Underwriting ratios are calculated for net losses and LAE, net acquisition expense and net underwriting expense. The ratios are calculated by dividing the related expense by net premiums earned. The combined ratio is the sum of the net losses and LAE, net acquisition expense and net underwriting expense ratios.
Segment underwriting income or loss is reconciled to the U.S. GAAP measure of income or loss before income taxes in Note 11 to the “Consolidated Financial Statements” in this Form 10-K.
Book value per common share represents total shareholders’ equity divided by the number of common shares outstanding. Management uses growth in book value per common share as an indicator of the value provided to common shareholders and believes that, over time, book value per common share is a key driver of share price. The most significant influences on our book value per common share are net income or loss, other comprehensive income or loss and share repurchase activities.
Return on equity represents net income available to common shareholders divided by the beginning shareholders' equity for the year, adjusted for material capital transactions during the year. Management uses return on equity as a financial performance measure in determining incentive compensation as set forth in the Proxy Statement.
As of December 31, 2013, our capital resources of $2.0 billion consisted of $1.7 billion of common shareholders’ equity and $250.0 million of debt obligations. As of December 31, 2012, our capital resources of $2.1 billion consisted of $1.9 billion of common shareholders’ equity and $250.0 million of debt obligations. As of December 31, 2013 and 2012, our investable assets were $3.5 billion and $4.0 billion, respectively.
Our net income was $223.3 million and $327.2 million for the years ended December 31, 2013 and December 31, 2012, respectively, and our net loss was $224.1 million for the year ended December 31, 2011. Our net premiums written were $567.1 million, $565.0 million and $651.5 million for the years ended December 31, 2013, 2012 and 2011, respectively.
Over the last several years, we have seen a significant increase in overall reinsurance industry capacity resulting from strong financial results and the influx of new competitors.
Terms and conditions have been relaxed in favor of the buyers of reinsurance, with ceding commissions in many cases significantly exceeding the buyers’ costs to produce this business. The alteration to terms and conditions also potentially alters the behavior of ceding companies as they can write underlying business that may have been previously unprofitable.
In the Casualty segment, we expect casualty insurance and reinsurance capacity to remain abundant for the rest of 2014. If this is the case, the potential for improvement in the risk adjusted total return we are able to achieve on this business will be limited. We believe the casualty market is presently such that reinsurance rate adequacy is expected to produce returns at or below the cost of capital, yet competition for this business remains strong. Under these conditions many treaties do not meet our pricing standards. Unless these conditions change, we expect that the total return available from the casualty business will not improve materially. Accordingly, we expect to write a similar sized portfolio during 2014 in our Casualty segment as compared with our current in-force book of business.
The impact on our investment portfolio from the recent rise in interest rates was mitigated by our prior efforts to reduce our portfolio duration. When interest rates and spreads are at attractive levels, we expect to continue deploying cash into high quality fixed income securities. Additionally, we may begin considering riskier assets.
Absent a major event in the insurance or capital markets, we expect continued pressure on reinsurance rate adequacy. We will continue with our strategy of responding to changes in market conditions and of underwriting for profitability, not market share.
Based on our current reserve position, our net in-force portfolio of reinsurance business, and our asset portfolio we believe that we are strongly capitalized with a comfortable capital cushion above the rating agency targets for a company with our ratings. If the business performs as we anticipate, our capital cushion would grow over time. Under those conditions we would have the financial flexibility to expand our underwriting, hold riskier assets, or buy back shares. Our decision-making will be guided by the pricing we observe in the various markets.
Due to the nature of reinsurance, ceding companies routinely report and remit premiums to us subsequent to the contract coverage period. Consequently, premiums written and receivable include amounts reported by the ceding companies, supplemented by our estimates of premiums that are written but not reported. The estimation of written premiums may be affected by early cancellation, election of contract provisions for cut-off and return of unearned premiums or other contract disruptions. The time lag involved in the process of reporting premiums is shorter than the lag in reporting losses. Premiums are generally reported to us in full within two years from the inception of the contract.
As of December 31, 2013, the selected estimates of premiums receivable and unearned premiums were lower than the initial estimates made by our underwriters by $3.1 million or 2.2% and by $0.9 million or 0.7%, respectively. We believe that we reasonably could have made a decrease of between $0 and $3.1 million for premiums receivable and between $0 and $0.9 million for unearned premiums. As of December 31, 2012, the selected estimates of premiums receivable and unearned premiums were lower than the initial estimates made by our underwriters by $6.1 million or 4.7% and by $2.4 million or 2.1%, respectively. We believe that we reasonably could have made a decrease of between $0 and $6.1 million for premiums receivable and between $0 and $2.4 million for unearned premiums. Key factors that affect premium estimates of our underwriters and management include: (1) the competition in many classes of business that make it difficult for ceding companies to achieve their premium targets, and (2) the lack of a historical track record for some ceding companies writing new programs.
