We maintain office facilities in Bermuda, the U.S., Europe, Canada, Singapore, Latin America and the Middle East. We own the property in which our offices are located in Dublin, Ireland, and we lease office space in the other countries. We renew and enter into new leases in the ordinary course of business as required. Our global headquarters is located at 92 Pitts Bay Road, AXIS House, Pembroke HM 08, Bermuda. We believe that our office space is sufficient for us to conduct our operations for the foreseeable future.
The following is a discussion and analysis of our results of operations for the years ended December 31, 2017, 2016 and 2015 and our financial condition at December 31, 2017 and 2016. This should be read in conjunction with the Consolidated Financial Statements and related notes included in Item 8 of this report. Tabular dollars are in thousands, except per share amounts. Amounts in tables may not reconcile due to rounding differences.
Non-GAAP operating loss(1) of $265 million, or $(3.15) per diluted common share(1)
Reserve for losses and loss expenses of $13.0 billion and reinsurance recoverable of $3.3 billion
On December 31, 2017, the authorization under our Board-authorized share repurchase program for common share repurchases expired. A common share repurchase program has not been authorized for 2018.
growth of our syndicate at Lloyd's of London ("Lloyd's") which provides us with access to Lloyd's worldwide licenses and an extensive distribution network. During the first quarter of 2016 we commenced writing business through our underwriting division at Lloyd's in China.
broadened risk-funding sources and developed vehicles that utilize third-party capital including:
AXIS Ventures Reinsurance Limited, which manages capital for investors interested in deploying funds directly into the property-catastrophe and other short-tail business.
On April 1, 2017, ("closing date") we acquired general aviation insurer and reinsurer Aviabel, increasing our scale and relevance in the global aviation market. We will continue to maintain Aviabel's physical presence in Brussels and Amsterdam. The results of Aviabel are included in the results of our insurance segment from the closing date.
Effective July 1, 2017, our reinsurance segment no longer writes derivative-based risk management products which address weather risks.
from this date. On October 6, 2017, we received clearance from all applicable regulators, including the European Commission, and commenced management control and integration of the combined businesses from this date.
On July 14, 2017, we announced that we had received final authorization from Lloyd's, the Prudential Regulation Authority ("PRA") and the Financial Conduct Authority ("FCA") for our own Lloyd's managing agent, AXIS Managing Agency Limited ("AXIS Managing Agency"). Effective August 4, 2017, AXIS Managing Agency assumed management of Syndicate 1686 at Lloyd's, replacing our third-party managing agency agreement with Asta Managing Agency Limited, which had been in place since 2014.
On December 6, 2017, we issued $350 million aggregate principal amount of 4.0% senior unsecured notes (the "4.0% Senior Notes") which will mature on December 6, 2027. We used a portion of the proceeds from the issuance of 4.0% Senior Notes to repay a Novae term loan of $67 million and intends to use a further portion of the proceeds from the issuance of 4.0% Senior Notes to repay or redeem its 2.650% Senior Notes which are due on April 1, 2019.
On January 1, 2018, AXIS Managing Agency, entered into an agreement for the Reinsurance to Close ("RITC") of the 2015 and prior years of account of Syndicate 2007. This RITC transaction covers the net reserve for losses and loss expenses associated with all business underwritten by Novae Group plc ("Novae") in the 2015 and prior years. The transaction resulted in a positive financial impact, which was reflected in the fair values of Novae's assets acquired and liabilities assumed on the acquisition date.
On January 23, 2018, we announced that we plan to realign our accident and health line of business during the first quarter of 2018. This business is currently included in our insurance segment. As a result of the realignment, this business will also be included in our reinsurance segment.
Underwriting-related general and administrative expenses include those general and administrative expenses that are incremental and/or directly attributable to our individual underwriting operations. While this financial measure is presented in Item 8, Note 4 to the Consolidated Financial Statements 'Segment Information', it is considered a non-GAAP financial measure when presented elsewhere on a consolidated basis.
The bargain purchase gain, recognized upon the acquisition of Aviabel, reflects the excess of the fair value of the net identifiable assets acquired over the fair value of consideration transferred, and is not related to the underwriting process, therefore it is excluded from consolidated underwriting income.
Loss on repurchase of preferred shares arose from capital transactions that are not reflective of underlying business performance, therefore, this expense is excluded from consolidated underwriting income.
Amortization of intangibles arose from business decisions, the nature and timing of which are not related to the underwriting process therefore, these expenses are excluded from consolidated underwriting income.
We believe that presentation of underwriting-related general and administrative expenses and consolidated underwriting income provides investors with an enhanced understanding of our results of operations, by highlighting the underlying pre-tax profitability of our underwriting activities. The reconciliation of consolidated underwriting income to income before income taxes and interest in income (loss) of equity method investments, the most comparable GAAP financial measure, is presented in the 'Results of Operations'.
Although the investment of premiums to generate income and realized investment gains (losses) is an integral part of our operations, the determination to realize investment gains (losses) is independent of the underwriting process and is heavily influenced by the availability of market opportunities. Furthermore, many users believe that the timing of the realization of investment gains (losses) is somewhat opportunistic for many companies.
Foreign exchange losses (gains) in our Consolidated Statements of Operations are primarily driven by the impact of foreign exchange rate movements on net insurance related-liabilities. However, this movement is only one element of the overall impact of foreign exchange rate fluctuations on our financial position. In addition, we recognize unrealized foreign exchange losses (gains) on our available-for-sale investments in other comprehensive income and foreign exchange losses (gains) realized upon the sale of these investments in net realized investments gains (losses). These unrealized and realized foreign exchange rate movements generally offset a large portion of the foreign exchange losses (gains) reported separately in net income (loss), thereby minimizing the impact of foreign exchange rate movements on total shareholders’ equity. As such, foreign exchange losses (gains) in our Statements of Operations in isolation are not a fair representation of the performance of our business.
The revaluation of net deferred tax asset resulted in a tax expense recognized in the fourth quarter of 2017 related to the revaluation of our net DTA, due to the reduction in the U.S. corporate income tax rate from 35% to 21% enacted as part of the U.S. Tax Reform. The nature and timing of the tax expense associated with the U.S. Tax Reform is not related to the underwriting process and is not representative of underlying business performance.
The bargain purchase gain, recognized upon the acquisition of Aviabel, reflects the excess of the fair value of the net identifiable assets acquired over the fair value of consideration transferred and is not indicative of future revenues.
Transaction and reorganization expenses are primarily driven by business decisions, the nature and timing of which are not related to the underwriting process and are not representative of underlying business performance.
Certain users of our financial statements evaluate performance excluding after-tax net realized investment gains (losses), foreign exchange losses (gains), revaluation of deferred tax asset, bargain purchase gain, transaction and reorganization expenses, and losses on repurchase of preferred shares to understand the profitability of recurring sources of income
We present gross premiums written, net premiums written and net premiums earned on a constant currency basis in this MD&A. The amounts presented on a constant currency basis are calculated by applying the average foreign exchange rate from the current year to the prior year amounts. We believe this presentation enables investors and other users of our financial information to analyze growth in gross premiums written, net premiums written and net premiums earned on a constant basis. The reconciliation to gross premiums written, net premiums written and net premiums earned on a GAAP basis is presented in the 'Group Underwriting Results' section of this MD&A.
Tax cost (benefit) of ($7,777), $2,114 and $3,021 for the year ended December 31, 2017, 2016 and 2015, respectively. Tax impact is estimated by applying the statutory rates of applicable jurisdictions, after consideration of other relevant factors including the tax status of specific foreign exchange transactions.
Tax cost (benefit) of ($2,839), $nil and $(2,943) for the year ended December 31, 2017, 2016 and 2015, respectively. Tax impact is estimated by applying the statutory rates of applicable jurisdictions, after consideration of other relevant factors including the tax status of specific foreign exchange transactions.
Non-GAAP operating ROACE, a non-GAAP measure as defined in Item 10(e) of SEC Regulation S-K, is calculated by dividing annualized operating income for the period by the average common shareholders' equity.
The reinsurance segment underwriting income decreased by $427 million in 2017, compared to 2016. The decrease in underwriting income was primarily driven by an increase in catastrophe and weather-related losses, a decrease in net favorable prior year reserve development and an increase in the current accident year loss ratio excluding catastrophe and weather-related losses, partially offset by a decrease in general and administrative expenses and acquisition costs.
The reinsurance segment underwriting income decreased by $19 million in 2016, compared to 2015. The decrease in underwriting income was primarily driven by an increase in catastrophe and weather-related losses and a higher acquisition cost ratio partially offset by an increase in net favorable prior year loss reserve development, other insurance-related income and lower general and administrative expenses.
The variability in net investment income from 2015 through 2017 was largely attributable to the performance of our other investments portfolio. Income from this portfolio increased by $34 million in 2017, compared to 2016, attributable to higher returns from investments in hedge funds and direct lending funds due to the strong performance of global equity and credit
markets. Comparatively, income from this portfolio increased by $22 million in 2016, compared to 2015, attributable to higher returns from investments in equity tranches of collateralized loan obligations ("CLO-Equities"), which increased in value along with other risk assets.
During 2017, net realized investment gains were $28 million compared to net realized investment losses of $61 million in 2016 and net realized investment losses of $138 million in 2015. Net realized investment gains in 2017 were primarily attributable to realized investment gains associated with the sale of ETFs, due to the strong performance of global equity markets. Net realized investment losses in 2016 and 2015 were primarily due to foreign exchange losses on non-U.S. denominated fixed maturities, as a result of the strengthening of the U.S. dollar. Other than temporary impairment ("OTTI") charges were $14 million, $26 million and $73 million in 2017, 2016 and 2015, respectively.
Corporate expenses increased to $130 million in 2017 from $120 million in 2016. The increase was primarily driven by higher personnel costs including senior executive transition costs as well as executive retirement costs, and information technology project costs, partially offset by a decrease in performance-related compensation costs. Corporate expenses also increased to $120 million in 2016 from $110 million in 2015. The increase was attributable to adjustments to senior leadership executive stock-compensation awards benefiting 2015, an increase in personnel costs including senior executive transition costs in 2016, partially offset by reorganization related expenses adverse to 2015.
The financial results for 2017 resulted in a tax benefit of $8 million primarily attributable to the geographic distribution of income with the benefit being driven by losses in our U.S. and U.K. operations, largely offset by a tax charge of $42 million related to the revaluation of net deferred tax assets associated with the reduction in the U.S. corporate income tax rate from 35% to 21% enacted as part of the U.S. Tax Reform.
On April 1, 2017, we acquired general aviation insurer and reinsurer, Aviabel. The purchase price was allocated to the assets acquired and liabilities assumed of Aviabel based on estimated fair values on the closing date and a bargain purchase gain of $15 million was recognized.
During 2015, we implemented a number of profitability enhancement initiatives which resulted in a recognition of reorganization and related expenses of $46 million and additional corporate expenses of $5 million in the Consolidated Statement of Operations. Refer to Item 8, Note 5 to the Consolidated Financial Statements 'Goodwill and Intangibles' and to Note 18 'Transaction and Reorganization Expenses' for additional information.
During 2015, we announced that we had accepted a request from PartnerRe to terminate the Amalgamation Agreement with the Company. PartnerRe paid us $315 million to immediately terminate the Amalgamation Agreement, the amount was comprised of a termination fee of $280 million and a reimbursement of merger-related expenses of $35 million.
Interest in loss of equity method investments represents our aggregate share of losses related to investments in which we have significant influence over the operating and financial policies of the investee. Interest in loss of equity method investments of $8 million in 2017 included impairment losses of $9 million related to an investment in a U.S. based insurance company, partially offset by income of $1 million related to our aggregate share of profits in a company in which we have significant influence over the operating and financial policies.
Interest in loss of equity method investments of $2 million in 2016 represented our aggregate share of losses related to investments in which we have significant influence over the operating and financial policies of the investee.
Non-GAAP operating ROACE is calculated by dividing non-GAAP operating income for the year by the average common shareholders’ equity determined by using the common shareholders’ equity balances at the beginning and end of the year. Non-GAAP operating ROACE is a non-GAAP financial measure, as defined in Item 10(e) of SEC Regulation S-K. The reconciliation to ROACE, the most comparable GAAP measure, is presented in the 'Results of Operations'. Refer to ‘Non-GAAP Financial Measures’ for additional information.
Calculation of diluted book value per common share per common share at December 31, 2015 includes 1,358,380 additional shares delivered to us in January 2016 under the ASR agreement. Refer to Item 8, Note 14 to the Consolidated Financial Statements 'Shareholders' Equity' for information relating to the ASR.
Our objective is to generate superior returns on capital that appropriately reward our common shareholders for the risks we assume and to grow revenue only when we expect the returns will meet or exceed our requirements. We recognize that the nature of underwriting cycles and the frequency or severity of large loss events in any one year may challenge the ability to achieve a profitability target in any specific period, therefore our goal is to achieve top-quintile industry non-GAAP operating ROACE and growth in book value per share adjusted for dividends, with volatility consistent with the industry average.
The decrease in ROACE in 2016, compared to 2015, was primarily driven by the termination fee received from Partner Re in 2015, a decrease in underwriting income and higher corporate expenses partially offset by the favorable impacts of a decrease in net realized investment losses, reorganization and related expenses incurred in 2015 and an increase in net investment income and foreign exchange gains.
Non-GAAP operating ROACE excludes the impact of net realized investment gains (losses), foreign exchange losses (gains), the revaluation of net deferred tax assets, the bargain purchase gain, the transaction and reorganization expenses and the loss on repurchase of preferred share
The decrease in non-GAAP operating ROACE in 2017, compared to 2016, was primarily driven by the underwriting loss generated in 2017, as well the amortization expenses associated with the acquisition of Novae partially offset by an increase in net investment income and a tax benefit in 2017 compared to a tax expense in 2016.
During 2017 our diluted book value per common share decreased by 8%, driven primarily by the net loss available to common shareholders of $416 million and common dividends declared. In 2016 our diluted book value per common share appreciated 8%, driven by net income available to common shareholders of $465 million, partially offset by common dividends declared.
Taken together, we believe that growth in diluted book value per common share and common share dividends declared represent the total value created for our common shareholders. As companies in the insurance industry have differing dividend payout policies, we believe that investors use the diluted book value per common share adjusted for dividends metric to measure comparable performance across the industry.
