In July 2003, we acquired new offices at 70 Gracechurch Street, London, which have become our London headquarters. The acquisition was made through a purchase, sale and leaseback transaction. The move to the new offices was completed in 2004 and consolidated our London businesses in one location. The capital lease asset and liability associated with this transaction totaled $98.5 million at December 31, 2012.
Total rent expense for the years ended December 31, 2012, 2011 and 2010 was $35.6 million, $32.9 million and $31.8 million, respectively. See Item 8, Note 17(d), “Commitments and Contingencies - Properties,” to the Consolidated Financial Statements included herein, for discussion of our lease commitments for real property.
In 2008, net loss from operating affiliates includes losses totaling approximately $1.4 billion related to the closing of the Master Agreement as well as losses recorded throughout 2008 and up until the closing of the Master Agreement that were associated with previous reinsurance and guarantee agreements with Syncora. In 2010, net income from operating affiliates included $50.2 million relating to sale of a majority of our shareholding in Primus Guaranty Ltd.
Preference dividends represent dividends on the Redeemable Series C preference ordinary shares and the Series D and E preference ordinary shares. Following our Redomestication, subsequent to July 1, 2010, the Redeemable Series C preference ordinary shares and the Series E preference ordinary shares represent non-controlling interests in our consolidated financial statements. For additional information see Item 8, Note 1, “General,” to the Consolidated Financial Statements.
Effective for the fiscal year beginning January 1, 2009 and for all interim periods within 2009, we adopted final authoritative guidance that addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing basic earnings per share (“EPS”) pursuant to the two-class method described in EPS guidance. A share-based payment award that contains a non-forfeitable right to receive cash when dividends are paid to ordinary shareholders irrespective of whether that award ultimately vests is considered a participating security as these rights to dividends provide a non-contingent transfer of value to the holder of the share-based payment award. Accordingly, these awards are included in the computation of basic EPS pursuant to the two-class method. Under the terms of our restricted stock awards, grantees are entitled to receive dividends on the unvested portions of their awards. There is no requirement to return these dividends in the event the unvested awards are forfeited in the future. Accordingly, this guidance had an impact on our EPS calculations. All prior period EPS data presented has been adjusted retrospectively to conform to the provisions of this guidance. The adoption of this guidance reduced basic loss per ordinary share for fiscal 2008 by $0.08 and reduced diluted loss per ordinary share for fiscal 2008.
The underwriting expense ratio related to the property and casualty operations is the sum of acquisition expenses and operating expenses for the Insurance and Reinsurance segments divided by net premiums earned for the Insurance and Reinsurance segments. See Item 8, Note 4, “Segment Information,” to the Consolidated Financial Statements included herein, for further information.
the potential effect of regulatory developments in the jurisdictions in which we operate, including those which could impact the financial markets or increase our business costs and required capital levels;
In both 2011 and 2012, the global insurance and reinsurance markets experienced significant losses from natural catastrophes. See “Significant Items Affecting Results of Operations-1) The impact of significant large loss events” below for a discussion of our loss estimates for the year ended December 31, 2012 from natural catastrophes.
In 2012, we continued to focus on strategic growth initiatives, building on the significant investments we have made in recent years to achieve greater efficiency from improved systems, to create a platform from which we can grow as markets allow and to expand our margins. The following outlines some of these growth initiatives as well as recent renewal activity and January 2013 rate indications for each of our Insurance and Reinsurance segments together with any potential trends relevant to our P&C operations.
The trading environment for the core lines of insurance business that we write remains competitive. However, the favorable pricing trends that we began seeing in late 2011 have continued throughout 2012. While we continue our disciplined underwriting approach to grow on a very selective basis and exit lines where margins are unacceptable, our retention ratios and new business development continue to remain strong as we move premium rates upward in nearly all of our businesses.
With regard to market conditions, within the Insurance segment’s core lines of business, fourth quarter and full year 2012 renewals reflected sustainable rate increases both in aggregate and across nearly all business lines. For the full year, we experienced positive pricing of over 3%, and in our North America P&C business unit the increase was more than 6%. Professional pricing was also positive for the year where there was material improvement in the U.S. D&O book where rate increases exceeded 5% during the fourth quarter and nearly 4% for the full the year. International P&C and Specialty also finished the year with positive rate increases in the low single digits, with a very strong fourth quarter for IPC, but a flat quarter for Specialty due to the competitive December airline renewals.
The following table presents an analysis of our net income (loss) attributable to ordinary shareholders and other financial measures (described below) for the years ended December 31, 2012, 2011 and 2010:
premiums earned for our insurance and reinsurance operations. A combined ratio of less than 100% indicates an underwriting profit and greater than 100% reflects an underwriting loss.
Our combined ratio of 107.5% for the year ended December 31, 2011 was higher than the 94.8% combined ratio in 2010, primarily as a result of an increase in the loss and loss expense ratio while the underwriting expense ratio was flat. The loss and loss expense ratio increased in 2011 as a result of higher levels of catastrophe losses and other large loss events in both the insurance and reinsurance segments. For further information on our combined ratio, see “Income Statement Analysis” below.
Net investment income related to P&C operations, which includes interest and dividend income together with the amortization of premium and discount on fixed maturities and short-term investments, net of related investment expenses, is an important measure that affects our overall profitability. Our largest liability relates to our unpaid loss reserves, and our investment portfolio provides liquidity for claims settlements of these reserves as they become due. As a result, a significant part of the investment portfolio is invested in fixed income securities. Net investment income is influenced by a number of factors, including the amounts and timing of inward and outward cash flows, the level of interest rates and credit spreads and changes in overall asset allocation. See the segment results at “Investment Activities” below for a discussion of our net investment income for the year ended December 31, 2012.
Operating net income per share is derived from the non-GAAP operating net income measure by dividing operating net income by the weighted average number of ordinary shares and ordinary share equivalents outstanding for each period.
ROE is another non-GAAP financial measure that we consider important in evaluating our operating performance and view as a key measure of return generated for ordinary shareholders. ROE is calculated by dividing the net income (loss) attributable to ordinary shareholders for any period by the average of the opening and closing ordinary shareholders’ equity. We establish minimum target ROEs for our total operations, segments and lines of business. If our minimum ROE targets over the longer term are not met with respect to any line of business, we seek to modify and/or exit this line. In addition, among other
factors, compensation of our senior officers is dependent on the achievement of our performance goals to enhance ordinary shareholder value as measured by ROE (adjusted for certain items considered to be “non-operating” in nature).
In 2012, ROE was 6.5%, which was 11.5 percentage points higher than 2011 when it was negative 5.0%. In 2011, ROE was negative due to the net loss from the significant catastrophe losses and the impairment of goodwill and other large loss events which are discussed under “Significant Items Affecting the Results of Operations.”
Operating ROE is another non-GAAP financial measure that we consider important in evaluating our operating performance. Operating ROE is derived from the non-GAAP operating net income measure by dividing the operating net income for any period by the average of the opening and closing ordinary shareholders’ equity.
The decrease in 2011 was primarily due to the net loss attributable to ordinary shareholders of $474.8 million and the impact of the settlement of the forward purchase contracts associated with the 10.75% equity security units (the “10.75% Units”), which resulted in the issuance of an aggregate of 30,456,600 ordinary shares, partially offset by an increase in net unrealized gains on available for sale investments and the benefit of share buyback activity.
Fully diluted tangible book value per ordinary share is a non-GAAP financial measure and is calculated by dividing ordinary shareholders’ equity excluding intangible assets (as disclosed on the face of the balance sheet) by the number of outstanding ordinary shares at any period end combined with the impact from dilution of share-based compensation and certain conversion features where dilutive. Fully diluted tangible book value per ordinary share increased by $5.04 and $1.17 during the years ended December 31, 2012 and 2011, respectively, as a result of the factors noted above.
The following is a reconciliation of net income (loss) attributable to ordinary shareholders to operating net income (loss) and also includes the calculation of return on average ordinary shareholders’ equity (based on operating net income (loss)) for the years ended December 31, 2012, 2011 and 2010:
The following table outlines the underwriting losses and loss ratio impact for the Insurance and Reinsurance segments from natural catastrophes for the years ended December 31:
The following are analyses of the financial impact on our results of operations for the year ended December 31, 2012 from natural catastrophes:
In the year ended December 31, 2012, our results from operations were impacted by significant losses from large non-catastrophe loss events in both the Insurance and Reinsurance segments. In 2012, the impact was mainly related to a single large marine loss during the first quarter. Management’s loss estimate for this large marine loss at December 31, 2012, net of reinsurance recoveries and reinstatement premiums, was $58.5 million, of which $26.4 million was attributable to the Insurance segment and $32.1 million to the
See “Income Statement Analysis,” herein for further information regarding these large loss events within each applicable operating segment.
See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, Note 10, “Losses and Loss Expenses,” to the Consolidated Financial Statements included herein, for further information regarding the developments in prior year loss reserve estimates for each of the years indicated within each of our operating segments.
Net realized gains on investments in the year ended December 31, 2012 totaled $14.1 million, including $94.8 million from sales activities partially offset by net realized losses of approximately $80.7 million related to other-than-temporary declines in investment (“OTTI”) charges on certain of our fixed income investments. For further analysis of this, see “Results of Operations” below.
On February 27, 2012, we announced that the XL-Ireland Board of Directors approved the February 2012 Program, authorizing the purchase of up to $750 million of our ordinary shares. This authorization replaced the approximately $190 million remaining under the share buyback program that was authorized in November 2010. During 2012, we purchased and canceled 18.3 million ordinary shares under the February 2012 Program for $401.6 million. At December 31, 2012, $348.4 million remained available for purchase under this program. Between January 1 and February 22, 2013 we purchased and canceled an additional 3.8 million shares for $98.4 million. All share buybacks were carried out by way of redemption in accordance with Irish law and XL-Ireland’s constitutional documents. All shares so redeemed were canceled upon redemption. On February 22, 2013, we announced that the XL-Ireland Board of Directors approved a new share buyback program, authorizing the purchase of up to $850 million of our ordinary shares. This replaced the approximately $250 million remaining under the February 2012 Program.
Detailed analyses of aggregated in-force exposures and maximum loss levels are done periodically. The measurement dates represent the date of the last completed detailed analysis by geographical zone.
As we earn premiums for the underwriting risks we assume, we also establish an estimate of the expected ultimate losses related to the premium. Loss reserves for unpaid loss and loss expenses are established due to the significant periods of time that may elapse between the occurrence, reporting and settlement of a loss. The process of establishing reserves for unpaid property and casualty claims can be complex and is subject to considerable variability, as it requires the use of informed estimates and judgments. These estimates and judgments are based on numerous factors, and may be revised as additional experience and other data become available and are reviewed, as new or improved methodologies are developed or as current laws change. Loss reserves include:
With respect to our insurance operations, we are notified of insured losses and record a case reserve for the estimated amount of the settlement, if any. The estimate reflects the judgment of claims personnel based on general reserving practices, the experience and knowledge of such personnel regarding the nature of the specific claim and, where appropriate, advice of legal counsel. Reserves are also established to provide for the estimated expense of settling claims, including legal and other fees and the general expenses of administering the claims adjustment process. With respect to our reinsurance operations, case reserves for reported claims are generally established based on reports received from ceding companies. Additional case reserves may be established by us to reflect the estimated ultimate cost of a loss. The uncertainty in the reserving process for reinsurers is due, in part, to the time lags inherent in reporting from the original claimant to the primary insurer to the reinsurer. As a predominantly broker market reinsurer for both excess-of-loss and proportional contracts, we are subject to a potential additional time lag in the receipt of information as the primary insurer reports to the broker who in turn reports to us.
Since we rely on information regarding paid losses, case reserves and IBNR provided by ceding companies in order to assist us in estimating our liability for unpaid losses and LAE, we maintain certain procedures in order to help determine the completeness and accuracy of such information. Periodically, management assesses the reporting activities of our ceding companies on the basis of qualitative and quantitative criteria. In addition to conferring with ceding companies or brokers on claims matters, our claims personnel conduct periodic audits of specific claims and the overall claims procedures of our ceding companies at their offices. We rely on our ability to effectively monitor the claims handling and claims reserving practices of ceding companies in order to help establish the proper reinsurance premium for reinsurance agreements and to establish proper loss reserves. Disputes with ceding companies have been rare and generally have been resolved through negotiation.
While the reliance on loss reports from ceding companies may increase the level of uncertainty associated with the estimation of total loss reserves for property catastrophe reinsurance relative to direct property insurance, there are several factors which serve to reduce the uncertainty in loss reserve estimates for property catastrophe reinsurance. First, for large natural catastrophe events, aggregate limits in property catastrophe reinsurance contracts are generally fully exhausted by the loss reserve estimates. Second, as a reinsurer, we have access to information from a broad cross section of the insurance industry. We utilize such information in order to perform consistency checks on the data provided by ceding companies and are able to identify trends in loss reporting and settlement activity and incorporate such information in our estimate of IBNR reserves. Finally, we also supplement the loss information received from cedants with loss estimates developed by market share techniques and/or from third party catastrophe models applied to exposure data supplied by cedants.
method and frequency and severity approaches. IBNR related to a specific event may be based on our estimated exposure to an industry loss and may include the use of catastrophe modeling software. On a quarterly basis, IBNR reserves are reviewed by our actuaries, and are adjusted as new information becomes available. Any such adjustments are accounted for as changes in estimates and are reflected in the results of operations in the period in which they are made.
