(1) In 2011 and 2008, “Diluted” loss per share is the same as “Basic” loss per share since there was a net loss for that year.
(2) Our 2011 loss and combined ratios were impacted by a $3.4 million increase of net losses and loss adjustment expenses for prior accident years. Our 2010 loss and combined ratios were impacted by a $54.1 million reduction of net losses and loss adjustment expenses for prior accident years. Our 2009 loss and combined ratios were impacted by a $9.1 million reduction of net losses and loss adjustment expenses for prior accident years. Our 2008 loss and combined ratios were impacted by a $34.9 million increase of net losses and loss adjustment expenses for prior accident years. Our 2007 loss and combined ratios were impacted by a $29.1 million reduction of net losses and loss adjustment expenses for prior accident years. See “Results of Operations” in
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and accompanying notes of Global Indemnity included elsewhere in this report. Some of the information contained in this discussion and analysis or set forth elsewhere in this report, including information with respect to our plans and strategy, constitutes forward-looking statements that involve risks and uncertainties. Please see “Cautionary Note Regarding Forward-Looking Statements” at the end of this Item 7 and “Risk Factors” in Item 1A above for more information. You should review “Risk Factors” in Item 1A above for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained herein.
On September 15, 2011, the Company’s Board of Directors authorized the repurchase of up to $100.0 million of the Company’s Class A ordinary shares. Stock repurchases may be made in both open market and privately negotiated transactions, and may include the use of derivative contracts, structured share repurchase agreements and Rule 10b5-1 trading plans. The timing and amount of any repurchase transactions, if any, under this program will depend upon market conditions as well as other factors. We may decide to buy or not buy any of our ordinary shares or discontinue our share repurchase program at any time, any of which may impact our stock price. Important factors that could cause us to discontinue our share repurchases include, among others, market conditions, increases in the market price of our ordinary shares, the nature of other investment opportunities presented to us from time to time, and the availability of funds necessary to continue purchasing common stock. Through March 14, 2012, we have purchased 1,945,023 shares under this program for an aggregate amount of $36.7 million, or $18.87 per share.
On February 24, 2012, we announced that Michael J. Marchio has retired from the Company’s Board of Directors effective February 27, 2012.
Our Reinsurance Operations are comprised of the operations of Wind River Reinsurance, a Bermuda based treaty reinsurer of excess and surplus lines and specialty property and casualty insurance.
Loss reserve estimates for our Reinsurance Operations are developed by independent, external actuaries, however management is responsible for the final determination of loss reserve selections. The data for this analysis is organized by treaty and treaty year. As with our reserves for our Insurance Operations, reserves for our Reinsurance Operations are characterized as short-tail through long-tail. Most of our business can be characterized as medium to long-tail. Long-tail exposures include workers compensation, professional liability, and excess and umbrella liability. Short-tail exposures are primarily catastrophe exposed property accounts. Every treaty is reviewed each quarter, both gross and net of reinsurance.
The Bornhuetter-Ferguson method using premiums and incurred losses is similar to the Bornhuetter-Ferguson method using premiums and paid losses except that it uses case incurred losses. The use of case incurred losses instead of paid losses can result in development patterns that are less variable than paid development patterns. However, the inclusion of case reserves can lead to distortions if changes in case reserving practices have taken place. The method requires analysis of all the factors that need to be reviewed for the Expected Loss Ratio and Incurred Development methods.
Generally, reserves for long-tail lines use the Expected Loss Ratio method for the most recent accident year, shift to the Bornhuetter-Ferguson methods for the next two years, and then shift to the Incurred and/or Paid Development method. Claims related to umbrella business are usually reported later than claims for other long-tail lines. For umbrella business, the Expected Loss Ratio and Bornhuetter-Ferguson methods are used for as many as six years before shifting to the Incurred Development method. Reserves for short-tail lines use the Bornhuetter-Ferguson methods for the most recent accident year and shift to the Incurred and/or Paid Development method in subsequent years.
For other more complex reserve categories where the above methods may not produce reliable indications, we use additional methods tailored to the characteristics of the specific situation. Such reserve categories include losses from construction defects and A&E.
Establishing reserves for A&E and other mass tort claims involves considerably more judgment than other types of claims due to, among other things, inconsistent court decisions, an increase in bankruptcy filings as a result of asbestos-related liabilities, and judicial interpretations that often expand theories of recovery and broaden the scope of coverage. The insurance industry continues to receive a substantial number of asbestos-related bodily injury claims, with an increasing focus being directed toward other parties, including installers of products containing asbestos rather than against asbestos manufacturers. This shift has resulted in significant insurance coverage litigation implicating applicable coverage defenses or determinations, if any, including but not limited to, determinations as to whether or not an asbestos-related bodily injury claim is subject to aggregate limits of liability found in most comprehensive general liability policies. In response to these continuing developments, management increased gross and net A&E reserves during the second quarter of 2008 to reflect its best estimate of A&E exposures. In 2009, one of our insurance companies was dismissed from a lawsuit seeking coverage from it and other unrelated insurance companies. The suit involved issues related to approximately 3,900 existing asbestos related bodily injury claims and future claims. The dismissal was the result of a settlement of a disputed claim related to accident year 1984. The settlement is conditioned upon certain legal events occurring which will trigger financial obligations by the insurance company. Management will continue to monitor the developments of the litigation to determine if any additional financial exposure is present.
The key assumptions fundamental to the reserving process are often different for various reserve categories and accident years. Some of these assumptions are explicit assumptions that are required of a particular method, but most of the assumptions are implicit and cannot be precisely quantified. An example of an explicit assumption is the pattern employed in the Paid Development method. However, the assumed pattern is itself based on several implicit assumptions such as the impact of inflation on medical costs and the rate at which claim professionals close claims. 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. Each reserve segment has an implicit frequency and severity for each accident year as a result of the various assumptions made.
Previous reserve analyses have resulted in our identification of information and trends that have caused us to increase or decrease our frequency and severity assumptions in prior periods and could lead to the identification of a need for additional material changes in loss and loss adjustment expense reserves, which could materially affect our results of operations, equity, business and insurer financial strength and debt ratings. Factors affecting loss frequency include, among other things, the effectiveness of loss controls and safety programs and changes in economic activity or weather patterns. Factors affecting loss severity include, among other things, changes in policy limits and deductibles, 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 us. The length of the loss reporting lag affects our ability to accurately predict loss frequency (loss frequencies are more predictable for short-tail lines) as well as the amount of reserves needed for IBNR.
If the actual levels of loss frequency and severity are higher or lower than expected, the ultimate losses will be different than management’s best estimate. For most of our reserving classes, we believe that frequency can be predicted with greater accuracy than severity. Therefore, we believe management’s best estimate is more sensitive to changes in severity than frequency. The following table, which we believe reflects a reasonable range
Our net reserves for losses and loss expenses of $687.7 million as of December 31, 2011 relate to multiple accident years. Therefore, the impact of changes in frequency and severity for more than one accident year could be higher or lower than the amounts reflected above.
We regularly review the collectability of our reinsurance receivables, and we include adjustments resulting from this review in earnings in the period in which the adjustment arises. A.M. Best ratings, financial history, available collateral, and payment history with the reinsurers are several of the factors that we consider when judging collectability. Changes in loss reserves can also affect the valuation of reinsurance receivables if the change is related to loss reserves that are ceded to reinsurers. Certain amounts may be uncollectible if our reinsurers dispute a loss or if the reinsurer is unable to pay. If our reinsurers do not pay, we are still legally obligated to pay the loss.
The carrying amount of our investments approximates their estimated fair value. We regularly perform various analytical valuation procedures with respect to investments, including reviewing each fixed maturity security in an unrealized loss position to determine the amount of unrealized loss related to credit loss and the amount related to all other factors, such as changes in interest rates. The credit loss represents the portion of the amortized book value in excess of the net present value of the projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. The credit loss component of the other than temporary impairment is recorded through earnings, whereas the amount relating to factors other than credit losses are recorded in other comprehensive income, net of taxes. During our review, we consider credit rating, market price, and issuer specific financial information, among other factors, to assess the likelihood of collection of all principal and interest as contractually due. Securities for which we determine that a credit loss is likely are subjected to further analysis to estimate the credit loss to be recognized in earnings, if any. See Note 5 of the notes to consolidated financial statements in Item 8 of Part II of this report for the specific methodologies and significant assumptions used by asset class. Upon identification of such securities and periodically thereafter, a detailed review is performed to determine whether the decline is considered other than temporary. This review includes an analysis of several factors, including but not limited to, the credit ratings and cash flows of the securities, and the magnitude and length of time that the fair value of such securities is below cost.
