The following Management's Discussion and Analysis should be read in conjunction
with the Consolidated Financial Statements and the related Notes as of June 30,
2012 and December 31, 2011.
Overview
We are a specialty insurance group with offices in the United States, the United
Kingdom, Spain and Ireland, transacting business in approximately 180 countries.
Our shares trade on the New York Stock Exchange and closed at $30.81 on July 27,
2012, resulting in market capitalization of $3.1 billion.
We underwrite a variety of relatively non-correlated specialty insurance
products, including property and casualty, accident and health, surety and
credit product lines. We market our insurance products through a network of
independent agents and brokers, managing general agents and directly to
consumers. In addition, we assume insurance written by other insurance
companies. We manage our businesses through five insurance underwriting segments
and our Investing segment. Our insurance underwriting segments are U.S.
Property & Casualty, Professional Liability, Accident & Health, U.S. Surety &
Credit and International.
Our business philosophy is to maximize underwriting profit while managing risk.
We concentrate our insurance writings in selected specialty lines of business in
which we believe we can achieve meaningful underwriting profit. We also rely on
our experienced underwriting personnel and our access to and expertise in the
reinsurance marketplace to limit or reduce risk. Our business plan is shaped by
our underlying business philosophy. As a result, our primary objective is to
maximize net earnings and grow book value per share, rather than to grow gross
written premium or our market share.
Our major domestic and international insurance companies have financial strength
ratings of AA (Very Strong) from Standard & Poor's Corporation, A+ (Superior)
from A.M. Best Company, Inc., AA (Very Strong) from Fitch Ratings and A1 (Good
Security) from Moody's Investors Service, Inc.
Key facts about our consolidated group as of and for the six months and quarter
ended June 30, 2012 were as follows:
• We had consolidated shareholders' equity of $3.3 billion, with a book
value per share of $33.19.
• We generated year-to-date net earnings of $176.1 million, or $1.71 per diluted share. Our second quarter earnings were $93.5 million, or $0.92
per diluted share.
• We produced total revenue of $1.2 billion and $632.3 million in the first
six months and second quarter, respectively. In the first six months, 90%
related to net earned premium and 9% related to net investment income.
• In the first six months, we recognized $12.3 million of net catastrophe
losses - $4.0 million in our U.S. Property & Casualty segment from storms
in the United States and $8.3 million in our International segment from
other small catastrophes. The second quarter included net catastrophe
losses of $4.7 million.
• Our year-to-date net loss ratio was 59.8% and our combined ratio was 85.0%.
• Our debt to capital ratio was 15.0%.
• We purchased $126.4 million, or 4.1 million shares, of our common stock at
an average cost of $30.88 per share in the first six months of 2012.
• We declared dividends of $0.31 per share and paid $32.0 million of
dividends in the first six months of 2012.
Comparisons in the following sections refer to the first six months of 2012
compared to the same period of 2011, unless otherwise noted. Certain 2011
amounts have been adjusted to reflect our adoption of a new accounting standard
as of January 1, 2012. See Note 1, "General Information - Accounting Guidance
Adopted in 2012" to the Consolidated Financial Statements for a description of
this guidance and the impact of our retrospective adoption on prior year
results. Amounts in tables are in thousands, except for earnings per share,
percentages, ratios and number of employees.
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Results of Operations
Our results and key metrics for the six months and quarter ended June 30, 2012
and 2011 were as follows:
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Net earnings $ 176,077 $ 116,468 $ 93,493 $ 69,478
Earnings per diluted share $ 1.71 $ 1.02 $ 0.92 $ 0.61
Net loss ratio 59.8 % 66.0 % 59.6 % 63.8 %
Expense ratio 25.2 25.9 25.3 25.4
Combined ratio 85.0 % 91.9 % 84.9 % 89.2 %
In 2012, we recognized catastrophe losses from United States storms, primarily
in our public risk line of business within our U.S. Property and Casualty
segment and from other small catastrophes in our property treaty line of
business within our International segment. In 2011, we recognized losses from
catastrophic events in Japan, New Zealand, Australia, the United States and
Denmark. We reinsure a portion of our exposure to catastrophic events, although
we incur some additional cost for reinstatement premium to continue our
reinsurance coverage for future loss events. The following table summarizes our
catastrophe losses, as well as the impact on our net earnings and key metrics in
2012 and 2011:
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Gross losses $ 14,795 $ 120,259 $ 7,735 $ 15,059
Net losses, after reinsurance and
reinstatement premium $ 12,257 $ 73,328 $ 4,653 $ 21,863
Impact of net catastrophe losses on:
Net earnings per diluted share $ (0.08) $ (0.42) $ (0.03) $ (0.13)
Net loss ratio (percentage points) 1.1 % 6.6 % 0.9 % 3.9 %
Combined ratio (percentage points) 1.1 % 6.9 % 0.8 % 4.1 %
Revenue
Total revenue increased $93.3 million in the first six months of 2012, compared
to the same period in 2011, primarily due to higher net earned premium.