When estimating IBNR reserves, each of our insurance and reinsurance business units segregate business into exposure classes. Within each class, the business is further segregated by either the year in which the contract incepted (“underwriting year”), the year in which the claim occurred (“accident year”), or the year in which the claim is reported (“report year”). The majority of the Insurance segment is reviewed on an accident year basis. Professional lines insurance business is reviewed on a report year basis due to the claims made nature of the underlying policies. The majority of the Reinsurance segment is reviewed on an underwriting year basis. In each case we believe the selected method most accurately represents the economic condition of the business.
environment are considered, but involve considerable judgment. When estimating IBNR reserves, more judgment is typically required for lines of business with longer loss emergence patterns.
Reinsurance operations by their nature add further complications to the reserving process, particularly for casualty business written, in that there is an inherent lag in the timing and reporting of a loss event from an insured or ceding company to the reinsurer. This reporting lag creates an even longer period of time between the policy inception and when a claim is finally settled. As a result, more judgment is required to establish reserves for ultimate claims in our reinsurance operations.
In our reinsurance operations, case reserves for reported claims are generally established based on reports received from ceding companies. Additional case reserves may be established by us to reflect our estimated ultimate cost of a loss.
Other within the Insurance segment includes: excess and surplus, surety, structured indemnity and certain other discontinued lines. Other within the Reinsurance segment includes: whole account contracts, surety, structured indemnity and other lines.
Property catastrophe IBNR includes event specific reserves for losses that our insureds and cedants have informed us they expect to incur but have not yet had reported known claims.
As noted above, management reviews the IBNR estimates produced by our actuaries who determine the best estimate of the liabilities to record in our financial statements. We consider this single point estimate to be the mean expected outcome. Management believes that the actuarial methods utilized adequately provide for loss development.
Management does not build in a provision for uncertainty outside of the estimates prepared by our actuaries.
The range for the total Insurance and Reinsurance segment reserves is narrower than the sum of the ranges for the lines of business shown in the table due to diversification benefits across the lines of business.
Our methodology in 2012 for calculating reserve ranges around our single point reserve estimate is consistent with that used in 2011. We modeled a statistical distribution of potential reserve outcomes over a one year run-off period for each of the approximately 35 lines of business. Where appropriate, lines of business were evaluated at a more granular level and then aggregated to appropriately reflect differing levels of volatility within each line of business, for example, in respect of attritional, large, catastrophe and clash losses. In doing so we evaluated a number of alternative models, and for each line of business our actuaries selected the distribution parameters deemed to be most appropriate. Factors affecting this decision included an assessment of the model fit, availability and relevance of data and the impact of changes in business mix. We used the modeled statistical distribution to calculate an 80% confidence interval for the potential reserve outcomes over this one year run-off period. The high and low end points of the ranges set
Reserve volatility was analyzed for each line of business (excluding structured indemnity) within both the Reinsurance and Insurance segments using our historical data, supplemented by industry data. These ranges were then aggregated to the lines of business shown above taking into account correlation between lines of business. The practical result of the correlation approach to aggregation is that the ranges by line of business disclosed above are narrower than the sum of the ranges of the individual lines of business. Similarly, the range for our total reserves in the aggregate, is narrower than the sum of the ranges for the lines of business disclosed above.
On an annual basis, we review the correlation assumptions between our various lines of business. Since 2006, we have utilized a simplified approach of assigning ratings of low, medium or high to its correlation assumptions for each line of business pairing based on the judgment of the reserving actuaries. This simplified approach has been utilized due to the limited amount of historical experience within our portfolio as well as limited applicable industry data. However, our actual historical experience and industry data were used to judgmentally select a range of values for the low, medium and high correlations, respectively, of 15%, 30% and 50%. It should be noted that both our own experience and the industry data exhibit negative correlations in reserve developments between certain lines of business. However, as a measure of prudence in evaluating the reserve ranges, we have used a minimum of 15% correlation between any two lines of business. The analysis of correlations and the reflection of potential diversification benefits across lines of business represent another area of uncertainty in the development of estimated reserve ranges.
We use a default analysis to estimate uncollectible reinsurance. The primary components of the default analysis are reinsurance recoverable balances by reinsurer, net of collateral, estimated recovery rates and default factors used to determine the portion of a reinsurer’s balance deemed uncollectible. The definition of collateral for this purpose requires some judgment and is generally limited to assets held in trust, letters of credit, and liabilities held by us with the same legal entity for which we believe there is a right of offset. Default factors require considerable judgment and are determined using the current rating, or rating equivalent, of each reinsurer as well as other key considerations and assumptions.
For certain of these contracts, a single premium is paid at inception of the contract by way of a transfer of cash and investments to us.
approximately $4.1 million. While no changes to the locked-in assumptions were made in 2012 or in 2011, a review of lapse experience in 2010 led to an increase in the reserve of $2.2 million.
We also provided reinsurance of a block of U.S. based term assurance, which was novated to us from an insurance affiliate in December 2002. The future policy benefit reserves for these contracts amounted to approximately $257 million and $258 million at December 31, 2012 and 2011, respectively. Future policy benefit reserves are established in accordance with the provisions of general authoritative guidance on accounting for insurance enterprises, including the lock-in of assumptions at inception with periodic review against experience.
The liabilities relate to in-force blocks of business, which are comprised of underlying insurance policies that provide mainly lump sum benefits if the policyholder dies. The liabilities are therefore driven by the rates of mortality, and a 1% increase in the mortality rate relative to the reserving assumption would increase the value of future claims by approximately $7 million. The liabilities are also affected by lapse experience, and a 1% decrease in lapse rates relative to the reserving assumption would increase the reserve by approximately $0.8 million. No changes to the locked-in assumptions were made in years ended December 31, 2012, 2011 and 2010.
Our process for identifying declines in the fair value of investments that are other-than-temporary involves consideration of several factors. These primary factors include (i) an analysis of the liquidity, business prospects and financial condition of the issuer including consideration of credit ratings, (ii) the significance of the decline, (iii) an analysis of the collateral structure and other credit support, as applicable, of the securities in question, and (iv) for debt securities, whether we intend to sell such securities. In addition, the authoritative guidance requires that OTTI for certain asset backed and mortgage backed securities are recognized if the fair value of the security is less than its discounted cash flow value and there has been a decrease in the present value of the expected cash flows since the last reporting period. Where our analysis of the above factors results in our conclusion that declines in fair values are other-than-temporary, the cost of the security is written down to discounted cash flow and a portion of the previously unrealized loss is therefore realized in the period such determination is made.
We review, on a quarterly basis, the entirety of the fixed maturity securities in our investment portfolio that are in a gross unrealized loss position to assess whether we believe a credit loss, relative to the current amortized cost of the security, exists. We utilize specific screening criteria to identify securities at risk for a credit loss, and if any of these conditions exists, subject the individual security to a detailed review to determine if a credit loss exists. The screening criteria used by us include the absolute degree of impairment of the security as a percentage of amortized cost, the credit rating of the security and the market yield-to-maturity of the security. Any securities that have previously been identified as impaired due to credit losses are at elevated risk of further impairments. In addition, on a quarterly basis, we review any current market developments and identify any new issues that may adversely impact our investment portfolio, and review any impacted holdings and any pending sales programs.
We estimate that the cumulative losses on the mortgage structures we own will vary depending on the vintage and collateral of the underlying loans in the holdings. Cumulative deal loss expectations are projected based on the number of loans expected to take a loss and the severity of loss upon default. Loan
In conjunction with our investment managers, we utilize a scenario-based approach to reviewing the majority of our CDO portfolio, which consists primarily of collateralized loan obligations. The five significant scenarios utilized in the model consist of:
2 base cases assuming asset defaults are equivalent to either the expected corporate default probabilities, or the cumulative default rates for similar time frames from the period of 1983 to 2010.
The remainder of the gross unrealized losses related to our structured securities portfolio are concentrated in the following significant asset classes:
Credit losses on corporate securities are determined on an individual security basis. We review the circumstances and conditions associated with credit issuers, including considering credit rating and forecasted operating and financing activities of the issuer, and will make a determination as to whether we believe the issuer is likely to fully meet its contractual principal and interest obligations. To the extent we do not believe the issuers will meet these obligations, we recognize a credit loss as the difference between amortized cost and the estimated present value of cash flows expected to be received. We review the ability
to pay at the lowest tier (i.e., most subordinated) of the capital structure at which we hold securities, and, to the extent we are satisfied in the performance of the lower tier, conclude that any more senior tiers are also likely to meet obligations.
We evaluate the credit losses associated with medium term notes, which generally represent notes backed primarily by investment grade European credit. We evaluate the cash flows expected from the notes over their remaining expected life, including an evaluation of the likelihood of current holdings to meet their principal and interest obligations, and incorporate current reinvestment assumptions on any security maturities or reinvestment of cash flows. These cash flows are discounted at the current yield, adjusted for changes in interest rates for floating rate securities expected from these securities, and, to the extent the discounted cash flow value is below the amortized cost, we recognize an impairment charge.
We write business on both an excess of loss and proportional basis. In the case of excess of loss contracts, the subject written premium is generally outlined within the treaty and we receive a minimum and/or deposit premium on a quarterly basis, which is normally followed by an adjustment premium based on the ultimate subject premium for the contract. We estimate the premium written on the basis of the expected subject premium and regularly review this against actual quarterly statements to revise the estimate based on the information provided by the cedant. An estimate of premium is recorded at the inception of the contract.
The amount of proportional and excess of loss reinsurance gross premiums written and gross acquisition expenses recognized by our reinsurance operations for each line of business for the years ended December 31, 2012, 2011 and 2010 was as follows:
We have recorded goodwill in connection with various acquisitions in prior years. Goodwill represents the excess of the purchase price over the fair value of net assets acquired. We test goodwill for potential impairment annually as of June 30 and between annual tests if an event occurs or circumstances change that may indicate that potential exists for the fair value of a reporting unit to be reduced to a level below its carrying amount. We test for impairment at the reporting unit level in accordance with the authoritative guidance on intangibles and goodwill. For the reinsurance segment, a reporting unit is one level below the business segment, while for insurance, the segment is also the reporting unit. The first step is to identify potential impairment by comparing the estimated fair value of a reporting unit to the estimated book value, including goodwill. The fair value of each reporting unit is derived based upon valuation techniques and
assumptions we believe market participants would use to value the business and this is then compared to the book value of the business. We derive the net book value of our reporting units by estimating the amount of shareholders’ equity required to support the activities of each reporting unit. The estimated fair values of the reporting units are generally determined utilizing methodologies that incorporate price-to-net-tangible-book and price-to-earnings multiples of certain comparable companies, from an operational and economic standpoint. If such estimated fair value, combined with an estimate of an appropriate control premium, indicates a “close call” or potential impairment, further analysis using discounted cash flows is performed and the results of the various valuation methodologies are weighted to arrive at the estimated fair value for each reporting unit. A control premium represents the value an investor would pay above minority interest transaction prices in order to obtain a controlling interest in the respective company. If the estimated fair value exceeds the book value, goodwill at the reporting unit level is not deemed to be impaired. If the book value exceeds the estimated fair value, the second step of the process is performed to measure the amount of impairment.
We are organized into three operating segments: Insurance, Reinsurance and Life operations. Our general investment and financing operations are reflected in Corporate.
The combined ratio related to the P&C operations is the sum of the loss and loss expense ratio and the underwriting expense ratio. A combined ratio under 100% represents an underwriting profit and over 100% represents an underwriting loss.
Net fee income and other includes operating expenses from our loss prevention consulting services business.
2012 vs. 2011: Gross written premiums increased by 7.1%. The following is a summary of the premium movements by business group:
IPC - decrease of 2.2% mainly due to lower retention and new business in property as a result of underwriting actions for business that did not meet our return requirements and the unfavorable impact of foreign exchange rates in all lines. Partially offsetting this decrease was improved retention levels and positive amendments to prior year premium estimates in primary casualty and middle market lines.
NAPC - increase of 20.0% largely driven by new business growth across most lines including surplus lines, construction and primary casualty, improved retention for property, construction, and
primary casualty, and improved pricing in all lines over the prior year, partially offset by lower multi-year transactions in excess casualty.
Professional - increase of 6.0% largely driven by improved pricing and retention as well as new business in the U.S. professional business, and favorable retention in the Select and International businesses, partially offset by lower new business in International.
2011 vs. 2010: Gross written premiums increased by 9.2%. The following is a summary of the premium movements by business group:
NAPC - increase of 25.0% largely driven by new business growth across all lines, including the new surety and construction initiatives, and improved pricing in all lines over the prior year including property, partially offset by lower multi-year transactions in excess casualty.
Professional - decrease of 2.4% due to lower multi-year deals, lower new business in U.S. Professional partially offset by growth in new business in International and Select professional., and lower retention in US professional, partially offset by favorable retention in International.
Specialty - increase of 5.2% largely driven by new business growth in general aviation and specie lines and favorable amendments to prior year premium estimates in discontinued lines.
Foreign exchange rate movements also impacted our gross premiums written. When evaluated in local currency, our gross written premiums increased by 6.8%, compared to the 9.2% shown above.
