We lease approximately 1,390,000 square feet throughout the United States and internationally. These leases are generally short-term to medium-term leases for commercial office space. For additional information about these leases, see Note 25. "Commitments and Contingencies."
We are a multinational specialty property and casualty insurer focused on generating consistent underwriting profits. We provide insurance coverage for small businesses and products with high volumes of insureds and loss profiles that we believe are predictable. We target lines of insurance that we believe generally are under served by the market. We have grown by hiring teams of underwriters with expertise in our specialty lines, through acquisitions of companies and assets that, in each case, provide access to distribution networks and renewal rights to established books of specialty insurance business. We have operations in three business segments:
Specialty Program. We write commercial insurance for narrowly defined classes of insureds, requiring an in-depth knowledge of the insured’s industry segment, through general and other wholesale agents.
We transact business primarily through our insurance subsidiaries, the majority of which are domiciled in the United States. We also transact business through insurance subsidiaries domiciled internationally, primarily in Bermuda and Europe. We are authorized to write business in all 50 states, the District of Columbia, Puerto Rico, and in the European Union. Through our subsidiary, AmTrust at Lloyd's, we are licensed to underwrite business internationally in locations where Lloyd's is licensed. Our principal operating subsidiaries are rated "A" (Excellent) by A.M. Best Company ("A.M. Best").
For the year ended December 31, 2016, our results of operations include activity of the entities we acquired subsequent to December 31, 2015, primarily:
Republic Underwriters Insurance Company, Republic-Vanguard Insurance Company, Southern Underwriters Insurance Company, Republic Fire & Casualty Insurance Company, Southern Insurance Company, Republic Diversified Services, Inc., Republic Lloyds, Republic Group No. Two Company, Southern County Mutual Insurance Company, Canyon State Auto Insurance Services, Inc., and Eagle General Agency, Inc. (collectively, "Republic")
In conjunction with the settlement of a dispute with our former Italian medical liability broker, on July 20, 2016, we obtained the renewal rights associated with all the in-force business produced by Trust Risk Group ("TRG") prior to the termination of our brokerage and agency relationship with TRG, and a non-compete agreement with TRG and related parties for a period of three years in exchange for €16 million (or $17.7 million), as well as the release of a receivable balance due from TRG of €14 million (or $15.5 million).
On May 31, 2016, we completed the acquisition of N.V. Nationale Borg-Maatscappij and its affiliates ("Nationale Borg") for approximately €161.4 million (or $180 million). Nationale Borg is an Amsterdam-based international direct writer and reinsurer of surety and trade credit insurance in over 70 countries that has been in existence for approximately 120 years. Nationale Borg's results of operations are included as a component of the Specialty Risk and Extended Warranty segment. We anticipate completing our acquisition accounting by the first half of 2017. As a result of this acquisition, we recorded approximately $64.4 million of gross written premium during the year ended December 31, 2016.
On May 20, 2016, we completed the acquisition of First Nationwide Title Agency and its subsidiaries ("First Nationwide"). First Nationwide is a title agency providing title insurance products primarily in the State of New York. The consideration for the purchase consisted of approximately $24.0 million at closing and contingent consideration based on profitability of the agency over a five-year period. First Nationwide's results of operations are included as a component of the Specialty Risk and Extended Warranty segment. We anticipate completing our acquisition accounting by the first half of 2017. As a result of this acquisition, we recorded service and fee income of $12.5 million for the year ended December 31, 2016.
On May 9, 2016, we completed the acquisition of Genworth Financial Mortgage Insurance Ltd. ("Genworth"). Genworth provides mortgage insurance in Europe, primarily in the U.K., Finland, Italy and Germany. The consideration given for Genworth consisted of cash of approximately $54.5 million. Genworth's results of operations are included as a component of the Specialty Risk and Extended Warranty segment. We anticipate completing our acquisition accounting in the first half of 2017. As a result of this acquisition, we recorded approximately $17.3 million of gross written premium during the year ended December 31, 2016.
The consideration given for Republic consisted of approximately $113.5 million of cash at closing, a promissory note payable of approximately $104.7 million due to Delek Group Ltd. and deferred payments of approximately $15.2 million that are owed to the minority owners of Republic. Republic's results of operations are included as a component of the Small Commercial Business and Specialty Program segments. We anticipate completing our acquisition accounting in the first half of 2017. As a result of this acquisition, we recorded approximately $484.3 million of gross written premium and $5.9 million of services and fee income during the year ended December 31, 2016.
On January 22, 2016, we completed the acquisition of ARI Holdco Inc. ("ARIH") and its subsidiaries. ARIH's primary operating subsidiary, ARI Insurance Company ("ARI"), is an underwriter of commercial automobile insurance in New Jersey, Pennsylvania and Maryland. Immediately prior to the acquisition, ARI converted from a mutual form to a stock form of ownership in a transaction "sponsored" by us. The consideration given for ARIH was approximately $3.8 million. ARI's results of operations are included as a component of the Small Commercial Business segment. As a result of this acquisition, we recorded approximately $43.3 million of gross written premium during the year ended December 31, 2016.
On October 7, 2015, we completed the acquisition of Springfield Insurance Company and its affiliates, Springfield Insurance Company Ltd. and Unified Grocers Insurance Services (collectively, "Springfield") for approximately $26.6 million in cash and a contingent earn-out valued at $5.0 million as of the acquisition date. Springfield, domiciled in California, is an insurance carrier providing workers' compensation and commercial package insurance to Unified Grocers Inc., an association of independently owned grocery stores, its members and its customers. Springfield's results of operations are included as a component of the Small Commercial Business segment. As a result of this acquisition, we recorded approximately $10.8 million and $3.2 million of gross written premium for the years ended December 31, 2016 and 2015, respectively, and $1.5 million and $0.6 million of service and fee income during the years ended December 31, 2016 and 2015, respectively.
On March 2, 2015, we completed the acquisition of CorePointe Insurance Company ("CorePointe") for approximately $68.8 million. CorePointe, a Michigan-based specialty property and casualty insurance company, markets commercial package insurance products primarily to automobile and motorcycle dealerships and auto repair shops. The majority of CorePointe's insurance products and services are distributed through managing general agents ("MGAs") with whom it has long-standing relationships. CorePointe's results of operations are included in our Specialty Program segment. We recorded approximately $21.1 million and $39.4 million of gross written premium during the years ended December 31, 2016 and 2015, respectively, as a result of this acquisition.
We provide NGHC and its affiliates information technology development services in connection with the development and licensing of a policy management system. We provide the license at a cost that is currently 1.25% of gross premium written by NGHC and its affiliates plus our costs for development and support services. We provide development services at a price of cost plus 20%. In addition, we provide NGHC and its affiliates printing and mailing services at a per piece cost for policy and policy related materials, such as invoices, quotes, notices and endorsements, associated with the policies we process for NGHC and its affiliates on the policy management system. We also provide NGHC and its affiliates lockbox services for policies processed on the system, and scanning of correspondence and supplemental materials. We charge NGHC for these services based on actual volume and actual cost. We recorded approximately $46.1 million, $35.9 million and $25.6 million of fee income for the years ended December 31, 2016, 2015 and 2014, respectively, related to this agreement.
We have a 50% ownership interest in each of three entities (collectively, the “LSC Entities”) formed for the purpose of acquiring life settlement contracts, with a subsidiary of NGHC owning the remaining 50% interest. The LSC Entities are: Tiger Capital LLC (“Tiger”), AMT Capital Alpha, LLC (“AMT Alpha”) and AMT Capital Holdings, S.A. (“AMTCH”).
Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses consist of policy acquisition expenses, salaries and benefits and general and administrative expenses, net of ceding commissions. These items are described below:
Policy acquisition expenses comprise commissions directly attributable to those agents, wholesalers or brokers that produce premiums written on our behalf. In most instances, we pay commissions based on collected premium, which reduces our credit risk exposure associated with producers in case a policyholder does not pay a premium. We pay state and local taxes, licenses and fees, assessments and contributions to various state guaranty funds based on our premiums or losses in each state. Surcharges that we may be required to charge and collect from insureds in certain jurisdictions are recorded as accrued liabilities, rather than expense. These expenses are offset by ceding commissions received.
recognized. Ceding commissions received from reinsurance transactions that represent the recovery of other underwriting expenses are recognized in the income statement over the insurance contract period in proportion to the insurance protection provided and classified as a reduction of acquisition costs and other underwriting expenses. Ceding commissions received, but not yet earned, that represent the recovery of other underwriting expenses are classified as a component of accrued expenses and other current liabilities. We allocate earned ceding commissions to its segments based on each segment’s proportionate share of total acquisition costs and other underwriting expenses recognized during the period.
Net Expense Ratio. The net expense ratio is a measure of an insurance company’s operational efficiency in administering its business. Expressed as a percentage, this is the ratio of the sum of acquisition costs and other underwriting expenses to net premiums earned. As we allocate certain acquisition costs and other underwriting expenses based on premium volume to our segments, net expense ratio on a segment basis may be impacted period over period by a shift in the mix of net written premium.
Premiums. We recognize insurance premiums, other than in our Specialty Risk and Extended Warranty segment, as earned on the straight-line basis over the contract period. Insurance premiums on Specialty Risk and Extended Warranty business are earned based on estimated program coverage periods. We base these estimates on the expected distribution of coverage periods by contract at inception, and because a single contract may contain multiple coverage period options, we revise these estimates based on the actual coverage periods selected by the insured. Unearned premiums represent the portion of premiums written that is applicable to the unexpired term of the contract or policy in force. We base premium adjustments on contracts and audit premiums on estimates made over the contract period. Earned but unbilled premium (“EBUB”) estimates the amount of audit premium for those policies that have yet to be audited as of the date of the quarter or year end. Workers’ compensation policies are subject to audit and the final premium may increase or decrease materially from the original premium due to revisions to actual payroll and/or employee classification. Based on guidance in FASB ASC 944 as well as Statement of Statutory Accounting Principles 53, we determine EBUB using statistically supported aggregate calculations based on our historical premium audit results. We have not had a material adjustment as a result of actual premium audits materially differing from the estimates used in calculating EBUB. We also estimate an allowance for doubtful accounts based on a percentage of premium.
Reserves for Loss and Loss Adjustment Expenses and Unearned Premium Reserves. We record reserves for estimated losses under insurance policies that we write and for loss adjustment expenses related to the investigation and settlement of policy claims. Our reserves for loss and loss adjustment expenses represent the estimated cost of all reported and unreported loss and loss adjustment expenses incurred and unpaid at any given point in time based on known facts and circumstances. In establishing our reserves, we do not use loss discounting, which would involve recognizing the time value of money and offsetting estimates of future payments by future expected investment income. Our reserves for loss and loss adjustment expenses are estimated using case-by-case valuations and actuarial analysis.
We utilize a combination of generally accepted and standard actuarial methods to estimate our reserves for loss and loss adjustment expenses. Embedded within these actuarial methods are loss development assumptions selected by either a review of our specific loss development history, industry loss development characteristics, or a combination of both depending on the line of business and the maturity of the loss experience to date. Our actuaries generate a range within which it is reasonably likely that our ultimate loss and loss adjustment expenses for claims incurred in a particular time period will fall. Although not an exhaustive list, the range is affected by factors such as line of business, volatility of losses, duration of liabilities and other macroecomic factors that create uncertainty around the estimate. The results of multiple actuarial methods may also influence the range selection.