In 2016, the increase in diluted book value per common share adjusted for dividend was due to our net income and a decrease in unrealized investment losses included in other comprehensive income.
The following table provides our group underwriting results for the years indicated. Underwriting income is a pre-tax measure of underwriting profitability that takes into account net premiums earned and other insurance related income (loss) as revenues and net losses and loss expenses, acquisition costs and underwriting-related general and administrative costs as expenses.
2017 versus 2016: Gross premiums written in 2017 increased by $586 million or 12% compared to 2016 due to increases in both our reinsurance and insurance segments.
The increase in our reinsurance segment's gross premiums written of $178 million or 8% was attributable to our catastrophe, agriculture, property and motor lines, partially offset by a decrease in our credit and surety lines. The increase in gross premiums written was driven by new business, favorable premium adjustments and reinstatement premium, partially offset by the impact of foreign exchange movements and a lower level of premiums written on a multi-year basis in 2017, compared to 2016.
2016 versus 2015: Gross premiums written in 2016 increased by $366 million or 8% ($442 million or 10% increase on a constant currency basis(1)) due to increases in both the reinsurance and insurance segments.
The increase in the reinsurance segment's gross premiums written of $229 million or 11% was impacted by an increase in the level of premiums written on a multi-year basis in 2016 compared to 2015. This increase in multi-year contracts increased the amount of premium recorded in 2016 relating to future years compared to 2015. The increase in gross premiums written was partially offset by foreign exchange movements as the strengthening of the U.S. dollar drove comparative premium decreases in treaties denominated in foreign currencies. After adjusting for the impact of the multi-year contracts and foreign exchange movement, gross premiums written increased by $171 million. The increase was driven by growth in our liability, marine and other, catastrophe, agriculture, motor and credit and surety lines. These increases were partially offset by a decrease in our property lines.
(1) Amounts presented on a constant currency basis are non-GAAP financial measures as defined in Item 10(e) of SEC Regulation S-K. The constant currency basis is calculated by applying the average foreign exchange rate from the current year to the prior year balance.
The increase was driven by growth in our accident and health, property, professional, and liability lines. These increases were partially offset by decreases in our marine and credit and political risk lines.
Ceded premiums written in 2016 were $1,217 million, or 24% of gross premiums written, compared to $929 million, or 20%, in 2015 The increase in the ceded premiums written in the reinsurance segment was due to a new retrocessional cover entered into with Harrington Re, which increased premiums ceded in our liability and professional lines, together with new retrocessional treaties that increased ceded premiums in our catastrophe and property business. The increase in the ceded premiums written in the insurance segment was driven by increased cessions in our professional and liability lines.
2017 versus 2016: Net premiums earned in 2017 increased by $443 million or 12% compared to 2016 due to increases in both our reinsurance and insurance segments.
Net premiums earned in our insurance segment in 2017 increased by $329 million or 19%, compared to 2016. The increase in net premiums earned included $162 million attributable to our acquisition of Novae. In addition, net premiums earned increased by $167 million or 9% (10% on a constant currency basis(1)) attributable to our accident and health, property and aviation lines.
The increase in net premiums earned in the reinsurance segment in 2016 compared to 2015, was driven by an increase in gross premiums earned across many lines of business due to growth in the business written and the impact of favorable premium adjustments, partially offset by an increase in ceded premiums earned reflecting the impact of increased retrocessions in our catastrophe and property lines as well as the new retrocessions to Harrington Re in our liability and professional lines.
The general and administration expense ratio includes corporate expenses not allocated to underwriting segments of 3.1%, 3.2% and 3.0% for 2017, 2016 and 2015, respectively. These costs are further discussed in the ‘Other Expenses (Revenues), Net’ section.
After adjusting for the impact of the catastrophe and weather-related losses, our current accident year loss ratio increased to 63.7% in 2017 from 61.8% in 2016. The increase in the current accident year loss ratio after adjusting for the impact of the catastrophe and weather-related losses was driven elevated loss experience in our insurance and reinsurance property lines, together with the impact of the Ogden Rate change on our reinsurance motor lines, and adverse impact of the rate and trend, partially offset by favorable changes in business mix in our accident and health lines.
Our December 31, 2017 net reserve for losses and loss expenses includes estimated amounts for numerous catastrophe events. We caution that the magnitude and/or complexity of losses arising from these events, in particular Hurricanes Harvey, Irma and Maria, the two earthquakes in Mexico and the wildfires in Northern and Southern California in 2017 inherently increase the level of uncertainty and, therefore, the level of management judgment involved in arriving at our estimated net reserve for losses and loss expenses. As a result, our actual losses for these events may ultimately differ materially from our current estimates.
Our short-tail business includes the underlying exposures in our property and other, marine and aviation reserve classes within our insurance segment and the property and other reserve class within our reinsurance segment.
Our credit and political risk reserve class recorded net adverse development of $15 million in 2015 primarily relating to an increase in loss estimates for one specific claim.
Our motor reserve classes contributed net favorable prior year reserve development of $1 million, $55 million and $37 million, in 2017, 2016 and 2015, respectively. The net favorable prior year reserve development on the motor reserve class in 2016 and 2015 related to favorable loss emergence trends on several classes of business spanning multiple accident years. Net favorable prior year development in 2017 was impacted by the U.K. Ministry of Justice’s announcement of a decrease in the discount rate used to calculate lump sum awards in U.K. bodily injury cases, known as the Ogden Rate. Effective March 20, 2017, the Ogden Rate changed from plus 2.5% to minus 0.75%.
This net favorable prior year development was partially offset by net adverse prior year development in our insurance liability reserve class of $8 million, $8 million and $27 million in 2017, 2016 and 2015, respectively, primarily related to reserve strengthening within our excess casualty book. In particular, the adverse development during 2015 was mainly driven by a higher frequency of large auto liability claims.
At the acquisition date, the fair value of reserves for losses and loss expenses for Syndicate 2007 was established giving weight to the observable value of these reserves based on a Reinsurance to Close ("RITC") transaction of the Syndicate’s 2015 and prior years of account, which was completed prior to the allocation of purchase price. Management made no change to the initial estimate when establishing its best estimate of reserves for losses and loss expenses at December 31, 2017.
See 'Critical Accounting Estimates - Reserve for Losses and Loss Expenses' section for further details. We caution that conditions and trends that impacted the development of our reserve for losses and loss expenses in the past may not recur in the future.
In 2017, we recognized $49 million of net favorable prior year reserve development, the principal components of which were:
$26 million of net favorable prior year reserve development on professional lines business, due to the recognition of better the expected emerging loss experience, particularly on the 2013 and 2014 accident years.
$14 million of net favorable prior year reserve development on professional lines business, driven by better than expected development related to various accident years, partially offset by reserve strengthening relating to updated information on specific claims impacting accident years 2010 and 2011.
$12 million of net favorable prior year reserve development on marine business, driven by better than expected loss emergence, primarily driven by reductions in mid-size loss estimates impacting accident year 2015.
$27 million of net favorable prior year reserve development on credit and surety business, spanning multiple accident years and driven by better than expected loss emergence, as well as additional information obtained about a specific claim.
Acquisition Cost Ratio: The decrease in the acquisition cost ratio to 19.9% in 2017 from 20.2% in 2016 was driven by a decrease in our reinsurance segment. The decrease in the reinsurance segment's acquisition cost ratio was primarily due to changes in business mix, together with favorable adjustments related to loss sensitive features and reinstatement premiums. This decrease was partially offset by an increase in the insurance segment's acquisition cost ratio driven by changes in business mix in our accident and health lines.
The general and administrative expense ratio was consistent in 2016 compared to 2015 at 16.2%. An increase in personnel expenses including transition and severance costs was offset by the benefits of arrangements with our strategic capital partners and an increase in net premiums earned.
The following table provides gross premiums written by line of business:
2017 versus 2016: Ceded premiums written in 2017 were $1,040 million, or 33%, of gross premiums written, compared to $913 million, or 34%, in 2016. The increase in ceded premiums written included $102 million primarily attributable to property and professional lines associated with our acquisition of Novae. In addition, ceded premiums written increased by $25 million driven by our liability lines, partially offset by a decrease in premiums ceded in our property lines.
2016 versus 2015: Ceded premiums written in 2016 were $913 million, or 34%, of gross premiums written, compared to $824 million, or 32%, in 2015. The increase in premiums ceded and the related ceded ratio was due to an increase in premiums ceded in our professional and liability lines partially offset by a reduction in reinsurance purchased in our accident and health lines.
2016 versus 2015: Net premiums earned in 2016 decreased by $21 million or 1% ($9 million or 1% increase on a constant currency basis) compared to 2015. The decrease in net premiums earned was primarily driven by an increase in in our professional lines' ceded reinsurance programs. Gross premiums earned increased in 2016 compared to 2015, driven by growth in gross premiums written in our accident and health lines in recent periods, partially offset by a decrease in gross premiums written in our marine lines and the impact of our exit from retail insurance operations in Australia on our professional lines.
2017 versus 2016: The current accident year loss ratio increased to 81.2% in 2017 from 67.4% in 2016. The increase was primarily due to an increase in catastrophe and weather-related losses. During 2017 we incurred pre-tax catastrophe and weather-related net losses of $412 million, or 19.6 points attributable to Hurricanes Harvey, Irma and Maria, the two earthquakes in Mexico, the wildfires in Northern and Southern California and other U.S. weather-related events. Comparatively, in 2016 we incurred $121 million, or 6.8 points of losses attributable to catastrophe and weather-related events.
The decrease in the acquisition cost ratio to 14.1% in 2016 from 14.5% in 2015, primarily reflected an increase in ceding commissions following increased cessions in our professional lines, partially offset by higher variable acquisition costs paid on certain lines of business, and favorable federal excise tax adjustment which benefitted 2015.
See ‘Critical Accounting Estimates - Premiums’ section for a further discussion of related estimates.
2017 versus 2016: Net premiums earned in 2017 increased by $114 million or 6% compared to 2016. The increase in net premiums earned was driven by an increase in gross premiums earned attributable to new business written in our property and motor lines, as well as favorable premium adjustments impacting our agriculture, motor and property lines, partially offset by decrease in gross premiums earned in our professional lines.
The increase in gross premiums earned was partially offset by an increase in ceded premium earned reflecting the impact of the retrocessions to Harrington Re on our professional lines and increased retrocessions in our agriculture and property lines.
Other insurance related loss in 2017 of $5 million compared to other insurance related income in 2016 of $7 million, a decrease of $12 million, primarily related to a decrease in realized mark-to-market gains on our weather and commodities derivative portfolio and a decrease in profit commissions associated with third party retrocessions, partially offset by fees from strategic capital partners and an increase in realized gains on economic hedges purchased to protect our agriculture line of business against fluctuations in commodity prices.
The other insurance related income in 2016 primarily related to fees from strategic capital partners and realized mark-to-market gains on our weather and commodity derivatives portfolio which were largely offset by realized losses on economic hedges purchased to protect our agriculture line of business against fluctuations in commodity prices.
2017 versus 2016: The current accident year loss ratio increased to 87.0% in 2017 from 67.4% in 2016. The increase was primarily due to an increase catastrophe and weather-related losses. During 2017, we incurred pre-tax catastrophe and weather-related losses, net of reinstatement premiums, of $422 million, or 21.1 points attributable to the Hurricanes Harvey, Irma and Maria, the two earthquakes in Mexico, the wildfires in Northern and Southern California and other U.S. weather-related events. Comparatively, in 2016 we incurred $83 million or 4.4 points of net losses attributable to catastrophe and weather-related events.
After adjusting for the impact of the catastrophe and weather-related losses, our current accident year loss ratio increased to 65.9% in 2017 from 63.0% in 2016. The increase in the current accident year loss ratio after adjusting for the impact of the catastrophe and weather-related losses was driven by a large risk loss in our property lines, the impact of the Ogden Rate change in our motor lines and adverse impact of rate and trend.
General and Administrative Expense Ratio: The decrease in the general and administrative expense ratio to 5.2% in 2017 from 7.0% in 2016, was primarily driven by a decrease in performance-related compensation costs, together with an increase in fees from our strategic capital partners.
The decrease in the general and administrative expense ratio to 7.0% in 2016 from 7.7% in 2015, was primarily driven by an increase in net premiums earned, benefits of arrangements with our strategic capital partners, and lower professional fees, partially offset by higher personnel costs.
The following table provides a breakdown of our other expenses, net:
Corporate Expenses: Our corporate expenses include holding company costs necessary to support our worldwide insurance and reinsurance operations and costs associated with operating as a publicly-traded company. As a percentage of net premiums earned, corporate expenses were 3.1%, 3.2% and 3.0% in 2017, 2016 and 2015, respectively. The increase in corporate expenses in 2017 compared to 2016 was primarily driven by higher personnel costs including senior executive transition costs as well as executive retirement costs, and information technology project costs, partially offset by a decrease in performance-related compensation costs.
Foreign Exchange Losses (Gains): Some of our business is written in currencies other than the U.S. dollar. Foreign exchange losses in 2017 were driven primarily by the impact of the weakening of the U.S. dollar on the re-measurement of net insurance-related liabilities mainly denominated in pound sterling and euro. In addition, foreign exchange losses included the reclassification of a cumulative translation adjustment balance of $24 million related to our AXIS Specialty Australia from accumulated other comprehensive income on our balance sheet to foreign exchange loss on our income statement due to the wind-down of these operations which was substantially complete at March 31, 2017.
Comparatively, foreign exchange gains in 2016 were driven primarily by the strengthening of the U.S. dollar on the re-measurement of net insurance-related liabilities denominated in pound sterling. During 2015, the foreign exchange gains were primarily driven by the depreciation of the euro, pound sterling and Australian dollar against the U.S. dollar.
Income Tax (Benefit) Expense: Income tax (benefit) primarily results from income (loss) generated by our foreign operations in the U.S. and Europe. Our effective tax rate, which is calculated as income tax (benefit) expense divided by income before tax including interest in loss of equity method investments, was 2.0%, 1.2%, and 0.5%, in 2017, 2016, and 2015, respectively. This effective rate can vary between years depending on the distribution of net income (loss) amongst tax jurisdictions, as well as other factors.