During the years ended December 31, 2013, 2012 and 2011, we recorded net written premiums of $567.1 million, $565.0 million and $651.5 million. In those years, we recorded increases in prior year net written premiums of $47.1 million, $44.8 million and $23.9 million, respectively. Substantially all of the change in prior year net premiums written relates to the two most recent underwriting years and were primarily the result of updated premiums reported by our ceding companies. During the years ended December 31, 2013, 2012 and 2011, we recorded increases in prior year net premiums earned of $30.6 million, $30.4 million and $15.3 million, respectively. The effect on net income from the increase in estimates of prior years’ net premiums earned, after considering corresponding changes in losses and acquisition expenses attributable to those changes in premiums, was not significant. We do not believe that the increases in prior year premium estimates in 2013, 2012 and 2011 are indicative of prospective net premium adjustments in future years because conditions and trends that affected prior years’ premium estimates may not exist in the future.
Our actuaries prepare estimates of our ultimate liability for unpaid losses and LAE based on various actuarial methods including the loss ratio method, the Bornhuetter-Ferguson method and the chain ladder method, each of which is discussed below. We believe that the quantitative actuarial methods used to estimate our liabilities are enhanced by management’s professional judgment. We review the actuarial estimates of our liability and determine our best estimate of the liabilities to record as unpaid losses and LAE in our consolidated financial statements. We use the same processes and procedures for estimating unpaid losses and LAE for annual and interim periods.
Unpaid losses and LAE represent management’s best estimate at a given point in time and are subject to the effects of trends in loss severity and frequency. Provisions for economic inflation and changes in the social and legal environment are also considered in the loss estimation process. These estimates are reviewed regularly and adjusted as loss experience develops or new information becomes available, such as rate changes in the policies underlying our reinsurance contracts or in the mix of business by reserving class. Any adjustments are accounted for as changes in estimates and are reflected in the results of operations in the period in which they are made. It is possible that the ultimate liability may differ materially from such estimates.
As of December 31, 2013 and 2012, the liabilities recorded on our consolidated balance sheets for unpaid losses and LAE were $1.7 billion and $2.0 billion, respectively. These amounts exclude any amounts we may recover from our retrocessionaires under coverage we purchased for such losses. We record estimates of amounts we expect to recover from retrocessionaires as assets on the consolidated balance sheets. The following table sets forth our case reserves, additional case reserves and IBNR by segment as of December 31, 2013 and 2012 ($ in thousands):
Reserves, excluding major catastrophes, were $1.4 billion as of December 31, 2013, representing 87% of our unpaid losses and LAE. When estimating unpaid losses and LAE, we segregate the business into classes by reinsurance subsidiary, by type of coverage and by type of contract (resulting in approximately 65 classes). Within each class, the business is further segregated by Underwriting Year, starting with 2002, our first year of operations.
The determination of when reported losses are sufficient and credible to warrant selection of an ultimate loss ratio different from initial expected loss ratio also requires judgment. We generally make adjustments for reported loss experience indicating unfavorable variances from initial expected loss ratios sooner than reported loss experience indicating favorable variances. This is because the reporting of losses in excess of expectations tends to have greater credibility than an absence or lower than expected level of reported losses. While we continue with this approach, in the fourth quarter of 2012 we began reflecting favorable variances in reported losses in our selection of ultimate loss ratios at an earlier point in the loss development pattern than we had in the past. For further discussion, see “Independent Actuarial Review” below.
Loss development patterns are determined utilizing actuarial analysis, including management’s judgment, and are based on historical patterns of paid losses and reporting of case reserves to us, as well as industry loss development patterns. Information that may cause future loss development patterns to differ from historical loss development patterns is considered and reflected in our selected loss development patterns as appropriate. For property and health classes, these patterns indicate that a substantial portion of the ultimate losses are reported within two to three years after the contract is effective. Casualty loss development patterns can vary from three years to over twenty years depending on the type of business.
In casualty classes, the loss development patterns are primarily based on our historical reported loss data and that of our predecessor, and for the North American casualty classes they are supplemented by industry data from the Reinsurance Association of America (“RAA”) and Insurance Services Offices, Inc. Due to the long loss development pattern in general liability, various sources are used to estimate the end of the loss development pattern referred to as the “tail”. To estimate the tail, we supplement our historical data, and the data available from our predecessor, with industry data, generally from the RAA, and data received from external actuarial firms. Loss development patterns are analyzed for various reinsurance sub-classes and an overall pattern for each Underwriting Year is determined by the mix of business within that Underwriting Year.
We analyze historical loss development patterns and may adjust them for observed anomalies. For example, we observed that loss development patterns were much slower in Underwriting Years that were characterized by especially intense competition, known as the “soft market”, particularly in the North American excess-of-loss claims made class. We believe this is due to multiple year policies written by ceding companies and the deterioration in underwriting standards during these periods. In determining our loss development patterns for certain classes, we may exclude certain historical data from the soft market years. However, one of the risks of excluding some of the data from those years is that we could be obscuring trends in loss development patterns. Our actuaries consider this when determining the credibility of indications that use these patterns. For certain reinsurance contracts, historical loss development patterns may be developed from ceding company data or other sources.
