Our earnings before income taxes in 2011 decreased from 2010, primarily reflecting higher loss and LAE, lower net premiums earned and lower net investment income, partially offset by higher net realized capital gains. The increase in loss and LAE primarily reflects a $28.7 million increase in PCC’s prior year reserves and higher catastrophe and other large property losses at RSUI in the 2011 period, partially offset by a higher net release of prior year casualty reserves by RSUI. The decrease in net premiums earned reflects the impact of continuing competition at CATA, as well as a reduction in net premiums written in certain specialty classes of business by CATA. The decrease in net investment income is due primarily to an increase in catastrophe losses related to our investment in Homesite, partially offset by higher dividend income.
As noted above, there was favorable loss emergence in 2012 compared with loss emergence patterns assumed in earlier periods in many of RSUI’s casualty lines of business. Specifically, cumulative losses for such lines of business, which include both loss payments and case reserves, in respect of prior accident years were expected to be higher through December 31, 2012 than the actual cumulative losses through that date. The amount of lower cumulative losses, expressed as a percentage of carried loss and LAE reserves at the beginning of the year, was 0.2 percent. Such reduction did not impact the assumptions used in estimating RSUI’s loss and LAE liabilities for such lines for business earned in 2012.
We believe that the reserves for unpaid loss and LAE established by our reinsurance and insurance operating units are adequate as of December 31, 2012; however, additional reserves, which could have a material impact upon our financial condition, results of operations, and cash flows, may be necessary in the future.
The primary actuarial assumptions used by our reinsurance and insurance operating units include the following:
Management’s assessment of equity securities initially involves an evaluation of all securities that are in an unrealized loss position, regardless of the duration or severity of the loss, as of the applicable balance sheet date. Such initial review consists primarily of assessing whether: (i) there has been a negative credit or news event with respect to the issuer that could indicate the existence of an OTTI; and (ii) we have the ability and intent to hold an equity security for a period of time sufficient to allow for an anticipated recovery (generally considered to be less than one year from the balance sheet date).
Dividends. We have declared stock dividends in lieu of cash dividends every year since 1987 except 1998, when our wholly-owned subsidiary, Chicago Title Corporation, was spun off to our stockholders and 2012. In light of the merger, our board of directors determined not to declare a stock dividend for 2012.
* Includes Belgium, the Czech Republic, Denmark, Finland, Luxembourg, Norway, Poland, Sweden and Switzerland.
We have audited the accompanying consolidated balance sheets of Alleghany Corporation and subsidiaries as of December 31, 2011, and the related consolidated statements of earnings and comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2011. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
estimated are accurately recorded and that the data inputs and the valuation techniques used are appropriate, consistently applied, and that the assumptions are reasonable and consistent with the objective of determining fair value. Alleghany assesses the reasonableness of individual security values received from valuation service providers through various analytical techniques. In addition, Alleghany validates the reasonableness of fair values by comparing information obtained from Alleghany’s valuation service providers to other third party valuation sources for selected securities. Alleghany also validates prices obtained from brokers for selected securities through reviews by those who have relevant expertise and who are independent of those charged with executing investing transactions.
Basic earnings per share of common stock is based on the average number of shares of common stock, par value $1.00 per share, of Alleghany (“Common Stock”) outstanding during the period, retroactively adjusted for stock dividends. Diluted earnings per share of Common Stock are based on those shares used to calculate basic earnings per share of Common Stock plus the dilutive effect of stock-based compensation awards, retroactively adjusted for stock dividends. See Note 11 for additional information on earnings per share.
Certain prior year amounts have been reclassified to conform to the 2012 presentation of the financial statements.
Pursuant to the terms of the Merger Agreement, each outstanding stock option to acquire Old TransRe common stock was converted into the right to receive a cash payment based on its Black-Scholes value on the
(3) Principally consists of Level 3 assets acquired as part of the merger.
The amortized cost or cost and the fair value of AFS securities as of December 31, 2012 and 2011 are summarized as follows (in millions):
RSUI reinsures its property lines of business through a program consisting of surplus share treaties, facultative placements, per risk, and catastrophe excess of loss treaties. RSUI’s catastrophe reinsurance program (which covers catastrophe risks including, among others, windstorms and earthquakes) and per risk reinsurance program run on an annual basis from May 1 to the following April 30 and thus will expire on April 30, 2013.
Alleghany believes that, as of December 31, 2012, it had no material uncertain tax positions. Interest and penalties relating to unrecognized tax expenses (benefits) are recognized in income tax expense, when applicable. There was no liability for interest or penalties accrued as of December 31, 2012.
Loss and LAE include amounts for risks relating to asbestos-related illnesses and environmental impairment. As of December 31, 2012 and 2011, such gross and net reserves were as follows (in millions):
Foreign net premiums earned from the Acquisition Date through December 31, 2012 were $1,430.6 million. The foreign country in which Alleghany generates the largest amount of premium revenues is the United Kingdom. Net premiums earned by the London office from the Acquisition Date through December 31, 2012 were $562.9 million.
Alleghany provided incentive compensation to management employees through its 2002 Long-Term Incentive Plan (the “2002 LTIP”) until December 31, 2006 when the 2002 LTIP expired. In December 2006, Alleghany adopted the 2007 Long-Term Incentive Plan (the “2007 LTIP”) which was approved by Alleghany stockholders in April 2007. The 2007 LTIP expired on April 27, 2012. In February 2012, Alleghany adopted the 2012 Long-Term Incentive Plan (the “2012 LTIP”) which was approved by Alleghany stockholders in April 2012. The provisions of the 2007 LTIP and 2012 LTIP are substantially similar. Awards under the 2007 LTIP and 2012 LTIP may include, but are not limited to, cash and/or shares of Common Stock, rights to receive cash and/or shares of Common Stock and options to purchase shares of Common Stock, including options intended to qualify as incentive stock options under the Internal Revenue Code of 1986, as amended, and options not intended to so qualify. Under the 2002 and 2007 LTIP, the following types of awards were outstanding as of December 31, 2012:
Restricted Share Awards - From time to time, Alleghany has awarded to certain management employees restricted shares of Common Stock. These awards entitle the participants to a specified maximum amount equal to the value of one share of Common Stock for each restricted share issued to them based on the market value on the grant date. In many instances, payouts are made, provided defined levels of performance are achieved. The expense is recognized ratably over the performance period, which can be extended under certain circumstances.