Consolidated underwriting income (loss) is a non-GAAP financial measure as defined in Item 10(e) of SEC Regulation S-K. The reconciliation to net income (loss) before income taxes and interest in income (loss) of equity method investments, the most comparable GAAP measure, is presented in the 'Results of Operations', which is included in the 'Executive Summary' section of this MD&A.
relevance in the London marketplace, and we expect to be well-positioned to capitalize on new opportunities and benefit from improved market conditions emerging through the international specialty insurance market, including Lloyd's of London.
Consolidated underwriting income is a pre-tax measure of underwriting profitability that takes into account net premiums earned and other insurance related income (losses) as revenues and net losses and loss expenses, acquisition costs and underwriting-related general and administrative costs as expenses. While this measure is presented in Item 8, Note 4 to the Consolidated Financial Statements 'Segment Information', it is considered a non-GAAP financial measure when presented elsewhere on a consolidated basis.
We believe that showing net income available to common shareholders exclusive of net realized investment gains (losses), foreign exchange losses (gains), revaluation of deferred tax asset, bargain purchase gain, transaction and reorganization expenses, and losses on repurchase of preferred shares reflects the underlying fundamentals of our business. In addition, we believe that this presentation enables investors and other users of our financial information to analyze performance in a manner similar to how our management analyzes the underlying business performance. We also believe this measure follows industry practice and, therefore, facilitates comparison of our performance with our peer group. We believe that equity analysts and certain rating agencies that follow us, and the insurance industry as a whole, generally exclude these items from their analyses for the same reasons. The reconciliation of non-GAAP operating income to net income available to shareholders, the most comparable GAAP measure, is presented in the 'Results of Operations'.
We expect to achieve run-rate cost savings of approximately $60 million on the combined 2016 expense base by 2020. We expect that approximately $30 to $35 million of these cost savings will be realized in 2018, increasing to $50 to $55 million in
2019, with the balance of these cost savings to be realized in 2020. These expense savings will be achieved through an increased focus on key underwriting product growth areas, the elimination of duplicate corporate roles, leveraging AXIS Capital's technology platforms and the rationalization of third party contracts and professional fees. We expect to incur additional integration costs in 2018 through 2020 to achieve the cost savings. These expenses will not be included in non-GAAP operating income.
In 2017 unrealized investment gains, and in 2016 a decrease in unrealized investment losses, which are included in accumulated other comprehensive income, also contributed to the growth in diluted book value per share.
We believe in returning excess capital to our shareholders by way of dividends (as well as share repurchases) accordingly, our dividend policy is an integral part of the value we create for our shareholders. Our cumulatively strong earnings have permitted our Board of Directors to approve fourteen successive annual increases in quarterly common share dividends.
$28 million of net favorable prior year reserve development on marine business, due to better than expected loss emergence on more recent accident years including a large case reserve reduction on a 2013 accident year claim.
General and Administrative Expense Ratio: The decrease in general and administrative expense to 14.0% in 2017 from 16.2% in 2016 was primarily driven by a decrease in performance-related compensation costs and an increase in fees from strategic capital partners.
After adjusting for the impact of the catastrophe and weather-related losses, our current accident year loss ratio increased to 61.6% in 2017 from 60.6% in 2016. The increase in the current accident year loss ratio after adjusting for the impact of the catastrophe and weather-related losses was driven by an increase in attritional loss experience in our property lines together with the adverse impact of rate and trend, partially offset by a decrease in mid-size loss experience in our marine and credit and political risk lines and favorable changes in business mix.
2016 versus 2015: The current accident year loss ratio increased to 67.4% in 2016 from 65.5% in 2015. The increase was primarily due to an increase in catastrophe and weather-related losses. During 2016 we incurred pre-tax catastrophe and weather-related net losses of $121 million, or 6.8% points attributable to U.S. weather-related events, Hurricane Matthew, the Japanese earthquake and the Fort McMurray wildfires. Comparatively, in 2015 we incurred $54 million, or 3.0 points of losses attributable to catastrophe and weather-related events.
After adjusting for the impact of the catastrophe and weather-related losses, our current accident year loss ratio decreased from 63.3% in 2015 to 63.0% in 2016. The decrease in the current accident year loss ratio after adjusting for the impact of the catastrophe and weather-related losses was driven by decreased loss experience in our credit and surety lines, partially offset by the ongoing adverse impact of rate and trend, and an increase in loss experience in our agriculture lines.
The increase in corporate expenses during 2016 compared to 2015 is attributable to adjustments to senior leadership executive stock-compensation awards benefiting 2015, an increase in personnel costs including senior executive transition costs in 2016, partially offset by reorganization related expenses adverse to 2015.
The following provides a breakdown of our investment in fixed maturities:
During 2016, we paid $108 million including direct transactions costs to acquire 19% of the common equity of Harrington, the parent company of Harrington Re, an independent reinsurance company jointly sponsored by AXIS Capital and Blackstone. Harrington is not a variable interest entity. Given that we exercise significant influence over this investee we account for our ownership in Harrington under the equity method of accounting.
