W. R. Berkley Corporation is an insurance holding company that is among the largest commercial lines writers in the United States and operates worldwide in two business segments of the property and casualty business: Insurance and Reinsurance & Monoline Excess. Our decentralized structure provides us with the flexibility to respond quickly and efficiently to local or specific market conditions and to pursue specialty business niches. It also allows us to be closer to our customers in order to better understand their individual needs and risk characteristics. While providing our business units with certain operating autonomy, our structure allows us to capitalize on the benefits of economies of scale through centralized capital, investment, reinsurance and enterprise risk management, and actuarial, financial and corporate legal staff support. The Company's primary sources of revenues and earnings are its insurance operations and its investments.
The profitability of the Company’s insurance business is affected primarily by the adequacy of premium rates. The ultimate adequacy of premium rates is not known with certainty at the time an insurance policy is issued because premiums are determined before claims are reported. The ultimate adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural and other disasters, regulatory measures and court decisions that define and change the extent of coverage and the effects of economic or social inflation on the amount of compensation for injuries or losses. General insurance prices are also influenced by available insurance capacity, i.e., the level of capital employed in the industry, and the industry’s willingness to deploy that capital.
The Company also invests in equity securities, merger arbitrage securities, investment funds, private equity, loans and real estate related assets. The Company's investments in investment funds and its other alternative investments have experienced, and the Company expects to continue to experience, greater fluctuations in investment income. The Company's share of the earnings or losses from investment funds is generally reported on a one-quarter lag in order to facilitate the timely completion of the Company's consolidated financial statements.
Adverse Legislative and Regulatory Action. Legislative and regulatory initiatives taken or that may be taken in response to COVID-19, such as those that seek to retroactively mandate or provide a presumption of coverage for losses which our insurance policies would not otherwise cover and were not priced to cover, may adversely affect us, particularly in our workers’ compensation and property coverages businesses.
Claim Losses and Adjustment Expenses May Increase. As the effects of COVID-19 on industry practices and economic, legal, judicial, social and other environmental conditions continue to evolve, unexpected and unintended issues related to claims and coverages may emerge (including in the area of property coverages where physical damage requirements and communicable disease exclusions are currently being challenged).
Reserves for Losses and Loss Expenses. To recognize liabilities for unpaid losses, either known or unknown, insurers establish reserves, which is a balance sheet account representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred. Estimates and assumptions relating to reserves for losses and loss expenses are based on complex and subjective judgments, often including the interplay of specific uncertainties with related accounting and actuarial measurements. Such estimates are also susceptible to change as significant periods of time may elapse between the occurrence of an insured loss, the report of the loss to the insurer, the ultimate determination of the cost of the loss and the insurer’s payment of that loss.
In general, when a claim is reported, claims personnel establish a “case reserve” for the estimated amount of the ultimate payment based upon known information about the claim at that time. The estimate represents an informed judgment based on general reserving practices and reflects the experience and knowledge of the claims personnel regarding the nature and value of the specific type of claim. Reserves are also established on an aggregate basis to provide for losses incurred but not reported (“IBNR”) to the insurer, potential inadequacy of case reserves and the estimated expenses of settling claims, including legal and other fees and general expenses of administrating the claims adjustment process. Reserves are established based upon the then current legal interpretation of coverage provided.
The key assumptions used to arrive at the best estimate of loss reserves are the expected loss ratios, rate of loss cost inflation, and reported and paid loss emergence patterns. Expected loss ratios represent management’s expectation of losses at the time the business is priced and written, before any actual claims experience has emerged. This expectation is a significant determinant of the estimate of loss reserves for recently written business where there is little paid or incurred loss data to consider. Expected loss ratios are generally derived from historical loss ratios adjusted for the impact of rate changes, loss cost trends and known changes in the type of risks underwritten. Expected loss ratios are estimated for each key line of business within each operating unit. Expected loss cost inflation is particularly important for the long-tail lines, such as excess casualty, and claims with a high medical component, such as workers’ compensation. Reported and paid loss emergence patterns are used to project current reported or paid loss amounts to their ultimate settlement value. Loss development factors are based on the historical emergence patterns of paid and incurred losses, and are derived from the Company’s own experience and industry data. The paid loss emergence pattern is also significant to excess and assumed workers’ compensation reserves because those reserves are discounted to their estimated present value based upon such estimated payout patterns. Management believes the estimates and assumptions it makes in the reserving process provide the best estimate of the ultimate cost of settling claims and related expenses with respect to insured events which have occurred; however, different assumptions and variables could lead to significantly different reserve estimates.