In accordance with accounting guidance for insurance enterprises, the method followed in computing such amounts limits them to their estimated realizable value that gives effect to the premium to be earned, related investment income, losses and loss adjustment expenses, and certain other costs expected to be incurred as the premium is earned. A premium deficiency shall be recognized if the sum of expected loss and loss adjustment expenses and unamortized acquisition costs exceeds related unearned premium. Any future expected loss on the related unearned premium is recorded first by impairing the unamortized acquisition costs on the related unearned premium followed by an increase to loss and loss adjustment expense reserves on additional expected loss in excess of unamortized acquisition costs.
As of December 31, 2011, the Company’s deferred acquisition costs were $4.8 million lower than they would have been and loss and loss adjustment expense reserves were $4.1 million higher than they would have been due to premium deficiencies. Deferred acquisition costs were deemed to be fully recoverable as of December 31, 2010.
We provide for income taxes in accordance with applicable accounting guidance. Our deferred tax assets and liabilities primarily result from temporary differences between the amounts recorded in our consolidated financial statements and the tax basis of our assets and liabilities.
In 2009, we recognized $8.6 million of investment income related to the liquidation of investments in two limited partnerships. Our 2009 tax provision includes federal income tax expense of $3.0 million related to this investment income.
We apply a more likely than not recognition threshold for all tax uncertainties, only allowing the recognition of those tax benefits that have a greater than 50% likelihood of being sustained upon examination by the taxing authorities. Please see Note 10 of the notes to the consolidated financial statements in Item 8 of Part II of this report for a discussion of our tax uncertainties.
We evaluate the performance of our Insurance Operations and Reinsurance Operations segments based on gross and net premiums written, revenues in the form of net premiums earned, and expenses in the form of (1) net losses and loss adjustment expenses, (2) acquisition costs, and (3) other underwriting expenses.
See “Business Segments” in Item 1 of Part I of this report for a description of our segments.
The following table sets forth an analysis of financial data for our segments during the periods indicated:
(1) Excludes net investment income and net realized investment gains (losses), which are not allocated to our segments.
(3) Includes excise tax of $1,060, $1,021, and $1,342 related to cessions from our U.S. Insurance Companies to Wind River Reinsurance for 2011, 2010, and 2009, respectively.
(4) Our insurance combined ratios are non-GAAP financial measures that are generally viewed in the insurance industry as indicators of underwriting profitability. The loss ratio is the ratio of net losses and loss adjustment expenses to net premiums earned. The expense ratio is the ratio of acquisition costs and other underwriting expenses to net premiums earned. The combined ratio is the sum of the loss and expense ratios.
All percentage changes included in the text below have been calculated using the corresponding amounts from the applicable tables.
Gross premiums written, which represents the amount received or to be received for insurance policies written without reduction for reinsurance costs or other deductions, was $229.1 million for 2011, compared with $245.5 million for 2010, a decrease of $16.3 million or 6.7%. The decrease was primarily due to declines in our general liability, professional liability and auto lines and price decreases in the aggregate of 1.5%. This decrease was offset partially by increases in certain products within the property and casualty brokerage lines. We are exiting certain unprofitable casualty classes.
The loss ratio for our Insurance Operations was 86.9% for 2011 compared with 36.6% for 2010. The loss ratio is a non-GAAP financial measure that is generally viewed in the insurance industry as an indicator of underwriting profitability and is calculated by dividing net losses and loss adjustment expenses by net premiums earned.
The non-catastrophe loss ratio decreased 1.1 points from 57.5% in 2010 to 56.4% in 2011. Non-catastrophe losses were $55.1 million and $43.2 million for the years ended December 31, 2011 and 2010, respectively.
The loss ratio increased by 24.8 points resulting from a decrease of net losses and loss adjustment expenses for prior accident years of $9.7 million in 2011 compared to a decrease of net losses and loss adjustment expenses for prior accident years of $56.8 million in 2010. When analyzing loss reserves and prior year development, we
Umbrella: The $1.7 million reduction in the umbrella lines primarily related to accident years 2010 and prior primarily due to continued favorable emergence. Umbrella coverage typically attaches to other coverage lines, so these net decreases follow the decreases in general liability above.
Professional Liability: The increase in the professional liability lines primarily consisted of increases of $19.0 million related to accident years 1998, 2009 and 2010, offset partially by decreases of $13.2 million related to all other accident years. In 2011, we exited certain professional liability classes where the volume of premium was low and loss volatility was high. We are focused on writing business where we expect to realize profit that meets our return on investment thresholds.
In 2010, we reduced our prior accident year loss reserves by $56.6 million and reduced our allowance for uncollectible reinsurance by $0.2 million. The reduction of our prior accident year loss reserves primarily consisted of a $43.7 million reduction in our general liability lines, a $5.4 million reduction in our umbrella lines, a $4.9 million reduction in our professional liability lines, and a $2.0 million reduction in our property lines:
Net losses and loss adjustment expenses were $188.4 million for 2011, compared with $71.2 million for 2010, an increase of $117.2 million or 164.6%. Excluding the $9.7 million reduction of net losses and loss adjustment expenses for prior accident years in 2011 and the $56.8 million reduction of net losses and loss adjustment expenses for prior accident years in 2010, the current accident year net losses and loss adjustment expenses were $198.0 million and $128.0 million for 2011 and 2010, respectively. This increase is primarily attributable to an increase to losses related to a premium deficiency in the current year, the impact of an increase in current accident year loss reserves related to our general liability lines, the increase in net premiums earned, and the increase in current accident year severity as described above.
The increase in acquisition costs is primarily due to a write down of deferred acquisition costs related to premium deficiencies, an increase in commissions and premium taxes resulting mainly from an increase in net earned premiums and a decrease in ceding commissions resulting from an increase in retained business. As of December 31, 2011, deferred acquisition costs were $1.9 million lower than they would have been as a result of premium deficiencies.
The combined ratio for our Insurance Operations was 131.5% for 2011, compared with 83.7% for 2010. The combined ratio is a non-GAAP financial measure and is the sum of our loss and expense ratios. Excluding the impact of prior accident year adjustments, the combined ratio increased from 111.6% in 2010 to 136.0% in 2011. Excluding the impact of the write down to deferred acquisition costs related to premium deficiencies, the current accident year combined ratio was 133.5% in 2011. See discussion of loss ratio included in “Net Losses and Loss Adjustment Expenses” above and discussion of expense ratio in preceding paragraph above for an explanation of this increase.
The components of income from underwriting and underwriting ratios of our Reinsurance Operations segment are as follows:
Net premiums written, which equals gross premiums written less ceded premiums written, was $78.3 million for 2011, compared with $100.4 million for 2010, a decrease of $22.2 million or 22.1%. The decrease was primarily due to the decrease in gross premiums written as described above. The ratio of net premiums written to gross premiums written was 99.4% for 2011 and 100.2% for 2010, a decrease of 0.8 points.
The impact of changes to prior accident years is an increase of 13.2 points resulting from an increase of net losses and loss adjustment expenses for prior accident years of $13.1 million in 2011 and an increase of net losses and loss adjustment expenses for prior accident years of $2.7 million in 2010. When analyzing loss reserves and prior year development, we consider many factors, including the frequency and severity of claims, loss credit trends, case reserve settlements that may have resulted in significant development, and any other additional or pertinent factors that may impact reserve estimates.
Professional Liability: The decrease in professional liability lines are primarily related to accident years 2009 and 2010 and is the result of better than expected development on certain treaties.
In 2010, we increased our prior accident year loss reserves by $2.7 million. The increase in our prior accident year loss reserves primarily consisted of a $2.6 million increase in our automobile liability lines and a $0.5 million increase in our workers’ compensation lines, offset partially by a decrease of $0.5 million in our property lines:
The $1.5 million increase in other underwriting expenses is primarily due to an increase in compensation related to the hiring of new employees within this business unit.
The $1.4 million decrease in acquisition costs is primarily due to a decrease in contingent commissions resulting from higher than expected current and prior accident year losses discussed above, offset partially by a write down of deferred acquisition costs related to premium deficiencies. As of December 31, 2011, deferred acquisition costs were $2.9 million lower than they would have been as a result of premium deficiencies.
The combined ratio for our Reinsurance Operations was 144.1% for 2011, compared with 92.7% for 2010. The combined ratio is a non-GAAP financial measure and is the sum of our loss and expense ratios. Excluding the impact of prior accident year adjustments, the combined ratio increased from 88.2% in 2010 to 128.0% in 2011. Excluding the impact of the write down of deferred acquisition costs related to premium deficiencies, the current
accident year combined ratio was 123.6% for the year ended December 31, 2011. See discussion of loss ratio included in “Net Losses and Loss Adjustment Expenses” above and discussion of expense ratio in preceding paragraph above for an explanation of this increase.
