AMTRUST FINANCIAL SERVICES, INC. – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations
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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q.
Note on Forward-Looking Statements
This Form 10-Q contains certain forward-looking statements that are intended to be covered by the safe harbors created by The Private Securities Litigation Reform Act of 1995. When we use words such as "anticipate," "intend," "plan," "believe," "estimate," "expect," or similar expressions, we do so to identify forward-looking statements. Examples of forward-looking statements include the plans and objectives of management for future operations, including those relating to future growth of our business activities and availability of funds, and are based on current expectations that involve assumptions that are difficult or impossible to predict accurately, many of which are beyond our control. There can be no assurance that actual developments will be those anticipated by us. Actual results may differ materially from those expressed or implied in these statements as a result of significant risks and uncertainties, including, but not limited to, non-receipt of expected payments from insureds or reinsurers, changes in interest rates, a downgrade in the financial strength ratings of our insurance subsidiaries, the effect of the performance of financial markets on our investment portfolio, our estimates of the fair value of our life settlement contracts, development of claims and the effect on loss reserves, accuracy in projecting loss reserves, the cost and availability of reinsurance coverage, the effects of emerging claim and coverage issues, changes in the demand for our products, our degree of success in integrating acquired businesses, the effect of general economic conditions, state and federal legislation, regulations and regulatory investigations into industry practices, risks associated with conducting business outsidethe United States , developments relating to existing agreements, disruptions to our business relationships with Maiden Holdings, Ltd.,National General Holding Corp. , or third party agencies and warranty administrators, difficulties with technology or breaches in data security, heightened competition, changes in pricing environments, and changes in asset valuations. Additional information about these risks and uncertainties, as well as others that may cause actual results to differ materially from those projected, is contained in our filings with theSEC , including our Annual Report on Form 10-K for the year endedDecember 31, 2012 , and our quarterly reports on Form 10-Q. The projections and statements in this report speak only as of the date of this report and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law. Overview We are a multinational specialty property and casualty insurer focused on generating consistent underwriting profits. We provide insurance coverage for small businesses and products with high volumes of insureds and loss profiles that we believe are predictable. We target lines of insurance that we believe generally are underserved by the market. We have grown by hiring teams of underwriters with expertise in our specialty lines, through acquisitions of companies and assets that, in each case, provide access to distribution networks and renewal rights to established books of specialty insurance business. We have operations in four business segments:
• Small Commercial Business. We provide workers' compensation, commercial
package and other commercial insurance lines produced by wholesale
agents, retail agents and brokers in
• Specialty Risk and Extended Warranty. We provide coverage for consumer
and commercial goods and custom designed coverages, such as accidental
damage plans and payment protection plans offered in connection with the sale of consumer and commercial goods, inthe United States and
risks in
employers' liability and professional and medical liability. • Specialty Program. We write commercial insurance for narrowly defined
classes of insureds, requiring an in-depth knowledge of the insured's
industry segment, through general and other wholesale agents. • Personal Lines Reinsurance. We reinsure 10% of the net premiums of the GMACI personal lines business, pursuant to the Personal Lines Quota Share with the GMACI personal lines insurance companies.
We transact business primarily through our eight insurance subsidiaries domiciled in
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For the six months ended
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"CNH"
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and subsidiaries, collectively known as "FNIC"
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Additionally, inMay 2013 , one of our subsidiaries entered into a transaction with an international corporation through the issuance of insurance policies covering the risk related to certain contractual liabilities. We received approximately$148 million in cash to service the contractual liabilities. The polices cover any additional liabilities related to the payment of the contractual liabilities. During the three months endedJune 30, 2013 , we recognized approximately$3 million of earned premium related to these policies and incurred expenses of approximately$0.6 million .
Insurance, particularly workers' compensation, is generally affected by seasonality. The first quarter generally produces greater premiums than subsequent quarters. Nevertheless, the impact of seasonality on our Small Commercial Business and Specialty Program segments has not been significant. We believe that this is because we serve many small businesses in different geographic locations. In addition, we believe seasonality is muted by our acquisition activity.
We evaluate our operations by monitoring key measures of growth and profitability. We measure our growth by examining our net income, return on average equity, and our loss, expense and combined ratios. The following summary provides further explanation of the key measures that we use to evaluate our results: Gross Written Premium. Gross written premium represents estimated premiums from each insurance policy that we write, including as a servicing carrier for assigned risk plans, during a reporting period based on the effective date of the individual policy. Certain policies that we underwrite are subject to premium audit at that policy's cancellation or expiration. The final actual gross premiums written may vary from the original estimate based on changes to the final rating parameters or classifications of the policy. Net Written Premium. Net written premium is gross written premium less that portion of premium that we ceded to third party reinsurers under reinsurance agreements. The amount ceded under these reinsurance agreements is based on the contractual formula contained in the individual reinsurance agreements. Net Earned Premium. Net earned premium is the earned portion of our net written premiums. We earn insurance premiums on a pro-rata basis over the term of the policy. At the end of each reporting period, premiums written that are not earned are classified as unearned premiums, which are earned in subsequent periods over the remaining term of the policy. Our workers' compensation insurance and commercial package policies typically have a term of one year. Thus, for a one-year policy written onJuly 1, 2012 for an employer with a constant payroll during the term of the policy, we would earn half of the premiums in 2012 and the other half in 2013. We earn our specialty risk and extended warranty coverages over the estimated exposure time period. The terms vary depending on the risk and have an average duration of approximately 24 months, but range in duration from one month to 120 months. Net Investment Income and Realized Gains and (Losses). We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, fixed maturity and equity securities. Our net investment income includes interest and dividends earned on our invested assets. We report net realized gains and losses on our investments separately from our net investment income. Net realized gains occur when we sell our investment securities for more than their costs or amortized costs, as applicable. Net realized losses occur when we sell our investment securities for less than their costs or amortized costs, as applicable, or we write down the investment securities as a result of other-than-temporary impairment. We classify equity securities and our fixed maturity securities as available-for-sale. We report net unrealized gains (losses) on those securities classified as available-for-sale separately within accumulated other comprehensive income on our balance sheet. 45 -------------------------------------------------------------------------------- Ceding Commission Revenues. Ceding commission is a commission we receive from ceding gross written premium to third party reinsurers. We earn commissions on reinsurance premiums ceded in a manner consistent with the recognition of the direct acquisition costs of the underlying insurance policies, generally on a pro-rata basis over the terms of the policies reinsured. In connection with the Maiden Quota Share, which is our primary source of ceding commission, the amount we receive is a blended rate based on the contractual formula contained therein.The rate may not correlate specifically to the cost structure of our individual segments. As such, we allocate earned ceding commissions to our segments based on each segment's proportionate share of total acquisition costs and other underwriting expenses recognized during the period.
