(1) Includes results of Chaucer Holdings plc since the July 1, 2011 acquisition date.
Business operations consist of four operating segments: Commercial Lines, Personal Lines, Chaucer and Other.
Over recent years, weather-related catastrophe and non-catastrophe losses have been in excess of longer term averages. Pricing in our Commercial and Personal Lines remained strong throughout 2013 as the industry continues to respond to these increased weather-related losses, as well as to the earnings impact of reduced investment income as a result of low interest rates, and other factors. We are continuing efforts to improve our underwriting results in both our Commercial and Personal Lines, through rate increases and improvements to our mix of business.
We believe our unique approach to the small commercial market, distinctiveness in the middle market, and continued development of specialty lines provides us with a diversified portfolio of products and delivers significant value to agents and policyholders. The small commercial and middle market businesses are expected to contribute to premium growth in Commercial Lines over the next several years as we continue to pursue our core strategy of developing strong partnerships with agents, distinctive products, franchise value through limited distribution, and industry segmentation. Growth in our specialty lines continues to be an important part of our strategy, with the expansion of our product offerings in these lines supported by acquisitions of specialized business over the past several years.
We believe these efforts have driven, and will continue to drive, improvement in our overall mix of business and ultimately our underwriting profitability. Commercial Lines net premiums written grew by 5.5% in 2013, driven by our core commercial businesses. This growth is primarily due to rate increases, strong retention and targeted new business expansion.
Underwriting results improved in 2013, as compared to 2012, primarily due to higher favorable development on prior years’ loss reserves and lower catastrophe losses, partially offset by higher non-catastrophe losses. Favorable development on prior years’ loss reserves during 2013 was $94.6 million, compared to $72.6 million during 2012, a change of $22.0 million. Chaucer net premiums written grew by 12.8% in 2013, primarily due to an increase in Chaucer’s economic interests in Syndicate 1084 to 98% for 2013, up from 84% in 2012. While we benefited from favorable rates in certain catastrophe-exposed marine and property lines following high levels of insured market losses in recent years, we experienced overall downward pressure on rates throughout 2013 because of new capital inflows and an absence of major market losses in the current year. Rates in the energy market remained under pressure throughout 2013 due to a continued absence of major market losses. Also, net premiums written in our energy line were lower due to a reduction of estimated premiums for both the exploration and production coverage class and the construction coverage class. The aviation and casualty markets continued to remain soft as a result of low loss activity and industry excess capacity. U.K. motor market rates continued their modest decline, following the significant increases in 2010 and 2011. In response, we continue to actively manage Chaucer’s underwriting portfolio, using our expertise, distinctive underwriting capabilities and market knowledge to target specific attractive underwriting opportunities despite an uncertain international Lloyd’s market environment.
Primary business operations include insurance products and services currently provided through four operating segments. Our domestic operating segments are Commercial Lines, Personal Lines, and Other. Our international operating segment is Chaucer. Commercial Lines includes commercial multiple peril, commercial automobile, workers’ compensation and other commercial coverages, such as specialty program business, inland marine, management and professional liability and surety. Personal Lines includes personal automobile, homeowners and other personal coverages. Chaucer includes marine and aviation, energy, property, U.K. motor, and casualty and other coverages (which includes international liability, specialist coverages, and syndicate participations). Included in Other are Opus Investment Management, Inc., which markets investment management services to institutions, pension funds and other organizations; earnings on holding company assets; and, a voluntary pools business which is in run-off. We present the separate financial information of each segment consistent with the manner in which our chief operating decision maker evaluates results in deciding how to allocate resources and in assessing performance.
Operating income before interest expense and income taxes was $393.4 million for the year ended December 31, 2013, compared to $75.1 million for the year ended December 31, 2012, an increase of $318.3 million reflecting improvements in each of our insurance segments. This increase in operating income is primarily due to lower catastrophe and non-catastrophe related losses and higher favorable development.
Net premiums written grew by $184.3 million for the year ended December 31, 2013, compared to the year ended December 31, 2012, and net premiums earned grew by $211.4 million. Chaucer accounted for $127.0 million of the net premiums written increase and $71.1 million of the net premiums earned increase, primarily due to the aforementioned increase in Chaucer’s economic interests in Syndicate 1084. Additionally, growth in our core commercial businesses, resulting from rate increases, strong retention and targeted new business expansion, was partially offset by a decrease in our Personal Lines net premiums written.
Operating income before interest expense and income taxes was $75.1 million for the year ended December 31, 2012, compared to $71.8 million for the year ended December 31, 2011, an increase in earnings of $3.3 million. This increase is primarily due to a $103.9 million increase in Chaucer operating income, reflecting a full year of earnings for Chaucer compared to only six months in 2011 and lower loss activity in most Chaucer product classes, partially offset by a $96.6 million decrease in Commercial Lines earnings. The Commercial Lines earnings decrease was primarily due to unfavorable development on prior years’ loss reserves and increased catastrophe losses.
Our consolidated catastrophe related activity for the year ended December 31, 2012 was $369.9 million, compared to $361.6 million for the year ended December 31, 2011, an increase of $8.3 million. Both our 2012 and 2011 results reflected significantly elevated levels of catastrophe losses compared to our historical averages. Catastrophe losses in 2012 were primarily the result of $198.1 million of pre-tax losses related to Superstorm Sandy during the fourth quarter, and from several tornadoes during the first six months of the year. Our 2011 catastrophe losses resulted principally from winter storms, tornado, hail and windstorm activity in the first half of the year, and from Hurricane Irene and floods in Thailand and Denmark during the second half of the year.
Favorable development on prior years’ loss reserves was $15.8 million for the year ended December 31, 2012, compared to $103.3 million for the year ended December 31, 2011, a decrease of $87.5 million. For 2012, $72.6 million of favorable development related to our Chaucer segment was partially offset by $56.8 million of unfavorable development related to our domestic operations. For the year ended December 31, 2011, $67.8 million of favorable development was related to our domestic operations and $35.5 million was related to our Chaucer segment.
The following table summarizes GAAP underwriting results for the Commercial Lines, Personal Lines, Chaucer and Other segments and reconciles it to operating income.
Commercial Lines net premiums written were $2,007.2 million in the year ended December 31, 2013, compared to $1,902.0 million in the year ended December 31, 2012. This $105.2 million increase was primarily driven by rate increases, strong retention, and targeted new business expansion in our core commercial businesses, partially offset by exposure management actions that focus on reducing volatility from weather-related events and driving profit improvement.
Personal Lines current accident year underwriting profit, excluding catastrophes, was $118.2 million in the year ended December 31, 2013, compared to $94.0 million for the year ended December 31, 2012. This $24.2 million improvement in non-catastrophe current accident year results was primarily due to lower losses in our homeowners line, which we attribute to rate increases and profit improvement actions.
Although we have been able to obtain rate increases in our Personal Lines markets and believe that our ability to obtain these increases will continue, our ability to maintain Personal Lines net premiums written and to maintain and improve underwriting results may be affected by price competition, recent years’ weather-related losses, our exposure management actions, recent loss trends in bodily injury and personal injury protection claims, and regulatory and legal developments. In the past several years prior to 2013, weather-related catastrophe and non-catastrophe losses have been in excess of longer term averages. We monitor these trends and consider them in our rate actions.
Chaucer’s net premiums written were $1,117.5 million for the year ended December 31, 2013, compared to $990.5 million for the year ended December 31, 2012, an increase of $127.0 million, or 12.8%. This growth was primarily due to the aforementioned increase in
Chaucer’s underwriting profit for the year ended December 31, 2013 was $107.7 million, compared to $93.5 million for the year ended December 31, 2012, an improvement of $14.2 million. These improved results were primarily due to increased favorable development on prior years’ loss reserves and lower catastrophe losses, partially offset by higher non-catastrophe losses. Favorable development on prior years’ loss reserves for the year ended December 31, 2013 was $94.6 million, compared to $72.6 million for the year ended December 31, 2012, a change of $22.0 million. Catastrophe losses for the year ended December 31, 2013 were $34.4 million, compared to $41.7 million for the year ended December 31, 2012, a decrease of $7.3 million. Higher non-catastrophe losses were primarily due to several single large losses in our energy, U.K. motor and aviation lines.
Commercial Lines underwriting loss for the year ended December 31, 2012 was $224.2 million, compared to $123.0 million for the year ended December 31, 2011, or $101.2 million of increased losses. This was primarily due to unfavorable development on prior years’ loss reserves and increased catastrophe related activity. Unfavorable development on prior years’ loss reserves for the year ended December 31, 2012 was $29.0 million, compared to favorable development of $34.7 million for the year ended December 31, 2011, a change of $63.7 million. Included in these amounts are $26.5 million and $9.2 million, respectively, of unfavorable development in our surety line in 2012 and 2011. Catastrophe related activity for the year ended December 31, 2012 was $193.4 million, compared to $148.4 million for the year ended December 31, 2011, an increase of $45.0 million. The impact of Superstorm Sandy was $124.8 million for the year ended December 31, 2012.