Investment expenses were $4.7 million for 2011, compared with $6.0 million for 2010, a decrease of $1.3 million or 21.0%. The decrease is primarily due to trust fee reductions in the current period.
Corporate and other operating expenses consist of outside legal fees, other professional fees, development costs, directors’ fees, management fees, salaries and benefits for holding company personnel, and taxes incurred which are not directly related to operations. Corporate and other operating expenses were $13.5 million for 2011, compared with $21.1 million for 2010, a decrease of $7.6 million or 36.0%. The decrease is primarily due to cost savings resulting from our previously disclosed Profit Enhancement Initiative and a decrease in share-based compensation related to the forfeiture of unvested restricted shares and options, offset partially by an increase in outside legal fees.
Income tax expense was $2.1 million for 2011, compared with $8.9 million for 2010. See Note 10 of the notes to the consolidated financial statements in Item 8 of Part II of this report for an analysis of income tax expense between periods.
Equity in net earnings of partnerships, net of tax was $0.05 million for 2011, compared with equity in net loss of partnerships, net of tax of $0.02 million for 2010, an increase of $0.07 million.
The factors described above resulted in a net loss of $39.6 million in 2011, compared with net income of $84.9 million in 2010, a decrease of $124.5 million.
Net premiums written, which equals gross premiums written less ceded premiums written, was $196.1 million for 2010, compared with $218.3 million for 2009, a decrease of $22.2 million or 10.2%. The decrease was primarily due to the reduction of gross premiums written noted above, higher reinsurance costs, and a minimum premium charge of $1.5 million related to the curtailment of our workers’ compensation initiative. In 2011, we increased retention on our property per risk reinsurance agreement from $1 million to $2 million as well as cancelled our Penn-America property quota share treaty. Please see Note 9 of the notes to the consolidated financial statements in Item 8 of Part II of this report for more information on our treaty renewals.
The loss ratio improved 25.7 points resulting from a decrease of net losses and loss adjustment expenses for prior accident years of $56.8 million in 2010 compared to a decrease of net losses and loss adjustment expenses for prior accident years of $9.1 million in 2009. When analyzing loss reserves and prior year development, we consider many factors, including the frequency and severity of claims, loss credit trends, case reserve settlements that may have resulted in significant development, and any other additional or pertinent factors that may impact reserve estimates.
In 2009, we reduced our prior accident year loss reserves by $8.4 million and reduced our allowance for uncollectible reinsurance by $0.7 million. The reduction of our prior accident year loss reserves primarily consisted of a $5.5 million reduction in our property lines, a $2.9 million reduction in our general liability lines, and a $4.7 million reduction in our umbrella lines, offset by a $4.7 million increase in our professional liability lines:
Umbrella: The reduction in the umbrella lines primarily consisted of net reductions of $5.1 million related to accident years 2007 and prior that were driven by loss emergence throughout the year that was consistently better than expected, partially offset by increases of $0.4 million related to accident year 2008.
The current accident year property loss ratio increased 5.9 points from 55.3% in 2009 to 61.2% in 2010, which consisted of a 6.1 point increase in the non-catastrophe loss ratio from 51.4% in 2009 to 57.5% in 2010, offset by a 0.1 point decrease in the catastrophe loss ratio from 3.9% in 2009 to 3.8% in 2010. There was very little significant catastrophe activity during 2010 and 2009. Catastrophe losses were $2.8 million and $4.0 million in 2010 and 2009, respectively. The property loss ratio was impacted by rate decreases of approximately 3.4% as well as higher reinsurance costs in 2010 when compared to 2009. Property net premiums earned for 2010 and 2009 were $75.2 million and $103.5 million, respectively.
Net losses and loss adjustment expenses were $71.2 million for 2010, compared with $146.2 million for 2009, a decrease of $75.0 million or 51.3%. Excluding the $56.8 million reduction of net losses and loss adjustment expenses for prior accident years in 2010 and the $9.1 million reduction of net losses and loss adjustment expenses for prior accident years in 2009, the current accident year net losses and loss adjustment expenses were $128.0 million and $155.3 million for 2010 and 2009, respectively. This decrease is primarily attributable to a decrease in net premiums earned.
Acquisition costs and other underwriting expenses were $91.5 million for 2010, compared with $106.3 million for 2009, a decrease of $14.8 million or 14.0%. The decrease is due to a $12.6 million decrease in acquisition costs and a $2.2 million decrease in other underwriting expenses. We incurred $2.8 million in acquisition costs related to prior accident years in 2010, compared with $0.8 million related to prior accident years in 2009, an increase of $2.0 million.
The factors described above resulted in income from underwriting for our Insurance Operations of $32.2 million for 2010, compared with a loss from underwriting of $2.1 million for 2009, an increase of $34.3 million.
Net premiums earned were $92.6 million for 2010, compared with $51.3 million for 2009, an increase of $41.3 million or 80.6%. The increase was primarily due to new reinsurance treaties that commenced during 2009 and 2010. Property net premiums earned for 2010 and 2009 were $35.3 million and $23.5 million, respectively. Casualty net premiums earned for 2010 and 2009 were $57.3 million and $27.8 million, respectively.
The impact of changes to prior accident years is an increase of 2.9 points resulting from an increase of net losses and loss adjustment expenses for prior accident years of $2.7 million in 2010 and an increase of net losses and loss adjustment expenses for prior accident years of $0.03 million in 2009. When analyzing loss reserves and prior year development, we consider many factors, including the frequency and severity of claims, loss credit trends, case reserve settlements that may have resulted in significant development, and any other additional or pertinent factors that may impact reserve estimates.
Workers’ Compensation: The increase in our workers’ compensation lines is related to an accident year 2009 structured excess of loss treaty where we increased our loss estimates based on industry workers’ compensation results.
In 2010, the current accident year loss ratio increased 15.8 points from 45.2% in 2009 to 61.0% in 2010. The casualty lines loss ratio was 75.1% in 2010 compared to 77.1% in 2009. The property lines loss ratio was 38.2% in 2010 compared to 7.5% in 2009. We experienced abnormally low levels of catastrophe losses in 2009. In 2010, we experienced catastrophe losses from New Zealand earthquakes, Perth hail storms, Australian floods and other smaller events.
The factors described above resulted in income from underwriting for our Reinsurance Operations of $6.7 million in 2010, compared to $14.4 million in 2009, a decrease of $7.7 million.
The average duration of our fixed maturities portfolio was 2.2 years as of December 31, 2010, compared with 2.8 years as of December 31, 2009. Including cash and short-term investments, the average duration of our fixed maturities portfolio as of December 31, 2010 and 2009 was 2.1 years. Changes in interest rates can cause principal payments on certain investments to extend or shorten which can impact duration. At December 31, 2010, our book yield on our fixed maturities, not including cash, was 3.92% compared with 4.34% at December 31, 2009. As of December 31, 2010, our investment portfolio held $180.9 million in tax-exempt municipals with a book yield of 3.68% and $64.1 million in taxable municipals with a book yield of 2.99%.
Net realized investment gains were $26.4 million for 2010, compared with $15.9 million for 2009. The net realized investment gains for 2010 consist primarily of net gains of $17.4 million relative to our fixed maturities and $9.5 relative to our equity securities, offset by other than temporary impairment losses of $0.5 million. The net realized investment gains for 2009 consist primarily of net gains of $5.4 million relative to market value changes in our convertible portfolio and net gains of $16.1 million relative to our fixed maturities and equity portfolios, offset by other than temporary impairment losses of $5.6 million.
See Note 6 of the notes to the consolidated financial statements in Item 8 of Part II of this report for an analysis of total investment return on an after-tax basis for the years ended December 31, 2010 and 2009.
Interest expense was $7.0 million and $7.2 million for 2010 and 2009, respectively. The reduction was due to decreases in LIBOR rates during 2010, which is the basis for interest paid on the trust preferred debt. See Note 12 of the notes to the consolidated financial statements in Item 8 of Part II of this report for details on our debt.
Income tax expense was $8.9 million for 2010, compared with $4.3 million for 2009. See Note 10 of the notes to the consolidated financial statements in Item 8 of Part II of this report for an analysis of income tax expense between periods.
Equity in net loss of partnerships, net of tax was $0.02 million for 2010, compared with equity in net earnings of partnerships, net of tax of $5.3 million for 2009, a decrease of $5.3 million. The income in 2009 was due to the performances of limited partnership investments which invest mainly in high yield bonds and corporate loans. All but the remaining value of $1.1 million of the partnership interests that generated income in 2009 was redeemed as of December 31, 2009. The Company’s remaining interest of $1.1 million was liquidated in February, 2011.
Global Indemnity is a holding company. Its principal asset is its ownership of the shares of its direct and indirect insurance subsidiaries, including United National Insurance Company, Diamond State Insurance Company, United National Specialty Insurance Company, United National Casualty Insurance Company, Wind River Reinsurance, Penn-America Insurance Company, Penn-Star Insurance Company, and Penn-Patriot Insurance Company.