The key assumptions used in calculating the most recent estimate of the loss reserves are reviewed each quarter and adjusted, to the extent necessary, to reflect the latest reported loss data, current trends and other factors observed. If the actual level of loss frequency and severity are higher or lower than expected, the ultimate losses will be different than management’s estimate. The following table reflects the impact of changes (which could be favorable or unfavorable) in frequency and severity, relative to our assumptions, on our loss estimate for claims occurring in 2020:
Approximately $2.6 billion, or 22%, of the Company’s net loss reserves as of December 31, 2020 relate to the Reinsurance & Monoline Excess segment. There is a higher degree of uncertainty and greater variability regarding estimates of excess workers' compensation and assumed reinsurance loss reserves. In the case of excess workers’ compensation, our policies generally attach at $1 million or higher. The claims which reach our layer therefore tend to involve the most serious injuries and many remain open for the lifetime of the claimant, which extends the claim settlement tail. These claims also occur less frequently but tend to be larger than primary claims, which increases claim variability. In the case of assumed reinsurance our loss reserve estimates are based, in part, upon information received from ceding companies. If information received from ceding companies is not timely or correct, the Company’s estimate of ultimate losses may not be accurate. Furthermore, due to
delayed reporting of claim information by ceding companies, the claim settlement tail for assumed reinsurance is also extended. Management considers the impact of delayed reporting and the extended tail in its selection of loss development factors for these lines of business.
Following is a summary of the Company’s reserves for losses and loss expenses by business segment as of December 31, 2020 and 2019:
(2)Short-tail lines include commercial multi-peril (non-liability), inland marine, accident and health, fidelity and surety, boiler and machinery and other lines.
Insurance - Reserves for the Insurance segment developed favorably by $24 million in 2020 (net of additional and return premiums). Continuing the pattern seen in recent years, the overall favorable development in 2020 resulted from more significant favorable development on workers’ compensation business, which was partially offset by unfavorable development on professional liability, including excess professional liability.
business, we continue to see an increase in the number of large losses reported and a lengthening of the reporting “tail” beyond historical levels. We believe a contributing cause is rising social inflation in the form of, for example, higher jury awards on cases that go to trial, and the corresponding higher demands from plaintiffs and higher values required to reach settlement on cases that do not go to trial. The unfavorable development for professional liability affected mainly accident years 2016 through 2018.
For professional liability business, the unfavorable development was driven mainly by an increase in the number of large losses reported in the lawyers professional liability and directors and officers (“D&O”) liability lines of business. Many of the lawyers large losses involved claims made against insured law firms relating to work performed on matters stemming from the 2008 financial crisis. These claims affected mainly accident years 2013 through 2016. In addition, for both of these lines of business, we have seen evidence of social inflation in the form of higher jury awards on cases that go to trial, and corresponding higher demands from plaintiffs and higher values required to reach settlement on cases that do not go to trial. The unfavorable development for D&O affected mainly accident years 2014 through 2017.
workers’ compensation losses in 2018 continued to be below our expectations at most of our operating units, and were below the assumptions underlying our previous reserve estimates.
Reserve Discount. The Company discounts its liabilities for certain workers’ compensation reserves. The amount of workers’ compensation reserves that were discounted was $1,655 million and $1,731 million at December 31, 2020 and 2019, respectively. The aggregate net discount for those reserves, after reflecting the effects of ceded reinsurance, was $483 million and $530 million at December 31, 2020 and 2019, respectively. At December 31, 2020, discount rates by year ranged from 0.7% to 6.5%, with a weighted average discount rate of 3.6%.
Assumed Reinsurance Premiums. The Company estimates the amount of assumed reinsurance premiums that it will receive under treaty reinsurance agreements at the inception of the contracts. These premium estimates are revised as the actual amount of assumed premiums is reported to the Company by the ceding companies. As estimates of assumed premiums are made or revised, the related amount of earned premiums, commissions and incurred losses associated with those premiums are recorded. Estimated assumed premiums receivable were approximately $44 million and $43 million at December 31, 2020 and 2019, respectively. The assumed premium estimates are based upon terms set forth in reinsurance agreements, information received from ceding companies during the underwriting and negotiation of agreements, reports received from ceding companies and discussions and correspondence with reinsurance intermediaries. The Company also considers its own view of market conditions, economic trends and experience with similar lines of business. These premium estimates represent management’s best estimate of the ultimate amount of premiums to be received under its assumed reinsurance agreements.
Fixed Maturity Securities - For fixed maturity securities in an unrealized loss position where the Company intends to sell, or it is more likely than not that it will be required to sell the security before recovery in value, the amortized cost basis is written down to fair value through net investment gains (losses). For fixed maturity securities in an unrealized loss position where the Company does not intend to sell, or it is more likely than not that it will not be required to sell the security before recovery in value, the Company evaluates whether the decline in fair value has resulted from credit losses or all other factors (non-credit factors). In making this assessment, the Company considers the extent to which fair value is less than amortized cost, changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, an allowance for expected credit losses is recorded for the credit loss through net investment gains (losses), limited by the amount that the fair value is less than the amortized cost basis. Effective January 1, 2020, the allowance is adjusted for any change in expected credit losses and subsequent recoveries through net investment gains (losses). The impairment related to non-credit factors is recognized in other comprehensive income (loss) .
