See Note 1(a) and Note 2 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for information on changes in subsidiaries for the five year period ended December 31, 2019.
The following is a discussion and analysis of our financial condition and results of operations for the twelve months ended December 31, 2019, 2018 and 2017. This discussion and analysis should be read in conjunction with our audited consolidated financial statements and Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties and that are not historical facts, including statements about our beliefs and expectations. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and particularly under the headings “Risk Factors,” “Business” and “Note on Forward-Looking Statements” contained in Item 1A, Item 1, and Part I of this Form 10-K, respectively.
Adjusted earnings before income taxes is a non-GAAP financial measure for our Alleghany Capital segment. Adjusted earnings before income taxes represents noninsurance revenue and net investment income less other operating expenses and interest expense, and does not include: (i) amortization of intangible assets; (ii) change in the fair value of equity securities; (iii) net realized capital gains; (iv) OTTI losses; and (v) income taxes. Because adjusted earnings before income taxes excludes amortization of intangible assets, change in the fair value of equity securities, net realized capital gains, OTTI losses and income taxes, it provides an indication of economic performance that is not affected by levels of effective tax rates or levels of amortization resulting from acquisition accounting. We use adjusted earnings before income taxes as a supplement to earnings before income taxes, the most comparable GAAP financial measure, to evaluate the performance of certain of our noninsurance operating subsidiaries and investments. A reconciliation of adjusted earnings before income taxes to earnings before income taxes is presented within “Consolidated Results of Operations.”
Net earnings attributable to Alleghany stockholders were $857.8 million in 2019, compared with $39.5 million in 2018 and $90.1 million in 2017.
Underwriting profit was $33.0 million in 2019, compared with underwriting losses of $161.5 million in 2018 and $316.4 million in 2017.
Net favorable prior accident year loss reserve development was $184.7 million in 2019, compared with $329.0 million in 2018 and $298.6 million in 2017.
We incurred significant catastrophe losses in 2019, 2018 and 2017, primarily arising from several major typhoons, hurricanes and wildfires. More specifically, in 2019,
Hurricane Maria caused widespread property damage and flooding in September 2017, primarily in Puerto Rico.
Includes elimination of minor reinsurance activity between segments. Also includes certain minor, legacy investments that were previously reflected in Alleghany Capital in 2018 and prior periods.
The loss ratio is derived by dividing the amount of net loss and LAE by net premiums earned, all as determined in accordance with GAAP.
The increase in net premiums written in 2019 from 2018 primarily reflects higher gross premiums written and lower ceded premiums written due to a decrease in retrocessional coverage purchased in 2019 at our reinsurance segment.
The increase in net premiums earned in 2018 from 2017 reflects an increase at our reinsurance segment due to an increase in net premiums written in recent quarters, partially offset by a decrease at our insurance segment due to the impact of the sale of PacificComp.
2019 vs 2018. The increase in net loss and LAE in 2019 from 2018 primarily reflects the impact of higher net premiums earned and lower favorable prior accident year loss reserve development, partially offset by significantly lower catastrophe losses,
primarily at our reinsurance segment. The catastrophe losses in 2019 primarily include $183.7 million related to Typhoon Hagibis, $95.4 million related to Typhoon Faxai, $22.3 million related to civil unrest in Chile and $13.6 million related to Hurricane Dorian. The catastrophe losses in 2018 primarily include $183.4 million related to Typhoon Jebi, $182.0 million related to wildfires in California, $135.2 million related to Hurricane Michael, $70.4 million related to Hurricane Florence and $33.7 million related to Typhoon Trami.
2018 vs 2017. The decrease in net loss and LAE in 2018 from 2017 primarily reflects significantly lower catastrophe losses at our reinsurance and insurance segments and the impact of the sale of PacificComp. The catastrophe losses in 2018 are noted above. The catastrophe losses in 2017 primarily include $252.1 million related to Hurricane Irma, $217.7 million related to Hurricane Harvey and $216.8 million related to Hurricane Maria, as well as losses related to wildfires in California and earthquakes in Mexico.
2019 vs 2018. The increase in commissions, brokerage and other underwriting expenses in 2019 from 2018 primarily reflects the impact of higher net premiums earned, partially offset by lower overall commission rates due to a change in the mix of business.
A detailed comparison of commissions, brokerage and other underwriting expenses by segment for 2019, 2018 and 2017 is contained on pages 97 and 103.
Underwriting profit. The following table presents our consolidated underwriting profit (loss):
2018 vs 2017. The decrease in underwriting loss in 2018 from 2017 primarily reflects significantly lower catastrophe losses, as discussed above.
In the first quarter of 2018, we adopted new investment accounting guidance which required changes in the fair value of equity securities, except those accounted for under the equity method, to be recognized in net earnings. In earlier periods, equity securities
were considered to be available-for-sale, or “AFS,” and were included in the analysis of OTTI. See Note 1(r) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information regarding our adoption of this new guidance.
On July 18, 2019, AIHL purchased an exchange-traded equity derivative index put option, or the “Put Option,” for $38.4 million to hedge the downside equity market risk on approximately $1.0 billion of our equity portfolio. The Put Option did not qualify for hedge accounting. The Put Option expired worthless on December 31, 2019, and the resulting $38.4 million decline in value of the Put Option was recorded as a reduction to net realized capital gains.
2018 vs 2017. The increase in net investment income in 2018 from 2017 primarily reflects higher dividend income, primarily resulting from an increase in the size of our equity securities portfolio during the first three quarters of 2018 and, to a lesser extent, an increase in interest income primarily resulting from higher yields on short-term investments and floating-rate debt securities, partially offset by the impact of the sale of PacificComp.
The net realized capital losses in 2018 compared with net realized capital gains in 2017 primarily reflect the absence of net realized capital gains from equity securities in 2018 as a result of our adoption of the new investment accounting guidance discussed above, net realized capital losses taken in 2018 from the sale of debt securities and an impairment charge from the write-down of certain SORC assets, as discussed above, partially offset by a gain on AIHL’s conversion of its limited partnership interests in certain subsidiaries of Ares into Ares common units, as discussed above.
Noninsurance revenue and Other operating expenses. Noninsurance revenue and other operating expenses primarily include sales and expenses associated with our Alleghany Capital segment. Other operating expenses also include the long-term incentive
On October 1, 2019, Jazwares acquired the outstanding equity of WCT for $159.0 million. Jazwares funded the acquisition with $135.5 million of incremental debt and the issuance of certain noncontrolling interests in Jazwares, which were valued at $23.5 million and which increased the aggregate noncontrolling interests in Jazwares from approximately 23 percent to approximately 25 percent.
The increases in noninsurance revenue and other operating expenses in 2019 from 2018 primarily reflect higher sales at IPS, W&W|AFCO Steel and Jazwares, as well as the acquisitions of Hirschfeld, Concord and WCT. The increase in other operating expenses in 2019 from 2018 also reflects increases in long-term compensation at our reinsurance and insurance segments, as discussed above.
Corporate administration. The increase in corporate administration expense in 2019 from 2018 reflects higher Alleghany parent-company long-term incentive compensation accruals due primarily to the impact of appreciation on the value of our consolidated debt and equity securities portfolios in 2019, compared with depreciation in 2018 and Alleghany stock price appreciation.
Amortization of intangible assets. The increase in amortization expense in 2019 from 2018 primarily reflects the Concord acquisition, Kentucky Trailer’s acquisition of two manufacturers of aluminum feed transportation equipment in December 2018 and July 2019, PCT’s acquisition of a consumable cutting tool manufacturer in June 2019, Jazwares’ acquisition of WCT in October 2019 and IPS’s acquisition in May 2019.
The increase in amortization expense in 2018 from 2017 primarily reflects the W&W|AFCO Steel, Hirschfeld and Concord acquisitions.
2019 vs 2018. The income taxes in 2019 compared to income tax benefit in 2018 primarily reflects substantially higher earnings before income taxes. The increase in effective tax rate in 2019 compared with 2018 primarily reflects the impact of higher
earnings before income taxes and, to a lesser extent, lower tax-exempt interest income arising from municipal bond securities and lower dividends-received deductions, partially offset by higher state income taxes.
The increase in net earnings attributable to noncontrolling interests in 2019 from 2018 primarily reflects profitable growth at Alleghany Capital, as discussed above, as well as the impact of the Concord acquisition.
2018 vs 2017. The increase in earnings before income taxes in 2018 from 2017 primarily reflects significantly lower catastrophe losses and, to a lesser extent, lower long-term incentive compensation expense accruals, partially offset by depreciation of our equity securities portfolio and net realized capital losses in 2018 compared with net realized capital gains in 2017, all as discussed above. The decrease in net earnings attributable to Alleghany stockholders in 2018 from 2017 primarily reflects a significantly lower income tax benefit, as discussed above.
The increase in net earnings attributable to noncontrolling interests in 2018 from 2017 primarily reflects profitable growth at Alleghany Capital, as discussed above.