Personal Lines net premiums written were $1,475.6 million in the year ended December 31, 2012, compared to $1,461.2 million in the year ended December 31, 2011, an increase of $14.4 million. The factors contributing to this modest increase were higher rates in both our homeowners and personal automobile lines. These increases were partially offset by our continued property-focused exposure management actions. Our actions to reduce homeowners policy exposures, including increases in rate, have resulted in an increase in policy attrition.
Net premiums written in the personal automobile line of business for the year ended December 31, 2012 were $922.7 million compared to $910.5 million for the year ended December 31, 2011. Growth in premiums resulting primarily from rate increases were partially offset by a decline in policies in force of 2.2%, primarily as a result of fewer policies in force in Michigan, Florida, New York, Connecticut and Oklahoma. Net premiums written in the homeowners line of business increased 0.6%, resulting primarily from rate increases, partially offset by a 3.7% decline in policies in force primarily attributable to fewer policies in force in Michigan, New York and New Jersey. These declines in both our personal automobile and homeowners lines are attributed to more selective portfolio management, including attrition resulting from rate increases we have implemented despite the competitive pricing environment.
Personal Lines underwriting loss for the year ended December 31, 2012 was $67.3 million, compared to $72.6 million for the year ended December 31, 2011, an improvement of $5.3 million. This was primarily due to decreased catastrophe related activity and non-catastrophe weather-related losses, partially offset by unfavorable development on prior years’ loss reserves. Catastrophe related activity for the year ended December 31, 2012 was $134.8 million, including Superstorm Sandy of $45.2 million, compared to $163.7 million for the year ended December 31, 2011, a decrease of $28.9 million. Unfavorable development on prior years’ loss reserves for the year ended December 31, 2012 was $26.5 million, compared to favorable development of $33.0 million for the year ended December 31, 2011, a change of $59.5 million. The unfavorable development was primarily in the personal automobile bodily injury and personal injury protection coverages as we and the industry have experienced higher loss severity.
Chaucer’s net premiums written were $990.5 million for the year ended December 31, 2012. By line of business, Chaucer’s net premiums written were comprised of 26.2% U.K. motor, 23.7% marine and aviation, 19.7% energy, 16.3% property, and 14.1% casualty and other lines. This mix of business was driven and supported by our specialist underwriting strategy which is focused on actively managing the premium portfolio and risk exposures.
Management’s process for establishing loss reserves is a comprehensive process that involves input from multiple functions throughout our organization, including finance, actuarial, claims, legal, underwriting, distribution and business operations management. The process incorporates facts currently known and the current, and in some cases, the anticipated, state of the law and coverage litigation. Based on information currently available, we believe that the aggregate loss reserves at December 31, 2013 were adequate to cover claims for losses that had occurred as of that date, including both those known to us and those yet to be reported. However, as described below, there are significant uncertainties inherent in the loss reserving process. Our estimate of the ultimate liability for losses that had occurred as of December 31, 2013 is expected to change in future periods as we obtain further information, and such changes could have a material effect on our results of operations and financial condition.
Given the inherent complexity of our loss reserve estimation process and the potential variability of the assumptions used, the actual emergence of losses will vary, perhaps substantially, from the estimate of losses included in our financial statements, particularly in those instances where settlements or other claim resolutions do not occur until well into the future. Our net loss reserves at December 31, 2013 were $4.3 billion. Therefore, a relatively small percentage change in the estimate of net loss reserves would have a material effect on our results of operations.
There is greater inherent uncertainty in estimating insurance reserves for certain types of property and casualty insurance lines, particularly liability lines, where a longer period of time may elapse before a definitive determination of ultimate liability and losses may be made. In addition, the technological, judicial, regulatory and political climates involving these types of claims are continuously evolving. There is also greater uncertainty in establishing reserves with respect to business that is new to us, particularly new business which is generated with respect to newly introduced product lines, by newly appointed agents or in geographies in which we have less experience in conducting business, such as the program business written by our AIX subsidiary, Chaucer’s international liability lines, our professional liability specialty lines, and business written in the western part of the United States. In some of these cases, there is less historical experience or knowledge and less data upon which we can rely. A combination of business that is both new to us and has longer development periods, provides even greater uncertainty in estimating insurance reserves. In our management and professional liability and healthcare lines, we are modestly increasing, and expect to continue to increase, our exposure to longer-tailed liability lines, including directors and officers liability, errors and omissions liability and product liability coverages. The Chaucer business acquired in 2011 contains several international and U.S. liability lines, of which financial institution and professional liability, international liability and energy liability, contribute the most uncertainty.
Personal and Commercial Automobile Bodily Injury - reserves recorded for bodily injury on U.S. voluntary business were $495.9 million as of December 31, 2013. A key assumption for bodily injury is the inflation rate underlying the estimated reserve. A five point change (e.g. 4% changed to 9% or -1%) in the imbedded inflation would have changed estimated IBNR by approximately $49 million, either positive or negative, respectively, at December 31, 2013.
ultimate costs, as represented by the tail factor. A five point change in the imbedded inflation and a one point change to the tail factor assumption (e.g. 1.02 changed to 1.01 or 1.03) would have changed estimated IBNR by approximately $27 million, either positive or negative, at December 31, 2013.
Specialty Programs - reserves recorded (including allocated LAE) for the AIX Companies were $252.2 million as of December 31, 2013. Two key assumptions underlying the actuarial reserve analysis for specialty programs are the expected loss and allocated LAE ratio (“ELR”) and the tail factor selection. A ten point change to the ELR and a five point change in the tail factor on AIX would have changed estimated IBNR by approximately $23 million at December 31, 2013.
marine and aviation line, primarily in the 2010 through 2012 accident years.
Lower than expected losses within our commercial multi-peril line, primarily related to accident year 2012.
Within Personal Lines, higher than expected losses within our personal automobile line, primarily related to bodily injury severity in the 2010 and 2011 accident years, and higher than expected homeowners property losses from non-catastrophe weather related activity in the 2011 accident year.
Lower than expected losses within our workers’ compensation line related to the 2007 through 2010 accident years.
Although we attempt to limit our exposures to asbestos and environmental damage liability through specific policy exclusions, we have been and may continue to be subject to claims related to these exposures. Ending loss and LAE reserves for all direct business written by our property and casualty companies related to asbestos and environmental damage liability were $11.5 million, $9.8 million and $10.0 million, net of reinsurance of $20.6 million, $20.4 million, and $18.7 million for the years ended December 31, 2013, 2012 and 2011, respectively.
The following table provides information about the investment types of our fixed maturities portfolio:
Net unrealized gains on fixed maturities decreased $267.3 million, or 63.2%, to a net unrealized gain of $155.4 million at December 31, 2013, compared to $422.7 million at December 31, 2012, primarily due to higher prevailing interest rates.
Other investments consisted primarily of overseas deposits, which are U.S. dollar and foreign denominated investments maintained in overseas funds and managed exclusively by Lloyd’s. These funds are required in order to protect policyholders in overseas markets and enable Chaucer to operate in those markets. Access to those funds is restricted and we have no control over the investment strategy. Also included in other investments were investments in limited partnerships, which were accounted for at cost or under the equity method of accounting.
Our sovereign debt totaled $45.5 million, or 0.6% of investment assets as of December 31, 2013, and was limited to the highly rated country of the U.K. In addition, our supranational and foreign agency exposure totaled $199.2 million, or 2.5% of investment assets, and primarily consisted of debt securities from the highly rated countries of Germany, the Netherlands, and the U.K. Our exposure to European non-sovereign financials, excluding those based in the U.K., totaled $120.7 million, or 1.5% of investment assets. Exposure to non-sovereign U.K. financial debt consisted primarily of term deposits and senior notes of banks. Also, we held money market funds totaling $136.5 million, or 1.7% of investment assets, which were comprised of a well-diversified portfolio of short-term debt securities of predominately large financial institutions domiciled in highly rated countries. The remainder of our European non-sovereign debt exposure, excluding the U.K., was $347.4 million, which represented 4.3% of investment assets. Generally, these securities were high quality, large cap multi-national companies that were well diversified by sector, country and issuer. Included in our non-financial, non-sovereign exposure were issuers domiciled in Spain, Italy, Ireland and Portugal totaling $56.5 million, or 0.7% of investment assets. These consisted of large market capitalization issuers that provide essential products and/or services.
We determined country exposures based on the country of domicile for the ultimate parent company of the various issuers we held as of December 31, 2013; however, in light of the economic and financial inter-relatedness and dependencies that exist among European countries and related financial systems, economic turmoil in one country could trigger a contagion effect on other countries. We believe the quality of our European credit exposure remains sound based on ratings and issuer strength, position in the capital structure, support through guarantees and partial government ownership by highly rated countries, diversity and quality of non-financial issuers and blend of industry exposures, and yield curve position. We believe that we do not have meaningful indirect exposures in our portfolio and we do not invest in credit derivatives.