The Company classifies its fixed maturity securities by credit rating, primarily based on ratings assigned by credit rating agencies. For purposes of classifying securities with different ratings, the Company uses the average of the credit ratings assigned, unless in limited situations the Company’s own analysis indicates an internal rating is more appropriate. Securities that are not rated by a rating agency are evaluated and classified by the Company on a case-by-case basis.
The following is a summary of pricing sources for the Company's fixed maturity securities available for sale as of December 31, 2020:
Results of Operations for the Years Ended December 31, 2020 and 2019
Following is a summary of gross and net premiums written, net premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of net premiums earned), expense ratios (underwriting expenses expressed as a percentage of net premiums earned) and GAAP combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the years ended December 31, 2020 and 2019. The GAAP combined ratio represents a measure of underwriting profitability, excluding investment income. A GAAP combined ratio in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit.
The Company reported net income of $531 million in 2020 compared to $682 million in 2019. The $151 million decrease in net income was primarily due to an after-tax decrease in net investment income of $47 million mainly due to reduced investment yields in fixed maturity securities and repositioning a larger portion of the investment portfolio to cash and cash equivalents, an after-tax decrease in underwriting income of $46 million resulted from COVID-19-related losses and other catastrophe losses, a $39 million increase in tax expense due to change in effective tax rate, a $23 million decrease in after-tax foreign currency gains as the U.S. dollar weakened against a wide spectrum of currencies, a decrease in after-tax net investment gains of $13 million, a $6 million debt extinguishment expense on debt redeemed in 2020 and an after-tax decrease in other income of $1 million, partially offset by an after-tax reduction in corporate expenses of $12 million, an after-tax increase in insurance service fee income of $9 million, an after-tax reduction of $2 million from interest expense, and an after-tax increase in income from non-insurance businesses of $1 million. The number of weighted average diluted shares decreased by approximately 5 million for 2020 compared to 2019, mainly reflecting shares repurchased in 2020.
A summary of gross premiums written in 2020 compared with 2019 by line of business within each business segment follows:
•Insurance gross premiums increased 6% to $7,837 million in 2020 from $7,398 million in 2019. Gross premiums increased $270 million (11%) for other liability, $196 million (20%) for professional liability, and $92 million (5%) for short-tail lines and $74 million (9%) for commercial auto, and decreased $193 million (15%) for workers' compensation.
•Reinsurance & Monoline Excess gross premiums increased 17% to $1,010 million in 2020 from $864 million in 2019. Gross premiums written increased $105 million (22%) for casualty lines, $27 million (14%) for property lines, and $14 million (7%) for monoline excess.
Net investment income decreased 10% to $584 million in 2020 from $646 million in 2019 primarily due to a $92 million decrease in income from fixed maturity securities driven by lower investment yields and repositioning a larger portion of the investment portfolio to cash and cash equivalents, a $15 million decrease in income from investment funds and an increase in investment expenses of $3 million, partially offset by a $43 million increase in arbitrage trading account and a $5 million increase in equity securities. Investment funds are reported on a one quarter lag. The average annualized yield for fixed maturity securities was 2.7% in 2020 and 3.4% in 2019. The effective duration of the fixed maturity portfolio was 2.4 years at December 31, 2020 and 2.8 years at December 31, 2019. The Company shortened the duration of its fixed maturity security portfolio, thereby reducing the potential impact of mark-to-market on the portfolio and positioning the Company to react quickly to changes in the current interest rate environment. Average invested assets, at cost (including cash and cash equivalents), were $20.0 billion in 2020 and $19.1 billion in 2019.
Net Realized and Unrealized Gains on Investments. The Company buys and sells securities and other investment assets on a regular basis in order to maximize its total return on investments. Decisions to sell securities and other investment assets are based on management’s view of the underlying fundamentals of specific investments as well as management’s expectations regarding interest rates, credit spreads, currency values and general economic conditions. Net realized and unrealized gains on investments were $74 million in 2020 compared with $121 million in 2019. In 2020, the gains reflected net realized gains on investment of $99 million, including the sale of a building for a gain of $105 million, and decreased by a change in unrealized
Revenues from Non-Insurance Businesses. Revenues from non-insurance businesses were derived from businesses engaged in the distribution of promotional merchandise, world-wide textile solutions, and aviation-related businesses that provide services to aviation markets, including (i) the distribution, manufacturing, repair and overhaul of aircraft parts and components, (ii) the sale of new and used aircraft, and (iii) avionics, fuel, maintenance, storage and charter services. Revenues from non-insurance businesses were $390 million in 2020 and $407 million in 2019. The decrease mainly relates to a reduction in revenues from the aviation-related businesses impacted by COVID-19.