The reinsurance segment is composed of TransRe’s property and casualty & other lines of business. TransRe also writes a modest amount of property and casualty insurance business, which is included in the reinsurance segment. For a more detailed description of our reinsurance segment, see Part I, Item 1, “Business-Segment Information-Reinsurance Segment” of this
The following tables present the underwriting results of the reinsurance segment:
Casualty & other. The increase in gross premiums written in 2019 from 2018 primarily reflects: (i) higher gross premiums written by the domestic operations, which include the impact of the Renewal Rights Purchase, partially offset by lower gross premiums written related to the Quota Share Treaty; and (ii) higher gross premiums written by the European operations mainly in the auto/motor, marine and accident & health lines of business, partially offset by the impact of changes in foreign currency exchange rates. Gross premiums written related to the Quota Share Treaty were $414.5 million and $456.8 million in 2019 and 2018, respectively, reflecting a reduction of TransRe’s quota share participation. Excluding the impact of changes in foreign currency exchange rates, gross premiums written increased by 12.0 percent in 2019 from 2018. The increase in net premiums earned in 2019 from 2018 primarily reflects the impact of higher gross premiums written and lower ceded premiums in recent quarters due to a decrease in retrocessional coverage purchased in 2019, partially offset by the impact of changes in foreign currency exchange rates. Excluding the impact of changes in foreign currency exchange rates, net premiums earned increased by 11.2 percent in 2019 from 2018.
The increase in gross premiums written in 2018 from 2017 primarily reflects the impact of the Renewal Rights Purchase, an increase in casualty-related Quota Share Treaty premiums written and an increase in premiums written by the domestic and Asia-Pacific operations. Gross premiums written related to the Quota Share Treaty were $456.8 million and $416.6 million in 2018 and 2017, respectively, reflecting an increase in casualty-related premiums written, partially offset by a reduction of TransRe’s quota share participation. Excluding the impact of changes in foreign currency exchange rates, gross premiums written increased by 9.8 percent in 2018 from 2017. The increase in net premiums earned in 2018 from 2017 primarily reflects an increase in gross premiums written in recent quarters. Excluding the impact of changes in foreign currency exchange rates, net premiums earned increased by 5.0 percent in 2018 from 2017.
Property. The decrease in net loss and LAE in 2019 from 2018 primarily reflects significantly lower catastrophe losses. Catastrophe losses in 2019 include $164.6 million related to Typhoon Hagibis, $86.9 million related to Typhoon Faxai, $22.3 million related to civil unrest in Chile, $10.3 million related to Hurricane Dorian and $9.1 million related to other catastrophes. Catastrophe losses in 2018 include $163.2 million related to Typhoon Jebi, $160.6 million related to wildfires in California, $76.7 million related to Hurricane Michael, $31.9 million related to Hurricane Florence, $29.7 million related to Typhoon Trami and $19.7 million related to several severe weather events in East Asia.
The decrease in net loss and LAE in 2018 from 2017 primarily reflects lower catastrophe losses, partially offset by higher non-catastrophe losses and less favorable prior accident year loss reserve development. Catastrophe losses in 2018 are as discussed above. Catastrophe losses in 2017 include $181.3 million related to Hurricane Maria, $128.1 million related to Hurricane Irma, $110.8 million related to Hurricane Harvey, $69.2 million related to wildfires in California and $26.9 million related to earthquakes in Mexico.
Reflects favorable prior accident year loss reserve development related to several catastrophes primarily in the 2016 accident year.
The favorable prior accident year loss reserve development in 2019, 2018 and 2017 reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods. The favorable prior accident year loss reserve development in 2019 did not impact assumptions used in estimating TransRe’s loss and LAE liabilities for business earned in 2019.
Casualty & other. The increase in net loss and LAE in 2019 from 2018 primarily reflects the impact of higher net premiums earned and, to a lesser extent, less favorable prior accident year loss reserve development, partially offset by lower casualty-related catastrophe losses. Catastrophe losses generally relate to the marine and nontraditional lines of business. In 2019, catastrophe losses include $3.6 million related to Typhoon Hagibis, $2.9 million related to Hurricane Dorian and $0.9 million related to other catastrophes. Catastrophe losses in 2018 include $4.6 million related to Hurricane Florence, $3.4 million related to Hurricane Michael, $3.1 million related to wildfires in California and $4.0 million related to Typhoon Jebi.
The increase in net loss and LAE in 2018 from 2017 primarily reflects the impact of higher net premiums earned, partially offset by lower catastrophe losses. Catastrophe losses in 2018 are as discussed above. Catastrophe losses in 2017 primarily include $26.2 million related to Hurricane Irma, $20.1 million related to Hurricane Harvey and $15.4 million related to Hurricane Maria.
Represents unfavorable prior accident year loss reserve development related to the U.K. Ministry of Justice’s reduction in the discount rate used to calculate lump-sum bodily injury payouts in personal injury insurance claims in the U.K to negative 0.75 percent as of March 20, 2017 from 2.50 percent.
Primarily reflects favorable prior accident year loss reserve development in the longer-tailed casualty lines of business in the 2014 and prior accident years and, to a lesser extent, shorter-tailed lines of business in the 2014 and prior accident years, partially offset by unfavorable prior accident year loss reserve development in the marine and aviation lines of business in the 2018 accident year.
Primarily reflects favorable prior accident year loss reserve development in: (i) longer-tailed professional liability and general liability lines of business in the 2003 through 2012 accident years; and (ii) shorter-tailed casualty lines of business in the 2010 through 2014 accident years; partially offset by unfavorable prior accident year loss reserve development in shorter-tailed casualty lines of business in the 2015 and 2016 accident years.
Property. The increase in commissions, brokerage and other underwriting expenses in 2019 from 2018 primarily reflects the impact of higher net premiums earned, higher overall commission rates due primarily to a change in the mix of business and higher overhead expenses. The slight increase in commissions, brokerage and other underwriting expenses in 2018 from 2017 primarily reflects higher commission rates, partially offset by the impact of slightly lower net premiums earned.
Casualty & other. The decrease in underwriting profit in 2019 from 2018 primarily reflects less favorable prior accident year loss reserve development, partially offset by the impact of higher net premiums earned, all as discussed above. The increase in underwriting profit in 2018 from 2017 primarily reflects lower catastrophe losses, as discussed above.
Underwriting profit represents net premiums earned less net loss and LAE and commissions, brokerage and other underwriting expenses, all as determined in accordance with GAAP, and does not include net investment income, change in the fair value of equity securities, net realized capital gains, OTTI losses, noninsurance revenue, other operating expenses, corporate administration, amortization of intangible assets and interest expense. Underwriting profit is a non-GAAP financial measure and does not replace earnings before income taxes determined in accordance with GAAP as a measure of profitability. See “Comment on Non-GAAP Financial Measures” herein for additional detail on the presentation of our results of operations.
The increase in net premiums earned in 2019 from 2018 primarily reflects increases in gross premiums written in recent quarters, partially offset by higher ceded premiums earned related to the growth in the heavily-reinsured property lines of business. The increase in net premiums earned in 2018 from 2017 primarily reflects an increase in gross premiums written in recent quarters, partially offset by higher ceded premiums earned related to reinstatement premiums on RSUI’s per risk property reinsurance treaties and the impact of growth in the heavily-reinsured property lines of business.
CapSpecialty. The increase in gross premiums written in 2019 from 2018 primarily reflects growth in the healthcare, professional liability, specialty casualty and surety lines of business due to increases in business opportunities and CapSpecialty’s expanded product offerings, and the impact of CapSpecialty’s February 2018 purchase of certain renewal rights to a small environmental liability block of business. To a lesser extent, the increase in gross premiums written in 2019 from 2018 also reflects the impact of CapSpecialty’s September 2019 purchase of certain renewal rights associated with a small lawyer’s professional liability block of business.
The increases in net premiums earned in 2019 from 2018 and in 2018 from 2017 primarily reflect increases in gross premiums written.
Primarily reflects favorable prior accident year loss reserve development related to Superstorm Sandy in the 2012 accident year, Hurricanes Florence and Michael in the 2018 accident year and Hurricanes Harvey and Maria in the 2017 accident year, partially offset by assumed property reinsurance lines of business from both catastrophe and non-catastrophe losses in the 2018 accident year.
Primarily reflects favorable catastrophe prior accident year loss reserve development in the 2016 accident year, partially offset by unfavorable prior accident year property loss reserve development in the binding authority lines of business primarily in the 2015 and 2016 accident years.
CapSpecialty. The increase in net loss and LAE in 2019 from 2018 primarily reflects unfavorable prior accident year loss reserve development in 2019, compared with favorable prior accident year loss reserve development in 2018, the impact of higher net premiums earned and, to a lesser extent, an increase in initial loss estimates in the current accident year. The increase in net loss and LAE in 2018 from 2017 primarily reflects the impact of higher net premiums earned and higher 2018 accident year losses due primarily to an increase in net premiums earned for certain lines of business with a higher loss ratio, partially offset by lower catastrophe losses and an increase in favorable prior accident year loss reserve development.
