Net earnings attributable to Alleghany stockholders were $560.3 million in 2015, compared with $679.2 million in 2014 and $628.4 million in 2013.
Net investment income decreased by 4.6 percent in 2015 from 2014, and decreased by 1.2 percent in 2014 from 2013.
Net premiums written decreased by 0.2 percent in 2015 from 2014, and increased by 4.9 percent in 2014 from 2013.
Underwriting profit was $466.6 million in 2015, compared with $494.8 million in 2014 and $420.7 million in 2013.
The combined ratio for our reinsurance and insurance segments was 89.0 percent in 2015, compared with 88.8 percent in 2014 and 90.1 percent in 2013.
Catastrophe losses, net of reinsurance, were $62.0 million in 2015, compared with $95.2 million in 2014 and $150.9 million in 2013.
Net favorable prior accident year development on loss reserves was $215.5 million in 2015, compared with $215.2 million in 2014 and $203.0 million in 2013.
Segment results for our two reportable segments and for corporate activities for 2015, 2014 and 2013 are shown in the tables below:
(2) Underwriting profit represents net premiums earned less net loss and LAE and commissions, brokerage and other underwriting expenses, all as determined in accordance with GAAP, and does not include net investment income, net realized capital gains, OTTI losses, other income, other operating expenses, corporate administration, amortization of intangible assets or interest expense. Underwriting profit is a non-GAAP financial measure and does not replace earnings before income taxes determined in accordance with GAAP as a measure of profitability. See “Comment on Non-GAAP Financial Measures” herein for additional detail on the presentation of our results of operations.
(5) The combined ratio is the sum of the loss ratio and the expense ratio, all as determined in accordance with GAAP. The combined ratio represents the percentage of each premium dollar a reinsurance or an insurance company has to spend on net loss and LAE, and commissions, brokerage and other underwriting expenses.
The decrease in net premiums earned in 2015 from 2014 reflects a decrease at our reinsurance segment, partially offset by an increase at our insurance segment. The decrease in net premiums earned at our reinsurance segment primarily reflects the impact of changes in foreign exchange rates, reduced participation in or non-renewal of certain treaties and reductions in pricing and higher ceded premiums earned due to an increase in reinsurance coverage purchased by TransRe in 2015. In addition, there were no net premiums earned in 2015 in connection with the large whole account quota share treaty placed by TransRe on December 31, 2015. The increase at our insurance segment reflects significant growth at PacificComp and CapSpecialty, partially offset by a decrease at RSUI.
Premiums for 2015, 2014 and 2013 are more fully described in the following pages.
Net loss and LAE. The following table summarizes our consolidated net loss and LAE.
2014 vs 2013. The increase in net loss and LAE in 2014 from 2013 primarily reflects the impact of increased net premiums earned at our insurance segment, as discussed above, and lower net favorable prior year loss reserve development at our reinsurance segment, partially offset by lower catastrophe losses at our reinsurance and insurance segments, and net favorable prior year loss reserve development in 2014 compared with net adverse prior year loss reserve development in 2013 at our insurance segment.
Net loss and LAE for 2015, 2014 and 2013 are more fully described in the following pages.
2015 vs 2014. Commissions, brokerage and other underwriting expenses in 2015 approximated commissions, brokerage and other underwriting expenses from 2014, reflecting a decrease at our reinsurance segment, offset by an increase at our insurance segment. The decrease at our reinsurance segment primarily reflects the impact of lower net premiums earned, as discussed above, partially offset by higher commission rates and employee-related benefit and compensation costs. The increase at our insurance segment primarily reflects the impact of higher net premiums earned, as discussed above.
Commissions, brokerage and other underwriting expenses for 2015, 2014 and 2013 are more fully described in the following pages.
2015 vs 2014. The decrease in underwriting profit in 2015 from 2014 reflects a decrease in underwriting profit at our reinsurance segment and our insurance segment. The decrease in underwriting profit at our reinsurance segment primarily reflects the impact of lower net premiums earned, partially offset by lower catastrophe losses and more favorable prior year loss reserve development, all as discussed above. The decrease in underwriting profit at our insurance segment primarily reflects less favorable prior year loss reserve development overall and higher current year losses, partially offset by lower catastrophe losses, all as discussed above.
2015 vs 2014. The decrease in net investment income in 2015 from 2014 primarily reflects lower dividends from common stocks in our equity securities portfolio, lower interest income and lower earnings from other invested assets. The decrease in dividends is due primarily to a modification of our equity investment strategy during 2015, which resulted in several changes to our equity security holdings, higher realized gains and lower dividend income in 2015. The decrease in interest income is due primarily to lower investible balances and the impact of changes in foreign exchange rates.
Investment results for 2015, 2014 and 2013 are more fully described in the following pages.
Other income and expenses. The following table summarizes our consolidated other income and expenses.
Other income and Other operating expenses. Other income and other operating expenses include revenues and expenses associated with our non-insurance operations. Other operating expenses also includes the long-term incentive compensation of our reinsurance segment and insurance segment, which totaled $77.6 million, $83.5 million and $80.1 million for 2015, 2014 and 2013, respectively. See Note 14 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information.
The increase in other income in 2015 from 2014 primarily reflects the acquisition of IPS on October 31, 2015 and, to a lesser extent, growth at Kentucky Trailer. The increase in other operating expenses in 2015 from 2014 primarily reflects the acquisition of IPS and, to a lesser extent, increased expenses at Kentucky Trailer and SORC, partially offset by a decrease in the long-term incentive compensation expense of our reinsurance and insurance segments due to less favorable operating results. The increases in other income and other operating expenses in 2014 from 2013 primarily reflect the acquisition of Kentucky Trailer on August 30, 2013 and, to a lesser extent, increased expenses at SORC.
Amortization of intangible assets. Amortization of intangible assets in 2015 and 2014 reflects the amortization of net intangible liabilities. Amortization of intangible assets in 2015 also reflects the acquisition of IPS. Amortization of intangible assets in 2013 primarily reflects the amortization of net intangible assets acquired in the merger with TransRe in 2012.
Income taxes. The following table summarizes our consolidated income tax expense.
2014 vs 2013. The increases in earnings before income taxes and net earnings attributable to Alleghany stockholders in 2014 from 2013 primarily reflect higher underwriting profits, all as discussed above.
(2) Underwriting profit (loss) represents net premiums earned less net loss and LAE and commissions, brokerage and other underwriting expenses, all as determined in accordance with GAAP, and does not include net investment income, net realized capital gains, OTTI losses, other income, other operating expenses, corporate administration, amortization of intangible assets or interest expense. Underwriting profit is a non-GAAP financial measure and does not replace earnings before income taxes determined in accordance with GAAP as a measure of profitability. See “Comment on Non-GAAP Financial Measures” herein for additional detail on the presentation of our results of operations.
The increase in gross premiums written in 2014 from 2013 primarily reflects the impact of certain expanded treaty participations with existing long-term clients, partially offset by reductions in pricing for property reinsurance contracts as the market became increasingly price competitive and the impact of changes in foreign currency rates. Excluding the impact of changes in foreign currency rates, gross premiums written increased 8.0 percent in 2014 from 2013. The increase in net premiums earned in 2014 from 2013 reflects certain expanded treaty participations with existing long-term clients, partially offset by the impact of changes in foreign currency rates. Excluding the impact of changes in foreign currency rates, net premiums earned increased 7.5 percent in 2014 from 2013.
Casualty & other. The increase in gross premiums written in 2015 from 2014 reflects $156.9 million of casualty-related premiums recorded on December 31, 2015 in connection with a large whole account quota share treaty placed as of that date, partially offset by the impact of changes in foreign exchange rates. Excluding the impact of changes in foreign exchange rates, gross premiums written in 2015 increased 8.0 percent in 2015 from 2014. The decrease in net premiums earned in 2015 from 2014 reflects the impact of changes in foreign exchange rates. Excluding the impact of changes in foreign exchange rates, net premiums earned increased 1.3 percent in 2015 from 2014. There were no net premiums earned in 2015 in connection with the large whole account quota share treaty placed on December 31, 2015.
(2) Includes favorable prior accident year development on loss reserves of ($1.6) million from Super Storm Sandy in 2012 and ($15.7) million of net favorable prior accident year development on loss reserves from other catastrophes. The ($15.7) million primarily reflects favorable prior accident year development on loss reserves from several catastrophes that occurred primarily in the 2011 and 2013 accident years, partially offset by unfavorable prior accident year development on loss reserves from the New Zealand earthquake in 2010.
(4) Reflects favorable prior accident year development on loss reserves primarily related to the 2013 and 2014 accident years.
(6) Reflects favorable prior accident year development on loss reserves primarily related to the 2011 and 2012 accident years.
(4) Generally reflects favorable prior accident year development on loss reserves in a variety of casualty & other lines of business primarily from the 2003 through 2007 and 2010 through 2011 accident years, partially offset by unfavorable prior accident year development on loss reserves from the 2013 accident year and the 2002 and prior accident years.