Deferred Policy Acquisition Costs. We defer commissions, premium taxes and certain other costs that are incrementally or directly related to the successful acquisition of new or renewal insurance contracts. Acquisition-related costs may be deemed ineligible for deferral when they are based on contingent or performance criteria beyond the basic acquisition of the insurance contract, or when efforts to obtain or renew the insurance contract are unsuccessful. All eligible costs are capitalized and charged to expense ratably as premiums are earned. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value. This would also give effect to the premiums to be earned and anticipated losses and settlement expenses, as well as certain other costs expected to be incurred as the premiums are earned. Judgments as to the ultimate recoverability of such deferred costs are reviewed on a segment basis and are highly dependent upon estimated future loss costs associated with the premiums written. This deferral methodology applies to both gross and ceded premiums and acquisition costs.
Fair Value of Financial Instruments. Our estimates of fair value for financial assets and financial liabilities are based on the framework established in ASC 820 Fair Value Measurements and Disclosures. The framework is based on the inputs used in valuation and gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates in the ASC 820 hierarchy is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect our significant market assumptions. Additionally, valuation of fixed maturity investments is more subjective when markets are less liquid due to lack of market based inputs, which may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction could occur. Fair values of other financial instruments approximate their carrying values. We report fixed maturity securities and equity securities classified as available-for-sale at their estimated fair values based on quoted market prices or a recognized pricing service, with unrealized gains and losses, net of tax effects, reported as a separate component of comprehensive income in stockholders’ equity. Equity securities classified as trading securities are
Other Investments. Other investments consist primarily of investments in private limited partnerships, real estate partnerships and syndicated loans. We use the equity method of accounting to account for a majority of our other investments, which are typically accounted for on a three-month lag basis.
Other-than-temporary-impairment (“OTTI”). Quarterly, our Investment Committee (“Committee”) evaluates each security that has an unrealized loss as of the end of the subject reporting period for “OTTI”. The Committee uses a set of quantitative and qualitative criteria to review our investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of our investments. The criteria the Committee primarily considers include:
Life Settlement Profit Commission. We retained a third party service provider to perform certain administration functions to effectively manage the life settlement contracts held by Tiger Capital, LLC and AMT Capital Holdings II S.A. and a portion of their fee was contingent on the overall profitability of the life settlement contracts. We accrued the related profit commission on life settlements at fair value, in relation to life settlements purchased through this provider. This profit commission was calculated based on the discounted anticipated cash flows and the provisions of the underlying contract, and was settled with the third party administrator in 2016. In addition, we accrue a best estimate in relation to profit commission due on certain life settlement contracts acquired subsequent to December 31, 2010.
not be recoverable. If the goodwill or intangible asset is impaired, it is written down to its realizable value with a corresponding expense reflected in the consolidated statement of operations.
Income Taxes. We file a consolidated United States income tax return for our eligible domestic subsidiaries. Our non-domestic subdivisions file income tax returns in their respective local jurisdictions. As part of the U.S. consolidated income tax return filing, we are party to federal income tax allocation agreements amongst the includible entities. Under the tax allocation agreements, we pay to or receive from our subsidiaries the amount, if any, by which the group’s federal income tax liability was affected by virtue of inclusion of the subsidiary in the consolidated federal return.
We recognize tax benefits only for tax positions that are more likely than not to be sustained upon examination by taxing authorities. Our policy is to prospectively classify accrued interest and penalties related to any unrecognized tax benefits in our income tax provision. We file our tax returns as prescribed by the tax laws of the jurisdictions in which we operate. Primarily tax years 2013 through 2015 are still subject to examination. We do not anticipate any significant changes to our total unrecognized tax benefits within the next 12 months.
Gross Written Premium. Gross written premium increased $1,149.7 million, or 16.9%, to $7,949.3 million from $6,799.5 million for the years ended December 31, 2016 and 2015, respectively. The increase of $1,149.7 million was attributable to growth in our Small Commercial Business and Specialty Risk and Extended Warranty segments, while growth in our Specialty Program segment was relatively flat. The majority of the increase in the Small Commercial Business segment was attributable to an increase in the number of workers' compensation policies issued, and the acquisitions of Republic, ARI and Springfield, which contributed approximately $380 million of gross written premium. The increase in our Specialty Risk and Extended Warranty segment was attributable to our acquisitions of ANV, Nationale Borg and Warranty Solutions, which contributed approximately $237 million of gross written premium, expansion of our existing programs in Europe, and growth within our Lloyd's platform, partially offset by the negative foreign currency impact of the weakening of the British pound sterling and the Euro against the U.S. dollar. The increase of gross written premium in our Specialty Program segment as a result of the April 2016 acquisition of Republic, which contributed $155 million, was partially offset by the reduction or termination of certain workers' compensation and commercial package programs.
Net Written Premium. Net written premium increased $589.4 million, or 13.8%, to $4,851.3 million from $4,261.9 million for the years ended December 31, 2016 and 2015, respectively. The increase by segment was: Small Commercial Business - $314.1 million; Specialty Risk and Extended Warranty - $271.3 million; and Specialty Program - $4.0 million. Net written premium increased for the year ended December 31, 2016 compared to 2015 due to an increase in gross written premium, partially offset by a decrease in the retention of gross written premium to 61.0% from 62.7% for the years ended December 31, 2016 and 2015, respectively. The decrease in retention resulted from a small increase, as compared to the same period in 2015, in business written that is reinsured under the Maiden Quota Share agreement or with other third party reinsurers.