Lower cessions as a result of lower level of premiums subject to the Professional treaty; and
Partially offsetting these were ceded premium increases as a result of:
The loss and loss expense ratio includes net losses incurred for both the reported year and any favorable or adverse prior year development of loss and loss expense reserves held at the beginning of the year. The following table summarizes these components of the loss ratio for the Insurance segment for the years ended December 31, 2012, 2011 and 2010:
2011 vs. 2010: The 8.0 percentage point increase in the loss ratio excluding prior year development was predominantly due to the high levels of catastrophe losses occurring in 2011. Losses net of reinsurance recoveries and reinstatement premiums related to natural catastrophe events were $219.5 million higher in 2011 as compared to 2010. Excluding prior year development, net catastrophe losses and related
Acquisition expense ratio increase - largely from the impact of reinstatement premiums and other earned premium adjustments, lower ceding income in IPC, NAPC and Professional and a change in the mix of direct business in Professional.
Acquisition expense ratio increase - primarily from a favorable adjustment to guaranty fund assessments in 2010, higher commissions and lower amounts of fee-based business in U.S., Bermuda and International professional, as well as excess casualty and aerospace and the impact of the catastrophe, property and marine reinstatement premiums on the ratio in 2011.
Operating expense ratio increase - mainly as a result of increased compensation costs from certain severance costs, higher number of employees, partially offset by lower variable compensation costs and unfavorable foreign exchange impacts.
2011 vs. 2010: The decrease reflects the overall run-off nature of this line of business combined with a change in the interest rate hedging strategy on one of the larger transactions during 2010.
2012 vs. 2011: The increase was a result of higher income related to our loss prevention consulting services as well as lower expenses in professional lines related to the cost of an endorsement facility with National Indemnity Company, which ended in 2011. For further information about this facility, see Item 8, Note 7, “Other Investments,” to the Consolidated Financial Statements included herein.
As already outlined in Item 1, “Business,” the Reinsurance segment provides casualty, property risk, property catastrophe, marine, aviation and other specialty reinsurance on a global basis, with business being written on both a proportional and non-proportional treaty basis and also on a facultative basis. Our reinsurance operations are structured into geographical business groups: Bermuda, North America, International (Europe and Asia Pacific) and Latin America.
North America - there was a decrease primarily as a result of changes in the structure of a U.S. agricultural program that renewed as reinsurance rather than as primary business, as well as a reduction in volume, shares and price for certain renewed property quota share and property excess of loss contracts, partially offset by new business.
Foreign exchange rate movements also impacted our gross premiums written. When evaluated in local currency, our gross written premiums decreased by 1.6%, compared to the 3.2% decrease shown above.
2011 vs. 2010: Gross premiums written increased by 12.5%. The following is a summary of the premium movements by business group:
Bermuda - there was premium growth from new business in the year, growth in the property catastrophe line through price and capacity increases and from natural catastrophe reinstatement premiums, partially offset by the non-renewal of certain property treaties.
North America - there was premium growth mainly from the property line on a U.S. agricultural program due to rising commodity prices in 2011, partially offset by decreases in casualty due to current market conditions and the non-renewal of certain treaties.
2011 vs. 2010: The increase of 10.7% is a reflection of the overall growth in net premiums written in 2011 combined with catastrophe loss related reinstatement premiums earned in 2011.
2011 vs. 2010: The 16.9 percentage point increase in the loss ratio excluding prior year development was predominantly due to higher levels of catastrophe losses occurring in 2011, noted above. Losses net of reinsurance recoveries and reinstatement premiums related to natural catastrophe events were $247.3 million higher in 2011 compared to 2010. Excluding prior year development, net catastrophe losses and related reinstatement premiums in both years, the loss ratio increased by 2.3 points from 2010 to 2011 mainly due to higher levels of large loss events in U.S. property including a deterioration in the performance of a large U.S. agricultural program, higher attritional losses and business mix changes.
For further information on the net favorable prior year reserve development for the years ended December 31, 2012, 2011 and 2010, see Item 8, Note 10 to the Consolidated Financial Statements, “Losses and Loss Expenses.”
2011 vs. 2010: The decrease of 3.1 percentage points was due to a decrease in the acquisition expense ratio of 1.9 points combined with a decrease in the operating expense ratio of 1.2 points, as follows:
Acquisition expense ratio decrease - primarily due to a U.S. agricultural program, where fees received were higher and profit commissions paid were lower in 2011.
2012 vs. 2011: The decrease relates to a higher interest expense recorded in the second quarter of 2012, due to an accretion rate adjustment from changes in expected cash flows and payout patterns on one
2011 vs. 2010: The increase relates to a higher interest expense recorded in the third quarter of 2010, due to an accretion rate adjustment from changes in expected cash flows and payout patterns on one of the larger structured indemnity contracts.
2012 vs. 2011: The decrease was a result of fees earned in Latin America on some treaties which were not renewed.
2011 vs. 2010: The increase was due in part to the amendment to the sales proceeds for the renewal rights of the European life, accident and health business, resulting in a charge for the prior year period. In addition, fees earned in Latin America increased during 2011 due to the extension in duration for some treaties.
The following table is an analysis of the Life operations’ gross premiums written, net premiums written and net premiums earned for the year ended December 31, 2012 and 2011:
2012 vs. 2011: The 9.8% decrease was driven predominantly by the Other Life business and was in line with the run-off expectations, as well as being impacted by unfavorable foreign exchange movements. Gross premiums written relating to annuity business and ceded premiums written also decreased due to foreign exchange movements.
2011 vs. 2010: The 5.2% decrease in both net written and net earned premiums resulted from the gross written premium decreases outlined above, partially offset by an increase in ceded written premiums due to foreign exchange movements.
2012 vs. 2011: The 9.1% decrease was due to the run-off nature of the Life operations business, combined with favorable foreign exchange impacts during 2012.
2011 vs. 2010: The 4.1% increase was primarily due to adverse foreign exchange impacts and reserve increases during the year combined with 2010 experiencing reserve releases on recaptured treaties that were not repeated in 2011.
2011 vs. 2010: The 17.9% decrease was largely due to the recaptured treaties in 2010 and run-off expectations.
2011 vs. 2010: The 11.1% decrease was mainly due to lower compensation expenses as a result of severance costs in 2010 following the decision to place the Life operations business into run-off.
Net investment income is included in the calculation of contribution from Life operations, as it relates to income earned on portfolios of separately identified and managed life investment assets and other allocated assets.
2012 vs. 2011: The 5.9% decrease was due to unfavorable foreign exchange movements, lower investment yields and a lower invested asset base, reflecting the run-off nature of the Life operations business.
The following table illustrates the net investment income from P&C operations, net income from investment fund affiliates, net realized (losses) gains on investments and net realized and unrealized gains (losses) on investment and other derivative instruments for the years ended December 31, 2012, 2011 and 2010:
Net investment income relating to P&C operations includes the net investment income related to the net results from structured products.
The Company generally records the income related to alternative fund affiliates on a one-month lag and the private investment fund affiliates on a three-month lag based upon the availability of the information provided by the investees.
Net income from investment fund affiliates includes earnings from our investments in closed-end investment funds and partnerships and similar vehicles that are accounted for under the equity method.
investment strategies in 2012 vs. 2011, and our alternative fund affiliate managers in particular navigated market volatility better in 2012 as against the prior year.
Realized losses of approximately $80.7 million related to the write-down of certain of the Company’s AFS investments. The significant components of the net impairment charges were:
Net realized losses on investments in 2011 included net realized losses of $160.2 million related to the write-down of certain of our fixed income, equity and other investments with respect to which we determined that there was an other-than-temporary decline in the value of those investments, as well as $28.2 million of net realized losses from sales of investments principally on European financials and non-Agency RMBS, partially offset by gains on Agency RMBS and Government and Government Related and Supported securities.
The following table sets forth our other revenues and expenses for the years ended December 31, 2012, 2011 and 2010:
2011 vs. 2010: The decrease of 25.8% was due to losses from an insurance affiliate catastrophe bond fund in 2011 combined with higher income in 2010 from our Brazilian joint venture ITAÚ XL Seguros Corporativos S.A. (“ITAU”), which was sold during the second quarter of 2010.
The foreign exchange losses in 2012 were a result of an overall weakening of the value of the U.S. dollar against the Company’s major currency exposures, which include the U.K. sterling, the Euro and the Swiss franc. In 2011, foreign exchange gains were produced as a result of a stronger U.S. dollar against the U.K. sterling, the Brazilian real and the Swiss franc, which more than offset losses that were driven by a stronger Australian dollar. In 2010, foreign exchange gains were marginal as a result of a limited overall movement in the value of the U.S. dollar.
2011 vs. 2010: The decrease of 3.2% was primarily as a result of the overall reduction in the Company’s debt following the purchase and retirement of the $500 million 8.25% Senior Notes in August 2011 and the sale of $400 million 5.75% Senior Notes in September 2011.
2010: As part of the continued management of certain legacy financial businesses, which were put into runoff in 2008, in the second quarter of 2010, management was successful in commuting our exposure to EIB. For further information on the loss on settlement of this guarantee, see Item 8, Note 17(h) to the Consolidated Financial Statements, “Financial and Other Guarantee Exposures.”
2012 vs. 2011: The tax charge of $34.0 million recognized in 2012 was lower than 2011 mainly as a result of the recognition in 2012 of a tax benefit of $24.5m arising on the release of valuation allowances held against capital loss carry-forwards that were utilized to offset 2012 realized gains and other discrete tax benefit items in 2012 which totaled $19.8 million. The 2011 tax charge was impacted by a number of items including the adverse global distribution of profits and losses as detailed below.
Included in Corporate - Financials are gross unrealized losses of $23.7 million and $108.8 million on Tier One and Upper Tier Two securities of financial institutions (“Hybrids”) with fair values of $308.5 million and $386.1 million at December 31, 2012 and 2011, respectively, as well as gross unrealized losses of $11.8 million and $70.1 million on subordinated debt (including lower Tier Two securities) with fair values of $649.4 million and $701.3 million at December 31, 2012 and 2011, respectively.
At December 31, 2012 and 2011, $194.3 million and $266.0 million or 0.6% and 0.8% of the fixed income portfolio, respectively, represents medium term notes rated at the average credit rating of the underlying asset pools backing the notes.
We had gross unrealized losses totaling $282.8 million on 1,223 securities out of a total of 7,331 AFS securities held at December 31, 2012 and $2.7 million on 5 securities out of a total of 206 HTM securities, which we consider to be temporarily impaired or with respect to which reflects non-credit losses on OTTI. Individual security positions comprising this balance have been evaluated by management, in conjunction with our investment managers, to determine the severity of these impairments and whether they should be considered other-than-temporary.
gross unrealized losses of $87.2 million related to the P&C portfolio of Core CDO holdings (defined by us as investments in non-subprime CDOs), which consisted primarily of collateralized loan obligations (“CLOs”) and had a fair value of $709.8 million at December 31, 2012.
gross unrealized losses of $51.3 million related to the corporate holdings within our non-Life fixed income portfolios, which had a fair value of $8.2 billion at December 31, 2012. Of the gross unrealized losses, $21.6 million relate to financial institutions. In addition, $5.2 million relate to medium term notes primarily supported by pools of European investment grade credit with varying degrees of leverage. These had a fair value of $194.3 million at December 31, 2012. Management believes that expected cash flows from these bonds over the expected holding period will be sufficient to support the remaining reported amortized cost.
The following shows the security type and length of time that AFS securities were in a continual gross unrealized loss position at December 31, 2012:
The following is the maturity profile of the AFS fixed income securities that were in a continual gross unrealized loss position at December 31, 2012:
Factors considered in determining that additional OTTI charges were not warranted include management’s consideration of current and near term liquidity needs along with other available sources of liquidity, and in certain instances an evaluation of the factors and time necessary for recovery. For further information, see Item 1, Note 5, “Investments,” to the Consolidated Financial Statements included herein.
As noted in Item 8, Note 2, “Significant Accounting Policies,” to the Consolidated Financial Statements included herein, the determination of the amount of OTTI varies by investment type and is based upon management’s periodic evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available. Management considers a wide range of factors about the securities and uses its best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management’s evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Management updates its evaluations regularly and reflects additional impairments in net income as determinations are made. Management’s determination of the amount of the impairment taken on investments is highly subjective and could adversely impact our results of operations. There can be no assurance that we have accurately assessed the level of OTTI taken and reflected in our financial statements. Furthermore, additional impairments may need to be taken in the future. Historical trends may not be indicative of future impairments.
Levels of write down or OTTI are also impacted by our assessment of the intent to sell securities that have declined in value prior to recovery. If, due to changes in circumstances, we determine to reposition or realign portions of the portfolio and we determine not to hold certain securities in an unrealized loss position to recovery, we will incur OTTI charges, which could be significant.
Management, in our assessment of whether securities in a gross unrealized loss position are temporarily impaired, considers the significance of the impairments. At December 31, 2012, we had corporate financial sector securities with gross unrealized losses of $44.5 million and we did not hold any corporate securities which had a cumulative fair value decline of greater than 50% of amortized cost.
At December 31, 2012, we had structured securities with gross unrealized losses of $76.9 million on non-Agency RMBS, $87.2 million on Core CDOs and $4.3 million on CMBS holdings. These securities included gross unrealized losses of $26.0 million, which had a fair value of $10.3 million and a cumulative fair value decline of greater than 50% of amortized cost. All of these are mortgage and asset-backed securities. We have evaluated each of these securities in conjunction with our investment manager service providers and believe it is more likely than not that the issuer will be able to fund sufficient principal and interest payments to support the current amortized cost.