Property. The decrease in commissions, brokerage and other underwriting expenses in 2015 from 2014 primarily reflects the impact of lower net premiums earned, partially offset by higher employee-related benefit and compensation costs. The increase in commissions, brokerage and other underwriting expenses in 2014 from 2013 primarily reflects higher employee-related benefit and compensation costs. In addition, 2013 reflects the favorable impact of deferred acquisition costs being written off in 2012 under the acquisition method of accounting for the merger with TransRe.
Property. The decrease in underwriting profit in 2015 from 2014 primarily reflects the impact of lower net premiums earned, partially offset by a decrease in commissions, brokerage and other underwriting expenses and lower catastrophe losses, all as discussed above. The decrease in underwriting profit in 2014 from 2013 primarily reflects the increase in net loss and LAE and commissions, brokerage and other underwriting expenses, partially offset by an increase in net premiums earned, all as discussed above.
RSUI. The decrease in gross premiums written in 2015 from 2014 primarily reflects declines in the property line of business and, to a lesser extent, declines in the directors’ and officers’ liability, umbrella/excess and general liability lines of business, all due to an increase in competition. The decrease in gross premiums written in 2014 from 2013 reflects declines in the property line of business due to an increase in competition and a decrease in rates, partially offset by generally favorable market conditions in most other lines of business, particularly for the binding authority and directors’ and officers’ liability lines of business.
The decrease in net premiums earned in 2015 from 2014 primarily reflects a decrease in gross premiums written in recent quarters. The increase in net premiums earned in 2014 from 2013 primarily reflects an increase in gross premiums written in early 2014 and late 2013 and, to a lesser extent, lower ceded premiums written due primarily to declines in the heavily-reinsured property line of business.
The increase in net premiums earned in 2015 from 2014 primarily reflects an increase in gross premiums written in recent quarters and lower ceded premiums earned due to a reduction in reinsurance coverage in 2015. The increase in net premiums earned in 2014 from 2013 primarily reflects an increase in gross premiums written, partially offset by higher ceded premiums earned arising from an increase in reinsurance coverage.
Catastrophe losses in 2015 primarily reflect several occurrences of severe weather in the Southeastern and Midwestern U.S. Catastrophe losses in 2014 primarily reflect the impact of nationwide severe winter weather in the U.S. in January and February and hail storms in the spring, summer and fall. Catastrophe losses in 2013 include flooding in Colorado in September and severe weather in the Midwestern U.S., including tornados in Oklahoma in May.
Net loss and LAE in 2015, 2014 and 2013 include (favorable) unfavorable prior accident year development on loss reserves as shown in the table below:
(6) Includes $8.5 million of unfavorable prior accident year development on loss reserves from Hurricane Katrina, which resulted from a significant claim that settled for more than previously estimated due to an adverse court ruling, partially offset by net favorable prior accident year development on loss reserves with respect to other property reserves.
The favorable prior accident year development on loss reserves in 2015, 2014 and 2013 reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods. The favorable prior accident year development on loss reserves in 2015 did not impact assumptions used in estimating RSUI’s loss and LAE liabilities for business earned in 2015.
(1) Represents certain specialty classes of business written through a program administrator in connection with a terminated program related to the 2010 and 2009 accident years and reflects (favorable) unfavorable loss emergence compared with loss emergence patterns assumed in earlier periods for such business.
(2) Primarily reflects unfavorable prior accident year development on loss reserves related to the casualty lines of business from the 2011 through 2013 accident years.
CapSpecialty. The slight increase in commissions, brokerage and other underwriting expenses in 2015 from 2014 primarily reflects the impact of higher overall net premiums earned, partially offset by CapSpecialty’s surety lines of business, which incur a higher commission rate than CapSpecialty’s other lines of business, representing a declining portion of CapSpecialty’s overall book of business. The increase in commissions, brokerage and other underwriting expenses in 2014 from 2013 is due primarily to the impact of higher net premiums earned.
RSUI. The decrease in underwriting profit in 2015 from 2014 primarily reflects less favorable prior accident year development on loss reserves, a higher current accident year loss ratio for the casualty lines of business and the impact of lower net premiums earned, partially offset by lower catastrophe losses, all as discussed above. The increase in RSUI’s underwriting profit in 2014 from 2013 reflects the impact of an increase in net premiums earned, partially offset by increases in net loss and LAE and commissions, brokerage and other underwriting expenses, all as discussed above.
CapSpecialty. The decrease in underwriting losses in 2015 from 2014 primarily reflects the impact of higher net premiums earned and lower property losses, partially offset by higher surety losses and higher unfavorable prior accident year development on loss reserves in 2015, all as discussed above. The decrease in CapSpecialty’s underwriting loss in 2014 from 2013 reflects an increase in net premiums earned and a decrease in net loss and LAE, partially offset by an increase in commissions, brokerage and other underwriting expenses, all as discussed above.
PacificComp. PacificComp reported underwriting losses in 2015, 2014 and 2013 primarily as a result of its ongoing expenses relative to comparatively low premiums earned and, for 2014 and 2013 only, unfavorable prior accident year development on loss reserves. The decrease in underwriting losses in 2015 from 2014 primarily reflects the beneficial impact of growing net premiums earned and the lack of unfavorable development on prior accident year loss reserves in 2015 compared with unfavorable prior accident year development on loss reserves in 2014, all as discussed above. The decrease in underwriting losses in 2014 from 2013 is primarily due to less unfavorable prior accident year development on loss reserves and an increase in net premiums earned, all as discussed above.
Net Investment Income. The decrease in net investment income in 2015 from 2014 primarily reflects lower dividends from common stocks in our equity securities portfolio, lower interest income and lower earnings from other invested assets. The decrease in dividends is due primarily to a modification of our equity investment strategy during 2015, which resulted in several changes to our equity security holdings, higher realized gains and lower dividend income in 2015. The decrease in interest income is due primarily to lower investible balances and the impact of changes in foreign exchange rates.
After adjusting the cost basis of securities for the recognition of OTTI losses, the remaining gross unrealized investment losses for debt and equity securities as of December 31, 2015 were deemed to be temporary, based on, among other factors: (i) the duration of time and the relative magnitude to which the fair values of these securities had been below cost were not indicative of an OTTI loss (for example, no equity security was in a continuous unrealized loss position for 12 months or more as of December 31, 2015); (ii) the absence of compelling evidence that would cause us to call into question the financial condition or near-term business prospects of the issuers of the securities; and (iii) our ability and intent to hold the securities for a period of time sufficient to allow for any anticipated recovery.
In October 2015, Alleghany Capital acquired a majority interest in IPS, a technical service provider focused on the global pharmaceutical and biotechnology industries. Corporate activities include the results of IPS beginning October 31, 2015. In July 2014, Alleghany Capital acquired a 30 percent equity interest in Jazwares, a toy and consumer electronics company, headquartered in Sunrise, Florida. Jazwares is accounted for under the equity-method of accounting and is included in corporate activities for segment reporting purposes. Corporate activities include the results of Kentucky Trailer beginning August 30, 2013.
Net investment income. Net investment income in 2015 approximated net investment income from 2014. The decrease in net investment income in 2014 from 2013 primarily relates to Homesite, which was sold on December 31, 2013. In 2013, net investment income included $42.9 million for Homesite, primarily reflecting favorable prior accident year development on loss reserves on its loss and LAE reserves and favorable levels of weather-related claims.
Other than temporary impairment losses. OTTI losses in 2015 reflect unrealized losses related to equity securities held at the Alleghany parent company that were deemed to be other than temporary and, as such, were required to be charged against earnings.
(Losses) earnings before income taxes. The increase in losses before income taxes in 2015 from 2014 primarily reflects net realized capital losses in 2015 compared with net realized capital gains in 2014 and, to a lesser extent, higher interest expense and OTTI losses in 2015, all as discussed above. The loss before income taxes in 2014 compared with the earnings before income taxes in 2013 primarily reflects a decrease in net investment income and net realized capital gains, and an increase in other expenses, corporate administration expenses and interest expense, partially offset by an increase in other income, all as discussed above.
(1) Primarily consists of the following reinsurance lines of business: directors’ and officers’ liability; errors and omissions liability; general liability; medical malpractice; ocean marine and aviation; auto liability; accident and health; surety; asbestos-related illness and environmental impairment liability; and credit.
As noted above, as of any balance sheet date, not all claims that have occurred have been reported to us, and if reported may not have been settled. The time period between the occurrence of a loss and the time it is settled is referred to as the “claim tail.” In general, actuarial judgments for shorter-tailed lines of business generally have much less of an effect on the determination of the loss reserve amount than when those same judgments are made regarding longer-tailed lines of business. Reported losses for the shorter-tailed classes, such as property and certain marine, aviation and energy classes, generally reach the ultimate level of incurred losses in a relatively short period of time. Rather than having to rely on actuarial assumptions for many accident years, these assumptions are generally only relevant for the more recent accident years. Therefore, these assumptions tend to be less critical and the reserves calculated pursuant to these assumptions are subject to less variability for the shorter-tailed lines of business.