Provision for Income Tax. Income tax expense was $85.3 million for the year ended December 31, 2016, which resulted in an effective tax rate of 17.1%. Income tax expense was $38.9 million for the year ended 2015, which resulted in an effective tax rate of 8.3% for the year ended December 31, 2015. Our effective tax rate increased in 2016 compared to 2015 due to several factors. During 2015, our provision for income tax benefited from a return to provision adjustment during the third quarter of approximately $80 million, or 17.0%. The return to provision was driven primarily by changes in permanent transfer pricing tax adjustments. During 2016, our favorable permanent transfer pricing adjustment was reduced from $372 million to $8 million as a result of fewer transactions between our Bermuda reinsurer and our Luxembourg reinsurers. The deferred tax liabilities attributable to our Luxembourg reinsurers included a valuation allowance of approximately $5 million and $81 million at December 31, 2016 and 2015, respectively. The valuation allowance was the result of our current inability to generate sufficient future income in Luxembourg in order to fully utilize the net operating losses (NOLs) incurred to date.
Gross Written Premium. Gross written premium increased $707.1 million, or 11.6%, to $6,799.5 million from $6,092.4 million for the years ended December 31, 2015 and 2014, respectively. The increase of $707.1 million is attributable to growth in all three of our segments, both organically and from the acquisitions of CorePointe, Springfield and Warranty Solutions. The majority of the increase in the Small Commercial Business segment was attributable to an increase in the number of workers' compensation policies issued, partially offset by the assumption of $199.7 million of non-recurring premium during the first quarter of 2014 as part of the cut through reinsurance agreement with Tower. The largest increases came from the states of California, Florida and New York. The increase in the Specialty Program segment resulted primarily from expansion of our existing programs. The majority of the increase in our Specialty Risk and Extended Warranty segment resulted from growth in our domestic business from expansion of existing programs, which was partially offset by declines in gross written premium in our European business due to the strengthening of the U.S. dollar relative to the Euro and British Pound.
Net Written Premium. Net written premium increased $320.7 million, or 8.1%, to $4,261.9 million from $3,941.2 million for the years ended December 31, 2015 and 2014, respectively. The increase by segment was: Small Commercial Business - $49.7 million; Specialty Risk and Extended Warranty - $132.5 million; and Specialty Program - $138.5 million. Net written premium increased for the year ended December 31, 2015 compared to 2014 due to an increase in gross written premium, which was partially offset by a decrease in the retention of gross written premium to 62.7% from 65.0% for the years ended December 31, 2015 and 2014, respectively. The decrease in retention resulted primarily from an increase in business written that is covered under the Maiden Quota Share in 2015 and the assumption of non-recurring premium during the first quarter of 2014 that was not subject to the Maiden Quota Share. Additionally, the increase in net written premium was partially offset by $174 million of non-recurring unearned premium we assumed from Tower during the first quarter of 2014. Absent this assumption, net written premium would have increased approximately $477 million, or 13.1%.
Service and Fee Income. Service and fee income increased $62.8 million, or 17.2%, to $428.1 million from $365.4 million for the years ended December 31, 2015 and 2014, respectively. We increased service and fee income by approximately $38.4 million from acquisitions, including Oryx, TMIS and Warranty Solutions. Additionally, fees for services provided to Maiden, NGHC and ACP Re increased by approximately $17.8 million in 2015 compared to 2014.
Other. Other expenses increased $50.7 million, or 12.0%, to $473.3 million for the year ended December 31, 2015 from $422.5 million for the year ended December 31, 2014. The increase resulted primarily from the expansion of our product warranty registration and claims handling services for CNH. We also incurred an additional $17.3 million of depreciation and amortization expense in 2015 compared to 2014.
Income Before Other Income (Expense), Income Taxes and Equity in Earnings of Unconsolidated Subsidiaries. Income before other income (expense), income taxes and equity in earnings of unconsolidated subsidiaries increased $63.2 million, or 16.0%, to $458.8 million from $395.7 million for the years ended December 31, 2015 and 2014, respectively. The change in income from 2015 to 2014 resulted primarily from an increase in underwriting income, income from our fee based business and income from our investment portfolio.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $226.4 million, or 18.3%, to $1,460.5 million for the year ended December 31, 2016 from $1,234.1 million for the year ended December 31, 2015. Our loss ratio for the segment for the year ended December 31, 2016 increased to 66.3% from 65.4% for the year ended December 31, 2015. The increase in the loss ratio resulted from higher selected ultimate losses for the prior accident years as compared to the originally selected ultimate losses. This was the result of adverse prior period development, driven primarily by our commercial auto liability and general liability businesses, as well as increases to our non-California related workers' compensation prior selected ultimate losses, which were offset by prior selected ultimate losses for our California workers' compensation business.
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $105.8 million, or 21.7%, to $592.6 million for the year ended December 31, 2016 from $486.8 million for the year ended December 31, 2015. Acquisition costs and other underwriting expenses were reduced by ceding commission earned during
the years ended December 31, 2016 and 2015 of $288.8 million and $253.2 million, respectively. The ceding commission increased period over period as a result of an increase in net earned premium, as the segment received a consistent allocation of ceding commission for its proportionate share of our overall policy acquisition expense. The expense ratio increased to 26.9% for the year ended December 31, 2016 compared to 25.8% for the year ended December 31, 2015, respectively, primarily as a result of higher direct acquisition costs from Republic, a large percentage of the business in this segment during the year ended December 31, 2016.