Gross written premium, net written premium and net earned premium are detailed
below by segment.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
U.S. Property & Casualty $ 318,613 $ 265,511 $ 165,466 $ 135,961
Professional Liability 245,750 262,272 144,505 161,152
Accident & Health 434,264 397,823 218,141 201,523
U.S. Surety & Credit 110,702 113,953 56,209 60,182
International 364,911 351,581 207,235 183,233
Exited Lines 2 150 (3) 31
Total gross written premium $ 1,474,242$ 1,391,290 $ 791,553 $ 742,082
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Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
U.S. Property & Casualty $ 197,894 $ 180,436 $ 105,566 $ 93,714
Professional Liability 171,137 190,648 100,224 116,857
Accident & Health 433,740 397,500 217,856 201,395
U.S. Surety & Credit 96,096 105,101 51,392 55,394
International 301,623 274,922 167,053 142,482
Exited Lines 2 150 (3) 31
Total net written premium $ 1,200,492 $ 1,148,757 $ 642,088 $ 609,873
U.S. Property & Casualty $ 177,852 $ 159,175 $ 88,834 $ 78,921
Professional Liability 200,905 203,174 99,467 102,424
Accident & Health 436,397 400,657 218,730 202,117
U.S. Surety & Credit 100,844 101,403 53,115 50,039
International 196,472 168,164 105,188 90,717
Exited Lines 2 158 (3) 33
Total net earned premium $ 1,112,472 $ 1,032,731
$ 565,331 $ 524,251
Growth in premium occurred in the U.S. Property & Casualty segment from our new
business lines added in 2011 and increased aviation, public risk, contingency,
residual value and title reinsurance premium; the Accident & Health segment from
higher writings of our medical stop-loss product; and the International segment
from new business and pricing increases in our energy line of business. In 2011,
we recorded $11.6 million ($12.7 million ceded, net of $1.1 million assumed) of
catastrophe-related reinstatement premium, which reduced the International
segment's 2011 net written and net earned premium. See the "Segment Operations"
section below for further discussion of the relationship and changes in premium
revenue within each segment.
Net investment income, which is included in our Investing segment, increased 6%
year-over-year primarily due to higher income from fixed maturity securities,
generated from an increased amount of investments. Our fixed maturity portfolio
increased 9% from $5.6 billion at June 30, 2011 to $6.1 billion at June 30,
2012. In addition, we invested $92.6 million in an equities portfolio in the
second quarter of 2012. The growth in investments resulted primarily from cash
flow from operations and a $192.7 million increase in the net unrealized gain on
available for sale securities since June 30, 2011.
The following table details the components of our other operating income. The
fee and commission income relates to third party agency and broker commissions.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Fee and commission income $ 10,542 $ 13,221
$ 6,139 $ 6,612
Financial instruments 330 385 115 122
Other 1,517 1,190 934 741
Other operating income $ 12,389 $ 14,796 $ 7,188 $ 7,475
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Loss and Loss Adjustment Expense
The tables below detail, by segment, our net loss and loss adjustment expense
and our net loss ratios.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
U.S. Property & Casualty $ 100,927 $ 92,428 $ 51,666 $ 44,944
Professional Liability 134,323 138,015 65,168 71,752
Accident & Health 324,717 291,605 163,004 146,747
U.S. Surety & Credit 26,723 29,687 15,690 14,648
International 79,623 130,393 41,856 56,221
Exited Lines (560) (260) (559) (30)
Net loss and loss adjustment expense $ 665,753$ 681,868
$ 336,825$ 334,282
U.S. Property & Casualty 56.7 % 58.1 % 58.2 % 56.9 %
Professional Liability 66.9 67.9 65.5 70.1
Accident & Health 74.4 72.8 74.5 72.6
U.S. Surety & Credit 26.5 29.3 29.5 29.3
International 40.5 77.5 39.8 62.0
Consolidated net loss ratio 59.8 % 66.0 % 59.6 % 63.8 %
Consolidated accident year net loss ratio 59.8 % 63.9 % 59.6 % 61.2 %
Loss development represents an increase or decrease in estimates of ultimate
losses related to prior accident years. Deficiencies and redundancies in
ultimate loss estimates occur as we review our loss exposure with our actuaries,
increasing or reducing estimates of our ultimate losses as a result of such
reviews and as losses are finally settled or claims exposures change. The excess
of total recorded net reserves over the actuarial point estimate approximated
4.3% of our recorded net reserves at June 30, 2012, compared to 4.2% at
December 31, 2011. We recognized no development in the first six months of 2012,
compared to adverse development of $22.3 million in the first six months of 2011
(of which $13.3 million was recognized in the second quarter), primarily in our
Professional Liability segment. Our consolidated accident year net loss ratio
was lower in 2012, compared to 2011, primarily due to higher catastrophe losses
in 2011. See the "Segment Operations" section below for additional discussion of
the changes in our net loss and loss adjustment expense and net loss ratios for
each segment.
The table below provides a reconciliation of our consolidated reserves for loss
and loss adjustment expense payable, net of reinsurance ceded, the amount of our
paid claims, and our net paid loss ratio.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Net reserves for loss and loss
adjustment expense payable at
beginning of period $ 2,683,483 $ 2,537,772 $ 2,699,717 $ 2,611,096
Net reserve additions from
acquired businesses 14,705 645 - -
Foreign currency adjustment (4,456) 27,986 (21,579) 5,770
Net loss and loss adjustment
expense 665,753 681,868 336,825 334,282
Net loss and loss adjustment
expense payments (610,490) (635,326) (265,968) (338,203)
Net reserves for loss and loss
adjustment expense payable at end
of period $ 2,748,995 $ 2,612,945 $ 2,748,995 $ 2,612,945
Net paid loss ratio 54.9 % 61.5 % 47.0 % 64.5 %
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Our net paid loss ratio decreased in 2012 due to substantially lower claims
payments in our Professional Liability segment and our energy line of business
in the second quarter of 2012, compared to the same period in 2011. We paid
$27.5 million in the first quarter of 2012 and $26.7 million in the second
quarter of 2011 to commute large contracts included in our Exited Lines. These
commutations had no material effect on net earnings but increased our net paid
loss ratios by 2.5 percentage points for the first six months of 2012, and 2.6
percentage points and 5.1 percentage points for the first six months and second
quarter of 2011, respectively. The amount of claims paid fluctuates period to
period due to our mix of business and the timing of claims settlement and
catastrophic events.
Policy Acquisition Costs
Our policy acquisition cost percentage was 12.9% and 13.1% for the first six
months of 2012 and 2011, respectively, and 13.2% and 12.6% for the second
quarter of 2012 and 2011, respectively. The lower year-to-date percentage
primarily relates to a change in the mix of business. The 2011 policy
acquisition cost percentage was increased 0.1 percentage points due to $11.6
million of reinstatement premium (recorded as a reduction of net earned
premium).
Other Operating Expense
For the first six months of 2012, 62% of our other operating expense related to
compensation and benefits for our 1,866 employees. Other operating expense
increased 5% year-over-year, primarily due to increased bonus expense related to
higher net earnings in 2012. Other operating expense decreased 2%
quarter-over-quarter, primarily due to higher foreign currency benefit in 2012.
We recognized foreign currency benefit of $1.4 million and $4.2 million in the
first six months and second quarter of 2012, respectively, directly related to
the fluctuations in the British pound sterling. The foreign currency benefit was
$2.0 million and $0.8 million in the first six months and second quarter of
2011, respectively. Other operating expense included stock-based compensation
expense of $6.4 million in 2012 and $7.8 million in 2011. At June 30, 2012,
there was approximately $26.7 million of total unrecognized compensation expense
related to unvested options and restricted stock awards and units that is
expected to be recognized over a weighted-average period of 2.8 years.
Interest Expense
Interest expense on debt and short-term borrowings was $13.1 million and $11.0
million in the first six months of 2012 and 2011, respectively, and $6.2 million
and $5.4 million in the second quarter of 2012 and 2011, respectively. Our
interest expense increased in 2012 due to a higher amount of outstanding
borrowings on our $600.0 million Revolving Loan Facility, primarily to fund
purchases of our common stock. Our interest expense for 2012 and 2011 included
$9.7 million for our Senior Notes.
Income Tax Expense
Our effective income tax rate was 29.9% for the first six months of 2012,
compared to 27.1% for the same period of 2011. The higher effective rate in 2012
is due to the relationship of pretax income and tax-exempt investment income in
the two periods. Our pretax income was substantially lower in the first six
months of 2011 due to $73.3 million of net catastrophe losses, whereas our
tax-exempt investment income was essentially flat during the 2012 and 2011
six-month periods.
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Segment Operations
Each of our insurance segments bears risk for insurance coverage written within
its portfolio of insurance products. Each segment generates income from premium
written by our underwriting agencies, through third party agents and brokers, or
on a direct basis. The insurance segments also write facultative or individual
account reinsurance, as well as treaty reinsurance business. In some cases, we
purchase reinsurance to limit the segments' net losses from both individual
policy losses and multiple policy losses from catastrophe occurrences. Our
segments maintain disciplined expense management and a streamlined management
structure, which results in favorable expense ratios. The following provides
operational information about our five insurance segments and our Investing
segment.
U.S. Property & Casualty Segment
The following tables summarize the operations of the U.S. Property & Casualty
segment.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Net earned premium $ 177,852 $ 159,175 $ 88,834 $ 78,921
Other revenue 6,885 9,666 4,522 4,787
Segment revenue 184,737 168,841 93,356 83,708
Loss and loss adjustment expense, net 100,927 92,428 51,666 44,944
Other expense 59,767 55,575 30,045 27,169
Segment expense 160,694 148,003 81,711 72,113
Segment pretax earnings $ 24,043 $ 20,838 $ 11,645 $ 11,595
Net loss ratio 56.7 % 58.1 % 58.2 % 56.9 %
Expense ratio 32.4 32.9 32.2 32.5
Combined ratio 89.1 % 91.0 % 90.4 % 89.4 %
Aviation $ 58,220 $ 54,600 $ 29,397 $ 27,318
E&O 31,979 38,357 15,602 18,800
Public Risk 31,792 23,179 16,574 11,927
Other 55,861 43,039 27,261 20,876
Total net earned premium $ 177,852 $ 159,175 $ 88,834 $ 78,921
Aviation 55.8 % 63.7 % 64.5 % 68.9 %
E&O 60.8 57.3 60.6 55.0
Public Risk 77.8 66.9 63.9 60.5
Other 43.4 46.8 46.4 41.0
Total net loss ratio 56.7 % 58.1 % 58.2 % 56.9 %
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Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Aviation $ 82,870 $ 79,056 $ 45,780 $ 37,608
E&O 31,493 36,998 14,602 17,305
Public Risk 43,245 34,298 23,461 16,845
Other 161,005 115,159 81,623 64,203
Total gross written premium $ 318,613 $ 265,511 $ 165,466 $ 135,961
Aviation $ 63,405 $ 59,085 $ 35,898 $ 31,691
E&O 30,235 36,586 13,730 17,020
Public Risk 35,567 26,396 19,973 13,144
Other 68,687 58,369 35,965 31,859
Total net written premium $ 197,894 $ 180,436 $ 105,566 $ 93,714
Our U.S. Property & Casualty segment pretax earnings increased 15%
year-over-year due to higher net earned premium and a lower net loss ratio. Net
earned premium was higher in 2012 due to $6.0 million of additional premium from
our new technical property, primary casualty and excess casualty underwriting
teams, as well as increases in aviation, public risk, contingency, residual
value and title reinsurance premium. These increases more than offset lower
premium in our E&O line of business. Our new underwriting teams wrote $28.4
million of gross premium in the first six months of 2012, compared to $4.5
million in the same period of 2011. Segment earnings were impacted by $4.0
million of net catastrophe losses in the first quarter of 2012, primarily in our
public risk line of business. The 2011 segment earnings and net loss ratio
reflect the impact of $2.5 million of adverse loss development, including $1.0
million in the second quarter of 2011. The segment had no loss development in
2012.
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Professional Liability Segment
The following tables summarize the operations of the Professional Liability
segment.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Net earned premium $ 200,905 $ 203,174 $ 99,467 $ 102,424
Other revenue 267 249 134 48
Segment revenue 201,172 203,423 99,601 102,472
Loss and loss adjustment expense, net 134,323 138,015 65,168 71,752
Other expense 36,207 34,032 18,676 16,928
Segment expense 170,530 172,047 83,844 88,680
Segment pretax earnings $ 30,642 $ 31,376 $ 15,757 $ 13,792
Net loss ratio 66.9 % 67.9 % 65.5 % 70.1 %
Expense ratio 18.0 16.7 18.8 16.5
Combined ratio 84.9 % 84.6 % 84.3 % 86.6 %
U.S. D&O $ 170,667 $ 180,254 $ 84,413 $ 90,279
International D&O 30,238 22,920 15,054 12,145
Total net earned premium $ 200,905 $ 203,174 $ 99,467 $ 102,424
U.S. D&O 69.7 % 69.3 % 68.3 % 72.2 %
International D&O 51.0 57.2 50.1 54.3
Total net loss ratio 66.9 % 67.9 % 65.5 % 70.1 %
U.S. D&O $ 186,184 $ 200,661 $ 111,188 $ 123,470
International D&O 59,566 61,611 33,317 37,682
Total gross written premium $ 245,750 $ 262,272 $ 144,505 $ 161,152
U.S. D&O $ 136,826 $ 153,692 $ 81,121 $ 94,081
International D&O 34,311 36,956 19,103 22,776
Total net written premium $ 171,137 $ 190,648 $ 100,224$ 116,857
Our Professional Liability segment pretax earnings decreased 2% year-to-date due
to lower net earned premium in 2012 and increased 14% quarter-over-quarter due
to adverse development in 2011. Premium was lower in 2012 primarily due to
reunderwriting our diversified financial products (DFP) product, which is
included in U.S. D&O. In addition, we obtained more reinsurance in 2012. In
2011, the segment had adverse loss development related to DFP of $17.0 million
(representing 6.0 percentage points of the net loss ratio) in the first six
months, and $10.8 million (11.9 percentage points) in the second quarter. The
segment had no adverse loss development in 2012. We increased DFP's ultimate
loss ratio on underwriting year 2011 in the third quarter of 2011 and continued
to use that same ultimate loss ratio in 2012 for DFP's underwriting year 2011
premium that earned in 2012.
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Accident & Health Segment
The following tables summarize the operations of the Accident & Health segment.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Net earned premium $ 436,397 $ 400,657 $ 218,730 $ 202,117
Other revenue 2,496 2,194 1,158 1,178
Segment revenue 438,893 402,851 219,888 203,295
Loss and loss adjustment expense, net 324,717 291,605 163,004 146,747
Other expense 63,482 61,995 32,164 31,577
Segment expense 388,199 353,600 195,168 178,324
Segment pretax earnings $ 50,694 $ 49,251 $ 24,720 $ 24,971
Net loss ratio 74.4 % 72.8 % 74.5 % 72.6 %
Expense ratio 14.5 15.4 14.6 15.5
Combined ratio 88.9 % 88.2 % 89.1 % 88.1 %
Medical Stop-loss $ 387,673 $ 351,056 $ 194,586 $ 176,147
Other 48,724 49,601 24,144 25,970
Total net earned premium $ 436,397 $ 400,657 $ 218,730 $ 202,117
Medical Stop-loss 75.5 % 74.0 % 75.7 % 74.1 %
Other 65.9 64.2 65.3 62.2
Total net loss ratio 74.4 % 72.8 % 74.5 % 72.6 %
Medical Stop-loss $ 387,974 $ 351,154 $ 194,741 $ 176,197
Other 46,290 46,669 23,400 25,326
Total gross written premium $ 434,264 $ 397,823 $ 218,141 $ 201,523
Medical Stop-loss $ 387,673 $ 351,056 $ 194,586 $ 176,147
Other 46,067 46,444 23,270 25,248
Total net written premium $ 433,740 $ 397,500 $ 217,856$ 201,395
The Accident & Health segment pretax earnings increased 3% in the first six
months of 2012, compared to 2011. This increase was directly related to higher
net earned premium in our medical stop-loss product line due to writing new
business and rate increases, which were in line with medical loss cost trends,
on renewal business.
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U.S. Surety & Credit Segment
The following tables summarize the operations of the U.S. Surety & Credit
segment.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Net earned premium $ 100,844 $ 101,403 $ 53,115 $ 50,039
Other revenue 415 701 200 455
Segment revenue 101,259 102,104 53,315 50,494
Loss and loss adjustment expense, net 26,723 29,687 15,690 14,648
Other expense 55,523 55,252 27,403 26,997
Segment expense 82,246 84,939 43,093 41,645
Segment pretax earnings $ 19,013 $ 17,165 $ 10,222 $ 8,849
Net loss ratio 26.5 % 29.3 % 29.5 % 29.3 %
Expense ratio 54.8 54.1 51.4 53.5
Combined ratio 81.3 % 83.4 % 80.9 % 82.8 %
Surety $ 79,608 $ 80,809 $ 39,688 $ 40,148
Credit 21,236 20,594 13,427 9,891
Total net earned premium $ 100,844 $ 101,403 $ 53,115 $ 50,039
Surety 24.8 % 25.3 % 24.8 % 25.2 %
Credit 33.0 44.9 43.7 45.8
Total net loss ratio 26.5 % 29.3 % 29.5 % 29.3 %
Surety $ 80,762 $ 86,962 $ 40,836 $ 45,257
Credit 29,940 26,991 15,373 14,925
Total gross written premium $ 110,702 $ 113,953 $ 56,209 $ 60,182
Surety $ 73,385 $ 82,743 $ 37,251 $ 42,985
Credit 22,711 22,358 14,141 12,409
Total net written premium $ 96,096 $ 105,101 $ 51,392 $ 55,394
Our U.S. Surety & Credit segment pretax earnings increased 11% year-over-year
and 16% quarter-over-quarter. Gross and net written premium in our surety line
of business decreased in 2012 due to lower production of commercial bonds. New
quota share reinsurance on certain products also reduced the 2012 net written
premium. In the first quarter of 2012, we had a large loss in our credit line of
business, which had significant reinsurance recoveries. Our losses net of these
reinsurance recoveries were limited, resulting in a lower 2012 year-to-date loss
ratio. The benefit related to the lower loss ratio was partially offset by a
reduction of net written premium and net earned premium due to $4.3 million of
reinstatement premium related to this large loss.
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International Segment
The following tables summarize the operations of the International segment.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Net earned premium $ 196,472 $ 168,164 $ 105,188 $ 90,717
Other revenue 2,135 1,902 941 894
Segment revenue 198,607 170,066 106,129 91,611
Loss and loss adjustment expense, net 79,623 130,393 41,856 56,221
Other expense 68,765 64,020 36,612 32,355
Segment expense 148,388 194,413 78,468 88,576
Segment pretax income (loss) $ 50,219 $ (24,347 ) $ 27,661 $ 3,035
Net loss ratio 40.5 % 77.5 % 39.8 % 62.0 %
Expense ratio 34.6 37.6 34.5 35.3
Combined ratio 75.1 % 115.1 % 74.3 % 97.3 %
Energy $ 40,889 $ 28,683 $ 25,795 $ 16,634
Property Treaty 49,007 37,965 26,918 21,961
Liability 39,131 39,898 19,649 19,966
Surety & Credit 34,945 36,057 17,184 18,683
Other 32,500 25,561 15,642 13,473
Total net earned premium $ 196,472 $ 168,164 $ 105,188 $ 90,717
Energy 41.6 % 59.8 % 44.2 % 44.5 %
Property Treaty 17.7 103.4 21.7 86.5
Liability 49.5 51.2 47.9 50.6
Surety & Credit 58.2 41.2 48.2 42.0
Other 43.7 151.3 44.2 88.2
Total net loss ratios 40.5 % 77.5 % 39.8 % 62.0 %
Energy $ 110,714 $ 96,381 $ 90,119 $ 80,078
Property Treaty 113,855 104,115 44,517 32,296
Liability 40,242 48,071 20,982 23,953
Surety & Credit 43,451 47,189 22,493 20,516
Other 56,649 55,825 29,124 26,390
Total gross written premium $ 364,911 $ 351,581 $ 207,235 $ 183,233
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Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Energy $ 81,013 $ 62,897 $ 68,189 $ 57,845
Property Treaty 99,819 86,126 37,517 24,966
Liability 37,316 44,433 19,424 22,073
Surety & Credit 39,813 43,466 20,786 18,708
Other 43,662 38,000 21,137 18,890
Total net written premium $ 301,623 $ 274,922 $ 167,053$ 142,482
Our International segment pretax earnings were impacted in both years by net
catastrophe losses, which were substantially higher in 2011. The 2012 losses
related to small catastrophes in our property treaty business. In 2011, we
experienced losses from catastrophes in Japan, New Zealand, Australia, the
United States and Denmark. The 2011 catastrophic events impacted our energy and
property treaty lines of business, as well as our property (direct and
facultative) and accident and health lines of business (both included in Other).
