Selected consolidated statement of operations data, ending consolidated balance sheet data and share data for each of the five years ended December 31, 2014, follows:
(c) Represents the interests in the entities included within our Collateralized Reinsurance segment that are attributable to third-party investors.
Our underwriting results for 2013 benefitted from a low level of net catastrophe losses as well as $144.4 million of prior year favorable loss reserve development. Our investment results for 2013 included $49.2 million of net realized and unrealized investment losses, which were comprised of $60.6 million in net losses from fixed maturities, $7.2 million in net gains from equity securities and $4.2 million in net gains from other investments.
The following table presents our computations of book value per Common Share (“BVPCS”) and FCBVPCS as of December 31, 2014, 2013 and 2012:
(1) Computed as the change in FCBVPCS after taking into account dividends declared on Common Shares of $0.65, $0.47 and $0.43 during 2014, 2013 and 2012, respectively.
The Company’s increase in FCBVPCS serves as the performance measure for both the portion of our annual employee cash bonuses that are based on Company performance and for our Variable RSU awards in the Initial RSU Period (each as defined on page of this report). We believe that this performance measure: (i) directly aligns our interests and motivations with those of our stakeholders; and (ii) provides our employees with the ability to easily understand, and identify with, their incentive hurdle, and allows our stakeholders to easily track the Company’s performance with respect to this goal, since we present our calculations of FCBVPCS and the increase in our FCBVPCS in our quarterly earnings releases and our annual and quarterly filings with the SEC.
During 2014 each of our operating segments, Montpelier Bermuda, Montpelier at Lloyd’s and Collateralized Reinsurance, experienced strong profitability. Overall, we achieved a 15.0% increase in our FCBVPCS for the year while returning $215.8 million to holders of our Common Shares through share repurchases and dividends.
In addition, the launch of BCRH on the New York Stock Exchange in November 2013 and the subsequent growth experienced by the BCGR Listed Fund further expanded our presence in the collateralized reinsurance market. These initiatives, as well as the various underwriting partnerships that we continue to successfully develop, served to significantly increase the amount of third-party assets that we manage, enabling us to provide a broader product mix and increased line sizes for select clients. As of January 1, 2015, Blue Capital® had approximately $790 million of capital under management, of which $625 million represented capital from third-parties.
Despite the competitive market conditions we currently face, through our efforts thus far in 2015, we believe that we have: (i) achieved preferred signings; (ii) maintained strong relationships with our key business partners; and (iii) expanded our product mix. Further, through the recent reductions to our largest projected exposures from single event losses versus those of a year ago, we have retained the ability to quickly adapt and respond to new market opportunities while continuing our strategic focus on property, marine and other short-tail lines. Given our strong balance sheet, disciplined underwriting and specialist approach, we believe we are positioned to perform well into 2015 and beyond.
Our multi-tiered risk management approach focuses on tracking exposed contract limits, estimating the potential impact of a single natural catastrophe event and simulating our yearly net operating result to reflect an aggregation of modeled underwriting, investment and other risks. Management routinely seeks to refine and improve our risk management system and the Board regularly reviews the outputs from this process.
The following discussion should be read in conjunction with the “Risk Factors” contained in Item 1A herein, in particular the specific risk factor entitled “Our stated catastrophe and enterprise-wide risk management exposures are based on estimates and judgments which are subject to significant uncertainties.”
Our January 1, 2015 net reinsurance treaty limits by zone were as follows:
For U.S. earthquake, the regional limits shown are for earthquake ground motion damage only, i.e., they exclude limits for contracts that do not specifically cover earthquake damage but may provide coverage for fire following an earthquake event. Contracts that provide coverage for multiple regions are included in the totals for each potentially exposed zone; therefore, the limits for a single multi-zone policy may be included within several different zone limits.
These treaty limits are a snapshot of our exposure as of January 1, 2015. As of that date, New Madrid earthquake represented our largest concentration of net reinsurance treaty limits among the selected zones. The relative comparison between zones and the absolute level of exposure may change materially at any time due to changes in the composition of our portfolio and changes in our ceded reinsurance program.
For certain defined natural catastrophe region and peril combinations, we assess the probability and likely magnitude of losses using a combination of industry third-party models, CATM®and underwriting judgment. We attempt to model the projected net impact from a single event, taking into account contributions from property catastrophe reinsurance (including retrocessional business), property pro-rata reinsurance, workers compensation catastrophe reinsurance, event-linked derivative securities and individual risk business, offset by the net benefit of any reinsurance or derivative protections we purchase and the benefit of reinstatement premiums.
