The decline in consolidated earned premiums for the year ended December 31, 2011 as compared to the same period in 2010 was due to reduced premium writings in 2010 and continuing into the first half of 2011. Earned premiums within our U.S segments declined from $822.9 million (on gross written premiums of $962.7 million) for the year ended December 31, 2010 to $721.2 million (on gross written premiums of $913.2 million) for the same period in 2011. Our U.S. operations have continued to experience competition and declining rates, and as a result, discontinued the writing of several programs beginning in late 2009. Earned premiums at Argo International have declined from $290.1 million (on gross written premiums of $389.9 million) for the year ended December 31, 2010 to $259.3 million (on gross written premiums of $438.5 million) for the same period ended 2011. The decrease in earned premiums in 2011 as compared to 2010 was the result of planned reduction in property binder business and by significant competition in direct and facultative brokered business in 2010. Gross written premiums at Argo International increased for the second half of 2011 due to the introduction of new specialty line and aerospace programs. Argo Re contributed earned premiums of $101.5 million (on gross written premiums of $193.1 million) for the year ended December 31, 2011 compared to $100.2 million (on gross written premiums of $176.1 million) for the same period ended 2010. The increase in gross written and earned premiums at Argo Re was primarily due to new business written by our casualty and professional lines unit. The decrease in consolidated gross written premiums and earned premiums for the year ended December 31, 2010 as compared to the same period in 2009 was primarily attributable to the planned reduction of various programs where profitability had been declining.
Consolidated losses and loss adjustment expenses were $863.1 million for the year ended December 31, 2011, compared to $777.5 million and $853.1 million for the same periods in 2010 and 2009, respectively. Included in losses and loss adjustment expenses for the year ended December 31, 2011 was $208.6 million in catastrophe losses resulting from the Japan and New Zealand earthquakes, storm activity in the United States and flooding in Australia and Thailand. Additionally, we recognized $9.3 million in losses under aggregate reinsurance covers. Partially offsetting these 2011 accident year losses was $3.4 million in net favorable loss reserve development on prior accident years. The Excess and Surplus Lines segment had $33.8 million in net favorable loss reserve development primarily in the general and products liability lines. The Commercial Specialty segment had $8.4 million of net unfavorable loss reserve development primarily in general liability, partially offset by favorable development in the workers compensation lines of business and in an assumed directors and officers program. The International Specialty segment had net favorable loss reserve development of $4.6 million primarily attributable to short-tail non-catastrophe losses. The Syndicate 1200 segment had net unfavorable loss reserve development of $18.7 million in the liability lines and the property lines of business. The Run-off Lines segment had $7.9 million in net unfavorable loss reserve development attributable to asbestos and environmental exposure in the general liability lines and the legacy PXRE claims, partially offset by favorable reserve development in the run-off workers compensation lines.
When determining reserve levels, we recognize that there are several factors that present challenges and uncertainties to the estimation of loss reserves. Examples of these uncertainties include changes to the reinsurance structure and potential increases in inflation. Our net retained losses vary by product and they have generally increased over time. To properly recognize these uncertainties, actuarial reviews have given significant consideration to the paid and incurred Bornhuetter-Ferguson (“BF”) methodologies. Compared with other actuarial methodologies, the paid and incurred BF methods assign smaller weight to actual reported loss experience, with the greatest weight assigned to an expected or planned loss ratio. The expected or planned loss ratio has typically been determined using various assumptions pertaining to prospective loss frequency and loss severity. In setting reserves at December 31, 2011, we continued to consider the paid and incurred BF methods for recent years.
Consolidated underwriting, acquisition and insurance expenses were $426.7 million, $472.6 million and $517.9 million for the years ended December 31, 2011, 2010 and 2009, respectively. The decrease in the dollar value of expenses between the three periods was primarily attributable to lower acquisition expense related to the aforementioned reduction in earned premium. The increase in the consolidated expense ratio for 2011 as compared to 2010 reflects approximately $7.6 million of expense related to the Company’s investments in start-up operations abroad and a new information technology business delivery platform. The increase in the consolidated expense ratio for 2010 as compared to 2009 was primarily attributable to declining premium volumes.