Service and Fee Income. We currently generate service and fee income from the following sources:
• Product warranty registration and service - Our Specialty Risk and
Extended Warranty business generates fee revenue for product warranty
registration and claims handling services provided to unaffiliated
third parties. • Servicing carrier - We act as a servicing carrier for workers' compensation assigned risk plans in nine states. In addition, we also offer claims adjusting and loss control services for fees to unaffiliated third parties.
• Management services - We provide services to insurance consumers,
traditional insurers and insurance producers by offering flexible and cost effective alternatives to traditional insurance tools in the form
of various risk retention groups and captive management companies, as
well as management of workers' compensation and commercial property
programs. We also offer programs and alternative funding options for non-profit and public sector organizations for the management of their state unemployment insurance obligations. • Installment, reinstatement and policy fees - We recognize fee income associated with the issuance of workers' compensation policies for
installment fees, in jurisdictions where it is permitted and approved,
and reinstatement fees, which are fees charged to reinstate a policy
after it has been canceled for non-payment, in jurisdictions where it
is permitted and approved. Additionally, we recognize policy fees
associated with general liability policies placed by our subsidiary,
Builders & Tradesmen's
• Broker services - We provide brokerage services to Maiden in connection
with our reinsurance agreement for which we receive a fee. • Asset management services - We currently manage the investment portfolios of Maiden,National General Holdings Corp ("NGHC"), which changed its name fromAmerican Capital Acquisition Corp , or ACAC, inApril 2013 , andACP Re, Ltd. for which we receive a management fee.
• Information technology services - We provide information technology and
printing and mailing services to NGHC and its affiliates for a fee. Loss and Loss Adjustment Expenses Incurred. Loss and loss adjustment expenses ("LAE") incurred represent our largest expense item and, for any given reporting period, include estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims. These expenses fluctuate based on the amount and types of risks we insure. We record loss and loss adjustment expenses related to estimates of future claim payments based on case-by-case valuations and statistical analyses. We seek to establish all reserves at the most likely ultimate exposure based on our historical claims experience. It is typical for our more serious bodily injury claims to take several years to settle and we revise our estimates as we receive additional information about the condition of injured employees and claimants and the costs of their medical treatment. Our ability to estimate loss and loss adjustment expenses accurately at the time of pricing our insurance policies is a critical factor in our profitability.
Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses consist of policy acquisition expenses, salaries and benefits and general and administrative expenses. These items are described below:
• Policy acquisition expenses comprise commissions directly attributable
to those agents, wholesalers or brokers that produce premiums written
on our behalf. In most instances, we pay commissions based on collected
premium, which reduces our credit risk exposure associated with producers in case a policyholder does not pay a premium. We pay state and local taxes, licenses and fees, assessments and contributions to various state guaranty funds based on our premiums or losses in each state. Surcharges that we may be required to charge and collect from
insureds in certain jurisdictions are recorded as accrued liabilities,
rather than expense. 46
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• Salaries and benefits expenses are those salaries and benefits expenses for employees that are directly involved in the origination, issuance and maintenance of policies, claims adjustment and accounting for
insurance transactions. We classify salaries and benefits associated
with employees that are involved in fee generating activities as other expenses. • General and administrative expenses are comprised of other costs associated with our insurance activities, such as federal excise tax, postage, telephones and internet access charges, as well as legal and auditing fees and board and bureau charges. Gain (loss) on Investment in Life Settlement Contracts. The gain (loss) on investment in life settlement contracts includes the gain on acquisition of life settlement contracts, the gain realized upon a mortality event and the change in fair value of the investments in life settlements as evaluated at the end of each reporting period.. We determine fair value based upon our estimate of the discounted cash flow related to policies (net of reserves for improvements in mortality, the possibility that the high net worth individuals represented in our portfolio may have access to better health care, the volatility inherent in determining the life expectancy of insureds with significant reported health impairments, the possibility that the issuer of the policy or a third party will contest the payment of the death benefit payable to us and the future expenses related to the administration of the portfolio), which incorporates a number of factors, such as current life expectancy assumptions, expected premium payment obligations and increased cost assumptions, credit exposure to the insurance companies that issued the life insurance policies and the rate of return that a buyer would require on the policies. The gain (loss) realized upon a mortality event is the difference between the death benefit received and the recorded fair value of that particular policy. We allocate gain (loss) on investment in life settlement contracts to our segments based on gross written premium by segment.
Net Loss Ratio. The net loss ratio is a measure of the underwriting profitability of an insurance company's business. Expressed as a percentage, this is the ratio of net losses and LAE incurred to net premiums earned.
Net Expense Ratio. The net expense ratio is a measure of an insurance company's operational efficiency in administering its business. Expressed as a percentage, this is the ratio of the sum of acquisition costs and other underwriting expenses less ceding commission revenue to net premiums earned. As we allocate certain acquisition costs and other underwriting expenses based on premium volume to our segments, net loss ratio on a segment basis may be impacted period over period by a shift in each segment's proportionate share of net written premium.
Net Combined Ratio. The net combined ratio is a measure of an insurance company's overall underwriting profit. This is the sum of the net loss and net expense ratios. If the net combined ratio is at or above 100%, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient.
Net Premiums Earned less Expenses Included in Combined Ratio (Underwriting Income). Underwriting income is a measure of an insurance company's overall operating profitability before items such as investment income, interest expense and income taxes.
Return on Equity. We calculate return on equity by dividing net income by the average of shareholders' equity.