We currently have no unfunded investment exposures or commitments to either sovereign or non-sovereign entities within these EU nations. We do invest in various alternative and private investment funds that from time to time may invest in securities or investments related to these five EU nations. Currently, these are not material exposures.
During 2012, Covered Bonds have been included within Other asset-backed securities under Structured Securities to align our classification to market indices. Prior periods have been reclassified to conform to current period presentation.
The following table details the gross and net unrealized (loss) gain position at December 31, 2012 relating to GIIPS:
Covered Bonds have been included within Other asset-backed securities under Structured Securities to align our classification to market indices. Prior periods have been reclassified to conform to current period presentation.
In addition to the direct investment portfolio considerations discussed above, as an international (re)insurance company, European credit exposures may exist for us within unpaid losses and loss expenses recoverable and reinsurance balances receivable. For further details on these balances including the names of the our most significant reinsurance counterparties, see Item 8, Note 9, “Reinsurance,” to the Consolidated Financial Statements included herein. Other sources of potential exposure to European credit issues may exist within certain lines of insurance or reinsurance business written (including but not limited to lines such as surety, business interruption, and political risk), or within underlying investments held in securitized financial instruments or in structured transactions in which we have an interest. We consider these potential exposures as part of our ongoing enterprise risk management processes.
At December 31, 2012, the fair value of Level 3 assets and liabilities as a percentage of our total assets and liabilities that are carried at fair value was as follows:
During 2012, Covered Bonds previously included as Corporate securities are now classified as Other asset-backed securities to align our classification to market indices. At December 31, 2012, these securities had a fair value of $647.1 million.
The Other investments balance excludes certain structured transactions including certain investments in project finance transactions and a payment obligation (for further information, see Item 8, Note 7, “Other Investments,” to the Consolidated Financial Statements included herein) that has provided liquidity financing to a structured credit vehicle as a part of a third party medium term note facility. These Other investments are carried at amortized cost that totaled $312.1 million at December 31, 2012 and $323.7 million at December 31, 2011.
See Item 1, Note 3, “Fair Value Measurements,” to the Consolidated Financial Statements included herein, for an analysis of the change in fair value of Level 3 Assets and Liabilities.
We establish reserves to provide for estimated claims, the general expenses of administering the claims adjustment process and losses incurred but not reported. These reserves are calculated using actuarial and
A downgrade below “A -” of our principal insurance and reinsurance subsidiaries by either S&P or A.M. Best, which is two notches below the current S&P financial strength rating of “A” (Positive) and the A.M. Best financial strength rating of “A” (Stable) of these subsidiaries, may trigger cancelation provisions in a significant amount of our assumed reinsurance agreements and may potentially require us to return unearned premiums to cedants. In addition, due to collateral posting requirements under our letter of credit and revolving credit facilities, such a downgrade may require the posting of cash collateral in support of
As holding companies, XL-Ireland and XL-Cayman have no operations of their own and their assets consist primarily of investments in subsidiaries. XL-Ireland’s principal uses of liquidity are ordinary share-related transactions, including dividend payments to holders of its ordinary shares as well as share buybacks, capital investments in its subsidiaries and certain corporate operating expenses. XL-Cayman’s principal uses of liquidity are preference share related transactions, including dividend payments to its preference shareholders as well as preference share buybacks from time to time, interest and principal payments on debt and certain corporate operating expenses.
Under Irish law, share premium was required to be converted to “distributable reserves” for XL-Ireland to pay cash dividends and redeem and buyback shares following the Redomestication. On July 23, 2010, the Irish High Court approved XL-Ireland’s conversion of share premium to $5.0 billion of distributable reserves, subject to the completion of certain formalities under Irish Company law. These formalities were completed in early August 2010. At December 31, 2012, XL-Ireland had $3.6 billion in distributable reserves.
Historically, cash receipts from operations, consisting of premiums and investment income, generally have provided sufficient funds to pay losses as well as operating expenses of our subsidiaries and to fund dividends to XL-Ireland. Cash receipts from operations are generally derived from the receipt of investment income on our investment portfolio as well as the net receipt of premiums less claims and expenses related to our underwriting activities in our P&C and Life operations. Our operating subsidiaries provide liquidity in that premiums are generally received months or even years before losses are paid under the policies related to such premiums. Premiums and acquisition expenses are settled based on terms of trade as stipulated by an underwriting contract, and generally are received within the first year of inception of a policy when the premium is written, but can be up to three years on certain reinsurance business assumed. Operating expenses are generally paid within a year of being incurred. Claims, especially for casualty business, may take a much longer time before they are reported and ultimately settled, requiring the establishment of reserves for unpaid losses and loss expenses. Therefore, the amount of claims paid in any one year is not necessarily related to the amount of net losses incurred, as reported in the consolidated statement of income.
During the year ended December 31, 2012, net cash flows provided by operating activities were $1.1 billion compared to net cash flows provided by operating activities of $327.2 million for the same period in 2011. The operating cash increase was primarily due to the increase in net income in the year ended December 31, 2012 compared to the same period in 2011.
On February 27, 2012, we announced that the XL-Ireland Board of Directors approved the February 2012 Program, authorizing the purchase of up to $750 million of our ordinary shares. This authorization replaced the approximately $190 million remaining under the share buyback program that was authorized in November 2010 as described in further detail in Item 8, Note 18, “Share Capital,” to the Consolidated Financial Statements herein. During 2012, we purchased and canceled 18.3 million ordinary shares under the February 2012 Program for $401.6 million. At December 31, 2012, $348.4 million remained available for purchase under this program. Between January 1 and February 22, 2013 we purchased and canceled an additional 3.8 million shares for $98.4 million. All share buybacks were carried out by way of redemption in accordance with Irish law and XL-Ireland’s constitutional documents. All shares so redeemed were canceled upon redemption. On February 22, 2013, we announced that the XL-Ireland Board of Directors approved a new share buyback program, authorizing the purchase of up to $850 million of our ordinary shares. This replaced the approximately $250 million remaining under the February 2012 Program.
At December 31, 2012 and December 31, 2011, we had total shareholders’ equity of $11.9 billion and $10.8 billion, respectively. In addition to ordinary share capital, we depend on external sources of financing to support its underwriting activities in the form of:
letters of credit and other forms of collateral that are required to be posted or deposited, as the case may be, by our operating subsidiaries that are “non-admitted” under U.S. state insurance regulations in order for the U.S. cedant to receive statutory credit for reinsurance. We also uses letters of credit to support its operations at Lloyd’s; and
the credit available from banks may be reduced resulting in our need to pledge its investment portfolio to customers. This could result in a lower investment yield;
the volume of business that our subsidiaries that are not admitted in the United States are able to transact could be reduced if we are unable to renew its letter of credit facilities at an appropriate amount.
$600 million senior notes due September 2014, with a fixed coupon of 5.25%. The security is publicly traded. The notes were issued in two tranches of $300 million aggregate principal amount each - one tranche at 99.432% and the other at 98.419% with aggregate net proceeds of $590.9 million. Related expenses of the offering amounted to $2.7 million.
On December 5, 2011, we repurchased 5,000 of the outstanding Series D Preference Ordinary Shares with a liquidation preference value of $5.0 million for $3.7 million, including accrued dividends. As a result of these repurchases, we recorded a gain of approximately $1.3 million through Non-controlling interests in the Consolidated Statement of Income in the fourth quarter of 2011. At both December 31, 2012 and December 31, 2011, the face value of the outstanding Series D Preference Ordinary Shares was $345.0 million.
On December 9, 2011, we entered into (i) a new secured credit agreement (the “December 2011 Secured Credit Agreement”) and (ii) a new unsecured credit agreement (the “December 2011 Unsecured Credit Agreement” and together with the December 2011 Secured Credit Agreement, the “December 2011 Credit Agreements”). In connection with the December 2011 Credit Agreements, the 2007 Credit Agreement was terminated. The March 2011 Credit Agreement continues in force, but was amended to conform certain of its terms to those of the December 2011 Secured Credit Agreement.
The December 2011 Secured Credit Agreement provides for the issuance of letters of credit in an aggregate amount of up to $650 million. The December 2011 Unsecured Credit Agreement is a $1.35 billion facility that provides for the issuance of letters of credit and revolving credit loans in an aggregate amount up to $1 billion. We have the option to increase the maximum amount of letters of credit available by an additional $500 million across the facilities under the December 2011 Credit Agreements.
In October 2011, the $75,000 letter of credit facility that was supporting one of our subsidiaries was terminated.
Our Credit Facilities contain a number of financial covenants that must be met and maintained and that, among other things, could restrict, subject to certain exceptions, our financial flexibility including the ability to:
The following outlines the covenant requirements and actual amounts as of December 31, 2012:
The ratio of total funded debt to total capitalization not to be greater than 0.35:1.00. This ratio is defined as total funded debt to the sum of total funded debt plus consolidated net worth.
Consolidated net worth means, at any time, our consolidated stockholders’ equity excluding (a) the effect of any adjustments required under the authoritative accounting guidance for accounting for certain investments in debt and equity securities; and (b) any exempt indebtedness (and the assets relating thereto) in the event such exempt indebtedness is consolidated on our consolidated balance sheet.
Covenants require that none of XL Insurance (Bermuda) Ltd, XL Re Ltd or XL Re Europe Ltd has a financial strength ratings of less than “A -” from A.M. Best. At December 31, 2012, we were in compliance with such covenants.
The following describes certain terms of the documents referred to below. All documents referred to below have been filed with the SEC and should be referred to for an assessment of our complete contractual obligations.
Under the March 2011 Credit Agreement and December 2011 Credit Agreements, in the event that XL Insurance (Bermuda) Ltd, XL Re Ltd or XL Re Europe Ltd fail to maintain a financial strength rating of at least “A -” from A.M. Best, an event of default would occur.
Deposit liabilities on our Consolidated Balance Sheet at December 31, 2012 were $1.5 billion. The difference from the amount included above relates to the discount on payments due in the future. The payment related to these liabilities varies primarily based on interest rates. The ultimate payments associated with these liabilities could differ from our estimate. See Item 8, Note 11, “Deposit Liabilities,” to the Consolidated Financial Statements included herein, for further information.
The unpaid loss and loss expenses were $20.5 billion on our Consolidated Balance Sheet at December 31, 2012. The difference from the amount included above relates to the discount on payments due in the future for certain workers compensation lines and certain U.K. motor liability claims. The timing and amounts of actual claims payments related to these P&C reserves vary based on many factors including large individual losses, changes in the legal environment, as well as general market conditions. The ultimate amount of the claims payments could differ materially from our estimated amounts. For information regarding the estimates for unpaid loss and loss expenses as well as factors affecting potential payment patterns of reserves for actual and potential claims related our different lines of business, see “Critical Accounting Policies and Estimates” above. Certain lines of business written by us, such as excess casualty, have loss experience characterized as low frequency and high severity. This may result in significant variability in loss payment patterns and, therefore, may impact the related asset/liability investment management process. In order to be in a position, if necessary, to make these payments, our liquidity requirements are supported by having revolving lines of credit facilities available to us and significant reinsurance programs, in addition to our general high grade fixed income investment portfolio.
At times, we have utilized VIEs both indirectly and directly in the ordinary course of our business.
We entered into this facility on December 5, 2006. We and ceding insurers entered into a securities issuance agreement, and certain of our ceding insurers entered into a reinsurance agreement, with Stoneheath. The net effect of these agreements to us was the creation of a contingent put option in the amount of $350.0 million in the aggregate. Our interests in Stoneheath represented an interest in a variable interest entity under current authoritative accounting guidance, however, we were not the primary beneficiary as contemplated in that guidance. For further details see Item 8, Note 15, “Off-Balance Sheet Arrangements,” to the Consolidated Financial Statements included herein.
Prices provided by independent pricing services and independent broker quotes can vary widely even for the same security. The use of different methodologies and assumptions may have a material effect on the estimated fair value amounts.
All investment transactions are recorded on a trade date basis. Realized gains and losses on sales of equities and fixed income investments are determined on a first-in, first-out basis. Investment income is recognized when earned and includes interest and dividend income together with the amortization of premium and discount on fixed maturities and short-term investments, and is recorded net of related investment expenses. Amortization of discounts on fixed maturities includes amortization to expected
Investments classified as held to maturity include securities for which the Company has the ability and intent to hold to maturity and are carried at amortized cost. For details see Note 5, “Investments.”
The Company generally records its alternative and private equity fund affiliates on a one-month and three-month lag, respectively, and its operating affiliates on a three-month lag. Significant influence is generally deemed to exist where the Company has an investment of 20% or more in the common stock of a corporation or an investment of 3% or more in closed end funds, limited partnerships, LLCs or similar investment vehicles. Significant influence is considered for other strategic investments on a case-by-case basis. Investments in affiliates are not subject to fair value measurement guidance as they are not considered to be fair value measured investments under U.S. GAAP. However, impairments associated with investments in affiliates that are deemed to be other-than-temporary are calculated in accordance with fair value measurement guidance and appropriate disclosures included within the financial statements during the period the losses are recorded.