We manage our country exposure using fundamental analysis coupled with relative value considerations. Investment decisions are based on the combination of a top-down macroeconomic perspective and bottom-up credit security analysis. We monitor political and economic developments; progress toward attainment of growth and budget targets; developments related to policy, reform and regulatory initiatives from European officials; progress toward funding objectives, including the availability and cost of funding; outlook for credit ratings; ability of banks to meet increased regulatory capital standards, operate in a weakened macroeconomic environment, and maintain adequate liquidity and sufficient access to capital to meet funding requirements; and contagion throughout the financial system as evidenced by increased costs for interbank funding, volatility in prices for stocks and corporate bonds, as well as the availability of capital.
Gross unrealized losses on fixed maturities and equity securities increased $69.9 million compared to December 31, 2012, primarily attributable to higher prevailing interest rates. At December 31, 2013, gross unrealized losses consisted primarily of $37.5 million of corporate fixed maturities, $19.1 million in municipal securities, $14.2 million of U.S. Treasury and government agency securities and $14.1 million of residential mortgage-backed securities.
We view gross unrealized losses on fixed maturities and equity securities as temporary since it is our assessment that these securities will recover in the near term, allowing us to realize their anticipated long-term economic value. With respect to gross unrealized losses on fixed maturities, we do not intend to sell, nor is it more likely than not we will be required to sell, such debt securities before this expected recovery of amortized cost (See also “Liquidity and Capital Resources” in Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-K). With respect to equity securities, we have the intent and ability to retain such investments for the period of time anticipated to allow for this expected recovery in fair value. Inherent in our assessment are the risks that, subsequent to the balance sheet date, market factors may differ from our expectations; the global economic recovery is less robust than we expect or reverts to recessionary trends; we may decide to subsequently sell a security for unforeseen business needs; or changes in the credit assessment or equity characteristics from our original assessment may lead us to determine that a sale at the current value would maximize recovery on such investments. To the extent that there are such adverse changes, an OTTI would be recognized as a realized loss. Although unrealized losses are not reflected in the results of financial operations until they are realized or deemed “other-than-temporary”, the fair value of the underlying investment, which does reflect the unrealized loss, is reflected in our Consolidated Balance Sheets.
The following table sets forth gross unrealized losses for fixed maturities by maturity period and for equity securities at December 31, 2013 and 2012. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties, or we may have the right to put or sell the obligations back to the issuers.
We did not use derivative instruments in 2013. In 2012, we realized a loss of $5.1 million on futures contracts relating to the release of tax capital loss carryforwards. Additionally, we recognized a gain of $0.7 million on a foreign currency forward used to mitigate changes in fair value caused by foreign currency fluctuation in converting U.K. pound sterling (“GBP”) denominated securities into their U.S. dollar denominated equivalent.
In 2013, through several transactions, we repurchased senior debentures with a net carrying value of $73.8 million at a cost of $93.7 million, resulting in a loss of $19.9 million. Additionally in 2013, we repaid $46.3 million of our FHLBB advances plus prepayment fees of $7.8 million for a total payment of $54.1 million. In 2012, we repurchased $65.4 million of our subordinated unsecured notes related to Chaucer at a par value. These notes had a carrying value of $60.3 million, resulting in a net loss of $5.1 million on the repurchases. In addition, we repurchased $7.0 million of capital securities related to AIX Holdings, Inc. (“AIX”) at par value. In 2011, we repurchased in several transactions, $69.5 million of our subordinated debentures at a cost of $72.1 million, resulting in a net loss of $2.6 million on the repurchases. In addition, we repurchased $8.0 million of capital securities related to AIX at a cost of $7.7 million, resulting in a gain of $0.3 million.
Operations are subject to risk resulting from interest rate fluctuations which may adversely impact the valuation of the investment portfolio. In a rising interest rate environment, the value of the fixed income sector, which comprises 86% of our investment portfolio, may decline as a result of decreases in the fair value of the securities. Our intent is to hold securities to maturity and recover the decline in valuation as prices accrete to par. However, our intent may change prior to maturity due to changes in the financial markets, our analysis of an issuer’s credit metrics and prospects, or as a result of changes in cash flow needs. Interest rate fluctuations may also reduce net investment income and as a result, profitability. The portfolio may realize lower yields and therefore lower net investment income on securities because the securities with prepayment and call features may prepay at a different rate than originally projected. Also, funds may not be available to invest at higher interest rates.
The majority of our assets are invested in the fixed income markets. Through fundamental research and credit analysis, with a focus on value investing, our investment professionals seek to identify a portfolio of stable income-producing higher quality U.S. government, foreign government, municipal, corporate, residential and commercial mortgage-backed securities and asset-backed securities. We have a general policy of diversifying investments both within and across major investment and industrial sectors to mitigate credit and interest rate risk. We monitor the credit quality of our investments and our exposure to individual markets, borrowers, industries, sectors and, in the case of direct commercial mortgages and commercial mortgage-backed securities, property types and geographic locations. In addition, we currently carry debt which is subject to interest rate risk, which was issued at fixed interest rates between 5.50% and 8.207%. Current market conditions, in light of our risk tolerance, restrict our ability to invest fixed income assets at similar rates of return; therefore, earnings on a similar level of assets are not sufficient to cover current debt interest costs.
The following tables for the years ended December 31, 2013 and 2012 provide information about financial instruments that are sensitive to changes in interest rates. The tables present principal cash flows and related weighted-average interest rates by expected maturities. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties, or we may have the right to put or sell the obligations back to the issuers. Mortgage-backed and asset-backed securities are included in the category representing their expected maturity. Available-for-sale securities include both U.S. and foreign-denominated fixed maturities. Additionally, we have assumed available-for-sale securities are similar enough to aggregate those securities for presentation purposes. Specifically, variable rate available-for-sale securities comprise an immaterial portion of the portfolio and do not have a significant impact on weighted-average interest rates. Therefore, the variable rate investments are not presented separately; instead they are included in the tables at their current interest rate. Debt is presented at contractual maturities, except for the FHLBB advances which were repaid in January 2013.
The Discontinued Accident and Health Business had no significant financial results that impacted 2013, 2012 or 2011.
Results from discontinued operations for the year ended December 31, 2013 include $5.8 million relating to our former life insurance businesses. This was primarily due to an insurance settlement related to a class action lawsuit, net of tax.
Included in our deferred tax asset as of December 31, 2013 is an asset of $42.1 million related to U.S. net operating loss carryforwards and a deferred tax asset of $22.4 million related to foreign net operating loss carryforwards. Our pre-tax U.S. operating loss carryforwards of $120.3 million will expire beginning in 2031. Our pre-tax foreign operating loss carryforwards of $66.2 million were generated in the U.K. and have no expiration date. It is our opinion that there will be sufficient future U.S. and U.K. taxable income to utilize these loss carryforwards. Our estimate of the gross amount and likely realization of loss carryforwards may change over time.
Included in our deferred tax net asset as of December 31, 2013 are assets of $110.3 million related to alternative minimum tax (“AMT”) credit carryforwards and $12.8 million related to foreign tax credit carryforwards. We may utilize these credits to offset future taxable income. The result of their utilization will be a lower current tax rate offset by a higher deferred tax provision, and also lower cash expenditures for federal income taxes during the utilization period. There is no expiration on AMT credit carryforwards and our foreign tax credit carryforwards will expire beginning in 2022. It is our opinion that there will be sufficient future U.S. and U.K. taxable income to utilize these tax credit carryforwards. Our estimate of the gross amount and likely realization of tax credit carryforwards may change over time.
During 2013, we recorded a valuation allowance of $2.9 million related to our deferred tax asset on the unrealized depreciation in our investment portfolio. It is our opinion that it is more likely than not that this asset will not be realized and accordingly, we recorded this valuation allowance as an adjustment to accumulated other comprehensive income.
As of December 31, 2013 and 2012, we determined our discount rate utilizing an independent yield curve which provides for a portfolio of high quality bonds that are expected to match the cash flows of our pension plan. Bond information used in the yield curve included only those rated Aa or better as of December 31, 2013 and 2012, respectively, and had been rated by at least two well-known rating agencies. At December 31, 2013, based upon our qualified plan liabilities and cash flows in relation to this discount curve, we increased our discount rate to 5.00%, from 4.25% at December 31, 2012.
For the years ended December 31, 2013 and 2012, the expected rate of return on our qualified plan assets was 5.25% and 6.0%, respectively. The decrease reflects declines in the fixed maturities markets in general. Actual returns of the plan investments generated approximately $3 million of losses and $57 million of gains during 2013 and 2012, respectively, as compared to expected returns of approximately $30 million and $33 million, respectively. The plan assets consisted of 84% fixed maturities and 16% equities at December 31, 2013.
