The remainder of our leased space is in Irvine, California; New Haven, Connecticut; Ft. Lauderdale, Florida; Maitland, Florida; Atlanta, Georgia; Chicago, Illinois; Quincy, Massachusetts; Westborough, Massachusetts; Portland, Maine; Moorestown, New Jersey; Melville, New York; Williamsville, New York; Irving, Texas and Petaluma, California.
(1) Includes insurance contract acquisition expenses and other underwriting expenses (which are general administrative expenses related to underwriting operations in our insurance subsidiaries), other insurance services expenses (which are general administrative expenses related to insurance services operations) and other corporate related expenses.
Previously, on October 7, 2013, Demotech had lowered its rating on TICNY and three other U.S. based insurance subsidiaries (Kodiak Insurance Company, Massachusetts Homeland Insurance Company and York Insurance Company of Maine) from A’ (A prime) to A (A exceptional). In addition, Demotech removed its previous A’ (A prime) rating on six other U.S. based insurance subsidiaries (CastlePoint Florida Insurance Company, CastlePoint Insurance Company, CastlePoint National Insurance Company, Hermitage Insurance Company, North East Insurance Company and Preserver Insurance Company). Demotech also affirmed its A ratings on Adirondack Insurance Exchange, New Jersey Skylands Insurance Association, New Jersey Skylands Insurance Company and Mountain Valley Indemnity Company.
Net investment income and net realized gains (losses). Net investment income increased 0.5% for the year ended December 31, 2012 compared to 2011. Net investment income was comparable to the prior year period as average cash and invested assets were relatively constant for the year ended December 31, 2012 as compared to 2011. Operating cash invested in fixed income securities in 2012 and in 2011 has been affected by an extended low interest rate environment. Investments in high-yield securities, dividend paying equity securities and in alternative investments continue to be made to help maintain overall portfolio yield and to partially mitigate the impact of the lower interest rate environment.
The net loss in 2012 is primarily due to the reserve increase from Superstorm Sandy discussed above. 2012 net loss included losses of $80.1 million after-tax from Superstorm Sandy, as well as an after-tax reserve increase of $60.7 million recorded in 2012 for accident years 2011 and prior.
Ceding commission revenue. Ceding commission revenue increased for the year ended December 31, 2013 by $22.4 million compared to 2012 as a result of the aforementioned quota share reinsurance treaties. This increase was offset by a decline in ceding commission revenue attributable to the increase of prior year loss reserves for the year ended December 31, 2013, which resulted in $9.8 million of return commissions to reinsurers on prior year quota share treaties. The Company recognized a $4.2 million return commission for the year ended December 31, 2012
OUE increased in 2013 compared to 2012 due to the additional operating expenses incurred because of the Canopius Merger Transaction, including the addition of another insurance subsidiary (TRL) and related costs. The gross underwriting expense ratio was 20.8% for the year ended December 31, 2013 compared to 36.7% in 2012. The assumed commission portion of the gross underwriting expense ratio, which is expressed as a percentage of assumed premiums earned, was 18.0% for the year ended December 31, 2013 compared to 35.5% for 2012. The commission expense in 2013 included federal excise tax of $9.8 million on business retroceded from CastlePoint Re to TRL and no such federal excise tax was recorded in 2012. Gross premiums earned increased by 130.0% in 2013 compared to 2012. Ceded written premium increased by $159.7 million as a result of the reinsurance agreements entered into during the third quarter of 2013. The increase in gross written premium is the main cause of the decrease in the gross underwriting expense ratio in 2013 compared to the prior year
For Tower personal lines, excluding the Reciprocal Exchanges, the net calendar year loss ratios were 58.6% and 72.5% for the years ended December 31, 2013 and 2012, respectively. The accident year loss ratios for the years ended December 31, 2013 and 2012 were 59.0% and 71.3%, respectively. Estimates of prior accident year loss and loss expenses decreased by $1.4 million for the year ended December 31, 2013, compared to an increase of $4.0 million for the year ended December 31, 2012.
