References to the "Company," "Alleghany," "we," "us," and "our" in Items 2, 3
and 4 of Part I, as well as in Part II, of this Quarterly Report on Form 10-Q,
or "this Form 10-Q," refer to Alleghany Corporation and its consolidated
subsidiaries unless the context otherwise requires. In addition, unless the
context otherwise requires, references to
• "Transatlantic" are to our reinsurance holding company subsidiary
Transatlantic Holdings, Inc. and its subsidiaries,
• "AIHL" are to our insurance holding company subsidiary Alleghany Insurance
Holdings LLC,
• "RSUI" are to our subsidiary RSUI Group, Inc. and its subsidiaries,
• "CATA" are to our subsidiary Capitol Transamerica Corporation and its
subsidiaries, and also include the operations and results of Platte River
Insurance Company, or "Platte River," unless the context otherwise
requires,
• "PCC" are to our subsidiary Pacific Compensation Corporation,
• "Alleghany Properties" are to our subsidiary Alleghany Properties Holdings
LLC and its subsidiaries, and
• "Bourn & Koch" are to our majority-owned subsidiary BKH Holdings, Inc.,
and its wholly-owned subsidiary Bourn & Koch, Inc.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Quantitative and Qualitative Disclosures About Market Risk"
contain disclosures which are forward-looking statements as defined in the
Private Securities Litigation Reform Act of 1995. Forward-looking statements
include all statements that do not relate solely to historical or current facts,
and can be identified by the use of words such as "may," "will," "expect,"
"project," "estimate," "anticipate," "plan," "believe," "potential," "should,"
"continue" or the negative versions of those words or other comparable words.
These forward-looking statements are based upon our current plans or
expectations and are subject to a number of uncertainties and risks that could
significantly affect current plans, anticipated actions and our future financial
condition and results. These statements are not guarantees of future
performance, and we have no specific intention to update these statements. The
uncertainties and risks include, but are not limited to,
• significant weather-related or other natural or human-made catastrophes
and disasters;
• the cyclical nature of the property and casualty reinsurance and insurance industries;
• changes in market prices of our significant equity investments and changes
in value of our debt securities portfolio;
• adverse loss development for events insured by our reinsurance and
insurance operating units in either the current year or prior years;
• the long-tail and potentially volatile nature of certain casualty lines of
business written by our reinsurance and insurance operating units;
• the cost and availability of reinsurance;
• exposure to terrorist acts and acts of war;
• the willingness and ability of our reinsurance and insurance operating
units' reinsurers to pay reinsurance recoverables owed to our reinsurance
and insurance operating units;
• changes in the ratings assigned to our reinsurance and insurance operating units;
• claims development and the process of estimating reserves;
• legal, political, judicial and regulatory changes, including the federal
financial regulatory reform of the insurance industry by the Dodd-Frank
Wall Street Reform and Consumer Protection Act or, the "Dodd-Frank Act";
• the uncertain nature of damage theories and loss amounts;
• the reliance by our reinsurance operating units on a limited number of
brokers;
• increases in the levels of risk retention by our reinsurance and insurance operating units;
• the loss of key personnel;
• fluctuation in foreign currency exchange rates;
• risks associated with our failure to comply with the restrictive covenants
contained in the agreements governing our indebtedness;
• risks associated with our ability to make payments on, or repay or
refinance, our debt;
• risks associated with our ability to successfully integrate
Transatlantic's operations and employees; and
• risks inherent in international operations.
Additional risks and uncertainties include general economic and political
conditions, including the effects of a prolonged U.S. or global economic
downturn or recession; changes in costs; variations in political, economic or
other factors; risks relating to conducting operations in a competitive
environment; effects of acquisition and disposition activities, inflation rates,
or recessionary or
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expansive trends; changes in interest rates; extended labor disruptions, civil
unrest, or other external factors over which we have no control; and changes in
our plans, strategies, objectives, expectations, or intentions, which may happen
at any time at our discretion. As a consequence, current plans, anticipated
actions, and future financial condition and results may differ from those
expressed in any forward-looking statements made by us or on our behalf. See
Part II, Item 1A of this Form 10-Q for a more detailed discussion of these risks
and uncertainties.
Critical Accounting Estimates
This discussion and analysis of financial condition and results of operations is
based on our consolidated financial statements which have been prepared in
accordance with accounting principles generally accepted in the United States of
America, or "GAAP." The preparation of financial statements in conformity with
GAAP requires management to make estimates and assumptions about future events
that directly affect our reported financial condition and operating performance.
More specifically, these estimates and assumptions affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements, as well as the reported amounts of
revenues and expenses during the reporting period. We rely on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances to make judgments about the carrying value of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ materially from reported results to the extent that estimates and
assumptions prove to be inaccurate.
We believe our most critical accounting estimates are those with respect to the
liability for unpaid loss and loss adjustment expense, or "LAE," fair value
measurements of certain financial assets, other than temporary impairment, or
"OTTI," losses on investments, goodwill and other intangibles, and reinsurance
premium revenues, as they require management's most significant exercise of
judgment on both a quantitative and qualitative basis in the preparation of our
consolidated financial statements and accompanying notes. The accounting
estimates that result require the use of assumptions about certain matters that
are highly uncertain at the time of estimation. To the extent actual experience
differs from the assumptions used, our financial condition, results of
operations, and cash flows would be affected, possibly materially.
Unpaid Loss and LAE
Overview. The estimation of the liability for unpaid loss and LAE is inherently
difficult and subjective, especially in view of changing legal and economic
environments that impact the development of loss reserves, and therefore,
quantitative techniques frequently have to be supplemented by subjective
considerations and managerial judgment. In addition, trends that have affected
development of liabilities in the past may not necessarily occur or affect
liability development to the same degree in the future.
Each of our reinsurance and insurance operating units establishes reserves on
its balance sheet for unpaid loss and LAE related to its property and casualty
reinsurance and insurance contracts. As of any balance sheet date, historically
there have been claims that have not yet been reported, and some claims may not
be reported for many years after the date a loss occurs. As a result of this
historical pattern, the liability for unpaid loss and LAE includes significant
estimates for incurred but not reported, or "IBNR," claims. Additionally,
reported claims are in various stages of the settlement process. Each claim is
settled individually based upon its merits, and certain claims may take years to
settle, especially if legal action is involved. As a result, the liabilities for
unpaid loss and LAE include significant judgments, assumptions and estimates
made by management relating to the actual ultimate losses that will arise from
the claims. Due to the inherent uncertainties in the process of establishing
these liabilities, the actual ultimate loss from a claim is likely to differ,
perhaps materially, from the liability initially recorded and could be material
to the results of our operations. The accounting policies that we use in
connection with the establishment of these liabilities include critical
accounting estimates.
As noted above, as of any balance sheet date, not all claims that have occurred
have been reported to us, and if reported may not have been settled. The time
period between the occurrence of a loss and the time it is settled is referred
to as the "claim tail." In general, actuarial judgments for shorter tailed lines
of business generally have much less of an effect on the determination of the
loss reserve amount than when those same judgments are made regarding longer
tailed lines of business. Reported losses for the shorter tailed classes, such
as property and certain marine and energy classes, generally reach the ultimate
level of incurred losses in a relatively short period of time. Rather than
having to rely on actuarial assumptions for many accident years, these
assumptions are generally only relevant for the most recent accident year or
two. Therefore, these assumptions tend to be less critical and the reserves
calculated pursuant to these assumptions are subject to less variability for the
shorter tailed lines of business.
Standard actuarial methodologies employed to estimate ultimate losses
incorporate the inherent lag from the time claims occur to when they are
reported to the insurer and, if applicable, to when the insurer reports the
claims to the reinsurer. Certain actuarial methodologies may be more appropriate
than others in instances where this lag may not be consistent from period to
period. Consequently, additional actuarial judgment is employed in the selection
of methodologies to best incorporate the potential impact of this situation.
Property insurance claims usually have a fairly short claim tail and, absent
claim litigation, are typically reported and settled within no more than a few
years of the date they occur. For short-tail lines, loss reserves consist
primarily of reserves for reported claims. The process of recording quarterly
and annual liabilities for unpaid loss and LAE for short-tail lines is primarily
focused on maintaining an appropriate reserve level for reported claims and
IBNR. Specifically, we assess the reserve adequacy of IBNR in light
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of such factors as the current levels of reserves for reported claims and
expectations with respect to reporting lags, historical data, legal
developments, and economic conditions, including the effects of inflation.
Our insurance operating units provide coverage on both a claims-made and
occurrence basis. Claims-made policies generally require that claims occur and
be reported during the coverage period of the policy. Occurrence policies allow
claims which occur during a policy's coverage period to be reported after the
coverage period, and as a result, these claims can have a very long claim tail,
occasionally extending for decades. Casualty claims can have a very long claim
tail, in certain situations extending for many years. In addition, casualty
claims are more susceptible to litigation and the legal environment and can be
significantly affected by changing contract interpretations, all of which
contribute to extending the claim tail. For long-tail casualty lines of
business, estimation of ultimate liabilities for unpaid loss and LAE is a more
complex process and depends on a number of factors, including the line and
volume of the business involved. For these reasons, our insurance operating
units will generally use actuarial projections in setting reserves for all
casualty lines of business.
While the reserving process is difficult for insurance business, the inherent
uncertainties of estimating loss reserves are even greater for reinsurance
business, due primarily to the longer tailed nature of much of the reinsurance
business, the diversity of development patterns among different types of
reinsurance contracts, the necessary reliance on the ceding companies for
information regarding reported claims and differing reserving practices among
ceding companies, which can be subject to change without notice. We write a
significant amount of non-proportional assumed casualty reinsurance as well as
proportional assumed reinsurance of excess liability business for classes such
as medical malpractice, directors and officers, or "D&O," liability, errors and
omissions liability and general casualty. Claims from such classes can exhibit
greater volatility over time than most other classes due to their low frequency,
high severity nature and loss cost trends that are more difficult to predict.
The estimation of unpaid losses and LAE for our reinsurance operations is
principally based on reports and individual case estimates received from ceding
companies. Data received from cedants is subjected to audits periodically by our
claims and underwriting personnel, to help ensure that reported data is
supported by proper documentation and conforms to contract terms, and is
analyzed, as appropriate, by our underwriting and actuarial personnel. Such
analysis often includes a detailed review of reported data to assess the
underwriting results of reinsurance assumed and to explain any significant
departures from expected performance. Over time, reported loss information is
ultimately corroborated when such information eventually attains paid status.
In addition, the estimation of unpaid losses and LAE, including IBNR, for our
reinsurance operations also takes into account our assumptions with respect to
many factors that will affect ultimate loss costs but are not yet known. The
ultimate process by which actual carried reserves are determined considers not
only actuarial estimates but a myriad of other factors. Such factors, both
internal and external, which contribute to the variability and unpredictability
of loss costs, include trends relating to jury awards, social trends, medical
inflation, worldwide economic conditions, tort reforms, court interpretations of
coverages, the regulatory environment, underlying policy pricing, terms and
conditions and claims handling, among others. In addition, information gathered
through underwriting and claims audits is also considered. We assess the
reasonableness of our unpaid losses and LAE for our reinsurance operations using
various actuarial methodologies, principally the paid development method, the
reported loss development method and the Bornhuetter-Ferguson method as
described below.
In conformity with GAAP, we are not permitted to establish IBNR reserves for
catastrophe losses that have not occurred. Therefore, losses related to a
significant catastrophe, or accumulation of catastrophes, in any reporting
period could have a material, negative impact on our results of operations and
financial condition during that period.
Although we are unable at this time to determine whether additional reserves,
which could have a material impact upon our financial condition, results of
operations, and cash flows, may be necessary in the future, we believe that the
reserves for unpaid loss and LAE established by our reinsurance and insurance
operating units are adequate as of June 30, 2012.
Methodologies and Assumptions. We use a variety of techniques that employ
significant judgments and assumptions to establish the liabilities for unpaid
loss and LAE recorded at the balance sheet date. These techniques include
detailed statistical analyses of past claim reporting, settlement activity,
claim frequency, internal loss experience, changes in pricing or coverages and
severity data when sufficient information exists to lend statistical credibility
to the analyses. More subjective techniques are used when statistical data is
insufficient or unavailable. These liabilities also reflect implicit or explicit
assumptions regarding the potential effects of future inflation, judicial
decisions, changes in laws and recent trends in such factors, as well as a
number of actuarial assumptions that vary across our reinsurance and insurance
operating units and across lines of business. This data is analyzed by line of
business, coverage, accident year or underwriting year and reinsurance contract
type, as appropriate.
Our loss reserve review processes use actuarial methods that vary by operating
unit and line of business and produce point estimates for each class of
business. The actuarial methods used include the following methods:
• Reported Loss Development Method: a reported loss development pattern is
calculated based on historical loss development data, and this pattern is
then used to project the latest evaluation of cumulative reported losses
for each accident year or underwriting year, as appropriate, to ultimate
levels;
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• Paid Development Method: a paid loss development pattern is calculated
based on historical paid loss development data, and this pattern is then
used to project the latest evaluation of cumulative paid losses for each
accident year or underwriting year, as appropriate, to ultimate levels;
• Expected Loss Ratio Method: expected loss ratios are applied to premiums earned, based on historical company experience, or historical insurance
industry results when company experience is deemed not to be
sufficient; and
• Bornhuetter-Ferguson Method: the results from the Expected Loss Ratio
Method are essentially blended with either the Reported Loss Development
Method or the Paid Development Method.