Consolidated foreign currency exchange loss was $3.5 million for the year ended December 31, 2011 compared to gains of $3.8 million and $0.2 million for the same periods ended 2010 and 2009. For the year ended December 31, 2011, non U.S. Dollar currencies strengthened against the U.S. Dollar, excluding British Sterling which was flat, resulting in the foreign currency exchange loss. By comparison, for the year ended December 31, 2010, non U.S. Dollar currencies weakened considerably against the U.S. Dollar, resulting in the foreign currency exchange gain.
In 2009, we deemed the value assigned to the former trade name of our Syndicate 1200 segment impaired after an evaluation of the value of the name. The expense recognized as a result of this impairment was $5.9 million, which represented the unamortized balance as of the impairment date.
Consolidated provisions for income taxes were $19.5 million, $32.7 million and $24.9 million for the years ended December 31, 2011, 2010 and 2009, respectively. For the year ended December 31, 2011, the tax provision generated by our operations based in the United States was partially offset by tax benefits for our operations based in the United Kingdom. Included in the consolidated provision for income taxes for the year ended December 31, 2010 was $1.3 million in tax expense from Argo Ireland to the Internal Revenue Service for withholding on dividends received from Argo Group US. Included in the consolidated provision for income taxes for the year ended December 31, 2009 was a $5.6 million tax refund received from the state of California due to a favorable tax settlement. Offsetting this tax refund was $7.7 million in tax expense from Argo Ireland to the Internal Revenue Service for withholding on dividends received from Argo Group US. The consolidated income tax provision represents the income tax expense associated with our operations based on the tax laws of the jurisdictions in which they operate. Therefore, the consolidated provision for income taxes represents taxes on net income for our United States, Ireland, Belgium, Brazil, Switzerland, and United Kingdom operations. Additionally, our tax rates for years presented were impacted by fluctuations in foreign exchange rates within the International Specialty segment.
During the first quarter of 2011, we evaluated the operating structure of our Bermuda and London-based business segments. To more appropriately align our operating structure with the management of the business, we concluded that operating activities associated with our London operations (our former International Specialty segment) would be principally managed and evaluated as a Lloyd’s of London (“Lloyd’s”) market syndicate business, while our Bermuda operations (our former Reinsurance Segment) would serve as the center for our international insurance and reinsurance business, including our product development and global strategic expansion initiatives. These changes resulted in our Bermuda operations, and subsequently our new non-syndicate international insurance operations, being identified as our International Specialty segment. Our London-based operation, focused on the management and growth of our Lloyd’s syndicate operations, is now known as our Syndicate 1200 segment. Additionally, we have a Run-off Lines segment for products we no longer underwrite.
In evaluating the operating performance of our segments, we focus on core underwriting and investing results before consideration of realized gains or losses from the sales of investments. Management excludes realized investment gains and losses from segment results, as decisions regarding the sales of investments are made at the corporate level. Although this measure of profit (loss) does not replace net income (loss) computed in accordance with GAAP as a measure of profitability, management utilizes this measure of profit (loss) to focus its reporting segments on generating operating income.
The increase in the expense ratio for the year ended December 31, 2011 as compared to the same periods in 2010 and 2009 was primarily attributable to the reductions in earned premiums outpacing the reductions in total underwriting expenses.
Included in losses and loss adjustment expenses for the year ended December 31, 2009 was $10.4 million in catastrophe losses from storm activity in the United States. The Commercial Specialty segment recognized $3.7 million of net favorable reserve development on prior accident year’s loss reserves. This favorable development was comprised primarily of $6.2 million of favorable development in workers compensation, $3.5 million of favorable development in short tail lines, $2.5 million of adverse development in other liability, and $3.5 million of adverse development in commercial auto liability.