The tax benefit of $8 million in 2017 was primarily attributable to the geographic distribution of income with the benefit being driven by losses in our U.S. and U.K. operations, share based compensation excess tax benefits which were recognized in the year, a tax adjustment related to the bargain purchase gain recognized in connection with the acquisition of Aviabel,
2017 versus 2016: Net investment income in 2017 was $313 million compared to net investment income of $305 million in 2016, an increase of $8 million or 2%. The increase was attributable to our acquisition of Novae and Aviabel.
The pre-tax return on other investments is non-annualized and calculated by dividing total net investment income from other investments by the average month-end fair value balances held for the periods indicated, excluding overseas deposits.
2017 versus 2016: Pre-tax return on other investments increased to 9.6% in 2017 compared to 5.1% in 2016. The increase was due to higher returns from hedge and direct lending funds as a result of the strong performance of global equity and credit markets.
2016 versus 2015: Pre-tax return on other investments increased to 5.1% in 2016 compared to 2.3% in 2015. The increase was due to higher returns from investments in equity tranches of CLO-Equities in 2016 which increased in value along with other risk assets.
2017 versus 2016: Net realized investment gains in 2017 were $28 million compared to net realized investment losses of $61 million in 2016. Net realized investment gains reported in 2017 primarily reflected realized gains on the sale of ETFs, as a result of the strong performance of global equity markets. This was partially offset by foreign exchange losses on non-U.S. denominated fixed maturities, as a result of the strengthening of the U.S. dollar during 2017.
2016 versus 2015: Net realized investment losses in 2016 were $61 million compared to net realized investment losses of $138 million in 2015. Net realized investment losses reported in 2016 primarily reflected foreign exchange losses on non-U.S. denominated fixed maturities, as a result of the strengthening of the U.S. dollar during 2016.
Refer to the ‘Critical Accounting Estimates - OTTI’ section for details on our impairment review process.
Given that none of our derivative instruments are designated as hedges under current accounting guidance, net unrealized gains (losses) on the hedged securities were recorded in accumulated other comprehensive income in shareholders' equity.
Change in net unrealized gains (losses) is calculated by taking net unrealized gains (losses) at period end less net unrealized gains (losses) at the prior period end.
The fair value of total investments increased by $1.3 billion in 2017, driven by the acquisition of Novae and Aviabel, portfolio yield and market value changes due to the tightening of credit spreads on both investment grade and high-yield corporate debt, and the strong performance of global equity markets. This was partially offset by the funding of financing and operating activities.
At December 31, 2017, fixed maturities had a weighted average credit rating of AA- (2016: AA-), a book yield of 2.5% (2016: 2.6%), an average duration of 3.3 years (2016: 3.5 years) and duration inclusive of interest rate swaps of 3.2 years. At December 31, 2017, inclusive of short-term investments and cash and cash equivalents (i.e. total investments of $14.0 billion), the weighted average credit rating was AA- (2016: AA-), the average duration was 3.0 years (2016: 3.2 years), and duration inclusive of interest rate swaps was 2.9 years.
To calculate the weighted average credit rating for fixed maturities, we assign points to each rating with 29 points for the highest rating (AAA) and 2 points for the lowest rating (D) and then calculate the weighted average based on the fair values of the individual securities. Securities that are not rated by S&P, Moody’s or Fitch are excluded from weighted average calculations. At December 31, 2017, the fair value of fixed maturities not rated was $53.1 million (2016: $42.8 million).
Non-U.S. government securities include bonds issued by non-U.S. governments and their agencies along with supranational organizations (collectively also known as sovereign debt securities). The table below summarizes our aggregate fixed maturity exposures to governments in the eurozone and other non-U.S. government concentrations by fair value at December 31, 2017 and 2016:
"Other" is mainly local currency emerging market sovereign debt and was reduced during the year. At December 31, 2017, this portfolio had a weighted average credit rating of BBB+ (2016: BBB+), a duration of 6.0 years (2016: 5.3 years) and a yield-to-worst of 7.1% (2016: 7.6%).
At December 31, 2017, our non-investment grade portfolio had a fair value of $978 million (2016: $1,101 million), a weighted average credit rating of B (2016: B) and duration of 2.0 years (2016: 2.2 years). At December 31, 2017, our total corporate debt portfolio, including non-investment grade securities, had a duration of 3.2 years (2016: 3.4 years).
Agency RMBS consist of bonds issued by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association which are primarily AAA rated and are supported by loans which are diversified across geographical areas. At December 31, 2017, our agency RMBS holdings had an average duration of 4.3 years (2016: 5.0 years).
ABS include mostly investment-grade bonds backed by pools of loans with a variety of underlying collateral, including automobile loan receivables, student loans, credit card receivables, and CLO Debt originated by a variety of financial institutions. The following table provides a breakdown of the fair value of our ABS by underlying collateral and credit rating:
G.O. bonds are backed by the full faith and credit of the authority that issued the debt and are secured by the taxing powers of those authorities. Revenue bonds are backed by the revenue stream generated by the services provided by the issuer (e.g. sewer, water or utility projects). As issuers of revenue bonds do not have the ability to draw from tax revenues or levy taxes to fund obligations, revenue bonds may carry a greater risk of default than G.O. bonds. At December 31, 2017, 90% of our municipals are taxable with the remainder tax exempt.
At December 31, 2017, the gross unrealized losses on our fixed maturities portfolio were $91 million (2016: $197 million).
The decrease in gross unrealized losses on investment-grade fixed maturities reflected the tightening of credit spreads on investment grade corporate debt holdings.
The following table provides information on the severity of the unrealized loss position as a percentage of amortized cost for all non-investment grade fixed maturities in an unrealized loss position at December 31, 2017 and 2016:
The decrease in gross unrealized losses on non-investment grade fixed maturities is primarily due to the tightening of credit spreads on non-investment grade high yield corporate debt holdings.
During 2017, our investment in commercial mortgage loans decreased to $325 million from $350 million, a decrease of $25 million. Our commercial mortgage loans are high quality and collateralized by a variety of commercial properties and are diversified both geographically throughout the U.S., and by property type, to reduce the risk of concentration. At December 31, 2017, there were no credit losses associated with our commercial mortgage loans portfolio.
The composition of our other investment portfolio is summarized as follows:
During 2017, we recorded an impairment charge of $9 million, related to a U.S. based insurance company, which reduced the carrying value of the investment to $nil. This charge is included in interest in loss of equity method investments in the Consolidated Statement of Operations.
As a holding company, AXIS Capital has no operations of its own and its assets consist primarily of investments in its subsidiaries. Accordingly, AXIS Capital’s future cash flows depend on the availability of dividends or other statutorily permissible distributions, such as returns of capital, from its subsidiaries. The ability to pay such dividends and/or distributions is limited by the applicable laws and regulations of the various countries and states in which AXIS Capital’s subsidiaries operate (refer to Item 8, Note 21 to the Consolidated Financial Statements 'Statutory Financial Information' for further details), as well as the need to maintain capital levels to adequately support (re)insurance operations and to preserve financial strength ratings issued by independent rating agencies. During 2017, AXIS Capital received $768 million (2016: $550 million; 2015: $420 million) of distributions from its subsidiaries. AXIS Capital’s primary uses of funds are dividend payments to both common and preferred shareholders, share repurchases, interest and principal payments on debt, capital investments in subsidiaries and payment of corporate operating expenses. We believe the dividend/distribution capacity of AXIS Capital’s subsidiaries, which was $1.1 billion at December 31, 2017, will provide AXIS Capital with sufficient liquidity for the foreseeable future.
The (re)insurance business of our operating subsidiaries inherently provides liquidity, as premiums are received in advance (sometimes substantially in advance) of the time claims are paid. However, the amount of cash required to fund claim payments can fluctuate significantly from period to period, due to the low frequency/high severity nature of certain types of business we write.
Refer to Consolidated Statements of Cash Flows included in Item 8, ‘Financial Statements and Supplementary Data’, for further details.
Should claim payment obligations accelerate beyond our ability to fund payments from operating cash flows, we would utilize our cash and cash equivalent balances and/or liquidate a portion of our investment portfolio. Our investment portfolio is heavily weighted towards conservative, high quality and highly liquid securities. We expect that, if necessary, approximately $13.8 billion of cash and invested assets at December 31, 2017 could be available in one to three business days under normal market conditions; of this amount, $7.0 billion relates to restricted assets, which primarily support our obligations in regulatory jurisdictions where we operate as a non-admitted carrier (refer to Item 8, Note 6(g) to the Consolidated Financial Statements 'Investments' for further details). For context, our largest 1-in-250 year return period, single occurrence, single-zone modeled probable maximum loss (Southeast U.S. Hurricane) is approximately $0.8 billion, net of reinsurance; our claim payments pertaining to such an event would be paid out over a period spanning many months. Our internal risk tolerance framework aims to limit both the loss of capital due to a single event, and the loss of capital that would occur from multiple but perhaps smaller events, in any year (refer to Item 1 ‘Risk and Capital Management’ for further details).
We continue to expect that cash flows generated from our operations, combined with the liquidity provided by our investment portfolio, will be sufficient to cover our required cash outflows and other contractual commitments through the foreseeable future. For further details about the anticipated amounts and timing of our contractual obligation and commitments refer to 'Contractual Obligations and Commitments' below.
On March 19, 2012, we issued $400 million of 6.875% Series C preferred shares. Dividends on the Series C preferred shares are non-cumulative. To the extent declared, dividends will accumulate, with respect to each dividend period, in an amount per share equal to 6.875% of the liquidation preference per annum. We may redeem the shares on or after April 15, 2017 at a redemption price of $25.00 per share.
During October and November 2016, we repurchased 1,957,045 Series C preferred shares at an average purchase price of $25.67 per share for $50 million. On April 17, 2017, we repurchased the remaining $351 million of 6.875% Series C preferred shares.
expansion of our business and the loss experience of such business. A portion of these facilities may also be used for liquidity purposes.
Each of our existing facilities is described further below (refer to Item 8, Note 10(b) of the Consolidated Financial Statements 'Debt and Financing Arrangements' for further details).
On March 26, 2013, we entered into a $250 million credit facility (the "Credit Facility"), which provided us with combined borrowing and letter of credit issuance capacity up to the aggregate amount of the facility. Under the terms of the Credit Facility, loans are available for general corporate purposes and letters of credit may be issued in the ordinary course of business, Interest on loans issued under this facility is payable based on underlying market rates at the time of loan issuance. While any loans are unsecured, we have the option to issue letters of credit on a secured basis in order to reduce associated fees. Letters of credit issued under the Credit Facility are principally being used to support the (re)insurance obligations of our operating subsidiaries. This facility is subject to certain non-financial covenants that we believe are customary for facilities of this type, including limitations on fundamental changes, the incurrence of additional indebtedness and liens and certain transactions with affiliates and investments, as defined in the facility documents. Compliance with certain financial covenants that we believe are customary for (re)insurance companies in credit facilities of this type is also required.
At December 31, 2017, we had $387 million outstanding under the LOC Facility. The remaining available capacity under the LOC Facility and the $250 Million Facility is $363 million. At December 31, 2017, we were in compliance with all necessary undertakings of the LOC Facility and the $250 Million Facility.
Such financial strength ratings represent the opinions of the rating agencies on the overall financial strength of a company and its capacity to meet the obligations of its (re)insurance contracts. Independent ratings are one of the important factors that establish our competitive position in (re)insurance markets. The rating agencies consider many factors in determining the
financial strength rating of an insurance company, including the relative level of statutory surplus necessary to support the business operations of the company. These ratings are based upon factors considered by the rating agencies to be relevant to policyholders, agents and intermediaries and are not directed toward the protection of investors. Such ratings are not recommendations to buy, sell or hold securities.
(1) On July 6, 2017, following the offer to acquire Novae, Standard & Poor's revised its outlook from stable to negative. The change in outlook reflects its concerns about the level of capital redundancy at the 'AAA' level on a pro-forma consolidated basis. Standard & Poor's will monitor the integration of Novae over the 24 month period following the offer, which could result in the current ratings being affirmed, or a revision in its outlook to stable, or a lowering of its rating by one notch, to A, based on the performance of Novae and our rebuilding of capital adequacy.
(2) On February 16, 2018, A.M. Best revised its outlook from stable to negative. The revised outlooks are based on unfavorable trends in the Group's operating performance, particularly from our insurance segment.
We are obligated to pay claims for specified loss events covered by the (re)insurance contracts we write. Such loss payments represent our most significant future payment obligation. In contrast to our other contractual obligations, our cash payments are not determinable from the terms specified within the underlying contracts. The total amount in the table above reflects our best estimate of our reserve for losses and loss expenses. However, the actual amounts and timing may differ materially refer to ‘Critical Accounting Estimates - Reserve for Losses and Loss Expenses’ for further details. We have not taken into account corresponding reinsurance recoverable amounts that would be due to us.
We believe that the amounts included in our Consolidated Financial Statements reflect our best judgment. However, factors such as those described in Item 1A 'Risk Factors' could cause actual events or results to differ materially from our underlying assumptions and estimates; this could lead to a material adverse impact on our results of operations, financial condition and/or liquidity.
The estimation of IBNR is necessary due to the time lags between when a loss event occurs and when it is actually reported to us, referred to as the reporting lag. Reporting lags may arise from a number of factors, including but not limited to the nature of the loss, the use of intermediaries and complexities in the claims adjusting process. By definition, we do not have specific information on IBNR so it must be estimated. IBNR is calculated by deducting incurred losses (i.e. paid losses and case reserves) from management’s best estimate of ultimate losses. In contrast to case reserves, which are established at the contract level, IBNR reserves are generally estimated at an aggregate level and cannot be identified as reserves for a particular loss event or contract. For additional information on reserving for such events, refer to the 'Reserving For Significant Catastrophic Events' below.
