The following is a discussion and analysis of our financial condition and results of operations for the twelve months ended December 31, 2016, 2015 and 2014. This discussion and analysis should be read in conjunction with our audited consolidated financial statements and Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties and that are not historical facts, including statements about our beliefs and expectations. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and particularly under the headings “Risk Factors,” “Business” and “Note on Forward-Looking Statements” contained in Item 1A, Item 1, and Part I of this Form 10-K, respectively.
Throughout this Form 10-K, our analysis of our financial condition and results of operations is based on our consolidated financial statements which have been prepared in accordance with GAAP. Our results of operations have been presented in the way that we believe will be the most meaningful and useful to investors, analysts, rating agencies and others who use financial information in evaluating our performance. This presentation includes the use of underwriting profit and Adjusted EBITDA, which are “non-GAAP financial measures,” as such term is defined in Item 10(e) of Regulation S-K promulgated by the SEC. The presentation of these financial measures is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. Also note that these measures may be different from non-GAAP financial measures used by other companies, limiting their usefulness for comparison purposes. A discussion of our calculation and use of these financial measures is provided below.
Adjusted EBITDA is a non-GAAP financial measure for our non-insurance operating subsidiaries and investments held by Alleghany Capital. Adjusted EBITDA represents other revenue less certain other expenses, and does not include: (i) depreciation expense (a component of other operating expenses); (ii) amortization of intangible assets; (iii) interest expense; (iv) net realized capital gains; (v) OTTI losses; and (vi) income taxes. Because Adjusted EBITDA excludes interest, income taxes, net realized capital gains, OTTI losses, depreciation and amortization, it provides an indication of economic performance that is not affected by levels of debt, interest rates, effective tax rates or levels of depreciation and amortization resulting from purchase accounting. We use Adjusted EBITDA as a supplement to earnings before income taxes, the most comparable GAAP financial measure, to evaluate the performance of certain of our non-insurance operating subsidiaries and investments. A reconciliation of Adjusted EBITDA to earnings before income taxes is presented within “Consolidated Results of Operations.”
The following overview does not address all of the matters covered in the other sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations or contain all of the information that may be important to our stockholders or the investing public. This overview should be read in conjunction with the other sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Net earnings attributable to Alleghany stockholders were $456.9 million in 2016, compared with $560.3 million in 2015 and $679.2 million in 2014.
Net investment income in 2016 approximated net investment income in 2015, and decreased by 4.6 percent in 2015 from 2014.
Net favorable prior accident year loss reserve development was $368.0 million in 2016, compared with $215.5 million in 2015 and $215.2 million in 2014.
2015 vs 2014. The increase in gross premiums written in 2015 from 2014 reflects a slight increase at our reinsurance segment, partially offset by a slight decrease at our insurance segment. The increase in gross premiums written at our reinsurance segment primarily reflects $221.6 million of premiums recorded on December 31, 2015 related to the Quota Share Treaty, partially offset by the impact of changes in foreign exchange rates, reduced participation in or non-renewal of certain treaties and reductions in pricing. The decrease in gross premiums written at our insurance segment primarily reflects lower premiums at RSUI, partially offset by continued significant growth in premiums at PacificComp and CapSpecialty.
A comparison of premiums by segment for 2016, 2015 and 2014 is more fully described in the following pages.
2016 vs 2015. The increase in net loss and LAE in 2016 from 2015 primarily reflects an increase at our reinsurance segment due primarily to higher net premiums earned, as discussed above, higher catastrophe losses, as well as higher non-catastrophe losses in the current accident year related to the Quota Share Treaty, partially offset by an increase in favorable prior accident year loss reserve development.
2015 vs 2014. The decrease in net loss and LAE in 2015 from 2014 reflects a decrease at our reinsurance segment, partially offset by an increase at our insurance segment. The decrease at our reinsurance segment primarily reflects the impact of lower net premiums earned, as discussed above and, to a lesser extent, lower catastrophe losses and more favorable prior year loss reserve development. The increase at our insurance segment primarily reflects the impact of higher net premiums earned and less favorable prior year loss reserve development overall, partially offset by lower catastrophe losses.
A comparison of commissions, brokerage and other underwriting expenses by segment for 2016, 2015 and 2014 is more fully described in the following pages.
A comparison of underwriting profits by segment for 2016, 2015 and 2014 is more fully described in the following pages.
The decrease in net realized capital gains in 2016 from 2015 primarily reflects a $98.8 million capital loss due to an impairment charge from a write-down of certain SORC assets as of December 31, 2016 and lower gains from the sales of equity securities, partially offset by a $13.2 million realized gain recorded on April 15, 2016 by Alleghany Capital and a $25.8 million capital loss due to an impairment charge from a write-off of our investment in ORX recorded on December 31, 2015. Realized capital gains from equity securities for 2015 includes the sales of certain equity securities resulting from a partial restructuring of the equity portfolio, as well as the sales of certain equity securities which had their cost basis reduced in earlier periods for the recognition of OTTI losses.
The decrease in net realized capital gains in 2015 from 2014 primarily reflects lower gains from the debt securities portfolio and a $25.8 million capital loss due to an impairment charge related to a write-off of our investment in ORX, partially offset by higher gains for the equity securities portfolio. Realized capital gains in 2015 include the sales of certain equity securities resulting from a partial restructuring of the equity portfolio and the sales of certain equity securities which had their cost basis reduced in earlier periods for the recognition of OTTI losses. Realized capital gains in 2014 include a realized capital gain of $34.0 million from the sales of long-dated U.S. Treasury Strip debt securities in April 2014, some additional realized capital gains taken on debt securities and a $9.4 million realized capital loss on the early redemption of $300 million par value of TransRe’s 5.75% senior notes due on December 14, 2015, or the “2015 Senior Notes.”
The increase in OTTI losses in 2015 from 2014 primarily reflects significant losses on equity securities in the energy, pharmaceutical, gaming and airline sectors in 2015.
On April 15, 2016, Alleghany Capital acquired an additional 50 percent of Jazwares’ outstanding equity, bringing its equity ownership interest to 80 percent and, as of that date, the results of Jazwares have been included in our consolidated results. Prior to April 15, 2016, Jazwares was accounted for under the equity method of accounting.
Corporate administration. The decrease in corporate administration expense in 2016 from 2015 primarily reflects lower long-term incentive compensation expense accruals due mainly to the impact of less favorable financial results, partially offset by a rise in the price per share of our common stock during 2016. Corporate administration expense in 2015 approximated the expense from 2014.
2016 vs 2015. The decrease in income taxes in 2016 from 2015 primarily reflects a decrease in earnings before income taxes partially offset by prior period income tax expense adjustments. The increase in the effective tax rate in 2016 from 2015 primarily reflects larger prior period income tax adjustments, higher state income taxes and lower tax-exempt interest income arising from municipal bond securities. Prior period income tax expense adjustments for 2016 include $16.1 million of out-of-period reductions to current and deferred TransRe tax assets recorded in 2016 that relate primarily to periods prior to the merger with TransRe in 2012.
2015 vs 2014. The decreases in earnings before income taxes and in net earnings attributable to Alleghany stockholders in 2015 from 2014 primarily reflect higher OTTI losses, as well as lower net realized capital gains, underwriting profits and net investment income, all as discussed above.
Property. The increase in gross premiums written in 2016 from 2015 primarily reflects $353.2 million of property-related premiums in 2016 compared with $64.7 million in 2015 related to the Quota Share Treaty, and to a lesser extent, increases arising from certain other large whole account quota share treaties. Excluding the impact of changes in foreign exchange rates, gross premiums written increased 29.5 percent in 2016 from 2015. The increase in net premiums earned in 2016 from 2015 primarily reflects net premiums earned related to the Quota Share Treaty, partially offset by higher ceded premiums earned due to an increase in retrocessional coverage purchased in 2016. There were no net premiums earned in 2015 related to the Quota Share Treaty. Excluding the impact of changes in foreign exchange rates, net premiums earned increased 31.9 percent in 2016 from 2015.
The decrease in gross premiums written in 2015 from 2014 reflects the impact of changes in foreign exchange rates. Excluding the impact of changes in foreign exchange rates, gross premiums written increased 3.7 percent in 2015 from 2014, primarily reflecting $64.7 million of property-related premiums recorded on December 31, 2015 related to the Quota Share Treaty, partially offset by reduced participation in or non-renewal of certain treaties and reductions in pricing for property reinsurance contracts as the market became increasingly competitive. The decrease in net premiums earned in 2015 from 2014 reflects, in part, the impact of changes in foreign exchange rates. Excluding the impact of changes in foreign exchange rates, net premiums earned decreased 10.0 percent in 2015 from 2014, primarily reflecting a decrease in gross premiums written in recent quarters and higher ceded premiums earned due to an increase in reinsurance coverage purchased in 2015. There were no net premiums earned in 2015 related to the Quota Share Treaty.