Net Earned Premium Less Expenses Included in Combined Ratio (Underwriting Income). Net earned premium less expenses included in combined ratio decreased to $150.4 million for the year ended December 31, 2016 compared to $166.0 million for the year ended December 31, 2015. The decrease in underwriting income related primarily to an increase in combined ratio during the year ended December 31, 2016 compared to the year ended December 31, 2015, which was partially offset by an increase in the level of earned premium.
Net Earned Premium. Net earned premium increased $280.1 million, or17.4%, to $1,886.9 million for the year ended December 31, 2015 from $1,606.8 million for the year ended December 31, 2014. As premiums written are earned ratably over an annual period, the increase in net earned premium resulted from higher net written premium for the year ended December 31, 2015 compared to the year ended December 31, 2014, and premium assumed in 2014 through the cut through reinsurance agreement with Tower, which was not subject to the Maiden Quota Share.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $178.6 million, or 16.9%, to $1,234.1 million for the year ended December 31, 2015 from $1,055.5 million for the year ended December 31, 2014. Our loss ratio for the segment for the year ended December 31, 2015 decreased to 65.4% from 65.7% for the year ended December 31, 2014. The decrease in the loss ratio was the result, primarily, of lower current accident year selected ultimate losses in 2015 as compared to selected ultimate losses in 2014. The decrease in the loss ratio resulted from improved pricing on policy issuances combined with stable claims frequency and severity. We did not have any material increases or decreases as a result of prior year loss development in 2015.
Net Earned Premium Less Expenses Included in Combined Ratio (Underwriting Income). Net earned premium less expenses included in combined ratio increased to $166.0 million for the year ended December 31, 2015 compared to $129.9 million for the year ended December 31, 2014. The increase resulted primarily from an increase in the level of earned premium during the year
Net Written Premium. Net written premium increased $271.3 million, or 18.7%, to $1,722.1 million from $1,450.8 million for the years ended December 31, 2016 and 2015, respectively. The increase in net written premium resulted from an increase of gross written premium for the year ended December 31, 2016 compared to the year ended December 31, 2015, and an increase in our retention of gross written premium period over period. Our overall retention of gross written premium for the segment was 68.3% and 67.2% for the years ended December 31, 2016 and 2015, respectively. The slight increase in the retention of gross written premium related to the Warranty Solutions business, acquired in September 2015, and the ANV business, acquired in November 2016, neither of which is reinsured under the Maiden Quota Share agreement. In addition, beginning in July 2016, our U.K. subsidiary began ceding 32.5% of its Italian medical liability business to Maiden, down from 40%.
The decrease in the loss ratio resulted from having a higher percentage of earned premium in lines of business with lower ultimate loss selections during the year ended December 31, 2016 compared to the year ended December 31, 2015. We did not have any material increases or decreases as a result of prior year loss development.
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $94.7 million, or 34.1%, to $372.4 million for the year ended December 31, 2016 from $277.8 million for the year ended December 31, 2015. Acquisition costs and other underwriting expenses were reduced by ceding commission of $181.5 million and $138.4 million earned during the years ended December 31, 2016 and 2015, respectively. The ceding commission increased period over period as the segment received a consistent allocation of ceding commission for its proportionate share of our overall policy acquisition expense. The expense ratio was 24.1% for the year ended December 31, 2016 compared to 21.3% for the year ended December 31, 2015. The increase in the expense ratio resulted from increases in policy acquisition expenses from our acquisitions of Warranty Solutions, Nationale Borg and ANV.
Net Earned Premium Less Expenses Included in Combined Ratio (Underwriting Income). Net earned premium less expenses included in combined ratio increased to $148.0 million for the year ended December 31, 2016 compared to $144.9 million for the year ended December 31, 2015. The increase was attributable to an increase in the segment's earned premium and a decrease in the segment’s loss ratio during the year ended December 31, 2016 compared to the year ended December 31, 2015.
Specialty Risk and Extended Warranty Segment Results of Operations 2015 Compared to 2014
Net Written Premium. Net written premium increased $132.5 million, or 10.1%, to $1,450.8 million from $1,318.3 million for the years ended December 31, 2015 and 2014, respectively. The increase in net written premium resulted from an increase of gross written premium for the year ended December 31, 2015 compared to the year ended December 31, 2014, as well as a consistent retention of gross written premium period over period. Our overall retention of gross written premium for the segment was 67.2% and 66.3% for the years ended December 31, 2015 and 2014, respectively.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expense increased $75.8 million, or 9.4%, to $882.3 million for the year ended December 31, 2015 from $806.5 million for the year ended December 31, 2014. Our loss ratio for the segment for the year ended December 31, 2015 increased to 67.6% from 66.5% for the year ended December 31, 2014. The increase in the loss ratio for the year ended December 31, 2015 resulted primarily from increases in selected ultimate losses for our European business for current and prior accident years resulting from the increase in our carried incurred but not reported claim reserves during the second half of 2015, which was offset by declines in our domestic selected ultimate losses compared to selected losses in prior accident years. This increase was muted by consistent accident year selected ultimate losses compared to selected ultimate losses in prior accident years for our domestic business. We did not have any material increases or decreases as a result of prior year loss development.
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $15.5 million, or 5.9%, to $277.8 million for the year ended December 31, 2015 from $262.3 million for the year ended December 31, 2014. Acquisition costs and other underwriting expenses were reduced by ceding commission earned during the years ended December 31, 2015 and 2014 of $138.4 million and $120.3 million, respectively. Although ceding commission increased period over period, the segment received a smaller allocation of ceding commission for its proportionate share of our overall policy acquisition expense as a result of the growth in our Small Commercial Business segment. Our expense ratio remained consistent at 21.3% for the year ended December 31, 2015 compared to 21.6% for the year ended December 31, 2014.
December 31, 2015 compared to 2014, partially offset by an increase in earned premium during the year ended December 31, 2015 as compared to the year ended December 31, 2014.
Gross Written Premium. Gross written premium increased $87.8 million, or 6.7%, to $1,407.8 million for the year ended December 31, 2016 from $1,320.0 million for the year ended December 31, 2015. Gross written premium increased period over period from the acquisition of Republic, which contributed $154.5 million of gross written premium, but was partially offset by the termination or reduction of certain workers' compensation programs and commercial package programs.
Net Earned Premium. Net earned premium increased $91.3 million, or 11.0%, to $920.6 million for the year ended December 31, 2016 from $829.3 million for the year ended December 31, 2015. As premiums written are earned ratably over an annual period, the increase in net premium earned resulted from higher net written premium for 2016 compared to 2015. Net earned premium increased year over year proportionately more than net written premium during the same comparative periods because, with the acquisition of Republic occurring mid-year 2016, more of the premium earned in this segment during 2016 was from our historic program business, which we retain at a higher rate than we retain the Republic business.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $115.3 million, or 25.3%, to $571.7 million for the year ended December 31, 2015 compared to $456.4 million for the year ended December 31, 2014. Our loss ratio for the segment for the year ended December 31, 2015 increased to 68.9% from 67.3% for the year ended December 31, 2014. The increase in the loss ratio resulted primarily from higher current accident year selected ultimate losses as compared to selected ultimate losses in prior accident years in certain general liability programs, and was partially offset by improved pricing. We did not have any material increases or decreases as a result of prior year loss development.
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $44.6 million, or 24.2%, to $228.9 million for the year ended December 31, 2015 from $184.3 million for the year ended December 31, 2014. Acquisition costs and other underwriting expenses were reduced by ceding commission earned during the years ended December 31, 2015 and 2014 by $119.2 million and $87.1 million, respectively. The ceding commission increased period over period as a result of an increase in net earned premium, as the segment received a larger allocation of ceding commission for its proportionate share of our overall policy acquisition expense. The expense ratio increased to 27.6% for the year ended December 31, 2015 from 27.2% for the year ended December 31, 2014. The increase in the expense ratio during 2015 related to the increase in the percentage of business in this segment derived from our commercial automobile and general liability businesses, which have higher policy acquisition costs than other types of business in this segment.
Net Earned Premium Less Expenses Included in Combined Ratio (Underwriting Income). Net earned premium less expenses included in combined ratio were $28.7 million and $37.9 million for the years ended December 31, 2015 and 2014, respectively. The decrease resulted primarily from an increase in the combined ratio in 2015 compared to 2014.
The first priority of our investment strategy is preservation of capital, with a secondary focus on maximizing an appropriate risk adjusted return. We expect to maintain sufficient liquidity from funds generated from operations to meet our anticipated insurance obligations and operating and capital expenditure needs, including debt service and additional payments in connection with our past producer network and renewal rights acquisitions. The excess funds will be invested in accordance with both the overall corporate investment guidelines as well as an individual subsidiary’s investment guidelines. Our investment guidelines are designed to maximize investment returns through a prudent distribution of cash and cash equivalents, fixed maturities and equity positions. Cash and cash equivalents include cash on deposit, commercial paper, pooled short-term money market funds and certificates of deposit with an original maturity of 90 days or less. Our fixed maturity securities include obligations of the U.S. Treasury or U.S. government agencies, obligations of local governments, obligations of foreign governments, obligations of U.S. and Canadian corporations, mortgages guaranteed by the Federal National Mortgage Association, the Government National Mortgage Association, the Federal Home Loan Mortgage Corporation, Federal Farm Credit entities, and asset-backed securities and commercial mortgage obligations. Our equity securities include common stocks of U.S. and Canadian corporations.
Our cash and investment portfolio, exclusive of our life settlement contracts, equity investment in unconsolidated related party subsidiaries, and other investments, is summarized in the table below by type of investment:
Our investment portfolio increased $1.9 billion, or 27.7%, to $8.9 billion at December 31, 2016 from $7.0 billion as of December 31, 2015. The investment portfolio increased during the year ended December 31, 2016, primarily from the acquisitions of ANV, ARI, Genworth, Nationale Borg and Republic, as well as the utilization of excess cash from our preferred stock offerings during 2016. Our investment portfolio is primarily classified as available-for-sale, as defined by ASC 320, Investments - Debt and Equity Securities. Our fixed maturity securities had a fair value of $7.4 billion and an amortized cost of $7.3 billion as of December 31, 2016. Our equity securities had a fair value of $219.1 million with a cost of $231.9 million as of December 31, 2016.
The fair value of our investments is subject to risks of fluctuations in credit quality and interest rates. We use various models and stress test scenarios to monitor and manage interest rate risk. We attempt to manage our interest rate risk by maintaining an appropriate relationship between the effective duration of the investment portfolio and the approximate duration of our liabilities (e.g., policy claims and debt obligations). The table below summarizes the average rate duration by type of fixed maturity as well as detailing the average yield as of December 31, 2016 and 2015:
Quarterly, our Investment Committee (“Committee”) evaluates each security that has an unrealized loss as of the end of the subject reporting period for other-than-temporary impairment ("OTTI"). The Committee uses a set of quantitative and qualitative criteria to review our investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of our investments. The criteria the Committee primarily considers include:
The total impairment charges of our fixed and equity securities classified as available-for-sale for the years ended December 31, 2016, 2015 and 2014 are presented in the table below:
As of December 31, 2016, we had $62.4 million of gross unrealized losses related to fixed income securities. Corporate bonds represent 54.5% of the fair value of our fixed maturities and 41.7% of the total unrealized losses of our fixed maturities. We own 2,566 purchase lots of corporate bonds in the industrial, bank/financial and utilities sectors, which comprise approximately 30.7%, 21.2% and 2.7%, respectively, of the fair value of our fixed maturities, and 27.4%, 12.4% and 1.9% of the total unrealized losses. We believe that the unrealized losses in these securities are the result, primarily, of general economic conditions and not the condition of the issuers, which we believe are solvent and have the ability to meet their obligations. Therefore, we expect that the market price for these securities should recover within a reasonable time. Additionally, we do not intend to sell the investments and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost basis.
The table below summarizes the gross unrealized losses of our available-for-sale fixed maturity and available-for-sale equity securities by length of time the security has continuously been in an unrealized loss position as of December 31, 2016:
There are 2,125 securities at December 31, 2016 that account for the gross unrealized loss, none of which we deem to be OTTI. Significant factors influencing our determination that unrealized losses were temporary included the magnitude of the unrealized losses in relation to each security’s cost, the nature of the investment and management’s intent not to sell these securities and it being not more likely than not that we will be required to sell these investments before anticipated recovery of fair value to our cost basis.
We are organized as a holding company with domestic and international insurance company subsidiaries, as well as various other non-insurance subsidiaries. Our primary liquidity needs include payment of interest on various debt facilities, stockholder dividends and taxes. Our income is generated primarily from our insurance subsidiaries, service and fee income and investment income.
Our principal sources of operating funds are premiums, service and fee income, investment income and proceeds from sales and maturities of investments. Our primary uses of operating funds include payments of claims and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash primarily in fixed maturity and equity securities. We expect that projected cash flow from operations will provide us sufficient liquidity to fund anticipated growth, by providing capital to increase the surplus of our insurance subsidiaries, as well as for payment of claims and operating expenses, payment of interest and principal on our debt facilities, payment of any cash in settlement of our convertible senior notes submitted by holders for conversion, and other holding company expenses for at least the next twelve months. However, if our growth attributable to
potential acquisitions, internally generated growth or a combination of these, exceeds our projections, we may have to raise additional capital sooner to support our growth. If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements and, as a result, our business, financial condition and results of operations could be adversely affected.
We earn a significant amount of our operating funds outside the United States, which are deemed to be indefinitely reinvested in foreign jurisdictions. We currently do not intend or foresee a need to repatriate these funds. We expect existing domestic cash, short-term investments and cash flows from operations to continue to be sufficient to fund our domestic operating activities and cash commitments for investing and financing activities, such as payment of dividends, debt repayment and capital expenditures. If we should require more capital in the United States than is generated by our domestic operations (e.g., to fund significant discretionary activities such as business acquisitions or share repurchases), we could elect to repatriate future earnings from foreign jurisdictions. This could result in higher effective tax rates or dilution of our earnings.
Net cash used in investing activities was $1,606.0 million for the year ended December 31, 2016 and $1,639.0 million for the year ended December 31, 2015. In 2016, net cash used in investing activities primarily included approximately $951 million for the net purchase of fixed maturity and equity securities, approximately $402 million for acquisitions, approximately $117 million for capital expenditures and approximately $221 million for an increase of restricted cash, partially offset by the receipt of approximately $38 million from life settlement contract payouts. In 2015, net cash used in investing activities primarily included approximately $1,184 million for the net purchase of fixed maturity and equity securities, approximately $242 million for acquisitions, approximately $152 million for capital expenditures and approximately $195 million for an increase of restricted cash, partially offset by the receipt of approximately $102 million from life settlement contract payouts.
Net cash provided by financing activities was $268.4 million for the year ended December 31, 2016 compared to $766.5 million for the year ended December 31, 2015. In 2016, we received proceeds of $417 million from the issuance of preferred stock and $160 million from entering into repurchase agreements, which was partially offset by payments of $156 million for common and preferred stock dividends and $152 million for the common share repurchases. In 2015, we received proceeds of $487 million and $177 million from the issuance of common stock and preferred stock, respectively, and $285 million from the issuance of subordinated debt, which was partially offset by payments of $117 million for common and preferred stock dividends and $62 million for the settlement of convertible debt.
As of December 31, 2016, we had outstanding letters of credit of £511.2 million (or $630.0 million) in place under this facility, which reduced the aggregate availability under this facility to £3.8 million (or $4.7 million). We recorded total interest expense of approximately $4.5 million, $3.4 million and $2.8 million for the years ended December 31, 2016, 2015, and 2014, respectively.
For further information on these credit facilities, including interest rates, applicable restrictive covenants and events of default, see Note 15. “Debt” in the audited consolidated financial statements included elsewhere in this report.
We have outstanding $250.0 million aggregate principal amount of our 6.125% notes due 2023 ("2023 Notes"), with a carrying value of approximately $248 million, that bear interest at a rate equal to 6.125% per year, payable semiannually in arrears on February 15th and August 15th of each year. The interest rate will increase by 0.50% per year if our consolidated leverage ratio exceeds 30% and will increase an additional 1.00% per year (for an aggregate increase of 1.50% per year) if our consolidated leverage ratio exceeds 35%. As of December 31, 2016, our consolidated leverage ratio was less than 30%. Interest expense recognized on these notes was $15.6 million for each of the years ended December 31, 2016, 2015, and 2014. For further information on these notes, including restrictive covenants and events of default, see Note 15. “Debt” in the audited consolidated financial statements included elsewhere in this report.
During the last three years, we did not engage in short-term borrowings to fund our operations or for liquidity purposes. As discussed above, our insurance subsidiaries create liquidity by collecting and investing insurance premiums in advance of paying claims. Details about our investment portfolio can be found under “- Investment Portfolio” appearing elsewhere in this Form 10-K.
In 2016, fixed maturities increased $1,964.3 million and resulted primarily from utilizing cash from preferred stock offerings, acquisitions and operations. The increase in reinsurance recoverable is directly related to the increase in loss and loss expense reserves and acquisitions. The increase in prepaid reinsurance premium resulted from acquisitions and an increase in premium writings.
Loss and loss expense reserves increased $2,932.3 million and unearned premium increased $865.7 million in 2016 due primarily to higher premium writings in 2016 compared to 2015 as well as assumed amounts from acquisitions in 2016. Debt increased by $241.8 million in 2016 primarily as a result of the assumption of debt from the acquisition of Republic.
We monitor our financial exposure to the reinsurance market and take necessary actions in an attempt to mitigate our exposure to possible loss. We limit our liquidity exposure for uncollected recoverables by holding funds, letters of credit or other security, with the result that net balances due from reinsurers are significantly less than the gross balances shown in our consolidated balance sheets. We monitor the collectability of our reinsurance recoverables and record a reserve for uncollectible reinsurance when we determine an amount is potentially uncollectible. Our evaluation is based on our periodic reviews of our disputed and aged recoverables, as well as our assessment of recoverables due from reinsurers known to be in financial difficulty. In some cases, we make estimates as to what portion of a recoverable may be uncollectible. Our estimates and judgment about the collectability of the recoverables and the financial condition of reinsurers can change, and these changes can affect the level of reserve required.
The following table summarizes the top ten reinsurers that account for approximately 76% of our reinsurance recoverables on paid and unpaid losses and loss adjustment expenses as of December 31, 2016:
The following tables provide a summary of our primary treaty reinsurance programs as of December 31, 2016 for the United States and internationally:
If we incur catastrophe losses and loss settlement expenses that exceed the coverage limits of our reinsurance program, many of our property catastrophe programs have built in a fixed number of reinstatement of limits. For example, if we incur a property catastrophe loss, we are required to pay the reinsurers a reinstatement premium equal to the percentage of the limit exhausted by the loss, multiplied by the amount of the original reinsurance premium.
In 2007, we entered into a master agreement with Maiden, as amended, by which our Bermuda subsidiary, AII, and Maiden Reinsurance Ltd. ("Maiden Reinsurance") entered into a quota share reinsurance agreement (the “Maiden Quota Share”), as amended. Under this agreement, AII retrocedes to Maiden Reinsurance an amount equal to 40% of the premium written by our U.S., Irish and U.K. insurance companies (the “AmTrust Ceding Insurers”), net of the cost of unaffiliated inuring reinsurance (and in the case of our U.K. insurance subsidiary, AEL, net of commissions). AII also retrocedes 40% of losses. Certain business that we commenced writing after the effective date of the Maiden Quota Share, including, among other lines, our European medical liability business included in the table above, business assumed from Tower pursuant to the cut through reinsurance agreement, and risks, other than workers’ compensation risks and certain business written by our Irish subsidiary, AIU, for which the AmTrust Ceding Insurers’ net retention exceeds $5 million is not ceded to Maiden Reinsurance under the Maiden Quota Share (ceded business defined as “Covered Business”).
ceded by AEL decreased to 32.5%, and, effective July 1, 2017, will decrease to 20%. The quota share had an initial term of one year and has been renewed through March 31, 2018. The agreement can be terminated at any April 1 by either party on four months’ prior written notice. Maiden Reinsurance pays us a 5% ceding commission, and we will earn a profit commission of 50% of the amount by which the ceded loss ratio is lower than 65%. We did not receive any profit commissions for this business for the years ended December 31, 2016 or 2015.
We recorded approximately $599.5 million, $510.8 million and $405.1 million of ceding commission during 2016, 2015 and 2014, respectively, as a result of the Maiden Quota Share.
The following table sets forth certain of our contractual obligations as of December 31, 2016:
The loss and loss adjustment expense payments due by period in the table above are based upon the loss and loss adjustment expense estimates as of December 31, 2016 and actuarial estimates of expected payout patterns and are not contractual liabilities as to a time certain. Our contractual liability is to provide benefits under the policy. As a result, our calculation of loss and loss adjustment expense payments due by period is subject to the same uncertainties associated with determining the level of loss and loss adjustment expenses generally and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. For a discussion of our loss and loss adjustment expense estimate process, see “Item 1. Business - Loss Reserves.” Actual payments of loss and loss adjustment expenses by period will vary, perhaps materially, from the table above to the extent that current estimates of loss and loss adjustment expenses vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns. See “Item 1A. Risk Factors - Risks Related to Our Business - Our loss reserves are based on estimates and may be inadequate to cover our actual losses” for a discussion of the uncertainties associated with estimating loss and loss adjustment expenses.
We currently own 254 life settlement contracts with a fair value of $356.9 million. In order for us to derive the economic benefit of the face value of the policies, we are required to make these premium payments. The contractual obligations are on a consolidated basis. As we have a 50% ownership interest in these life insurance policies, NGHC has an obligation for 50% of the above contractual obligations.
We establish property and casualty insurance premiums before we know the amount of losses and loss adjustment expenses or the extent to which inflation may affect such amounts. We attempt to anticipate the potential impact of inflation in establishing our reserves, especially as it relates to medical and hospital rates where historical inflation rates have exceeded the general level of inflation. Inflation in excess of the levels we have assumed could cause loss and loss adjustment expenses to be higher than we anticipated, which would require us to increase reserves and reduce earnings. Fluctuations in rates of inflation also influence interest rates, which in turn impact the market value of our investment portfolio and yields on new investments. Operating expenses, including salaries and benefits, generally are impacted by inflation.