FORM 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

(Mark One)

  þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: September 30, 2013

OR

 

  ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to

Commission file number: 001-32938

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

(Exact Name of Registrant as Specified in Its Charter)

 

Switzerland   98-0681223
(State or Other Jurisdiction of   (I.R.S. Employer
Incorporation or Organization)   Identification No.)

Lindenstrasse 8

6340 Baar

Zug, Switzerland

(Address of Principal Executive Offices and Zip Code)

41-41-768-1080

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer þ     Accelerated filer ¨

  Non-accelerated filer ¨   Smaller reporting company ¨

(Do not check if a smaller reporting company)                                                       

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ

As of October 14, 2013, 33,761,646 common shares were outstanding.


Table of Contents

TABLE OF CONTENTS

 

PART I

  FINANCIAL INFORMATION   

Item 1.

  Financial Statements      1   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      28   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      63   

Item 4.

  Controls and Procedures      66   

PART II

  OTHER INFORMATION   

Item 1.        

  Legal Proceedings      67   

Item 1A.

  Risk Factors      67   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      67   

Item 3.

  Defaults Upon Senior Securities      68   

Item 4.

  Mine Safety Disclosures      68   

Item 5.

  Other Information      68   

Item 6.

  Exhibits      68   

SIGNATURES

     69   

EXHIBIT INDEX

  

 

-i-


Table of Contents

PART I

FINANCIAL INFORMATION

 

Item 1.       Financial Statements.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

as of September 30, 2013 and December 31, 2012

(Expressed in thousands, except share and per share amounts)

 

     As of
  September 30,  
2013
     As of
  December 31,  
2012
 

ASSETS:

     

Fixed maturity investments trading, at fair value (amortized cost: 2013: $5,996,065; 2012: $6,473,429)

   $ 6,047,883       $ 6,626,454   

Equity securities trading, at fair value (cost: 2013: $679,228; 2012: $480,312)

     708,929         523,949   

Other invested assets

     905,025         783,534   
  

 

 

    

 

 

 

Total investments

     7,661,837         7,933,937   

Cash and cash equivalents

     953,047         681,879   

Restricted cash

     257,517         183,485   

Insurance balances receivable

     740,112         510,532   

Funds held

     375,131         336,368   

Prepaid reinsurance

     327,052         277,406   

Reinsurance recoverable

     1,226,034         1,141,110   

Accrued investment income

     25,471         29,135   

Net deferred acquisition costs

     145,951         108,010   

Goodwill

     268,376         268,376   

Intangible assets

     49,464         51,365   

Balances receivable on sale of investments

     237,031         418,879   

Net deferred tax assets

     41,832         25,580   

Other assets

     68,665         63,884   
  

 

 

    

 

 

 

Total assets

   $ 12,377,520       $ 12,029,946   
  

 

 

    

 

 

 

LIABILITIES:

     

Reserve for losses and loss expenses

   $ 5,780,781       $ 5,645,549   

Unearned premiums

     1,515,746         1,218,021   

Reinsurance balances payable

     193,643         136,264   

Balances due on purchases of investments

     497,974         759,934   

Senior notes

     798,426         798,215   

Dividends payable

     16,952         —   

Accounts payable and accrued liabilities

     130,070         145,628   
  

 

 

    

 

 

 

Total liabilities

   $ 8,933,592       $ 8,703,611   
  

 

 

    

 

 

 

Commitments and contingencies

     

SHAREHOLDERS’ EQUITY:

     

Common shares: 2013: par value CHF 12.30 per share and 2012: par value CHF 12.64 per share (2013: 34,972,795; 2012: 36,369,868 shares issued and 2013: 33,814,920; 2012: 34,797,781 shares outstanding)

     424,837         454,980   

Treasury shares, at cost (2013: 1,157,875; 2012: 1,572,087)

     (85,845)         (113,818)   

Retained earnings

     3,104,936         2,985,173   
  

 

 

    

 

 

 

Total shareholders’ equity

     3,443,928         3,326,335   
  

 

 

    

 

 

 

Total liabilities and shareholders’ equity

   $ 12,377,520       $ 12,029,946   
  

 

 

    

 

 

 

See accompanying notes to the consolidated financial statements.

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

for the three and nine months ended September 30, 2013 and 2012

(Expressed in thousands, except share and per share amounts)

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2013      2012      2013      2012  

REVENUES:

           

Gross premiums written

   $ 580,893       $ 504,420       $ 2,183,174       $ 1,832,219   

Premiums ceded

     (127,816)         (112,883)         (453,823)         (357,019)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net premiums written

     453,077         391,537         1,729,351         1,475,200   

Change in unearned premiums

     57,696         49,480         (248,079)         (202,546)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net premiums earned

     510,773         441,017         1,481,272         1,272,654   

Net investment income

     39,271         39,121         110,294         128,781   

Net realized investment gains (losses)

     27,487         149,813         (8,074)         292,057   
  

 

 

    

 

 

    

 

 

    

 

 

 
     577,531         629,951         1,583,492         1,693,492   
  

 

 

    

 

 

    

 

 

    

 

 

 

EXPENSES:

           

Net losses and loss expenses

     276,970         258,948         807,276         724,530   

Acquisition costs

     65,114         51,086         186,416         149,812   

General and administrative expenses

     88,553         78,572         251,818         222,917   

Amortization of intangible assets

     633         633         1,900         1,900   

Interest expense

     14,094         13,822         42,416         41,579   

Foreign exchange loss (gain)

     4,353         1,023         7,361         (77)   
  

 

 

    

 

 

    

 

 

    

 

 

 
     449,717         404,084         1,297,187         1,140,661   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before income taxes

     127,814         225,867         286,305         552,831   

Income tax expense

     4,971         6,220         6,332         18,677   
  

 

 

    

 

 

    

 

 

    

 

 

 

NET INCOME

     122,843         219,647         279,973         534,154   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other comprehensive loss:

           

Unrealized (losses) gains on investments arising during the period net of applicable deferred income tax benefit (expense) for the three and nine months ended September 30, 2012: $15 and ($81), respectively

     —          (29)         —          150   

Reclassification adjustment for net realized investment gains included in net income, net of applicable income tax

     —          —          —          (13,249)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other comprehensive loss

     —          (29)         —          (13,099)   
  

 

 

    

 

 

    

 

 

    

 

 

 

COMPREHENSIVE INCOME

   $ 122,843       $ 219,618       $ 279,973       $ 521,055   
  

 

 

    

 

 

    

 

 

    

 

 

 

PER SHARE DATA

           

Basic earnings per share

   $ 3.61       $ 6.16       $ 8.15       $ 14.68   

Diluted earnings per share

   $ 3.54       $ 6.00       $ 7.97       $ 14.28   

Weighted average common shares outstanding

         33,991,359             35,652,768             34,340,227             36,379,514   

Weighted average common shares and common share equivalents outstanding

     34,728,193         36,616,734         35,131,092         37,393,093   

Dividends paid per share

   $ 0.500       $ 0.750       $ 0.875       $ 1.500   

 

 

See accompanying notes to the consolidated financial statements.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

for the nine months ended September 30, 2013 and 2012

(Expressed in thousands)

 

                          Accumulated                
            Additional             Other                
     Share      Paid-in      Treasury      Comprehensive      Retained         
     Capital      Capital      Shares      Income      Earnings      Total  

December 31, 2012

   $ 454,980       $ —        $ (113,818)       $ —        $ 2,985,173       $ 3,326,335   

Net income

     —          —          —          —          279,973         279,973   

Dividends — par value reduction

     (12,981)         —          —          —          —          (12,981)   

Dividends

     —          —          —          —          (34,069)         (34,069)   

Stock compensation (1)

     —          —          26,093         —          (18,278)         7,815   

Share repurchases

     —          —          (123,145)         —          —          (123,145)   

Shares cancelled

     (17,162)         —          125,025         —          (107,863)         —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

September 30, 2013

   $       424,837       $ —        $ (85,845)       $ —        $     3,104,936       $     3,443,928   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

   $ 557,153       $         78,225       $     (136,590)       $           14,484       $ 2,635,750       $ 3,149,022   

Net income

     —          —          —          —          534,154         534,154   

Dividends — par value reduction

     (40,419)         —          —          —          —          (40,419)   

Other comprehensive loss

     —          —          —          (13,099)         —          (13,099)   

Stock compensation (1)

     —          (23,050)         36,226         —          —          13,176   

Share repurchases

     —          —          (207,048)         —          —          (207,048)   

Shares cancelled

     (39,488)         (55,175)         186,468         —          (91,805)         —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

September 30, 2012

   $ 477,246       $ —        $ (120,944)       $ 1,385       $ 3,078,099       $ 3,435,786   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)   Includes stock compensation expense for the period and shares issued out of treasury for awards exercised or vested.

 

See accompanying notes to the consolidated financial statements.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

for the nine months ended September 30, 2013 and 2012

(Expressed in thousands)

 

     Nine Months Ended
September 30,
 
     2013      2012  

CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:

     

Net income

   $ 279,973       $ 534,154   

Adjustments to reconcile net income to cash provided by operating activities:

     

Net realized gains on sales of investments

     (76,104)         (63,625)   

Mark to market adjustments

     80,136         (225,425)   

Stock compensation expense

     9,282         13,118   

Undistributed income of equity method investments

     (4,313)         —   

Changes in:

     

Reserve for losses and loss expenses, net of reinsurance recoverables

     50,308         151,041   

Unearned premiums, net of prepaid reinsurance

     248,079         202,545   

Insurance balances receivable

     (229,580)         (121,422)   

Funds held

     (38,763)         18,602   

Reinsurance balances payable

     57,379         (4,107)   

Net deferred acquisition costs

     (37,941)         (27,193)   

Net deferred tax assets

     (16,252)         1,850   

Accounts payable and accrued liabilities

     (18,540)         (2,996)   

Other items, net

     34,508         23,677   
  

 

 

    

 

 

 

Net cash provided by operating activities

     338,172         500,219   
  

 

 

    

 

 

 

CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:

     

Purchases of trading securities

         (4,955,817)             (6,328,719)   

Purchases of other invested assets

     (211,501)         (52,578)   

Sales of available for sale securities

     —         215,318   

Sales of trading securities

     5,137,280         5,778,138   

Sales of other invested assets

     189,155         110,429   

Purchases of fixed assets

     (4,171)         (2,041)   

Change in restricted cash

     (74,032)         35,685   
  

 

 

    

 

 

 

Net cash provided by (used in) investing activities

     80,914         (243,768)   
  

 

 

    

 

 

 

CASH FLOWS USED IN FINANCING ACTIVITIES:

     

Dividends paid - partial par value reduction

     (12,981)         (54,721)   

Dividends paid

     (17,117)         —   

Proceeds from the exercise of stock options

     8,465         9,104   

Share repurchases

     (120,163)         (204,746)   
  

 

 

    

 

 

 

Net cash used in financing activities

     (141,796)         (250,363)   
  

 

 

    

 

 

 

Effect of exchange rate changes on foreign currency cash

     (6,122)         (567)   

NET INCREASE IN CASH AND CASH EQUIVALENTS

     271,168         5,521   

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     681,879         633,996   
  

 

 

    

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 953,047       $ 639,517   
  

 

 

    

 

 

 

Supplemental disclosure of cash flow information:

     

Cash paid for income taxes

   $ 17,249       $ 18,912   

Cash paid for interest expense

   $ 45,750       $ 45,750   

See accompanying notes to the consolidated financial statements.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

1. GENERAL

Allied World Assurance Company Holdings, AG, a Swiss holding company (“Allied World Switzerland”), through its wholly-owned subsidiaries (collectively, the “Company”), provides property and casualty insurance and reinsurance on a worldwide basis through operations in Bermuda, the United States, Europe, Hong Kong and Singapore. References to $ are to the lawful currency of the United States and to CHF are to the lawful currency of Switzerland.

2. BASIS OF PREPARATION AND CONSOLIDATION

These unaudited condensed consolidated financial statements include the accounts of the Company and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with Article 10 of Regulation S-X as promulgated by the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments that are normal and recurring in nature and necessary for a fair presentation of financial position and results of operations as of the end of and for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for a full year.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The significant estimates reflected in the Company’s financial statements include, but are not limited to:

 

  The premium estimates for certain reinsurance agreements,

 

  Recoverability of deferred acquisition costs,

 

  The reserve for outstanding losses and loss expenses,

 

  Valuation of ceded reinsurance recoverables,

 

  Determination of impairment of goodwill and other intangible assets, and

 

  Valuation of financial instruments.