Loss Development Method (also referred to as the Chain Ladder Method or Link Ratio Method): This method assumes that the losses incurred/paid for each accident year or underwriting year at a particular development stage follow a relatively similar pattern. It assumes that on average, every accident year or underwriting year will display the same percentage of ultimate losses incurred/paid at the same point in time after the inception of that year. The percentages incurred/paid are established for each development stage (e.g. 12 months, 24 months, etc.) after examining historical averages from historical loss development data and/or external industry benchmark information. Ultimate losses are then estimated by multiplying the actual incurred/paid losses by the reciprocal of the established incurred/paid percentage. The strengths of this method are that it reacts to loss emergence/payments and that it makes full use of historical claim emergence/payment experience. However, this method has weaknesses when the underlying assumption of stable loss development/payment patterns is not valid. This could be the consequence of changes in business mix, claim inflation trends or claim reporting practices and/or the presence of large claims, amongst other things. Furthermore, this method tends to produce volatile estimates of ultimate losses where there is volatility in the underlying incurred/paid patterns. In particular, where the expected percentage of incurred/paid losses is low, small deviations between actual and expected claims can lead to very volatile estimates of ultimate losses. As a result, this method is often unsuitable at early development stages for an accident year or underwriting year.
Our credit and political risk insurance business consists primarily of credit insurance and confiscation, expropriation, nationalization and deprivation coverages ("CEND"). Claims for this business tend to be characterized by their severity risk, as opposed to their frequency risk. Therefore, claim payment and reporting patterns are anticipated to be volatile. Under the notification provisions of our credit insurance, we anticipate being advised of an insured event within a relatively short time period. As a result, we generally estimate ultimate losses based on a contract-by-contract analysis which considers the contracts’ terms, the facts and circumstances of underlying loss events and qualitative input from claims managers.
We cannot estimate losses from widespread catastrophic events, such as hurricanes and earthquakes, using the traditional actuarial methods described above. Rather, loss reserves for such events are estimated by management after a catastrophe occurs by completing an in-depth analysis of individual contracts which may potentially be impacted by the catastrophic event. This in-depth analysis may rely on several sources of information, including:
a review of our portfolio of contracts performed to identify those contracts which may be exposed to the catastrophic event;
discussions of the impact of the event with our customers and brokers and
We began operations in late 2001. In our earlier years, we placed significant reliance on industry benchmarks in establishing our expected loss ratios. Over time, we have placed more reliance on our historical loss experience in establishing these ratios where we believe the weight of our own actual experience has become sufficiently credible for consideration. The weight given to our experience differs for each of our three claim tail classes and is discussed further in 'Claim Tail Analysis' below. In establishing expected loss ratios for our insurance segment, we give consideration to a number of other factors, including exposure trends, rate adequacy on new and renewal business, ceded reinsurance costs, changes in claims emergence and our underwriters’ view of terms and conditions in the market environment. For our reinsurance segment, expected loss ratios are based on a contract-by-contract review, which considers information provided by clients together with estimates provided by our underwriters and actuaries about the impact of changes in pricing, terms and conditions and coverage. We also have considered the market experience of some classes of business as compiled and analyzed by an independent actuarial firm, as appropriate.
Our short-tail business generally includes exposures for which losses are usually known and paid within a relatively short period of time after the underlying loss event has occurred. Our short-tail business primarily relates to property coverages and includes the majority of our property, terrorism and marine business and certain aviation business within our insurance segment, together with the property, catastrophe and agriculture business within our reinsurance segment as well as discontinued lines - Novae.
The key actuarial assumptions for our short-tail business in our early accident years were primarily developed with reference to industry benchmarks for both expected loss ratios and loss development patterns. As our own historical loss experience amassed, it gained credibility and became relevant for consideration in establishing these key actuarial assumptions. As a result, we gradually increased the weighting assigned to our own historical experience in selecting the expected loss ratios and loss development patterns utilized to establish our estimates of ultimate losses for an accident year.
Our medium-tail business primarily consists of professional lines (re)insurance, discontinued lines - Novae, and trade credit and surety reinsurance business. Certain other classes of business, including aviation hull and engineering reinsurance, are also considered to have a medium-tail. Claim reporting and settlement periods on these classes are generally longer than those of our short-tail reserving classes. We also consider our credit and political risk insurance business to have a medium tail, due to the complex nature of claims and the potential additional time that may be required to realize our subrogation assets.
For our earliest accident and underwriting years, our initial key actuarial expected loss ratio and loss development assumptions were established utilizing industry benchmarks. Due to the longer claim tail, the length of time required to develop our own credible loss history for use in the reserving process is greater for our medium-tail business than for our short-tail business. As a result, the number of years where we relied heavily on industry benchmarks to establish our key actuarial assumptions is greater for our medium-tail business. Our reserving approach for medium-tail business is tailored by line of business, with our significant lines being specifically addressed below.
Loss reporting patterns for professional lines business tend to be volatile, causing instability in actuarial indications based on incurred loss data until an accident year matures for a number of years. Consequently, our initial loss reserves for an accident year or underwriting year are generally based upon an ELR method and the consideration of relevant qualitative factors. As accident years and underwriting years mature, we increasingly give more weight to methods that reflect our actual experience
See 'Underwriting Results - Group, Prior Year Development' for a discussion of the development recognized during the last three years.
To date, our key actuarial assumptions for our long-tail business have been derived extensively from industry benchmarks supplemented with our own historical experience. Given our relatively short operating history in comparison to the development tail for this business, we do not believe that our own historical loss development for our long-tail business has amassed an appropriate volume to serve as a fully credible input into the key actuarial assumptions previously outlined. While we consider industry benchmarks that we believe reflect the nature and coverage of our business, our actual loss experience may differ from the benchmarks based on industry averages.
Commencing with our fourth quarter 2012 reserving process, we began to give weight to actuarial methods that reflect our actual experience for liability business as we believed that our oldest accident years were at a stage of expected development where such methods would produce meaningful actuarial indications. In 2017, we continued to give weight to experience-based methods on the earlier years for the liability line of business leading to the recognition of some favorable experience on the reinsurance classes.
While we believe that our loss reserves at December 31, 2017 are adequate, new information, events or circumstances may result in ultimate losses that are materially greater or less than provided for in our loss reserves. As previously noted, there are many factors that may cause our reserves to increase or decrease, particularly those related to catastrophe losses and long-tail lines of business.
The following tables show the effect on our estimate of gross loss reserves of reasonably likely changes in the two key assumptions used to estimate our gross loss reserves at December 31, 2017.
The results show the cumulative increase (decrease) in our loss reserves across all accident years. For example, if our assumed loss development pattern for our property and other insurance business was three months shorter with no accompanying change in our ELR assumption, our loss reserves may decrease by approximately $87 million. Each of the impacts set forth in the tables is estimated individually, without consideration for any correlation among key assumptions or among reserving classes. Therefore, it would be inappropriate to take each of the amounts and add them together in an attempt to estimate total volatility. While we believe the variations in the expected loss ratios and loss development patterns presented could be reasonably expected, our own historical data regarding variability is generally limited and actual
variations may be greater or less than these amounts. It is also important to note that the variations are not meant to be a "best-case" or "worst-case" series of scenarios and, therefore, it is possible that future variations in our loss reserves may be more or less than the amounts presented. While we believe that these are reasonably likely scenarios, we do not believe this sensitivity analysis should be considered an actual reserve range.
We apply case-specific provisions against certain recoveries that we deem unlikely to be collected in full. In addition, we use a default analysis to estimate our provision for uncollectible amounts on the remainder of the balance. The principal components of the default analysis are reinsurance recoverable by reinsurer and default factors applied to estimate uncollectible amounts based on our reinsurers’ credit ratings. The default factors are based on a model developed by a major rating agency. The provision recorded against reinsurance recoverable was $17 million and $20 million at December 31, 2017 and 2016, respectively. We have not written off any significant reinsurance recoverable balances in the last three years. At December 31, 2017, the use of different assumptions within our approach could have a material effect on our provision for uncollectible reinsurance recoverable. To the extent the creditworthiness of our reinsurers was to deteriorate due to an adverse event affecting the reinsurance industry, such as a large number of major catastrophes, actual uncollectible amounts could be significantly greater than our provision. Given the various considerations used to estimate our uncollectible provision, we cannot precisely quantify the effect a specific industry event may have on our provision.
A limited portion of our insurance business is written on a line slip or proportional basis, under which we assume a fixed percentage of the premiums and losses on a particular risk or group of risks along with numerous other unrelated insurers. Although premiums on this business are not contractually stated, we recognize gross premiums written based on estimates provided by clients through brokers. For further details on the estimation process, see the discussion provided for the reinsurance segment below. We review these estimates on a quarterly basis and record significant adjustments in premium estimates when identified. Gross premiums written on a line slip/proportional basis comprised 14%, 15% and 13% of the segment’s total for the years ended December 31, 2017, 2016 and 2015, respectively, and therefore the associated impact of these estimates on our pre-tax net income was immaterial. The decrease in 2017 compared to 2016 is due to a lower mix of proportional business associated with our recent acquisition of Novae. The increase in 2016 compared to 2015 was driven by an increase in the amount of proportional business written in our accident and health lines.
Our reinsurance segment provides excess of loss and proportional coverages to cedants (i.e. insurance companies). In most cases, cedants seek protection from us for business that they have not yet written at the time they enter into agreements with us. As a result, cedants must estimate their underlying premiums when purchasing reinsurance coverage from us.
Many of our excess of loss contracts also include provisions that require an automatic reinstatement of coverage in the event of a loss. In a year of large loss events, reinstatement premiums will be higher than in a year in which there are no such events. Reinstatement premiums are recognized when a triggering loss event occurs and losses are recorded by us. While the reinstatement premium amount is defined by contract terms, our recognition of reinstatement premiums is dependent on our estimate of losses and loss expenses, which reflect management’s best judgment as described above in 'Critical Accounting Estimates - Reserves for Losses and Loss Expenses'.
Our historical experience has shown that cumulative adjustments to our annual initial premium estimates on proportional reinsurance contracts have ranged from 0% to 5% over the last 5 years. Giving more weight to recent years where premium volume was comparable to current levels, we believe that a reasonably likely change in our 2017 proportional reinsurance gross premiums written estimate would be 5% in either direction. Such a change would result in a variance in our gross premiums written of approximately $80 million and an immaterial impact on our pre-tax net income. However, larger variations, both positive and negative, are possible.
Refer to Item 8, Note 7 to the Consolidated Financial Statements 'Fair Value Measurements' for further details on the valuation techniques and assumptions used in estimating the fair value of our financial instruments.
As the significant inputs used in our discounted cash flow model to price CLO-Equities are unobservable, the fair values of these securities continue to be classified the CLO-Equities as Level 3.
Other privately held securities include convertible preferred shares, convertible notes and notes payable. These securities are initially valued at cost which approximates fair value. In subsequent measurement periods, the fair values of these securities are determined using an internally developed discounted cash flow model.
As the significant inputs used to price these securities are unobservable, the fair value of these securities are classified as Level 3.
The credit loss component of OTTI recognized in net income is calculated based on the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to the impairment. The significant inputs and the methodology used to estimate credit losses are disclosed in Item 8, Note 6 (f) to the Consolidated Financial Statements 'Investments'.
Refer to Item 8, Note 2(m) to the Consolidated Financial Statements 'Significant Accounting Policies' for a discussion of recently issued accounting pronouncements that we have not yet adopted.
At December 31, 2017, we are not party to any off-balance sheet arrangements, as defined by Item 303(a)(4) of Regulation S-K to which an entity unconsolidated with us is a party that management believes is reasonably likely to have a current or future effect on its financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that we believe is material to investors.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2018 expressed an unqualified opinion on the Company's internal control over financial reporting.
reinsurance recoverable on unpaid losses, including the provision for uncollectible amounts;
The Company recognizes investment income from fixed maturities based on the constant effective yield method, which includes an adjustment for estimated principal repayments, if any. The effective yield used to determine the amortization for fixed maturities subject to prepayment risk (e.g. asset-backed, loan-backed and other structured securities) is recalculated and adjusted periodically based upon actual historical and/or projected future cash flows. The adjustments to the yield for highly-rated prepayable fixed maturities are accounted for using the retrospective method. The adjustments to the yield for other prepayable fixed maturities are accounted for using the prospective method.
A fixed maturity is impaired if the fair value of the investment is below amortized cost. If a fixed maturity is impaired, additional analysis is performed to determine whether the impairment is temporary or other-than-temporary. For an impaired fixed maturity where the Company intends to sell the security or it is more likely than not that the Company will be required to sell the security before its anticipated recovery, the impairment is considered other than temporary. The full amount of the impairment is charged to net income and is included in net realized investment gains (losses). In instances, where the Company intends to hold the impaired fixed maturity, the Company estimates the anticipated credit loss of the security and recognizes only this portion of the impairment in net income, with the remaining non-credit related balance of the impairment (i.e. related to interest rates, market conditions, etc.) recognized in AOCI.
The Company recognizes impairments on equity securities in an unrealized loss position when the Company does not have the ability and intent to hold the security for a reasonable period of time to allow for a full recovery. The full amount of the impairment is charged to net income and is included in net realized investment gains (losses).
Cash equivalents include money-market funds, fixed interest deposits and reverse repurchase agreements placed with a maturity of under 90 days when purchased. Cash and cash equivalents are recorded at amortized cost, which approximates fair value due to the short-term, liquid nature of these securities. Restricted cash primarily relates to funds held in trust in support of obligations in regulatory jurisdictions where the Company operates as a non-admitted carrier and to support the underwriting activities of the Syndicate 1686 and Syndicate 2007 at Lloyd's of London ("Lloyd's").
(Re)insurance premiums are earned evenly over the period during which the Company is exposed to the underlying risk, which is generally one to two years with the exception of multi-year contracts. Unearned premiums represent the portion of premiums written which is applicable to the unexpired risks under contracts in force.
Reserve for losses and loss expenses represents an estimate of the unpaid portion of the ultimate liability for losses and loss expenses for (re)insured events that have occurred at or before the balance sheet date. The balance reflects both claims that have been reported ("case reserves") and claims that have been incurred but not yet reported ("IBNR"). These amounts are reduced for estimated amounts of salvage and subrogation recoveries.
The Company reviews its reserve for losses and loss expenses on a quarterly basis. Case reserves are primarily established based on amounts reported from insureds and/or their brokers. Management estimates IBNR after reviewing detailed actuarial analyses and applying informed judgment regarding qualitative factors that may not be fully captured in the actuarial estimates. A variety of actuarial methods are utilized in this process, including the Expected Loss Ratio, Bornhuetter-Ferguson and Chain Ladder methods. The estimate is highly dependent on management’s judgment as to which method(s) are most appropriate for a particular accident year and class of business. Historical claims data is often supplemented with industry benchmarks when applying these methodologies.