Primarily reflects favorable prior accident year loss reserve development in the casualty lines of business in the 2010, 2014, 2015 and 2016 accident years.
The unfavorable prior accident year loss reserve development in 2019 reflects unfavorable loss emergence compared with loss emergence patterns assumed in earlier periods. The unfavorable prior accident year loss reserve development in 2019 impacted assumptions used in estimating CapSpecialty’s loss and LAE liabilities for business earned in 2019.
CapSpecialty. The underwriting loss in 2019 compared with the underwriting profit in 2018 primarily reflects unfavorable prior accident year loss reserve development in 2019, compared with favorable prior accident year loss reserve development in 2018, as discussed above. The increase in underwriting profit in 2018 from 2017 primarily reflects the impact of higher net premiums earned and, to a lesser extent, an increase in favorable prior accident year loss reserve development, all as discussed above.
The following table presents the investment results for our reinsurance and insurance segments:
Net Investment Income. The increase in net investment income in 2019 from 2018 primarily reflects higher interest income, partially offset by lower dividend income. The increase in interest income and the decrease in dividend income primarily relate to a reallocation of a significant portion of our investment portfolio from equity securities to debt securities in the first quarter of 2019. The increase in net investment income in 2018 from 2017 primarily reflects higher dividend income primarily resulting from an increase in the size of our equity securities portfolio during the first three quarters of 2018 and, to a lesser extent, an increase in interest income primarily resulting from higher yields on short-term investments and floating-rate debt securities, partially offset by the impact of the sale of PacificComp.
includes a $12.9 million increase in the carrying value of our equity investment in Ares. See Note 4(i) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information.
Net Realized Capital Gains. Net realized capital gains in 2019 primarily reflect gains on the sale of debt securities, partially offset by the $38.4 million decline in value of the Put Option in 2019. Net realized capital losses in 2018 primarily reflect a $35.4 million capital loss due to an impairment charge from the write-down of certain SORC assets in 2018 arising from a decline in energy prices as of December 31, 2018, as well as losses on the sale of debt securities, partially offset by a $45.7 million gain on AIHL’s conversion of its limited partnership interests in certain subsidiaries of Ares into Ares common units in 2018. See Note 4(i) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on AIHL’s conversion.
OTTI losses in 2018 reflect $1.3 million of unrealized losses on debt securities, primarily in the energy and industrial sectors, that were deemed to be other than temporary and, as such, were required to be charged against earnings. The determination that unrealized losses on debt securities were other than temporary was primarily due to the deterioration of creditworthiness of the issuers.
The following tables present the results of the Alleghany Capital segment for 2019, 2018 and 2017:
Adjusted earnings before income taxes is a non-GAAP financial measure and does not replace earnings before income taxes determined in accordance with GAAP as a measure of profitability. See “Comment on Non-GAAP Financial Measures” herein for additional detail on the presentation of our results of operations. Adjusted earnings before income taxes represents noninsurance revenue and net investment income less other operating expenses and interest expense and does not include: (i) amortization of intangible assets; (ii) change in the fair value of equity securities; (iii) net realized capital gains; (iv) OTTI impairment losses; and (v) income taxes.
The changes in Alleghany Capital’s equity for 2019, 2018 and 2017 are presented in the table below:
During 2019, the noncontrolling interests outstanding were approximately as follows: Kentucky Trailer - 23 percent; W&W|AFCO Steel - 20 percent; IPS - 15 percent; and Concord - 15 percent. In connection with an acquisition on October 1, 2019, the noncontrolling interests of Jazwares were increased from approximately 23 percent to approximately 25 percent. Effective April 1, 2019, all noncontrolling interests of PCT have exercised their repurchase options and sold their ownership interests to PCT.
The increase in noninsurance revenue in 2018 from 2017 primarily reflects an increase in industrial operations, due primarily to the acquisitions of Hirschfeld and W&W|AFCO Steel and, to a lesser extent, higher sales at Kentucky Trailer and PCT. The increase in noninsurance revenue in 2018 from 2017 also reflects an increase in non-industrial operations due primarily to higher sales at Jazwares and IPS, as well as the acquisition of Concord.
Net investment income. The increases in net investment income in 2019 from 2018 and in 2018 from 2017 primarily reflect Alleghany Capital’s earnings from its investment in Wilbert, due to higher earnings at Wilbert.
Net realized capital gains. Net realized capital gains in 2019 and 2018 primarily reflect modest gains from the sale of certain investments and equipment, as well as certain foreign currency exchange rate impacts. Net realized capital gains in 2017 primarily reflect a $20.9 million capital gain due to a bulk settlement of certain contingent consideration obligations that were made by Alleghany Capital in connection with its acquisition of Jazwares’ outstanding equity, or the “Jazwares Settlement Gain.”
Other operating expenses. The increase in other operating expenses in 2019 from 2018 primarily reflects increases in non-industrial and industrial operations. The increase in non-industrial other operating expenses primarily reflects higher costs related to higher sales at IPS and Jazwares, as well as the impact of the acquisitions of Concord and WCT, partially offset by the impact of certain Toys “R” Us Inc. liquidation-related charges in early 2018. The increase in industrial other operating expenses primarily reflects higher costs related to higher sales at W&W|AFCO Steel, including the impact of W&W|AFCO Steel’s acquisition of Hirschfeld in 2018, and, to a lesser extent, Kentucky Trailer due to higher sales, partially offset by the impact of certain facility consolidation activities at Kentucky Trailer in 2018. The increase in other operating expenses in 2019 from 2018 also relates, to a lesser extent, to higher employee costs, including incentive compensation, in Alleghany Capital’s corporate operations.
The increase in other operating expenses in 2018 from 2017 primarily reflects a significant increase in industrial operations, due primarily to the acquisitions of Hirschfeld and W&W|AFCO Steel and, to a lesser extent, higher costs related to higher sales at Kentucky Trailer and PCT, as well as facility consolidation activities at Kentucky Trailer. With respect to non-industrial operations, the increase in other operating expenses in 2018 primarily reflects higher costs at Jazwares and IPS resulting from higher sales, as well as the acquisition of Concord. Higher costs at Jazwares also reflect increased marketing expenditures and the impact of certain Toys “R” Us Inc. liquidation-related charges.
Amortization of intangible assets. The increase in amortization expense in 2019 from 2018 primarily reflects the Concord acquisition, Kentucky Trailer’s acquisition of two manufacturers of aluminum feed transportation equipment in December 2018 and July 2019, PCT’s acquisition of a consumable cutting tool manufacturer in June 2019, Jazwares’ acquisition of WCT in October 2019 and IPS’s acquisition in May 2019. The increase in amortization expense in 2018 from 2017 primarily reflects the W&W|AFCO Steel, Hirschfeld and Concord acquisitions.
The primary components of corporate activities are Alleghany Properties, SORC and activities at the Alleghany parent company. The following table presents the results for corporate activities:
Corporate administration. The increase in corporate administration expense in 2019 from 2018 reflects higher Alleghany parent-company long-term incentive compensation accruals due primarily to the impact of appreciation in the value of our consolidated debt and equity securities portfolios in 2019, compared with depreciation in 2018 and Alleghany stock price appreciation. The decrease in corporate administration expense in 2018 from 2017 primarily reflects lower Alleghany parent-company long-term incentive compensation expense accruals, driven by the impact of depreciation in the value of our debt and equity securities portfolios in 2018 compared with appreciation in the value of our equity and, to a lesser extent, debt securities portfolios in 2017, partially offset by the impact of lower catastrophe losses in 2018.
Losses before income taxes. The increase in losses before income taxes in 2019 from 2018 primarily reflects higher corporate administration expense and lower property sales at Alleghany Properties, partially offset by appreciation in the value of the equity securities held at the Alleghany parent company-level compared with depreciation in 2018, all as discussed above. The increase in losses before income taxes in 2018 from 2017 primarily reflects depreciation in the value of equity securities held at the Alleghany parent company-level and the SORC impairment loss, partially offset by an increase in sales at Alleghany Properties and lower corporate administration expense, all as discussed above.
Changes in Gross and Net Loss and LAE Reserves between December 31, 2019 and December 31, 2018. Gross and net loss and LAE reserves as of December 31, 2019 decreased from December 31, 2018, primarily reflecting payments on catastrophe losses incurred in 2017 and 2018 and favorable prior accident year loss reserve development, partially offset by the impact of growing net premiums earned and catastrophe losses incurred in 2019. The 2019 catastrophe losses, net of reinsurance, include $183.7 million related to Typhoon Hagibis, $95.4 million related to Typhoon Faxai, $22.3 million related to civil unrest in Chile and $13.6 million related to Hurricane Dorian.
As of December 31, 2019, our reinsurance and insurance subsidiaries had total reinsurance recoverables of $1,682.0 million, consisting of $1,583.9 million of ceded outstanding loss and LAE and $98.1 million of recoverables on paid losses. See Part I, Item 1, “Business - Reinsurance Protection” of this Form 10-K for additional information on the reinsurance purchased by our reinsurance and insurance subsidiaries.
We had no allowance for uncollectible reinsurance as of December 31, 2019. See Note 5 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information regarding our ceded reinsurance, the concentration of our reinsurance recoverables and the ratings profile of our reinsurers as of December 31, 2019.
We believe that the reserves for unpaid loss and LAE established by our reinsurance and insurance subsidiaries are adequate as of December 31, 2019; however, additional reserves, which could have a material impact upon our financial condition, results of operations and cash flows, may be necessary in the future.
percentage change in an estimate can result in a material effect on our reported earnings. The following table presents the impact of changes, which could be favorable or unfavorable, in frequency and severity on our loss estimates for claims occurring in 2019:
Prior Year Development. Our reinsurance and insurance subsidiaries continually evaluate the potential for changes, both favorable and unfavorable, in their estimates of loss and LAE liabilities and use the results of these evaluations to adjust both recorded liabilities and underwriting criteria. With respect to liabilities for unpaid loss and LAE established in prior years, these liabilities are periodically analyzed and their expected ultimate cost adjusted, where necessary, to reflect favorable or unfavorable development in loss experience and new information, including, for certain catastrophic events, revised industry estimates of the magnitude of a catastrophe. Adjustments to previously recorded liabilities for unpaid loss and LAE, both favorable and unfavorable, are reflected in our financial results in the periods in which these adjustments are made and are referred to as prior accident year loss reserve development. We adjusted our prior year loss and LAE reserve estimates during 2019, 2018 and 2017 based on current information that differed from previous assumptions made at the time such loss and LAE reserves were previously estimated. See Note 6(b) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for a table presenting the favorable and unfavorable prior accident year loss reserve development for 2019, 2018 and 2017.
Asbestos-Related Illness and Environmental Impairment Reserves. Loss and LAE include amounts for risks related to asbestos-related illness and environmental impairment. The reserves carried for such claims, including the IBNR portion, are based upon known facts and current law at the respective balance sheet dates. However, significant uncertainty exists in determining the amount of ultimate liability for asbestos-related illness and environmental impairment losses. This uncertainty is due to, among other reasons, inconsistent and changing court resolutions and judicial interpretations with respect to underlying policy intent and coverage and uncertainties as to the allocation of responsibility for resultant damages, among other reasons. Further, possible future changes in statutes, laws, regulations, theories of liability and other factors could have a material effect on these liabilities and, accordingly, future earnings. Although we are unable at this time to determine whether additional reserves, which could have a material adverse effect upon our results of operations, may be necessary in the future, we believe that our asbestos-related illness and environmental impairment reserves are adequate as of December 31, 2019. See Note 12(c) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” and pages 64 and 65 of this Form 10-K for additional information on loss and LAE reserves related to asbestos-related illness and environmental impairment.
Reinsurance. Our reinsurance and insurance subsidiaries reinsure portions of the risks they underwrite in order to reduce the effect of individual or aggregate exposure to losses, manage capacity, protect capital resources, reduce volatility in specific lines of business, improve risk-adjusted portfolio returns and enable them to increase gross premium writings and risk capacity without requiring additional capital. Our reinsurance and insurance subsidiaries generally purchase reinsurance and retrocessional coverages from highly-rated, third-party reinsurers. If the assuming reinsurers are unable or unwilling to meet the obligations assumed under the applicable reinsurance agreements, our reinsurance and insurance subsidiaries would remain liable for such reinsurance portion not paid by these reinsurers. Recoverables recorded with respect to claims ceded to reinsurers under reinsurance contracts are predicated in large part on the estimates for unpaid losses and, therefore, are also subject to a significant degree of uncertainty. In addition to the factors cited above, reinsurance recoverables may prove uncollectible if a reinsurer is unable or unwilling to perform under a contract. Reinsurance purchased by our reinsurance and insurance subsidiaries does not relieve them of their obligations to their own policyholders or cedants. Additional information regarding the use of, and risks related to the use of reinsurance by our reinsurance and insurance subsidiaries can be found on pages 55, 56, 67 and 68 of this Form 10-K. Also see Note 1(f) and Note 5 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on our reinsurance recoverables.
Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between willing, able and knowledgeable market participants at the measurement date. Fair value measurements are not adjusted for transaction costs. In addition, a three-tiered hierarchy for inputs is used in management’s determination of fair value of financial instruments that emphasizes the use of observable inputs over the use of unobservable inputs by requiring that the observable
See Notes 1(b), 1(c), 3 and 4 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on our investments and fair value.
See Note 1(b) and Note 4(f) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on our investments and investment impairments.
Our consolidated balance sheet as of December 31, 2019 includes goodwill of $523.0 million related primarily to Jazwares, Concord, Kentucky Trailer, PCT, W&W|AFCO Steel and IPS, and intangible assets, net of amortization, of $686.0 million related
primarily to Jazwares, W&W|AFCO Steel, TransRe, Concord, IPS, PCT and Kentucky Trailer. See Note 1(i) and Note 2 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on our goodwill and other intangible assets.
Debt. On September 9, 2014, we completed a public offering of $300.0 million aggregate principal amount of our 4.90% senior notes due on September 15, 2044, or the “2044 Senior Notes.” The 2044 Senior Notes are unsecured and unsubordinated
Credit Agreement. On July 31, 2017, we entered into a five-year credit agreement, or the “Credit Agreement,” with certain lenders party thereto, which provides for an unsecured revolving credit facility in an aggregate principal amount of up to $300.0 million. The credit facility is scheduled to expire on July 31, 2022, unless earlier terminated. Borrowings under the Credit Agreement will be available for working capital and general corporate purposes, including permitted acquisitions and repurchases of Common Stock. Borrowings under the Credit Agreement bear a floating rate of interest based in part on our credit rating, among other factors. The Credit Agreement contains representations, warranties and covenants customary for bank loan facilities of this nature. There were no borrowings under the Credit Agreement from inception through December 31, 2019.
The Credit Agreement contains representations, warranties and covenants customary for bank loan facilities of this nature and substantially similar to the Prior Credit Agreement. In this regard, the Credit Agreement requires Alleghany to, among other things, (x) maintain consolidated net worth of not less than the sum of (i) $5.3 billion plus (ii) 50% of the cumulative consolidated net income earned in each fiscal quarter thereafter (if positive) commencing with the fiscal quarter ending June 30, 2017 and (y) maintain a ratio of consolidated total indebtedness to consolidated capital as of the end of each fiscal quarter of not greater than 0.35 to 1.0. Additionally, the Credit Agreement contains various negative covenants with which Alleghany must comply, including, but not limited to, limitations respecting: the creation of liens on any property or asset; the incurrence of indebtedness; mergers, consolidations, liquidations and dissolutions; change of business; sales of assets; transactions with affiliates; and other provisions customary in similar types of agreements.
Capital Contributions. From time to time, we make capital contributions to our subsidiaries. In 2019, we made aggregate capital contributions of $50.2 million to Alleghany Capital to: (i) fund a portion of PCT’s acquisition of a consumable cutting tool manufacturer in June 2019 for $29.4 million; (ii) fund a portion of Kentucky Trailer’s acquisition of a manufacturer of aluminum feed transportation equipment in July 2019 for $12.2 million; and (iii) purchase all PCT noncontrolling interests effective April 1, 2019 for $8.6 million. In addition, in 2019, we contributed $8.3 million to SORC for purposes of ongoing operations.
In 2018, we made aggregate capital contributions of $144.1 million to Alleghany Capital to: (i) acquire approximately 85 percent of the equity in Concord for $68.6 million (excluding amounts for transaction-related expenses and estimates of future amounts payable); and (ii) fund Alleghany Capital’s portion of the acquisition of Hirschfeld by its subsidiary W&W|AFCO Steel for $75.5 million (excluding amounts for transaction-related expenses). In addition, in 2018 we contributed $14.1 million to SORC for purposes of ongoing operations.
In 2017, we made aggregate capital contributions of $236.2 million to Alleghany Capital to: (i) acquire approximately 80 percent of the equity in W&W|AFCO Steel for $163.9 million (excluding amounts for transaction-related expenses and estimates of future amounts payable); and (ii) acquire a 45 percent equity interest in Wilbert for $72.3 million. In addition, in 2017, we made a $4.0 million contribution to PacificComp prior to its sale on December 31, 2017, and we contributed $12.5 million to SORC for purposes of ongoing operations.
Contractual Obligations. We have certain obligations to make future payments under contracts and credit-related financial instruments and commitments. The following table presents certain long-term aggregate contractual obligations and credit-related financial commitments as of December 31, 2019:
Primarily reflects obligations related to employee long-term compensation plans and retirement benefit plans. See Notes 14 and 15 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on long-term compensation and retirement benefit plans, respectively.
In July 2013, AIHL invested $250.0 million in Ares, an asset manager, in exchange for a 6.25 percent equity stake in Ares, with an agreement to engage Ares to manage up to $1.0 billion in certain investment strategies. In May 2014, Ares completed an initial public offering of its common units. Upon completion of the initial public offering, Alleghany’s equity investment in Ares converted into limited partnership interests in certain Ares subsidiaries that were convertible into Ares common units. On March 15, 2018, most of AIHL’s limited partnership interests were converted into Ares common units. As a result of the conversion and with respect to the limited partnership interests that were converted into Ares common units, AIHL: (i) reclassified its converted interests from other invested assets to equity securities; (ii) increased its carrying value to $208.2 million to reflect the fair value of Ares common units; and (iii) recorded the $45.7 million increase in carrying value as a realized capital gain as of March 15, 2018. As a result of the conversion and with respect to the unconverted limited partnership interests, AIHL: (i) changed its accounting method from the equity method to fair value; (ii) increased its carrying value to $58.7 million to reflect the fair value of Ares limited partnership interests; and (iii) recorded the $12.9 million increase in carrying value as a component of net investment income as of March 15, 2018. On September 24, 2018, AIHL’s remaining Ares limited partnership interests were converted into Ares common units and, as a result, AIHL reclassified the remaining $56.9 million of its converted interests from other invested assets to equity securities. In the second quarter of 2019, AIHL sold all of its remaining holdings of Ares common units.
Investments in Commercial Mortgage Loans. As of December 31, 2019, the carrying value of our commercial mortgage loan portfolio was $686.2 million, representing the unpaid principal balance on the loans. As of December 31, 2019, there was no allowance for loan losses. Our commercial mortgage loan portfolio consists primarily of first mortgages on commercial properties in major metropolitan areas in the U.S. The loans earn interest at fixed- and floating-rates, mature in two to ten years from loan origination and the principal amounts of the loans were no more than approximately two-thirds of the property’s appraised value at the time the loans were made. The estimated fair value of the commercial mortgage loan portfolio approximated carrying value as of December 31, 2019. In addition, the estimated fair value of the underlying collateral was approximately double that of the commercial mortgage loan portfolio carrying value as of December 31, 2019. Fair value estimates of underlying collateral are updated on a rolling basis annually, with a portion of the portfolio updated each quarter.
Energy Holdings. As of December 31, 2019, we had holdings in energy sector businesses of $530.9 million, comprised of $329.2 million of debt securities, $115.0 million of equity securities and $86.7 million of our equity attributable to SORC.
The obligations and cash outflow of our reinsurance and insurance subsidiaries include claim settlements, commission expenses, administrative expenses, purchases of investments and interest and principal payments on TransRe’s 8.00% senior notes due on November 30, 2039. In addition to premium collections, cash inflow is obtained from interest and dividend income, maturities and sales of investments and reinsurance recoveries. Because cash inflow from premiums is received in advance of cash outflow required to settle claims, our reinsurance and insurance operating units accumulate funds which they invest pending the need for liquidity. As the cash needs of a reinsurance or an insurance company can be unpredictable due to the uncertainty of the claims settlement process, the portfolios of our reinsurance and insurance subsidiaries consist primarily of debt securities and short-term investments to ensure the availability of funds and maintain a sufficient amount of liquid securities.
Included in Alleghany Capital is debt associated with its operating subsidiaries, which totaled $367.1 million as of December 31, 2019, which is generally used to support working capital needs and to help finance acquisitions. The $367.1 million includes:
$59.5 million of term loans at Kentucky Trailer primarily related to borrowings to finance small acquisitions, including its acquisitions of a controlling interest in two manufacturers of aluminum feed transportation equipment in December 2018 and July 2019, and borrowings under its available credit facilities;
$32.4 million of term loans at PCT primarily related to borrowings to finance the acquisition of a waterjet orifice and nozzle manufacturer in 2016 and the acquisition of a consumable cutting tool manufacturer in June 2019.
None of the above liabilities are guaranteed by Alleghany or Alleghany Capital. In December 2019, third-party, floating-rate term loans at Concord were repaid and replaced with $33.2 million of intercompany floating-rate debt funded by the Alleghany parent company. The intercompany debt and related interest expenses are eliminated at our consolidated level.
Investment Strategy and Holdings. Our investment strategy seeks to preserve principal and maintain liquidity while trying to maximize our risk-adjusted, after-tax rate of return. Our investment decisions are guided mainly by the nature and timing of expected liability payouts, management’s forecast of cash flows and the possibility of unexpected cash demands, such as to satisfy claims due to catastrophe losses. Our consolidated investment portfolio currently consists mainly of highly rated and liquid debt and equity securities listed on national securities exchanges. The overall credit quality of the debt securities portfolio is measured using the lowest rating of S&P, Moody’s or Fitch. In this regard, the overall weighted-average credit quality rating of our debt securities portfolio as of December 31, 2019 and 2018 was AA-. Although a portion of our debt securities, which consist predominantly of municipal bonds, are insured by third-party financial guaranty insurance companies, the impact of such insurance was not significant to the debt securities credit quality rating as of December 31, 2019. The following table presents the ratings of our debt securities as of December 31, 2019:
On a consolidated basis, our invested assets increased to approximately $18.9 billion as of December 31, 2019 from approximately $17.5 billion as of December 31, 2018, primarily reflecting appreciation in the value of our equity and debt securities portfolios, partially offset by repurchases of our common stock, all as discussed above. The appreciation in the value of our debt securities portfolio reflects a decrease in interest rates and credit spreads. During the first quarter of 2019, we reallocated a significant portion of our investment portfolio from equity securities to debt securities.
See Note 8 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on the Senior Notes and other debt.
We set and monitor subsidiary and group-level limits to single zone exposures as well as to aggregate exposures from multiple events within any one year and at multiple points along the loss distribution curve. For example, we seek to limit the after-tax impact of all natural catastrophes occurring in any given year, net of related estimated pre-overhead underwriting profit, to 15 percent of Alleghany’s stockholders’ equity at the 250-year return period (having a likelihood of being exceeded in any single year of 0.4 percent). Our loss estimates for zonal and aggregate catastrophe exposures are updated and reviewed against tolerances as part of our risk oversight processes on a quarterly basis. Risk tolerances are subject to change based on our view of the risk-return characteristics of business being underwritten.
Potential catastrophe losses are typically expressed in terms of the probable maximum loss, or “PML.” PMLs may be expressed as Occurrence Exceedance Probability, or “OEP,” which reflect losses that may occur in any single event due to the defined peril in the indicated region, or as Aggregate Exceedance Probability, or “AEP,” which reflect losses from multiple events that may occur in any given year. The following is an overview of such modeled OEP PMLs from property, engineering, marine and energy exposures and the associated natural perils that we deem most significant based upon contracts in force at January 1, 2020 for TransRe and December 1, 2019 for RSUI. In addition to the single zone PMLs, we have added a “U.S. wind” PML to our disclosures which
reflects our occurrence PML for the entire U.S. Modeled results also reflect losses arising from certain of our invested assets that have specific catastrophe exposures. The estimated amount of these modeled losses are presented for both a 100-year return period (having a likelihood of being exceeded in any single year of 1.0 percent) and a 250-year return period (having a likelihood of being exceeded in any single year of 0.4 percent). These modeled losses are presented in two ways: (i) gross catastrophe losses; and (ii) after-tax net catastrophe costs (that is, gross losses, net of reinsurance, net reinstatement premiums and taxes). The reduction for reinsurance assumes that all reinsurers fulfill their obligations in accordance with contract terms. Given the uncertainty of the frequency, severity and location of catastrophe events, we may experience losses significantly larger than the estimated PMLs in any given year.
“Florida, Wind” and “Northeast U.S., Wind” have the highest modeled after-tax net catastrophe costs for a 100 and 250-year return period single zone occurrence, respectively. These costs would represent approximately 7 percent and 8 percent, respectively, of stockholders’ equity attributable to Alleghany as of December 31, 2019, compared with approximately 6 percent and 8 percent, respectively, for the highest modeled after-tax net catastrophe costs for a 100 and 250-year return period single zone occurrence as of December 31, 2018. There is much uncertainty and imprecision in the compilation of these estimates. Moreover, the makeup of our in-force business is constantly changing as new business is added and existing contracts terminate or expire, including contracts for reinsurance coverage purchased by us. In addition, there could be possible scenarios that are not captured in our analysis. Additionally, other risks, such as an outbreak of a pandemic disease, a major terrorist event, the bankruptcy of a major company or a marine and/or aviation disaster, could also have a material adverse effect on our business and operating results.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 19, 2020 expressed an unqualified opinion thereon.