As losses from major catastrophes mature, our actuaries generally consider losses reported to us relative to loss development patterns from prior major catastrophe events. Our estimate of ultimate liability for losses and LAE related to a major catastrophe event will generally be based on these development patterns after approximately twelve months following the event. However, since loss development patterns may be inconsistent between events, for very large major catastrophes, such as the 2010 and 2011 earthquakes in New Zealand, we will generally review information on a contract-by-contract basis for a longer period. Estimates of ultimate losses for a major catastrophe event are typically well established within 12 to 24 months following the event, although ultimate losses from an earthquake may take longer to emerge. As an example, as of December 31, 2013, the paid and reported losses as a percentage of the current estimated ultimate loss were 86% and 99%, respectively, for the Tohoku earthquake of 2011. However, as of December 31, 2013, the paid and reported losses as a percentage of current estimated ultimate loss were only 67% and 96%, respectively, for the three New Zealand earthquakes of 2010 and 2011.
As part of the 2006, 2009 and 2012 reviews, the independent actuarial firms also provided shorter and longer loss development patterns by reserving class. The Company’s actuarial staff applied these shorter and longer loss development patterns for certain of our North American casualty excess-of-loss classes to develop alternative indications of ultimate losses. We considered these alternative indications, along with the indications developed using loss development patterns determined by the Company’s own actuaries, in the selection of ultimate loss ratios.
Generally, the loss development patterns provided by the independent actuarial firms were shorter than the patterns produced in the 2006 and 2009 reviews, indicating that losses were expected to be reported faster than previously estimated by the firms. The shorter patterns generally resulted in lower indicated loss ratios.
The liability for unpaid losses and LAE as of the balance sheet date represents management’s best estimate of the ultimate liabilities as of that date. The actuarial techniques used by our actuaries in estimating our liabilities produces a central estimate of ultimate losses and LAE for each class and underwriting year. These techniques do not produce a range of reasonably possible outcomes. For some classes, the ultimate value of the liability for unpaid losses and LAE will not be known for decades. We expect that the ultimate value will differ from current estimates as losses are reported and paid and that difference could be material as reported losses reflect the actual emergence of factors that influence claim costs. We believe, however, that as a greater percentage of losses are reported, the likelihood of material changes to ultimate losses declines. Each quarter, we re-estimate ultimate losses and LAE and reflect updated information in those estimates.
Valuations are based on unobservable inputs for assets and liabilities where there is little or no market activity. Unadjusted third party pricing sources or management’s assumptions and internal valuation models may be used to determine the fair value of financial assets or liabilities.
The fair value of our fixed maturity securities and short-term investments is based on prices primarily obtained from index providers, pricing vendors, or broker-dealers using observable inputs. Index providers utilize external sources and pricing models to value index-eligible securities across numerous sectors and asset classes. Pricing vendors collect, edit, maintain, evaluate and model data on a large number of securities utilizing primarily market data and observable inputs. Broker-dealers value securities through proprietary trading desks primarily based on observable inputs. As of December 31, 2013, approximately 49% of the fair value of our fixed maturity securities was valued using prices obtained from index providers, 47% using prices obtained from pricing vendors and 4% using prices obtained from broker-dealers.
The fair value measurements of our investments classified as Level 3 were approximately 0.1% of our total investments as of December 31, 2013. Specifically, the fair value measurements of our non-agency residential mortgage-backed securities and sub-prime asset-backed securities classified as Level 3 used significant unobservable inputs that include prepayment rates, probability of default and loss severity in the event of default. The prices we obtained to determine these measurements were based upon unadjusted third party pricing sources.
For additional information on our investment portfolio including the credit quality and the net unrealized gain and loss of our investments as of December 31, 2013, see “Financial Condition - Liquidity - Sources of Liquidity” in this Form 10-K.
We provide for income taxes for our operations in income tax paying jurisdictions. Our provision relies on estimates and interpretations of currently enacted tax laws. We recognize deferred tax assets and liabilities based on the temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. Such temporary differences are primarily due to tax basis discounts on unpaid losses and LAE and unearned premiums, deferred acquisition costs and investments. A valuation allowance against deferred tax assets is recorded if it is more likely than not that all, or some portion, of the benefits related to deferred tax assets will not be realized. Any adjustments to deferred income taxes are accounted for as changes in estimates and are reflected in the results of operations in the period in which they are made. Any adjustments could be material and could significantly impact earnings in the period they are recorded.
In discussing our Results of Operations, in addition to referring to certain non-GAAP financial measures as defined in Item 6, “Selected Financial Data”, in this Form 10-K, we also refer to other financial measures such as net losses from major catastrophes and net favorable or unfavorable development.
2013 versus 2012: The change in net income and diluted earnings per common share for the year ended December 31, 2013 as compared with the year ended December 31, 2012 was primarily due to a decrease in net investment income and net realized gains on investments.
Net favorable development was $173.2 million and $234.0 million for the years ended December 31, 2013 and 2012, respectively. Net losses from current year major catastrophes were $26.1 million and $68.9 million for the years ended December 31, 2013 and 2012, respectively.
The underwriting result related to our 2013 North American crop business improved to underwriting income of $4.1 million for the year ended December 31, 2013, from an underwriting loss on our 2012 North American crop business of $17.6 million for the year ended December 31, 2012.
Net losses from current year major catastrophes were $68.9 million and $510.0 million for the years ended December 31, 2012 and 2011, respectively. Net favorable development was $234.0 million and $104.4 million for the years ended December 31, 2012 and 2011, respectively.
Net losses from current year major catastrophes were $26.1 million and $68.9 million for the years ended December 31, 2013 and 2012, respectively. Net losses from 2013 major catastrophes for the year ended December 31, 2013 were attributable to German hailstorms, floods in central and eastern Europe, primarily in Germany, and Property Claims Services (“PCS”) Catastrophe 14, tornadoes in the U.S. Midwest, primarily in Oklahoma. Net losses from 2012 major catastrophes for the year ended December 31, 2012 were primarily attributable to Hurricane Sandy and PCS Catastrophes 66 and 67, tornado and hailstorm events, primarily in Kentucky and Tennessee.
Underwriting income related to our 2013 North American crop business was $4.1 million for the year ended December 31, 2013, and the underwriting loss related to our 2012 North American crop business, as a result of the severe drought conditions in the United States, was $17.6 million for the year ended December 31, 2012.
Net favorable development was $50.1 million and $40.5 million for the years ended December 31, 2012 and 2011, respectively.
2013 versus 2012: The Property and Marine segment gross premiums written decreased by $20.4 million, and by $12.0 million excluding reinstatement premiums written related to major catastrophes, for the year ended December 31, 2013 as compared with the year ended December 31, 2012. The decrease in gross premiums written was primarily due to decreases in the crop and catastrophe classes partially offset by one large new contract in the North American property proportional class for the year ended December 31, 2013 as compared with 2012. The decrease in gross premiums written resulted from fewer opportunities that met our underwriting standards.
Ceded premiums written increased by $6.3 million for the year ended December 31, 2013 as compared with the year ended December 31, 2012. The increase in ceded premiums written was due to an increase in our purchase of retrocessional coverage on catastrophe business.
Net premiums earned decreased by $103.4 million for the year ended December 31, 2012 as compared with 2011, primarily as a result of decreases in net premiums written in current and prior periods. Net premiums written and earned were also impacted by changes in the mix of business and the structure of the underlying reinsurance contracts.
2013 versus 2012: Net losses and LAE decreased by $98.2 million for the year ended December 31, 2013 as compared with the year ended December 31, 2012. The decrease in net losses and LAE was primarily due to a decrease in net losses from current year major catastrophes, an increase in net favorable loss development and an improvement in our underwriting result in our North American crop class.
The Property and Marine segment net losses from current year major catastrophes, with related premium adjustments, increased the net loss and LAE ratio by 12.5 points, 30.2 points and 149.1 points for the years ended December 31, 2013, 2012 and 2011, respectively.
The following table sets forth the components of pre-tax net losses from 2013 major catastrophes for the year ended December 31, 2013 ($ in thousands):
The following table sets forth the components of pre-tax net losses from 2012 major catastrophes for the year ended December 31, 2012 ($ in thousands):
Any favorable or unfavorable development related to these major catastrophes subsequent to December 31, 2012 is included in prior years’ loss development, as described below, for the major catastrophe class of business.
The following table sets forth the components of pre-tax net losses from 2011 major catastrophes for the year ended December 31, 2011 ($ in thousands):
The following table sets forth the net favorable (unfavorable) development by class of business for the year ended December 31, 2012 ($ in thousands):
Calendar Year Losses - Excluding Current Year Major Catastrophes and Prior Years’ Loss Development
2013 versus 2012: The Property and Marine segment calendar year losses, excluding current year major catastrophes and prior years’ loss development, were $78.0 million and $99.3 million for the years ended December 31, 2013 and 2012, respectively. The calendar year loss ratios, excluding current year major catastrophes and prior years’ loss development, were 34.8% and 41.6% for the years ended December 31, 2013 and 2012, respectively. The decrease in calendar year losses and the related loss ratios, excluding current year major catastrophes and prior years’ loss development, resulted primarily from underwriting income in our North American crop business in 2013 as compared with an underwriting loss for the same period in 2012. Underwriting income related to our 2013 North American crop business was $4.1 million for the year ended December 31, 2013, and the underwriting loss related to our 2012 North American crop business was $17.6 million for the year ended December 31, 2012, as a result of the severe drought conditions in the United States. The calendar year losses and the related loss ratios, excluding current year major catastrophes, prior years’ loss development and the underwriting result from our North American crop business, were 38.0% and 38.1% for the years ended December 31, 2013 and 2012, respectively. Calendar year losses and related loss ratios were also impacted by changes in the mix of business.