Property. The increase in net loss and LAE in 2016 from 2015 primarily reflects the impact of higher net premiums earned, higher catastrophe losses, as well as higher non-catastrophe property losses in the current accident year in connection with the Quota Share Treaty, partially offset by an increase in favorable prior accident year loss reserve development. The catastrophe losses in 2016 relate to wildfire losses in Alberta, Canada, earthquake losses in Japan, earthquake losses in Ecuador, all of which occurred in the second quarter, typhoon and flood losses in China in the third quarter, earthquake losses from an earthquake in New Zealand in the fourth quarter and $21.8 million of losses from Hurricane Matthew, which caused property damage and flooding in the Southeast Coast of the U.S. in October. Catastrophe losses for 2015 relate to the chemical explosion in Tianjin, China in August.
China in August 2015. Catastrophe losses for 2014 reflect losses from severe snowstorms across northeast Japan in February 2014 and from wind and hailstorm Ela, which struck Europe in June 2014.
(5) Reflects favorable prior accident year loss reserve development primarily related to the 2013 and 2014 accident years.
(1) Represents certain medical malpractice treaties pursuant to which the increased underwriting profits created by the favorable prior accident year loss reserve development reserves are largely retained by the cedants. As a result, the favorable prior accident year development is largely offset by an increase in profit commission expense incurred when such favorable prior accident year loss reserve development occurs.
(4) Generally reflects favorable prior accident year loss reserve development in a variety of casualty & other lines of business primarily from the 2005 through 2014 accident years, including ($30.7) million of favorable prior accident year development related to French medical malpractice loss reserves commuted in the fourth quarter of 2015 with a European cedant, partially offset by unfavorable prior accident year development from the 2004 and prior accident years.
Reinsurance Segment: Underwriting profit. The following table summarizes our underwriting profit for the reinsurance segment.
Property. The decrease in underwriting profit in 2016 from 2015 primarily reflects an increase in catastrophe losses, partially offset by an increase in favorable prior accident year loss reserve development, all as discussed above. The decrease in underwriting profit in 2015 from 2014 primarily reflects the impact of lower net premiums earned, partially offset by a decrease in commissions, brokerage and other underwriting expenses and lower catastrophe losses, all as discussed above.
Casualty & other. The increase in underwriting profit in 2016 from 2015 primarily reflects an increase in favorable prior accident year loss reserve developments, as discussed above. The decrease in underwriting profit in 2015 from 2014 primarily reflects lower net premiums earned, the presence of catastrophe losses in 2015 and higher commission rates in 2015, partially offset by more favorable prior accident year loss reserve development, all as discussed above.
The decrease in net premiums earned in 2016 from 2015 primarily reflects a decrease in gross premiums written in recent quarters. The decrease in net premiums earned in 2015 from 2014 reflects decreases in gross premiums written in earlier quarters, partially offset by a decrease in ceded premiums earned due to the reduction in property premiums ceded.
RSUI. The decrease in net loss and LAE in 2016 from 2015 primarily reflects an increase in favorable prior accident year loss reserve development and the impact of lower net premiums earned, partially offset by higher catastrophe losses. The slight increase in net loss and LAE in 2015 from 2014 primarily reflects less favorable prior accident year loss reserve development and a higher current accident year loss ratio for the casualty lines of business, partially offset by lower catastrophe losses and the impact of lower net premiums earned.
(1) Primarily reflects favorable prior accident year loss reserve development in the umbrella/excess, general liability and professional liability lines of business related to the 2006 through 2012 accident years.
(2) Primarily reflects favorable prior accident year loss reserve development in the umbrella/excess, general liability and professional liability lines of business related to the 2006 through 2011 accident years, partially offset by unfavorable prior accident year loss reserve development in the directors’ and officers’ liability lines of business related to the 2011 through 2014 accident years.
(4) Includes favorable prior accident year loss reserve development of ($20.6) million from Super Storm Sandy in 2012 and various other smaller amounts primarily from the non-catastrophe property lines of business in recent accident years.
(5) Primarily reflects favorable prior accident year development of ($4.1) million from Super Storm Sandy in 2012, net of reinsurance, and favorable prior accident year loss reserve development related to unallocated LAE reserves.
CapSpecialty. The increase in net loss and LAE in 2016 from 2015 primarily reflects the impact of higher net premiums earned, partially offset by favorable prior accident year loss reserve development in 2016 compared with prior accident year loss reserve development in 2015. The increase in net loss and LAE in 2015 from 2014 primarily reflects the impact of higher net premiums earned, substantially higher unfavorable prior accident year loss reserve development and higher surety losses in the 2015 accident year, partially offset by lower property losses. The higher surety losses relate to a few large claims that were incurred in 2015 related to a discontinued large construction contract line of business. Lower property losses in 2015 reflect lower fire and weather-related losses in that year.
(1) Represents certain specialty lines of business written through a program administrator in connection with a terminated program related to the 2010 and 2009 accident years and reflects (favorable) loss emergence compared with loss emergence patterns assumed in earlier periods for such business.
(2) Primarily reflects unfavorable prior accident year loss reserve development related to the casualty lines of business from the 2011 through 2013 accident years.
PacificComp. The increase in net loss and LAE in 2016 from 2015 primarily reflects the impact of higher net premiums earned, partially offset by favorable prior accident year loss reserve development in 2016. The increase in net loss and LAE in 2015 from 2014 primarily reflects the impact of higher net premiums earned, partially offset by unfavorable prior accident year loss reserve development in 2014.
CapSpecialty. The underwriting profit in 2016 compared with the underwriting loss in 2015 primarily reflects favorable prior accident year loss reserve development in 2016, compared with unfavorable prior accident year loss reserve development in 2015, and the impact of higher net premiums earned, all as discussed above. The decrease in underwriting losses in 2015 from 2014 primarily reflects the impact of higher net premiums earned and lower property losses, partially offset by higher surety losses and higher unfavorable prior accident year loss reserve development in 2015, all as discussed above.
beneficial impact of growing net premiums earned, favorable prior accident year loss reserve development in 2016 and, to a lesser extent, the deferral of certain acquisition costs for new business commencing in 2016, all as discussed above. The decrease in underwriting losses in 2015 from 2014 primarily reflects the beneficial impact of growing net premiums earned and the lack of unfavorable development on prior accident year loss reserves in 2015 compared with unfavorable prior accident year loss reserve development in 2014, all as discussed above.
Net Investment Income. The slight increase in net investment income in 2016 from 2015 primarily reflects higher interest income from funds withheld by cedants, partially offset by lower dividend income and lower income from other invested assets. Interest income was reduced in the fourth quarter of 2016 by approximately $7 million of adjustments made to more accurately reflect premium amortization associated with certain bonds.
Other Than Temporary Impairment Losses. OTTI losses in 2016 reflect $45.2 million of unrealized losses that were deemed to be other than temporary and, as such, were required to be charged against earnings. Upon the ultimate disposition of the securities for which OTTI losses have been recorded, a portion of the loss may be recoverable depending on market conditions at the time of disposition. Of the $45.2 million of OTTI losses, $23.3 million related to equity securities, primarily in the retail, financial service, technology, chemical and entertainment sectors, and $21.9 million related to debt securities, primarily in the energy sector. The determination that unrealized losses on equity and debt securities were other than temporary was primarily due to the severity and duration of the decline in the fair value of equity and debt securities relative to their costs.
OTTI losses in 2015 reflect $125.5 million of unrealized losses that were deemed to be other than temporary and, as such, were required to be charged against earnings. Of the $125.5 million of OTTI losses, $107.2 million related to equity securities, primarily in the energy, pharmaceutical, gaming and airline sectors, and $18.3 million related to debt securities, primarily in the energy and financial service sectors. The determination that unrealized losses on equity and debt securities were other than temporary was primarily based on the fact that we lacked the intent to hold the securities for a period of time sufficient to allow for an anticipated recovery and, to a lesser extent, the duration of the decline in the fair value of equity securities relative to their costs.
OTTI losses in 2014 reflect $36.3 million of unrealized losses that were deemed to be other than temporary and, as such, were required to be charged against earnings. Of the $36.3 million of OTTI losses, $28.7 million relate to equity securities, primarily in the mining sector, and $7.6 million relate to debt securities, primarily in the energy sector. The determination that unrealized losses on such securities were other than temporary was primarily based on the severity of the decline in the fair value of equity securities relative to their cost as of the balance sheet date, and the fact that we lacked the intent to hold debt securities for a period of time sufficient to allow for an anticipated recovery.
After adjusting the cost basis of securities for the recognition of OTTI losses, the remaining gross unrealized investment losses for debt and equity securities as of December 31, 2016 were deemed to be temporary, based on, among other factors: (i) the duration of time and the relative magnitude to which the fair values of these securities had been below cost were not indicative of an OTTI loss; (ii) the absence of compelling evidence that would cause us to call into question the financial condition or near-term business prospects of the issuers of the securities; and (iii) our ability and intent to hold the securities for a period of time sufficient to allow for any anticipated recovery.
(1) Adjusted EBITDA is a non-GAAP financial measure and does not replace earnings before income taxes determined in accordance with GAAP as a measure of profitability. See “Comment on Non-GAAP Financial Measures” herein for additional detail on the presentation of our results of operations. Adjusted EBITDA represents other revenue less certain other expenses, and does not include: (i) depreciation expense (a component of other operating expenses); (ii) amortization of intangible assets; (iii) interest expense; (iv) net realized capital gains; (v) OTTI impairment; and (vi) income taxes.
(1) Income taxes for certain Alleghany Capital subsidiaries are incurred at the Alleghany Capital corporate level.
The SORC assets that were written-down relate specifically to SORC’s acquisition of a certain legacy oil field for the sole purpose of applying enhanced oil recovery techniques. After completing construction of its underground facility in 2014, SORC commenced its drilling program in 2015. The drilling program, however, was delayed by third-party equipment problems that have since been corrected as well as a longer than expected trial-and-error process determining the optimum well completion technique for the reservoir, and efforts to address a lack of vertical permeability in the reservoir formation. SORC engaged a third-party petroleum engineering firm to provide an assessment of its oil-recovery prospects and based on this assessment and other factors including oil prices, SORC wrote-down its legacy oil field assets to estimated fair value as of December 31, 2016.
Net realized capital losses in 2015 primarily reflect a $25.8 million capital loss related to an impairment charge related to a write-off of our investment in ORX. Net realized capital gains in 2014 primarily reflect a gain from the sale of an equity investment.
Other revenue and Other operating expenses. The increase in other revenue and other operating expenses in 2016 from 2015 primarily reflects the acquisition of IPS on October 31, 2015, the inclusion of Jazwares in our consolidated results as of April 15, 2016 and, to a lesser extent, growth at Kentucky Trailer. The increase in other revenue in 2015 from 2014 primarily reflects the acquisition of IPS on October 31, 2015 and, to a lesser extent, growth at Kentucky Trailer. The increase in other operating expenses in 2015 from 2014 primarily reflects the acquisition of IPS and, to a lesser extent, increased expenses at Kentucky Trailer and SORC.
Amortization of intangible assets. The increase in amortization of intangible assets in 2016 from 2015 primarily reflects the amortization of intangible assets from the acquisitions of IPS and Jazwares. The increase in amortization of intangible assets in 2015 from 2014 primarily reflects the amortization of intangible assets from the acquisition of IPS.
Earnings (losses) before income taxes. The increase in losses before income taxes in 2016 from 2015 primarily reflects the impairment charge from a write-down of certain SORC assets, partially offset by the acquisitions of IPS and Jazwares, growth at Kentucky Trailer, the Jazwares Remeasurement Gain in 2016 and the impairment charge related to a write-off of our investment in ORX in 2015, all as discussed above. The increase in losses before income taxes in 2015 from 2014 primarily reflects the impairment charge related to a write-off of our investment in ORX in 2015, as discussed above.
Net investment income. The increase in net investment income in 2016 from 2015 primarily reflects higher income from other invested assets. The decrease in net investment income in 2015 from 2014 primarily reflects lower dividend income.
(Losses) earnings before income taxes. The decrease in losses before income taxes in 2016 from 2015 primarily reflects the absence of OTTI losses in 2016 which were significant in 2015, an increase in other revenues and a decrease in corporate administration, partially offset by an increase in realized capital losses, all as discussed above. The increase in losses before income taxes in 2015 from 2014 primarily reflects net realized capital losses in 2015 compared with net realized capital gains in 2014, higher interest expense, and OTTI losses that were incurred in 2015, all as discussed above.
Changes in Gross and Net Loss and LAE Reserves between December 31, 2016 and December 31, 2015. Gross and net loss and LAE reserves as of December 31, 2016 increased from December 31, 2015, reflecting increases in our reinsurance and insurance segments. The increase in gross and net loss and LAE reserves at our reinsurance segment primarily reflects the impact of higher net premiums earned and higher catastrophe losses, partially offset by favorable prior accident year loss reserve development, all as discussed above. The increase in gross and net loss and LAE reserves at our insurance segment primarily reflects higher current accident year losses and higher catastrophe losses, partially offset by favorable prior accident year loss reserve development, all as discussed above.
Our reinsurance and insurance subsidiaries reinsure portions of the risks they underwrite in order to reduce the effect of individual or aggregate exposure to losses, manage capacity, protect capital resources, reduce volatility in specific lines of business, improve risk-adjusted portfolio returns and enable them to increase gross premium writings and risk capacity without requiring additional capital. Our reinsurance and insurance subsidiaries purchase reinsurance and retrocessional coverages from highly-rated third-party reinsurers. If the assuming reinsurers are unable or unwilling to meet the obligations assumed under the applicable
reinsurance agreements, our reinsurance and insurance subsidiaries would remain liable for such reinsurance portion not paid by these reinsurers. As such, funds, trust agreements and letters of credit are held to collateralize a portion of our reinsurance and insurance subsidiaries’ reinsurance recoverables, and our reinsurance and insurance subsidiaries reinsure portions of the risks they underwrite or assume with multiple reinsurance programs.
As of December 31, 2016, our reinsurance and insurance subsidiaries had total reinsurance recoverables of $1,272.2 million, consisting of $1,236.2 million of ceded outstanding loss and LAE and $36.0 million of recoverables on paid losses. See Part I, Item 1, “Business - Reinsurance Protection” of this Form 10-K for additional information on the reinsurance purchased by our reinsurance and insurance subsidiaries.
The following table presents information regarding concentration of our reinsurance recoverables and the ratings profile of our reinsurers as of December 31, 2016:
Overview. The estimation of the liability for unpaid loss and LAE is inherently difficult and subjective, especially in view of changing legal and economic environments that impact the development of loss reserves, and therefore, quantitative techniques
frequently have to be supplemented by subjective considerations and managerial judgment. In addition, trends that have affected development of liabilities in the past may not necessarily occur or affect liability development to the same degree in the future.
Our net reserves for loss and LAE of $9.9 billion as of December 31, 2016 relate to multiple accident years. Therefore, the impact of changes in frequency or severity for more than one accident year could be higher or lower than the amounts reflected above. We believe the above analysis provides a reasonable benchmark for sensitivity, as we believe it is within historical variation for our reserves. Currently, none of the scenarios is believed to be more likely than the other. See Note 1(k) and Note 6 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on our loss and LAE.
(10) Generally reflects favorable prior accident year loss reserve development in a variety of casualty & other lines of business primarily from the 2005 through 2014 accident years, including ($30.7) million of favorable prior accident year development related to French medical malpractice loss reserves commuted in the fourth quarter of 2015 with a European cedant, partially offset by unfavorable prior accident year development from the 2004 and prior accident years.
(15) Includes favorable prior accident year loss reserve development of ($20.6) million from Super Storm Sandy in 2012 and various other smaller amounts primarily from the non-catastrophe property lines of business in recent accident years.
(18) Primarily reflects unfavorable prior accident year loss reserve development related to the casualty lines of business from the 2011 through 2013 accident years.
(19) Represents certain specialty lines of business written through a program administrator in connection with a terminated program related to the 2010 and 2009 accident years and reflects (favorable) loss emergence compared with loss emergence patterns assumed in earlier periods for such business.
Reinsurance. Our reinsurance and insurance subsidiaries reinsure portions of the risks they underwrite in order to reduce the effect of individual or aggregate exposure to losses, manage capacity, protect capital resources, reduce volatility in specific lines of business, improve risk-adjusted portfolio returns and enable them to increase gross premium writings and risk capacity without requiring additional capital. Our reinsurance and insurance subsidiaries purchase reinsurance and retrocessional coverages from highly-rated third-party reinsurers. If the assuming reinsurers are unable or unwilling to meet the obligations assumed under the applicable reinsurance agreements, our reinsurance and insurance subsidiaries would remain liable for such reinsurance portion not paid by these reinsurers. Recoverables recorded with respect to claims ceded to reinsurers under reinsurance contracts are predicated in large part on the estimates for unpaid losses and, therefore, are also subject to a significant degree of uncertainty. In addition to the factors cited above, reinsurance recoverables may prove uncollectible if a reinsurer is unable or unwilling to perform under a contract. Reinsurance purchased by our reinsurance and insurance subsidiaries does not relieve them of their obligations to their own policyholders or cedants. Additional information regarding the use of, and risks related to the use of reinsurance by our reinsurance and insurance subsidiaries can be found on pages 42 through 44 and pages 54 and 55 of this Form 10-K. Also see Note 1(f) and Note 5 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on our reinsurance recoverables.
Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between willing, able and knowledgeable market participants at the measurement date. Fair value measurements are not adjusted for transaction costs. In addition, a three-tiered hierarchy for inputs is used in management’s determination of fair value of financial instruments that emphasizes the use of observable inputs over the use of unobservable inputs by requiring that the observable inputs be used when available. Observable inputs are market participant assumptions based on market data obtained from sources independent of the reporting entity. Unobservable inputs are the reporting entity’s own assumptions about market participant assumptions based on the best information available under the circumstances. In assessing the appropriateness of using observable inputs in making our fair value determinations, we consider whether the market for a particular security is “active” or not based on all the relevant facts and circumstances. A market may be considered to be inactive if there are relatively few recent transactions or if there is a significant decrease in market volume. Furthermore, we consider whether observable transactions are “orderly” or not. We do not consider a transaction to be orderly if there is evidence of a forced liquidation or other distressed condition; as such, little or no weight is given to that transaction as an indicator of fair value.
