For several years, the Company’s investment philosophy has emphasized the purchase of short-term bonds with maximum quality and liquidity. As flat yield curves have not provided incentive to lengthen maturities in recent years, the Company has continued to maintain its fixed maturity portfolio at short-term levels. While the average contractual life of the Company’s bond and short-term investment portfolio increased from 3.6 to 4.9 years during 2013, the average duration of the Company’s fixed maturity portfolio remains much shorter than the contractual maturity average and significantly shorter than the duration of the Company’s liabilities. The Company also remains an active participant in the equity securities market using capital which is in excess of amounts considered necessary to fund current operations. The long-term horizon for the Company’s equity investments allows it to invest in positions where ultimate value, and not short-term market fluctuation, is the primary focus. Investments made by the Company’s domestic Insurance Subsidiaries are regulated by guidelines promulgated by the National Association of Insurance Commissioners which are designed to provide protection for both policyholders and shareholders.
At December 31, 2013, $92.1 million, or 27% of shareholders’ equity, represented net assets of the Company’s Insurance Subsidiaries which, at that time, could not be transferred in the form of dividends, loans or advances to the parent company because of minimum statutory capital requirements. However, management believes that these restrictions pose no material liquidity concerns for the Company. The financial strength and stability of the subsidiaries permit ready access by the parent company to short-term and long-term sources of credit. The Company maintains a $30 million unsecured line of credit with $20.0 million of unused capacity at December 31, 2013.
Other operating expenses for 2013, before credits for ceding allowances from reinsurers, increased $13.6 million (15%) to $106.2 million. This increase is due primarily to a $5.7 million increase in salary and salary related expenses, reflective of the Company’s growing workforce in response to the continued expansion of the Company’s products and services and to a $4.9 million increase in commission expenses, representing an increase in average commission rates from 15.4% to 16.4% due to higher profit commissions on favorable property reinsurance results. Reinsurance ceded credits were $5.6 million (37%) higher in 2013, resulting from favorable changes to the terms of certain reinsurance treaties as well as increased business ceded to other companies under quota share reinsurance treaties which provide commissions to the Insurance Subsidiaries. After consideration of these expense offsets, operating expenses increased $7.9 million, or 10% from the prior year.
A portion of the Company’s fleet transportation business is produced by the direct sales efforts of Baldwin & Lyons, Inc. employees and, accordingly, this business does not incur commission expense on a consolidated basis. Rather, the expenses of the agency operations, including salaries and bonuses of salesmen, travel expenses, etc. is included in operating expenses. In general, commissions paid by the Insurance Subsidiaries to the parent company exceed related acquisition costs incurred in the production of the property and casualty insurance business. The ratio of net operating expenses of the Insurance Subsidiaries to net premiums earned was 32.4% in 2013 and 30.8% in 2012. Including the agency operations and corporate expenses, and after elimination of inter-company commissions, the ratio of operating expenses to operating revenue (defined as total revenue less gains (losses) on investments) was 31.9% for 2013 compared with 30.6% for 2012 with the current year increase being largely attributable to higher salary expense as noted above.
The ratio of net operating expenses of the Insurance Subsidiaries to net premiums earned was 30.8% in 2012 and 30.2% in 2011. Including the agency operations and corporate expenses, and after elimination of inter-company commissions, the ratio of operating expenses to operating revenue (defined as total revenue less gains (losses) on investments) was 30.6% for 2012 compared with 28.1% for 2011 with the current year increase being attributable to higher salary expense as noted above.
Approximately 66% of the Company’s assets are composed of investments at December 31, 2013. Approximately 90% of these investments are publicly-traded, owned directly and have readily-ascertainable market values. The remaining 10% of investments are composed primarily of minority interests in several limited partnerships. These limited partnerships are engaged in the trading of public and non-public equity securities and debt, hedging transactions, real estate development and venture capital investment. These partnerships, themselves, do not have readily-determinable market values. Rather, the values recorded are those provided to the Company by the respective partnerships based on the underlying assets of the partnerships. While the majority of the underlying assets are publicly-traded securities, those which are not publically traded have been valued by the respective partnerships using their experience and judgment.