The estimation of unpaid loss and LAE for our reinsurance operations is principally based on reports and individual case estimates received from ceding companies. Data received from cedants is audited periodically by TransRe’s claims and underwriting personnel, to help ensure that reported data is supported by proper documentation and conforms to contract terms, and is analyzed, as appropriate, by its underwriting and actuarial personnel. Such analysis often includes a detailed review of reported data to assess the underwriting results of assumed reinsurance and to explain any significant departures from expected performance. Over time, reported loss information is ultimately corroborated when the underlying claims are paid.
In addition, the estimation of unpaid loss and LAE, including IBNR, for our reinsurance operations also takes into account assumptions with respect to many factors that will affect ultimate loss costs but are not yet known. The process by which actual carried reserves are determined considers not only actuarial estimates but a myriad of other factors. Such factors, both internal and external, which contribute to the variability and unpredictability of loss costs, include trends relating to jury awards, social trends, medical inflation, worldwide economic conditions, tort reforms, court interpretations of coverages, the regulatory environment, underlying policy pricing, terms and conditions and claims handling, among others. In addition, information gathered through underwriting and claims audits is also considered. We assess the reasonableness of our unpaid loss and LAE for our reinsurance operations using various actuarial methodologies, principally the paid development method, the reported loss development method and the Bornhuetter-Ferguson method as described below.
Loss Frequency and Severity. Loss frequency and severity are measures of loss activity that are considered in determining the key assumptions described above. Loss frequency is a measure of the number of claims per unit of insured exposure, and loss severity is a measure of the average size of claims. Factors affecting loss frequency include the effectiveness of loss controls and safety programs and changes in economic conditions or weather patterns. Factors affecting loss severity include changes in policy limits, retentions, rate of inflation and judicial interpretations. Another factor affecting estimates of loss frequency and severity is the loss reporting lag,
which is the period of time between the occurrence of a loss and the date the loss is reported to our reinsurance or insurance operating subsidiary. The length of the loss reporting lag affects their ability to accurately predict loss frequency (loss frequencies are more predictable for lines with short reporting lags), as well as the amount of reserves needed for IBNR. If the actual level of loss frequency and severity is higher or lower than expected, the ultimate losses will be different than management’s estimates. A small percentage change in an estimate can result in a material effect on our reported earnings. The following table reflects the impact of changes, which could be favorable or unfavorable, in frequency and severity on our loss estimates for claims occurring in 2015:
(1) Includes favorable prior accident year development on loss reserves of ($27.7) million from Super Storm Sandy in 2012 and various smaller amounts on catastrophes that occurred in the 2010, 2011, 2013 and 2014 accident years, partially offset by unfavorable prior accident year development from the New Zealand earthquake in 2010.
(3) Includes favorable prior accident year development on loss reserves of ($73.7) million from Super Storm Sandy in 2012 and ($35.6) million from other catastrophe losses, principally flooding that took place in Thailand in 2011 and the Tohoku earthquake in Japan in 2011, partially offset by unfavorable prior accident year development on loss reserves from the New Zealand earthquake in 2010.
(7) As a result of the Malpractice Treaties, TransRe records an offsetting increase in profit commission expense incurred when such favorable prior accident year development occurs.
(12) Primarily reflects favorable prior accident year development on loss reserves in the umbrella/excess, general liability and professional liability lines of business related to the 2006 through 2011 accident years, partially offset by unfavorable prior accident year development in the directors’ and officers’ liability line of business related to the 2011 through 2014 accident years.
(17) Includes $8.5 million of unfavorable prior accident year development on loss reserves from Hurricane Katrina, which resulted from a significant claim that settled for more than previously estimated due to an adverse court ruling, partially offset by net favorable prior accident year development on loss reserves with respect to other property reserves.
(21) The unfavorable prior accident year development on loss reserves in 2014 and 2013 related primarily to the 2009 and prior accident years.
Asbestos-Related Illness and Environmental Impairment Reserves. Loss and LAE include amounts for risks relating to asbestos-related illness and environmental impairment. The reserves carried for such claims, including the IBNR portion, are based upon known facts and current law at the respective balance sheet dates. However, significant uncertainty exists in determining the amount of ultimate liability for asbestos-related illness and environmental impairment losses, particularly for those occurring in 1985 and prior, which, prior to the Commutation Agreement, represented the majority of TransRe’s asbestos-related illness and environmental impairment reserves. This uncertainty is due to inconsistent and changing court resolutions and judicial interpretations with respect to underlying policy intent and coverage and uncertainties as to the allocation of responsibility for resultant damages, among other reasons. Further, possible future changes in statutes, laws, regulations, theories of liability and other factors could have a material effect on these liabilities and, accordingly, future earnings. Although we are unable at this time to determine whether additional reserves, which could have a material adverse effect upon our results of operations, may be necessary in the future, we believe that our asbestos-related illness and environmental impairment reserves are adequate as of December 31, 2015. See Note 12(d) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” and pages 40 and 41 of this Form 10-K for additional information on loss and LAE for risks relating to asbestos-related illness and environmental impairment.
subject to a significant degree of uncertainty. In addition to the factors cited above, reinsurance recoverables may prove uncollectible if a reinsurer is unable or unwilling to perform under a contract. Reinsurance purchased by our reinsurance and insurance subsidiaries does not relieve them of their obligations to their own policyholders or cedants. Additional information regarding the use of, and risks related to, the use of reinsurance by our reinsurance and insurance subsidiaries can be found on pages 42 through 44 and pages 56 and 57 of this Form 10-K. Also see Note 1(f) and Note 5 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on our reinsurance recoverables.
We then evaluate those equity securities where the unrealized loss is at least 20 percent of cost as of the balance sheet date or which have been in an unrealized loss position continuously for six months or more preceding the balance sheet date. This evaluation takes into account quantitative and qualitative factors in determining whether such securities are other than temporarily impaired including: (i) market valuation metrics associated with the equity security (such as dividend yield and price-to-earnings ratio); (ii) current views on the equity security, as expressed by either our internal stock analysts and/or by third-party stock analysts or rating agencies; and (iii) credit or news events associated with a specific issuer, such as negative news releases and rating agency downgrades with respect to the issuer of the investment.
Debt securities in an unrealized loss position are evaluated for OTTI if they meet any of the following criteria: (i) they are trading at a discount of at least 20 percent to amortized cost for an extended period of time (nine consecutive months or longer); (ii) there has been a negative credit or news event with respect to the issuer that could indicate the existence of an OTTI; or (iii) we intend to sell or it is more likely than not that we will sell the debt security before recovery of its amortized cost basis.
Goodwill and other intangible assets deemed to have an indefinite useful life are tested annually in the fourth quarter of every year for impairment. Goodwill and other intangible assets are also tested whenever events and changes in circumstances suggest that the carrying amount may not be recoverable. A significant amount of judgment is required in performing goodwill and other intangible asset impairment tests. These tests may include estimating the fair value of our subsidiaries and other intangible assets. If it is determined that an asset has been impaired, the asset is written down by the amount of the impairment, with a corresponding charge to net earnings. Subsequent reversal of any impairment charge is not permitted.
Our consolidated balance sheet as of December 31, 2015 includes goodwill of $141.0 million related primarily to IPS, RSUI, CapSpecialty, Bourn & Koch and Kentucky Trailer, and intangible assets, net of amortization, of $212.8 million related primarily to TransRe, IPS, RSUI, CapSpecialty, Bourn & Koch and Kentucky Trailer. See Note 1(i) and Note 2 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on our goodwill and other intangible assets.
General. In general, we follow a policy of maintaining a relatively liquid financial condition at our unrestricted holding companies. This policy has permitted us to expand our operations through internal growth at our subsidiaries and through acquisitions of, or substantial investments in, operating companies. As of December 31, 2015, we held total marketable securities and cash of $821.3 million, compared with $1,032.0 million as of December 31, 2014. The decrease in 2015 primarily reflects repurchases of shares of our common stock, the maturity and repayment of the 2015 Senior Notes, capital contributions to SORC and the acquisition of IPS, partially offset by the receipt of dividends from RSUI and TransRe, all as further described below. The $821.3 million is comprised of $332.9 million at the Alleghany parent company, $382.4 million at AIHL and $106.0 million at the TransRe holding company. We also hold certain non-marketable investments at our unrestricted holding companies. We believe that we have and will have adequate internally generated funds, cash resources and unused credit facilities to provide for the currently foreseeable needs of our business, and we had no material commitments for capital expenditures as of December 31, 2015.
Stockholders’ equity attributable to Alleghany stockholders was approximately $7.6 billion as of December 31, 2015, compared with approximately $7.5 billion as of December 31, 2014. The slight increase in stockholders’ equity in 2015 primarily reflects net earnings, partially offset by repurchases of our common stock and a decrease in unrealized appreciation on our debt and equity securities portfolios. The decrease in unrealized appreciation on our debt securities portfolio is due to a modest increase in longer-term interest rates and credit spreads that occurred in 2015. As of December 31, 2015, we had 15,544,077 shares of our common stock outstanding, compared with 16,054,323 shares of our common stock outstanding as of December 31, 2014.
Debt. On September 9, 2014, we completed a public offering of $300.0 million aggregate principal amount of our 4.90% senior notes due on September 15, 2044, or the “2044 Senior Notes.” The 2044 Senior Notes are unsecured and unsubordinated general obligations of Alleghany. Interest on the 2044 Senior Notes is payable semi-annually on March 15 and September 15 of each year. The terms of the 2044 Senior Notes permit redemption prior to their maturity. The indenture under which the 2044 Senior Notes were issued contains covenants that impose conditions on our ability to create liens on, or engage in sales of, the capital stock of AIHL, TransRe or RSUI. The 2044 Senior Notes were issued at approximately 99.3 percent of par, resulting in
On June 26, 2012, we completed a public offering of $400.0 million aggregate principal amount of our 4.95% senior notes due on June 27, 2022, or the “2022 Senior Notes.” The 2022 Senior Notes are unsecured and unsubordinated general obligations of Alleghany. Interest on the 2022 Senior Notes is payable semi-annually on June 27 and December 27 of each year. The terms of the 2022 Senior Notes permit redemption prior to their maturity. The indenture under which the 2022 Senior Notes were issued contains covenants that impose conditions on our ability to create liens on, or engage in sales of, the capital stock of AIHL, TransRe or RSUI. The 2022 Senior Notes were issued at approximately 99.9 percent of par, resulting in proceeds after underwriting discount, commissions and other expenses of $396.0 million, and an effective yield of approximately 5.05 percent. Approximately $3.6 million of underwriting discount, commissions and other expenses were recorded as deferred charges, which are amortized over the life of the 2022 Senior Notes.
On September 20, 2010, we completed a public offering of $300.0 million aggregate principal amount of our 5.625% senior notes due on September 15, 2020, or the “2020 Senior Notes.” The 2020 Senior Notes are unsecured and unsubordinated general obligations of Alleghany. Interest on the 2020 Senior Notes is payable semi-annually on March 15 and September 15 of each year. The terms of the 2020 Senior Notes permit redemption prior to their maturity. The indenture under which the 2020 Senior Notes were issued contains covenants that impose conditions on our ability to create liens on, or engage in sales of, the capital stock of AIHL, TransRe or RSUI. The 2020 Senior Notes were issued at approximately 99.6 percent of par, resulting in proceeds after underwriting discount, commissions and other expenses of $298.9 million, and an effective yield of approximately 5.67 percent. Approximately $2.8 million of underwriting discount, commissions and other expenses were recorded as deferred charges, which are amortized over the life of the 2020 Senior Notes.
Alternate Base Rate Borrowings under the Credit Agreement bear interest at (x) the greatest of (a) the administrative agent’s prime rate, (b) the federal funds effective rate plus 0.5 percent, or (c) an adjusted London Interbank Offering Rate, or “Adjusted LIBO Rate,” for a one month interest period on such day plus 1 percent, plus (y) an applicable margin. Eurodollar Borrowings under the Credit Agreement bear interest at the Adjusted LIBO Rate for the interest period in effect plus an applicable margin. The Credit Agreement requires that all loans be repaid in full no later than October 15, 2017. The Credit Agreement requires us to pay a commitment fee each quarter in a range of between 0.125 and 0.30 percent per annum, based upon our credit ratings, on the daily unused amount of the commitments.
In the United States, our reinsurance and insurance subsidiaries are subject to insurance laws and regulations that restrict the amount and timing of dividends they may pay without the prior approval of regulatory authorities. Under the insurance holding company laws and regulations, our reinsurance and insurance subsidiaries may not pay an “extraordinary” dividend or distribution, or pay a dividend except out of earned surplus, without the approval of state insurance regulators. In general, an “extraordinary” dividend or distribution is defined as a dividend or distribution that, together with other dividends and distributions made within the preceding 12 months, exceeds the greater (or, in some jurisdictions, the lesser) of (i) 10 percent of the insurer’s statutory surplus as of the end of the prior calendar year, and (ii) the adjusted statutory net investment income during the prior calendar year.
As of December 31, 2015, a maximum amount of $81.7 million was available for dividends by TRC without prior approval of the applicable regulatory authorities.
Pursuant to the 2014 Repurchase Program and the 2012 Repurchase Program, we repurchased shares of our common stock in 2015, 2014 and 2013 as follows:
Dividends. From 1987 through 2011, we declared stock dividends in lieu of cash dividends every year except 1998, when our wholly-owned subsidiary, Chicago Title Corporation, was spun off to our stockholders. Our Board of Directors determined not to declare a dividend, cash or stock, for 2012 through 2015.
Capital Contributions. From time to time, we make capital contributions to our subsidiaries. In 2015, we made capital contributions to Alleghany Capital to: (i) make $88.2 million of capital contributions to SORC for purposes of making an acquisition and ongoing operations; and (ii) make an $89.9 million investment in IPS (excluding amounts for transaction costs and estimates of future amounts payable). In 2014, we made a $297.3 million capital contribution to TransRe to redeem $300 million par value of the 2015 Senior Notes, as described above. In 2014, we also made capital contributions to Alleghany Capital to: (i) make $96.6 million of capital contributions to SORC; (ii) exercise an option to increase its ownership in Kentucky Trailer by $15.0 million; and (iii) make a $60.3 million investment in Jazwares. In 2013, we made a $14.7 million capital contribution to AIHL Re to provide capital to support an intercompany reinsurance contract between AIHL Re and PCIC. In 2013, we also made $40.7 million of capital contributions to Alleghany Capital to make capital contributions to SORC and to make an investment in Kentucky Trailer of $24.9 million. We expect that we will continue to make capital contributions to our subsidiaries from time to time in the future for similar or other purposes.
Investments in Certain Other Invested Assets. In December 2012, TransRe obtained an ownership interest in Pillar Capital Holdings Limited, or “Pillar Holdings,” a Bermuda-based insurance asset manager focused on collateralized reinsurance and catastrophe insurance-linked securities. Additionally, TransRe invested $175.0 million and AIHL invested $25.0 million in limited partnership funds managed by Pillar Holdings, or the “Funds.” The objective of the Funds is to create portfolios with attractive risk-reward characteristics and low correlation with other asset classes, using the extensive reinsurance and capital market experience of the principals of Pillar Holdings. We have concluded that both Pillar Holdings and the Funds, which we collectively refer to as the “Pillar Investments,” represent variable interest entities and that we are not the primary beneficiary, as we do not have the ability to direct the activities that most significantly impact each entity’s economic performance. Therefore, the Pillar Investments are not consolidated and are accounted for under the equity method of accounting. Our potential maximum loss in the Pillar Investments is limited to our cumulative net investment. As of December 31, 2015, our carrying value in the Pillar Investments, as determined under the equity method of accounting, was $238.8 million, which is net of returns of capital received from the Pillar Investments.
Investments in Commercial Mortgage Loans. In 2015, we invested in certain commercial mortgage loans. As of December 31, 2015, the carrying value of the commercial loan portfolio was $177.9 million, representing the unpaid principal balance on the loans. As of December 31, 2015, there was no allowance for loan losses. The commercial loan portfolio consists primarily of high quality fixed- and floating-rate loans with terms of 2-10 years, backed by high-quality commercial properties in the U.S.
Energy Holdings. As of December 31, 2015, we had holdings in energy-related businesses of $551.7 million, comprised of $274.6 million of debt securities, $71.1 million of equity securities and $206.0 million of Alleghany’s equity attributable to SORC.
Financial strength is also a high priority of our subsidiaries, whose assets stand behind their financial commitments to their customers and vendors. We believe that our subsidiaries have and will have adequate internally generated funds, cash resources and unused credit facilities to provide for the currently foreseeable needs of their businesses. Our subsidiaries had no material commitments for capital expenditures as of December 31, 2015.
Included in corporate activities is debt associated with Alleghany Capital’s operating subsidiaries. This includes $36.3 million of borrowings by Kentucky Trailer as of December 31, 2015 related primarily to a mortgage loan, borrowings to finance small acquisitions and borrowings under its available credit facility. None of these liabilities are guaranteed by Alleghany or Alleghany Capital, and they are classified as a component of other liabilities
Investment Strategy and Holdings. Our investment strategy seeks to preserve principal and maintain liquidity while trying to maximize our risk-adjusted, after-tax rate of return. Our investment decisions are guided mainly by the nature and timing of expected liability payouts, management’s forecast of cash flows and the possibility of unexpected cash demands, for example, to satisfy claims due to catastrophe losses. Our consolidated investment portfolio currently consists mainly of highly rated and liquid debt and equity securities listed on national securities exchanges. The overall debt securities portfolio credit quality is measured using the lowest rating of S&P, Moody’s or Fitch Ratings, Inc. In this regard, the overall weighted-average credit quality rating of our debt securities portfolio as of December 31, 2015 and 2014 was AA-. Although many of our debt securities, which consist predominantly of municipal bonds, are insured by third-party financial guaranty insurance companies, the impact of such insurance was not significant to the debt securities credit quality rating as of December 31, 2015. As of December 31, 2015, the ratings of our debt securities portfolio were as follows:
(1) Consists of $136.7 million of securities rated BB / Ba, $274.7 million of securities rated B, $31.5 million of securities rated CCC, $9.7 million of securities rated CC, $4.0 million of securities rates below CC and $37.1 million of not-rated securities.
Effective duration measures a portfolio’s sensitivity to changes in interest rates. In this regard, as of December 31, 2015, our debt securities portfolio had an effective duration of approximately 4.6 years compared with 3.9 years as of December 31, 2014. The increase in duration in 2015 primarily reflects the purchase of long-dated corporate and U.S. Government debt securities in the second quarter of 2015. As of December 31, 2015, approximately $3.4 billion, or 25.2 percent, of our debt securities portfolio represented securities with maturities of five years or less. See Note 4(b) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional detail on the contractual maturities of our consolidated debt securities portfolio. We may modestly increase the proportion of our debt securities portfolio held in securities with maturities of more than five years should the yields of these securities provide, in our judgment, sufficient compensation for their increased risk. We do not believe that this strategy would reduce our ability to meet ongoing claim payments or to respond to significant catastrophe losses.
(1) This table includes AFS investments (debt and equity securities as well as partnership and non-marketable equity investments carried at fair value that are included in other invested assets). This table excludes investments accounted for using the equity method and commercial mortgage loans that are carried at unpaid principal balance. The fair value of short-term investments approximates amortized cost. The fair value of all other categories of investments is discussed below.
(2) See Note 8 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on the Senior Notes.
(2) Includes $946.7 million and $900.7 million of collateralized loan obligations as of December 31, 2015 and 2014, respectively.
(3) Includes partnership and non-marketable equity investments accounted for on an AFS basis, and excludes investments accounted for using the equity method and commercial mortgage loans that are carried at unpaid principal balance.
The business of our reinsurance and insurance subsidiaries exposes them to losses from various catastrophe events. In a catastrophe event, losses from many insureds across multiple lines of business may result directly or indirectly from such single occurrence. Our reinsurance and insurance subsidiaries take certain measures to mitigate the impact of catastrophe events through various means including considering catastrophe risks in their underwriting and pricing decisions, purchasing reinsurance, monitoring and modeling accumulated exposures and managing exposure in key geographic zones and product lines that are prone to catastrophe events.
In May 2014, the FASB, together with the International Accounting Standards Board, issued guidance on the recognition of revenue from contracts with customers. Under the new guidance, revenue is recognized as the transfer of goods and services to customers takes place, and in amounts that reflect the payment or payments that are expected to be received from the customers for those goods and services. The new guidance also requires new disclosures about revenue. Revenues related to insurance and reinsurance are not impacted by this guidance. In July 2015, the FASB decided to delay the effective date of the new revenue standard by a year. This guidance is now effective in the first quarter of 2018 for public entities, with early adoption permitted in 2017. We will adopt this guidance in the first quarter of 2018 and do not currently believe that the implementation will have a material impact on our results of operations and financial condition.
In April 2015, the FASB issued guidance that requires debt issuance costs related to debt liabilities be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, which is consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected. This guidance is effective in the first quarter of 2016 for public entities, with early adoption permitted. We will adopt this guidance in the first quarter of 2016 and do not currently believe that the implementation will have an impact on our results of operations and financial condition.
In May 2015, the FASB issued guidance that requires disclosures related to short-duration insurance contracts. The guidance applies to property and casualty insurance and reinsurance entities, among others, and requires the following annual disclosure related to the liability for loss and LAE: (i) net incurred and paid claims development information by accident year for up to 10 years; (ii) a reconciliation of incurred and paid claims development information to the aggregate carrying amount of the liability for loss and LAE; (iii) incurred-but-not-reported liabilities by accident year and in total; (iv) a description of reserving methodologies (as well as any changes to those methodologies); (v) quantitative information about claim frequency by accident year; and (vi) the average annual percentage payout of incurred claims by age by accident year. In addition, the guidance requires insurance entities to disclose for annual and interim reporting periods a roll-forward of the liability for loss and LAE. This guidance is effective for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016, with early adoption permitted. We will adopt this guidance as of December 31, 2016 and do not currently believe that the implementation will have an impact on our results of operations and financial condition.
In January 2016, the FASB issued guidance that changes the recognition and measurement of certain financial instruments. The new guidance requires investments in equity securities (except those accounted for under the equity method of accounting) to be measured at fair value with changes in fair value recognized in net income. For equity securities that do not have readily determinable fair values, measurement may be at cost, adjusted for any impairment and changes resulting from observable price changes for a similar investment of the same issuer. The new guidance also changes the presentation and disclosure of financial instruments by: (i) requiring that financial instrument disclosures of fair value use the exit price notion; (ii) requiring separate presentation of financial assets and financial liabilities by measurement category and form, either on the balance sheet or the accompanying notes to the financial statements; (iii) requiring separate presentation in other comprehensive income for the portion of the change in a liability’s fair value resulting from instrument-specific credit risk when an election has been made to measure the liability at fair value; and (iv) eliminating the requirement to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet. The new guidance is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Except for the change in presentation for instrument-specific credit risk, the new guidance does not permit early adoption. We will adopt this guidance in the first quarter of 2018. As of January 1, 2018, unrealized gains or losses of equity securities, net of deferred taxes, will be reclassified from accumulated other comprehensive income to retained earnings. Subsequently, all changes in unrealized gains or losses of equity securities, net of deferred taxes, will be presented in the consolidated statement of earnings, rather than the consolidated statement of comprehensive income. We do not currently believe that the implementation will have a material impact on our financial condition.
We have audited the accompanying consolidated balance sheets of Alleghany Corporation and subsidiaries (the “Company”) as of December 31, 2015 and 2014, and the related consolidated statements of earnings and comprehensive income, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2015. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Alleghany Corporation and subsidiaries at December 31, 2015 and 2014, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Alleghany Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 23, 2016 expressed an unqualified opinion thereon.
Alleghany Corporation (“Alleghany”), a Delaware corporation, owns and manages certain operating subsidiaries and investments, anchored by a core position in property and casualty reinsurance and insurance. Alleghany was initially incorporated in 1929, was subsequently incorporated in 1984 under the laws of the State of Delaware, and in December 1986, it succeeded to the business of its parent company, Alleghany Corporation. Through its wholly-owned subsidiary Alleghany Insurance Holdings LLC (“AIHL”) and its subsidiaries, Alleghany is engaged in the property and casualty insurance business. AIHL’s insurance operations are principally conducted by its subsidiaries RSUI Group, Inc. (“RSUI”), CapSpecialty, Inc. (“CapSpecialty”) and Pacific Compensation Corporation (“PacificComp”). CapSpecialty has been a subsidiary of AIHL since January 2002, RSUI has been a subsidiary of AIHL since July 2003 and PacificComp has been a subsidiary of AIHL since July 2007. AIHL Re LLC (“AIHL Re”), a captive reinsurance company which provides reinsurance to Alleghany’s insurance operating subsidiaries and affiliates, has been a wholly-owned subsidiary of Alleghany since its formation in May 2006. Alleghany’s reinsurance operations commenced on March 6, 2012 when Alleghany consummated a merger with Transatlantic Holdings, Inc. (“TransRe”), and TransRe became one of Alleghany’s wholly-owned subsidiaries. Alleghany’s public equity investments, including those held by TransRe’s and AIHL’s operating subsidiaries, are managed primarily through Alleghany’s wholly-owned subsidiary Roundwood Asset Management LLC.
The accompanying consolidated financial statements include the results of Alleghany and its wholly-owned and majority-owned subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). All significant inter-company balances and transactions have been eliminated in consolidation. The results of Kentucky Trailer have been included in Alleghany’s consolidated results beginning August 30, 2013, the date of Alleghany Capital’s initial investment in Kentucky Trailer, and the results of IPS have been included in our consolidated results beginning October 31, 2015, the date of Alleghany Capital’s acquisition of a majority interest.
Net investment income consists primarily of: (i) interest income from debt securities, short-term investments, commercial mortgage loans and cash, including any premium amortization or discount accretion; (ii) dividend income from equity securities; and (iii) investment income from other invested assets, which generally includes distributions when receivable and earnings from investments accounted for under the equity method; less expenses related to investments. Interest income is accrued when earned. Premiums and discounts arising from the purchase of certain debt securities are treated as a yield adjustment over the estimated useful life of the securities, adjusted for anticipated prepayments using the retrospective interest method. Under this method, the effective yield on a security is estimated. Such estimates are based on the prepayment terms of the security, past actual cash flows, and assumptions as to future expected cash flow. The future cash flow assumptions consider various prepayment assumptions based on historical experience, as well as current market conditions. Periodically, the effective yield is re-estimated to reflect actual prepayments and updated future cash flow assumptions. Upon a re-estimation, a security’s book value is restated at the most recently calculated effective yield, assuming that yield had been in effect since the security was purchased. This treatment results in an increase or decrease to net investment income (accretion of premium or amortization of discount) at the new measurement date.
Although Alleghany is responsible for the determination of the fair value of the financial assets and the supporting methodologies and assumptions, it employs third-party valuation service providers to gather, analyze and interpret market information and derive fair values based upon relevant methodologies and assumptions for individual instruments. When those providers are unable to obtain sufficient market observable information upon which to estimate the fair value for a particular security, fair value is determined either by requesting a quote, which is generally non-binding, from brokers who are knowledgeable about these securities or by employing widely accepted internal valuation models.
Mortgage-backed and asset-backed securities are initially valued at the transaction price. Subsequently, Alleghany uses widely accepted valuation practices that produce a fair value measurement. The vast majority of fair values are determined using an income approach. The income approach primarily involves developing a discounted cash flow model using the future projected cash flows of the underlying collateral, as well as other inputs described below. A few Level 3 valuations are based entirely on non-binding broker quotes. These securities consist primarily of mortgage-backed and asset-backed securities where reliable pool and loan level collateral information cannot be reasonably obtained, and as such, an income approach is not feasible.
Premiums are recognized as revenue on a pro rata basis over the term of an insurance policy. Assumed reinsurance premiums written and earned are based on reports received from ceding companies for pro rata treaty contracts and are generally recorded as written based on contract terms for excess-of-loss treaty contracts. Premiums are earned ratably over the terms of the related coverages.
Premium balances receivable are reported net of an allowance for estimated uncollectible premium amounts. Such allowance is based upon an ongoing review of amounts outstanding, length of collection periods, the creditworthiness of the insured and other relevant factors. Amounts deemed to be uncollectible are written off against the allowance.
Acquisition costs related to unearned premiums that vary with, and are directly related to, the production of such premiums are deferred. Furthermore, such deferred costs: (i) represent only incremental, direct costs associated with the successful acquisition of a new or renewal insurance or reinsurance contract; (ii) are essential to the contract transaction; (iii) would not have been incurred had the contract transaction not occurred; and
(iv) are related directly to the acquisition activities involving underwriting, policy issuance and processing. Acquisition costs principally relate to commissions. To a lesser extent, acquisition costs can include premium taxes and certain qualifying underwriting expenses. For insurance policies written, acquisition costs are generally incurred directly, and include commissions, premium taxes and certain qualifying underwriting expenses. For reinsurance contracts written, acquisition costs are generally incurred through brokerage commissions and indirectly through ceding commissions, which are deferred. Deferred acquisition costs are amortized to expense as the related premiums are earned, generally over a period of one year. Deferred acquisition costs are reviewed at least annually to determine their recoverability from future income, including investment income. If any such costs are determined not to be recoverable they are charged to expense.
Property and equipment is carried at cost, net of accumulated depreciation and amortization. Depreciation of buildings and equipment is principally calculated using the straight-line method over the estimated useful life of the respective assets. Estimated useful lives for such assets range from three to 20 years. Amortization of leasehold improvements is principally calculated using the straight-line method over the estimated useful life of the leasehold improvement or the life of the lease, whichever is less. Rental expense on operating leases is recorded on a straight-line basis over the term of the lease, regardless of the timing of actual lease payments.
While the reserving process is difficult for the insurance business, the inherent uncertainties of estimating loss reserves are even greater for the reinsurance business, due primarily to the longer-term nature of much of the reinsurance business, the diversity of development patterns among different types of reinsurance contracts, the necessary reliance on the ceding companies for information regarding reported claims, and differing reserving practices among ceding companies, which may change without notice. TransRe writes a significant amount of non-proportional assumed casualty reinsurance as well as proportional assumed reinsurance of excess liability business for classes such as medical malpractice, directors’ and officers’ liability, errors and omissions liability and general liability. Claims from such classes can exhibit greater volatility over time than most other classes due to their low frequency, high severity nature and loss cost trends that are more difficult to predict. Net loss and LAE also include amounts for risks relating to asbestos-related illness and environmental impairment.
July 2015, the FASB decided to delay the effective date of the new revenue standard by a year. This guidance is now effective in the first quarter of 2018 for public entities, with early adoption permitted in 2017. Alleghany will adopt this guidance in the first quarter of 2018 and does not currently believe that the implementation will have a material impact on its results of operations and financial condition.
On October 31, 2015, Alleghany, through its Alleghany Capital subsidiary, acquired approximately 84 percent of the equity in IPS for $106.3 million, including $89.9 million in cash paid on November 2, 2015, $12.5 million of estimated contingent consideration based on future profitability and $3.9 million of estimated purchase price adjustments. In connection with the acquisition, $23.5 million, $27.9 million and $49.3 million of goodwill, indefinite-lived intangible assets and finite-lived intangible assets, respectively, were recorded. Indefinite-lived intangible assets relate to trade name, and finite-lived intangible assets relate to customer relationships, back-log and covenants not-to-compete.
The amount of goodwill and intangible assets, net of accumulated amortization expense, reported on Alleghany’s consolidated balance sheets as of December 31, 2015 and 2014 is as follows:
(3) Primarily represents goodwill and other intangible assets related to the acquisition of: (i) IPS on October 31, 2015; (ii) Bourn & Koch on April 26, 2012; and (iii) a controlling equity interest in Kentucky Trailer on August 30, 2013. On January 2, 2014, for an additional investment of $15.0 million, Alleghany exercised its option to increase its common equity interest in Kentucky Trailer to 80 percent, and to increase its preferred equity interest by $1.6 million to $15.9 million. Also includes minor acquisitions made by Alleghany Capital’s subsidiaries.
In 2014, there were transfers of $58.4 million of debt securities into Level 3 that were principally due to a decrease in observable inputs related to the valuation of such securities. Of the $58.4 million, $29.1 million related to other asset-backed securities (specifically, collateralized loan obligations), $23.2 million related to U.S. corporate bonds and $6.1 million related to foreign corporate bonds. There were no other transfers between Levels 1, 2 or 3 in 2014.
The following tables present reconciliations of the changes during 2015 and 2014 in Level 3 assets measured at fair value:
(1) Includes $946.7 million and $900.7 million of collateralized loan obligations as of December 31, 2015 and 2014, respectively.
The amount of gross realized capital gains and gross realized capital losses in 2015, 2014 and 2013 were as follows:
Alleghany holds its equity and debt securities as AFS and as such, these securities are recorded at fair value. Alleghany continually monitors the difference between cost and the estimated fair value of its investments, which involves uncertainty as to whether declines in value are temporary in nature. The analysis of any individual security’s decline in value is performed in its functional currency. If the decline of a particular investment is deemed temporary, Alleghany records the decline as an unrealized loss in stockholders’ equity. If the decline is deemed to be other than temporary, Alleghany writes its cost-basis or amortized cost-basis down to the fair value of the investment and records an OTTI loss on its statement of earnings. In addition, any portion of such decline related to debt securities that is believed to arise from factors other than credit is recorded as a component of other comprehensive income rather than charged against earnings.
Debt securities in an unrealized loss position are evaluated for OTTI if they meet any of the following criteria: (i) they are trading at a discount of at least 20 percent to amortized cost for an extended period of time (nine consecutive months or longer); (ii) there has been a negative credit or news event with respect to the issuer that could indicate the existence of an OTTI; or (iii) Alleghany intends to sell, or it is more likely than not that Alleghany will sell, the debt security before recovery of its amortized cost basis.
If Alleghany intends to sell, or it is more likely than not that Alleghany will sell, a debt security before recovery of its amortized cost basis, the total amount of the unrealized loss position is recognized as an OTTI loss in earnings. To the extent that a debt security that is in an unrealized loss position is not impaired based on the preceding, Alleghany will consider a debt security to be impaired when it believes it to be probable that Alleghany will not be able to collect the entire amortized cost basis. For debt securities in an unrealized loss position as of the end of each quarter, Alleghany develops a best estimate of the present value of expected cash flows. If the results of the cash flow analysis indicate Alleghany will not recover the full amount of its amortized cost basis in the debt security, Alleghany records an OTTI loss in earnings equal to the difference between the present value of expected cash flows and the amortized cost basis of the debt security. If applicable, the difference between the total unrealized loss position on the debt security and the OTTI loss recognized in earnings is the non-credit related portion and is recorded as a component of other comprehensive income.
OTTI losses in 2014 reflect $36.3 million of unrealized losses that were deemed to be other than temporary and, as such, were required to be charged against earnings. Of the $36.3 million of OTTI losses incurred during 2014, $28.7 million relate to equity securities, primarily in the mining sector, and $7.6 million relate to debt securities, primarily in the energy sector. The determination that unrealized losses on such securities were other than temporary was primarily based on the severity of the decline in the fair value of equity securities relative to their cost as of the balance sheet date, and the fact that Alleghany lacked the intent to hold debt securities for a period of time sufficient to allow for an anticipated recovery.
As of December 31, 2015, Alleghany held a total of 1,137 debt securities and equity securities that were in an unrealized loss position, of which 102 securities, all debt securities, were in an unrealized loss position continuously for 12 months or more. The unrealized losses associated with the 102 debt securities consisted primarily of losses related to U.S. corporate bonds, other asset-backed securities, municipal bonds and RMBS.
As of December 31, 2015, the vast majority of Alleghany’s debt securities were rated investment grade, with approximately 3.6 percent of debt securities having issuer credit ratings that were below investment grade or not rated.
Investments with fair values of approximately $1.5 billion as of December 31, 2015, the substantial majority of which were debt securities and equity securities, were deposited with governmental authorities as required by law.
In July 2013, AIHL invested $250.0 million in Ares, an asset manager, in exchange for a 6.25 percent equity stake in Ares, with an agreement to engage Ares to manage up to $1.0 billion in certain investment strategies. In May 2014, Ares completed an initial public offering of its common units. Upon completion of the initial public offering, Alleghany’s equity investment in Ares converted to limited partner interests in certain Ares subsidiaries that are convertible into an aggregate 5.9 percent interest in Ares common units. As of December 31, 2015, at Alleghany’s discretion, half of these interests may be converted at any time, and the remaining half may be converted in May 2016. Until Alleghany determines to convert its limited partner interests into Ares common units, Alleghany classifies its investment in Ares as a component of other invested assets, and accounts for its investment using the equity method of accounting. As of December 31, 2015, AIHL’s carrying value in Ares was $224.7 million, which is net of returns of capital received from Ares.
(4) Approximately 95 percent of our reinsurance recoverables balance as of December 31, 2015 was due from reinsurers having an A.M. Best Company, Inc. financial strength rating of A (Excellent) or higher.
Alleghany had no allowance for uncollectible reinsurance as of December 31, 2015 and 2014.
The following table indicates property and casualty premiums written and earned for 2015, 2014 and 2013:
In the second quarter of 2013, AIHL Re and PacificComp’s wholly-owned subsidiary Pacific Compensation Insurance Company (“PCIC”), entered into an intercompany reinsurance contract, effective January 1, 2013, pursuant to which AIHL Re provides PCIC with coverage for adverse development on net loss and allocated loss adjustment expenses in excess of PCIC’s carried reserves at December 31, 2012 and accident year stop-loss coverage for any net losses and allocated loss adjustment expenses in excess of 75.0 percent of net premiums earned for PCIC for accident years 2013 through 2017. AIHL Re’s commitments also are intended to cover the statutory collateral requirements at PCIC, if and when necessary. AIHL Re’s obligations are subject to an aggregate limit of $100.0 million. In connection with such intercompany reinsurance agreement, Alleghany and AIHL Re entered into a contract whereby Alleghany will guarantee the recoverable balances owed to PCIC from AIHL Re up to $100.0 million. Subsequent to the entry into the above agreements, A.M. Best Company, Inc. upgraded PCIC’s rating to A- (Excellent) from B++ (Good). The above agreements had no impact on Alleghany’s consolidated results of operations and financial condition.
Activity in liability for loss and LAE in 2015, 2014 and 2013 is summarized as follows:
(2) Represents reserves acquired in connection with a loss portfolio transfer transaction.
Gross loss and LAE reserves as of December 31, 2015 decreased from December 31, 2014, reflecting a decrease in our reinsurance segment loss and LAE reserves, partially offset by an increase at our insurance segment. The decrease in gross loss and LAE reserves in the reinsurance segment primarily reflects favorable prior accident year loss reserve development, loss payments including amounts related to commutations in the fourth quarter of 2015 with certain cedants and the impact of changes in foreign currency exchange rates. The increase in gross loss and LAE reserves in the insurance segment primarily reflects higher current accident year losses.
The (favorable) unfavorable prior accident year development on loss reserves for 2015, 2014 and 2013 is summarized as follows:
(9) Generally reflects favorable prior accident year development on loss reserves in a variety of casualty & other lines of business primarily from the 2005 and 2014 accident years, including ($30.7) million of favorable prior accident year development related to French medical malpractice loss reserves commuted in the fourth quarter of 2015 with a European cedant, partially offset by unfavorable prior accident year development from the 2004 and prior accident years.
(11) Generally reflects favorable prior accident year development on loss reserves in a variety of casualty & other lines of business.
(13) Primarily reflects favorable prior accident year development on loss reserves in the professional liability, general liability and umbrella/excess lines of business, and primarily related to the 2006 through 2010 accident years, partially offset by unfavorable prior accident year development on loss reserves in the directors’ and officers’ liability line of business in the 2011 and 2012 accident years.
(15) Primarily reflects favorable prior accident year development of ($4.1) million from Super Storm Sandy in 2012, net of reinsurance, and favorable prior accident year development on loss reserves related to unallocated LAE reserves.
(16) Primarily reflects favorable prior accident year development on unallocated LAE reserves and prior year catastrophe loss reserves from recent accident years.
In the fourth quarter of 2015, Alleghany borrowed and repaid $60.0 million under the Credit Agreement. As of December 31, 2015, there were no outstanding borrowings under the Credit Agreement.
On September 9, 2014, Alleghany completed a public offering of $300.0 million aggregate principal amount of its 4.90% senior notes due on September 15, 2044 (the “2044 Senior Notes”). The 2044 Senior Notes are unsecured and unsubordinated general obligations of Alleghany. Interest on the 2044 Senior Notes is payable semi-annually on March 15 and September 15 of each year. The terms of the 2044 Senior Notes permit redemption prior to their maturity. The indenture under which the 2044 Senior Notes were issued contains covenants that impose conditions on Alleghany’s ability to create liens on, or engage in sales of, the capital stock of AIHL, TransRe or RSUI. The 2044 Senior Notes were issued at approximately 99.3 percent of par, resulting in proceeds after underwriting discount, commissions and other expenses of $294.3 million, and an effective yield of approximately 5.0 percent. Approximately $3.6 million of underwriting discount, commissions and other expenses were recorded as deferred charges, which are amortized over the life of the 2044 Senior Notes.
On June 26, 2012, Alleghany completed a public offering of $400.0 million aggregate principal amount of its 4.95% senior notes due on June 27, 2022 (the “2022 Senior Notes”). The 2022 Senior Notes are unsecured and unsubordinated general obligations of Alleghany. Interest on the 2022 Senior Notes is payable semi-annually on June 27 and December 27 of each year. The terms of the 2022 Senior Notes permit redemption prior to their maturity. The indenture under which the 2022 Senior Notes were issued contains covenants that impose conditions on Alleghany’s ability to create liens on, or engage in sales of, the capital stock of AIHL, TransRe or RSUI. The 2022 Senior Notes were issued at approximately 99.9 percent of par, resulting in proceeds after underwriting discount, commissions and other expenses of $396.0 million, and an effective yield of approximately 5.05 percent. Approximately $3.6 million of underwriting discount, commissions and other expenses were recorded as deferred charges, which are amortized over the life of the 2022 Senior Notes.
On September 20, 2010, Alleghany completed a public offering of $300.0 million aggregate principal amount of its 5.625% senior notes due on September 15, 2020 (the “2020 Senior Notes”). The 2020 Senior Notes are unsecured and unsubordinated general obligations of Alleghany. Interest on the 2020 Senior Notes is payable semi-annually on March 15 and September 15 of each year. The terms of the 2020 Senior Notes permit redemption prior to their maturity. The indenture under which the 2020 Senior Notes were issued contains covenants that impose conditions on Alleghany’s ability to create liens on, or engage in sales of, the capital stock of AIHL or RSUI. The 2020 Senior Notes were issued at approximately 99.6 percent of par, resulting in proceeds after underwriting discount, commissions and other expenses of $298.9 million, and an effective yield of approximately 5.67 percent. Approximately $2.8 million of underwriting discount, commissions and other expenses were recorded as deferred charges, which are amortized over the life of the 2020 Senior Notes.
The slight decrease in the effective tax rate in 2015 compared to 2014 primarily reflects lower taxable income in 2015, partially offset by lower interest income arising from municipal bond securities.
The slightly higher effective tax rate in 2014 compared to 2013 primarily reflects higher taxable income in 2014 relative to a fairly steady level of tax-exempt interest income arising from municipal bond securities.
The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities as of December 31, 2015 and 2014 are as follows:
The Internal Revenue Code provides for limits on the utilization of certain tax benefits following a corporate ownership change. Upon the closing of the merger with TransRe, TransRe was subject to an annual limitation on its ability to use its foreign tax credit carryforwards and its minimum tax credit carryforwards. The total amount of foreign tax credit carryforwards and minimum tax credit carryforwards that were available prior to the merger are not diminished by this provision. The limitation provides for an annual limit on the amount of the carryforwards that can be used each year. The unused carryovers are available to be used in subsequent years, subject to the annual limitation. The annual limitation is estimated at approximately $42.7 million.
