The Company leases office space in Hamilton (Bermuda) where the Company’s principal executive offices are located. Additionally, the Company leases office space in various locations, principally in Dublin, Greenwich (Connecticut), Paris and Zurich.
The following discussion provides an overview of the Company’s business and trends and commentary regarding the outlook for 2014 in each business.
The Non-life reinsurance market has historically been highly cyclical in nature. The reinsurance cycle is driven by competition, the amount of capital and capacity in the industry, loss events and investment returns. The Company’s long-term strategy to generate total shareholder value focuses on broad product, asset and geographic diversification of risks.
The cyclicality of the Non-life reinsurance market is characterized by cycles of growth and decline, known as hard and soft insurance cycles. Since late 2003, the Company began to see the emergence of a soft market across most lines of business with general decreases in pricing and profitability. With the exception of lines and markets impacted by specific catastrophic or large loss events, this trend continued throughout the decade. From 2011 to 2013, the Company experienced increases in pricing in certain loss affected lines of business and markets, which were primarily related to the increased catastrophic and large loss activity during 2011 and from the impact of Superstorm Sandy in 2012. During 2013, in lines of business and markets that have not been specifically impacted by any large losses in recent years, the terms and conditions continued to be mainly static and soft in most markets, with price deteriorations observed in some markets as a result of increased competition and excess capacity in the industry.
During the January 1, 2014 renewals the Company experienced an increase of approximately 3% in renewable Non-life treaty business, on a constant foreign exchange basis. The increase in expected premium volume was driven primarily by the Company’s diversifying lines, and was mainly attributable to certain contracts negotiated earlier in 2013 and incepting on January 1, 2014. As a result, the North America and Global Specialty sub-segments experienced increases in renewable premium base, while the Catastrophe and Global (Non-U.S.) P&C sub-segments experienced declines driven by declining pricing and pressure on terms and conditions in most markets that were not loss affected. The Company writes a large majority of its business on a treaty basis and renews approximately 65% of its total annual Non-life treaty business on January 1. The remainder of the Non-life treaty business renews at other times during the year.
capital flows into the industry, continue to provide a challenge to writing business meeting our profitability requirements. Despite these persistent challenging market conditions, the Company believes that its strong global franchise and geographic footprint, long track record and broad yet highly technical capabilities over many lines of business, position the Company well. The Company expects to continue with its initiatives to find new diversifying risks and expand relationships with existing clients.
The Company follows prudent investment guidelines through a strategy that seeks to maximize returns while managing investment risk in line with the Company’s overall objectives of earnings stability and long-term book value growth. The Company allocates its invested assets into two categories: liability funds and capital funds. See the discussion of liability funds and capital funds in Financial Condition, Liquidity and Capital Resources. A key challenge for the Company is achieving the right balance between current investment income and total returns (that include price appreciation or depreciation) in changing market conditions. The Company regularly reviews the allocation of investments to asset classes within its investment portfolio and its funds held - directly managed account and allocates investments to those asset classes the Company anticipates will outperform in the near future, subject to limits and guidelines. Similarly, the Company reduces its exposure to risk asset classes where returns are underperforming. The Company may also lengthen or shorten the duration of its fixed maturity portfolio in anticipation of changes in interest rates, or increase or decrease the amount of credit risk it assumes, depending on credit spreads and anticipated economic conditions.
The decrease in net income of $462 million, from $1,135 million in 2012 to $673 million in 2013 resulted primarily from:
a decrease of $87 million in net investment income, primarily driven by lower reinvestment rates; and
an increase of $68 million in other operating expenses, primarily driven by the restructuring charges described below; partially offset by
an increase of $170 million in the Non-life underwriting result, which was mainly driven by a lower level of large catastrophic losses and large losses and an increase in favorable prior year loss development and partially offset by a higher level of mid-sized loss activity;
a decrease of $155 million in income tax expense, primarily resulting from a lower pre-tax net income in 2013 compared to 2012; and
an increase of $28 million in the Life and Health underwriting result, primarily driven by an increase in favorable prior year loss development.
The decrease in net income attributable to PartnerRe Ltd. common shareholders and diluted net income per share for the year ended December 31, 2013 compared to 2012 was primarily due to the above factors. For diluted net income per share specifically, the decrease was partially offset by the accretive impact of a reduction in the diluted number of common shares and common share equivalents outstanding as a result of share repurchases.
an increase of $1,429 million in the Non-life underwriting result, which was primarily driven by a decrease of $1,417 million in large catastrophic losses and large losses; and
The following key factors affected the year over year comparison of the Company’s results and are discussed in more detail in Review of Net Income (Loss) below.
The combined impact of the large catastrophic losses and large losses, the impact on the Company’s technical result, net realized and unrealized investment gains or losses, pre-tax net income or loss, loss ratio, technical ratio and combined ratio by segment and sub-segment, and the large catastrophic losses and large losses by event for the years ended December 31, 2013, 2012 and 2011 was as follows (in millions of U.S. dollars):
(2) The Company recorded an additional IBNR reserve related to the 2011 catastrophic events, above the sum of the recorded point estimates, given the high frequency of, and uncertainty related to, these complex and highly volatile events.
In 2013, U.S. and European risk-free interest rates increased and equity markets improved and credit spreads narrowed, while the U.S. dollar ending exchange rate at December 31, 2013 weakened against most major currencies compared to December 31, 2012. As a result of these movements, the value of the Company’s investment portfolio and cash and cash equivalents at December 31, 2013 decreased compared to December 31, 2012, with the resulting mark-to-market net loss recorded in net income. Offsetting the gross mark-to-market loss was an unrealized gain related to the initial public offering of an investment in a mortgage guaranty insurance company.
In April 2013, the Company announced the restructuring of its business support operations into a single integrated worldwide support platform and changes to the structure of its Global Non-life Operations. The restructuring includes involuntary and voluntary employee termination plans in certain jurisdictions (collectively, termination plans) and certain real estate costs. Employees affected by the termination plans have varying leaving dates, largely through to mid-2014.
In connection with the restructuring, and included within the total expected costs of between $60 million and $70 million announced by the Company in April 2013, the Company expects to incur further real estate costs totaling between $5 million and $10 million in the first half of 2014.
The Company’s long-term objective is to manage a portfolio of diversified risks that will create total shareholder value. The Company measures its success in achieving its long-term objective by targeting a return, which is variable and can be adjusted by Management, in excess of a referenced risk-free rate over the reinsurance cycle. The return, which is currently targeted to exceed 700 basis points in excess of the referenced risk-free rate, is calculated using compound annual growth in diluted tangible book value per common share and common share equivalents outstanding plus dividends per common share (growth in Diluted Tangible Book Value per Share plus dividends). Management uses growth in Diluted Tangible Book Value per Share plus dividends as its prime measure of long-term financial performance and believes this measure aligns the Company’s stated long-term objective with the measure most investors use to evaluate total shareholder value creation given that it focuses on the tangible value of total shareholder returns, excluding the impact of goodwill and intangibles. Given the Company’s profitability in any particular quarterly or annual period can be significantly affected by the level of large catastrophic losses, Management assesses this long-term objective over the reinsurance cycle as the Company’s performance during any particular quarterly or annual period is not necessarily indicative of its performance over the longer-term reinsurance cycle.
and other dilutive securities). The presentation of Diluted Tangible Book Value per Share is a non-GAAP financial measure within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and is reconciled to the most directly comparable GAAP financial measure below.
(2) Growth in diluted tangible book value per common share and common share equivalents outstanding plus dividends (growth in Diluted Tangible Book Value per Share plus dividends) is calculated using Diluted Tangible Book Value per Share plus dividends per common share divided by Diluted Tangible Book Value per Share at the beginning of the year. The presentation of growth in Diluted Tangible Book Value per Share plus dividends is a non-GAAP financial measure within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and is reconciled to the most directly comparable GAAP financial measure below.
(3) Operating earnings or loss attributable to PartnerRe Ltd. common shareholders (operating earnings or loss) is calculated as net income or loss available to PartnerRe Ltd. common shareholders excluding net realized and unrealized gains or losses on investments, net of tax (except where the Company has made a strategic investment in an insurance or reinsurance related investee), net foreign exchange gains or losses, net of tax, loss on redemption of preferred shares and the interest in earnings or losses of equity investments, net of tax (except where the Company has made a strategic investment in an insurance or reinsurance related investee and where the Company does not control the investee’s activities), and is calculated after preferred dividends. Operating earnings or loss per common share and common share equivalent outstanding (diluted operating earnings or loss per share) are calculated using operating earnings or loss for the period divided by the weighted average number of common shares and common share equivalents outstanding. The presentation of operating earnings or loss and diluted operating earnings or loss per share are non-GAAP financial measures within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and are reconciled to the most directly comparable GAAP financial measure below.
(4) Operating return on beginning diluted book value per common share and common share equivalents outstanding (Operating ROE) is calculated using operating earnings or loss, as defined above, per diluted common share and common share equivalents outstanding, divided by diluted book value per common share and common share equivalents outstanding as of the beginning of the year, as defined above. The presentation of Operating ROE is a non-GAAP financial measure within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and is reconciled to the most directly comparable GAAP financial measure below.