Intercompany accounts and transactions have been eliminated on consolidation and all entities meeting consolidation requirements have been included in the unaudited condensed consolidated financial statements. To facilitate comparison of information across periods, certain reclassifications have been made to prior year amounts to conform to the current year’s presentation.

These unaudited condensed consolidated financial statements, including these notes, should be read in conjunction with the Company’s audited consolidated financial statements, and related notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

3. NEW ACCOUNTING PRONOUNCEMENTS

In December 2011 (with a clarification amendment issued in January 2013), the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2011-11, “Disclosures about Offsetting Assets and Liabilities” (“ASU 2011-11”). The objective of ASU 2011-11 was to enhance disclosures about derivatives, repurchase agreements and reverse repurchase agreements, securities borrowing and securities lending transactions to the extent they are subject to master netting arrangements or similar agreements. The Company adopted ASU 2011-11 on January 1, 2013. The adoption of ASU 2011-11 did not have an impact on the presentation of the financial statements.

In July 2013, the FASB issued Accounting Standards Update 2013-10, “Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes” (“ASU 2013-10”). Prior to the issuance of ASU 2013-10, only interest rates on U.S. Treasury securities and the London Interbank Offered Rate (“LIBOR”) swap rate were considered benchmark interest rates in the application of hedge accounting under U.S. GAAP. ASU 2013-10 permits the Fed Funds Effective Swap Rate to be used as a U.S. benchmark interest rate for hedge accounting purposes in addition to U.S. Treasury securities and LIBOR. ASU 2013-10 was effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. ASU 2013-10 did not have any impact on the financial statements upon adoption, as the Company does not apply hedge accounting.

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

4. INVESTMENTS

a) Trading Securities

Securities accounted for at fair value with changes in fair value recognized in the unaudited condensed consolidated statements of operations and comprehensive income (“consolidated income statements”) by category are as follows:

 

                                                                                           
    September 30, 2013     December 31, 2012  
    Fair Value     Amortized Cost     Fair Value     Amortized Cost  

U.S. Government and Government agencies

  $ 1,850,335      $ 1,851,002      $ 1,865,913      $ 1,854,198   

Non-U.S. Government and Government agencies

    209,625        214,114        261,627        253,657   

States, municipalities and political subdivisions

    95,381        95,661        40,444        39,342   

Corporate debt:

       

Financial institutions

    841,930        826,763        866,140        835,587   

Industrials

    1,146,793        1,140,636        1,153,909        1,139,706   

Utilities

    74,764        74,865        69,153        67,463   

Mortgage-backed

    1,373,161        1,341,303        1,958,373        1,877,854   

Asset-backed

    455,894        451,721        410,895        405,622   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturity investments

  $ 6,047,883      $ 5,996,065      $ 6,626,454      $ 6,473,429   
 

 

 

   

 

 

   

 

 

   

 

 

 
    September 30, 2013     December 31, 2012  
    Fair Value     Original Cost     Fair Value     Original Cost  

Equity securities

  $ 708,929      $ 679,228      $ 523,949      $ 480,312   

Other invested assets

    767,071        680,986        655,888        606,521   
 

 

 

   

 

 

   

 

 

   

 

 

 
  $ 1,476,000      $ 1,360,214      $ 1,179,837      $ 1,086,833   
 

 

 

   

 

 

   

 

 

   

 

 

 

Other invested assets, included in the table above, include investments in private equity funds, hedge funds and a high yield loan fund that are accounted for at fair value, but excludes other private securities described below in Note 4(b) that are accounted for using the equity method of accounting.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

 

b) Other Invested Assets

Details regarding the carrying value, redemption characteristics and unfunded investment commitments of the other invested assets portfolio as of September 30, 2013 were as follows:

     Carrying      Investments      Estimated    Investments                       
     Value as of      with      Remaining    without             Redemption         
     September 30,      Redemption      Restriction    Redemption      Redemption      Notice      Unfunded  

Fund Type

   2013      Restrictions      Period    Restrictions(1)      Frequency(1)      Period(1)      Commitments  

Private equity

   $ 131,449       $ 131,449       3 - 10 Years    $ —             $ 252,571   

Mezzanine debt

     58,116         58,116       8 - 10 Years      —               203,969   

Distressed

     8,991         8,991       4 - 5 Years      —               5,102   
  

 

 

    

 

 

       

 

 

          

 

 

 

Total private equity structures

     198,556         198,556            —               461,642   
  

 

 

    

 

 

       

 

 

          

 

 

 

Distressed

     150,775         134,127       1 - 2 Years      16,648         Quarterly         45 - 65 Days         —   

Equity long/short

     116,019         —            116,019         Quarterly         30 - 60 Days         —   

Multi-strategy

     131,224         —            131,224         Quarterly         45 - 90 Days         —   

Global macro

     19,641         —            19,641         Monthly         3 Days         —   

Event driven

     18,445         —            18,445         Annual         60 Days         —   

Relative value credit

     101,311         —            101,311         Quarterly         60 Days         —   
  

 

 

    

 

 

       

 

 

          

 

 

 

Total hedge funds

     537,415         134,127            403,288               —   
  

 

 

    

 

 

       

 

 

          

 

 

 

Other private securities

     137,954         —            137,954               5,000   

High yield loan fund

     31,100         —            31,100         Monthly         30 Days         —   
  

 

 

    

 

 

       

 

 

          

 

 

 

Total other invested assets

   $ 905,025       $ 332,683          $ 572,342             $ 466,642   
  

 

 

    

 

 

       

 

 

          

 

 

 

 

(1) The redemption frequency and notice periods only apply to the investments without redemption restrictions. Some or all of these investments may be subject to a gate.

In general, the Company has invested in hedge funds that require at least 30 days’ notice of redemption and may be redeemed on a monthly, quarterly, semi-annual, annual or longer basis, depending on the fund. Certain hedge funds have lock-up periods ranging from one to three years from initial investment. A lock-up period refers to the initial amount of time an investor is contractually required to invest before having the ability to redeem. Funds that provide for periodic redemptions may, depending on the funds’ governing documents, have the ability to deny or delay a redemption request, called a “gate.” The fund may implement this restriction because the aggregate amount of redemption requests as of a particular date exceeds a specified level, generally ranging from 15% to 25% of the fund’s net assets. The gate is a method for executing an orderly redemption process to reduce the possibility of adversely affecting investors in the fund. Typically, the imposition of a gate delays a portion of the requested redemption, with the remaining portion settled in cash sometime after the redemption date. Certain funds may impose a redemption fee on early redemptions. Interests in private equity funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

The following describes each investment type:

 

  Private equity funds: Primary funds may invest in companies and general partnership interests. Secondary funds buy limited partnership interests from existing limited partners of primary private equity funds. As owners of private equity funds seek liquidity, they can sell their existing investments, plus any remaining commitment, to secondary market participants. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

 

  Mezzanine debt funds: Mezzanine debt funds primarily focus on providing capital to upper middle market and middle market companies and private equity sponsors, in connection with leveraged buyouts, mergers and acquisitions, recapitalizations, growth financings and other corporate transactions. The most common position in the capital structure will be between the senior secured debt holder and the equity; however, the funds will utilize a flexible approach when structuring investments, which may include secured debt, subordinated debt, preferred stock and/or private equity. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

 

  Distressed funds: In distressed debt investing, managers take positions in the debt of companies experiencing significant financial difficulties, including bankruptcy, or in certain positions of the capital structure of structured securities. The manager relies on the fundamental analysis of these securities, including the claims on the assets and the likely return to bondholders. Certain funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

 

  Equity long/short funds: In equity long/short funds, managers take long positions in companies they deem to be undervalued and short positions in companies they deem to be overvalued. Long/short managers may invest in countries, regions or sectors and vary by their use of leverage and by their targeted net long position.

 

  Multi-strategy funds: These funds may utilize many strategies employed by specialized funds including distressed investing, equity long/short, merger arbitrage, convertible arbitrage, fixed income arbitrage and macro trading.

 

  Global macro funds: These funds focus on a top-down analysis of global markets as influenced by major political and economic trends or events. Global macro managers develop investment strategies that aim to forecast movements in interest rates, fund flows, political changes and other wide-ranging systematic factors. The portfolios of these funds can include long or short positions in equities, fixed-income securities, currencies and commodities in the form of cash or derivatives instruments.

 

  Event driven funds: Event driven strategies seek to deploy capital into specific securities whose returns are affected by a specific event that affects the value of one or more securities of a company. Returns for such securities are linked primarily to the specific outcome of the events and not by the overall direction of the bond or stock markets. Examples could include mergers and acquisitions (arbitrage), corporate restructurings and spin-offs, and capital structure arbitrage.

 

  Relative value credit funds: These funds seek to take exposure to credit-sensitive securities, long and/or short, based upon credit analysis of issuers and securities and credit market views.

 

  Other private securities: These securities include strategic non-controlling minority investments in private asset management companies and other insurance related investments that are accounted for using the equity method of accounting.

 

  High yield loan fund: A long-only private mutual fund that invests in high yield fixed income securities.

c) Net Investment Income

                                                                                   
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2013     2012     2013     2012  

Fixed maturity investments

  $ 31,179      $ 36,778      $ 96,366      $ 120,883   

Equity securities

    6,110        5,211        13,718        13,706   

Other invested assets

    5,809        164        11,116        4,387   

Cash and cash equivalents

    302        640        1,319        1,797   

Expenses

    (4,129)        (3,672)        (12,225)        (11,992)   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income

  $ 39,271      $ 39,121      $ 110,294      $ 128,781   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income from other invested assets included the distributed and undistributed net income from investments accounted for using the equity method of accounting for the three and nine months ended September 30, 2013.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

d) Components of Realized Gains and Losses

                                                                                           
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2013     2012     2013     2012  

Gross realized gains on sale of invested assets

  $ 51,915      $ 27,210      $ 154,387      $ 119,154   

Gross realized losses on sale of invested assets

    (40,770)        (6,686)        (82,812)        (43,355)   

Net realized and unrealized (losses) gains on derivatives

    (4,169)        (962)        3,392        (192)   

Mark-to-market gains (losses):

       

Fixed maturity investments, trading

    30,383        99,821        (101,205)        144,024   

Equity securities, trading

    (17,198)        18,913        (18,555)        38,516   

Other invested assets, trading

    7,326        11,517        36,719        33,910   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net realized investment gains (losses)

  $ 27,487      $ 149,813      $ (8,074)      $ 292,057   
 

 

 

   

 

 

   

 

 

   

 

 

 

Proceeds from sale of available for sale securities

  $ —      $ 1,000      $ —      $ 214,716   

e) Pledged Assets

As of September 30, 2013 and December 31, 2012, $ 2,556,660 and $2,141,249, respectively, of cash and cash equivalents and investments were deposited, pledged or held in trust accounts in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions, insurance laws and other contract provisions.

In addition, as of September 30, 2013 and December 31, 2012, a further $ 1,063,086 and $1,225,155, respectively, of cash and cash equivalents and investments were pledged as collateral for the Company’s letter of credit facilities. See Note 8(d) to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 for details on the Company’s credit facilities.

5. DERIVATIVE INSTRUMENTS

As of September 30, 2013 and December 31, 2012, none of the Company’s derivatives were designated as hedges for accounting purposes. The following table summarizes information on the location and amounts of derivative fair values on the unaudited condensed consolidated balance sheets (“consolidated balance sheets”):

 

                                                                                                                       
    September 30, 2013     December 31, 2012  
    Asset           Liability           Asset           Liability        
     Derivative      Asset      Derivative      Liability      Derivative      Asset      Derivative      Liability  
    Notional      Derivative      Notional      Derivative      Notional      Derivative      Notional     Derivative  
    Amount      Fair Value      Amount     Fair Value     Amount     Fair Value     Amount      Fair Value   

Put options

  $ —       $ —       $ —       $ —       $ 5,152      $ 532      $ —       $ —    

Foreign exchange contracts

    197,811        2,493        279,050        7,062        127,712        1,713        194,566        2,656   

Interest rate swaps

    33,000        5        327,000        172        —         —         —         —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivatives

  $ 230,811      $ 2,498      $ 606,050      $ 7,234      $ 132,864      $ 2,245      $ 194,566      $ 2,656   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Derivative assets and derivative liabilities relating to the put options are classified within “equity securities trading, at fair value” on the consolidated balance sheets. All other asset and liability derivatives are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

The following table provides the net realized and unrealized gains (losses) on derivatives not designated as hedges recorded on the consolidated income statements:

                                                                                   
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2013     2012     2013     2012  

Foreign exchange contracts

  $ (2,336)      $ (676)      $ (1,091)      $ (96)   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total included in foreign exchange (loss) gain

    (2,336)        (676)        (1,091)        (96)   
 

 

 

   

 

 

   

 

 

   

 

 

 

Put options

    —         —         (3,822)        (336)   

Foreign exchange contracts

    (4,164)        (2,751)        1,925        (641)   

Interest rate futures and swaps

    (5)        1,789        5,289        785   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total included in net realized investment gains

    (4,169)        (962)        3,392        (192)   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total realized and unrealized (losses) gains on derivatives

  $ (6,505)      $ (1,638)      $ 2,301      $ (288)   
 

 

 

   

 

 

   

 

 

   

 

 

 

Derivative Instruments Not Designated as Hedging Instruments

The Company is exposed to foreign currency risk in its investment portfolio. Accordingly, the fair values of the Company’s investment portfolio are partially influenced by the change in foreign exchange rates. These foreign currency hedging activities have not been designated as specific hedges for financial reporting purposes.

