The principal executive offices of Alleghany, ACC and Roundwood are located in leased office space in New York, New York. TransRe leases office space in New York, New York for its headquarters and office space in almost all of its locations around the world. RSUI leases office space in Atlanta, Georgia for its headquarters and office space in Sherman Oaks, California. CapSpecialty leases office space in Middleton, Wisconsin for its headquarters. PacificComp leases office space in Agoura Hills, California. Bourn & Koch and Kentucky Trailer own their principal offices and manufacturing facilities, which are located in Rockford, Illinois and Louisville, Kentucky, respectively. SORC leases office space in Austin, Texas for its headquarters. Alleghany Properties leases office space in Sacramento, California. Management considers its facilities suitable and adequate for the current level of operations.
Net earnings attributable to Alleghany stockholders were $679.2 million in 2014, compared with $628.4 million in 2013 and $702.2 million in 2012.
Net premiums written increased by 4.9 percent in 2014 over 2013, and increased by 15.1 percent in 2013 over 2012.
Underwriting profit was $494.8 million in 2014, compared with $420.7 million in 2013 and $220.3 million in 2012.
The combined ratio for our reinsurance and insurance segments was 88.8 percent in 2014, compared with 90.1 percent in 2013 and 94.1 percent in 2012.
Catastrophe losses, net of reinsurance, were $95.2 million in 2014, compared with $150.9 million in 2013 and $470.1 million in 2012.
Net favorable prior accident year development on loss and LAE reserves was $215.2 million in 2014, compared with $203.0 million in 2013 and $12.3 million in 2012. The 2012 figure excludes $87.8 million of favorable prior accident year development on loss and LAE reserves acquired in the merger, which is included in TransRe’s current year net loss and LAE.
(1) Consist of Alleghany Properties, SORC, our investments in Homesite (prior to its sale on December 31, 2013), and ORX and corporate activities at the parent level. In addition, beginning April 26, 2012, August 30, 2013 and July 31, 2014, corporate activities include the operating results of Bourn & Koch, Kentucky Trailer and our investment in Jazwares, respectively. Corporate activities also include interest expense associated with the senior notes issued by Alleghany, whereas interest expense associated with the senior notes issued by TransRe is included in “total reinsurance and insurance segments.” Information related to the senior notes can be found in Note 8 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K.
Segment results for our two reportable segments and for corporate activities for 2014, 2013 and 2012 are shown in the tables below:
(6) $87.8 million of favorable prior accident year on loss and LAE reserves acquired in the merger is included in current year net loss and LAE.
A comparison of our consolidated results for 2014 compared with 2013, and for 2013 compared with 2012 follows. Our results for 2013 compared with 2012 reflect certain impacts that arose from the merger. These impacts primarily relate to the gain on bargain purchase of $494.9 million in 2012, due diligence, legal, investment banking and other merger-related costs, or “Transaction Costs,” (a component of corporate administration expense) of $33.8 million in 2012, and the write-off of deferred acquisition costs of TransRe as of the TransRe Acquisition Date, as well as the establishment of an intangible asset roughly approximating the amount of deferred acquisition costs. This intangible asset was amortized over an approximate one year period, similar to how deferred acquisition costs are amortized, but is shown as part of amortization of intangible assets as opposed to part of commissions, brokerage and other underwriting expenses. This amortization was largely completed as of March 6, 2013, the one year anniversary of the TransRe Acquisition Date. In addition, as the merger closed on March 6, 2012, comparative amounts for 2013 reflect activity for the entire year while amounts for 2012 reflect activity at TransRe only for the 300 day period from the TransRe Acquisition Date to December 31, 2012. Information related to the merger can be found in Note 2 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K.
2014 vs 2013. The increases in gross premiums written and net premiums written in 2014 from 2013 reflect increases at our reinsurance segment and, to a lesser extent, at our insurance segment. The increase at our reinsurance segment primarily reflects certain expanded treaty participations with existing long-term clients. The increase at our insurance segment reflects significant growth at CapSpecialty and PacificComp. The increases in net premiums earned in 2014 from 2013 reflect increases at our insurance segment and, to a lesser extent, at our reinsurance segment.
2014 vs 2013. The increase in net loss and LAE in 2014 from 2013 primarily reflects the impact of increased net premiums earned at our insurance segment, as discussed above, and lower net favorable prior year loss and LAE reserve development at our reinsurance segment, partially offset by lower catastrophe losses at our reinsurance and insurance segments, and net favorable prior year loss and LAE reserve development in 2014 compared to net adverse prior year loss and LAE reserve development in 2013 at our insurance segment. By contrast, our loss ratio was lower in 2014 from 2013, primarily reflecting lower catastrophe losses at our reinsurance and insurance segments.
2014 vs 2013. The increase in underwriting profit in 2014 from 2013 primarily reflects lower catastrophe losses at our reinsurance and insurance segments.
Underwriting profits for 2014, 2013 and 2012 are more fully described in the following pages.
2013 vs 2012. The increase in net investment income in 2013 from 2012 primarily reflects the merger impacts discussed above.
Other income and other operating expenses. Other income and other operating expenses include revenues and expenses associated with our non-insurance operations. Other operating expenses also includes the long-term incentive compensation of our reinsurance segment and insurance segment, which totaled $83.5 million, $80.1 million and $84.9 million for 2014, 2013 and 2012, respectively (see Note 14 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information).
The increases in other income and other operating expenses in 2014 from 2013 and 2013 from 2012 primarily reflect the acquisition of Kentucky Trailer on August 30, 2013 and Bourn & Koch on April 26, 2012 and, to a lesser extent, increased expenses at SORC.
Amortization of intangible assets. Amortization of intangible assets in 2012 and 2013 primarily reflect the merger impacts discussed above. Amortization of intangible assets in 2014 reflects the amortization of net intangible liabilities arising from the merger.
(6) $56.6 million, $31.2 million and $87.8 million of favorable prior accident year development on loss and LAE reserves acquired in the merger for property, casualty & other and total, respectively, are included in current year net loss and LAE.
Reinsurance Segment: Premiums. The following table summarizes premiums for the reinsurance segment.
Property. Gross premiums written increased 6.7 percent in 2014 from 2013, primarily reflecting the impact of certain expanded treaty participations with existing long-term clients, partially offset by reductions in pricing for property reinsurance contracts as the market became increasingly price competitive and the impact of changes in foreign currency rates. Excluding the impact of changes in foreign currency rates, gross premiums written increased 8.0 percent in 2014 from 2013. Net premiums earned in 2014 increased by 6.0 percent from 2013. The increase in net premiums earned reflects certain expanded treaty participations with existing long-term clients, partially offset by the impact of changes in foreign currency rates. Excluding the impact of changes in foreign currency rates, net premiums earned increased 7.5 percent in 2014 from 2013.
Casualty & other. The increase in gross premiums written in 2014 from 2013 primarily reflects increases in premiums written for the general liability, auto liability and guaranty lines of business, partially offset by decreases in the directors’ and officers’ liability, errors and omission liability and accident and health lines of business. These changes in premiums include the impact of new or expanded treaties, tempered by the impact of an increasingly competitive casualty reinsurance market and a decreasing amount of risk premium being ceded by insurers. Net premiums earned in 2014 approximated those in 2013, primarily reflecting a decrease in gross premiums written in the latter half of 2013 and an increase in ceded premiums earned, offset by the increase in gross premiums written in 2014.
(1) $56.6 million, $31.2 million and $87.8 million of favorable prior accident year development on loss and LAE reserves acquired in the merger for property, casualty & other and total, respectively, are included in current year net loss and LAE in 2012.
Property. The increase in net loss and LAE in 2014 from 2013 primarily reflects less favorable prior accident year development on loss reserves and higher non-catastrophe losses incurred, partially offset by lower catastrophe losses. Catastrophe losses, net of reinsurance, were $46.8 million and $92.1 million in 2014 and 2013, respectively. Catastrophe losses for 2014 reflect losses from severe snowstorms across northeast Japan in February 2014 and from wind and hailstorm Ela, which struck Europe in June 2014. The $92.1 million of catastrophe losses in 2013 primarily reflect net losses from flooding in Germany in May 2013, flooding in Central Europe and Canada in June 2013, hurricanes in Mexico in September 2013 and hailstorms in Germany and Canada in July 2013.
(1) $31.2 million of favorable development on loss and LAE reserves acquired in the merger are included in current year net loss and LAE.
(2) Represents certain medical malpractice treaties pursuant to which the increased underwriting profits created by the favorable development are retained by the cedants, or the “Malpractice Treaties.” As a result, TransRe records an offsetting increase in profit commission expense incurred when such favorable development occurs.
The favorable development in 2014 and 2013 reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods. The favorable development in 2014 did not impact assumptions used in estimating TransRe’s loss and LAE liabilities for business earned in 2014.
Reinsurance Segment: Commissions, brokerage and other underwriting expenses. The following table summarizes commissions, brokerage and other underwriting expenses for the reinsurance segment.
For both the property and the casualty & other lines of business, applying the acquisition method of accounting for the merger had a favorable impact on the expense ratio for 2012 because deferred acquisition costs were written off at the TransRe Acquisition Date. As of March 6, 2013, the application of the acquisition method of accounting no longer had a significant impact on the expense ratio. Excluding the impact of the application of the acquisition method of accounting, the estimated expense ratio for the reinsurance segment would have been approximately 29 percent for 2012.
Casualty & other. The increase in commissions, brokerage and other underwriting expenses in 2014 from 2013 primarily reflects an increase in commission rates being demanded by cedants in 2014, partially offset by a decrease in profit commissions related to the Malpractice Treaties. The increase in commissions, brokerage and other underwriting expenses in 2014 from 2013 also reflects the absence of the favorable impact arising from the acquisition method of accounting, which was present in part of 2013. The increase in commissions, brokerage and other underwriting expenses in 2013 from 2012 primarily reflects the diminished favorable impact arising from the acquisition method of accounting, as explained above, and to a lesser extent, the $35.7 million of profit commission expense incurred related to the Malpractice Treaties, as described above.
RSUI. The decrease in gross premiums written in 2014 from 2013 reflects declines in the property line of business due to an increase in competition and a decrease in rates, partially offset by generally favorable market conditions in most other lines of business, particularly for the binding authority and directors’ and officers’ liability lines of business. The increase in gross premiums written in 2013 from 2012 primarily reflects some improvements in market conditions in most lines of business, particularly for the umbrella, directors’ and officers’ liability, professional liability and binding authority lines of business, evidenced by favorable renewal retention rates and strong new business submissions. The increase in net premiums earned in 2014 from 2013 primarily reflects an increase in gross premiums written in early 2014 and late 2013 and, to a lesser extent, lower ceded premiums written due primarily to declines in the heavily-reinsured property line of business. The increase in net premiums earned in 2013 from 2012 primarily reflects an increase in gross premiums written.
CapSpecialty. The increase in gross premiums written in 2014 from 2013 reflects growth in the property and casualty lines of business, including strong growth in the professional lines of business. The increase in gross premiums written in 2013 from 2012 primarily reflects growth in the property and casualty lines of business and, to a lesser extent, the surety lines of business. Net premiums earned increased in 2014 from 2013 primarily reflecting an increase in gross premiums written, partially offset by higher ceded premiums earned arising from an increase in reinsurance coverage. Net premiums earned increased in 2013 from 2012 primarily reflecting an increase in gross premiums written.
(2) Primarily reflects favorable development in the umbrella/excess liability, professional liability lines of business, and primarily related to the 2005 through 2010 accident years.
(3) Primarily reflects favorable development in the umbrella/excess liability, general liability, professional liability and directors’ and officers’ liability lines of business, and primarily related to the 2005 through 2008 accident years.
(4) Primarily reflects favorable development on unallocated LAE reserves and prior year catastrophe reserves from recent accident years.
(5) Includes $8.5 million of unfavorable development from Hurricane Katrina, which resulted from a significant claim that settled for more than previously estimated due to an adverse court ruling, partially offset by net favorable development with respect to other property reserves.
(6) Includes $9.7 million of unfavorable development from Hurricane Ike in 2008.
The favorable development in 2014, 2013 and 2012 reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods. Specifically relating to the favorable development in 2014, actual losses relating to prior accident years for such lines of business, which include both loss payments and case reserves, were lower than expected through December 31, 2014. The amount of lower actual losses than expected, expressed as a percentage of carried loss and LAE reserves at the beginning of the year, was 0.3 percent. The favorable development in 2014 did not impact assumptions used in estimating RSUI’s loss and LAE liabilities for business earned in 2014.
(2) Primarily reflects unfavorable development from workers’ compensation and certain other casualty lines of business, and related primarily to unfavorable loss emergence on a few individual claims, partially offset by favorable development on surety and property lines of business.
The unfavorable development in 2013 and 2012 reflects unfavorable loss emergence compared with loss emergence patterns assumed in earlier periods.
Insurance Segment: Commissions, brokerage and other underwriting expenses. The following table summarizes commissions, brokerage and other underwriting expenses for the insurance segment.
CapSpecialty. The decrease in CapSpecialty’s underwriting loss in 2014 from 2013 reflects an increase in net premiums earned and a decrease in net loss and LAE, partially offset by an increase in commissions, brokerage and other underwriting expenses, all as discussed above. The increase in CapSpecialty’s underwriting loss in 2013 from 2012 primarily reflects an increase in loss and LAE, partially offset by an increase in net premiums earned, all as discussed above.
Approximate yields of the reinsurance and insurance segments’ debt securities for 2014, 2013 and 2012 are as follows:
(4) Pre-tax net interest income for the period divided by average investments for the same period.
(5) After-tax net interest income for the period divided by average investments for the same period.
After adjusting the cost basis of securities for the recognition of OTTI losses, the remaining gross unrealized investment losses for debt and equity securities as of December 31, 2014 were deemed to be temporary, based on, among other factors: (i) the duration of time and the relative magnitude to which the fair values of these securities had been below cost were not indicative of an OTTI loss (for example, no equity security was in a continuous unrealized loss position for 12 months or more as of December 31, 2014); (ii) the absence of compelling evidence that would cause us to call into question the financial condition or near-term business prospects of the issuers of the securities; and (iii) our ability and intent to hold the securities for a period of time sufficient to allow for any anticipated recovery.
Corporate administration. The increase in corporate administration expense in 2014 from 2013 primarily reflects the absence of a one-time reduction in expenses from the freezing of pension benefits at the parent-level. On July 16, 2013, our Board of Directors decided to: (i) freeze the benefits associated with our unfunded, noncontributory defined benefit pension plan for parent-level executives, effective December 31, 2013; and (ii) terminate our two retiree health plans for parent-level executives and employees, effective September 30, 2013. As a result of these decisions, we recorded a pre-tax $8.8 million reduction to corporate administration expense in the third quarter of 2013.
Interest expense. The increase in interest expense in 2014 from 2013 is due to the issuance of the 2044 Senior Notes (as defined on page 99 of this Form 10-K) on September 9, 2014. The increase in interest expense in 2013 from 2012 is due to the issuance of the 2022 Senior Notes (as defined on page 99 of this Form 10-K) on June 26, 2012.
favorable prior accident year development on loss reserves and payments related to catastrophe events occurring in prior years. The slight increase in gross and net loss and LAE reserves in the insurance segment primarily reflects the impact of higher net premiums earned in 2013, partially offset by the impact of property loss claims resulting from Super Storm Sandy paid by RSUI in 2013.
Our net reserves for loss and LAE of $10.3 billion as of December 31, 2014 relate to multiple accident years. Therefore, the impact of changes in frequency or severity for more than one accident year could be higher or lower than the amounts reflected above. We believe the above analysis provides a reasonable benchmark for sensitivity as we believe it is within historical variation for our reserves. Currently, none of the scenarios is believed to be more likely than the other. See Note 1(k) and Note 6 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional information on our loss and LAE.
Prior Year Development. Our reinsurance and insurance subsidiaries continually evaluate the potential for changes, both positive and negative, in their estimates of their loss and LAE liabilities and use the results of these evaluations to adjust both recorded liabilities and underwriting criteria. With respect to liabilities for unpaid loss and LAE established in prior years, these liabilities are periodically analyzed and their expected ultimate cost adjusted, where necessary, to reflect favorable or unfavorable development in loss experience and new information, including, for certain catastrophe events, revised industry estimates of the magnitude of a catastrophe. Adjustments to previously recorded liabilities for unpaid loss and LAE, both favorable and unfavorable, are reflected in our financial results in the periods in which these adjustments are made and are referred to as prior accident year reserve development. We adjusted our prior year loss and LAE reserve estimates during 2014, 2013 and 2012 based on current information that differed from previous assumptions made at the time such loss and LAE reserves were previously estimated. The (favorable) unfavorable prior accident year development on loss reserves for 2014, 2013 and 2012 is summarized as follows:
(1) $87.8 million of favorable prior accident year development on loss and LAE reserves acquired in the merger are included in current year net loss and LAE for the reinsurance segment.
(5) Reflects favorable development primarily related to the 2011 and 2012 accident years.
(6) Represents certain medical malpractice treaties pursuant to which the increased underwriting profits created by the favorable development are retained by the cedants. As a result, TransRe records an offsetting increase in profit commission expense incurred when such favorable development occurs.
(7) Generally reflects favorable development in a variety of casualty & other lines of business primarily from the 2003 through 2007 and 2010 through 2011 accident years, partially offset by unfavorable development from the 2013 accident year and the 2002 and prior accident years.
Asbestos-Related Illness and Environmental Impairment Reserves. Loss and LAE include amounts for risks relating to asbestos-related illness and environmental impairment. The reserves carried for such claims, including the IBNR portion, are based upon known facts and current law at the respective balance sheet dates. However, significant uncertainty exists in determining the amount of ultimate liability for asbestos-related illness and environmental impairment losses, particularly for those occurring in 1985 and prior, which represents the majority of TransRe’s asbestos-related illness and environmental impairment reserves. This uncertainty is due to inconsistent and changing court resolutions and judicial interpretations with respect to underlying policy intent and coverage and uncertainties as to the allocation of responsibility for resultant damages, among other reasons. Further, possible future changes in statutes, laws, regulations, theories of liability and other factors could have a material effect on these liabilities and, accordingly, future earnings. Although we are unable at this time to determine whether additional reserves, which could have a material adverse effect upon our results of operations, may be necessary in the future, we believe that our asbestos-related illness and environmental impairment reserves are adequate as of December 31, 2014. See Note 12(d) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” and pages 35 and 36 of this Form 10-K for additional information on loss and LAE for risks relating to asbestos-related illness and environmental impairment.
A three-tiered hierarchy for inputs is used in management’s determination of fair value of financial instruments that emphasizes the use of observable inputs over the use of unobservable inputs by requiring that the observable inputs be used when available. Assets classified as Level 3 principally include certain residential mortgage-backed securities, or “RMBS,” commercial mortgage-backed securities, or “CMBS,” other asset-backed securities, partnership investments and non-marketable equity investments. The valuation of Level 3 assets requires the greatest degree of judgment, as these valuations are based on techniques that use significant inputs that are unobservable. These measurements may be made under circumstances in which there is little, if any, market activity for the asset. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment. In making the assessment, we consider factors specific to the asset. Some Level 3 valuations are based entirely on non-binding broker quotes. These securities consist primarily of mortgage-backed and asset-backed securities where reliable pool and loan level collateral information cannot be reasonably obtained.
We hold our equity and debt securities as available-for-sale, or “AFS,” and as such, these securities are recorded at fair value. We continually monitor the difference between cost and the estimated fair value of our investments, which involves uncertainty as to whether declines in value are temporary in nature. The analysis of any individual security’s decline in value is performed in its functional currency. If the decline of a particular investment is deemed temporary, we record the decline as an unrealized loss in stockholders’ equity. If the decline is deemed to be other than temporary, we write our cost-basis or amortized cost-basis down to the fair value of the investment and record an OTTI loss on our statement of earnings. In addition, any portion of such decline related to debt securities that is believed to arise from factors other than credit is recorded as a component of other comprehensive income rather than charged against earnings.
In developing the cash flow analyses for debt securities, we consider various factors for the different categories of debt securities. For municipal bonds, we take into account the taxing power of the issuer, source of
Goodwill and other intangible assets deemed to have an indefinite useful life are tested annually in the fourth quarter of every year for impairment. Goodwill and other intangible assets are also tested whenever events and changes in circumstances suggest that the carrying amount may not be recoverable. A significant amount of judgment is required in performing goodwill and other intangible asset impairment tests. These tests may include estimating the fair value of our operating subsidiaries and other intangible assets. If it is determined that an asset has been impaired, the asset is written down by the amount of the impairment, with a corresponding charge to net earnings. Subsequent reversal of any impairment charge is not permitted.
Stockholders’ equity attributable to Alleghany stockholders was approximately $7.5 billion as of December 31, 2014, compared with approximately $6.9 billion as of December 31, 2013. The increase in stockholders’ equity in 2014 primarily reflects net earnings and an increase in unrealized appreciation on our debt securities portfolio, partially offset by repurchases of our common stock and, to a lesser extent, the impact
plus (y) an applicable margin. Eurodollar Borrowings under the Credit Agreement bear interest at the Adjusted LIBO Rate for the interest period in effect plus an applicable margin. The Credit Agreement requires that all loans be repaid in full no later than October 15, 2017. The Credit Agreement requires us to pay a commitment fee each quarter in a range of between 0.125 and 0.30 percent per annum, based upon our credit ratings, on the daily unused amount of the commitments.
In addition, at any time when a default has occurred and is continuing or would result therefrom, the Credit Agreement proscribes our ability to declare or pay, or permit certain of our subsidiaries to declare or pay, any dividend on, or make any payment on account of, or set apart assets for a sinking or other analogous fund for, the purchase, redemption, defeasance, retirement or acquisition of, any of our stock or the stock of any such subsidiary.
There were no borrowings under the Credit Agreement since its inception through December 31, 2014.
governing constitution of technical reserves and remittance balances in some countries may hinder remittance of
A summary of dividends paid to Alleghany by its reinsurance and insurance subsidiaries in 2014, 2013 and 2012 follows:
Common Stock Repurchases. In October 2012, our Board of Directors authorized a program to repurchase shares of our common stock, at such times and at prices as management determines advisable, up to an aggregate of $300.0 million, or the “2012 Repurchase Program.” In July 2014, our Board of Directors authorized, upon the completion of the 2012 Repurchase Program, the repurchase of additional shares of common stock, at such times and at prices as management may determine advisable, up to an aggregate of $350.0 million, or the “2014 Repurchase Program.” As of December 31, 2014, we completed the 2012 Repurchase Program, and we had repurchased approximately $58.6 million of shares under the 2014 Repurchase Program.
Pursuant to the Alleghany Board of Directors authorizations, we repurchased shares of our common stock in 2014, 2013 and 2012 as follows:
(1) “Senior Notes” refers to: (i) the “Alleghany Senior Notes,” consisting of the 2020 Senior Notes, the 2022 Senior Notes and the 2044 Senior Notes; and (ii) the “TransRe Senior Notes,” consisting of the 2015 Senior Notes and TransRe’s 8.00% senior notes due on November 30, 2039. See Note 8 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for further details on the Senior Notes.
Investments in Certain Other Invested Assets. In December 2012, TransRe obtained an ownership interest in Pillar Capital Holdings Limited, or “Pillar Holdings,” a Bermuda-based insurance asset manager focused on collateralized reinsurance and catastrophe insurance-linked securities. Additionally, TransRe invested $175.0 million and AIHL invested $25.0 million in limited partnership funds managed by Pillar Holdings, or the “Funds.” The objective of the Funds is to create portfolios with attractive risk-reward characteristics and low correlation with other asset classes, using the extensive reinsurance and capital market experience of the principals of Pillar Holdings. We have concluded that both Pillar Holdings and the Funds, which we collectively refer to as the “Pillar Investments,” represent variable interest entities and that we are not the primary beneficiary, as we do not have the ability to direct the activities that most significantly impact each entity’s economic performance. Therefore, the Pillar Investments are not consolidated and are accounted for under the equity method of accounting. Our potential maximum loss in the Pillar Investments is limited to our cumulative investment. As of December 31, 2014, our carrying value in the Pillar Investments, as determined under the equity method of accounting, was $235.2 million, which is reported in other invested assets on our consolidated balance sheets.
half of these interests may be converted beginning at the end of a one-year waiting period, and the remaining half may be converted beginning at the end of a two-year waiting period. Until our limited partner interests convert into Ares common units, we classify our investment in Ares as a component of other invested assets, and we account for our investment using the equity method of accounting. As of December 31, 2014, AIHL’s carrying value in Ares was $231.7 million, which is net of returns of capital received from Ares.
Of our non-insurance operating subsidiaries, SORC has largely depended on Alleghany to support its growth. From formation in 2011 through December 31, 2014, we have invested $155.7 million in SORC. In April 2014, SORC obtained a $250.0 million secured bank credit facility. As of December 31, 2014, SORC had $6.8 million of borrowings under the facility, representing its borrowing capacity as of December 31, 2014. In addition, Kentucky Trailer had $29.2 million of borrowings as of December 31, 2014 related to a mortgage loan and borrowings under its available credit facility. None of these liabilities are guaranteed by Alleghany or ACC, and they are classified as a component of other liabilities on our consolidated balance sheets.
Effective duration measures a portfolio’s sensitivity to changes in interest rates. In this regard, as of December 31, 2014, our debt securities portfolio had an effective duration of approximately 3.9 years compared with 4.5 years as of December 31, 2013. The decline in duration in 2014 primarily reflects the sales of long-dated U.S. Treasury Strip debt securities in April 2014. As of December 31, 2014, approximately $3.9 billion, or 26.7 percent, of our debt securities portfolio represented securities with maturities of five years or less. See Note 4(b) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for additional detail on the contractual maturities of our consolidated debt securities portfolio. We may modestly increase the proportion of our debt securities portfolio held in securities with maturities of more than five years should the yields of these securities provide, in our judgment, sufficient compensation for their increased risk. We do not believe that this strategy would reduce our ability to meet ongoing claim payments or to respond to significant catastrophe losses.
On a consolidated basis, our invested assets decreased to approximately $18.8 billion as of December 31, 2014 from approximately $19.0 billion as of December 31, 2013, primarily reflecting the impact of repurchases of our common stock, changes in foreign currency exchange rates on our foreign currency-denominated securities and an increase in cash balances, partially offset by the impact of an increase in unrealized appreciation on our debt securities portfolio, due to a modest decrease in longer-term interest rates that occurred in 2014.
Although we are responsible for the determination of the fair value of our financial assets and the supporting methodologies and assumptions, we employ third party valuation service providers to gather, analyze and interpret market information and derive fair values based upon relevant methodologies and assumptions for individual instruments. When those providers are unable to obtain sufficient market observable information upon
which to estimate the fair value for a particular security, fair value is determined either by requesting a quote, which is generally non-binding, from brokers who are knowledgeable about these securities or by employing widely accepted internal valuation models.
Level 2: Valuations are based on direct and indirect observable inputs other than quoted market prices included in Level 1. Level 2 inputs include quoted prices for similar assets in active markets and inputs other than quoted prices that are observable for the asset, such as the terms of the security and market-based inputs. Terms of the security include coupon, maturity date and any special provisions that may, for example, enable the investor, at its election, to redeem the security prior to its scheduled maturity date. Market-based inputs include interest rates and yield curves that are observable at commonly quoted intervals and current credit rating(s) of the security. Level 2 assets generally include short-term investments and most debt securities. Our Level 2 liabilities consist of the senior notes.
Level 3: Valuations are based on techniques that use significant inputs that are unobservable. The valuation of Level 3 assets requires the greatest degree of judgment. These measurements may be made under circumstances in which there is little, if any, market activity for the asset. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment. In making the assessment, we consider factors specific to the asset. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement is classified is determined based on the lowest level input that is significant to the fair value measurement in its entirety. Some Level 3 valuations are based entirely on non-binding broker quotes. These securities consist primarily of mortgage-backed and asset-backed securities where reliable pool and loan level collateral information cannot be reasonably obtained. Assets classified as Level 3 principally include certain RMBS, CMBS, other asset-backed securities (primarily, collateralized loan obligations), partnership investments and non-marketable equity investments. See Note 1(c) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K for our accounting policy on fair value.
assess the reasonableness of individual security values received from valuation service providers through various analytical techniques. In addition, we validate the reasonableness of fair values by comparing information obtained from our valuation service providers to other third party valuation sources for selected securities. We also validate prices obtained from brokers for selected securities through reviews by those who have relevant expertise and who are independent of those charged with executing investing transactions.
strategies. In May 2014, Ares completed an initial public offering of its common units. Upon completion of the initial public offering, our equity investment in Ares converted to limited partner interests in certain Ares subsidiaries that are convertible into an aggregate 5.9 percent interest in Ares common units. At our discretion,
(2) Includes $900.7 million and $237.9 million of collateralized loan obligations as of December 31, 2014 and December 31, 2013, respectively.
Natural disasters such as hurricanes, other windstorms, earthquakes and other catastrophes have the potential to materially and adversely affect our operating results. Other risks, such as an outbreak of a pandemic disease, a major terrorist event, the bankruptcy of a major company or a marine and / or aviation disaster, could also have a material adverse effect on our business and operating results.
We have audited the accompanying consolidated balance sheets of Alleghany Corporation and subsidiaries (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of earnings and comprehensive income, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2014. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
Alleghany Corporation (“Alleghany”), a Delaware corporation, owns and manages certain operating subsidiaries and investments, anchored by a core position in property and casualty reinsurance and insurance. Alleghany was initially incorporated in 1929, was subsequently incorporated in 1984 under the laws of the State of Delaware, and in December 1986, it succeeded to the business of its parent company, Alleghany Corporation. Through its wholly-owned subsidiary Alleghany Insurance Holdings LLC (“AIHL”) and its subsidiaries, Alleghany is engaged in the property and casualty insurance business. AIHL’s insurance operations are principally conducted by its subsidiaries RSUI Group, Inc. (“RSUI”), CapSpecialty, Inc. (“CapSpecialty”) and Pacific Compensation Corporation (“PacificComp”). CapSpecialty, formerly known as Capitol Transamerica Corporation, has been a subsidiary of AIHL since January 2002, RSUI has been a subsidiary of AIHL since July 2003, and PacificComp has been a subsidiary of AIHL since July 2007. AIHL Re LLC (“AIHL Re”) has been a wholly-owned subsidiary of Alleghany since its formation in May 2006. AIHL Re is a captive reinsurance company which provides reinsurance to Alleghany’s insurance operating subsidiaries and affiliates. On March 6, 2012 (the “TransRe Acquisition Date”), Alleghany consummated a merger transaction (the “merger”) with Transatlantic Holdings, Inc. (“TransRe”), at which time TransRe became one of Alleghany’s wholly-owned subsidiaries and Alleghany’s reinsurance operations commenced. Alleghany’s public equity investments, including those held by TransRe’s and AIHL’s operating subsidiaries, are managed primarily by Alleghany’s wholly-owned subsidiary Roundwood Asset Management LLC (“Roundwood”).
Although Alleghany’s primary sources of revenues and earnings are its reinsurance and insurance operations and investments, Alleghany also manages, sources, executes and monitors certain private capital investments primarily through its wholly-owned subsidiary Alleghany Capital Corporation (“ACC”). ACC’s private capital investments are included in corporate activities for segment reporting purposes and include: (i) Stranded Oil Resources Corporation (“SORC”), an exploration and production company focused on enhanced oil recovery, headquartered in Austin, Texas; (ii) Bourn & Koch, Inc. (“Bourn & Koch”), a manufacturer and remanufacturer/retrofitter of precision machine tools and supplier of replacement parts, headquartered in Rockford, Illinois; (iii) R.C. Tway Company, LLC (“Kentucky Trailer”), a manufacturer of custom trailers and truck bodies for the moving and storage industry and other markets, headquartered in Louisville, Kentucky; (iv) an approximately 40 percent equity interest in ORX Exploration, Inc. (“ORX”), a regional oil and gas exploration and production company, headquartered in New Orleans, Louisiana; and (v) a 30 percent equity interest in Jazwares, LLC (“Jazwares”), a toy and consumer electronics company, headquartered in Sunrise, Florida, which interest was acquired on July 31, 2014 for $60.3 million. ORX and Jazwares are accounted for under the equity-method of accounting. In addition, Alleghany owns and manages properties in the Sacramento, California region through its wholly-owned subsidiary Alleghany Properties Holdings LLC (“Alleghany Properties”).
The portion of stockholders’ equity, net earnings and accumulated other comprehensive income that is not attributable to Alleghany stockholders is presented on the Consolidated Balance Sheets, the Consolidated Statements of Earnings and Comprehensive Income and the Consolidated Statements of Changes in Stockholders’ Equity as noncontrolling interest. Bourn & Koch and Kentucky Trailer each have approximately 20 percent noncontrolling interests outstanding during 2014.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Alleghany relies on historical experience and on various other assumptions that it believes to be reasonable under the circumstances to make judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from those reported results to the extent that those estimates and assumptions prove to be inaccurate. Changes in estimates are reflected in the consolidated statement of earnings and comprehensive income in the period in which the change is made.
Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between willing, able and knowledgeable market participants at the measurement date. Fair value measurements are not adjusted for transaction costs. In addition, a three-tiered hierarchy for inputs is used in management’s determination of fair value of financial instruments that emphasizes the use of observable inputs over the use of unobservable inputs by requiring that the observable inputs be used when available. Observable inputs are market participant assumptions based on market data obtained from sources independent of the reporting entity. Unobservable inputs are the reporting entity’s own assumptions about market participant assumptions based on the best information available under the circumstances. In assessing the appropriateness of using observable inputs in making its fair value determinations, Alleghany considers whether the market for a particular security is “active” or not based on all the relevant facts and circumstances. A market may be considered to be inactive if there are relatively few recent transactions or if there is a significant decrease in market volume. Furthermore, Alleghany considers whether observable transactions are “orderly” or not. Alleghany does not consider a transaction to be orderly if there is evidence of a forced liquidation or other distressed condition, and as such, little or no weight is given to that transaction as an indicator of fair value.
judgment. An active market is defined as a market where transactions for the financial instrument occur with sufficient frequency and volume to provide pricing information on an ongoing basis. Alleghany’s Level 1 assets include publicly traded common stocks and mutual funds (which are included on the balance sheet in equity securities) where Alleghany’s valuations are based on quoted market prices.
Level 2: Valuations are based on direct and indirect observable inputs other than quoted market prices included in Level 1. Level 2 inputs include quoted prices for similar assets in active markets and inputs other than quoted prices that are observable for the asset, such as the terms of the security and market-based inputs. Terms of the security include coupon, maturity date and any special provisions that may, for example, enable the investor, at its election, to redeem the security prior to its scheduled maturity date. Market-based inputs include interest rates and yield curves that are observable at commonly quoted intervals and current credit rating(s) of the security. Level 2 assets generally include short-term investments and most debt securities. Alleghany’s Level 2 liabilities consist of the senior notes.
Level 3: Valuations are based on techniques that use significant inputs that are unobservable. The valuation of Level 3 assets requires the greatest degree of judgment. These measurements may be made under circumstances in which there is little, if any, market activity for the asset. Alleghany’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment. In making the assessment, Alleghany considers factors specific to the asset. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement is classified is determined based on the lowest level input that is significant to the fair value measurement in its entirety. Some Level 3 valuations are based entirely on non-binding broker quotes. These securities consist primarily of mortgage-backed and asset-backed securities where reliable pool and loan level collateral information cannot be reasonably obtained. Assets classified as Level 3 principally include certain residential mortgage-backed securities (“RMBS”), commercial mortgage-backed securities (“CMBS”), other asset-backed securities (primarily, collateralized loan obligations), partnership investments and non-marketable equity investments.
has correlated the portfolio of investments to the market. Also, any changes made by the investee to the investment strategy of the non-marketable equity investments could result in significant changes to fair value that have a positive or negative correlation to the performance observed in the equity markets. For those investments whose performance is based on the results of operations within a specific industry, significant events impacting that industry could materially impact fair value. Also, decisions and changes to strategy made by management of the investee could result in positive or negative outcomes, which could significantly impact the results of operations of the investee and subsequently fair value.
Cash includes all deposit balances with a bank that are available for immediate withdrawal, whether interest-bearing or non-interest bearing.
Reinsurance is used to mitigate the exposure to losses, manage capacity and protect capital resources. Reinsuring loss exposures does not relieve a ceding entity from its obligations to policyholders and cedants. Reinsurance recoverables (including amounts related to claims incurred but not reported) and ceded unearned premiums are reported as assets. To minimize exposure to losses from a reinsurer’s inability to pay, the financial condition of such reinsurer is evaluated initially upon placement of the reinsurance and periodically thereafter. In addition to considering the financial condition of a reinsurer, the collectability of the reinsurance recoverables is
evaluated (and where appropriate, whether an allowance for estimated uncollectible reinsurance recoverables is to be established) based upon a number of other factors. Such factors include the amounts outstanding, length of collection periods, disputes, any collateral or letters of credit held and other relevant factors. To the extent that an allowance for uncollectible reinsurance recoverable is established, amounts deemed to be uncollectible are written off against the allowance for estimated uncollectible reinsurance recoverables. Alleghany currently has no allowance for uncollectible reinsurance recoverables.
Ceded premiums written are recorded in accordance with the applicable terms of the various reinsurance contracts and ceded premiums earned are charged against revenue over the period of the various reinsurance contracts. This also generally applies to reinstatement premiums paid to a reinsurer, which arise when contractually-specified ceded loss triggers have been breached. Ceded commissions reduce commissions, brokerage and other underwriting expenses and ceded losses incurred reduce net loss and loss adjustment expense (“LAE”) incurred over the applicable periods of the various reinsurance contracts with third party reinsurers. If premiums or commissions are subject to adjustment (for example, retrospectively-rated or experience-rated), the estimated ultimate premium or commission is recognized over the period of the contract.
Acquisition costs related to unearned premiums that vary with, and are directly related to, the production of such premiums are deferred. Furthermore, such deferred costs: (i) represent only incremental, direct costs associated with the successful acquisition of a new or renewal insurance or reinsurance contract; (ii) are essential to the contract transaction; (iii) would not have been incurred had the contract transaction not occurred; and (iv) are related directly to the acquisition activities involving underwriting, policy issuance and processing. Acquisition costs principally relate to commissions. To a lesser extent, acquisition costs can include premium taxes and certain qualifying underwriting expenses. For insurance policies written, acquisition costs are generally incurred directly, and include commissions, premium taxes and certain qualifying underwriting expenses. For reinsurance contracts written, acquisition costs are generally incurred through brokerage commissions and indirectly through ceding commissions, which are deferred. Deferred acquisition costs are amortized to expense as the related premiums are earned, generally over a period of one year. Deferred acquisition costs are reviewed at least annually to determine their recoverability from future income, including investment income. If any such costs are determined not to be recoverable they are charged to expense.
The determination of the fair value of other intangible assets and net assets often involves the use of valuation models and other estimates, which involve many assumptions and variables and are inherently subjective. Other intangible assets that are not deemed to have an indefinite useful life are amortized over their estimated useful lives. Goodwill and those intangible assets that have an indefinite useful life are not subject to amortization.
See Note 2 for additional information on goodwill and other intangible assets.
Alleghany files a consolidated federal income tax return with its subsidiaries. Following the TransRe Acquisition Date, Alleghany’s consolidated federal income tax return includes as part of its taxable income those items of income of non-U.S. subsidiaries that are subject to U.S. income tax currently, pursuant to Subpart F income rules of the Internal Revenue Code. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Current tax liabilities or assets are recognized for the estimated taxes payable or refundable on tax returns for the current year.
The reserves for loss and LAE include but are not limited to: (i) reports and individual case estimates received from ceding companies with respect to assumed reinsurance business; (ii) the accumulation of individual estimates for claims reported with respect to direct insurance business; (iii) estimates for incurred but not reported claims based on past experience, modified for current trends and industry data; and (iv) estimates of expenses for investigating and settling claims based on past experience. The methods used to determine such estimates and to establish the resulting reserves are continually reviewed and updated. Any adjustments are reflected in current income. Net loss and LAE incurred consists of the estimated ultimate cost of settling claims incurred within the reporting period (net of related reinsurance recoverable), including IBNR claims, plus changes in estimates of prior period losses.
The process of estimating these reserves is inherently difficult and involves a considerable degree of judgment, especially in view of changing legal and economic environments that impact the development of loss reserves. Therefore, quantitative techniques have to be supplemented by subjective considerations and managerial judgment. In addition, trends that have affected development of liabilities in the past may not necessarily occur or affect liability development to the same degree in the future.
In April 2014, the Financial Accounting Standards Board (the “FASB”) issued guidance that changed the criteria for reporting discontinued operations. Under the new guidance, only disposals that represent a strategic shift in operations qualify as discontinued operations. In addition, the new guidance requires expanded disclosures about discontinued operations. This guidance is effective in the first quarter of 2015. Alleghany will adopt this guidance in the first quarter of 2015, and Alleghany does not currently believe that the implementation will have an impact on its results of operations and financial condition.
Following the TransRe Acquisition Date, the Alleghany Board of Directors consisted of all 11 members from its pre-merger Board of Directors and three additional members (the “Continuing Directors”) who had served on the Board of Directors of Old TransRe.
Pursuant to the terms of the Merger Agreement, each outstanding Old TransRe restricted stock unit (including performance-based Old TransRe restricted stock units) held by current or former employees or non-employee directors of Old TransRe was converted into the right to receive a cash payment in an amount equal to the Per Share Consideration, with the same terms and conditions as were applicable under such restricted stock unit prior to its conversion, that was: (i) deemed notionally invested in the equity of TransRe, referred to as “book value units;” (ii) with respect to the Continuing Directors, deemed notionally invested in Common Stock; or (iii) maintained in a cash account while continuing to vest on the existing vesting schedule. As of the TransRe Acquisition Date, the value of the Old TransRe restricted stock units was determined to be $49.5 million, none of which remain outstanding as of December 31, 2014.
Net deferred tax assets - Adjustment to deferred tax assets, net, related to fair value adjustments. See Note 9 for additional information on net deferred tax assets.
Gain contingency on dispute previously in arbitration - Estimated minimum recovery, net of estimated legal costs, from a dispute between TransRe and American International Group, Inc. (“AIG”) previously in arbitration, which was subsequently settled in the third quarter of 2012. See Note 12(a) for additional information on the AIG dispute previously in arbitration.
Internally-developed software - Addition of the estimated fair value of identifiable intangible assets resulting from the merger arising from internally-developed software. This will be amortized on a straight-line basis over its economic useful life.
The following information summarizes the results of TransRe from the TransRe Acquisition Date to December 31, 2012 that have been included within Alleghany’s Consolidated Statements of Earnings and Comprehensive Income:
(1) Among other adjustments, reflects an increase in amortization expense on TransRe’s AFS debt securities resulting from the adjustment of amortized cost to their fair value as of the Pro Forma TransRe Acquisition Date. Such adjustment reduced the net investment income of TransRe.
(2) Among other adjustments, reflects adjustments to amortization expense on the TransRe Senior Notes resulting from the adjustment to their fair value as of the Pro Forma TransRe Acquisition Date. Such adjustment reduced the interest expense of TransRe. See Note 8(b) for additional information on the TransRe Senior Notes. Also reflects adjustments to amortization expense associated with intangible assets arising from the merger.
The pro forma results include RSUI’s pre-tax catastrophe losses, net of reinsurance and reinstatement premiums, of $197.9 million in 2012.
The amount of goodwill and intangible assets, net of accumulated amortization expense, reported on Alleghany’s consolidated balance sheets as of December 31, 2014 and 2013 is as follows:
(1) Goodwill and intangible assets have been reduced by amounts written-down in prior periods. The 2013 insurance segment intangible assets reflect a $5.0 million non-cash impairment charge recorded in 2013 for certain finite-lived intangible assets at CapSpecialty.
(2) See Note 13 for additional information on Alleghany’s segments of business.
(3) Primarily represents goodwill and other intangible assets related to the acquisition of Bourn & Koch on April 26, 2012, which was purchased for $55.0 million, including estimated contingent consideration of $8.0 million based on future profitability, and to the acquisition of a controlling equity interest in Kentucky Trailer on August 30, 2013 for $24.9 million. On January 2, 2014, for an additional investment of $15.0 million, Alleghany exercised its option to increase its common equity interest in Kentucky Trailer to 80 percent, and to increase its preferred equity interest by $1.6 million to $15.9 million. Also includes minor acquisitions made by ACC’s subsidiaries.
The economic useful lives of intangible assets are as follows: agency relationships - 15 years; state and foreign insurance licenses - indefinite; trade names - indefinite; brokerage and reinsurance relationships - 15 years; renewal rights - between five and 14 years; value of business-in-force - one year; loss and LAE reserves - 15 years; leases - 10 years; and internally developed software - 2.5 years.
Alleghany’s financial instruments measured at fair value and the level of the fair value hierarchy of inputs used as of December 31, 2014 and 2013 were as follows:
(2) Includes $900.7 million and $237.9 million of collateralized loan obligations as of December 31, 2014 and 2013, respectively.
(3) Includes partnership and non-marketable equity investments accounted for on an AFS basis, and excludes investments accounted for using the equity method and certain loans receivable that are carried at cost.
The following tables present reconciliations of the changes during 2014 and 2013 in Level 3 assets measured at fair value:
(1) Includes partnership and non-marketable equity investments accounted for on an AFS basis.
(1) Includes $900.7 million and $237.9 million of collateralized loan obligations as of December 31, 2014 and 2013, respectively.
million gain on the sale of Homesite, and a $5.0 million non-cash impairment charge related to certain finite-lived intangible assets at CapSpecialty. Realized capital gains for 2012 included $63.1 million of capital gains from the sales of shares of common stock of Exxon Mobil Corporation in January 2012.
The amount of gross realized capital gains and gross realized capital losses in 2014, 2013 and 2012 were as follows:
To the extent that an equity security in an unrealized loss position is not impaired based on the initial review described above, Alleghany then further evaluates such equity security and deems it to be other than temporarily impaired if it has been in an unrealized loss position for 12 months or more or if its unrealized loss position is greater than 50 percent of its cost, absent compelling evidence to the contrary.
Alleghany then evaluates those equity securities where the unrealized loss is 20 percent or more of cost as of the balance sheet date or which have been in an unrealized loss position continuously for six months or more preceding the balance sheet date. This evaluation takes into account quantitative and qualitative factors in determining whether such securities are other than temporarily impaired including: (i) market valuation metrics associated with the equity security (such as dividend yield and price-to-earnings ratio); (ii) current views on the equity security, as expressed by either Alleghany’s internal stock analysts and / or by third party stock analysts or rating agencies; and (iii) credit or news events associated with a specific issuer, such as negative news releases and rating agency downgrades with respect to the issuer of the investment.
In developing the cash flow analyses for debt securities, Alleghany considers various factors for the different categories of debt securities. For municipal bonds, Alleghany takes into account the taxing power of the issuer, source of revenue, credit risk and credit enhancements and pre-refunding. For mortgage and asset-backed securities, Alleghany discounts its best estimate of future cash flows at an effective rate equal to the original effective yield of the security or, in the case of floating rate securities, at the current coupon. Alleghany’s models include assumptions about prepayment speeds, default and delinquency rates and underlying collateral (if any), as well as credit ratings, credit enhancements and other observable market data. For corporate bonds, Alleghany reviews business prospects, credit ratings and available information from asset managers and rating agencies for individual securities.
OTTI losses in 2014 reflect $36.3 million of unrealized losses that were deemed to be other than temporary and, as such, were required to be charged against earnings. Upon the ultimate disposition of the securities for which OTTI losses have been recorded, a portion of the loss may be recoverable depending on market conditions at the time of disposition. Of the $36.3 million of OTTI losses incurred during 2014, $28.7 million relate to equity securities, primarily in the mining sector, and $7.6 million relate to debt securities, primarily in the energy sector. The determination that unrealized losses on such securities were other than temporary was primarily based on the severity of the decline in the fair value of equity securities relative to their cost as of the balance sheet date, and the fact that Alleghany lacked the intent to hold debt securities for a period of time sufficient to allow for an anticipated recovery.
OTTI losses in 2012 reflect $2.9 million of unrealized losses that were deemed to be other than temporary and, as such, were required to be charged against earnings. Of the $2.9 million of OTTI losses incurred during 2012, $1.7 million relate to equity securities, primarily in the energy sector, and $1.2 million relate to debt securities. The determination that unrealized losses on such securities were other than temporary was primarily based on the duration of the decline in the fair value of such security relative to their cost as of the balance sheet date.
After adjusting the cost basis of securities for the recognition of OTTI losses, the remaining gross unrealized investment losses for debt and equity securities as of December 31, 2014 were deemed to be temporary, based on, among other factors: (i) the duration of time and the relative magnitude to which the fair value of these investments had been below cost were not indicative of an OTTI loss (for example, no equity security was in a continuous unrealized loss position for 12 months or more as of December 31, 2014); (ii) the absence of compelling evidence that would cause Alleghany to call into question the financial condition or near-term business prospects of the issuer of the investment; and (iii) Alleghany’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery.
As of December 31, 2014 and 2013, gross unrealized losses and related fair values for equity securities and debt securities, grouped by duration of time in a continuous unrealized loss position, were as follows:
As of December 31, 2014, Alleghany held a total of 662 debt securities and equity securities that were in an unrealized loss position, of which 169 securities, all debt securities, were in an unrealized loss position continuously for 12 months or more. The unrealized losses associated with the 169 debt securities consisted primarily of losses related to RMBS and municipal bonds.
In December 2012, TransRe obtained an ownership interest in Pillar Capital Holdings Limited (“Pillar Holdings”), a Bermuda-based insurance asset manager focused on collateralized reinsurance and catastrophe insurance-linked securities. Additionally, TransRe invested $175.0 million and AIHL invested $25.0 million in limited partnership funds managed by Pillar Holdings (the “Funds”). The objective of the Funds is to create portfolios with attractive risk-reward characteristics and low correlation with other asset classes, using the extensive reinsurance and capital market experience of the principals of Pillar Holdings. Alleghany has concluded that both Pillar Holdings and the Funds (collectively, the “Pillar Investments”) represent variable interest entities and that Alleghany is not the primary beneficiary, as it does not have the ability to direct the activities that most significantly impact each entity’s economic performance. Therefore, the Pillar Investments are not consolidated and are accounted for under the equity method of accounting. Alleghany’s potential maximum loss in the Pillar Investments is limited to its cumulative investment. As of December 31, 2014, Alleghany’s carrying value in the Pillar Investments, as determined under the equity method of accounting, was $235.2 million, which is reported in other invested assets on Alleghany’s consolidated balance sheets.
Alleghany’s reinsurance and insurance subsidiaries reinsure portions of the risks they underwrite in order to reduce the effect of individual or aggregate exposure to losses, manage capacity, protect capital resources, reduce volatility in specific lines of business, improve risk-adjusted portfolio returns, and enable them to increase gross premium writings and risk capacity without requiring additional capital. Alleghany’s reinsurance and insurance subsidiaries purchase reinsurance and retrocessional coverages from highly-rated third party reinsurers. If the assuming reinsurers are unable or unwilling to meet the obligations assumed under the applicable reinsurance agreements, Alleghany’s reinsurance and insurance subsidiaries would remain liable for such reinsurance portion not paid by these reinsurers. As such, funds, trust agreements and letters of credit are held to
collateralize a portion of Alleghany’s reinsurance and insurance subsidiaries’ reinsurance recoverables, and Alleghany’s reinsurance and insurance subsidiaries reinsure portions of the risks they underwrite or assume with multiple reinsurance programs.
Amounts recoverable from reinsurers are recognized in a manner consistent with the claims liabilities associated with the reinsurance placement and presented on the balance sheet as reinsurance recoverables. Such balances as of December 31, 2014 and 2013 consist of the following:
Information regarding concentration of Alleghany’s reinsurance recoverables and the ratings profile of its reinsurers as of December 31, 2014 is as follows:
(3) Includes favorable development of $73.7 million from Super Storm Sandy in 2012 and $35.6 million from other catastrophe losses, principally flooding that took place in Thailand in 2011 and the Tohoku earthquake in Japan in 2011, partially offset by unfavorable development from the New Zealand earthquake in 2010.
(10) Primarily reflects favorable development in the umbrella/excess liability, professional liability lines of business, and primarily related to the 2005 through 2010 accident years.
(12) Primarily reflects favorable development on unallocated LAE reserves and prior year catastrophe reserves from recent accident years.
On September 20, 2010, Alleghany completed a public offering of $300.0 million aggregate principal amount of its 5.625% senior notes due on September 15, 2020 (the “2020 Senior Notes”). The 2020 Senior Notes are unsecured and unsubordinated general obligations of Alleghany. Interest on the 2020 Senior Notes is payable
On December 14, 2005, TransRe completed a public offering of $750.0 million aggregate principal amount of its 2015 Senior Notes. Prior to the TransRe Acquisition Date, a portion of the 2015 Senior Notes was repurchased by Old TransRe. On October 15, 2014, TransRe redeemed $300.0 million aggregate principal amount of the 2015 Senior Notes for $324.4 million, consisting of the $300.0 million aggregate principal amount redeemed, $18.6 million of redemption premium and $5.8 million of accrued and unpaid interest to the date of redemption. Of the $324.4 million redemption amount, $297.3 million was funded by a capital contribution from Alleghany primarily using the $294.3 million of net proceeds from Alleghany’s issuance of the 2044 Senior Notes. As a result of this early extinguishment of debt, TransRe recorded a realized loss, before tax, of $9.4 million in 2014. As of December 31, 2014, the outstanding principal amount of the 2015 Senior Notes was $367.0 million.
The Internal Revenue Code provides for limits on the utilization of certain tax benefits following a corporate ownership change. Upon the closing of the merger, TransRe was subject to an annual limitation on its ability to use its foreign tax credit carryforwards and its minimum tax credit carryforwards. The total amount of foreign tax credit carryforwards and minimum tax credit carryforwards that were available prior to the merger are not diminished by this provision. The limitation provides for an annual limit on the amount of the carryforwards that can be used each year. The unused carryovers are available to be used in subsequent years, subject to the annual limitation. The annual limitation is estimated at approximately $42.7 million.
Alleghany’s income tax returns are not currently under examination by the Internal Revenue Service. TransRe’s income tax returns, which all relate to periods prior to the merger with Alleghany, are currently under examination by the Internal Revenue Service. The following table lists the tax years of Alleghany and TransRe tax returns that remain subject to examination by major tax jurisdictions as of December 31, 2014:
Alleghany filed amended Federal income tax returns and applied for Federal income tax refunds for the tax years 2007 to 2012 related to TransRe’s foreign taxes. To the extent a requested amended return relates to a tax year where the statute of limitations has expired, the filing of the amended return will cause that tax year to re-open.
In October 2012, the Alleghany Board of Directors authorized a program to repurchase shares of Common Stock, at such times and at prices as management determines advisable, up to an aggregate of $300.0 million (the “2012 Repurchase Program”). In July 2014, the Alleghany Board of Directors authorized, upon the completion of the 2012 Repurchase Program, the repurchase of additional shares of Common Stock, at such times and at prices as management may determine advisable, up to an aggregate of $350.0 million (the “2014 Repurchase Program”). As of December 31, 2014, Alleghany completed the 2012 Repurchase Program, and had repurchased approximately $58.6 million of shares under the 2014 Repurchase Program.
The following table presents a reconciliation of the changes during 2014 and 2013 in accumulated other comprehensive income attributable to Alleghany stockholders:
Reclassifications out of accumulated other comprehensive income attributable to Alleghany stockholders during 2014 and 2013 were as follows:
As of December 31, 2014, approximately $6.3 billion of Alleghany’s total equity of $7.5 billion was unavailable for dividends or advances to Alleghany from its subsidiaries. The remaining $1.2 billion was available for dividends or advances to Alleghany from its subsidiaries, or was retained at the Alleghany parent-level, and as such, was available to pay dividends to Alleghany’s stockholders as of December 31, 2014.
In 2014, TRC paid dividends of $400.0 million to TransRe, of which $300.0 million was in turn paid to Alleghany. In 2013, TRC paid dividends of $200.0 million to TransRe, of which $150.0 million was in turn paid to Alleghany. TransRe’s operating subsidiaries could pay additional dividends without regulatory approval based on statutory surplus. As of December 31, 2014, a maximum of $78.6 million was available for dividends without prior approval of the New York State Department of Financial Services. The maximum is calculated based on 10 percent of statutory surplus less dividends paid in the prior twelve months and is recalculated on a rolling basis throughout the year.
The statutory net income of Alleghany’s reinsurance and insurance subsidiaries was $786.5 million and $836.9 million for the years ended December 31, 2014 and 2013, respectively. As of December 31, 2014 and 2013, the combined statutory capital and surplus of Alleghany’s reinsurance and insurance subsidiaries was $6.6 billion and $6.5 billion, respectively. As of December 31, 2014, the amount of statutory capital and surplus necessary to satisfy regulatory requirements was not significant in relation to actual statutory capital and surplus.
The following is a reconciliation of the earnings and share data used in the basic and diluted earnings per share computations for 2014, 2013 and 2012:
Certain of Alleghany’s subsidiaries are parties to pending litigation and claims in connection with the ordinary course of their businesses. Each such subsidiary makes provisions for estimated losses to be incurred in such litigation and claims, including legal costs. In the opinion of management, such provisions are adequate.
On January 26, 2012, TransRe reached an agreement with AIG to settle and mediate a dispute previously in arbitration, which arose as a result of losses claimed by TransRe from its participation in a securities lending program administered and managed by AIG. On July 20, 2012, in accordance with the agreement between the parties, a mediator awarded TransRe a settlement payment of $75.0 million with respect to the securities lending claim. In connection with its accounting for the acquisition of TransRe, Alleghany established an asset of $36.0 million, representing an estimate based on the minimum recovery previously agreed to by the parties, net of estimated legal costs. A pre-tax net benefit of $23.5 million resulting from this settlement was recorded as other income in 2012, representing the portion of the settlement payment above such minimum recovery, net of additional estimated legal costs.
On July 14, 2005 (the “Closing Date”), Alleghany completed the sale of its world-wide industrial minerals business, World Minerals, Inc. (“World Minerals”), to Imerys USA, Inc. (the “Purchaser”), a wholly-owned subsidiary of Imerys, S.A., pursuant to a Stock Purchase Agreement, dated as of May 19, 2005, by and among the Purchaser, Imerys, S.A. and Alleghany (the “Stock Purchase Agreement”). Pursuant to the Stock Purchase Agreement, Alleghany undertook certain indemnification obligations, including a general indemnification for breaches of representations and warranties set forth in the Stock Purchase Agreement, and a special indemnification (the “Products Liability Indemnification”) related to products liability claims arising from events that occurred during pre-closing periods, including the period of Alleghany ownership (the “Alleghany Period”). Under the terms of the Stock Purchase Agreement, with respect to products liability claims arising in respect of events occurring during the period prior to the Alleghany Period, Alleghany will provide indemnification at a rate of 100.0 percent for the first $100.0 million of losses arising from such claims, and at a rate of 50.0 percent
The insurance segment consists of property and casualty insurance operations conducted in the U.S. by AIHL through its insurance operating subsidiaries RSUI, CapSpecialty and PacificComp. RSUI also writes a modest amount of assumed reinsurance business, which is included in the insurance segment.
Segment results for Alleghany’s two reportable segments and for corporate activities for 2014, 2013 and 2012 (which include TransRe from the TransRe Acquisition Date through December 31, 2012) are shown in the tables below:
(5) Underwriting profit represents net premiums earned less net loss and LAE and commissions, brokerage and other underwriting expenses, all as determined in accordance with GAAP, and does not include net investment income, net realized capital gains, OTTI losses, gain on bargain purchase, other income, other operating expenses, corporate administration, amortization of intangible assets or interest expense. Underwriting profit does not replace earnings before income taxes determined in accordance with GAAP as a measure of profitability. Rather, Alleghany believes that underwriting profit enhances the understanding of its segments’ operating results by highlighting net earnings attributable to their underwriting performance. Earnings before income taxes (a GAAP measure) may show a profit despite an underlying underwriting loss. Where underwriting losses persist over extended periods, a reinsurance or an insurance company’s ability to continue as an ongoing concern may be at risk. Therefore, Alleghany views underwriting profit as an important measure in the overall evaluation of performance.
As of December 31, 2014, Alleghany had long-term compensation plans for parent-level employees and directors. Parent-level, long-term compensation plans to current employees do not include stock options but consist only of restricted stock awards, including restricted stock units and performance share awards. Parent-level, long-term compensation payments to non-employee directors consist of annual awards of restricted stock and restricted stock units.
Amounts recognized as compensation expense in the consolidated statements of earnings and comprehensive income with respect to long-term compensation awards under plans for parent-level employees and directors were $21.2 million, $18.7 million and $19.4 million in 2014, 2013 and 2012, respectively. The amount of related income tax benefit recognized as income in the consolidated statements of earnings and comprehensive income with respect to these plans was $7.4 million, $6.5 million and $6.8 million in 2014, 2013 and 2012, respectively. In 2014, 2013 and 2012, $4.5 million, $6.4 million and $4.9 million of Common Stock at fair market value, respectively, and $7.6 million, $16.3 million and $5.3 million of cash, respectively, was paid by Alleghany under these plans for parent-level employees and directors. As noted above, as of December 31, 2014 and December 31, 2013, all outstanding awards were accounted for under the fair-value-based method of accounting.
A summary of the parent-level, long-term compensation plans is as follows:
The automatic annual grant to each non-employee director consists of either restricted stock or restricted stock units, at the director’s election. Awards granted to non-employee directors were not material to Alleghany’s results of operations, financial condition or cash flows for the three years ended December 31, 2014.
TransRe has a Book Value Unit Plan and a Mid-Term Incentive Plan (collectively, the “TransRe Plans”) for the purpose of providing incentives to key employees of TransRe. Under the TransRe Plans, book value units (“BVUs”) and mid-term incentive plan (“MTIP”) awards are issued. BVUs and MTIP awards may only be settled in cash. The fair value of each BVU is calculated as stockholder’s equity of TransRe, adjusted for certain capital transactions, divided by the adjusted number of BVUs outstanding. Pursuant to the terms of the Merger Agreement, certain Old TransRe restricted stock units held by current or former employees were converted into BVUs. BVUs have vesting dates of up to approximately the fourth anniversary of the date of grant, with converted Old TransRe restricted stock units retaining their pre-conversion vesting dates. The fair value of MTIP awards is calculated based on underwriting results compared to specified targets. MTIP awards have vesting dates of approximately the second anniversary of the date of grant. The BVUs and MTIP awards contain certain restrictions, relating to, among other things, forfeiture in the event of termination of employment and
transferability. In 2014, 2013 and 2012, TransRe recorded $55.3 million, $52.2 million and $63.9 million, respectively, in compensation expense and a deferred tax benefit of $19.4 million, $18.3 million and $22.4 million, respectively, related to the TransRe Plans.
These employee retirement plans are not material to Alleghany’s results of operations, financial condition or cash flows for the three years ended December 31, 2014.
2013; and (ii) terminate both retiree health plans, effective September 30, 2013. The funded, noncontributory defined benefit pension plan for parent-level employees is unaffected. As a result of these decisions, Alleghany recorded a pre-tax $8.8 million reduction to corporate administration expense in 2013.
The projected benefit obligations of the defined benefit pension plans as of December 31, 2014 and 2013 was $28.0 million and $21.6 million, respectively, and the related fair value of plan assets was $2.5 million and $2.4 million, respectively.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Alleghany Corporation and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of earnings and comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2014 of Alleghany Corporation and subsidiaries and our report dated February 24, 2015 expressed an unqualified opinion thereon.