Precision Cutting Technologies, Inc. (“PCT”), a holding company headquartered in Rockford, Illinois, with three operating businesses: (i) Bourn & Koch, Inc., a provider of precision automated machine tool solutions; (ii) Diamond Technology Innovations, Inc., a manufacturer of waterjet orifices and nozzles and a provider of related services; and (iii) Coastal Industrial Distributors, LLC, a provider of high-performance solid carbide end mills;
IPS-Integrated Project Services, LLC (“IPS”), a design, engineering, procurement, construction management, and validation service provider focused on the global pharmaceutical and biotechnology industries, headquartered in Blue Bell, Pennsylvania;
WWSC Holdings, LLC (“W&W|AFCO Steel”), a structural steel fabricator and erector, headquartered in Oklahoma City, Oklahoma;
CHECO Holdings, LLC (“Concord”), a hotel management and development company, headquartered in Raleigh, North Carolina; and
The portion of stockholders’ equity, net earnings and comprehensive income that is not attributable to Alleghany stockholders is presented on the consolidated balance sheets, the consolidated statements of earnings and comprehensive income and the consolidated statements of changes in stockholders’ equity as noncontrolling interests. Because all noncontrolling interests have the option to sell their ownership interests to Alleghany in the future (generally through 2024), the portion of stockholders’ equity that is not attributable to Alleghany stockholders is presented on the consolidated balance sheets and the consolidated statements of changes in stockholders’ equity as redeemable noncontrolling interests for all periods presented. In addition, Alleghany accretes the redeemable noncontrolling interests up to its future estimated redemption value over the period from the date of issuance to the earliest redemption date. The redemption value of the equity interests is generally based on the respective subsidiary’s earnings in specified periods preceding the redemption date, calculated based on either a specified formula or an independent fair market valuation. During 2019, the noncontrolling interests outstanding were approximately as follows: Kentucky Trailer - 23 percent; IPS - 15 percent; W&W|AFCO Steel - 20 percent; and Concord - 15 percent. In connection with an acquisition on October 1, 2019, the noncontrolling interests of Jazwares were increased from approximately 23 percent to approximately 25 percent. Effective April 1, 2019, all noncontrolling interest holders of PCT have exercised their repurchase options and sold their ownership interests to PCT.
Investments consist of debt securities, equity securities, short-term investments, commercial mortgage loans and other invested assets. Alleghany considers all of its marketable debt securities and short-term investments as available-for-sale (“AFS”). Debt securities consist of securities with an initial fixed maturity of more than one year. Debt securities typically take the form of bonds and redeemable preferred stock. Equity securities generally consist of securities that represent ownership interests in an enterprise. Equity securities typically take the form of common stock or perpetual preferred stock. Mutual funds and exchange-traded securities are also classified as equity securities, including those that invest mostly in debt securities. Commencing January 1, 2018, all marketable equity securities are measured at fair value with changes in fair value recognized in net earnings, and prior to that date, were considered AFS. Short-term investments include commercial paper, certificates of deposit, money market instruments and any fixed maturity investment with an initial maturity of one year or less.
Net investment income consists primarily of: (i) interest income from debt securities, short-term investments, commercial mortgage loans, funds withheld by cedants and cash, including any premium amortization or discount accretion; (ii) dividend income from equity securities; and (iii) investment income from other invested assets, which includes results arising from partnership investments, whether accounted for under the equity method or at fair value. Interest income is accrued when earned.
Alleghany employs specific control processes to determine the reasonableness of the fair values of its financial assets and liabilities. Alleghany’s processes are designed to ensure that the values received or internally estimated are accurately recorded and that the data inputs and the valuation techniques used are appropriate, consistently applied and that the assumptions are reasonable and consistent with the objective of determining fair value. Alleghany assesses the reasonableness of individual security values received from valuation service providers through various analytical techniques. In addition, Alleghany validates the reasonableness of fair values by comparing information obtained from Alleghany’s valuation service providers to other third-party valuation sources for
selected securities. Alleghany also validates prices obtained from brokers for selected securities through reviews by those who have relevant expertise and who are independent of those charged with executing investing transactions.
enactment date. Current tax liabilities or assets are recognized for the estimated taxes payable or refundable on tax returns for the current year.
Noninsurance revenues relate primarily to manufactured products and services sold by Alleghany Capital’s subsidiaries. Manufactured products primarily include fabricated steel, toys, trailers and machine tools. Services primarily include facility construction, technical services and hotel management. Noninsurance revenues and related operating expenses arising from the sale of manufactured goods and services are generally recognized as the transfer of goods and services to customers takes place. Payment terms for products and services vary by the type of product or service offered. Noninsurance revenues reflect the payment or payments that are expected to be received from the customers for those goods and services. Other operating expenses consist of the cost of goods and services sold and selling, general and administrative expenses. Other operating expenses also include: (i) advertising and marketing costs; and (ii) finders’ fees, legal and accounting costs and other transaction-related expenses, all of which are recognized as incurred.
In February 2018, the Financial Accounting Standards Board (the “FASB”) issued guidance on certain tax effects caused by the Tax Cuts and Jobs Act of 2017 (the “Tax Act”). The Tax Act, among other things, reduced the U.S. corporate federal income tax rate for the 2018 tax year from 35.0 percent to 21.0 percent. Under such circumstances, GAAP requires that the value of deferred tax assets and liabilities be reduced through tax expense. The new guidance provides an option to reclassify to retained earnings any stranded tax amounts that remain in accumulated other comprehensive income, either retrospectively or at the beginning of the period in which the adoption is elected. This guidance became effective in the first quarter of 2018 for public entities, with early adoption permitted in 2017. Alleghany adopted this guidance in the first quarter of 2018 and has elected to reclassify to retained earnings stranded tax amounts that remain in accumulated other comprehensive income, in the amount of approximately $135 million, as of January 1, 2018. See Note 10(b) for additional information on accumulated other comprehensive income. See Note 9 for additional information on the Tax Act and its impact on Alleghany.
In March 2017, the FASB issued guidance that reduces the amortization period for the premium on certain purchased callable debt securities to the earliest call date. The guidance applies specifically to noncontingent call features that are callable at a predetermined and fixed price and date. The accounting for purchased callable debt securities held at a discount is not affected. This guidance became effective in the first quarter of 2019 for public entities, with early adoption permitted. Alleghany adopted this guidance in the fourth quarter of 2017 and recorded a cumulative effect reduction of approximately $13 million directly to opening 2017 retained earnings and an offsetting increase in opening 2017 accumulated other comprehensive income. The implementation did not have a material impact on Alleghany’s results of operations and financial condition.
In February 2016, the FASB issued guidance on leases. Under this guidance, a lessee is required to recognize lease liabilities and corresponding right-of-use assets for leases with terms of more than one year, whereas under the prior guidance, a lessee is only required to recognize assets and liabilities for those leases qualifying as capital leases. This guidance also requires new disclosures about the amount, timing and uncertainty of cash flows arising from leases. The accounting by lessors remains largely unchanged. This guidance became effective in the first quarter of 2019 for public entities, with early adoption permitted. A modified retrospective transition approach was elected for all leases in existence as of, or entered into after, the beginning of the earliest comparative period presented in the financial statements. Alleghany adopted this guidance in the first quarter of 2019, and the implementation did not have a material impact on its results of operations and financial condition. As part of its implementation, Alleghany elected to not separate lease components from non-lease components (such as office cleanings, security and maintenance services provided by Alleghany’s lessors for certain of its leases). Alleghany also elected the package of practical expedients under the transition guidance, which allowed Alleghany to not reevaluate existing lease classifications, among others. As of January 1, 2019, Alleghany’s adoption of this guidance resulted in recognition of an additional right-of-use asset of approximately $0.2 billion and a corresponding lease liability of $0.2 billion. See Note 12(b) for further information on Alleghany’s leases.
The following table presents the amount of goodwill and intangible assets, net of accumulated amortization expense, reported on Alleghany’s consolidated balance sheets as of December 31, 2019 and 2018:
See Note 13 for additional information on Alleghany’s segments of business.
In most instances, trade names and state and foreign insurance licenses have an indefinite useful life. The economic useful lives of significant intangible assets in the reinsurance and insurance segments are as follows: agency relationships - 15 years; brokerage and reinsurance relationships - 15 years; renewal rights - between 3 and 14 years; loss and LAE reserves - 15 years;
The following table presents the carrying value and estimated fair value of Alleghany’s consolidated financial instruments as of December 31, 2019 and 2018:
Includes $834.2 million and $1,266.9 million of collateralized loan obligations as of December 31, 2019 and 2018, respectively.
Includes partnership and non-marketable equity investments accounted for at fair value and excludes investments accounted for using the equity method.
In 2019, Alleghany transferred into Level 3 $21.8 million of financial instruments, principally due to a decrease in observable inputs related to the valuation of such assets. Specifically, during 2019, there was an increase in the weight given to non-binding broker quotes and, as a result, there was a corresponding decrease in quoted prices for similar assets in active markets. Of the $21.8 million of transfers, $14.7 million related to foreign corporate bonds, with the remainder related to other types of debt securities.
There were no other material transfers between Levels 1, 2 or 3 in 2019.
Other than the $56.9 million of Ares-related other invested assets transferred out of Level 3, in 2018, Alleghany transferred out of Level 3 $164.7 million of financial instruments, principally due to an increase in observable inputs related to the valuation of such assets. Specifically, during 2018, there was a decrease in the weight given to non-binding broker quotes, and as a result, there was a corresponding increase in quoted prices for similar assets in active markets. Of the $164.7 million of transfers, $150.6 million related to RMBS, $11.0 million related to other asset-backed securities and $3.1 million related to several other types of securities.
The following tables present reconciliations of the changes during 2019 and 2018 in Level 3 assets measured at fair value:
Includes partnership and non-marketable equity investments accounted for at fair value.
There were no OTTI losses recorded in net earnings related to Level 3 instruments still held as of December 31, 2019 and 2018.
Net unrealized losses related to Level 3 assets as of December 31, 2019 and 2018 were not material.
The increase in Senior Notes and other debt included in Level 3 for 2019 primarily reflects increased borrowings at Jazwares to fund its acquisition of WCT and, to a lesser extent, increased borrowings at Kentucky Trailer, IPS and PCT to fund acquisitions and support working capital needs.
As of December 31, 2019, non-income producing invested assets were insignificant.
The proceeds from sales of debt and equity securities were $5.9 billion, $5.3 billion and $8.3 billion for 2019, 2018 and 2017, respectively.
On July 18, 2019, AIHL purchased an exchange-traded equity derivative index put option (the “Put Option”) for $38.4 million to hedge the downside equity market risk on approximately $1.0 billion of Alleghany’s equity portfolio. The Put Option did not qualify for hedge accounting. The Put Option expired worthless on December 31, 2019, and the resulting $38.4 million decline in value of the Put Option was recorded as a reduction to net realized capital gains.
Net realized capital gains in 2017 primarily reflect sales of certain exchange-traded funds, sales of certain equity securities resulting from a partial restructuring of the equity portfolio, an $8.4 million pre-tax gain realized on the sale of PacificComp on December 31, 2017 and a $20.9 million realized gain on a bulk settlement of certain contingent consideration liabilities by Alleghany Capital, partially offset by a $4.8 million loss realized on the from the sale of a SORC legacy oil field on December 29, 2017 and a $7.9 million write-down of certain reinsurance segment assets.
OTTI losses in 2019 reflect $19.7 million of unrealized losses on debt securities, primarily related to the energy sector, that were deemed to be other than temporary and, as such, were required to be charged against earnings. The determination that unrealized losses on these debt securities were other than temporary was primarily due to the deterioration of creditworthiness of the issuers in the domestic energy sector. In addition, certain foreign bonds were impaired in 2019 due to a significant decline in fair value.
Alleghany may ultimately record a realized loss after having originally concluded that the decline in value was temporary. Risks and uncertainties are inherent in the methodology. Alleghany’s methodology for assessing other than temporary declines in value contains inherent risks and uncertainties which could include, but are not limited to, incorrect assumptions about financial condition, liquidity or future prospects, inadequacy of any underlying collateral and unfavorable changes in economic conditions or social trends, interest rates or credit ratings.
As of December 31, 2019, the vast majority of Alleghany’s debt securities were rated investment grade, with 3.6 percent of debt securities having issuer credit ratings that were below investment grade or not rated, compared with 4.4 percent as of December 31, 2018.
As of December 31, 2019, the carrying value of Alleghany’s commercial mortgage loan portfolio was $686.2 million, representing the unpaid principal balance on the loans. As of December 31, 2019, there was no allowance for loan losses. The commercial mortgage loan portfolio consists primarily of first mortgages on commercial properties in major metropolitan areas in the U.S. The loans earn interest at fixed- and floating-rates, mature in two to ten years from loan origination and the principal amounts of the loans were no more than approximately two-thirds of the property’s appraised value at the time the loans were made. The estimated fair value of the commercial mortgage loan portfolio approximated carrying value as of December 31, 2019 and 2018.
Amounts recoverable from reinsurers are recognized in a manner consistent with the claims liabilities associated with the reinsurance placement and presented on the balance sheet as reinsurance recoverables. Such balances as of December 31, 2019 and 2018 are presented in the table below:
Represents reinsurance recoverables secured by funds held, trust agreements or letters of credit.
Approximately 66 percent of Alleghany’s reinsurance recoverables balance as of December 31, 2019 was due from reinsurers having an A.M. Best Company, Inc. financial strength rating of A (Excellent) or higher, with a majority of the other reinsurance recoverables being secured by funds held, trust agreements or letters of credit.
Alleghany had no allowance for uncollectible reinsurance as of December 31, 2019 and 2018.
The following table presents property and casualty premiums written and earned for 2019, 2018 and 2017:
The following table presents the activity in the liability for loss and LAE in 2019, 2018 and 2017:
Primarily represents the impact on net reserves arising from the sale of PacificComp.
The following table presents the (favorable) unfavorable prior accident year loss reserve development for 2019, 2018 and 2017:
Represents certain specialty lines of business written through a program administrator in connection with a terminated program in the 2010 and 2009 accident years and reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods for such business.
Includes unallocated LAE, which aggregate to 1.1 percent of gross loss and LAE reserves as of December 31, 2019. Net loss and LAE reserves by component are shown in the preceding tables, and consolidated gross loss and LAE reserves is presented in the consolidated balance sheets.
The following table presents supplemental information about average historical loss and LAE duration, net of reinsurance, as of December 31, 2019.
On September 20, 2010, Alleghany completed a public offering of $300.0 million aggregate principal amount of its 5.625% senior notes due on September 15, 2020 (the “2020 Senior Notes”). The 2020 Senior Notes are unsecured and unsubordinated general obligations of Alleghany. Interest on the 2020 Senior Notes is payable semi-annually on March 15 and September 15 of each year. The terms of the 2020 Senior Notes permit redemption prior to their maturity. The indenture under which the 2020 Senior Notes were issued contains covenants that impose conditions on Alleghany’s ability to create liens on, or engage in sales of, the capital stock of AIHL or RSUI. The 2020 Senior Notes were issued at approximately 99.6 percent of par, resulting in proceeds after underwriting discount, commissions and other expenses of $298.9 million and an effective yield of approximately 5.67 percent.
On January 15, 2020, Alleghany redeemed all of its outstanding 2020 Senior Notes for $312.7 million, consisting of the $300.0 million aggregate principal amount redeemed, $7.1 million of redemption premium and $5.6 million of accrued and unpaid interest on the principal amount being redeemed to the date of redemption. As a result of this early extinguishment of debt, Alleghany will record a realized loss, before tax, of $7.1 million in the first quarter of 2020.
On November 23, 2009, TransRe completed a public offering of $350.0 million aggregate principal amount of its 8.00% senior notes due on November 30, 2039 (the “2039 Senior Notes”). The 2039 Senior Notes are unsecured and unsubordinated general obligations of TransRe and are not guaranteed by Alleghany. Interest on the 2039 Senior Notes is payable semi-annually. The terms of the 2039 Senior Notes permit redemption prior to their maturity. The indentures under which the 2039 Senior Notes were issued contain covenants that impose conditions on TransRe’s ability to create liens on, or engage in sales of, the capital stock of certain of its subsidiaries, including Transatlantic Reinsurance Company, TransRe Europe S.A. or Fair American Insurance and Reinsurance Company.
The debt associated with Alleghany Capital’s operating subsidiaries totaled $367.1 million and $284.5 million as of December 31, 2019 and 2018, respectively. As of December 31, 2019, the $367.1 million includes:
$177.7 million of borrowings by Jazwares under its available credit facility and borrowings incurred and assumed from its acquisition of WCT;
$32.4 million of term loans at PCT primarily related to borrowings to finance the acquisition of a waterjet orifice and nozzle manufacturer in 2016 and the acquisition of a consumable cutting tool manufacturer in June 2019;
The Tax Act was signed into law on December 22, 2017. Among other provisions, the Tax Act reduced the corporate federal income tax rate from 35.0 percent to 21.0 percent, effective January 1, 2018, for the 2018 and subsequent tax years. As a result, the value of Alleghany’s deferred tax assets and liabilities as of December 31, 2017 was reduced. Alleghany has reflected the impact of the Tax Act in its financial statements. The net impact of this reduction to Alleghany’s consolidated 2017 tax expense was not material.
The increase in effective tax rate in 2019 compared with 2018 primarily reflects the impact of higher earnings before income taxes and, to a lesser extent, lower tax-exempt interest income arising from municipal bond securities and lower dividends-received deductions, partially offset by higher state income taxes.
The following table presents the tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities as of December 31, 2019 and 2018:
The following table presents a reconciliation of the changes during 2019 and 2018 in accumulated other comprehensive income attributable to Alleghany stockholders:
See Note 1(r) for additional information regarding Alleghany’s adoption of new investment accounting guidance and new guidance on certain tax effects caused by the Tax Act.
For 2019, excludes a $38.4 million pre-tax loss on the Put Option and a $13.6 million pre-tax loss from the December 2019 sale of a privately held investment accounted for under the equity method. For 2018, excludes a $45.7 million pre-tax gain from AIHL’s conversion of its limited partnership interests in certain subsidiaries of Ares into Ares common units, and a $35.4 million capital loss due to an impairment charge from the write-down of certain SORC assets arising from a decline in energy prices as of December 31, 2018. See Note 4 for additional information.
TransRe’s operations are also regulated in various foreign jurisdictions with respect to currency, amount and type of security deposits, amount and type of reserves and amount and type of local investment. Regulations governing constitution of technical reserves and remittance balances in some countries may hinder remittance of profits and repatriation of assets. International operations and assets held abroad may also be adversely affected by political and other developments in foreign countries, including possible tax
changes, nationalization and changes in regulatory policy, as well as by consequences of hostilities and unrest. The risks of such occurrences and their overall effect upon TransRe vary from country to country and cannot easily be predicted.
Dividends to Alleghany were reduced as a consequence of significant TransRe and RSUI catastrophe losses in the third quarter of 2017.
Contingently issuable shares were potentially available in the periods presented, but were not included in the diluted earnings per share computations because the impact was anti-dilutive to the earnings per share calculation.
Lease expense was $40.0 million, $38.8 million and $37.0 million in 2019, 2018 and 2017, respectively. The following table presents Alleghany’s consolidated lease liabilities and right-of-use lease assets related to operating leases as of December 31, 2019:
As of December 31, 2019, the weighted average lease term was approximately 12 years.
Loss and LAE include amounts for risks related to asbestos-related illness and environmental impairment. The following table presents such gross and net reserves as of December 31, 2019 and 2018:
As of December 31, 2019, Alleghany had holdings in energy sector businesses of $530.9 million, comprised of $329.2 million of debt securities, $115.0 million of equity securities and $86.7 million of Alleghany’s equity attributable to SORC.
Alleghany’s segments are reported in a manner consistent with the way management evaluates the businesses. As such, Alleghany classifies its businesses into three reportable segments - reinsurance, insurance and Alleghany Capital. Alleghany determined that Alleghany Capital qualified as a reportable segment in the first quarter of 2018, reflecting the increased significance of Alleghany Capital’s business to Alleghany and corporate activities.
The Alleghany Capital segment consists of industrial operations, non-industrial operations and corporate operations at the Alleghany Capital level. Industrial operations are conducted through PCT, Kentucky Trailer, W&W|AFCO Steel, and a 45 percent equity interest in Wilbert. Non-industrial operations are conducted through IPS, Jazwares and Concord.
Corporate activities are not classified as a segment. The primary components of corporate activities are Alleghany Properties, SORC and activities at the Alleghany parent company.
The following tables present segment results for Alleghany’s three reportable segments and for corporate activities for 2019, 2018 and 2017:
Foreign gross premiums written in 2019, 2018 and 2017 were approximately $1.7 billion, $1.6 billion and $1.5 billion, respectively.
Foreign net premiums earned in 2019, 2018 and 2017 were approximately $1.5 billion, $1.4 billion and $1.4 billion, respectively. The foreign country in which Alleghany generates the largest amount of premium revenues is the U.K. Net premiums earned by operations in the U.K. in 2019, 2018 and 2017 were $615.6 million, $583.8 million and $612.1 million, respectively.
The following table presents identifiable assets, the portion of identifiable assets related to cash and invested assets, and equity attributable to Alleghany, for Alleghany’s reportable segments and for corporate activities as of December 31, 2019:
For Alleghany Capital’s industrial and non-industrial operations, noninsurance revenue consists of the sale of manufactured goods and services. The following table presents noninsurance revenue for the Alleghany Capital segment for 2019, 2018 and 2017:
For 2019 and 2018, the vast majority of industrial noninsurance revenues were recognized as goods and services transferred to customers over time. For 2017, approximately 72 percent of noninsurance revenues that were recognized as services were transferred to customers over time, with the remainder recognized as goods transferred at a point in time. See Note 1(r) additional information regarding Alleghany’s adoption of new revenue recognition accounting guidance effective in the first quarter of 2018.
For 2019, 2018 and 2017, approximately 70 percent, 63 percent and 66 percent, respectively, of non-industrial noninsurance revenues were recognized as services transferred to customers over time, with the remainder recognized as goods transferred at a point in time. See Note 1(r) for additional information on Alleghany’s adoption of new revenue recognition accounting guidance effective in the first quarter of 2018.
Significant portions of the reinsurance segment’s gross premiums written are produced by a limited number of brokers. Gross premiums written produced by the reinsurance segment’s three largest brokers were approximately 26 percent, 17 percent and 16 percent in 2019, 26 percent, 18 percent and 15 percent in 2018 and 24 percent, 19 percent, and 16 percent in 2017.
A large whole account quota share treaty accounted for approximately 14 percent in 2019, 17 percent in 2018 and 19 percent in 2017 of gross premiums written in the reinsurance segment.
were $38.7 million, ($12.0) million and $17.1 million in 2019, 2018 and 2017, respectively. The negative expense for 2018 reflects a reversal of certain long-term incentive compensation expense accruals, driven primarily by the impacts of depreciation in the value of Alleghany’s consolidated debt and equity securities portfolio, as well as significant catastrophe losses incurred at Alleghany’s reinsurance and insurance subsidiaries in 2018. The amount of related income tax (expenses) benefit in the consolidated statements of earnings and comprehensive income with respect to these plans was $8.1 million, ($2.5) million and $3.6 million in 2019, 2018 and 2017, respectively. In 2019, 2018 and 2017, $2.4 million, $4.3 million and $7.1 million of Common Stock at fair market value, respectively, and $2.2 million, $17.1 million and $19.3 million of cash, respectively, was paid by Alleghany under these plans for Alleghany parent company-level employees and non-employee directors. As noted above, as of December 31, 2019 and 2018, all outstanding awards were accounted for under the fair-value-based method of accounting.
The following is a summary of the Alleghany parent company-level, long-term compensation plans.
The following types of awards were outstanding as of December 31, 2019:
Performance Share Awards - Participants are entitled, at the end of a multi-year award period, to a maximum amount equal to the value of one and one-half shares of Common Stock for each performance share issued to them based on market value on the payment date. Payouts are made provided defined levels of performance are achieved. Expenses are recorded based on changes in the fair value of the awards. The fair value is calculated based primarily on the value of Common Stock as of the balance sheet date, the degree to which performance targets have been achieved and the time elapsed with respect to each award period.
TransRe has a Book Value Unit Plan and a Mid-Term Incentive Plan (collectively, the “TransRe Plans”) for the purpose of providing incentives to key employees of TransRe. Under the TransRe Plans, book value units (“BVUs”) and mid-term incentive plan (“MTIP”) awards are issued. BVUs and MTIP awards may only be settled in cash. The fair value of each BVU is calculated as the stockholder’s equity of TransRe, adjusted for certain capital transactions, divided by the adjusted number of BVUs outstanding. BVUs have vesting dates of up to approximately the fourth anniversary of the date of grant. The fair value of MTIP awards is calculated based on underwriting results compared to specified targets or based on overall results as determined by TransRe’s board of directors. MTIP awards have vesting dates of approximately the second or third anniversary of the date of grant. The BVUs and MTIP awards contain certain restrictions, related to, among other things, forfeiture in the event of termination of employment and transferability. In 2019, 2018 and 2017, TransRe recorded $48.7 million, $35.6 million and $46.6 million, respectively, in compensation expense and a deferred tax benefit of $10.2 million, $7.5 million and $9.8 million, respectively, related to the TransRe Plans.
Under the RSU Plan, restricted stock units (“RSUs”) were issued. Additional RSUs, defined as the “Deferred Equity Pool,” were issued in 2018 and 2017. RSUs may only be settled in cash. The fair value of each unit is calculated as the stockholder’s equity of RSUI, adjusted for certain capital transactions and accumulated compensation expense recognized under the RSU Plan, divided by the sum of RSUI common stock outstanding and the original units available under the RSU Plan. The units vest on the fourth anniversary of the date of grant and contain certain restrictions, related to, among other things, forfeiture in the event of termination of employment and transferability. Effective July 1, 2019, no additional units will be awarded from the RSU Plan.
In 2019, 2018 and 2017, RSUI recorded $37.4 million, $11.7 million and $26.3 million, respectively, in compensation expense related to the RSUI Plans. During the same periods, a deferred tax benefit of $7.8 million, $2.4 million and $5.5 million, respectively, related to the compensation expense were recorded.
Long-term incentive plans exist at certain other subsidiaries for the purpose of providing equity-like incentives to key employees. The awards under such plans were not material to Alleghany’s results of operations, financial condition or cash flows for the three years ended December 31, 2019.
TransRe has an unfunded, noncontributory defined benefit plan and a funded noncontributory defined benefit plan for certain of its employees in the U.S. Benefits under TransRe’s defined benefit plans were frozen as of December 31, 2009 and the unfunded, noncontributory defined benefit plan was terminated in December 2019. As of December 31, 2019 and 2018, the projected benefit obligation was $79.0 million and $65.5 million, respectively, and the related fair value of plan assets was $56.9 million and $49.1 million, respectively.
Selected quarterly financial data for 2019 and 2018 are presented below:
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of Alleghany Corporation and subsidiaries as of December 31, 2019 and 2018, and the related consolidated statements of earnings and comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2019 and the related notes and the financial statement schedules listed in the Index at Item 15(a)(2) and our report dated February 19, 2020 expressed an unqualified opinion thereon.