We reinsured a portion of our exposure to these catastrophic events and incurred
net reinstatement premium for continued reinsurance coverage, which reduced 2011
net written and net earned premium. The following table summarizes the segment's
catastrophe losses, as well as the impact on key metrics:
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Loss and loss adjustment expense, after
reinsurance $ 8,668 $ 60,672 $ 5,835 $ 18,300
Reinstatement premium, net (411) 11,608 (1,182) 4,515
Total net catastrophe losses $ 8,257 $ 72,280
$ 4,653 $ 22,815
Impact of net catastrophe losses
(percentage points):
Net loss ratio 4.3 % 38.7 % 5.2 % 22.2 %
Expense ratio (0.1 ) 2.4 (0.4 ) 1.6
Combined ratio 4.2 % 41.1 % 4.8 % 23.8 %
The segment's increase in net earned premium primarily related to higher
writings in our energy product line, as well as the impact of reinstatement
premium in our property treaty and property (direct and facultative) lines. The
energy, property treaty and Other net loss ratios reflect the catastrophe
losses. The higher expense ratios in 2011 were due to the impact of
reinstatement premium on net earned premium.
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Investing Segment
We invest the majority of our funds in highly-rated fixed maturity securities,
which are designated as available for sale securities. We held $6.1 billion of
fixed maturity securities at June 30, 2012. Substantially all of our fixed
maturity securities were investment grade and 77% were rated AAA or AA. At
June 30, 2012, the portfolio's average tax equivalent yield was 4.8%, the
weighted-average life was 7.8 years, and the weighted-average duration was 4.5
years.
The following tables summarize the investment results of our Investing segment.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Fixed maturity securities $ 111,090 $ 104,045 $ 53,363 $ 52,039
Equity securities 993 - 993 -
Short-term investments 102 321 40 165
Other investments 868 2,030 401 1,388
Net realized investment gain 7,047 495 6,876 1,054
Other-than-temporary impairment credit
losses (397) (3,479) (397) (350)
Investment expenses (2,753) (2,379) (1,507) (1,170)
Segment pretax earnings $ 116,950 $ 101,033 $ 59,769 $ 53,126
Fixed maturity securities:
Average yield * 3.9 % 3.9 % 3.8 % 3.9 %
Average tax equivalent yield * 4.8 % 4.8 % 4.6 % 4.7 %
Weighted-average life 7.8 years 7.2 years
Weighted-average duration 4.5 years 5.3 years
Weighted-average rating AA AA+
* Excluding realized and unrealized gains and losses.
In 2012, we began investing in bank loans (classified as Corporate securities),
which we expect will generate attractive yields and lower our overall duration
without altering the weighted-average duration of the portfolio. We also began
investing in publicly-traded equity securities. As of June 30, 2012, we have
invested $98.7 million in bank loans and $92.6 million in equity securities.
The weighted-average duration of our fixed maturity securities portfolio dropped
between June 30, 2011 and June 30, 2012, primarily due to the impact of lower
market interest rates on our municipal and structured securities with prepayment
options. The decline in the weighted-average rating of our portfolio, which
occurred in the third quarter of 2011, was a direct result of Standard & Poor's
Corporation's downgrade of the U.S. government debt rating in August 2011.
On March 31, 2012, we reclassified our entire portfolio of fixed maturity
securities classified as held to maturity, which consisted of corporate
securities, U.S. government and foreign government securities, to fixed maturity
securities classified as available for sale. Financial markets have been
disrupted recently by several events, including the European debt crisis and the
August 2011 downgrade of U.S. government debt by Standard & Poor's Corporation.
Due to these market disruptions and our desire to maintain greater flexibility
in managing our entire investment portfolio in an uncertain economy, we changed
our prior intent to hold these securities to maturity. On the date of transfer,
these securities had a fair value of $139.1 million and an amortized cost of
$136.0 million. The transferred securities' net unrealized appreciation, net of
tax, increased our accumulated other comprehensive income and shareholders'
equity by $2.0 million as of March 31, 2012.
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This table summarizes our investments by type, substantially all of which were
reported at fair value, at June 30, 2012 and December 31, 2011.
June 30, 2012 December 31, 2011
Amount % Amount %
Fixed maturity securities
U.S. government and government
agency securities $ 228,971 4 % $ 302,677 5 %
Fixed maturity securities of
states, municipalities and
political subdivisions 1,073,868 17 1,085,341 18
Special purpose revenue bonds of
states, municipalities and
political subdivisions 2,007,548 31 1,863,888 31
Corporate securities 1,129,657 17 956,617 16
Residential mortgage-backed
securities 902,832 14 1,100,086 18
Commercial mortgage-backed
securities 416,700 6 256,124 4
Asset-backed securities 46,182 1 34,746 1
Foreign government securities 292,108 5 280,457 4
Equity securities 93,660 1 - -
Short-term investments 217,087 3 133,917 2
Other investments 37,720 1 35,897 1
Total investments $ 6,446,333 100 % $ 6,049,750 100 %
Our total investments increased $396.6 million in 2012, principally from: 1)
operating cash flow, 2) consolidation of our Lloyd's of London Syndicate 4040
upon its merger into Syndicate 4141 as of January 1, 2012 and 3) a $54.7 million
increase in the pretax net unrealized gain associated with our available for
sale securities in the first six months of 2012. During 2011, we substantially
reduced our short-term investments and re-invested the funds in long-term fixed
maturity securities in order to maximize our investment return.
The ratings of our individual securities within our fixed maturity securities
portfolio at June 30, 2012 were as follows:
Amount %
AAA $ 855,164 14 %
AA 3,837,496 63
A 1,039,604 17
BBB 254,520 4
BB and below 111,082 2
Total fixed maturity securities $ 6,097,866 100 %
At June 30, 2012, we held $2.0 billion of special purpose revenue bonds, as well
as $1.1 billion of general obligation bonds, which are issued by states,
municipalities and political subdivisions and collectively referred to, in the
investment market, as municipal bonds. The overall rating of our municipal bonds
was AA at June 30, 2012. Within our municipal bond portfolio, we held $366.8
million of pre-refunded bonds, which are supported by U.S. government debt
obligations. Our special purpose revenue bonds are secured by revenue sources
specific to each security. At June 30, 2012, the percentages of our special
purpose revenue bond portfolio supported by these major revenue sources were as
follows: 1) water and sewer - 25%, 2) education - 22%, 3) transportation - 20%,
4) leasing - 9% and 5) electric - 7%.
Many of our special purpose revenue bonds are insured by mono-line insurance
companies or supported by credit enhancement programs of various states and
municipalities. We view bond insurance as credit enhancement and not credit
substitution. We base our investment decision on the strength of the issuer. A
credit review is performed on each issuer and on the sustainability of the
revenue source before we acquire a special purpose revenue bond and
periodically, on an ongoing basis, thereafter. The underlying average credit
rating of our special purpose revenue bond issuers, excluding any bond
insurance, was AA at June 30, 2012. Although recent economic conditions in the
United States may reduce the source of revenue to support certain of these
securities, the majority are supported by revenue from essential sources, as
indicated above, which we believe generate a stable source of revenue.
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At June 30, 2012, we held corporate fixed maturity securities issued by foreign
corporations with an aggregate fair value of $422.1 million. In addition, we
held securities issued by foreign governments, agencies or supranational
entities with an aggregate fair value of $292.1 million. At June 30, 2012, our
holdings of foreign debt were relatively unchanged from our holdings of foreign
debt at December 31, 2011.
At June 30, 2012, we held a commercial mortgage-backed securities portfolio with
a fair value of $416.7 million, an average rating of AA+ and an average
loan-to-value ratio of 71%. We owned no collateralized debt obligations (CDOs)
or collateralized loan obligations (CLOs), and we are not a counterparty to any
credit default swap transactions.
The methodologies used to determine the fair value of our investments are
described in Note 3, "Fair Value Measurements" to the Consolidated Financial
Statements. The accounting policies and procedures that we use to determine our
other-than-temporary impairment losses are described in Note 2, "Investments" to
the Consolidated Financial Statements and "Critical Accounting Policies -
Other-than-temporary Impairments in Investments" in Management's Discussion and
Analysis of Financial Condition and Results of Operations in our Annual Report
on Form 10-K for the year ended December 31, 2011.
Corporate & Other
The following table summarizes activity in the Corporate & Other category.
Six months ended June 30, Three months ended June 30,
2012 2011 2012 2011
Net earned premium $ 2 $ 158 $ (3) $ 33
Other revenue 191 84 233 113
Total revenue 193 242 230 146
Loss and loss adjustment expense, net (560) (260) (559) (30)
Other expense - Exited Lines 1,625 2,101 980 1,034
Other expense - Corporate 28,006 25,204 13,427 13,080
Interest expense 12,844 10,734 6,042 5,305
Foreign currency benefit (1,440) (2,005) (4,205) (780)
Total expense 40,475 35,774 15,685 18,609
Pretax loss $ (40,282) $ (35,532) $ (15,455) $ (18,463)
Our Corporate expenses not allocable to the segments increased $2.8 million in
2012, primarily due to higher employee compensation and benefit costs and
incremental expense related to our new technology systems. Our interest expense
increased due to a higher amount of outstanding borrowings on our $600.0 million
Revolving Loan Facility in 2012.
The impact of foreign currency fluctuated period-over-period due to our
increased level of available for sale securities denominated in foreign
currencies and weakening of the British pound sterling relative to the U.S.
dollar in 2012. We hold available for sale securities denominated in foreign
currencies to economically hedge the currency exchange risk on our
foreign-denominated loss reserves. The foreign currency gain or loss related to
loss reserves is recorded through the income statement, while the foreign
currency gain or loss related to available for sale securities is recorded
through other comprehensive income within shareholders' equity. This mismatch
may cause fluctuations in our reported foreign currency benefit or expense in
future periods.
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Liquidity and Capital Resources
We believe we have sufficient sources of liquidity at a reasonable cost at the
present time. Our primary sources of liquidity are as follows:
• We held $280.3 million of cash and liquid short-term investments at June 30,
2012.
• Our available for sale securities portfolio had a fair value of $6.2 billion
at June 30, 2012, of which $209.4 million was bonds and equity securities
that are held directly by the parent company. We generally intend to hold
fixed maturity securities until their maturity, but we would be able to sell
securities to generate cash if the need arises.
• We have a four-year $600.0 million Revolving Loan Facility that expires on
March 8, 2015. We had $298.1 million of borrowing capacity available at
June 30, 2012.
• Our long-term debt consists of $300.0 million principal amount of unsecured
6.30% Senior Notes due November 15, 2019. Our debt to total capital ratio
was 15.0% at June 30, 2012 and 12.8% at December 31, 2011, with the increase
related to our borrowings under the Revolving Loan Facility.
• We have a $90.0 million Standby Letter of Credit Facility that expires on
December 31, 2015, which is used to guarantee our performance in our Lloyd's
of London syndicate.
• Our domestic insurance subsidiaries have the ability to pay $255.1 million in dividends in 2012 to the parent company without obtaining special
permission from state regulatory authorities. HCC can utilize these
dividends for any purpose, including paying down debt, paying dividends to
shareholders, funding acquisitions, purchasing our common stock and paying
operating expenses.
• We have a new "Universal Shelf" registration statement, which was filed and
became effective in March 2012 and expires in March 2015. The current shelf
registration statement provides for the issuance of an aggregate of $1.0
billion of securities. These securities may be debt securities, equity
securities, or a combination thereof. The shelf registration statement
provides us the means to access the debt and equity markets relatively
quickly, if we are satisfied with the current pricing in the financial
market.
Capital Management
Notes Payable
There have been no changes to the terms and conditions related to our Senior
Notes, the $600.0 million Revolving Loan Facility (the Facility) or the Standby
Letter of Credit Facility from those described in Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources" in our Annual Report on Form 10-K for the year
ended December 31, 2011.
As of June 30, 2012, we had outstanding borrowings under the Facility of $292.0
million, primarily to fund purchases of our common stock. The weighted-average
interest rate on borrowings under the Facility at June 30, 2012 was 1.62%. The
borrowings and letters of credit issued under the Facility reduced our available
borrowing capacity on the Facility to $298.1 million at June 30, 2012.
We were in compliance with debt covenants related to our Senior Notes, the
Facility, and the Standby Letter of Credit Facility at June 30, 2012.
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Share Repurchases
On September 23, 2011, the Board approved the purchase of up to $300.0 million
of our common stock (the Plan). Purchases under the Plan may be made in the open
market or in privately negotiated transactions from time-to-time in compliance
with applicable laws, rules and regulations, including Rule 10b-18 under the
Securities Exchange Act of 1934, as amended. Purchases under the Plan will be
made opportunistically from time-to-time, subject to market and business
conditions, the level of cash generated from our operations, cash required for
acquisitions, our debt covenant compliance, and other relevant factors. The Plan
does not obligate us to purchase any particular number of shares, has no
expiration date, and may be suspended or discontinued at any time at the Board's
discretion.
In the second quarter of 2012, we purchased $59.5 million, or 1.9 million
shares, at an average cost of $31.17 per share. We purchased $126.4 million, or
4.1 million shares, at an average cost of $30.88 per share in the first six
months of 2012. As of July 27, 2012, $100.0 million of repurchase authority
remains under the Plan.
Hedge of Investment in Subsidiary
During the second quarter of 2012, we entered into a forward contract to sell
45.0 million Euros for U.S. dollars in the third quarter of 2013. This
transaction hedges our net investment in a Euro-functional currency subsidiary
by limiting the negative impact of future decreases in the Euro relative to the
U.S. dollar. Because this transaction qualifies as a hedge of our net investment
in a Euro-functional currency subsidiary, changes in fair value of the forward
contract will offset changes in the value of the net investment in subsidiary
that is being hedged, with no impact on pretax earnings. The fair value of the
forward contract was a $0.9 million liability at June 30, 2012. See Note 1,
"General Information -Derivative Financial Instrument" to the Consolidated
Financial Statements.
Cash Flow
We receive substantial cash from premiums, reinsurance recoverables, surety
collateral, outward commutations, proceeds from sales and redemptions of
investments, and investment income. Our principal cash outflows are for the
payment of claims and loss adjustment expenses, premium payments to reinsurers,
return of surety collateral, inward commutations, purchases of investments, debt
service, policy acquisition costs, operating expenses, taxes, dividends, and
common stock purchases. Cash provided by operating activities can fluctuate due
to timing differences in the collection of premium receivables, reinsurance
recoverables and surety collateral; the payment of losses, premium payables,
return of surety collateral; and the completion of commutations.
The components of our net operating cash flows are summarized in the following
table.
Six months ended June 30,
2012 2011
Net earnings $ 176,077 $ 116,468
Change in premium, claims and other receivables, net of
reinsurance, premium and claims payables
and excluding restricted cash (64,793) (133,658)
Change in unearned premium, net 83,497
99,885
Change in loss and loss adjustment expense payable, net
of reinsurance recoverables 87,846 63,142
Other, net (38,076) (24,053)
Cash provided by operating activities $ 244,551
$ 121,784
We generated $122.8 million more cash flow from operating activities in the
first six months of 2012 than in the same period of 2011. The increase was
primarily from additional premium collections, lower paid losses and the timing
of tax payments. Our cash flow from operating activities was reduced $27.5
million in 2012 and $26.7 million in 2011 for payments we made to commute large
contracts in our assumed accident and health reinsurance business reported in
Exited Lines. Receipt and repayment of collateral funds related to surety bonds
also decreased our cash flow from operating activities by $21.2 million and
$18.4 million in 2012 and 2011, respectively.
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Accounting Guidance Adopted in 2012
See Note 1, "General Information - Accounting Guidance Adopted in 2012" to the
Consolidated Financial Statements for a description of recently adopted
accounting guidance related to deferred policy acquisition costs and its
retrospective impact on our prior year consolidated financial statements.
Critical Accounting Policies
We provided information about our critical accounting policies in Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Critical Accounting Policies" in our Annual Report on Form 10-K for
the year ended December 31, 2011. We have made no changes in the identification
or methods of application of these policies.