The principal source of cash that Global Indemnity needs to meet its short term and long term liquidity needs, including the payment of corporate expenses, includes dividends and other permitted disbursements from its direct and indirect subsidiaries and reimbursement for equity awards granted to employees. The principal sources of funds at these direct and indirect subsidiaries include underwriting operations, investment income, and proceeds from sales and redemptions of investments. Funds are used principally by these operating subsidiaries to pay claims and operating expenses, to make debt payments, to purchase investments, and to make dividend payments. The future liquidity of Global Indemnity is dependent on the ability of its subsidiaries to pay dividends. Currently, Global Indemnity has no planned capital expenditures that could have a material impact on its short-term or long-term liquidity needs.
The U.S. Insurance Companies are restricted by statute as to the amount of dividends that they may pay without the prior approval of regulatory authorities. The dividend limitations imposed by the state laws are based on the statutory financial results of each company within our Insurance Operations that are determined by using statutory accounting practices that differ in various respects from accounting principles used in financial statements prepared in conformity with GAAP. See “Regulation-Statutory Accounting Principles.” Key differences relate to among other items, deferred acquisition costs, limitations on deferred income taxes, reserve calculation assumptions and surplus notes.
Under Indiana law, Diamond State Insurance Company and United National Casualty Insurance Company may not pay any dividend or make any distribution of cash or other property, the fair market value of which, together with that of any other dividends or distributions made within the 12 consecutive months ending on the date on which the proposed dividend or distribution is scheduled to be made, exceeds the greater of (1) 10% of its surplus as of the 31st day of December of the last preceding year, or (2) its net income for the 12 month period ending on the 31st day of December of the last preceding year, unless the commissioner approves the proposed payment or fails to disapprove such payment within 30 days after receiving notice of such payment. An additional limitation is that Indiana does not permit a domestic insurer to declare or pay a dividend except out of earned surplus unless otherwise approved by the commissioner before the dividend is paid. See Note 19 of the notes to consolidated financial statements in Item 8 of Part II of this report for the dividends declared and paid by the U.S. Insurance Subsidiaries in 2011.
See Note 19 of the notes to consolidated financial statements in Item 8 of Part II of this report for the dividends declared and paid by the U.S. Insurance Companies in 2011 and the maximum amount of distributions that they could pay as dividends in 2012.
Wind River Reinsurance is prohibited, without the approval of the BMA, from reducing by 15% or more its total statutory capital as set out in its previous year’s statutory financial statements, and any application for such approval must include such information as the BMA may require. Based upon the total statutory capital plus the statutory surplus as set out in its 2011 statutory financial statements that will be filed in 2012, we believe Wind River Reinsurance could pay a dividend of up to $192.6 million without requesting BMA approval.
Our U.S. Insurance Companies are required by law to maintain a certain minimum level of policyholders’ surplus on a statutory basis. Policyholders’ surplus is calculated by subtracting total liabilities from total assets. The NAIC adopted risk-based capital standards that are designed to identify property and casualty insurers that may be inadequately capitalized based on the inherent risks of each insurer’s assets and liabilities and mix of net premiums written. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action. Based on the standards currently adopted, the policyholders’ surplus of each of our U.S. Insurance Companies is in excess of the prescribed minimum company action level risk-based capital requirements.
In 2010, the increase in operating cash flows of approximately $51.6 million from the prior year was primarily a net result of the following items:
The U.S. Insurance Companies participate in quota share reinsurance agreements with Wind River Reinsurance. The U.S. Insurance Companies have agreed to cede 50% of their net unearned premiums as of December 31, 2006, plus 50% of the net retained insurance liability of all new and renewal business bound on or after January 1, 2007 to Wind River Reinsurance. Wind River Reinsurance is an unauthorized reinsurer. As a result, any losses and unearned premium that are ceded to Wind River Reinsurance by the U.S. Insurance Companies must be collateralized. To satisfy this requirement, Wind River Reinsurance has set up custodial trust accounts on behalf of the U.S. Insurance Companies.
Wind River Reinsurance has established independent reinsurance trust accounts for the benefit of each of the U.S. Insurance Companies. Wind River also has established trust accounts to collateralize exposure it has to third party ceding companies. We invest the funds in securities that have durations that closely match the expected duration of the liabilities assumed. We believe that Wind River Reinsurance will have sufficient liquidity to pay claims prospectively.
In 2012, we expect that, in the aggregate, our Insurance Operations and Reinsurance Operations will have sufficient liquidity to pay claims. We monitor our portfolios to assure liability and investment durations are closely matched.
In July 2005, we sold $90.0 million of guaranteed senior notes, due July 20, 2015. These senior notes have an interest rate of 6.22%, payable semi-annually. In accordance with the agreement, on July 20, 2011, we prepaid $18.0 million of the principal amount of the guaranteed senior notes. As of December 31, 2011, we owe $72.0 million under these agreements. On July 20, 2012 and on each anniversary thereafter to and including July 20, 2014, we are required to prepay $18.0 million of the principal amount. On July 20, 2015, we are required to pay any remaining outstanding principal amount on the notes. We are dependent on dividends received from our Insurance Operations to fund this debt service. The notes are guaranteed by Global Indemnity (Cayman) Ltd. In the event that debt service obligations were not satisfied, Global Indemnity Group would be precluded from paying dividends to U.A.I. (Luxembourg) Investment S.à.r.l., its parent company.
On January 18, 2006, U.A.I. (Luxembourg) Investment S.à.r.l. loaned $6.0 million to United America Indemnity, Ltd. The loan has been used to pay operating expenses that arise in the normal course of business. The loan is a demand loan and bears interest at 4.38%. At December 31, 2011, there was $1.6 million of accrued interest on the loan. United America Indemnity, Ltd. is dependent on its subsidiaries to pay its dividends and operating expenses.
AIS owes $30.9 million to affiliated parties in junior subordinated debentures which are due in 2033. Interest is payable quarterly. See Note 12 of the notes to consolidated financial statements in Item 8 of Part II of this report for the terms of these notes. In the event that debt service obligations were not satisfied, AIS would be precluded from paying dividends to Global Indemnity Group, its parent company.
The proceeds from the above offerings were used to purchase junior subordinated interest notes and to support business growth in the insurance subsidiaries and general business needs.
Distributions on the above securities can be deferred up to five years, but in the event of such deferral, we may not declare or pay cash dividends on the common stock of the applicable subsidiary.
We are party to a management agreement with Fox Paine & Company, LLC, whereby in connection with certain management services provided to us by Fox Paine & Company, LLC, Global Indemnity (Cayman), Ltd. agreed to pay an annual management fee of $1.5 million to Fox Paine & Company, LLC.
(1) We lease office space and equipment as part of our normal operations. The amounts shown above represent future commitments under such operating leases, net of expected sub-lease income from abandoned space. As part of our Profit Enhancement Initiative, we incurred charges in 2011 and 2010 resulting from future minimum lease commitments related to unused space. Cash payment on leases related to unused space will be paid in future periods and are included in this table.
The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are set forth in “Risk Factors” in Item 1A and elsewhere in this Annual Report on Form 10-K. Our forward-looking statements speak only as of the date of this report or as of the date they were made. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.
(1) In computing the basic and diluted weighted share counts the number of shares outstanding prior to May 5, 2009 (the date that the ordinary stock was issued in conjunction with the Stockholders’ Rights Offering) was adjusted by a factor of 1.114 to reflect the impact of a bonus element associated with the Stockholders’ Rights Offering in accordance with GAAP.
(2) Shares outstanding and per share amounts for 2009 have been retrospectively restated to reflect the 1-for-2 stock exchange effective July 2, 2010 when the Company completed its re-domestication to Ireland.
Share amounts prior to July 2, 2010 have been retrospectively restated to reflect the 1-for-2 stock exchange when the Company completed its re-domestication to Ireland.
Global Indemnity plc (“Global Indemnity” or “the Company”) was incorporated on March 9, 2010 and is domiciled in Ireland. Global Indemnity replaced the Company’s predecessor; United America Indemnity, Ltd., as the ultimate parent company as a result of a re-domestication transaction. See Note 3 below for details regarding the re-domestication. United America Indemnity, Ltd. was incorporated on August 26, 2003, and is domiciled in the Cayman Islands. United America Indemnity, Ltd. is now a subsidiary of the Company and an Irish tax resident. The Company’s Class A ordinary shares are publicly traded on the NASDAQ Global Select Market. On July 6, 2010, the Company changed its trading symbol on the NASDAQ Global Select Market from “INDM” to “GBLI.”