Any adjustments to previous reserve for losses and loss expenses estimates are recognized in the period they are determined. While the Company believes that its reserves for losses and loss expenses are adequate, this estimate requires significant judgment and new information, events or circumstances may result in ultimate losses that are materially greater or less than provided for in the Consolidated Balance Sheets.
In the normal course of business, the Company purchases reinsurance protection to limit its ultimate losses from catastrophic events and to reduce its loss aggregation risk. The premiums paid to reinsurers (i.e. premiums ceded) are expensed over the coverage period. Prepaid reinsurance premiums represent the portion of premiums ceded applicable to the unexpired term of the contracts in force. Reinstatement-related premiums ceded are recorded at the time a loss event occurs and coverage limits for the remaining life of a contract are reinstated under pre-defined contract terms with premiums are expensed over the remaining risk period.
Reinsurance recoverable is presented net of a provision for uncollectible amounts, reflecting the amount the Company believes will ultimately not be recovered due to reinsurer insolvency, contractual disputes and/or some other reason. The Company applies case-specific provisions against certain recoveries that it deems unlikely to be collected in full. In addition, the Company uses a default analysis to estimate the provision for uncollectible amounts on the remainder of the balance.
Retroactive reinsurance reimburses a ceding company for liabilities incurred as a result of past insurable events covered under contracts subject to the reinsurance. In certain instances, reinsurance contracts cover losses both on a prospective basis and on a retroactive basis and where practical the Company bifurcates the prospective and retrospective elements of these reinsurance contracts and accounts for each element separately. Initial gains in connection with retroactive reinsurance contracts are deferred and amortized into income over the settlement period while losses are recognized immediately. When changes in the estimated amount recoverable from the reinsurer or in the timing of receipts related to that amount occur, a cumulative amortization adjustment is recognized in earnings in the period of the change so that the deferred gain reflects the balance that would have existed had the revised estimate been available at the inception of the reinsurance transaction.
recognized as an increase or decrease to share-based compensation expense for the period. Effective, January 1, 2017, the Company made an accounting policy election to account for forfeitures when they occur.
For the purposes of evaluating goodwill for impairment, the Company may first perform a qualitative assessment , to determine whether it is necessary to perform the two-step goodwill impairment test. If determined to be necessary, the two-step impairment test is used to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized, if any. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired and the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test shall be performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill.
For the purposes of evaluating indefinite lived intangibles for impairment, the Company may first perform a qualitative assessment to determine whether it is necessary to perform the quantitative impairment test. If the Company elects to perform a qualitative assessment, it first assesses qualitative factors to determine whether it is more likely than not that an indefinite lived intangible asset is impaired. If the Company determines that it is not more likely than not that the indefinite lived intangible asset is impaired, the Company does not calculate the fair value of the intangible asset and perform the quantitative impairment test.
For other definite lived intangible asset the Company tests for recoverability whenever events or changes in circumstances indicate its carrying amount may not be recoverable. The Company recognizes an impairment loss if the carrying amount of
the asset is not recoverable and exceeds its fair value. The carrying amount of a definite lived intangible asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset.
Common shares repurchased by the Company and not subsequently canceled are classified as treasury shares and are recorded at cost. This results in a reduction of shareholders’ equity in the Consolidated Balance Sheets. When shares are reissued from treasury, the Company uses the average cost method to determine the cost of the reissued shares. Gains on sales/reissuances of treasury shares are credited to additional paid-in capital, while losses are charged to additional paid-in capital to the extent that previous net gains from reissued treasury shares were included therein; otherwise losses are charged to retained earnings.
Effective January 1, 2017, the Company adopted Accounting Standards Update ("ASU" ) ASU 2016-09, "Compensation - Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting" which simplifies several aspects of the accounting for share-based payments to employees including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The guidance requires all excess tax benefits and tax deficiencies to be recognized in the income statement with the tax effects of exercised or vested awards to be treated as discrete items in the reporting period in which they occur. Excess tax benefits should be classified along with other income tax cash flows as an operating activity on the statement of cash flows. In addition, companies are required to make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur. The guidance allows withholding up to the maximum statutory tax rates in the applicable jurisdictions to cover income taxes on share-based compensation awards without requiring liability classification. Cash paid by an employer when directly withholding shares for tax withholding purposes should be classified as a financing activity. Cash paid by the Company by directly withholding shares for tax withholding purposes is included in taxes paid on withholding shares in the Consolidated Statement of Cash Flows. To facilitate comparison of information with prior year amounts, the corresponding amounts for the years ended December 31, 2016 and 2015 have been reclassified to conform to the current year's presentation. The adoption of this guidance did not have a material impact on the Company's results of operations, financial condition and liquidity.
In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)". This guidance affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB delayed the effective date by one year through the issuance of ASU 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date". This guidance is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted for interim and annual reporting periods beginning after December 15, 2016. Accounting for insurance contracts is not within the scope of ASU 2014-09. The Company generates an insignificant amount of fee income, primarily from strategic capital partners, which is reported in other insurance related income (losses) in the Consolidated Statements of Operations and is within the scope of ASU 2014-09. The Company's current accounting policy to recognize fee income when the related services have been performed is consistent with the guidance in this ASU. As a result, the Company does not expect the adoption of this guidance to have a material impact on its results of operations, financial condition and liquidity.
In January 2016, the FASB issued ASU 2016-01 "Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities" which requires:
equity investments (except those accounted for under the equity method of accounting, investments that are consolidated or those that meet a practicability exception) to be measured at fair value with changes in fair value recognized in net income,
requires separate presentation in other comprehensive income of the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the organization has elected to measure the liabilities in accordance with the fair value option,
requires the separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements; and
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments" which replaces the "incurred loss" impairment methodology with an approach based on "expected losses" to estimate credit losses on certain types of financial instruments and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The guidance requires financial assets measured at amortized cost to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost of the financial asset to present the net carrying value at the amount expected to be collected on the financial asset. Credit losses relating to available-for-sale debt securities will be recorded through an allowance for credit losses. The guidance also provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. This guidance is effective for interim and annual periods beginning after December 15, 2019. Early adoption is permitted for interim and annual periods beginning after December 15, 2018. The Company is currently evaluating the impact of this guidance on its results of operations, financial condition and liquidity.
In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments" which addresses diversity in practice in how eight specific cash receipts and cash payments should be presented and classified on the statement of cash flows. This guidance is effective for interim and annual periods beginning after December 15, 2017, with early adoption permitted. As this guidance relates solely to financial statement disclosures, the adoption of ASU 2016-18, will not impact the Company's results of operations, financial condition and liquidity.
In May 2017, the FASB issued ASU 2017-09 "Compensation - Stock Compensation (Topic 718) - Scope of Modification Accounting" to provide clarity and reduce diversity in practice of applying the guidance in Topic 718 to a change to the terms or conditions of a share-based payment award. This ASU provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. The guidance states that an entity should account for the effects of a modification unless all the following are met:
the classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified.
In February 2018, the FASB issued ASU 2018-02 "Income Statement - Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income" in response to a financial reporting issue that arose as a consequence of the U.S. federal government tax bill, H.R.1, An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018 ("U.S. Tax Reform") which was enacted on December 22, 2017.
The amendments in this Update allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from U.S. Tax Reform. Consequently, the amendments eliminate the stranded tax effects resulting from U.S. Tax Reform and will improve the usefulness of information reported to financial statement users. However, because the amendments only relate to the reclassification of the income tax effects of U.S. Tax Reform, the
The allocation of the purchase price is based on information included in Novae's audited financial statements at October 2, 2017. The allocation is subject to change if additional information becomes available within the measurement period, which cannot exceed 12 months from the acquisition date. The fair values of the assets acquired and liabilities assumed may be subject to adjustments, which may impact the amounts recorded for the assets acquired and liabilities assumed as well as the goodwill.
Other liabilities: To reflect deferred tax liabilities on fair value adjustments.
Coverholders: The value of sales of insurance policies that result directly from relationships with insurance intermediaries who are authorized by Novae's managing agent to enter into contracts of insurance to be underwritten by Syndicate 2007, in accordance with the terms of a binding authority.
Lloyd's syndicate capacity: Lloyd's syndicate capacity was valued using the Multi-Period Excess Earnings Method, an application of the Income Approach. Key inputs used in the valuation model used for this intangible asset included projected pre-tax operating profit attributable to syndicate capacity, contributory asset charges which represent the required return on and of intangibles assets utilized to generate future revenue and operating income, and an appropriate discount rate.
The following selected unaudited pro forma financial information is a summary of the combined results of the Company and Novae, assuming the transaction had been effected on January 1, 2016. The unaudited pro forma data is for informational purposes only and does not necessarily represent results that would have occurred if the transaction had taken place on January 1, 2016.
The unaudited pro forma consolidated financial information does not consider the impact of possible revenue enhancements, expense efficiencies, or synergies that may result from the acquisition of Novae. In addition, the unaudited pro forma consolidated financial information does not include costs associated with restructuring or integration activities resulting from the acquisition of Novae.
On April 1, 2017 (the "closing date" or the "acquisition date"), the Company acquired a 100% ownership interest in Compagnie Belge d'Assurances Aviation NV/SA ("Aviabel"). Aviabel is an insurer operating under Belgian law that has its head office in Belgium, a branch office in the Netherlands and a reinsurance company, Aviabel RE S.A. ("Aviabel RE"), in Luxembourg. The acquisition of Aviabel was undertaken to increase its scale and relevance in the global aviation market.
AXIS Capital's underwriting operations are organized around its global underwriting platforms, AXIS Insurance and AXIS Re. The Company has determined that it has two reportable segments; insurance and reinsurance. The Company does not allocate its assets by segment, with the exception of goodwill and intangible assets, as it evaluates the underwriting results of each segment separately from the results of its investment portfolio.
The Company's insurance segment offers specialty insurance products to a variety of niche markets on a worldwide basis. The product lines in this segment are property, marine, terrorism, aviation, credit and political risk, professional lines, liability, accident and health together with discontinued lines which represents lines of business that Novae exited or placed into run-off in the three month period ended December 31, 2016 and in the three month period ended March 31, 2017.
The following tables summarize the underwriting results of the reportable segments, as well as the carrying values of allocated goodwill and intangible assets:
During the year ended December 31, 2017, an amount of $6,136 and 7,945 was adjusted from gross amount and accumulated amortization, respectively, as a result of the wind-down of the Company's retail insurance operations in Australia.
The estimated amortization expense of VOBA and intangible assets with a finite life is shown in the following table:
The estimated remaining useful lives of finite lived intangible assets range from 1 to 15 years.
The Company's impairment reviews of goodwill and indefinite lived intangibles did not result in the recognition of impairment losses for the years ended December 31, 2017 and 2016. In 2015, the Company recognized $13 million of impairment losses related to the wind-down all of its retail insurance operations in Australia.
In the normal course of investing activities, the Company actively manages allocations to non-controlling tranches of structured securities (variable interests) issued by Variable Interest Entities ("VIEs"). These structured securities include RMBS, CMBS and ABS and are included in the above table. Additionally, within the other investments portfolio, the Company also invests in limited partnerships (hedge funds, direct lending funds, private equity funds and real estate funds) and CLO equity tranched securities, which are all variable interests issued by VIEs (see Note 6(c) 'Other Investments'). For these variable interests, the Company does not have the power to direct the activities that are most significant to the economic performance of the VIEs therefore the Company is not the primary beneficiary of any of these VIEs. The maximum exposure to loss on these interests is limited to the amount of investment by the Company. The Company has not provided financial or other support with respect to these structured securities other than the original investment.
At December 31, 2017, 2,424 fixed maturities (2016: 1,881) were in an unrealized loss position of $91 million (2016: $197 million) of which $7 million (2016: $15 million) was related to securities below investment grade or not rated.
At December 31, 2017, 627 securities (2016: 330) had been in a continuous unrealized loss position for 12 months or greater and had a fair value of $1,533 million (2016: $971 million). Following a credit impairment review, it was concluded that these securities as well as the remaining securities in an unrealized loss position in the above table were temporarily impaired at December 31, 2017, and were expected to recover in value as the securities approach maturity. Further, at December 31, 2017, the Company did not intend to sell these securities in an unrealized loss position and it is more likely than not that the Company will not be required to sell these securities before the anticipated recovery of their amortized costs.
At December 31, 2017, 29 securities (2016: 23) were in an unrealized loss position of $2 million (2016: $12 million).
At December 31, 2017, there were no securities (2016: 3 securities) in a continuous unrealized loss position for 12 months or greater. Based on the impairment review process and the ability and intent to hold these securities for a reasonable period of time sufficient for a full recovery, the Company concluded that the above equities in an unrealized loss position were temporarily impaired at December 31, 2017.
The following tables provide a breakdown of the Company's other investments, together with additional information relating to the liquidity of each category:
Long/short equity funds: Seek to achieve attractive returns primarily by executing an equity trading strategy involving both long and short investments in publicly-traded equities.
At December 31, 2017, the Company had $115 million (2016: $140 million) of unfunded commitments as a limited partner in funds which invest in real estate and real estate securities and businesses. These funds have investment terms ranging from 7 years to the dissolution of the underlying fund.
At December 31, 2017, the Company had $21 million (2016: $24 million) of unfunded commitments as a limited partner in a private equity fund. The life of the fund is subject to the dissolution of the underlying funds. The Company expects the overall holding period to be over 10 years.
During 2015, the Company made a $50 million commitment as a limited partner of a bank revolver opportunity fund. The fund is subject to an investment term of 7 years and the General Partners have the option to extend the term by up to 2 years. At December 31, 2017, this commitment remains unfunded. It is not anticipated that the full amount of this fund will be drawn.
During 2016, the Company paid $108 million including direct transaction costs to acquire 19% of the common equity of Harrington Reinsurance Holdings Limited ("Harrington"), the parent company of Harrington Re Ltd. ("Harrington Re"), an independent reinsurance company jointly sponsored by AXIS Capital and The Blackstone Group L.P. ("Blackstone"). Through long-term service agreements, AXIS Capital will serve as Harrington Re's reinsurance underwriting manager and Blackstone will serve as exclusive investment management service provider. As an investor, the Company expects to benefit from underwriting profit generated by Harrington Re and the income and capital appreciation Blackstone seeks to deliver through its investment management services. In addition, the Company has entered into an arrangement with Blackstone under which underwriting and investment related fees will be shared equally. Harrington is not a variable interest entity. Given that the Company exercises significant influence over the operating and financial policies of this investee the Company accounts for its ownership in Harrington under the equity method of accounting. The Company's proportionate share of the underlying equity in net assets resulted in a basis difference of $5 million which represents initial transactions costs.
The following table provides a roll forward of credit losses ("credit loss table"), before income taxes, for which a portion of the OTTI charge was recognized in AOCI:
For non-agency RMBS, the Company's projected cash flows incorporated underlying data from widely accepted third-party data sources along with certain internal assumptions and judgments regarding the future performance of the security. These assumptions included the following: default, delinquency, loss severity and prepayment rates. The assumptions used to calculate the credit losses in 2017 have not changed significantly since December 31, 2016. At December 31, 2017, the fair value of the Company's non-agency RMBS was $47 million (2016: $57 million), consisting primarily of $34 million (2016: $40 million) of Prime and $8 million (2016: $10 million) of Alt-A MBS. The Company has concluded there are no credit losses anticipated for any of its non-agency RMBS at December 31, 2017, other than those already recorded.
In order to support the Company's obligations in regulatory jurisdictions where it operates as a non-admitted carrier, the Company provides collateral in the form of assets held in trust and, to a lesser extent, letters of credit (see Note 11(b) 'Debt and Financing Arrangements').
In addition, the Company operates in the Lloyd’s market through its corporate member AXIS Corporate Capital UK Limited, which represents its participation in Syndicate 1686 and Novae Corporate Underwriting Limited, the sole corporate member of Syndicate 2007. Lloyd’s sets capital requirements for corporate members annually through the application of a capital model that is based on regulatory rules pursuant to Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking up and pursuit of business of Insurance and Reinsurance (Solvency II) ("Solvency II").
At December 31, 2017, the Company held $37 million (2016: $176 million) of reverse repurchase agreements. These loans are fully collateralized, are generally outstanding for a short period of time and are presented on a gross basis as part of cash and cash equivalents on the Company's consolidated balance sheet. The required collateral for these loans is either cash or U.S. Treasuries at a minimum rate of 102% of the loan principal. Upon maturity, the Company receives principal and interest income. The Company monitors the estimated fair value of the securities loaned and borrowed on a daily basis with additional collateral obtained as necessary throughout the duration of the transaction.
At each valuation date, the Company uses the market approach valuation technique to estimate the fair value of the fixed maturities portfolio, when possible. This market approach includes, but is not limited to, prices obtained from third party pricing services for identical or comparable securities and the use of "pricing matrix models" using observable market inputs such as yield curves, credit risks and spreads, measures of volatility, and prepayment speeds. Pricing from third party pricing services is sourced from multiple vendors, when available, and the Company maintains a vendor hierarchy by asset type based on historical pricing experience and vendor expertise. When prices are unavailable from pricing services, the Company obtains non-binding quotes from broker-dealers who are active in the corresponding markets. The valuation techniques including significant inputs generally used to determine the fair values of the Company's fixed maturities by asset class as well as the classifications of the fair values of these securities in the fair value hierarchy are described in detail below.
ABS include mostly investment-grade bonds backed by pools of loans with a variety of underlying collateral, including automobile loan receivables, student loans, credit card receivables, and CLO debt originated by a variety of financial institutions. The fair values of these securities are determined using a model which uses prepayment speeds and spreads sourced primarily from the new issue market. As the significant inputs used to price these securities are observable market inputs, the fair values of ABS are classified as Level 2. Where pricing is unavailable from pricing services, the Company obtains non-binding quotes from broker-dealers to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, the fair values of these securities are classified as Level 3.
Equity securities include common stocks, exchange-traded funds and bond mutual funds. As the fair values of common stocks and exchange-traded funds are based on unadjusted quoted market prices in active markets, these securities are classified as Level 1. As bond mutual funds have daily liquidity with redemptions based on the Net Asset Values per share ("NAV") of the funds, the fair values of these securities are classified as Level 2.
Indirect investments in CLO-Equities are classified as Level 3 as the fair values of these securities are estimated using an income approach valuation technique (discounted cash flow model) due to the lack of observable and relevant trades in secondary markets. Direct investments in CLO-Equities are also classified as Level 3 as the fair values of these securities are estimated using a liquidation valuation.
Insurance-linked securities comprise an investment in a catastrophe bond. As pricing is unavailable from pricing services, the Company obtains non-binding quotes from broker-dealers to estimate the fair values of these securities. Pricing is generally unavailable where there is a low volume of trading activity and current transactions are not orderly. Accordingly, the fair values of these securities are classified as Level 3.
Cash settled awards comprise restricted stock units that form part of the Company's compensation program. Although the fair values of these awards are determined using observable quoted market prices in active markets, the restricted stock units are not actively traded. Accordingly, the fair values of these liabilities are classified as Level 2.
Other privately held securities are initially valued at cost which approximates fair value. In subsequent measurement periods, the fair values of these securities are determined using internally developed discounted cash flow models. These models include inputs that are specific to each investment. The inputs used in the fair value measurements include dividend or interest rates and appropriate discount rates. The selection of an appropriate discount rate is judgmental and is the most significant unobservable input used in the valuation of these securities. A significant increase (decrease) in this input in isolation could result in significantly lower (higher) fair value measurement for other privately held securities. Where relevant, the Company also considers the contractual agreements which stipulate methodologies for calculating the dividend rate to be paid upon liquidation, conversion or redemption. In order to assess the reasonableness of the inputs that are used in the discounted cash flow models, the Company maintains an understanding of current market conditions, historical results, as well as investee specific information that may impact future cash flows.
Gains and losses included in other comprehensive income ("OCI") on fixed maturities are included in unrealized gains (losses) arising during the period.
The transfers to Level 3 from Level 2 made during 2016 were primarily due to the lack of observable market inputs and multiple quotes from pricing vendors and broker-dealers for certain fixed maturities and as a result of a change in the valuation methodology used to fair value the CLO-equity fund. An income approach valuation technique (discounted cash flow model) was used to estimate the fair value of the CLO-equity fund at December 31, 2016. As the NAV practical expedient was not used to determine the fair value of the CLO-equity fund, the fair value of the fund was categorized within the fair value hierarchy.
For direct lending funds, private equity funds, real estate funds and two of the Company's hedge funds, valuation statements are typically released on a three month reporting lag therefore the Company estimates the fair value of these funds by starting with the prior quarter-end fund valuations and adjusting for capital calls, redemptions, drawdowns and distributions. Return estimates are not available from the relevant fund managers for these funds. Accordingly, the Company typically has a reporting lag in fair value measurements of these funds. In 2017, funds reported on a lag represented 44% (2016: 35%) of the Company's total other investments balance.
The Company often does not have access to financial information relating to the underlying securities held within the funds, therefore management is unable to corroborate the fair values placed on the securities underlying the asset valuations provided by fund managers or fund administrators. In order to assess the reasonableness of the NAVs, the Company performs a number of monitoring procedures on a quarterly basis, to assess the quality of the information provided by fund managers and fund administrators. These procedures include, but are not limited to, regular review and discussion of each fund's performance with its manager, regular evaluation of fund performance against applicable benchmarks and the backtesting of the Company's fair value estimates against subsequently received NAVs. Backtesting involves comparing the Company's previously reported fair values for each fund against NAVs per audited financial statements (for year-end values) and final NAVs from fund managers and fund administrators (for interim values).
The fair values of hedge funds, direct lending funds, private equity funds and real estate funds are measured using the NAV practical expedient, therefore the fair values of these funds have not been categorized within the fair value hierarchy.
The fair value of financial instruments accounting guidance also applies to financial instruments disclosed, but not carried, at fair value, except for certain financial instruments, including insurance contracts.
The carrying values of cash and cash equivalents (including restricted amounts), accrued investment income, receivable for investments sold, certain other assets, payable for investments purchased and certain other liabilities approximated their fair values at December 31, 2017, due to their respective short maturities. As these financial instruments are not actively traded, their fair values are classified as Level 2.
At December 31, 2017, senior notes are recorded at amortized cost with a carrying value of $1,341 million (2016: $993 million) and a fair value of $1,412 million (2016: $1,050 million). The fair values of the senior notes are based on prices obtained from a third party pricing service and are determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As these spreads and the yields for the risk-free yield curve are observable market inputs, the fair values of senior notes are classified as Level 2.
At December 31, 2017, notes payable are recorded at amortized cost with a carrying value of $36 million and a fair value of $36 million. The fair values of the notes payable are primarily determined by estimating expected future cash flows and discounting them using current interest rates for notes payable with similar credit risk. As notes payable are not actively traded their fair values are classified as Level 3.
The balance sheet classification of derivatives recorded at fair value is shown in the following table. The notional amount of derivative contracts represents the basis upon which pay or receive amounts are calculated and is presented in the table to quantify the volume of the Company's derivative activities. Notional amounts are not reflective of credit risk.
The Company's derivative instruments are generally traded under International Swaps and Derivatives Association master netting agreements, which establish terms that apply to all transactions. In the event of a bankruptcy or other stipulated event, master netting agreements provide that individual positions be replaced with a new amount, usually referred to as the termination amount, determined by taking into account market prices and converting into a single currency. Effectively, this contractual close-out netting reduces credit exposure from gross to net exposure. A reconciliation of gross derivative assets and liabilities to the net amounts presented in the Consolidated Balance Sheets, with the difference being attributable to the impact of master netting agreements, is shown in the following table.
The Company's investment portfolio contains a large percentage of fixed maturities which expose it to significant interest rate risk. As part of overall management of this risk, the Company may use interest rate swaps.
The Company's (re)insurance subsidiaries and branches operate in various foreign countries. Consequently, some of its business is written in currencies other than the U.S. dollar therefore, the underwriting portfolio is exposed to significant foreign currency risk. The Company manages foreign currency risk by seeking to match its foreign-denominated net liabilities under (re)insurance contracts with cash and investments that are denominated in such currencies. The Company may also use derivative instruments, specifically forward contracts and currency options, to economically hedge foreign currency exposures.
Within the Company's (re)insurance portfolio it is exposed to commodity price risk. The Company may hedge a portion of this price risk by entering into commodity derivative contracts.
The following tables reconcile reserve classes to the lines of business categories and the expected claim tails:
As part of the loss reserve review process, the Company's actuaries employ the estimation method(s) that they believe will produce the most reliable estimate of ultimate losses, at that particular evaluation date, for each reserve class and accident year or underwriting year combination. Often, this is a blend (i.e. weighted average) of the results of two or more appropriate actuarial methods. These ultimate loss estimates are generally utilized to evaluate the adequacy of ultimate loss estimates for previous accident or underwriting years, as established in the prior reporting period. For the initial estimate of the current accident or underwriting year, the available claim data is typically insufficient to produce a reliable estimate of ultimate losses. As a result, initial estimates for an accident or underwriting year are generally based on the ELR Method for longer tailed lines and a BF Method for shorter tailed lines. The initial ELR for each reserve class is established collaboratively by actuaries, underwriters and management at the start of the year as part of the planning process, taking into consideration prior accident years’ or underwriting years' experience and industry benchmarks, adjusted after considering factors such as exposure trends, rate differences, changes in contract terms and conditions, business mix changes and other known differences between the current year and prior accident or underwriting years. The initial expected loss ratios for a given accident or underwriting year may be modified over time if the underlying assumptions, such as loss development or premium rate changes, differ from the original assumptions.
discussions of the impact of the event with customers and brokers and
The Company writes business with loss experience generally characterized as low frequency and high severity in nature, which can result in volatility in its financial results. During 2017, 2016 and 2015, respectively, the Company recognized net losses and loss expenses, net of reinstatement premiums, of $835 million, $204 million and $100 million attributable to catastrophe and weather-related events.
Prior year reserve development arises from changes to loss and loss expense estimates related to loss events that occurred in previous calendar years. Such development is summarized by segment in the following table:
Short-tail business includes the underlying exposures in property and other, marine and aviation reserve classes within the insurance segment and the property and other reserve class within the reinsurance segment.
The insurance professional reserve class recorded net favorable prior year development of $26 million in 2017 reflecting the generally favorable experience on earlier accident years as the Company transitions to more experienced based methods. As loss experience has generally been better than expected, this resulted in the recognition of net favorable prior year reserve development. The insurance professional reserve class recorded net favorable prior year reserve development of $14 million in 2016, also driven by overall better than expected development. The insurance professional reserve class recorded adverse prior year development of $14 million in 2015 due to reserve strengthening on the Australian book of business during the three months ended September 30, 2015.
The credit and political risk reserve class recorded net adverse development of $15 million in 2015 primarily related to an increase in loss estimates for one specific claim.
The motor reserve class contributed net favorable prior year reserve development of $1 million, $55 million and $37 million, in 2017, 2016 and 2015, respectively. The net favorable prior year reserve development on the motor reserve class in 2016 and 2015 related to favorable loss emergence trends on several classes of business spanning multiple accident years. Net favorable prior year development in 2017 was impacted by the U.K. Ministry of Justice's announcement of a decrease in the discount rate used to calculate lump sum awards in U.K. bodily injury cases, known as the Ogden Rate. Effective March 20, 2017, the Ogden rate changed from plus 2.5% to minus 0.75%.
This favorable prior year development was partially offset by net adverse prior year development in the insurance liability reserve class of $8 million, $8 million and $27 million in 2017, 2016 and 2015, respectively, primarily related to reserve strengthening within the excess casualty book. In particular, the adverse development during 2015 was mainly driven by a higher frequency of large auto liability claims.
At December 31, 2017 net reserve for losses and loss expenses includes estimated amounts for numerous catastrophe events. The magnitude and/or complexity of losses arising from certain of these events, in particular Hurricanes Harvey, Irma and Maria, the two earthquakes in Mexico and the wildfires in Northern and Southern California in 2017, inherently increases the level of uncertainty and, therefore, the level of management judgment involved in arriving at estimated net reserves for losses and loss expenses. As a result, actual losses for these events may ultimately differ materially from current estimates.
The following tables present net incurred and paid claims development by accident year, total incurred-but-not-reported liabilities plus expected development on reported claims, cumulative reported claims frequency and claims duration for each reserve class. The development triangles are presented on an accident year basis for both the insurance and reinsurance segments. The Company does not discount unpaid losses and loss expense reserves.
The Company has presented separate loss development tables for the Aviabel and Novae business prospectively from the date of acquisition. The prospective treatment for the acquisition of Aviabel and Novae was adopted primarily due to the data necessary to produce the loss development tables by accident year not being available prior to the acquisition date. With regard to establishing the fair value of reserves for losses and loss expenses for Novae at the acquisition date, weight was given to the observable value of these reserves based on a Reinsurance to Close (“RITC”) transaction of the Syndicate’s 2015 and prior years of account, which was completed prior to the allocation of purchase price. Management made no change to the initial estimate when establishing its best estimate of reserves for losses and loss expenses at December 31, 2017. This is consistent with the Company's general approach of recognizing all or part of the anticipated cost of third party liability commutations if the transaction has either completed or is considered sufficiently likely to be completed in the near term.
There are many considerations in establishing loss reserves and an attempt to evaluate loss reserves using solely the data presented in these tables could be misleading. The Company cautions against mechanical application of standard actuarial methodologies to project ultimate losses using data presented in this disclosure.
The reporting of cumulative claims frequency for the reserve classes within the insurance segment has been measured by counting the number of unique claim references including claim references assigned to nil and nominal case reserves. Claim references are grouped by claimant by loss event for each class of business. For certain insurance facilities and business produced by managing general agents where underlying data is reported to the Company in an aggregated format, the information necessary to provide cumulative claims frequency is not available therefore reporting of claims frequency is deemed to be impracticable.
The property line of business provides physical loss or damage, business interruption and machinery breakdown cover for virtually all types of property, including commercial buildings, residential premises, construction projects and onshore energy installations. This line of business includes both primary and excess risks, some of which are catastrophe-exposed.
The terrorism line of business provides cover for physical damage and business interruption of an insured following an act of terrorism and includes kidnap & ransom, and crisis management insurance.
This reserve class includes the marine line of business which provides cover for traditional marine classes, including offshore energy, cargo, liability, recreational marine, fine art, specie as well as hull and war. Offshore energy includes physical damage, business interruption, operators extra expense and liability coverage for all aspects of offshore upstream energy, from exploration and construction through the operation and distribution phases. The complex nature of claims arising under marine policies tends to result in reporting and payment patterns that are longer than those of the property and other class. Exposure to natural perils such as windstorm and earthquake can result in volatility.
This reserve class includes the aviation line of business which provides cover for hull and liability, and specific war covers primarily for passenger airlines but also for cargo operations, general aviation operations, airports, aviation authorities, security firms and product manufacturers. The claims reporting pattern varies by insurance coverage provided. Losses arising from war or terrorism and damage to hulls of aircraft are generally reported quickly compared with liability claims which involve passengers and third parties which generally exhibit longer reporting and payment patterns. To date, the claims reported to the Company have predominantly related to damage to hulls, therefore reporting and payment patterns have typically exhibited a relatively short tail.
This reserve class includes the professional line of business which provides directors’ and officers’ liability, errors and omissions liability, employment practices liability, fiduciary liability, crime, professional indemnity, cyber and privacy insurance, medical malpractice and other financial insurance related covers for commercial enterprises, financial institutions and not-for-profit organizations. This business is predominantly written on a claims-made basis. Typically this reserve class is anticipated to exhibit medium to long tail claim reporting and payment patterns.
With respect to key actuarial assumptions, the Company is progressively giving more weight to its own experience when establishing expected loss ratios and selected loss development patterns, though it continues to consider industry benchmarks. Loss reporting patterns for professional lines business tend to be volatile, causing instability in actuarial indications based on incurred loss data until an accident year matures for a number of years. Consequently, initial loss reserves for an accident year are generally based upon an ELR method and the consideration of relevant qualitative factors. As accident years mature, the Company increasingly gives more weight to methods that reflect its actual experience until its selections are based almost exclusively on experience-based methods. The Company evaluates the appropriateness of the transition to experience-based methods at the reserve class level, commencing this transition when it believes that its incurred loss development is sufficient to produce meaningful actuarial indications. The rate at which the Company transitions fully to sole reliance on experience-based methods can vary, depending on its assessment of the stability and relevance of such indications. For some professional
This reserve class includes the liability line of business which primarily targets primary and low/mid-level excess and umbrella commercial liability risks in the U.S. wholesale markets in addition to primary and excess of loss employers, public, and products liability predominately in the U.K. Target industry sectors include construction, manufacturing, transportation and trucking and other services. The delay between the writing of a contract, notification and subsequent settlement of a claim in respect of that contract results in claim reporting and payment patterns that are typically long tail in nature. A consequence of the claim development tail is that this line of business is particularly exposed, amongst a number of uncertainties, to the potential for unanticipated levels of claim inflation relative to that assumed when the contracts were written. Factors influencing claim inflation on this class can include, but are not limited to, underlying economic and medical inflation, judicial inflation, mass tort and changing social trends.
The presentation of net incurred and paid claims development tables by accident year for the reinsurance segment is challenging due to need to the allocate loss information related to proportional treaties to the appropriate accident years. Information related to proportional treaty reinsurance contracts are generally submitted to the Company using quarterly bordereau reporting by underwriting year, with a supplemental listing of large losses. The large losses can be allocated to the corresponding accident years accurately. However, the remaining losses can generally only be allocated to accident years based on estimated premiums earned and loss reporting patterns. To the extent management’s assumptions and allocation procedures differ from the actual loss development patterns, the actual loss development may differ materially from the net incurred and paid claims development presented in the tables below.
This reserve class includes property, catastrophe, engineering, agriculture, as well as marine and other.
The property line of business provides protection for property damage and related losses resulting from natural and man-made perils contained in underlying personal and commercial policies. While the predominant exposure is to property damage, other risks, including business interruption and other non-property losses, may also be covered when arising from a covered peril. While the most significant exposures typically relate to losses from windstorms, tornadoes and earthquakes, the Company is also exposed to other perils such as freezes, riots, floods, industrial explosions, fires, hail and a number of other loss events. The Company underwrites property reinsurance business on both a proportional and excess of loss basis.
The engineering line of business provides protection for all types of construction risks and risks associated with erection, testing and commissioning of machinery and plants during the construction stage. This line of business also includes coverage for losses arising from operational failures of machinery, plant and equipment and electronic equipment as well as business interruption.
This reserve class includes the credit and surety line of business which provides reinsurance of trade credit insurance products and includes both proportional and excess of loss structures. The underlying insurance indemnifies sellers of goods and services in the event of a payment default by the buyer of those goods and services. The Company provides credit insurance cover to mortgage guaranty insurers and government sponsored entities. Coverages for losses arising from a broad array of surety bonds issued by insurers to satisfy regulatory demands or contract obligations in a variety of jurisdictions around the world are also offered.
The Company offers traditional proportional and non-proportional reinsurance as well as structured solutions predominantly relating to European exposures. The business written on a proportional basis has expanded significantly since 2010 and now represents the majority of the premium written within this line of business. Most of the premium relates to a relatively small number of large United Kingdom ("U.K.") and, to a lesser extent, Greek quota share treaties. The motor proportional class generally has a significantly shorter reported and payment pattern relative to the motor non-proportional class.
The motor non-proportional business consists of standard excess of loss contracts written for cedants in several European countries with most of the premium related to two major markets, U.K. and France. Since 2009/2010, an increasing number of large bodily injury settlements in the U.K. market were settled using indexed annuities (Periodical Payment Orders "PPOs"). This led to a materially longer development tail on the older accident years for the U.K. non-proportional motor book. This also resulted in a move towards generally lower treaty attachment points and the inclusion of capitalization clauses on a number of U.K. motor treaties to help mitigate the lengthening of the development tail on more recent accident years. Despite the trend toward a greater number of claims settlements using PPOs, there has been a trend towards generally quicker and more adequate reporting of losses in recent years.
Claim reporting and payment patterns are typically long-tail in nature and, therefore, subject to increased uncertainty surrounding future loss development. In particular, claims can be subject to inflation from a number of sources including, but not limited to, economic and medical inflation, judicial inflation and changing social trends.
The Company has determined that reporting of cumulative claims frequency for direct insurance lines of business is impracticable as data by accident year is not available. Further for certain insurance facilities and business produced by managing general agents where underlying data is reported to the Company in an aggregated format, the information necessary to provide cumulative claims frequency is not available therefore reporting of claims frequency is deemed to be impracticable. In addition, the information necessary to provide cumulative claims frequency for reinsurance lines of business is not available to the Company, therefore reporting of claims frequency is deemed to be impracticable.
Credit & political risk: International trade credit and political risks business was written from 2000 onwards. Typically this business is anticipated to exhibit medium to long tail claim reporting and payment patterns.
Motor: Motor line of business was written on a direct basis until this business was discontinued in 2015. Motor business has been written on an excess of loss basis since 2010. The business predominantly covers U.K. based risks. Typically, this business is anticipated to exhibit long-tail claim reporting and payment patterns.
Treaty reinsurance provides cover for a specified type or category of risks. The Company's treaty reinsurance agreements provide this cover on either an excess of loss or a proportional basis. Excess of loss covers provide a contractually set amount of coverage after a specified loss amount has been reached. These treaties can provide cover for a number of lines of business within one contract. Under proportional reinsurance, the Company cedes an agreed proportion of the premiums and the losses and loss expenses on the policies it underwrites. These treaties provide us with a specified percentage of coverage from the first dollar of loss.
All of these reinsurance covers provide us the right to recover a portion of specified losses and loss expenses from reinsurers. However, to the extent that reinsurers do not meet their obligations under these agreements due to solvency issues, contractual disputes or other reasons, the Company remains liable. The Company predominantly cedes its business to reinsurers rated A- or better by A.M. Best Company, Inc. ("A.M. Best").
For the year ended December 31, 2017, the Company recognized ceded losses and loss expenses of $1,010 million (2016: $556 million; 2015: $577 million).
At December 31, 2017, the Company's provision for unrecoverable reinsurance was $17 million (2016: $20 million).
At December 31, 2017, gross reinsurance recoverables collectible from reinsurers rated A- or better by A.M. Best were 88.8% (2016: 96.7%).
On March 13, 2014, AXIS Specialty Finance PLC, a 100% owned finance subsidiary, issued $250 million aggregate principal amount of 2.65% senior unsecured notes (the "2.65% Senior Notes") at an issue price of 99.896% and $250 million aggregate
principal amount of 5.15% senior unsecured notes (the "5.15% Senior Notes", and, together with the 5.875% Senior Notes and the 2.65% Senior Notes, the "Senior Notes") at an issue price of 99.474%. The net proceeds of the issuance, after consideration of the offering discount and underwriting expenses and commissions, totaled approximately $248 million and $246 million for the 2.65% Senior Notes and the 5.15% Senior Notes, respectively. Interest on the 2.65% Senior Notes and the 5.15% Senior Notes is payable semi-annually in arrears on April 1 and October 1 of each year, beginning on October 1, 2014. Unless previously redeemed, the 2.65% Senior Notes and the 5.15% Senior Notes will mature on April 1, 2019 and April 1, 2045, respectively. The 2.65% Senior Notes and the 5.15% Senior Notes are ranked as unsecured senior obligations of AXIS Specialty Finance PLC. AXIS Capital has fully and unconditionally guaranteed all obligations of AXIS Specialty Finance PLC under the 2.65% Senior Notes and the 5.15% Senior Notes. AXIS Capital's obligations under this guarantee are unsecured senior obligations and rank equally with all other senior obligations of AXIS Capital.
Interest expense recognized in relation to Senior Notes includes interest payable, amortization of the offering discounts and amortization of debt offering expenses. The offering discounts and debt offering expenses are amortized over the period of time during which the Senior Notes are outstanding. For the year ended December 31, 2017, the Company incurred interest expense of $51 million (2016: $50 million, 2015: $50 million).
On June 30, 2004, Novae issued $15 million aggregate principal amount of LIBOR plus 3.50% subordinated unsecured notes (the "$15 million Dekania Notes") and $11 million aggregate principal amount of LIBOR plus 4.05% subordinated unsecured notes (the "$11 million Dekania Notes"). On September 29, 2004, Novae issued $10 million aggregate principal amount of LIBOR + 3.50% subordinated notes (the "$10 million Dekania Notes" and together with the "$15 million Dekania Notes" and the "$11 million Dekania Notes" the "Dekania Notes"). The net proceeds of the issuance, after consideration of the offering discount and underwriting expenses and commissions, totaled approximately $35 million. Interest on the Dekania Notes is payable quarterly in arrears on February 15, May 15, August 15 and November 15 of each year. Unless previously redeemed, the $15 million Dekania Notes and the $11 million Dekania Notes will mature on June 30, 2034 and the $10 million Dekania Notes will mature on September 29, 2034. The Dekania Notes are ranked as unsecured and subordinated obligations of Novae. AXIS Capital has not fully and unconditionally guaranteed obligations of Novae under the Dekania Notes.
Interest expense recognized in relation to the Dekania Notes includes interest payable, amortization of the offering discounts and amortization of debt offering expenses. The offering discounts and debt offering expenses are amortized over the period of time during which the Dekania Notes are outstanding. For the year ended December 31, 2017, the Company incurred interest expense of $2 million.
On March 26, 2013, AXIS Capital and certain of its subsidiaries entered into a $250 million credit facility (the "Credit Facility"), which was issued by a syndication of lenders pursuant to a Credit Agreement and other ancillary documents (together, the "Facility Documents") and will expire in March 2017. At the request of the Company and subject to the satisfaction of certain conditions, the aggregate commitment available under the Credit Facility may be increased by up to $150 million. Under the terms of the Credit Facility, loans are available for general corporate purposes and letters of credit may be issued in the ordinary course of business, with total usage not to exceed the aggregate commitment available. Interest on loans issued under the Credit Facility is payable based on underlying market rates at the time of loan issuance. While loans under the Credit Facility are unsecured, the Company has the option to issue letters of credit on a secured basis in order to reduce associated fees. Letters of credit issued under the Credit Facility would principally be used to support the (re)insurance obligations of the Company's operating subsidiaries. Each of AXIS Capital, AXIS Specialty Finance LLC, AXIS Specialty Holdings Bermuda Limited and AXIS Specialty Finance PLC guarantees the obligations of the other parties to the Credit Facility. The Credit Facility is subject to certain non-financial covenants, including limitations on fundamental changes, the incurrence of additional indebtedness and liens and certain transactions with affiliates and investments, as defined in the Facility Documents. The Credit Facility also requires compliance with certain financial covenants, including a maximum debt to capital ratio and a minimum consolidated net worth requirement. In addition, each of AXIS Capital’s material (re)insurance subsidiaries party to the Credit Facility must maintain a minimum A.M. Best financial strength rating. In the event of default, including a breach of these covenants, the lenders may exercise certain remedies including the termination of the Credit Facility, the declaration of all principal and interest amounts related to Credit Facility loans to be immediately due and the requirement that all outstanding letters of credit be collateralized.
On March 31, 2015, the Company entered into an amendment to reduce the maximum aggregate utilization capacity of the LOC Facility from $750 million to $500 million. All other material terms and conditions remained unchanged.
On December 29, 2017, the term loan was repaid and the letter of credit and revolving credit facility was terminated. For the year ended December 31, 2017, the Company recognized $1 million of interest expense in relation to the syndicated bank financing facility.
The Company monitors and manages the aggregation of credit risk on a group-wide basis allowing it to consider exposure management strategies for individual companies, countries, regions, sectors and any other relevant inter-dependencies. The Company's credit exposures are aggregated based on the origin of risk. As part of its credit aggregation framework, the Company also assigns aggregate credit limits by single counterparty (a group of companies or country). These limits are based on and adjusted for a variety of factors including the prevailing economic environment and the nature of the underlying credit exposures. The Company's credit aggregation measurement and reporting process is facilitated by its credit risk exposure database, which contains relevant information on counterparty details and credit risk exposures. The Company also licenses third party tools to provide credit risk assessments.
The assets that potentially subject the Company to concentrations of credit risk consist principally of cash and investments, reinsurance recoverable and (re)insurance premiums receivable balances, as described below:
At December 31, 2017, the Company was in compliance with these limits.
Within the Company's reinsurance purchasing activities, it is exposed to the credit risk of a reinsurer failing to meet its obligations under reinsurance contracts. To help mitigate this, the Company's reinsurance purchasing is subject to financial security requirements specified by its Reinsurance Security Committee. This Committee maintains a list of approved reinsurers, performs credit risk assessments for potential new reinsurers, regularly monitors approved reinsurers with consideration for events which may have a material impact on their creditworthiness, recommends counterparty tolerance levels for different types of ceded business and monitors concentrations of credit risk. This assessment considers a wide range of individual attributes, including a review of the counterparty’s financial strength, industry position and other qualitative factors. Generally, the Committee requires that reinsurers who do not meet specified requirements provide collateral.
These contractual rights contribute to the mitigation of credit risk, as does monitoring of aged premium balances receivable. In light of these mitigating factors, and considering that a significant portion of premium balances receivable are not currently due based on the terms of the underlying contracts, the Company does not utilize specific credit quality indicators to monitor its premium balances receivable.
For the year ended December 31, 2017, bad debt expense was $nil (2016: $1 million).
From time to time, the Company is subject to routine legal proceedings, including arbitrations, arising in the ordinary course of business. These legal proceedings generally relate to claims asserted by or against the Company in the ordinary course of insurance or reinsurance operations. Estimated amounts payable under such proceedings are included in the reserve for losses and loss expenses in the Consolidated Balance Sheets.
At December 31, 2017 the Company has $414 million (2016: $401 million) of unfunded investment commitments related to the other investment portfolio, which are callable by investment managers (see Note 6(c) 'Investments'). At December 31, 2017 the Company has a $16 million (2016: $2 million) commitment to purchase commercial mortgage loans.
The capital provided to support underwriting, or FAL may be satisfied by cash, certain investments and letters of credit provided by approved banks.
The following table presents a comparison of basic and diluted earnings per common share:
On August 17, 2015, the Company entered into an Accelerated Share Repurchase ("ASR") agreement (see Note 14 'Shareholders' Equity'). The weighted-average number of shares outstanding used in the computation of basic and diluted earnings per share reflects the Company’s receipt of 4,149,378 shares delivered to the Company on August 20, 2015, and 1,358,380 common shares delivered to the Company on January 15, 2016 under the Company's ASR agreement.
Shares are repurchased from employees to satisfy withholding tax liabilities upon the vesting of restricted stock awards, restricted stock units, and the exercise of stock options. Share repurchases from employees are excluded from the authorized share repurchase plan noted above.
On November 23, 2005, the Company issued $250 million of 7.50% Series B preferred shares, par value $0.0125 per share, with a liquidation preference of $100.00 per share. The Company may redeem the Series B preferred shares on or after
During April 2012, the Company closed a cash tender offer for any and all of the outstanding 7.50% Series B preferred shares at a purchase price of $102.81 per share. As a result, the Company purchased 2,471,570 Series B preferred shares for $254 million. In connection with this tender offer, a loss on redemption of $9 million (calculated as the difference between the redemption price and the carrying value) was recognized in determining net income available to common shareholders.
In 2017, total dividends declared on Series D preferred shares were $1.3750 per share, of which $1.0313 was paid in 2017 and the remaining $0.34375 is payable in 2018. In 2016 and 2015, total dividends declared and paid on Series D preferred shares were $1.3750 per share.
During 2017, total pension expenses were $24 million (2016: $23 million and 2015: $21 million) for the above retirement benefits.
Restricted stock awards ("RSAs") granted pursuant to the 2007 Plan generally vest in four equal installments on the first, second, third and fourth anniversaries of the grant date.
Grants provided under the 2017 Plan and the 2007 Plan generally allow for accelerated vesting provisions upon the employee’s death, permanent disability, or certain terminations following a change in control of the Company occurring within two years of the change in control event. Notwithstanding these vesting provisions, the Compensation Committee of our Board has broad authority to accelerate vesting at its own discretion.
(1) Fair value is based on the closing price of our common shares on the grant approval date.
At December 31, 2017, the liability for cash-settled restricted stock units, included in other liabilities in the Consolidated Balance Sheets, was $22 million (2016: $48 million).
During 2017, the Company incurred share-based compensation costs of $68 million (2016: $74 million; 2015: $59 million) related to restricted stock awards, share-settled restricted stock units, and cash-settled restricted stock units. In addition, the Company recorded associated tax benefits of $15 million (2016: $16 million; 2015: $15 million), including $7 million related to excess tax benefits associated with the vesting of restricted stock units.
A member of the Company’s Board of Directors, Mr. Charles Davis, is the Chief Executive Officer of Stone Point Capital, LLC ("Stone Point"). In the ordinary course of business, the Company engages SKY Harbor Capital Management, LLC, an affiliate of Stone Point, to provide asset management services for certain short duration high yield debt portfolios. For the year ended December 31, 2017, total fees paid to SKY Harbor Capital Management, LLC, were $2 million (2016: $3 million; 2015: $3 million). In 2015, the Company engaged StoneRiver RegEd, also an affiliate of Stone Point, to provide broker and adjuster licensing, appointment and compliance service. For the year ended December 31, 2015 total fees paid to StoneRiver RegEd were $0.5 million.
The Company currently has $30 million committed to the NXT Capital Senior Loan Fund II and $30 million committed to NXT Capital Senior Loan Fund III. The manager of these funds is an indirect subsidiary of NXT Capital Holdings, L.P. ("NXT Capital"). Investment funds managed by Stone Point own approximately 42% of NXT Capital. For the year ended December 31, 2017, fees paid to NXT Capital totaled $1 million (2016: $1 million; 2015: $1 million). In addition, the Company currently has $50 million committed to the Freedom Consumer Credit Fund, LLC Series B. The manager of this fund is Freedom Financial Asset Management, LLC ("Freedom") which is an indirect subsidiary of Pantheon Partners, LLC ("Pantheon"). Investment funds managed by Stone Point own approximately 14.5% of Pantheon. For the year ended December 31, 2017, fees paid to Freedom totaled $1.1 million.
On November 5, 2013, the Company formed Ventures Re, a Bermuda domiciled insurer. With effect from January 1, 2015, Ventures Re is no longer consolidated in the financial statements of the Company. All of Ventures Re's directors are employees of the Company. In the normal course of business, the Company enters into certain reinsurance contracts with Ventures Re. For the year ended December 31, 2017, the Company ceded premiums of $107 million (2016: $40 million) and ceded losses of $126 million (2016: $10 million) to Ventures Re. In addition, Ventures Re paid certain acquisition costs and administrative fees to the Company. At December 31, 2017, the amount of reinsurance recoverable on unpaid and paid losses was $131 million (2016: $22 million) and the amount of ceded reinsurance payable included in insurance and reinsurance balances payable was $17 million (2016: $15 million ) in the Consolidated balance sheets. All transactions were conducted at market rates consistent with negotiated arms-length contracts.
An analysis of income tax expense and net tax assets is shown in the following table:
On December 22, 2017, H.R.1, An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018 ("U.S. Tax Reform") was signed into law. U.S. Tax Reform, among other things, reduced the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018. Consequently, the Company reduced its net deferred tax assets as of December 31, 2017 by $41.6 million which is reflected in deferred tax expense.
Total operating and capital loss carryforwards and tax credits are summarized in the following table:
An analysis of the movement in the Company's valuation allowance is shown in the following table:
At December 31, 2017 and 2016, the Company established a full valuation allowance on: (1) operating and capital loss carryforwards relating to operations in Australia and Singapore; (2) un-utilized foreign tax credits available in Ireland and (3)
Although realization is not assured, management believes it is more likely than not that the tax benefit of the recorded net deferred tax assets will be realized. In evaluating the Company's ability to recover these tax assets within the jurisdiction from which they arise, it considered all available positive and negative evidence, including historical results, operating loss carry-back potential and scheduled reversals of deferred tax liabilities. The Company believes its U.S. and U.K. operations will produce significant taxable income in future periods and have deferred tax liabilities that will reverse in future periods, such that the Company believes sufficient ordinary taxable income is available to utilize all remaining ordinary deferred tax assets. In 2017 and 2016, there were sufficient net unrealized gains or capital loss carryback potential to offset remaining impairments, therefore, a valuation allowance on such impairments in the U.S. was not considered necessary.
At December 31, 2017 and 2016, there were no unrecognized tax benefits.
On March 27, 2017, as part of the wind down of the Company's Australia operation, the Australia Prudential Regulation Authority revoked the authorization of AXIS Specialty Australia to carry on insurance business in Australia. As this resulted in the substantial liquidation of AXIS Specialty Australia, the cumulative translation adjustment related to AXIS Specialty Australia of $24 million was released from accumulated other comprehensive income in the Consolidation Balance Sheet to foreign exchange losses in the Consolidated Statement of Operations.
The Company's (re)insurance operations are subject to insurance and/or reinsurance laws and regulations in the jurisdictions in which they operate, the most significant of which include Bermuda, Ireland, the U.S. and Lloyd's. These regulations include certain restrictions on the amount of dividends or other distributions, such as loans or cash advances, available to shareholders without prior approval of the insurance regulatory authorities.
The Company's Irish subsidiaries may declare dividends subject to meeting their solvency and capital requirements. The maximum dividend is limited to "excess eligible own funds" which is defined as excess Solvency II capital over the SCR and may also be limited to "profits available for distribution'', which is defined as accumulated realized profits less accumulated realized losses and statutory reserves. At December 31, 2017, the maximum dividend the Company's Irish subsidiaries could pay, having met their solvency and capital requirements was approximately $52 million (2016: $372 million).
In addition, the Company operates in the Lloyd's market through Novae Corporate Underwriting Limited, the sole corporate member of Syndicate 2007 and owns Lloyd’s managing agency, Novae Syndicates Limited ("NSL") which operated in the Lloyd’s insurance market and managed Syndicate 2007 and SPA 6129.
SPA 6129 commenced trading on January 1, 2016, was managed by NSL and all of its capacity was provided by third party capital represented by Securis Investment Partners LLP, a Lloyd’s member agent. For the three month period ended December 31, 2017, NSL received a managing agency fee from SPA 6129 and allocated a proportion of administrative expenses to SPA 6129.
The capital provided to support underwriting, or Funds at Lloyd’s ("FAL") is not available for distribution for the payment of dividends or for working capital requirements. Corporate members may also be required to maintain funds under the control of Lloyd’s in excess of their capital requirements and such funds also may not be available for distribution for the payment of dividends. Lloyd’s sets the corporate members’ required capital annually through the application of a capital model that is based on regulatory rules pursuant to Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking up and pursuit of business of Insurance and Reinsurance (Solvency II) ("Solvency II"). FAL may comprise cash, certain investments and letters of credit provided by approved banks.
FAL may be satisfied by cash, certain investments and letters of credit provided by approved banks. At December 31, 2017 fixed maturities and short term investments with a fair value of $557 million (2016: $293 million), equity securities with a fair value of $nil (2016: $83 million), and cash of $12 million (2016: $7 million), respectively, were restricted to satisfy AXIS
On January 1, 2018, the Company received authorization from Lloyd’s for AXIS Managing Agency to commence management and oversight of Syndicate 2007 and SPA 6129.
Total statutory net income (loss) of the Company's operating subsidiaries was $(94) million, $598 million, $457 million for 2017, 2016 and 2015, respectively. The differences between statutory financial statements and statements prepared in accordance with U.S. GAAP vary by jurisdiction, however, the primary differences are that statutory financial statements may not reflect deferred acquisition costs, certain net deferred tax assets, goodwill and intangible assets, unrealized appreciation or depreciation on debt securities or certain unauthorized reinsurance recoverables.
On January 1, 2018, AXIS Managing Agency, the managing agent of Syndicate 2007 entered into an agreement for the RITC of the 2015 and prior years of account of Syndicate 2007. This contract will be accounted for as a novation reinsurance contract in the three month period ended March 31, 2018. The Company will cede $819 million of reserves for losses and loss expenses, included in Syndicate 2007's balance sheet at December 31, 2017, to a reinsurer. This transaction will result in a reduction in investments and cash representing the consideration due to the reinsurer together with a reduction in reserves for losses and loss expenses representing the transfer of liabilities to the reinsurer.