Alleghany believes that, as of December 31, 2015, it had no material uncertain tax positions. Interest and penalties relating to unrecognized tax expenses (benefits) are recognized in income tax expense, when applicable. There was no material liabilities for interest or penalties accrued as of December 31, 2015.
In October 2012, the Alleghany Board of Directors authorized a program to repurchase shares of Common Stock, at such times and at prices as management determined advisable, up to an aggregate of $300.0 million (the “2012 Repurchase Program”). In July 2014, the Alleghany Board of Directors authorized, upon the completion of the 2012 Repurchase Program, the repurchase of additional shares of Common Stock, at such times and at prices as management determines to be advisable, up to an aggregate of $350.0 million (the “2014 Repurchase Program”). In the fourth quarter of 2014, Alleghany completed the 2012 Repurchase Program and subsequent repurchases have been made pursuant to the 2014 Repurchase Program. In November 2015, the Alleghany Board of Directors authorized, upon the completion of the 2014 Repurchase Program, the repurchase of additional shares of Common Stock, at such times and at prices as management determines to be advisable, up to an aggregate of $400.0 million.
The following table presents a reconciliation of the changes during 2015 and 2014 in accumulated other comprehensive income attributable to Alleghany stockholders:
(1) For 2015, excludes a $25.8 million realized capital loss related to a non-cash impairment charge related to a write-off of Alleghany’s investment in ORX. For 2014, excludes a $9.4 million realized capital loss on the early redemption of the 2015 Senior Notes (see Note 8(b) for additional information).
The ability of Alleghany’s reinsurance and insurance subsidiaries to pay dividends or other distributions is subject to the laws and regulations applicable to each subsidiary, as well as each subsidiary’s need to maintain capital requirements adequate to maintain its operations and financial strength ratings issued by independent rating agencies.
(1) In 2015, Transatlantic Reinsurance Company (“TRC”) paid dividends of $400.0 million to the TransRe holding company, of which $250.0 million was in turn paid to Alleghany. In 2014, TRC paid dividends of $400.0 million to the TransRe holding company, of which $300.0 million was in turn paid to Alleghany. In 2013, TRC paid dividends of $200.0 million to the TransRe holding company, of which $150.0 million was in turn paid to Alleghany.
The statutory net income of Alleghany’s reinsurance and insurance subsidiaries was $741.0 million and $786.5 million for the years ended December 31, 2015 and 2014, respectively. As of December 31, 2015 and 2014, the combined statutory capital and surplus of Alleghany’s reinsurance and insurance subsidiaries was $6.6 billion and $6.6 billion, respectively. As of December 31, 2015, the amount of statutory capital and surplus necessary to satisfy regulatory requirements was not significant in relation to actual statutory capital and surplus.
The following is a reconciliation of the earnings and share data used in the basic and diluted earnings per share computations for 2015, 2014 and 2013:
Alleghany and its subsidiaries lease certain facilities, furniture and equipment under long-term lease agreements. In addition, certain land, office space and equipment are leased under non-cancelable operating leases that expire at various dates through 2031. Rent expense was $34.0 million, $33.8 million and $28.8 million in 2015, 2014 and 2013, respectively. The aggregate minimum payments under operating leases with initial or remaining terms of more than one year as of December 31, 2015 were as follows:
The reserves carried for such claims, including the incurred but not reported portion, are based upon known facts and current law at the respective balance sheet dates. However, significant uncertainty exists in determining the amount of ultimate liability for asbestos-related illness and environmental impairment losses, particularly for those occurring in 1985 and prior, which, prior to the Commutation Agreement, represented the majority of TransRe’s asbestos-related illness and environmental impairment reserves. This uncertainty is due to inconsistent and changing court resolutions and judicial interpretations with respect to underlying policy intent and coverage and uncertainties as to the allocation of responsibility for resultant damages, among other reasons. Further, possible future changes in statutes, laws, regulations, theories of liability and other factors could have a material effect on these liabilities and, accordingly, future earnings.
Alleghany’s segments are reported in a manner consistent with the way management evaluates the businesses. As such, Alleghany classifies its business into two reportable segments - reinsurance and insurance. In addition, reinsurance and insurance underwriting activities are evaluated separately from investment and corporate activities. Net realized capital gains and OTTI losses are not considered relevant in evaluating investment performance on an annual basis. Segment accounting policies are described in Note 1.
The reinsurance segment consists of property and casualty reinsurance operations conducted by TransRe’s reinsurance operating subsidiaries and is further reported by major product lines - property and casualty & other. TransRe provides property and casualty reinsurance to insurers and reinsurers through brokers and on a direct basis to ceding companies. TransRe also writes a modest amount of insurance business, which is included in the reinsurance segment. Approximately half of the premiums earned by TransRe’s operations are generated by offices located in Canada, Europe, Asia, Australia, Africa and those serving Latin America and the Caribbean. Although the majority of the premiums earned by these offices typically relate to the regions where they are located, a significant portion may be derived from other regions of the world, including the U.S. In addition, although a significant portion of the assets and liabilities of these foreign offices generally relate to the countries where ceding companies and reinsurers are located, most investments are located in the country of domicile of these offices.
Segment results for Alleghany’s two reportable segments and for corporate activities for 2015, 2014 and 2013 are shown in the tables below:
(3) Includes amortization associated with deferred acquisition costs of $1,024.5 million, $1,042.0 million and $973.5 million for the years ended December 31, 2015, 2014 and 2013, respectively.
(4) Underwriting profit represents net premiums earned less net loss and LAE and commissions, brokerage and other underwriting expenses, all as determined in accordance with GAAP, and does not include net investment income, net realized capital gains, OTTI losses, other income, other operating expenses, corporate administration, amortization of intangible assets or interest expense. Underwriting profit does not replace earnings before income taxes determined in accordance with GAAP as a measure of profitability. Rather, Alleghany believes that underwriting profit enhances the understanding of its segments’ operating results by highlighting net earnings attributable to their underwriting performance. Earnings before income taxes (a GAAP measure) may show a profit despite an underlying underwriting loss. Where underwriting losses persist over extended periods, a reinsurance or an insurance company’s ability to continue as an ongoing concern may be at risk. Therefore, Alleghany views underwriting profit as an important measure in the overall evaluation of performance.
Foreign net premiums earned in 2015, 2014 and 2013 were approximately $1.4 billion, $1.5 billion and $1.6 billion, respectively. The foreign country in which Alleghany generates the largest amount of premium revenues is the U.K. Net premiums earned by operations in the U.K. in 2015, 2014 and 2013 were $640.4 million, $654.8 million and $661.2 million, respectively.
As of December 31, 2015, the identifiable assets of the reinsurance segment, insurance segment and corporate activities were $15.6 billion, $6.3 billion and $1.0 billion, respectively, of which cash and invested assets represented $13.2 billion, $4.8 billion and $0.4 billion, respectively. As of December 31, 2015, Alleghany’s equity attributable to the reinsurance segment, insurance segment and corporate activities was $5.2 billion, $2.6 billion and ($0.2) billion, respectively.
A summary of the parent company level, long-term compensation plans is as follows:
Performance Share Awards - Participants are entitled, at the end of a four-year award period, to a maximum amount equal to the value of one and one-half shares of Common Stock for each performance share issued to them based on market value on the payment date. Payouts are made provided defined levels of performance are achieved. Expenses are recorded based on changes in the fair value of the awards. The fair value is calculated based primarily on: the value of Common Stock as of the balance sheet date; the degree to which performance targets specified in the 2012 LTIP have been achieved; and the time elapsed with respect to each award period.
certain restrictions, relating to, among other things, forfeiture in the event of termination of employment and transferability. In 2015, 2014 and 2013, TransRe recorded $54.9 million, $55.3 million and $52.2 million, respectively, in compensation expense and a deferred tax benefit of $19.2 million, $19.4 million and $18.3 million, respectively, related to the TransRe Plans.
Alleghany has endorsement split-dollar life insurance policies for its parent company level officers that are effective during employment, as well as retirement. Premiums are paid by Alleghany, and death benefits are split between Alleghany and the beneficiaries of the officers. Death benefits for current employees that inure to the beneficiaries are generally equal to four times the annual salary at the time of an officer’s death. After retirement, death benefits that inure to the beneficiaries are generally equal to the annual salary of the officer as of the date of retirement.
In addition, Alleghany has defined benefit pension and, prior to September 30, 2013, retiree health plans for parent company level employees, and TransRe has defined benefit pensions plans for certain of its employees, as further described below.
decided to: (i) freeze the benefits associated with the unfunded, noncontributory defined benefit pension plan for parent company level executives, effective December 31, 2013; and (ii) terminate both retiree health plans, effective September 30, 2013. The funded, noncontributory defined benefit pension plan for parent company level employees is unaffected. As a result of these decisions, Alleghany recorded a pre-tax $8.8 million reduction to corporate administration expense in 2013.
We have audited Alleghany Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Alleghany Corporation and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.