It is important to note that all available for sale securities included in the Company’s financial statements are valued at current fair market values. The evaluation process for determination of other-than-temporary decline in value of investments, as described above, does not change these valuations but, rather, determines when a decline in value will be recognized in the income statement (other-than-temporary decline) as opposed to a charge to shareholders’ equity (temporary decline). Another seemingly inconsistent aspect of this accounting policy which is important to understand is that any subsequent recovery in value of investments which have incurred other-than-temporary impairment adjustments are accounted for as unrealized gains until the security is actually disposed of or sold. At December 31, 2013, unrealized gains include $13.1 million of appreciation on investments previously adjusted for other-than-temporary impairment, compared to $6.8 million of impairment write-downs at that date. This evaluation process is subject to risks and uncertainties since it is not always clear what has caused a decline in value of an individual security or since some declines may be associated with general market conditions or economic factors which relate to an industry, in general, but not necessarily to an individual issue. The Company has attempted to minimize many of these uncertainties by adopting a largely objective evaluation process as described above. However, to the extent that certain declines in value are reported as unrealized at December 31, 2013, it is possible that future earnings charges will result should the declines in value increase or persist or should the security actually be disposed of while market values are less than cost. At December 31, 2013, the total gross unrealized loss included in the Company’s investment portfolio was approximately $4.6 million. No individual issue constituted a material amount of this total. Had this entire amount been considered other-than-temporary at December 31, 2013, there would have been no impact on total shareholders’ equity or book value since the decline in value of these securities was recognized as a reduction to shareholders’ equity.
Reinsurance ceded transactions were as follows for the years ended December 31 (dollars in thousands):
As with any receivable, credit risk exists in the recoverability of reinsurance. This may be even more pronounced than in normal receivable situations since recoverable amounts are not generally due until the loss is settled which, in some cases, may be many years after the contract was written. If a reinsurer is unable, in the future, to meet its financial commitments under the terms of the contracts, the Company would be responsible to satisfy the reinsurer's portion of the loss. The financial condition of each of the Company’s reinsurers is initially determined upon the execution of a given treaty and only reinsurers with the superior credit ratings available are utilized. However, as noted above, reinsurers are often not called upon to satisfy their obligations for several years and changes in credit worthiness can occur in the interim period. Reviews of the current financial strength of each reinsurer are made frequently and, should impairment in the ability of a reinsurer be determined to exist, current year operations would be charged in amounts sufficient to provide for the Company’s additional liability. Such charges are included in other operating expenses, rather than losses and loss expenses incurred, since the inability of the Company to collect from reinsurers is a credit loss rather than a deficiency associated with the loss reserving process.
The Company’s reserves for losses and loss expenses (“reserves”) are determined based on complex estimation processes using historical experience, current economic information and, when necessary, available industry statistics. The Company’s claims range from the very routine private passenger automobile “fender bender” to the highly complex and costly third party bodily injury claim involving large tractor-trailer rigs. Reserving for each class of claims requires a set of assumptions based upon historical experience, knowledge of current industry trends and seasoned judgment. The high limits provided in many of the Company’s policies provide for greater volatility in the reserving process for more serious claims. Court rulings, legislative actions and trends in jury awards also play a significant role in the estimation process of larger claims. The Company continuously reviews and evaluates loss developments subsequent to each measurement date and adjusts its reserve estimation assumptions, as necessary, in an effort to achieve the best possible estimate of the ultimate remaining loss costs at any point in time. Changes to previously established reserve amounts are charged or credited to losses and loss expenses incurred in the accounting periods in which they are determined. Note C to the consolidated financial statements includes additional information relating to loss and loss adjustment expense reserve development.