Refer to Item 8, Note 6 (g) to the Consolidated Financial Statements 'Investments'.
Nevertheless, other significant accounting policies are important to understanding our Consolidated Financial Statements. Refer Item 8, Note 2 to the Consolidated Financial Statements 'Significant Accounting Policies' for further details.
We believe the most significant accounting judgment we make is the estimate of our reserve for losses and loss expenses ("loss reserves"). Our loss reserves represent management’s estimate of the unpaid portion of our ultimate liability for losses and loss expenses ("ultimate losses") for (re)insured events that have occurred at or before the balance sheet date. Our loss reserves reflect both claims that have been reported to us ("case reserves") and claims that have been incurred but not yet reported to us ("IBNR"). Our loss reserves represent our best estimate of what the ultimate settlement and administration of claims will cost, based on our assessment of facts and circumstances known at that particular point in time.
Loss reserves are not an exact calculation of liability but instead are complex estimates. The process of estimating loss reserves involves a number of variables (see 'Selection of Reported Reserves (Management's Best Estimate)' below for further details). We review our estimate of loss reserves each reporting period and consider all significant facts and circumstances then known. As additional experience and other data become available and/or laws and legal interpretations change, we may adjust our previous estimates of loss reserves; these adjustments are recognized in the period they are determined and, therefore, can impact that period's underwriting results either favorably (when reserves established in prior years can be released) or adversely (when reserves established in prior years require upward adjustment).
Our results of operations for each of 2017, 2016 and 2015 were impacted by natural catastrophe activity. For a discussion of these events and the remaining associated uncertainties, refer to Item 7 'Underwriting Results - Group, Underwriting, Expenses'.
Similarly, we also placed significant reliance on industry benchmarks in selecting our loss development patterns in earlier years. Over time, we have given varying degrees of weight to our own historical loss experience, discussed further in 'Claim Tail Analysis' below.
Our OTTI review process for credit impairment excludes all fixed maturities guaranteed by the U.S. government and its agencies because we anticipate these securities will not be settled below amortized costs. However, these securities are still evaluated for intention to sell at a loss.
requires the use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes,
interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the impact of this guidance on the Company's results of operations, financial condition and liquidity.
The underwriting results of Aviabel are included in the underwriting results of the Company's insurance segment from the acquisition date.
Represents the non-credit component of the other-than-temporary impairment (OTTI) losses, adjusted for subsequent sales, maturities and redemptions. It does not include the change in fair value subsequent to the impairment measurement date.
Unrealized losses on securities issued or backed (either explicitly or implicitly) by the U.S. government are not analyzed for OTTI. The Company have concluded that the possibility of any credit losses on these securities is highly unlikely due to the explicit U.S. government guarantee on certain securities (e.g. GNMA issuances) and, on others, the implicit guarantee that has been validated by past actions (e.g. U.S. government bailout of FNMA and FHLMC during the 2008 credit crisis). Although not analyzed for credit losses, the securities are still evaluated for intention to sell and likely requirement to sell.
The Company's investments in ABS at December 31, 2017 consist mainly of CLO debt tranched securities ("CLO Debt") purchased primarily as new issues during 2015 through 2017. Of these new issues all had credit ratings of AA or better. The Company utilizes a scenario-based approach to reviewing the CLO Debt portfolio based on the current asset market price. The Company also reviews subordination levels of its securities to determine their ability to absorb credit losses of underlying collateral. If losses are forecast to be below the subordination level for the tranche held by the Company, the security is determined not to be impaired. The Company has concluded that there are no credit losses anticipated for any CLO Debt at December 31, 2017.
Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This may lead the Company to change the selection of valuation technique (from market to cash flow approach) or may cause the Company to use multiple valuation techniques to estimate the fair value of a financial instrument. This circumstance could cause an instrument to be reclassified between levels within the fair value hierarchy.
U.S. government and agency securities consist primarily of bonds issued by the U.S. Treasury and mortgage pass-through agencies such as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association. As the fair values of U.S. Treasury securities are based on unadjusted market prices in active markets, these securities are classified as Level 1. The fair values of U.S. government agency securities are determined using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads are observable market inputs, the fair values of U.S. government agency securities are classified as Level 2.
The CLO-Equities market continues to be relatively inactive with only a small number of transactions being observed, particularly as it relates to transactions involving CLO-Equities held by the Company. Accordingly, fair values of investments in CLO-Equities are determined using models. Given that all of the Company's direct investments in CLO-Equities are past their reinvestment period, there is uncertainty regarding the remaining time until maturity. As such the Company's direct investments in CLO-Equities are estimated using a liquidation valuation. Indirect investments in CLO-Equities are valued using a discounted cash flow model prepared by an external manager.
The transfers into Level 3 from Level 2 made during 2017 were primarily due to the lack of observable market inputs and multiple quotes from pricing vendors and broker-dealers for certain fixed maturities.
The Company has presented separate loss development tables for the Aviabel and Novae business prospectively from the date of acquisition.
The reinsurance credit and surety reserve class recorded net favorable prior year reserve development of $33 million, $10 million, and $27 million in 2017, 2016, and 2015, respectively due to the recognition of generally better than expected loss emergence.
Initial and most recent underwriting year loss projections are generally based on the ELR method, with consideration given to qualitative factors. Given that there is a quicker and more stable reporting pattern for trade credit business, the Company generally commences the transition to experience-based methods sooner for trade credit business than for the surety business.
In April 2017, the Company acquired Aviabel, an insurance and reinsurance operation founded in 1935 with headquarters in Europe. Aviabel’s main lines of business consist of general aviation, airlines, products and manufacturers, airports and treaty reinsurance. With regards to airlines, manufactures and airports, Aviabel focuses on smaller operators rather than the large players. The claims reporting pattern varies by coverage provided but are typically short tailed in nature.
Property: The property line of business includes exposures related to worldwide direct property facilities for retail and small commercial risks, worldwide catastrophe reinsurance written on a proportional and excess of loss basis, and worldwide direct and facultative cover of larger commercial risks. In general, reporting and payment patterns are relatively short-tailed although they can be volatile due to the incidence of catastrophe events.
In the ordinary course of business, the Company purchases treaty and facultative reinsurance to reduce exposure to significant losses. Facultative reinsurance provides cover for all or a portion of the losses incurred for a single policy and the Company separately negotiates each facultative contract.
Marsh & McLennan Companies Inc. accounted for 20% (2016: 21%; 2015: 22%), Aon plc for 17% (2016: 19%; 2015: 18%), and Willis Tower Watson PLC for 12% (2016: 12%; 2015: 13%).
The Company operates in the Lloyd’s market through its corporate member, AXIS Corporate Capital UK Limited which represents its participation in Syndicate 1686 and Novae Corporate Underwriting Limited, the sole corporate member of Syndicate 2007. Lloyd’s sets capital requirements for corporate members annually through the application of a capital model that is based on regulatory rules pursuant to Solvency II.
On August 17, 2015, the Company entered into an Accelerated Share Repurchase ("ASR") agreement with Goldman, Sachs & Co. ("Goldman Sachs") to repurchase an aggregate of $300 million of the Company's ordinary shares under an accelerated share repurchase program.
During August 2015, under the terms of this agreement, the Company paid $300 million to Goldman Sachs and initially repurchased 4,149,378 common shares. The initial shares acquired represented 80% of the $300 million total paid to Goldman Sachs and were calculated using the Company’s stock price at activation of the program. The ASR program was accounted for as an equity transaction. Accordingly, at December 31, 2015, $240 million of common shares repurchased were included as treasury shares in the Consolidated Balance Sheets with the remaining $60 million included as a reduction to additional paid-in capital.
On March 19, 2012, the Company issued $400 million of 6.875% Series C preferred shares, par value $0.0125 per share, with a liquidation preference of $25.00 per share. The Company may redeem the Series C preferred shares on or after April 15, 2017 at a redemption price of $25.00 per share. Dividends on the Series C preferred shares are non-cumulative. Holders of the Series C preferred shares will be entitled to receive, only when, as and if declared by the board of directors, non-cumulative cash dividends, from the original issue date, quarterly in arrears on the fifteenth day of January, April, July and October of each year, commencing on July 15, 2012. To the extent declared, these dividends will accumulate, with respect to each dividend period, in an amount per share equal to 6.875% of the liquidation preference per annum.
The Company's Chairman, Mr. Butt, received $0.5 million in consulting fee payments in 2017 pursuant to the terms of a consulting agreement by and between Mr. Butt and the Company dated May 3, 2012, as amended (2016: $0.6 million; 2015: $1 million). The consulting agreement was further amended on December 7, 2017 to extend the term of the agreement to the Company's 2019 Annual General Meeting for an annual fee of $0.5 million.
All operating and capital loss carryforwards and tax credits can be carried forward indefinitely with the exception of the U.S. net operating loss which will expire in 2037.
As a result of ceasing the Company's Australian operations, operating loss and capital loss carryforwards were written off.
Under the Insurance Act 1978, amendments thereto and Related Regulations of Bermuda (the "Act"), the Company's Bermuda subsidiary, AXIS Specialty Bermuda is required to maintain minimum statutory capital and surplus equal to the greater of a minimum solvency margin ("MSM") and the Enhanced Capital Requirement ("ECR"). The MSM is the greater of $100 million, 50% of net premiums written, 15% of the net reserve for losses and loss expenses or 25% of the ECR. The ECR is calculated based on either an internally developed risk-based capital model or a standard risk-based capital model developed by the Bermuda Monetary Authority ("BMA"). In 2016, the BMA implemented an Economic Balance Sheet ("EBS") framework which was used as the basis to determine the ECR. At December 31, 2017 and 2016, the required and available statutory capital and surplus were based on this EBS framework.