A three-tiered hierarchy for inputs is used in management’s determination of fair value of financial instruments that emphasizes the use of observable inputs over the use of unobservable inputs by requiring that the observable inputs be used when available. Assets classified as Level 3 principally include certain residential mortgage-backed securities, or “RMBS,” commercial mortgage-backed
securities, or “CMBS,” other asset-backed securities, U.S. corporate bonds, partnership investments and non-marketable equity investments. The valuation of Level 3 assets requires the greatest degree of judgment, as these valuations are based on techniques that use significant inputs that are unobservable. These measurements may be made under circumstances in which there is little, if any, market activity for the asset. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment. In making the assessment, we consider factors specific to the asset.
We hold our equity and debt securities as available-for-sale, or “AFS,” and as such, these securities are recorded at fair value. We continually monitor the difference between cost and the estimated fair value of our equity and debt investments, which involves uncertainty as to whether declines in value are temporary in nature. The analysis of a security’s decline in value is performed in its functional currency. If the decline is deemed temporary, we record the decline as an unrealized loss in stockholders’ equity. If the decline is deemed to be other than temporary, we write our cost-basis or amortized cost-basis down to the fair value of the security and record an OTTI loss on our statement of earnings. In addition, any portion of such decline related to a debt security that is believed to arise from factors other than credit is recorded as a component of other comprehensive income rather than charged against earnings.
Management’s assessment of equity securities initially involves an evaluation of all securities that are in an unrealized loss position, regardless of the duration or severity of the loss, as of the applicable balance sheet date. Such initial review consists primarily of assessing whether: (i) there has been a negative credit or news event with respect to the issuer that could indicate the existence of an OTTI; and (ii) we have the ability and intent to hold an equity security for a period of time sufficient to allow for an anticipated recovery (generally considered to be 12 months from the balance sheet date).
If we intend to sell or it is more likely than not that we will sell a debt security before recovery of its amortized cost basis, the total amount of the unrealized loss position is recognized as an OTTI loss in earnings. To the extent that a debt security that is in an unrealized loss position is not impaired based on the preceding, we will consider a debt security to be impaired when we believe it to be probable that we will not be able to collect the entire amortized cost basis. For debt securities in an unrealized loss position as of the end of each quarter, we develop a best estimate of the present value of expected cash flows. If the results of the cash flow analysis indicate that we will not recover the full amount of its amortized cost basis in the debt security, we record an OTTI loss in earnings equal to the difference between the present value of expected cash flows and the amortized cost basis of the debt security. If applicable, the difference between the total unrealized loss position on the debt security and the OTTI loss recognized in earnings is the non-credit related portion, which is recorded as a component of other comprehensive income.
Our consolidated balance sheet as of December 31, 2016 includes goodwill of $285.0 million related primarily to Jazwares, IPS, RSUI, CapSpecialty, Bourn & Koch and Kentucky Trailer, and intangible assets, net of amortization, of $378.7 million related primarily to TransRe, Jazwares, IPS, RSUI, CapSpecialty, Bourn & Koch and Kentucky Trailer. See Note 1(i) and Note 2 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on our goodwill and other intangible assets.
In the U.S., our reinsurance and insurance subsidiaries are subject to insurance laws and regulations that restrict the amount and timing of dividends they may pay without the prior approval of regulatory authorities. Under the insurance holding company laws and regulations, our reinsurance and insurance subsidiaries may not pay an “extraordinary” dividend without the approval of state insurance regulators. In general, an “extraordinary” dividend or distribution is defined as a dividend or distribution that, together with other dividends and distributions made within the preceding 12 months, exceeds the lesser (or, in some jurisdictions, the greater) of (i) 10 percent of the statutory surplus of the reinsurer or insurer as of the end of the prior calendar year (or, in certain states, as of the end of the prior quarter) and (ii) the net income during the prior calendar year (or, in certain states, the adjusted statutory net investment income). In addition, certain states where Alleghany’s reinsurance and insurance subsidiaries are domiciled prohibit a domestic insurance company from paying dividends except out of earned surplus.
TransRe’s operations are also regulated in various foreign jurisdictions with respect to currency, amount and type of security deposits, amount and type of reserves and amount and type of local investment. Regulations governing constitution of technical reserves and remittance balances in some countries may hinder remittance of profits and repatriation of assets. International operations and assets held abroad may also be adversely affected by political and other developments in foreign countries, including possible tax changes, nationalization and changes in regulatory policy, as well as by consequences of hostilities and unrest. The risks of such occurrences and their overall effect upon TransRe vary from country to country and cannot easily be predicted.
Program.” In July 2014, our Board of Directors authorized the repurchase, upon the completion of the 2012 Repurchase Program, of additional shares of common stock, at such times and at prices as management determines to be advisable, up to an aggregate of $350.0 million, or the “2014 Repurchase Program.” In the fourth quarter of 2014, we completed the 2012 Repurchase Program and subsequent repurchases have been made pursuant to the 2014 Repurchase Program. In November 2015, our Board of Directors authorized the repurchase, upon the completion of the 2014 Repurchase Program, of additional shares of common stock, at such times and at prices as management determines to be advisable, up to an aggregate of $400.0 million, or the “2015 Repurchase Program.” In the first quarter of 2016, we completed the 2014 Repurchase Program and subsequent repurchases have been made pursuant to the 2015 Repurchase Program. As of December 31, 2016, we had $379.2 million remaining under our share repurchase authorization.
Pursuant to the 2012 Repurchase Program, 2014 Repurchase Program and the 2015 Repurchase Program, as applicable, we repurchased shares of our common stock in 2016, 2015 and 2014 as follows:
Dividends. From 1999 through 2011, we declared stock dividends in lieu of cash dividends every year. Our Board of Directors determined not to declare a dividend, cash or stock, for 2012 through 2016.
Investments in Certain Other Invested Assets. In December 2012, TransRe obtained an ownership interest in Pillar Capital Holdings Limited, or “Pillar Holdings,” a Bermuda-based insurance asset manager focused on collateralized reinsurance and catastrophe insurance-linked securities. Additionally, TransRe invested $175.0 million and AIHL invested $25.0 million in limited partnership funds managed by Pillar Holdings, or the “Funds.” The objective of the Funds is to create portfolios with attractive risk-reward characteristics and low correlation with other asset classes, using the extensive reinsurance and capital market experience of the principals of Pillar Holdings. We have concluded that both Pillar Holdings and the Funds, which we collectively refer to as the “Pillar Investments,” represent variable interest entities and that we are not the primary beneficiary, as we do not have the ability to direct the activities that most significantly impact each entity’s economic performance. Therefore, the Pillar Investments are not consolidated and are accounted for under the equity method of accounting. Our potential maximum loss in the Pillar Investments is limited to our cumulative net investment. As of December 31, 2016, our carrying value in the Pillar Investments, as determined under the equity method of accounting, was $233.7 million, which is net of returns of capital received from the Pillar Investments.
Investments in Commercial Mortgage Loans. As of December 31, 2016, the carrying value of our commercial loan portfolio was $594.9 million, representing the unpaid principal balance on the loans. As of December 31, 2016, there was no allowance for loan losses. The commercial loan portfolio consists primarily of first mortgages on commercial properties in major metropolitan areas in the U.S. The loans earn interest at fixed- and floating-rates, mature in two to ten years and the principal amounts of the loans were no more than approximately two-thirds of the property’s appraised value at the time the loan was made.
Financial strength is also a high priority of our subsidiaries, whose assets stand behind their financial commitments to their customers and vendors. We believe that our subsidiaries have and will have adequate internally generated funds, cash resources and unused credit facilities to provide for the currently foreseeable needs of their businesses. Our subsidiaries had no material commitments for capital expenditures as of December 31, 2016.
Included in other activities is debt associated with Alleghany Capital’s operating subsidiaries. As of December 31, 2016, this includes $41.0 million of debt at Kentucky Trailer related primarily to a mortgage loan, borrowings to finance small acquisitions and borrowings under its available credit facility, $31.2 million of borrowings by Jazwares under its available credit facility and $20.6 million of debt at Bourn & Koch related to borrowings to finance an acquisition. None of these liabilities are guaranteed by Alleghany or Alleghany Capital.
Investment Strategy and Holdings. Our investment strategy seeks to preserve principal and maintain liquidity while trying to maximize our risk-adjusted, after-tax rate of return. Our investment decisions are guided mainly by the nature and timing of expected liability payouts, management’s forecast of cash flows and the possibility of unexpected cash demands, for example, to satisfy claims
Level 2: Valuations are based on direct and indirect observable inputs other than quoted market prices included in Level 1. Level 2 inputs include quoted prices for similar assets in active markets and inputs other than quoted prices that are observable for the asset, such as the terms of the security and market-based inputs. Terms of the security include coupon,
maturity date and any special provisions that may, for example, enable the investor, at its election, to redeem the security prior to its scheduled maturity date (such provisions may apply to all debt securities except U.S. Government obligations). Market-based inputs include interest rates and yield curves that are observable at commonly quoted intervals and current credit rating(s) of the security. Market-based inputs may also include credit spreads of all debt securities except U.S. Government obligations, and currency rates for certain foreign government obligations and foreign corporate bonds denominated in foreign currencies. Fair values are determined using a market approach that relies on the securities’ relationships to quoted prices for similar assets in active markets, as well as the other inputs described above. In determining the fair values for the vast majority of CMBS and other asset-backed securities, as well as a small portion of RMBS, an income approach is used to corroborate and further support the fair values determined by the market approach. The income approach primarily involves developing a discounted cash flow model using the future projected cash flows of the underlying collateral, and the terms of the security. Level 2 assets generally include short-term investments and most debt securities. Our Level 2 liabilities consist of the Senior Notes.
Level 3: Valuations are based on techniques that use significant inputs that are unobservable. The valuation of Level 3 assets requires the greatest degree of judgment. These measurements may be made under circumstances in which there is little, if any, market activity for the asset. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment. In making the assessment, we consider factors specific to the asset. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement is classified is determined based on the lowest level input that is significant to the fair value measurement in its entirety. Assets classified as Level 3 principally include certain RMBS, CMBS, other asset-backed securities (primarily, collateralized loan obligations), U.S. corporate bonds, partnership investments and non-marketable equity investments.
The estimated fair values of our financial instruments measured at fair value and the level of the fair value hierarchy of inputs used as of December 31, 2016 and 2015 were as follows:
Municipal Bonds. The following table provides the fair value of our municipal bonds as of December 31, 2016, categorized by state and revenue source. Special revenue bonds are debt securities for which the payment of principal and interest is available solely from the cash flows of the related 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 general obligation bonds.
The business of our reinsurance and insurance subsidiaries exposes them to losses from various catastrophe events. In a catastrophe event, losses from many insureds across multiple lines of business may result directly or indirectly from such single occurrence. Our reinsurance and insurance subsidiaries take certain measures to mitigate the impact of catastrophe events through
various means including considering catastrophe risks in their underwriting and pricing decisions, purchasing reinsurance, monitoring and modeling accumulated exposures and managing exposure in key geographic zones and product lines that are prone to catastrophe events.
“Florida, Wind” has the highest modeled after-tax net catastrophe costs for both a 100 and 250 year return period. These costs would represent approximately 5 percent and 7 percent, respectively, of stockholders’ equity attributable to Alleghany as of December 31, 2016, compared with approximately 7 and 10 percent as of December 31, 2015, respectively. The decline in net PMLs is due in part to the changes in the timing of retrocessional reinsurance purchases. Excluding the timing impact of additional cover due to expire in May 2017, after-tax net PMLs for “Florida, Wind” at a 100 and 250 year return period would have been approximately 6 percent and 8 percent of stockholders’ equity attributable to Alleghany, respectively, as of December 31, 2016. If multiple severe catastrophe events occur in any one year, or a single catastrophe event affects more than one geographic area, the potential economic cost to us could be materially higher than any one of the amounts shown above.
There is much uncertainty and imprecision in the compilation of these estimates at many stages in the process. Moreover, the makeup of our in-force business is constantly changing as new business is added and existing contracts terminate or expire, including contracts for reinsurance coverage purchased by us. In addition, these estimates take into account what we believe to be the most likely accumulation of territories, but there can be no assurance that we have captured every possible scenario in our analysis. As a result of these factors, among others, there can be no assurance that we will not experience after-tax net catastrophe costs from individual events that will exceed these estimates by a material amount. There also can be no assurance that we will not experience
In February 2015, the FASB issued guidance that amended the analysis that must be performed to determine whether an entity should consolidate certain types of legal entities. Under this guidance, the evaluation of whether limited partnerships and similar entities are variable interest entities or voting interest entities is modified, the presumption that general partners should consolidate limited partnerships is eliminated and the process to determine the primary beneficiary of a variable interest entity is modified. This guidance was effective in the first quarter of 2016. We adopted this guidance in the first quarter of 2016 and the implementation did not have a material impact on our results of operations and financial condition.
In May 2014, the FASB, together with the International Accounting Standards Board, issued guidance on the recognition of revenue from contracts with customers. Under this guidance, revenue is recognized as the transfer of goods and services to customers takes place and in amounts that reflect the payment or payments that are expected to be received from the customers for those goods and services. This guidance also requires new disclosures about revenue. Revenues related to insurance and reinsurance are not impacted by this guidance. In July 2015, the FASB determined that it would delay the effective date of the new revenue standard by a year. This guidance is now effective in the first quarter of 2018 for public entities, with early adoption permitted in 2017. We will adopt this guidance in the first quarter of 2018 and do not currently believe that the implementation will have a material impact on our results of operations and financial condition.
In January 2016, the FASB issued guidance that changes the recognition and measurement of certain financial instruments. This guidance requires investments in equity securities (except those accounted for under the equity method of accounting) to be measured at fair value with changes in fair value recognized in net income. For equity securities that do not have readily determinable fair values, measurement may be at cost, adjusted for any impairment and changes resulting from observable price changes for a similar investment of the same issuer. This guidance also changes the presentation and disclosure of financial instruments by: (i) requiring that financial instrument disclosures of fair value use the exit price notion; (ii) requiring separate presentation of financial assets and financial liabilities by measurement category and form, either on the balance sheet or the accompanying notes to the financial statements; (iii) requiring separate presentation in other comprehensive income for the portion of the change in a liability’s fair value resulting from instrument-specific credit risk when an election has been made to measure the liability at fair value; and (iv) eliminating the requirement to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet. This guidance is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Except for the change in presentation for instrument-specific credit risk, this guidance does not permit early adoption. We will adopt this guidance in the first quarter of 2018. As of January 1, 2018, unrealized gains or losses of equity securities, net of deferred taxes, will be reclassified from accumulated other comprehensive income to retained earnings. Subsequently, all changes in unrealized gains or losses of equity securities, net of deferred taxes, will be presented in the consolidated statement of earnings, rather than the consolidated statement of comprehensive income. We do not currently believe that the implementation will have a material impact on our financial condition.
In February 2016, the FASB issued guidance on leases. Under this guidance, a lessee is required to recognize assets and liabilities for leases with terms of more than one year, whereas under current guidance, a lessee is only required to recognize assets and liabilities for those leases qualifying as capital leases. This guidance also requires new disclosures about the amount, timing and uncertainty of cash flows arising from leases. The accounting by lessors is to remain largely unchanged. This guidance is effective in the first quarter of 2019 for public entities, with early adoption permitted. We will adopt this guidance in the first quarter of 2019 and do not currently believe that the implementation will have a material impact on our results of operations and financial condition. See Note 12(b) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for further information on our leases.
In June 2016, the FASB issued guidance on credit losses. Under this guidance, a company is required to measure all expected credit losses on loans, reinsurance recoverables and other financial assets accounted for at cost or amortized cost, as applicable. Estimates of expected credit losses are to be based on historical experience, current conditions and reasonable and supportable forecasts. Credit losses for securities accounted for on an AFS basis are to be measured in a manner similar to GAAP as currently applied and cannot exceed the amount by which fair value is less than the amortized cost. Credit losses for all financial assets are to be recorded through an allowance for credit losses. Subsequent reversals in credit loss estimates are permitted and are to be recognized in earnings. This guidance also requires new disclosures about the significant estimates and judgments used in estimating credit losses, as well as the credit quality of financial assets. This guidance is effective in the first quarter of 2020 for public entities, with early adoption permitted. We will adopt this guidance in the first quarter of 2020 and do not currently believe that the implementation will have a material impact on our results of operations and financial condition.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Alleghany Corporation and subsidiaries at December 31, 2016 and 2015, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Alleghany Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 22, 2017 expressed an unqualified opinion thereon.
Alleghany Corporation (“Alleghany”), a Delaware corporation owns and manages certain operating subsidiaries and investments, anchored by a core position in property and casualty reinsurance and insurance. Through its wholly-owned subsidiary Alleghany Insurance Holdings LLC (“AIHL”) and its subsidiaries, Alleghany is engaged in the property and casualty insurance business. AIHL’s insurance operations are principally conducted by its subsidiaries RSUI Group, Inc. (“RSUI”), CapSpecialty, Inc. (“CapSpecialty”) and Pacific Compensation Corporation (“PacificComp”). CapSpecialty has been a subsidiary of AIHL since January 2002, RSUI has been a subsidiary of AIHL since July 2003 and PacificComp has been a subsidiary of AIHL since July 2007. AIHL Re LLC (“AIHL Re”), a captive reinsurance company which provides reinsurance to Alleghany’s insurance operating subsidiaries and affiliates, has been a wholly-owned subsidiary of Alleghany since its formation in May 2006. Alleghany’s reinsurance operations commenced on March 6, 2012 when Alleghany consummated a merger with Transatlantic Holdings, Inc. (“TransRe”) and TransRe became one of Alleghany’s wholly-owned subsidiaries.
Bourn & Koch, Inc. (“Bourn & Koch”), a manufacturer and remanufacturer/retrofitter of precision machine tools and supplier of replacement parts, headquartered in Rockford, Illinois;
Jazwares, LLC (together with its affiliates, “Jazwares”), a toy and consumer electronics company, headquartered in Sunrise, Florida.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
Other invested assets include invested assets not identified above, primarily related to: (i) equity investments in operating companies where Alleghany has significant influence (an aggregate common stock position held at or above 20 percent is presumed to convey significant influence); (ii) partnership investments (including hedge funds and private equity funds); and (iii) non-marketable equity investments. Equity investments in operating companies where Alleghany has significant influence are accounted for using the equity method. Partnership investments are accounted for as either AFS or using the equity method where Alleghany has significant influence. Non-marketable equity investments are accounted for as AFS securities.
Mortgage-backed and asset-backed securities are initially valued at the transaction price. Subsequently, Alleghany uses widely accepted valuation practices that produce a fair value measurement. The vast majority of fair values are determined using an income approach. The income approach primarily involves developing a discounted cash flow model using the
Level 3 liabilities consist of the debt of Alleghany Capital’s operating subsidiaries.
Premiums are recognized as revenue on a pro rata basis over the term of an insurance policy. Assumed reinsurance premiums written and earned are based on reports received from ceding companies for pro rata treaty contracts and are generally recorded as
Unearned premiums and ceded unearned premiums represent the portion of gross premiums written and ceded premiums written, respectively, relating to the unexpired periods of such coverages. Assumed reinsurance premiums written and earned, along with related costs, for which data has not been reported by the ceding companies, are estimated based on historical patterns and other relevant factors. These estimates may change when actual data for such estimated items becomes available.
Reinsurance is used to mitigate the exposure to losses, manage capacity and protect capital resources. Reinsuring loss exposures does not relieve a ceding entity from its obligations to policyholders and cedants. Reinsurance recoverables (including amounts related to incurred but not yet reported (“IBNR”) claims) and ceded unearned premiums are reported as assets. To minimize exposure to losses from a reinsurer’s inability to pay, the financial condition of such reinsurer is evaluated initially upon placement of the reinsurance and periodically thereafter. In addition to considering the financial condition of a reinsurer, the collectability of the reinsurance recoverables is evaluated (and where appropriate, whether an allowance for estimated uncollectible reinsurance recoverables is to be established) based upon a number of other factors. Such factors include the amounts outstanding, length of collection periods, disputes, any collateral or letters of credit held and other relevant factors. To the extent that an allowance for uncollectible reinsurance recoverable is established, amounts deemed to be uncollectible are written off against the allowance for estimated uncollectible reinsurance recoverables. Alleghany currently has no allowance for uncollectible reinsurance recoverables.
Ceded premiums written are recorded in accordance with the applicable terms of the various reinsurance contracts and ceded premiums earned are charged against revenue over the period of the various reinsurance contracts. This also generally applies to reinstatement premiums paid to a reinsurer, which arise when contractually-specified ceded loss triggers have been breached. Ceded commissions reduce commissions, brokerage and other underwriting expenses and ceded losses incurred reduce net loss and loss adjustment expense (“LAE”) incurred over the applicable periods of the various reinsurance contracts with third-party reinsurers. If premiums or commissions are subject to adjustment (for example, retrospectively-rated or experience-rated), the estimated ultimate premium or commission is recognized over the period of the contract.
The estimation of the liability for unpaid loss and LAE is inherently difficult and subjective, especially in view of changing legal and economic environments that impact loss reserve development and, therefore, quantitative techniques frequently have to be supplemented by subjective considerations and managerial judgment. In addition, trends that have affected development of liabilities in the past may not necessarily occur or affect liability development to the same degree in the future.
Alleghany’s loss reserve review processes use actuarial methods that vary by operating subsidiary and line of business and produce point estimates for each class of business. The actuarial methods used include the following methods:
Debt consists of senior notes issued by Alleghany (the “Alleghany Senior Notes”), senior notes issued by TransRe (the “TransRe Senior Notes,” and together with the Alleghany Senior Notes, the “Senior Notes”), and other debt. The Senior Notes and other debt are carried at unpaid principal balance including any unamortized premium or discount.
In April 2015, the FASB issued guidance that requires debt issuance costs related to debt liabilities be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, which is consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected. This guidance was effective in the first quarter of 2016. Alleghany adopted this guidance on a retrospective basis in the first quarter of 2016 and the implementation resulted in a reduction of other assets and a corresponding decrease in Senior Notes and other debt of approximately $7 million as of March 31, 2016 and December 31, 2015.
In May 2015, the FASB issued guidance that requires disclosures related to short-duration insurance contracts. The guidance applies to property and casualty insurance and reinsurance entities, among others, and requires the following annual disclosure related to the liability for loss and LAE: (i) net incurred and paid claims development information by accident year for up to ten years; (ii) a reconciliation of incurred and paid claims development information to the aggregate carrying amount of the liability for loss and LAE; (iii) IBNR liabilities by accident year and in total; (iv) a description of reserving methodologies (as well as any changes to those methodologies); (v) quantitative information about claim frequency by accident year; and (vi) the average annual percentage payout of incurred claims by age by accident year. In addition, the guidance requires insurance entities to disclose for annual and interim reporting periods a roll-forward of the liability for loss and LAE. This guidance is effective for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016, with early adoption permitted. Alleghany has adopted this guidance as of December 31, 2016 and the implementation did not have an impact on its results of operations and financial condition. See Note 1(k) and Note 6 for the new disclosures.
In January 2017, the FASB issued guidance that simplifies the subsequent measurement of goodwill. Under this guidance, if an initial qualitative assessment indicates that the fair value of an operating subsidiary may be less than its carrying amount, an impairment charge is recognized for the amount by which the carrying amount of the operating subsidiary exceeds its estimated fair value. Any resulting impairment loss recognized cannot exceed the total amount of goodwill associated with the operating subsidiary. This guidance is effective in the first quarter of 2020 for public entities. Alleghany will adopt this guidance in the first quarter of 2020 and does not currently believe that the implementation will have a material impact on its results of operations and financial condition.
(3) Primarily represents goodwill and other intangible assets related to the acquisition of: (i) Jazwares on April 15, 2016; (ii) IPS on October 31, 2015; (iii) Bourn & Koch on April 26, 2012; and (iv) a controlling equity interest in Kentucky Trailer on August 30, 2013. Also reflects minor acquisitions made by Jazwares and Bourn & Koch in 2016 and Kentucky Trailer in 2015 and 2014.
In 2015, there were transfers of $22.9 million of securities out of Level 3 that were principally due to an increase in observable inputs related to the valuation of such assets. Of the $22.9 million of transfers, $15.9 million related to U.S. corporate bonds, $5.5 million related to foreign corporate bonds and $1.5 million related to other invested assets.
(2) There were no OTTI losses recorded in net earnings related to Level 3 instruments still held as of December 31, 2016 and 2015.
Net unrealized losses related to Level 3 investments as of December 31, 2016 and 2015 were not material.
(1) Includes $903.8 million and $946.7 million of collateralized loan obligations as of December 31, 2016 and 2015, respectively.
(1) Mortgage and asset-backed securities by their nature do not generally have single maturity dates.
Realized capital gains and losses in 2016 primarily reflect sales of equity and debt securities. Realized capital gains and losses for 2015 and 2014 generally reflect sales of equity securities. In addition, Alleghany Capital recognized a $98.8 million capital loss due to an impairment charge from a write-down of certain SORC assets in 2016 and a gain of $13.2 million on April 15, 2016 in connection with its acquisition of an additional 50 percent equity ownership in Jazwares, when its pre-existing 30 percent equity ownership was remeasured at estimated fair value (the “Jazwares Remeasurement Gain”).
the reservoir, and efforts to address a lack of vertical permeability in the reservoir formation. SORC engaged a third-party petroleum engineering firm to provide an assessment of its oil-recovery prospects and based on this assessment and other factors including oil prices, SORC wrote-down its legacy oil field assets to estimated fair value as of December 31, 2016.
If Alleghany intends to sell, or it is more likely than not that Alleghany will sell, a debt security before recovery of its amortized cost basis, the total amount of the unrealized loss position is recognized as an OTTI loss in earnings. To the extent that a debt security that is in an unrealized loss position is not impaired based on the preceding, Alleghany will consider a debt security to be impaired when it believes it to be probable that Alleghany will not be able to collect the entire amortized cost basis. For debt securities
in an unrealized loss position as of the end of each quarter, Alleghany develops a best estimate of the present value of expected cash flows. If the results of the cash flow analysis indicate that Alleghany will not recover the full amount of its amortized cost basis in the debt security, Alleghany records an OTTI loss in earnings equal to the difference between the present value of expected cash flows and the amortized cost basis of the debt security. If applicable, the difference between the total unrealized loss position on the debt security and the OTTI loss recognized in earnings is the non-credit related portion, which is recorded as a component of other comprehensive income.
OTTI losses in 2016 reflect $45.2 million of unrealized losses that were deemed to be other than temporary and, as such, were required to be charged against earnings. Upon the ultimate disposition of the securities for which OTTI losses have been recorded, a portion of the loss may be recoverable depending on market conditions at the time of disposition. Of the $45.2 million of OTTI losses, $23.3 million related to equity securities, primarily in the retail, financial service, technology, chemical and entertainment sectors, and $21.9 million related to debt securities, primarily in the energy sector. The determination that unrealized losses on equity and debt securities were other than temporary was primarily due to the severity and duration of the decline in the fair value of equity and debt securities relative to their costs.
OTTI losses in 2014 reflect $36.3 million of unrealized losses that were deemed to be other than temporary and, as such, were required to be charged against earnings. Of the $36.3 million of OTTI losses, $28.7 million relate to equity securities, primarily in the mining sector, and $7.6 million relate to debt securities, primarily in the energy sector. The determination that unrealized losses on such securities were other than temporary was primarily based on the severity of the decline in the fair value of equity securities relative to their cost as of the balance sheet date, and the fact that Alleghany lacked the intent to hold debt securities for a period of time sufficient to allow for an anticipated recovery.
As of December 31, 2016 and 2015, gross unrealized losses and related fair values for equity securities and debt securities, grouped by duration of time in a continuous unrealized loss position, were as follows:
As of December 31, 2016, Alleghany held a total of 1,317 debt securities and equity securities that were in an unrealized loss position, of which 138 securities, all debt securities, were in an unrealized loss position continuously for 12 months or more. The unrealized losses associated with these debt securities consisted primarily of losses related to other asset-backed securities, municipal bonds and CMBS.
As of December 31, 2016, the vast majority of Alleghany’s debt securities were rated investment grade, with 5.1 percent of debt securities having issuer credit ratings that were below investment grade or not rated, compared with 3.6 percent as of December 31, 2015.
Reinsured loss and LAE ceded included in Alleghany’s consolidated statements of earnings were $325.8 million, $309.6 million and $250.3 million for 2016, 2015 and 2014, respectively.
Alleghany’s reinsurance and insurance subsidiaries reinsure portions of the risks they underwrite or assume with multiple reinsurance programs. A discussion of the more significant programs follows.
RSUI reinsures its property lines of business through a program consisting of surplus share treaties, facultative placements, per risk and catastrophe excess of loss treaties. RSUI’s catastrophe reinsurance program and property per risk reinsurance program run on an annual basis from May 1 to the following April 30.
RSUI’s catastrophe reinsurance program covers catastrophe risks including, among others, windstorms and earthquakes. As of December 31, 2016, the catastrophe reinsurance program consisted of three layers, with portions of the first and second layers placed on May 1, 2015 and May 1, 2016 and portions of the third layer placed on May 1, 2014 and May 1, 2016. The catastrophe reinsurance program provides coverage for $600.0 million of losses in excess of a $200.0 million net retention after application of surplus share treaties and facultative reinsurance. The first layer provides coverage for $300.0 million of losses, subject to a 5.0 percent co-participation by RSUI in excess of $200.0 million, the second layer provides coverage for $100.0 million of losses in excess of $500.0 million, with no co-participation by RSUI and the third layer provides coverage for $200.0 million of losses in excess of $600.0 million, with no co-participation by RSUI. The first and second layers of coverage include the following expiration terms: approximately 34 percent of coverage limits, which originally expired on April 30, 2016 and was renewed May 1, 2016, currently expires on April 30, 2019; approximately 33 percent of coverage limits expire on April 30, 2017; and approximately 33 percent of coverage limits expire on April 30, 2018. The third layer of coverage originally expired on April 30, 2017. However, effective May 1, 2016, approximately 39 percent of the third layer of coverage was cancelled and replaced with the same coverage for a three year period expiring on April 30, 2019. The remaining coverage limits expire on April 30, 2017.
In the second quarter of 2013, AIHL Re and PacificComp’s wholly-owned subsidiary Pacific Compensation Insurance Company (“PCIC”), entered into an intercompany reinsurance contract, effective January 1, 2013, pursuant to which AIHL Re provides PCIC with coverage for adverse development on net loss and allocated LAE in excess of PCIC’s carried reserves at December 31, 2012 and accident year stop-loss coverage for any net losses and allocated LAE in excess of 75.0 percent of net premiums earned for PCIC for accident years 2013 through 2017. AIHL Re’s commitments also are intended to cover the statutory collateral requirements at PCIC, if and when necessary. AIHL Re’s obligations are subject to an aggregate limit of $100.0 million. In connection with such intercompany reinsurance agreement, Alleghany and AIHL Re entered into a contract whereby Alleghany will guarantee the recoverable balances owed to PCIC from AIHL Re up to $100.0 million. Subsequent to the entry into the above agreements, A.M. Best Company, Inc. upgraded PCIC’s rating to A- (Excellent) from B++ (Good). The above agreements had no impact on Alleghany’s consolidated results of operations and financial condition.
In the third quarter of 2015, AIHL Re and CapSpecialty (specifically, the insurance subsidiaries of CapSpecialty) entered into an intercompany reinsurance contract, effective July 1, 2015, pursuant to which AIHL Re provides CapSpecialty with coverage
Activity in liability for loss and LAE in 2016, 2015 and 2014 is summarized as follows:
Gross loss and LAE reserves as of December 31, 2015 decreased from December 31, 2014, reflecting a decrease in the reinsurance segment loss and LAE reserves, partially offset by an increase in the insurance segment. The decrease in gross loss and LAE reserves in the reinsurance segment primarily reflects favorable prior accident year loss reserve development, loss payments including amounts related to commutations in the fourth quarter of 2015 with certain cedants and the impact of changes in foreign currency exchange rates. The increase in gross loss and LAE reserves in the insurance segment primarily reflects higher current accident year losses.
(2) Includes favorable prior accident year loss reserve development of ($27.7) million from Super Storm Sandy in 2012 and various smaller amounts on catastrophes that occurred in the 2010, 2011, 2013 and 2014 accident years, partially offset by unfavorable prior accident year development from the New Zealand earthquake in 2010.
(3) Includes favorable prior accident year loss reserve development of ($1.6) million from Super Storm Sandy in 2012 and ($15.7) million of net favorable prior accident year loss reserve development from other catastrophes. The ($15.7) million primarily reflects favorable prior accident year loss reserve development from several catastrophes that occurred primarily in the 2011 and 2013 accident years, partially offset by unfavorable prior accident year loss reserve development from the New Zealand earthquake in 2010.
(7) Represents certain medical malpractice treaties pursuant to which the increased underwriting profits created by the favorable prior accident year loss reserve development are largely retained by the cedants. As a result, the favorable prior accident year development is largely offset by an increase in profit commission expense incurred when such favorable prior accident year loss reserve development occurs.
(9) Generally reflects favorable prior accident year loss reserve development in a variety of casualty & other lines of business primarily from the 2003 through 2015 accident years.
(17) Primarily reflects favorable prior accident year development on unallocated LAE reserves and prior year catastrophe loss reserves from recent accident years.
(c) Supplementary Information on Incurred and Paid Loss and LAE Development
Loss and LAE Reserve Summary and Reconciliation to Consolidated Balance Sheet
(1) Includes unallocated LAE, which aggregate to 1.3 percent of gross loss and LAE reserves as of December 31, 2016. Net loss and LAE Reserves by component are shown in the preceding tables, and consolidated gross loss and LAE reserves is presented in the Consolidated Balance Sheets.
The following is supplemental information about average historical loss and LAE duration, net of reinsurance, as of December 31, 2016.
Borrowings under the Credit Agreement bear a floating rate of interest based in part on Alleghany’s credit rating, among other factors. The Credit Agreement requires that all loans be repaid in full no later than October 15, 2017. The Credit Agreement also requires Alleghany to pay a commitment fee each quarter in a range of between 0.125 and 0.30 percent per annum, based upon
Alleghany’s credit rating, on the daily unused amount of the commitments. The Credit Agreement contains representations, warranties and covenants customary for bank loan facilities of this nature.
On September 20, 2010, Alleghany completed a public offering of $300.0 million aggregate principal amount of its
5.625% senior notes due on September 15, 2020 (the “2020 Senior Notes”). The 2020 Senior Notes are unsecured and unsubordinated general obligations of Alleghany. Interest on the 2020 Senior Notes is payable semi-annually on March 15 and September 15 of each year. The terms of the 2020 Senior Notes permit redemption prior to their maturity. The indenture under which the 2020 Senior Notes were issued contains covenants that impose conditions on Alleghany’s ability to create liens on, or engage in sales of, the capital stock of AIHL or RSUI. The 2020 Senior Notes were issued at approximately 99.6 percent of par, resulting in proceeds after underwriting discount, commissions and other expenses of $298.9 million and an effective yield of approximately 5.67 percent.
The debt associated with Alleghany Capital’s operating subsidiaries totaled $92.8 million and $36.3 million as of December 31, 2016 and 2015, respectively. As of December 31, 2016, the $92.8 million includes $41.0 million of debt at Kentucky Trailer related primarily to a mortgage loan, borrowings to finance small acquisitions and borrowings under its available credit facility, $31.2 million of borrowings by Jazwares under its available credit facility and $20.6 million of debt at Bourn & Koch related to borrowings to finance an acquisition. None of these liabilities are guaranteed by Alleghany or Alleghany Capital.
The difference between the federal income tax rate and the effective income tax rate was as follows:
The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities as of December 31, 2016 and 2015 are as follows:
In October 2012, the Alleghany Board of Directors authorized the repurchase of shares of Common Stock, at such times and at prices as management determined to be advisable, up to an aggregate of $300.0 million (the “2012 Repurchase Program”). In July 2014, the Alleghany Board of Directors authorized, upon the completion of the 2012 Repurchase Program, the repurchase of shares of Common Stock at such times and at prices as management determines to be advisable, up to an aggregate of $350.0 million (the “2014 Repurchase Program”). In the fourth quarter of 2014, Alleghany completed the 2012 Repurchase Program and subsequent repurchases have been made pursuant to the 2014 Repurchase Program. In November 2015, the Alleghany Board of Directors authorized the repurchase, upon the completion of the 2014 Repurchase Program, of additional shares of Common Stock, at such times and at prices as management determines to be advisable, up to an aggregate of $400.0 million (the “2015 Repurchase Program”). In the first quarter of 2016, Alleghany completed the 2014 Repurchase Program and subsequent repurchases have been made pursuant to the 2015 Repurchase Program. As of December 31, 2016, Alleghany had $379.2 million remaining under its share repurchase authorization.
Pursuant to the 2012 Repurchase Program, 2014 Repurchase Program and the 2015 Repurchase Program, as applicable, Alleghany repurchased shares of Common Stock in 2016, 2015 and 2014 as follows:
Reclassifications out of accumulated other comprehensive income attributable to Alleghany stockholders during 2016 and 2015 were as follows:
A summary of dividends paid to Alleghany by its reinsurance and insurance subsidiaries in 2016, 2015 and 2014 follows:
(1) In 2016, 2015 and 2014, TRC paid dividends of $350.0 million, $400.0 million and $400.0 million, respectively, to the TransRe holding company.
As of December 31, 2016, a maximum amount of $15.0 million was available for dividends by TRC without prior approval of the applicable regulatory authorities.
The statutory net income of Alleghany’s reinsurance and insurance subsidiaries was $688.9 million and $741.0 million for the years ended December 31, 2016 and 2015, respectively. As of December 31, 2016 and 2015, the combined statutory capital and surplus of Alleghany’s reinsurance and insurance subsidiaries was $6.7 billion and $6.6 billion, respectively. As of December 31, 2016, the amount of statutory capital and surplus necessary to satisfy regulatory requirements was not significant in relation to the actual statutory capital and surplus of Alleghany’s reinsurance and insurance companies in the U.S.
The following is a reconciliation of the earnings and share data used in the basic and diluted earnings per share computations for 2016, 2015 and 2014:
The reserves carried for such claims, including the IBNR portion, are based upon known facts and current law at the respective balance sheet dates. However, significant uncertainty exists in determining the amount of ultimate liability for asbestos-related illness and environmental impairment losses, particularly for those occurring in 1985 and prior, which, before TransRe’s entry into the Commutation Agreement, represented the majority of TransRe’s asbestos-related illness and environmental impairment reserves. This uncertainty is due to inconsistent and changing court resolutions and judicial interpretations with respect to underlying policy intent and coverage and uncertainties as to the allocation of responsibility for resultant damages, among other reasons. Further, possible future changes in statutes, laws, regulations, theories of liability and other factors could have a material effect on these liabilities and, accordingly, future earnings.
The primary components of corporate activities are Alleghany Properties and other activities at the Alleghany parent company.
In addition, corporate activities include interest expense associated with the Alleghany Senior Notes, whereas interest expense associated with the TransRe Senior Notes is included in “Total Segments” and interest expense associated with other debt is included in Alleghany Capital. Information related to Senior Notes and other debt can be found in Note 8.
Segment results for Alleghany’s two reportable segments and for corporate activities for 2016, 2015 and 2014 are shown in the tables below:
(4) Underwriting profit represents net premiums earned less net loss and LAE and commissions, brokerage and other underwriting expenses, all as determined in accordance with GAAP, and does not include net investment income, net realized capital gains, OTTI losses, other revenue, other operating expenses, corporate administration, amortization of intangible assets or interest expense. Underwriting profit does not replace earnings before income taxes determined in accordance with GAAP as a measure of profitability. Rather, Alleghany believes that underwriting profit enhances the understanding of its segments’ operating results by highlighting net earnings attributable to their underwriting performance. Earnings before income taxes (a GAAP measure) may show a profit despite an underlying underwriting loss. Where underwriting losses persist over extended periods, a reinsurance or an insurance company’s ability to continue as an ongoing concern may be at risk. Therefore, Alleghany views underwriting profit as an important measure in the overall evaluation of performance.
As of December 31, 2016, the identifiable assets of the reinsurance segment, insurance segment and other activities were $15.7 billion, $6.7 billion and $1.4 billion, respectively, of which cash and invested assets represented $13.1 billion, $5.1 billion and $0.5 billion, respectively. As of December 31, 2016, Alleghany’s equity attributable to the reinsurance segment, insurance segment and other activities was $5.2 billion, $2.8 billion and ($0.1) billion, respectively.
As of December 31, 2016, Alleghany had long-term compensation plans for parent company-level employees and directors. Parent company-level, long-term compensation awards to current employees do not include stock options but consist only of restricted stock awards, including restricted stock units and performance share awards. Parent company-level, long-term compensation awards to non-employee directors consist of annual grants of restricted shares and restricted stock units of Common Stock.
Amounts recognized as compensation expense in the consolidated statements of earnings and comprehensive income with respect to long-term compensation awards under plans for parent company-level employees and directors were $17.1 million, $19.7 million and $21.2 million in 2016, 2015 and 2014, respectively. The amount of related income tax benefit in the consolidated statements of earnings and comprehensive income with respect to these plans was $6.0 million, $6.9 million and $7.4 million in 2016, 2015 and 2014, respectively. In 2016, 2015 and 2014, $5.7 million, $4.7 million and $4.5 million of Common Stock at fair market value, respectively, and $14.4 million, $10.9 million and $7.6 million of cash, respectively, was paid by Alleghany under these plans for parent company-level employees and directors. As noted above, as of December 31, 2016 and 2015, all outstanding awards were accounted for under the fair-value-based method of accounting.
Performance Share Awards - Participants are entitled, at the end of a four-year award period, to a maximum amount equal to the value of one and one-half shares of Common Stock for each performance share issued to them based on market value on the payment date. Payouts are made provided defined levels of performance are achieved. Expenses are recorded based on changes in the fair value of the awards. The fair value is calculated based primarily on the value of Common Stock as of the balance sheet date, the degree to which performance targets specified in the 2012 LTIP have been achieved and the time elapsed with respect to each award period.
Restricted Share Awards - From time to time, Alleghany has awarded to certain management employees restricted shares or restricted stock units of Common Stock. These awards entitle the participants to a specified maximum amount equal to the value of one share of Common Stock for each restricted share or restricted stock unit issued to them based on the market value on the grant date, subject to certain conditions. The expense is recognized ratably over the performance period, which can be extended under certain circumstances.
TransRe has a Book Value Unit Plan and a Mid-Term Incentive Plan (collectively, the “TransRe Plans”) for the purpose of providing incentives to key employees of TransRe. Under the TransRe Plans, book value units (“BVUs”) and mid-term incentive plan (“MTIP”) awards are issued. BVUs and MTIP awards may only be settled in cash. The fair value of each BVU is calculated as stockholder’s equity of TransRe, adjusted for certain capital transactions, divided by the adjusted number of BVUs outstanding. BVUs have vesting dates of up to approximately the fourth anniversary of the date of grant. The fair value of MTIP awards is calculated based on underwriting results compared to specified targets. MTIP awards have vesting dates of approximately the second or third anniversary of the date of grant. The BVUs and MTIP awards contain certain restrictions, relating to, among other things, forfeiture in the event of termination of employment and transferability. In 2016, 2015 and 2014, TransRe recorded $50.7 million, $54.9 million and $55.3 million, respectively, in compensation expense and a deferred tax benefit of $17.7 million, $19.2 million and $19.4 million, respectively, related to the TransRe Plans.
Long-term incentive plans exist at certain other subsidiaries for the purpose of providing equity-like incentives to key employees. The awards under such plans were not material to Alleghany’s results of operations, financial condition or cash flows for the three years ended December 31, 2016.
Alleghany has endorsement split-dollar life insurance policies for its parent company-level officers that are effective during employment, as well as retirement. Premiums are paid by Alleghany and death benefits are split between Alleghany and the beneficiaries of the officers. Death benefits for current employees that inure to the beneficiaries are generally equal to four times the annual salary at the time of an officer’s death. After retirement, death benefits that inure to the beneficiaries are generally equal to the annual salary of the officer as of the date of retirement.
In addition, Alleghany and TransRe have defined benefit pensions plans for certain of their employees, as further described below.
These employee retirement plans are not material to Alleghany’s results of operations, financial condition or cash flows for the three years ended December 31, 2016.
Selected quarterly financial data for 2016 and 2015 are presented below:
We have audited Alleghany Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Alleghany Corporation and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
In our opinion, Alleghany Corporation and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Alleghany Corporation and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of earnings and comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016 of Alleghany Corporation and subsidiaries and our report dated February 22, 2017 expressed an unqualified opinion thereon.