•Reinsurance & Monoline Excess - The loss ratio of 61.3% in 2020 was 0.2 points lower than the loss ratio of 61.5% in 2019. Catastrophe losses were $33 million in 2020 compared with $22 million in 2019. The Company reflected a best estimate (net of reinsurance) based upon available information for COVID-19-related losses of approximately $10 million, which was included in catastrophe losses and primarily related to excess workers’ compensation and short-tail lines. Adverse prior year reserve development was $8 million in 2020 compared with adverse prior year reserve development of $2 million in 2019. The loss ratio excluding catastrophe losses and prior year reserve development decreased 1.5 points to 56.6% in 2020 from 58.1% in 2019.
Net foreign currency losses (gains) result from transactions denominated in a currency other than an operating unit’s functional currency. Net foreign currency losses were $0.4 million in 2020 compared to gains of $31 million in 2019, mainly due to U.S. dollar weakening in relation to a wide spectrum of currencies in 2020.
Debt extinguishment costs of $8 million in 2020 related to the redemption of subordinated debentures that were due in 2053.
Interest Expense. Interest expense was $151 million in 2020 compared with $153 million in 2019. During 2019, the Company repaid at maturity $489 million aggregate principal amount of senior notes and other debt. In December 2019, the Company issued $300 million aggregate principal amount of 5.10% subordinated debentures due 2059. In May 2020, the Company issued $300 million aggregate principal amount of 4.00% senior notes due 2050. In September 2020, the Company issued an additional $170 million aggregate principal amount of 4.00% senior notes due 2050 and issued $250 million aggregate principal amount of 4.25% subordinated debentures due 2060 and repaid $300 million aggregate principal amount of 5.375% senior notes at maturity. In October 2020, the Company redeemed $350 million aggregate principal amount of 5.625% subordinated debentures due 2053. Accordingly, the timing of the repayments of debt at maturity and redemption that took place throughout 2019 and 2020 and issuances in 2019 and 2020 led to the decrease in interest expense for the year ended December 31, 2020 compared to 2019. The redemption of debentures and issuance of additional debentures in 2021, as described below in "Liquidity and Capital Resources -- Debt," are also expected to impact interest expense in 2021.
Income Taxes. The effective income tax rate was 24.4% in 2020 and 19.8% in 2019. The effective income tax rate differs from the federal income tax rate of 21% principally because the utilization of losses in certain foreign jurisdictions was limited, which was partially offset by tax-exempt investment income and tax benefits related to equity-based compensation. See Note 16 of the Consolidated Financial Statements for a reconciliation of the income tax expense and the amounts computed by applying the Federal and foreign income tax rate of 21%.
Results of Operations for the Years Ended December 31, 2019 and 2018
For a comparison of the Company’s results of operations for the year ended December 31, 2019 to the year ended December 31, 2018, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, which was filed with the Securities and Exchange Commission on February 20, 2020.
As part of its investment strategy, the Company establishes a level of cash and highly liquid short-term and intermediate-term securities that, combined with expected cash flow, it believes is adequate to meet its payment obligations. Due to the low fixed maturity investment returns, the Company invests in equity securities, merger arbitrage securities, investment funds, private equity, loans and real estate related assets. The Company's investments in investment funds and its other alternative investments have experienced, and the Company expects to continue to experience, greater fluctuations in investment income.
The Company also attempts to maintain an appropriate relationship between the effective duration of the investment portfolio and the approximate duration of its liabilities (i.e., policy claims and debt obligations). The effective duration of the investment portfolio was 2.4 years at December 31, 2020 and 2.8 years at December 31, 2019. The Company’s investment portfolio and investment-related assets as of December 31, 2020 were as follows:
(1)Pre-refunded securities are securities for which an escrow account has been established to fund the remaining payments of principal and interest through maturity. Such escrow accounts are funded almost exclusively with U.S. Treasury and U.S. government agency securities.
Loans Receivable. Loans receivable, which are carried at amortized cost (net of allowance for expected credit losses), had an amortized cost of $85 million and an aggregate fair value of $87 million at December 31, 2020. The amortized cost of loans receivable is net of an allowance for expected credit losses of $5 million as of December 31, 2020. Loans receivable include real estate loans of $52 million that are secured by commercial real estate located primarily in New York. Real estate loans receivable generally earn interest at floating LIBOR-based interest rates and have maturities (inclusive of extension options) through August 2025. Loans receivable include commercial loans of $33 million that are secured by business assets and have fixed interest rates and floating LIBOR-based interest rates with varying maturities not exceeding 10 years.
Debt. At December 31, 2020, the Company had senior notes, subordinated debentures and other debt outstanding with a carrying value of $2,725 million and a face amount of $2,743 million, including $300 million aggregate principal amount of its 4.00% senior notes due 2050 issued in May 2020 as well as an additional $170 million aggregate principal amount of its 4.00% senior notes due 2050 and $250 million aggregate principal amount of its 4.25% subordinated debentures due 2060 issued in September 2020. The Company redeemed $350 million aggregate principal amount of its subordinated debentures due 2053 in October 2020. The maturities of the outstanding debt are $3 million in 2021, $427 million in 2022, $6 million in 2025, $102 million in 2028, $250 million in 2037, $350 million in 2044, $470 million in 2050, $400 million in 2056, $185 million in 2058, $300 million in 2059 and $250 million in 2060.
In January 2021, the Company called its $110 million aggregate principal amount of 5.90% subordinated debentures for redemption on March 1, 2021. Additionally in February 2021, the Company issued $300 million aggregate principal amount of 4.125% subordinated debentures due 2061.
•Property reinsurance treaties - The Company purchases property reinsurance to reduce its exposure to large individual property losses and catastrophe events. Following is a summary of significant property reinsurance treaties in effect as of January 1, 2021: The Company’s property per risk reinsurance generally covers losses between $2.5 million and $65 million. The Company’s catastrophe excess of loss reinsurance program provides protection for net losses between $17.5 million and $395 million for the majority of business written by its U.S. Insurance segment operating units and Lloyd's Syndicate, excluding offshore energy, but some perils are protected above $15 million. The Company’s catastrophe reinsurance agreements are subject to certain limits, exclusions and reinstatement premiums.
•Casualty reinsurance treaties - The Company purchases casualty reinsurance to reduce its exposure to large individual casualty losses, workers’ compensation catastrophe losses and casualty losses involving multiple claimants or insureds for the majority of business written by its U.S. companies. A significant casualty treaty (casualty catastrophe) in effect as of January 1, 2021 provides significant protection for losses between $5 million and $75 million from single events with claims involving two or more insurable interests or for systemic events involving multiple insureds and/or policy years. The treaty also covers casualty contingency losses in excess of $5 million and up to $100 million. For losses involving two or more claimants for primary workers’ compensation business, coverage is generally in place for losses between $10 million and $270 million. For excess workers’ compensation business, such coverage is generally in place for losses between $25 million and $545 million.
•Other reinsurance - Depending on the operating unit, the Company purchases specific additional reinsurance to supplement the above programs.
The Company places a number of its casualty treaties on a “risk attaching” basis. Under risk attaching treaties, all claims from policies incepting during the period of the reinsurance contract are covered even if they occur after the expiration date of the reinsurance contract. If the Company is unable to renew or replace its existing reinsurance coverage, protection for unexpired policies would remain in place until their expiration. In such case, the Company could revise its underwriting strategy for new business to reflect the absence of reinsurance protection. The casualty catastrophe treaty highlighted above was purchased on a losses discovered basis. Property catastrophe and workers’ compensation catastrophe reinsurance is generally placed on a “losses occurring basis,” whereby only claims occurring during the period are covered. If the Company is unable to renew or replace these reinsurance coverages, unexpired policies would not be protected, though we frequently have the option to purchase run-off coverage in our treaties.
The following table presents the credit quality of amounts due from reinsurers as of December 31, 2020. Amounts due from reinsurers are net of reserves for uncollectible reinsurance of $1 million in the aggregate.
The estimated payments for reserves for losses and loss expenses in the above table represent the projected (undiscounted) payments for gross loss and loss expense reserves related to losses incurred as of December 31, 2020. The estimated payments in the above table do not consider payments for losses to be incurred in future periods. These amounts include reserves for reported losses and reserves for incurred but not reported losses. Estimated amounts recoverable from reinsurers are not reflected. The estimated payments by year are based on historical loss payment patterns.The actual payments may differ from the estimated amounts due to changes in ultimate loss reserves and in the timing of the settlement of those reserves. In addition, at December 31, 2020, the Company had commitments to invest up to $124 million and $200 million in certain investment funds and real estate construction projects, respectively. These amounts are not included in the above table.
•examining the Company’s actuarial methodologies for compliance with Actuarial Standards of Practice;
•evaluating the Company’s actuarial point estimate by examining the Company actuaries’ process, and certain key assumptions for the remaining operating units;
•developing an independent range of reserves based on actuarial methodologies and assumptions and comparing to the Company’s recorded reserves;
•evaluating the Company’s recorded reserves and year-over-year movements of the Company’s reserves relative to, and within, the independently developed range of reserves.
Insurance premiums are recognized as written at the inception of the policy. Reinsurance premiums are estimated based upon information received from ceding companies, and subsequent differences from such estimates are recorded in the period they are determined. Insurance and reinsurance premiums are primarily earned on a pro rata basis over the policy term. Fees for services are earned over the period that the services are provided. Premiums and fees receivable are reported net of an allowance for expected credit losses, with the allowance being estimated based on current and future expected conditions, historical loss data and specific identification of collectability concerns where applicable. Changes in the allowance are reported within other operating costs and expenses.
Audit premiums are recognized when they are reliably determinable. The change in accruals for earned but unbilled audit premiums (decreased) increased net premiums written and premiums earned by $(27) million, $4 million and $(4) million in 2020, 2019 and 2018, respectively.
Cash equivalents consist of funds invested in money market accounts and investments with an effective maturity of three months or less when purchased.
Loans receivable primarily represent commercial real estate mortgage loans and bank loans and are carried at amortized cost. The accrual of interest on loans receivable is discontinued if the loan is 90 days past due based on the contractual terms of the loan unless the loan is adequately secured and in process of collection. In general, loans are placed on non-accrual status or charged off at an earlier date if collection of principal or interest is considered doubtful. Interest on these loans is accounted for on a cash basis until qualifying for return to accrual status. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.
For financial assets carried at amortized cost, which includes held to maturity securities and loans receivable, the Company estimates an allowance for expected credit losses based on relevant information about past events, including historical loss experience, current conditions and forecasts that affect the expected collectability of the amortized cost of the financial asset. The allowance for expected credit losses is presented as a reduction to amortized cost of the financial asset in the consolidated balance sheet and changes to the estimate for expected credit losses are recognized through net investment gains.
The Company reports accrued investment income separately from fixed maturity securities, and has elected not to measure an allowance for expected credit losses for accrued investment income. Accrued investment income is written off through net investment income at the time the issuer of the bond defaults or is expected to default on payments.
The unearned portion of premiums ceded to reinsurers is reported as prepaid reinsurance premiums and earned ratably over the policy term. The estimated amounts of reinsurance recoverable on unpaid losses are reported as due from reinsurers. To the extent any reinsurer does not meet its obligations under reinsurance agreements, the Company must discharge its liability. Amounts due from reinsurers are reflected net of funds held where the right of offset is present. The Company has provided an allowance for expected credit losses for estimated uncollectible reinsurance. The allowance is estimated based on the composition of the recoverable balance, considering reinsurer credit ratings, collateral received from financial institutions and funds withheld arrangements, length of collection periods, probability of default methodology, and specific identification of collectability concerns. Changes in the allowance are reported within losses and loss expenses.
Property, furniture and equipment are carried at cost less accumulated depreciation. Depreciation is calculated using the estimated useful lives of the respective assets. Depreciation expense was $53 million, $54 million and $54 million for 2020, 2019 and 2018, respectively.
Goodwill and other intangible assets are tested for impairment on an annual basis and at interim periods where circumstances require. The Company's impairment test as of December 31, 2020 indicated that there were no material impairment losses related to goodwill and other intangible assets. Intangible assets of $93 million and $99 million are included in other assets as of December 31, 2020 and 2019, respectively.
Interest payments were $155 million, $160 million and $155 million in 2020, 2019 and 2018, respectively. Income taxes paid were $103 million, $125 million and $186 million in 2020, 2019 and 2018, respectively. Other non-cash items include unrealized investment gains and losses. (See Note 10 of Notes to Consolidated Financial Statements.)
In June 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-13, Financial Instruments - Credit Losses, which amended the accounting guidance for credit losses on financial instruments. The updated guidance amended the current other-than-temporary impairment model for available for sale debt securities by requiring the recognition of impairments relating to expected credit losses through an allowance account and limits
All other accounting and reporting standards that became effective in 2020 were either not applicable to the Company or their adoption did not have a material impact on the Company.
The following table presents the rollforward of the allowance for expected credit losses for held to maturity securities for the year ended December 31, 2020:
At December 31, 2020 and 2019, there were no investments, other than investments in United States government and government agency securities, which exceeded 10% of common stockholders’ equity. At December 31, 2020, investments with a carrying value of $1,838 million were on deposit in custodial or trust accounts, of which $1,223 million was on deposit with insurance regulators, $576 million was on deposit in support of the Company’s underwriting activities at Lloyd’s, $35 million was on deposit as security for reinsurance clients and $4 million was on deposit as security for letters of credit issued in support of the Company’s reinsurance operations.
At December 31, 2020 and 2019, the fair value and carrying value of the arbitrage trading account were $341 million and $401 million, respectively. The primary focus of the trading account is merger arbitrage. Merger arbitrage is the business of investing in the securities of publicly held companies which are the targets in announced tender offers and mergers. Arbitrage investing differs from other types of investing in its focus on transactions and events believed likely to bring about a change in value over a relatively short time period (usually four months or less).
The Company uses put options and call options in order to mitigate the impact of potential changes in market conditions on the merger arbitrage trading account. These options are reported at fair value. As of December 31, 2020, the fair value of long option contracts outstanding was zero (notional amount of $12.0 million) and the fair value of short option contracts outstanding was $326 thousand (notional amount of $3.2 million). Other than with respect to the use of these trading account securities, the Company does not make use of derivatives.
The Company’s maximum exposure to loss with respect to these investments is limited to the carrying amount reported on the Company’s consolidated balance sheet and its unfunded commitments of $124 million as of December 31, 2020.
During the fourth quarter of 2020, the Company sold an office complex in New York City.
In evaluating the real estate loans, the Company considers their credit quality indicators, including loan to value ratios, which compare the outstanding loan amount to the estimated value of the property, the borrower’s financial condition and performance with respect to loan terms, the position in the capital structure, the overall leverage in the capital structure and other market conditions.
(3) The inclusion of the allowance for expected credit losses on investments commenced on January 1, 2020 due to the adoption of ASU 2016-13. See Note 1 for more details.
The following tables summarize all fixed maturity securities in an unrealized loss position at December 31, 2020 and 2019 by the length of time those securities have been continuously in an unrealized loss position.
Fixed Maturity Securities - A summary of the Company’s non-investment grade fixed maturity securities that were in an unrealized loss position at December 31, 2020 is presented in the table below:
For fixed maturity securities that management does not intend to sell or to be required to sell, the portion of the decline in value that is considered to be due to credit factors is recognized in earnings, and the portion of the decline in value that is considered to be due to non-credit factors is recognized in other comprehensive income.
The Company has evaluated its fixed maturity securities in an unrealized loss position and believes the unrealized losses are due primarily to temporary market and sector-related factors rather than to issuer-specific factors. None of these securities are delinquent or in default under financial covenants. Based on its assessment of these issuers, the Company expects them to continue to meet their contractual payment obligations as they become due.
The following tables summarize changes in Level 3 assets and liabilities for the years ended December 31, 2020 and 2019:
The Company's reserves for losses and loss expenses are comprised of case reserves and incurred but not reported liabilities (IBNR). When a claim is reported, a case reserve is established for the estimated ultimate payment based upon known information about the claim. As more information about the claim becomes available over time, case reserves are adjusted up or down as appropriate. Reserves are also established on an aggregate basis to provide for IBNR liabilities and expected loss reserve development on reported claims.
The most commonly used claim count method is by event. Most of the Company's operating units use the number of events to define and quantify the number of claims. However, in certain lines of business, where it is common for multiple parties to claim damages arising from a single event, an operating unit may quantify claims on the basis of the number of separate parties involved in an event. This may be the case with businesses writing substantial automobile or transportation exposure.
The following is supplementary information regarding average historical claims duration as of December 31, 2020:
(1)The cumulative effect adjustment resulting from changes in accounting principals relates to the allowance for expected credit losses on reinsurance recoverables that commenced on January 1, 2020 due to the adoption of ASU 2016-13. See Note 1 for more details.
(3)The change in estimates for claims occurring in prior years is net of loss reserve discount. On an undiscounted basis, the estimates for claims occurring in prior years decreased by $21 million in 2020, increased by $19 million in 2019, and decreased by $4 million in 2018, respectively.
(4)For certain retrospectively rated insurance polices and reinsurance agreements, changes in loss and loss expenses for prior years are offset by additional or return premiums.
For the year ended December 31, 2020, the Company recognized losses for COVID-19-related claims activity, net of reinsurance, of approximately $171 million, of which $161 million related to the Insurance segment and $10 million related to the Reinsurance & Monoline Excess segment. Such $171 million of COVID-19-related losses included $95 million of reported losses and $76 million of IBNR.
Insurance - Reserves for the Insurance segment developed favorably by $24 million in 2020 net of additional and return premiums). Continuing the pattern seen in recent years, the overall favorable development in 2020 resulted from more significant favorable development on workers’ compensation business, which was partially offset by unfavorable development on professional liability, including excess professional liability.
Favorable prior year development (net of additional and return premiums) was $39 million in 2018.
Environmental and Asbestos - To date, known environmental and asbestos claims have not had a material impact on the Company’s operations, because its subsidiaries generally did not insure large industrial companies that are subject to significant environmental or asbestos exposures prior to 1986 when an absolute exclusion was incorporated into standard policy language.
The Company’s net reserves for losses and loss expenses relating to asbestos and environmental claims on policies written before adoption of the absolute exclusion was $19 million at December 31, 2020 and $24 million at December 31, 2019. The estimation of these liabilities is subject to significantly greater than normal variation and uncertainty because it is difficult to make an actuarial estimate of these liabilities due to the absence of a generally accepted actuarial methodology for these exposures and the potential effect of significant unresolved legal matters, including coverage issues, as well as the cost of litigating the legal issues.
Additionally, the determination of ultimate damages and the final allocation of such damages to financially responsible parties are highly uncertain.
The following table presents the rollforward of the allowance for expected credit losses for premiums and fees receivable for the year ended December 31, 2020:
Estimated amounts due from reinsurers are reported net of an allowance for expected credit losses of $7,800,649, $690,127 and $946,965 as of December 31, 2020, 2019 and 2018, respectively. The following table presents the rollforward of the allowance for expected credit losses associated with due from reinsurers for the year ended December 31, 2020:
(1) Subsidiary debt is due as follows: $3 million in 2021, $6 million in 2025, and $102 million in 2028.
Income before income taxes from domestic operations was $831 million, $739 million and $755 million for the years ended December 31, 2020, 2019 and 2018, respectively. (Loss) income before income taxes from foreign operations was ($126) million, $114 million and $57 million for the years ended December 31, 2020, 2019 and 2018, respectively.