2012 versus 2011: The Property and Marine segment calendar year losses, excluding current year major catastrophes and prior years’ loss development, were $99.3 million and $128.9 million for the years ended December 31, 2012 and 2011, respectively. The calendar year loss ratios, excluding current year major catastrophes and prior years’ loss development, were 41.6% and 39.5% for the years ended December 31, 2012 and 2011, respectively. The increase in calendar year losses and the related loss ratios, excluding current year major catastrophes and prior years’ loss development, resulted primarily from an increase in underwriting losses in our North American crop business in 2012 as a result of the severe drought conditions in the United States. Underwriting losses related to our 2012 North American crop business were $17.6 million for year ended December 31, 2012 compared with underwriting losses of $1.5 million on our 2011 North American crop business for the year ended December 31, 2011. The calendar year losses and the related loss ratios, excluding current year major catastrophes, prior years’ loss development and the underwriting result from our North American crop business, were 38.1% and 45.9% for the years ended December 31, 2012 and 2011, respectively. The loss ratio was also impacted by improved results in the catastrophe excess-of-loss (non-major events) class in 2012 as compared with 2011. Calendar year losses and related loss ratios were also impacted by changes in the mix of business.
2012 versus 2011: The Property and Marine segment other underwriting expenses were $31.1 million and $27.6 million for the years ended December 31, 2012 and 2011, respectively. The increase was primarily the result of an increase in performance-based compensation accruals in 2012 versus 2011.
The following table sets forth underwriting results, ratios and the change year over year for the Casualty segment for the years ended December 31, 2013, 2012 and 2011 ($ in thousands):
2012 versus 2011: The Casualty segment underwriting income increased by $110.1 million for the year ended December 31, 2012 as compared with the year ended December 31, 2011 as a result of an increase in net favorable development. Net favorable development was $184.1 million and $59.9 million for the years ended December 31, 2012 and 2011, respectively.
The Casualty segment generated 52.1%, 50.8% and 45.6% of our net premiums written for the years ended December 31, 2013, 2012 and 2011, respectively.
Net premiums earned decreased by $24.6 million for the year ended December 31, 2012 as compared with the year ended December 31, 2011. Net premiums earned in the years ended December 31, 2012 and 2011 were impacted by increases to prior years’ premium estimates of $23.0 million and $11.7 million, respectively. Excluding the impact of increases to prior years’ premium estimates, net premiums earned decreased by $35.9 million. Net premiums earned decreased as a result of the decreases in net premiums written in current and prior periods. Net premiums written and earned were also impacted by changes in the mix of business and the structure of the underlying reinsurance contracts.
2013 versus 2012: Net losses and LAE increased by $72.1 million for the year ended December 31, 2013 as compared with the year ended December 31, 2012, primarily due to a decrease in net favorable loss development.
2012 versus 2011: The Casualty segment net favorable loss development was $182.0 million and $59.4 million for the years ended December 31, 2012 and 2011, respectively. Net favorable loss development and related premium adjustments decreased the net loss and LAE ratios by 62.5 points and 18.8 points for the years ended December 31, 2012 and 2011, respectively. Net favorable loss development for the years ended December 31, 2012 and 2011 were primarily attributable to a level of cumulative losses reported by our ceding companies that was lower than expected and that, in our judgment, resulted in sufficient credibility in the loss experience to change our previously selected loss ratios. For the year ended December 31, 2011, net favorable development of $4.9 million related to changes in loss development patterns. The net loss and LAE ratios were also impacted by changes in the mix of business.
The following table sets forth the net favorable (unfavorable) development by class of business for the year ended December 31, 2013 ($ in thousands):
2012 versus 2011: The Casualty segment net acquisition expenses and related net acquisition expense ratios were $69.0 million and 23.5%, respectively, for the year ended December 31, 2012 and $72.7 million and 22.8%, respectively, for the year ended December 31, 2011. Net acquisition expenses and related net acquisition expense ratios were impacted by changes in the mix of business.
During the years ended December 31, 2013, 2012 and 2011, the in-force Finite Risk portfolio consisted of one contract and we expect minor activity in this segment in the foreseeable future due to the relatively low level of demand for finite risk products. Due to the inverse relationship between losses and commissions for this segment, we believe it is important to evaluate the overall combined ratio, rather than its component parts of net loss and LAE ratio and net acquisition expense ratio. Due to the small amount of premium volume in recent years, current year ratios may be significantly impacted by relatively small adjustments of prior years’ reserves.
2013 versus 2012: Net premiums written increased by $20.2 million for the year ended December 31, 2013 as compared with the year ended December 31, 2012. Net premiums written were impacted by increases to prior years’ premium estimates of $9.2 million and $5.8 million for the years ended December 31, 2013 and 2012, respectively. Excluding the impact of increases to prior years’ premium estimates, net premiums written increased by $16.9 million. The increases in both current and prior years’ premium estimates relate to the one in-force contract.
2013 versus 2012: The Finite Risk segment net losses, LAE and acquisition expenses increased by $11.5 million for the year ended December 31, 2013 as compared with the year ended December 31, 2012, primarily due to an increase in net premiums earned. Net favorable development was $1.8 million for the year ended December 31, 2013 and net unfavorable development was $0.2 for the year ended December 31, 2012.
2012 versus 2011: The Finite Risk segment net losses, LAE and acquisition expenses increased by $9.6 million for the year ended December 31, 2012 as compared with the year ended December 31, 2011 primarily due to an increase in premiums earned. Also, net unfavorable development was $0.2 million for the year ended December 31, 2012 and net favorable development was $4.0 million for the year ended December 31, 2011. Net favorable development for the year ended December 31, 2011 was primarily related to contracts from the 2004 underwriting year offset by net unfavorable development related to a contract from the 2003 underwriting year. The net unfavorable development increased the net loss and LAE and acquisition expense ratio by 1.3 points for the year ended December 31, 2012 and the net favorable development decreased the net loss and LAE and acquisition expense ratio by 29.0 points for the year ended December 31, 2011. In addition, a change in underwriting conditions resulted in an increase in the net loss and LAE ratio for the year ended December 31, 2012.
2013 versus 2012: Net realized gains on investments were $23.9 million and $88.8 million for the years ended December 31, 2013 and 2012, respectively. Sales of investments resulted in net realized gains of $27.2 million for the year ended December 31, 2013 and included $18.3 million from the sale of municipal bonds, $6.1 million from the sale of corporate bonds and $2.5 million from the sale of commercial mortgage-backed securities ("CMBS”). Also included in net realized gains for the year ended December 31, 2013 was a net negative impact from fair value adjustments on trading securities of $3.3 million related to non-U.S government securities.
The following table sets forth other revenues and expenses for the years ended December 31, 2013, 2012 and 2011 ($ in thousands):
2013 versus 2012: Other income (expense) includes changes in the fair value and interest income on our reinsurance deposit assets of $3.6 million and $0.7 million for the years ended December 31, 2013 and 2012.
Operating expenses not allocated to underwriting segments were $27.2 million and $25.3 million for the years ended December 31, 2013 and 2012, respectively. The increase was due to an increase in our executive incentive plan compensation expense, which is based on our average annual return on equity over three years, partially offset by a decrease in our annual incentive plan compensation expense, which is based on our current year return on equity.
2012 versus 2011: Other income (expense) includes changes in the fair value and interest income on our reinsurance deposit assets of $0.7 million for the year ended December 31, 2012. We had no reinsurance deposit assets during the year ended December 31, 2011.
There were no net changes in the fair value of derivatives for the years ended December 31, 2013 and 2012 as we did not hold any derivatives during this period. Net changes in the fair value of derivatives of $4.3 million for the year ended December 31, 2011 were primarily attributable to expenses of $2.5 million for a derivative agreement that was used to manage our exposure to certain underwriting risks until it expired on July 31, 2011 and expenses of $1.6 million related to put options on treasury futures that were purchased to temporarily protect our investment portfolio against a sudden increase in interest rates.
Interest expense was $19.1 million for both the years ended December 31, 2012 and 2011 and related to our $250.0 million of debt obligations.
Pre-tax income was $151.3 million and $106.9 million in our Bermuda and U.S. companies, respectively, for the year ended December 31, 2013. Pre-tax income was $272.2 million and $80.3 million in our Bermuda and U.S. companies, respectively, for the year ended December 31, 2012.
2012 versus 2011: Income tax expense was $25.0 million and income tax benefit was $3.1 million for the years ended December 31, 2012 and 2011, respectively. Our effective tax rate was 7.1% and (1.4%) for the years ended December 31, 2012 and 2011, respectively.
Pre-tax loss was $235.6 million in our Bermuda companies and pre-tax income was $7.4 million in our U.S. companies, for the year ended December 31, 2011. In 2011, pre-tax loss in our Bermuda companies resulted primarily from losses related to major catastrophes.
Platinum Holdings is a holding company, the assets of which consist primarily of shares of its subsidiaries. Platinum Holdings’ liquidity requirements, and those of Platinum Finance, include the payment of operating expenses, debt service obligations and income taxes. Our reinsurance subsidiaries’ principal liquidity requirements are the payment of losses and LAE, commissions, brokerage, operating expenses, income taxes and dividends to Platinum Holdings and Platinum Finance. We consider the impact of dividends and other distributions from our reinsurance subsidiaries on their respective capital levels, which may impact the financial strength ratings assigned to our subsidiaries by A.M. Best and S&P.