The increase in the expense ratio for the year ended December 31, 2011 as compared to the same period in 2010 was primarily attributable to the reductions in earned premiums outpacing the reductions in total underwriting expenses. The increase in the expense ratio for the year ended December 31, 2010 as compared to the same period in 2009 was primarily attributable to lower premium volumes and reduced ceding commissions received on the state fund program, coupled with an increase in the allocation of operating expenses to underwriting activities.
Fee income, net consists of commissions earned by our managing general underwriters for brokerage business placed outside Argo Group minus the expenses associated with generating the commissions. The decline in fee income, net was due to declining premium volumes as discussed above.
The increase in the expense ratio for 2011 as compared to 2010 was primarily attributable to the inclusion of $5.9 million in expense for new business units in Brazil, Dubai and the European Union, for which minimal earned premiums were recognized. Expenses associated with these start up operations will be disproportionately higher than the rate at which premiums are earned. The decrease in the expense ratio for the year ended December 31, 2010 as compared to 2009 was due to increased ceding commissions.
In 2011 we increased our participation in Syndicate 1200 to 69% from 61% for both 2010 and 2009. For the year ended December 31, 2011, the property division wrote $250.0 million in gross written premiums, compared to $257.7 million and $522.4 million for the same periods in 2010 and 2009. The casualty division wrote $124.0 million, $127.8 million and $183.6 million for the years ended December 31, 2011, 2010 and 2009, respectively. The decrease in property written premiums in 2011 and 2010 was driven by a planned reduction in property binder business and by significant competition in the direct and facultative market. The decrease in casualty written premiums beginning in 2010 and continuing into 2011 was driven by our being more selective in accepting risks within a highly competitive marketplace. Offsetting these declines in gross written premiums was $54.1 million in gross written premiums for the specialty division and $9.7 million for the aerospace divisions, which are new for 2011. Discontinued lines accounted for the remaining $0.3 million and $4.4 million for the years ended December 31, 2011 and 2010, respectively.
Losses and loss adjustment expenses are reported net of losses ceded to the trade capital providers. Included in losses and loss adjustment expenses for the year ended December 31, 2011 was $61.9 million of catastrophe losses consisting of $29.2 million from the New Zealand and Japan earthquakes, $21.8 million from the Thailand and Australia floods and the Danish Cloudburst and $10.9 million from storms in the United States. Additionally, included in losses and loss adjustment expenses for 2011 was $18.7 million in unfavourable prior year development primarily driven by a reduction in the estimate of future reinsurance recoveries for various liability classes of business and unfavorable development related to the medical malpractice and discontinued liability lines of business where the claims experience was worse than expected.
Included in losses and loss adjustment expenses for the year ended December 31, 2010 was $23.8 million of catastrophe losses primarily attributable to the earthquakes in Chile, New Zealand and Haiti. Losses and loss adjustment expenses for the year ended December 31, 2009 did not include significant catastrophe losses. Net unfavorable loss reserve development on prior accident years during 2010 and 2009 was $4.4 million and $23.5 million, respectively. The 2009 loss development was offset by additional premiums of $24.1 million with both the additional premium and losses primarily related to the late reported property binder business.
The increase in the expense ratio for the year ended December 2011 as compared to the same periods in 2010 and 2009 was primarily attributable to the reduction in net earned premium. Business written through Lloyd’s typically incurs higher acquisition expenses compared to other insurance markets due to the distribution model.
Losses and loss adjustment expenses for the year ended December 31, 2010 included $1.9 million in net favorable loss reserve development on prior accident years. The favorable development included $9.0 million of favorable loss reserve development for workers compensation lines, $2.6 million of favorable loss reserve development for PXRE non-catastrophe lines and $0.8 million in unallocated loss adjustment expense. Partially offsetting the favorable development was $9.5 million in unfavorable reserve development resulting from strengthening the reserves for our asbestos and environmental exposure and $1.0 million due to the unwinding of the workers compensation reserve discount.
We perform an extensive actuarial analysis of the asbestos and environmental reserves on at least an annual basis. The process is typically completed in the third quarter of the calendar year and reviewed/updated during the fourth quarter. We continually monitor the status of the claims, and may make adjustments outside of the annual review period. The review entails a detailed analysis of our direct and assumed exposure. Management considers the indications from the various actuarial methods from
The following table represents a reconciliation of the number of asbestos and environmental claims outstanding for each of the years in the three-year period ended December 31, 2011:
The following table represents gross payments on asbestos and environmental claims for each of the years in the three-year period ended December 31, 2011:
For the years ended December 31, 2011, 2010 and 2009, net cash used by financing activities was $61.6 million, $115.4 million, and $48.1 million, respectively. During 2011, our use of cash was primarily attributed to the repurchase of approximately 1.6 million shares of our common stock for a total cost of $49.5 million, and the payment of dividends to our shareholders totaling $13.1 million. During 2010, our use of cash was primarily attributed to the repurchase of approximately 3.2 million shares of our common stock for a total cost of $105.2 million and the payment of dividends to our shareholders totaling $14.2 million. The increase in cash used in financing activities in 2009 primarily resulted from the net cash payment on the revolving credit facility.
In addition, our ability to receive dividends from our downstream subsidiaries is subject to the ability of each parent corporation within the corporate ownership structure to receive dividends from its respective subsidiary(ies), based upon the subsidiary’s domiciliary regulations. Argo Re is the primary direct subsidiary of Argo Group and is subject to Bermuda insurance laws. Argo Ireland is indirectly owned by Argo Re and is a mid-level holding company subject to Irish laws, and its primary subsidiary is Argo Group US. Argo Group US is a mid-level holding company subject to Delaware laws. Argo Group US is the parent of all of our U.S. insurance subsidiaries.
In December 2011, Argo Group received a dividend in the amount of $100.0 million in cash from Argo Re which was used to repay an intercompany note. In June 2011, Argo Group US received an extraordinary dividend in the amount of $30.0 million in cash from Rockwood. In December 2011 Argo Group US received an extraordinary dividend of $99.4 million, in the form of $48.1 million in cash and $51.3 million in securities, from Colony Insurance Company.
The payment of dividends by Argo Re is limited under Bermuda insurance laws, which require Argo Re to maintain certain measures of solvency and liquidity. As of December 31, 2011, Argo Re’s solvency and liquidity margins and statutory capital and surplus were in excess of the minimum levels required by the Insurance Act. As of December 31, 2011, the unaudited statutory capital and surplus of Argo Re was estimated to be $1,172.0 million and the amount required to be maintained was estimated to be $224.0 million, thereby allowing Argo Re the potential to pay dividends or capital distributions within the parameters of the solvency and liquidity margins. We believe that the dividend and capital distribution capacity of Argo Re will provide us with sufficient liquidity to meet our operating and debt service commitments, as well as other obligations.
On April 30, 2010, each of Argo Group International Holdings, Ltd., Argo Group US, Inc. (“Argo Group US”), Argo International Holdings Limited, and Argo Underwriting Agency Limited (the “Borrowers”) entered into a $150,000,000 Credit Agreement (“Credit Agreement”) with major money center banks. On July 22, 2011 the Borrowers entered into Amendment No. 2 to the Credit Agreement which increased the revolving credit facility under the Credit Agreement from $150.0 million to $170.0 million, extended the maturity date from April 30, 2013 to April 30, 2014, and modified certain other terms. Borrowings under the Credit Agreement may be used for general corporate purposes, including working capital and permitted acquisitions, and each of the Borrowers has agreed to be jointly and severally liable for the obligations of the other Borrowers under the Credit Agreement.
Currently, we do not have an outstanding balance under the $170.0 million credit facility. The credit facility allows up to $15.0 million of the facility to be used for letters of credit, subject to availability under the line. Currently, we have a $0.4 million letter of credit issued and outstanding under the facility.
Under certain insurance programs (i.e. large deductible programs, surety bonds) and various reinsurance agreements, collateral and letters of credit are held for our benefit to secure performance of insureds and reinsurers in meeting their obligations. At December 31, 2011, the amount of such collateral and letters of credit held under insurance and reinsurance agreements were $391.6 million and $283.3 million, respectively. Collateral can be provided in the form of trust accounts. As we are only the beneficiaries of amounts held in trust accounts, these amounts are not reflected in our Consolidated Balance Sheets. Collateral provided by an insured or reinsurer may exceed or fall below their total outstanding obligation.
Through a series of trusts, that are wholly-owned subsidiaries (non-consolidated), we issued debt. The debentures are variable and fixed rate, with the variable rate being reset periodically and subject to certain interest rate ceilings. Interest payments are payable quarterly or semiannually. The debentures are all unsecured and are subordinated to other indebtedness. All are redeemable subject to certain terms and conditions at a price equal to 100% of the principal plus accrued and unpaid interest, except as noted in the footnotes to the following table. These obligations are summarized as follows:
(1) Redeemable at a call price (expressed as a percentage of principal) of 104.875% at May 2008 declining annually to 100.975% at May 2012, and 100% thereafter, plus accrued and unpaid interest in all cases.
(2) Redeemable at a call price (expressed as a percentage of principal) of 104.180% at February 2007 declining annually to 100.418% at February 2016, and 100% thereafter, plus accrued and unpaid interest in all cases.
On February 18, 2011, May 3, 2011, August 5, 2011 and November 8, 2011, our Board of Directors declared a quarterly cash dividend in the amount of $0.12 on each share of common stock outstanding. On March 15, 2011, June 15, 2011, September 15, 2011 and December 15, 2011, we paid $3.3 million, $3.3 million, $3.3 million and $3.1 million to our shareholders of record on March 1, 2011, June 1, 2011, September 1, 2011 and December 1, 2011, respectively. The declaration and payment of dividends is at the discretion of the Board and will depend on our financial results, cash requirements, future prospects and other factors deemed relevant by the Board.
We invest excess cash in a variety of investment securities. As of December 31, 2011, our investment portfolio consisted of 77.5% fixed maturities, 7.2% equity securities, 5.6% other investments and 9.7% short-term investments (based on fair value) compared to 79.7% fixed maturities, 7.7% equity securities, 3.7% other investments and 8.9% short-term investments for the same period in 2010. We classify the majority of our investment portfolio as available-for-sale; resulting in these investments being reported at fair market value, with unrealized gains and losses, net of tax, being reported as a component of shareholders’ equity. At December 31, 2011, no investments were designated as trading. No issuer (excluding United States Government and United States Governmental agencies) of fixed income or equity securities represents more than 5.2% of shareholders’ equity at December 31, 2011.
Our insurance subsidiaries require liquidity and adequate capital to meet ongoing obligations to policyholders and claimants, and to fund operating expenses. During the year ended December 31, 2011, we used cash flows from operations of $17.7 million. Cash flow from investing activities satisfied this use of cash. Additionally, based on current premium volumes and other measures of capital deployed in our business, we determined we had excess capital and, therefore, returned capital to our shareholders through the share buy-back program and through dividend payments to our shareholders. We believe our liquidity generated from operations and, if required, from our investment portfolio, will be sufficient to meet our obligations for the foreseeable future. We believe we have access to various sources of liquidity including cash, investments and the ability to borrow under our revolving credit facility. Additionally, we continue to have access to the debt and equity markets, though we currently do not foresee needing access to these sources of liquidity.
We invest in the debt securities markets, which exposes us to credit risk. As a consequence of extending credit and/or carrying investment positions, we have exposure to credit risk arising from the uncertainty associated with a financial instrument obligor’s ability to make timely principal and/or interest payments. We attempt to mitigate this risk by limiting credit concentrations, diversification, and frequently monitoring the credit quality of issuers and counterparties.