On January 24, 2005, the Company’s predecessor changed its name from United National Group, Ltd. to United America Indemnity, Ltd. On March 14, 2005, the Company changed its trading symbol on the NASDAQ Global Select Market from “UNGL” to “INDM.”
The Company offers property and casualty insurance products in the excess and surplus lines marketplace through its Insurance Operations and provides third party treaty reinsurance for writers of excess and surplus and specialty lines of property and casualty insurance through its Reinsurance Operations. The Company manages its Insurance Operations by differentiating them into three product classifications: Penn-America, which markets to small commercial businesses through a select network of wholesale general agents with specific binding authority; United National, which markets insurance products for targeted insured segments, including specialty products, such as property, general liability, and professional lines through program administrators with specific binding authority; and Diamond State, which markets property, casualty, and professional lines products, which are developed by the Company’s underwriting department by individuals with expertise in those lines of business, through wholesale brokers and also markets through program administrators having specific binding authority. These product classifications comprise our Insurance Operations business segment and are not considered individual business segments because each product has similar economic characteristics, distribution, and coverage. Collectively, the Company’s U.S. insurance subsidiaries are licensed in all 50 states and the District of Columbia. The Company’s Reinsurance Operations consist solely of the operations of its Bermuda-based wholly-owned subsidiary, Wind River Reinsurance. Wind River Reinsurance provides reinsurance solutions through brokers, primary writers, including regional insurance companies, and program managers. Wind River Reinsurance also participates as a retrocessionaire on business assumed by other reinsurers.
The Company’s wholly-owned business trust subsidiaries, United National Group Capital Trust I (“UNG Trust I”), United National Group Capital Statutory Trust II (“UNG Trust II”), are not consolidated pursuant to the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (the “Codification”). The Company’s business trust subsidiaries have issued $30.0 million in floating rate capital securities (“Trust Preferred Securities”) and $0.9 million of floating rate common securities. The sole assets of the Company’s
The Company recognizes a premium deficiency if the sum of expected loss and loss adjustment expenses and unamortized acquisition costs exceeds related unearned premium and anticipated investment income. Any future expected loss on the related unearned premium is recorded first by impairing the unamortized acquisition costs on the related unearned premium followed by an increase to loss and loss adjustment expense reserves on additional expected loss in excess of unamortized acquisition costs.
On November 2, 2010, we committed to a Profit Enhancement Initiative with respect to our Insurance Operations. The plan was initiated on November 4, 2010, and is part of our efforts to streamline our operations in response to the continuing impact of the domestic recession as well as the competitive landscape within the excess and surplus lines market. This initiative is intended to enhance profitability and earnings by aligning corporate overhead costs with changes in our business. In the fourth quarter of 2010, the Company reduced its U.S. based census by approximately 25%, closed underperforming U.S. facilities, and supplemented staffing in Bermuda and in Ireland. All action items relating to this initiative were implemented by December 31, 2010.
The total cost of implementing this initiative was recorded in our consolidated statements of operations within our Insurance Operations segment in the fourth quarter of 2010. Components of the initiative included: (1) employee termination and severance charges of $1.71 million; (2) expenses of $1.53 million relating to discontinuing use of leased office space, net of expected sub-lease income; (3) restructuring expenses of $0.63 million for related asset and leasehold improvement impairments; and (4) expenses of $2.91 million relating to the curtailment of our workers’ compensation product initiative, consisting of a minimum ceded premium charge of $1.48 million on our workers’ compensation reinsurance treaty and $1.43 million in asset impairments.
In December of 2011 we incurred additional costs related to streamlining our operations in response to the continued competitive landscape within the excess and surplus lines market. These charges were recorded within our consolidated statement of operations in the fourth quarter of 2011 and impacted both our United States based Insurance Operations as well as our Bermuda based Reinsurance Operations. All action items related to the reorganization were implemented by December 31, 2011.
Components of the reorganization included (1) employee termination and severance charges of $0.79 million; (2) charges of $0.84 million related to discontinuing use of leased office space, net of expected sub-lease income; and (3) fixed asset and leasehold improvement impairments of $1.17 million. Of the $2.79 million in additional charges incurred, $2.03 million were recorded within our Insurance Operations segment and $0.76 million were recorded within our Reinsurance Operations segment.
The following table summarizes charges incurred by expense type and the remaining liability as of December 31, 2011 and 2010:
The following table summarizes the charges incurred within our consolidated statement of operations for the years ended December 31, 2011 and 2010:
As of December 31, 2011 and 2010, the Company did not hold any convertible bonds or convertible preferred stock. As of December 31, 2009, the Company held $0.6 million of convertible preferred stock. The change in the difference between the amortized cost and the market value of the convertible portfolio is included in income as a component of net realized investments gains (losses). The Company realized $0.003 million and $5.4 million in realized gains for the years ended December 31, 2010 and 2009, respectively, due to market value changes related to convertible securities.
The Company’s investments in other invested assets are comprised of limited liability partnership interests. Partnership interests where we owned more than 3% at any time are carried at their fair value. The change in the difference between amortized cost and fair value of partnership interests of 3% ownership or greater, net of the effect of deferred income taxes, is reflected in income. Partnership interests of less than 3% ownership are carried at their fair value. The change in the difference between amortized cost and the fair value of the partnership interests of less than 3% ownership, net of the effect of deferred income taxes, is reflected in accumulated other comprehensive income in shareholders’ equity and, accordingly, has no effect on net income other than for impairments deemed to be other than temporary.
The Company’s investments in other invested assets were valued at $6.6 million and $5.4 million as of December 31, 2011 and 2010, respectively. All of these amounts were comprised of securities for which there is no readily available independent market price. The estimated fair value of these limited partnerships is measured utilizing the Company’s net asset value as a practical expedient for each limited partnership. Material assumptions and factors utilized in pricing these securities include future cash flows, constant default rates, recovery rates, and any market clearing activity that may have occurred since the prior month-end pricing period.
For an analysis of other than temporary losses that were recorded for the years ended December 31, 2011, 2010, and 2009, please see Note 6 below.
The Company tests for impairment of goodwill at least annually and more frequently as circumstances warrant in accordance with applicable accounting guidance. Impairment of goodwill is recognized only if the carrying amount of the business unit, including goodwill, exceeds the fair value of the reporting unit. The amount of the impairment loss would be equal to the excess carrying value of the goodwill over the implied fair value of the reporting unit goodwill. Based on the analysis performed in 2011, there was no impairment of goodwill as of December 31, 2011.
The Company regularly reviews the collectability of reinsurance receivables. Any changes in the allowances resulting from this review are included in income during the period in which the determination is made. During 2011, the Company decreased its uncollectible reinsurance reserve by $2.7 million due to write-offs of receivables deemed to be uncollectible and a decrease in the amount of carried reinsurance receivables. During 2010, the Company decreased its uncollectible reinsurance reserve by $0.2 million due to a decrease in the amount of carried reinsurance receivables.
In accordance with the applicable accounting guidance that establishes standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity, the Company’s junior subordinated debentures are classified as a liability on the balance sheets and the related distributions are recorded as interest expense in the Statements of Operations.
Certain professional general agencies of the Insurance Operations are paid special incentives, referred to as commissions, when results of business produced by these agencies are more favorable than predetermined thresholds. Similarly, in some circumstances, insurance companies that cede business to the Company’s Reinsurance Operations are paid ceding or profit commissions based on the profitability of the ceded portfolio. These commissions are charged to other underwriting expenses when incurred. The liability for the unpaid portion of these commissions, which is stated separately on the face of the consolidated balance sheet as contingent commissions, was $7.5 million and $9.3 million as of December 31, 2011 and 2010, respectively.
Basic earnings per share have been calculated by dividing net income available to common shareholders by the weighted-average ordinary shares outstanding. Diluted earnings per share has been calculated by dividing net income available to common shareholders by the sum of the weighted-average ordinary shares outstanding and the weighted-average common share equivalents outstanding, which include options, warrants, and other equity awards. See Note 18 for details.
The amortized cost and estimated fair value of investments were as follows as of December 31, 2011 and 2010:
(1) Fixed maturities in a gross unrealized loss position for twelve months or longer is primarily comprised of non-credit losses on investment grade securities where management does not intend to sell, and it is more likely than not that the Company will not be forced to sell the security before recovery. The Company has analyzed these securities and has determined that they are not impaired.
(2) Fixed maturities in a gross unrealized loss position for twelve months or longer is primarily comprised of non-credit losses on investment grade securities where management does not intend to sell, and it is more likely than not that the Company will not be forced to sell the security before recovery. The Company has analyzed these securities and has determined that they are not impaired.