The Company’s insurance and reinsurance subsidiaries and branches operate in various foreign countries and consequently the Company’s underwriting portfolio is exposed to foreign currency risk. The Company manages foreign currency risk by seeking to match liabilities under the insurance policies and reinsurance contracts that it writes and that are payable in foreign currencies with cash and investments that are denominated in such currencies. When necessary, the Company may also use derivatives to economically hedge un-matched foreign currency exposures, specifically forward contracts and currency options.

The Company also purchases and sells interest rate future and interest rate swap contracts to actively manage the duration and yield curve positioning of its fixed income portfolio. Interest rate futures and interest rate swaps can efficiently increase or decrease the overall duration of the portfolio. Additionally, interest rate future and interest rate swap contracts can be utilized to obtain the desired position along the yield curve in order to protect against certain future yield curve shapes.

The Company also purchases options to actively manage the Company’s equity portfolio.

6. FAIR VALUE OF FINANCIAL INSTRUMENTS

In accordance with U.S. GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. There is a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement date, with quoted market prices being the highest level (Level 1) and unobservable inputs being the lowest level (Level 3). A fair value measurement will fall within the level of the hierarchy based on the input that is significant to determining such measurement. The three levels are defined as follows:

 

  Level 1: Observable inputs to the valuation methodology that are quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

  Level 2: Observable inputs to the valuation methodology other than quoted market prices (unadjusted) for identical assets or liabilities in active markets. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical assets in markets that are not active and inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.

 

  Level 3: Inputs to the valuation methodology that are unobservable for the asset or liability.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

The following table shows the fair value of the Company’s financial instruments and where in the fair value hierarchy the fair value measurements are included as of the dates indicated below:

 

     Carrying      Total                       

September 30, 2013

   Amount      Fair Value      Level 1      Level 2      Level 3  

Fixed maturity investments:

              

U.S. Government and Government agencies

   $ 1,850,335       $ 1,850,335       $ 1,522,185       $ 328,150       $ —    

Non-U.S. Government and Government agencies

     209,625         209,625         —          209,625         —    

States, municipalities and political subdivisions

     95,381         95,381         —          95,381         —    

Corporate debt

     2,063,487         2,063,487         —          2,063,487         —    

Mortgage-backed

     1,373,161         1,373,161         —          1,183,907         189,254   

Asset-backed

     455,894         455,894         —          375,861         80,033   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturity investments

     6,047,883         6,047,883         1,522,185         4,256,411         269,287   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities

     708,929         708,929         641,458         —          67,471   

Other invested assets

     767,071         767,071         —          —          767,071   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $     7,523,883       $     7,523,883       $     2,163,643       $     4,256,411       $     1,103,829   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Derivative assets:

              

Foreign exchange contracts

   $ 2,493       $ 2,493       $ —        $ 2,493       $ —    

Interest rate futures

     5         5         —          5         —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Derivative liabilities:

              

Foreign exchange contracts

   $ 7,062       $ 7,062       $ —        $ 7,062       $ —    

Interest rate swaps

     172         172         —          172         —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Senior notes

   $ 798,426       $ 904,010       $ —        $ 904,010       $ —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Carrying      Total                       

December 31, 2012

   Amount      Fair Value      Level 1      Level 2      Level 3  

Fixed maturity investments:

              

U.S. Government and Government agencies

   $ 1,865,913       $ 1,865,913       $ 1,529,158       $ 336,755       $ —    

Non-U.S. Government and Government agencies

     261,627         261,627         —          261,627         —    

States, municipalities and political subdivisions

     40,444         40,444         —          40,444         —    

Corporate debt

     2,089,202         2,089,202         —          2,089,202         —    

Mortgage-backed

     1,958,373         1,958,373         —          1,790,548         167,825   

Asset-backed

     410,895         410,895         —          348,649         62,246   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturity investments

     6,626,454         6,626,454         1,529,158         4,867,225         230,071   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities

     523,949         523,949         469,269         —          54,680   

Other invested assets

     655,888         655,888         —          —          655,888   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 7,806,291       $ 7,806,291       $ 1,998,427       $ 4,867,225       $ 940,639   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Derivative assets:

              

Foreign exchange contracts

   $ 1,713       $ 1,713       $ —        $ 1,713       $ —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Derivative liabilities:

              

Foreign exchange contracts

   $ 2,656       $ 2,656       $ —        $ 2,656       $ —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Senior notes

   $ 798,215       $ 918,627       $ —        $ 918,627       $ —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

“Other invested assets” excluded other private securities that the Company did not measure at fair value, but are accounted for using the equity method of accounting. Derivative assets and derivative liabilities relating to foreign exchange contracts and interest rate swaps are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

The following describes the valuation techniques used by the Company to determine the fair value of financial instruments held as of the balance sheet date.

U.S. Government and Government agencies: Comprised primarily of bonds issued by the U.S. Treasury, the Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association. The fair values of the Company’s U.S. government securities are based on quoted market prices in active markets and are included in the Level 1 fair value hierarchy. The Company believes the market for U.S. Treasury securities is an actively traded market given the high level of daily trading volume. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are included in the Level 2 fair value hierarchy.

Non-U.S. Government and Government agencies: Comprised of fixed income obligations of non-U.S. governmental entities. The fair values of these securities are based on prices obtained from international indices and are included in the Level 2 fair value hierarchy.

States, municipalities and political subdivisions: Comprised of fixed income obligations of U.S. domiciled state and municipality entities. The fair values of these securities are based on prices obtained from the new issue market, and are included in the Level 2 fair value hierarchy.

Corporate debt: Comprised of bonds issued by or loan obligations of corporations that are diversified across a wide range of issuers and industries. The fair values of corporate debt that are short-term are priced using spread above the LIBOR yield curve, and the fair values of corporate debt that are long-term are priced using the spread above the risk-free yield curve. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price corporate bonds are observable market inputs, the fair values of corporate debt are included in the Level 2 fair value hierarchy.

Mortgage-backed: Primarily comprised of residential and commercial mortgages originated by both U.S. government agencies (such as the Federal National Mortgage Association) and non-U.S. government agencies. The fair values of mortgage-backed securities originated by U.S. government agencies and non-U.S. government agencies are based on a pricing model that incorporates prepayment speeds and spreads to determine appropriate average life of mortgage-backed securities. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the mortgage-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the mortgage-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

Asset-backed: Principally comprised of bonds backed by pools of automobile loan receivables, home equity loans, credit card receivables and collateralized loan obligations originated by a variety of financial institutions. The fair values of asset-backed securities are priced using prepayment speed and spread inputs that are sourced from the new issue market or broker-dealer quotes. As the significant inputs used to price the asset-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the asset-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

Equity securities: Comprised of common and preferred stocks and mutual funds. Equities are generally included in the Level 1 fair value hierarchy as prices are obtained from market exchanges in active markets. Non-U.S. mutual funds where the net asset value is not provided on a daily basis are included in the Level 3 fair value hierarchy.

Other invested assets: Comprised of funds invested in a range of diversified strategies. In accordance with U.S. GAAP, the fair values of the funds are based on the net asset value of the funds as reported by the fund manager that the Company believes is an unobservable input, and as such, the fair values of those funds are included in the Level 3 fair value hierarchy.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

Derivative instruments: The fair value of foreign exchange contracts, interest rate futures and interest rate swaps are priced from quoted market prices for similar exchange-traded derivatives and pricing valuation models that utilize independent market data inputs. The fair value of derivatives are included in the Level 2 fair value hierarchy.

Senior notes: The fair value of the senior notes is based on reported trades. The fair value of the senior notes is included in the Level 2 fair value hierarchy.

The Company measures the fair value of certain assets on a non-recurring basis, generally quarterly, annually or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. These assets include investments accounted for using the equity method, goodwill and intangible assets. The Company uses a variety of techniques to measure the fair value of these assets when appropriate, as described below:

Investments accounted for using the equity method: When the Company determines that the carrying value of these assets may not be recoverable, the Company records the assets at fair value with the loss recognized in income. In such cases, the Company measures the fair value of these assets using discounted cash flow models.

Goodwill and intangible assets: The Company tests goodwill and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable, but at least annually for goodwill and indefinite-lived intangibles. If the Company determines that goodwill and intangible assets may be impaired, the Company uses techniques, including discounted expected future cash flows and market multiple models, to measure fair value.

The following is a reconciliation of the beginning and ending balance of financial instruments using significant unobservable inputs (Level 3):

 

     Other invested
assets
     Mortgage-backed      Asset-backed      Equities  
Three Months Ended September 30, 2013                            

Opening balance

   $ 714,391       $ 198,003       $ 61,285       $ 53,499   

Realized and unrealized gains (losses) included in net income

     9,403         464         (313)         3,972   

Purchases

     67,554         69,775         16,969         10,000   

Sales

     (24,277)         (79,001)         (1,302)         —    

Transfers into Level 3 from Level 2

     —          13         3,394         —    

Transfers out of Level 3 into Level 2 (1)

     —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance

   $ 767,071       $ 189,254       $ 80,033       $           67,471   
  

 

 

    

 

 

    

 

 

    

 

 

 
Three Months Ended September 30, 2012                            

Opening balance

   $         520,890       $         157,959       $         117,586       $ —    

Realized and unrealized gains included in net income

     11,871         4,855         988         —    

Purchases

     34,800         40,481         7,466         —    

Sales

     (2,859)         (48,728)         (7,326)         —    

Transfers into Level 3 from Level 2

     —          14,730         12,495         —    

Transfers out of Level 3 into Level 2 (1)

     —          (27)         (55,442)         —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance

   $ 564,702       $ 169,270       $ 75,767       $ —    
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

 

                                                                                   
     Other invested
assets
     Mortgage-backed      Asset-backed      Equities  
Nine Months Ended September 30, 2013                            

Opening balance

   $ 655,888       $ 167,825       $ 62,246       $ 54,680   

Realized and unrealized gains (losses) included in net income

     53,365         (5,910)         (791)         2,791   

Purchases

     237,506         102,369         42,956         10,000   

Sales

     (179,688)         (69,968)         (26,728)         —    

Transfers into Level 3 from Level 2

     —          5,073         2,350         —    

Transfers out of Level 3 into Level 2 (1)

     —          (10,135)         —          —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance

   $ 767,071       $ 189,254       $ 80,033       $ 67,471   
  

 

 

    

 

 

    

 

 

    

 

 

 
Nine Months Ended September 30, 2012                            

Opening balance

   $ 540,409       $ 249,204       $ 94,745       $ —    

Realized and unrealized gains included in net income

     26,753         10,951         1,643         —    

Purchases

     52,578         50,302         32,573         —    

Sales

     (55,038)         (124,940)         (57,325)         —    

Transfers into Level 3 from Level 2

     —          18,461         15,835         —    

Transfers out of Level 3 into Level 2 (1)

     —          (34,708)         (11,704)         —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance

   $ 564,702       $ 169,270       $ 75,767       $ —    
  

 

 

    

 

 

    

 

 

    

 

 

 

 

 

(1)   Transfers out of Level 3 are primarily attributable to the availability of market observable information.

The Company attempts to verify the significant inputs used by broker-dealers in determining the fair value of the securities priced by them. If the Company could not obtain sufficient information to determine if the broker-dealers were using significant observable inputs, then such securities have been transferred to the Level 3 fair value hierarchy. The Company believes the prices obtained from the broker-dealers are the best estimate of fair value of the securities being priced as the broker-dealers are typically involved in the initial pricing of the security, and the Company has compared the price per the broker-dealer to other pricing sources and noted no material differences. The Company recognizes transfers between levels at the end of the reporting period. There were no transfers between Level 1 and Level 2 during the period.

The Company’s external investment accounting service provider receives prices from internationally recognized independent pricing services to measure the fair values of its fixed maturity investments. Pricing sources are evaluated and selected in a manner to ensure that the most reliable sources are used. The Company uses a pricing service ranking to consistently select the most appropriate pricing service in instances where it receives multiple quotes on the same security. The Company obtains multiple quotes for the majority of its securities. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. Each pricing service has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing service uses observable market inputs, including, but not limited to, reported trades, benchmark yields, broker-dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value.

All of the Company’s securities classified as Level 3, other than investments in other invested assets, are valued based on unadjusted broker-dealer quotes. This includes less liquid securities such as lower quality asset-backed securities, commercial mortgage-backed securities and residential mortgage-backed securities. The primary valuation inputs include monthly payment information, the probability of default, loss severity rates and estimated prepayment rates. Significant changes in these inputs in isolation would result in a significantly lower or higher fair value measurement. In general, a change in the assumption of the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity in an event of default and prepayment rates.

The Company records the unadjusted price provided and validates this price through a process that includes, but is not limited to, monthly and/or quarterly: (i) comparison of prices between two independent sources, with significant differences requiring additional price sources; (ii) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to their target benchmark, with

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

significant differences identified and investigated); (iii) evaluation of methodologies used by external parties to calculate fair value, including a review of the inputs used for pricing; (iv) comparing the price to the Company’s knowledge of the current investment market; and (v) back-testing, which includes randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates from the pricing service. In addition to internal controls, management relies on the effectiveness of the valuation controls in place at the Company’s external investment accounting service provider (supported by a Statement on Standards for Attestation Engagements No. 16 report) in conjunction with regular discussion and analysis of the investment portfolio’s structure and performance.

7. RESERVE FOR LOSSES AND LOSS EXPENSES

The reserve for losses and loss expenses consists of the following:

 

                                                 
     September 30,      December 31,  
     2013      2012  

Outstanding loss reserves

   $ 1,517,049       $ 1,539,114   

Reserves for losses incurred but not reported

     4,263,732         4,106,435   
  

 

 

    

 

 

 

Reserve for losses and loss expenses

   $ 5,780,781       $ 5,645,549   
  

 

 

    

 

 

 

The table below is a reconciliation of the beginning and ending liability for unpaid losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables.

 

                                                                                           
     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2013      2012      2013      2012  

Gross liability at beginning of period

   $ 5,696,865       $ 5,377,518       $ 5,645,549       $ 5,225,143   

Reinsurance recoverable at beginning of period

     (1,179,525)         (1,073,612)         (1,141,110)         (1,002,919)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net liability at beginning of period

     4,517,340         4,303,906         4,504,439         4,222,224   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net losses incurred related to:

           

Current year

     338,420         315,102         961,224         862,088   

Prior years

     (61,450)         (56,154)         (153,948)         (137,558)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total incurred

     276,970         258,948         807,276         724,530   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net paid losses related to:

           

Current year

     30,399         16,323         54,983         36,163   

Prior years

     213,252         179,666         696,137         542,077   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total paid

     243,651         195,989         751,120         578,240   
  

 

 

    

 

 

    

 

 

    

 

 

 

Foreign exchange revaluation

     4,088         6,400         (5,848)         4,751   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net liability at end of period

     4,554,747         4,373,265         4,554,747         4,373,265   

Reinsurance recoverable at end of period

     1,226,034         1,077,522         1,226,034         1,077,522   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross liability at end of period

   $ 5,780,781       $ 5,450,787       $ 5,780,781       $ 5,450,787   
  

 

 

    

 

 

    

 

 

    

 

 

 

For the three months ended September 30, 2013, the Company had net favorable reserve development in its international insurance and reinsurance segments due to actual loss emergence being lower than initially expected. The majority of the net favorable reserve development was recognized in the 2007 through 2011 loss years across most lines of business. In addition, the reinsurance segment recognized net favorable reserve development for the 2012 loss year due to the low level of reported property losses. This was partially offset by adverse development in the U.S. insurance segment in the 2011 and 2012 loss years primarily caused by adverse development on reported claims for certain healthcare, errors and omissions and private/not for profit directors’ and officers’.

For the nine months ended September 30, 2013, the Company had net favorable reserve development in its international insurance and reinsurance segments due to actual loss emergence being lower than initially expected, for most loss years. The reinsurance segment recognized net favorable reserve development for the 2012 loss year due to the low level of reported property losses. This was partially offset by adverse development in the U.S. insurance segment in the 2011 and 2012 loss years for certain healthcare, errors and omissions and not-for-profit director’s and officers’ classes of business.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

For the three months ended September 30, 2012, the Company had net favorable reserve development in each of its segments due to actual loss emergence being lower than initially expected. The majority of the net favorable reserve development was recognized by each segment in the 2004 through 2008 loss years. The Company had net unfavorable reserve development in its U.S. insurance segment in the 2010 and 2011 loss years, primarily due to higher than expected losses on a terminated program, and in its international insurance segment in the 2011 loss year, primarily due to an individual full-limit general casualty claim.

For the nine months ended September 30, 2012, the Company had net favorable reserve development in each of its segments due to actual loss emergence being lower than initially expected. The majority of the net favorable reserve development was recognized in the international insurance and reinsurance segments in the 2004 through 2008 loss years.

While the Company has experienced favorable reserve development in its insurance and reinsurance lines, there is no assurance that conditions and trends that have affected the development of liabilities in the past will continue. It is not appropriate to extrapolate future redundancies based on prior years’ development. The methodology of estimating loss reserves is periodically reviewed to ensure that the key assumptions used in the actuarial models continue to be appropriate.

8. INCOME TAXES

Under Swiss law, a resident company is subject to income tax at the federal, cantonal and communal levels that is levied on net income. Income attributable to permanent establishments or real estate located abroad is excluded from the Swiss tax base. Allied World Switzerland is a holding company and, therefore, is exempt from cantonal and communal income tax. As a result, Allied World Switzerland is subject to Swiss income tax only at the federal level. Allied World Switzerland is a resident of the Canton of Zug and, as such, is subject to an annual cantonal and communal capital tax on the taxable equity of Allied World Switzerland. Allied World Switzerland has a Swiss operating company resident in the Canton of Zug. The operating company is subject to federal, cantonal and communal income tax and to annual cantonal and communal capital tax.

Under current Bermuda law, Allied World Assurance Company Holdings, Ltd (“Allied World Bermuda”) and its Bermuda subsidiaries are not required to pay taxes in Bermuda on either income or capital gains. Allied World Bermuda and Allied World Assurance Company, Ltd have received an assurance from the Bermuda Minister of Finance under the Exempted Undertakings Tax Protection Act 1966 of Bermuda, that in the event of any such taxes being imposed, Allied World Bermuda and Allied World Assurance Company, Ltd will be exempted until March 2035.

Certain subsidiaries of Allied World Switzerland file U.S. federal income tax returns and various U.S. state income tax returns, as well as income tax returns in the United Kingdom, Ireland, Switzerland, Hong Kong and Singapore. To the best of the Company’s knowledge, there are no income tax examinations pending by any tax authority.

Management has deemed all material tax positions to have a greater than 50% likelihood of being sustained based on technical merits if challenged. The Company does not expect any material unrecognized tax benefits within 12 months of September 30, 2013.

9. SHAREHOLDERS’ EQUITY

a) Authorized shares

The issued share capital consists of the following:

 

                                                 
     September 30,      December 31,  
     2013      2012  

Common shares issued and fully paid, 2013: CHF 12.30 per share; 2012: CHF 12.64 per share

     34,972,795         36,369,868   
  

 

 

    

 

 

 

Share capital at end of period

   $ 424,837       $ 454,980   
  

 

 

    

 

 

 

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

 

     Nine Months  
     Ended  
     September 30,  
     2013  

Shares issued at beginning of period

     36,369,868   

Shares cancelled

     (1,397,073)   
  

 

 

 

Total shares issued at end of period

     34,972,795   
  

 

 

 

Treasury shares issued at beginning of period

     1,572,087   

Shares repurchased

     1,367,833   

Shares issued out of treasury

     (384,972)   

Shares cancelled

     (1,397,073)   
  

 

 

 

Total treasury shares at end of period

     1,157,875   
  

 

 

 

Total shares outstanding at end of period

           33,814,920   
  

 

 

 

During the nine months ended September 30, 2013, 1,367,833 voting shares repurchased and designated for cancellation were constructively retired and cancelled.

Effective July 9, 2013, the Company cancelled 29,240 non-voting shares held in treasury and 1,538,686 shares previously repurchased and constructively retired, following a required filing with the Swiss Commercial Register in Zug.

Allied World Switzerland’s articles of association authorized its Board of Directors to increase the share capital by a maximum of up to CHF 92,259 or 7,500,728 voting shares.

b) Dividends

The Company paid the following dividends during the nine months ended September 30, 2013:

 

     Partial                
     Par Value      Dividend      Total  
     Reduction      Per      Amount  
Dividend Paid    Per Share      Share      Paid  

March 12, 2013

       CHF             0.34         $             0.375       $             12,981   

July 3, 2013

     -         -       $ 0.500       $ 17,117   

On May 3, 2012, the shareholders approved the Company’s proposal to pay cash dividends in the form of a distribution by way of par value reductions. The aggregate reduction amount was paid to shareholders in four installments of $0.375 per share, with the last of such quarterly dividend payments being made on March 12, 2013.

On May 2, 2013, the shareholders approved the Company’s proposal to pay cash dividends in the form of a distribution out of general legal reserve from capital contributions. The distribution amount will be paid to shareholders in quarterly dividends of $0.50 per share. The first dividend was paid on July 3, 2013. The second dividend was paid on October 3, 2013. The Company expects to pay the remaining dividends in January 2014 and April 2014.

c) Share Repurchases

In May 2012, the Company established a new share repurchase program in order to repurchase up to $500,000 of its common shares. Repurchases may be effected from time to time through open market purchases, privately negotiated transactions, tender offers or otherwise. The timing, form and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, the Company’s capital position, legal requirements and other factors. Under the terms of this new share repurchase program, common shares repurchased shall be designated for cancellation at acquisition and shall be cancelled upon shareholder approval.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

Shares repurchased by the Company and not designated for cancellation are classified as “Treasury shares, at cost” on the consolidated balance sheets. The Company will issue shares out of treasury principally related to the Company’s employee benefit plans. Shares repurchased and designated for cancellation are constructively retired and recorded as a share cancellation.

The Company’s share repurchases were as follows:

 

                                                                                                   
     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2013      2012      2013      2012  

Common shares repurchased

     427,388         605,898         1,367,833         2,942,085   

Total cost of shares repurchased

   $ 40,574       $ 47,590       $ 123,145       $ 207,048   

Average price per share

   $ 94.93       $ 78.54       $ 90.03       $ 70.37   

10. EARNINGS PER SHARE

The following table sets forth the comparison of basic and diluted earnings per share:

 

                                                                                                   
     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2013      2012      2013      2012  

Basic earnings per share:

           

Net income

   $ 122,843       $ 219,647       $ 279,973       $ 534,154   

Weighted average common shares outstanding

     33,991,359         35,652,768         34,340,227         36,379,514   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic earnings per share

   $ 3.61       $ 6.16       $ 8.15       $ 14.68   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2013      2012      2013      2012  

Diluted earnings per share:

           

Net income

   $ 122,843       $ 219,647       $ 279,973       $ 534,154   

Weighted average common shares outstanding

     33,991,359         35,652,768         34,340,227         36,379,514   

Share equivalents:

           

Options

     500,114         461,373         497,458         429,393   

Restricted stock units and performance-based equity awards

     236,133         501,633         292,369         583,226   

Employee share purchase plan

     587         960         1,038         960   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average common shares and common share equivalents outstanding - diluted

     34,728,193         36,616,734         35,131,092         37,393,093   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted earnings per share

   $ 3.54       $ 6.00       $ 7.97       $ 14.28   
  

 

 

    

 

 

    

 

 

    

 

 

 

For the three and nine months ended September 30, 2013, no employee stock options and restricted stock units (“RSUs”) were considered anti-dilutive.

For the three and nine months ended September 30, 2012, a weighted average of 221,008 and 338,395 employee stock options and RSUs were considered anti-dilutive and were therefore excluded from the calculation of the diluted earnings per share, respectively.

11. SEGMENT INFORMATION

The determination of reportable segments is based on how senior management monitors the Company’s underwriting operations. Management monitors the performance of its direct underwriting operations based on the geographic location of the Company’s offices, the markets and customers served and the type of accounts written. The Company is currently organized into three operating segments: U.S. insurance, international insurance and reinsurance. All product lines fall within these classifications.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

The U.S. insurance segment includes the Company’s direct specialty insurance operations in the United States. This segment provides both direct property and specialty casualty insurance primarily to non-Fortune 1000 North American domiciled accounts. The international insurance segment includes the Company’s direct insurance operations in Bermuda, Europe, Singapore and Hong Kong. This segment provides both direct property and casualty insurance primarily to Fortune 1000 North American domiciled accounts from the Bermuda office and direct property and specialty casualty insurance to our non-North American domiciled accounts from the European, Singapore and Hong Kong offices. The reinsurance segment includes the Company’s reinsurance operations in the United States, Bermuda, Europe, Singapore and Hong Kong. This segment provides reinsurance of property, general casualty, professional liability, specialty lines and property catastrophe coverages written by insurance companies. The Company presently writes reinsurance on both a treaty and a facultative basis, targeting several niche reinsurance markets.

Responsibility and accountability for the results of underwriting operations are assigned by major line of business within each segment. Because the Company does not manage its assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments. General and administrative expenses are allocated to segments based on various factors, including staff count and each segment’s proportional share of gross premiums written.

Management measures results for each segment on the basis of the “loss and loss expense ratio,” “acquisition cost ratio,” “general and administrative expense ratio” and the “combined ratio.” The “loss and loss expense ratio” is derived by dividing net losses and loss expenses by net premiums earned. The “acquisition cost ratio” is derived by dividing acquisition costs by net premiums earned. The “general and administrative expense ratio” is derived by dividing general and administrative expenses by net premiums earned. The “combined ratio” is the sum of the “loss and loss expense ratio,” the “acquisition cost ratio” and the “general and administrative expense ratio.”

The following tables provide a summary of the segment results:

 

                                                                                                   

Three Months Ended September 30, 2013

   U.S. Insurance      International
Insurance
     Reinsurance      Total  

Gross premiums written

   $ 308,709       $ 132,881       $ 139,303       $ 580,893   

Net premiums written

     238,792         75,632         138,653         453,077   

Net premiums earned

     207,602         87,554         215,617         510,773   

Net losses and loss expenses

     (141,222)         (31,094)         (104,654)         (276,970)   

Acquisition costs

     (28,426)         282         (36,970)         (65,114)   

General and administrative expenses

     (41,616)         (26,450)         (20,487)         (88,553)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Underwriting (loss) income

     (3,662)         30,292         53,506         80,136   

Net investment income

              39,271   

Net realized investment gains

              27,487   

Amortization of intangible assets

              (633)   

Interest expense

              (14,094)   

Foreign exchange loss

              (4,353)   
           

 

 

 

Income before income taxes

            $ 127,814   
           

 

 

 

Loss and loss expense ratio

     68.0%         35.5%         48.5%         54.2%   

Acquisition cost ratio

     13.7%         (0.3%)         17.1%         12.7%   

General and administrative expense ratio

     20.0%         30.2%         9.5%         17.3%   
  

 

 

    

 

 

    

 

 

    

 

 

 

Combined ratio

     101.7%         65.4%         75.1%         84.2%   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

 

                                                                                           
            International                

Three Months Ended September 30, 2012

   U.S. Insurance      Insurance      Reinsurance      Total  

Gross premiums written

   $ 263,129       $ 121,315       $ 119,976       $ 504,420   

Net premiums written

     200,779         71,199         119,559         391,537   

Net premiums earned

     173,948         85,329         181,740         441,017   

Net losses and loss expenses

     (109,111)         (15,099)         (134,738)         (258,948)   

Acquisition costs

     (22,696)         266         (28,656)         (51,086)   

General and administrative expenses

     (37,388)         (22,920)         (18,264)         (78,572)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Underwriting income

     4,753         47,576         82         52,411   

Net investment income

              39,121   

Net realized investment gains

              149,813   

Amortization of intangible assets

              (633)   

Interest expense

              (13,822)   

Foreign exchange loss

              (1,023)   
           

 

 

 

Income before income taxes

            $ 225,867   
           

 

 

 

Loss and loss expense ratio

     62.7%         17.7%         74.1%         58.7%   

Acquisition cost ratio

     13.0%         (0.3%)         15.8%         11.6%   

General and administrative expense ratio

     21.5%         26.9%         10.0%         17.8%   
  

 

 

    

 

 

    

 

 

    

 

 

 

Combined ratio

     97.2%         44.3%         99.9%         88.1%   
  

 

 

    

 

 

    

 

 

    

 

 

 
            International                

Nine Months Ended September 30, 2013

   U.S. Insurance      Insurance      Reinsurance      Total  

Gross premiums written

   $ 872,024       $ 453,990       $ 857,160       $ 2,183,174   

Net premiums written

     652,464         259,771         817,116         1,729,351   

Net premiums earned

     593,477         258,809         628,986         1,481,272   

Net losses and loss expenses

     (398,910)         (90,997)         (317,369)         (807,276)   

Acquisition costs

     (78,824)         1,489         (109,081)         (186,416)   

General and administrative expenses

     (119,514)         (75,374)         (56,930)         (251,818)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Underwriting (loss) income

     (3,771)         93,927         145,606         235,762   

Net investment income

              110,294   

Net realized investment losses

              (8,074)   

Amortization of intangible assets

              (1,900)   

Interest expense

              (42,416)   

Foreign exchange loss

              (7,361)   
           

 

 

 

Income before income taxes

            $ 286,305   
           

 

 

 

Loss and loss expense ratio

     67.2%         35.2%         50.5%         54.5%   

Acquisition cost ratio

     13.3%         (0.6%)         17.3%         12.6%   

General and administrative expense ratio

     20.1%         29.1%         9.1%         17.0%   
  

 

 

    

 

 

    

 

 

    

 

 

 

Combined ratio

     100.6%         63.7%         76.9%         84.1%   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

20


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

 

                                                                                           
            International                

Nine Months Ended September 30, 2012

   U.S. Insurance      Insurance      Reinsurance      Total  

Gross premiums written

   $ 733,314       $ 418,498       $ 680,407       $ 1,832,219   

Net premiums written

     551,286         255,150         668,764         1,475,200   

Net premiums earned

     490,091         247,805         534,758         1,272,654   

Net losses and loss expenses

     (309,889)         (75,432)         (339,209)         (724,530)   

Acquisition costs

     (63,918)         1,376         (87,270)         (149,812)   

General and administrative expenses

     (103,162)         (66,969)         (52,786)         (222,917)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Underwriting income

     13,122         106,780         55,493         175,395   

Net investment income

              128,781   

Net realized investment gains

              292,057   

Amortization of intangible assets

              (1,900)   

Interest expense

              (41,579)   

Foreign exchange gain

              77   
           

 

 

 

Income before income taxes

            $ 552,831   
           

 

 

 

Loss and loss expense ratio

     63.2%         30.4%         63.4%         56.9%   

Acquisition cost ratio

     13.0%         (0.6%)         16.3%         11.8%   

General and administrative expense ratio

     21.0%         27.0%         9.9%         17.5%   
  

 

 

    

 

 

    

 

 

    

 

 

 

Combined ratio

     97.2%         56.8%         89.6%         86.2%   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table shows an analysis of the Company’s gross premiums written by geographic location of the Company’s subsidiaries and branches. All intercompany premiums have been eliminated.

 

                                                                                           
     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2013      2012      2013      2012  

United States

   $ 377,618       $ 312,807       $ 1,296,212       $ 1,051,355   

Bermuda

     111,103         108,955         550,815         484,313   

Europe

     52,004         46,836         198,747         182,220   

Singapore

     35,515         31,902         122,546         101,213   

Hong Kong

     4,653         3,920         14,854         13,118   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total gross premiums written

   $ 580,893       $ 504,420       $ 2,183,174       $ 1,832,219   
  

 

 

    

 

 

    

 

 

    

 

 

 

Europe includes gross premiums written attributable to Switzerland of $10,509 and $7,039 for the three months ended September 30, 2013 and 2012, respectively, and $57,183 and $40,474 for the nine months ended September 30, 2013 and 2012, respectively.

12. COMMITMENTS AND CONTINGENCIES

The Company, in common with the insurance industry in general, is subject to litigation and arbitration in the normal course of its business. These legal proceedings generally relate to claims asserted by or against the Company in the ordinary course of insurance or reinsurance operations. Estimated amounts payable under these proceedings are included in the reserve for losses and loss expenses in the Company’s consolidated balance sheets. As of September 30, 2013, the Company was not a party to any material legal proceedings arising outside the ordinary course of business that management believes will have a material adverse effect on the Company’s results of operations, financial position or cash flow.

13. CONDENSED CONSOLIDATED GUARANTOR FINANCIAL STATEMENTS

The following tables present unaudited condensed consolidating financial information as of September 30, 2013 and December 31, 2012 and for the three and nine months ended September 30, 2013 and 2012 for Allied World Switzerland (the “Parent Guarantor”) and Allied World Bermuda (the “Subsidiary Issuer”). The Subsidiary Issuer is a direct, 100%-owned subsidiary of the Parent Guarantor. Investments in subsidiaries are accounted for by the Parent Guarantor under the equity method for purposes of the supplemental consolidating presentation. Earnings of subsidiaries are reflected in the Parent Guarantor’s investment accounts and earnings. The Parent Guarantor fully and unconditionally guarantees the senior notes issued by the Subsidiary Issuer.

 

21


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

Unaudited Condensed Consolidating Balance Sheet:

 

                                                                                                                  
     Allied World      Allied World                       
     Switzerland      Bermuda      Other Allied             Allied World  
     (Parent      (Subsidiary      World      Consolidating      Switzerland  

As of September 30, 2013

   Guarantor)      Issuer)      Subsidiaries      Adjustments      Consolidated  

ASSETS:

              

Investments

   $ —        $ —        $ 7,661,837       $ —        $ 7,661,837   

Cash and cash equivalents

     56,060         8,388         888,599         —          953,047   

Insurance balances receivable

     —          —          740,112         —          740,112   

Funds held

     —          —          375,131         —          375,131   

Reinsurance recoverable

     —          —          1,226,034         —          1,226,034   

Net deferred acquisition costs

     —          —          145,951         —          145,951   

Goodwill and intangible assets

     —          —          317,840         —          317,840   

Balances receivable on sale of investments

     —          —          237,031         —          237,031   

Investments in subsidiaries

     3,407,988         4,509,074         —          (7,917,062)         —    

Due (to) from subsidiaries

     (967)         (14,679)         15,646         —          —    

Other assets

     1,897         5,038         713,602         —          720,537   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 3,464,978       $ 4,507,821       $ 12,321,783       $ (7,917,062)       $ 12,377,520   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

LIABILITIES:

              

Reserve for losses and loss expenses

   $ —        $ —        $ 5,780,781       $ —        $ 5,780,781   

Unearned premiums

     —          —          1,515,746         —          1,515,746   

Reinsurance balances payable

     —          —          193,643         —          193,643   

Balances due on purchases of investments

     —          —          497,974         —          497,974   

Senior notes

     —          798,426         —          —          798,426   

Other liabilities

     21,050         17,457         108,515         —          147,022   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

     21,050         815,883         8,096,659         —          8,933,592   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total shareholders’ equity

     3,443,928         3,691,938         4,225,124         (7,917,062)         3,443,928   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities and shareholders’ equity

   $ 3,464,978       $ 4,507,821       $ 12,321,783       $ (7,917,062)       $ 12,377,520   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

 

                                                                                                                  
     Allied World      Allied World                       
     Switzerland      Bermuda      Other Allied             Allied World  
     (Parent      (Subsidiary      World      Consolidating      Switzerland  

As of December 31, 2012

   Guarantor)      Issuer)      Subsidiaries      Adjustments      Consolidated  

ASSETS:

              

Investments

   $ —        $ —        $ 7,933,937       $ —        $ 7,933,937   

Cash and cash equivalents

     19,997         11,324         650,558         —          681,879   

Insurance balances receivable

     —          —          510,532         —          510,532   

Funds held

     —          —          336,368         —          336,368   

Reinsurance recoverable

     —          —          1,141,110         —          1,141,110   

Net deferred acquisition costs

     —          —          108,010         —          108,010   

Goodwill and intangible assets

     —          —          319,741         —          319,741   

Balances receivable on sale of investments

     —          —          418,879         —          418,879   

Investments in subsidiaries

     3,337,446         4,768,769         —          (8,106,215)         —    

Due (to) from subsidiaries

     (23,864)         (7,173)         31,037         —          —    

Other assets

     1,499         6,081         571,910         —          579,490   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 3,335,078       $ 4,779,001       $ 12,022,082       $ (8,106,215)       $ 12,029,946   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

LIABILITIES:

              

Reserve for losses and loss expenses

   $ —        $ —        $ 5,645,549       $ —        $ 5,645,549   

Unearned premiums

     —          —          1,218,021         —          1,218,021   

Reinsurance balances payable

     —          —          136,264         —          136,264   

Balances due on purchases of investments

     —          —          759,934         —          759,934   

Senior notes

     —          798,215         —          —          798,215   

Other liabilities

     8,743         17,727         119,158         —          145,628   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

     8,743         815,942         7,878,926         —          8,703,611   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total shareholders’ equity

     3,326,335         3,963,059         4,143,156         (8,106,215)         3,326,335   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities and shareholders’ equity

   $ 3,335,078       $ 4,779,001       $ 12,022,082       $ (8,106,215)       $ 12,029,946   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unaudited Condensed Consolidating Income Statement:

 

                                                                                                                  
     Allied World      Allied World                       
     Switzerland      Bermuda      Other Allied             Allied World  
     (Parent      (Subsidiary      World      Consolidating      Switzerland  

Three Months Ended September 30, 2013

   Guarantor)      Issuer)      Subsidiaries      Adjustments      Consolidated  

Net premiums earned

   $ —        $ —        $ 510,773       $ —        $ 510,773   

Net investment income

     3         —          39,268         —          39,271   

Net realized investment losses

     —          —          27,487         —          27,487   

Net losses and loss expenses

     —          —          (276,970)         —          (276,970)   

Acquisition costs

     —          —          (65,114)         —          (65,114)   

General and administrative expenses

     (7,323)         (4,961)         (76,269)         —          (88,553)   

Amortization of intangible assets

     —          —          (633)         —          (633)   

Interest expense

     —          (13,838)         (256)         —          (14,094)   

Foreign exchange gain (loss)

     (13)         (212)         (4,128)         —          (4,353)   

Income tax (expense) benefit

     —          —          (4,971)         —          (4,971)   

Equity in earnings of consolidated subsidiaries

     130,176         150,653         —          (280,829)         —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

NET INCOME (LOSS)

   $ 122,843       $ 131,642       $ 149,187       $ (280,829)       $ 122,843   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Other comprehensive income

     —          —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

COMPREHENSIVE INCOME (LOSS)

   $ 122,843       $ 131,642       $ 149,187       $ (280,829)       $ 122,843   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

23


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

 

                                                                                                        

Three Months Ended September 30, 2012

   Allied World
Switzerland
(Parent
Guarantor)
     Allied World
Bermuda
(Subsidiary
Issuer)
     Other Allied
World
Subsidiaries
     Consolidating
Adjustments
     Allied World
Switzerland
Consolidated
 

Net premiums earned

   $ —        $ —        $ 441,017       $ —        $ 441,017   

Net investment income

     7         6         39,108         —          39,121   

Net realized investment gains

     —          —          149,813         —          149,813   

Net losses and loss expenses

     —          —          (258,948)         —          (258,948)   

Acquisition costs

     —          —          (51,086)         —          (51,086)   

General and administrative expenses

     (6,013)         (235)         (72,324)         —          (78,572)   

Amortization of intangible assets

     —          —          (633)         —          (633)   

Interest expense

     —          (13,822)         —          —          (13,822)   

Foreign exchange gain (loss)

     (206)         (83)         (734)         —          (1,023)   

Income tax (expense) benefit

     —          —          (6,220)         —          (6,220)   

Equity in earnings of consolidated subsidiaries

     225,859         231,471         —          (457,330)         —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

NET INCOME (LOSS)

   $ 219,647       $ 217,337       $ 239,993       $ (457,330)       $ 219,647   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unrealized losses on investments arising during the period net of applicable deferred income tax benefit of $15

     (29)         —          (29)         29         (29)   

Reclassification adjustment for net realized investment gains included in net income, net of applicable income tax

     —          —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Other comprehensive loss

     (29)         —          (29)         29         (29)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

COMPREHENSIVE INCOME (LOSS)

   $ 219,618       $ 217,337       $ 239,964       $ (457,301)       $ 219,618   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

24


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

 

                                                                                                        

Nine Months Ended September 30, 2013

   Allied World
Switzerland
(Parent
Guarantor)
     Allied World
Bermuda
(Subsidiary
Issuer)
     Other Allied
World
Subsidiaries
     Consolidating
Adjustments
     Allied World
Switzerland
Consolidated
 

Net premiums earned

   $ —        $ —        $ 1,481,272       $ —        $ 1,481,272   

Net investment income

     11         4         110,279         —          110,294   

Net realized investment losses

     —          —          (8,074)         —          (8,074)   

Net losses and loss expenses

     —          —          (807,276)         —          (807,276)   

Acquisition costs

     —          —          (186,416)         —          (186,416)   

General and administrative expenses

     (26,875)         (5,873)         (219,070)         —          (251,818)   

Amortization of intangible assets

     —          —          (1,900)         —          (1,900)   

Interest expense

     —          (41,503)         (913)         —          (42,416)   

Foreign exchange loss (gain)

     261         (935)         (6,687)         —          (7,361)   

Income tax (expense) benefit

     —          —          (6,332)         —          (6,332)   

Equity in earnings of consolidated subsidiaries

     306,576         353,280         —          (659,856)         —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

NET INCOME (LOSS)

   $ 279,973       $ 304,973       $ 354,883       $ (659,856)       $ 279,973   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Other comprehensive income

     —          —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

COMPREHENSIVE INCOME (LOSS)

   $ 279,973       $ 304,973       $ 354,883       $ (659,856)       $ 279,973   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
                                    

Nine Months Ended September 30, 2012

   Allied World
Switzerland
(Parent
Guarantor)
     Allied World
Bermuda
(Subsidiary
Issuer)
     Other Allied
World
Subsidiaries
     Consolidating
Adjustments
     Allied World
Switzerland
Consolidated
 

Net premiums earned

   $ —        $ —        $ 1,272,654       $ —        $ 1,272,654   

Net investment income

     21         17         128,743         —          128,781   

Net realized investment gains

     —          —          292,057         —          292,057   

Net losses and loss expenses

     —          —          (724,530)         —          (724,530)   

Acquisition costs

     —          —          (149,812)         —          (149,812)   

General and administrative expenses

     (14,247)         (2,689)         (205,981)         —          (222,917)   

Amortization of intangible assets

     —          —          (1,900)         —          (1,900)   

Interest expense

     —          (41,579)         —          —          (41,579)   

Foreign exchange gain (loss)

     343         (150)         (116)         —          77   

Income tax (expense) benefit

     71         —          (18,748)         —          (18,677)   

Equity in earnings of consolidated subsidiaries

     547,966         580,880         —          (1,128,846)         —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

NET INCOME (LOSS)

   $ 534,154       $ 536,479       $ 592,367       $ (1,128,846)       $ 534,154   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unrealized gains on investments arising during the period net of applicable deferred income tax expense of $81

     150         —          150         (150)         150   

Reclassification adjustment for net realized investment gains included in net income, net of applicable income tax

     (13,249)         —          (13,249)         13,249         (13,249)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Other comprehensive loss

     (13,099)         —          (13,099)         13,099         (13,099)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

COMPREHENSIVE INCOME (LOSS)

   $ 521,055       $ 536,479       $ 579,268       $ (1,115,747)       $ 521,055   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

25


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

 

Unaudited Condensed Consolidating Cash Flows:

 

                                                                                                        

Nine Months Ended September 30, 2013

   Allied World
Switzerland
(Parent
Guarantor)
     Allied World
Bermuda
(Subsidiary
Issuer)
     Other Allied
World
Subsidiaries
     Consolidating
Adjustments
     Allied World
Switzerland
Consolidated
 

CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES

   $ 177,859       $ (2,936)       $ 157,127       $ —        $ 332,050   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:

              

Purchases trading securities

     —          —          (4,955,817)         —          (4,955,817)   

Purchases of other invested assets

     —          —          (211,501)         —          (211,501)   

Sales of available for sale securities

     —          —          —          —          —    

Sales of trading securities

     —          —          5,137,280         —          5,137,280   

Sales of other invested assets

     —          —          189,155         —          189,155   

Other

     —          —          (78,203)         —          (78,203)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net cash provided by (used in) investing activities

     —          —          80,914         —          80,914   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:

              

Dividends paid - partial par value reduction

     (12,981)         —          —          —          (12,981)   

Dividends paid

     (17,117)         —          —          —          (17,117)   

Proceeds from the exercise of stock options

     8,465         —          —          —          8,465   

Share repurchases

     (120,163)         —          —          —          (120,163)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net cash provided by (used in) financing activities

     (141,796)         —          —          —          (141,796)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     36,063         (2,936)         238,041         —          271,168   

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     19,997         11,324         650,558         —          681,879   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 56,060       $ 8,388       $ 888,599       $ —        $ 953,047   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

 

 

                                                                                                        

Nine Months Ended September 30, 2012

   Allied World
Switzerland
(Parent
Guarantor)
     Allied World
Bermuda
(Subsidiary
Issuer)
     Other Allied
World
Subsidiaries
     Consolidating
Adjustments
     Allied World
Switzerland
Consolidated
 

CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:

   $ 162,141       $ 687       $ 336,824       $ —        $ 499,652   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:

              

Purchases of available for sale securities

     —          —          —          —          —    

Purchases of trading securities

     —          —          (6,328,719)         —          (6,328,719)   

Purchases of other invested assets

     —          —          (52,578)         —          (52,578)   

Sales of available for sale securities

     —          —          215,318         —          215,318   

Sales of trading securities

     —          —          5,778,138         —          5,778,138   

Sales of other invested assets

     —          —          110,429         —          110,429   

Other

     —          —          33,644         —          33,644   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net cash provided by (used in) investing activities

     —          —          (243,768)         —          (243,768)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:

              

Partial par value reduction

     (54,721)         —          —          —          (54,721)   

Proceeds from the exercise of stock options

     9,104         —          —          —          9,104   

Share repurchases

     (204,746)         —          —          —          (204,746)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net cash provided by (used in) financing activities

     (250,363)         —          —          —          (250,363)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     (88,222)         687         93,056         —          5,521   

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     112,672         8,886         512,438         —          633,996   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 24,450       $ 9,573       $ 605,494       $ —        $ 639,517   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Notes to Parent Company Condensed Financial Information

a) Dividends

Allied World Switzerland received cash dividends from its subsidiaries of $237,000 and $285,000 for the nine months ended September 30, 2013 and 2012, respectively. Such dividends are included in “cash flows provided by (used in) operating activities” in the unaudited condensed consolidating cash flows.

14. SUBSEQUENT EVENTS

On October 3, 2013, the Company paid a quarterly dividend of $0.50 per share to shareholders of record on September 24, 2013.

 

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Table of Contents
Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q. References in this Form 10-Q to the terms “we,” “us,” “our,” the “Company” or other similar terms mean the consolidated operations of Allied World Assurance Company Holdings, AG, a Swiss holding company, and our consolidated subsidiaries, unless the context requires otherwise. References in this Form 10-Q to the term “Allied World Switzerland” or “Holdings” means only Allied World Assurance Company Holdings, AG. References to “Allied World Bermuda” mean only Allied World Assurance Company Holdings, Ltd, a Bermuda holding company. References to “our insurance subsidiaries” may include our reinsurance subsidiaries. References in this Form 10-Q to $ are to the lawful currency of the United States and to CHF are to the lawful currency of Switzerland. References in this Form 10-Q to Holdings’ “common shares” mean its registered voting shares.

Note on Forward-Looking Statement

This Form 10-Q and other publicly available documents may include, and our officers and representatives may from time to time make, projections concerning financial information and statements concerning future economic performance and events, plans and objectives relating to management, operations, products and services, and assumptions underlying these projections and statements. These projections and statements are forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995 and are not historical facts but instead represent only our belief regarding future events, many of which, by their nature, are inherently uncertain and outside our control. These projections and statements may address, among other things, our strategy for growth, product development, financial results and reserves. Actual results and financial condition may differ, possibly materially, from these projections and statements and therefore you should not place undue reliance on them. Factors that could cause our actual results to differ, possibly materially, from those in the specific projections and statements are discussed throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations and in “Risk Factors” in Item 1A. of Part I of our 2012 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on February 26, 2013 (the “2012 Form 10-K”). We are under no obligation (and expressly disclaim any such obligation) to update or revise any forward-looking statement that may be made from time to time, whether as a result of new information, future developments or otherwise.

Overview

Our Business

We write a diversified portfolio of property and casualty insurance and reinsurance internationally through our subsidiaries and branches based in Bermuda, Europe, Hong Kong, Singapore and the United States as well as our Lloyd’s Syndicate 2232. We manage our business through three operating segments: U.S. insurance, international insurance and reinsurance. As of September 30, 2013, we had approximately $12.4 billion of total assets, $3.4 billion of total shareholders’ equity and $4.2 billion of total capital, which includes shareholders’ equity and senior notes.

During the three months ended September 30, 2013, we continued to see rate improvement during the quarter on some lines of business in certain jurisdictions, particularly in our U.S. insurance segment. Rates on property lines, across our segments, have begun to flatten, particularly those accounts that had experienced loss activity in the prior year. We believe that there are opportunities where certain products have attractive premium rates and that the expanded breadth of our operations allows us to target those classes of business.

Our consolidated gross premiums written increased by $76.5 million, or 15.2%, for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. Our net income decreased by $96.8 million to $122.8 million compared to the three months ended September 30, 2012. The decrease was due to lower net realized investment gains (losses) of $122.3 million for the three months ended September 30, 2013 compared to the same period in 2012, partially offset by an increase in underwriting income of $27.7 million.

Our consolidated gross premiums written increased by $351.0 million, or 19.2%, for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. Our net income decreased by $254.2 million to $280.0 million compared to the nine months ended September 30, 2012. The decrease was due to lower net realized investment gains (losses) of $300.1 million for the nine months ended September 30, 2013 compared to the same period in 2012, partially offset by an increase in underwriting income of $60.4 million.

 

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Table of Contents

Financial Highlights

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2013     2012     2013     2012  
    ($ in millions except share, per share and percentage data)  

Gross premiums written

  $ 580.9      $ 504.4      $ 2,183.2      $ 1,832.2   

Underwriting income

    80.1        52.4        235.8        175.4   

Net income

    122.8        219.6        280.0        534.2   

Operating income

    101.8        79.2        289.5        258.0   

Basic earnings per share:

       

Net income

  $ 3.61      $ 6.16      $ 8.15      $ 14.68   

Operating income

  $ 2.99      $ 2.22      $ 8.43      $ 7.09   

Diluted earnings per share:

       

Net income

  $ 3.54      $ 6.00      $ 7.97      $ 14.28   

Operating income

  $ 2.93      $ 2.16      $ 8.24      $ 6.90   

Weighted average common shares outstanding:

       

Basic

    33,991,359        35,652,768        34,340,227        36,379,514   

Diluted

      34,728,193          36,616,734          35,131,092          37,393,093   

Basic book value per common share

  $ 101.85      $ 97.05      $ 101.85      $ 97.05   

Diluted book value per common share

  $ 99.16      $ 93.82      $ 99.16      $ 93.82   

Annualized return on average equity (ROAE), net income

    14.4%        26.2%        11.0%        21.7%   

Annualized ROAE, operating income

    11.9%        9.4%        11.4%        10.5%   

Non-GAAP Financial Measures

In presenting the company’s results, management has included and discussed certain non-GAAP financial measures, as such term is defined in Item 10(e) of Regulation S-K promulgated by the SEC. Management believes that these non-GAAP measures, which may be defined differently by other companies, better explain the company’s results of operations in a manner that allows for a more complete understanding of the underlying trends in the company’s business. However, these measures should not be viewed as a substitute for those determined in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).

Operating income and operating income per share

Operating income is an internal performance measure used in the management of our operations and represents after-tax operational results excluding, as applicable, net realized investment gains or losses, net impairment charges recognized in earnings, net foreign exchange gain or loss, and other non-recurring items. We exclude net realized investment gains or losses, net impairment charges recognized in earnings, net foreign exchange gain or loss and any other non-recurring items from our calculation of operating income because these amounts are heavily influenced by and fluctuate in part according to the availability of market opportunities and other factors. In addition to presenting net income determined in accordance with U.S. GAAP, we believe that showing operating income enables investors, analysts, rating agencies and other users of our financial information to more easily analyze our results of operations and our underlying business performance. Operating income should not be viewed as a substitute for U.S. GAAP net income. The following is a reconciliation of operating income to its most closely related U.S. GAAP measure, net income.

 

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Table of Contents
                                                                                   
    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2013     2012     2013     2012  
    ($ in millions, except share, per share and percentage data)  

Net income

  $ 122.8      $ 219.6      $ 280.0      $ 534.2   

Add after tax effect of:

       

Net realized investment (gains) losses

    (25.4)        (141.4)        2.2        (276.1)   

Foreign exchange loss (gain)

    4.4        1.0        7.3        (0.1)   
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

  $ 101.8      $ 79.2      $ 289.5      $ 258.0   
 

 

 

   

 

 

   

 

 

   

 

 

 

Basic per share data:

       

Net income

  $ 3.61      $ 6.16      $ 8.15      $ 14.68   

Add after tax effect of:

       

Net realized investment (gains) losses

    (0.75)        (3.97)        0.06        (7.59)   

Foreign exchange loss (gain)

    0.13        0.03        0.22        —   
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

  $ 2.99      $ 2.22      $ 8.43      $ 7.09   
 

 

 

   

 

 

   

 

 

   

 

 

 

Diluted per share data:

       

Net income

  $ 3.54      $ 6.00      $ 7.97      $ 14.28   

Add after tax effect of:

       

Net realized investment (gains) losses

    (0.73)        (3.86)        0.06        (7.38)   

Foreign exchange loss (gain)

    0.12        0.02        0.21        —   
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

  $ 2.93      $ 2.16      $ 8.24      $ 6.90   
 

 

 

   

 

 

   

 

 

   

 

 

 

Diluted book value per share

We have included diluted book value per share because it takes into account the effect of dilutive securities; therefore, we believe it is an important measure of calculating shareholder returns.

 

    As of September 30,  
    2013     2012  
   

($ in millions, except share and

per share data)

 

Price per share at period end

  $ 99.39      $ 77.25   

Total shareholders’ equity

  $ 3,443.9      $ 3,435.8   

Basic common shares outstanding

    33,814,920        35,402,558   

Add:

   

Unvested restricted stock units

    83,240        179,986   

Performance based equity awards

    270,853        508,130   

Employee share purchase plan

    15,320        5,925   

Dilutive options outstanding

    1,050,832        1,306,837   

Weighted average exercise price per share

  $ 47.77      $ 46.14   

Deduct:

   

Options bought back via treasury method

    (505,057)        (780,502)   
 

 

 

   

 

 

 

Common shares and common share equivalents outstanding

      34,730,108          36,622,934   

Basic book value per common share

  $ 101.85      $ 97.05   

Diluted book value per common share

  $ 99.16      $ 93.82   

Annualized return on average equity

Annualized return on average shareholders’ equity (“ROAE”) is calculated using average shareholders’ equity, excluding the average after tax unrealized gains or losses on investments. We present ROAE as a measure that is commonly recognized as a standard of performance by investors, analysts, rating agencies and other users of our financial information.

 

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Table of Contents

Annualized operating return on average shareholders’ equity is calculated using operating income and average shareholders’ equity, excluding the average after tax unrealized gains or losses on investments.

 

                                                                                   
     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2013      2012      2013      2012  
     ($ in millions except percentage data)  

Opening shareholders’ equity

   $ 3,373.2       $ 3,283.9       $ 3,326.3       $ 3,149.0   

Deduct: accumulated other comprehensive income

     -         (1.4)         -         (14.5)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Adjusted opening shareholders’ equity

   $ 3,373.2       $ 3,282.5       $ 3,326.3       $ 3,134.5   

Closing shareholders’ equity

   $ 3,443.9       $ 3,435.8       $ 3,443.9       $ 3,435.8   

Deduct: accumulated other comprehensive income

     -         (1.4)         -         (1.4)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Adjusted closing shareholders’ equity

   $ 3,443.9       $ 3,434.4       $ 3,443.9       $ 3,434.4   

Average shareholders’ equity

   $ 3,408.6       $ 3,358.4       $ 3,385.1       $ 3,284.5   

Net income available to shareholders

   $ 122.8       $ 219.6       $ 280.0       $ 534.2   

Annualized return on average shareholders’ equity —
net income available to shareholders

     14.4%         26.2%         11.0%         21.7%   
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating income available to shareholders

   $ 101.8       $ 79.2       $ 289.5       $ 258.0   

Annualized return on average shareholders’ equity —
operating income available to shareholders

     11.9%         9.4%         11.4%         10.5%   
  

 

 

    

 

 

    

 

 

    

 

 

 

Relevant Factors

Revenues

We derive our revenues primarily from premiums on our insurance policies and reinsurance contracts, net of any reinsurance or retrocessional coverage purchased. Insurance and reinsurance premiums are a function of the amounts and types of policies and contracts we write, as well as prevailing market prices. Our prices are determined before our ultimate costs, which may extend far into the future, are known. In addition, our revenues include income generated from our investment portfolio, consisting of net investment income and net realized investment gains or losses. Investment income is principally derived from interest and dividends earned on investments, as well as distributed and undistributed income from equity method investments, partially offset by investment management expenses and fees paid to our custodian bank. Net realized investment gains or losses include gains or losses from the sale of investments, as well as the change in the fair value of investments that we mark-to-market through net income.

Expenses

Our expenses consist largely of net losses and loss expenses, acquisition costs and general and administrative expenses. Net losses and loss expenses incurred are comprised of three main components:

 

  losses paid, which are actual cash payments to insureds and reinsureds, net of recoveries from reinsurers;

 

  outstanding loss or case reserves, which represent management’s best estimate of the likely settlement amount for known claims, less the portion that can be recovered from reinsurers; and

 

  reserves for losses incurred but not reported, or “IBNR”, which are reserves (in addition to case reserves) established by us that we believe are needed for the future settlement of claims. The portion recoverable from reinsurers is deducted from the gross estimated loss.

Acquisition costs are comprised of commissions, brokerage fees, insurance taxes and other acquisition related costs such as profit commissions. Commissions and brokerage fees are usually calculated as a percentage of premiums and depend on the market and line of business. Acquisition costs are reported after (1) deducting commissions received on ceded reinsurance, (2) deducting the part of deferred acquisition costs relating to the successful acquisition of new and renewal insurance and reinsurance contracts and (3) including the amortization of previously deferred acquisition costs.

 

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Table of Contents

General and administrative expenses include personnel expenses including stock-based compensation expense, rent expense, professional fees, information technology costs and other general operating expenses.

Ratios

Management measures results for each segment on the basis of the “loss and loss expense ratio,” “acquisition cost ratio,” “general and administrative expense ratio,” “expense ratio” and the “combined ratio.” Because we do not manage our assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments. General and administrative expenses are allocated to segments based on various factors, including staff count and each segment’s proportional share of gross premiums written. The loss and loss expense ratio is derived by dividing net losses and loss expenses by net premiums earned. The acquisition cost ratio is derived by dividing acquisition costs by net premiums earned. The general and administrative expense ratio is derived by dividing general and administrative expenses by net premiums earned. The expense ratio is the sum of the acquisition cost ratio and the general and administrative expense ratio. The combined ratio is the sum of the loss and loss expense ratio, the acquisition cost ratio and the general and administrative expense ratio.

Critical Accounting Policies

It is important to understand our accounting policies in order to understand our financial position and results of operations. Our unaudited condensed consolidated financial statements reflect determinations that are inherently subjective in nature and require management to make assumptions and best estimates to determine the reported values. If events or other factors cause actual results to differ materially from management’s underlying assumptions or estimates, there could be a material adverse effect on our financial condition or results of operations. We believe that some of the more critical judgments in the areas of accounting estimates and assumptions that affect our financial condition and results of operations are related to reserves for losses and loss expenses, reinsurance recoverables, premiums and acquisition costs, valuation of financial instruments and goodwill and other intangible asset impairment valuation. For a detailed discussion of our critical accounting policies, please refer to our 2012 Form 10-K. There were no material changes in the application of our critical accounting estimates subsequent to that report.

 

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Table of Contents

Results of Operations

The following table sets forth our selected consolidated statement of operations data for each of the periods indicated.

 

                                                                                   
     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2013      2012      2013      2012  
     ($ in millions)  

Revenues

           

Gross premiums written

   $ 580.9       $ 504.4       $ 2,183.2       $ 1,832.2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net premiums written

   $ 453.1       $ 391.5       $ 1,729.4       $ 1,475.2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net premiums earned

   $ 510.8       $ 441.0       $ 1,481.3       $ 1,272.7   

Net investment income

     39.3         39.1         110.3         128.8   

Net realized investment gains (losses)

     27.5         149.8         (8.1)         292.0   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 577.6       $ 629.9       $ 1,583.5       $ 1,693.5   
  

 

 

    

 

 

    

 

 

    

 

 

 

Expenses

           

Net losses and loss expenses

   $ 277.0       $ 258.9       $ 807.3       $ 724.5   

Acquisition costs

     65.1         51.1         186.4         149.8   

General and administrative expenses

     88.6         78.6         251.8         223.0   

Amortization of intangible assets

     0.7         0.6         1.9         1.9   

Interest expense

     14.1         13.8         42.4         41.6   

Foreign exchange loss (gain)

     4.4         1.0         7.4         (0.1)   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 449.9       $ 404.0       $ 1,297.2       $ 1,140.7   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before income taxes

     127.7         225.9         286.3         552.8   

Income tax expense

     4.9         6.3         6.3         18.6   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income

   $ 122.8       $ 219.6       $ 280.0       $ 534.2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Ratios

           

Loss and loss expense ratio

     54.2%         58.7%         54.5%         56.9%   

Acquisition cost ratio

     12.7%         11.6%         12.6%         11.8%   

General and administrative expense ratio

     17.3%         17.8%         17.0%         17.5%   
  

 

 

    

 

 

    

 

 

    

 

 

 

Expense ratio

     30.0%         29.4%         29.6%         29.3%   
  

 

 

    

 

 

    

 

 

    

 

 

 

Combined ratio

     84.2%         88.1%         84.1%         86.2%   
  

 

 

    

 

 

    

 

 

    

 

 

 

Comparison of Three Months Ended September 30, 2013 and 2012

Premiums

Gross premiums written increased by $76.5 million, or 15.2%, for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. The overall increase in gross premiums written was primarily the result of the following:

 

  U.S. insurance: Gross premiums written increased by $45.6 million, or 17.3%. The increase in gross premiums written was primarily due to new business across existing lines that added $102.9 million during the quarter combined with premium rate increases in all lines of business. The increase in new business for the quarter was primarily driven by our general casualty, programs, and inland marine lines of business. Our new lines of business, primary construction and surety, contributed a further $8.1 million in new business;

 

 

International insurance: Gross premiums written increased by $11.6 million, or 9.6%. The increase was primarily due to new business written of $13.1 million in our new aviation line of business. Effective October 1, 2013, we acquired the renewal rights to a book of aviation business from Markel International that was written through Lloyd’s Syndicate 1400 and Markel Europe plc. In conjunction with the renewal rights agreement, in August we assumed the unexpired inforce aviation business from Markel International, which resulted in gross premiums written of $13.1 million this quarter. This business encompasses

 

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Table of Contents
  airlines, aerospace (primarily airports and aviation products) and general aviation classes. In addition, we had continued growth in our professional liability line of business, driven by the expansion of new initiatives. However, this growth was partially offset by $7.1 million of non-recurring premiums in our trade credit line of business recorded in 2012; and

 

  Reinsurance: Gross premiums written increased by $19.3 million, or 16.1%. The increase was driven by new business in the specialty lines primarily written out of Asia and Latin America, combined with increased participations on renewing business and rate increases for certain lines of business.

The table below illustrates our gross premiums written by underwriter location for each of the periods indicated.

 

                                                                                           
     Three Months Ended
September 30,
     Dollar      Percentage  
     2013      2012      Change      Change  
     ($ in millions)                  

United States

   $ 377.6       $ 312.9       $ 64.7         20.7%   

Bermuda

     111.1         108.9         2.2         2.0%   

Europe

     51.9         46.8         5.1         10.9%   

Singapore

     35.5         31.9         3.6         11.3%   

Hong Kong

     4.8         3.9         0.9         23.1%   
  

 

 

    

 

 

    

 

 

    
   $ 580.9       $ 504.4       $ 76.5         15.2%   
  

 

 

    

 

 

    

 

 

    

Net premiums written increased by $61.6 million, or 15.7%, for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. The increase in net premiums written was due to the increase in gross premiums written. The difference between gross and net premiums written is the cost to us of purchasing reinsurance coverage, including the cost of property catastrophe reinsurance coverage. We ceded 22.0% of gross premiums written for the three months ended September 30, 2013 compared to 22.4% for the same period in 2012.

Net premiums earned increased by $69.8 million, or 15.8%, for the three months ended September 30, 2013 compared to the three months ended September 30, 2012 as a result of higher net premiums written in 2012 and 2013.

We evaluate our business by segment, distinguishing between U.S. insurance, international insurance and reinsurance. The following table illustrates the mix of our business on both a gross premiums written and net premiums earned basis.

 

                                                                                           
     Gross Premiums Written      Net Premiums Earned  
     Three Months Ended      Three Months Ended  
     September 30,      September 30,  
     2013      2012      2013      2012  

U.S. insurance

     53.1%         52.2%         40.7%         39.5%   

International insurance

     22.9%         24.0%         17.1%         19.3%   

Reinsurance

     24.0%         23.8%         42.2%         41.2%   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     100.0%         100.0%         100.0%         100.0%   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Investment Income

Net investment income increased by $0.2 million, or 0.5%, for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. The increase was due to an increase in the distributed and undistributed earnings of our equity method investments that we invested in at the end of 2012, as well as higher income from our hedge fund and private equity investments. This increase was partially offset by lower net investment income for our fixed maturity investments as we increased the allocation of our investment portfolio to other invested assets that contribute to our total return but carry little or no current yield. The annualized period book yield of the investment portfolio for the three months ended September 30, 2013 and 2012 was 1.9% and 1.9%, respectively.

As of September 30, 2013, we held 10.3% of our total investments and cash equivalents in other invested assets compared to 6.4% as of September 30, 2012.

 

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Investment management expenses of $4.1 million and $3.7 million were incurred during the three months ended September 30, 2013 and 2012, respectively.

As of September 30, 2013, approximately 89.1% of our fixed income investments consisted of investment grade securities. As of September 30, 2013 and December 31, 2012, the average credit rating of our fixed income portfolio was AA- as rated by Standard & Poor’s.

Realized Investment Gains (Losses)

Net realized investment gains (losses) were comprised of the following:

 

                                                 
     Three Months Ended
September 30,
 
     2013      2012  
     ($ in millions)  

Net realized gains (losses) on sale:

     

Fixed maturity investments, trading

   $ (4.8)       $ 12.9   

Equity securities, trading

     13.9         7.5   

Other invested assets: hedge funds and private equity, trading

     2.1         0.2   
  

 

 

    

 

 

 

Total net realized gains on sale

     11.2         20.6   
  

 

 

    

 

 

 

Net realized and unrealized losses on derivatives

     (4.2)         (1.0)   

Mark-to-market gains (losses):

     

Fixed maturity investments, trading

     30.4         99.8   

Equity securities, trading

     (17.2)         18.9   

Other invested assets: hedge funds and private equity, trading

     7.3         11.5   
  

 

 

    

 

 

 

Total mark-to-market gains

     20.5         130.2   
  

 

 

    

 

 

 

Net realized investment gains

   $ 27.5       $ 149.8   
  

 

 

    

 

 

 

The total return of our investment portfolio was 0.8% and 2.2% for the three months ended September 30, 2013 and 2012, respectively. The decrease in total return is primarily due to lower mark-to-market gains on our fixed maturity, mark-to-market losses on our equity securities and lower realized gains from the sale of investments. The lower mark-to-market gains on our fixed maturity securities were caused by modest increases in interest rates on our fixed income portfolio during the three months ended September 30, 2013 compared to the same period in 2012. The rising interest rate environment also negatively impacted our dividend focused equity portfolio, which underperformed the S&P 500 for the quarter.

Net Losses and Loss Expenses

Net losses and loss expenses increased by $18.1 million, or 7.0%, for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. The loss and loss expense ratio decreased by 4.5 percentage points for the same period. The increase in net loss and loss expenses was due to growth in net premiums earned, partially offset by higher net favorable prior year reserve development in 2013.

Excluding the prior year reserve development, the loss and loss expense ratios would have been 66.2% and 71.4% for the three months ended September 30, 2013 and 2012, respectively. The decrease in the loss and loss expense ratio of 5.2 points was primarily due to fewer current year reported large losses in the three months ended September 30, 2013 compared to the three months ended September 30, 2012. The reported large losses were $25.2 million for the three months ended September 30, 2013 compared to $53.7 million for the same period in 2012. The reported large losses in the three months ended September 30, 2012 included approximately $40.0 million of crop reinsurance-related losses and loss expenses related to drought conditions across much of the United States and $5.0 million for Hurricane Isaac.

We classify catastrophe losses as those losses that result from a major singular event or series of similar events (such as tornadoes) which are assigned a catastrophe loss number by industry data services, where our consolidated losses are expected to be at least $10 million per loss event or series of similar events and where we believe it is important to our investors’ understanding of our operations.

 

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    Three Months Ended
September 30, 2013
    Three Months Ended
September 30, 2012
    Dollar     Change in
Percentage
    Amount     % of NPE (1)     Amount     % of NPE (1)     Change     Points
                ($ in millions)                        

Non-catastrophe

  $             338.4        66.2   $ 310.1        70.3   $ 28.3        (4.1) Pts   

Property catastrophe

    —        —        5.0        1.1        (5.0)        (1.1)     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Current period

    338.4                       66.2                      315.1                        71.4                        23.3        (5.2)     

Prior period

    (61.4)        (12.0)        (56.2)        (12.7)        (5.2)                          0.7     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Net losses and loss expenses

  $ 277.0        54.2   $ 258.9        58.7   $ 18.1        (4.5) Pts   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

(1) “NPE” means net premiums earned.

We recorded net favorable reserve development related to prior years of $61.4 million during the three months ended September 30, 2013 compared to net favorable reserve development of $56.2 million for the three months ended September 30, 2012, as shown in the tables below.

 

                                                                                                                                              
    (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
    For the Three Months Ended September 30, 2013  
    2003 and
Prior
    2004     2005     2006     2007     2008     2009     2010     2011     2012     Total  
    ($ in millions)  

U.S. insurance

  $ (3.0)      $ (0.6)      $ (1.1)      $ (6.1)      $ (5.5)      $ (2.9)      $ (3.5)      $ (4.8)      $ 13.2      $ 18.1      $ 3.8   

International insurance

    0.2        (1.2)        3.2        (4.0)        (8.6)        (4.7)        (5.9)        (4.1)        (2.1)        (2.5)        (29.7)   

Reinsurance

    (1.6)        (2.4)        1.5        —        0.2        (2.1)        (2.0)        (2.6)        (12.1)        (14.4)        (35.5)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ (4.4)      $ (4.2)      $ 3.6      $ (10.1)      $ (13.9)      $ (9.7)      $ (11.4)      $ (11.5)      $ (1.0)      $ 1.2      $ (61.4)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The unfavorable reserve development for the 2011 loss year for our U.S. insurance segment was primarily due to adverse development on reported claims in our healthcare and errors and omissions (“E&O”) products. The unfavorable reserve development for the 2012 loss year for our U.S. insurance segment was primarily due to adverse development on reported claims in our healthcare, private/not for profit directors’ and officers’ (“D&O”) and lawyers E&O. In response to the underwriting experience in these lines, we continue to take rate action, as well as make changes to policy terms and conditions, resulting in flat or reduced gross premiums written but reduced exposures.

The additions to the 2011 and 2012 loss years noted above are consistent with our practice of addressing unfavorable loss emergence early in our long-tail lines of business. We tend to recognize favorable loss emergence more slowly in our long-tail lines once actual loss emergence and data provides greater confidence around the adequacy of ultimate estimates.

The favorable reserve development for the reinsurance segment was primarily related to our property reinsurance line of business, and included favorable reserve development related to recent catastrophic events that occurred in 2010 through 2012.

 

 

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The following table shows the net favorable reserve development by loss year for each of our segments for the three months ended September 30, 2012.

 

                                                                                                                                 
    (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
    For the Three Months Ended September 30, 2012