Platinum Bermuda is not licensed, approved or accredited as a reinsurer in the United States and, therefore, under the terms of its contracts with U.S. ceding companies, it is required to provide collateral to its ceding companies for unpaid losses and LAE and unearned premiums in a form acceptable to state insurance regulators. Platinum Bermuda and Platinum US also provide reinsurance coverage in many international jurisdictions, several of which require us to provide collateral directly with regulators or ceding companies.
Platinum Bermuda and Platinum US also have reinsurance and other contracts that require them to provide collateral to ceding companies when certain levels of assumed liabilities are attained. Should certain events occur, such as a decline in our financial strength rating by A.M. Best or S&P below specified levels or a decline in statutory equity below specified amounts, the amount of collateral required may increase. Some reinsurance contracts also have special termination provisions that permit early termination should certain events occur.
Platinum Holdings fully and unconditionally guarantees the outstanding $250.0 million of debt obligations of Platinum Finance. Platinum Finance pays interest at a rate of 7.5% per annum on June 1 and December 1 of each year.
Platinum Holdings may also require cash to pay for share repurchases. See “Capital Resources - Share and Debt Repurchases” below for additional discussion of share repurchases.
Platinum Holdings and Platinum Finance’s sources of liquidity include cash and cash equivalents, liquid investments, potential borrowings from our syndicated credit facility, the potential issuance of securities, and dividends and other distributions from subsidiaries. Our reinsurance subsidiaries’ sources of liquidity consist primarily of cash and cash equivalents, inflows of premiums, investment income, proceeds from the sales, maturities and paydowns of investments, capital contributions from Platinum Holdings and Platinum Finance and potential borrowings from our syndicated credit facility.
As of December 31, 2013, we had consolidated cash and cash equivalents of $1.5 billion, including $88.4 million at Platinum Holdings and $230.8 million at Platinum Finance. We expect that Platinum Holdings’ and Platinum Finance’s liquidity needs for the next twelve months will be met by our cash and cash equivalents and available dividend capacity from our subsidiaries. We expect that our reinsurance subsidiaries’ liquidity needs for the next twelve months will be met by our cash and cash equivalents, inflows of premiums, investment income and proceeds from the sales, maturities and paydowns of investments.
The following table summarizes the cash provided by or used in our operating, investing and financing activities and the effect of foreign currency exchange rate changes on cash and cash equivalents for the years ended December 31, 2013, 2012 and 2011 ($ in thousands):
Net cash provided by investing activities in both 2013 and 2012 was primarily due to sales, maturities and paydowns of fixed maturity available-for-sale securities and short-term investments, partially offset by the acquisition of fixed maturity available-for-sale securities and short-term investments. In 2011, net cash used in investing activities was primarily due to an increase in the acquisition of short-term investments partially offset by sales and maturities of fixed maturity available-for-sale and short-term investments. We have increased our cash balance from investing activities to manage the overall duration of our portfolio and to provide ample liquidity.
Net cash used in financing activities primarily related to repurchases of common shares of $303.3 million, $115.7 million and $94.7 million in 2013, 2012 and 2011, respectively. Net cash used in financing activities in 2011 also included the purchase of common share options totaling $47.9 million.
The change in the credit quality of our investable assets was primarily due to a $256.0 million decrease in our cash and cash equivalents.
See Note 3 to the “Consolidated Financial Statements” in this Form 10-K for discussion of the fair value measurements of our financial assets and liabilities.
Our non-U.S. government bond portfolio consists of securities issued by governments, provinces, agencies and supranationals.
The following table provides additional detail on the fair value and amortized cost of our portfolio of non-U.S. government fixed maturity available-for-sale securities, fixed maturity trading securities and short-term investments converted to U.S. dollars as of December 31, 2013 ($ in thousands):
The following table provides additional information on the fair values, net unrealized gains and losses and credit quality of our fixed maturity available-for-sale securities as of December 31, 2013 ($ in thousands):
The net unrealized gain position of our CMBS portfolio was $4.9 million as of December 31, 2013 as compared with $8.4 million as of December 31, 2012. The decrease in the net unrealized gain position in our CMBS portfolio was primarily the result of realized gains from sales activities. We analyze our CMBS on a periodic basis using default loss models based on the performance of the underlying loans. Performance metrics include delinquencies, defaults, foreclosures, debt-service-coverage ratios and cumulative losses incurred. The expected losses for a mortgage pool are compared with the current level of credit support, which generally represents the point at which our security would experience losses. We evaluate projected cash flows as well as other factors in order to determine if a credit impairment has occurred. Our portfolio consists primarily of senior tranches of CMBS with high credit ratings and strong credit support.