In 2013, actuarial gains of approximately $37 million primarily resulting from the increase in the discount rate from the prior year were partially offset by investment losses of approximately $33 million. Actuarial losses of approximately $48 million experienced in 2012 primarily as a result of a decrease in the discount rate from the prior year were offset by the benefit from investment gains of approximately $24 million. The net gain in 2013 resulted in an adjustment to our accumulated actuarial loss of $4.2 million, which is reflected as an increase to our accumulated other comprehensive income. The net loss in 2012 resulted in an adjustment to our accumulated net actuarial losses of $23.7 million, which is reflected as a decrease to our accumulated other comprehensive income. The change in these actuarial gains and losses is amortized into earnings in future years. In addition to the adjustments to accumulated other comprehensive income from the actuarial gains occurring in 2013 was amortization of actuarial losses from prior years of $12.9 million. The adjustments to accumulated other comprehensive income from the actuarial losses occurring in 2012 were offset by the amortization of actuarial losses from prior years of $10.8 million. Given the effect of our actual investment experience in 2013, and taking into consideration the increase in discount rates in 2014, U.S. pension related expenses are expected to increase slightly from 2013. Accordingly, in 2014 we expect our pre-tax pension expense for the U.S. qualified defined benefit pension plan to remain consistent with that in 2013 at approximately $8 million.
Holding all other assumptions constant, sensitivity to changes in our key assumptions related to our U.S. qualified defined benefit pension plan is as follows:
As of December 31, 2013 and 2012, we determined the discount rate utilizing an independent yield curve which provides for a portfolio of high quality bonds that are expected to match the cash flows of the Chaucer plan. At December 31, 2013, based upon Chaucer’s plan liabilities and cash flows in relation to these yield curves, we decreased the discount rate to 4.50% from 4.80% at December 31, 2012.
The benefits from the investment gains experienced in 2013 and 2012 were partially offset by decreases in the discount rate from the prior year, resulting in net actuarial gains for the Chaucer plan of approximately $7.5 million and $2.5 million in 2013 and 2012, respectively. These gains are reflected as increases to our accumulated other comprehensive income. This balance is amortized into earnings in future periods. Given the effect of our actual investment experience in 2013, expected rates of return on investments in 2014 and taking into consideration the slight decrease in discount rates, pension related expenses for the Chaucer plan are expected to decrease by approximately $1 million (using the December 31, 2013 GBP to U.S. dollar conversion rate of 1.56) to a benefit of $0.4 million.
Holding all other assumptions constant (using the December 31, 2013 GBP to U.S. dollar conversion rate of 1.56), sensitivity to changes in our key assumptions related to our Chaucer pension plan is as follows:
Discount Rate - A 25 basis point increase in the discount rate would decrease our pension expense in 2014 by $0.1 million and decrease our projected benefit obligation by $7.1 million. A 25 basis point reduction in the discount rate would increase our pension expense by $0.1 million and increase our projected benefit obligation by $7.5 million.
Expected Return on Plan Assets - A 25 basis point increase or decrease in the expected return on plan assets would decrease or increase our pension expense in 2014 by $ 0.3 million.
We monitor corporate fixed maturity securities with unrealized losses on a quarterly basis and more frequently when necessary to identify potential credit deterioration as evidenced by ratings downgrades, unexpected price variances, and/or company or industry specific concerns. We apply consistent standards of credit analysis which includes determining whether the issuer is current on its contractual payments and we consider past events, current conditions and reasonable forecasts to evaluate whether we expect to recover the entire amortized cost basis of the security. We utilize valuation declines as a potential indicator of credit deterioration and apply additional levels of scrutiny in our analysis as the severity of the decline increases or duration persists.
Temporary declines in market value are recorded as unrealized losses, which do not affect net income and earnings per share, but reduce accumulated other comprehensive income, which is reflected in our Consolidated Balance Sheets. We cannot provide assurance that the OTTIs will be adequate to cover future losses or that we will not have substantial additional impairments in the future. (See “Investments” in Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-K for further discussion regarding OTTIs and securities in an unrealized loss position).
The realization of deferred tax assets depends upon the existence of sufficient taxable income within the carryback or carryforward periods under the tax law in the applicable tax jurisdiction. Consideration is given to available positive and negative evidence, including reversals of deferred tax liabilities, projected future taxable income in each tax jurisdiction, tax planning strategies and recent financial operations. Valuation allowances are established if, based on the weight of available information, it is more likely than not that all or some portion of the deferred tax assets will not be realized. The determination of the valuation allowance for our deferred tax assets requires management to make certain judgments and assumptions. Our judgments and assumptions are subject to change given the inherent uncertainty in predicting future performance and specific industry and investment market conditions. Changes in valuation allowances are generally reflected in income tax expense or as an adjustment to other comprehensive income (loss) depending on the nature of the item for which the valuation allowance is being recorded.
The following are the components of our deferred tax assets and liabilities with the associated valuation allowance as of December 31, 2013.
We have $110.3 million of alternative minimum tax credit carryforwards and $12.8 million of foreign tax credit carryforwards. The alternative minimum tax credit carryforwards have no expiration date and may be used to offset regular federal income taxes due from future income. The foreign tax credit carryforwards will expire beginning in 2022 and may be used to offset federal income taxes due from future foreign sourced income. In addition, we have operating loss carryforwards that relate to current year U.S. net operating loss and foreign net operating loss carryforwards from our Chaucer segment. The U.S. net operating loss carryforwards expire beginning in 2031 and the Chaucer net operating loss carryforwards have no expiration date. Based on our projection of future economic conditions, taxable income, reversals of existing taxable temporary liabilities, and our strategic tax planning strategies, we believe that these tax credit carryforwards and operating loss carryforwards will be fully realized.
At December 31, 2013, the deferred tax liability on our investment portfolio is comprised of a deferred tax liability of $14.7 million related to our foreign portfolio and a deferred tax asset of $6.3 million related to our U.S. portfolio. Due to the nature of the deductibility of these unrealized tax losses in our federal tax return, we recorded a valuation allowance against this asset. In making our valuation allowance assessment, we considered our carryback capacity, reversals of deferred tax liabilities related to our investment portfolio, and tax planning strategies that include holding a portion of debt securities with market value losses until recovery. Given the nature and the magnitude of the unrealized loss and current market conditions, it is more likely than not that this asset will not be realized.
We believe the remaining deferred tax asset from other temporary differences is fully realizable based on our projected future taxable income and recent financial operations. Although we believe that these assets are fully recoverable, there can be no certainty that future events will not affect their recoverability. Future economic conditions and debt market volatility, including increases in interest rates, can adversely impact our tax planning strategies.
The statutory capital and surplus for our U.S. insurance subsidiaries increased $310.9 million during 2013, primarily due to operating results, an increase in admitted assets, and unrealized and realized gains on investments.
the capital requirements. We have the following securities, assets and letters of credit pledged to Lloyd’s to satisfy these capital requirements at December 31, 2013. In 2012, we decided not to renew the capital provision reinsurance treaty for the 2013 underwriting year with Flagstone Re. In accordance with the terms of the capital provision reinsurance treaty, Flagstone Re is obligated to provide funds at Lloyd’s in relation to its participation during the 2009 through 2012 underwriting years, until such time that these years close. We expect to be able to meet these capital requirements in the future.
Liquidity is a measure of our ability to generate sufficient cash flows to meet the cash requirements of business operations. As a holding company, our primary ongoing source of cash is dividends from our insurance subsidiaries. However, dividend payments to us by our U.S. insurance subsidiaries are subject to limitations imposed by regulators, such as prior notice periods and the requirement that dividends in excess of a specified percentage of statutory surplus or prior year’s statutory earnings receive prior approval (so called “extraordinary dividends”). No dividends were paid to the holding company by Hanover Insurance in 2013 or 2012. In 2011, a $99 million ordinary dividend was paid by Hanover. This dividend was used to help fund the acquisition of Chaucer.
Dividend payments to the holding company by Chaucer are regulated by U.K. law. Dividends from Chaucer are dependent on dividends from its subsidiaries. Annual dividend payments from Chaucer are limited to retained earnings that are not restricted by capital and other requirements for business at Lloyd’s. Also, Chaucer must provide advance notice to the U.K.’s Prudential Regulation Authority (“PRA”), one of the successors to the Financial Services Authority, of certain proposed dividends or other payments from PRA regulated entities. Chaucer paid approximately $14 million in dividends during 2013 to the holding company. No dividends were paid by Chaucer to the holding company in 2012 or 2011.
Supplementary Data of this Form 10-K. During 2011, cash provided by investing activities primarily resulted from $756.1 million of cash and cash equivalents acquired from Chaucer. This increase was partially offset by cash paid for the Chaucer acquisition totaling $468.4 million, which included an $11.3 million payment related to a foreign currency exchange forward contract, and the investment of a portion of our Chaucer segment’s cash into fixed maturities.
Net cash used in financing activities was $105.5 million during 2013, as compared to $133.4 million in 2012 and net cash provided by financing activities of $127.3 million in 2011. During 2013, cash used in financing activities primarily resulted from the repayment of approximately $121 million of debt, repurchases of common stock and the payment of dividends to shareholders, partially offset by the proceeds from the issuance, on March 20, 2013, of $175.0 million of unsecured subordinated debentures. During 2012, cash used in financing activities primarily resulted from the repayment of $72.4 million of debt, the payment of dividends to shareholders, repurchases of our common stock and repayments of collateral held for our securities lending program, partially offset by the proceeds from the FHLBB debt borrowings. During 2011, cash provided by financing activities primarily resulted from the issuance, on June 17, 2011, of $300.0 million of unsecured senior debentures. Cash received from the issuance of debt was partially offset by the repayment of $86.8 million of debt, the payment of dividends to our shareholders, repayments of collateral related to our securities lending program, and repurchases of common stock.
Financing obligations generally include repayment of our senior debentures, subordinated debentures, borrowings from the FHLBB, and operating lease payments. The following table represents our annual payments related to the contractual principal and interest payments of these financing obligations as of December 31, 2013 and operating lease payments reflect expected cash payments based upon lease terms. In addition, we also have included our estimated payments related to our loss and LAE obligations and our current expectation of payments to be made to support the obligations of our benefit plans. The following table also includes commitments to purchase investment securities at a future date. Actual payments may differ from the contractual and/or estimated payments in the table.
(1) Debt includes our senior debentures due in 2025, which pay annual interest at a rate of 7 5/8%, our senior debentures due in 2020, which pay annual interest at a rate of 7.50%, our senior debentures due in 2021, which pay annual interest at a rate of 6.375%, our subordinated debentures due in 2053, which pay annual interest at a rate of 6.35% and our subordinated debentures due in 2027, which pay cumulative dividends at an annual rate of 8.207%. Payments related to the principal amounts of these agreements represent contractual maturity; therefore, principal and interest associated with these obligations are reflected in the above table based upon the contractual maturity dates. In addition, we have $125.0 million of borrowings under a collateralized borrowing program with the FHLBB which pays interest monthly at a rate of 5.50% annually. Such borrowings are available for a twenty-year term or through September 25, 2029.
(2) Our U.S. and international subsidiaries are lessees with a number of operating leases.
(4) Non-qualified defined benefit pension and postretirement benefit obligations reflect estimated payments to be made through plan year 2023 for pension, postretirement and postemployment benefits. Estimates of these payments and the payment patterns are based upon historical experience.
Management’s Discussion and Analysis contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. For a discussion of indicators of forward-looking statements and specific important factors that could cause actual results to differ materially from those contained in forward-looking statements, see “Risk Factors” in Part 1 - Item 1A of this Form 10-K. This Management’s Discussion and Analysis should be read and interpreted in light of such factors.
Capacity - The maximum amount of business which may be accepted by a syndicate or a corporate member on a syndicate, expressed in terms of gross premium written, net of commission.
Catastrophe loss - Loss and directly identified loss adjustment expenses from catastrophes. The Insurance Services Office (“ISO”) Property Claim Services (“PCS”) defines a catastrophe loss as an event that causes $25 million or more in U.S. industry insured property losses and affects a significant number of property and casualty policyholders and insurers. In addition to those catastrophe events declared by ISO, claims management also generally includes within the definition of a “catastrophe loss”, a property loss event that causes approximately $5 million or more in company insured losses and affects in excess of one hundred policyholders or multiple independent risks. For the international business in our Chaucer segment, management utilizes a “catastrophe loss” definition that is substantially consistent with the ISO definition framework.
Current accident year loss results - A non-GAAP measure of the estimated earnings impact of current premiums offset by estimated loss experience and expenses for the current accident year. This measure includes the estimated increase in revenue associated with higher prices (premiums), including those caused by price inflation and changes in exposure, partially offset by higher volume driven expenses and inflation of loss costs. Volume driven expenses include acquisition costs such as commissions paid to agents, which are typically based on a percentage of premium dollars.
The Authorized Control Level authorizes the commissioner of the state of domicile to take whatever regulatory actions considered necessary to protect the best interest of the policyholders and creditors of the insurer.
Syndicate - A group of members underwriting insurance at Lloyd’s through the agency of a managing agent, to whom a particular syndicate number is assigned.
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of The Hanover Insurance Group, Inc. and its subsidiaries at December 31, 2013 and December 31, 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15(a)(2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
The Company reviews investments in an unrealized loss position to identify other-than-temporary declines in value. When it is determined that a decline in value of an equity security is other-than-temporary, the Company reduces the cost basis of the security to fair value with a corresponding charge to earnings. When an other-than-temporary decline in value of a debt security is deemed to have occurred, the Company must assess whether it intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis. If the debt security meets either of these two criteria, an other-than-temporary impairment (“OTTI”) is recognized in earnings equal to the entire difference between the security’s amortized cost basis and its fair value at the impairment measurement date. If the Company does not intend to sell the debt security and it is not more likely than not the Company will be required to sell the security before recovery of its amortized cost basis, the credit loss portion of an OTTI is recorded through earnings while the portion attributable to all other factors is recorded separately as a component of other comprehensive income. The amount of the OTTI that relates to credit is estimated by comparing the amortized cost of the fixed maturity security with the net present value of the security’s projected future cash flows, discounted at the effective interest rate implicit in the investment prior to impairment. The non-credit portion of the impairment is equal to the difference between the fair value and the net present value of the security’s cash flows at the impairment measurement date. Once an OTTI has been recognized, the new amortized cost basis of the security is equal to the previous amortized cost less the amount of OTTI recognized in earnings. For equity method investments, an impairment is recognized when evidence demonstrates that an other-than-temporary loss in value has occurred, including the absence of the ability to recover the carrying amount of the investment or the inability of the investee to sustain a level of earnings that would justify the carrying amount of the investment.
In accordance with the provisions of ASC 350, Intangibles- Goodwill and Other, the Company carries its goodwill at cost, net of amortization prior to January 1, 2002 and net of impairments. Increases to goodwill are generated through acquisition and represent the excess of the cost of an acquisition over the fair value of net assets acquired, including any intangibles acquired. Since January 1, 2002 goodwill is no longer amortized but rather, is reviewed for impairment. Additionally, acquisitions can also produce intangible assets, which have either a definite or indefinite life. Intangible assets with definite lives are amortized over that life, whereas those intangible assets determined to have an indefinite life are reviewed at least annually for impairment.
The Company is subject to the tax laws and regulations of the U.S. and foreign countries in which it operates. The Company files a consolidated U.S. federal income tax return that includes the holding company and its U.S. subsidiaries. Generally, taxes are accrued at the U.S. statutory tax rate of 35% for income from the U.S. operations. The Company’s primary non-U.S. jurisdiction is the United Kingdom (“U.K.”). In July 2012, the U.K. statutory rate decreased from 26% to 24% effective April 1, 2012 and from 24% to 23% effective April 1, 2013. Further decreases were enacted in July 2013 to reduce the statutory rate from 23% to 21% effective April 1, 2014 and from 21% to 20% effective April 1, 2015. The Company accrues taxes on certain non-U.S. income that is subject to U.S. tax at the U.S. tax rate. Foreign tax credits, where available, are utilized to offset U.S. tax as permitted. Certain of our non-U.S. income is not subject to U.S. tax until repatriated. Foreign taxes on this non-U.S. income are accrued at the local foreign rate and do not have an accrual for U.S. deferred taxes since these earnings are intended to be indefinitely reinvested overseas.
Deferred income taxes are generally recognized when assets and liabilities have different values for financial statement and tax reporting purposes, and for other temporary taxable and deductible differences as defined by ASC 740, Income Taxes (“ASC 740”). These temporary differences are measured at the balance sheet date using enacted tax rates expected to apply to taxable income in the years the temporary differences are expected to reverse. These differences result primarily from insurance reserves, deferred acquisition costs, tax credit carryforwards, loss carryforwards and employee benefit plans.
Earnings per share (“EPS”) for the years ended December 31, 2013, 2012 and 2011 is based on a weighted average of the number of shares outstanding during each year. Basic and diluted EPS is computed by dividing income available to common stockholders by the weighted average number of shares outstanding for the period. The weighted average shares outstanding used to calculate basic EPS differ from the weighted average shares outstanding used in the calculation of diluted EPS due to the effect of dilutive employee stock options, nonvested stock grants and other contingently issuable shares. If the effect of such items is antidilutive, the weighted average shares outstanding used to calculate diluted EPS are equal to those used to calculate basic EPS.
In June 2011, the FASB issued ASC Update No. 2011-05 (Topic 220) Presentation of Comprehensive Income (“ASC Update No. 2011-05”). This ASC update requires companies to present net income and other comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of income and other comprehensive income. The option to present items of other comprehensive income in the statement of changes in equity is eliminated. In addition, an entity is required to present on the face of the financial statements reclassification adjustments from other comprehensive income to net income. This ASC update should be applied retrospectively and except for the provisions related to reclassification adjustment, was effective for interim and annual periods beginning after December 15, 2011. In December 2011, the FASB issued ASC Update 2011-12 (Topic 220) Comprehensive Income which deferred the implementation date of the reclassification adjustment guidance in ASC Update No. 2011-05 and was subsequently replaced by ASC Update No. 2013-02, as described above. The Company implemented the guidance related to financial statements presentation effective January 1, 2012. The effect of implementing the guidance related to financial statements presentation did not have a significant impact to the Company’s financial statement presentation.
In May 2011, the FASB issued ASC Update No. 2011-04 (Topic 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASC update results in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value for both U.S. GAAP and International Financial Reporting Standards (“IFRS”). The new guidance includes changes to how and when the valuation premise of highest and best use applies, clarification on the application of blockage factors and other premiums and discounts, as well as new and revised disclosure requirements. This ASC update was effective for interim and annual periods beginning after December 15, 2011. The Company implemented this guidance as of January 1, 2012. The effect of implementing this guidance was not material to the Company’s financial position or results of operations.
In July 2013, the FASB issued ASC Update No. 2013-11 (Topic 740) Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force). This ASC update clarifies the applicable guidance for the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward as long as it is available, at the reporting date under the tax law of the applicable jurisdiction, to settle any additional income taxes that would result from the disallowance of a tax position (with certain exceptions). The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. This ASC update is effective for annual and interim periods beginning after December 15, 2013, with early adoption permitted, and is to be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The Company does not expect the adoption of ASC Update 2013-11 to have a material impact on its financial position or results of operations.
In March 2013, the FASB issued ASC Update No. 2013-05 (Topic 830) Foreign Currency Matters-Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity (a consensus of the FASB Emerging Issues Task Force). This ASC update clarifies the applicable guidance for the release of the cumulative translation adjustment into net income when a parent either sells all or a portion of its investment in a foreign entity. This guidance is also required to be applied when an entity no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity (with certain exceptions). Additionally, this update clarifies that the sale of an investment in a foreign entity includes events that result in an acquirer obtaining control of an acquiree in which it held an equity interest immediately before the acquisition date in a business combination achieved in stages. This ASC update is effective for annual and interim periods beginning after December 15, 2013, with early adoption permitted, and is to be applied prospectively to derecognition events occurring after the effective date. The Company does not expect the adoption of ASC Update 2013-05 to have a material impact on its financial position or results of operations.
Acquisition costs, which include advisory, legal, and accounting costs, totaled $11.7 million and were expensed as incurred.
The following unaudited pro forma information presents the combined revenues, net income (loss) and net income (loss) per share of THG and Chaucer for the year ended December 31, 2011 with pro forma purchase accounting adjustments as if the acquisition had been consummated as of January 1, 2011. This pro forma information is not necessarily indicative of what would have occurred had the acquisition and related transactions been made on the date indicated, or of future results of the Company. Amounts in 2011 are converted from GBP to U.S. dollar at a 1.60 exchange rate.
In 2013, the Company recognized a $5.8 million gain relating to its former life insurance businesses. This was primarily due to an insurance settlement related to a class action lawsuit, net of tax.
OTTI unrealized losses in the tables above represent OTTI recognized in accumulated other comprehensive income. This amount excludes net unrealized gains on impaired securities relating to changes in the value of such securities subsequent to the impairment measurement date of $16.4 million and $20.5 million as of December 31, 2013 and 2012, respectively.
The Company participates in a security lending program for the purpose of enhancing income. Securities on loan to various counterparties had a fair value of $13.6 million and $29.2 million at December 31, 2013 and 2012, respectively, and were fully collateralized by cash. The fair value of the loaned securities is monitored on a daily basis, and the collateral is maintained at a level of at least 102% of the fair value of the loaned securities. Securities lending collateral is recorded by the Company in cash and cash equivalents, with an offsetting liability included in expenses and taxes payable.
The Company maintains an overall risk management strategy that incorporates the use of derivative instruments, as necessary, to manage significant unplanned fluctuations in earnings that may be caused by foreign currency exchange and interest rate volatility.
The Company did not use derivative instruments in 2013. In 2012, the Company realized a loss of $5.1 million on futures contracts relating to the realization for tax purposes only, of unrealized gains in its investment portfolio. Additionally, the Company utilized a foreign currency forward contract to mitigate changes in fair value caused by foreign currency fluctuation in converting GBP denominated securities into their U.S. dollar denominated equivalent. The contract was terminated in March 2012 and the Company recognized a gain of $0.7 million.
Equity securities and other balances at December 31, 2013, 2012 and 2011 include after-tax net appreciation on other invested assets of $2.9 million, $2.1 million and $1.9 million, respectively. Fixed maturities at December 31, 2013, 2012 and 2011 include after-tax net depreciation on derivative instruments of $0.9 million, $1.0 million and $1.2 million, respectively.
The Company views gross unrealized losses on fixed maturities and equity securities as being temporary since it is its assessment that these securities will recover in the near term, allowing the Company to realize the anticipated long-term economic value. The Company employs a systematic methodology to evaluate declines in fair value below amortized cost for fixed maturity securities or cost for equity securities. In determining OTTI of fixed maturity and equity securities, the Company evaluates several factors and
circumstances, including the issuer’s overall financial condition; the issuer’s credit and financial strength ratings; the issuer’s financial performance, including earnings trends, dividend payments and asset quality; any specific events which may influence the operations of the issuer; the general outlook for market conditions in the industry or geographic region in which the issuer operates; and the length of time and the degree to which the fair value of an issuer’s securities remains below the Company’s cost. With respect to fixed maturity investments, the Company considers any factors that might raise doubt about the issuer’s ability to make contractual payments as they come due and whether the Company expects to recover the entire amortized cost basis of the security. With respect to equity securities, the Company considers its ability and intent to hold the investment for a period of time to allow for a recovery in value.
On December 21, 2012, the Company sold an office building and adjacent garage that it had developed for $75.9 million, and recognized an estimated gain of $3.3 million. In 2013, upon receipt of final construction costs, the gain was adjusted by $(0.9) million, to $2.4 million. The project was financed, in part, with $46.3 million of FHLBB advances through the Company’s membership in the FHLBB, which was repaid in January 2013.
For 2013, total OTTI was $7.0 million. Of this amount, $6.0 million was recognized in earnings and $1.0 million was recorded as unrealized losses in accumulated other comprehensive income. Of the $6.0 million recorded in earnings, $2.5 million related to an emerging markets exchange-traded fund, $1.6 million related to common stocks, $1.4 million was estimated credit losses on fixed maturity securities and $0.5 million related to fixed maturity securities that the Company intends to sell.
The methodology and significant inputs used to measure the amount of credit losses on fixed maturities in 2013, 2012 and 2011 were as follows:
Corporate bonds - the Company utilized a financial model that derives expected cash flows based on probability-of-default factors by credit rating and asset duration and loss-given-default factors based on security type. These factors are based on historical data provided by an independent third-party rating agency.
Level 3 - Unobservable inputs that are supported by little or no market activity.
including, but not limited to yield curves and issuer spreads. Level 3 securities include issues for which little observable data can be obtained, primarily due to the illiquid nature of the securities, and for which significant inputs used to determine fair value are based on the Company’s own assumptions. Non-binding broker quotes are also included in Level 3.
The Company utilizes a third party pricing service for the valuation of the majority of its equity securities and receives one quote for each equity security. When quoted market prices in an active market are available, they are provided by the pricing service as the fair value and such values are classified as Level 1. Generally, all prices provided by the pricing service, except quoted market prices, are reported as Level 2. The Company holds certain equity securities that have been issued by privately-held entities that do not have an active market and for which the pricing service cannot provide fair values. Generally, the Company estimates fair value for these securities based on the issuer’s book value and market multiples. These securities are reported as Level 3 as market multiples represent significant unobservable inputs.
During the years ended December 31, 2013 and 2012, the Company transferred fixed maturities between Level 2 and Level 3 primarily as a result of assessing the significance of unobservable inputs on the fair value measurement. There were no transfers between Level 1 and Level 2 during 2013 or 2012.
The following table provides quantitative information about the significant unobservable inputs used by the Company in the fair value measurements of Level 3 assets. Where discounted cash flows were used in the valuation of fixed maturities, the internally-developed discount rate was adjusted by the significant unobservable inputs shown in the table. Valuations for securities based on broker quotes for which there was a lack of transparency as to inputs used to develop the valuations have been excluded.
Significant increases (decreases) in any of the above inputs in isolation would result in a significantly lower (higher) fair value measurement. There were no interrelationships between these inputs which might magnify or mitigate the effect of changes in unobservable inputs on the fair value measurement.
On March 20, 2013, the Company issued $175.0 million aggregate principal amount of 6.35% subordinated unsecured debentures due March 30, 2053. These debentures pay interest quarterly. The Company may redeem these debentures in whole at any time, or in part from time to time, on or after March 30, 2018, at a redemption price equal to their principal amount plus accrued and unpaid interest.
On June 17, 2011, the Company issued $300.0 million aggregate principal amount of 6.375% senior unsecured debentures due June 15, 2021. Additionally, on February 23, 2010, the Company issued $200.0 million aggregate principal amount of 7.50% senior unsecured debentures due March 1, 2020. The Company also issued 7.625% senior unsecured debentures with a par value of $200.0 million on October 16, 1995. As of December 31, 2013 and 2012, the remaining 7.625% senior debentures have a par value of $81.2 million and $120.9 million, respectively, and mature on October 15, 2025. All of the Company’s senior debentures are subject to certain restrictive covenants, including limitations on the issuance or disposition of stock of restricted subsidiaries and limitations on liens. These debentures pay interest semi-annually. In addition, the Company’s subordinated debentures maturing February 3, 2027 have a par value of $59.7 million as of December 31, 2013 and 2012 and pay cumulative dividends semi-annually at 8.207%.
As collateral to FHLBB, Hanover Insurance pledged government agency securities with a fair value of $148.1 million and $200.8 million, for the aggregate borrowings of $125.0 million and $171.3 million as of December 31, 2013 and December 31, 2012, respectively. The amount of required collateral decreased in conjunction with the repayment of the $46.3 million of FHLBB advances. The fair value of the collateral pledged must be maintained at certain specified levels of the borrowed amount, which can vary depending on the type of assets pledged. If the fair value of this collateral declines below these specified levels, Hanover Insurance would be required to pledge additional collateral or repay outstanding borrowings. Hanover Insurance is permitted to voluntarily repay the outstanding borrowings at any time, subject to a repayment fee. As a requirement of membership in the FHLBB, Hanover Insurance maintains a certain level of investment in FHLBB stock. Total holdings of FHLBB stock were $9.3 million and $9.7 million at December 31, 2013 and 2012, respectively.
At December 31, 2013, the Company had a $200.0 million credit agreement which expires in November 2018. The Company had no borrowings under this agreement. Additionally, the Company had a Standby Letter of Credit Facility not to exceed £130.0 million (or $215.8 million based on the foreign currency exchange rate of 1.66 at December 31, 2013). This Letter of Credit Facility provides regulatory capital supporting Chaucer’s underwriting activities for the 2014 and 2015 years of account and each prior open year of account. Simultaneous with this agreement, THG entered into a Guaranty Agreement with Lloyds Bank plc, as Facility Agent and Security Agent, pursuant to which, THG unconditionally guarantees the obligations of Chaucer under the Letter of Credit Facility.
In prior years, the Company completed several transactions which resulted in the realization, for tax purposes only, of unrealized gains in its investment portfolio. The Company realized $69.6 million and $98.4 million, respectively, in 2012 and 2011 as a result of such transactions. These transactions enabled the Company to realize capital loss carryforwards to offset these gains, and resulted in the release of the valuation allowance the Company held against the deferred tax asset related to these capital loss carryforwards. In 2012, the Company released $24.4 million of its valuation allowance which was recorded as a benefit in accumulated other comprehensive income. In 2011, the Company released $29.0 million of its valuation allowance which $0.2 million was reflected in income from continuing operations and the remaining $28.8 million was reflected as a benefit in accumulated other comprehensive income. During 2013, 2012 and 2011, the Company recognized in income from continuing operations, related to non-operating income, $17.5 million, $14.3 million and $9.7 million, respectively. The remaining amount of $107.7 million in accumulated other comprehensive income will be released into income from continuing operations in future years, as the investment securities subject to these transactions are sold or mature. During 2012, the Company released $35.9 million of its valuation allowance related to its deferred tax asset held at the beginning of the year. The release of this valuation allowance resulted from the aforementioned transaction which utilized capital loss carryforwards, unrealized appreciation in its investment portfolio, and net realized capital gains in its Consolidated Statements of Income. Accordingly, the Company recorded decreases in its valuation allowance of $25.3 million as an adjustment to accumulated other comprehensive income, $7.7 million as an adjustment to income tax expense from continuing operations, and $2.9 million in discontinued operations.
During 2011, the Company reduced its valuation allowance, for both continuing and discontinued operations, related to its deferred tax asset by $55.6 million, from $91.5 million to $35.9 million. There were four principal components to this reduction. First, the Company decreased its valuation allowance by $29.0 million as a result of the aforementioned transaction, which utilized the capital loss carryforwards. Second, the Company decreased its valuation allowance by $21.9 million on certain unrealized losses as a result of unrealized appreciation in its investment portfolio. This decrease was reflected as an increase in accumulated other comprehensive income. Third, as a result of $28.1 million in net realized gains during 2011, the Company decreased its valuation allowance by $7.5 million as an increase to income from continuing operations, since these gains utilized the Company’s capital loss carryforwards. Fourth, in the 2010 U.S. federal income tax return the Company was able to utilize an additional $7.6 million of capital loss carryforward that expired in 2010. As such, the valuation allowance was increased by $2.6 million with an equal and offsetting increase to the related deferred tax asset. The remaining increase of $0.2 million was attributable to other items reflected as an expense from discontinued operations.
Although most of the Company’s non - U.S. income is subject to U.S. federal income tax, certain of its non-U.S. income is not subject to U.S. federal income tax until repatriated. Foreign taxes on this non - U.S. income are accrued at the local foreign tax rate, as opposed to the higher U.S. statutory tax rate, since these earnings currently are expected to be indefinitely reinvested overseas. This assumption could change, as a result of a sale of the subsidiaries, the receipt of dividends from the subsidiaries, a change in management’s intentions, or as a result of various other events. The Company has not made a provision for U.S. taxes on $20.3 million, $10.0 million and $4.2 million of non-U.S. income for 2013, 2012 and 2011, respectively. However, in the future, if such earnings were distributed to the Company, taxes of $13.0 million would be payable on such undistributed earnings and would be reflected in the tax provision for the year in which these earnings are no longer intended to be indefinitely reinvested overseas, assuming all foreign tax credits are realized.
As of January 1, 2005, the defined benefit pension plans were frozen and since that date, no further cash balance allocations have been credited to participants. Participants’ accounts are credited with interest daily, based upon the General Agreement of Trades and Tariffs. In addition, the grandfathered benefits for the transition group were also frozen at January 1, 2005 levels with an annual transition pension adjustment calculated at an interest rate equal to 5% per year up to 35 years of completed service, and 3% thereafter. As of December 31, 2013, based on current estimates of plan liabilities and other assumptions, the projected benefit obligation of the qualified defined benefit pension plans exceeds plan assets by approximately $7 million.
Weighted-average assumptions used to determine pension benefit obligations are as follows:
The following tables present for each hierarchy level the U.S. qualified defined benefit plan’s investment assets that are measured at fair value at December 31, and 2012. (Refer to Note 5 - “Fair Value” for a description of the different levels in the Fair Value Hierarchy).
Securities classified as Level 1 at December 31, 2013 and 2012 include actively traded mutual funds that are publicly traded and which primarily invest in equity securities that are valued at quoted market prices. Additionally, Level 1 securities at December 31, 2012 include 466,755 shares of THG common stock held by the plan, which were valued at quoted market prices. The plan held no shares of THG common stock at December 31, 2013. Securities classified as Level 2 include investments in commingled pools that primarily invest in publicly traded common stocks and international equity securities. The fair value of each of the Level 2 investments is determined daily as the NAV based on the value of the underlying investments, which is determined independently by the investment manager. The daily NAV, which is not published as a quoted market price for these investments, is used as the basis for transactions. Redemption of these funds is not subject to restriction.
Real estate fund investments classified as Level 3 at December 31, 2013 and 2012 are valued based upon the values of the net assets of the fund. Although the NAV is calculated daily, transactions also consider cash inflows and outflows of the fund. The price where units are transacted includes the NAV, which is adjusted for investment charges and other estimated acquisition costs such as legal fees, taxes, planning and architect fees, survey and agent fees, among others.
Contributions include $0.4 million of Chaucer employee contributions during 2013 and 2012. All other contributions for all plans were made by the Company.
defined benefit pension plans and the Chaucer pension plan as of December 31, 2013 and 2012.
In accordance with ERISA guidelines, the Company is not required to fund its U.S. qualified benefit plan in 2014. The Company expects to contribute $3.3 million to its U.S. non-qualified pension plans to fund 2014 benefit payments, and approximately $2 million to the Chaucer pension plan. At this time, no additional discretionary contributions are expected to be made to the plans during 2014 and the Company does not expect that any funds will be returned from the plans to the Company during 2014.
Chaucer also provides a defined contribution plan for its employees which provides for employer provided contributions. The Company’s expense for 2013 and 2012 was $5.0 million and $4.8 million, respectively.
Prior to June 2013, the Company also had postretirement death benefits providing for payment at death up to the retirees’ final annual salary. In May 2013, the Company settled and defeased the life insurance portion of its postretirement benefits by decreasing the level of death benefits and concurrently fully funding the remaining benefits through the purchase of life insurance policies for the plan beneficiaries from an unaffiliated life insurer, resulting in a net settlement gain. This plan was also unfunded.
The amount reclassified from accumulated other comprehensive income for the pension and postretirement benefits was allocated approximately 40% to loss adjustment expenses and 60% to other operating expenses for each of the years ended December 31, 2013, 2012 and 2011.
Performance-based restricted stock units are based upon the achievement of the performance metric at 100%. These units have the potential to range from 0% to 200% of the shares disclosed, which varies based on grant year and individual participation level. Increases above the 100% target level are reflected as granted in the period in which performance-based stock unit goals are achieved. Decreases below the 100% target level are reflected as forfeited. In 2013, performance-based stock units of 8,244 were included as forfeited due to completion levels less than 100% for units granted in 2011. The weighted average grant date fair value for these awards was $46.47. In 2012, performance-based stock units of 31,750 were included as forfeited due to completion levels of less than the threshold achievement level for shares granted in 2010. The weighted average grant date fair value for these awards was $42.15. In 2011, performance-based stock units of 47,375 were included as forfeited due to completion levels of less than the threshold achievement level for shares granted in 2009. The weighted average grant date fair value for these awards was $34.19.
The intrinsic value, which is equal to the fair value for restricted stock and for restricted stock units that vested during the year ended December 31, 2013 and 2012, was $1.8 million and $1.7 million, respectively. For performance-based restricted stock units that would have vested in 2013 and 2012, there was no intrinsic value since these awards were forfeited due to the aforementioned completion levels of less than threshold. The intrinsic value of restricted stock units and performance-based restricted units that vested during the year ended December 31, 2011 were $10.2 million and $1.3 million, respectively.
At December 31, 2013, the aggregate intrinsic value of restricted stock and restricted stock units was $31.4 million and the weighted average remaining contractual life was 1.1 years. The aggregate intrinsic value of performance and market-based restricted stock units was $11.0 million and the weighted average remaining contractual life was 2.0 years. As of December 31, 2013, there was $12.1 million of total unrecognized compensation cost related to unvested restricted stock units and performance and market-based restricted stock units, assuming performance and market-based restricted stock units are achieved at 100% of the performance metric. The cost is expected to be recognized over a weighted-average period of 1.8 years. Compensation cost associated with restricted stock, restricted stock units and performance and market-based restricted stock units is generally calculated based upon grant date fair value, which is determined using current market prices.
Since October 2007 and through December 2013, the Company’s Board of Directors has authorized aggregate repurchases of the Company’s common stock of up to $600 million, including a $100 million increase in the program in 2013. As of December 31, 2013, the Company has $137.0 million available for repurchases under these repurchase authorizations. Repurchases may be executed using open market purchases, privately negotiated transactions, accelerated repurchase programs or other transactions. The Company is not required to purchase any specific number of shares or to make purchases by any certain date under this program. During 2013, the Company purchased 1.6 million shares of the Company’s common stock at a cost of $78.2 million.
The Company’s primary business operations include insurance products and services provided through four operating segments. The domestic operating segments are Commercial Lines, Personal Lines and Other, and the Company’s international operating segment is Chaucer. Commercial Lines includes commercial multiple peril, commercial automobile, workers’ compensation, and other commercial coverages, such as specialty program business, inland marine, management and professional liability and surety. Personal Lines includes personal automobile, homeowners and other personal coverages. Chaucer includes marine and aviation, energy, property, U.K. motor, and casualty and other coverages (which includes international liability, specialist coverages, and syndicate participations). Included in Other are Opus Investment Management, Inc., which markets investment management services to institutions, pension funds and other organizations; earnings on holding company assets; and, a voluntary pools business which is in run-off. The separate financial information is presented consistent with the way results are regularly evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance.
The Company reports interest expense related to debt separately from the earnings of its operating segments. This consists of interest on the Company’s senior debentures, subordinated debentures, collateralized borrowings with the Federal Home Loan Bank of Boston, and letter of credit facility. Management evaluates the results of the aforementioned segments based on operating income (loss) before taxes (formerly referred to as segment income) which also excludes interest expense on debt. Operating income (loss) before taxes excludes certain items which are included in net income (loss), such as net realized investment gains and losses (including gains and losses on certain derivative instruments). Such gains and losses are excluded since they are determined by interest rates, financial markets and the timing of sales. Also, operating income (loss) before taxes excludes net gains and losses on disposals of businesses, gains and losses related to the repayment of debt, discontinued operations, costs to acquire businesses, restructuring costs, extraordinary items, the cumulative effect of accounting changes and certain other items. Although the items excluded from operating income (loss) before taxes may be important components in understanding and assessing the Company’s overall financial performance, management believes that the presentation of operating income (loss) before taxes enhances an investor’s understanding of the Company’s results of operations by highlighting net income (loss) attributable to the core operations of the business. However, operating income (loss) before taxes should not be construed as a substitute for income (loss) before income taxes and operating income (loss) should not be construed as a substitute for net income (loss).
The following table provides identifiable assets for the Company’s business segments and discontinued operations:
The following table presents the Company’s gross written premium (“GWP”) based on the location of the risk:
Long-lived assets located outside the U.S. were not material for the year ended December 31, 2013 or 2012. The Company does not have revenue from transactions with a single agent or broker amounting to 10 percent or more of its consolidated revenue.
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company; consequently, allowances are established for amounts deemed uncollectible. The Company determines the appropriate amount of reinsurance based on evaluations of the risks accepted and analyses prepared by consultants and on market conditions (including the availability and pricing of reinsurance). The Company also believes that the terms of its reinsurance contracts are consistent with industry practice in that they contain standard terms with respect to lines of business covered,
limit and retention, arbitration and occurrence. The Company believes that its reinsurers are financially sound. This belief is based upon an ongoing review of its reinsurers’ financial statements, reported financial strength ratings from rating agencies, reputations in the marketplace, and the analysis and guidance of THG’s reinsurance advisors.
As a condition to conduct certain business in various states, the Company is required to participate in residual market mechanisms, facilities and pooling arrangements such as the Michigan Catastrophic Claims Association (“MCCA”). The Company is subject to concentration of risk with respect to reinsurance ceded to the MCCA. Funding for MCCA comes from assessments against automobile insurers based upon their share of insured automobiles in the state. Insurers are allowed to pass along this cost to Michigan automobile policyholders. The Company ceded to the MCCA premiums earned and losses and LAE incurred of $72.2 million and $76.6 million in 2013, $74.0 million and $99.9 million in 2012, $69.6 million and $122.6 million in 2011, respectively. MCCA, which represented 37.1% of the total reinsurance receivable balance at December 31, 2013, is the Company’s only reinsurer representing at least 10% of its reinsurance assets. Reinsurance recoverables related to MCCA were $867.0 million and $856.3 million at December 31, 2013 and 2012, respectively. Because the MCCA is supported by assessments permitted by statute, and there have been no significant uncollectible balances from MCCA identified during the three years ending December 31, 2013, the Company believes that it has no significant exposure to uncollectible reinsurance balances from this entity.
The following table provides the effects of reinsurance. Amounts reflect activity of Chaucer since the July 1, 2011 acquisition date.
(2) In 2013, we did not renew the capital provision reinsurance treaty with Flagstone Re. This reduced ceded premiums written, premiums earned and losses and LAE for the year ended December 31, 2013.
primarily related to bodily injury severity in the 2010 and 2011 accident years, and higher than expected homeowners property losses from non-catastrophe weather related activity in the 2011 accident year. Partially offsetting the unfavorable development was lower than expected losses within the commercial multiple peril line, related to the 2008 through 2011 accident years.
Loss and LAE reserves related to asbestos and environmental damage liability, primarily in other commercial lines, were $61.9 million, $60.5 million and $59.8 million as of December 31, 2013, 2012 and 2011, respectively. Ending loss and LAE reserves for all direct business written by the Company related to asbestos and environmental damage liability, included in the reserve for losses and LAE, were $11.5 million, $9.8 million and $10.0 million, net of reinsurance of $20.6 million, $20.4 million and $18.7 million as of December 31, 2013, 2012 and 2011, respectively. As a result of the Company’s historical direct underwriting mix of Commercial Lines policies toward smaller and middle market risks, past asbestos and environmental damage liability loss experience has remained minimal in relation to the Company’s total loss and LAE incurred experience. In addition, the Company has established gross loss and LAE reserves for its run-off voluntary assumed reinsurance pool business with asbestos and environmental damage liability of $29.8 million, $30.3 million and $31.1 million at December 31, 2013, 2012 and 2011, respectively. These reserves relate to pools in which the Company has terminated its participation; however, the Company continues to be subject to claims related to years in which it was a participant. Because of the inherent uncertainty regarding the types of claims in these pools, the Company cannot provide assurance that its reserves will be sufficient.
On March 12, 2007, a putative class action suit captioned Jennifer A. Durand v. The Hanover Insurance Group, Inc., and The Allmerica Financial Cash Balance Pension Plan was filed in the United States District Court for the Western District of Kentucky. The named plaintiff, a former employee who received a lump sum distribution from the Company’s Cash Balance Plan (the “Plan”) at or about the time of her termination, claims that she and others similarly situated did not receive the appropriate lump sum distribution because in computing the lump sum, the Company and the Plan understated the accrued benefit in the calculation. The plaintiff claims that the Plan underpaid her distributions and those of similarly situated participants by failing to pay an additional so-called “whipsaw” amount reflecting the present value of an estimate of future interest credits from the date of the lump sum distribution to each participant’s retirement age of 65.
The Company’s U.S. insurance subsidiaries are required to file annual statements with state regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory basis), as codified by the National Association of Insurance Commissioners. Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, may differ from company to company within a state, and may change in the future. The Company’s U.S. insurance subsidiaries did not have any permitted practices as of or for the years ended December 31, 2013, 2012 and 2011.
The minimum statutory capital and surplus necessary to satisfy the Company’s regulatory requirements was $354.5 million, $329.0 million and $291.0 million, which equals the Authorized Control Level at December 31, 2013, 2012 and 2011, respectively.
The quarterly results of operations for 2013 and 2012 are summarized below.