The primary actuarial assumptions used by our reinsurance and insurance
operating units include the following:
• Expected loss ratios represent management's expectation of losses, in
relation to earned premium, at the time business is written, before any
actual claims experience has emerged. This expectation is a significant
determinant of the estimate of loss reserves for recently written business
where there is little paid or incurred loss data to consider. Expected
loss ratios are generally derived from historical loss ratios adjusted for
the impact of rate changes, loss cost trends and known changes in the type
of risks underwritten. For certain longer tailed reinsurance business that
are typically lower frequency, high severity classes, expected loss ratios
are often utilized for the last several accident years or underwriting
years, as appropriate.
• Rate of loss cost inflation (or deflation) represents management's
expectation of the inflation associated with the costs we may incur in the
future to settle claims. Expected loss cost inflation is particularly
important for longer tailed classes.
• Reported and paid loss emergence patterns represent management's expectation of how losses will be reported and ultimately paid in the
future based on the historical emergence patterns of reported and paid
losses and are derived from past experience of our operating units,
modified for current trends. These emergence patterns are used to project
current reported or paid loss amounts to their ultimate settlement value.
Each of the above actuarial assumptions may also incorporate data from the
insurance or reinsurance industries as a whole, or peer companies writing
substantially similar coverages, in the absence of sufficiently credible
internally-derived historical information. Data from external sources may be
used to set expectations, as well as assumptions regarding loss frequency or
severity relative to an exposure unit or claim, among other actuarial
parameters. Assumptions regarding the application or composition of peer group
or industry reserving parameters require substantial judgment.
Prior Year Development. Our reinsurance and insurance operating units
continually evaluate the potential for changes, both positive and negative, in
their estimates of their loss and LAE liabilities and use the results of these
evaluations to adjust both recorded liabilities and underwriting criteria. With
respect to liabilities for unpaid loss and LAE established in prior years, these
liabilities are periodically analyzed and their expected ultimate cost adjusted,
where necessary, to reflect positive or negative development in loss experience
and new information, including, for certain catastrophic events, revised
industry estimates of the magnitude of a catastrophe. Adjustments to previously
recorded liabilities for unpaid loss and LAE, both positive and negative, are
reflected in our financial results in the periods in which these adjustments are
made and are referred to as prior year reserve development. We adjusted our
prior year loss and LAE reserve estimate during the three and six months ended
June 30, 2012 and 2011 based on current information that differed from previous
assumptions made at the time such loss and LAE reserves were previously
estimated (see the consolidated results of operations for further detail).
Asbestos and Environmental Impairment Reserves. Loss and LAE include amounts for
risks relating to asbestos-related illnesses and environmental impairment. See
Note 12(d) to the Unaudited Consolidated Financial Statements set forth in Part
I, Item 1 of this Form 10-Q for further information.
Reinsurance. Our operating units reinsure portions of the risk they underwrite
in order to reduce the effect of individual or aggregate exposure to losses,
manage capacity, protect capital resources, reduce volatility in specific lines,
improve risk-adjusted portfolio returns and to enable us to increase gross
premium writings and risk capacity without requiring additional capital. If the
assuming reinsurers are unable or unwilling to meet the obligations assumed
under the applicable reinsurance agreements, our operating units would remain
liable for such reinsurance portion not paid by their reinsurers. Recoverables
recorded with respect to claims ceded to reinsurers under reinsurance contracts
are predicated in large part on the estimates for unpaid losses and, therefore,
are also subject to a significant degree of uncertainty. In addition to the
factors cited above, reinsurance recoverables may prove uncollectible if the
reinsurer is unable to perform under the contract. Reinsurance purchased by our
operating units does not relieve them of their obligations to their own
policyholders or cedants.
Fair Value Measurement of Certain Financial Assets
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 willing, able and
knowledgeable market participants at the measurement date. Fair value
measurements are not adjusted for transaction costs. In addition, a three-tiered
hierarchy for inputs is used in management's determination of fair value of
financial instruments that emphasizes the use of observable inputs over the use
of unobservable inputs by requiring that the observable inputs be
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used when available. Observable inputs are market participant assumptions based
on market data obtained from sources independent of the reporting entity.
Unobservable inputs are the reporting entity's own assumptions about market
participant assumptions based on the best information available under the
circumstances. In assessing the appropriateness of using observable inputs in
making fair value determinations, we consider whether the market for a
particular security is "active" or not based on all the relevant facts and
circumstances. A market may be considered to be inactive if there are relatively
few recent transactions or if there is a significant decrease in market volume.
Furthermore, we consider whether observable transactions are "orderly" or not.
We do not consider a transaction to be orderly if there is evidence of a forced
liquidation or other distressed condition, and as such, little or no weight is
given to that transaction as an indicator of fair value.
A three-tiered hierarchy for inputs is used in management's determination of
fair value of financial instruments that emphasizes the use of observable inputs
over the use of unobservable inputs by requiring that the observable inputs be
used when available. The valuation of Level 3 assets requires the greatest
degree of judgment, as these valuations are based on techniques that use
significant inputs that are unobservable. These measurements may be made under
circumstances in which there is little, if any, market activity for the asset.
Our assessment of the significance of a particular input to the fair value
measurement in its entirety requires judgment. In making the assessment, we
consider factors specific to the asset. Some Level 3 valuations are based
entirely on non-binding broker quotes. These securities consist primarily of
mortgage and asset-backed securities where reliable pool and loan level
collateral information cannot be reasonably obtained. Assets classified as Level
3 principally include certain residential mortgage-based securities, or "RMBS,"
commercial mortgage-backed securities, or "CMBS," other asset-backed securities,
and partnership investments.
Mortgage and asset-backed securities are initially valued at the transaction
price. Subsequently, we use widely accepted valuation practices that produce, a
fair value measurement by comparison to transactions in similarly structured
instruments, use of discounted cash flows, or option adjusted spread analyses.
Unobservable inputs, significant to the measurement and valuation of mortgage
and asset-backed securities, include assumptions about prepayment speed and
collateral performance, including default, delinquency and loss severity rates.
Significant changes to any one of these inputs, or combination of inputs, could
significantly change the fair value measurement for these securities.
Fair values for partnership and private equity investments are initially valued
at the transaction price. Subsequently, fair value is based on the performance
of the portfolio of investments or results of operations of the investee.
Significant improvements or disruptions in the financial markets may result in
directionally similar or opposite changes to the portfolio of the investee,
depending on how management of the investee has correlated the portfolio of
investments to the market. Also, any changes made by the investee to the
investment strategy of the private equity investment could result in significant
changes to fair value that have a positive or negative correlation to the
performance observed in the equity markets. For those investments whose
performance is based on the results of operations within a specific industry,
significant events impacting that industry could materially impact fair value.
Also, decisions and changes to strategy made by management of the investee could
result in positive or negative outcomes, which could significantly impact the
results of operations of the investee and subsequently fair value.
See Notes 1(b), 1(c), 3 and 4 to the Unaudited Consolidated Financial Statements
set forth in Part I, Item 1 of this Form 10-Q for additional information on our
investments and fair value.
Investment Impairment
The determination that an investment has incurred an OTTI loss in value requires
the judgment of management and consideration of the fundamental condition of the
issuer, its near-term prospects and all the relevant facts and circumstances.
We hold our equity and debt securities as available-for-sale, or "AFS," and as
such, these securities are recorded at fair value. We continually monitor the
difference between cost and the estimated fair value of our investments, which
involves uncertainty as to whether declines in value are temporary in nature.
The analysis of any individual security's decline in value is performed in its
functional currency. If the decline of a particular investment is deemed
temporary, we record the decline as an unrealized loss in stockholders' equity.
If the decline is deemed to be other than temporary, we write our cost- or
amortized cost-basis down to the fair value of the investment and record an OTTI
loss on our statement of earnings, regardless of whether we continue to hold the
security. In addition, any portion of such decline that relates to debt
securities that is believed to arise from factors other than credit is recorded
as a component of other comprehensive income, rather than charged against
earnings.
Management's assessment of equity securities initially involves an evaluation of
all securities that are in an unrealized loss position, regardless of the
duration or severity of the loss, as of the applicable balance sheet date. Such
initial review consists primarily of assessing whether:
(i) there has been a negative credit or news event with respect to the issuer
that could indicate the existence of an OTTI; and
(ii) we have the ability and intent to hold an equity security for a period of
time sufficient to allow for an anticipated recovery (generally
considered to be less than one year from the balance sheet date).
To the extent that an equity security in an unrealized loss position is not
impaired based on the initial review described above, we then further evaluate
such equity security and deem it to be other-than-temporarily impaired if it has
been in an unrealized loss
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position for twelve months or more or if its unrealized loss position is greater
than 50 percent of its cost, absent compelling evidence to the contrary.
We then evaluate those equity securities where the unrealized loss is 20 percent
or more of cost as of the balance sheet date or which have been in an unrealized
loss position continuously for six months or more preceding the balance sheet
date. This evaluation takes into account quantitative and qualitative factors in
determining whether such securities are other-than-temporarily impaired
including:
(i) market valuation metrics associated with the equity security (e.g.,
dividend yield and price-to-earnings ratio);
(ii) current views on the equity security, as expressed by either our internal
stock analysts and/or by third party stock analysts or rating agencies;
and
(iii) discrete credit or news events associated with a specific company, such
as negative news releases and rating agency downgrades with respect to
the issuer of the investment.
Debt securities in an unrealized loss position are evaluated for OTTI if they
meet any of the following criteria:
(i) they are trading at a 20 percent discount to amortized cost for an
extended period of time (nine consecutive months or longer);
(ii) there has been a negative credit or news event with respect to the issuer
that could indicate the existence of an OTTI;
(iii) we intend to sell or it is more likely than not that we will sell the
debt security before recovery of its amortized cost basis; and
(iv) we may not realize a full recovery on our investment, regardless of the
occurrence of one or more of the foregoing events.
If we intend to sell or it is more likely than not that we will sell a debt
security before recovery of its amortized cost basis, the total amount of the
unrealized loss position is recognized as an OTTI loss in earnings. To the
extent that a debt security that is in an unrealized loss position is not
impaired based on the preceding, we will consider a debt security to be impaired
when we believe it to be probable that we will not be able to collect the entire
amortized cost basis. For debt securities in an unrealized loss position as of
the end of each quarter, we develop a best estimate of the present value of
expected cash flows on a security by security basis. If the results of the cash
flow analysis indicate we will not recover the full amount of its amortized cost
basis in the investment, we record an OTTI loss in earnings equal to the
difference between the present value of expected cash flows and the amortized
cost basis of the security. If applicable, the difference between the total
unrealized loss position on the security and the OTTI loss recognized in
earnings is the non-credit related portion and is recorded as a component of
other comprehensive income.
In developing the cash flow analyses for debt securities, we consider various
factors for the different categories of debt securities. For municipal bonds, we
take into account the taxing power of the issuer, source of revenue, credit risk
and credit enhancements and pre-refunding. For mortgage and asset-backed
securities, we discount our best estimate of future cash flows at an effective
rate equal to the original effective yield of the security or, in the case of
floating rate securities, at the current coupon. Our models include our
assumptions about prepayment speeds, default and delinquency rates, and
underlying collateral (if any), as well as credit ratings, credit enhancements
and other observable market data. For corporate bonds, we review business
prospects, credit ratings and available information from asset managers and
rating agencies for individual securities.
We may ultimately record a realized loss after having originally concluded that
the decline in value was temporary. Risks and uncertainties are inherent in the
methodology we use to assess other-than-temporary declines in value. Risks and
uncertainties could include, but are not limited to, incorrect assumptions about
financial condition, liquidity or future prospects, inadequacy of any underlying
collateral, and unfavorable changes in economic conditions or social trends,
interest rates or credit ratings.
See Note 1(b) and Note 4(e) to the Unaudited Consolidated Financial Statements
set forth in Part I, Item 1 of this Form 10-Q for additional information on our
investments and investment impairments.
Goodwill and Other Intangible Assets
Goodwill and other intangible assets, net of amortization, are recorded as a
consequence of business acquisitions. Goodwill represents the excess, if any, of
the amount paid to acquire subsidiaries and other businesses over the fair value
of their net assets at the date of acquisition. Other intangible assets are
recorded at their fair value as of the acquisition date. A significant amount of
judgment is needed to determine the fair values at the date of acquisition of
other intangible assets and the net assets acquired in a business acquisition.
The determination of the fair value of other intangible assets and net assets
often involves the use of valuation models and other estimates, which involve
many assumptions and variables and are inherently subjective. Other intangible
assets that are not deemed to have an indefinite useful life are amortized over
their estimated useful lives. Goodwill and intangible assets that have an
indefinite useful life are not subject to amortization.
Goodwill and other intangible assets deemed to have an indefinite useful life
are tested annually in the fourth quarter of every year for impairment. Goodwill
and other intangible assets are also tested whenever events and changes in
circumstances suggest that
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the carrying amount may not be recoverable. A significant amount of judgment is
required in performing goodwill and other intangible asset impairment tests.
These tests include estimating the fair value of our operating units and other
intangible assets. If it is determined that an asset has been impaired, the
asset is written down by the amount of the impairment, with a corresponding
charge to net earnings. Subsequent reversal of any impairment charge is not
permitted.
With respect to goodwill, a qualitative assessment is first made to determine
whether it is necessary to perform quantitative testing. This initial assessment
includes, among others, consideration of: (i) past, current and projected future
earnings and equity; (ii) recent trends and market conditions; and
(iii) valuation metrics involving similar companies that are publicly-traded and
acquisitions of similar companies, if available. If this initial qualitative
assessment indicates that the fair value of an operating unit of ours may be
less than its respective carrying amount, a second step is taken, involving a
comparison between the estimated fair values of our operating units with their
respective carrying amounts including goodwill. Under GAAP, fair value refers to
the amount for which the entire operating unit may be bought or sold. The
methods for estimating operating unit values include asset and liability fair
values and other valuation techniques, such as discounted cash flows and
multiples of earnings or revenues. All of these methods involve significant
estimates and assumptions. If the carrying value exceeds estimated fair value,
there is an indication of potential impairment, and a third step is performed to
measure the amount of impairment. The third step involves calculating an implied
fair value of goodwill by measuring the excess of the estimated fair value of
the operating units over the aggregate estimated fair values of the individual
assets less liabilities. If the carrying value of goodwill exceeds the implied
fair value of goodwill, an impairment charge is recorded for the excess.
Our consolidated balance sheet as of June 30, 2012 includes goodwill of $82.5
million related to RSUI, CATA and Bourn & Koch, and intangible assets, net of
amortization, of $275.1 million, related to Transatlantic, RSUI, CATA and
Bourn & Koch. See Note 1(i), Note 1(q) and Note 2 to the Unaudited Consolidated
Financial Statements set forth in Part I, Item 1 of this Form 10-Q for
additional information on our goodwill and other intangible assets.
Reinsurance Premium Revenues
We must make certain judgments in the determination of assumed reinsurance
premiums written and earned. For pro rata contracts, premiums written and earned
are generally based on reports received from ceding companies. For
excess-of-loss contracts, premiums are generally recorded as written based on
contract terms and are earned ratably over the periods the related coverages are
provided. Unearned premiums and ceded unearned premiums represent the portion of
gross premiums written and ceded premiums written, respectively, relating to the
unexpired periods of such coverages. The relationship between net premiums
written and net premiums earned will, therefore, generally vary depending on the
volume and inception dates of the business assumed and ceded and the mix of such
business between pro rata and excess-of-loss reinsurance.
Premiums written and earned, along with related costs, for which data have not
been reported by the ceding companies, are estimated based on historical
patterns and other relevant information. Such estimates of premiums earned are
considered when establishing the IBNR portion of loss reserves. The differences
between these estimates and actual data subsequently reported, which may be
material as a result of the diversity of cedants and reporting practices and the
inherent difficulty in estimating premium inflows, among other factors, are
recorded in the period when actual data become available and such differences
may materially affect our results of operations.
In addition to the policies described above which contain critical accounting
estimates, our other accounting policies are described in Note 1 to the
Unaudited Consolidated Financial Statements set forth in Part I, Item 1 of this
Form 10-Q. The accounting policies described in Note 1 require us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities that do not meet the level of materiality required for a
determination that the accounting policy includes critical accounting estimates.
On an ongoing basis, we evaluate our estimates, including those related to the
value of deferred acquisition costs, incentive compensation, income taxes,
pension benefits and contingencies and litigation. Our estimates are based on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances. Our actual results may differ from these
estimates under different assumptions or conditions.
Comment on Non-GAAP Financial Measures
Throughout this Form 10-Q, our results of operations have been presented in the
way that we believe will be the most meaningful and useful to investors,
analysts, rating agencies and others who use financial information in evaluating
the performance of Alleghany. This presentation includes the use of underwriting
profit, which is a "non-GAAP financial measure," as such term is defined in
Item 10(e) of Regulation S-K promulgated by the Securities and Exchange
Commission. Underwriting profit represents net premiums earned less net loss and
LAE and commissions, brokerage and other underwriting expenses, all as
determined in accordance with GAAP, and does not include net investment income,
net realized capital gains, OTTI losses, other income, other operating expenses,
amortization of intangible assets and interest expense. We consistently use
underwriting profit as a supplement to earnings before income taxes, the most
comparable GAAP financial measure, to evaluate the performance of our segments
and believe that underwriting profit provides useful additional information to
investors because it highlights net earnings attributable to a segment's
underwriting performance. Earnings before income taxes may show a profit despite
an underlying underwriting loss, and when underwriting losses persist over
extended periods, a reinsurance or insurance company's ability to continue as an
ongoing concern may be at risk. However, underwriting profit is not meant to be
considered in isolation or as a substitute for earnings before income taxes or
any other measures of operating performance prepared in accordance with GAAP.
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A reconciliation of underwriting profit to earnings before income taxes is
presented within "Consolidated Results of Operations."
Merger with Transatlantic
On November 20, 2011, we entered into an Agreement and Plan of Merger, or the
"Merger Agreement," with our wholly-owned subsidiary, Shoreline Merger Sub, LLC
(subsequently converted into a corporation), or "Merger Sub," and Transatlantic
Holdings, Inc., or "Old Transatlantic." On March 6, 2012, or the "Acquisition
Date," Old Transatlantic was merged with (the "merger") and into Merger Sub,
which was renamed "Transatlantic Holdings, Inc.," and became our wholly-owned
subsidiary.
Pursuant to the terms of the Merger Agreement, on the Acquisition Date, former
stockholders of Old Transatlantic were entitled to receive, in exchange for each
share of Old Transatlantic common stock held, either shares of our common stock
or cash consideration with a value equal to approximately $61.14. In total, we
paid to the former stockholders of Old Transatlantic consideration of
approximately $3.5 billion, consisting of cash consideration of $816.0 million
and stock consideration of 8,360,959 shares of our common stock.
Following the Acquisition Date, our board of directors consisted of all 11
members from our pre-merger board of directors and three additional members who
had served on the board of directors of Old Transatlantic. See Note 2 to Notes
to Unaudited Consolidated Financial Statements set forth in Part I, Item 1 of
this Form 10-Q for further detail on the merger.
Consolidated Results of Operations
Overview
We are primarily engaged, through Transatlantic and its subsidiaries, in the
property and casualty reinsurance business, and through AIHL and its
subsidiaries, in the property and casualty insurance business. We refer to these
businesses as our reinsurance segment and insurance segment, respectively, and
we collectively refer to them as our segments. We also own and manage land in
the Sacramento, California region through our subsidiary Alleghany Properties
and seek out strategic investments and conduct other activities at the parent
level. Primarily through our wholly-owned subsidiary, Alleghany Capital
Partners, we manage our public equity investments, including those held by our
reinsurance and insurance operating units, as well as conduct equity investment
and non-insurance acquisition research. Strategic investments currently include,
among others, an approximately 33 percent stake in Homesite, a national,
full-service, mono-line provider of homeowners insurance, and an approximately
38 percent stake in ORX, a regional gas and oil exploration and production
company. On April 26, 2012, our majority-owned subsidiary BKH Holdings, Inc.
acquired Bourn & Koch, Inc., a manufacturer and remanufacturer/retrofitter of
precision machine tools and supplier of replacement parts, headquartered in
Rockford, Illinois. Our primary sources of revenues and earnings are our
reinsurance and insurance operations and investments.
The profitability of our reinsurance and insurance operating units, and as a
result, our profitability, is primarily impacted by the adequacy of premium
rates, level of catastrophe losses, investment returns, intensity of competition
and the cost of reinsurance. The adequacy of premium rates is affected mainly by
the severity and frequency of claims, which are influenced by many factors,
including natural disasters, regulatory measures and court decisions that define
and expand the extent of coverage, and the effects of economic inflation on the
amount of compensation due for injuries or losses. The ultimate adequacy of
premium rates is not known with certainty at the time property and casualty
insurance policies are issued or reinsurance contracts are entered into because
premiums are determined before claims are reported.
Catastrophe losses, or the absence thereof, can have a significant impact on our
results. The incidence and severity of catastrophes in any short period of time
are inherently unpredictable. Catastrophes can cause losses in a variety of our
property and casualty lines of business. We have significant exposure to both
natural disasters, such as hurricanes and earthquakes, as well as man-made
disasters. Longer-term natural catastrophe trends may be changing due to climate
change, a phenomenon that has been associated with extreme weather events linked
to rising temperatures, and includes effects on global weather patterns, sea,
land and air temperatures, sea levels, rain and snow. Climate change, to the
extent it produces rising temperatures and changes in weather patterns, could
impact the frequency or severity of weather events such as hurricanes and
tornado activity. To the extent climate change increases the frequency and
severity of such weather events, our reinsurance and insurance operating units
may face increased claims, particularly with respect to properties located in
coastal areas. Our reinsurance and insurance operating units take certain
measures to mitigate the impact of such events through various means including
giving consideration to these risks in their underwriting and pricing decisions,
through the purchase of reinsurance, monitoring and modeling accumulated
exposures and managing exposure in key geographic zones and product lines that
are prone to catastrophic events.
The profitability of our reinsurance and insurance operating units is also
impacted by competition generally and price competition in particular.
Historically, the performance of the property and casualty reinsurance and
insurance industries has tended to fluctuate in cyclical periods of price
competition and excess underwriting capacity followed by periods of high premium
rates and shortages of underwriting capacity. Although an individual insurance
or reinsurance company's performance is dependent on its own specific business
characteristics, the profitability of most property and casualty reinsurance and
insurance companies tends to follow
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this cyclical market pattern. The property and casualty reinsurance industry has
also been highly competitive in recent years, although, following the
significant catastrophe events in 2010 and 2011, property catastrophe rates
improved in the first six months of 2012. Although terms and conditions for
casualty reinsurance lines largely remained stable in the first six months of
2012, rate movements were generally mixed, with some lines improving and others
experiencing downward pressure. In the past few years, our insurance operating
units have faced increasing competition as a result of an increased flow of
capital into the insurance industry, with both new entrants and existing
insurers seeking to gain market share. This resulted in decreased premium rates
and less favorable contract terms and conditions. In particular, RSUI and CATA's
specialty lines of business increasingly encountered competition from the
standard market. Although the property and casualty insurance market continues
to be competitive, some improvement in market conditions has occurred in the
first six months of 2012, particularly in property insurance and workers'
compensation pricing. As part of their overall risk and capacity management
strategy, our reinsurance and insurance operating units purchase reinsurance for
certain amounts of risk underwritten by them, especially catastrophe risks. The
reinsurance programs purchased by our reinsurance and insurance operating units
are generally subject to annual renewal. Market conditions beyond the control of
our reinsurance and insurance operating units determine the availability and
cost of the reinsurance protection they purchase, which may affect the level of
business written and thus their profitability.
As of June 30, 2012, we had consolidated total investments of approximately
$18.1 billion, of which $15.6 billion was invested in debt securities, $1.1
billion was invested in equity securities, $1.0 billion was invested in
short-term investments and $0.4 billion was invested in other invested assets.
Net realized capital gains, OTTI losses and net investment income related to
such investment assets are subject to market conditions and management
investment decisions and as a result can have a significant impact on our
results. For example, net realized capital gains were $107.5 million in the
first six months of 2012, compared with $41.2 million in the first six months of
2011.
The following table summarizes our consolidated revenues, costs and expenses and
earnings (in millions).
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Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
Revenues
Net premiums earned $ 1,095.9 $ 183.9 $ 1,530.1 $ 364.8
Net investment income 90.9 28.6 144.1 60.2
Net realized capital gains 39.4 6.5 107.5 41.2
Other than temporary impairment losses (1.1 ) - (2.9 ) -
Gain on bargain purchase - - 494.9 -
Other income 9.3 0.2 9.6 1.1
Total revenues 1,234.4 219.2 2,283.3 467.3
Costs and Expenses
Net loss and loss adjustment expenses 680.9 122.6 914.8 193.6
Commissions, brokerage and other underwriting
expenses 239.1 64.1 339.1 130.6
Other operating expenses 34.8 7.9 50.5 17.4
Corporate administration 11.1 5.0 58.4 11.4
Amortization of intangible assets 108.1 0.8 140.0 1.6
Interest expense 15.8 4.3 24.8 8.7
Total costs and expenses 1,089.8 204.7 1,527.6 363.3
Earnings before income taxes 144.6 14.5 755.7 104.0
Income taxes 35.3 (0.6 ) 86.3 17.6
Net earnings $ 109.3 $ 15.1 $ 669.4 $ 86.4
Revenues:Total reinsurance and insurance segments $ 1,230.2$ 221.5
$ 1,733.0 $ 467.5
Corporate activities* 4.2 (2.3 ) 550.3 (0.2 )
Earnings before income taxes:
Total reinsurance and insurance segments $ 167.3 $ 27.5 $ 285.8 $ 126.1
Corporate activities* (22.7 ) (13.0 ) 469.9 (22.1 )
* Consist of Alleghany Properties, our investments in Homesite and ORX and
corporate activities at the parent level, including the gain on bargain
purchase in connection with the merger and due diligence, legal, investment
banking and other merger-related costs, or "Transaction Costs." As of April 26,
2012, corporate activities also includes the operating results of Bourn & Koch.
Corporate activities also includes interest expense associated with the
Alleghany Senior Notes (as defined below), whereas interest expense associated
with the Transatlantic Senior Notes (as defined below) is included in "Total
Segments."
Our earnings before income taxes in the second quarter of 2012 increased from
the second quarter of 2011, primarily reflecting the impact of the merger and
higher net realized capital gains. The impact of the merger included increases
in net premiums earned and net investment income, which were partially offset by
an increase in net loss and LAE, commissions, brokerage and other underwriting
expenses and amortization of intangible assets.
Our earnings before income taxes in the first six months of 2012 increased from
the first six months of 2011, primarily reflecting the impact from the
Acquisition Date through June 30, 2012 of the merger, including the gain on
bargain purchase and increases in net premiums earned and net investment income,
which were partially offset by an increase in net loss and LAE, commissions,
brokerage and other underwriting expenses, corporate administration and
amortization of intangible assets. The gain on bargain purchase reflects the
excess of the fair value of the net assets of Transatlantic we acquired over the
purchase price we paid for such assets. Net realized capital gains in the first
six months of 2012 include a $63.1 million gain from the sale of our holdings of
Exxon Mobil Corporation common stock in January 2012. The increase in corporate
administration expense primarily reflects the impact of Transaction Costs of
$33.8 million in the first six months of 2012 in connection with the merger. See
Note 2 to Notes to Unaudited Consolidated Financial Statements set forth in Part
I, Item 1 of this Form 10-Q for further discussion of the merger and the related
gain on bargain purchase and Transaction Costs.
The effective tax rate for the first six months of 2012 was 11.4 percent,
compared with 16.9 percent for the first six months of 2011. The lower effective
tax rate in the first six months of 2012 primarily reflects the impact of the
non-taxable gain on bargain
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purchase and, to a lesser extent, the impact of higher tax-exempt interest
income generated by Transatlantic from the Acquisition Date through June 30,
2012, partially offset by the impact of higher taxable earnings in the first six
months of 2012 and the impact of certain non-deductible Transaction Costs. The
gain on bargain purchase resulted in a significant increase in earnings before
income taxes without a corresponding increase in income taxes, whereas certain
non-deductible Transaction Costs resulted in losses before income taxes without
a corresponding decrease in income taxes. As a result of these non-recurring,
merger-related items, the effective tax rate for the first six months of 2012
was reduced by a net 10.3 percentage points.
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Total Reinsurance and Insurance Segment Results
Three Months Ended June 30, 2012 Three Months Ended June 30, 2011
Reinsurance Insurance Total(1) Reinsurance Insurance Total(1)
(in millions, except ratios)
Gross premiums written $ 964.3 $ 410.5 $ 1,374.8 $ - $ 360.0 $ 360.0
Net premiums written 942.9 280.8 1,223.7 - 244.6 244.6
Net premiums earned $ 893.3 $ 202.6 $ 1,095.9 $ - $ 183.9 $ 183.9
Net loss and LAE 560.8 120.1 680.9 - 122.6 122.6
Commissions, brokerage and other
underwriting expenses 167.0 72.1 239.1 - 64.1 64.1
Underwriting profit (loss)(2) $ 165.5 $ 10.4
175.9 $ - $ (2.8 ) (2.8 )
Net investment income 95.3 31.0
Net realized capital gains 39.4 6.5
OTTI losses (1.1 ) -
Gain on bargain purchase - -
Other income 0.7 0.1
Other operating expenses 23.7 6.5
Corporate administration - -
Amortization of intangible assets 108.1 0.8
Interest expense 11.1 -
Earnings before income taxes $ 167.3 $ 27.5
Loss ratio(3) 62.8 % 59.3 % 62.1 % - 66.7 % 66.7 %
Expense ratio(4) 18.7 % 35.6 % 21.8 % - 34.9 % 34.9 %
Combined ratio(5) 81.5 % 94.9 % 83.9 % - 101.6 % 101.6 %
Six Months Ended June 30, 2012 Six Months Ended June 30, 2011
Reinsurance Insurance Total(1) Reinsurance Insurance Total(1)
(in millions, except ratios)
Gross premiums written $ 1,210.4 $ 699.0 $ 1,909.4 $ - $ 610.2 $ 610.2
Net premiums written 1,179.2 478.7 1,657.9 - 411.2 411.2
Net premiums earned $ 1,136.4 $ 393.7 $ 1,530.1 $ - $ 364.8 $ 364.8
Net loss and LAE 708.5 206.3 914.8 - 193.6 193.6
Commissions, brokerage and other
underwriting expenses 196.2 142.9 339.1 - 130.6 130.6
Underwriting profit(2) $ 231.7 $ 44.5 276.2 $ - $ 40.6 40.6
Net investment income 136.0 61.2
Net realized capital gains 68.8 41.2
OTTI losses (2.9 ) -
Gain on bargain purchase - -
Other income 1.0 0.3
Other operating expenses 37.5 15.6
Corporate administration - -
Amortization of intangible assets 140.0 1.6
Interest expense 15.8 -
Earnings before income taxes $ 285.8 $ 126.1
Loss ratio(3) 62.3 % 52.4 % 59.8 % - 53.1 % 53.1 %
Expense ratio(4) 17.3 % 36.3 % 22.2 % - 35.8 % 35.8 %
Combined ratio(5) 79.6 % 88.7 % 82.0 % - 88.9 % 88.9 %
(1) Excludes elimination of minor reinsurance activity between segments (which is
reported in corporate activities).
(2) Represents net premiums earned less net loss and LAE and commissions,
brokerage and other underwriting expenses, all as determined in accordance
with GAAP, and does not include net investment income, net realized capital
gains, OTTI losses,
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other income, other operating expenses or amortization of intangible assets.
Underwriting profit is a non-GAAP financial measure and does not replace net
earnings determined in accordance with GAAP as a measure of profitability
(see "Comment on Non-GAAP Financial Measures").
(3) Net loss and LAE divided by net premiums earned, all as determined in
accordance with GAAP.
(4) Commission, brokerage and other underwriting expenses divided by net premiums
earned, all as determined in accordance with GAAP.
(5) The sum of the loss ratio and expense ratio, all as determined in accordance
with GAAP, representing the percentage of each premium dollar a reinsurance
company has to spend on net loss and LAE, and commission, brokerage and other
underwriting expenses.
Earnings before income taxes for our reinsurance and insurance segments in the
second quarter and first six months of 2012 increased from the corresponding
2011 periods, primarily reflecting the impact of the merger and higher net
realized capital gains. The impact of the merger included increases in net
premiums earned and net investment income, which were partially offset by an
increase in net loss and LAE, commissions, brokerage and other underwriting
expenses and amortization of intangible assets.
Reinsurance Segment Underwriting Results
The reinsurance segment is comprised of Transatlantic's property and casualty
operations. The underwriting results of the reinsurance segment are presented
below, commencing on the Acquisition Date. See Note 2 to the Unaudited
Consolidated Financial Statements set forth in Part I, Item 1 of this Form 10-Q.
Reinsurance Segment Underwriting Results
Property Casualty & Other(1) Total
(in millions, except ratios)
Three Months Ended June 30, 2012
Gross premiums written $ 307.8 $ 656.5 $ 964.3
Net premiums written 296.9 646.0 942.9
Net premiums earned $ 272.8 $ 620.5 $ 893.3
Net loss and LAE 94.0 466.8 560.8
Commissions, brokerage and other
underwriting expenses 57.6 109.4 167.0
Underwriting profit(2) $ 121.2 $ 44.3 $ 165.5
Loss ratio(3) 34.5 % 75.2 % 62.8 %
Expense ratio(4) 21.1 % 17.6 % 18.7 %
Combined ratio(5) 55.6 % 92.8 % 81.5 %
Property Casualty & Other(1) Total
(in millions, except ratios)
Six Months Ended June 30, 2012
Gross premiums written $ 378.9 $ 831.5 $ 1,210.4
Net premiums written 360.6 818.6 1,179.2
Net premiums earned $ 338.9 $ 797.5 $ 1,136.4
Net loss and LAE 111.8 596.7 708.5
Commissions, brokerage and other
underwriting expenses 65.7 130.5 196.2
Underwriting profit(2) $ 161.4 $ 70.3 $ 231.7
Loss ratio(3) 33.0 % 74.8 % 62.3 %
Expense ratio(4) 19.4 % 16.4 % 17.3 %
Combined ratio(5) 52.4 % 91.2 % 79.6 %
(1) Primarily consists of assumed: D&O liability; errors and omissions liability;
general liability; medical malpractice; ocean marine and aviation; auto
liability; accident and health; surety; and credit.
(2) Represents net premiums earned less net loss and LAE and commissions,
brokerage and other underwriting expenses, all as determined in accordance
with GAAP, and does not include net investment income, net realized capital
gains, OTTI losses,
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other income, other operating expenses or amortization of intangible assets.
Underwriting profit is a non-GAAP financial measure and does not replace net
earnings determined in accordance with GAAP as a measure of profitability
(see "Comment on Non-GAAP Financial Measures").
(3) Net loss and LAE divided by net premiums earned, all as determined in
accordance with GAAP.
(4) Commission, brokerage and other underwriting expenses divided by net premiums
earned, all as determined in accordance with GAAP.
(5) The sum of the loss ratio and expense ratio, all as determined in accordance
with GAAP, representing the percentage of each premium dollar a reinsurance
company has to spend on net loss and LAE, and commission, brokerage and other
underwriting expenses.
Reinsurance Segment - Property. For the second quarter of 2012 and for the
period from the Acquisition Date through June 30, 2012, Transatlantic's property
underwriting profit was $121.2 million and $161.4 million, respectively,
primarily reflecting the absence of catastrophe losses.
Reinsurance Segment - Casualty & Other. For the second quarter of 2012 and for
the period from the Acquisition Date through June 30, 2012, Transatlantic's
casualty & other underwriting profit was $44.3 million and $70.3 million,
respectively, primarily reflecting the general absence of large losses.
For both the property and the casualty & other lines of business, the expense
ratio for the second quarter 2012 and for the period from the Acquisition Date
through June 30, 2012 was favorably impacted as a result of applying the
acquisition method of accounting for the merger because deferred acquisition
costs were written off at the Acquisition Date. We expect that the expense ratio
in subsequent quarters will gradually increase until all unearned premiums as of
the Acquisition Date are fully earned. As the proportion of premiums earned
related to premiums written after the Acquisition Date compared with premiums
earned related to premiums written before the Acquisition Date increases, we
expect that overall commission and brokerage expense as a percentage of premiums
earned (a component of the expense ratio) for the reinsurance segment will also
increase. Excluding the impact of applying the acquisition method of accounting,
the expense ratio for the reinsurance segment was estimated to be approximately
29 percent for both the second quarter of 2012 and for the period from the
Acquisition Date through June 30, 2012.
Insurance Segment Underwriting Results
The insurance segment is comprised of AIHL's RSUI, CATA and PCC operating units.
RSUI also writes a modest amount of business on an assumed basis, which is
included in the insurance segment. The underwriting results of the insurance
segment are presented below.
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Insurance Segment Underwriting Results
RSUI CATA PCC Total
(in millions, except ratios)
Three Months Ended June 30, 2012
Gross premiums written $ 365.2 $ 41.7 $ 3.6 $ 410.5
Net premiums written 237.7 39.4 3.7 280.8
Net premiums earned $ 163.9 $ 35.6 $ 3.1 $ 202.6
Net loss and LAE 91.7 25.4 3.0 120.1
Commissions, brokerage and other
underwriting expenses 45.8 19.6 6.7 72.1
Underwriting profit (loss)(1) $ 26.4 $ (9.4 ) $ (6.6 ) $ 10.4
Loss ratio(2) 55.9 % 71.3 % 97.1 % 59.3 %
Expense ratio(3) 27.9 % 55.1 % 215.8 % 35.6 %
Combined ratio(4) 83.8 % 126.4 % 312.9 % 94.9 %
Three Months Ended June 30, 2011
Gross premiums written $ 320.7 $ 38.6 $ 0.7 $ 360.0
Net premiums written 206.6 36.2 1.8 244.6
Net premiums earned $ 144.4 $ 37.9 $ 1.6 $ 183.9
Net loss and LAE 84.0 22.5 16.1 122.6
Commissions, brokerage and other
underwriting expenses 40.9 17.1 6.1 64.1
Underwriting profit (loss)(1) $ 19.5 $ (1.7 ) $ (20.6 ) $ (2.8 )
Loss ratio(2) 58.2 % 59.5 % 1,006.1 % 66.7 %
Expense ratio(3) 28.3 % 45.1 % 386.6 % 34.9 %
Combined ratio(4) 86.5 % 104.6 % 1,392.7 % 101.6 %
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RSUI CATA PCC Total
(in millions, except ratios)
Six Months Ended June 30, 2012
Gross premiums written $ 612.5 $ 80.2 $ 6.3 $ 699.0
Net premiums written 396.6 75.7 6.4 478.7
Net premiums earned $ 317.8 $ 70.3 $ 5.6 $ 393.7
Net loss and LAE 156.8 43.9 5.6 206.3
Commissions, brokerage and other
underwriting expenses 90.6 38.9 13.4 142.9
Underwriting profit (loss)(1) $ 70.4 $ (12.5 ) $ (13.4 ) $ 44.5
Loss ratio(2) 49.3 % 62.6 % 99.4 % 52.4 %
Expense ratio(3) 28.5 % 55.2 % 239.1 % 36.3 %
Combined ratio(4) 77.8 % 117.8 % 338.5 % 88.7 %
Six Months Ended June 30, 2011
Gross premiums written $ 532.9 $ 76.2 $ 1.1 $ 610.2
Net premiums written 337.4 71.6 2.2 411.2
Net premiums earned $ 286.0 $ 77.1 $ 1.7 $ 364.8
Net loss and LAE 135.2 41.6 16.8 193.6
Commissions, brokerage and other
underwriting expenses 82.3 36.5 11.8 130.6
Underwriting profit (loss)(1) $ 68.5 $ (1.0 ) $ (26.9 ) $ 40.6
Loss ratio(2) 47.3 % 53.9 % 992.3 % 53.1 %
Expense ratio(3) 28.8 % 47.4 % 697.2 % 35.8 %
Combined ratio(4) 76.1 % 101.3 % 1,689.5 % 88.9 %
(1) Represents net premiums earned less net loss and LAE and commissions,
brokerage and other underwriting expenses, all as determined in accordance
with GAAP, and does not include net investment income, net realized capital
gains, OTTI losses, other income, other operating expenses or amortization of
intangible assets. Underwriting profit is a non-GAAP financial measure and
does not replace net earnings determined in accordance with GAAP as a measure
of profitability (see "Comment on Non-GAAP Financial Measures").
(2) Net loss and LAE divided by net premiums earned, all as determined in
accordance with GAAP.
(3) Commission, brokerage and other underwriting expenses divided by net premiums
earned, all as determined in accordance with GAAP.
(4) The sum of the loss ratio and expense ratio, all as determined in accordance
with GAAP, representing the percentage of each premium dollar an insurance
company has to spend on net loss and LAE, and commission, brokerage and other
underwriting expenses.
RSUI. Gross premiums written increased by 13.9 percent and 14.9 percent,
respectively, in the second quarter and the first six months of 2012 from the
corresponding 2011 periods, primarily reflecting improved market conditions in
all lines of business, particularly property. The increase in net premiums
earned in the second quarter and the first six months of 2012, compared with the
corresponding 2011 periods, primarily reflects an increase in gross premiums
written in recent quarters.
The increase in net loss and LAE in the second quarter and first six months of
2012 from the corresponding 2011 periods primarily reflects the impact of
increases in net premiums earned, partially offset by slightly lower catastrophe
losses. Catastrophe losses, net of reinsurance and reinstatement premiums, were
$22.3 million in the second quarter of 2012, compared with $23.6 million in the
second quarter of 2011, and were $23.5 million in the first six months of 2012,
compared with $26.4 million in the first six months of 2011. Catastrophe losses
in the second quarter and first six months of 2012 primarily reflect net losses
from severe weather in 2012 and adverse development from prior year
catastrophes, primarily from a $9.7 million loss recorded in the second quarter
of 2012 related to Hurricane Ike in 2008. Catastrophe losses in the second
quarter and first six months of 2011 primarily reflect net losses from severe
weather, particularly tornados, in the southeastern and midwestern United States
during the period.
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Net loss and LAE for the second quarter of 2012 reflect an $11.9 million release
of prior accident year casualty loss reserves, compared with a $12.1 million
release during the second quarter of 2011. The $11.9 million release of prior
year reserves relates primarily to umbrella/excess liability, general liability
and professional liability lines of business primarily for the 2005 through 2008
accident years, and reflects favorable loss emergence compared with loss
emergence patterns assumed in earlier periods for such lines of business. The
$12.1 million release of prior year reserves in the second quarter of 2011
related primarily to the umbrella/excess liability, professional liability and
general liability lines of business primarily for the 2004 through 2008 accident
years, and reflects favorable loss emergence compared with loss emergence
patterns assumed in earlier periods for such lines of business.
Net loss and LAE for the first six months of 2012 reflect a $26.1 million
release of prior accident year casualty loss reserves, compared with a $27.9
million release during the first six months of 2011. In addition to the release
of prior year reserves in the second quarter of 2012 noted above, net loss and
LAE in the first six months of 2012 reflects a $14.2 million release of prior
year casualty reserves in the 2012 first quarter, compared with a $15.8 million
release of prior year casualty reserves in the 2011 first quarter. The $14.2
million release of prior year reserves relates primarily to the D&O liability,
umbrella/excess and general liability lines of business, primarily for the 2005
through 2008 accident years and reflects favorable loss emergence compared with
loss emergence patterns assumed in earlier periods for such lines of business.
The $15.8 million release of prior year reserves in the first quarter of 2011
relates primarily to the umbrella/excess, general liability and professional
liability lines of business, primarily for the 2004 through 2008 accident years
and reflects favorable loss emergence compared with loss emergence patterns
assumed in earlier periods for such lines of business.
As noted above, there was favorable loss emergence in the first six months of
2012 compared with loss emergence patterns assumed in earlier periods in many of
RSUI's casualty lines of business. Specifically, cumulative losses for such
lines of business, which include both loss payments and case reserves, in
respect of prior accident years were expected to be higher through June 30, 2012
than the actual cumulative losses through that date. The amount of lower
cumulative losses, expressed as a percentage of carried loss and LAE reserves at
the beginning of the year, was 0.6 percent. Such reduction did not impact the
assumptions used in estimating RSUI's loss and LAE liabilities for such lines
for business earned in the first six months of 2012.
The increase in commissions, brokerage and other underwriting expenses in the
second quarter and first six months of 2012 compared with the corresponding 2011
periods is due primarily to the increase in net premiums earned.
The increase in RSUI's underwriting profit in the second quarter and first six
months of 2012 compared with the corresponding 2011 periods primarily reflects
increases in net premiums earned, partially offset by increases in net loss and
LAE and commissions, brokerage and other underwriting expenses.
Although RSUI continues to see a competitive property and casualty insurance
market, it has seen improving market conditions in the first six months of 2012,
particularly in property insurance pricing.
As discussed in the 2011 10-K, RSUI reinsures its property lines of business
through a program consisting of surplus share treaties, facultative placements,
per risk, and catastrophe excess of loss treaties. RSUI's catastrophe
reinsurance program (which covers catastrophe risks including, among others,
windstorms and earthquakes) and per risk reinsurance program run on an annual
basis from May 1 to the following April 30 and thus expired on April 30, 2012.
RSUI placed its catastrophe reinsurance program for the 2012-2013 period.
The new reinsurance program provides coverage in three layers for $500.0 million
of losses in excess of a $100.0 million net retention after application of the
surplus share treaties, facultative reinsurance and per risk covers. The first
layer provides coverage for $100.0 million of losses, before a 60.0 percent
co-participation by RSUI (compared with 47.0 percent co-participation under the
expired program), in excess of the $100.0 million net retention, and the second
layer provides coverage for $300.0 million of losses, before a 5.0 percent
co-participation by RSUI (the same percent co-participation under the expired
program), in excess of $200.0 million. RSUI expanded the new catastrophe
reinsurance program to provide a new third layer of coverage of $100.0 million
in excess of $500.0 million, with no co-participation by RSUI. In addition,
RSUI's property per risk reinsurance program for the 2012-2013 period provides
RSUI with coverage for $90.0 million of losses, before a 10.0 percent
co-participation by RSUI, in excess of a $10.0 million net retention per risk
after application of the surplus share treaties and facultative reinsurance.
CATA. Gross premiums written increased by 8.0 percent and 5.2 percent,
respectively, in the second quarter and the first six months of 2012 from the
corresponding 2011 periods, primarily reflecting growth in CATA's property and
casualty lines of business. In addition, CATA's surety business grew modestly in
the first six months of 2012 compared with the first six months of 2011. Net
premiums earned decreased in the second quarter and first six months of 2012
compared with the corresponding 2011 periods as a result of lower gross premiums
written during the third and fourth quarters of 2011 compared with gross
premiums written in the third and fourth quarters of 2010.
The increase in net loss and LAE in the second quarter and first six months of
2012 from the corresponding 2011 periods primarily reflects the impact of prior
year development, partially offset by the impact of lower net premiums earned.
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Net loss and LAE for the second quarter of 2012 reflect a net $8.4 million
increase of prior accident year loss reserves, compared with a net $2.7 million
increase during the second quarter of 2011. The net $8.4 million increase
relates primarily to a $17.1 million increase in prior year reserves related to
writings of certain specialty classes of business through a program
administrator in connection with a terminated program ("Terminated Program
Business") in the 2010 and 2009 accident years, partially offset by a decrease
in prior year reserves in certain of CATA's casualty and surety lines of
business. The net $8.4 million increase reflects unfavorable loss emergence
compared with loss emergence patterns assumed in earlier periods for such
business. The net $2.7 million increase in the second quarter of 2011 relates
primarily to an increase in prior year reserves related to the Terminated
Program Business in the 2010 and 2009 accident years, partially offset by a
decrease in prior year reserves in certain of CATA's casualty lines of business.
The net $2.7 million reflects unfavorable loss emergence compared with loss
emergence patterns assumed in earlier periods for such business.
Net loss and LAE for the first six months of 2012 reflect a $9.9 million
increase of prior accident year casualty loss reserves, compared with a net $1.0
million increase during the first six months of 2011. In addition to the
increase of prior year reserves in the second quarters of 2012 and 2011 noted
above, net loss and LAE in the first six months of 2012 reflect a net increase
in prior year reserves of $1.5 million in the 2012 first quarter, compared with
a net reserve release of $1.7 million in the 2011 first quarter. The $1.5
million increase relates primarily to CATA's small workers' compensation line of
business and is related to the 2008-2010 accident years reflecting unfavorable
loss emergence compared with loss emergence patterns assumed in earlier periods
for such line of business. The $1.7 million reserve release relates primarily to
favorable development on the property lines of business from the 2010 accident
year and, to a lesser extent, a prior year reserve release in the casualty lines
of business from older accident years, reflecting favorable loss emergence
compared with loss emergence patterns assumed in earlier periods for such lines
of business. Such prior year reserve development did not impact the assumptions
used in estimating CATA's loss and LAE liabilities for business earned in the
first six months of 2012.
As noted above, there was unfavorable loss emergence in the first six months of
2012 compared with loss emergence patterns assumed in earlier periods associated
with CATA's Terminated Program Business. Specifically, cumulative losses for
this business, which include both loss payments and case reserves, in respect of
prior accident years were expected to be lower through June 30, 2012 than the
actual cumulative losses through that date. The amount of higher cumulative
losses, expressed as a percentage of carried loss and LAE reserves at the
beginning of the year, was 9.3 percent.
The increase in CATA's underwriting loss in the second quarter and first six
months of 2012 from the corresponding 2011 periods primarily reflects increases
in loss and LAE and decreases in net premiums earned.
PCC. Commencing August 1, 2009, PCC ceased soliciting new or renewal business on
a direct basis due to its determination that it was unable to write business at
rates it deemed adequate due to the difficult state of the California workers'
compensation market. After taking steps to transition to being a brokerage
carrier, PCC began writing a modest amount of new business through brokers
during 2011. PCC reported an underwriting loss of $6.6 million and $20.6 million
in the second quarter of 2012 and 2011, respectively, and $13.4 million and
$26.9 million in the first six months of 2012 and 2011, respectively. The
underwriting losses primarily reflect PCC's ongoing staffing and related
expenses being in excess of premiums earned.
PCC's underwriting loss for the first six months of 2011 also reflects a $15.0
million increase of prior accident year workers' compensation loss reserves and
LAE. Of the $15.0 million increase, $10.0 million relates to an unanticipated
increase in medical claims emergence and the absence of anticipated favorable
indemnity claims emergence. PCC had anticipated favorable indemnity claims
emergence based upon prior claims development experience indicating that injured
workers would be returning to work, thereby curtailing lost wage costs. In
making its decision to increase reserves, PCC determined that the weak
California employment environment had, however, hindered the ability of injured
workers to return to work and indirectly influenced indemnity claims. The
remaining $5.0 million of the $15.0 million increase related to an increase in
allocated LAE reserves arising in part from an increased utilization of outside
counsel to assist in the settlement process, as well as a decrease in ceded loss
and LAE reserves based on a second quarter 2011 review of reinsurance coverage
estimates. The review of reinsurance coverage estimates also resulted in a $1.1
million decrease in ceded premiums earned, which increased net premiums earned.
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Total Reinsurance and Insurance Segments Investment Results
Following is information relating to segment investment results (in millions).
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
Net investment income $ 95.3 $ 31.0 $ 136.0 $ 61.2
Net realized capital gains 39.4 6.5 68.8 41.2 Other than temporary impairment losses (1.1 ) - (2.9 ) -
Net Investment Income. The increase in total reinsurance and insurance segments
net investment income in the second quarter and first six months of 2012 from
the corresponding 2011 periods is due principally to the impact of the inclusion
of Transatlantic's results commencing on the Acquisition Date, partially offset
by lower insurance segment investment income, reflecting a decrease in interest
income due to lower prevailing market yields.
Net Realized Capital Gains. Net realized capital gains in the first six months
of 2012 and 2011 relate primarily to sales of equity securities in the energy
sector, including a gain from the sale of shares of common stock of Exxon Mobil
Corporation held at the insurance segment in January 2012. Net realized capital
gains in the second quarter of 2012 also include significant net realized
capital gains from the sales of equity securities in the chemical sector.
Other Than Temporary Impairment Losses. OTTI losses for the six months ended
June 30, 2012 reflect $2.9 million of unrealized losses that were deemed to be
other than temporary and, as such, were required to be charged against earnings,
compared with no OTTI losses for the six months ended June 30, 2011. Upon the
ultimate disposition of securities for which OTTI losses have been recorded, a
portion of the loss may be recoverable depending on market conditions at the
time of disposition. Of the $2.9 million, $1.7 million is related to equity
securities (primarily in the energy sector), and $1.2 million is related to debt
securities. The determination that unrealized losses on such securities were
other than temporary was primarily based on the duration of the decline in fair
value of such security relative to their cost as of the balance sheet date.
After adjusting the cost basis of securities for the recognition of OTTI losses,
the remaining gross unrealized investment losses for debt and equity securities
as of June 30, 2012 were deemed to be temporary, based on, among other things:
(i) the duration of time and the relative magnitude to which fair values of
these investments has been below cost were not indicative of an OTTI loss
(for example, no equity security was in a continuous unrealized loss
position for twelve months or more as of June 30, 2012);
(ii) the absence of compelling evidence that would cause us to call into
question the financial condition or near-term prospects of the issuer of
the investment; and
(iii) our ability and intent to hold the investment for a period of time
sufficient to allow for any anticipated recovery.
See Note 4 to the Unaudited Consolidated Financial Statements set forth in Part
I, Item 1 of this Form 10-Q for further details concerning gross unrealized
investment losses for debt and equity securities as of June 30, 2012.
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Corporate Activities Operating Results
The operating results of corporate activities is presented below (in millions).
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
Net premiums earned $ - $ - $ - $ -
Net investment income (4.4 ) (2.4 ) 8.1 (1.0 )
Net realized capital gains - - 38.7 -
Other than temporary impairment losses - - - -
Gain on bargain purchase - - 494.9 -
Other income 8.6 0.1 8.6 0.8
Total revenues 4.2 (2.3 ) 550.3 (0.2 )
Net loss and LAE - - - -
Commissions, brokerage and other underwriting
expenses - - - -
Other operating expenses 11.1 1.4 13.0 1.8
Corporate administration 11.1 5.0 58.4 11.4
Amortization of intangible assets - - - -
Interest expense 4.7 4.3 9.0 8.7
Earnings (loss) before income taxes $ (22.7 ) $ (13.0 ) $ 469.9 $ (22.1 )
The higher loss before income taxes in the second quarter of 2012 compared with
the loss before income taxes in the second quarter of 2011 primarily reflects
higher compensation and incentive compensation expense.
The earnings before income taxes in the first six months of 2012 compared with
the loss before income taxes in the first six months of 2011 primarily reflects
the gain on bargain purchase from the merger and, to a lesser extent, realized
capital gains in the corresponding 2012 period, partially offset by higher
corporate administration expense. Net realized capital gains in the first six
months of 2012 primarily reflects a gain from the sale of shares of Exxon Mobil
Corporation common stock held at the corporate-level in January 2012. The higher
corporate administration expense in the first six months of 2012 is due
primarily to $33.8 million of Transaction Costs, including $18.0 million payable
to our investment bankers. For more information on the merger, see Note 2 to the
Unaudited Consolidated Financial Statements set forth in Part I, Item 1 of this
Form 10-Q. Corporate administration expense in the first six months of 2012 also
reflects higher compensation and incentive compensation expense.
Corporate activities results for the second quarter and first six months of 2012
also reflect the impact of our acquisition of Bourn & Koch for the period from
April 26, 2012 through June 30, 2012, including increases in other income which
were essentially offset by corresponding increases in other operating expenses.
Net investment income for corporate activities includes our equity share of
(losses) earnings in Homesite and ORX, as follows (in millions):
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
Homesite $ (2.2 ) $ (6.6 ) $ 12.4 $ (7.1 )
ORX (1.5 ) (1.2 ) (3.3 ) (2.2 )
Interest, dividends and other - net (0.7 ) 5.4 (1.0 ) 8.3
Net investment income $ (4.4 ) $ (2.4 ) $ 8.1 $ (1.0 )
Net investment income in the second quarter and first six months of 2012 reflect
the absence of dividend income, which was significant in the corresponding 2011
periods, primarily due to the sale of shares of Exxon Mobil Corporation common
stock held at the corporate level in January 2012.
The Homesite gain in the first six months of 2012 includes a reversal of a $10
million tax-related adjustment recorded by us in the fourth quarter of 2011.
Homesite losses in the second quarter and first six months of 2011 primarily
reflect the impact of increased homeowners insurance claims from severe weather,
particularly tornados, in the southeastern and midwestern United States during
the period.
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Reserve Review Process
Our reinsurance and insurance operating units analyze, at least quarterly,
liabilities for unpaid loss and LAE established in prior years and adjust their
expected ultimate cost, where necessary, to reflect positive or negative
development in loss experience and new information, including, for certain
catastrophic events, revised industry estimates of the magnitude of a
catastrophe. Adjustments to previously recorded liabilities for unpaid loss and
LAE, both positive and negative, are reflected in our financial results in the
periods in which these adjustments are made and are referred to as prior year
reserve development. The following table presents the reserves established in
connection with the loss and LAE of our reinsurance and insurance operating
units on a gross and net basis by line of business. These reserve amounts
represent the accumulation of estimates of ultimate loss (including for IBNR)
and LAE.
As of June 30, 2012 As of December 31, 2011
Reinsurance Reinsurance
Gross Loss and Recoverables on Net Loss and LAE Gross Loss and Recoverables on Net Loss and LAE
LAE Reserves Unpaid Losses Reserves LAE Reserves Unpaid Losses Reserves
(in billions)
Reinsurance Segment
Property $ 1.2 $ - $ 1.2 $ - $ - $ -
Casualty & other(1) 8.2 (0.4 ) 7.8 - - -
9.4 (0.4 ) 9.0 - - -
Insurance Segment
Property 0.2 (0.1 ) 0.1 0.2 (0.1 ) 0.1
Casualty(2) 1.8 (0.7 ) 1.1 1.8 (0.7 ) 1.1
Workers' Compensation 0.2 - 0.2 0.2 - 0.2
All other(3) 0.1 - 0.1 0.1 - 0.1
2.3 (0.8 ) 1.5 2.3 (0.8 ) 1.5
Total $ 11.7 $ (1.2 ) $ 10.5 $ 2.3 $ (0.8 ) $ 1.5
(1) Primarily consists of assumed: D&O liability; errors and omissions liability;
general liability; medical malpractice; ocean marine and aviation; auto
liability; accident and health; surety; asbestos-related illness and
environmental impairment; and credit.
(2) Primarily consists of direct: umbrella/excess; D&O liability; professional
liability; and general liability.
(3) Primarily consists of commercial multi-peril, surety and loss and LAE
reserves for terminated lines of business and loss reserves acquired in
connection with prior acquisitions for which the sellers provided loss
reserve guarantees.
Changes in Loss and LAE Reserves between June 30, 2012 and December 31, 2011
Gross and Net Reserves. The significant increase in gross and net loss and LAE
reserves as of June 30, 2012 compared with December 31, 2011 is primarily due to
reserves acquired as a result of the merger.
Reinsurance Recoverables
As of June 30, 2012, we had total reinsurance recoverables of $1,292.9 million,
consisting of $1,237.7 million of ceded outstanding loss and LAE and $55.2
million of recoverables on paid losses. The reinsurance purchased by our
reinsurance and insurance operating units does not relieve them from their
obligations to their policyholders and cedants, and therefore, the financial
strength of their reinsurers is important.
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Information regarding concentration of our reinsurance recoverables and the
ratings profile of our reinsurers as of June 30, 2012 is as follows (dollars in
millions):
Reinsurer(1) Rating(2) Amount Percentage
Swiss Reinsurance Company A+(Superior) $ 164.0 12.7 %
American International Group, Inc. A (Excellent) 107.1 8.3
Platinum Underwriters Holdings, Ltd. A (Excellent) 96.9 7.5
PartnerRe Ltd. A+(Superior) 90.0 7.0
The Chubb Corporation A++ (Superior) 76.2 5.9
All other reinsurers(3) 758.7 58.6
Total reinsurance recoverables $ 1,292.9 100.0 %
Secured reinsurance recoverables(4) $ 182.0 14.1 %
(1) Reinsurance recoverables reflect amounts due from one or more reinsurance
subsidiaries of the listed company.
(2) Represents the A.M. Best Company, Inc. financial strength rating for the
applicable reinsurance subsidiary or subsidiaries from which the reinsurance
recoverable is due.
(3) Approximately 87.4 percent of our reinsurance recoverables balance as of
June 30, 2012 was due from reinsurers having an A.M. Best Company, Inc.
financial strength rating of "A" (Excellent) or higher.
(4) Represents reinsurance recoverables secured by funds held, trust agreements
and letters of credit.
We had no allowance for uncollectible reinsurance as of June 30, 2012.
Financial Condition
Parent Level
General. In general, we follow a policy of maintaining a relatively liquid
financial condition at the parent company. This policy has permitted us to
expand our operations through internal growth at our subsidiaries and through
acquisitions of, or substantial investments in, operating companies. As of
June 30, 2012, we held total marketable securities and cash of $914.2 million,
compared with $1,234.9 million as of December 31, 2011, primarily reflecting
payment of the $816.0 million cash portion of our purchase price for
Transatlantic, partially offset by $396.0 million of proceeds from the issuance
of the Alleghany Senior Notes (discussed below). The $914.2 million is comprised
of $698.5 million at the parent company, $63.1 million at AIHL and $152.6
million at the holding company level of Transatlantic. We believe that we have
and will have adequate internally generated funds, cash resources and unused
credit facilities to provide for the currently foreseeable needs of our
business, and we had no material commitments for capital expenditures as of
June 30, 2012.
Stockholders' equity was approximately $6.3 billion as of June 30, 2012,
compared with approximately $2.9 billion as of December 31, 2011. The increase
in stockholders' equity primarily reflects $2.7 billion from 8,360,959 shares
issued under the merger and net earnings in the first six months of 2012,
including the gain on bargain purchase. As of June 30, 2012 and December 31,
2011, we had 16,930,793 and 8,551,646 shares of our common stock outstanding,
respectively.
2022 Senior Notes. On June 26, 2012, we completed a public offering of $400.0
million aggregate principal amount of our 4.95% senior notes due on June 27,
2022, or the "2022 Senior Notes." The 2022 Senior Notes are unsecured and
unsubordinated general obligations of Alleghany. Interest is payable
semi-annually on June 27 and December 27 of each year. The terms of the 2022
Senior Notes permit redemption prior to their maturity. The indenture under
which the 2022 Senior Notes were issued contains covenants that impose
conditions on our ability to create liens on, or engage in sales of, the capital
stock of AIHL, Transatlantic or RSUI. The 2022 Senior Notes were issued at
approximately 99.9 percent of par, resulting in proceeds of $396.0 million,
after underwriting discount, commissions and other expenses, and an effective
yield of approximately 5.05 percent. Approximately $3.6 million of underwriting
discount, commissions and other expenses were recorded as deferred charges,
which are amortized over the life of the 2022 Senior Notes. We currently intend
to use the net proceeds from the sale of the 2022 Senior Notes for general
corporate purposes including, but not limited to, acquisitions, additions to
working capital, capital expenditures, investments, contributions of capital to
our subsidiaries, and repayment of debt.
Credit Agreement. On September 9, 2010, we entered into a three-year credit
agreement (the "Credit Agreement") with a bank, providing commitments (the
"Commitments") for a two tranche revolving credit facility in an aggregate
principal amount of up to $100.0 million, consisting of (i) a secured credit
facility, subject to a borrowing base as set forth in the Credit Agreement, in
an aggregate principal amount of up to $50.0 million and (ii) an unsecured
credit facility in an aggregate principal amount of up to $50.0
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million. The Commitments under the Credit Agreement are scheduled to terminate
on September 9, 2013, unless terminated earlier. Borrowings under the Credit
Agreement will be available for working capital and general corporate purposes.
There were no borrowings under the Credit Agreement since its inception through
June 30, 2012.
Dividends from Subsidiaries. Our reinsurance and insurance subsidiaries are
subject to various regulatory restrictions that limit the maximum amount of
dividends available to be paid by them without prior approval of insurance
regulatory authorities.
With respect to Transatlantic, its operating subsidiaries could ordinarily pay
dividends without regulatory approval based on statutory surplus. However, for a
period of 24 months following the Acquisition Date, Transatlantic's operating
subsidiaries are prohibited from paying a dividend to Transatlantic in excess of
$200.0 million in the aggregate in any given 12 month period without the prior
approval of the New York State Department of Financial Services. From the
Acquisition Date through June 30, 2012, TRC declared dividends of $100.0 million
payable to Transatlantic.
With respect to AIHL, its operating subsidiaries could also pay dividends
without regulatory approval based on statutory surplus. A maximum of $35.9
million was available for dividends from AIHL's insurance operating units
without prior approval of the applicable insurance regulatory authorities.
Common Stock Repurchases. In July 2010, our board of directors authorized the
repurchase of shares of our common stock, at such times and at prices as
management may determine advisable, up to an aggregate of $300.0 million. Such
share repurchase program was terminated upon the entry in November 2011 into the
Merger Agreement with Transatlantic.
Dividends. In February 2011, our board of directors declared a stock dividend
for holders of our common stock consisting of one share of our common stock for
every 50 shares outstanding. In light of the merger, our board of directors
determined not to declare a stock dividend for 2012.
Contractual Obligations. We have certain obligations to make future payments
under contracts and credit-related financial instruments and commitments. As of
June 30, 2012, certain long-term aggregate contractual obligations and
credit-related financial commitments were as follows (in millions):
More than 1 Year More than 3 Years
but Within 3 but Within 5
Contractual Obligations Total Within 1 Year Years Years More than 5 years
Loss and LAE $ 11,720.9 $ 2,783.5 $ 3,519.1 $ 1,975.3 $ 3,443.0
Senior Notes and related interest(1) 2,961.4 103.0 206.1 815.5 1,836.8
Operating lease obligations 156.4 22.0 44.3 34.7 55.4
Investments(2) 37.6 22.0 7.8 7.8 -
Other long-term liabilities(3) 361.4 138.3 111.7 51.7 59.7
Total $ 15,237.7 $ 3,068.8 $ 3,889.0 $ 2,885.0 $ 5,394.9
(1) "Senior Notes" refers to: (i) the "Transatlantic Senior Notes," which
consists of Transatlantic's 5.75% senior notes due on December 14, 2015, or
the "2015 Notes," and the 8.00% senior notes due on November 30, 2039, or the
"2039 Notes;" and (ii) the "Alleghany Senior Notes," which consists of our
5.625% senior notes due on September 15, 2020, or the "2020 Senior Notes,"
and the 2022 Senior Notes. See Note 8 to the Unaudited Consolidated Financial
Statements set forth in Part I, Item 1 of this Form 10-Q for further details
on the Senior Notes.
(2) Primarily reflect capital commitments to investment partnerships.
(3) Primarily reflect employee pension obligations, certain retired executive
pension obligations and obligations under certain incentive compensation
plans.
Our reinsurance and insurance operating units have obligations to make certain
payments for loss and LAE pursuant to insurance policies and reinsurance
contracts they issue. These future payments are reflected as reserves on our
consolidated financial statements. With respect to loss and LAE, there is
typically no minimum contractual commitment associated with insurance policies
and reinsurance contracts, and the timing and ultimate amount of actual claims
related to these reserves is uncertain.
Subsidiaries. Financial strength is also a high priority of our subsidiaries,
whose assets stand behind their financial commitments to their customers and
vendors. We believe that our subsidiaries have and will have adequate internally
generated funds, cash resources, and unused credit facilities to provide for the
currently foreseeable needs of their businesses. Our subsidiaries have no
material commitments for capital expenditures.
The obligations and cash outflow of our reinsurance and insurance operating
units include claim settlements, commission expenses, administrative expenses,
purchases of investments, and interest and principal payments on the
Transatlantic Senior Notes.
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In addition to premium collections, cash inflow is obtained from interest and
dividend income and maturities and sales of investments. Because cash inflow
from premiums is received in advance of cash outflow required to settle claims,
our reinsurance and insurance operating units accumulate funds which they invest
pending the need for liquidity. As a reinsurance or insurance company's cash
needs can be unpredictable due to the uncertainty of the claims settlement
process, our reinsurance and insurance operating units' portfolios consist
primarily of debt securities and short-term investments to ensure the
availability of funds and maintain a sufficient amount of liquid securities.
Consolidated Investment Holdings
Investment Strategy and Holdings. Our investment strategy seeks to preserve
principal and maintain liquidity while trying to maximize our risk-adjusted,
after-tax rate of return. Our investment decisions are guided mainly by the
nature and timing of expected liability payouts, management's forecast of cash
flows and the possibility of unexpected cash demands, for example, to satisfy
claims due to catastrophic losses. Our consolidated investment portfolio
currently consists mainly of highly rated and liquid debt securities and equity
securities listed on national securities exchanges. The overall debt securities
portfolio credit quality is measured using the lower of the Standard & Poor's
Ratings Services, Moody's Investor Services or Fitch's Ratings rating. In this
regard, the overall weighted-average credit quality rating of our debt
securities portfolio as of June 30, 2012 was "AA-". Although many of our debt
securities, which consist predominantly of municipal bonds, are insured by third
party financial guaranty insurance companies, the impact of such insurance was
not significant to the debt securities credit quality rating as of June 30,
2012. As of June 30, 2012, the ratings of our debt securities portfolio was as
follows (dollars in millions):
Ratings as of June 30, 2012
Below
BBB / Baa
AAA / Aaa AA / Aa A BBB / Baa or Not-Rated* Total
U.S. Government obligations $ - $ 528.6 $ - $ - $ - $ 528.6
Municipal bonds 940.2 4,515.8 989.8 122.8 33.7 6,602.3
Foreign government obligations 589.1 89.3 140.0 - 5.8 824.2
U.S. corporate bonds 18.9 392.0 1,896.3 733.7 - 3,040.9
Foreign corporate bonds 310.1 531.6 838.9 236.2 28.1 1,944.9
Mortgage and asset-backed
securities:
RMBS 47.8 1,834.1 20.4 1.9 74.5 1,978.7
CMBS 337.9 31.2 34.2 12.0 12.5 427.8
Other asset-backed securities 198.5 19.8 28.8 2.1 0.2 249.4
Total debt securities $ 2,442.5 $ 7,942.4 $ 3,948.4 $ 1,108.7 $ 154.8 $ 15,596.8
Percentage of debt securities 15.7 % 50.9 % 25.3 % 7.1 % 1.0 % 100.0 %
* Consists of $33.5 million of securities rated "BB / Ba," $4.8 million of
securities rated "B," $40.6 million of securities rated "CCC," $17.7 million of
securities rated "CC," $13.3 million of securities rates below "CC" and $44.9
million of not-rated securities.
Our debt securities portfolio has been designed to enable management to react to
investment opportunities created by changing interest rates, prepayments, tax
and credit considerations or other factors, or to circumstances that could
result in a mismatch between the desired duration of debt securities and the
duration of liabilities, and, as such, is classified as AFS.
Effective duration measures a portfolio's sensitivity to change in interest
rates. In this regard, as of June 30, 2012, our debt securities portfolio had an
effective duration of approximately 3.7 years compared with 4.0 years as of
December 31, 2011. As of June 30, 2012, approximately $5.3 billion, or 34.0
percent, of our debt securities portfolio represented securities with maturities
of five years or less, and $1.0 billion of our investments were in short-term
investments. See Note 4 to the Unaudited Consolidated Financial Statements set
forth in Part I, Item 1 of this Form 10-Q for further details concerning the
contractual maturities of our consolidated debt securities portfolio. We may
modestly increase the proportion of our debt securities portfolio held in
securities with maturities of more than five years should the yields of these
securities provide, in our judgment, sufficient compensation for their increased
risk. We do not believe that this strategy would reduce our ability, as
necessary, to meet ongoing claim payments or to respond to significant
catastrophe losses.
In the event paid losses accelerate beyond the ability of our reinsurance and
insurance operating units to fund these paid losses from current cash balances,
current operating cash flow, coupon receipts and security maturities, we would
need to liquidate a portion of our investment portfolio, make capital
contributions to our reinsurance and insurance operating units, and/or arrange
for financing. Strains on liquidity could result from:
(i) the occurrence of several significant catastrophic events in a relatively
short period of time;
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(ii) the sale of investments into a depressed marketplace to fund these paid
losses;
(iii) the uncollectibility of reinsurance recoverables on these paid losses;
(iv) the significant decrease in the value of collateral supporting
reinsurance recoverables; or
(v) a significant reduction in our net premium collections.
We may, from time to time, make significant investments in the common stock of a
public company, subject to limitations imposed by applicable regulations.
On a consolidated basis, our invested assets were approximately $18.1 billion as
of June 30, 2012, an increase of 275.0 percent from December 31, 2011. The
increase is due primarily to the investments acquired as a result of the merger
with Transatlantic, and to a lesser extent, the proceeds received from our
issuance of the 2022 Senior Notes discussed above.
Fair Value. The carrying values and estimated fair values of our consolidated
financial instruments as of June 30, 2012 and December 31, 2011 were as follows
(in millions):
June 30, 2012 December 31, 2011
Carrying Carrying
Value Fair Value Value Fair Value
Assets
Investments (excluding equity method
investments)* $ 17,704.6 $ 17,704.6 $ 4,670.6 $ 4,670.6
Liabilities
Senior Notes $ 1,819.8 $ 1,878.3 $ 299.0 $ 314.8
* This table includes AFS investments (debt and equity securities as well as
partnership investments carried at fair value that are included in other
invested assets). This table excludes investments accounted for using the
equity method (including Homesite, ORX and other equity method investments) and
certain loans receivable that are carried at cost, all of which are included in
other invested assets. The fair value of short-term investments approximates
amortized cost. The fair value of all other categories of investments is
discussed below.
Fair value is defined as the price that would be received upon the sale of an
asset or paid to transfer a liability in an orderly transaction between willing,
able and knowledgeable market participants at the measurement date. Fair value
measurements are not adjusted for transaction costs. In addition, a three-tiered
hierarchy for inputs is used in management's determination of fair value of
financial instruments that emphasizes the use of observable inputs over the use
of unobservable inputs by requiring that the observable inputs be used when
available. Observable inputs are market participant assumptions based on market
data obtained from sources independent of the reporting entity. Unobservable
inputs are the reporting entity's own assumptions about market participant
assumptions based on the best information available under the circumstances. In
assessing the appropriateness of using observable inputs in making our fair
value determinations, we consider whether the market for a particular security
is "active" or not based on all the relevant facts and circumstances. A market
may be considered to be inactive if there are relatively few recent transactions
or if there is a significant decrease in market volume. Furthermore, we consider
whether observable transactions are "orderly" or not. We do not consider a
transaction to be orderly if there is evidence of a forced liquidation or other
distressed condition, and as such, little or no weight is given to that
transaction as an indicator of fair value.
Although we are responsible for the determination of the fair value of the
financial assets and the supporting methodologies and assumptions, we employ
third party valuation service providers to gather, analyze and interpret market
information and derive fair values based upon relevant methodologies and
assumptions for individual instruments. When those providers are unable to
obtain sufficient market observable information upon which to estimate the fair
value for a particular security, fair value is determined either by requesting a
quote, which is generally non-binding, from brokers who are knowledgeable about
these securities or by employing widely accepted internal valuation models.
Valuation service providers typically obtain data about market transactions and
other key valuation model inputs from multiple sources and, through the use of
widely accepted internal valuation models, provide a single fair value
measurement for individual securities for which a fair value has been requested
under the terms of service agreements. The inputs used by the valuation service
providers include, but are not limited to, market prices from recently completed
transactions and transactions of comparable securities, interest rate yield
curves, credit spreads, currency rates, and other market observable information,
as applicable. The valuation models take into account, among other things,
market observable information as of the measurement date as well as the specific
attributes of the security being valued including its term, interest rate,
credit rating, industry sector, and when applicable, collateral quality and
other issue or issuer specific information. When market transactions or other
market observable data is limited, the extent to which judgment is applied in
determining fair value is greatly increased.
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The hierarchy is broken down into three levels based on the reliability of
inputs as follows:
• "Level 1" - Valuations are based on unadjusted quoted prices in active
markets that we have the ability to access for identical, unrestricted
assets, and do not involve any meaningful degree of judgment. An active
market is defined as a market where transactions for the financial
instrument occur with sufficient frequency and volume to provide pricing
information on an ongoing basis. Our Level 1 assets include publicly
traded common stocks and mutual funds (which are included on the balance
sheet in equity securities), where our valuations are based on quoted
market prices.
• "Level 2" - Valuations are based on direct and indirect observable inputs
other than quoted market prices included in Level 1. Level 2 inputs
include quoted prices for similar assets in active markets and inputs
other than quoted prices that are observable for the asset, such as the terms of the security and market-based inputs. Terms of the security
include coupon, maturity date, and any special provisions that may, for
example, enable the investor, at its election, to redeem the security
prior to its scheduled maturity date. Market-based inputs include interest
rates and yield curves that are observable at commonly quoted intervals
and current credit rating(s) of the security. Level 2 assets generally
include short-term investments and most debt securities. Our Level 2
liabilities consist of the Senior Notes.
• "Level 3" - Valuations are based on techniques that use significant inputs
that are unobservable. The valuation of Level 3 assets requires the
greatest degree of judgment, as these valuations are based on techniques
that use significant inputs that are unobservable. These measurements may
be made under circumstances in which there is little, if any, market
activity for the asset. Our assessment of the significance of a particular
input to the fair value measurement in its entirety requires judgment. In
making the assessment, we consider factors specific to the asset. In
certain cases, the inputs used to measure fair value may fall into
different levels of the fair value hierarchy. In such cases, the level in
the fair value hierarchy within which the fair value measurement is
classified is determined based on the lowest level input that is
significant to the fair value measurement in its entirety. Some Level 3
valuations are based entirely on non-binding broker quotes. These
securities consist primarily of mortgage and asset-backed securities where
reliable pool and loan level collateral information cannot be reasonably
obtained. Assets classified as Level 3 principally include certain RMBS,
CMBS, other-asset backed securities, and partnership investments. See Note
1(c) to the Unaudited Consolidated Financial Statements set forth in Part
I, Item 1 of this Form 10-Q for our accounting policy on fair value.
We employ specific control processes to determine the reasonableness of the fair
values of our financial assets and liabilities. Our processes are designed to
ensure that the values received or internally estimated are accurately recorded
and that the data inputs and the valuation techniques utilized are appropriate,
consistently applied, and that the assumptions are reasonable and consistent
with the objective of determining fair value. We assess the reasonableness of
individual security values received from valuation service providers through
various analytical techniques. In addition, we validate the reasonableness of
fair values by comparing information obtained from our valuation service
providers to other third party valuation sources for selected securities. We
also validate prices obtained from brokers for selected securities through
reviews by those who have relevant expertise and who are independent of those
charged with executing investing transactions.
In addition to such procedures, we review the reasonableness of our
classification of securities within the three-tiered hierarchy to ensure that
the classification is consistent with GAAP.
The estimated fair values of our financial instruments measured at fair value
and the level of the fair value hierarchy of inputs used as of June 30, 2012 and
December 31, 2011 were as follows (in millions):
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Level 1 Level 2 Level 3 Total
As of June 30, 2012
Equity securities:
Common stock(1) $ 1,047.1 $ - $ - $ 1,047.1
Preferred stock - - - -
Total equity securities 1,047.1 - - 1,047.1
Debt securities:
U.S. Government obligations - 528.6 - 528.6
Municipal bonds - 6,602.3 - 6,602.3
Foreign government obligations - 824.2 - 824.2
U.S. corporate bonds - 3,034.6 6.3 3,040.9
Foreign corporate bonds - 1,944.9 - 1,944.9
Mortgage and asset-backed securities:
RMBS(2) - 1,927.8 50.9 1,978.7
CMBS - 393.5 34.3 427.8
Other asset-backed securities - 242.8 6.6 249.4
Total debt securities - 15,498.7 98.1 15,596.8
Short-term investments - 1,023.1 - 1,023.1
Other invested assets (excluding equity
method investments)(3) - - 37.6 37.6
Total Investments (excluding equity method
investments) $ 1,047.1 $ 16,521.8 $ 135.7 $ 17,704.6
Senior Notes $ - $ 1,878.3 $ - $ 1,878.3
Level 1 Level 2 Level 3 Total
As of December 31, 2011
Equity securities:
Common stock(1) $ 871.0 $ - $ - $ 871.0
Preferred stock - - - -
Total equity securities 871.0 - - 871.0
Debt securities:
U.S. Government obligations 267.8 - - 267.8
Municipal bonds - 1,113.6 - 1,113.6
Foreign government obligations - - - -
U.S. corporate bonds - 354.1 - 354.1
Foreign corporate bonds - 83.5 - 83.5
Mortgage and asset-backed securities:
RMBS(2) - 497.3 - 497.3
CMBS - 144.7 - 144.7
Other asset-backed securities - 218.5 - 218.5
Total debt securities 267.8 2,411.7 - 2,679.5
Short-term investments 54.3 1,042.2 - 1,096.5
Other invested assets (excluding equity
method investments)(3) - - 23.6 23.6
Total Investments (excluding equity method
investments) $ 1,193.1 $ 3,453.9 $ 23.6 $ 4,670.6
Senior Notes $ - $ 314.8 $ - $ 314.8
(1) Of the $1,047.1 million and $871.0 million of fair value as of June 30, 2012
and December 31, 2011, $461.8 million and $573.3 million, respectively,
related to certain energy sector businesses.
(2) Includes government agency pass-through securities guaranteed by a government
agency or government sponsored enterprise, among other types of RMBS.
(3) Includes partnership investments accounted for on an AFS basis.
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European securities. The following table provides a breakdown of the fair value,
net unrealized gains (losses) and the average rating of our debt securities from
governments and companies in Europe as of June 30, 2012 (in millions):
Net Unrealized
Fair Valule Gains (Losses) Average Rating
United Kingdom
Foreign government $ 127.0 $ 1.3 AAA /Aaa
Foreign corporate-financial 193.0 3.3 A
Foreign corporate-non-financial 209.7 3.2 A
Asset-backed 82.6 (0.8 ) A
Total United Kingdom $ 612.3 $ 7.0
Netherlands
Foreign government $ 30.9 $ 0.1 AAA / Aaa
Foreign corporate-financial 160.3 2.0 A
Foreign corporate-non-financial 149.1 1.3 A
Asset-backed 6.6 0.2 A
Total Netherlands $ 346.9 $ 3.6
France
Foreign government $ 53.2 $ 0.9 AA / Aa
Foreign corporate-financial 63.8 0.7 A
Foreign corporate-non-financial 129.7 0.2 A
Asset-backed 0.6 - AAA / Aaa
Total France $ 247.3 $ 1.8
Germany
Foreign government $ 115.6 $ 1.3 AAA / Aaa
Foreign corporate-financial 96.7 1.2 AA / Aa
Foreign corporate-non-financial 4.2 - A
Total Germany $ 216.5 $ 2.5
Spain
Foreign corporate-financial $ 14.6 $ (0.5 ) BBB / Baa
Foreign corporate-non-financial 21.4 (1.4 ) BBB / Baa
Total Spain $ 36.0 $ (1.9 )
Italy
Foreign corporate-financial $ 9.6 $ (0.2 ) BBB / Baa
Foreign corporate-non-financial 3.7 - BBB / Baa
Total Italy $ 13.3 $ (0.2 )
Ireland
Foreign corporate-non-financial $ 8.6 $ (0.1 ) BB
Other*
Supranational $ 88.6 $ 1.2 AAA / Aaa
Foreign government 10.4 - AA / Aa
Foreign corporate-financial 101.8 1.3 A
Foreign corporate-non-financial 92.9 1.4 A
Total Other $ 293.7 $ 3.9
* Includes Belgium, the Czech Republic, Denmark, Finland, Luxembourg, Norway,
Poland, Sweden and Switzerland.
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Municipal Bonds. The following table provides the fair value of our municipal
bonds as of June 30, 2012, categorized by state and revenue source (in
millions). Special revenue bonds are debt securities for which the payment of
principal and interest is available solely from the cash flows of the related
projects. As issuers of revenue bonds do not have the ability to draw from tax
revenues or levy taxes to fund obligations, revenue bonds may carry a greater
risk of default than general obligation bonds.
Special Revenue
All Other Total Special Total General Total Fair
State Education Hospital Housing Lease Revenue Special Tax Transit Utilities Sources Revenue Obligation Value
Texas $ 41.1 $ 3.2 $ 5.8 $ - $ 15.6 $ 89.6$ 113.7 $ - $ 269.0 $ 352.5 $ 621.5
New York 25.9 - 6.4 - 81.0 196.3 146.0 24.4 480.0 15.4 495.4
California 45.0 2.6 - 51.3 - 36.0 90.9 - 225.8 187.0 412.8
Massachusetts 17.9 25.4 6.4 - 19.9 61.1 16.0 0.2 146.9 133.9 280.8
Florida - - 2.1 54.9 1.0 52.2 5.6 4.5 120.3 151.8 272.1
Arizona - 10.8 - - 55.8 26.8 128.4 - 221.8 - 221.8
North Carolina 13.0 13.2 7.1 4.2 - 0.6 26.0 14.6 78.7 132.3 211.0
Illinois 0.3 31.1 - - 23.3 62.2 12.5 10.6 140.0 58.8 198.8
Washington - - - - - 4.6 106.9 - 111.5 86.4 197.9
Missouri 4.2 51.8 7.0 - 4.9 34.0 36.3 39.8 178.0 11.9 189.9
All other states 147.0 36.6 188.1 183.8 182.2 363.2 327.9 98.6 1,527.4 686.1 2,213.5
Total $ 294.4$ 174.7$ 222.9 $ 294.2 $ 383.7 $ 926.6$ 1,010.2$ 192.7 $ 3,499.4 $ 1,816.1 5,315.5
Total advance refunded
/escrowed
maturity bonds 1,286.8
Total municipal bonds $ 6,602.3
Catastrophe Exposure
The nature of our reinsurance and insurance operating units exposes them to
losses from various catastrophe events. In a catastrophe event, losses from many
insureds across multiple lines of business may result directly or indirectly
from such single occurrence. Our reinsurance and insurance operating units take
certain measures to mitigate the impact of such events through various means
including giving consideration to these risks in their underwriting and pricing
decisions, through the purchase of reinsurance, monitoring and modeling
accumulated exposures and managing exposure in key geographic zones and product
lines that are prone to catastrophic events.
Natural disasters such as hurricanes, earthquakes and other catastrophes have
the potential to adversely affect our operating results by material amounts.
Other risks, such as an outbreak of a pandemic disease, a major terrorist event,
the bankruptcy of a major company, or a marine and/or aviation disaster, could
also have a material adverse effect on our business and operating results to an
extent that may be only partially offset by reinsurance.
We evaluate catastrophic events and assess the probability of occurrence and
magnitude through the use of industry recognized models and other techniques. We
supplement these models by periodically monitoring the exposure risks of our
operations and adjusting such modeled output accordingly. There is no single
standard methodology to project the possible losses from catastrophe exposures.
Further, there are no industry standard assumptions to be utilized in projecting
these losses, and the form and quality of the data obtained from ceding
companies used in these models are not uniformly compatible with the data
requirements of all models. The use of different methodologies and assumptions
could materially change the projected losses. Therefore, these modeled losses
may not be comparable with estimates made by other companies.
Although the analytical tools used to estimate catastrophe exposure are useful
in both pricing and monitoring catastrophe risk, the estimates derived by use of
these techniques are inherently uncertain and do not reflect our maximum
exposures to these events. Although the models are frequently updated, these
projections are nevertheless inherently imprecise. It is highly likely that our
losses will vary, perhaps materially, from these estimates.
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Projections of potential catastrophe losses are typically expressed in terms of
the probable maximum loss, or "PML." We define PML as our anticipated maximum
loss (taking into account contract limits) caused by a single catastrophic event
affecting a broad contiguous area. These modeled losses are estimated based upon
contracts in force at January 1, 2012 for Transatlantic and February 1, 2012 for
RSUI.
The following is an overview of such modeled PMLs from property, engineering,
marine and energy exposures and the associated natural perils that we deem most
significant. The estimated amount of these modeled losses are presented for both
a 100 year return period (having a likelihood of being exceeded in any single
year of 1.0 percent), and a 250 year return period (having a likelihood of being
exceeded in any single year of 0.4 percent), and are presented in two ways:
(i) gross catastrophe losses; and (ii) after-tax net catastrophe costs (i.e.,
gross losses, net of reinsurance, net reinstatement premiums and taxes). The
reduction for reinsurance assumes that all reinsurers fulfill their obligations
in accordance with contract terms.
100 Year Return Period 250 Year Return Period
Gross Loss Net Loss Gross Loss Net Loss
(before tax) (after tax) (before tax) (after tax)
(in billions)
Florida, Wind $ 1.3 $ 0.5 $ 2.0 $ 0.9
California, Earthquake 1.0 0.5 1.6 0.7
Northeast U.S., Wind 0.7 0.4 1.4 0.7
Gulf Coast, Wind 0.8 0.3 1.4 0.6
Japan, Earthquake 0.6 0.4 0.8 0.4
Japan, Wind 0.6 0.3 0.6 0.3
Europe, Wind 0.4 0.2 0.6 0.3
"Florida, Wind" has the highest modeled after-tax net catastrophe costs for both
a 100 and 250 year return period, and would represent approximately 8 percent
and 14 percent, respectively, of stockholders' equity as of June 30, 2012. If
multiple severe catastrophic events occur in any one year, the potential
economic cost to us could be materially higher than any one of the amounts shown
above.
There is much uncertainty and imprecision in the compilation of these estimates
at many stages in the process. Moreover, the makeup of our in-force business is
constantly changing as new business is added and existing contracts terminate or
expire, including contracts for reinsurance coverage purchased by us. In
addition, these estimates take into account what we believe to be the most
likely accumulation of territories, but there can be no assurance that we have
captured every possible scenario in our analysis. As a result of these factors,
among others, there can be no assurance that we will not experience after-tax
net catastrophe costs from individual events that will exceed these estimates by
a material amount. There also can be no assurance that we will not experience
catastrophe events more frequently than the modeled probabilities would suggest.
In any given year, catastrophe events could have a material adverse effect on
our financial condition, results of operations, cash flows and liquidity.
Recent Accounting Standards
Recently Adopted
In September 2011, the Financial Accounting Standards Board, or the "FASB,"
issued revised guidance on the testing of goodwill for impairment. This guidance
simplifies how an entity tests goodwill for impairment by allowing an entity to
first make a qualitative assessment to determine whether it is necessary to
perform quantitative testing. Based on the results of such assessment, an entity
will no longer be required to perform quantitative testing if it is more likely
than not that the fair value of a reporting unit is greater than its carrying
value. This guidance is effective for annual and interim goodwill impairment
tests performed for fiscal years beginning after December 15, 2011, with early
adoption permitted. We adopted this guidance in the first quarter of 2012, and
the implementation did not have an impact on our results of operations and
financial condition.
In June 2011, the FASB issued guidance on the presentation of comprehensive
income. This guidance, as amended in December 2011, increases the prominence of
other comprehensive income in the financial statements and eliminates the
current option to report other comprehensive income and its components in the
statement of changes in equity. This guidance does not change the items that
must be reported within other comprehensive income. This guidance is generally
effective for interim and annual periods beginning after December 15, 2011. We
adopted this guidance in the first quarter of 2012, and the implementation did
not have an impact on our results of operations and financial condition.
In May 2011, the FASB issued guidance that addresses requirements for measuring
fair value. Among other things, the guidance clarifies that the "highest and
best use" valuation premise applies only to non-financial assets, and that
premiums or discounts should be applied to valuations of an individual asset or
liability only when market participants would do so. The guidance also permits
measurement of fair value of financial instruments (that are carried at fair
value) based on an entity's net exposure to a particular
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market or credit risk on a net basis if there is evidence that the entity
manages its financial instruments in this way. The guidance provides for
additional financial statement disclosure regarding fair value measurements,
including disclosure involving transfers between categories within the fair
value hierarchy, and quantitative and qualitative information about fair value
measurements that involve a significant degree of judgment. This guidance is
effective for interim and annual periods ending after December 15, 2011. We
adopted this guidance in the first quarter of 2012, and the implementation did
not have a material impact on our results of operations and financial condition.
In October 2010, the FASB issued guidance that provides additional clarification
for costs associated with acquiring or renewing insurance contracts. This
guidance states that only incremental, direct costs associated with the
successful acquisition of a new or renewal insurance contract may be capitalized
as deferred acquisition costs. Furthermore, such costs: (i) must be essential to
the contract transaction; (ii) would not have been incurred had the contract
transaction not occurred; and (iii) must be related directly to the acquisition
activities involving underwriting, policy issuance and processing, medical and
inspection, and sales force contract selling. Advertising costs should be
included in deferred acquisition costs only if the capitalization criteria in
separate "direct response" advertising guidance within GAAP are met. All other
acquisition-related costs and other expenses should be charged to expense as
incurred. This guidance is effective for interim and annual periods beginning
after December 15, 2011, with early adoption permitted. We adopted this guidance
in the first quarter of 2012, and the implementation did not have a material
impact on our results of operations and financial condition.
Future Application of Accounting Standards
In July 2012, the FASB issued revised guidance on the testing of certain
intangible assets for impairment. This guidance simplifies how an entity tests
for impairment intangible assets other than goodwill, such as licenses and trade
names, that are determined to have an indefinite life. It does so by allowing an
entity to first make a qualitative assessment to determine whether it is
necessary to perform quantitative testing. Based on the results of such
assessment, an entity will only be required to perform quantitative testing if
it is more likely than not that the asset is impaired. This guidance is
effective for annual and interim impairment tests performed for fiscal years
beginning after September 15, 2012, with early adoption permitted. We will adopt
this guidance in the fourth quarter of 2012, and we currently do not believe
that the implementation will have a material impact on our results of operations
and financial condition.
In December 2011, the FASB issued guidance on disclosure requirements related to
offsetting arrangements. The guidance provides for additional financial
statement disclosure regarding offsetting and related arrangements to enable
financial statement users to understand the effect of those arrangements on an
entity's financial position. This guidance is effective for interim and annual
reporting periods beginning on or after January 1, 2013. We will adopt this
guidance in the first quarter of 2013, and we currently do not believe that the
implementation will have a material impact on our results of operations and
financial condition.