The noncredit portion of any OTTI losses on securities classified as available for sale is recorded as a component of other comprehensive income with an offsetting adjustment to the carrying value of the security. The fair value adjustment could increase or decrease the carrying value of the security. The noncredit portion of any OTTI losses recognized in accumulated other comprehensive loss for debt securities classified as held to maturity would be accreted over the remaining life of the debt security (in a pro rata manner based on the amount of actual cash flows received as a percentage of total estimated cash flows) as an increase in the carrying value of the security until the security is sold, the security matures, or there is an additional OTTI that is recognized in earnings.
utilized in arriving at the valuations is obtained. Where models are used, the selection of a particular model to value an OTC derivative depends upon the contractual terms and specific risks inherent in the instrument as well as the availability of pricing information in the market. The Company generally uses similar models to value similar instruments. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs. For OTC derivatives that trade in liquid markets, such as generic forwards, interest rate swaps and options, model inputs can generally be verified and model selection does not involve significant management judgment. Such instruments comprise the majority of derivatives held by the Company and are typically classified within Level 2 of the fair value hierarchy.
Changes in the fair value of a derivative that is designated and qualifies as a fair value hedge, along with the changes in the fair value of the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings (through “net realized and unrealized gains and losses on derivative instruments”) with any differences between the net change in fair value of the derivative and the hedged item representing the hedge ineffectiveness. Periodic derivative net coupon settlements are recorded in net investment income with the exception of hedges of Company issued debt, which are recorded in interest expense. The Company may designate fair value hedging relationships where interest rate swaps are used to hedge the changes in fair value of certain fixed rate liabilities and fixed maturity securities due to changes in the designated benchmark interest rate.
Changes in the fair value of a derivative that is designated and qualifies as a cash flow hedge are recorded in accumulated other comprehensive income (“AOCI”) and are reclassified into earnings when the variability of the cash flow of the hedged item impacts earnings. Gains and losses on derivative contracts that are reclassified from AOCI to current period earnings are included in the line item in the consolidated statements of operations in which the cash flows of the hedged item are recorded. Any hedge ineffectiveness is recorded immediately in current period earnings as “net realized and unrealized gains and
The Company’s other intangible assets consist of both amortizable and non-amortizable intangible assets. The Company’s amortizable intangible assets consist primarily of acquired customer relationships and acquired software. All of the Company’s amortizable intangible assets are carried at net book value and are amortized over their estimated useful lives. The amortization periods approximate the periods over which the Company expects to generate future net cash inflows from the use of these assets. Accordingly, customer relationships are amortized over a useful life of 10 years and acquired software is amortized over a useful life of 5 years. The Company’s policy is to amortize intangibles on a straight-line basis.
All of the Company’s amortizable intangible assets, as well as other amortizable or depreciable long-lived assets such as premises and equipment, are subject to impairment testing in accordance with authoritative guidance for the impairment or disposal of long-lived assets when events or conditions indicate that the carrying value of an asset may not be fully recoverable from future cash flows.
The assumptions used to determine future policy benefit reserves are best estimate assumptions that are determined at the inception of the contracts and are locked-in throughout the life of the contract unless a premium deficiency develops. As the experience on the contracts emerges, the assumptions are reviewed. If such review would produce reserves in excess of those currently held, then the lock-in assumptions will be revised and a claim and policy benefit is recognized at that time.
In May 2011, the FASB issued an accounting standards update to amend existing requirements for fair value measurements and disclosures. The guidance expands the disclosure requirements around fair value measurements categorized in Level 3 of the fair value hierarchy, requiring quantitative and qualitative information to be disclosed related to: (1) the valuation processes used, (2) the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs, and (3) use of a nonfinancial asset in a way that differs from the asset’s highest and best use. The guidance requires disclosure of the level in the fair value hierarchy of items that are not measured at fair value, but whose fair value must be disclosed. It also clarifies and expands upon existing requirements for fair value measurements of financial assets and liabilities, as well as instruments classified in shareholders’ equity. The Company adopted this guidance from January 1, 2012; however, it impacted disclosure only and did not have an impact on the Company’s financial condition or results of operations. See Note 3, “Fair Value Measurements,” for these updated disclosures.
In July 2012, the FASB issued an accounting standards update to simplify how entities test indefinite-lived intangible assets for impairment. Under this new guidance, an entity is allowed the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying value. After assessing the circumstances that should be considered in making the qualitative assessment, if an entity determines that the fair value of the intangible asset as compared to its carrying value meets the threshold, it may bypass the existing requirements to perform a full quantitative impairment test on the intangible asset, a test which otherwise would have to be performed annually, at a minimum. The guidance was effective during the fourth quarter of 2012. The adoption of this guidance did not have an impact on the Company’s consolidated financial condition, results of operations or cash flows.
Included within Corporate are certain medium term notes supported primarily by pools of European investment grade credit with varying degrees of leverage. The notes, which are in a gross unrealized loss position, had a fair value of $194.3 million and $266.0 million and an amortized cost of $194.8 million and $297.7 million at December 31, 2012 and December 31, 2011, respectively. These notes allow the investor to participate in cash flows of the underlying bonds including certain residual values, which could serve to either decrease or increase the ultimate values of these notes.
Included within Equity securities are investments in fixed income funds with a fair value of $101.9 million and $91.6 million at December 31, 2012 and December 31, 2011, respectively.
Short-term investments consist primarily of Corporate securities and U.S. and Non-U.S. Government and Government-Related/Supported securities.
The Other investments balance excludes certain structured transactions including certain investments in project finance transactions, a payment obligation and liquidity financing provided to a structured credit vehicle as a part of a third party medium term note facility. These investments, which totaled $312.1 million at December 31, 2012 and $323.7 million at December 31, 2011, are carried at amortized cost. For further details regarding the nature of Other investments and related features see Note 7, “Other Investments,” to the Consolidated Financial Statements.
Other assets and other liabilities include derivative instruments. The derivative balances included in each category are reported on a gross basis by level with a netting adjustment presented separately in the Collateral and Counterparty Netting column. The Company often enters into different types of derivative contracts with a single counterparty and these contracts are covered under a netting agreement. In addition, at December 31, 2012 the Company paid net cash collateral related to these derivative positions of $12.1 million. The assets related to the net collateral paid were recorded as Other assets within the balance sheet. At December 31, 2011, the Company held net cash collateral of $77.1 million. The collateral balance was included within Cash and cash equivalents and the corresponding liability to return the collateral has been offset against the derivative asset within the balance sheet as appropriate under the netting agreement. The fair values of the individual derivative contracts are reported gross in their respective levels based on the fair value hierarchy.
Financial instruments sold, but not yet purchased, represent “short sales” and are included within “Payable for investments purchased” on the balance sheet.
In general, Level 3 assets include securities for which values were obtained from brokers where either significant inputs were utilized in determining the values that were difficult to corroborate with observable market data, or sufficient information regarding the specific inputs utilized by the broker was not available to support a Level 2 classification. Transfers into or out of Level 3 primarily arise as a result of the valuations utilized by the Company changing between either those provided by independent pricing services that do not contain significant observable inputs, or other valuations sourced from brokers that are considered Level 3.
The Company is organized into three operating segments: Insurance, Reinsurance and Life operations. The Company’s general investment and financing operations are reflected in Corporate.
The net results from P&C structured products include net investment income and interest expense of $71.7 million and $66.4 million, respectively.
The Company records the income related to the alternative funds and to the private investment and operating fund affiliates on a one-month and three-month lag, respectively.
Other within the Insurance segment includes: excess and surplus, surety, structured indemnity and certain other discontinued lines. Other within the Reinsurance segment includes: whole account contracts, surety and other lines.
At December 31, 2012, Covered Bonds within Fixed maturities - AFS with an amortized cost of $605.4 million and a fair value of $647.1 million and Covered Bonds within Fixed maturities - HTM with an amortized cost of $8.4 million and a fair value of $8.6 million have been included within Other asset-backed securities to align the Company’s classification to market indices. Covered Bonds were included in Corporate prior to January 1, 2012.
At December 31, 2012 and December 31, 2011, approximately 2.9% and 2.4%, respectively, of the Company’s fixed income investment portfolio at carrying value was invested in securities that were below investment grade or not rated. Approximately 37.7% and 31.4% of the gross unrealized losses in the Company’s fixed income securities portfolio at December 31, 2012 and December 31, 2011, respectively, related to securities that were below investment grade or not rated.
Covered Bonds were included within Corporate securities prior to January 1, 2012. Beginning in 2012, they were classified as Other asset-backed securities to align the Company’s classification to market indices. At December 31, 2011, Covered Bonds with a fair value of $353.9 million have been reclassified from Corporate to Other asset-backed securities to conform to current period presentation.
Included in the table above are Tier One and Upper Tier Two securities, representing committed term debt and hybrid instruments, which are senior to the common and preferred equities of the financial institutions, at their fair value of $308.5 million and $386.1 million at December 31, 2012 and December 31, 2011, respectively. These securities are reflected in the table based on their call date and have net unrealized losses of $19.1 million and $108.8 million at December 31, 2012 and December 31, 2011, respectively.
Factors considered for all securities on a quarterly basis in determining that a gross unrealized loss is not other-than-temporarily impaired include management’s consideration of current and near term liquidity needs and other available sources of funds, an evaluation of the factors and time necessary for recovery and an assessment of whether the Company has the intention to sell or considers it more likely than not that it will be forced to sell a security.
Certain of the Company’s invested assets are held in trust and pledged in support of insurance and reinsurance liabilities as well as credit facilities. Such pledges are largely required by the Company’s operating subsidiaries that are “non-admitted” under U.S. state insurance regulations, in order for the U.S. cedant to receive statutory credit for reinsurance. Also, certain deposit liabilities and annuity contracts require the use of pledged assets. At December 31, 2012 and December 31, 2011, the Company had $16.9 billion and $17.2 billion in pledged assets, respectively.
The following is an analysis of how long the AFS and HTM securities at December 31, 2012 and December 31, 2011 had been in a continual unrealized loss position:
Included within Corporate are Tier One and Upper Tier Two securities, representing committed term debt and hybrid instruments, which are senior to the common and preferred equities of the financial institutions. These securities, which are in a gross unrealized loss position, have a fair value of $308.5 million and an amortized cost of $327.6 million at December 31, 2012.
Included within equity securities are investments in fixed income funds with a fair value of $101.9 million and an amortized cost of $100.0 million at December 31, 2012.
The Company had gross unrealized losses totaling $282.8 million on 1,223 securities out of a total of 7,331 held at December 31, 2012 in its AFS portfolio and $2.7 million on 5 securities out of a total of 206 held in its HTM portfolio, which it considers to be temporarily impaired or with respect to which reflects non- credit losses on OTTI. Individual security positions comprising this balance have been evaluated by management to determine the severity of these impairments and whether they should be considered other-than-temporary. Management believes it is more likely than not that the issuer will be able to fund sufficient principal and interest payments to support the current amortized cost.
Management, in its assessment of whether securities in a gross unrealized loss position are temporarily impaired, as described above, considers the significance of the impairments. At December 31, 2012, the Company had structured securities with gross unrealized losses of $26.0 million, which had a fair value of
$19.1 million related to medium term notes backed primarily by European investment grade credit. On certain notes, management concluded that expected future returns on the underlying assets were
$5.3 million related to currency losses primarily arising on Swiss franc and U.K. sterling denominated securities held in U.S. dollar portfolios.
The following table sets forth the amount of credit loss impairments on fixed income securities held by the Company as of the dates indicated, for which a portion of the OTTI loss was recognized in OCI, and the corresponding changes in such amounts.
The Company has invested in certain closed end funds, certain limited partnerships, LLCs and similar investment vehicles, including funds managed by certain of its investment manager affiliates. Collectively,
side-pockets was $39.7 million and $30.7 million, respectively. The underlying assets within these positions are generally expected to be liquidated over a period of approximately two to four years.
The Company generally records its operating affiliates on a three month lag. Estimated assets and liabilities are generally at September 30, 2012 and 2011, respectively.
During the year ended December 31, 2012 and 2011 the Company received distributions from its Investment Manager Affiliates of approximately $58.3 million and $23.2 million respectively. During 2011 the Company sold its interests in Finisterre for total proceeds of $35.0 million as explained below at “Investment Manager Affiliates.”
See Note 17(c), “Commitments and Contingencies - Investments in Affiliates,” for further information regarding commitments related to investment in affiliates.
The Company had no significant financial operating affiliates during 2012 or 2011 following the sale, during the fourth quarter of 2010, of approximately 76% of its investment in Primus Guaranty, Ltd. (“Primus”), reducing the Company’s ownership interest from 39.7% to 9.8% at December 31, 2010. This sale generated total proceeds of $51.6 million during the year ended December 31, 2010. Given management’s view of the risk exposure, expected losses and the uncertainty facing the entire financial guarantee industry in 2007, the Company had reduced the reported value of its investment in Primus to nil at December 31, 2007. The Company did not record any equity earnings during 2010, 2009 or 2008 in
relation to Primus because of the significant losses and negative book value reported by Primus during these periods. Therefore, the sale in the fourth quarter of 2010 resulted in the recording of a gain of $51.6 million through “Income from operating affiliates.” Subsequent to the sale, the Company’s ownership of Primus shares was accounted for as an available for sale equity security.
During the years ended December 31, 2012, 2011 and 2010, the Company’s larger investment manager affiliates included Highfields Capital, a global equity investment firm, Polar Capital, an investment firm offering traditional and alternative products and HighVista Strategies, a diversified wealth management firm. The Company recorded, through net income in affiliates, other-than-temporary declines in the values of certain investment manager affiliates totaling nil, $0.6 million and $4.4 million, for the years ended December 31, 2012, 2011 and 2010, respectively.
During May 2012, the Company invested $25.0 million to obtain an approximately 94% interest in Five Oaks Investment Corp. (“Five Oaks”), a newly formed private investment company. Five Oaks is a mortgage real estate investment trust that is focused on investing in, financing and managing a leveraged portfolio of agency and non-agency residential mortgage-backed securities, residential mortgage loans and other mortgage-related investments. At December 31, 2012, the Company has consolidated Five Oaks resulting in the recording within its balance sheet of: RMBS securities at their fair value of $81.0 million (amortized cost: $77.3 million) within Fixed maturities, $8.4 million of Derivatives, $6.0 million of Cash and cash equivalents, $63.4 million of liabilities related to obligations under repurchase agreements within Other liabilities, and $1.8 million of Non-controlling interest in equity of consolidated subsidiaries. $66.3 million of securities held by Five Oaks and consolidated by the Company are pledged as collateral under the repurchase agreements. The repurchase agreements do not provide the counterparties any recourse to assets of the Company aside from its investment in Five Oaks. Amounts recorded within the Company’s consolidated statement of income related to Five Oaks were immaterial during the year ended December 31, 2012. In addition, during March 2012, the Company purchased an equity interest in Oak Circle Capital Partners (“Oak Circle”), the investment management company that provides portfolio management and other administrative services to Five Oaks. The Company’s investment in Oak Circle is included in investment manager affiliates.
Contained within this asset class are equity interests in investment funds, limited partnerships and unrated tranches of collateralized debt obligations for which the Company does not have sufficient rights or ownership interests to follow the equity method of accounting. The Company accounts for such equity securities at estimated fair value with changes in fair value recorded through AOCI as it has no significant influence over these entities. Also included within other investments are structured transactions that are carried at amortized cost.
Other investments comprised the following at December 31, 2012 and 2011:
At December 31, 2012, the alternative fund portfolio, accounted for as other investments, employed four strategies invested in 17 underlying funds, respectively. The Company is able to redeem the hedge funds on the same terms that the underlying funds can be redeemed. In general, the funds in which the Company is invested require at least 30 days notice of redemption, and may be redeemed on a monthly, quarterly, semi-annual, annual or longer basis, depending on the fund.
Certain funds may be allowed to invest a portion of their assets in illiquid securities, such as private equity or convertible debt. In such cases, a common mechanism used is a side-pocket, whereby the illiquid security is assigned to a separate memorandum capital account or other designated account. Typically, the investor loses its redemption rights in the designated account. Only when the illiquid securities in the side-pocket are sold, or otherwise deemed liquid by the fund, may investors redeem that portion of their interest that has been “side-pocketed”. At December 31, 2012 and 2011, the fair value of our funds held in side-pockets was $25.0 million and $28.4 million, respectively. The underlying assets within these positions are generally expected to be liquidated over a period of approximately two to four years.
The Company historically participated in structured transactions in project finance related areas under which the Company provided a cash loan supporting project finance transactions. These transactions are accounted for in accordance with guidance governing accounting by certain entities (including entities with trade receivables) that lend to or finance the activities of others under which the loans are considered held for investment as the Company has the intent and ability to hold for the foreseeable future or until maturity or payoff. Accordingly, these funded loan participations are reported in the balance sheet at outstanding principal adjusted for any allowance for loan losses as considered necessary by management.
The following table shows a summary of the structured project finance loans for the years ended December 31, 2012 and 2011:
The Company has goodwill of $392.9 million at December 31, 2012, all related to the Reinsurance segment. The estimated fair values of the reporting units’ carrying goodwill exceeded their estimated net book values at December 31, 2012 and therefore no impairments were recorded during 2012. The Company recorded a non-cash impairment of $429.0 million during the fourth quarter of 2011 to write-off all of the goodwill associated with its Insurance segment reporting unit, as discussed further below. At December 31, 2012 and 2011, the ending goodwill balance is comprised of gross goodwill of $1.8 billion, offset by accumulated impairment charges of $ 1.4 billion.
financial performance for a ten-year period combined with an estimated terminal value. The most significant assumptions used in the discounted cash flow methodology are the discount rate, the terminal value and expected future revenues, gross margins and operating margins, which vary among reporting units. If the individual reporting unit net book values exceed their related individual reporting unit estimated fair values based on this additional methodology, the second step of the goodwill impairment testing process is performed to measure the amount of impairment.
The Company utilizes reinsurance and retrocession agreements principally to increase aggregate capacity and to reduce the risk of loss on business assumed. The Company’s reinsurance and retrocession agreements provide for recovery of a portion of losses and loss expenses from reinsurers and reinsurance recoverables are recorded as assets. The Company is liable if the reinsurers are unable to satisfy their obligations under the agreements. Under its reinsurance security policy, the Company seeks to cede business to reinsurers generally with a financial strength rating of “A” or better. The Company considers reinsurers that are not rated or do not fall within the above rating categories and may grant exceptions to the Company’s general policy on a case-by-case basis. The effect of reinsurance and retrocessional activity on premiums written and earned from property and casualty operations is shown below:
The Company recorded reinsurance recoveries on losses and loss expenses incurred of $0.6 billion, $1.1 billion and $1.0 billion for the years ended December 31, 2012, 2011 and 2010, respectively.
At December 31, 2012 and 2011, the total reinsurance assets of $3.4 billion and $3.9 billion, respectively, included reinsurance receivables for paid losses and loss expenses of $58.4 million and $220.0 million, respectively, with $3.4 billion and $3.7 billion relating to the ceded reserve for losses and loss expenses, including ceded losses incurred but not reported for each year end. Although the contractual obligation of individual reinsurers to pay their reinsurance obligations is based on specific contract provisions, the collectability of such amounts requires significant estimation by management. The majority of the balance the Company has accrued as recoverable will not be due for collection until sometime in the future. Over this period of time, economic conditions and operational performance of a particular reinsurer may impact its ability to meet these obligations and while it may continue to acknowledge its contractual obligation to do so, it may not have the financial resources or willingness to fully meet its obligations to the Company.
At December 31, 2012 and 2011, the allowance for uncollectible reinsurance relating to both reinsurance balances receivable and unpaid losses and loss expenses recoverable were $107.9 million and $99.2 million, respectively. To estimate the provision for uncollectible reinsurance recoverable, the reinsurance recoverable must first be allocated to applicable reinsurers. As part of this process, ceded IBNR is allocated by reinsurer. The allocations are generally based on historical relationships between gross and ceded losses. If actual experience varies materially from historical experience, the allocation of reinsurance recoverable by reinsurer will change.
At December 31, 2012, the use of different assumptions within the model could have a material effect on the bad debt provision reflected in the Company’s Consolidated Financial Statements. To the extent the
Current year net losses incurred decreased by $281.9 million in 2012 as compared to 2011. This was mainly as a result of the current year loss ratio excluding prior year development decreasing by 11.1 loss percentage points due to lower losses from natural catastrophes as compared to 2011. In addition, the current year loss ratio excluding natural catastrophes improved in both the Insurance and Reinsurance segments due to lower large property risk losses, as well as business mix changes and other underwriting improvements.
Current year net losses incurred increased by $778.6 million in 2011 as compared to 2010. This was mainly as a result of the current year loss ratio excluding prior year development increasing by 10.7 loss percentage points due to higher losses from natural catastrophes as compared to 2010, but also from the following: (i) the Insurance segment in 2011 experienced higher large loss activity in the energy, property and marine businesses, as compared to 2010; and (ii) the Reinsurance segment in 2011 experienced higher levels of large loss events in U.S. property including a deterioration in the performance of a large U.S. agricultural program, higher attritional losses as well as business mix changes, as compared to 2010.
The following table summarizes the net (favorable) adverse prior year development by line of business relating to the Insurance segment for the last three years ended December 31:
For property lines, net prior year development during the year was $46.7 million favorable. This was driven by a release of $26.5 million for the non-catastrophe exposures in the general property, energy and construction books due to better than expected reported loss experience predominantly in the 2011 accident year. It was also driven by releases totaling $19.6 million for the catastrophe exposures, with $12.5 million and $6.1 million arising from the 2010 and 2011 accident years, respectively.
For professional lines, net prior year development during the year was $106.4 million favorable. This was driven by releases in reserves for clash losses (which cover a number of substantially similar claims against multiple policyholders) in the U.S. and Bermuda core professional businesses totaling $120.8 million. This is comprised of $44.2 million and $37.0 million released from the 2010 and 2011 report years, respectively, to reflect the limited clash events for these years. In addition, $48.4 million was released from the 2007 report year to reflect that subprime claims are developing better than expected. Finally, the 2006 and prior report years were strengthened by $8.8 million to reflect the unfavorable reported loss experience across these years.
The following table summarizes the net (favorable) adverse prior year development by line of business relating to the Reinsurance segment for the last three years ended December 31:
Net favorable prior year development during the year of $107.6 million for the short-tailed lines and details of these by specific lines are as follows:
For property catastrophe lines, net prior year development during the year was $16.5 million favorable mainly driven by lower than expected incurred losses for the 2011 and 2005 catastrophe losses on the Bermuda book.
For property other lines, net prior year development during the year was $49.0 million favorable mainly due to favorable claim development on the International, North America and Bermuda books offset by some unfavorable claim development on the Latin America book.
For marine and aviation lines, net prior year development during the year was $42.2 million favorable due mainly to favorable attritional development of $27.3 million on the International book together with $6.1 million release on prior year large losses. There is an additional $4.9 million favorable prior year development in Bermuda and $4.1 million favorable prior year development in North America.
For casualty lines, net prior year development during the year was $60.3 million favorable arising mainly out of the North America book due to more favorable than expected development on the 2003 and 2004 underwriting years.
For other lines, net prior year development during the year was $7.9 million favorable mainly driven by $8.4 million release on the Structured Indemnity book.
Net favorable prior year reserve development for the Reinsurance segment of $245.5 million for the year ended December 31, 2010 was attributable to a net favorable prior year development of $145.8 million for the short-tailed lines and a net favorable prior year development of $99.7 million for the long-tailed lines. The net favorable prior year development for short-tailed lines was explained by $35.6 million net in favorable property catastrophe development, by $87.4 million in favorable property other lines releases and by additional $22.8 million net in favorable marine and aviation development. The net favorable prior year development for long-tailed lines was explained by $25.2 million in favorable casualty and professional development and by additional $74.5 million in favorable other lines development is mainly driven by reserve releases on whole account treaties written in Lloyd’s syndicates.
Exchange rate effects on net loss reserves in each of the three years ended December 31, 2012, 2011 and 2010 related to our global operations primarily where reporting units have a functional currency that is not the U.S. dollar. In 2012, the U.S. dollar was weaker against the major currencies to which we are exposed, including the U.K. sterling, the Euro and the Swiss franc. In 2011, the U.S. dollar was stronger against U.K. sterling, the Euro, the Brazilian real and the Swiss franc, which more than offset losses that were driven by a stronger Australian dollar. In 2010, the U.S. dollar was stronger against the Euro, while weaker against the Swiss franc, Canadian dollar and Brazilian real. These movements in the U.S. dollar gave rise to translation and revaluation exchange movements related to carried loss reserve balances of $156.2 million, $(130.5) million and $(125.1) million in the years ended December 31, 2012, 2011 and 2010, respectively.
The Company did not dispose of or acquire net loss reserves in 2012, 2011 or 2010.
from reinsurers was $107.9 million and $99.2 million, respectively. For further information, see Note 9, “Reinsurance.”
The Company’s reserving process includes a continuing evaluation of the potential impact on unpaid liabilities from exposure to discontinued asbestos and run-off environmental claims, including related loss adjustment expenses. Liabilities are established to cover both known and incurred but not reported claims. The Company’s reserving and exposures to environmental liability business currently written within the NAPC and IPC business groups are not included in this note, which only relates to specific discontinued and/or run-off coverages, not originally written specifically to cover such environmental hazards.
Reserves for incurred but not reported losses, net of reinsurance, included in the above table were $52.2 million, $47.2 million and $54.9 million in 2012, 2011 and 2010, respectively. Unpaid losses recoverable are net of potential uncollectible amounts.
At December 31, 2012, the Company had 1,073 open claim files for potential discontinued asbestos claims exposures and 354 open claim files for potential run-off environmental claims exposures. Approximately 42%, 43% and 44% of the open claim files are due to precautionary claim notices in 2012, 2011 and 2010, respectively. Precautionary claim notices are submitted by the ceding companies in order to preserve their right to receive coverage under the reinsurance contract.
The estimation of loss and loss expense liabilities for discontinued asbestos and run-off environmental exposures is subject to much greater uncertainty than is normally associated with the establishment of liabilities for certain other exposures due to several factors, including: (i) uncertain legal interpretation and application of insurance and reinsurance coverage and liability; (ii) the lack of reliability of available historical claims data as an indicator of future claims development; (iii) an uncertain political climate which may impact, among other areas, the nature and amount of costs for remediating waste sites; and (iv) the potential of insurers and reinsurers to reach agreements in order to avoid further significant legal costs. Due to the potential significance of these uncertainties, the Company believes that no meaningful range of loss and loss expense liabilities beyond recorded reserves can be established. As the Company’s net unpaid loss and loss expense reserves related to discontinued asbestos and run-off environmental exposures are less than 1% of the total net reserves at December 31, 2012 and 2011, further adverse development is not expected to be material to the Company’s overall net loss reserves. The Company believes it has made reasonable provision for its discontinued asbestos and run-off environmental exposures and is unaware of any specific issues that would significantly affect its estimate for loss and loss expenses.
“In Use” and “Outstanding” data represent December 31, 2012 and 2011 accreted values.
All outstanding debt of the Company at December 31, 2012, as noted in the table above, was issued by XL-Cayman. At December 31, 2011, all outstanding debt was issued by XL-Cayman except for the $600 million par value 6.5% Guaranteed Senior Notes (the “XLCFE Notes”) which were issued by XL Capital Finance (Europe) plc (“XLCFE”) and were repaid at maturity on January 15, 2012. Both XL-Cayman and XLCFE are 100% owned subsidiaries of XL-Ireland. The XLCFE Notes were fully and unconditionally guaranteed by XL Company Switzerland GmbH. XL-Cayman’s outstanding debt is fully and unconditionally guaranteed by XL-Ireland. The ability of XL-Cayman, like that of the Company’s to obtain funds from its subsidiaries to satisfy any of its obligations under guarantees is subject to certain contractual restrictions, applicable laws and statutory requirements of the various countries in which the Company operates, including, among others, Bermuda, the United States, Ireland, Switzerland and the U.K. For details of the required statutory capital and surplus for the principal operating subsidiaries of the Company, see Note 23, “Statutory Financial Data.”
interest in a senior note issued by the Company due August 15, 2021 with a principal amount of $1,000. The senior notes were pledged by the holders to secure their obligations under the purchase contract.
The number of shares issued under the purchase contract was contingently adjustable based on, among other things, the share price of the Company on the stock purchase date and the dividend rate of the Company. The Company made quarterly payments at the annual rate of 2.50% and 8.25% under the purchase contracts and senior notes, respectively. For all periods reported, the Company had the right to defer the contract payments on the purchase contract, but not the senior notes, until the stock purchase date. In August 2011, the senior notes were remarketed whereby the interest rate on the senior notes was to be reset in order to generate sufficient remarketing proceeds to satisfy the 10.75% Unit holders’ obligations under the purchase contracts.
In connection with this transaction, $37.9 million, which is the estimated fair value of the purchase contract, was charged to “Additional paid in capital” and a corresponding liability was established. Of the $18.0 million total accrued costs associated with the issuance of the 10.75% Units, $14.7 million was charged to “Additional paid in capital” with the remainder deferred and amortized over the term of the senior debt.
In August 2011, in accordance with the terms of the 10.75% Units, XL-Cayman purchased and retired all of the 8.25% senior notes due August 2021 (the “8.25% Senior Notes”) for $575 million in a remarketing. These notes comprised a part of the 10.75% Units. The proceeds from the remarketing were used to satisfy the purchase price for XL-Ireland’s ordinary shares issued to holders of the 10.75% Units pursuant to the forward purchase contracts comprising a part of the 10.75% Units. Each forward purchase contract provided for the issuance of 1.3242 ordinary shares of XL-Ireland at a price of $25 per share. The settlement of the forward purchase contracts resulted in XL-Ireland’s issuance of an aggregate of 30,456,600 ordinary shares for an aggregate purchase price of $575 million. As a result of the settlement of the forward purchase contracts, the 10.75% Units ceased to exist and are no longer traded on the NYSE.
At December 31, 2012 and December 31, 2011, there were five available letter of credit facilities.
At December 31, 2012 and December 31, 2011, the revolving credit facility was unutilized.
The commitments under each December 2011 Credit Agreement expire on, and such credit facilities are available until, the earlier of (i) December 9, 2015 and (ii) the date of termination in whole of the commitments upon an optional termination or reduction of the commitments by the account parties or upon an event of default.
The availability of letters of credit under the December 2011 Secured Credit Agreement and the March 2011 Credit Agreements is subject to a borrowing base requirement, determined on the basis of specified percentages of the face value of eligible categories of assets varying by type of collateral.
In general, all of the Company’s bank facilities, indentures and other documents relating to the Company’s outstanding indebtedness (collectively, the “Company’s Debt Documents”), as described above, contain cross acceleration or cross default provisions to each other and the Company’s Debt Documents contain affirmative covenants. These covenants provide for, among other things, minimum required ratings of the Company’s insurance and reinsurance operating subsidiaries and the level of secured indebtedness in the future. In addition, generally each of the Company’s Debt Documents provide for an event of default in the event of a change of control of the Company or some events involving bankruptcy, insolvency or reorganization of the Company. The Company’s credit facilities also contain minimum consolidated net worth covenants.
Under the March 2011 Credit Agreement and December 2011 Credit Agreements, in the event that XL Insurance (Bermuda) Ltd, XL Re Ltd or XL Re Europe Ltd fail to maintain a financial strength rating of at least “A - ” from A.M. Best, an event of default would occur.
Instruments.” The following table summarizes information on the location and gross amounts of derivative fair values contained in the consolidated balance sheet as at December 31, 2012 and 2011:
At December 31, 2012, the Company paid net cash collateral related to these derivative positions of $12.1 million. The assets related to the net collateral paid have been recorded as Other assets within the balance sheet. At December 31, 2011, the Company held net cash collateral of $77.1 million. The collateral balance is included within Cash and cash equivalents and the corresponding liability to return the collateral has been offset against the derivative asset within the balance sheet as appropriate under the netting agreement.
The Company may hedge portions of its liabilities against changes in the applicable designated benchmark interest rate. Interest rate swaps are also used to hedge the changes in fair value of certain fixed rate liabilities and fixed income securities due to changes in the designated benchmark interest rate. In addition, the Company utilizes foreign exchange contracts to hedge the fair value of certain fixed income securities as well as to hedge certain net investments in foreign operations.
During the year ended December 31, 2010, the Company settled the interest rate contracts designated as fair value hedges of certain of the Company’s notes payable and debt and also settled three interest rate contracts designated as fair value hedges of certain of the Company’s deposit liability contracts. The cumulative increase recorded to the carrying value of the hedged notes payable and debt of $21.6 million, and the deposit liability contracts of $149.5 million, representing the effective portion of the hedging relationship, is amortized through interest expense over the remaining terms of the debt and deposit liability contracts.
In July 2012, the Company settled two interest rate contracts designated as fair value hedges of certain of the Company’s deposit liability contracts. At settlement, the cumulative increase recorded to the carrying value of the hedged deposit liability contracts was $83.7 million. This amount will be amortized, through
A summary of the fair value hedges that have been settled and their impact on results during the year ended December 31, 2012 and 2011 is shown below:
The following table provides the total impact on earnings relating to derivative instruments not formally designated as hedging instruments under authoritative accounting guidance and from the ineffective portion of fair value hedges. The impacts are all recorded through Net realized and unrealized gains (losses) on derivatives in the income statement for the years ended December 31, 2012, 2011 and 2010:
The Company utilizes risk management and overlay strategies that incorporate the use of derivative financial instruments, primarily to manage its fixed income portfolio duration and exposure to interest rate risks associated with primarily those assets and liabilities related to certain legacy other financial lines and structured indemnity transactions. The Company uses interest rate swaps to convert certain liabilities from a fixed rate to a variable rate of interest and may also use them to convert a variable rate of interest from one basis to another.
The Company has exposure to foreign currency exchange rate fluctuations through its operations and in its investment portfolio. The Company uses foreign exchange contracts to manage its exposure to the effects of fluctuating foreign currencies on the value of certain of its foreign currency fixed maturities primarily within its Life operations portfolio. These contracts are not designated as specific hedges for financial
In addition, certain of the Company’s investment managers may, subject to investment guidelines, enter into forward contracts where potential gains may exist.
Credit derivatives may be purchased within the Company’s investment portfolio in the form of single name and basket credit default swaps, which are used to mitigate credit exposure through a reduction in credit spread duration (i.e., macro credit strategies rather than single-name credit hedging) or exposure to selected issuers, including issuers that are not held in the underlying bond portfolio.
The Company also has derivatives embedded in certain reinsurance contracts. For a certain life reinsurance contract, the Company pays the ceding company a fixed amount equal to the estimated present value of the excess of guaranteed benefit over the account balance upon the policyholder’s election to take the income benefit. The fair value of this derivative is determined based on the present value of expected cash flows. In addition, the Company has modified coinsurance and funds withheld reinsurance agreements that provide for a return based on a portfolio of fixed income securities. As such, the agreements contain embedded derivatives. The embedded derivative is bifurcated from the funds withheld balance and recorded at fair value with changes in fair value recognized in earnings through Net realized and unrealized gains and losses on derivative instruments.
Certain derivatives agreements entered into by the Company or its subsidiaries contain rating downgrade provisions that permit early termination of the agreement by the counterparty if collateral is not posted following failure to maintain certain credit ratings from one or more of the principal credit rating agencies. If the Company were required to early terminate such agreements due to a rating downgrade, it could potentially be in a net liability position at the time of settlement. The aggregate fair value of all derivatives agreements containing such rating downgrade provisions that were in a liability position and the collateral posted under any of these agreements as of December 31, 2012 and December 31, 2011 were as follows:
There were no material off-balance sheet arrangements at December 31, 2012.
On December 5, 2006, the Company and certain operating subsidiaries (“Ceding Insurers”) entered into a securities issuance agreement (the “Securities Issuance Agreement”), and certain of the Company’s foreign insurance and reinsurance subsidiaries (“Ceding Insurers”) entered into an excess of loss reinsurance agreement (the “Reinsurance Agreement”), with Stoneheath Re (“Stoneheath”). The net effect of these agreements to the Company was the creation of a contingent put option to issue $350.0 million of preference ordinary shares in the aggregate of XL-Cayman. The agreements provided the Company with a Reinsurance Collateral Account in support of certain covered perils named in the Reinsurance Agreement. The covered perils included United States wind, European wind, California earthquake and terrorism worldwide. After an initial three-month period, the covered perils as well as the attachment points and aggregate retention amounts could be changed by the Ceding Insurers in their sole discretion, which could have resulted in a material increase or decrease in the likelihood of payment under the Reinsurance Agreement. On each date on which a Ceding Insurer withdrew funds from the Reinsurance Collateral Account, the Company would have been required to issue and deliver to Stoneheath an amount of Series D Preference Ordinary Shares having an aggregate liquidation preference that is equal to the amount of funds so withdrawn from the Collateral Account. The Company was obligated to reimburse Stoneheath for certain fees and ordinary expenses. The initial term of the Reinsurance Agreement was for the period from the December 5, 2006 through June 30, 2007, with four annual mandatory extensions through June 30, 2011 (unless coverage was exhausted thereunder prior to such date). At the Ceding Insurers’ option, the Reinsurance Agreement was extended to December 31, 2011.
At times, the Company has utilized variable interest entities (“VIEs”) both indirectly and directly in the ordinary course of the Company’s business.
The Company has a limited number of remaining outstanding credit enhancement exposures, including written financial guarantee and credit default swap contracts. The obligations related to these transactions are often securitized through VIEs. The Company is not the primary beneficiary of these VIEs as contemplated in current authoritative accounting guidance on the basis that management does not believe that the Company has the power to direct the activities, such as asset selection and collateral management, which most significantly impact each entity’s economic performance. For further details on the nature of the obligations and the size of the Company’s maximum exposure, see Note 14, “Derivative Instruments,” and Note 17 (h), “Commitments and Contingencies - Financial and Other Guarantee Exposures.”
The Company has committed to invest in several limited partnerships and provide liquidity financing to a structured investment vehicle. At December 31, 2012, the Company has commitments, which include potential additional add-on clauses, to invest an additional $92.4 million over approximately the next nine years.
The Company rents space for certain of its offices under leases that expire up to 2031. Total rent expense under operating leases for the years ended December 31, 2012, 2011 and 2010 was approximately $35.6 million, $32.9 million and $31.8 million, respectively. Future minimum rental commitments under existing operating leases are expected to be as follows:
XL-Ireland is an Irish corporation and, except as described below, neither it nor its non-U.S. subsidiaries have paid U.S. corporate income taxes (other than withholding taxes on dividend income) on the basis that they are not engaged in a trade or business or otherwise subject to taxation in the United States However, because definitive identification of activities which constitute being engaged in a trade or business in the United States is not provided by the Internal Revenue Code of 1986, regulations or court decisions, there can be no assurance that the Internal Revenue Service will not contend that the Company or its non-U.S. subsidiaries are engaged in a trade or business or otherwise subject to taxation in the United States If the Company or its non-U.S. subsidiaries were considered to be engaged in a trade or business in the United States (and, if the Company or such subsidiaries were to qualify for the benefits under the income tax treaty between the United States and Bermuda and other countries in which the Company operates, such businesses were attributable to a “permanent establishment” in the United States), the
Company or such subsidiaries could be subject to U.S. tax at regular tax rates on its taxable income that is effectively connected with its U.S. trade or business plus an additional “branch profits” tax (at a rate as high as 30%) on such income remaining after the regular tax, in which case there could be a significant adverse effect on the Company’s results of operations and financial condition.
At December 31, 2012 and 2011, $1.8 billion and $1.9 billion of letters of credit were outstanding, of which 93.3% and 93.8%, respectively, were collateralized by the Company’s investment portfolios, primarily supporting U.S. non-admitted business and the Company’s Lloyd’s syndicates’ capital requirements.
Legal actions are subject to inherent uncertainties, and future events could change management’s assessment of the probability or estimated amount of potential losses from pending or threatened legal actions. Based on available information, it is the opinion of management that the ultimate resolution of pending or threatened legal actions other than claims proceedings, both individually and in the aggregate, will not result in losses having a material adverse effect on the Company’s financial position or liquidity at December 31, 2012.
During January 2011, the Company commuted 32 of the 37 financial guarantee transactions that were outstanding at December 31, 2010 and were part of the Company’s legacy financial guarantee business, including three non-performing transactions. This commutation eliminated $41.9 million of notional financial guarantee exposure (including principal and interest) for a payment of $22.1 million. The $22.1 million was included in the gross claim liability at December 31, 2010. In addition, during the fourth quarter of 2011, one guarantee was terminated upon prepayment of the underlying notes.
Includes share buybacks associated with authorized share buyback programs as well as purchases related to satisfying tax withholding obligations of employees in connection with the vesting of restricted shares granted under the Company’s restricted stock plan.
On February 27, 2012, the Company announced that the XL-Ireland Board of Directors approved a share buyback program, authorizing the Company to purchase up to $750 million of its ordinary shares (the “February 2012 Program”). This authorization replaced the approximately $190 million remaining under the share buyback program that was authorized in November 2010. During 2012, the Company purchased and canceled 18.3 million ordinary shares under the February 2012 Program for $401.6 million. At December 31, 2012, $348.4 million remained available for purchase under the program. Between January 1 and February 22, 2013 the Company purchased and canceled an additional 3.8 million shares for $98.4 million. All share buybacks were carried out by way of redemption in accordance with Irish law and the Company’s constitutional documents. All shares so redeemed were canceled upon redemption. On February 22, 2013, the Company announced that the XL-Ireland Board of Directors approved a new share buyback program, authorizing the purchase of up to $850 million of its ordinary shares. This replaced the approximately $250 million remaining under the February 2012 Program.
On February 16, 2011, the Company repurchased 30,000 of the outstanding Redeemable Series C preference ordinary shares with a liquidation preference value of $0.75 million for $0.65 million.
The following is a summary of the stock option plans for the three years ended December 31:
The following is a summary of the stock options at December 31, 2012, and related activity for the year then ended for the Company:
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the 2012 fiscal year and the exercise price, multiplied by the number of in-the-money-options) that would have been received by the option holders had all option holders exercised their options on December 31, 2012. Total unrecognized stock-based compensation expense related to non-vested stock options was approximately $9.9 million at December 31, 2012, related to approximately 2.2 million options, which is expected to be recognized over a weighted- average period of 1.3 years. The exercise price of the Company’s outstanding options granted is the market price of the Company’s ordinary shares on the grant date, except that during 2004, 295,000 options were granted with an exercise price of $88.00 when the market price was $77.10.
Total unrecognized stock based compensation expense related to non-vested restricted stock awards was approximately $5.8 million at December 31, 2012, related to approximately 0.5 million restricted stock awards, which is expected to be recognized over 1.4 years.
A summary of the restricted stock units issued to officers of the Company and its subsidiaries for the three years ended December 31 is as follows:
Total unrecognized stock-based compensation expense related to non-vested performance units was approximately $27.2 million as of the end of December 31, 2012, related to approximately 2.5 million performance units, which is expected to be recognized over 1.9 years. Non-vested restricted performance units as of December 31, 2012 were as follows:
The Company has qualified defined contribution plans which are managed externally and whereby employees and the Company contribute a certain percentage of the employee’s gross compensation (base salary and annual bonus) into the plan each month. The Company’s contribution generally vests over five years. The Company’s expenses for its qualified contributory defined contribution retirement plans were $53.6 million, $42.4 million and $37.8 million at December 31, 2012, 2011 and 2010, respectively.
A qualified non-contributory defined benefit pension plan exists to cover a number of its U.S. employees. The plan was curtailed in 2002 and was closed to new entrants at that time. Under the terms of the curtailment, existing plan participants were no longer entitled to earn additional defined benefits for future services performed after the curtailment date; however, accrued benefits are eligible for annual cost-of-living increases. This plan also includes a non-qualified supplemental defined benefit plan designed to compensate individuals to the extent that their benefits under the Company’s qualified plan are curtailed due to IRS Code limitations. Benefits are based on years of service and compensation, as defined in the plan, during the highest consecutive three years of the employee’s last ten years of employment. Under
these plans, the Company’s policy is to make annual contributions to the plan that are deductible for federal income tax purposes and that meet the minimum funding standards required by law. The contribution level is determined by utilizing the entry age cost method and different actuarial assumptions than those used for pension expense purposes.
The U.S. Plan assets at December 31, 2012 and 2011 consist of two mutual funds. The first fund employs a core bond portfolio strategy that seeks maximum current income and price appreciation consistent with the preservation of capital and prudent risk taking with the focus on intermediate - term high quality bonds.
The second fund seeks long term growth of capital by investing in a diversified group of domestic and international companies. Using a quantitative approach, portfolio managers identify companies that they believe have favorable prospects for above average growth.
The fair value of the U.S. Plan assets at December 31, 2012 and 2011 was $29.8 million and $25.9 million, respectively. As both of the retirement plan’s investments are mutual funds, they fall within Level 1 in the fair value hierarchy.
The U.K. pension plan assets are held in a separate trustee administered fund to meet long term liabilities to past and present employees. The table below shows the composition of the Scheme’s assets and the fair value of each major category of plan assets as of December 31, 2012 and 2011, as well as the potential returns of the different asset classes. The totals of the asset values held in various externally managed portfolios are provided by third party pricing vendors. There is no significant concentration of risk within plan assets. The assets in the scheme and the expected rates of return were as follows:
The components of the net benefit cost for the years ended December 31, 2012 and 2011 are as follows:
The December 31, 2012, 2011 and 2010 balance of each component of accumulated other comprehensive income (loss) were as follows:
Following completion of the Redomestication, with effect from July 1, 2010, the Company is subject to income and capital gains tax in Ireland under applicable Irish law. Prior to July 1, 2010, the Company was resident for tax purposes in the Cayman Islands and in accordance with Cayman law, was not subject to any taxes in the Cayman Islands on either income or capital gains.
The Company has open examinations by tax authorities in the U.S. (2010), Ireland (2006 to 2009), the U.K. (2007 to 2010), Germany (2006 to 2009), Switzerland (2009 and 2010), India (2006 to 2011) and Singapore (2010). The Company believes that these examinations will be concluded within the next 24 months; however, it is not currently possible to estimate the outcome of these examinations.
The Company’s income (loss) before income tax was distributed for the years ended December 31, 2012, 2011 and 2010 as follows:
The weighted average expected tax provision has been calculated using the pre-tax accounting income (loss) in each jurisdiction multiplied by that jurisdiction’s applicable statutory tax rate. The applicable statutory tax rates of the most significant jurisdictions contributing to the overall taxation of the Company are: Ireland 12.5% and 25%, Bermuda 0%, the U.S. 35%, the U.K. 24.5%, Switzerland 7.83% and 21.2%, Germany 15%, and France 36.13%. Reconciliation of the difference between the provision for income taxes and the expected tax provision at the weighted average tax rate for the years ended December 31, 2012, 2011 and 2010 is provided below:
The deferred tax asset and liability balances presented above represent the gross deferred tax asset and liability balances across each tax jurisdiction. The deferred tax asset balances of $166.1 million and $115.6 million at December 31, 2012 and 2011, respectively, and deferred tax liability balances of $141.8 million and $91.1 million at December 31, 2012 and 2011, respectively, as disclosed on the consolidated balance sheets include netting of certain deferred tax assets and liabilities within a tax jurisdiction to the extent such netting is consistent with the regulations of the tax authorities in those jurisdictions.
The valuation allowance at December 31, 2012 and 2011 of $297.6 million and $497.2 million, respectively, related primarily to net operating loss carry forwards in Switzerland ($9.9 million and $183.1 million at December 31, 2012 and 2011 respectively), net operating loss and capital loss carry forwards in Ireland ($59.2 million and $53.1 million at December 31, 2012 and 2011 respectively), and net unrealized capital losses and realized capital loss carry forwards in the U.S. that may not be realized within a reasonable period ($196.5 million and $237.2 million at December 31, 2012 and 2011 respectively). The reduction in the valuation allowance in 2012 was primarily due to the expiration of $784.8 million of Swiss net operating losses, with a related valuation allowance of $166.4 million, and the release of certain valuation allowances held against capital loss carry-forwards in the U.S.
At December 31, 2012, net operating loss carry forwards in the U.K. were approximately $45.2 million ($10.5 million tax effected) and have no expiration. A valuation allowance of $1.8 million has been established in respect of $7.8 million of these U.K. losses given management’s expectation that losses in specific U.K. entities will not be utilized in the future. At December 31, 2012, net operating loss carry forwards in Switzerland were approximately $68.3 million, of which $7.1 million will expire at the end of 2013 with the balance expiring in future years through 2019. A valuation allowance of $9.9 million has been established in respect of $62.8 million of the Swiss net operating losses which includes the $7.1 million of Swiss net operating losses that will expire in 2013. At December 31, 2012, net operating loss carry forwards in Ireland were approximately $150.9 million, with a further $122.1 million of capital losses carried forward. Although these Irish losses may be carried forward indefinitely, a valuation allowance ($59.2 million) has been established in respect of all of these Irish losses due to the uncertainty surrounding any future loss utilization.
Required statutory capital and surplus at December 31, 2012 represents 100% Bermuda Solvency Capital Requirement (“BSCR”) level for the top Bermuda operating subsidiary, XL Insurance (Bermuda) Ltd, calculated on a consolidated basis (and therefore includes a BSCR requirement for all regions). Required statutory capital and surplus at December 31, 2011 represents 100% BSCR level for the principal Bermuda operating subsidiaries only. If the December 31, 2011 required statutory capital and surplus had been determined on a consolidated basis, consistent with the 2012 requirement, the amount would have been $6.5 billion.
In early July 2008, the Insurance Amendment Act of 2008 was passed, which introduced a number of changes to the Bermuda Insurance Act 1978, such as allowing the Bermuda Monetary Authority (BMA) to prescribe standards for an enhanced capital requirement and a capital and solvency return that insurers and reinsurers must comply with. The Bermuda Solvency Capital Requirement (BSCR) employs a standard mathematical model that can relate more accurately the risks taken on by (re)insurers to the capital that is dedicated to their business. Insurers and reinsurers may adopt the BSCR model or, where an insurer or reinsurer believes that its own internal model better reflects the inherent risk of its business, an in-house
Under the Insurance Act 1978, amendments thereto and related regulations of Bermuda, Class 4 (re)insurers are prohibited from declaring or paying dividends of more than 25% of each of their prior year’s statutory capital and surplus unless they file with the BMA an affidavit stating that the dividend has not caused the Class 4 (re)insurer to fail to meet its relevant margins. At December 31, 2012 and 2011, the maximum dividend that our Bermuda Class 4 (re)insurers could pay, without a signed affidavit, having met minimum levels of statutory capital and surplus and liquidity requirements, was approximately $1.4 billion and $1.3 billion, respectively. No Class 4 (re)insurer may reduce its total statutory capital by 15% or more unless it has received the prior approval of the BMA, and it must also submit an affidavit stating that the proposed reduction will not cause it to fail to meet its minimum solvency margin or minimum liquidity ratio.
XL-Ireland is subject to certain legal constraints that affect its ability to pay dividends on or redeem or buyback its ordinary shares. While XL-Ireland’s articles of association authorize its board of directors to declare and pay dividends as justified from the profits, under Irish law, XL-Ireland may only pay dividends or buyback or redeem shares using distributable reserves. In addition, no dividend or distribution may be made unless the net assets of XL-Ireland are not less than the aggregate of its share capital plus
undistributable reserves and the distribution does not reduce XL-Ireland’s net assets below such aggregate. As of December 31, 2012, XL-Ireland had $3.6 billion in distributable reserves.
In addition, XL-Cayman is subject to certain constraints that affect its ability to pay dividends on its preferred shares. Under Cayman Islands law, XL-Cayman may not declare or pay a dividend if there are reasonable grounds for believing that XL-Cayman is, or would after the payment be, unable to pay its liabilities as they become due in the ordinary course of business. Also, the terms of XL-Cayman’s preferred shares prohibit declaring or paying dividends on the ordinary shares unless full dividends have been declared and paid on the outstanding preferred shares. Full dividends have been declared and paid on the outstanding preferred shares at December 31, 2012.
At December 31, 2012, XL-Ireland and XL-Cayman held cash and investments, net of liabilities associated with cash sweeping arrangements, of $11.0 million and $1.4 billion, respectively, compared to $1.6 million and $2.0 billion, respectively, at December 31, 2011.
24. Computation of Earnings Per Ordinary Share and Ordinary Share Equivalent (Continued)
At December 31, 2012 and 2011, the Company owned minority stakes in four and three, respectively, independent investment management companies (“Investment Manager Affiliates”) that are actively managing client capital and seeking growth opportunities. The Company seeks to develop relationships with specialty investment management organizations, generally acquiring an equity interest in the business. The Company also invests in certain of the funds and limited partnerships and other legal entities managed by these affiliates and through these funds and partnerships pays management and performance fees to the Company’s Investment Manager Affiliates.
In addition, the Company had entered into a reinsurance contract with another strategic affiliate, ITAU, which, as disclosed in Note 6, “Investments in Affiliates,” was sold during the second quarter of 2010.