We maintain office facilities in Bermuda, the U.S., Europe, Singapore, and Canada. We own the building in which our office is located in Dublin, Ireland, and we lease office space in the other countries. We renew and enter into leases in the ordinary course of business as required. Our global headquarters is located at 92 Pitts Bay Road, AXIS House, Pembroke HM 08, Bermuda. We believe that our office space is sufficient for us to conduct our operations for the foreseeable future.
•Operating loss(1) of $174 million, or $(2.08) per diluted common share(1)
(1) Operating income (loss) and operating income (loss) per diluted common share are non-GAAP financial measures as defined in Item 10(e) of SEC Regulation S-K. The reconciliations to the most comparable GAAP financial measures, net income (loss) available (attributable) to common shareholders and earnings (loss) per diluted common share, respectively, and a discussion of the rationale for the presentation of these items are provided in 'Management's Discussion and Analysis of Financial Condition and Results of Operations - Non-GAAP Financial Measures Reconciliation'.
The reinsurance market is also experiencing an improvement in rates and terms and conditions. These improvements are due to a combination of pressures on the industry including near-term drivers such as the failure of the industry to meet cost of capital in the last four years, the increased frequency of natural catastrophe events and the increased cost of retro protection together with long term drivers such as the pressure on reserve adequacy levels, low interest rates and the looming uncertainty related to social inflation. Balanced with the case for change is the strong industry capitalization. We believe the improvements will translate to a healthier and more profitable market. This environment requires a combination of strong underwriting and portfolio management mixed with smart incremental growth where returns are attractive. We have repositioned our portfolio during the last several years and believe our business is well-positioned for the current market environment.
As our industry and society continue to navigate the challenges brought on by COVID-19, we are closely monitoring cash receipts from our customers and reinsurers, giving due consideration to related directives issued by certain government agencies. At December 31, 2020, we considered the potential financial impact of COVID-19 when determining allowances for expected credit losses for insurance and reinsurance premium balances receivable and reinsurance recoverable balances on unpaid losses. Based on facts and circumstances at that time, we did not adjust allowances for expected credit losses at December 31, 2020. We will continue to monitor the appropriateness of allowances for expected credit losses as new information comes to light. Adjustments to allowances for expected credit losses in subsequent periods could be material.
We expect cash flows generated from operations, combined with liquidity provided by our investment portfolio, to be sufficient to cover cash outflows and other contractual commitments that become due through the foreseeable future (refer to 'Capital and Liquidity' for further details).
Other insurance related loss was $11 million in 2020, compared to other insurance related income of $14 million in 2019. The decrease of $24 million was primarily due to the recognition of a full limit loss of $10 million associated with the WHO pandemic risk-linked swap and a decrease in fees associated with arrangements with strategic capital partners.
The underwriting-related general and administrative expense ratio increased to 4.8% in 2020 from 4.3% in 2019, mainly driven by decreases in net premium earned and fees associated with arrangements with strategic capital partners, partially offset by a decrease in travel and entertainment expenses.
2020 versus 2019: Net investment income in 2020 decreased by $67 million or 17%, compared to 2019 due to a decrease in yields and a smaller allocation of the portfolio to fixed maturities.
We evaluate our underwriting results separately from the performance of our investment portfolio. As a result, we believe it is appropriate to exclude net investment income and net investment gains (losses) from our underwriting profitability measure.
(5)Debt (interest payments) includes $15 million of unamortized discount and debt issuance expenses.
Our quarterly loss reserving process begins with the collection and analysis of paid and incurred claim data for each of the segments. The segmental data is disaggregated by reserve class and further disaggregated by underwriting year and accident year. Underwriting year or accident year information is used to analyze our business and to estimate loss reserves. Reserve classes are selected to ensure that the underlying contracts have homogeneous loss development characteristics, while remaining large enough to make the estimation of trends credible. Reserve classes are reviewed on a regular basis and adjusted over time as our business evolves. The paid and incurred claim data, in addition to industry benchmarks, serves as a key input to many of the methods employed by our actuaries. The relative weights assigned to our historical loss data versus industry
The estimation of the value of recoveries on credit and political risk business requires significant management judgment. At December 31, 2020, estimated recoveries on credit and political risk business were $52 million (2019: $35 million).
Loss reserves related to catastrophes other than the COVID-19 pandemic represent our best estimate of losses and loss expenses that have been incurred at the balance sheet date. The determination of these loss reserves is estimated by management after a catastrophe occurs by completing an in-depth analysis of individual contracts which may potentially have been impacted by the catastrophic event. This in-depth analysis may rely on several sources of information including:
While we believe our estimate of loss reserves is adequate for losses and loss expenses that have been incurred at the balance sheet date based on current facts and circumstances, we monitor changes in paid and incurred losses in relation to each significant catastrophe in subsequent reporting periods, and adjustments are made to estimates of ultimate losses for each event if there are developments that are different from previous expectations. Adjustments are recorded in the period in which they are identified. Actual losses for these event may ultimately differ materially from current estimates.
Expected loss ratios are a key assumption in estimates of ultimate losses for business at an early stage of development. A higher expected loss ratio results in a higher ultimate loss estimate, and vice versa. Assumed loss development patterns are another significant assumption in estimating loss reserves. Accelerating a loss reporting pattern (i.e. shortening the claim tail) results in lower ultimate losses, as the estimated proportion of losses already incurred would be higher. The uncertainty in the timing of the emergence of claims (i.e. the length of the development pattern) is generally greater for a company with a relatively limited operating history, therefore, we rely on industry benchmarks to a certain extent when establishing loss reserve estimates.
The reinsurance segment provides cover to cedants (i.e. insurance companies) on an excess of loss and proportional basis. In most cases, cedants seek protection from us for business that they have not yet written at the time they enter into agreements with us, therefore, cedants must estimate their underlying premiums when purchasing reinsurance cover from us.
•We tested the effectiveness of controls over the valuation of the recorded loss and loss expense reserves, including the review and approval process that management has in place for significant actuarial methods and assumptions used and the approval of management’s best estimate of loss and loss expense reserves.
On a quarterly basis, the Company assesses whether unrealized losses on fixed maturities represent credit impairments by considering the following factors:
In instances where the Company intends to hold the impaired fixed maturity, the Company estimates the anticipated credit loss on the security and this component of the impairment is charged to net income and is included in net investment gains (losses) in the consolidated statements of operations. On recognition of an OTTI charge, the new cost basis for the security is the amortized cost basis less the OTTI charge recognized in net income. The new cost basis is not adjusted for subsequent increases in fair value. The difference between the new cost basis and the cash flows expected to be collected is accreted or amortized on a quarterly basis to net investment income over the remaining life of the fixed maturity.
The Company recognizes goodwill and other intangible assets in connection with certain acquisitions. Goodwill represents the excess of the purchase price paid over the fair value of the net assets acquired in these acquisitions and is not amortized. Other intangible assets with a finite life are amortized over the estimated useful live of the intangible asset. Other intangible assets with an indefinite life are not amortized.
For the purpose of evaluating indefinite lived intangibles for impairment, the Company may first perform a qualitative assessment to determine whether it is necessary to perform the quantitative impairment test. If the Company elects to perform a qualitative assessment, it first assesses qualitative factors to determine whether it is more likely than not that an indefinite lived intangible asset is impaired. If the Company determines that it is more likely than not that the indefinite lived intangible asset is impaired, the Company performs the quantitative impairment test.
The Company does not record office property and equipment leases with an initial term of 12 months or less (short-term) in the Company's consolidated balance sheets.
In instances where the Company intends to hold the impaired fixed maturity, and it does not anticipate to fully recover the amortized cost, an allowance for expected credit losses is established. At December 31, 2020, the allowance for expected credit losses was $(0.3) million.
AXIS Capital's underwriting operations are organized around its global underwriting platforms, AXIS Insurance and AXIS Re. The Company has determined that it has two reportable segments, insurance and reinsurance. The Company does not allocate its assets by segment, with the exception of goodwill and intangible assets.
The following table provides the amortized cost and fair values of the Company's fixed maturities classified as available for sale:
•Long/short equity funds: Seek to achieve attractive returns primarily by executing an equity trading strategy involving long and short investments in publicly-traded equity securities.
The following table provides a reconciliation of the beginning and ending balances of the allowance for expected credit losses on fixed maturities classified as available for sale:
To estimate expected credit losses for corporate debt securities, the Company's projected cash flows are primarily driven by assumptions regarding the severity of loss, probability of default and projected recovery rates. The Company's default and loss severity rates are based on credit rating, credit analysis and macroeconomic forecasts. In 2020, the allowance for expected credit losses on corporate debt securities mainly related to loss severity where the forecasted recovery to amortized cost was uncertain.
The following table quantifies the significant unobservable inputs used in estimating fair values at December 31, 2020 of investments classified as Level 3 in the fair value hierarchy:
The transfers into Level 3 from Level 2 during 2020 were primarily due to the lack of observable market inputs and multiple quotes from pricing vendors and broker-dealers for certain fixed maturities. There were no transfers into Level 3 from Level 2 during 2019.
For hedge funds, direct lending funds, private equity funds and real estate funds, valuation statements are typically released on a reporting lag therefore, the Company estimates the fair value of these funds by starting with the most recent fund valuations and adjusting for capital calls, redemptions, drawdowns and distributions. Return estimates are not available from the relevant fund managers for these funds, therefore the Company typically has a reporting lag in its fair value measurements of these funds. At December 31, 2020, funds reported on a lag represented 86% (2019: 68%) of the Company's total other investments balance.
(1)Net asset and liability derivatives are classified within other assets and other liabilities in the consolidated balance sheets.
The Company's investment portfolio includes a large percentage of fixed maturities which exposes it to significant interest rate risk. As part of overall management of this risk, the Company may use interest rate swaps.
The Company's insurance and reinsurance subsidiaries and branches operate in various countries. Some of its business is written in currencies other than the U.S. dollar, therefore the underwriting portfolio is exposed to significant foreign currency risk. The Company manages foreign currency risk by seeking to match its foreign-denominated net liabilities under insurance and reinsurance contracts with cash and investments that are denominated in the same currencies. The Company uses derivative instruments, specifically, forward contracts to economically hedge foreign currency exposures
For the Company's earliest accident and underwriting years, initial key actuarial expected loss ratio and loss development assumptions were established utilizing industry benchmarks. Due to the longer claim tail, the length of time required to develop credible loss history for use in the reserve process is greater for medium-tail business than for short-tail business.
As a general rule, estimates of accident year or underwriting year ultimate losses for long-tail business are notably more uncertain than those for short and medium-tail business. To date, key actuarial assumptions for long-tail business have been derived from a combination of industry benchmarks supplemented with Company historical loss experience. While industry benchmarks that the Company believes reflect the nature and coverage of its business are considered, actual loss experience may differ from the benchmarks based on industry averages. Due to the length of the development tail for this business, reserve estimates for most accident years and underwriting years are predominantly based on the BF Method or ELR Method and the consideration of qualitative factors.
The Company cannot estimate losses from widespread catastrophic events, such as hurricanes and earthquakes, using the traditional actuarial methods described above. The magnitude and complexity of losses associated with certain of these events inherently increase the level of uncertainty and, therefore, the level of management judgment involved in arriving at estimated net reserves for losses and loss expenses. As a result, actual losses for these events may ultimately differ materially from current estimates.
In 2019, we recognized $26 million of net favorable prior year reserve development, the principal components of which were:
At December 31, 2020, the Company was in compliance with these limits.
The following table presents the Company’s total lease expense and the cash flows arising from lease transactions:
(4) Weighted-average discount was calculated on the basis of the discount rate that was used to calculate the lease liability balance for each lease at the reporting date and the remaining balance of the lease payments for each lease at the reporting date.
AXIS Capital's U.S. subsidiaries are subject to federal, state and local corporate income taxes, and other taxes applicable to U.S. corporations. The provision for federal income taxes has been determined under the principles of the consolidated tax provisions of the U.S. Internal Revenue Code and regulations. Should the U.S. subsidiaries pay a dividend outside the U.S. group, withholding taxes will apply. The Company's U.S. subsidiaries are not under examination but remain subject to examination for tax years 2017 through 2020.
At December 31, 2020 and 2019, the Company established a full valuation allowance on: (1) operating loss carryforwards relating to operations in Singapore; (2) un-utilized foreign tax credits available in Ireland and (3) certain other deferred tax assets related to branch operations. At December 31, 2019, the valuation allowance on certain unrealized investment losses was released as the Company was in an unrealized investment gain position.
Effective January 1, 2016, the Company's Irish subsidiaries, AXIS Specialty Europe and AXIS Re SE, are required to maintain the Minimum Capital Requirement ("MCR") and the Solvency Capital Requirement ("SCR") at all times. The capital requirements are calculated by reference to Solvency II definitions. If an entity falls below the MCR or SCR, the Central Bank of Ireland is authorized to take action to restore the financial position of the Company's Irish subsidiaries. During 2020 and 2019, the Company's Irish subsidiaries were in compliance with these requirements.
The Company's U.S. operations required statutory capital and surplus is determined using the risk-based capital formula ("RBC"), which is the National Association of Insurance Commissioners' (the "Commissioner") method of measuring the minimum capital appropriate for U.S. reporting entities to support its overall business operations in consideration of its size and risk profile. If a company falls below the authorized control level as determined under the RBC, the Commissioner is authorized to take whatever regulatory actions may be considered necessary to protect policyholders and creditors. The maximum dividend that may be paid by the Company's U.S. insurance subsidiaries is restricted by the regulatory requirements of the domiciliary states. Generally, the maximum dividend that may be paid by each of the Company's U.S. insurance subsidiaries is limited to unassigned surplus (statutory equivalent of retained earnings) and may also be limited to statutory net income, net investment income or 10% of total statutory capital and surplus. At December 31, 2020, the maximum dividend that the Company's U.S. insurance operations could pay without regulatory approval was approximately $110 million (2019: $141 million).
(1)Consolidated underwriting income is a pre-tax measure of underwriting profitability that takes into account net premiums earned and other insurance related income (loss) as revenues and net losses and loss expenses, acquisition costs and underwriting-related general and administrative expenses as expenses. Consolidated underwriting income (loss) is a non-GAAP financial measure as defined in Item 10(e) of SEC Regulation S-K. The reconciliation to income (loss) before income taxes and interest in income (loss) of equity method investments, the most comparable GAAP financial measure, is provided in Note 3 'Segment Information'.