(5) The combined ratio of the Non-life segment is calculated as the sum of the technical ratio (losses and loss expenses and acquisition costs divided by net premiums earned) and the other operating expense ratio (other operating expenses divided by net premiums earned).
Over the past five years, since December 31, 2008, and over the past ten years, since December 31, 2003, the Company has generated a compound annual growth in Diluted Tangible Book Value per Share plus dividends in excess of 14%.
equity investments (except where the Company has made a strategic investment in an investee whose operations are insurance or reinsurance related and where the Company does not control the investee’s activities). Net realized and unrealized gains or losses on investments in any particular period are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and financial market conditions, and the timing of realized gains or losses on investments is largely opportunistic. Net foreign exchange gains or losses are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and foreign exchange market conditions. Loss on the redemption of preferred shares is not indicative of the performance of, and distorts trends in, the Company’s business as it resulted from general economic and financial market conditions, and the timing of the loss on redemption was largely opportunistic. Interest in earnings or losses of equity investments are also not indicative of the performance of, or trends in, the Company’s business where the investee’s operations are not insurance or reinsurance related and where the Company does not control the investee companies’ activities. Management believes that the use of operating earnings or loss and diluted operating earnings or loss per share enables investors and other users of the Company’s financial information to analyze its performance in a manner similar to how Management analyzes performance. Management also believes that these measures follow industry practice and, therefore, allow the users of financial information to compare the Company’s performance with its industry peer group, and that the equity analysts and certain rating agencies which follow the Company, and the insurance industry as a whole, generally exclude these items from their analyses for the same reasons.
Operating earnings or loss attributable to PartnerRe Ltd. common shareholders and diluted operating earnings or loss per share are non-GAAP financial measures within the meaning of Regulation G and should be considered in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP (see Comment on Non-GAAP Measures). The reconciliation of operating earnings or loss and diluted operating earnings or loss per share to the most directly comparable GAAP financial measure for the years ended December 31, 2013, 2012 and 2011 was as follows (in millions of U.S. dollars):
Operating ROE: Management uses Operating ROE as a measure of profitability that focuses on the return to common shareholders on an annual basis. To support the Company’s growth objectives, most economic decisions, including capital attribution and underwriting pricing decisions, incorporate an Operating ROE impact analysis. For the purpose of that analysis, an appropriate amount of capital (equity) is attributed to each transaction for determining the transaction’s priced return on attributed capital. Subject to an adequate return for the risk level as well as other factors, such as the contribution of each risk to the overall risk level and risk diversification, capital is attributed to the transactions generating the highest priced return on deployed capital. Management’s challenge consists of (i) attributing an appropriate amount of capital to each transaction based on the risk created by the transaction, (ii) properly estimating the Company’s overall risk level and the impact of each transaction on the overall risk level, (iii) assessing the diversification benefit, if any, of each transaction, and (iv) deploying available capital. The risk for the Company lies in mis-estimating any one of these factors, which are critical in calculating a meaningful priced return on deployed capital, and entering into transactions that do not contribute to the Company’s growth objectives.
The average Operating ROE for the last five years and ten years was 8.9% and 11.5%, respectively. Both the five-year and the ten-year averages primarily reflect some years that were impacted by significant catastrophic losses and other years that were not impacted by catastrophes. Due to the volatility related to the
The presentation of Operating ROE is a non-GAAP financial measure within the meaning of Regulation G and should be considered in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP (see Comment on Non-GAAP Measures). The reconciliation of Operating ROE to the most directly comparable GAAP financial measure for the years ended December 31, 2013, 2012 and 2011 was as follows:
Since 2003, the Company has had nine years of underwriting profitability reflected in combined ratios of less than 100% for its Non-life segment, with the only exceptions being 2005 and 2011. In 2005, when the industry recorded its worst year in history in terms of catastrophe losses in the U.S., with Hurricane Katrina being the largest insured event ever, the Company recorded a net underwriting loss and Non-life combined ratio of 116.3%. In 2011, when the industry incurred a high frequency of large losses related to the 2011 catastrophic events the Company recorded a net underwriting loss and Non-life combined ratio of 125.4%.
estimates used by Management, there could be material adjustments to prior estimates that could potentially adversely affect the Company’s results of operations, financial condition and liquidity. These critical accounting policies and estimates should be read in conjunction with the Notes to Consolidated Financial Statements, including Note 2, Significant Accounting Policies, for a full understanding of the Company’s accounting policies. The sensitivity estimates that follow are based on outcomes that the Company considers reasonably likely to occur.
Because a significant amount of time can elapse between the assumption of risk, occurrence of a loss event, the reporting of the event to an insurance company (the primary company or the cedant), the subsequent reporting to the reinsurance company (the reinsurer) and the ultimate payment of the claim on the loss event by the reinsurer, the Company’s liability for unpaid losses and loss expenses (loss reserves) is based largely upon estimates. The Company categorizes loss reserves into three types of reserves: reported outstanding loss reserves (case reserves), additional case reserves (ACRs) and IBNR. The Company updates its estimates for each of the aforementioned categories on a quarterly basis using information received from its cedants. Case reserves represent unpaid losses reported by the Company’s cedants and recorded by the Company. ACRs are established for particular circumstances where, on the basis of individual loss reports, the Company estimates that the particular loss or collection of losses covered by a treaty may be greater than those advised by the cedant. IBNR reserves represent a provision for claims that have been incurred but not yet reported to the Company, as well as future loss development on losses already reported, in excess of the case reserves and ACRs. Unlike case reserves and ACRs, IBNR reserves are often calculated at an aggregated level and cannot usually be directly identified as reserves for a particular loss or treaty. The Company also estimates the future unallocated loss adjustment expenses (ULAE) associated with the loss reserves and these form part of the Company’s loss adjustment expense reserves. The Company’s Non-life loss reserves for each category, line and sub-segment are reported in the tables included later in this section.
The Company analyzes its ultimate losses and loss expenses after consideration of the loss experience of various reserving cells. The Company assigns treaties to reserving cells and allocates losses from the treaty to the reserving cell. The reserving cells are selected in order to ensure that the underlying treaties have homogeneous loss development characteristics (e.g., reporting tail) but are large enough to make estimation of trends credible. The selection of reserving cells is reviewed annually and changes over time as the business of the Company evolves. For each reserving cell, the Company tabulates losses in reserving triangles that show the total reported or paid claims at each financial year end by underwriting year cohort. An underwriting year is the year during which the reinsurance treaty was entered into as opposed to the year in which the loss occurred (accident year), or the calendar year for which financial results are reported. For each reserving cell, the Company’s estimates of
loss reserves are reached after a review of the results of several commonly accepted actuarial projection methodologies. In selecting its best estimate, the Company considers the appropriateness of each methodology to the individual circumstances of the reserving cell and underwriting year for which the projection is made. The methodologies that the Company employs include, but may not be limited to, paid and reported Chain Ladder methods, Expected Loss Ratio method, paid and reported Bornhuetter-Ferguson (B-F) methods, and paid and reported Benktander methods. In addition, the Company uses other methodologies to estimate liabilities for specific types of claims. For example, internal and vendor catastrophe models are typically used in the estimation of loss and loss expenses at the early stages of catastrophe losses before loss information is reported to the reinsurer. In the case of asbestos and environmental claims, the Company has established reserves for future losses and allocated loss expenses based on the results of periodic actuarial studies, which consider the underlying exposures of the Company’s cedants.
The reserve methodologies employed by the Company are dependent on data that the Company collects. This data consists primarily of loss amounts and loss payments reported by the Company’s cedants, and premiums written and earned reported by cedants or estimated by the Company. The actuarial methods used by the Company to project loss reserves that it will pay in the future do not generally include methodologies that are dependent on claim counts reported, claim counts settled or claim counts open as, due to the nature of the Company’s business, this information is not routinely provided by cedants for every treaty.
This method estimates ultimate losses for an underwriting year by applying an estimated loss ratio to the earned premium for that underwriting year. Although the method is insensitive to actual reported or paid losses, it can often be useful at the early stages of development when very few losses have been reported or paid, and the
These methods can be viewed as a blend between the Chain Ladder Development and the B-F methods described above. The blend is based on predetermined weights at each development stage that depend on the reported (paid) development patterns.
Although mitigated to some extent, this method still exhibits the same advantages and disadvantages as the B-F method, but the mechanics of the calculation imply that it is more reactive to loss emergence (payment) than the B-F method.
The reserving methods used by the Company are dependent on a number of key parameter assumptions. The principal parameter assumptions underlying the methods used by the Company are:
The validity of all parameter assumptions used in the reserving process is reaffirmed on a quarterly basis. Reaffirmation of the parameter assumptions means that the actuaries determine that the parameter assumptions continue to form a sound basis for projection of future liabilities. Parameter assumptions used in projecting future
liabilities are themselves estimates based on historical information. As new information becomes available (e.g., additional losses reported), the Company’s actuaries determine whether a revised estimate of the parameter assumptions that reflects all available information is consistent with the previous parameter assumptions employed. In general, to the extent that the revised estimate of the parameter assumptions are within a close range of the original assumptions, the Company determines that the parameter assumptions employed continue to form an appropriate basis for projections and continue to use the original assumptions in its models. In this case, any differences could be attributed to the imprecise nature of the parameter estimation process. However, to the extent that the deviations between the two sets of estimates are not within a close range of the original assumptions, the Company reacts by adopting the revised assumptions as a basis for its reserve models. Notwithstanding the above, even where the Company has experienced no material deviations from its original assumptions during any quarter, the Company will generally revise the reserving parameter assumptions at least once a year to reflect all accumulated available information.
the Company can form a credible initial expectation of the ultimate loss ratio of recent underwriting years through a review of pricing information, supplemented by qualitative information on market events.
(1) Net prior year reserve development due to changes in premiums includes, but it is not limited to, the impact to prior years’ reserves associated with increases in the estimated or actual premium exposure reported by cedants.
The net prior year favorable loss development for the year ended December 31, 2013 by reserving line for the Company’s Non-life segment was as follows (in millions of U.S. dollars):
Agriculture: Aggregate losses reported in 2013 for North America business related to the 2012 underwriting year were a modest amount above the Company’s expectations. In addition, the Company’s Global Specialty agriculture business experienced lower than expected reported losses. The Company increased its loss ratios for the North America business and lowered its loss ratios for the Global Specialty business, however, it did not otherwise materially alter its reserving assumptions.
Aviation / Space: Aggregate losses reported in 2013 were significantly lower than the Company’s expectations. The Company reflected this experience by selecting lower loss ratios for underwriting years 2008 to 2012.
Catastrophe: Reserves established for the catastrophe line are primarily a function of the presence or absence of catastrophic events during the year, and the complexity and uncertainty associated with estimating unpaid losses from these large disclosed events. In addition, reserves are established in consideration of mid-sized and attritional loss events that occur during a year. In aggregate, the Company has not significantly changed its loss estimates for the Japan Earthquake and the 2010 and the February and June 2011 New Zealand Earthquakes, although it did modestly reduce the unallocated IBNR recorded in 2011 specifically for these events during 2013 (see below for more details). In addition, the Company has recorded modest reductions in ultimate loss estimates during 2013 for a number of prior year loss events across several underwriting years to reflect lower loss emergence.
Specialty business, loss development during 2013 was better than expected for Credit and Surety business combined, primarily for the underwriting years 2009 to 2012. The Company reduced its loss ratios for these recent underwriting years to reflect the lower than expected loss emergence. This was partially offset by adverse development in the older underwriting years.
Energy Onshore: Aggregate losses reported in 2013 were lower than expected across most underwriting years. The Company reflected the favorable development by reducing its loss ratios for most underwriting years.
Aggregate losses reported in 2013 for the Global (Non-U.S.) P&C motor non-proportional line were lower than expected resulting in the Company reducing its loss ratios. The Company further increased its weightings to more experience-based indications resulting in further prior year releases on underwriting years 2002 to 2007.
Aggregate losses reported in 2013 for the Global (Non-U.S.) P&C motor proportional line were modestly lower than expectations in aggregate, allowing the Company to select lower loss ratios on some underwriting years.
Multiline: Aggregate reported losses in 2013 were lower than expected for North America business for underwriting years 2012 and prior, resulting in modest levels of reserve releases.
The gross reserves reported by cedants (case reserves), those estimated by the Company (ACRs and IBNR reserves) and the total gross, ceded and net loss reserves recorded at December 31, 2013 by reserving line for the Company’s Non-life operations were as follows (in millions of U.S. dollars):
The net loss reserves represent the Company’s best estimate of future losses and loss expense amounts based on the information available at December 31, 2013. Loss reserves rely upon estimates involving actuarial and statistical projections at a given time that reflect the Company’s expectations of the costs of the ultimate settlement and administration of claims. Estimates of ultimate liabilities are contingent on many future events and the eventual outcome of these events may be different from the assumptions underlying the reserve estimates. In the event that the business environment and social trends diverge from historical trends, the Company may have to adjust its loss reserves to amounts falling significantly outside its current estimate. These estimates are continually reviewed and the ultimate liability may be in excess of, or less than, the amounts provided, for which any adjustments will be reflected in the period in which the need for an adjustment is determined.
The point estimates related to net loss reserves recorded by the Company and the range of actuarial estimates at December 31, 2013 and 2012 for each Non-life sub-segment were as follows (in millions of U.S. dollars):
Of the Company’s $10,379 million of net Non-life loss reserves at December 31, 2013, net loss reserves for accident years 2005 and prior of $727 million are guaranteed by Colisée Re, pursuant to the Reserve Agreement. The Company is not subject to any loss reserve variability associated with the guaranteed reserves. See Business-Reserves in Item 1 of Part I this report.
periodic reserving process and changes to the amounts recorded may either result in: (i) the reallocation of some or all of the additional reserves to one or more of the these events; or (ii) the release of some or all of the additional reserves to net income in future periods; or (iii) an increase in additional reserves recorded.
During the year ended December 31, 2013, the Company cautiously reduced the additional gross reserves by $10 million to $40 million, primarily reflecting the reduced level of uncertainty associated with the Japan Earthquake in the first half of 2013. As a result of further cedant revisions to loss estimates and cedants reallocating their losses between the different New Zealand Earthquakes during the latter half of 2013, the Company determined to maintain the additional gross reserves of $40 million at December 31, 2013 and have primarily allocated this remaining reserve to the New Zealand Earthquakes to reflect the continuing uncertainty related to these events described above. Based upon information currently available and the estimated range of potential ultimate liabilities, the Company believes that unpaid loss and loss expense reserves contemplate a reasonable provision for the remaining exposure related to the New Zealand Earthquakes and Japan Earthquake.
Included in the business that is considered to have a long reporting tail is the Company’s exposure to asbestos and environmental claims. The Company’s net reserves for unpaid losses and loss expenses at December 31, 2013 included $193 million that represents estimates of its net ultimate liability for asbestos and environmental claims. The gross liability for such claims at December 31, 2013 was $203 million, which primarily relates to Paris Re’s gross liability for asbestos and environmental claims for accident years 2005 and prior of $123 million, with any favorable or adverse development being subject to the Reserve Agreement. Of the remaining $80 million in gross reserves, the majority relates to casualty exposures in the United States arising from business written by the French branch of PartnerRe Europe and PartnerRe U.S.
Policy benefits for life and annuity contracts relate to the business in the Company’s Life and Health segment, which predominantly includes:
mortality business, which includes death and disability covers (with various riders) primarily written in Continental Europe, TCI primarily written in the U.K. and Ireland, and GMDB business primarily written in Continental Europe; and
The Company’s reserving practices begin with the categorization of the contracts written as short duration, long duration, or universal life business for U.S. GAAP reserving purposes. This categorization determines the Company’s reserving methodology which is described by line of business below.
The reserves for the annuity portfolio of reinsurance contracts within the longevity book are established in accordance with the provisions for long duration insurance contracts under U.S. GAAP. Many of these contracts subject the Company to risks arising from policyholder mortality over a period that extends beyond the periods in which premiums are collected. For long duration contracts, the Company establishes initial reserves based upon Management’s best estimate of policy benefits and includes a provision for adverse deviation. Management’s best estimate relies upon actuarial indications of future policy benefits. The provision for adverse deviation contemplates reasonable deviations from the best estimate assumptions for the key risk elements relevant to the product being evaluated, including mortality expenses, and discount rate among others, and are recorded in accordance with U.S. GAAP and applicable actuarial standards. The Company’s actuaries annually verify the current reserving assumptions in consideration of evolving experience and the actuarial indications for assumptions relating to future policy benefits, including mortality and future investment income, among others. Management makes no adjustments to recorded deferred acquisition costs or future policy benefits if the actuarial indications conclude that current recorded U.S. GAAP policy benefits are adequate. The Company establishes a premium deficiency reserve, or an increase to future policy benefits to the extent that deferred acquisition costs are insufficient to cover the premium deficiency reserve, if the actuarial indication of life policy benefits is greater than current recorded aggregate amounts for policy benefits, settlement costs, and deferred acquisition costs.
The reserves for the GMDB reinsurance business are established in accordance with the provisions for universal life contracts under U.S. GAAP. Key actuarial assumptions for this business are mortality, lapses, interest rates, expected returns on cash and bonds and stock market performance. For the last parameter, a stochastic option pricing approach is used and the benefits used in calculating the liabilities are based on the average benefits payable over a range of scenarios. The assumptions of investment performance and volatility are consistent with expected future experience of the respective underlying funds available for policyholder investment options. Recorded reserves for GMDB reflect Management’s best estimate which relies upon the quarterly actuarial indications.
The Company’s gross and net policy benefits for life and annuity contracts by reserving line at December 31, 2013 were as follows (in millions of U.S. dollars):
As an example of the sensitivity of the Company’s policy benefits for life and annuity contracts to reserving parameter assumptions by reserving line, the effect of different assumption selections based on the amounts recorded at December 31, 2013 was as follows:
The Company provides proportional and non-proportional reinsurance coverage to cedants (insurance companies). In most cases, cedants seek protection for business that they have not yet written at the time they enter into reinsurance agreements and thus have to estimate the volume of premiums they will cede to the
Company. Reporting delays are inherent in the reinsurance industry and vary in length by reinsurance market (country of cedant) and type of treaty. As delays can vary from a few weeks to a year or sometimes longer, the Company produces accounting estimates to report premiums and acquisition costs until it receives the cedants’ actual premium reported data. Approximately 48%, 43% and 43% of the Company’s reported net premiums written for the years ended December 31, 2013, 2012 and 2011, respectively, were based upon estimates.
These increases in net premiums written and earned, after the corresponding adjustments to acquisition costs and losses and loss expenses, did not have a material impact on the Company’s consolidated pre-tax net income.
As an example of the sensitivity of the Company’s Non-life net premiums written and acquisition costs to changes in estimates, the effect of different assumption selections on pre-tax net income based on amounts recorded for the year ended December 31, 2013 was as follows (in millions of U.S. dollars):
(1) The estimate assumes that the changes in net premiums written become known at the mid-point of the risk period and is made by applying the reported technical ratio for the year ended December 31, 2013.
(2) The estimate assumes that the changes in net premiums written become known at the mid-point of the risk period and also assume there is no change in losses and loss expenses and is made by applying the reported acquisition ratio for the year ended December 31, 2013.
Under U.S. GAAP, a deferred tax asset or liability is to be recognized for the estimated future tax effects attributable to temporary differences and carryforwards. U.S. GAAP also establishes procedures to assess whether a valuation allowance should be established for deferred tax assets. All available evidence, both positive and negative, is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed for some portion or all of a deferred tax asset. Management must use its judgment in considering the relative impact of positive and negative evidence. The Company has also established tax liabilities relating to uncertain tax positions as defined under U.S. GAAP of $21 million at December 31, 2013 (see Notes 2(l) and 15 to Consolidated Financial Statements in Item 8 of Part II of this report).
The Company has estimated the future tax effects attributed to temporary differences and has a deferred tax asset at December 31, 2013 of $156 million, after a valuation allowance of $46 million. The most significant component of the deferred tax asset (after valuation allowance) relates to loss reserve discounting for tax purposes.
In accordance with U.S. GAAP, the Company has assumed that the future reversal of deferred tax liabilities will result in an increase in taxes payable in future years. Underlying this assumption is an expectation that the Company will continue to be subject to taxation in the various tax jurisdictions and that the Company will continue to generate taxable revenues in excess of deductions.
As an example of the sensitivity of the Company’s unrecognized tax benefit related to uncertain tax positions, deferred tax asset and net deferred tax liability, the impact of different assumption selections on the Company’s net income and the corresponding impact on net assets based on amounts recorded at December 31, 2013 was as follows (in millions of U.S. dollars):
For the Company’s fixed maturities, equities, other invested assets and investments underlying the funds held - directly managed account categorized as Level 3, a 10% decline in the fair value of these investments at December 31, 2013 would result in a $71 million pre-tax charge to net income or loss and a corresponding reduction in total assets.
In addition to other invested assets included in the table above for Level 3 and the combined fair value of Level 1 and Level 2 derivative assets of $31 million, the Company’s other invested assets also include various investments which are accounted for using the cost method of accounting or equity method of accounting, totaling $186 million at December 31, 2013. The Company does not measure its investments that are accounted for using any of these methods at fair value. For investments that are accounted for using the cost method of accounting or equity method of accounting, a 10% decline in the carrying value of these investments at December 31, 2013 would result in a $19 million pre-tax charge to net income or loss and a corresponding reduction in investments and total assets.
The Company utilizes derivatives for a variety of purposes. The Company’s derivatives are carried at fair value, which is based on quoted market prices or internal valuation models where quoted market prices are not available. Most of the Company’s derivatives are fair valued using significant other observable inputs (fair value of $10 million net unrealized loss at December 31, 2013), referred to as Level 2 assets, and included foreign exchange forward contracts, interest rate swaps, foreign currency options, credit default swaps and to-be-announced mortgage-backed securities (TBAs). The Company’s derivatives that are fair valued using quoted prices in active markets, referred to as Level 1 assets, had fair value of $41 million at December 31, 2013, and included treasury and equity futures. In addition, the Company has certain total return swaps and insurance-linked securities that are fair valued using significant other unobservable inputs, and are included in the Level 3 other invested assets. The total return swaps and insurance-linked securities that are classified as Level 3 have an insignificant combined fair value at December 31, 2013, based on a combined notional exposure of $200 million.
In aggregate, the Company is not significantly exposed to changes in the valuation of its total return and interest rate swap portfolio due to changes in the general level of interest rates. At December 31, 2013, the Company estimated that a 100 basis point increase or decrease in all risk spread assumptions used in the Company’s internal valuation models would result in a $2 million decrease or increase, respectively, in the fair value of its total return and interest rate swap portfolio categorized as Level 3.
Goodwill represents the excess of the purchase price over the fair value of the net assets acquired of PartnerRe SA, Winterthur Re, Paris Re and PartnerRe Health. The Company assesses the appropriateness of its valuation of goodwill on at least an annual basis or more frequently if events or changes in circumstances indicate that the carrying amount may not be recoverable. If, as a result of the assessment, the Company determines that the value of its goodwill is impaired, goodwill will be written down in the period in which the determination is made. Neither the Company’s initial valuation nor its subsequent valuations has indicated any impairment of the Company’s goodwill asset of $456 million at December 31, 2013.
In making an assessment of the value of its goodwill, the Company uses both market based and non-market based valuations. The fair value of the reporting units is determined based on the earnings multiple, price to tangible book value multiple, present value of estimated cash flows and present value of future profits methods. Significant changes in the data underlying these assumptions could result in an assessment of impairment of the Company’s goodwill asset. In addition, if the current economic environment and/or the Company’s financial performance were to deteriorate significantly, this could lead to an impairment of goodwill, the write-off of which would be recorded against net income in the period such deterioration occurred.
the U.S. dollar ending exchange rate weakened against most currencies, except the Japanese yen and Canadian dollar, at December 31, 2013 compared to December 31, 2012.
The components of net income (loss) for the years ended December 31, 2013, 2012 and 2011 were as follows (in millions of U.S. dollars):
(2) Technical result and other income primarily relate to income on insurance-linked securities and principal finance transactions within the Corporate and Other segment.
The following table provides the components of the underwriting result and combined ratio for the Non-life segment for the years ended December 31, 2013, 2012 and 2011 and the components are discussed further below (in millions of U.S. dollars):
(1) Large catastrophic losses and large losses are shown net of any related reinsurance, reinstatement premiums and profit commissions.
The underwriting result for the Non-life segment increased by $170 million (corresponding to a decrease of 2.5 points in the combined ratio), from $456 million (87.8 points on the combined ratio) in 2012 to $626 million (85.3 points on the combined ratio) in 2013. The increase in the Non-life underwriting result and the corresponding decrease in the combined ratio in 2013 compared to 2012 was primarily attributable to:
Net favorable prior year loss development-an increase of $93 million from $628 million (17.0 points on the technical ratio) in 2012 to $721 million (17.0 points on the technical ratio) in 2013. The increase in net favorable prior year loss development was primarily driven by increases in the Global (Non-U.S.) P&C and Catastrophe sub-segments, which were partially offset by a decrease in the Global Specialty sub-segment. While net favorable prior year loss development increased in 2013 compared to 2012, this did not decrease the technical ratio as a result of higher net premiums earned in 2013. The components of the net favorable prior year loss development are described in more detail in the discussion of individual sub-segments in Results by Segment below.
Net investment income decreased by $87 million, from $571 million in 2012 to $484 million in 2013. The decrease in net investment income was primarily attributable to a decrease in net investment income from fixed maturities due to lower reinvestment rates. See Corporate and Other - Net Investment Income below for more details.
Other operating expenses included in Corporate and Other increased by $68 million, from $102 million in 2012 to $170 million in 2013. The increase was primarily due to restructuring charges described in Overview above.
Net foreign exchange losses increased by $18 million, from breakeven in 2012 to losses of $18 million in 2013. The net foreign exchange losses in 2013 resulted primarily from currency movements on certain unhedged equity securities. The Company hedges a significant portion of its currency risk exposure as discussed in Quantitative and Qualitative Disclosures about Market Risk in
The Company’s fixed maturity portfolio and the fixed maturity securities in the investment portfolio underlying the funds held - directly managed account are exposed to interest rate risk. Fluctuations in interest rates have a direct impact on the market valuation of these securities. The Company manages interest rate risk on liability funds by constructing bond portfolios in which the economic impact of a general interest rate shift is comparable to the impact on the related liabilities. The Company believes that this process of matching the duration mitigates the overall interest rate risk on an economic basis. For unpaid loss reserves and policy benefits related to non-life and traditional life business, the estimated duration of the Company’s liabilities is based on projected claims payout patterns. For policy benefits related to annuity business, the Company estimates duration based on its commitment to annuitants. The Company manages the exposure to interest rate volatility on capital funds by choosing a duration profile that it believes will optimize the risk-reward relationship.
While this matching of duration insulates the Company from the economic impact of interest rate changes, changes in interest rates do impact the Company’s shareholders’ equity. The Company’s liabilities are carried at their nominal value, and are not adjusted for changes in interest rates, with the exception of certain policy benefits for life and annuity contracts and deposit liabilities that are interest rate sensitive. However, substantially all of the Company’s invested assets (including the investments underlying the funds held - directly managed account) are carried at fair value, which reflects such changes. As a result, an increase in interest rates will result in a decrease in the fair value of the Company’s investments (including the investments underlying the funds held - directly managed account) and a corresponding decrease, net of applicable taxes, in the Company’s shareholders’ equity. A decrease in interest rates would have the opposite effect.
At December 31, 2013, the Company held approximately $3,442 million of its total invested assets in mortgage/asset-backed securities. These assets are exposed to prepayment risk, the adverse impact of which is more evident in a declining interest rate environment.
(1) Includes certain other invested assets, certain cash and cash equivalents and funds holding fixed income securities.
As discussed above, the Company strives to match the foreign currency exposure in its fixed income portfolio to its multicurrency liabilities. The Company believes that this matching process creates a diversification benefit. Consequently, the exact market value effect of a change in interest rates will depend on which countries experience interest rate changes and the foreign currency mix of the Company’s fixed maturity portfolio at the time of the interest rate changes. See Foreign Currency Risk below.
The fair value of the debt related to Senior Notes issued by PartnerRe Finance B LLC, PartnerRe Finance A LLC and the CENts was calculated based on discounted cash flow models using observable market yields and contractual cash flows based on the aggregate principal amount outstanding of $500 million from PartnerRe Finance B LLC, $250 million from PartnerRe Finance A and $63 million from PartnerRe Finance II, respectively. For the Company’s Series D and Series E cumulative preferred shares, and the Series F non-cumulative preferred shares, fair value is based on quoted market prices, while carrying value is based on the aggregate liquidation value of the shares.
Other than the changes related to the redemption of the Series C preferred shares and the issuance of the Series F preferred shares, the fair value of the Company’s preferred securities declined at December 31, 2013, compared to December 31, 2012 due to rising risk-free interest rates. See Shareholders’ Equity and Capital Resources Management-Shareholders’ Equity above for a discussion the issuance of the Series F preferred shares in February 2013 and the redemption of the Series C preferred shares in March 2013.
The Company’s fixed maturity portfolio and the fixed maturity securities in the investment portfolio underlying the funds held - directly managed account are exposed to credit spread risk. Fluctuations in market credit spreads have a direct impact on the market valuation of these securities. The Company manages credit spread risk by the selection of securities within its fixed maturity portfolio. Changes in credit spreads directly affect the market value of certain fixed maturity securities, but do not necessarily result in a change in the future expected cash flows associated with holding individual securities. Other factors, including liquidity, supply and demand, and changing risk preferences of investors, may affect market credit spreads without any change in the underlying credit quality of the security.
At December 31, 2013, the Company estimates that the hypothetical case of an immediate 100 basis points or 200 basis points parallel shift in global credit spreads would result in a change in the fair value of investments and the fair value of funds held - directly managed account exposed to credit spread risk, total invested assets and shareholders’ equity as follows (in millions of U.S. dollars):
The changes above also do not take into account any potential mitigating impact from the equity market, taxes, and the change in the economic value of the Company’s reinsurance liabilities, which may offset the economic impact on invested assets.
The Company is generally able to match its liability funds against its net reinsurance liabilities both by currency and duration to protect the Company against foreign exchange and interest rate risks. However, a natural offset does not exist for all currencies. For the non-U.S. dollar currencies for which the Company deems the net asset or liability exposures to be material, the Company employs a hedging strategy utilizing foreign exchange forward contracts and other derivative financial instruments, as appropriate, to reduce exposure and more appropriately match the liability funds by currency. The Company does not hedge currencies for which its asset or liability exposures are not material or where it is unable or impractical to do so. In such cases, the Company is exposed to foreign currency risk. However, the Company does not believe that the foreign currency risks corresponding to these unhedged positions are material, except for those related to the Company’s capital funds.
The Company’s gross and net exposure in its Consolidated Balance Sheet at December 31, 2013 to foreign currency as well as the associated foreign currency derivatives the Company has entered into to manage this exposure, was as follows (in millions of U.S. dollars):
The above numbers include the Company’s investment in PartnerRe Holdings Europe Limited, whose functional currency is the euro, and certain of its subsidiaries and branches, whose functional currencies are the euro or Canadian dollar.
At December 31, 2013, approximately 77% the Company’s fixed maturity and short-term investments (including funds holding fixed maturity securities and excluding the funds held - directly managed account) were rated A- or better and 8% were rated below investment grade or not rated. The Company believes this high quality concentration reduces its exposure to credit risk on fixed maturity investments to an acceptable level. At December 31, 2013, the Company is not exposed to any significant credit concentration risk on its investments, excluding securities issued by the U.S. government which are rated AA+. The single largest non-U.S. sovereign government issuer accounted for less than 19% of the Company’s total non-U.S. sovereign government, supranational and government related category (excluding the funds held - directly managed account) and less than 3% of total investments and cash (excluding the funds held - directly managed account) at December 31, 2013. In addition, the single largest corporate issuer and the top 10 corporate issuers accounted for less than 3% and less than 19% of the Company’s total corporate fixed maturity securities (excluding the funds held - directly
The funds held - directly managed account due to the Company is related to one cedant, Colisée Re (see Investments underlying the Funds Held - Directly Managed Account in Item 1 of Part I of this report). The Company is subject to the credit risk of this cedant in the event of insolvency or Colisée Re’s failure to honor the value of the funds held balances for any other reason. However, the Company’s credit risk is somewhat mitigated by the fact that the Company generally has the right to offset any shortfall in the payment of the funds held balances with amounts owed by the Company to the cedant for losses payable and other amounts contractually due. See also Risk Factors in Item 1A of Part I of this report for additional discussion of the Company’s exposure if Colisée Re, or its affiliates, breach or do not satisfy their obligations. In addition to exposure to Colisée Re, the Company is also subject to the credit risk of AXA or its affiliates in the event of their insolvency or their failure to honor their obligations under the acquisition agreements.
The Company is also exposed to credit risk in its underwriting operations, most notably in the credit/surety line and for alternative risk products. Loss experience in these lines of business is cyclical and is affected by the general economic environment. The Company provides its clients in these lines of business with protection against credit deterioration, defaults or other types of financial non-performance of or by the underlying credits that are the subject of the protection provided and, accordingly, the Company is exposed to the credit risk of those credits. As with all of the Company’s business, these risks are subject to rigorous underwriting and pricing standards. In addition, the Company strives to mitigate the risks associated with these credit-sensitive lines of business through the use of risk management techniques such as risk diversification, careful monitoring of risk aggregations and accumulations and, at times, through the use of retrocessional reinsurance protection and the purchase of credit default swaps and total return and interest rate swaps. At December 31, 2013, the Company purchased protection related to its credit/surety line primarily in the form of credit default swaps with a notional value of $14 million and an insignificant fair value.
Company receives an investment return based upon either the results of a pool of assets held by the cedant or the investment return earned by the cedant on its investment portfolio are exposed to an additional layer of credit risk. The Company is also exposed to some extent to the underlying financial market risk of the pool of assets, inasmuch as the underlying policies may have guaranteed minimum returns.
The Company has exposure to credit risk as it relates to its reinsurance balances receivable and reinsurance recoverable on paid and unpaid losses. Reinsurance balances receivable from the Company’s clients at December 31, 2013 were $2,466 million, including balances both currently due and accrued. The Company believes that credit risk related to these balances is mitigated by several factors, including but not limited to, credit checks performed as part of the underwriting process and monitoring of aged receivable balances. In addition, as the majority of its reinsurance agreements permit the Company the right to offset reinsurance balances receivable from clients against losses payable to them, the Company believes that the credit risk in this area is substantially reduced. Provisions are made for amounts considered potentially uncollectible and the allowance for uncollectible premiums receivable was $8 million at December 31, 2013.
The Company purchases retrocessional reinsurance and requires its reinsurers to have adequate financial strength. The Company evaluates the financial condition of its reinsurers and monitors its concentration of credit risk on an ongoing basis. Provisions are made for amounts considered potentially uncollectible. At December 31, 2013, the balance of reinsurance recoverable on paid and unpaid losses was $274 million, which is net of the allowance provided for uncollectible reinsurance recoverables of $15 million. At December 31, 2013, 72% of the Company’s reinsurance recoverable on paid and unpaid losses were either due from reinsurers with an A- or better rating from Standard & Poor’s. See Financial Condition, Liquidity and Capital Resources-Reinsurance Recoverable on Paid and Unpaid Losses above for details of the Company’s reinsurance recoverable on paid and unpaid losses categorized by the reinsurer’s Standard & Poor’s rating.
The Company invests a portion of its capital funds in marketable equity securities (fair market value of $1,036 million, excluding funds holding fixed income securities of $185 million) at December 31, 2013. These equity investments are exposed to equity price risk, defined as the potential for loss in market value due to a decline in equity prices. The Company believes that the effects of diversification and the relatively small size of its investments in equities relative to total invested assets mitigate its exposure to equity price risk. The Company estimates that its equity investment portfolio has a beta versus the S&P 500 Index of approximately 0.92 on average. Portfolio beta measures the response of a portfolio’s performance relative to a market return, where a beta of 1 would be an equivalent return to the index. Given the estimated beta for the Company’s equity portfolio, a 10% and 20% movement in the S&P 500 Index would result in a change in the fair value of the Company’s equity portfolio, total invested assets and shareholders’ equity at December 31, 2013 as follows (in millions of U.S. dollars):
(2) Includes total investments, cash and cash equivalents, the investment portfolio underlying the funds held - directly managed account and accrued interest.
This change does not take into account any potential mitigating impact from the fixed maturity securities or taxes.
Other invested assets consist primarily of investments in non-publicly traded companies, private placement equity and fixed maturity investments, derivative financial instruments and other specialty asset classes. Non-publicly traded entities in which the Company has an ownership of more than 20% and less than 50% of the voting shares, and limited partnerships in which the Company has more than a minor interest, are accounted for using either the equity method or the fair value option. The remaining other invested assets are recorded based on valuation techniques depending on the nature of the individual assets. The valuation techniques used by the Company are generally commensurate with standard valuation techniques for each asset class.
The Company recognizes a tax benefit relating to uncertain tax positions only where the position is more likely than not to be sustained assuming examination by tax authorities. A liability must be recognized for any tax benefit (along with any interest and penalty, if applicable) claimed in a tax return in excess of the amount allowed to be recognized in the financial statements under U.S. GAAP. Any changes in amounts recognized are recorded in the period in which they are determined.
The Company’s investment strategy allows for the use of derivative instruments, subject to strict limitations. The Company utilizes various derivative instruments such as foreign exchange forward contracts, foreign currency option contracts, futures contracts, to-be-announced mortgage-backed securities (TBAs) and credit default swaps, for the purpose of managing overall currency risk, market exposures and portfolio duration, for hedging certain investments, or for enhancing investment performance that would be allowed under the Company’s investment policy if implemented in other ways. These instruments are recorded at fair value as assets and liabilities in the Consolidated Balance Sheets. Changes in fair value are included in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations, except changes in the fair
Common shares repurchased by the Company and not canceled are classified as treasury shares, and are recorded at cost. This results in a reduction of shareholders’ equity in the Consolidated Balance Sheets. When shares are reissued from treasury, the Company uses the average cost method to determine the cost of the reissued shares. Gains on sales of treasury shares are credited to additional paid-in capital, while losses are charged to additional paid-in capital to the extent that previous net gains from sales of treasury shares are included therein, otherwise losses are charged to retained earnings.
The Company currently uses six types of share-based compensation: share options, restricted shares (RS), restricted share units (RSUs), performance-based RSUs (PSUs), share-settled share appreciation rights (SSARs) and shares issued under the Company’s employee share purchase plans.
Those share-based compensation awards that do not meet the equity classification criteria, are classified as liability awards. Liability-classified awards are recorded at fair value in the Accounts payable, accrued expenses and other in the Consolidated Balance Sheets with changes in fair value relating to the vested portion of the award recorded within Other operating expenses in the Consolidated Statements of Operations.
The Company also has three indirect 100% owned subsidiaries, PartnerRe Finance A LLC, PartnerRe Finance B LLC and PartnerRe Finance II Inc., that are considered to be VIEs, which were utilized to issue the Company’s Senior Notes and Capital Efficient Notes (CENts). The Company determined that it was not the primary beneficiary of any of these VIEs at December 31, 2013. As a result, the Company has not consolidated PartnerRe Finance A LLC, PartnerRe Finance B LLC and PartnerRe Finance II Inc., and has reflected the debt issued by the Company related to the Senior Notes and CENts as liabilities in the Consolidated Balance Sheets (see Note 10). The interest on the debt related to the Senior Notes and CENts is reported as interest expense in the Consolidated Statements of Operations.
In July 2013, the Financial Accounting Standards Board issued new guidance aimed at harmonizing presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The guidance is effective for interim and annual periods beginning on or after December 15, 2013. The Company does not expect adoption of this guidance to have a significant impact on its Consolidated Financial Statements or disclosures.
The Company’s financial instruments that it measures at fair value using Level 3 inputs generally include: inactively traded fixed maturities including U.S. state, territory and municipal bonds; privately issued corporate securities; special purpose financing asset-backed bonds; unlisted equities; real estate and certain other mutual fund investments; inactively traded weather derivatives; notes and loan receivables, notes securitizations, annuities and residuals, private equities and longevity and other total return swaps.
(2) Settlements and sales of notes and loan receivables and notes securitization include sales of $4.7 million.
The significant unobservable inputs used in the valuation of financial instruments measured at fair value using Level 3 inputs at December 31, 2013 and 2012 were as follows (fair value in thousands of U.S. dollars):
The tables above do not include financial instruments that are measured using unobservable inputs (Level 3) where the unobservable inputs were obtained from external sources and used without adjustment. These financial instruments include mutual fund investments (included within equities), certain insurance-linked securities (included within other invested assets) and mortality bonds (included within corporate fixed maturities).
The Company has established a Valuation Committee which is responsible for determining the Company’s invested asset valuation policy and related procedures, for reviewing significant changes in the fair value measurements of securities classified as Level 3 from period to period, and for reviewing in accordance with the invested asset valuation policy an independent internal peer analysis that is performed on the fair value measurements of significant securities that are classified as Level 3. The Valuation Committee is comprised of members of the Company’s senior management team and meets on a quarterly basis. The Company’s invested asset valuation policy is monitored by the Company’s Audit Committee of the Board of Directors (Board) and approved annually by the Company’s Risk and Finance Committee of the Board.
Changes in the fair value of the Company’s financial instruments subject to the fair value option during the years ended December 31, 2013, 2012 and 2011 were as follows (in thousands of U.S. dollars):
U.S. government and government sponsored enterprises-U.S. government and government sponsored enterprises securities consist primarily of bonds issued by the U.S. Treasury, corporate debt securities issued by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, the Federal Home Loan Bank and the Private Export Funding Corporation. These securities are generally priced by independent pricing services. The independent pricing services may use actual transaction prices for securities that have been actively traded. For securities that have not been actively traded, each pricing source has its own proprietary method to determine the fair value, which may incorporate option adjusted spreads (OAS), interest rate data and market news. The Company generally classifies these securities in Level 2.
Equity securities include U.S. and foreign common and preferred stocks, real estate investment trusts, mutual funds and exchange traded funds. Equities, real estate investment trusts and exchange traded funds are generally classified in Level 1 as the Company uses prices received from independent pricing sources based on quoted prices in active markets. Equities classified as Level 2 are generally mutual funds invested in fixed income securities, where the net asset value of the fund is provided on a daily basis, and common stocks traded in inactive markets. Equities classified as Level 3 are generally mutual funds invested in securities other than the
the fair value of the Senior Notes was calculated based on discounted cash flow models using observable market yields and contractual cash flows based on the aggregate principal amount outstanding of $250 million from PartnerRe Finance A LLC and $500 million from PartnerRe Finance B LLC at December 31, 2013 and 2012; and
(2) PartnerRe Finance II Inc., the issuer of the CENts, does not meet consolidation requirements under U.S. GAAP. Accordingly, the Company shows the related intercompany debt of $71 million in its Consolidated Balance Sheets at December 31, 2013 and 2012.
The cost, gross unrealized gains, gross unrealized losses and fair value of investments classified as trading securities at December 31, 2013 and 2012 were as follows (in thousands of U.S. dollars):
The distribution of fixed maturities and short-term investments at December 31, 2013, by contractual maturity date, is shown below (in thousands of U.S. dollars). Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.
The components of net investment income for the years ended December 31, 2013, 2012 and 2011 were as follows (in thousands of U.S. dollars):
Included within Other assets in the Consolidated Balance Sheet at December 31, 2013 and Accounts payable, accrued expenses and other in the Consolidated Balance Sheet at December 31, 2012 were amounts of gross receivable balances for securities sold and gross payable balances for securities purchased as follows (in thousands of U.S. dollars):
Following Paris Re’s acquisition of substantially all of the reinsurance operations of Colisée Re (previously known as AXA RE), a subsidiary of AXA SA (AXA), in 2006, Paris Re and its subsidiaries entered into an issuance agreement and a quota share retrocession agreement to assume business written by Colisée Re from January 1, 2006 to September 30, 2007 as well as the in-force business at December 31, 2005. The agreements provided that the premium related to the transferred business was retained by Colisée Re and credited to a funds held account. The decrease from December 31, 2012 to December 31, 2013 in the fair value of the investment portfolio underlying the funds held - directly managed account from $833 million to $561 million was primarily related to the run-off of the underlying loss reserves associated with this account and increases in U.S. and European risk-free interest rates.
The cost, gross unrealized gains, gross unrealized losses and fair value of investments underlying the funds held - directly managed account at December 31, 2013 and 2012 were as follows (in thousands of U.S. dollars):
The Company purchases protection through credit default swaps to mitigate the risk associated with its underwriting operations, most notably in the credit/surety line, and to manage market exposures.
(2) The Company enters into interest rate swaps to mitigate notional exposures on certain total return swaps and certain fixed maturities. Only the notional value of interest rate swaps on fixed maturities is presented separately in the table.
The fair value of all derivatives at December 31, 2013 and 2012 is recorded in Other invested assets in the Company’s Consolidated Balance Sheets. At December 31, 2013 and 2012, none of the Company’s derivatives were designated as hedges.
The gross carrying value and accumulated amortization of intangible assets by type at December 31, 2013 and 2012 is as follows (in thousands of U.S. dollars):
Unpaid losses and loss expenses are categorized into three types of reserves: case reserves, ACRs and IBNR reserves. Case reserves represent unpaid losses reported by the Company’s cedants and recorded by the Company. ACRs are established for particular circumstances where, on the basis of individual loss reports, the Company estimates that the particular loss or collection of losses covered by a treaty may be greater than those advised by the cedant. IBNR reserves represent a provision for claims that have been incurred but not yet reported to the Company, as well as future loss development on losses already reported, in excess of the case reserves and ACRs. The Company’s gross liability for unpaid losses and loss expenses reported by cedants (case reserves) and those estimated by the Company (ACRs and IBNR reserves) at December 31, 2013 and 2012 was as follows (in thousands of U.S. dollars):
The reconciliation of losses and loss expenses including life policy benefits for the years ended December 31, 2013, 2012 and 2011 was as follows (in thousands of U.S. dollars):
The net favorable prior year loss development for each of the Company’s Non-life sub-segments for the years ended December 31, 2013, 2012 and 2011 was as follows (in thousands of U.S. dollars):
Within the Company’s North America sub-segment, the Company reported net favorable loss development for prior accident years in 2013, 2012 and 2011. The net favorable loss development for prior accident years in 2013, 2012 and 2011 was driven by most lines of business, with the casualty line being the most pronounced. The net favorable loss development in each year was primarily due to favorable loss emergence.
For the Global (Non-U.S.) P&C sub-segment, the Company reported net favorable loss development for prior accident years in 2013, 2012 and 2011. The net favorable loss development for prior accident years in 2013 was driven by all lines of business, with the property line being the most pronounced, and included favorable loss
Favorable or adverse development related to the guaranteed reserves is recorded as a change in unpaid losses and loss expenses in the Consolidated Balance Sheets and as a change in the Reserve Agreement payable or receivable balance to/from Colisée Re, which is included within the Funds held - directly managed account and Other reinsurance balances payable in the Consolidated Balance Sheets at December 31, 2013 and 2012, respectively. Accordingly, the reconciliation of the beginning and ending gross and net liability for unpaid losses and loss expenses for the years ended December 31, 2013, 2012 and 2011 includes the change in the Reserve Agreement. At December 31, 2013 and 2012, the Company’s net liability for unpaid losses and loss expenses includes $727 million and $857 million, respectively, of guaranteed reserves, with the decrease from December 31, 2012 to December 31, 2013 being primarily related to the run-off of the underlying loss reserves.
A significant amount of judgment was used to estimate the range of potential losses related to the 2010 and the February and June 2011 New Zealand Earthquakes (collectively, the New Zealand Earthquakes) and the Japan Earthquake, and there remains a considerable degree of uncertainty related to the range of possible ultimate losses related to these events and, in particular, the New Zealand Earthquakes. Loss estimates arising from earthquakes are inherently more uncertain than those from other catastrophic events and the Company believes the ultimate losses arising from the New Zealand Earthquakes may be materially in excess of, or less than, the amounts provided for in the Consolidated Balance Sheet at December 31, 2013.
The remaining significant risks and uncertainties related to the New Zealand Earthquakes include the ongoing cedant revisions of loss estimates for each of these events, the degree to which inflation impacts
construction materials required to rebuild affected properties, the characteristics of the Company’s program participation for certain affected cedants and potentially affected cedants, and the expected length of the claims settlement period. In addition, there is additional complexity related to the New Zealand Earthquakes given multiple earthquakes occurred in the same region in a relatively short period of time, resulting in cedants continuing to revise their allocation of losses between the various events and between different treaties, under which the Company may provide different amounts of coverage.
The Company’s net reserves for unpaid losses and loss expenses at December 31, 2013 and 2012 included $193 million and $199 million, respectively, that represent estimates of its net ultimate liability for asbestos and environmental claims. The gross liability for such claims at December 31, 2013 and 2012 was $203 million and $205 million, respectively, which primarily relate to Paris Re’s gross liability for asbestos and environmental claims for accident years 2005 and prior of $123 million and $125 million, respectively, with any favorable or adverse development being subject to the Reserve Agreement. Of the remaining $80 million in gross reserves at December 31, 2013 and 2012, the majority relates to casualty exposures in the United States arising from business written by the French branch of PartnerRe Europe and PartnerRe U.S.
The Life and Health segment reported net favorable loss development for prior accident years of $39 million, $14 million and $1 million for the years ended December 31, 2013, 2012 and 2011, respectively.
The modest net favorable prior year loss development of $1 million in 2011 was the net result of favorable prior year loss development on certain mortality treaties and the GMDB business, which were almost entirely offset by adverse prior year loss development related to disability riders on certain short-term non-proportional treaties in the mortality line following the receipt of updated information from cedants.
The Company used interest rate assumptions to estimate its liabilities for policy benefits for life and annuity contracts which ranged from 0.1% to 6.8% and 0.2% to 6.6% at December 31, 2013 and 2012, respectively.
The Company uses retrocessional agreements to reduce its exposure to risk of loss on reinsurance assumed. These agreements provide for recovery from retrocessionaires of a portion of losses and loss expenses. The Company remains liable to its cedants to the extent that the retrocessionaires do not meet their obligations under these agreements, and therefore the Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk on an ongoing basis. The Company actively manages its reinsurance exposures by generally selecting retrocessionaires having a credit rating of A- or higher. In certain cases where an otherwise suitable retrocessionaire has a credit rating lower than A-, the Company generally requires the posting of collateral, including escrow funds and letters of credit, as a condition to its entering into a retrocession agreement. The Company regularly reviews its reinsurance recoverable balances to estimate an allowance for uncollectible amounts based on quantitative and qualitative factors. The allowance for uncollectible reinsurance recoverable was $15 million and $13 million at December 31, 2013 and 2012, respectively.
For each of the years ended December 31, 2013, 2012 and 2011, the Company incurred interest expense and paid interest of $27.5 million in relation to the 2010 Senior Notes issued by PartnerRe Finance B.
At December 31, 2013 and 2012, the total authorized shares of the Company were 200 million shares, par value $1.00 per share, as follows (in millions of shares):
During 2013, the Company repurchased, under its authorized share repurchase program, 7.7 million of its common shares at a total cost of $695.3 million, representing an average cost of $90.73 per share. At December 31, 2013, the Company had approximately 5.0 million common shares remaining under its current share repurchase authorization and approximately 34.2 million common shares were held in treasury and are available for reissuance.
Dividends on each of the Series D and E preferred shares are cumulative from the date of issuance and are payable quarterly in arrears. Dividends on Series F preferred shares are non-cumulative and are payable quarterly.
In March 2013, the Company formed with other third party investors, Lorenz Re, a Bermuda domiciled special purpose insurer to provide additional capacity to the Company for a diversified portfolio of catastrophe reinsurance treaties over a multi-year period on a fully collateralized reinsurance basis. The original business was written by the Company and was ceded to Lorenz Re effective April 1, 2013.
At December 31, 2013, the total assets of Lorenz Re were $99.6 million, primarily consisting of cash and investments, and the total liabilities were $11.1 million, primarily consisting of unearned premiums and unpaid losses and loss expenses. The assets of Lorenz Re can only be used to settle the liabilities of Lorenz Re and there is no recourse to the Company for any liabilities of Lorenz Re.
The reconciliation of the beginning and ending balance of the noncontrolling interests in Lorenz Re for the year ended December 31, 2013 is as follows (in thousands of U.S. dollars):
PartnerRe Europe may declare dividends subject to it continuing to meet its minimum solvency and capital requirements, which are to hold statutory capital and surplus equal to or exceeding the Required Solvency Margin (RSM). The RSM is calculated with reference to Solvency I regulations. The maximum dividend is limited to “profits available for distribution”, which consist of accumulated realized profits less accumulated realized losses. At December 31, 2013, the maximum dividend that PartnerRe Europe could pay without prior regulatory approval was approximately $565 million.
The statutory financial statements and returns of the Company’s reinsurance subsidiaries at, and for the year ended, December 31, 2013 are due to be submitted to the relevant regulatory authorities later in 2014, with different filing dates in each jurisdiction. In certain jurisdictions, the statutory financial statements and returns are subject to the review and final approval of the relevant regulatory authorities.
At December 31, 2013 and 2012, the Company has Swiss and French branches of PartnerRe Europe that are regulated by the Central Bank of Ireland, as prescribed by the EU Reinsurance Directive.
Deferred tax assets and liabilities reflect the tax impact of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Significant components of the net deferred tax assets and liabilities at December 31, 2013 and 2012 were as follows (in thousands of U.S. dollars):
Realization of the deferred tax assets is dependent on generating sufficient taxable income in future periods. Although realization is not assured, Management believes that it is more likely than not that the deferred tax assets will be realized. The valuation allowance recorded at December 31, 2013 related to a foreign tax credit carryforward of $24.7 million in Ireland and to a tax loss carryforward of $21.4 million in Singapore. The valuation allowance recorded at December 31, 2012 related to a tax loss carryforward of $34.2 million in Singapore and to a foreign tax credit carryforward of $13.2 million in Ireland.
At December 31, 2013, the deferred tax assets (after valuation allowance) included foreign tax credit carryforwards of $14.4 million in Ireland, which can be carried forward for an unlimited period of time, and $3.6 million in the United States, which can be carried forward for 10 years. At December 31, 2012, the deferred tax assets (after valuation allowance) included foreign tax credit carryforwards of $14.6 million in Ireland, which can be carried forward for an unlimited period of time, and $9.7 million in the United States, which can be carried forward for 10 years, and tax loss carryforwards of $9.9 million in Canada, which can be carried forward for 20 years.
At December 31, 2013, the total amount of unrecognized tax benefits for which it is reasonably possible to change within twelve months was $7.3 million, which primarily relates to the expected expiration of the statute of limitations related to certain tax positions.
The Company’s Employee Equity Plan (EEP), which was approved by the Company’s shareholders, permits the grant of share options, RS, RSUs, SSARs or other share-based awards to employees of the Company. The EEP is administered by the Compensation and Management Development Committee of the Board (the Committee). From 2013, the Company also grants PSUs to employees of the Company.
For the years ended December 31, 2013, 2012 and 2011, the Company’s share-based compensation expense was $29.8 million, $26.8 million and $24.2 million, respectively, with a tax benefit of $3.3 million, $3.6 million and $2.4 million, respectively. Included within these tax benefits are amounts related to the exercise of share options and the conversion of RSUs and SSARs into shares by employees of the Company’s U.S. subsidiaries of $7.0 million, $1.6 million and $3.1 million for the years ended December 31, 2013, 2012 and 2011, respectively.
The activity related to share options granted and exercised for the years ended December 31, 2013, 2012 and 2011 was as follows:
The activity related to the Company’s share options for the year ended December 31, 2013 was as follows:
The weighted average remaining contractual term and the aggregate intrinsic value of share options outstanding, exercisable, vested and expected to vest at December 31, 2013, was 5.1 years and $22.4 million, respectively.
The Company values SSARs issued with a Black-Scholes valuation model and used the following assumptions for the years ended December 31, 2013, 2012 and 2011:
In determining the weighted average assumptions used, the Company used the same methodology as described for share options above.
In 2009, the Company issued 27,655 replacement warrants as part of the acquisition of Paris Re. At December 31, 2013, 8,853 warrants are outstanding and fully vested with a weighted average remaining contractual life of 3.0 years and a weighted average exercise price of $32.34. During the year ended December 31, 2013, 2,390 warrants were exercised with a weighted average exercise price of $32.90.
For employee retirement benefits, the Company maintains certain defined contributions plans and other active and frozen defined benefit plans. The majority of the defined benefit obligation at December 31, 2013 relates to the active defined benefit plan for the Company’s Zurich office employees (the Zurich Plan).
The net periodic benefit cost for the years ended December 31, 2013, 2012 and 2011 were $10.7 million, $8.3 million and $10.0 million, respectively.
The fair value of the Zurich Plan’s assets at December 31, 2013 and 2012 were insured funds and cash (Level 2) of $101.8 million and $102.4 million, respectively. The insured funds comprise the accumulated pension plan contributions and investment returns thereon, which are held in an insurance arrangement that provides at least a guaranteed minimum investment return. The insured funds are held by a collective foundation of AXA Life Ltd. and are guaranteed under the insurance arrangement.
At December 31, 2013, estimated employer contributions to be paid in 2014 related to the Zurich Plan were $5.8 million and future benefit payments were estimated to be paid as follows (in thousands of U.S. dollars):
The Company’s investment portfolio is managed following prudent standards of diversification and a prudent investment philosophy. The Company is not exposed to any significant credit concentration risk on its investments, except for debt securities issued by the U.S. government and other highly rated non-U.S. sovereign governments’ securities. At December 31, 2013 and 2012, other than the U.S. government, the Company’s fixed maturity investment portfolio did not contain exposure to any non-U.S. sovereign government or any other issuer that accounted for more than 10% of the Company’s shareholders’ equity attributable to PartnerRe. The Company keeps cash and cash equivalents in several banks and ensures that there are no significant concentrations at any point in time, in any one bank.
The Company is also subject to the credit risk of its cedants in the event of insolvency or the cedant’s failure to honor the value of funds held balances for any other reason. The funds held - directly managed account is with
Rent expense for the years ended December 31, 2013, 2012 and 2011 was $33.0 million, $36.3 million, and $37.0 million, respectively, excluding any restructuring charges related to real estate.
At December 31, 2013, the Company was not a party to any litigation or arbitration that it believes could have a material effect on the financial condition, results of operations or liquidity of the Company.
In the normal course of its operations, the Company enters into agreements with financial institutions to obtain unsecured and secured credit facilities. At December 31, 2013, the total amount of such credit facilities available to the Company was approximately $850 million, with each of the significant facilities described below. These facilities are used primarily for the issuance of letters of credit, although a portion of these facilities may also be used for liquidity purposes. Under the terms of certain reinsurance agreements, irrevocable letters of credit were issued on an unsecured and secured basis in the amount of $137 million and $410 million, respectively, at December 31, 2013, in respect of reported loss and unearned premium reserves.
In the normal course of its underwriting activities, the Company and certain subsidiaries entered into reinsurance contracts with Atradius N.V. The activity included in the Consolidated Statements of Operations related to Atradius N.V. for the years ended December 31, 2012 and 2011 was as follows (in thousands of U.S. dollars):
In the normal course of its investment operations, the Company bought or held securities of companies in which board members of the Company are also directors or non-executive directors. All transactions entered into as part of the investment portfolio were completed on market terms.
The North America sub-segment includes agriculture, casualty, credit/surety, motor, multiline, property and other risks generally originating in the United States. The Global (Non-U.S.) P&C sub-segment includes casualty, motor and property business generally originating outside of the United States. The Global Specialty sub-segment is comprised of business that is generally considered to be specialized due to the sophisticated technical underwriting required to analyze risks, and is global in nature. This sub-segment consists of several lines of business for which the Company believes it has developed specialized knowledge and underwriting capabilities. These lines of business include agriculture, aviation/space, credit/surety, energy, engineering, marine, specialty casualty, specialty property and other lines. The Catastrophe sub-segment is comprised of the Company’s catastrophe line of business. The Life and Health segment includes mortality, longevity and accident and health lines of business. Corporate and Other is comprised of the capital markets and investment related activities of the Company, including principal finance transactions, insurance-linked securities and strategic investments, and its corporate activities, including other operating expenses.
Since the Company does not manage its assets by segment, net investment income is not allocated to the Non-life segment. However, because of the interest-sensitive nature of some of the Company’s Life and Health products, net investment income is considered in Management’s assessment of the profitability of the Life and Health segment. The following items are not considered in evaluating the results of the Non-life and Life and Health segments: net realized and unrealized investment gains and losses, interest expense, amortization of intangible assets, net foreign exchange gains and losses, income tax expense or benefit and interest in earnings and losses of equity investments. Segment results are shown before consideration of intercompany transactions.
The following table provides the geographic distribution of gross premiums written based on the location of the underlying risk for the years ended December 31, 2013, 2012 and 2011:
The Company had two brokers that individually accounted for 10% or more of its gross premiums written during the years ended December 31, 2013, 2012 and 2011. The brokers accounted for 22%, 24%, and 26% and 21%, 22%, and 21% of gross premiums written for the years ended December 31, 2013, 2012 and 2011, respectively.
The following table summarizes the percentage of gross premiums written through these two brokers by segment and sub-segment for the years ended December 31, 2013, 2012 and 2011: