GENERAL
On July 1, 2010, XL Group plc, an Irish public limited company
("XL-Ireland"), and XL Group Ltd. (now known as XLIT Ltd.), a Cayman Islands
exempted company ("XL-Cayman"), completed a redomestication transaction in which
all of the ordinary shares of XL-Cayman were exchanged for all of the ordinary
shares of XL-Ireland (the "Redomestication"). As a result, XL-Cayman became a
wholly owned subsidiary of XL-Ireland. Prior to July 1, 2010, unless the context
otherwise indicates, references in this "Management's Discussion and Analysis of
Financial Condition and Results of Operations" to the "Company" are to XL-Cayman
and its consolidated subsidiaries. On and subsequent to July 1, 2010, unless the
context otherwise indicates, references herein to the "Company" are to
XL-Ireland and its consolidated subsidiaries.
The following is a discussion of the Company's financial condition and
liquidity and results of operations. Certain aspects of the Company's business
have loss experience characterized as low frequency and high severity. This may
result in volatility in both the Company's and an individual segment's results
of operations and financial condition.
This "Management's Discussion and Analysis of Financial Condition and
Results of Operations" contains forward-looking statements that involve inherent
risks and uncertainties. Statements that are not historical facts, including
statements about the Company's beliefs and expectations, are forward-looking
statements. These statements are based upon current plans, estimates and
expectations. Actual results may differ materially from those projected in such
forward-looking statements, and therefore undue reliance should not be placed on
them. See "Cautionary Note Regarding Forward-Looking Statements" for a list of
additional factors that could cause actual results to differ materially from
those contained in any forward-looking statement, as well as Item 1, "Risk
Factors," included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2011.
This discussion and analysis should be read in conjunction with the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the audited Consolidated Financial Statements and Notes thereto,
presented under Item 7 and Item 8, respectively, of the Company's Annual Report
on Form 10-K for the year ended December 31, 2011.
EXECUTIVE OVERVIEW
See Item 7, "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Executive Overview," included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2011. That discussion
is updated with the disclosures set forth below.
RESULTS OF OPERATIONS AND KEY FINANCIAL MEASURES
Results of Operations
The following table presents an analysis of the Company's net income
available to ordinary shareholders and other financial measures (described
below) for the three and six months ended June 30, 2012 and 2011:
Three Months Ended Six Months Ended
June 30, June 30,
(U.S. dollars in thousands, except share and
per share amounts) 2012 2011 2012 2011
Net income (loss) attributable to ordinary
shareholders $ 221,156 $ 225,663 $ 397,784 $ (1,621 )
Earnings (loss) per ordinary share - basic $ 0.71 $ 0.73 $ 1.27 $ (0.01 )
Earnings (loss) per ordinary share - diluted $ 0.71 $ 0.69 $ 1.26 $ (0.01 )
Weighted average number of ordinary shares and
ordinary share equivalents - basic 309,765 309,184 312,442 310,325
Weighted average number of ordinary shares and
ordinary share equivalents - diluted 312,435 341,989 315,010 310,325
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Key Financial Measures
The following are some of the financial measures management considers
important in evaluating the Company's operating performance in the Company's P&C
operations:
Three Months Ended Six Months Ended
June 30, June 30,
(U.S. dollars in thousands, except
ratios) 2012 2011 2012 2011
Underwriting profit (loss) - P&C
operations $ 129,372 $ 67,049 $ 192,612 $ (261,015 )
Combined ratio - P&C operations 90.8 % 94.9 % 93.0 % 110.1 %
Net investment income - P&C
operations (1) $ 187,986 $ 214,448 $ 378,202 $ 417,735
Annualized return on average
ordinary shareholders' equity (2) 9.0 % 9.6 % 8.3 % 0.0 %
June 30, December 31,
(U.S. dollars) 2012 2011
Book value per ordinary share (3) $ 32.27 $ 29.81
Fully diluted book value per ordinary share (4) $ 31.96 $ 29.59
(1) Net investment income relating to P&C operations includes the net investment
income related to the net results from structured products.
(2) Annualized return on average ordinary shareholders' equity ("ROE") is a
non-GAAP financial measure and is calculated by dividing the net income
(loss) for the year by the average of the opening and closing ordinary
shareholders' equity. See "Annualized Return on Ordinary Shareholders' Equity
Calculation" herein for a reconciliation of ROE to average ordinary
shareholders' equity.
(3) Book value per ordinary share, a non-GAAP financial measure, is calculated by
dividing ordinary shareholders' equity (total shareholders' equity less
non-controlling interest in equity of consolidated subsidiaries) by the
number of outstanding ordinary shares at the applicable period end. Book
value per ordinary share is affected primarily by the Company's net income
(loss), by any changes in the net unrealized gains and losses on its
investment portfolio, by currency translation adjustments and also by the
impact of any share buyback or issuance activity. Ordinary shareholders'
equity was $9.9 billion and $9.4 billion and the number of ordinary shares
outstanding was 305.7 million and 315.7 million at June 30, 2012 and December
31, 2011, respectively. Ordinary shares outstanding include all ordinary
shares legally issued and outstanding (as disclosed on the face of the
balance sheet) as well as all director share units outstanding.
(4) Fully diluted book value per ordinary share, a non-GAAP financial measure,
represents book value per ordinary share combined with the dilutive impact of
potential future share issuances at period end. The Company believes that
book value per share and fully diluted book value per ordinary share are
financial measures important to investors and other interested parties.
However, these measures may not be comparable to similarly titled measures
used by companies either outside or inside of the insurance industry.
Underwriting profit - property and casualty ("P&C") operations
One way that the Company evaluates the performance of its insurance and
reinsurance operations is by underwriting profit or loss. The Company does not
measure performance based on the amount of gross premiums written. Underwriting
profit or loss is calculated from premiums earned less net losses incurred and
expenses related to underwriting activities. The Company's underwriting profit
for the three and six months ended June 30, 2012 was consistent with the
combined ratio discussed below.
Combined ratio - P&C operations
The combined ratio for P&C operations is used by the Company and many other
insurance and reinsurance companies as another measure of underwriting
profitability. The combined ratio is calculated from the net losses incurred and
underwriting expenses as a ratio of the net premiums earned for the Company's
insurance and reinsurance operations. A combined ratio of less than 100%
indicates an underwriting profit and greater than 100% reflects an underwriting
loss. The Company's combined ratio for the three and six months ended June 30,
2012 is lower than for the same periods in the previous year, as a result of a
decrease in the loss and loss expense ratio partially offset by a marginal
increase in the underwriting expense ratio. The loss and loss expense ratio,
which is the ratio of losses and loss expenses incurred to net premiums earned,
has decreased as a result of overall lower levels of catastrophe losses and
other large loss events for the three and six months ended June 30, 2012 as
compared to the same periods of 2011. The increased underwriting expense ratio,
which is the ratio of the sum of acquisition expenses and operating expenses to
the net premiums earned, is reflective of the additional costs incurred from
strategic initiatives and compensation costs.
Net investment income - P&C operations
Net investment income related to P&C operations is an important measure
that affects the Company's overall profitability. The largest liability of the
Company relates to its unpaid loss reserves, and the Company's investment
portfolio provides liquidity for claims settlements of these reserves as they
become due. As a result, a significant part of the investment portfolio is
invested in fixed income securities. Net investment income is influenced by a
number of factors, including the amounts and timing of inward and outward cash
flows, the level of interest rates and credit spreads and changes in overall
asset allocation.
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Book value per ordinary share
Management also views the change in the Company's book value per ordinary
share as an additional measure of the Company's performance. Book value per
ordinary share, a non-GAAP financial measure, is calculated by dividing ordinary
shareholders' equity (total shareholders' equity less non-controlling interest
in equity of consolidated subsidiaries) by the number of outstanding ordinary
shares at the applicable period end. Book value per ordinary share is affected
primarily by the Company's net income (loss), by any changes in the net
unrealized gains and losses on its investment portfolio, currency translation
adjustments and also the impact of any share buyback or issuance activity.
Ordinary shareholders' equity was $9.9 billion and $9.4 billion and the number
of ordinary shares outstanding was 305.7 million and 315.6 million at June 30,
2012 and December 31, 2011, respectively. Ordinary shares outstanding include
all ordinary shares legally issued and outstanding (as disclosed on the face of
the balance sheet) as well as all director share units outstanding.
Book value per ordinary share increased by $1.13 in the three months ended
June 30, 2012 and by $2.46 in the six months ended June 30, 2012. These
increases were due to the net income in both periods, an increase in net
unrealized gains on investments and the benefit of share buyback activity. In
the three months ended June 30, 2011 and the six months ended June 30, 2011,
book value per share increased by $1.59 and $1.17, respectively, due to an
increase in net unrealized gains on available for sale investments and the
benefit of share buyback activity offset by catastrophe losses in the first
quarter of 2011.
Fully diluted book value per ordinary share, a non-GAAP financial measure,
represents book value per ordinary share combined with the dilutive impact of
potential future share issuances at period end. In the three and six months
ended June 30, 2012, fully diluted book value per ordinary share increased by
$1.08 and $2.37, respectively, as a result of the factors contributing to the
increase in book value per share noted above. In the three and six months ended
June 30, 2011, fully diluted book value per share increased by $1.84 and $1.09,
respectively, as a result of the factors contributing to the increase in book
value per share noted above.
Annualized return on average ordinary shareholders' equity("ROE")
ROE is another non-GAAP financial measure that management considers
important in evaluating the Company's operating performance. ROE is calculated
by dividing the net income attributable to ordinary shareholders for any period
by the average of the opening and closing ordinary shareholders' equity. The
Company establishes minimum target ROEs for its total operations, segments and
lines of business. If the Company's minimum ROE targets over the longer term are
not met with respect to any line of business, the Company seeks to modify and/or
exit this line. In addition, among other factors, the Company's compensation of
its senior officers is dependent on the achievement of the Company's performance
goals to enhance ordinary shareholder value as measured by ROE (adjusted for
certain items considered to be "non-operating" in nature). For the six months
ended June 30, 2012, annualized ROE was 8.3% and for the same period in the
prior year it was negative due primarily to the net loss attributable to
ordinary shareholders as a result of natural catastrophe losses in that period.
See "Annualized Return on Ordinary Shareholders' Equity Calculation" herein for
the calculation of annualized ROE to average ordinary shareholders' equity.
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SIGNIFICANT ITEMS AFFECTING THE RESULTS OF OPERATIONS
The Company's net income and other financial measures as shown above for
the three and six months ended June 30, 2012 have been affected by, among other
things, the following significant items:
1) the impact of significant large loss events;
2) market movement impacts on the Company's investment portfolio; and
3) continuing competitive factors impacting the underwriting environment.
1) The impact of significant large loss events
The Company had a P&C underwriting profit of $129.4 million and $192.6
million for the three and six months ended June 30, 2012, respectively, compared
to a P&C underwriting profit of $67.0 and an underwriting loss of $261.0 million
for the same periods of 2011, respectively. The increase in underwriting profit
in the three and six months ended June 30, 2012 was primarily due to lower
levels of natural catastrophe losses and lower non-natural catastrophe large
loss activity in energy, property and marine business units as explained further
below.
Natural Catastrophe Losses
For the three months ended June 30, 2012, natural catastrophe losses net of
reinsurance recoveries and including reinstatement premiums were $60.6 million,
compared to $68.3 million in the same period of 2011.
For the six months ended June 30, 2012, natural catastrophe losses net of
reinsurance recoveries and including reinstatement premiums were $80.6 million,
compared to $455.7 million in the same period of 2011. Natural catastrophe
losses in the first half of 2011 included the March 11, 2011 earthquake and
tsunami in Japan, the earthquake that struck Christchurch, New Zealand on
February 22, 2011, the 2011 flooding events in Australia and the severe weather
occurrences, including tornado activity, in the United States over the periods
April 22 - 28 and May 20 - 23, 2011.
Large Loss Events
The three and six months ended June 30, 2012 and 2011 were impacted by
significant losses from large non-natural catastrophe loss events in both the
Insurance and Reinsurance segments. In 2012, the impact was largely related to a
single large marine loss during the first quarter. Management's preliminary loss
estimates for large marine loss activity in the six months ended June 30, 2012,
net of reinsurance and reinstatement premiums, were $46.6 million, of which
$24.3 million was attributable to the Insurance segment and $22.3 million to the
Reinsurance segment. In the three and six months ended June 30, 2011 the large
loss activity relates to several losses in the International Property and
Casualty ("IPC") and North America Property and Casualty ("NAPC") energy and
property Insurance units and a large international marine loss.
See "Income Statement Analysis," herein for further information regarding
these large loss events within each of the Company's operating segments.
2) Market movement impacts on the Company's investment portfolio
During the three months ended June 30, 2012, interest rates decreased,
partially offset by widening credit spreads. The net impact of the market
conditions on the Company's investment portfolio for the three months was
favorable and resulted in an increase in the amount of $141.4 million in net
unrealized gains on available for sale investments as compared to March 31,
2012. This represents an approximately 0.3% appreciation in average assets for
the three months ended June 30, 2012.
The following table provides further detail regarding the movements in
relevant credit markets, as well as in government interest rates using selected
market indices:
Interest Rate Movement for Credit Spread Movement for the three
the three months months ended
ended June 30, 2012 (1) June 30, 2012 (2)
('+'/'-' represents ('+'/'-' represents widening /
increases / decreases tightening
in interest rates) of credit spreads)
United States -32 basis points (5 year +21 basis points (US Corporate A
Treasury) rated)
+7 basis points (US Mortgage Master
Index)
+6 basis points (US CMBS,AAA rated)
United Kingdom -47 basis points (10 year +14 basis points (UK Corporate, AA
Gilt) rated)
Euro-zone -19 basis points (5 year +19 basis points (Europe Corporate,
Bund) A rated)
(1) Source: Bloomberg Finance L.P.
(2) Source: Merrill Lynch Global Indices.
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Net realized losses on investments in the three months ended June 30, 2012
totaled $12.4 million, including net realized losses of approximately $28.2
million related to the impairment of certain of the Company's fixed income
investments, where the Company determined that there was an other-than-temporary
decline in the value of those investments related to credit. For further
analysis of this, see "Results of Operations" below.
During the six months ended June 30, 2012, credit spreads tightened
combined with decreasing interest rates. The net impact of the market conditions
on the Company's investment portfolio for the six-month period was favorable and
resulted in an increase in the amount of $369.9 million in net unrealized gains
on available for sale investments as compared to December 31, 2011. This
represents an approximately 0.8% appreciation in average assets for the six
months ended June 30, 2012.
The following table provides further detail regarding the movements in
relevant credit markets, as well as in government interest rates using selected
market indices:
Interest Rate Movement for the Credit Spread Movement for the six
six months ended months ended
June 30, 2012 (1) June 30, 2012 (2)
('+'/'-' represents increases ('+'/'-' represents widening /
/ decreases tightening
in interest rates) of credit spreads)
United States -11 basis points (5 year -52 basis points (US Corporate A
Treasury) rated)
-7 basis points (US Mortgage Master
Index)
-58 basis points (US CMBS, AAA
rated)
United Kingdom -15 basis points (10 year -17 basis points (UK Corporate, AA
Gilt) rated)
Euro-zone -24 basis points (5 year Bund) -85 basis points (Europe Corporate,
A rated)
(1) Source: Bloomberg Finance L.P.
(2) Source: Merrill Lynch Global Indices.
Net realized gains on investments in the six months ended June 30, 2012
totaled $8.4 million, including net realized losses of approximately $49.2
million related to the impairment of certain of the Company's fixed income
investments, where the Company determined that there was an other-than-temporary
decline in the value of those investments related to credit. For further
analysis of this, see "Results of Operations" below.
3) Continuing competitive factors impacting the underwriting environment
Insurance
The trading environment for the core lines of insurance business written
by the Company remains competitive, although the gradual rate improvement which
began in the second half of 2011 has been sustained through the first half of
2012. Gross premiums written in the Insurance segment increased in the three
months ended June 30, 2012 as compared to the same period in 2011 by 1.6%. This
premium increase was partly driven by improved pricing, further outlined below,
and also from new business in NAPC property, construction and surplus lines,
higher retention levels and new business in the U.S. D&O book, as well as growth
in the new political risk and trade credit business.
Improved pricing contributed to the premium growth with an overall 4% rate
improvement achieved for the segment during the second quarter of 2012. Rate
improvement was experienced in all four business groups and nearly all of the
segment's businesses. NAPC rates improved by 6% led by double digit increases in
property and surplus lines businesses, a rate increase of 3% in IPC, a rate
increase of 2% in Professional driven by U.S. D&O and an improvement in
Specialty pricing of 5%, with the strongest movement in marine and offshore
energy.
Reinsurance
The Reinsurance segment's gross premiums written decreased by 4.2% in the
three months ended June 30, 2012 as compared to the same period in 2011. The
premium decrease was predominantly from the North America, Latin America and
International business groups, attributable to volume and share reductions, and
selective cancelations, partially offset by premium growth from Bermuda.
July 1 renewals saw pricing broadly in line with management's expectations.
Both the primary and reinsurance markets remain highly competitive with
substantial capacity available in both traditional and non-traditional forms.
However, the Reinsurance segment will continue its disciplined underwriting and
risk management strategies.
There can be no assurance, however, that such (re)insurance rate conditions
or growth opportunities will be sustained or further materialize, or lead to
improvements in our books of business. See "Cautionary Note Regarding
Forward-Looking Statements." The Company continues its disciplined underwriting
approach to grow on a very selective basis and exit lines where margins are
unacceptable.
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OTHER KEY FOCUSES OF MANAGEMENT
The Company remains focused on, among other things, managing its capital
and enhancing its enterprise risk management capabilities. Details of these and
other initiatives are outlined below.
Capital Management
Fundamental to supporting the Company's business model is its ability to
underwrite business, which is largely dependent upon the quality of its claims
paying and financial strength ratings as evaluated by independent rating
agencies. As a result, in the event that the Company is downgraded, its ability
to write business, as well as its financial condition and/or results of
operations, could be adversely affected.
Buybacks of Ordinary Shares
On February 27, 2012, the Company announced that its Board of Directors
approved a share buyback program, authorizing the Company to purchase up to $750
million of its ordinary shares. This authorization replaced the approximately
$190 million remaining under the share buyback program that was authorized in
November 2010 as described in further detail in Item 8, Note 18, "Share
Capital," to the Consolidated Financial Statements included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2011. During the
three months ended March 31, 2012 and the three months ended June 30, 2012, the
Company purchased and canceled 4.7 million and 6.1 million ordinary shares,
respectively, under the new program for $100.0 million and $125.0 million,
respectively. All share buybacks were carried out by way of redemption in
accordance with Irish law and the Company's constitutional documents. All shares
so redeemed were canceled upon redemption. At June 30, 2012, $525.0 million
remained available for purchase under the new program.
Repayment of the 6.5% Guaranteed Senior Notes due January 2012 (the "XLCFE
Notes")
On January 15, 2012, the $600 million principal amount outstanding on the
XLCFE Notes, which were issued by XL Capital Finance (Europe) plc ("XLCFE"), was
repaid at maturity. For further detail, see Item 1, Note 8, "Notes Payable and
Debt Financing Arrangements," to the Unaudited Consolidated Financial Statements
included herein.
Risk Management
The Company's risk management and risk appetite framework is detailed in
Item 1, "Business - Enterprise Risk Management," included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2011. The table below
shows the Company's estimated per event net 1% and 0.4% exceedance probability
exposures for certain peak natural catastrophe peril regions. These estimates
assume that amounts due from reinsurance and retrocession purchases are 100%
collectible. There may be credit or other disputes associated with these
potential receivables. Finally, the probable maximum losses in the table below
were derived by application of a vendor model that was released during the first
quarter of 2011 and, accordingly, could be more unreliable than the model that
was used historically.
1-in-100 Event 1-in-250 Event
Percentage of Percentage of
Measurement Tangible Tangible
(U.S. dollars Date Shareholders' Shareholders'
in millions) of In-Force Probable Equity at Probable Equity at
Geographical Exposures Maximum June 30, Maximum June 30,
Zone Peril (1) Loss (2) 2012 Loss (2) 2012
North America Earthquake April 1, 2012 $ 877 8.1 % $ 1,451 13.4 %
North
Atlantic Windstorm April 1, 2012 1,303 12.1 % 1,724 16.0 %
U.S. Windstorm April 1, 2012 1,288 11.9 % 1,707 15.8 %
Europe Windstorm April 1, 2012 550 5.1 % 792 7.3 %
Japan Earthquake April 1, 2012 269 2.5 % 352 3.3 %
Japan Windstorm April 1, 2012 165 1.5 % 231 2.1 %
(1) Detailed analyses of aggregated in-force exposures and maximum loss levels
are done periodically. The measurement dates represent the date of the last
completed detailed analysis by geographical zone.
(2) Probable maximum losses, which include secondary uncertainty that
incorporates variability around the expected probable maximum loss for each
event, do not represent the Company's maximum potential exposures and are
pre-tax.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
See the discussion of the Company's Critical Accounting Policies and
Estimates in Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Critical Accounting Policies and
Estimates," included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2011.
VARIABLE INTEREST ENTITIES AND OTHER OFF-BALANCE SHEET ARRANGEMENTS
For further information, see the discussion of the Company's variable
interest entities and other off-balance sheet arrangements in Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Variable Interest Entities ("VIEs") and Other Off-Balance Sheet
Arrangements," of the Company's Annual Report on Form 10-K for the year ended
December 31, 2011 and Item 1, Note 10, "Variable Interest Entities," to the
Unaudited Consolidated Financial Statements included herein.
SEGMENTS
The Company is organized into three operating segments: Insurance,
Reinsurance and Life operations. The Company's general investment and financing
operations are reflected in Corporate.
The Company evaluates the performance of both the Insurance and Reinsurance
segments based on underwriting profit and the performance of the Life operations
segment based on its contribution to net income. Other items of revenue and
expenditure of the Company are not evaluated at the segment level for reporting
purposes. In addition, the Company does not allocate investment assets by
segment for its P&C operations. Investment assets related to the Company's Life
operations and certain structured products included in the Insurance and
Reinsurance segments are held in separately identified portfolios. As such, net
investment income from these assets is included in the contribution from the
applicable segment. See Item 1, Note 4, "Segment Information," to the Unaudited
Consolidated Financial Statements included herein for a reconciliation of
segment data to the Company's Unaudited Consolidated Financial Statements.
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INCOME STATEMENT ANALYSIS
Segment Results for the three months ended June 30, 2012 compared to the three
months ended June 30, 2011
Insurance
The Company's Insurance segment provides commercial property, casualty and
specialty insurance products on a global basis. Products generally provide
tailored coverages for complex corporate risks and include the following lines
of business: property, casualty, professional liability, environmental
liability, aviation and satellite, marine and offshore energy, equine, fine art
and specie, excess and surplus lines, political risk and trade credit, product
recall, surety and other insurance coverages including those mentioned above,
through the Company's program business. The Company focuses on those lines of
business within its insurance operations that are believed to provide the best
return on capital over time. These lines of business are divided into the
following business groups: NAPC, IPC, Global Professional Lines ("Professional")
and Global Specialty ("Specialty").
The following table summarizes the underwriting profit (loss) for the
Insurance segment:
Three Months Ended
June 30,
(U.S. dollars in thousands) 2012 2011 % change
Gross premiums written $ 1,311,034 $ 1,290,030 1.6 %
Net premiums written 944,267 893,191 5.7 %
Net premiums earned 959,294 907,443 5.7 %
Net losses and loss expenses (635,284 ) (608,182 ) 4.5 %
Acquisition costs (123,284 ) (113,883 ) 8.3 %
Operating expenses (192,247 ) (166,608 ) 15.4 %
Underwriting profit (loss) $ 8,479$ 18,770 (54.8 )%
Net results - structured products 9,047
2,690 236.3 %
Net fee income and other (1,847 ) (3,218 ) (42.6 )%
Gross premiums written increased in the three months ended June 30, 2012 as
compared to the same period of 2011 by 1.6% and, when evaluated in local
currency, increased by 4.2%. All business groups with the exception of IPC
experienced an increase in gross premiums written predominantly from new
business, improved pricing and higher retention levels, partially offset by the
unfavorable impact of foreign exchange rates and targeted non-renewals. For
NAPC, the growth in premium was largely driven by new business growth and
improved retention across most lines, and pricing mainly in property, partially
offset by certain premium adjustments. In Professional, new business primarily
in the U.S. professional business and improved pricing contributed to increased
premiums but were partially offset by the non-renewal of under-priced business.
In Specialty, there was premium growth from favorable amendments to prior year
premium estimates, increased writings from the new business lines of political
risk and product recall, and new business in marine cargo lines, partially
offset by lower retention levels and adverse amendments to prior year premium
estimates in aerospace. The decline in IPC was from lower retention and lower
new business. The lower retention relates to the non-renewal of property
accounts that did not meet the Company's pricing requirements.
Net premiums written increased by 5.7% in the three months ended June 30,
2012 as compared to the same period of 2011. The increase resulted from the
gross written premium increases outlined above together with a decrease in ceded
written premiums. The decrease in ceded premiums relates to decreased
utilization of facultative reinsurance, primarily in IPC, following the
cancelation of a large general property program, from lower cessions as a result
of lower retention levels in IPC property and from reduced ceded reinstatement
premiums related to marine losses partially offset by changes in the structure
and cost of certain property reinsurance treaties.
Net premiums earned increased by 5.7% in the three months ended June 30,
2012 as compared to the same period of 2011. The increase primarily resulted
from higher net written premiums earned in NAPC, Professional and Specialty
partially offset by the decrease in IPC property premiums as outlined above.
The following table presents the ratios for the Insurance segment:
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Three Months Ended
June 30,
2012 2011
Loss and loss expense ratio 66.2 % 67.0 %
Acquisition expense ratio 12.9 % 12.5 %
Operating expense ratio 20.0 % 18.4 %
Underwriting expense ratio 32.9 % 30.9 %
Combined ratio 99.1 % 97.9 %
The loss and loss expense ratio includes net losses incurred for both the
current quarter and any favorable or adverse prior year development of loss and
loss expense reserves held at the beginning of the year. The following table
summarizes the net (favorable) adverse prior year development relating to the
Insurance segment for the three months ended June 30, 2012 as compared to the
same period of 2011:
Three Months Ended
June 30,
(U.S. dollars in millions, except ratios) 2012 2011
Property $ 1.2 $ (16.7 )
Casualty (56.9 ) 11.8
Professional (28.3 ) (77.1 )
Specialty and other 41.1 18.3
Total $ (42.9 ) $ (63.7 )
Loss and loss expense ratio excluding prior year development 70.7 % 74.0 %
Excluding prior year development, the loss ratio for the three months ended
June 30, 2012 decreased by 3.3 loss percentage points as compared to the same
period in 2011 despite higher levels of catastrophe losses occurring in the
second quarter of 2012. Losses net of reinsurance recoveries and including
reinstatement premiums recorded related to natural catastrophe events for the
three months ended June 30, 2012 were $ 49.3 million compared to $13.1 million
in the same period of 2011. Excluding favorable prior year development, net
catastrophe losses and related reinstatement premiums in both quarters, the loss
ratio for the three months ended June 30, 2012 compared to the same period of
2011 decreased by 6.8 points to 65.8%, mainly due to significant large loss
activity in Specialty, specifically from marine and aerospace losses in the
second quarter of 2011.
Net favorable prior year reserve development of $42.9 million for the three
months ended June 30, 2012 was mainly attributable to the following:
• For property lines, net prior year development was $1.2 million unfavorable.
• For casualty lines, net prior year development was $56.9 million favorable.
This was driven by a release of $34.6 million in primary casualty due to
better than expected reported loss experience. The primary casualty releases
related to the 2002 to 2007 accident years as well as the 2010 and 2011
accident years. There was also a release of $30.0 million in the excess
casualty lines due primarily to the favorable resolution of a mature claim.
The releases in primary and excess casualty were partially offset by an
increase of $9.6 million in U.S. middle markets due to worse than expected
reported loss experience.
• For Professional, net prior year development was $28.3 million favorable.
This was driven by releases in reserves for clash losses (which cover a
number of substantially similar claims against multiple policyholders) in
the U.S. and Bermuda core professional businesses totaling $50.4 million,
comprised of a release of $4.5 million for the 2006 and prior report years
to reflect favorable reported loss experience across these years, and a
release of $45.9 million for report year 2010 to reflect the limited clash
events in the U.S. and Bermuda core professional businesses for this year.
In terms of non-clash losses in the professional lines, the International
and Bermuda core professional businesses were strengthened by $37.1 million
and $5.0 million, respectively, due to unfavorable reported loss development
while $24.5 million was released from the U.S. core professional business
due to better than expected reported loss development. Finally, for the
professional lines, the Design portfolio covering architects and engineers
professional liability was strengthened by $4.8 million driven by worse than
expected reported loss experience in the Canadian book.
• For specialty and other lines, net prior year development was $41.1 million
unfavorable. This was driven by adverse reported loss development for the
non-catastrophe exposures in the excess and surplus lines, which led to a
strengthening of $30.0 million. For the same reason, marine was strengthened
by $12.6 million, run-off surety by $12.5 million, programs by $10.9 million
and environmental by $4.4 million. These increases were partially offset by
a release of $24.4 million in aerospace due to better than expected reported
loss experience and a release of $3.5 million for the catastrophe exposures
in marine.
49
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The increase in the underwriting expense ratio for the three months ended
June 30, 2012 as compared to the same period of 2011 was due to an increase in
the operating expense ratio of 1.6 points combined with an increase in the
acquisition expense ratio of 0.4 points. The increase in the operating expense
ratio was due to higher compensation expenses due to different bonus accrual
assumptions and severance costs in the three months ended June 30, 2012 as
compared to the same period of 2011. The increase in the acquisition expense
ratio was mainly from IPC due to higher premium taxes in the U.K. and Australia,
and from Professional through changes in the mix of business.
Fee income and other improved in the three months ended June 30, 2012 as
compared to the same period of 2011 as a result of expenses during the prior
year in professional lines related to the cost of an endorsement facility with
National Indemnity Company. For further information about this facility, see
Item 8, Note 7, "Other Investments," to the Consolidated Financial Statements
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2011.
Net results from structured insurance products include certain structured
indemnity contracts that are accounted for as deposit contracts. Net results
from these contracts improved in the three months ended June 30, 2012 as
compared to the same period of 2011 due to lower interest expense as a result of
an accretion rate adjustment recorded in the three months ended June 30, 2012
based on changes in expected cash flows and payout patterns on certain
structured indemnity contracts.
Reinsurance
The Company's Reinsurance segment provides casualty, property risk,
property catastrophe, marine, aviation and other specialty reinsurance on a
global basis with business being written on both a proportional and
non-proportional treaty basis and also on a facultative basis. The reinsurance
operations are structured into geographical business groups: North America,
Bermuda, International (Europe and Asia Pacific) and Latin America.
The following table summarizes the underwriting profit (loss) for the
Reinsurance segment:
Three Months Ended
June 30,
(U.S. dollars in thousands) 2012 2011 % change
Gross premiums written $ 452,417 $ 472,413 (4.2 )%
Net premiums written 403,011 412,868 (2.4 )%
Net premiums earned 441,678 398,682 10.8 %
Net losses and loss expenses (191,071 ) (215,402 ) (11.3 )%
Acquisition costs (87,723 ) (91,448 ) (4.1 )%
Operating expenses (41,991 ) (43,553 ) (3.6 )%
Underwriting profit (loss) $ 120,893$ 48,279 150.4 %
Net results - structured products (22,913 ) 2,226
*NM
Fee income and other 990 (9 ) *NM
* NM - Not Meaningful
Gross premiums written decreased in the three months ended June 30, 2012 as
compared to the same period of 2011 by 4.2% and, when evaluated in local
currency, decreased by 3.4%. The premium decrease was predominantly from the
International and North America business groups. The gross premiums written
decline from the International business group was mainly as a result of changes
in the renewal timing of certain casualty quota share contracts and the absence
of positive premium adjustments in the three months ended June 30, 2012 when
compared to the same period of 2011. The North America business group
experienced a decrease in gross premiums written, driven by a reduction in
volume, shares and price for certain renewed property quota share and property
excess of loss contracts, as well as changes in the structure of a U.S.
agricultural program. Premiums from the Latin America business group declined
compared to the prior year quarter due to the timing of certain property
renewals. Offsetting these declines was premium growth for the Bermuda business
group through both the timing of, and increased shares from property catastrophe
renewals. In 2011, the renewal dates for certain policies normally bound in the
second quarter were pushed back into the third quarter as a result of the Japan
earthquake and tsunami.
Net premiums written decreased by 2.4% in the three months ended June 30,
2012 as compared to the same period of 2011. The decrease resulted from the
gross written premium decreases outlined above offset by a reduction in ceded
written premiums. The decrease in ceded written premiums was mainly from the
North America business group reflecting the change in structure of the U.S.
agricultural program, partially offset by increased ceded premiums in the
Bermuda business group.
Net premiums earned increased by 10.8% in the three months ended June 30,
2012 as compared to the same period of 2011. The increase is a reflection of the
overall growth in net premiums written in recent quarters particularly from the
Bermuda and International business groups.
50--------------------------------------------------------------------------------
The following table presents the ratios for the Reinsurance segment:
Three Months Ended
June 30,
2012 2011
Loss and loss expense ratio 43.3 % 54.0 %
Acquisition expense ratio 19.9 % 22.9 %
Operating expense ratio 9.4 % 11.0 %
Underwriting expense ratio 29.3 % 33.9 %
Combined ratio 72.6 % 87.9 %
The loss and loss expense ratio includes net losses incurred for both the
current year and any favorable or adverse prior year development of loss and
loss expense reserves held at the beginning of the year. The following table
summarizes the net (favorable) adverse prior year development relating to the
Reinsurance segment for the three months ended June 30, 2012 and 2011:
Three Months Ended
June 30,
(U.S. dollars in millions, except ratios) 2012
2011
Property and other short-tail lines $ (11.5 ) $ (24.8 )
Casualty and other (46.9 ) (39.1 )
Total $ (58.4 ) $ (63.9 )
Loss and loss expense ratio excluding prior year development 56.5 % 70.1 %
Excluding prior year development, the loss ratio for the three months ended
June 30, 2012 decreased by 13.6 loss percentage points as compared to the same
period of 2011. Losses net of reinsurance recoveries and including reinstatement
premiums recorded related to natural catastrophe events for the three months
ended June 30, 2012 were $11.2 million compared to $55.2 million in the same
period of 2011. For further details on catastrophe losses in 2011, see Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations, Significant Items Affecting the Results of Operations - 1) The
impact of significant large natural catastrophe activity," included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2011.
Excluding favorable prior year development, net catastrophe losses and related
reinstatement premiums in both quarters, the loss ratio for the three months
ended June 30, 2012 compared to the same period of 2011 decreased by 2.3 points
to 53.7% mainly due to higher levels of losses from the property other lines in
Latin America incurred in 2011.
Net favorable prior year reserve development of $58.4 million for the three
months ended June 30, 2012 was mainly attributable to the following:
• Net favorable prior year development of $11.5 million for the short-tailed
lines and details of these by specific lines are as follows:
• For property catastrophe lines, net prior year development was $0.1
million favorable.
• For property other lines, net prior year development was $6.5 million
favorable mainly due to favorable attritional claim development on the
North America and Bermuda business groups offset by some
unfavorable
attritional claim development on the Latin America business group.
• For marine and aviation lines, net prior year development was $4.9
million favorable due mainly to favorable attritional claim
development together with releases on one old aviation loss.
• Net favorable prior year development of $46.9 million for the long-tailed
lines and details of these by specific lines are as follows.
• For casualty lines, net prior year development was $39.3 million
favorable arising mainly out of the North America business group due
to better than expected development on the 2003 and 2004
underwriting
years.
• For other lines, net prior year development was $7.6 million favorable
driven by a release on the structured indemnity book.
The decrease in the underwriting expense ratio for the three months ended
June 30, 2012 as compared to the same period of 2011 was due to a reduction in
the operating expense ratio of 1.6 points and a reduction in the acquisition
expense ratio of 3 points. The decrease in the operating expense ratio was due
to lower compensation expenses, as a result of severance costs in 2011 and
reduced professional fees as compared to the same period of 2011. The decrease
in the acquisition expense ratio was largely from decreased profit commissions
paid.
51
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Net results from structured reinsurance products include certain structured
indemnity contracts that are accounted for as deposit contracts. Net results
from these contracts have decreased in the three months ended June 30, 2012 as
compared to the same period of 2011 due to higher interest expense. The higher
interest expense was due to an accretion rate adjustment recorded in the three
months ended June 30, 2012 based on changes in expected cash flows and payout
patterns on one of the larger structured indemnity contracts and from lower net
investment income in the period reflecting lower investment yields and the
run-off nature of this line of business.
Life Operations
The following table summarizes the contribution from the Life operations
segment, which has been in run-off since 2009. Prior to the decision to run-off
the business, products offered included a broad range of underlying lines of
life reinsurance business, including term assurances, group life, critical
illness cover, immediate annuities and disability income. In addition, prior to
selling the renewal rights to the Continental European Business, the products
offered included short-term life, accident and health business. The segment also
covers a range of geographic markets, with an emphasis on the U.K., United
States, Ireland and Continental Europe:
Three Months Ended
June 30,
(U.S. dollars in thousands) 2012 2011 % change
Gross premiums written $ 92,904 $ 100,281 (7.4 )%
Net premiums written 85,623 92,194 (7.1 )%
Net premiums earned 85,623 92,214 (7.1 )%
Net losses and loss expenses (131,150 ) (137,416 ) (4.6 )%
Acquisition costs (7,930 ) (9,768 ) (18.8 )%
Operating expenses (2,829 ) (2,723 ) 3.9 %
Net investment income 74,645 82,057 (9.0 )%
Net fee income and other 42 96 (56.3 )%
Realized gains (losses) on investments (10,239 ) 704 *NM
Contribution from Life operations $ 8,162$ 25,164 (67.6 )%
* NM - Not Meaningful
The following table is an analysis of the Life operations' gross premiums
written, net premiums written and net premiums earned for the three months ended
June 30, 2012 and 2011:
Three Months Ended Three Months Ended
June 30, 2012 June 30, 2011
Gross Net Net Gross Net Net
(U.S. dollars in Premiums Premiums Premiums Premiums Premiums Premiums
thousands) Written Written Earned Written Written Earned
Other Life $ 54,713 $ 54,380 $ 54,380 $ 58,751 $ 58,226 $ 58,246
Annuity 38,191 31,243 31,243 41,530 33,968 33,968
Total $ 92,904 $ 85,623 $ 85,623 $ 100,281 $ 92,194 $ 92,214
Gross premiums written decreased by 7.4% in the three months ended June 30,
2012 as compared to the same period of 2011, across the lines of business. The
decrease was in line with the run-off expectations combined with unfavorable
foreign exchange movements. Ceded premiums written marginally decreased largely
due to timing differences.
Net premiums earned decreased by 7.1% in the three months ended June 30,
2012 as compared to the same period of 2011. This decrease was consistent with
the decrease in gross and net premiums written as described above.
Claims and policy benefit reserves decreased by 4.6% in the three months
ended June 30, 2012 as compared to the same period of 2011, as a result of the
factors noted above affecting gross and net premiums written, the impact of
foreign exchange movements and claims volatility.
Acquisition costs decreased by 18.8% in the three months ended June 30,
2012 as compared to the same period of 2011, mainly due to the impact of accrual
adjustments in the prior year that were one-off in nature.
Operating expenses increased by 3.9% in the three months ended June 30,
2012 or $0.1 million, as compared to the same period in the prior year.
52
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Net investment income is included in the calculation of contribution from
Life operations, as it relates to income earned on portfolios of separately
identified and managed life investment assets and other allocated assets. Net
investment income decreased by 9.0% in the three months ended June 30, 2012 as
compared to the same period of 2011 due to unfavorable foreign exchange
movements, lower investment yields and a lower invested asset base, reflecting
the run-off nature of the Life operations business.
Investment Activities
The following table illustrates the change in net investment income from
P&C operations, net income from investment fund affiliates, net realized
(losses) gains on investments and net realized and unrealized gains (losses) on
investment derivative instruments for the three months ended June 30, 2012 and
2011:
Three Months Ended
June 30,
(U.S. dollars in thousands) 2012 2011 % change
Net investment income - P&C operations (1) $ 187,986$ 214,448
(12.3 )%
Net income (loss) from investment fund
affiliates (2) 3,097 10,250 (69.8 )%
Net realized gains (losses) on investments (12,393 ) (9,544 ) 29.9 %
Net realized and unrealized gains (losses)
on investment and other derivative
instruments (3) (4,300 ) (10,950 ) (60.7 )%
(1) Net investment income relating to P&C operations includes the net investment
income related to the net results from structured products.
(2) The Company generally records the income related to alternative fund
affiliates on a one-month lag and the private investment fund affiliates on a
three-month lag in order for the Company to meet the filing deadlines for its
periodic reports.
(3) For a summary of realized and unrealized gains and losses on all derivative
instruments, see Item 1, Note 6, "Derivative Instruments," to the Unaudited
Consolidated Financial Statements included herein.
Net investment income related to P&C business decreased in the three months
ended June 30, 2012 as compared to the same period of 2011 due primarily to a
reduction in investment yields and cash outflows from the investment portfolio.
Net income from investment fund affiliates decreased in the three months
ended June 30, 2012 as compared to the same period of 2011. This was driven by
moderately negative results from alternative fund affiliates as compared to
positive results in the three months ended June 30, 2011, partially offset by an
improvement in the returns from private funds.
The Company manages its fixed income portfolio in accordance with
investment authorities approved by the Risk and Finance Committee of the Board
of Directors of XL-Ireland. The following is a summary of the investment
portfolio returns for the three months ended June 30, 2012 and 2011 of the fixed
income and non-fixed income portfolios:
Three Months Ended
June 30,
2012 (1) 2011 (1)
Total Return on Investments 1.4 % 1.7 %
P&C fixed income portfolio 1.0 % 1.6 %
Life fixed income portfolio 2.7 % 2.0 %
Other Portfolios
Alternative portfolio (2) (0.3 )% 1.1 %
Equity portfolio (6.9 )% 1.3 %
High-Yield fixed income portfolio 1.2 % 0.2 %
(1) Portfolio returns are calculated by dividing the sum of gross investment
income or net income from investment affiliates, realized gains (losses) and
unrealized gains (losses) by the average market value of each portfolio. The
performance of investment portfolios are measured on a local currency basis.
For aggregate performance calculation, respective local currency balances are
translated to U.S. dollars at quarter end rates to calculate composite
portfolio results.
(2) Performance on the alternative portfolio reflects the three months ended May
31, 2012 and 2011, respectively.
Net Realized Gains and Losses on Investments and Other-than-Temporary Declines
in the Value of Investments
Net realized losses on investments of $12.4 million in the three months
ended June 30, 2012 included net realized losses of approximately $28.2 million
related to the write-down of certain of the Company's AFS investments as well as
losses arising on targeted sales of European financial exposures, partially
offset by net realized gains of $24.0 million on sales of equity securities.
53
-------------------------------------------------------------------------------- The significant components of the net impairment charges of $28.2 million for
the three months ended June 30, 2012 were:
• $14.3 million for structured securities where the Company determined that
the likely recovery on these securities was below the carrying value and,
accordingly, recorded an impairment of the securities to the discounted
value of the cash flows expected to be received on these securities.
• $10.2 million related to medium term notes backed primarily by European
investment grade credit. On certain notes, management concluded that
expected future returns on the underlying assets were not sufficient to
support the previously reported amortized cost. The Company also adjusted
the estimated remaining holding period of certain notes resulting in a
shorter reinvestment spectrum.
• $2.2 million related to currency losses primarily arising on U.K.
sterling denominated securities held in U.S. dollar portfolios.
• $1.5 million related to equities as the holding was more than 50%
impaired.
Net realized losses on investments during the three months ended June 30,
2011 included net realized losses of $27.2 million related to the write-down of
certain of the Company's fixed income, equity and other investments with respect
to which the Company determined that there was an other-than-temporary decline
in the value of those investments as well as net realized gains of $17.7 million
from sales of investments.
Net Realized and Unrealized Gains and Losses on Derivatives
Net realized and unrealized losses on derivatives of $4.3 million in the
three months ended June 30, 2012 resulted from the Company's investment strategy
to manage interest rate risk, foreign exchange risk and credit risk, and to
replicate permitted investments. For a further discussion see Item 1, Note 6,
"Derivative Instruments," to the Unaudited Consolidated Financial Statements
included herein.
Other Revenues and Expenses
The following table sets forth other revenues and expenses of the Company
for the three months ended June 30, 2012 and 2011:
Three Months Ended
June 30,
(U.S. dollars in thousands) 2012 2011 % change
Net income (loss) from operating affiliates (1) $ 22,561$ 46,251
(51.2 )%
Exchange gains (losses) 17,976 8,498 111.5 %
Corporate operating expenses (50,061 ) (39,566 ) 26.5 %
Interest expense (2) (26,089 ) (41,599 ) (37.3 )%
Income tax (benefit) expense 29,812 24,826 20.1 %
(1) The Company generally records the income related to certain operating
affiliates on a three-month lag based upon the availability of the
information provided by the investees.
(2) Interest expense excludes interest expense related to structured products
recorded in the Insurance and Reinsurance segments.
The following table sets forth the net income (loss) from operating
affiliates for the three months ended June 30, 2012 and 2011:
Three Months Ended
June 30,
(U.S. dollars in thousands) 2012 2011 % change
Net income (loss) from financial operating
affiliates $ - $ (1,018 ) (100.0 )%
Net income (loss) from investment manager
affiliates 14,052 41,345 (66.0 )%
Net income (loss) from strategic operating
affiliates 8,509 5,924 43.6 %
Total $ 22,561 $ 46,251 (51.2 )%
The financial operating affiliate loss in the three months ended June 30,
2011 is wholly attributable to a write down in value of one investment following
a restructuring.
Investment manager affiliate income decreased in the three months ended
June 30, 2012 as compared to the same period in the prior year due to an
especially strong quarter for certain investment manager affiliates in the
second quarter of 2011 as a result of
54
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both strong performance by the investment manager affiliates and the achievement
of results that surpassed certain fee hurdles by various funds under management,
as compared to solid results for the investment manager affiliates in the second
quarter of this year.
Strategic operating affiliate income increased in the three months ended
June 30, 2012 as compared to the three months of 2011 due to a loss on one of
the strategic operating affiliates in the three months ended June 30 2011.
Foreign exchange gains in the three months ended June 30, 2012 were a
result of an overall strengthening of the value of the U.S. dollar against the
Company's major currency exposures, which include the Euro, U.K. sterling and
the Swiss franc.
Corporate operating expenses increased in the three months ended June 30,
2012 as compared to the same period in the prior year primarily as a result of
certain strategic corporate initiatives taking place in 2012.
Interest expense decreased in the three months ended June 30, 2012 as
compared to the same period in the prior year as a result of the overall
reduction in the Company's debt following the repayment at maturity on January
15, 2012 of $600 million principal amount outstanding 6.5% XLCFE Notes, the
purchase and retirement of the $575 million principal amount outstanding 8.25%
Senior Notes in August 2011, offset by the issuance of $400 million principal
amount outstanding 5.75% Senior Notes in September 2011. For further information
about these debt financing transactions, see Item 8, Note 13, "Notes Payable and
Debt Financing," to the Consolidated Financial Statements included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2011.
A tax charge of $29.8 million was incurred in the three months ended June
30, 2012. The Company recognized a tax charge of $24.8 million in the three
months ended June 30, 2011, which included a benefit of $11.9 million arising as
a result of a change in an overseas tax rule adopted in the three months ended
June 30, 2011. Excluding this benefit, the decrease in the Company's income tax
expense in the three months ended June 30, 2012 compared to the same quarter in
2011 reflects the Company's expected full year effective tax rate applicable in
each of the years.
Segment Results for the six months ended June 30, 2012 compared to the six
months ended June 30, 2011
Insurance
The following table summarizes the underwriting profit (loss) for the
Insurance segment:
Six Months Ended
June 30,
(U.S. dollars in thousands) 2012 2011 % change
Gross premiums written $ 2,647,668 $ 2,512,379 5.4 %
Net premiums written 1,980,793 1,812,181 9.3 %
Net premiums earned 1,893,350 1,783,363 6.2 %
Net losses and loss expenses (1,266,969 ) (1,396,695 ) (9.3 )%
Acquisition costs (251,540 ) (221,527 ) 13.5 %
Operating expenses (377,593 ) (330,703 ) 14.2 %
Underwriting profit (loss) $ (2,752 ) $ (165,562 ) (98.3 )%
Net results - structured products 11,866
5,950 99.4 %
Net fee income and other (3,867 ) (9,130 ) (57.6 )%
Gross premiums written increased in the six months ended June 30, 2012 as
compared to the same period of 2011 by 5.4% and, when evaluated in local
currency, increased by 7.4%. This increase was experienced across the business
groups predominantly from new business, improved pricing and higher retention
levels, partially offset by the unfavorable impact of foreign exchange rates.
For NAPC, the growth in premium was largely driven by new business growth across
most lines, improved retention for construction, property and primary casualty,
and improved pricing mainly in property over the prior year, partially offset by
certain premium adjustments in environmental and excess casualty. In
Professional, improved pricing and new business primarily in the U.S.
professional business and favorable amendments to prior year premium estimates
and retention levels contributed to increased premiums but were partially offset
by the non-renewal of certain under-priced business. In Specialty, there was
premium growth from favorable amendments to prior year premium estimates,
increased writings from the new business lines of political risk and product
recall, new business in marine cargo lines, partially offset by lower retention
levels and adverse amendments to prior year premium estimates in aerospace.
Finally, there was a decline in gross premiums written in IPC from lower
retention and reduced new business in property and primary casualty. The lower
retention relates to the non-renewal of property accounts that did not meet the
Company's pricing requirements. Partially offsetting these declines was improved
retention levels and growth over the prior year in middle market lines.
Net premiums written increased by 9.3% in the six months ended June 30,
2012 as compared to the same period of 2011. The increase resulted from the
gross written premium increases outlined above together with a decrease in ceded
written premiums. The decrease in ceded premiums relates to decreased
utilization of facultative reinsurance, primarily in IPC, following the
cancelation of a
55
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large general property program, from lower cessions as a result of lower
retention levels in IPC property, as outlined above, and from reduced ceded
reinstatement premiums related to marine losses, partially offset by changes in
the structure and costs of certain property reinsurance treaties.
Net premiums earned increased by 6.2% in the six months ended June 30, 2012
as compared to the same period of 2011. The increase primarily resulted from
higher net written premiums earned in NAPC, Professional and Specialty, and the
favorable amendments to certain prior year premium estimates partially offset by
marine reinstatement premiums.
The following table presents the ratios for the Insurance segment:
Six Months Ended
June 30,
2012 2011
Loss and loss expense ratio 66.9 % 78.3 %
Acquisition expense ratio 13.3 % 12.4 %
Operating expense ratio 19.9 % 18.6 %
Underwriting expense ratio 33.2 % 31.0 %
Combined ratio 100.1 % 109.3 %
The loss and loss expense ratio includes net losses incurred for both the
current quarter and any favorable or adverse prior year development of loss and
loss expense reserves held at the beginning of the year. The following table
summarizes the net (favorable) adverse prior year development relating to the
Insurance segment for the six months ended June 30, 2012 as compared to the same
period of 2011:
Six Months Ended
June 30,
(U.S. dollars in millions, except ratios) 2012 2011
Property $ (17.0 ) $ (23.7 )
Casualty (61.9 ) 12.0
Professional (52.6 ) (75.3 )
Specialty and other 34.7 16.7
Total $ (96.8 ) $ (70.3 )
Loss and loss expense ratio excluding prior year development 72.0 %
82.3 %
Excluding prior year development, the loss ratio for the six months ended
June 30, 2012 decreased by 10.3 loss percentage points as compared to the same
period in 2011 due to lower levels of catastrophe losses occurring in 2012.
Catastrophe and large loss activity net of reinsurance recoveries and including
reinstatement premiums was $76.4 million lower for the first six months of 2012
as compared to the same period of 2011. For further details on catastrophe
losses in 2011 see Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Significant Items Affecting the Results of
Operations - 1) The impact of significant large natural catastrophe activity,"
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2011. Excluding favorable prior year development, net catastrophe losses and
related reinstatement premiums in both periods, the loss ratio for the six
months ended June 30, 2012 compared to the same period of 2011 decreased by 5.6
points to 68.5%, due to significant large loss activity in the IPC and NAPC
energy and property units in the first quarter of 2011 partially offset by a
large marine loss in the first quarter of 2012.
Net favorable prior year reserve development of $96.8 million for the six
months ended June 30, 2012 was mainly attributable to the following:
• For property lines, net prior year development was $17.0 million favorable.
This was driven by releases of $17.3 million and $3.2 million for the
non-catastrophe exposures in the property and energy books, respectively,
due to better than expected reported loss experience mainly in the 2011
accident year. This favorable experience was partially offset by adverse
development of $7.3 million in the construction book also primarily
attributable to the 2011 accident year and again for the non-catastrophe
exposures. The catastrophe exposures saw releases totaling $2.8 million
overall with $6.6 million arising from the 2010 accident year offset by a
strengthening of $3.3 million in the 2011 accident year.
• For casualty lines, net prior year development was $61.9 million favorable.
This was driven by a release of $34.8 million in the primary casualty
business due to better than expected reported loss experience. The primary
casualty releases related to the 2002 to 2007 accident years as well as the
2010 and 2011 accident years. There was also a release of $37.5 million in
the excess casualty lines due primarily to the favorable resolution of a
mature claim. The releases in primary and excess casualty were partially
offset by strengthening of $9.6 million in U.S. middle markets due to worse
than expected loss experience.
• For Professional, net prior year development was $52.6 million favorable.
This was driven by releases in reserves for clash losses (which cover a
number of substantially similar claims against multiple policyholders) in
the U.S. and Bermuda core professional
56
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businesses totaling $50.4 million. This was comprised of a release of $4.5
million for the 2006 and prior report years to reflect favorable reported
loss experience across these years, and a release of $45.9 million for
report year 2010 to reflect the limited clash events in the U.S. and Bermuda
core professional businesses for this year.
In terms of non-clash losses in the professional lines, $24.5 million and
$18.1 million was released from the U.S. and Bermuda core professional
businesses, respectively, due to better than expected reported loss
development while the International core professional business was
strengthened by $37.1 million due to unfavorable reported loss development.
Finally for the professional lines, the Design portfolio covering
architects' and engineers' professional liability was strengthened by $4.8
million driven by worse than expected reported loss experience in the
Canadian book.
• For specialty and other lines, net prior year development was $34.7 million
unfavorable. This was driven by adverse reported loss development for the
non-catastrophe exposures in the excess and surplus lines, which led to a
strengthening of $30.0 million. For the same reason, marine was strengthened
by $13.3 million, run-off surety by $12.5 million, programs by $10.9 million
and environmental by $4.4 million. These increases were partially offset by
releases of $25.0 million in aerospace and $3.2 million in discontinued
lines due to better than expected reported loss experience, and a release of
$8.9 million for the catastrophe exposures in marine.
The increase in the underwriting expense ratio for the six months ended
June 30, 2012 as compared to the same period of 2011 was due to an increase in
the operating expense ratio of 1.3 points combined with an increase in the
acquisition expense ratio of 0.9 points. The increase in the operating expense
ratio was due to higher compensation expenses due to different bonus accrual
assumptions and severance costs in the six months ended June 30, 2012 as
compared to the same period of 2011. The increase in the acquisition expense
ratio was largely from the impact of marine reinstatement premiums and other
earned premium adjustments on the ratio, and a change in the mix of business in
Professional.
Fee income and other improved in the six months ended June 30, 2012 as
compared to the same period of 2011 mainly as a result of expenses during the
prior year in professional lines related to the cost of an endorsement facility
with National Indemnity Company. For further information about this facility,
see Item 8, Note 7, "Other Investments," to the Consolidated Financial
Statements included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2011.
Net results from structured insurance products include certain structured
indemnity contracts that are accounted for as deposit contracts. Net results
from these contracts have improved in the six months ended June 30, 2012 as
compared to the same period of 2011 due to a lower interest expense as a result
of an accretion rate adjustment recorded in the current quarter based on changes
in expected cash flows and payout patterns on certain structured indemnity
contracts.
Reinsurance
The following table summarizes the underwriting profit (loss) for the
Reinsurance segment:
Six Months Ended
June 30,
(U.S. dollars in thousands) 2012 2011 % change
Gross premiums written $ 1,432,767 $ 1,349,184 6.2 %
Net premiums written 1,329,713 1,208,160 10.1 %
Net premiums earned 865,520 794,458 8.9 %
Net losses and loss expenses (413,451 ) (635,754 ) (35.0 )%
Acquisition costs (175,967 ) (164,974 ) 6.7 %
Operating expenses (80,738 ) (89,183 ) (9.5 )%
Underwriting profit (loss) $ 195,364 $ (95,453 ) *NM
Net results - structured products (20,415 ) 6,440 *NM
Fee income and other 1,323 1,385 (4.5 )%
* NM - Not Meaningful
Gross premiums written increased in the six months ended June 30, 2012 as
compared to the same period of 2011 by 6.2% and, when evaluated in local
currency, increased by 7.7%. The premium growth was predominantly from the
International business group, attributable to casualty lines through new
writings and higher renewals; increased property catastrophe shares and rates in
Continental Europe; and new business and increased shares in Asia Pacific
property proportional lines of business. For the Bermuda business group, there
was premium growth from renewals both through price and capacity increases and
from the timing of certain Japanese treaties, since in 2011, the renewal dates
and periods of cover were affected by the Japan earthquake and tsunami. These
were partially offset by the absence of property catastrophe reinstatement
premiums in the Bermuda and International business units, which were written and
earned in the same period of 2011 in connection with natural catastrophe losses
from the Japan earthquake and
57
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tsunami. The North America business group experienced a decrease in gross
premiums written, driven by a reduction in volume, shares and price for certain
renewed property quota share and property excess of loss contracts, as well as
from changes in the structure of a U.S. agricultural program partially offset by
new business. Premiums from the Latin America business group declined compared
to the same period of the prior year mainly due to the timing of certain
property renewals.
Net premiums written increased by 10.1% in the six months ended June 30,
2012 as compared to the same period of 2011. The increase resulted from the
gross written premium increases outlined above coupled with a reduction in ceded
written premiums. The decrease in ceded written premiums was mainly from the
North America business group reflecting the change in structure of a U.S.
agricultural program, partially offset by increased ceded reinstatement premiums
in the International business group related to the 2011 Thailand flood loss.
Net premiums earned increased by 8.9% in the six months ended June 30, 2012
as compared to the same period of 2011. The increase is a reflection of the
overall growth in net premiums written in recent quarters partially offset by
the increase, in 2011, of reinstatement premiums on catastrophe losses, which
were earned immediately.
The following table presents the ratios for the Reinsurance segment:
Six Months Ended
June 30,
2012 2011
Loss and loss expense ratio 47.8 % 80.0 %
Acquisition expense ratio 20.3 % 20.8 %
Operating expense ratio 9.3 % 11.2 %
Underwriting expense ratio 29.6 % 32.0 %
Combined ratio 77.4 % 112.0 %
The loss and loss expense ratio includes net losses incurred for both the
current year and any favorable or adverse prior year development of loss and
loss expense reserves held at the beginning of the year. The following table
summarizes the net (favorable) adverse prior year development relating to the
Reinsurance segment for the six months ended June 30, 2012 and 2011:
Six Months Ended
June 30,
(U.S. dollars in millions, except ratios) 2012
2011
Property and other short-tail lines $ (40.6 ) $ (56.1 )
Casualty and other (44.2 ) (72.2 )
Total $ (84.8 ) $ (128.3 )
Loss and loss expense ratio excluding prior year development 57.6 %
96.2 %
Excluding prior year development, the loss ratio for the six months ended
June 30, 2012 decreased by 38.6 loss percentage points as compared to the same
period of 2011. Losses net of reinsurance recoveries and including reinstatement
premiums recorded related to natural catastrophe events for the six months ended
June 30, 2012 were $11.2 million compared to $309.9 million in the same period
of 2011. For further details on catastrophe losses in 2011 see Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations, Significant Items Affecting the Results of Operations - 1) The
impact of significant large natural catastrophe activity" included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2011.
Excluding favorable prior year development, net catastrophe losses and related
reinstatement premiums in both periods, the loss ratio for the six months ended
June 30, 2012 and 2011 was the same at 56.2%.
Net favorable prior year reserve development of $84.8 million for the six
months ended June 30, 2012 was mainly attributable to the following:
• Net favorable prior year development of $40.6 million for the short-tailed
lines and details of these by specific lines are as follows:
• For property catastrophe lines, net prior year development was $0.4
million favorable.
• For property other lines, net prior year development was $22.4 million
favorable mainly due to favorable attritional claim development on the
North America and Bermuda books offset by some unfavorable
attritional
claim development on the Latin America book. Unfavorable
development
on a property facultative loss was offset by favorable subrogation on
an older large loss.
• For marine and aviation lines, net prior year development was $17.8
million favorable due mainly to favorable attritionaldevelopment
together with releases on older large losses.
58
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• Net favorable prior year development of $44.2 million for the long-tailed
lines and details of these by specific lines are as follows:
• For casualty lines, net prior year development was $35.3 million
favorable arising mainly out of the North America book due to better
than expected development on the 2003 and 2004 underwriting years.
• For other lines, net prior year development was $8.9 million favorable
mainly driven by a release on the Structured Indemnity book.
The decrease in the underwriting expense ratio for the six months ended
June 30, 2012 as compared to the same period of 2011 was due to a reduction in
both the operating expense ratio of 1.9 points and the acquisition expense ratio
of 0.5 points. The decrease in the operating expense ratio was due to lower
compensation expenses in 2012 and reduced professional fees as compared to the
same period of 2011. The decrease in the acquisition expense ratio was largely
from decreased profit commissions paid as a result of lower net favorable prior
year development in North America compared to the same period of 2011.
Net results from structured reinsurance products include certain structured
indemnity contracts that are accounted for as deposit contracts. Net results
from these contracts have decreased in the six months ended June 30, 2012 as
compared to the same period of 2011 due to higher interest expense. The higher
interest expense was due to an accretion rate adjustment recorded in the current
quarter based on changes in expected cash flows and payout patterns on one of
the larger structured indemnity contracts and from lower net investment income
in the six months ended June 30, 2012 reflecting lower investment yields and the
run-off nature of this line of business.
Life Operations
The following table summarizes the contribution from the Life operations
segment, which has been in run-off since 2009.
Six Months Ended
June 30,
(U.S. dollars in thousands) 2012 2011 % change
Gross premiums written $ 179,587 $ 197,940 (9.3 )%
Net premiums written 164,119 181,866 (9.8 )%
Net premiums earned 164,143 181,901 (9.8 )%
Net losses and loss expenses (252,457 ) (270,647 ) (6.7 )%
Acquisition costs (15,581 ) (17,088 ) (8.8 )%
Operating expenses (5,436 ) (4,889 ) 11.2 %
Net investment income 149,671 159,033 (5.9 )%
Net fee income and other 90 137 (34.3 )%
Realized gains (losses) on investments (14,403 ) (38,847 ) (62.9 )%
Contribution from Life operations $ 26,027$ 9,600
*NM
* NM - Not Meaningful
The following table is an analysis of the Life operations' gross premiums
written, net premiums written and net premiums earned for the six months ended
June 30, 2012 and 2011:
Six Months Ended Six Months Ended
June 30, 2012 June 30, 2011
Gross Net Net Gross Net Net
(U.S. dollars in Premiums Premiums Premiums Premiums Premiums Premiums
thousands) Written Written Earned Written Written Earned
Other Life $ 102,767 $ 101,418 $ 101,443 $ 116,027 $ 114,975 $ 115,010
Annuity 76,820 62,701 62,700 81,913 66,891 66,891
Total $ 179,587 $ 164,119 $ 164,143 $ 197,940 $ 181,866 $ 181,901
Gross premiums written decreased in the six months ended June 30, 2012 as
compared to the same period of 2011 by 9.3%, driven predominantly by the Other
Life business. The decrease was in line with the run-off expectations combined
with unfavorable foreign exchange movements. Ceded premiums written marginally
decreased largely due to timing differences.
Net premiums earned decreased in the six months ended June 30, 2012 as
compared to the same period of 2011 by 9.8%. This decrease was consistent with
the decrease in gross and net premiums written as described above.
59
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Claims and policy benefit reserves decreased by 6.7% in the six months
ended June 30, 2012 as compared to the same period of 2011, as a result of the
factors noted above affecting gross and net premiums written, the impact of
foreign exchange movements and claims volatility.
Acquisition costs decreased in the six months ended June 30, 2012 as
compared to the same period of 2011 by 8.8%, mainly due to the impact of accrual
adjustments in the prior year that were one-off in nature.
Operating expenses increased by 11.2% in the six months ended June 30, 2012
as compared to the same period in the prior year due to certain accrual
adjustments in the prior year which lowered the expenses in that period.
Net investment income is included in the calculation of contribution from
Life operations, as it relates to income earned on portfolios of separately
identified and managed life investment assets and other allocated assets. Net
investment income decreased by 5.9% in the six months ended June 30, 2012 as
compared to the same period of 2011 due to unfavorable foreign exchange
movements, lower investment yields and a lower invested asset base, reflecting
the run-off nature of the Life operations business.
Investment Activities
The following table illustrates the change in net investment income from
P&C operations, net income from investment fund affiliates, net realized
(losses) gains on investments and net realized and unrealized gains (losses) on
investment derivative instruments for the six months ended June 30, 2012 and
2011:
Six Months Ended
June 30,
(U.S. dollars in thousands) 2012 2011 % change
Net investment income - P&C operations (1) $ 378,202$ 417,735
(9.5 )%
Net income (loss) from investment fund
affiliates (2) 22,505 37,400 (39.8 )%
Net realized gains (losses) on investments 8,410 (75,981 ) *NM
Net realized and unrealized gains (losses) on
investment and other derivative instruments (3) (3,598 ) (7,383 ) 51.3 %
(1) Net investment income relating to P&C operations includes the net investment
income related to the net results from structured products.
(2) The Company generally records the income related to alternative fund
affiliates on a one-month lag and the private investment fund affiliates on a
three-month lag in order for the Company to meet the filing deadlines for its
periodic reports.
(3) For a summary of realized and unrealized gains and losses on all derivative
instruments, see Item 1, Note 6, "Derivative Instruments," to the Unaudited
Consolidated Financial Statements included herein.
* NM - Not Meaningful
Net investment income related to P&C business decreased in the six months
ended June 30, 2012 as compared to the same period of 2011 due primarily to a
reduction in investment yields and cash outflows from the investment portfolio.
Net income from investment fund affiliates decreased in the six months
ended June 30, 2012 as compared to the same period of 2011. This was driven by
solid results from alternative fund affiliates in the first six months of 2012
as compared to strong results in the six months ended June 30, 2011 across both
alternative and private fund affiliates.
The Company manages its fixed income portfolio in accordance with
investment authorities approved by the Risk and Finance Committee of the Board
of Directors of XL-Ireland. The following is a summary of the investment
portfolio returns for the six months ended June 30, 2012 and 2011 of the fixed
income and non-fixed income portfolios:
60
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Six Months Ended
June 30,
2012 (1) 2011 (1)
Total Return on Investments 2.9 % 2.4 %
P&C fixed income portfolio 2.6 % 2.5 %
Life fixed income portfolio 4.4 % 2.1 %
Other Portfolios
Alternative portfolio (2) 1.9 % 4.4 %
Equity portfolio 4.3 % 6.1 %
High-Yield fixed income portfolio 4.0 % 3.0 %
(1) Portfolio returns are calculated by dividing the sum of gross investment
income or net income from investment affiliates, realized gains (losses) and
unrealized gains (losses) by the average market value of each portfolio. The
performance of investment portfolios are measured on a local currency basis.
For aggregate performance calculation, respective local currency balances are
translated to U.S. dollars at quarter end rates to calculate composite
portfolio results.
(2) Performance on the alternative portfolio reflects the three months ended May
31, 2012 and 2011, respectively.
Net Realized Gains and Losses on Investments and Other-than-Temporary Declines
in the Value of Investments
Net realized gains on investments of $8.4 million in the six months ended
June 30, 2012 included net realized losses of approximately $49.2 million
related to the write-down of certain of the Company's AFS investments as well as
losses arising on targeted sales of European financial exposures. In addition,
included in the net realized gains noted above are net realized gains of $57.6
million due primarily to gains from a repositioning of the Agency RMBS portfolio
and net realized gains of $33.8 million on sales of equity securities.
The significant components of the net impairment charges of $49.2 million
for the six months ended June 30, 2012 were:
• $31.3 million for structured securities where the Company determined that
the likely recovery on these securities was below the carrying value and,
accordingly, recorded an impairment of the securities to the discounted
value of the cash flows expected to be received on these securities.
• $13.2 million related to medium term notes backed primarily by European
investment grade credit. On certain notes, management concluded that
expected future returns on the underlying assets were not sufficient to
support the previously reported amortized cost. The Company also adjusted
the estimated remaining holding period of certain notes resulting in a
shorter reinvestment spectrum.
• $2.2 million related to currency losses primarily arising on U.K.
sterling denominated securities held in U.S. dollar portfolios.
• $1.5 million related to equities as the holding was more than 50%
impaired.
• $1.0 million for corporate securities, excluding medium term notes,
principally on hybrid securities.
Net realized losses on investments during the six months ended June 30,
2011 included net realized losses of $64.6 million related to the write-down of
certain of the Company's fixed income, equity and other investments with respect
to which the Company determined that there was an other-than-temporary decline
in the value of those investments as well as $11.4 million from sales of
investments principally on European financials and non-Agency RMBS.
Net Realized and Unrealized Gains and Losses on Derivatives
Net realized and unrealized losses on derivatives of $3.6 million in the
six months ended June 30, 2012 resulted from the Company's investment strategy
to manage interest rate risk, foreign exchange risk and credit risk, and to
replicate permitted investments. For a further discussion see Item 1, Note 6,
"Derivative Instruments," to the Unaudited Consolidated Financial Statements
included herein.
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Other Revenues and Expenses
The following table sets forth other revenues and expenses of the Company
for the six months ended June 30, 2012 and 2011:
Six Months Ended
June 30,
(U.S. dollars in thousands) 2012 2011 % change
Net income (loss) from operating affiliates (1) $ 38,814$ 59,887
(35.2 )%
Exchange gains (losses) 5,258 (1,016 ) NM*
Corporate operating expenses (94,321 ) (75,258 ) 25.3 %
Interest expense (2) (53,409 ) (83,498 ) (36.0 )%
Income tax (benefit) expense 51,362 (7,971 ) NM*
(1) The Company generally records the income related to certain operating
affiliates on a three-month lag based upon the availability of the
information provided by the investees.
(2) Interest expense excludes interest expense related to structured products
recorded in the Insurance and Reinsurance segments.
* NM - Not meaningful
The following table sets forth the net income (loss) from operating
affiliates for the six months ended June 30, 2012 and 2011:
Six Months Ended
June 30,
(U.S. dollars in thousands) 2012 2011 % change
Net income (loss) from financial operating
affiliates $ - $ (1,018 ) (100.0 )%
Net income (loss) from investment manager
affiliates $ 24,612 $ 46,512 (47.1 )%
Net income (loss) from strategic operating
affiliates 14,202 14,393 (1.3 )%
Total $ 38,814 $ 59,887 (35.2 )%
The financial operating affiliate loss in the six months ended June 30,
2011 is wholly attributable to a write down in the value of one investment
following a restructuring.
Investment manager affiliate income decreased in the six months ended June
30, 2012 as compared to the same period in the prior year due to especially
strong performance by the investment manager affiliates and the achievement of
results that surpassed certain fee hurdles by various funds under management in
the second quarter of 2011, as compared to solid results for the investment
manager affiliates in the six months ended June 30, 2012.
Strategic operating affiliate income for the six months ended June 30, 2012
was in line with the results for same period in the prior year.
Foreign exchange gains in the six months ended June 30, 2012 were a result
of an overall strengthening of the value of the U.S. dollar against the
Company's major currency exposures, which include the Euro and the Swiss franc.
In the six months ended June 30, 2011, the foreign exchange losses were due to a
weaker U.S. dollar against all of the Company's major currency exposures,
particularly the Swiss franc and the Euro.
Corporate operating expenses increased in the six months ended June 30,
2012 as compared to the same period in the prior year primarily as a result of
certain strategic corporate initiatives taking place in 2012.
Interest expense decreased in the six months ended June 30, 2012 as
compared to the same period in the prior year as a result of the overall
reduction in the Company's debt following the repayment at maturity on January
15, 2012 of $600 million 6.5% XLCFE Notes, the purchase and retirement of the
$575 million 8.25% Senior Notes in August 2011, offset by the issuance of $400
million 5.75% Senior Notes in September 2011. For further information about
these debt financing transactions see Item 8, Note 13, "Notes Payable and Debt
Financing," to the Consolidated Financial Statements included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2011.
A tax charge of $51.4 million was incurred in the six months ended June 30,
2012. The Company recognized a tax benefit of $8.0 million in the six months
ended June 30, 2011, which included a benefit of $11.9 million arising as a
result of a change in an overseas tax rule adopted in the three months ended
June 30, 2011. Excluding this benefit, the increase in the tax charge incurred
in the six months ended June 30, 2012 compared to the same period of 2011 arose
principally from higher income in taxable jurisdictions in the six months ended
June 30, 2012.
62
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BALANCE SHEET ANALYSIS
Investments
The primary objectives of the investment strategy are to support the
liabilities arising from the operations of the Company, generate stable
investment income and build book value for the Company over the longer term. The
strategy strives to balance investment returns against market and credit risk.
The Company's overall investment portfolio is structured to take into account a
number of variables including local regulatory requirements, business needs,
collateral management and risk tolerance.
At both June 30, 2012 and December 31, 2011, total investments, cash and
cash equivalents, accrued investment income and net receivable/(payable) for
investments sold/(purchased) were approximately $36 billion. The following table
summarizes the composition of the Company's invested assets at June 30, 2012 and
December 31, 2011:
June 30, 2012 December 31, 2011
Carrying Percent Carrying Percent
(U.S. dollars in thousands) Value (1) of Total Value (1) of Total
Cash and cash equivalents $ 3,311,146 9.3 % $ 3,825,125 10.7 %
Net receivable/ (payable) for
investments sold/ (purchased) 5,866 0.0 % 1,233 0.0 %
Accrued investment income 323,898 0.9 % 331,758 0.9 %
Short-term investments 227,380 0.7 % 359,063 1.0 %
Fixed maturities - AFS:
U.S. Government and
Government-Related/Supported (2) 2,101,625 5.9 % 1,990,983 5.5 %
Corporate - Financials (3) (4) (5) 2,809,953 7.9 % 3,038,398 8.5 %
Corporate - Non Financials (4) 6,911,200 19.4 % 7,070,224 19.7 %
RMBS - Agency 5,202,313 14.6 % 5,379,406 15.0 %
RMBS - Non-Agency 584,543 1.6 % 641,815 1.8 %
CMBS 904,792 2.6 % 974,835 2.8 %
CDO 650,018 1.8 % 658,602 1.8 %
Other asset-backed securities (5) 1,407,738 4.0 % 1,340,249 3.7 %
U.S. States and political
subdivisions of the States 1,764,431 5.0 % 1,797,378 5.0 %
Non-U.S. Sovereign Government,
Provincial, Supranational and
Government-Related/Supported (2) 3,906,189 11.0 % 3,298,135 9.2 %
Total fixed maturities - AFS $ 26,242,802 73.8 % $ 26,190,025 73.0 %
Fixed maturities - HTM:
U.S. Government and
Government-Related/Supported (2) 10,458 0.0 % 10,399 0.0 %
Corporate - Financials (3) (4) (5) 257,713 0.7 % 305,122 0.9 %
Corporate - Non Financials (4) 1,129,320 3.2 % 985,087 2.7 %
RMBS - Non-Agency 81,028 0.2 % 80,955 0.2 %
CMBS 12,546 0.0 % - 0.0 %
Other asset-backed securities (5) 217,347 0.6 % 288,741 0.8 %
Non-U.S. Sovereign Government,
Provincial, Supranational and
Government-Related/Supported (2) 1,007,945 2.8 % 998,674 2.8 %
Total fixed maturities - HTM $ 2,716,357 7.5 % $ 2,668,978 7.4 %
Equity securities (6) 529,056 1.5 % 468,197 1.3 %
Investments in affiliates 1,024,353 2.9 % 1,052,729 2.9 %
Other investments 1,208,220 3.4 % 985,262 2.8 %
Total investments and cash and cash
equivalents $ 35,589,078 100.0 % $ 35,882,370 100.0 %
(1) Carrying values represents the fair value for available for sale fixed maturities
and amortized cost for held to maturity securities.
(2) U.S. Government and Government-Related/Supported and Non U.S. Sovereign Government,
Provincial, Supranational and Government-Related include government-related
securities with an amortized cost of $2,012.4 million and $1,878.3 million and fair
value of $2,066.0 million and $1,915.6 million at June 30, 2012 and December 31,
2011, respectively, and U.S. Agencies with an amortized cost of $455.0 million and
$494.0 million and fair value of $500.5 million and $541.2 million at June 30, 2012
and December 31, 2011, respectively.
(3) Included in Corporate - Financials are gross unrealized losses of $74.7 million and
$108.8 million on Tier One and Upper Tier Two securities of financial institutions
("Hybrids") with fair value of $346.2 million and $386.1 million at June 30, 2012
and December 31, 2011, respectively, as well as gross unrealized losses of $36.5
million and $70.1 million on subordinated debt (including lower Tier Two
securities) with a fair value of $623.6 million and $701.3 million at June 30, 2012
and December 31, 2011, respectively.
(4) Included within Corporate are certain floating rate medium term notes supported
primarily by pools of European investment grade credit with varying degrees of
leverage. The notes have a fair value of $186.1 million and $266.0 million and an
amortized cost of $199.1 million and $297.7 million at June 30, 2012 and December
31, 2011, respectively. These securities have been allocated ratings of the
underlying pool of securities. These notes allow the investor to participate in
cash flows of the underlying bonds including certain residual values, which could
serve to either decrease or increase the ultimate values of these notes.
(5) At June 30, 2012, Covered Bonds within Fixed maturities - AFS with a carrying value
of $500.5 million and Covered Bonds within Fixed maturities - HTM with a carrying
value of $8.1 million have been included within Other asset-backed securities to
align the Company's classification to market indices. Covered Bonds were included
in Corporate prior to January 1, 2012. At December 31, 2011, Covered Bonds within
Fixed maturities - AFS with a carrying
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value of $353.9 million and Covered Bonds within Fixed maturities - HTM with
a carrying value of $8.1 million have been reclassified from Corporate to
Other asset-backed securities to conform to the current period presentation.
(6) Included within equity securities are investments in fixed income funds of
$95.8 million and $91.6 million at June 30, 2012 and December 31, 2011,
respectively.
The Company reviews its corporate debt investments on a regular basis to
consider its concentration, credit quality and compliance with established
guidelines. At both June 30, 2012 and December 31, 2011, the average credit
quality of the Company's total fixed income portfolio (including fixed
maturities, short-term investments, cash and cash equivalents and net
receivable/(payable) for investment sold/(purchased)) was "Aa2/AA". Included in
the table below are the credit ratings of the fixed income portfolio excluding
operating cash at June 30, 2012 and December 31, 2011:
June 30, 2012
December 31, 2011
Investments by Credit Rating (1) (2) Carrying Percent Carrying Percent
(U.S. dollars in millions) Value of Total Value of Total
AAA $ 16,350 51.1 % $ 16,276 51.1 %
AA 5,085 15.9 % 5,266 16.6 %
A 6,841 21.4 % 7,098 22.3 %
BBB 2,840 8.9 % 2,418 7.6 %
BB and below 826 2.6 % 718 2.3 %
Not rated 16 0.1 % 39 0.1 %
Total $ 31,958 100.0 % $ 31,815 100.0 %
(1) At June 30, 2012 and December 31, 2011, $186.1 million and $266.0 million or
0.6% and 0.8% of the portfolio, respectively, represents medium term notes
rated at the average credit rating of the underlying asset pools backing the
notes.
(2) The credit rating for each asset reflected above was principally determined
based on the weighted average rating of the individual securities from
Standard & Poor's, Moody's Investors Service and Fitch Ratings (when
available). U.S. Agency debt and related mortgage backed securities, whether
with implicit or explicit government support, reflect the credit quality
rating of the U.S. government for the purpose of these calculations.
Gross and Net Unrealized Gains and Losses on Investments
The Company had gross unrealized losses totaling $576.8 million on 1,308
securities out of a total of 7,156 held at June 30, 2012 in its AFS portfolio
and $12.5 million on 15 securities out of a total of 208 held in its HTM
portfolio, which it considers to be temporarily impaired or with respect to
which it reflects non-credit losses on OTTI. Individual security positions
comprising this balance have been evaluated by management, in conjunction with
its investments managers, to determine the severity of these impairments and
whether they should be considered other-than-temporary.
Gross unrealized losses can be attributed to the following significant
drivers:
• gross unrealized losses of $165.6 million related to the Non-Agency RMBS
portfolio (which consists of the Company's holdings of sub-prime
Non-Agency RMBS, second liens, ABS CDOs with sub-prime collateral, Alt-A
and Prime RMBS), which had a fair value of $665.6 million at June 30, 2012. The Company has incurred realized losses, consisting of charges for
OTTI and realized losses from sales, of approximately $1.4 billion since
the beginning of 2007 through June 30, 2012 on these asset classes.
• gross unrealized losses of $163.8 million related to the Company's Life
operations investment portfolio, which had a fair value of $6.4 billion
at June 30, 2012. Of these gross unrealized losses, $88.4 million related
to $1.1 billion of exposures to corporate financial institutions,
including $281.1 million related to Tier One and Upper Tier Two
securities.
At June 30, 2012, this portfolio had an average interest rate duration of
8.6 years, primarily denominated in U.K. sterling and Euros. As a result
of the long duration, significant gross losses have arisen as the fair
values of these securities are more sensitive to prevailing government
interest rates and credit spreads. This portfolio is generally matched to
corresponding long duration liabilities. A hypothetical parallel increase
in interest rates and credit spreads of 50 and 25 basis points,
respectively, would increase the unrealized losses related to this
portfolio at June 30, 2012 by approximately $280.0 million and $107.8
million, respectively, on both the AFS and HTM Life operations
investments portfolios.
Given the long term nature of the Life operations investments portfolio,
the level of credit spreads on financial institutions at June 30, 2012
relative to historical averages within the U.K. and Euro-zone, and the
Company's liquidity needs at June 30, 2012, the Company believes that
these assets will continue to be held until such time as they mature, or
credit spreads on financial institutions revert to levels more consistent
with historical averages.
• gross unrealized losses of $154.1 million related to the P&C portfolios
of Core CDO holdings (defined by the Company as investments in
non-subprime CDOs), which consisted primarily of collateralized loan
obligations ("CLOs") and had a fair value of $650.0 million at June 30,
2012.
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• gross unrealized losses of $73.8 million related to the corporate
holdings within the Company's non-life fixed income portfolios, which had
a fair value of $7.7 billion at June 30, 2012. Of the gross unrealized
losses, $36.0 million relate to financial institutions. In addition,
$14.3 million relate to medium term notes primarily supported by pools of
European investment grade credit with varying degrees of leverage. These
had a fair value of $186.1 million at June 30, 2012. Management believes
that expected cash flows from these bonds over the expected holding
period will be sufficient to support the remaining reported amortized
cost.
The following is the maturity profile of the available for sale fixed
income securities that were in a gross unrealized loss position at June 30,
2012:
June 30, 2012
Fair Value
(U.S. dollars in thousands) Amount of of Securities in
Security Type and Length of Time in a Continual Unrealized an Unrealized
Unrealized Loss Position Loss Loss Position
Fixed Maturities and Short-Term Investments
Less than 6 months $ (11,993 ) $
918,383
At least 6 months but less than 12 months (14,305 )
376,786
At least 12 months but less than 2 years (45,969 ) 327,766
2 years and over (476,700 ) 2,041,010
Total $ (548,967 ) $ 3,663,945
Equities
Less than 6 months $ (14,800 ) $ 319,720
At least 6 months but less than 12 months (13,071 ) 102,484
Total $ (27,871 ) $ 422,204
The following is the maturity profile of the AFS fixed income securities
that were in a gross unrealized loss position at June 30, 2012:
June 30, 2012
Fair Value
(U.S. dollars in thousands) Amount of of Securities in
Maturity profile in years of AFS fixed income Unrealized an Unrealized
securities in a gross unrealized loss position Loss Loss Position
Less than 1 year remaining $ (9,616 ) $
348,403
At least 1 year but less than 5 years remaining (1) (68,189 )
932,774
At least 5 years but less than 10 years remaining
(1) (43,302 )
417,596
At least 10 years but less than 20 years remaining
(1)
(45,193 )
248,718
At least 20 years or more remaining (1) (27,139 ) 186,723
RMBS - Agency (2,476 ) 114,691
RMBS - Non-Agency (165,588 ) 491,894
CMBS (4,068 ) 44,941
CDO (154,095 ) 640,745
Other asset-backed securities (29,301 ) 237,460
Total $ (548,967 ) $ 3,663,945
(1) Tier One and Upper Tier Two securities, representing committed term debt and
hybrid instruments senior to the common and preferred equities of the
financial institutions, are allocated based on the call date and medium term
notes supported primarily by pools of European investment grade credit with
varying degrees of leverage are allocated on contractual maturity.
65
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The following is the maturity profile of the HTM fixed income securities
that were in a gross unrealized loss position at June 30, 2012:
June 30, 2012
Fair Value
(U.S. dollars in thousands) Amount of of Securities in
Maturity profile in years of HTM fixed income Unrealized an Unrealized
securities in a gross unrealized loss position Loss Loss Position
Less than 1 year remaining $ - $ -
At least 1 year but less than 5 years remaining (307 )
8,935
At least 5 years but less than 10 years remaining (647 )
21,291
At least 10 years but less than 20 years remaining (4,928 )
24,599
At least 20 years or more remaining (6,139 ) 47,108
RMBS - Non-Agency (15 ) 4,996
Other asset-backed securities (464 ) 8,972
Total $ (12,500 ) $ 115,901
Factors considered in determining that additional OTTI charges were not
warranted include management's consideration of current and near term liquidity
needs along with other available sources, and in certain instances an evaluation
of the factors and time necessary for recovery. For further information, see
Item 1, Note 5, "Investments," to the Unaudited Consolidated Financial
Statements included herein.
As noted in Item 8, Note 2, "Significant Accounting Policies," to the
Consolidated Financial Statements included in the Company's Annual Report on
Form 10-K for the year ended December 31, 2011, the determination of the amount
of OTTI varies by investment type and is based upon management's periodic
evaluation and assessment of known and inherent risks associated with the
respective asset class. Such evaluations and assessments are revised as
conditions change and new information becomes available. Management considers a
wide range of factors about the securities and uses its best judgment in
evaluating the cause of the decline in the estimated fair value of the security
and in assessing the prospects for near-term recovery. Inherent in management's
evaluation of the security are assumptions and estimates about the operations of
the issuer and its future earnings potential. Management updates its evaluations
regularly and reflects additional impairments in net income as determinations
are made. Management's determination of the amount of the impairment taken on
investments is highly subjective and could adversely impact the Company's
results of operations. There can be no assurance that management has accurately
assessed the level of OTTI taken and reflected in the Company's financial
statements. Furthermore, additional impairments may need to be taken in the
future. Historical trends may not be indicative of future impairments.
Levels of write down or OTTI are also impacted by the Company's assessment
of the intent to sell securities that have declined in value prior to recovery.
If, due to changes in circumstances, the Company determines to reposition or
realign portions of the portfolio and the Company determines not to hold certain
securities in an unrealized loss position to recovery, then the Company will
incur OTTI charges, which could be significant.
Gross Unrealized Gains and Losses
Management, in its assessment of whether securities in a gross unrealized
loss position are temporarily impaired, considers the significance of the
impairments. These securities include gross unrealized losses of $165.6 million
on non-Agency RMBS, $154.1 million on Core CDOs and $4.1 million on CMBS
holdings. At June 30, 2012, the Company had structured credit securities with
gross unrealized losses of $55.2 million, which had a fair value of $26.3
million and a cumulative fair value decline of greater than 50% of amortized
costs. All of these are mortgage-and asset-backed securities. The Company has
evaluated each of these securities in conjunction with its investment manager
service providers and believes it is more likely than not that the issuer will
be able to fund sufficient principal and interest payments to support the
current amortized cost.
Net Unrealized Gains and Losses - Corporate Financial Sector Securities
At June 30, 2012, approximately $1.1 billion of the Company's $3.1 billion
in corporate financial sector securities was held in the portfolios supporting
the Company's Life operations portfolios representing 71.1% of the gross
unrealized losses on this asset class. The assets associated with that business
are more heavily weighted towards longer term securities from financial
institutions, including a significant portion of the Company's Tier One and
Upper Tier Two securities, representing committed term debt and hybrid
instruments senior to the common and preferred equity of the financial
institutions. Financials held in Life operations portfolios accounted for $71.0
million of the Company's net unrealized loss at June 30, 2012. At June 30, 2012,
approximately 42.7% of the overall sensitivity to interest rate risk and 35.1%
to credit risk was related to the Life operations portfolios, despite these
portfolios accounting for only 20.2% of the fixed income portfolio.
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Net Unrealized Gains and Losses - Structured Securities
The following table details the current exposures to structured credit
portfolios excluding Agency RMBS within the Company's fixed income portfolio as
well as the current net unrealized (loss) gain position at June 30, 2012 and
December 31, 2011:
June 30, 2012 December 31, 2011
Percent Percent
of Fixed Net of Fixed Net
(U.S. dollars Carrying Income Unrealized Carrying Income Unrealized
in thousands) Value Portfolio Gain (Loss) Value Portfolio Gain (Loss)
RMBS -
Non-Agency:
Sub-prime
first lien
mortgages $ 267,772 0.9 % $ (100,363 ) $ 295,498 1.0 % $ (136,981 )
Alt-A
mortgages 125,323 0.4 % (25,056 ) 114,506 0.4 % (39,659 )
Second lien
mortgages
(including
sub-prime
second lien
mortgages) 25,728 0.1 % (3,217 ) 26,461 0.1 % (6,076 )
Prime RMBS 133,425 0.5 % (15,385 ) 158,264 0.5 % (26,328 )
Other assets 113,323 0.4 % 255 128,041 0.4 % 5,790
Total exposure
to Non-Agency
RMBS $ 665,571 2.3 % $ (143,766 ) $ 722,770 2.4 % $ (203,254 )
CMBS 917,338 3.2 % 61,990 974,835 3.3 % 47,152
Core CDOs (1) 650,018 2.2 % (146,000 ) 662,949 2.3 % (185,611 )
Other
Structured 1,625,085 5.6 % 15,673 1,635,162 5.6 % 7,732
Total
Non-Agency
Structured
Securities $ 3,858,012 13.3 % $ (212,103 ) $ 3,995,716 13.6 % $ (333,981 )
(1) The Company defines Core CDOs as investments in non-subprime collateralized
debt obligations, which primarily consisted of CLOs.
At June 30, 2012, the Company's sub-prime, Alt-A and CDO exposures had
adequate underlying asset characteristics and the Company believed at such date
that the current amortized cost levels were at or below the discounted cash flow
value of the holdings, based on an analysis of subordination levels relative to
current expectations of prepayment rates, probability of default and loss
severity in the event of default. The Company had approximately $63.3 million of
Non-Agency RMBS downgraded during the three months ended June 30, 2012. However,
56.3% of the Company's holdings in Non-Agency RMBS remain rated investment grade
at June 30, 2012.
Refer to "Significant Items Affecting the Results of Operations" for
further discussion surrounding the impact of credit market movements on the
Company's investment portfolio.
European Sovereign Debt Crisis
The ongoing global financial crisis has led to the deterioration of
economies globally, as sovereign governments have reacted to the crisis by
further increasing public expenditures in order to provide stimulus and
security, which has created significant budgetary shortfalls. Several key
nations within the European Union - particularly Greece, Italy, Ireland,
Portugal and Spain ("GIIPS") - have suffered a high level of fiscal distress and
economic vulnerability due to overreliance on external credit sources and
imprudent borrowing and other monetary practices. This has raised doubts within
the global financial community as to whether these sovereign nations will remain
able to service their own debt obligations both at a national and local level
and as to whether the Euro will remain the currency for the European Union.
The Company's primary exposure to this European sovereign debt crisis is
from direct investment in fixed maturity securities issued by GIIPS national and
local governments, as well as from fixed maturity securities issued by certain
financial and non-financial corporate entities operating within GIIPS. The
Company continues to monitor its financial exposure to this crisis, and
continually assesses the impact of a potential default by any of GIIPS on their
respective debt issuances, including the associated impact on non-sovereign
entities in these five nations in the event of such a default. With regard to
non-sovereign securities, the Company considers a security to be at risk if the
security issuer's main operations are physically located within GIIPS, as
opposed to where the issuer is legally domiciled.
The Company currently has no unfunded investment exposures or commitments
to either sovereign or non-sovereign entities within these EU nations. The
Company does invest in various alternative and private investment funds that
from time to time may invest in securities or investments related to these five
EU nations. Currently, these are not material exposures.
The following is an analysis of the Company's AFS and HTM fixed maturity
investment exposures related to this GIIPS crisis at June 30, 2012 and December
31, 2011 and the contractual maturities of these securities. Actual maturities
may differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
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June 30, 2012 December 31, 2011
Amortized Fair Amortized Fair
(U.S. dollars in thousands) Cost Value Cost Value
Fixed maturities GIIPS - AFS
Sovereign investments - National
Governments $ 5,368 $ 4,730 $ 6,601 $ 5,927
Non-Sovereign investments -
Financial Institutions 372 325 6,001 4,626
Non-Sovereign investments -
Non-Financial Institutions 112,581 106,122 138,834 131,890
Structured Credit (1) 10,647 11,077 22,172 19,417
Total fixed maturities GIIPS -
AFS $ 128,968 $ 122,254 $ 173,608 $ 161,860
Due less than one year $ 12,283 $ 12,542 $ 13,824 $ 14,028
Due after 1 through 5 years 30,908 29,556 32,992 31,050
Due after 5 through 10 years 49,346 48,635 72,988 70,651
Due after 10 years 36,431 31,521 53,804 46,131
$ 128,968 $ 122,254 $ 173,608 $ 161,860
Fixed maturities GIIPS - HTM
Sovereign investments - National
Governments $ 11,828 $ 8,725 $ 11,738 $ 8,739
Sovereign investments - Local
Governments - - 9,360 7,649
Non-Sovereign investments -
Non-Financial Institutions 63,844 55,778 72,782 65,380
Total fixed maturities GIIPS -
HTM $ 75,672 $ 64,503 $ 93,880 $ 81,768
Due less than one year $ 6,199 $ 6,208 $ 6,264 $ 6,233
Due after 1 through 5 years 4,187 4,038 4,199 4,110
Due after 5 through 10 years 12,017 11,960 20,705 18,260
Due after 10 years 53,269 42,297 62,712 53,165
Total $ 75,672 $ 64,503 $ 93,880 $ 81,768
(1) During 2012, Covered Bonds have been included within Other asset-backed
securities under Structured Credit to align the Company's classification to
market indices. Prior periods have been reclassified to conform to current
period presentation.
The following table details the gross and net unrealized (loss) gain
position at June 30, 2012 relating to GIIPS:
June 30, 2012
(U.S. dollars in thousands) Greece Italy Ireland Portugal Spain TOTAL
Gross Unrealized (Losses) -
GIIPS
Sovereign investments -
National Governments $ - $ (3,741 ) $ - $ - $ - $ (3,741 )
Sovereign investments -
Local Governments - - - - - -
Non-Sovereign investments -
Financial Institutions - - (47 ) - - (47 )
Non-Sovereign investments -
Non-Financial Institutions (37 ) (9,468 ) - - (7,540 ) (17,045 )
Structured Credit (1) - (1,127 ) - - - (1,127 )
Total gross unrealized gains
(losses) relating to GIIPS $ (37 ) $ (14,336 ) $ (47 ) $ - $ (7,540 ) $ (21,960 )
Net Unrealized Gains
(Losses) - GIIPS
Sovereign investments -
National Governments $ - $ (638 ) $ - $ - $ - $ (638 )
Sovereign investments -
Local Governments - - - - - -
Non-Sovereign investments -
Financial Institutions - - (47 ) - - (47 )
Non-Sovereign investments -
Non-Financial Institutions 254 (2,369 ) - - (4,344 ) (6,459 )
Structured Credit (1) - (1,127 ) 1,557 - - 430
Total net unrealized gains
(losses) relating to GIIPS $ 254 $ (4,134 ) $ 1,510 $
- $ (4,344 ) $ (6,714 )
(1) Covered Bonds have been included within Other asset-backed securities under
Structured Credit to align the Company's classification to market indices.
Prior periods have been reclassified to conform to current period
presentation.
In addition to the direct investment portfolio considerations discussed
above, as an international (re)insurance company, European credit exposures may
exist for the Company within unpaid losses and loss expenses recoverable and
reinsurance balances receivable. For further details on these balances including
the names of the Company's most significant reinsurance counterparties, see Item
8, Note 9, "Reinsurance," to the Consolidated Financial Statements included in
the Company's Annual Report on Form 10-K for the year ended December 31, 2011.
Other sources of potential exposure to European credit issues may exist within
certain lines of insurance or reinsurance business written (including but not
limited to lines such as surety, business interruption, and political risk), or
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within underlying investments held in securitized financial instruments or in
structured transactions in which the Company has an interest. Management
considers these potential exposures as part of its ongoing enterprise risk
management processes.
Fair Value Measurements of Assets and Liabilities
As described in Item 1, Note 3, "Fair Value Measurements," to the Unaudited
Consolidated Financial Statements included herein, effective January 1, 2008,
the Company adopted the authoritative guidance on fair value measurements and,
accordingly, has provided required disclosures by level within the fair value
hierarchy of the Company's assets and liabilities that are carried at fair
value. As defined in the hierarchy, those assets and liabilities categorized as
Level 3 have valuations determined using unobservable inputs. Unobservable
inputs may include the entity's own assumptions about market participant
assumptions, applied to a modeled valuation, however, this is not the case with
respect to the Company's Level 3 assets and liabilities. The vast majority of
the assets and liabilities classified as Level 3 are made up of those securities
for which the values were obtained from brokers where either significant inputs
were utilized in determining the value that were difficult to corroborate with
observable market data, or sufficient information regarding the specific inputs
utilized by the broker was not obtained to support a Level 2 classification or
the Company utilized internal valuation models.
Controls over Valuation of Financial Instruments
The Company performs regular reviews of the prices received from its third
party valuation sources to assess if the prices represent a reasonable estimate
of the fair value. This process is completed by investment and accounting
personnel who are independent of those responsible for obtaining the valuations.
The approaches taken by the Company include, but are not limited to, annual
reviews of the controls of the external parties responsible for sourcing
valuations which are subjected to automated tolerance checks, quarterly reviews
of the valuation sources and dates, and monthly reconciliations between the
valuations provided by our external parties and valuations provided by our third
party investment managers at a portfolio level.
In addition, the Company assesses the effectiveness of valuation controls
performed by external parties responsible for sourcing appropriate valuations
from third parties on the Company's behalf. The approaches taken by these
external parties to gain comfort include, but are not limited to, comparing
valuations between external sources, completing recurring reviews of third party
pricing services' methodologies and reviewing controls of the third party
service providers to support the completeness and accuracy of the prices
received. Where broker quotes are the primary source of the valuations,
sufficient information regarding the specific inputs utilized by the brokers is
generally not available to support a Level 2 classification. The Company obtains
the majority of broker quoted values from third party investment managers who
perform independent verifications of these valuations using pricing matrices
based upon information gathered by market traders. In addition, for the majority
of these securities, the Company compares the broker quotes to independent
valuations obtained from third party pricing vendors, which may also consist of
broker quotes, to assess if the prices received represent a reasonable estimate
of the fair value.
Valuation Methodology of Level 3 Assets and Liabilities
Refer to Item 1, Note 3, "Fair Value Measurements," of the Unaudited
Consolidated Financial Statements included herein, for a description of the
valuation methodology utilized to value Level 3 assets and liabilities, how the
valuation methodology is validated as well as further details associated with
various assets classified as Level 3. At June 30, 2012, the Company did not have
any liabilities that were carried at fair value based on Level 3 inputs other
than derivative instruments in a liability position at June 30, 2012.
Fair Value of Level 3 Assets and Liabilities
At June 30, 2012, the fair value of Level 3 assets and liabilities as a
percentage of the Company's total assets and liabilities that are carried at
fair value was as follows:
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Level 3 Assets
Total Assets and Liabilities
and Liabilities as a Percentage
Carried at Fair Value of Total Assets
Fair Value at of Level 3 and Liabilities
June 30, Assets and Carried at Fair
(U.S. dollars in thousands) 2012 Liabilities Value, by Class
Assets
Fixed maturities, at fair value
U.S. Government and Government
Agency-Related/Supported $ 2,101,625 $ - 0.0 %
Corporate (1) 9,721,153 33,511 0.3 %
RMBS - Agency 5,202,313 52,588 1.0 %
RMBS - Non-Agency 584,543 1,596 0.3 %
CMBS 904,792 - 0.0 %
CDO 650,018 642,179 98.8 %
Other asset-backed securities (1) 1,407,738 25,248 1.8 %
U.S. States and political
subdivisions of the States 1,764,431 - 0.0 %
Non-U.S. Sovereign Government,
Supranational and Government-Related 3,906,189 - 0.0 %
Total Fixed maturities, at fair value $ 26,242,802 $ 755,122
2.9 %
Equity securities, at fair value 529,056 - 0.0 %
Short-term investments, at fair value 227,380 - 0.0 %
Total investments available for sale $ 26,999,238 $ 755,122
2.8 %
Cash equivalents (2) 2,461,281 - 0.0 %
Other investments (3) 894,203 117,765 13.2 %
Other assets (4) 53,430 - 0.0 %
Total assets carried at fair value $ 30,408,152 $ 872,887
2.9 %
Liabilities
Financial instruments sold, but not
yet purchased (5) $ 28,198 $ - 0.0 %
Other liabilities (6) 46,525 35,947 77.3 %
Total liabilities carried at fair
value $ 74,723 $ 35,947 48.1 %
(1) During 2012, Covered Bonds previously included as Corporate securities are
now classified as Other asset-backed securities to align the Company's
classification to market indices. At June 30, 2012, these securities had a
fair value of $500.5 million.
(2) Cash equivalents balances subject to fair value measurements include
certificates of deposit and money market funds.
(3) The Other investments balance excludes certain structured transactions
including certain investments in project finance transactions and a payment
obligation (for further information, see Item 8, Note 7, "Other Investments,"
to the Consolidated Financial Statements included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2011) that has provided
liquidity financing to a structured credit vehicle as a part of a third party
medium term note facility. These Other investments are carried at amortized
cost that totaled $314.0 million at June 30, 2012 and $323.7 million at
December 31, 2011.
(4) Other assets include derivative instruments, reported on a gross basis.
(5) Financial instruments sold, but not yet purchased are included within "Net
payable for investments purchased" on the balance sheet.
(6) Other liabilities include derivative instruments, reported on a gross basis.
At June 30, 2012, the Company's Level 3 assets represented approximately
2.9% of assets that are measured at fair value and less than 2% of total assets.
The Company's Level 3 liabilities represented approximately 48.1% of liabilities
that are measured at fair value and less than 1% of total liabilities at June
30, 2012.
Changes in the Fair Value of Level 3 Assets and Liabilities
See Item 1, Note 3, "Fair Value Measurements," to the Unaudited
Consolidated Financial Statements included herein, for an analysis of the change
in fair value of Level 3 Assets and Liabilities.
70
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Unpaid Losses and Loss Expenses
The Company establishes reserves to provide for estimated claims, the
general expenses of administering the claims adjustment process and losses
incurred but not reported. These reserves are calculated using actuarial and
other reserving techniques to project the estimated ultimate net liability for
losses and loss expenses. The Company's reserving practices and the
establishment of any particular reserve reflects management's judgment
concerning sound financial practice and do not represent any admission of
liability with respect to any claims made against the Company.
Unpaid losses and loss expenses totaled $20.0 billion and $20.6 billion at
June 30, 2012 and December 31, 2011, respectively. The table below represents a
reconciliation of the Company's P&C unpaid losses and loss expenses for the six
months ended June 30, 2012:
Unpaid
Gross unpaid losses and Net
losses and loss unpaid losses
loss expenses and loss
(U.S. dollars in thousands) expenses recoverable expenses
Balance at December 31, 2011 $ 20,613,901 $ (3,629,928 ) $ 16,983,973
Losses and loss expenses incurred 2,000,688 (320,268 ) 1,680,420
Losses and loss expenses paid/recovered (2,555,355 ) 625,458 (1,929,897 )
Foreign exchange and other (97,284 ) 3,299 (93,985 )
Balance at June 30, 2012 $ 19,961,950 $ (3,321,439 ) $ 16,640,511
While the Company reviews the adequacy of established reserves for unpaid
losses and loss expenses regularly, no assurance can be given that actual claims
made and payments related thereto will not be in excess of the amounts reserved.
In the future, if such reserves develop adversely, such deficiency would have a
negative impact on future results of operations. For further discussion, see
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations - Critical Accounting Policies and Estimates - 1) Unpaid Loss and
Loss Expenses and Unpaid Loss and Loss Expenses Recoverable," and Item 8, Note
10, "Losses and Loss Expenses," to the Consolidated Financial Statements
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2011.
Unpaid Losses and Loss Expenses Recoverable and Reinsurance Balances Receivable
In the normal course of business, the Company seeks to reduce the potential
amount of loss arising from claims events by reinsuring certain levels of risk
assumed in various areas of exposure with other insurers or reinsurers. While
reinsurance agreements are designed to limit the Company's losses from large
exposures and permit recovery of a portion of direct unpaid losses, reinsurance
does not relieve the Company of its ultimate liability to the Company's
insureds. Accordingly, the losses and loss expense reserves on the balance sheet
represent the Company's total unpaid gross losses. Unpaid losses and loss
expense recoverable relates to estimated reinsurance recoveries on the unpaid
loss and loss expense reserves.
Unpaid losses and loss expense recoverables were $3.3 billion and $3.7
billion at June 30, 2012 and December 31, 2011, respectively. At both June 30,
2012 and December 31, 2011, reinsurance balances receivable were $0.2 billion.
The table below presents the Company's net paid and unpaid losses and loss
expenses recoverable and reinsurance balances receivable at June 30, 2012 and
December 31, 2011.
June 30, December 31,
2012 2011
Reinsurance balances receivable $ 261,795 $ 263,877
Reinsurance recoverable on future policy benefits 21,189 25,020
Reinsurance recoverable on unpaid losses and loss
expenses 3,381,381
3,685,260
Bad debt reserve on unpaid losses and loss expenses
recoverable and reinsurance balances receivable
(98,550 )
(99,192 )
Net paid and unpaid losses and loss expenses recoverable
and reinsurance balances receivable
$ 3,565,815 $ 3,874,965
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LIQUIDITY AND CAPITAL RESOURCES
Liquidity is a measure of the Company's ability to generate sufficient cash
flows to meet the short and long-term cash requirements of the Company's
business operations. As a global insurance and reinsurance company, one of the
Company's principal responsibilities to its clients is to ensure that the
Company has ready access to funds with which to settle large unforeseen claims.
The Company would generally expect that positive cash flow from operations
(underwriting activities and investment income) will be sufficient to cover cash
outflows under most future loss scenarios. However, there is a possibility that
unforeseen demands could be placed on the Company due to extraordinary events
and, as such, the Company's liquidity needs may change. Such events include,
among other things, several significant catastrophes occurring in a relatively
short period of time resulting in material incurred losses; rating agency
downgrades of the Company's core insurance and reinsurance subsidiaries that
would require posting of collateral in connection with the Company's letter of
credit and revolving credit facilities, return of unearned premiums and/or the
settlement of derivative transactions and large scale uncollectible reinsurance
recoverables on paid losses (as a result of coverage disputes, reinsurers'
credit problems or decreases in the value of collateral supporting reinsurance
recoverables), etc. Any one or a combination of such events may cause a
liquidity strain for the Company. In addition, a liquidity strain could also
occur in an illiquid market, such as that which was experienced in 2008.
Investments that may be used to meet liquidity needs in the event of a liquidity
strain may not be liquid, given inactive markets, or may have to be sold at a
significant loss as a result of depressed prices. Because each subsidiary
focuses on a more limited number of specific product lines than is collectively
available from the consolidated group of companies, the mix of business tends to
be less diverse at the subsidiary level. As a result, the probability of a
liquidity strain, as described above, may be greater for individual subsidiaries
than when liquidity is assessed on a consolidated basis. If such a liquidity
strain were to occur in a subsidiary, XL-Ireland may be required to contribute
capital to the particular subsidiary and/or curtail dividends from the
subsidiary to support holding company operations, which may be difficult given
that XL-Ireland is a holding company and has limited liquidity.
A downgrade below "A-" of the Company's principal insurance and reinsurance
subsidiaries by either S&P or A.M. Best, which is two notches below the current
S&P financial strength rating of "A" (Stable) and the A.M. Best financial
strength rating of "A" (Stable) of these subsidiaries, may trigger cancelation
provisions in a significant amount of the Company's assumed reinsurance
agreements and may potentially require the Company to return unearned premiums
to cedants. In addition, due to collateral posting requirements under the
Company's letter of credit and revolving credit facilities, such a downgrade may
require the posting of cash collateral in support of certain "in use" portions
of these facilities. Specifically, a downgrade below "A-" by A.M. Best would
constitute an event of default under the Company's three largest credit
facilities and may trigger such collateral requirements. In certain limited
instances, such downgrades may require the Company to return cash or assets to
counterparties or to settle derivative and/or other transactions with the
respective counterparties. See Item 1A, "Risk Factors," included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2011.
Holding Company Liquidity
As holding companies, XL-Ireland and XL-Cayman have no operations of their
own and their assets consist primarily of investments in subsidiaries.
XL-Ireland's principal uses of liquidity are ordinary share-related
transactions, including dividend payments to holders of its ordinary shares as
well as share buybacks, capital investments in its subsidiaries and certain
corporate operating expenses. XL-Cayman's principal uses of liquidity are
preference share related transactions, including dividend payments to its
preference shareholders as well as preference share buybacks from time to time,
interest and principal payments on debt and certain corporate operating
expenses.
As holding companies, XL-Ireland's and XL-Cayman's future cash flows
largely depend on the availability of dividends or other statutorily permissible
payments from subsidiaries. The ability to pay such dividends is limited by the
applicable laws and regulations of the various countries and states in which
these subsidiaries operate, including, among others, the Cayman Islands,
Bermuda, the United States, New York, Ireland, Switzerland and the U.K. See Item
8, Note 23, "Statutory Financial Data," to the Consolidated Financial Statements
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2011 for further discussion and details regarding the dividend capacity of
the Company's major operating subsidiaries. See also Item 1A, "Risk Factors -
Our holding company structure and certain regulatory and other constraints
affect our ability to pay dividends, make payments on our debt securities and
make other payments," in the Company's Annual Report on Form 10-K for the year
ended December 31, 2011. The ability to pay such dividends is also limited by
the regulations of the Society of Lloyd's and certain contractual provisions. No
assurance can be given that the Company's subsidiaries will pay dividends in the
future to XL-Ireland and XL-Cayman.
Under Irish law, share premium was required to be converted to
"distributable reserves" for the Company to have the ability to pay cash
dividends and redeem and buyback shares following the Redomestication. On July
23, 2010, the Irish High Court approved XL-Ireland's conversion of share premium
to $5.0 billion of distributable reserves, subject to the completion of certain
formalities under Irish Company law. These formalities were completed in early
August 2010. At June 30, 2012, XL-Ireland had $3.8 billion in distributable
reserves.
During 2009, management changed the internal ownership structure of certain
of the Company's operating subsidiaries in Bermuda and Ireland in order to more
efficiently utilize capital and to improve overall liquidity. In connection with
these changes,
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certain dividends were paid to XL-Cayman by operating subsidiaries. At June 30,
2012, XL-Ireland and XL-Cayman held cash and investments, net of liabilities
associated with cash sweeping arrangements, of $(8.8) million and $1.2 billion,
respectively, compared to $1.6 million and $2.0 billion, respectively, at
December 31, 2011.
All outstanding debt of the Company at June 30, 2012 and December 31, 2011
was issued by XL-Cayman except for the $600 million XLCFE Notes which were
issued by XL Capital Finance (Europe) plc ("XLCFE") and were repaid at maturity
on January 15, 2012. Both XL-Cayman and XLCFE are wholly-owned subsidiaries of
XL-Ireland. XL-Cayman's outstanding debt is fully and unconditionally guaranteed
by XL-Ireland. The Company's ability to obtain funds from its subsidiaries to
satisfy any of its obligations under guarantees is subject to certain
contractual restrictions, applicable laws and statutory requirements of the
various countries in which the Company operates, including, among others,
Bermuda, the United States, Ireland, Switzerland and the U.K. At December 31,
2011, required statutory capital and surplus for the principal operating
subsidiaries of the Company was $6.7 billion.
XL-Ireland and its subsidiaries provide no guarantees or other commitments
(express or implied) of financial support to the Company's subsidiaries or
affiliates, except for such guarantees or commitments that are in writing.
See also the Unaudited Consolidated Statements of Cash Flows in Item 1,
Financial Statements included herein.
Sources of Liquidity for the Company
At June 30, 2012, the consolidated Company had cash and cash equivalents of
approximately $3.3 billion as compared to approximately $3.8 billion at December
31, 2011. There are three main sources of cash flows for the Company - those
provided by operations, investing activities and financing activities.
Operating Cash Flows
Historically, cash receipts from operations, consisting of premiums and
investment income, generally have provided sufficient funds to pay losses as
well as operating expenses of the Company's subsidiaries and to fund dividends
to XL-Ireland. Cash receipts from operations is generally derived from the
receipt of investment income on the Company's investment portfolio as well as
the net receipt of premiums less claims and expenses related to the Company's
underwriting activities in its P&C operations as well as its Life operations
segment. The Company's operating subsidiaries provide liquidity in that premiums
are generally received months or even years before losses are paid under the
policies related to such premiums. Premiums and acquisition expenses are settled
based on terms of trade as stipulated by an underwriting contract, and generally
are received within the first year of inception of a policy when the premium is
written, but can be up to three years on certain reinsurance business assumed.
Operating expenses are generally paid within a year of being incurred. Claims,
especially for casualty business, may take a much longer time before they are
reported and ultimately settled, requiring the establishment of reserves for
unpaid losses and loss expenses. Therefore, the amount of claims paid in any one
year is not necessarily related to the amount of net losses incurred, as
reported in the consolidated statement of income.
During the six months ended June 30, 2012, net cash flows provided by
operating activities were $483.6 million compared to net cash flows provided by
operating activities of $107.3 million for the same period in 2011. The
operating cash increase was primarily due to the increase in net income in the
six months ended June 30, 2012 compared to the same period in the prior year.
Investing Cash Flows
Generally, positive cash flow from operations and financing activities is
invested in the Company's investment portfolio, including affiliates or the
acquisition of subsidiaries.
Net cash used in investing activities was $5.5 million in the six months
ended June 30, 2012 compared to net cash provided of $84.4 million for the same
period in 2011. These cash flows were associated with the normal purchase and
sale of portfolio investments.
Certain of the Company's invested assets are held in trust and pledged in
support of insurance and reinsurance liabilities as well as credit facilities.
Such pledges are largely required by the Company's operating subsidiaries that
are "non-admitted" under U.S. state insurance regulations, in order for the U.S.
cedant to receive statutory credit for reinsurance. Also, certain deposit
liabilities and annuity contracts require the use of pledged assets. As further
outlined in Item 1, Note 5, "Investments - Pledged Assets," to the Unaudited
Consolidated Financial Statements included herein, certain assets of the
investment portfolio are collateralized for the Company's letter of credit
facilities. At June 30, 2012 and December 31, 2011, the Company had $17.5
billion and $17.2 billion in pledged assets, respectively.
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Financing Cash Flows
Cash flows related to financing activities include ordinary and preferred
share related transactions, the payment of dividends, the issue or repayment of
preference ordinary shares and deposit liability transactions. During the six
months ended June 30, 2012, net cash flows used in financing activities were
$988.4 million. Net cash outflows related primarily to the buybacks of the
Company's ordinary shares and repayment of debt as described below.
On February 27, 2012, the Company announced that its Board of Directors
approved a share buyback program, authorizing the Company to purchase up to $750
million of its ordinary shares. This authorization replaced the approximately
$190 million remaining under the share buyback program that was authorized in
November 2010 as described in further detail in Item 8, Note 18, "Share
Capital," to the Consolidated Financial Statements included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2011. During the
three months ended March 31, 2012 and the three months ended June 30, 2012, the
Company purchased and canceled 4.7 million and 6.1 million ordinary shares,
respectively, under the new program for $100.0 million and $125.0 million,
respectively. All share buybacks were carried out by way of redemption in
accordance with Irish law and the Company's constitutional documents. All shares
so redeemed were canceled upon redemption. At June 30, 2012, $525.0 million
remained available for purchase under the new program.
On January 15, 2012, the $600 million principal amount outstanding on the
XLCFE Notes, which were issued by XLCFE, was repaid at maturity. For further
detail, see Item 1, Note 8, "Notes Payable and Debt Financing Arrangements," to
the Unaudited Consolidated Financial Statements included herein.
In addition, the Company maintains credit facilities that provide
liquidity. Details of these facilities are described below in "Capital
Resources."
Capital Resources
At June 30, 2012 and December 31, 2011, the Company had total shareholders'
equity of $11.2 billion and $10.8 billion, respectively. In addition to ordinary
share capital, the Company depends on external sources of financing to support
its underwriting activities in the form of:
a. debt;
b. preference shares;
c. letter of credit facilities and other sources of collateral; and
d. revolving credit facilities.
In particular, the Company requires, among other things:
• sufficient capital to maintain its financial strength and credit ratings,
as issued by several ratings agencies, at levels considered necessary by
management to enable the Company's key operating subsidiaries to compete;
• sufficient capital to enable its regulated subsidiaries to meet the
regulatory capital levels required in the United States, the U.K.,
Bermuda, Ireland, Switzerland and other key markets;
• letters of credit and other forms of collateral that are required to be
posted or deposited, as the case may be, by the Company's operating
subsidiaries that are "non-admitted" under U.S. state insurance
regulations in order for the U.S. cedant to receive statutory credit for
reinsurance. The Company also uses letters of credit to support its
operations at Lloyd's; and
• revolving credit to meet short-term liquidity needs.
The following risks are associated with the Company's requirement to renew
its credit facilities:
• the credit available from banks may be reduced resulting in the Company's
need to pledge its investment portfolio to customers. This could result
in a lower investment yield;
• the Company may be downgraded by one or more rating agencies, which could
materially and negatively impact the Company's business, financial
condition, results of operations and/or liquidity; and
• the volume of business that the Company's subsidiaries that are not
admitted in the United States are able to transact could be reduced if
the Company is unable to renew its letter of credit facilities at an
appropriate amount.
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Consolidation within the banking industry may result in the aggregate
amount of credit provided to the Company being reduced. The Company attempts to
mitigate this risk by identifying and/or selecting additional banks that can
participate in the credit facilities upon renewal. See Item 1A, "Risk Factors,"
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2011.
The following table summarizes the components of the Company's current
capital resources at June 30, 2012 and December 31, 2011:
June 30, December 31,
(U.S. dollars in thousands) 2012
2011
Series D preference ordinary shares $ 345,000 $
345,000
Series E preference ordinary shares 999,500
999,500
Ordinary share capital 9,867,809
9,411,658
Total ordinary and non-controlling interests capital $ 11,212,309 $ 10,756,158
Notes payable and debt 1,665,293 2,264,618
Total capital $ 12,877,602 $ 13,020,776
Ordinary Share Capital
The following table reconciles the opening and closing ordinary share
capital positions at June 30, 2012 and December 31, 2011:
June 30, December 31,
(U.S. dollars in thousands) 2012 2011
Ordinary shareholders' equity - beginning of period $ 9,411,658$ 9,597,473
Net income (loss) attributable to XL Group plc
397,784 (474,760 )
Share buybacks (225,978 ) (667,022 )
Share issues 1,385 573,015
Ordinary share dividends (68,755 ) (138,978 )
Change in accumulated other comprehensive income 327,696
482,269
Share based compensation and other 24,019
39,661
Ordinary shareholders' equity - end of period $ 9,867,809$ 9,411,658
Debt
The following tables present the Company's debt under outstanding
securities and lenders' commitments at June 30, 2012:
Payments Due by Period
(U.S. dollars in Commitment/ In Use/ Year of Less than 1 to 3 3 to 5 After 5
thousands) Debt Outstanding Expiry 1 Year Years Years Years
4-year revolver $ 1,000,000 $ - 2015 $ - $ - $ - $ -
5.25% Senior Notes
600,000 597,963 2014 - 600,000 - -
5.75% Senior Notes 400,000 396,014 2021 - - - 400,000
6.375% Senior Notes 350,000 348,646 2024 - - - 350,000
6.25% Senior Notes 325,000 322,670 2027 - - - 325,000
$ 2,675,000 $ 1,665,293 $ - $ 600,000 $ - $ 1,075,000
Adjustment to carrying value - impact of
fair value hedges $ 8,628
Total $ 1,673,921
"In Use/Outstanding" data represent June 30, 2012 accreted values.
"Payments Due by Period" data represent ultimate redemption values.
In addition, see Item 1, Note 13, "Notes Payable and Debt and Financing
Arrangements," to the Consolidated Financial Statements included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2011 for
further information.
At June 30, 2012, banks and investors provided the Company and its
subsidiaries with $2.7 billion of debt capacity, of which $1.7 billion was
utilized by the Company. These facilities consist of:
• a revolving credit facility of $1.0 billion.
• senior unsecured notes of approximately $1.7 billion. These notes require
the Company to pay a fixed rate of interest during their terms. At June 30,
2012, there were four outstanding issues of senior unsecured notes:
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• $600 million senior notes due September 2014, with a fixed coupon of 5.25%.
The security is publicly traded. The notes were issued in two tranches of
$300 million aggregate principal amount each - one tranche at 99.432% and
the other at 98.419% with aggregate net proceeds were $589.6 million.
Related expenses of the offering amounted to $4 million.
• $400 million senior notes due October 2021, with a fixed coupon of 5.75%.
The security is publicly traded. The notes were issued at 100.0% and net
proceeds were $395.8 million. Related expenses of the offering amounted to
$4.2 million.
• $350 million senior notes due November 2024, with a fixed coupon of 6.375%.
The security is publicly traded. The notes were issued at 100.0% and net
proceeds were $348 million. Related expenses of the offering amounted to $2
million.
• $325 million of senior notes due May 2027, with a fixed coupon of 6.25%. The
security is publicly traded. The notes were issued at 99.805% and net
proceeds were $321.9 million. Related expenses of the offering amounted to
$2.5 million.
Preferred Shares and Non-controlling Interest in Equity of Consolidated
Subsidiaries
Neither the Redeemable Series C preference ordinary shares nor the Series E
preference ordinary shares were transferred from XL-Cayman to XL-Ireland in the
Redomestication. Accordingly, subsequent to July 1, 2010, these instruments
represent non-controlling interests in the consolidated financial statements of
the Company and have been reclassified to non-controlling interest in equity of
consolidated subsidiaries. See Item 8, Note 1, "General," to the Consolidated
Financial Statements included in the Company's Annual Report on Form 10-K for
the year ended December 31, 2011 for further information. During the third
quarter of 2011, all Redeemable Series C preference ordinary shares were
purchased and canceled. At June 30, 2012, the face value of the outstanding
Series E preference ordinary shares was $999.5 million.
On October 15, 2011, XL-Cayman issued 350,000 non-cumulative Series D
Preference Ordinary Shares for $350 million of cash and liquid investments that
were held in a trust account that was part of the Stoneheath facility. Holders
of the Stoneheath Securities received one Series D Preference Ordinary Share in
exchange for each Stoneheath Security. See Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Contingent Capital"
in the Company's Annual Report on Form 10-K for the year ended December 31, 2011
for further information.
On December 5, 2011, the Company repurchased 5,000 of the outstanding
Series D Preference Ordinary Shares with a liquidation preference value of $5.0
million for $3.7 million, including accrued dividends. As a result of these
repurchases, the Company recorded a gain of approximately $1.3 million through
Non-controlling interests in the Consolidated Statement of Income in the fourth
quarter of 2011. At December 31, 2011, the face value of the outstanding Series
D Preference Ordinary Shares was $345.0 million.
Letter of Credit Facilities and other sources of collateral
At June 30, 2012, the Company had five letter of credit ("LOC") facilities
in place with total availability of $4.0 billion, of which $1.7 billion was
utilized.
Amount of Commitment Expiration by Period
Commitment/ In Use/ Year of Less than 1 to 3 3 to 5 After 5(U.S. dollars in thousands) Debt Outstanding Expiry
1 Year Years Years Years
LOC Facility (1) $ 1,000,000 $ 798,046 $ 2014 $ - $ 798,046 $ - $ -
LOC Facility (2) (3) 1,350,000 116,664 2015 - - 116,664 -
LOC Facility (3) 650,000 371,690 2015 - - 371,690 -
LOC Facility 750,000 316,674 Continuous - - - 316,674
LOC Facility 250,000 125,874 Continuous - - - 125,874
Five LOC facilities $ 4,000,000 $ 1,728,948 $ - $ 798,046 $ 488,354 $ 442,548
(1) The Company has the option to increase the size of the March 2011 Credit
Agreement by an additional $500 million.
(2) This letter of credit facility includes $1.0 billion that is also included in
the "4-year revolver" listed under Notes Payable and Debt.
(3) The Company has the option to increase the size of the facilities under the
December 2011 Credit Agreements by an additional $500 million across both
such facilities.
In 2011, the Company and certain of its subsidiaries (i) entered into three
new credit agreements, which provided for an aggregate amount of outstanding
letters of credit and revolving credit loans up to $3 billion, subject to
certain options to increase the size of the facilities, and (ii) terminated the
five-year credit agreement dated June 21, 2007 (the "2007 Credit Agreement"),
which had provided for an aggregate amount of outstanding letters of credit and
revolving credit loans up to $4 billion.
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On March 25, 2011, the Company and certain of its subsidiaries entered into
a secured credit agreement (the "March 2011 Credit Agreement") that currently
provides for the issuance of letters of credit in an aggregate amount of up to
$1 billion with the option to increase the size of the facility by an additional
$500 million. Concurrent with the effectiveness of the March 2011 Credit
Agreement, the commitments of the lenders under the 2007 Credit Agreement were
reduced from $4 billion to $3 billion. The commitments under the March 2011
Credit Agreement will expire on, and the credit facility is available on a
continuous basis until, the earlier of (i) March 25, 2014 and (ii) the date of
termination in whole of the commitments upon an optional termination or
reduction of the commitments by the account parties or upon an event of default.
On December 9, 2011, the Company and certain of its subsidiaries entered
into (i) a new secured credit agreement (the "December 2011 Secured Credit
Agreement") and (ii) a new unsecured credit agreement (the "December 2011
Unsecured Credit Agreement" and together with the December 2011 Secured Credit
Agreement, the "December 2011 Credit Agreements"). In connection with the
December 2011 Credit Agreements, the 2007 Credit Agreement was terminated. The
March 2011 Credit Agreement continues in force, but was amended to conform
certain of its terms to those of the December 2011 Secured Credit Agreement.
The 2007 Credit Agreement had provided for letters of credit and for
revolving credit loans of up to $750 million with the aggregate amount of
outstanding letters of credit and revolving credit loans thereunder not to
exceed $3 billion. At the time at which it was terminated and the December 2011
Credit Agreements became effective, there were no outstanding revolving credit
loans under the 2007 Credit Agreement. A portion of the letters of credit
outstanding under the 2007 Credit Agreement at the time of its termination were
continued under the March 2011 Credit Agreement and the remainder were continued
under the December 2011 Credit Agreements.
The December 2011 Secured Credit Agreement provides for the issuance of
letters of credit in an aggregate amount of up to $650 million. The December
2011 Unsecured Credit Agreement is a $1.35 billion facility that provides for
the issuance of letters of credit and revolving credit loans in an aggregate
amount up to $1 billion. The Company has the option to increase the maximum
amount of letters of credit available by an additional $500 million across the
facilities under the December 2011 Credit Agreements.
The commitments under each December 2011 Credit Agreement expire on, and
such credit facilities are available until, the earlier of (i) December 9, 2015
and (ii) the date of termination in whole of the commitments upon an optional
termination or reduction of the commitments by the account parties or upon an
event of default.
The availability of letters of credit under the December 2011 Secured
Credit Agreement and the March 2011 Credit Agreements is subject to a borrowing
base requirement, determined on the basis of specified percentages of the face
value of eligible categories of assets varying by type of collateral. In the
event that such credit support is insufficient, the Company could be required to
provide alternative security to cedants. This could take the form of insurance
trusts supported by the Company's investment portfolio or funds withheld
(amounts retained by ceding companies to collateralize loss or premium reserves)
using the Company's cash resources or combinations thereof. The face amount of
letters of credit required is driven by, among other things, loss development of
existing reserves, the payment pattern of such reserves, the expansion of
business written by the Company and the loss experience of such business. In
addition to letters of credit, the Company has established insurance trusts in
the United States that provide cedants with statutory credit for reinsurance
under state insurance regulation in the United States.
The Company reviews current and projected collateral requirements on a
regular basis, as well as new sources of collateral. Management's objective is
to maintain an excess amount of collateral sources over expected uses. The
Company also reviews its liquidity needs on a regular basis.
In October 2011, the $75,000 letter of credit facility that was supporting
a subsidiary of the Company terminated.
Other
For information regarding cross-default and certain other provisions in the
Company's debt and convertible securities documents, see Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Cross-Default and Other Provisions in Debt Instruments," in the
Company's Annual Report on Form 10-K for the year ended December 31, 2011 and
the Company's Current Report on Form 8-K filed on March 28, 2011.
See Part II, Item 2, "Unregistered Sales of Equity Securities and Use of
Proceeds," below.
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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 ("PSLRA") provides a
"safe harbor" for forward-looking statements. Any prospectus, prospectus
supplement, the Company's Annual Report to ordinary shareholders, any proxy
statement, any Form 10-K, Form 10-Q or Form 8-K of the Company or any other
written or oral statements made by or on behalf of the Company may include
forward-looking statements that reflect the Company's current views with respect
to future events and financial performance. Such statements include
forward-looking statements both with respect to the Company in general, and to
the insurance and reinsurance sectors in particular (both as to underwriting and
investment matters). Statements that include the words "expect," "intend,"
"plan," "believe," "project," "anticipate," "will," "may" and similar statements
of a future or forward-looking nature identify forward-looking statements for
purposes of the PSLRA or otherwise.
All forward-looking statements address matters that involve risks and
uncertainties. Accordingly, there are or will be important factors that could
cause actual results to differ materially from those indicated in such
statements. The Company believes that these factors include, but are not limited
to, the following: (i) changes in the size of the Company's claims relating to
natural or man-made catastrophe losses due to the preliminary nature of some
reports and estimates of loss and damage to date; (ii) trends in rates for
property and casualty insurance and reinsurance; (iii) the timely and full
recoverability of reinsurance placed by the Company with third parties, or other
amounts due to the Company; (iv) changes in ratings, rating agency policies or
practices; (v) changes in the projected amount of ceded reinsurance recoverables
and the ratings and creditworthiness of reinsurers; (vi) the timing of claims
payments being faster or the receipt of reinsurance recoverables being slower
than anticipated by the Company; (vii) the Company's ability to successfully
implement its business strategy especially during a "soft" market cycle; (viii)
increased competition on the basis of pricing, capacity, coverage terms or other
factors, which could harm the Company's ability to maintain or increase its
business volumes or profitability; (ix) greater frequency or severity of claims
and loss activity than the Company's underwriting, reserving or investment
practices anticipate based on historical experience or industry data; (x)
changes in general economic conditions, including the effects of inflation on
the Company's business, including on pricing and reserving, and changes in
interest rates, credit spreads, foreign currency exchange rates and future
volatility in the world's credit, financial and capital markets that adversely
affect the performance and valuation of the Company's investments or access to
such markets; (xi) developments, including uncertainties related to the ability
of Euro-zone countries to service existing debt obligations and the strength of
the Euro as a currency and to the financial condition of counterparties,
reinsurers and other companies that are at risk of bankruptcy; (xii) the
potential impact on the Company from government-mandated insurance coverage for
acts of terrorism; (xiii) the potential for changes to methodologies,
estimations and assumptions that underlie the valuation of the Company's
financial instruments that could result in changes to investment valuations;
(xiv) changes to the Company's assessment as to whether it is more likely than
not that the Company will be required to sell, or has the intent to sell,
available for sale debt securities before their anticipated recovery; (xv) the
availability of borrowings and letters of credit under the Company's credit
facilities; (xvi) the ability of the Company's subsidiaries to pay dividends to
XL Group plc and XLIT Ltd.; (xvii) the potential effect of regulatory
developments in the jurisdictions in which the Company operates, including those
which could impact the financial markets or increase the Company's business
costs and required capital levels; (xviii) changes in regulations or laws
applicable to XL Group plc or its subsidiaries, brokers or customers; (xix)
acceptance of the Company's products and services, including new products and
services; (xx) changes in the availability, cost or quality of reinsurance;
(xxi) changes in the distribution or placement of risks due to increased
consolidation of insurance and reinsurance brokers; (xxii) loss of key
personnel; (xxiii) changes in accounting policies or practices or the
application thereof; (xxiv) legislative or regulatory developments including,
but not limited to, changes in regulatory capital balances that must be
maintained by the Company's operating subsidiaries and governmental actions for
the purpose of stabilizing the financial markets; (xxv) the effects of mergers,
acquisitions and divestitures; (xvi) developments related to bankruptcies of
companies insofar as they affect property and casualty insurance and reinsurance
coverages or claims that the Company may have as a counterparty; (xxvii) changes
in applicable tax laws, tax treaties or tax regulations or the interpretation or
enforcement thereof; (xxviii) the effects of business disruption or economic
contraction due to war, terrorism or other hostilities; (xxix) the Company's
ability to realize the expected benefits from the redomestication; and (xxx) the
other factors set forth in Item 1A, "Risk Factors," and the Company's other
documents on file with the SEC. The foregoing review of important factors should
not be construed as exhaustive and should be read in conjunction with the other
cautionary statements that are included herein or elsewhere. The Company
undertakes no obligation to update publicly or revise any forward-looking
statement, whether as a result of new information, future developments or
otherwise, except as required by the federal securities laws.
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ANNUALIZED RETURN ON ORDINARY SHAREHOLDERS' EQUITY CALCULATION
The following is a reconciliation of the Company's annualized return on
ordinary shareholders' equity for the three and six months ended June 30, 2012
and 2011 to annualized net income (loss) attributable to ordinary shareholders:
Three Months Ended Six Months Ended
June 30, June 30,
(U.S. dollars in thousands, except
percentages) 2012 2011 2012 2011
Opening shareholders' equity $ 11,054,489 $ 10,255,716 $ 10,756,130 $ 10,599,769
Less: Non-controlling interest in equity
of consolidated subsidiaries (1,344,467 ) (1,001,798 ) (1,344,472 ) (1,002,296 )
Opening ordinary shareholders' equity $ 9,710,022$ 9,253,918
$ 9,411,658$ 9,597,473
Closing shareholders' equity 11,213,802 10,614,451 11,213,802 10,614,451
Less: Non-controlling interest in equity
of consolidated subsidiaries (1,345,993 ) (1,001,781 )
(1,345,993 ) (1,001,781 )
Closing ordinary shareholders' equity $ 9,867,809$ 9,612,670
$ 9,867,809$ 9,612,670
Average ordinary shareholders' equity 9,788,915 9,433,294
9,639,733 9,605,071
Net income (loss) attributable to
ordinary shareholders 221,156 225,663 397,784 (1,621 )
Annualized net income (loss)
attributable to ordinary shareholders 884,624 902,652 795,568 (3,242 )
Annualized return on ordinary
shareholders' equity - Net income (loss)
attributable to ordinary shareholders 9.0 % 9.6 % 8.3 % 0.0 %
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