For the Company’s fleet transportation risks, which are covered by frequently changing reinsurance agreements and which contain wide-ranging self-insured retentions (“SIR”) as low as $25,000 per loss occurrence and as high as several million dollars per occurrence, traditional actuarial methods are supplemented by other methods in consideration of the Company’s exposures to loss. In situations where the Company’s reinsurance structure, the insured’s SIR selections, policy volume, and other factors are changing, current accident period loss exposures may not be homogenous with historical loss data to allow for reliable projection of future developed losses. Therefore, the Company supplements the above-described actuarial methods with loss ratio reserving techniques developed from our databases to arrive at the reserve for losses incurred but not reported for the calendar/accident period under review. Management relies on its extensive historical pricing and loss history databases to produce reserve factors unique to this specialty business. As losses for a given calendar/accident period develop with the passage of time, management evaluates such development on a quarterly basis and adjusts reserve factors, as necessary, to reflect current judgment with regard to the anticipated ultimate incurred losses. This process continues until all losses are settled for each period subject to this method.
Under reasonably possible scenarios, it is conceivable that the Company’s selected loss reserve estimates could be 10%, or more, redundant or deficient. The majority of the Company’s reserves for losses and loss expenses, on either a gross or a net of reinsurance basis, relates to its fleet transportation products. Perhaps the most significant example of sensitivity to variation in the key assumptions is the loss ratio selection for the Company’s fleet transportation products for policies subject to certain major reinsurance treaties (approximately $139.2 million, or approximately 34% of carried direct reserves for directly produced property and casualty business). The following table presents the approximate impacts on gross and net loss reserves of both a 10 percentage point and 20 percentage point increase or decrease in the loss factors actually utilized in the Company’s reserve determination at December 31, 2013. The Company’s selection of the range of values presented should not be construed as the Company’s prediction of future events, but rather an illustration of the impact of such events, should they occur:
The liability method is used in accounting for federal income taxes. Using this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The provision for deferred federal income tax was based on items of income and expense that were reported in different years in the financial statements and tax returns and were measured at the tax rate in effect in the year the difference originated. Net deferred tax liabilities reported at December 31 are as follows (dollars in thousands):
Deferred tax assets at December 31, 2013, include approximately $11.1 million related to the timing of deductibility of loss and loss expense reserves, the majority of which relates to policy liability discounts required by the Internal Revenue Code which are perpetual in nature and, in the absence of the termination of business, will not, in the aggregate, reverse to a material degree in the foreseeable future. An additional $2.1 million relates to impairment adjustments made to investments, as required by accounting regulations. The sizable unrealized gains in the Company’s investment portfolios would allow for the recovery of this deferred tax at any time. Unearned premiums discount and deferred ceding commissions represent $2.2 and $1.0 million of deferred tax assets, respectively. The balance of deferred tax assets consists of various normal operating expense accruals and is not considered to be material. As a result of its analysis, management has determined that no valuation allowance is necessary at December 31, 2013.
The Company operates within the property and casualty insurance industry and, accordingly, has significant invested assets which are exposed to various market risks. These market risks relate to interest rate fluctuations, equity security market prices and, to a far lesser extent, foreign currency rate fluctuations. All of the Company's invested assets, with the exception of investments in limited partnerships, are classified as available for sale.
Based on the structure of the Company’s investment portfolio, the most potentially significant of the three identified market risks relates to prices in the equity security market. Though not the largest category of the Company's invested assets, equity securities have a high potential for short-term price fluctuation. The market value of the Company's equity positions at December 31, 2013 was $145.8 million or approximately 21% of invested assets. This market valuation includes $73.7 million of appreciation over the adjusted cost basis of the equity security investments. Funds invested in the equities market are not considered to be assets necessary for the Company to conduct its daily operations and, therefore, can be committed for extended periods of time. The long-term nature of the Company's equity investments allows it to invest in positions where ultimate value, and not short-term market fluctuations, is the primary focus.
Reference is made to the discussion of limited partnership investments in Critical Accounting Policies in this report. All of the market risks, attendant to equity securities, apply to the underlying assets in these partnerships, and to a greater degree because of the generally more aggressive investment philosophies utilized by the partnerships. In addition, these investments are illiquid. There is no primary or secondary market on which these limited partnerships trade and, in most cases, the Company is prohibited from disposing of its limited partnership interests for some period of time and must seek approval from the general partner for any such disposal. Distributions of earnings from these partnerships are largely at the sole discretion of the general partners and distributions are generally not received by the Company for many years after the earnings have been reported. Finally, through the application of the equity method of accounting, the Company’s share of net income reported by the limited partnerships may include significant amounts of unrealized appreciation on the underlying investments. As such, the likelihood that reported income from limited partnership investments will be ultimately returned to the Company in the form of cash is markedly lower than the Company’s other investments, where appreciation is reported only when a security is actually sold.
The Company's fixed maturity portfolio totaled $431.6 million at December 31, 2013. Approximately 55% of this portfolio is made up of U.S. Government and government agency obligations and state and municipal debt securities; 74% of the portfolio matures within 5 years; and the average contractual maturity of the Company's fixed maturity investments is approximately 4.9 years with an average modified duration of approximately 3.2 years. Although the Company is exposed to interest rate risk on its fixed maturity investments, given the anticipated duration of the Company's liabilities (principally insurance loss and loss expense reserves) relative to investment maturities, even a 100 to 200 basis point increase in interest rates would not have even a moderate impact on the Company's ability to conduct daily operations or to meet its obligations and would, in fact, result in significantly higher investment income in a relatively short period of time as short term investments and maturing bonds could be reinvested in the higher yielding securities very quickly.
The table below sets forth the amounts of the Company's contractual obligations at December 31, 2013.
The Company’s loss and loss expense reserves do not have contractual maturity dates and the exact timing of the payment of claims cannot be predicted with certainty. However, based upon historical payment patterns, the above table presents an estimate of when we might expect our direct loss and loss expense reserves (without the benefit of reinsurance recoveries) to be paid. Timing of the collection of the related reinsurance recoverable, estimated to be $195.6 million at December 31, 2013, or 41% of the amounts presented in the above table, would approximate that of the above projected direct reserve payout.
The investment commitments in the above table relate to maximum unfunded capital obligations for limited partnership investments and unfunded bridge loan obligations at December 31, 2013. The actual call dates for such funding could vary from that presented.
We have audited the accompanying consolidated balance sheets of Baldwin & Lyons, Inc. and subsidiaries (the Company) as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive income (loss), shareholders' equity and cash flows for each of the three years in the period ended December 31, 2013. Our audits also included the financial statement schedules listed in the Index at Item 15(a). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Baldwin & Lyons, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our report dated March 7, 2014 expressed an unqualified opinion thereon.
The credit component of an other-than-temporary impairment is determined by comparing the net present value of projected future cash flows with the amortized cost basis of the fixed maturity security. The net present value is calculated by discounting the Company’s best estimate of projected future cash flows at the appropriate effective interest rate.
Newly Adopted Accounting Standards: In October 2010, the FASB issued updated guidance to address the diversity in practice for the accounting for costs associated with acquiring or renewing insurance contracts. This guidance modifies the definition of acquisition costs to specify that a cost must be directly related to the successful acquisition of a new or renewal insurance contract in order to be deferred. If application of this guidance would result in the capitalization of acquisition costs that had not previously been capitalized by a reporting entity, the entity may elect not to capitalize those costs. The guidance, which was effective January 1, 2012, had no impact on the Company’s consolidated financial statements.
In June 2011, the FASB issued revised accounting guidance that eliminates the option to present the components of other comprehensive income as part of the statement of shareholders' equity. Instead, comprehensive income must be reported in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. The guidance, which was effective January 1, 2012, had no financial impact on the Company’s consolidated financial statements; however certain modifications were made in the financial statement presentation to comply with the new requirements.
Unrealized losses in the Company’s fixed maturity portfolio are generally the result of interest rate fluctuations as well as the disruption of credit markets occasioned by financial market turmoil. The average unrealized loss for all fixed maturity securities in a loss position at December 31, 2013 is approximately 3% of original or adjusted cost. The Company does not intend to sell any fixed maturity securities and it is not more likely than not that the Company will have to sell any fixed maturity security before recovery of its amortized cost basis. For equity securities, the Company has evaluated the near-term prospects of the investment in relation to the severity and duration of the impairment and based on that evaluation the Company has the ability and intent to hold these investments until a recovery of fair value. Therefore, the Company does not believe the unrealized losses represent an other-than-temporary impairment as of December 31, 2013.
There is no primary or secondary market for the Company’s investments in limited partnerships and, in most cases, the Company is prohibited from disposing of its limited partnership interests for some period of time and generally must seek approval from the general partner for any such disposal. Distributions of earnings from these partnerships are largely at the sole discretion of the general partners and distributions are generally not received by the Company for many years after the earnings have been reported. The Company has commitments to contribute an additional $6,315 to various limited partnerships as of December 31, 2013.
The Company has invested a total of $23,000 in three limited partnerships, with an aggregate estimated value of $39,899 at December 31, 2013, that are managed by organizations in which three directors of the Company are executive officers, directors or owners. The Company’s ownership interest in these limited partnerships ranges from 4% to 14%. These limited partnerships added $1,154, $2,485 and ($18,673), net of fees, to investment gains (losses) in 2013, 2012 and 2011, respectively. During 2013, 2012 and 2011, the Company has recorded management fees of $640, $650 and $793, respectively, and performance-based fees of $18, $0 and $0, respectively, to these organizations for management of these limited partnerships. The Company has been informed that the fee rates applied to its investments in these limited partnerships are the same as, or lower than, the fee rates charged to unaffiliated customers for similar investments.
The Company utilized the services of a broker-dealer firm of which two directors of the Company are employees or partial owners. This broker-dealer serves as agent for purchases and sales of securities and manages an equity securities portfolio and fixed maturity portfolio with market values of approximately $2,760 and $19,427, respectively, at December 31, 2013. The Company has been informed that commission and management rates charged by this broker-dealer to the Company are commensurate with rates charged to non-affiliated customers for similar investments. Total commissions and net fees earned by the broker-dealer and affiliates on these transactions and for advice and consulting were approximately $239, $186 and $174 during 2013, 2012 and 2011, respectively.
The Company’s limited partnerships include one significant investment which invests in public and private equity markets in India. This limited partnership investment’s value as of December 31, 2013 and 2012 was $22,692 and $25,868, respectively. At December 31, 2013, the Company’s estimated ownership interest in this limited partnership investment was approximately 4%. The Company's share of earnings (losses) from this limited partnership investment was ($3,176), $2,404 and ($9,732) in 2013, 2012 and 2011, respectively. The summarized financial information of the significant limited partnership investment as of and for the years ended December 31 is as follows:
Short-term investments at December 31, 2013 include $4,891 in time certificates of deposit by a Bermuda bank.
Activity in the reserves for losses and loss expenses is summarized as follows. All amounts are shown net of reinsurance, unless otherwise indicated.
The table above shows that a savings of $5,563 was developed during 2013 in the settlement of claims occurring on or before December 31, 2012 with comparative developments for the two previous calendar years. The net savings for each year are composed of individual claim savings and deficiencies which, in the aggregate have resulted from the settlement of claims at amounts lower than previously reserved and from changes in estimates of losses incurred but not reported as part of the normal reserving process.
Favorable loss development is influenced by the Company’s long-standing policy of reserving for losses realistically and a willingness to settle claims based upon a seasoned evaluation of its exposures. Loss reserves pertaining to the Company’s reinsurance business are established partially by the ceding reinsurers although the Company routinely adjusts such reserves if management determines that additional reserves could be necessary. Accordingly, there is potential for fluctuations in loss developments related to reinsurance assumed to be more pronounced than those experienced on directly produced business which is reserved entirely by Company personnel. In addition, changes in the Company’s net retention under reinsurance treaties will impact developments as more or less business is retained. These trends were considered in the establishment of the Company’s reserves at December 31, 2013 and 2012.
Net losses and loss expenses incurred for 2013, 2012 and 2011 have been reduced by ceded reinsurance recoveries of approximately $107,321, $90,899, and $56,600, respectively. Ceded reinsurance premiums and loss recoveries for the purchase of catastrophe reinsurance coverage on the Company’s net direct business were not material.
Net losses and loss expenses incurred for 2013, 2012 and 2011 include approximately $20,014, $16,486, and $88,934, respectively, net of retrocessional recoveries of $20,000 during 2012, relating to reinsurance assumed from non-affiliated insurance or reinsurance companies.
The Company is required to establish a valuation allowance for any portion of the gross deferred tax asset that management believes will not be realized. Management has determined that no such valuation allowance is necessary at December 31, 2013 or 2012. As of December 31, 2013, the calendar years 2010 through 2013 remain subject to examination by the IRS.
The Company has no uncertain tax positions as of December 31, 2013 or 2012. The Company recognizes accrued interest and penalties, if any, related to unrecognized tax benefits in income tax expense and changes in such accruals would impact the Company’s effective tax rate. Amounts accrued for the payment of interest at December 31, 2013, 2012 and 2011 were not material.
Each year, beginning in 2009, the Company has issued shares of class B restricted stock to the Company’s outside directors. The shares serve as the annual retainer compensation for the outside directors for the periods shown below. The shares are distributed on the vesting date and have a total value of $440 for each of the annual periods. The table below provides detail of the stock issuances for 2013, 2012 and 2011:
Effective February 4, 2013, the Company issued 52,389 shares of class B restricted stock to certain of the Company’s executives. The restricted shares will be paid solely in the Company’s class B stock. The restricted shares represent a portion of the calendar year 2012 compensation to certain executives under the terms of the Company’s Executive Incentive Bonus Plan. The restricted shares will vest ratably over a three year period from the date of grant and are accelerated for retirement eligible recipients in accordance with the non-substantive post-grant date vesting clause of ASC 715, Compensation-Retirement Benefits. Restricted stock was valued based on the closing price of the stock on the day the award was granted. Each share was valued at $23.69 per share representing a total value of $1,241. Non-vested restricted shares will be forfeited should an executive’s employment terminate for any reason other than death, disability, or retirement as defined by the Compensation Committee.
Effective February 4, 2014, the Company issued 45,678 shares of class B restricted stock to certain of the Company’s executives. The restricted shares will be paid solely in the Company’s class B stock. The restricted shares represent a portion of the calendar year 2013 compensation to certain executives under the terms of the Company’s Executive Incentive Bonus Plan. The restricted shares will vest ratably over a three year period from the date of grant and are accelerated for retirement eligible recipients in accordance with the non-substantive post-grant date vesting clause of ASC 715, Compensation-Retirement Benefits. Restricted stock was valued based on the closing price of the stock on the day the award was granted. Each share was valued at $23.81 per share representing a total value of $1,088. Non-vested restricted shares will be forfeited should an executive’s employment terminate for any reason other than death, disability, or retirement as defined by the Compensation Committee.
One customer of the property and casualty insurance segment, FedEx Ground Systems, Inc. (“FedEx Ground”) and certain of its subsidiaries and related entities represents approximately $15,615, $19,052 and $23,347 of the Company’s consolidated direct and assumed premium written in 2013, 2012 and 2011, respectively.
The Company writes policies of excess insurance attaching above self-insured retentions ("SIR") and also writes policies that contain large, per-claim deductibles. Those losses and claims that fall within the SIR limits are obligations of the insured; however, the Company writes surety bonds in favor of various regulatory agencies guaranteeing the insureds’ payment of claims within the SIR. Further, specified portions of losses and claims incurred under large deductible policies, while obligations of the Company, are contractually reimbursable to the Company from the insureds. The Company requires collateral from its insureds to serve as a source of reimbursement if the Company is obligated to pay claims within the SIR by reason of an insured’s default or if the insured fails to reimburse the Company for deductible amounts paid by the Company.
The amount of collateral required of an insured is determined by the financial condition of the insured, the type of obligations guaranteed by the Company, estimated reserves for incurred losses within the SIR or deductible that have been reported to the insured or the Company, estimated incurred but not reported losses, and estimates for losses that are expected to occur, within the SIR or deductible, prior to the next collateral adjustment date. In general, the Company attempts to hold collateral equal to 100% of the ultimate losses that would be paid by or due the Company in the event of an insured’s default. Periodic audits are conducted by the Company to evaluate its exposure and the collateral required. If a deficiency in collateral is noted as the result of an audit, additional collateral is requested immediately. Because collateral amounts contain numerous estimates of the Company’s exposure, are adjusted only periodically and are sometimes reduced based on the superior financial condition of the insured, the amount of collateral held by the Company at a given point in time may not be sufficient to fully reimburse the Company for all of its guarantees or amounts due in the event of an insured’s default. In that regard, the Company is not fully collateralized for the guarantees made for, or the deductible amounts that may be due from FedEx Ground and certain of its subsidiaries and related entities, and in the event of their default, such default may have a material adverse impact on the Company. The Company estimates its uncollateralized exposure related to this customer to be as much as 30% of shareholders' equity at December 31, 2013.
Investments in limited partnerships include an aggregate of $39,899 invested in three limited partnerships, New Vernon India Fund, New Vernon Global Opportunity Fund and New Vernon Aegir Fund which are managed by organizations in which three directors of the Company are executive officers, directors and owners.
Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.
The Level 3 assets consist of a portfolio of insurance-linked securities. The insurance-linked securities are valued using the average of estimated market quotes from multiple insurance-linked securities brokers. The broker quotes include Level 3 inputs which are significant to the valuation of the insurance-linked securities. There were no Level 3 sale and no transfers into Level 3 during 2013 or 2012. Increased market availability to quality market pricing of insurance-linked securities resulted in transfers out of Level 3 of all insurance-linked securities during 2013. A reconciliation of the beginning and ending balances of assets measured at fair value on a recurring basis using Level 3 inputs is as follows for the years ended December 31:
Quoted market prices are obtained whenever possible. Where quoted market prices are not available, fair values are estimated using present value or other valuation techniques. These techniques are significantly affected by our assumptions, including discount rates and estimates of future cash flows. Potential taxes and other transaction costs have not been considered in estimating fair values.
Non-financial instruments such as real estate, property and equipment, other assets, deferred income taxes and intangible assets, and certain financial instruments such as policy reserve liabilities are excluded from the fair value disclosures. Therefore, the fair value amounts cannot be aggregated to determine the underlying economic value to the Company.
State regulatory authorities prescribe calculations of the minimum amount of statutory capital and surplus necessary for each insurance company to remain authorized. These computations are referred to as Risk Based Capital (“RBC”)requirements and are based on a number of complex factors taking into consideration the quality and nature of assets, the historical adequacy of recorded liabilities and the specific nature of business conducted. At December 31, 2013 the minimum statutory capital and surplus requirements of the insurance subsidiaries was $92,111. Actual consolidated statutory capital and surplus at December 31, 2013 exceeded this requirement by $283,714, which equals to 410% of minimum RBC.
The Company leases certain computer and related equipment using noncancelable operating leases. Lease expense for 2013, 2012 and 2011 was $1,324, $1,506 and $1,483, respectively. At December 31, 2013, future lease payments for operating leases with initial or remaining noncancelable terms of one year or more consisted of the following: