From 2005 through 2010, the property casualty insurance market was very competitive and insurance rates decreased across most business lines. Although prices have generally increased since the beginning of 2011, the current market is highly competitive and price levels for certain lines of business remain below the prices required for the Company to achieve its long-term return objectives. Part of the Company's strategy is to selectively reduce its business in areas where it believes returns are not adequate. Price changes are reflected in the Company’s results over time as premiums are earned.
The Company’s profitability is also affected by its investment income and investment gains. The Company’s invested assets, which are derived from its own capital and cash flow from its insurance business, are invested principally in fixed maturity securities. The return on fixed maturity securities is affected primarily by general interest rates, as well as the credit quality and duration of the securities. Returns available on fixed maturity investments are at historically low levels. The Company's investment income has been negatively impacted by the low fixed maturity investment returns, and will be further impacted if investment returns remain at this level.
Reserves do not represent an exact calculation of liability. Rather, reserves represent an estimate of what management expects the ultimate settlement and claim administration will cost. While the methods for establishing reserves are well tested over time, some of the major assumptions about anticipated loss emergence patterns are subject to unanticipated fluctuation. These estimates, which generally involve actuarial projections, are based on management’s assessment of facts and circumstances then known, as well as estimates of trends in claims severity and frequency, judicial theories of liability and other factors, including the actions of third parties which are beyond the Company’s control. These variables are affected by external and internal events, such as inflation and economic volatility, judicial and litigation trends, reinsurance coverage, legislative changes and claim handling and reserving practices, which make it more difficult to accurately predict claim costs. The inherent uncertainties of estimating reserves are greater for certain types of liabilities where long periods of time elapse before a definitive determination of liability is made. Because setting reserves is inherently uncertain, the Company cannot provide assurance that its current reserves will prove adequate in light of subsequent events.
Loss frequency and severity are measures of loss activity that are considered in determining the key assumptions described in our discussion of loss and loss expense reserves, including expected loss ratios, rate of loss cost inflation and reported and paid loss emergence patterns. Loss frequency is a measure of the number of claims per unit of insured exposure, and loss severity is a measure of the average size of claims. Factors affecting loss frequency include the effectiveness of loss controls and safety programs and changes in economic activity or weather patterns. Factors affecting loss severity include changes in policy limits, retentions, rate of inflation and judicial interpretations.
Our net reserves for losses and loss expenses of approximately $9 billion as of December 31, 2014 relate to multiple accident years. Therefore, the impact of changes in frequency or severity for more than one accident year could be higher or lower than the amounts reflected above.
Following is a summary of the Company’s reserves for losses and loss expenses by business segment as of December 31, 2014 and 2013:
The Company evaluates reserves for losses and loss adjustment expenses on a quarterly basis. Changes in estimates of prior year losses are reported when such changes are made. The changes in prior year loss reserve estimates are generally the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as additional information becomes known regarding individual claims and aggregate claim trends. Certain of the Company's insurance and reinsurance contracts are retrospectively rated, whereby the Company collects more or less premiums based on the level of loss activity. For those contracts, changes in loss and loss adjustment expenses for prior years may be fully or partially offset by additional or return premiums. Net prior year development (i.e, the sum of prior year reserve changes and prior year earned premiums changes) for each of the three years ended December 31, 2014 are as follows:
The following table provides a summary of fixed maturity securities in an unrealized loss position as of December 31, 2014:
Because many fixed maturity securities do not trade on a daily basis, the Company utilizes pricing models and processes which may include benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Market inputs used to evaluate securities include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. Quoted prices are often unavailable for recently issued securities that are infrequently traded or securities that are only traded in private transactions. For publicly traded securities for which quoted prices are unavailable, the Company determines fair value based on independent broker quotations and other observable market data. For securities traded only in private negotiations, the Company determines fair value based primarily on the cost of such securities, which is adjusted to reflect prices of recent placements of securities of the same issuer, financial data, projections and business developments of the issuer and other relevant information.
The following is a summary of pricing sources for the Company's fixed maturity securities available for sale as of December 31, 2014:
Net Income to Common Stockholders. The following table presents the Company’s net income to common stockholders and net income per diluted share for the years ended December 31, 2014 and 2013.
Net Investment Income. Following is a summary of net investment income for the years ended December 31, 2014 and 2013:
Insurance-International - The loss ratio of 62.8% in 2014 was 3.4 points higher than the loss ratio of 59.4% in 2013. Catastrophe losses were $20 million in 2014 compared with $11 million in 2013, an increase of 0.9 loss ratio points. Adverse prior year reserve development was $23 million in 2014 compared with $12 million in 2013, a difference of 1.2 loss ratio points. The loss ratio excluding catastrophe losses and prior year reserve development increased 1.3 points to 57.4% in 2014 from 56.1% in 2013.
Reinsurance-Global - The loss ratio of 62.0% in 2014 was 0.2 points lower than the loss ratio of 62.2% in 2013. Catastrophe losses were $2 million in 2014 compared with $16 million in 2013, a decrease of 1.9 loss ratio points. Favorable prior year reserve development was $16 million in 2014 compared with $39 million in 2013, a difference of 3.0 loss ratio points. The loss ratio excluding catastrophe losses and prior year reserve development decreased 1.3 points to 64.1% in 2014 from 65.4% in 2013.
Underwriting expenses are comprised of commissions paid to agents and brokers, premium taxes and other assessments and internal underwriting costs. Underwriting expenses increased 7% compared with an increase in net premiums earned of 10%. The expense ratio (underwriting expenses expressed as a percentage of premiums earned) was 33.0% in 2014, down from 33.9% in 2013, primarily due to higher earned premiums and to the impact of expense reduction initiatives.
However, in the future, if such earnings were distributed to the Company, taxes of approximately $3.1 million, assuming all tax credits are realized, would be payable on such undistributed earnings and would be reflected in the tax provision for the year in which these earnings are no longer intended to be permanently reinvested in the foreign subsidiary.
Net Income to Common Stockholders. The following table presents the Company’s net income to common stockholders and net income per diluted share for the years ended December 31, 2013 and 2012.
The Company reported net income of $500 million in 2013 compared to $511 million in 2012. The 2% decrease in net income was primarily due to decreases in after-tax net investment gains of $63 million and after-tax net investment income of $31 million, largely offset by an increase in after-tax underwriting income of $82 million. The number of weighted average diluted shares decreased as a result of the Company’s repurchases of its common stock in 2013 and 2012.
A summary of gross premiums written in 2013 compared with 2012 by line of business within each business segment follows:
Insurance-Domestic gross premiums increased 13% to $4,804 million in 2013 from $4,261 million in 2012. Gross premiums increased $247 million (19%) for other liability, $155 million (14%) for workers' compensation, $56 million (6%) for short-tail lines, $50 million (15%) for professional liability and $35 million (7%) for commercial auto.
Insurance-International gross premiums increased 12% to $899 million in 2013 from $802 million in 2012. Gross premiums increased $69 million (17%) for short-tail lines, $36 million (62%) for other liability and $2 million (3%) for workers' compensation and decreased $5 million (4%) for professional liability and $5 million (3%) for commercial auto.
Premiums earned increased 12% to $5,227 million in 2013 from $4,674 million in 2012. Insurance premiums (including the impact of rate changes) are generally earned evenly over the policy term, and accordingly we expect recent rate increases will be earned over the upcoming quarters. Premiums earned in 2013 are related to business written during both 2013 and 2012. Audit premiums were $120 million in 2013 compared with $89 million in 2012.
Net Realized Gains on Investment Sales. The Company buys and sells securities on a regular basis in order to maximize its total return on investments. Decisions to sell securities are based on management’s view of the underlying fundamentals of
specific securities as well as management’s expectations regarding interest rates, credit spreads, currency values and general economic conditions. Net realized gains on investment sales were $128 million in 2013 compared with $201 million in 2012.
For loans where the Company determines it is probable that the contractual terms will not be met, an analysis is performed and a valuation reserve is established, if necessary, with a charge to earnings. In 2012, the valuation allowance for mortgage loans decreased by $14 million. There was no change to the valuation allowance in 2013.
Revenues from Wholly-Owned Investees. Revenues from wholly-owned investees were derived from aviation-related businesses that provide services to the general aviation market, including fuel and line service, aircraft sales and maintenance, avionics and engineering services and parts fabrication. Revenues from wholly-owned investees increased to $408 million in 2013 from $247 million in 2012, primarily as a result of the acquisition of an aircraft equipment supplier in January 2013.
Losses and Loss Expenses. Losses and loss expenses increased to $3,197 million in 2013 from $2,948 million in 2012. The consolidated loss ratio was 61.2% in 2013 and 63.1% in 2012. Catastrophe losses, net of reinsurance recoveries and reinstatement premiums, were $65 million in 2013 compared with $80 million in 2012, a decrease of 0.5 loss ratio points. Favorable prior year reserve development (net of premium offsets) was $98 million in 2013 compared with $103 million in 2012, a difference of 0.3 loss ratio points. The loss ratio excluding catastrophe losses and prior year reserve development decreased 1.8 points to 61.8% in 2013 from 63.6% in 2012. A summary of loss ratios in 2013 compared with 2012 by business segment follows:
Insurance-Domestic - The loss ratio of 61.3% in 2013 was 2.2 points lower than the loss ratio of 63.5% in 2012. Catastrophe losses were $38 million in 2013 compared with $43 million in 2012, a decrease of 0.2 loss ratio points. Favorable prior year reserve development was $71 million in 2013 compared with $66 million in 2012. The loss ratio excluding catastrophe losses and prior year reserve development decreased 2.0 points to 62.2% in 2013 from 64.2% in 2012.
Expenses from Wholly-Owned Investees. Expenses from wholly-owned investees represent costs associated with aviation-related businesses that include cost of goods sold related to aircraft and other sales, labor and equipment costs related to repairs and other services and general and administrative expenses. Expenses from wholly-owned investees were $389 million in 2013 compared to $247 million in 2012, primarily as a result of the acquisition of an aircraft equipment supplier in January 2013.
At December 31, 2014, investments in foreign government fixed maturity securities were as follows:
(1) Supranational represents investments in the North American Development Bank, European Investment Bank and International Bank for Reconstruction & Development.
options) through August 2025. Loans receivable include commercial loans of $79 million that are secured by business assets. Commercial loans have fixed interest rates and varying maturities not exceeding 10 years.
Cash Flow. Cash flow provided from operating activities decreased to $735 million in 2014 from $820 million in 2013. The decrease in cash flow was due primarily to a decrease in cash flow from reinsurance and other underwriting activities and an increase in income taxes paid. Paid losses as a percent of earned premiums were 54% in 2014 compared with 55% in 2013.
As a holding company, the Company derives cash from its subsidiaries in the form of dividends, tax payments and management fees. Maximum amounts of dividends that our insurance companies can pay without regulatory approval are prescribed by statute. During 2015, the maximum amount of dividends which can be paid without regulatory approval is approximately $631 million. The ability of the holding company to service its debt obligations is limited by the ability of its insurance subsidiaries to pay dividends. In the event dividends, tax payments and management fees available to the holding company were inadequate to service its debt obligations, the Company would need to raise capital, sell assets or restructure its debt obligations.
The Company's insurance subsidiaries' principal sources of cash are premiums, investment income, service fees and proceeds from sales and maturities of portfolio investments. The principal uses of cash are payments for claims, taxes, operating expenses and dividends. The Company expects its insurance subsidiaries to fund the payment of losses with cash received from premiums, investment income and fees. The Company generally has targeted an average duration for its investment portfolio that is within one year of the average duration of its liabilities so that portions of its investment portfolio mature throughout the claim cycle and are available for the payment of claims if necessary. In the event operating cash flow and proceeds from maturities and prepayments of fixed income securities are not sufficient to fund claim payments and other cash requirements, the remainder of the Company's cash and investments is available to pay claims and other obligations as they become due. The Company's investment portfolio is highly liquid, with approximately 81% invested in cash, cash equivalents and marketable fixed income securities as of December 31, 2014. If the sale of fixed maturity securities were to become necessary, a realized gain or loss equal to the difference between the cost and sales price of securities sold would be recognized.
Debt. At December 31, 2014, the Company had senior notes, subordinated debentures and other debt outstanding with a carrying value of $2,456 million and a face amount of $2,481 million. The maturities of the outstanding debt are $276 million in 2015, $33 million in 2016, $42 million in 2017, $450 million in 2019, $300 million in 2020, $427 million in 2022, $1 million in 2023, $2 million in 2029, $250 million in 2037, $350 in 2044 and $350 million in 2053.
The Company repaid $200 million of 5.875% senior notes that matured in February 2013. In May 2013, the Company issued $350 million of 5.625% subordinated debentures due 2053 and prepaid $250 million of 6.75% subordinated debentures that were due in 2045. In August 2014, the Company issued $350 million of 4.75% senior notes due 2044. A portion of the proceeds will be used to repay $200 million of 5.60% senior notes that are due on May 15, 2015. In addition, the Company assumed $71 million of debt in conjunction with the acquisition of an office building in West Palm Beach, Florida, that matures in August 2015.
Equity. The Company repurchased 5,816,468, 3,924,355, and 3,428,175 shares of its common stock in 2014, 2013 and 2012, respectively. The aggregate cost of the repurchases was $239 million in 2014, $166 million in 2013, and $128 million in 2012. At December 31, 2014, total common stockholders’ equity was $4.6 billion, common shares outstanding were 126,749,000 and stockholders’ equity per outstanding share was $36.21.
The Company has not provided U.S. deferred income taxes on the undistributed earnings of approximately $58 million of its non-U.S. subsidiaries since these earnings are intended to be permanently reinvested in the non-U.S. subsidiaries. However, in
Property reinsurance treaties - The Company purchases property reinsurance to reduce its exposure to large individual property losses and catastrophe events. Following is a summary of significant property reinsurance treaties in effect as of January 1, 2015: The Company’s property per risk reinsurance generally covers losses between $2 million and $50 million. The Company’s catastrophe excess of loss reinsurance program provides protection for net losses between $30 million and $305 million for the majority of business written by its U.S. companies and its Lloyd's syndicate. The Company has separate catastrophe excess of loss reinsurance for business written through Lloyd’s that provides protection for losses between $20 million and $60 million for events in North America. The Company’s catastrophe reinsurance agreements are subject to certain limits, exclusions and reinstatement premiums.
Other reinsurance - Depending on the operating unit, the Company purchases specific additional reinsurance to supplement the above programs.
Following is a summary of the Company's contractual obligations as of December 31, 2014:
The Company utilizes letters of credit to back certain reinsurance payments and obligations. Outstanding letters of credit were $13 million as of December 31, 2014. The Company has made certain guarantees to state regulators that the statutory capital of certain subsidiaries will be maintained above certain minimum levels.
We have audited the accompanying consolidated balance sheets of W. R. Berkley Corporation and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2014. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
The consolidated financial statements, which include the accounts of W. R. Berkley Corporation and its subsidiaries (the "Company"), have been prepared on the basis of U.S. generally accepted accounting principles ("GAAP"). All significant intercompany transactions and balances have been eliminated. Reclassifications have been made in the 2013 and 2012 financial statements to conform to the presentation of the 2014 financial statements. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the revenues and expenses reflected during the reporting period. The most significant items on our balance sheet that involve a greater degree of accounting estimates that are subject to change in the future are the valuation of investments, other-than-temporary impairments, loss and loss adjustment expense reserves and premium estimates. Actual results could differ from those estimates.
Revenues from wholly-owned investees are derived from aircraft services provided to the general, commercial and military aviation markets. These services include (i) the distribution, manufacturing, repair and overhaul of aircraft parts and components, (ii) the sale of new and used aircraft, and (iii) avionics, fuel, maintenance, storage and charter services. Revenue is recognized upon the shipment of parts, the delivery of aircraft, the delivery of fuel, and upon completion of services.
real estate are reported as net investment income. The carrying value of real estate is reviewed for impairment and an impairment loss is recognized if the estimated undiscounted cash flows from the use and disposition of the property are less than the carrying value of the property.
Interest payments were $120 million, $125 million and $119 million in 2014, 2013 and 2012, respectively. Income taxes paid were $314 million, $186 million and $133 million in 2014, 2013 and 2012, respectively. Other non-cash items include acquisitions, unrealized investment gains and losses and pension expense. (See Note 2, Note 11 and Note 25 of Notes to Consolidated Financial Statements.)
In January 2014, the Financial Accounting Standards Board issued guidance relating to Accounting for Investments in Qualified Affordable Housing Projects. This guidance modified the amortization method on these investments and the statement of operations classification as pre-adoption amounts were presented in both pre-tax income and income tax expense while post adoption all impacts are recorded in income tax expense. The Company adopted this guidance effective January 1, 2014, and the impact of applying this guidance was immaterial.
All recently issued but not yet effective accounting and reporting standards are either not applicable to the Company or are not expected to have a material impact on the Company.
The following table presents the components of the changes in accumulated other comprehensive income (loss) (AOCI) as of and for the year ended December 31, 2014:
(3) Other operating costs and expenses in the consolidated statements of income.
At December 31, 2014 and 2013, investments in fixed maturity securities were as follows:
Gross unrealized losses for mortgage-backed securities include $1,095,671 and $1,961,247, as of December 31, 2014 and 2013, respectively, related to the non-credit portion of OTTI recognized in other comprehensive income.
In 2014, properties in operation included a long-term ground lease in Washington, D.C. and an office building in West Palm Beach, Florida. Properties in operation in 2013 included an office building located in London which was sold during 2014. Properties in operation are net of accumulated depreciation and amortization of $1,609,000 and $17,827,000 as of December 31, 2014 and 2013, respectively. Related depreciation expense was $4,808,000 and $7,474,000 for the years ended December 31, 2014 and 2013, respectively. Future minimum rental income expected on operating leases relating to properties in operation is $11,379,000 in 2015, $11,457,000 in 2016, $11,500,000 in 2017, $10,833,000 in 2018, $7,839,000 in 2019 and $336,653,000 thereafter.
The Company utilizes a risk rating system to assign a risk to each of its real estate loans. The loan rating system takes into consideration credit quality indicators including loan to value ratios, which compare the outstanding loan amount to the estimated value of the property, the borrower’s financial condition and performance with respect to loan terms, the Company’s position in the capital structure, and the overall leverage in the capital structure. Based on this rating system, none of the real estate loans were considered to be impaired at December 31, 2014, and accordingly, the Company determined that a specific valuation allowance was not required.
Loans Receivable - The Company monitors the performance of its loans receivable, including current market conditions for each loan and the ability to collect principal and interest. For loans where the Company determines it is probable that the contractual terms will not be met, an analysis is performed and a valuation reserve is established, if necessary, with a charge to earnings. Loans receivable are reported net of a valuation reserve of $3 million and $2 million at December 31, 2014 and 2013, respectively.
There were no transfers between Levels 1 and 2 for the years ended December 31, 2014 and 2013.
The following tables summarize changes in Level 3 assets and liabilities for the years ended December 31, 2014 and 2013:
For certain retrospectively rated insurance polices and reinsurance agreements, reserve development is offset by additional or return premiums. Favorable reserve development, net of additional and return premiums, was $85 million, $98 million and $103 million in 2014, 2013 and 2012, respectively.
The Company reinsures a portion of its exposures principally to reduce its net liability on individual risks and to protect against catastrophic losses. Estimated amounts due from reinsurers are reported net of reserves for uncollectible reinsurance of $1,144,000, $1,385,000 and $1,680,000 as of December 31, 2014, 2013 and 2012, respectively. The following table presents the amounts due from reinsurers as of December 31, 2014:
(1) Subsidiary debt is due as follows: $76 million in 2015, $33 million in 2016, $42 million in 2017 and $3 million thereafter.
At December 31, 2014 and 2013, the tax effects of differences that give rise to significant portions of the deferred tax asset and deferred tax liability are as follows:
The Company had current tax receivables of $67,623,000 and $24,737,000 at December 31, 2014 and 2013, respectively. At December 31, 2014, the Company had foreign net operating loss carryforwards of $559 thousand that expire beginning in 2015, $6 million that expire beginning in 2031, and an additional $12 million that have no expiration date. At December 31, 2014, the Company had a valuation allowance of $1,335,000, as compared to none at December 31, 2013. The Company has provided a valuation allowance against losses for certain foreign non-insurance related business. The statute of limitations has closed for the Company’s tax returns through December 31, 2010.
The National Association of Insurance Commissioners (“NAIC”) has risk-based capital (“RBC”) requirements that require insurance companies to calculate and report information under a risk-based formula which measures statutory capital and surplus needs based on a regulatory definition of risk in a company’s mix of products and its balance sheet. This guidance is used to calculate two capital measurements: Total Adjusted Capital and RBC Authorized Control Level. Total Adjusted Capital is equal to the Company’s statutory capital and surplus excluding capital and surplus derived from the use of permitted practices that differ from statutory accounting practices. RBC Authorized Control Level is the capital level used by regulatory authorities to determine whether remedial action is required. Generally, no remedial action is required if Total Adjusted Capital is 200% or more of the RBC Authorized Control Level. At December 31, 2014, BIC’s Total Adjusted Capital of $5.187 billion was 465% of its RBC Authorized Control Level.
At December 31, 2014, the Company had commitments to invest up to $242 million in certain investment funds.
The Company has not issued any stock options under its stock incentive plans since 2004, and there were no outstanding options at December 31, 2014. The following table summarizes stock option information:
The 2008 grant, which earned $23.0 million during the five years ended December 31, 2012, was paid in 2013.
Following is a summary of retirement benefit disclosures for prior years:
Corporate, other and eliminations represent corporate revenues and expenses and other items that are not allocated to business segments.