Underwriting expenses. Underwriting expenses, which include direct commissions and other underwriting expenses, increased by $21.5 million, or 9.4% for the year ended December 31, 2013 compared to the year ended December 31, 2012. The net underwriting expense ratio increased 1.8 percentage points from 2013 to 2012. The increase in underwriting expenses is related to impairment charges recorded on customer relationship intangible assets and an increase in operating expense relating to improving information technology systems and infrastructure.
The following table presents information regarding our invested assets that were in an unrealized loss position at December 31, 2013 and 2012 by amount of time in a continuous unrealized loss position:
For the year ended December 31, 2013, net cash used in operating activities was $350.0 million compared to cash provided by operations of $109.3 million in 2012. This decrease in operating cash flow is largely due to higher ceded premiums in 2013 as compared to 2012. The Company had the following new treaties in 2013 as compared to 2012: (i) $283 million of cash payments made to Southport Re pursuant to the Southport Re Quota Share and Southport Re ADC reinsurance agreements (these treaties were terminated in February 2014, at which time this cash was returned to Tower); (ii) $28 million of cash payments made to other reinsurers pursuant to reinsurance agreements executed in the third and fourth quarters of 2013; and (iii) an increase in loss payments in 2013 associated with Superstorm Sandy, a fourth quarter 2012 event.
Net cash flows used in investing activities were $100.7 million for the year ended December 31, 2012 compared to $111.9 million used for the year ended December 31, 2011. The year ended December 31, 2012 and 2011 included an increase to fixed assets of $19.5 million and $53.6 million, respectively, primarily related to the build out of new systems. The remaining cash flows in 2011 relates to the Company’s purchases and sales of fixed-maturity and equity investments. The remaining net cash outflows in 2012 relate primarily to the Company’s $71.5 million investment in Canopius Group and a $35.0 million increase in restricted cash collateral posted for assumed reinsurance business with Lloyd’s of London offset by securities sales to generate cash to pay Superstorm Sandy claims.
Based on RBC calculations as of December 31, 2013, six of Tower’s ten U.S. based insurance subsidiaries have capital and surplus below Company Action Level and do not meet the minimum capital and surplus requirements of their respective state regulators. As a result, management has discussed the ACP Re Merger Agreement and the Cut- Through Reinsurance Agreement and provided its 2014 RBC forecasts to the regulators to document the Company’s business plan to bring two of these U.S based insurance subsidiaries’ capital and surplus levels above Company Action Level.
The merger with ACP Re is expected to close in the summer of 2014, and there are contractual termination rights available to each of Tower and ACP Re under various circumstances. There can be no assurance that the merger will close, or that it will close under the same terms and conditions contained in the ACP Re Merger Agreement. There can be no guarantee that the Company will be able to remedy current statutory capital deficiencies in certain of its insurance subsidiaries or maintain adequate levels of statutory capital in the future.
commercial automobile liability, commercial multi-peril property, commercial multi-peril liability and brokerage other liability (mono line liability) businesses. The agreement covers losses occurring on or after July 1, 2013 for policies in-force as of June 30, 2013 and policies written or renewed from July 1, 2013 to December 31, 2013.
On January 2, 2014, Fitch downgraded Tower’s issuer default rating from “B” to “CC” and the insurer strength ratings of its insurance subsidiaries from “BB” to “B”. On October 7, 2013, Fitch downgraded Tower’s issuer default rating to “B” (the sixth highest of 11 such ratings) from “BBB” and the insurer strength ratings of its insurance subsidiaries to “B” (the fifth highest of Fitch Ratings’ nine such ratings) from “A-”. In downgrading such ratings, Fitch stated that it “is concerned that Tower’s competitive position has been materially damaged, negatively impacting the Company’s financial flexibility and ability to write new business” and that “the magnitude of the second quarter charges was large enough to cause several key ratios to fall well
Management expects these rating actions, in combination with other items that have impacted the Company in 2013, to result in a significant decrease in the amount of premiums the insurance subsidiaries are able to write. Direct written premiums were $1,606.2 million for the twelve months ended December 31, 2013. Business written through certain program underwriting agents requires an A.M. Best rating of A- or greater.
On November 22, 2013, the Company announced the implementation of an expense control initiative to streamline its operations and focus resources on its most profitable lines of business. As part of this initiative, the Company has implemented a workforce reduction affecting approximately 10% of the total employee population of approximately 1,400. The areas that are most significantly impacted are commercial lines underwriting as well as operations. This workforce reduction is expected to result in annualized cost savings of approximately $21.0 million. The Company currently recognized pre-tax charges of $5.5 million in the fourth quarter of 2013 for severance and other one-time termination benefits and other associated costs.
London Syndicate 4444 (“Syndicate 4444”) business for the Year of Account (“YOA”) 2012, YOA 2011 and prior years, which Canopius Bermuda assumed from Canopius Group. Syndicate 4444 is an insurance syndicate managed by Canopius Group. The Company accounts for these retrocession agreements in accordance with prospective accounting treatment, and reports the assumed and ceded assets and liabilities on a gross basis on the consolidated balance sheet. On September 30, 2013, Tower commuted the Syndicate 4444 YOA 2012 and YOA 2011 and prior years’ retrocession agreements with CRL and novated the assumed reinsurance with Canopius Group on these same contracts.
Substantially all of the portfolio valuations at December 31, 2013 classified as Level 1 or Level 2 in the above table is priced by utilizing the services of several independent pricing services that provide the Company with a price quote for each security. There were no adjustments made to the prices obtained from the independent pricing sources and dealers on securities classified as Level 1 or Level 2.
the portfolio managers to understand the underlying factors and inputs and to validate the reasonableness of pricing. Management also back-tests the prices on numerous sales of securities during the year to validate the previous pricing provided as well as utilizes other pricing sources to validate the pricing provided by our primary provider of the majority of the non-U.S. Treasury securities and non-agency securities included in Level 2.
The Company recorded amortization expense related to intangible assets with definite lives of $4.9 million, $8.2 million and $8.9 million in the years ended December 31, 2013, 2012 and 2011, respectively. The estimated amortization expense associated with these intangible assets for each of the next five years is:
In 2013 Tower purchased an Original Insured Market Loss Warranty basis, whereby the Company can recover up to the limit of the contract for its ultimate net loss arising from the windstorm peril in the Northeast in an event where the insured market loss exceeds a specified threshold.
Canopius Bermuda had 14,025,737 outstanding common shares outstanding on March 13, 2013 which were sold by Canopius Group to third-party investors in connection with the Canopius Merger Transaction.
The Board of Directors of Tower approved a $100 million share repurchase program on March 3, 2011. This authorization was in addition to the $100 million share repurchase program approved on February 26, 2010. Purchases under both programs could be made from time to time in the open market or in privately negotiated transactions in accordance with applicable laws and regulations. In the year ended December 31, 2012, 1.2 million shares were purchased under these programs at an aggregate consideration of $21.0 million. The March 3, 2011 and February 26, 2010 share repurchase programs were terminated in March 2013.
Aggregate scheduled maturities of the Company’s borrowings at December 31, 2013 are:
The following table provides an analysis of restricted stock activity for the years ended December 31, 2013, 2012 and 2011 (historical share counts and fair values have been adjusted for the 1.1330 share conversion ratio, as discussed more fully in “Note 3 - Canopius Merger Transaction”):
In preparing its statutory basis financial statements, the Company does not use any prescribed or permitted statutory accounting practices.
CastlePoint Re and TRL are registered as a Class 3 reinsurer under The Insurance Act 1978 (Bermuda), amendments thereto and related regulations (the “Insurance Act”). Under the Insurance Act, CastlePoint Re and TRL are required to prepare Statutory Financial Statements and to file a Statutory Financial Return. The Insurance Act also requires CastlePoint Re and TRL to maintain minimum share capital and surplus, and it has met these requirements as of December 31, 2013.