There is no single standard methodology or set of assumptions utilized industry-wide in estimating property catastrophe losses. As a result, it may be difficult to accurately compare estimates of risk exposure among different insurance and reinsurance companies, due to, among other things, underwriting judgment, differences in modeling, modeling assumptions, portfolio composition and concentrations, and selected event scenarios.
The table below details the projected net impact from single event losses as of January 1, 2015 for selected zones at selected return period levels using AIR Worldwide Corporation’s Touchstone 2.0 and CATRADER 16.0, both of which are industry-recognized third-party vendor models. It is important to note that each catastrophe model contains its own assumptions as to the frequency and severity of loss events, and results may vary significantly from model to model.
Since we utilize a combination of third-party models, CATM® and underwriting judgment to project the net impact from single event losses, our internal projections may be higher or lower than those presented in the table below.
Net Impact From Single Event Losses by Return Period (in years) (1)
The activities of the Company, certain of its intermediate holding and service companies, the Company’s former MUSIC Run-Off segment and eliminations relating to intercompany reinsurance and support services, collectively referred to as “Corporate and Other”, are also presented herein.
Net premiums written and earned by Montpelier Bermuda in 2014, 2013 and 2012 included increases due to reinstatements of $6.3 million, $4.6 million and $10.5 million, respectively. The level of reinstatement premiums that Montpelier Bermuda recognizes in any given period is a function of the nature and extent of losses recognized in that period.
Montpelier Bermuda purchases reinsurance in the normal course of its business in order to manage its exposures. The amount and type of reinsurance that Montpelier Bermuda purchases is dependent on a variety of factors, including the cost of a particular reinsurance cover and the nature of its gross premiums written during a particular period. Other factors affect Montpelier Bermuda’s appetite and capacity to write and retain risk. These factors include the impact of changes in frequency and severity assumptions used in our models and the corresponding pricing required to meet our return targets, evolving industry-wide capital requirements, increased competition, market conditions and other considerations.
Net premiums earned by Montpelier Bermuda in 2014, 2013 and 2012 were $315.9 million, $359.2 million and $369.5 million, respectively. Net premiums earned are primarily a function of the amount and timing of net premiums previously written.
Our best estimates of Montpelier Bermuda’s ending gross loss and LAE reserves at December 31, 2014 and 2013 were $408.8 million and $520.9 million, respectively. Montpelier Bermuda’s gross IBNR reserves, as a percentage of its total gross reserves, amounted to 65% and 64% as of December 31, 2014 and 2013, respectively.
We estimated Montpelier Bermuda’s gross and net loss and LAE reserves using the methodology outlined in our “Summary of Critical Accounting Policies and Estimates” contained in Item 7 herein. We did not make any significant changes in the assumptions or methodology used in Montpelier Bermuda’s reserving process during each of the years ended December 31, 2014 and 2013.
The following table presents Montpelier Bermuda’s net loss and LAE ratios for the years ended December 31, 2014, 2013 and 2012:
· 2012 and prior IBNR reductions associated with medical malpractice business ($14.3 million decrease),
· a settlement associated with the 2010 Deepwater Horizon oil rig explosion and fire ($5.6 million decrease).
· 2011 catastrophe losses relating to the Japanese earthquake, Thai floods, Hurricane Irene and other events ($34.1 million decrease), and
The remaining net favorable development on prior year loss reserves recognized during 2014, 2013 and 2012 related to several smaller adjustments made across multiple classes of business.
Montpelier Bermuda’s prior year losses and LAE incurred also includes foreign currency transaction gains (losses) relating to its prior year loss and LAE reserves of $1.3 million, $3.8 million and $(1.3) million during 2014, 2013 and 2012, respectively. Since these foreign currency transaction gains (losses) are reported as decreases (increases) in Montpelier Bermuda’s losses and LAE incurred, they have a direct impact on its underwriting results and its underwriting ratios.
The following table summarizes Montpelier Bermuda’s general and administrative expenses during the years ended December 31, 2014, 2013 and 2012:
Montpelier Bermuda’s operating expenses have decreased during the periods presented primarily as a result of reductions in information technology costs and a re-allocation of certain risk management expenses from Montpelier Bermuda to Corporate and Other. This re-allocation was made in response to an increase in the Company’s group-wide risk management activities, including Solvency II and related initiatives.
Incentive compensation expenses recorded at Montpelier Bermuda consist of two independent components. The first component represents amounts that are not, or are no longer, dependent on Company performance, and consist of: (i) Fixed RSUs and Variable RSUs granted in prior years that have been effectively converted to Fixed RSUs; and (ii) the portion of annual employee cash bonuses that is based on individual employee performance goals. The second component represents amounts that are entirely dependent on Company performance and consist of: (i) Variable RSUs in the Initial RSU Period; and (ii) the portion of annual employee cash bonuses that is based on Company performance.
The following table summarizes Montpelier at Lloyd’s premium writings, by line of business, for the years ended December 31, 2014, 2013 and 2012:
Note - Montpelier at Lloyd’s reinsurance premiums ceded during the years presented include amounts ceded to Montpelier Bermuda’s pursuant to inter-segment reinsurance agreements are eliminated in consolidation. See “Corporate and Other” under this Item 7.
Montpelier at Lloyd’s purchases reinsurance in the normal course of its business in order to manage its exposures. The amount and type of reinsurance that Montpelier at Lloyd’s purchases is dependent on a variety of factors, including the cost of a particular reinsurance cover and the nature of its gross premiums written during a particular period. Other factors affect Montpelier at Lloyd’s appetite and capacity to write and retain risk. These include the impact of changes in frequency and severity assumptions used in our models and the corresponding pricing required to meet our return targets, evolving industry-wide capital requirements, increased competition, market conditions and other considerations.
All of Montpelier at Lloyd’s reinsurance purchases to date have represented prospective cover; that is, reinsurance has been purchased to protect Montpelier at Lloyd’s against the risk of future losses as opposed to covering losses that have already occurred but have not been paid. Montpelier at Lloyd’s purchases: (i) excess-of-loss reinsurance covering one or more lines of its business; and (ii) quota share reinsurance with respect to specific lines of its business.
The following tables summarize Montpelier at Lloyd’s loss and LAE reserve movements for the years ended December 31, 2014, 2013 and 2012, and the composition of its gross loss and LAE reserves at December 31, 2014 and 2013:
(1) Montpelier at Lloyd’s ending gross unpaid loss and LAE reserves at December 31, 2014, 2013 and 2012 includes recoverables from Montpelier Bermuda of $8.6 million, $8.4 million and $13.3 million, respectively. The effects of these inter-segment reinsurance contracts are eliminated in consolidation.
The following table presents Montpelier at Lloyd’s net loss and LAE ratios for the years ended December 31, 2014, 2013 and 2012:
During 2014 and 2013 Montpelier at Lloyd’s incurred $169.8 million and $145.0 million, respectively, of current year net losses and LAE. There were no individually significant known catastrophe loss events affecting Montpelier at Lloyd’s during those years as most of the current year loss and LAE incurred related to claims and events that had been incurred during those years but had not yet been reported to us.
During 2012 Montpelier at Lloyd’s incurred $148.6 million of current year net losses and LAE. There were no individually significant known loss events impacting Montpelier at Lloyd’s during 2012, other than a $17.8 million net catastrophe loss associated with windstorm Sandy. Most of the remaining current year loss and LAE incurred during 2012 related to claims and events that had been incurred during that year but had not yet been reported to us.
In addition, claims reported to Montpelier at Lloyd’s during 2014 indicated that IBNR for natural catastrophe losses it initially recorded during 2013 exceeded the extent of losses that actually occurred, and, consequently, Montpelier at Lloyd’s decreased its loss and LAE reserves by $6.6 million.
In addition to the loss reserve movements referred to above, Montpelier at Lloyd’s prior year loss development also related to movements associated with reserves established in prior years in order to provide for claims and events that had been incurred in that year but had not yet been reported to us. These reserves were originally recorded by Montpelier at Lloyd’s largely on the basis of historical loss rates, industry data and actuarial judgment and experience as opposed to information received from cedants, brokers and other customers. As prior underwriting years have matured, Montpelier at Lloyd’s has increased its reliance on the loss data it has received and, as a result, has adjusted its estimates of ultimate losses accordingly.
Montpelier at Lloyd’s prior year losses and LAE incurred also includes foreign currency transaction gains (losses) relating to its prior year loss and LAE reserves of $(5.3) million, $(1.4) million and $5.3 million during 2014, 2013 and 2012, respectively. Since these foreign currency transaction gains (losses) are reported as decreases (increases) in Montpelier at Lloyd’s losses and LAE incurred, they have a direct impact on its underwriting results and its underwriting ratios.
For the year ended December 31, 2014, Montpelier at Lloyd’s loss and LAE ratio of 58.1% (as well as its combined ratio of 98.8%) included a 2.2 percentage point detriment relating to net foreign currency transaction losses on its prior year loss and LAE reserves. For the year ended December 31, 2013, Montpelier at Lloyd’s loss and LAE ratio of 49.6% (as well as its combined ratio of 91.3%) included a 0.7 percentage point detriment relating to net foreign currency transaction losses on its prior year loss and LAE reserves. For the year ended December 31, 2012, Montpelier at Lloyd’s loss and LAE ratio of 49.5% (as well as its combined ratio of 88.5%) included a 2.4 percentage point benefit relating to net foreign currency transaction gains on its prior year loss and LAE reserves.
Acquisition costs include commissions, profit commissions, brokerage costs and excise taxes, when applicable. Profit commissions and brokerage costs can vary based on the nature of business produced. Commissions earned by Montpelier at Lloyd’s from business that it cedes to reinsurers are recorded as reductions in its acquisition costs.
Profit commissions, which are paid by assuming companies to ceding companies in the event of a favorable loss experience, change as Montpelier at Lloyd’s estimates of loss and LAE fluctuate and are accrued based on the estimated results of the subject contract. Profit commissions incurred were less than $0.1 million, $3.4 million and $1.1 million during 2014, 2013 and 2012, respectively.
All other acquisition costs incurred by Montpelier at Lloyd’s are generally driven by contract terms and are normally a set percentage of gross premiums written. Such acquisition costs consist of commission expenses incurred on assumed business and commission revenue earned on purchased reinsurance covers, all of which is earned over the same period that the corresponding premiums are expensed.
The following table summarizes Montpelier at Lloyd’s general and administrative expenses during the years ended December 31, 2014, 2013 and 2012:
Incentive compensation expenses recorded at Montpelier at Lloyd’s consist of two independent components. The first component represents amounts that are not, or are no longer, dependent on Company performance, and consist of: (i) Fixed RSUs and Variable RSUs granted in prior years that have been effectively converted to Fixed RSUs; and (ii) the portion of annual employee cash bonuses that is based on individual employee performance goals. The second component represents amounts that are entirely dependent on Company performance and consist of: (i) Variable RSUs in the Initial RSU Period; and (ii) the portion of annual employee cash bonuses that is based on Company performance.
Gross premiums written by the Collateralized Reinsurance segment totaled $83.4 million, $39.8 million and $2.4 million during the years ended December 31, 2014, 2013 and 2012, respectively. The significant increases in gross premiums written within Collateralized Reinsurance during the periods presented reflect: (i) additional capital being deployed into Blue Water Re by the BCGR Listed Fund; and (ii) the operations of Blue Capital Re, which commenced operations in November 2013, but did not write any reinsurance premiums during that year.
The following tables summarize the Collateralized Reinsurance segment’s loss and LAE reserve movements for the years ended December 31, 2014, 2013 and 2012, and the composition of its gross loss and LAE reserves at December 31, 2014 and 2013:
The following table summarizes the Collateralized Reinsurance segment’s underwriting expenses for the years ended December 31, 2014, 2013 and 2012:
The Corporate and Other results for the years ended December 31, 2014, 2013 and 2012 were as follows:
Operating expenses during 2014 increased as compared to those of 2013 primarily as a result of BCRH becoming a publicly traded company in November 2013.
The following table summarizes our consolidated net investment income and total return on cash and investments for the years ended December 31, 2014, 2013 and 2012:
(1) Our weighted average investment portfolio and investment return calculations, as adjusted, exclude the cash, cash equivalents and short-term investments that relate to our Collateralized Reinsurance segment, which totaled $468.9 million, $394.9 million and $72.5 million at December 31, 2014, 2013 and 2012, respectively. These assets are earmarked for the benefit of our Collateralized Reinsurance segment’s cedants and counterparties and are not intended to provide Montpelier or its cedants and counterparties with any investment return.
Our total return on cash and investments for 2014 was higher than that of 2013, due primarily to lower net investment and derivative losses experienced in 2014 versus the amount of such losses we experienced in 2013. Our total return on cash and investments for 2013 was significantly lower than that of 2012, due primarily to net investment and investment-related derivative losses experienced in 2013 versus net gains experienced in 2012.
During 2014, 2013 and 2012, we experienced net foreign currency transaction gains (losses) on cash and investments (those in connection with our investing activities) of $(3.3) million, $(4.3) million and $2.3 million, respectively. These foreign currency transaction gains and losses represent foreign currency fluctuations in the value of our non-U.S. dollar managed cash and investments.
Our investments classified as Level 3 securities (as defined in GAAP) as of December 31, 2014 and 2013 consisted primarily of the following: (i) with respect to certain fixed maturity investments, bank loans and certain asset-backed securities, many of which are not actively traded; and (ii) with respect to other investments, certain investments in investment funds and limited partnerships. Our Level 3 securities measured at fair value represented 3.9% ($83.8 million) and 1.1% ($28.6 million) of our total invested assets measured at fair value as of December 31, 2014 and 2013, respectively. The increase in our level 3 securities from 2013 to 2014 primarily reflects the 2014 purchase of an interest in an investment fund that cannot be readily redeemed due to lock-up restrictions.
The following table summarizes the components of our consolidated net foreign currency gains (losses) for the years ended December 31, 2014, 2013 and 2012:
The following table summarizes our consolidated other revenues for the years ended December 31, 2014, 2013 and 2012:
Our consolidated other revenues are comprised of: (i) managing general agency fees earned by Cladium, commissions earned by our former wholly-owned subsidiary Paladin Underwriting Agency Limited (“PUAL”) and transitional services provided to Selective in connection with the MUSIC Sale; (ii) equity in the earnings of a specialty managing general agency in which we hold a minority investment; (iii) interest on funds advanced to ceding companies to cover losses in accordance with contract terms; (iv) amounts recorded in connection with the sale of PUAL; and (v) the proceeds from the Loss Development Cover.
In September 2012, we sold PUAL to a founding member of its management. In connection with the sale of PUAL, we received a note from the buyer under which the repayment of principal and interest was contingent on the future performance of that company. Due to the contingencies surrounding the note at the time of sale in 2012, we assigned no value to it and recognized a loss on the sale of PUAL of $0.5 million. Based on the subsequent performance of the note, we recognized its full value during 2013 and recorded a $0.4 million gain on the sale of PUAL. PUAL’s assets and operations were not material to the Company.
The following table summarizes our consolidated interest and other financing expenses for the years ended December 31, 2014, 2013 and 2012:
Our consolidated interest and financing expenses remained largely consistent from 2013 to 2014 because the annual interest expense in respect of the 2022 Senior Notes, which we issued in 2012, is highly consistent with that in respect of the 2013 Senior Notes, which were retired in 2012.
The following table summarizes our consolidated other expenses for the years ended December 31, 2014, 2013 and 2012:
During 2014 we recorded a net tax benefit of $2.7 million, consisting of a current tax provision of $2.0 million and a deferred tax benefit of $4.7 million. During 2013 we recorded a net tax benefit of $0.1 million, consisting of a current tax benefit of $0.3 million and a deferred tax provision of $0.2 million. During 2012 we recorded a net tax provision of $0.3 million, consisting of a current tax provision of $0.8 million and a deferred tax benefit of $0.5 million.
During 2014 and 2012, each of the entities within our U.K. group of companies generated taxable income so we were unable to utilize Group Relief to offset our U.K. net current income tax liabilities in those years. During 2013 we were able to utilize a combination of net operating losses and Group Relief to partially offset our U.K. net current income liabilities for that year.
During 2014, 2013 and 2012, our Bermuda operations generated income before income taxes of $246.7 million, $205.3 million and $232.2 million, respectively.
During 2014, 2013 and 2012, our U.K. operations generated income (losses) before income taxes of $(2.8) million, $4.6 million and $(4.4) million, respectively, and certain of these operations are currently in a net operating loss position.
The following table summarizes the net income attributable to non-controlling interests during the years ended December 31, 2014, 2013 and 2012:
During 2014, 2013 and 2012 we declared $13.3 million in cash dividends on our Preferred Shares.
The primary sources of cash for our regulated operating subsidiaries are premium collections, investment income, sales and maturities of investments and reinsurance recoveries. The primary uses of cash for our operating subsidiaries are payments of losses and LAE, acquisition costs, operating expenses, ceded reinsurance, investment purchases and dividends and distributions paid to the Company.
As of December 31, 2014, our sources of immediate and unencumbered liquidity consisted of: (i) $141.3 million of cash and cash equivalents; (ii) $48.0 million of highly liquid fixed maturity investments which currently trade at a very narrow bid-ask spread and whose proceeds are available within two business days; (iii) $159.4 million of publicly-traded equity securities whose proceeds are available within four business days; and (iv) $5.0 million of liquid fixed maturity investments which currently trade at a narrow bid-ask spread and whose proceeds are available within four business days. Further, we believe that we have significant sources of additional liquidity within our fixed maturity investment and other investment portfolios, although the bid-ask spreads associated with such investment securities could be broader, perhaps significantly, than those with respect to the securities referred to above, particularly if a large individual investment were required to be liquidated in an expeditious manner.
The Company does not have a revolving credit facility for its own purposes because its current cash and cash equivalent balances and projected future cash flows from its operations are expected to be sufficient to cover its cash obligations under most loss scenarios through the foreseeable future.
The Company serves as a guarantor of BCRH’s obligations under the BCRH Credit Agreement and receives an annual guarantee fee from BCRH equal to 0.125% of the facility’s total capacity.
As of December 31, 2014, BCRH had $8.0 million of outstanding borrowings under the BCRH Credit Agreement. Of these borrowings, $4.0 million was repaid on January 26, 2015, and (while outstanding) was subject to an annual interest rate of 1.33%, and $4.0 million must be repaid no later than April 10, 2015, and is subject to an annual interest rate of 1.32%.
The BCRH Credit Agreement contains covenants that limit BCRH’s and, to a lesser extent, the Company’s ability to, among other things, grant liens on its assets, sell assets, merge or consolidate, incur debt and enter into certain transactions with affiliates. The BCRH Credit Agreement also contains covenants that require: (i) BCRH to maintain a debt to total capitalization ratio less than or equal to 22.5%; (ii) the Company to maintain a financial strength rating from Fitch Ratings Ltd. of at least “BBB+”; and (iii) each of BCRH and the Company to maintain at least 70% of its net worth as of the date of the BCRH Credit Agreement. If BCRH or the Company were to fail to comply with any of these covenants, the lender could revoke the facility and exercise remedies against BCRH or the Company. As of December 31, 2014, BCRH and the Company (as a guarantor) were in compliance with each of the covenants associated with the BCRH Credit Agreement.
The Company serves as a guarantor of the BCGR Listed Fund’s obligations under the BCGR Credit Agreement and receives an annual guarantee fee from the BCGR Listed Fund equal to 0.125% of the facility’s total capacity.
As of December 31, 2014, the BCGR Listed Fund had a $4.0 million outstanding borrowing under the BCGR Credit Agreement. This borrowing was repaid by the BCGR Listed Fund on February 3, 2015, and (while outstanding) was subject to an annual interest rate of 1.27%.
The following table summarizes our capital structure as of December 31, 2014 and 2013:
Our total capital increased by $6.1 million during 2014 as a result of our recording comprehensive income available to the Company of $221.5 million, recognizing $13.4 million of additional paid-in capital through the amortization and issuance of share-based compensation, recognizing $0.3 million of additional paid-in capital from purchases of non-controlling interests, declaring $43.2 million in dividends to holders of Common Shares and Preferred Shares and repurchasing $185.9 million of Common Shares.
The issuance of any new debt, equity or hybrid financial instruments might contain terms and conditions that are more unfavorable to us, our existing shareholders and our debtholders than those contained within our current capital structure. More specifically, any new issuances of equity or hybrid securities could include the issuance of securities with rights, preferences and privileges that are senior or otherwise superior to those of our Common and Preferred Shares and could be dilutive to our existing holders of these equity securities. Further, if we cannot obtain adequate capital on favorable terms or otherwise, our business, financial condition and operating results could be adversely affected.
The agreements governing our letter of credit facilities contain covenants that limit our ability, among other things, to grant liens on our assets, sell our assets, merge or consolidate, incur debt and enter into certain agreements. In addition, our four year committed letter of credit facility requires us to maintain a debt to capital ratio of no greater than 30% and for Montpelier Re to maintain an A.M. Best financial strength rating of no less than “B++.” If we were to fail to comply with these covenants or fail to meet these financial ratios, the lenders could revoke these facilities and exercise remedies against us. As of December 31, 2014 and 2013, we were in compliance with each of the covenants contained in our letter of credit facilities.
We established the Reinsurance Trust and the Florida Multi-Beneficiary Reinsurance Trust as a means of providing statutory credit to Montpelier Re’s cedants and we established the Lloyd’s Deposit Trust Deed as a means of satisfying Lloyd’s capital requirements. As a result of these and other trust arrangements we currently utilize, our ongoing reliance on letter of credit facilities has been significantly reduced. See Note 6 of the Notes to Consolidated Financial Statements.
Our unfunded commitments to invest: (i) $7.9 million into a private investment fund; and (ii) up to $15.5 million into a private placement fixed maturity investment, are each assumed to be fully funded during 2015.
The Foreign Exchange Contracts, Credit Derivatives, Interest Rate Contracts, Investment Options and Futures, certain of our ongoing obligations to Selective in connection with the MUSIC Sale and the Company’s guarantee of the BCGR Listed Fund’s obligations under the BCGR Credit Agreement each constitute off-balance sheet arrangements. Excluding these specific transactions, as of December 31, 2014, we were not subject to any off-balance sheet arrangements that we believe are material to our investors.
We experienced a net increase (decrease) in our cash and cash equivalents of $(20.7) million, $185.0 million and $(22.1) million during 2014, 2013 and 2012, respectively.
Our investment activities provided (used) net cash and cash equivalents of $14.2 million, $36.6 million and $(141.5) million during 2014, 2013 and 2012, respectively. The cash and cash equivalents provided from our investing activities during 2014 primarily resulted from a decrease in restricted cash and settlements of reverse repurchase agreements offsetting net investment purchases. The cash and cash equivalents provided from our investment activities during 2013 resulted primarily from net sales of investment securities, whose proceeds were used to pay loss and LAE reserves and to fund repurchases of Common Shares. The cash and cash equivalents used for our investment activities during 2012 resulted primarily from net purchases of investment securities, representing the initial deployment of the net proceeds raised from the issuance of the 2022 Senior Notes and a lower level of Common Share repurchases.
Detailed information regarding our cash flows for the years ended December 31, 2014, 2013 and 2012, follows:
· we paid $655.3 million for net purchases of equity securities and other investments,
· we paid $7.9 million for purchases of BCRH Common Shares made by the Company,
· we paid $11.8 million pursuant to net settlements of repurchase agreements,
· we paid $5.5 million in dividends to non-controlling holders of BCRH Common Shares, and
Our cash flows provided from investing activities totaled $36.6 million, resulting from the following:
Our cash flows used for investing activities totaled $141.5 million, resulting from the following:
· we paid $12.6 million pursuant to net settlements of reverse repurchase agreements,
· we paid $2.7 million in expenses related to the issuance of the 2022 Senior Notes,
We also experienced a $5.4 million increase in the U.S. dollar value of our cash and cash equivalents due to foreign currency exchange rate fluctuations.
We have no current intention, or need, to repatriate any cash or cash equivalents from our U.K. or U.S. operations to Bermuda in order to satisfy our parent company obligations. Additionally, our current structure is such that any distributions of earnings, in the form of cash or otherwise, from our subsidiaries outside of Bermuda would not currently subject us to a material amount of incremental taxation.
Our Consolidated Financial Statements have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported and disclosed amounts of our assets and liabilities as of the balance sheet dates and the reported amounts of our revenues and expenses during the reporting periods. We believe the items that require the most subjective and complex estimates are: (i) our loss and LAE reserves; (ii) our written and earned insurance and reinsurance premiums; (iii) our ceded reinsurance; and (iv) our share-based compensation accruals. Our accounting policies for these items are of critical importance to our consolidated financial statements.
Most of our property treaty reinsurance contracts comprise business which has both a low frequency of claims occurrence and a high potential severity of loss, such as claims arising from natural catastrophes, terrorism, large individual property risks, and space and aviation risks. Given the high-severity, low-frequency nature of these events, the losses typically generated therefrom do not lend themselves to traditional actuarial reserving methods, such as statistical calculations of a range of estimates surrounding the best point estimate of our loss and LAE reserves. Therefore, our reserving approach for these types of coverages is to estimate the ultimate cost associated with a single loss event rather than analyzing the historical development patterns of past losses as a means of estimating ultimate losses for an entire accident year. We estimate our reserves for these large events on a contract-by-contract basis by means of a review of policies with known or potential exposure to a particular loss event.
While the approach we use in reserving for large events is applied with consistency, at any point in time the specific reserving assumptions may vary among contracts. The assumptions for a specific contract may depend upon the class of business, historical reporting patterns of the cedant, whether or not the cedant provides an IBNR estimate, how much of the loss has been paid, the number of underlying claims still open, the number of claims potentially subject to litigation and other factors. For example, the expected loss development for a contract with 1% of its claims still open would likely be less than for a contract with 50% of its claims still open.
The development of our prior-year losses is monitored during the course of subsequent calendar years by comparing the actual reported losses against expected losses. The analysis of this loss development is an important factor in our ongoing refinement of the assumptions underlying our reserving process. Our internal analysis of changes in prior year reserve estimates is focused on changes in the estimated ultimate loss and therefore management believes that it is not meaningful to split the movement of prior year loss reserve estimates between case reserves and IBNR. With regards to our short-tail property book of business, we do not feel that we can predict the breakdown of losses in the first year with a high level of accuracy. The percentage split between paid losses, case reserves and IBNR would vary greatly depending on the number, nature and timing of losses throughout the year. However, we would expect that by the end of the year subsequent to the year in which the loss occurred, the majority of these short-tail property losses would be reported to us, and by the end of the following year the majority would be paid.
Our internal actuaries, our CEO and our CFO each review our reserving assumptions and our methodologies on a quarterly basis. Our third quarter and year-end loss estimates are subject to a corroborative review by both an independent loss reserve specialist and an independent registered public accounting firm, each using generally accepted actuarial principles. The Audit Committee also reviews our quarterly and annual reserve analyses.