The net unrealized gain position of our RMBS portfolio was $0.3 million, with non-agency RMBS representing net unrealized losses of $0.7 million, as of December 31, 2013 as compared with a net unrealized loss position of $0.7 million, with non-agency RMBS representing net unrealized losses of $2.9 million, as of December 31, 2012. The decrease in the net unrealized loss position in our non-agency RMBS portfolio was primarily the result of the recognition of net impairment losses during the year ended December 31, 2013. Approximately 90% of the RMBS in our investment portfolio were issued or are guaranteed by the Government National Mortgage Association, the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, or the Federal Deposit Insurance Corporation and are referred to as U.S. Government agency RMBS. The remaining 10% of our RMBS were issued by non-agency institutions that relate exclusively to investments in securitized mortgages not guaranteed by U.S. government agencies. Securities with underlying sub-prime mortgages as collateral are included in ABS. We analyze our non-agency RMBS and sub-prime ABS on a periodic basis using default loss models based on the performance of the underlying loans. Performance metrics include, but are not limited to, delinquencies, defaults, foreclosures, prepayment speeds and cumulative losses incurred. The expected losses for a mortgage pool are compared with the current level of credit support, which generally represents the point at which our security would experience losses. We evaluate projected cash flows as well as other factors in order to determine if a credit impairment has occurred.
The Syndicated Credit Facility contains customary representations, warranties and covenants, including requirements to maintain a ratio of consolidated indebtedness to total capitalization of not greater than 0.35 to 1.0 and to maintain a consolidated tangible net worth of not less than the higher of (i) $1.25 billion or (ii) the sum of $1.258 billion plus 50% of positive net income for each fiscal year plus 75% of the aggregate increases in shareholders’ equity resulting from the issuance or sale of shares minus the amount of any extraordinary dividend payment or repurchase of shares during the facility agreement. As calculated, our consolidated tangible net worth was $1.70 billion, or $448.6 million greater than the current minimum consolidated tangible net worth covenant of $1.25 billion, as of December 31, 2013. In addition, each of our reinsurance subsidiaries must maintain a financial strength rating from A.M. Best of at least “B++” at all times. The financial strength rating of our reinsurance subsidiaries was “A” as of December 31, 2013.
On December 19, 2013, our reinsurance subsidiaries renewed a LOC facility with a financial institution in the aggregate amount of $100.0 million to extend the expiration date to December 31, 2015. Under the terms of the facility, up to $100.0 million is available for the issuance of LOC to support reinsurance obligations of our reinsurance subsidiaries. The facility contains customary representations, warranties and covenants.
Platinum Holdings receives dividends and other distributions from its subsidiaries as a source of liquidity and to fund the payment of dividends to its shareholders. Distributions to Platinum Holdings from its subsidiaries may be restricted as described below. The Company’s group regulatory capital requirements in Bermuda do not impose significant restrictions on retained earnings available for the payment of dividends by Platinum Holdings to its shareholders.
For 2014, Platinum Bermuda is generally restricted from declaring and paying dividends of more than 25% of its statutory capital and surplus as of December 31, 2013 unless an affidavit is filed with the Bermuda Monetary Authority stating it will continue to meet its capital and liquidity requirements. During 2014, the maximum amount available for the payment of dividends by Platinum Bermuda without filing an affidavit is $264.3 million. On February 12, 2014, Platinum Bermuda paid a dividend of $50.0 million to Platinum Holdings.
During the year ended December 31, 2013, dividends of $408.3 million were paid by the reinsurance subsidiaries of Platinum Holdings, of which $318.3 million was paid by Platinum Bermuda to Platinum Holdings and $90.0 million was paid by Platinum US to Platinum Finance.
As of December 31, 2013, our capital resources of $2.0 billion consisted of $1.7 billion of common shareholders’ equity and $250.0 million of debt obligations. As of December 31, 2012, our capital resources of $2.1 billion consisted of $1.9 billion of common shareholders’ equity and $250.0 million of debt obligations. The decrease in capital of $147.8 million during the year ended December 31, 2013 was primarily attributable to repurchases of common shares of $303.3 million and the decrease in net unrealized gains, net of tax, of $89.6 million, partially offset by net income of $223.3 million.
Our Board of Directors has authorized the repurchase of our common shares through a share repurchase program. Since the program was established, our Board of Directors has approved increases in the repurchase program from time to time, most recently on July 24, 2013, to result in authority as of such date to repurchase up to a total of $250.0 million of our common shares. The following table summarizes our repurchases of common shares for the years ended December 31, 2013, 2012 and 2011 ($ in thousands, except per share data):
We do not have any off-balance sheet arrangements, as defined for purposes of the SEC rules, which are not accounted for or disclosed in the consolidated financial statements as of December 31, 2013.
Our consolidated financial statements as of December 31, 2013 and 2012 and for each of the years in the three-year period ended December 31, 2013, together with the report thereon by KPMG Audit Limited, our independent registered public accounting firm, are set forth on pages through hereto.