A reconciliation of the income tax expense and the amounts computed by applying the Federal and foreign income tax rate of 21% for 2020, 2019 and 2018 to pre-tax income are as follows:
At December 31, 2020 and 2019, the tax effects of differences that give rise to significant portions of the deferred tax asset and deferred tax liability are as follows:
The Company had a current tax net payable of $35.4 million and net receivable of $13.4 million at December 31, 2020 and 2019, respectively. At December 31, 2020, the Company had foreign net operating loss carryforwards of $7.7 million that expire beginning in 2027, and an additional $305.4 million that have no expiration date. At December 31, 2020, the Company had a valuation allowance of $79.5 million, as compared to $33.3 million at December 31, 2019. The Company has provided a valuation allowance against the utilization of foreign tax credits and the future net operating loss carryforward benefits of certain foreign operations. The statute of limitations for the Company’s U.S. Federal tax returns has closed for calendar year 2016 and all years through December 31, 2013.
The Tax Cuts and Jobs Act of 2017 (the "Tax Act") provided for a reduction of the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018. The U.S. tax law requires insurance reserves to be discounted for tax purposes. The Tax Act modified this computation. The IRS issued revised discount factors to be applied to the 2017 reserves, which increased the beginning of year 2018 deferred tax asset for loss reserve discounting. Under the related transition rule, a deferred tax liability was established which will be included in taxable income over the eight year period that began in 2018.
BIC’s combined net income and statutory capital and surplus, as determined in accordance with statutory accounting practices ("SAP"), are as follows:
The National Association of Insurance Commissioners (“NAIC”) has risk-based capital (“RBC”) requirements that require insurance companies to calculate and report information under a risk-based formula which measures statutory capital and surplus needs based on a regulatory definition of risk in a company’s mix of products and its balance sheet. This guidance is used to calculate two capital measurements: Total Adjusted Capital and RBC Authorized Control Level. Total Adjusted Capital is equal to the Company’s statutory capital and surplus excluding capital and surplus derived from the use of permitted practices that differ from statutory accounting practices. RBC Authorized Control Level is the capital level used by regulatory authorities to determine whether remedial action is required. Generally, no remedial action is required if Total Adjusted Capital is 200% or more of the RBC Authorized Control Level. At December 31, 2020, BIC’s Total Adjusted Capital of $5.989 billion was 388% of its RBC Authorized Control Level.
The weighted average number of shares used in the computation of net income per share was as follows:
Treasury shares have been excluded from average outstanding shares from the date of acquisition. The weighted average number of basic shares outstanding includes the impact of 7,767,874 common shares held in a grantor trust. The common shares held in the grantor trust are for delivery upon settlement of vested but mandatorily deferred restricted stock units ("RSUs"). Shares held by the grantor trust do not affect diluted shares outstanding since shares deliverable under vested RSUs were already included in diluted shares outstanding. The difference in calculating basic and diluted net income per share is attributable entirely to the dilutive effect of stock-based compensation plans. Changes in shares of common stock outstanding, net of treasury shares, are presented below. Shares of common stock issued and outstanding do not include shares related to unissued restricted stock units (including shares held in the grantor trust).
The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments as of December 31, 2020 and 2019:
Lessees are required to recognize a right-of-use asset and a lease liability for leases with terms of more than 12 months on the balance sheet. All leases disclosed within this note are classified as operating leases. Recognized right-of-use asset and lease liability are reported within other assets and other liabilities, respectively, in the consolidated balance sheet. Lease expense is reported in other operating costs and expenses in the consolidated statement of income and accounted for on a straight-line basis over the lease term.
Contractual maturities of the Company’s future minimum lease payments are as follows:
Upon vesting, shares of the Company’s common stock equal to the number of vested RSUs are issued or deferred to a later date, depending on the terms of the specific award agreement. As of December 31, 2020, 7,519,447 RSUs had been deferred. RSUs that have not yet vested and vested RSUs that have been deferred are not considered to be issued and outstanding shares.
The fair value of RSUs at the date of grant are recorded as unearned compensation, a component of stockholders’ equity, and expensed over the vesting period. Following is a summary of changes in unearned compensation for the three years ended December 31, 2020:
The following table summarizes the LTIP expense for each of the three years ended December 31, 2020:
•Reinsurance & Monoline Excess - reinsurance business on a facultative and treaty basis, primarily in the United States, United Kingdom, Continental Europe, Australia, the Asia-Pacific region and South Africa, as well as operations that solely retain risk on an excess basis.
(2) Revenues for Insurance includes $691.5 million, $725.4 million, and $714.2 million in 2020, 2019, and 2018, respectively, from foreign countries. Revenues for Reinsurance & Monoline Excess includes $291.6 million, $249.6 million, and $228.1 million in 2020, 2019 and 2018, respectively, from foreign countries.