The following tables provide the details of our gross case reserves and IBNR, by line of business, at December 31, 2014 and 2013:
The portion of our gross loss and LAE reserves at any given time represented by IBNR tends to be lower in periods during which we experience large loss events (such as catastrophes) than those during which we experience loss events of a lower severity. This is because losses from larger events tend to move from IBNR to reported losses much faster than those of a lower severity. With respect to 2014 and 2013, years in which we experienced no large loss events, our ending gross IBNR reserves remained consistent at 61% and 62% of our total ending gross loss and LAE reserves, respectively.
We have determined that our best estimates for our gross loss and LAE reserves at December 31, 2014 and 2013 were $775.7 million and $881.6 million, respectively. Of these estimates, at December 31, 2014 and 2013, $167.6 million and $174.6 million related to our direct insurance business, respectively, and $608.1 million and $707.0 million related to our reinsurance business, respectively.
Premiums written are recognized as revenues, net of any applicable underlying ceded reinsurance, and are earned over the term of the related policy or contract. For direct insurance, and facultative and losses-occurring contracts, the earnings period is the same as the term of the reinsurance contract, which is ordinarily twelve months. For risks-attaching contracts, the earnings period is based on the terms of the underlying insurance policies, which extends from the inception date of the first policy bound during the contract term to the termination date of the last policy bound, and thereby exceeds the term of the reinsurance contract.
Reinsurance recoverable on paid losses represents amounts currently due from reinsurers. Reinsurance recoverable on unpaid losses represents amounts that will be collectible from reinsurers once the losses are paid. The recognition of reinsurance recoverable requires two key judgments. In determining our ceded IBNR, the first judgment involves the estimation of the amount of gross IBNR to be ceded to reinsurers. Ceded IBNR is developed as part of our loss reserving process and consequently, the estimate is subject to risks and uncertainties similar to the estimation of gross IBNR. The second judgment relates to the amount of the reinsurance recoverable balance that ultimately will not be collected from reinsurers due to insolvency, contractual dispute or other reasons.
As of December 31, 2014 and 2013, we recorded $7.1 million and $3.6 million in reinsurance recoverable on paid losses, respectively, and $48.7 million and $63.6 million in reinsurance recoverable on unpaid losses, respectively. We record provisions for uncollectible reinsurance recoverable when collection becomes unlikely due to the reinsurer’s inability to pay. Based on a review of the financial condition of the reinsurers and other factors, we have determined that a reserve for uncollectible reinsurance recoverable on paid and unpaid loss and LAE was not considered necessary as of December 31, 2014 and 2013.
For each of the years presented, the number of Variable RSUs expected to be formally awarded to employees was based on our increase in FCBVPCS for such year. FCBVPCS is computed by dividing the common shareholders’ equity available to the Company by the sum of its ending Common Shares and unvested RSUs outstanding. Our calculation of the increase in our FCBVPCS represents the growth in our FCBVPCS during the Initial RSU Period, after taking into account dividends on Common Shares declared during such period.
For the 2014-2017 Variable RSU award cycle, the targeted performance metric was based on a 2014 increase in FCBVPCS of 10.0%, which would have generated a grant of approximately 495,000 Variable RSUs to participants. The payout range for that year was from a threshold of 3.0% (generating no RSUs) to a maximum of 17.0% (generating approximately 990,000 Variable RSUs). Throughout the Initial RSU Period for this cycle, our quarterly Variable RSU accrual for this cycle varied in response to actual year-to-date results achieved and ranged from as many as 850,262 RSUs (as recorded at December 31, 2014) to as few as 494,340 RSUs (as recorded at March 31, 2014). Because we determined our achieved increase in FCBVPCS for 2014 to be 15.0%, the preliminary number of Variable RSUs expected to be granted for the 2014-2017 Variable RSU award cycle was determined to be 850,262 at December 31, 2014. The final number of Variable RSUs granted for the 2014-2017 Variable RSU award cycle will be formally determined by the Compensation Committee on February 26, 2015 and any adjustments required to be made will be recorded in our consolidated financial statements in the first quarter of 2015.
For the years covered by this Report on Form 10-K, we assumed a zero to 8.8% forfeiture rate depending on the nature and term of individual awards and past and recent experience. Our forfeiture assumptions serve to reduce the unamortized grant date fair value of outstanding RSUs as well as the associated RSU expense. As RSUs are actually forfeited, the number of RSUs outstanding is reduced and the remaining unamortized grant date fair value is compared to assumed forfeiture levels. True-up adjustments are made as deemed necessary.
During 2014, 2013 and 2012, we recognized $19.8 million, $18.0 million and $12.1 million of RSU expense, respectively.