Mortgage-backed securities-As of December 31, 2011, gross unrealized losses related to mortgage-backed securities were $0.2 million. Of this amount, $0.02 million has been in an unrealized loss position for twelve months or greater and are rated AA+ or better. The Company’s investment manager models each mortgage-backed security to project principal losses under downside, base, and upside scenarios for the economy and home prices. The primary assumption that drives the security and loan level modeling is the Home Price Index (“HPI”) projection. The Company’s investment manager first projects HPI at the national level, then at the zip-code level based on the historical relationship between the individual zip code HPI and the national HPI, using inputs from its macroeconomic team, mortgage portfolio management team, and structured analyst team. The model utilizes loan level data and borrower characteristics including FICO score, geographic location, original and current loan size, loan age, mortgage rate and type (fixed rate / interest-only / adjustable rate mortgage), issuer / originator, residential type (owner occupied / investor property), dwelling type (single family / multi-family), loan purpose, level of documentation, and delinquency status as inputs. The model also includes the explicit treatment of silent second liens, utilization of loan modification history, and the application of roll rate adjustments.
Asset backed securities (“ABS”)-As of December 31, 2011, gross unrealized losses related to asset backed securities were $0.06 million. Of this amount, $0.03 million has been in an unrealized loss position for twelve months or greater and are rated A- or better. The weighted average credit enhancement for the Company’s asset backed portfolio is 28.9. The Company’s investment manager analyzes every ABS transaction on a stand-alone basis. This analysis involves a thorough review of the collateral, prepayment, and structural risk in each transaction. Additionally, their analysis includes an in-depth credit analysis of the originator and servicer of the collateral. The Company’s investment manager projects an expected loss for a deal given a set of assumptions specific to the asset type. These assumptions are used to calculate at what level of losses that the deal will incur a dollar of loss. The major assumptions used to calculate this ratio are loss severities, recovery lags, and no advances on principal and interest.
operates, issuer’s current competitive position, vulnerability to changes in the competitive environment, regulatory environment, issuer liquidity, issuer commitment to bondholders, issuer creditworthiness, and asset protection. Part of the process also includes running downside scenarios to evaluate the expected likelihood of default as well as potential losses in the event of default.
Foreign bonds-As of December 31, 2011, gross unrealized losses related to foreign bonds were $0.1 million. All unrealized losses have been in an unrealized loss position for less than twelve months. These securities are rated investment grade. The Company’s investment manager maintains financial models for the Company’s bond issuers. These models include a projection of each issuer’s future financial performance including prospective debt servicing capabilities and capital structure composition. The analysis incorporates the macroeconomic environment, industry conditions in which the issuer operates, issuer’s current competitive position, vulnerability to changes in the competitive environment, regulatory environment, issuer liquidity, issuer commitment to bondholders, issuer creditworthiness, and asset protection.
The Company recorded the following other than temporary impairments (“OTTI”) on its investment portfolio for the years ended December 31, 2011, 2010, and 2009:
The following table is an analysis of the credit losses recognized in earnings on debt securities held by the Company as of December 31, 2011 for which a portion of the OTTI loss was recognized in other comprehensive income (loss).
The following table is an analysis of the credit losses recognized in earnings on debt securities held by the Company as of December 31, 2010 for which a portion of the OTTI loss was recognized in other comprehensive income (loss).
The following table is an analysis of the credit losses recognized in earnings on debt securities held by the Company as of December 31, 2009 for which a portion of the OTTI loss was recognized in other comprehensive income (loss).
The components of net realized investment gains (losses) on the sale of investments and other than temporary impairment losses for the years ended December 31, 2011, 2010, and 2009 were as follows:
The proceeds from sales of available for sale securities resulting in net realized investment gains (losses) for the years ended December 31, 2011, 2010, and 2009 were as follows:
The sources of net investment income for the years ended December 31, 2011, 2010, and 2009 were as follows:
(1) Average of total cash and invested assets, including receivable (payable) for securities, as of the beginning and ending of the period.
A summary of the Company’s insurance enhanced municipal bonds that are backed by financial guarantors, including the pre-refunded bonds that are escrowed in U.S. government obligations, as of December 31, 2011, is as follows:
The Company had no direct investments in the entities that have provided financial guarantees or other credit support to any security held by the Company at December 31, 2011.
The Company elected to apply the fair value option within its limited partnership investment portfolio to an investment where the Company previously owned more than a 3% interest. The fair value of this investment was $1.1 million as of December 31, 2010. In February, 2011, the Company liquidated its remaining interest in this limited partnership.
During 2009, the Company contributed $30.0 million to a limited partnership which invests in corporate loans. This partnership interest was redeemed as of December 31, 2009. The activity associated with this investment is classified as Level 3 within the fair value hierarchy. The Company obtained the value of this partnership at the end of each reporting period; however, the Company was not provided with a detailed listing of the investments held by the partnership. Accordingly, this investment was classified as Level 3 within the fair value hierarchy.
During the years ended December 31, 2011, 2010, and 2009, the Company recognized the following gains (losses), net of taxes, due to changes in the value of these investments.
The following table presents information about the Company’s invested assets measured at fair value on a recurring basis as of December 31, 2011 and 2010, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.
The following table presents changes in Level 3 investments measured at fair value on a recurring basis for 2011:
The investment classified as Level 3 in the above table consist of $6.6 million related to an investment in a limited partnership for which there is no readily available independent market price. The estimated fair value of this limited partnership is measured utilizing the Company’s net asset value as a practical expedient for the limited partnership. Material assumptions and factors utilized in pricing this investment include future cash flows, constant default rates, recovery rates, and any market clearing activity that may have occurred since the previous pricing period.
the Company’s net asset value as a practical expedient for each limited partnership. Material assumptions and factors utilized in pricing these securities include future cash flows, constant default rates, recovery rates, and any market clearing activity that may have occurred since the previous pricing period. Of the investments in limited partnerships, $1.1 million was related to a limited partnership which holds convertible preferred securities of a privately held company. These securities were subject to an appraisal action in Delaware State Court. In February, 2011, the Company’s remaining interest of $1.1 million was liquidated.
Included in “Other invested assets” in the fair value hierarchy at December 31, 2011 and 2010 are limited liability partnerships measured at fair value. The following table provides the fair value and future funding commitments related to these investments at December 31, 2011 and 2010.
(3) This limited partnership is a registered mutual fund which invests in a portfolio of high yield convertible securities issued by companies with small to medium market capitalizations and lower credit ratings (generally below investment grade). In accordance with the partnership agreement, the Company has exercised its right to submit a capital withdrawal request effective December 31, 2009. As of December 31, 2010, the Company was unable to redeem a portion of its ownership interest in this limited partnership with a fair market value of $1.1 million. This is related to convertible preferred securities of one company which were subject to an Appraisal Action in Delaware Court. In February, 2011, the Company’s remaining interest of $1.1 million was liquidated.
The Company’s pricing vendors provide prices for all investment categories except for investments in limited partnerships. One vendor provides prices for equity securities and select fixed maturity categories including: corporate loans, commercial mortgage backed securities, high yield, investment grade, short term securities, and international fixed income securities, if any. A second vendor provides prices for other fixed maturity categories
including: asset backed securities (“ABS”), collateralized mortgage obligations (“CMO”), and municipals. A third vendor provides prices for the remaining fixed maturity categories including mortgage backed securities (“MBS”) and treasuries.
Corporate bonds are individually evaluated on a nominal spread, discount margin, or an option adjusted spread basis depending on how the market trades a security or sector. Spreads are updated each day and compared with those from the broker/dealer community and contributing firms. Issues are generally benchmarked off of the U.S. treasuries or LIBOR.
For municipals, a series of matrices are used to evaluate securities within this asset class. The evaluated pricing models for this asset class incorporate security set-up, sector curves, yield to worst, ratings updates, and adjustments for material events notices.
For MBSs, the pricing vendor utilizes a matrix model correlation to TBA (a forward MBS trade) or benchmarking to value a security.
Corporate loans are priced using averages of bids and offers obtained from the broker/dealer community involved in trading such loans.
During 2011 or 2010, the Company did not adjust quotes or prices obtained from the pricing vendors.
In April 2010, the Company recorded goodwill of $4.8 million and intangible assets of $10.2 million as a result of an acquisition in exchange for $15.0 million in cash. The acquisition was recorded in our Insurance Operations as a business combination using the purchase method of accounting in accordance with applicable accounting guidance. The intangible assets were comprised of trademarks, customer relationships, and non-compete agreements. The trademarks have been determined to have an indefinite life and therefore are not be subject to amortization. The customer relationships and non-compete agreements have been determined to have definite lives and are therefore being amortized over their estimated useful lives. The customer relationships are being amortized over fifteen years, and the non-compete agreements are being amortized over two years.
Amortization related to our definite lived intangible assets was $0.4 million, $0.3 million and $0.07 million for the years ended December 31, 2011, 2010 and 2009, respectively.
We expect that amortization expense for the next five years will be as follows:
Property Per Risk Excess of Loss-Effective January 1, 2012, the Company renewed its property per risk excess of loss treaty which provides coverage of $13.0 million per risk in excess of $2.0 million per risk. This replaces the treaty that expired December 31, 2011, which provided identical coverage. The renewal treaty provides coverage in two layers: $3.0 million per risk in excess of $2.0 million per risk, and $10.0 million per risk in excess of $5.0 million per risk. The first layer is split into two sections, each subject to a $3.0 million limit of liability for all risks involved in one loss occurrence, and the second layer is subject to a $10.0 million limit for all risks involved in one loss occurrence.
Professional Liability Excess of Loss-Effective April 30, 2011, the Company’s professional liability excess of loss treaty was terminated. This treaty provided coverage of $4.0 million per policy/occurrence in excess of $1.0 million per policy/occurrence. Effective May 1, 2011, the professional liability exposure was added to the casualty excess of loss treaty.
Casualty Clash Excess of Loss-Effective January 1, 2011, the Company renewed its casualty clash excess of loss treaty which provides coverage of $10.0 million per occurrence in excess of $3.0 million per occurrence, subject to a $20.0 million limit for all loss occurrences. This replaces the treaty that expired December 31, 2010, which provided identical coverage. In December, 2011, this treaty was extended by four months to May 1, 2012 on a pro rata basis.
As of December 31, 2011, the Company had aggregate unsecured reinsurance receivables that exceeded 3% of shareholders’ equity from the following reinsurer. Unsecured reinsurance receivables include amounts receivable for paid and unpaid losses and loss adjustment expenses and prepaid reinsurance premiums, less amounts secured by collateral.
The statutory income tax rates of the countries where the Company does business are 35.0% in the United States, 0.0% in Bermuda, 0.0% in the Cayman Islands, 0.0% in Gibraltar, 28.8% in the Duchy of Luxembourg, and 25.0% on non-trading income and 12.5% on trading income in the Republic of Ireland. The statutory income tax rate of each country is applied against the annual taxable income of each country to calculate the annual income tax expense.
The Company’s income before income taxes from the Non-U.S. Subsidiaries and U.S. Subsidiaries, including the results of the quota share agreement between Wind River Reinsurance and the Insurance Operations, for the years ended December 31, 2011, 2010, and 2009 were as follows:
The effective income tax rate for 2011 was (5.6%), compared with an effective income tax rate of 9.5% for 2010 and 5.8% for 2009. For 2011 and 2010, the effective rate differed from the weighted average expected income tax expense rate primarily due to investments in tax-exempt securities. For 2009, the effective rate differed from the weighted average expected income tax expense rate primarily due to investments in tax-exempt securities and the decrease in prior years’ tax contingencies due to lapses on the statute of limitations.
Management believes it is more likely than not that the deferred tax assets will be completely utilized in future years. As a result, there is no valuation allowance at December 31, 2011 and 2010.
If recognized, the gross unrecognized tax benefits could lower the effective income tax rate in any future period. The provision for gross unrecognized tax benefits decreased $0.4 million during 2011 due to the expiration of the IRS statute of limitations on the Company’s 2007 federal income tax return.
Auto Liability: The increase in the automobile liability lines was primarily due to increases of $3.1 million related to accident year 2010 resulting from further unexpected development on non-standard auto treaties in our Reinsurance Operations which were not renewed in 2011. We also had increases of $1.8 million primarily related to accident year 2010 in our Insurance Operations due to higher than expected severity.
Workers’ Compensation: The increase in our workers’ compensation lines is related to a structured excess of loss treaty active in accident years 2009 and 2010 at our Reinsurance Operations and is the result of expected losses recorded on adjustment premiums recorded in 2011.
General Liability: The $2.9 million reduction primarily consisted of net reductions of $25.5 million in our Insurance Operations in accident years 2008 and prior due to continued favorable emergence. Incurred losses for these years have developed at a rate lower than the Company’s historical averages. We also decreased our reinsurance allowance in our Insurance Operations by $1.3 million in this line due to changes in our reinsurance exposure on specifically identified claims and general decreases in ceded reserves. Offsetting these decreases were increases of $13.9 million in our Insurance Operations in accident years 2009 and 2010 primarily driven by loss emergence as well as revised exposure estimates for construction defect liability. Increased estimates for construction defect were primarily the result of a methodology change during the year, with some increases in recent years due to a slight increase in claim frequency in one of our review segments. We are addressing profitability concerns by exiting certain classes of business within this line. These net reductions were offset by an increase of $8.7 million in our Reinsurance Operations primarily related to accident years 2009 and 2010 due to loss emergence that was greater than expected.
Umbrella: The $1.7 million reduction in the umbrella lines related to all accident years 2010 and prior in our Insurance Operations primarily due to continued favorable emergence. Umbrella coverage typically attaches to other coverage lines, so these net decreases follow the decreases in general liability above.
The reduction in the allowance for uncollectible reinsurance is due to write-offs of receivables deemed to be uncollectible and a decrease in the amount of carried reinsurance receivables.
During 2010, the Company reduced its prior accident year loss reserves by $53.9 million and reduced its allowance for uncollectible reinsurance by $0.2 million, which primarily consisted of a $43.7 million reduction in general liability lines, a $5.4 million reduction in umbrella lines, a $4.8 million reduction in professional liability lines, and a $2.5 million reduction in property lines, partially offset by a $2.0 million increase in auto liability lines and a $0.7 million increase in workers’ compensation lines:
Prior to 2001, the Company underwrote multi-peril business insuring general contractors, developers, and sub-contractors primarily involved in residential construction that has resulted in significant exposure to construction defect (“CD”) claims. The Company’s reserves for CD claims ($68.8 million and $50.8 million as of December 31, 2011 and 2010, net of reinsurance, respectively) are established based upon management’s best estimate in consideration of known facts, existing case law and generally accepted actuarial methodologies. However, due to the inherent uncertainty concerning this type of business, the ultimate exposure for these claims may vary significantly from the amounts currently recorded.
Debt consisted of the following as of December 31, 2011 and 2010:
Loans payable of $0.1 million and $0.4 million as of December 31, 2011 and 2010 was comprised of a loan payable to a former minority shareholder. This loan is due to be retired in 2012. Interest expense related to loans payable was $0.01 million, $0.02 million, and $0.03 million for 2011, 2010, and 2009, respectively.
The Rights Offering included an agreement with Fox Paine & Company and an investment entity referred to as the “Backstop Purchaser,” which is controlled by Fox Paine & Company. The Backstop Purchaser agreed, subject to certain conditions, to purchase all of the Class A and Class B ordinary shares offered in the Rights Offering and not subscribed for pursuant to the Rights Offering. The Company entered into the agreement to ensure that, subject to the conditions of the agreement, all Class A ordinary shares and Class B ordinary shares offered in the Rights Offering were either distributed in the Rights Offering or purchased subsequent to the Rights Offering at the same purchase price at which the rights were exercisable. Through this arrangement, the Company had a high degree of certainty that it would raise gross proceeds of $100.0 million through the Rights Offering. In the agreement and subject to the successful completion of the Rights Offering, the Company agreed to pay Fox Paine & Company an arrangement fee of $2.0 million and a backstop fee equal to 5% of the aggregate gross proceeds raised in the Rights Offering, or $5.0 million, for total payments of $7.0 million. Payment of these fees was subject to the prior approval by the Company’s shareholders, which was obtained at the Annual General Shareholders’ meeting that was held on October 27, 2009. The fees were paid on October 27, 2009.
Post the Rights Offering and including the impact of the one-for-two stock exchange, Fox Paine & Company and affiliated entities own 3.8 million of the total 16.8 million outstanding Class A ordinary shares and all 12.1 million of the outstanding Class B ordinary shares. In total, Fox Paine & Company and affiliated entities now own 54.8% of all outstanding shares and beneficially own shares having approximately 90.5% of the Company’s total outstanding voting power.
On September 15, 2011, we announced that our Board of Directors authorized us to repurchase up to $100.0 million of our Class A ordinary shares through a share repurchase program. The timing and amount of the repurchase transactions, if any, under this program will depend upon market conditions as well as other factors. All shares repurchased under this program may be retired and are held as treasury stock and recorded at cost.
(4) Purchased as part of the repurchase authorization announced in September 2011.
The following table provides information with respect to the Class A ordinary shares that were surrendered or repurchased in 2010:
(2) Approximate dollar value of shares is as of the last date of the applicable month.
As a result of the Rights Offering, the Company agreed to pay Fox Paine & Company an arrangement fee of $2.0 million and a backstop fee equal to 5% of the aggregate gross proceeds raised in the Rights Offering, or $5.0 million, for total payments of $7.0 million. Since Fox Paine & Company is a related party, and all other shareholders were not offered these fees in the Rights Offering, the payment of the fees was subject to the prior approval of the Company’s shareholders, which was obtained at the Annual General Shareholders’ meeting that was held on October 27, 2009. The fees were paid on October 27, 2009. See Note 13 above for more details concerning the Rights Offering.
At December 31, 2011 and 2010, Wind River Reinsurance was a limited partner in the Fox Paine Capital Fund, II, which is managed by Fox Paine & Company. This investment was originally made by United National Insurance Company in June 2000 and pre-dates the September 5, 2003 acquisition by Fox Paine & Company of
Wind River Investment Corporation, the holding company for the Company’s Predecessor Insurance Operations. The Company’s investment in this limited partnership was valued at $6.6 million and $4.3 million at December 31, 2011 and 2010, respectively. At December 31, 2011, the Company had an unfunded capital commitment of $2.5 million to the partnership.
An annual management fee of $1.5 million was paid to Fox Paine & Company, LLC in 2011, 2010 and 2009 and was recognized ratably over those years. The Company relies on Fox Paine & Company, LLC to provide management services and other services related to the operations of the Company.
In connection with the Rights Offering, the Company entered into an agreement with Citigroup Global Markets, Inc. (“Citi”), wherein Citi agreed to be the Company’s exclusive capital markets structuring adviser to provide
During each of the years ended December 31, 2011 and 2010 the Company paid $0.2 million in brokerage fees to Frank Crystal & Company, an insurance broker. James W. Crystal, the chairman and chief executive officer of Frank Crystal & Company, became a member of the Company’s Board of Directors effective July 6, 2010.
The prescribed accounting guidance also requires tax benefits relating to excess stock-based compensation deductions to be prospectively presented in the statement of cash flows as financing cash inflows. Tax expense resulting from stock-based compensation deductions in excess of amounts reported for financial reporting purposes were $0.1 million, $0.2 million and $0.3 million for the years ended December 31, 2011, 2010, and 2009, respectively.
Option intrinsic values, which are the differences between the fair market value of $19.83 at December 31, 2011 and the strike price of the option, are as follows:
During 2010, the Company granted an aggregate of 47,610 Restricted Shares to key employees of the Company and an aggregate of 76,648 fully vested Director Restricted Shares, at a weighted average fair value of $16.34 per share, to non-employee directors of the Company under the Plan. In 2010, the Company granted 8,149 Restricted Shares to key employees and 18,529 fully vested Director Restricted Shares to non-employee directors of the Company out of shares previously forfeited. Included in the 47,610 are 10,000 Restricted Shares granted by the Company to key executives of the Company in exchange for signed employment agreements. Included in the 10,000 are 5,000 shares that were forfeited in 2010 and 5,000 shares that vest 33 1/3% on each subsequent anniversary date of the award for a period of three years.
On May 10, 2007, Larry A. Frakes was hired as the Company’s President and Chief Operating Officer, as well as Chief Executive Officer of all of the Company’s Affiliates. Mr. Frakes’ four-year employment agreement included several equity components including (a) the granting of $10.0 million of stock options, or 197,473 shares split evenly between time-based and performance-based options at the grant date market value of $50.64 per share; (b) an annual bonus program under which the first $0.5 million was to be paid in restricted stock based on the market value at December 31 of the subject Bonus Year; (c) the purchase of $1.0 million of the Company’s Class A ordinary shares by Mr. Frakes; and (d) the requirement that, effective January 1, 2009, Mr. Frakes hold Class A ordinary shares of the Company with a value of the lesser of two times his Annual Compensation or the sum of owned, granted, and vested Class A ordinary shares. The time-based options vested at 25% on each December 31 of years 2008 through 2010. The performance-based options generally vested at the same rate based on the achievement of various Company financial performance goals. The restricted stock portion of the 2008, 2009, and 2010 bonuses vested at 25% per year each year after the bonus year.
On February 5, 2008, the Company entered into an amended and restated employment agreement with Mr. Frakes, which amended and restated Mr. Frakes’ original employment agreement that was entered into on May 10, 2007. The amended and restated employment agreement changed and clarified the terms of options granted under the original employment agreement. The amended and restated agreement granted Mr. Frakes $10.0 million of options with a strike price equal to the average price per share that was paid by Mr. Frakes upon his purchase of $1.0 million of the Company’s Class A ordinary shares.
During 2011, Mr. Frakes announced his retirement effective December 31, 2011 and, in accordance with his employment agreement, forfeited 31,178 Time-Based Options and 124,709 Performance-Based Options.
The Company maintains a 401(k) defined contribution plan that covers all eligible U.S employees. Under this plan, the Company matches 100% of the first 6% contributed by an employee. Vesting on contributions made by the Company is immediate. Total expenses for the plan were $1.1 million, $1.6 million, and $1.4 million for the years ended December 31, 2011, 2010, and 2009, respectively.
Earnings (loss) per share have been computed using the weighted average number of ordinary shares and ordinary share equivalents outstanding during the period. With the exception of the Rights Offering discussion below, all share counts and corresponding per share market prices have been adjusted to reflect the one-for-two stock exchange of Global Indemnity plc shares for United America Indemnity, Ltd. shares as part of the re-domestication to Ireland. See Note 3 above for more information regarding the re-domestication. As detailed below, share counts for prior years have also been restated as a result of the Rights Offering that took place in 2009.
The Company issued non-transferable rights to stockholders of record on March 16, 2009. The rights entitled the holders to purchase 0.9013 shares of common stock for every right held. The Rights Offering expired on April 6, 2009. On May 5, 2009, the Company issued 17.2 million Class A ordinary shares and 11.4 million Class B ordinary shares at a subscription price of $3.50 per share in conjunction with the Rights Offering.
A reconciliation of weighted average shares for basic earnings per share to weighted average shares for diluted earnings per share for the years ended December 31, 2011, 2010, and 2009 is as follows:
The weighted average shares outstanding used to determine dilutive earnings per share for the years ended December 31, 2011, 2010 and 2009 do not include 551,732, 350,059 and 426,310 shares, respectively, which were deemed to be anti-dilutive.
The Company’s U.S. insurance subsidiaries are required by law to maintain certain minimum surplus on a statutory basis, and are subject to regulations under which payment of a dividend from statutory surplus is restricted and may require prior approval of regulatory authorities. Applying the current regulatory restrictions as of December 31, 2011, the maximum amount of distributions that could be paid for 2012 by the United National Insurance Companies and the Penn-America Insurance Companies as dividends under applicable laws and regulations without regulatory approval is approximately $31.9 and $18.0 million, respectively. The Penn-America Insurance Companies limitation includes $5.9 million that would be distributed to United National Insurance Company or its subsidiary Penn Independent Corporation based on the December 31, 2011 ownership percentages. For 2011, the United National Insurance Companies and Penn-America Insurance Companies declared and paid dividends of $35.4 million and $21.4 million, respectively.
Based on the standards currently adopted, the Company reported in its 2011 statutory filings that the capital and surplus of the U.S. Insurance Companies are above the prescribed Company Action Level RBC requirements.
The following is selected information for the Company’s U.S. Insurance Companies, net of intercompany eliminations, where applicable, as determined in accordance with SAP:
Of the Company’s non-affiliated professional wholesale general agents and program administrators, the top five accounted for 23.1% of our Insurance Operations’ gross premiums written for the year ended December 31, 2011. No one agency accounted for more than 9.6% of our Insurance Operations’ gross premiums written.
(3) Includes excise tax of $1,060 related to cessions from U.S. Insurance Companies to Wind River Reinsurance.
The Company paid the following net federal income taxes and cash interest for 2011, 2010, and 2009:
In October, 2010, the FASB issued new accounting guidance that modified the definition of costs that can be capitalized in the acquisition of new and renewal business for insurance companies. The guidance defines criteria for the capitalization of acquisition costs in a more specific manner than defined in previous guidance. The guidance is effective for calendar years beginning after December 15, 2011. We intend to adopt this guidance retrospectively on January 1, 2012. The amount of acquisition costs we will defer under the new guidance will be less than the amount deferred under our current accounting practice. The adoption of this guidance is expected to result in a reduction of equity in a range of approximately $3 to $4 million to be recorded in the first quarter of 2012.
In May, 2011, the FASB issued new accounting guidance which was intended to bring about further convergence of International Financial Reporting Standards (“IFRS”) and U.S. GAAP on the topic of fair value. The guidance clarifies wording to provide harmonization when compared to IFRS, provides additional guidance for the application of fair value measurement in practice, and updates disclosure requirements surrounding fair value. This guidance is effective for calendar years beginning after December 15, 2011. The adoption of this guidance is not expected to have a material impact on our consolidated financial position and results of operations.
An unaudited summary of the Company’s 2011 and 2010 quarterly performance is as follows: