets acquired and liabilities assumed at the acquisition date.
The following table summarizes the provisional intangible assets recorded in connection with the acquisition:
The fair value of the Lloyd’s syndicate capacity was estimated using the multi-period excess-earnings method, a form of the income approach. Lloyd’s syndicate capacity represents Atrium’s authorized premium income limit to write insurance business in the Lloyd’s market. Atrium’s proportionate share of S609, (the syndicate through which it conducts its Lloyd’s operations) is approximately 25%. The capacity is renewed annually at no cost to the Company but may be freely purchased or sold, subject to Lloyd’s approval. The ability to write insurance business within the syndicate capacity is indefinite with the premium income limit being set annually by the Company, subject to Lloyd’s approval.
Distribution channels represent broker relationships and the network of insurance companies through which Atrium conducts its operations. The fair value of Atrium’s distribution channel was estimated using the income approach. Critical inputs into the valuation model for customer relationships and broker relationships include estimates of expected premium and attrition rates, and discounting at a weighted average cost of capital. Brand represents the intangible asset related to the name and was valued using the income approach.
From the date of acquisition to December 31, 2013, the Company earned premiums of $21.3 million, recorded losses incurred of $11.8 million on those earned premiums, and recorded $9.8 million in net earnings related to Arden in its consolidated statement of earnings.
On February 7, 2013, the Company completed its acquisition of 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 direct 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.
Pro Forma Financial Information - Atrium, Arden and the Pavonia companies (Unaudited)
The following pro forma condensed combined statement of earnings for the years ended December 31, 2013 and 2012 combines the historical consolidated statements of earnings of the Company (inclusive of those of
SeaBright since its acquisition on February 7, 2013) with those of Atrium, Arden and Pavonia, giving effect to the business combinations and related transactions of Atrium, Arden and Pavonia as if they had occurred on January 1, 2013 and 2012, respectively. For the year ended December 31, 2013, the results shown for Atrium, Arden and Pavonia represent their results from January 1, 2013 to the respective date of each acquisition. The results for Atrium, Arden and Pavonia post-acquisition are included in the results shown for the Company.
Summary of the Pro Forma Adjustments to the Pro Forma Condensed Combined Statement of Earnings for the Twelve Months Ended December 31, 2013 (Unaudited):
Summary of the Pro Forma Adjustments to the Pro Forma Condensed Combined Statement of Earnings for the Twelve Months Ended December 31, 2012 (Unaudited):
On July 12, 2011, the Company, through its wholly-owned subsidiary, Clarendon Holdings, Inc., completed the acquisition of 100% of the shares of Clarendon National Insurance Company (“Clarendon”) from Clarendon Insurance Group, Inc., an affiliate of Hannover Re (“Hannover”). Clarendon is a New Jersey-domiciled insurer that is in run-off. Clarendon owns three other insurers, two domiciled in New Jersey and one domiciled in Florida, that are also in run-off. The purchase price was $219.1 million and was financed in part by $106.5 million under a four-year term loan facility provided by NAB and the remainder from available cash on hand.
On March 25, 2011, the Company, through its wholly-owned subsidiary, 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 purchase price was 15.0 million (approximately $21.2 million) and was funded from available cash on hand. 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 gain on bargain purchase of approximately $13.1 million, relating to the acquisition of Laguna, arose primarily as a result of the reassessment by the Company, upon acquisition, of the total required estimated costs to manage the business to expiry. The Company’s assessment of costs was lower than the acquired costs recorded by the vendor in the financial statements of Laguna.
On July 6, 2012, PWIC entered into a definitive loss portfolio transfer reinsurance agreement with Reciprocal of America (in Receivership) and its Deputy Receiver relating to a portfolio of workers’ compensation business. The estimated total liabilities to be assumed are approximately $169.0 million, with an equivalent amount of assets to be received as consideration. Completion of the transaction is conditioned upon, among other things, regulatory approvals and satisfaction of customary closing conditions. The transaction is expected to close in the second quarter of 2014.
Effective January 1, 2013, Lloyd’s Syndicate 2008 entered into a RITC of the 2009 underwriting year of account of another Lloyd’s syndicate and a 100% quota share reinsurance agreement with a further Lloyd’s syndicate in respect of its 2010 underwriting year of account, under which S2008 assumed total gross insurance reserves of approximately £33.8 million (approximately $51.4 million) for consideration of an equal amount.
On August 6 and December 17, 2012, the Company, through Fitzwilliam, entered into novation agreements with Claremont and two of Claremont’s reinsurers with respect to their existing quota share contracts. Under the novation agreements, Fitzwilliam replaced the reinsurers on the quota share contracts in exchange for total assets and liabilities of approximately $38.0 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 years of account (the “2009 Liabilities”), under which S2008 assumed total gross insurance reserves of approximately £193.0 million (approximately $313.3 million) for consideration of an equal amount. Effective January 1, 2014, the 2012 Lloyd’s underwriting year of account of S2008 entered into a partial RITC transaction with respect to the 2009 liabilities.
On September 20, 2011, the Company, through its wholly-owned subsidiary, Gordian Run-off Limited (“Gordian”), acquired an inwards reinsurance portfolio from Insurance Australia Group Limited via an 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).
Included within residential and commercial mortgage-backed securities as at December 31, 2013 were securities issued by U.S. governmental agencies with a fair value of $177.9 million (as at December 31, 2012: $68.4 million within residential and commercial mortgage-backed securities).
The Company holds a portfolio of held-to-maturity securities to support the Pavonia annuity business. The amortized cost and estimated fair values of the Company’s fixed maturity securities classified as held-to-maturity were as follows:
As at December 31, 2013, none of these securities were considered to be other-than-temporarily impaired.
The contractual maturities of the Company’s fixed maturity securities classified as held-to-maturity 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 table set forth certain information regarding the credit ratings (provided by major rating agencies) of the Company’s fixed maturity securities classified as held-to-maturity:
Included within residential mortgage-backed securities as at December 31, 2013 were securities issued by U.S. governmental agencies with a fair value of $12.5 million (as at December 31, 2012: $3.5 million within residential and commercial mortgage-backed securities).
As at December 31, 2013 and 2012, the number of securities classified as available-for-sale in an unrealized loss position was 135 and 30, respectively, with a fair value of $121.8 million and $29.0 million, respectively. The increase in the number of these securities was due primarily to investment portfolios acquired in connection with acquisitions completed during 2013. Of these securities, the number of securities that had been in an unrealized loss position for twelve months or longer was 2 and 23, respectively. As of December 31, 2013, none of these securities were considered to be other than temporarily impaired.
As of December 31, 2013 and December 31, 2012, the Company had $161.2 million and $127.7 million, respectively, of other investments recorded in private equity funds, which represented 2.5% and 3.0% of total investments, cash and cash equivalents and restricted cash and cash equivalents at December 31, 2013 and December 31, 2012, 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 comprises 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 earliest date at which the funds will be eligible for redemption is March 2014.
This class primarily comprises 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 loan pools. This investment matures when the loans are paid down and cannot be redeemed before maturity.
Non-U.S. government securities consist of bonds issued by non-U.S. governments and agencies along with supranational organizations. The significant inputs used to determine the fair value of these securities include the spread above the risk-free yield curve, reported trades and broker-dealer quotes. These are considered to be observable market inputs and, therefore, the fair values of these securities are classified within Level 2.
Components of net realized and unrealized gains (losses) for the years ended December 31, 2013, 2012 and 2011 were as follows:
The increase of approximately $1.89 billion in restricted assets related primarily to restricted assets acquired in connection with the Company’s acquisitions of SeaBright, Pavonia, Arden and Atrium.
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, as well as for yield enhancement. These derivatives were not designated as hedging investments.
On an annual basis, Atrium purchases a tailored outwards reinsurance program designed to manage S609’s risk profile. In addition, Atrium maintains a quota share reinsurance agreement with Arden. The majority of Atrium’s total third party reinsurance cover is with Lloyd’s syndicates or other reinsurers rated A- or better.
At December 31, 2013 and 2012, the provision for uncollectible reinsurance recoverable relating to reinsurance balances recoverable was $338.6 million and $343.9 million, respectively. To estimate the provision for uncollectible reinsurance recoverable, the balances are first allocated to applicable reinsurers which involve management judgment. As part of this process, ceded incurred but not reported (“IBNR”) reserves are allocated by reinsurer. The ratio of the provision for uncollectible reinsurance recoverable to total non-life run-off and active underwriting reinsurance balances recoverable (excluding provision for uncollectible reinsurance recoverable) as of December 31, 2013 decreased to 19.9% as compared to 23.4% as of December 31, 2012,
As at December 31, 2013, the reinsurance balances recoverable associated with the Company’s life and annuities business amounting to $31.9 million consisted of term life business ceded by Pavonia to reinsurers under various quota share arrangements. All of the reinsurers are rated A- and above by a major rating agency.
The reserves for unpaid reported losses and loss adjustment expenses for Atrium are established by management based on reports from brokers, ceding companies and insureds and represents the estimated ultimate cost of events or conditions that have been reported to, or specifically identified by the Company. The reserve for incurred but not reported losses and loss expenses is established by management based on actuarially determined estimates of ultimate losses and loss expenses. Inherent in the estimate of ultimate losses and loss expenses are expected trends in claim severity and frequency and other factors which may vary significantly as claims are settled. Accordingly, ultimate losses and loss expenses may differ materially from the amounts recorded in the consolidated financial statements. These estimates are reviewed regularly and, as experience develops and new information becomes known, the reserves are adjusted as necessary. Such adjustments, if any, will be recorded in earnings in the period in which they become known. Prior period development arises from changes to loss estimates recognized in the current year that relate to loss reserves established in previous calendar years.
In establishing the reserves for losses and loss adjustment expenses related to asbestos and environmental claims, management considers facts currently known and the current state of the law and coverage litigation. Liabilities are recognized for known claims (including the cost of related litigation) when sufficient information has been developed to indicate the involvement of a specific insurance policy, and management can reasonably estimate its liability. In addition, reserves have been established to cover additional exposures on both known and unreported claims. Estimates of the reserves are reviewed and updated continually. Developed case law and adequate claim history do not exist for such claims, especially because significant uncertainty exists about the outcome of coverage litigation and whether past claim experience will be representative of future claim experience.
(1) For the years ended December 31, 2012 and 2011, the Company had no premium income and therefore no current period activity.
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 $3.1 million, resulting from settlement of net advised case and LAE reserves of $317.6 million for net paid losses of $314.5 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 estimates of net ultimate losses of $241.2 million comprised net incurred favorable loss development of $23.4 million and reductions in net IBNR reserves of $224.8 million. The decrease in the aggregate estimate of net IBNR reserves of $224.8 million was comprised of $57.9 million relating to asbestos liabilities, $2.8 million relating to environmental liabilities and $164.1 million relating to all other remaining liabilities. The aggregate reduction in net 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 the Company’s 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. 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 2011, including commutations and the favorable trend of loss development related to non-commuted policies compared to prior forecasts.
The net incurred favorable loss development of $23.4 million, resulting from settlement of net advised case and LAE reserves of $311.6 million for net paid losses of $288.2 million, related to the settlement of non-commuted losses in the year and approximately 110 commutations of assumed and ceded exposures, excluding the three commutations completed subsequent to December 31, 2011. Net incurred liabilities settled by way of commutation during the year ended December 31, 2011 (excluding the three commutations completed subsequent to December 31, 2011) amounted to $71.5 million compared to the net reduction in advised case reserves during the same period of $311.6 million.
The net increase in ultimate losses and loss adjustment expense liabilities for the active underwriting segment for the year ended December 31, 2013 was as follows:
The Company has entered into long duration contracts that subject the Company to mortality, longevity and morbidity risks and which are accounted for as life and annuity premiums earned. Life and annuity benefit reserves are established using assumptions for investment yields, mortality, morbidity, lapse and expenses, including a provision for adverse deviation. The Company establishes and reviews its life and annuity reserves regularly based upon cash flow projections. The Company establishes and maintains its life and annuity reinsurance reserves at a level that the Company estimates will, when taken together with future premium payments and investment income expected to be earned on associated premiums, be sufficient to support all future cash flow benefit obligations and third party servicing obligations as they become payable. The
Policy benefits for life and annuity contracts as at December 31, 2013 and 2012 were as follows:
Net premiums written and earned by SeaBright totaled $9.2 million and $112.6 million from the date of acquisition to December 31, 2013, respectively. Now that SeaBright’s exit from the mandatory renewal process
Net premiums written and earned by Atrium and Arden combined totaled $30.1 million and $32.2 million, respectively, from their dates of acquisition to December 31, 2013. As at December 31, 2013, Atrium and Arden had total unearned premiums of $59.5 million and $6.3 million, respectively.
Life and annuity premiums written by the Company’s life and annuities segment totaled $63.9 million, $3.5 million and $3.5 million for the years ended December 31, 2013, 2012 and 2011, respectively, and net earned premiums, over the same periods, totaled $95.0 million, $3.5 million and $3.5 million, respectively. The Company’s life companies continue to collect premiums in relation to the unexpired policies assumed on acquisition. As at December 31, 2013, Pavonia had total unearned premiums of $3.7 million.
For the year ended December 31, 2013, the Company’s life and annuities segment consisted of both Pavonia and Laguna, while for the years ended December 31, 2012 and 2011, it consisted of Laguna only.
(ii) Other intangible assets relate to the values associated with the distribution channel and brand related to the Company’s acquisition of Atrium. These assets will be amortized on a straight-line basis a over a period of ten to fifteen years.
The EGL Revolving Credit Facility is secured by a first priority lien on the stock of certain of the Company’s subsidiaries and certain bank accounts held with Barclays in the name of the Company and into which amounts received in respect of any capital release from certain of the Company’s subsidiaries are required to be paid. Interest is payable at the end of each interest period chosen by the Company or, at the latest, each six months. The interest rate is LIBOR plus 2.75%, plus an incremental amount tied to certain regulatory costs, if any, that may be incurred by the lenders. Any unused portion of the EGL Revolving Credit Facility will be subject to a commitment fee of 1.10%. The EGL Revolving Credit Facility imposes various financial and business covenants on the Company, the guarantors and certain other material subsidiaries, including limitations on mergers and consolidations, acquisitions, indebtedness and guarantees, restrictions as to dispositions of stock and assets, restrictions on dividends and limitations on liens. As of December 31, 2013 all of the financial covenants relating to the EGL Revolving Credit Facility were met.
During the existence of any event of default (as specified in the Restated Credit Agreement), 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. During the existence of any payment default, the interest rate would be increased by 1.0%. The EGL Revolving Credit Facility terminates and all amounts borrowed must be repaid on the fifth anniversary of the date of the Restated Credit Agreement.
During 2013, the Company borrowed $258.8 million under the EGL Revolving Credit Facility to fund certain acquisitions and for general corporate purposes. The interest rate on these borrowings was approximately 2.9%, subject to periodic adjustment in accordance with the terms of the EGL Revolving Credit Facility.
On July 31, 2013, the Company repaid $27.5 million of the outstanding principal on its Clarendon Facility reducing the outstanding principal as of December 31, 2013 to $79.0 million.
From the date of the SeaBright Facility until the draw down on February 5, 2013, the undrawn and uncancelled amount of the SeaBright Facility incurred a fee of 1% per annum. Interest on amounts borrowed under the SeaBright Facility is payable at the end of each interest period chosen by the borrower or, at the latest, each six months. The interest rate is LIBOR plus 2.75% for the first 18 months from February 5, 2013 and increases to LIBOR plus 3.50% thereafter; the interest rate is subject to increase by an incremental amount tied to certain regulatory costs, if any, that may be incurred by the lenders. The SeaBright Facility imposes various financial and business covenants on SeaBright, including limitations on mergers and consolidations, acquisitions, indebtedness and guarantees, restrictions as to dispositions of stock and assets (except for certain permitted dispositions), restrictions on dividends, and limitations on liens. As at December 31, 2013, all of the financial covenants relating to the SeaBright Facility were met.
The redeemable noncontrolling interest comprises the 40% ownership interest in Northshore held by Trident. Northshore owns 100% of Atrium and Arden. The redeemable noncontrolling interest is classified outside of permanent shareholders’ equity on the Company’s consolidated balance sheets due to the redemption
A reconciliation of the beginning and ending carrying amount of the equity attributable to the redeemable noncontrolling interest is as follows:
As at December 31, 2013 and 2012, the authorized share capital was 111,000,000 ordinary shares (“Voting Ordinary Shares”) and non-voting convertible ordinary shares (“Non-Voting Ordinary Shares”), each par value $1.00 per share and 45,000,000 preference shares of par value $1.00 per share. Each Voting Ordinary Share entitles the holder thereof to one vote. In accordance with the Company’s bye-laws, however, any U.S. shareholder or direct foreign shareholder group whose shares constitute 9.5% or more of the voting power of our Voting Ordinary Shares would be entitled to less than one vote for each Voting Ordinary Share held by them.
the “Purchasers”), each of which is an affiliate of Goldman, Sachs & Co., the Company has authorized Non-Voting Ordinary Shares in three different series: Series B, C and D. Only Series C Non-Voting Ordinary Shares are issued and outstanding. There is no economic difference in the sub-series of Non-Voting Ordinary Shares, but there are slight differences in the limited voting rights of each sub-series that are designed to address certain regulatory matters that may affect the Purchasers.
In connection with the agreement to acquire Torus, on July 8, 2013, the Company’s Board of Directors’ created 4,000,000 shares of Series B Convertible Participating Non-Voting Perpetual Preferred Stock, par value $1.00 per share (the “Non-Voting Preferred Shares”), from the authorized and unissued preference shares. The Company will issue a combination of Voting Ordinary Shares and Non-Voting Preferred Shares to certain shareholders of Torus at closing of the Amalgamation, as described in Note 3 - Acquisitions.
have no voting rights other than: (i) in the event of a proposed change to the Company’s organizational documents that would significantly and adversely affect the rights of the Non-Voting Preferred Shares, (ii) certain share exchanges or reclassifications of the Non-Voting Preferred Shares, (iii) certain mergers or consolidations of the Company, or (iv) a voluntary liquidation or dissolution of the Company.
For the years ended December 31, 2013, 2012 and 2011, nil, 191 and 16,328 shares, respectively, were awarded to employees under the 2006 Equity Incentive Plan (the “Equity Plan”).
The total unrecognized compensation cost related to the Company’s non-vested share awards under the Equity Plan as at December 31, 2013 and 2012 was $4.7 million and $7.6 million, respectively. This cost is expected to be recognized evenly over the next 1.8 years. Compensation costs of $2.9 million, $2.8 million and $2.7 million relating to these share awards were recognized in the Company’s statement of earnings for the years ended December 31, 2013, 2012 and 2011, respectively.
For the years ended December 31, 2013, 2012 and 2011, compensation costs of less than $0.1 million relating to the shares issued under the Amended and Restated Enstar Group Limited Employee Share Purchase Plan (the “Share Plan”) were recognized in the Company’s statement of earnings. As at December 31, 2013, 2012 and 2011, 4,959, 5,442 and 5,208 shares have been issued to employees under the Share Plan.
The Company has operating subsidiaries and branch operations in the United Kingdom, Australia, the United States and Europe and is subject to federal, foreign, state and local taxes in those jurisdictions. In addition, certain distributions from some foreign sources may be subject to withholding taxes.
Deferred income taxes arise from the recognition of temporary differences between income determined for financial reporting purposes and income tax purposes. The temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented in the table below:
The Company had unrecognized tax benefits of $2.2 million, $5.8 million and $5.6 million relating to uncertain tax positions as of December 31, 2013, 2012 and 2011, respectively.
Included in the balances at December 31, 2013, 2012 and 2011 were $1.5 million, $4.4 million and $4.4 million, respectively, of tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of the shorter deductibility period would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.
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, 2013, 2012 and 2011, 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 $0.2 million, $nil and $0.1 million, respectively. The Company had approximately $0.7 million, $1.5 million and $1.2 million accrued for the payment of interest and penalties related to unrecognized tax benefits at December 31, 2013, 2012 and 2011, respectively.
Following several private transactions occurring from May 2012 to July 2012, Trident acquired approximately 9.7% of the Company’s voting ordinary shares. On November 6, 2013, the Company appointed James D. Carey to its Board of Directors. Mr. Carey is the sole member of an entity that is one of four general partners of the entities serving as general partners for the Trident funds, is a member of the investment committees of such general partners, and is a member and senior principal of Stone Point Capital LLC, the manager of the Trident funds. In addition, the Company entered into certain agreements with Trident with respect to Trident’s co-investments in the Atrium and Arden acquisitions and the pending Torus acquisition. Refer to Note 3 - “Acquisitions” for a description of these co-investment transactions. Mr. Carey serves as a Trident representative on the board of the holding company established in connection with the Atrium/Arden co-investment transaction and is expected to serve as a representative on the Torus board and on the board of the holding company established in connection with the Torus co-investment transaction following the closing of the Amalgamation.
Subsequent to December 31, 2013, the Company made a commitment to invest up to $20.0 million in the Trident Parallel VI Fund, a fund managed by Stone Point Capital LLC.
As of December 31, 2013, affiliates of Goldman Sachs & Co. (“Goldman Sachs”) own approximately 4.8% of the Company’s voting ordinary shares and 100% of the Company’s non-voting convertible ordinary shares. Sumit Rajpal, a managing director of Goldman Sachs, was appointed to the Board of Directors in connection with Goldman Sachs’ investment in the Company. As of December 31, 2013, the Company had an investment in one fund (carried within other investments) affiliated with entities owned by Goldman Sachs, which had a fair value of $3.2 million. Subsequent to December 31, 2013, the Company invested £12.5 million in indirect non-voting interests of two companies affiliated with Hastings Insurance Group Limited. The Company’s interests are held in accounts managed by affiliates of Goldman Sachs. Goldman Sachs affiliates have an approximately 50% interest in the Hastings companies, and Mr. Rajpal serves as a director of the entities the Company has invested in.
Affiliates of Goldman Sachs own approximately 22% of Global Atlantic Financial Group (“GAFG”), which owns entities that provide reinsurance to Arden. As at December 31, 2013, the Company’s total reinsurance recoverable from GAFG entities amounted to $340.8 million. As at December 31, 2013, reinsurance balances recoverable from a particular non-rated GAFG entity with a carrying value of $256.1 million represented 10% or more of the Company’s total non-life run-off reinsurance balances recoverable. The $256.1 million recoverable from that GAFG entity at December 31, 2013 was secured by a trust account. The balance of $84.7 million as at December 31, 2013 was recoverable from GAFG entities rated A- and higher.
The statutory capital and surplus amounts for the years ended December 31, 2013 and 2012 and statutory net income (loss) amounts for the years ended December 31, 2013, 2012 and 2011 for the Company’s insurance and reinsurance subsidiaries based in Bermuda, the United Kingdom, Australia, the United States and Europe were as follows:
Each of the Company’s regulated Bermuda insurance and reinsurance subsidiaries would be prohibited from declaring or paying any dividends if it were in breach of its minimum solvency margin (which is a function of outstanding losses) or liquidity ratio (which is a function of relevant assets) or if the declaration or payment of such dividends would cause it to fail to meet such margin or ratio. In addition, each of the Company’s regulated Bermuda insurance and reinsurance subsidiaries is prohibited, without the prior approval of the Bermuda regulator, from reducing by 15% or more its total statutory capital as set out in its previous year’s statutory financial statements. In addition, the Company’s Bermuda insurance companies that are in run-off are required to seek regulatory approval for any dividends or distributions.
The Company’s U.K.-based insurance subsidiaries are required to maintain adequate financial resources in accordance with the requirements of the U.K. Regulator. The calculation of the minimum capital resources requirements in any particular case depends on, among other things, the type and amount of insurance business written and claims paid by the insurance company. As at December 31, 2013 and 2012, 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 U.K. Regulator from the requirement to remedy any shortfall) and complied with the relevant U.K. Regulator requirements. The U.K.-based insurance subsidiaries, in aggregate, maintained capital in excess of the minimum capital resources requirements by $509.6 million and $426.1 million as of December 31, 2013 and 2012, respectively.
In addition, the U.K. Regulator’s Individual Capital Adequacy Standards framework (“ICAS framework”), requires insurance companies to carry out various capital modeling and risk management exercises in order to calculate a company-specific Individual Capital Assessment amount (“ICA amount”), which is the company’s internal calculation of its capital requirements under the ICAS framework. This is intended to ensure a company holds sufficient capital such that there is no material risk that its liabilities cannot be met as they fall due. In 2009, the European Parliament approved the Solvency II framework directive. Solvency II is expected to take effect in January 2016. Solvency II will set out new, strengthened EU-wide requirements on capital adequacy and risk management for insurers with the aim of increasing policyholder protection, instilling greater risk awareness and improving the international competitiveness of EU insurers.
The underwriting capacity of a member of Lloyd’s must be supported by providing a deposit (referred to as “Funds at Lloyd’s”) in the form of cash, securities or letters of credit in an amount determined under the ICA. The amount of the Funds at Lloyd’s is assessed annually and is determined by Lloyd’s in accordance with the capital adequacy rules established by the U.K. Regulator. In order to achieve finality and to release their capital, Lloyd’s members are usually required to have transferred their liabilities through an approved RITC, such as offered by S2008. RITC is generally put in place after the third year of operations of a syndicate year of account. On successful conclusion of RITC, any profit from the syndicate’s operations for that year of account can be remitted by the managing agent to the syndicate’s members.
The Company’s U.S. non-life run-off 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.
The U.S. subsidiaries are required to file annual statements with insurance regulatory authorities prepared on a statutory basis prescribed or permitted by such authorities. Statutory accounting principles differ from U.S. GAAP in the treatment of various items, including treatment of deferred acquisition costs, deferred income taxes, required investment reserves, reserve calculation assumptions and surplus notes. For all of the Company’s U.S. insurance and reinsurance subsidiaries, with the exception of one subsidiary, there are no prescribed or permitted statutory accounting practices that differ significantly from the statutory accounting principles established by the National Association of Insurance Commissioners (“NAIC”). In 2013, one of the Company’s U.S. insurance and reinsurance subsidiaries increased reserves for adjusting and other expenses in its statutory financial statements. As at December 31, 2012, these reserves of approximately $47.0 million had been recorded at its immediate parent company level. This had no impact on the consolidated financial statements for the Company. The same U.S. insurance and reinsurance subsidiary also has a permitted accounting practice to treat an adverse development cover reinsurance agreement as prospective reinsurance. The U.S. insurance and reinsurance subsidiaries are also required to maintain minimum levels of solvency and liquidity as determined by law, and to comply with risk-based capital requirements and licensing rules.
The Company’s life and annuities subsidiaries file financial statements with state insurance regulatory authorities and the NAIC in the United States and the Office of Superintendent of Financial Institutions (“OSFI”) in Canada (as a result of one of the Company’s subsidiaries having a Canadian branch operation). Such statements are prepared in accordance with Statutory Accounting Principles (“SAP”) prescribed or permitted by such authorities which may vary materially from GAAP. SAP includes the Accounting Practices and Procedures Manual of the NAIC as well as other laws, regulations and administrative rules promulgated by the state insurance departments. SAP encompasses all accounting practices not so prescribed. The principal differences between statutory financial statements and financial statements prepared in accordance with GAAP are that statutory financial statements do not reflect deferred acquisition costs, some bond portfolios may be carried at amortized cost, assets and liabilities are presented net of reinsurance, contract holder liabilities are generally valued using more conservative assumptions and certain assets are non-admitted. Accordingly, statutory
As of December 31, 2013, the Company’s life and annuities subsidiaries exceeded their minimum RBC requirements by $104.5 million. These subsidiaries are restricted by state laws and regulations as to the amount of dividends they may pay to their parent without regulatory approval in any year, the purpose of which is to protect affected insurance policyholders, depositors or investors. Any dividends in excess of limits are deemed “extraordinary” and require approval. As of December 31, 2013, the maximum dividend payout which may be made without prior approval is $nil.
The Company’s Swiss insurance subsidiary is regulated by the Swiss Financial Market Supervisory Authority (“FINMA”) pursuant to the Insurance Supervisory Act 2004. This subsidiary is obligated to maintain a minimum solvency margin based on the Solvency I and Swiss Solvency Test regulations (“SST”) as stipulated by the Insurance Supervisory Act. As of December 31, 2013 and 2012, this subsidiary exceeded the Solvency I requirements by $118.1 million (2012: $103.9 million) and exceeded the SST requirements by $67.4 million (2012: $44.9 million). The amount of dividends that this subsidiary is permitted to distribute is restricted to freely distributable reserves, which consist of retained earnings, the current year profit and legal reserves. Any dividend exceeding the current year profit requires FINMA’s approval. The solvency and capital requirements must continue to be met following any distribution. During 2013, the Company exited Belgium, Denmark and Sweden.
One of the Company’s life insurance subsidiaries files its audited financial statements with the Companies Registration Office in Ireland. The financial statements are prepared in accordance with the provisions of the Companies Act, 1963 to 2013, and the European Communities (Insurance Undertakings: Accounts) Regulations, 1996.
The Company’s portfolio of other investments is managed pursuant to guidelines that emphasize diversification and liquidity. Pursuant to these guidelines, the Company manages and monitors risk across a variety of investment funds and vehicles, markets and counterparties. The Company believes that there are no significant concentrations of credit risk associated with its other investments.
Rent expense for the years ended December 31, 2013, 2012 and 2011 was $5.5 million, $3.9 million and $3.0 million, respectively.
Due to the Company’s acquisition of the Pavonia companies on March 31, 2013 and the acquisitions of Arden and Atrium on September 9, 2013 and November 25, 2013, respectively, the Company reevaluated its segment reporting and began measuring the results of its operations in three segments: (i) non-life run-off; (ii) life and annuities and (iii) active underwriting.