One of the key financial measures that we use to evaluate our operating performance is return on average equity. Our return on annualized average equity was 25.5% and 16.5% for the three months endedJune 30, 2013 and 2012, respectively, and 26.7% and 16.8% for the six months endedJune 30, 2013 and 2012, respectively. In addition, we target a net combined ratio of 95% or lower over the long term, while seeking to maintain optimal operating leverage in our insurance subsidiaries commensurate with ourA.M. Best rating objectives. Our net combined ratio was 91.3% and 88.9% for the three months endedJune 30, 2013 and 2012, respectively, and 90.5% and 88.7% for the six months endedJune 30, 2013 and 2012, respectively. Critical Accounting Policies Our discussion and analysis of our results of operations, financial condition and liquidity are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the amounts of assets and liabilities, revenues and expenses and disclosure of contingent assets and liabilities as of the date of the financial statements. As more information becomes known, these estimates and assumptions could change, which would have an impact on actual results that may differ materially from these estimates and judgments under different assumptions. We have not made any changes in estimates or judgments that have had a significant effect on the reported amounts as previously disclosed in our Annual Report on Form 10-K for the fiscal period endedDecember 31, 2012 . 47 --------------------------------------------------------------------------------
Results of Operations
Consolidated Results of Operations for the Three and Six Months EndedJune 30, 2013 and 2012 (Unaudited) Three Months Ended June 30, Six Months Ended June 30, (Amounts in Thousands) 2013 2012 2013 2012 Gross written premium$ 1,040,614 $ 637,438
Net written premium$ 639,997 $ 391,589 $ 1,172,103 $ 751,366 Change in unearned premium (103,458 ) (57,595 ) (227,570 ) (103,348 ) Net earned premiums 536,539 333,994 944,533 648,018 Ceding commission - primarily related party 67,157 44,550 131,115 90,824 Service and fee income (related parties - three months$14,414 ;$6,932 and six months$24,921 ;$13,024 ) 88,102 33,011 148,615 73,549 Net investment income 22,634 16,344 40,729 30,862 Net realized gain (loss) on investments 2,067 2,703 19,351 1,555 Total revenues 716,499 430,602 1,284,343 844,808 Loss and loss adjustment expense 364,110 211,787 636,366 411,716 Acquisition costs and other underwriting expenses 192,559 129,713 349,379 253,738 Other 80,985 32,320 133,137 67,959 Total expenses 637,654 373,820 1,118,882 733,413 Income before other income (expense), income taxes and equity in earnings of unconsolidated subsidiaries 78,845 56,782 165,461 111,395 Other income (expense): Interest expense (7,608 ) (6,994 ) (14,969 ) (14,085 ) Net gain on investment in life settlement contracts net of profit commission 1,080 1,961 4 2,051 Foreign currency gain (loss) 783 (2,455 ) 2,055 (2,034 ) Acquisition gain on purchase 31,956 - 58,023 - Total other income (expense) 26,211 (7,488 ) 45,113 (14,068 ) Income before income taxes and equity in earnings (loss) of unconsolidated subsidiaries 105,056 49,294 210,574 97,327 Provision for income taxes 31,993 11,742 55,910 22,919 Income before equity in earnings of unconsolidated subsidiaries 73,063 37,552 154,664 74,408 Equity in earnings of unconsolidated subsidiaries - related party 7,059 3,088 8,610 5,452 Net income 80,122 40,640 163,274 79,860 Non-controlling interest - (282 ) 877 (416 ) Net income attributable to AmTrust Financial Services, Inc.$ 80,122 $ 40,358
Net realized gain (loss) on investments: Total other-than-temporary impairment loss $ -$ (1,208 ) $ -$ (1,208 ) Portion of loss recognized in other comprehensive income - - - - Net impairment losses recognized in earnings - (1,208 ) - (1,208 ) Other net realized gain on investments 2,067 3,911 19,351 2,763 Net realized investment gain (loss) $ 2,067$ 2,703 $ 19,351 $ 1,555 Key measures: Net loss ratio 67.9 % 63.4 % 67.4 % 63.5 % Net expense ratio 23.4 % 25.5 % 23.1 % 25.1 % Net combined ratio 91.3 % 88.9 % 90.5 % 88.7 % 48
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Consolidated Results of Operations for the Three Months Ended
Gross Written Premium. Gross written premium increased$403.2 million , or 63.3%, to$1,040.6 million from$637.4 million for the three months endedJune 30, 2013 and 2012, respectively. The increase of$403.2 million was primarily attributable to growth in our three primary segments. The increase in Small Commercial Business resulted primarily from increases in the number of policies issued as well as the average policy size and the impact of the Sequoia and FNIC acquisitions. The largest increases came from the states ofCalifornia ,Florida, New York andPennsylvania . Additionally in our Small Commercial Business segment, we had an increase in our assigned risk premium. The increase in Specialty Risk and Extended Warranty resulted from non-recurring insurance policies written in the second quarter of 2013, the acquisition of Car Care in 2013, as well as organic growth in both inEurope and domestically. The increase in Specialty Program resulted primarily from growth in existing workers' compensation programs and commercial package programs. Net Written Premium. Net written premium increased$248.4 million , or 63.4%, to$640.0 million from$391.6 million for the three months endedJune 30, 2013 and 2012, respectively. The increase by segment was: Small Commercial Business -$114.3 million , Specialty Risk and Extended Warranty -$118.0 million million, Specialty Program -$16.0 million and Personal Lines -$0.1 million . Net written premium increased for the three months endedJune 30, 2013 compared to the same period in 2012 due to the increase in gross written premium in 2013 compared to 2012 and was partially offset by the lower retention of premiums written on programs in our Small Commercial Business segment and Specialty Risk and Extended Warranty segment that are not covered by the Maiden Quota Share. Our overall retention rates were 61.5% and 61.4% for the three months endedJune 30, 2013 and 2012, respectively. Net Earned Premium. Net earned premium increased$202.5 million , or 60.6%, to$536.5 million from$334.0 million for the three months endedJune 30, 2013 and 2012, respectively. The increase by segment was: Small Commercial Business -$94.7 million , Specialty Risk and Extended Warranty -$66.6 million , Specialty Program -$39.8 million , and Personal Lines -$1.4 million . The increase in net earned premium corresponded to the increase in net written premium. Ceding Commission. Ceding commission represents commission earned primarily through the Maiden Quota Share, whereby we receive a ceding commission of 31% of premiums ceded for all business except retail commercial package business, and 34.375% for retail commercial package business. The ceding commission earned during the three months endedJune 30, 2013 and 2012 was$67.2 million and$44.6 million , respectively. Ceding commission increased period over period as a result of increased premium writings and was consistent period over period as a percentage of earned premium. Service and Fee Income. Service and fee income increased$55.1 million , or 166.9%, to$88.1 million from$33.0 million for the three months endedJune 30, 2013 and 2012, respectively. The increase primarily related to additional fee income from acquisitions. We produced additional fee income of approximately$35.2 million during the three months endedJune 30, 2013 from the acquisitions of CPPNA and Car Care in 2013 and FNC and the CNH Capital Insurance Agencies in the second half of 2012. We also increased our warranty administration fees by$6.5 million in 2013 compared to 2012. Additionally, we had higher technology fee income from NGHC of approximately$2.4 million and higher reinsurance brokerage fees from Maiden of approximately$4.6 million . Net Investment Income. Net investment income increased$6.3 million , or 38.5%, to$22.6 million from$16.3 million for the three months endedJune 30, 2013 and 2012, respectively. The increase resulted primarily from having a higher average portfolio of fixed security investment securities during the three months endedJune 30, 2013 as a result of the Sequoia and FNIC acquisitions compared to the three months endedJune 30, 2012 , partially offset by lower overall yields. Net Realized Gains (Losses) on Investments. We had a net realized gain on investments of$2.1 million and$2.7 million for the three months endedJune 30, 2013 and 2012, respectively. The decrease in the realized gains for the three months endedJune 30, 2013 resulted primarily from fewer sales of equity securities in our investment portfolio during the three months endedJune 30, 2013 . Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased$152.3 million , or 71.9%, to$364.1 million from$211.8 million for the three months endedJune 30, 2013 and 2012, respectively. Our loss ratio for the three months endedJune 30, 2013 and 2012 was 67.9% and 63.4%, respectively. The increase in the loss ratio in 2013 primarily relates to higher ultimate loss selections in our Specialty Risk and Extended Warranty segment's European casualty business in the three months endedJune 30, 2013 compared to the three months endedJune 30, 2012 , and changes in the proportionate share of business written by segment. Additionally, the increase in the loss ratio was the result of having a higher percentage of earned premium in 2013 from workers' compensation policies in the state ofCalifornia , for which we assign a higher ultimate loss selection than for workers' compensation policies written in other states. 49
-------------------------------------------------------------------------------- Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased$62.9 million , or 48.5%, to$192.6 million from$129.7 million for the three months endedJune 30, 2013 and 2012, respectively. The expense ratio for the same periods decreased to 23.4% from 25.5%, and was distributed across our three primary segments. The decrease in the expense ratio resulted both from change in business mix and economies of scale. During the three months endedJune 30, 2013 , a higher percentage of the gross written premium increase was attributable to workers' compensation business in both the Small Commercial Business and Specialty Program segments, which has lower policy acquisition expenses. Additionally, salary expense increased at a slower rate than earned premium due to leveraging of our existing employee base. Income Before Other Income (Expense), Income Taxes and Equity Earnings of Unconsolidated Subsidiaries. Income before other income (expense), income taxes and equity earnings of unconsolidated subsidiaries increased$22.1 million , or 38.9%, to$78.8 million from$56.8 million for the three months endedJune 30, 2013 and 2012, respectively. The change in income from 2013 to 2012 resulted primarily from increases in income derived from service and fee income and a lower expense ratio, partially offset by a higher loss ratio. Interest Expense. Interest expense for the three months endedJune 30, 2013 was$7.6 million , compared to$7.0 million for the same period in 2012. The increase was primarily related to higher interest on repurchase agreements and interest on our promissory notes issued into during the third quarter of 2012. Net Gain (Loss) on Investment in Life Settlement Contracts. We recognized a gain on investment in life settlement contracts of$1.1 million for the three months endedJune 30, 2013 compared to a gain of$2.0 million for the three months ended 2012. The decrease in the gain from life settlement contracts resulted from a lower net increase in fair value of the life settlement contracts, which resulted from the updating of life expectancies of the underlying insureds. This decrease was partially offset by a gain realized upon a mortality event in the three months endedJune 30, 2013 . Acquisition Gain on Purchase. We recognized an acquisition gain on purchase for the three months endedJune 30, 2013 of$31.2 million compared to recognizing no gain on acquisition for the three months endedJune 30, 2012 . The gain on acquisition related to the purchase of FNIC and Sequoia during the three months endedJune 30, 2013 . Provision for Income Tax. Income tax expense for the three months endedJune 30, 2013 was$32.0 million , which resulted in an effective tax rate of 30.5% compared to$11.7 million for the three months endedJune 30, 2012 , which resulted in an effective tax rate of 23.8%. The effective rate increased during the three months endedJune 30, 2013 primarily from the gain recognized on the acquisition of FNIC and Sequoia. Equity in Earnings of Unconsolidated Subsidiary -Related Party . Equity in earnings of unconsolidated subsidiary - related party increased by$4.0 million for the three months endedJune 30, 2013 to$7.1 million compared to$3.1 million for the three months endedJune 30, 2012 . The increase in equity in earnings for the three months endedJune 30 2013 compared to the three months endedJune 30, 2012 resulted primarily from a realized gain of approximately$8.6 million from a decrease in our ownership percentage of NGHC from 21.25% to 15.4% as a result of NGHC's sale of shares in a 144A offering inJune 2013 , partially offset by a decline in earnings from our proportionate share of equity income from NGHC's results of operations.
Consolidated Results of Operations for the Six Months Ended
Gross Written Premium. Gross written premium increased$745.4 million , or 60.2%, to$1,984.5 million from$1,239.1 million for the six months endedJune 30, 2013 and 2012, respectively. The increase of$745.4 million was primarily attributable to growth in our three primary segments. The increase in Small Commercial Business resulted primarily from increases in the number of policies issued as well as the average policy size and the impact of the Sequoia and FNIC acquisitions. The largest increases came from the states ofCalifornia ,Florida, New York andPennsylvania . Additionally in our Small Commercial Business segment, we had an increase in our assigned risk premium. The increase in Specialty Risk and Extended Warranty resulted from non-recurring insurance policies written in the second quarter of 2013, the acquisition of Car Care in 2013, as well as organic growth in both inEurope and domestically. The increase in Specialty Program resulted primarily from growth in existing in workers' compensation programs and commercial package programs. 50 -------------------------------------------------------------------------------- Net Written Premium. Net written premium increased$420.7 million , or 56.0%, to$1,172.1 million from$751.4 million for the six months endedJune 30, 2013 and 2012, respectively. The increase by segment was: Small Commercial Business -$169.1 million , Specialty Risk and Extended Warranty -$161.3 million , Specialty Program -$90.1 million and Personal Lines -$0.2 million . Net written premium increased for the six months endedJune 30, 2013 compared to the same period in 2012 due to the increase in gross written premium in 2013 compared to 2012, and was partially offset by the lower retention of premiums written on programs in our Small Commercial Business segment and Specialty Risk and Extended Warranty segment that are not covered by the Maiden Quota Share. Our overall retention rates were 59.1% and 60.6% for the six months endedJune 30, 2013 and 2012, respectively. Net Earned Premium. Net earned premium increased$296.5 million , or 45.8%, to$944.5 million from$648.0 million for the six months endedJune 30, 2013 and 2012, respectively. The increase by segment was: Small Commercial Business -$129.0 million , Specialty Risk and Extended Warranty -$72.1 million , Specialty Program -$91.7 million , and Personal Lines -$3.7 million . The increase in net earned premium corresponded to the increase in net written premium. Ceding Commission. Ceding commission represents commission earned primarily through the Maiden Quota Share, whereby we receive a ceding commission of 31% of premiums ceded for all business except retail commercial package business, and 34.375% for retail commercial package business. The ceding commission earned during the six months endedJune 30, 2013 and 2012 was$131.1 million and$90.8 million , respectively. Ceding commission increased period over period as a result of increased premium writings and was consistent period over period as a percentage of earned premium. Service and Fee Income. Service and fee income increased$75.1 million , or 102.1%, to$148.6 million from$73.5 million for the six months endedJune 30, 2013 and 2012, respectively. The increase primarily related to additional fee income from acquisitions, as well as organic growth. We produced additional fee income of approximately$49.0 million during the six months endedJune 30, 2013 related to the acquisitions of Car Care and CPPNA in 2013, and FNC and CNH in the second half of 2012. We also increased our warranty administration fees by$10.1 million in 2013 compared to 2012. Additionally, we had higher technology fee income from NGHC of approximately$5.3 million and higher reinsurance brokerage fees from Maiden of approximately$6.1 million . Net Investment Income. Net investment income increased$9.8 million , or 32.0%, to$40.7 million from$30.9 million for the six months endedJune 30, 2013 and 2012, respectively. The increase resulted primarily from having a higher average portfolio of fixed security investment securities during the six months endedJune 30, 2013 , as a result of the acquisitions of Car Care, Sequoia and FNIC, compared to the six months endedJune 30, 2012 , partially offset by lower overall yields. Net Realized Gains (Losses) on Investments. We had a net realized gain on investments of$19.4 million for the six months endedJune 30, 2013 , compared to a net realized loss on investments of$1.6 million for the six months endedJune 30, 2012 . The increase in 2013 resulted from sales of securities with sizable unrealized gain positions during the first three months of 2013. Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased$224.7 million , or 54.6%, to$636.4 million from$411.7 million for the six months endedJune 30, 2013 and 2012, respectively. Our loss ratio for the six months endedJune 30, 2013 and 2012 was 67.4% and 63.5%, respectively. The increase in the loss ratio in 2013 primarily impacted our Specialty Risk and Extended Warranty segment and our Small Commercial Business segment. The increases resulted from higher ultimate loss selections in our European casualty business and a higher loss ratio from having a higher percentage of earned premium in 2013 from our workers' compensation business in the state ofCalifornia , for which we assign a higher ultimate loss selection than for workers' compensation policies written in other states, and changes in the proportionate share of business written by segment. Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased$95.7 million , or 37.7%, to$349.4 million from$253.7 million for the six months endedJune 30, 2013 and 2012, respectively. The expense ratio for the same periods decreased to 23.1% from 25.1%, respectively, and was distributed across our three primary segments. The decrease in the expense ratio resulted both from change in business mix and economies of scale. During the six months endedJune 30, 2013 , a higher percentage of the gross written premium increase was attributable to workers' compensation business in both the Small Commercial Business and Specialty Program segments, which has lower policy acquisition expenses. Additionally, salary expense increased at a slower rate than earned premium due to leveraging of our existing employee base. Income Before Other Income (Expense), Income Taxes and Equity Earnings of Unconsolidated Subsidiaries. Income before other income (expense), income taxes and equity earnings of unconsolidated subsidiaries increased$54.1 million , or 48.5%, to$165.5 million from$111.4 million for the six months endedJune 30, 2013 and 2012, respectively. The change in income from 2013 to 2012 resulted primarily from increases in underwriting income of$16.5 million , realized gains on sales of investments of$17.8 million and income derived from service and fee income of approximately$9.9 million . 51 -------------------------------------------------------------------------------- Interest Expense. Interest expense for the six months endedJune 30, 2013 was$15.0 million , compared to$14.1 million for the same period in 2012. The increase was primarily related to higher interest on repurchase agreements and interest on our promissory notes issued during the third quarter of 2012. Net Gain (Loss) on Investment in Life Settlement Contracts. We recognized a gain on investment in life settlement contracts of$0.004 million for the six months endedJune 30, 2013 compared to a gain of$2.1 million for the six months ended 2012. The decrease in the gain from life settlement contracts resulted from a lower net increase in fair value of the life settlement contracts, based on updated life expectancies of the underlying insureds. This decrease was partially offset by a gain realized upon two mortality events in the six months endedJune 30, 2013 . Acquisition Gain on Purchase. We recognized an acquisition gain on purchase for the six months endedJune 30, 2013 of$58.0 million compared to recognizing no gain on acquisition for the three months endedJune 30, 2012 . The gain on acquisition related to the purchase of Car Care, FNIC and Sequoia during the six months endedJune 30, 2013 . Provision for Income Tax. Income tax expense for the six months endedJune 30, 2013 was$55.9 million , which resulted in an effective tax rate of 26.6% compared to$22.9 million for the six months endedJune 30, 2012 , which resulted in an effective tax rate of 23.8%. The effective rate increased during the six months endedJune 30, 2013 primarily from the gain recognized on the acquisition of FNIC and Sequoia during the three months endedJune 30, 2013 . Equity in Earnings of Unconsolidated Subsidiary -Related Party . Equity in earnings of unconsolidated subsidiary - related party increased by$3.1 million for the six months endedJune 30, 2013 to$8.6 million compared to$5.5 million for the six months endedJune 30, 2012 . The increase in equity in earnings for the six months endedJune 30 2013 compared to the six months endedJune 30, 2012 resulted primarily from a realized gain of approximately$8.6 million from a decrease in our ownership percentage of NGHC from 21.25% to 15.4% as a result of NGHC's sale of shares in a 144A offering inJune 2013 , partially offset by a decline in earnings from our proportionate share of equity income from NGHC's results of operations. 52 --------------------------------------------------------------------------------
Small Commercial Business Segment Results of Operations for the Three and Six Months Ended
Three Months Ended June 30, Six Months Ended June 30, (Amounts in Thousands) 2013 2012 2013 2012 Gross written premium$ 389,911 $ 214,127
Net written premium 218,553 104,270 392,293 223,160 Change in unearned premium (30,253 ) (10,702 ) (77,393 ) (37,264 ) Net earned premiums 188,300 93,568
314,900 185,896
Ceding commission - primarily related party 28,322 15,458 52,488 32,590 Loss and loss adjustment expense (124,368 ) (60,305 ) (208,698 ) (119,529 ) Acquisition costs and other underwriting expenses (76,931 ) (42,165 )
(132,761 ) (85,095 )
(201,299 ) (102,470 ) (341,459 ) (204,624 ) Underwriting income$ 15,323 $ 6,556 $ 25,929 $ 13,862 Key measures: Net loss ratio 66.0 % 64.5 % 66.3 % 64.3 % Net expense ratio 25.8 % 28.5 % 25.5 % 28.2 % Net combined ratio 91.9 % 93.0 % 91.8 % 92.5 % Reconciliation of net expense ratio: Acquisition costs and other underwriting expenses$ 76,931 $ 42,165 $ 132,761 $ 85,095 Less: ceding commission revenue - primarily related party 28,322 15,458 52,488 32,590 48,609 26,707 80,273 52,505 Net earned premium$ 188,300 $ 93,568 $ 314,900 $ 185,896 Net expense ratio 25.8 % 28.5 % 25.5 % 28.2 %
Small Commercial Business Segment Results of Operations for the Three Months Ended
Gross Written Premium. Gross written premium increased$175.8 million , or 82.1%, to$389.9 million from$214.1 million for the three months endedJune 30, 2013 and 2012, respectively. The increase related primarily from the number of policies issued as well as the average policy size and the impact of the Sequoia and FNIC acquisitions. The majority of the$110 million increase came from the states ofCalifornia ,Florida, New York andPennsylvania . Additionally, we had an increase in our assigned risk premium of$23.5 million . Net Written Premium. Net written premium increased$114.3 million , or 109.6%, to$218.6 million from$104.3 million for the three months endedJune 30, 2013 and 2012, respectively. The increase in net premium resulted from an increase in gross written premium for the three months endedJune 30, 2013 compared to the three months endedJune 30, 2012 , as well as an increase in the retention of gross written premium period over period. Our retention rates for the segment were 56.1% and 48.7% for the three months endedJune 30, 2013 and 2012, respectively. The increase was partially offset by an increase in our assigned risk business in 2013, for which we cede 100 percent of our gross written business. Net Earned Premium. Net earned premium increased$94.7 million , or 101.2%, to$188.3 million from$93.6 million for the three months endedJune 30, 2013 and 2012, respectively. As premiums written earn ratably over an annual period, the increase in net premium earned resulted from higher net written premium for the twelve months endedJune 30, 2013 compared to the twelve months endedJune 30, 2012 . In addition, acquired unearned premium of approximately$66 million from the Sequoia and FNIC acquisitions impacted earned premium in 2013. 53 -------------------------------------------------------------------------------- Ceding Commission. The ceding commission earned during the three months endedJune 30, 2013 and 2012 was$28.3 million and$15.4 million , respectively. The ceding commission increased period over period as a result of an increase in net earned premium, as the segment received its allocation of ceding commission for its proportionate share of our overall policy acquisition expense. Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased$64.1 million , or 106.3%, to$124.4 million from$60.3 million for the three months endedJune 30, 2013 and 2012, respectively. Our loss ratio for the segment for the three months endedJune 30, 2013 increased to 66.0% from 64.5% for the three months endedJune 30, 2012 . The increase in the loss ratio in the three months endedJune 30, 2013 resulted primarily from having a higher percentage of earned premium in 2013 from workers' compensation policies in the state ofCalifornia , for which we assign a higher ultimate loss selection than for workers' compensation policies written in other states. Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased$34.7 million , or 82.3%, to$76.9 million from$42.2 million for the three months endedJune 30, 2013 and 2012, respectively. The expense ratio decreased to 25.8% for the three months endedJune 30, 2013 from 28.5% for the three months endedJune 30, 2012 . The decrease in the expense ratio resulted from a change in our business mix. During the three months endedJune 30, 2013 , a higher percentage of the gross written premium increase was attributable to workers' compensation business, which has lower policy acquisition expenses. Net Earned Premiums less Expense Included in Combined Ratio (Underwriting Income). Net premiums earned less expenses included in combined ratio increased$8.7 million , or 132.7%, to$15.3 million from$6.6 million for the three months endedJune 30, 2013 and 2012, respectively. The increase resulted primarily from an increase in the level of earned premium during the three months endedJune 30, 2013 compared to the three months endedJune 30, 2012 , as well as a lower expense ratio, partially offset by higher loss and loss adjustment expenses in the second quarter of 2013 compared to the second quarter of 2012.
Small Commercial Business Segment Results of Operations for the Six Months Ended
Gross Written Premium. Gross written premium increased$319.3 million , or 71.5%, to$765.8 million from$446.5 million for the six months endedJune 30, 2013 and 2012, respectively. The increase related primarily from the number of policies issued as well as the average policy size and the impact of the Sequoia and FNIC acquisitions. The majority of the$213 million increase came from the states ofCalifornia ,Florida, New York andPennsylvania . Additionally, we had an increase in our assigned risk premium of$40.5 million . Net Written Premium. Net written premium increased$169.1 million , or 75.8%, to$392.3 million from$223.2 million for the six months endedJune 30, 2013 and 2012, respectively. The increase in net premium resulted from an increase in gross written premium for the six months endedJune 30, 2013 compared to the six months endedJune 30, 2012 , as well as an increase in the retention of gross written premium period over period. Our retention rates for the segment were 51.2% and 50.0% for the three months endedJune 30, 2013 and 2012, respectively. This was partially offset by an increase in our assigned risk business in 2013, for which we cede 100 percent of our gross written business. Net Earned Premium. Net earned premium increased$129.0 million , or 69.4%, to$314.9 million from$185.9 million for the six months endedJune 30, 2013 and 2012, respectively. As premiums written earn ratably over an annual period, the increase in net premium earned resulted from higher net written premium for the twelve months endedJune 30, 2013 compared to the twelve months endedJune 30, 2012 . Ceding Commission. The ceding commission earned during the six months endedJune 30, 2013 and 2012 was$52.5 million and$32.6 million , respectively. The ceding commission increased period over period as a result of an increase in net earned premium, as the segment received its allocation of ceding commission for its proportionate share of our overall policy acquisition expense. Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased$89.2 million , or 74.6%, to$208.7 million from$119.5 million for the six months endedJune 30, 2013 and 2012, respectively. Our loss ratio for the segment for the six months endedJune 30, 2013 increased to 66.3% from 64.3% for the six months endedJune 30, 2012 . The increase in the loss ratio in the six months endedJune 30, 2013 resulted primarily from having a higher percentage of earned premium in 2013 from workers' compensation policies in the state ofCalifornia , for which we assign a higher ultimate loss selection than for workers' compensation policies written in other states. 54 -------------------------------------------------------------------------------- Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased$47.7 million , or 56.1%, to$132.8 million from$85.1 million for the six months endedJune 30, 2013 and 2012, respectively. The expense ratio decreased to 25.5% for the six months endedJune 30, 2013 from 28.2% for the six months endedJune 30, 2012 . The decrease in the expense ratio resulted both from a change in our business mix and economies of scale. During the six months endedJune 30, 2013 , a higher percentage of the gross written premium increase was attributable to workers' compensation business, which has lower policy acquisition expenses. Additionally, salary expense increased at a slower rate than earned premium due to the leveraging of our existing employee base. Net Earned Premiums less Expense Included in Combined Ratio (Underwriting Income). Net premiums earned less expenses included in combined ratio increased$12.0 million , or 86.6%, to$25.9 million from$13.9 million for the six months endedJune 30, 2013 and 2012, respectively. The increase resulted primarily from an increase in the level of earned premium during the six months endedJune 30, 2013 compared to the six months endedJune 30, 2012 , as well as a lower expense ratio, partially offset by higher loss and loss adjustment expenses in the first six months of 2013 compared to the first six months of 2012.
Specialty Risk and Extended Warranty Segment Results of Operations for the Three and Six Months Ended
Three Months Ended June 30, Six Months Ended June 30, (Amounts in Thousands) 2013 2012 2013 2012 Gross written premium$ 447,885 $ 272,610
Net written premium 290,272 172,259 474,714 313,420 Change in unearned premium (82,122 ) (30,652 ) (125,410 ) (36,240 ) Net earned premiums 208,150 141,607
349,304 277,180
Ceding commission - primarily related party 23,405 16,174 41,413 33,368 Loss and loss adjustment expense (144,050 ) (85,628 ) (237,021 ) (169,071 ) Acquisition costs and other underwriting expenses (62,846 ) (44,038 )
(104,749 ) (87,123 )
(206,896 ) (129,666 ) (341,770 ) (256,194 ) Underwriting income$ 24,659 $ 28,115 $ 48,947 $ 54,354 Key measures: Net loss ratio 69.2 % 60.5 % 67.9 % 61.0 % Net expense ratio 18.9 % 19.7 % 18.1 % 19.4 % Net combined ratio 88.2 % 80.1 % 86.0 % 80.4 % Reconciliation of net expense ratio: Acquisition costs and other underwriting expenses$ 62,846 $ 44,038 $ 104,749 $ 87,123 Less: ceding commission revenue - primarily related party 23,405 16,174 41,413 33,368 39,441 27,864 63,336 53,755 Net earned premium$ 208,150 $ 141,607 $ 349,304 $ 277,180 Net expense ratio 18.9 % 19.7 % 18.1 % 19.4 %
Specialty Risk and Extended Warranty Segment Results of Operations for the Three Months Ended
Gross Written Premium. Gross written premium increased$175.3 million , or 64.3%, to$447.9 million from$272.6 million for the three months endedJune 30, 2013 and 2012, respectively. The segment experienced growth both inEurope andthe United States . The growth inEurope was driven primarily by a non-recurring insurance policy totaling approximately$78 million of written premium and the acquisition of Car Care, which had premium writings of approximately$29 million . The growth inthe United States resulted from the underwriting of new programs. 55 -------------------------------------------------------------------------------- Net Written Premium. Net written premium increased$118.0 million , or 68.5%, to$290.3 million from$172.3 million for the three months endedJune 30, 2013 and 2012, respectively. The increase in net written premium resulted from an increase of gross written premium for the three months endedJune 30, 2013 compared to the three months endedJune 30, 2012 , as well as a higher retention of gross written premium during 2013 compared to 2012. Our overall retention rate for the segment was 64.8% and 63.2% for the three months endedJune 30, 2013 and 2012, respectively. Net Earned Premium. Net earned premium increased$66.6 million , or 47.1%, to$208.2 million from$141.6 million for the three months endedJune 30, 2013 and 2012, respectively. As net written premium is earned ratably over the term of a policy, which on average is 24 months, net earned premium did not increase proportionately to the increases in gross written premium and net written premium during the three months endedJune 30, 2013 . Ceding Commission. The ceding commission earned during the three months endedJune 30, 2013 and 2012 was$23.4 million and$16.2 million , respectively. The increase related to the allocation to this segment of its proportionate share of our overall policy acquisition expense. Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased$58.5 million , or 68.3%, to$144.1 million from$85.6 million for the three months endedJune 30, 2013 and 2012, respectively. Our loss ratio for the segment for the three months endedJune 30, 2013 increased to 69.2% from 60.5% for the three months endedJune 30, 2012 . The increase in the loss ratio for the three months endedJune 30, 2013 resulted primarily from our assignment of a higher ultimate loss selection for our European casualty business in the three months endedJune 30, 2013 compared to the three months endedJune 30, 2012 . Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased$18.8 million , or 42.7%, to$62.8 million from$44.0 million for the three months endedJune 30, 2013 and 2012, respectively. The expense ratio decreased to 18.9% for the three months endedJune 30, 2013 from 19.7% for the three months endedJune 30 , 2012.The decrease in the expense ratio resulted from from a decline in policy acquisition costs as a percentage of earned premium. Net Earned Premiums less Expenses Included in Combined Ratio (Underwriting Income). Net earned premiums less expenses included in combined ratio decreased$3.4 million , or 12%, to$24.7 million from$28.1 million for the three months endedJune 30, 2013 and 2012, respectively. The decrease was attributable primarily to an increase in the segment's loss ratio during the three months endedJune 30, 2013 compared to the three months endedJune 30, 2012 , partially offset by an increase in the segment's earned premium.
Specialty Risk and Extended Warranty Segment Results of Operations for the Six Months Ended
Gross Written Premium. Gross written premium increased$269.5 million , or 53.2%, to$776.2 million from$506.7 million for the six months endedJune 30, 2013 and 2012, respectively. The segment experienced growth both inEurope andthe United States . The growth inEurope was driven primarily by a non-recurring insurance policy totaling approximately$78 million of written premium and the acquisition of Car Care, which had premium writings of approximately$38 million . The growth inthe United States resulted from the underwriting of new programs, including programs related to our acquisition of CNH in 2012. Net Written Premium. Net written premium increased$161.3 million , or 51.5%, to$474.7 million from$313.4 million for the six months endedJune 30, 2013 and 2012, respectively. The increase in net written premium resulted from an increase of gross written premium for the six months endedJune 30, 2013 compared to the six months endedJune 30, 2012 , partially offset by a lower retention of gross written premium during 2013 compared to 2012. Our overall retention rate for the segment was 61.2% and 61.9% for the six months endedJune 30, 2013 and 2012, respectively. Net Earned Premium. Net earned premium increased$72.1 million , or 26.0%, to$349.3 million from$277.2 million for the six months endedJune 30, 2013 and 2012, respectively. As net written premium is earned ratably over the term of a policy, which on average is 24 months, net earned premium did not increase proportionately to the increases in gross written premium and net written premium during the six months endedJune 30, 2013 . Ceding Commission. The ceding commission earned during the six months endedJune 30, 2013 and 2012 was$41.4 million and$33.4 million , respectively. The increase related to the allocation to this segment of its proportionate share of our overall policy acquisition expense. 56 -------------------------------------------------------------------------------- Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased$67.9 million , or 40.2%, to$237.0 million from$169.1 million for the six months endedJune 30, 2013 and 2012, respectively. Our loss ratio for the segment for the six months endedJune 30, 2013 increased to 67.9% from 61.0% for the six months endedJune 30, 2012 . The increase in the loss ratio for the six months endedJune 30, 2013 resulted primarily from our assignment of a higher ultimate loss selection for our European casualty business in the six months endedJune 30, 2013 compared to the six months endedJune 30, 2012 . Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses decreased$17.6 million , or 20.2%, to$104.7 million from$87.1 million for the six months endedJune 30, 2013 and 2012, respectively. The expense ratio decreased to 18.1% for the six months endedJune 30, 2013 from 19.4% for the six months endedJune 30, 2012 . The decrease in the expense ratio resulted from a decline in policy acquisition costs as a percentage of earned premium. Net Earned Premiums less Expenses Included in Combined Ratio (Underwriting Income). Net earned premiums less expenses included in combined ratio decreased$5.5 million , or 10.1%, to$48.9 million from$54.4 million for the six months endedJune 30, 2013 and 2012, respectively. The decrease was attributable primarily to an increase in the segment's loss ratio during the six months endedJune 30, 2013 compared to the six months endedJune 30, 2012 , partially offset by an increase in the segment's earned premium.
Specialty Program Segment Results of Operations for Three and Six Months Ended
Three Months Ended June 30, Six Months Ended June 30, (Amounts in Thousands) 2013 2012 2013 2012 Gross written premium$ 173,843 $ 121,878
Net written premium 102,197 86,237 245,469 155,354 Change in unearned premium 8,479 (15,369 ) (23,315 ) (24,825 ) Net earned premium 110,676 70,868
222,154 130,529
Ceding commission - primarily related party 15,430 12,918 37,214 24,866 Loss and loss adjustment expense (75,820 ) (47,826 ) (151,374 ) (88,020 ) Acquisition costs and other underwriting expenses (43,799 ) (34,985 )
(94,126 ) (64,924 )
(119,619 ) (82,811 ) (245,500 ) (152,944 ) Underwriting income$ 6,487 $ 975$ 13,868 $ 2,451 Key measures: Net loss ratio 68.5 % 67.5 % 68.1 % 67.4 % Net expense ratio 25.6 % 31.1 % 25.6 % 30.7 % Net combined ratio 94.1 % 98.6 % 93.8 % 98.1 % Reconciliation of net expense ratio: Acquisition costs and other underwriting expenses$ 43,799 $ 34,985 $ 94,126 $ 64,924 Less: ceding commission revenue - primarily related party 15,430 12,918 37,214 24,866 28,369 22,067 56,912 40,058 Net earned premium$ 110,676 $ 70,868 $ 222,154 $ 130,529 Net expense ratio 25.6 % 31.1 % 25.6 % 30.7 % 57
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Specialty Program Segment Results of Operations for Three Months Ended
Gross Written Premium. Gross premium increased$51.9 million , or 42.6%, to$173.8 million from$121.9 million</money> for the three months ended June 30, 2013 and 2012, respectively. The segment benefited from growth in new programs and existing programs, including both workers' compensation programs and commercial package policy programs. Additionally, the segment benefited from new programs, including both workers' compensation programs and commercial package policy programs, which accounted for 37% of the total increase in gross written premium during the second quarter of 2013. Net Written Premium. Net written premium increased$16.0 million million, or 18.5%, to$102.2 million from$86.2 million for the three months endedJune 30, 2013 and 2012, respectively. The increase in net written premium resulted from an increase in gross written premium for the three months endedJune 30, 2013 compared to for the three months endedJune 30, 2012 , partially offset by a lower retention of gross written premium during 2013 compared to 2012. Our overall retention rate for the segment was 58.8% and 70.8% for the three months endedJune 30, 2013 and 2012, respectively. Net Earned Premium. Net earned premium increased$39.8 million , or 56.2%, to$110.7 million from$70.9 million for the three months endedJune 30, 2013 and 2012, respectively. As premiums written earn ratably over an annual period, the increase in net premium earned resulted from higher net written premium for 2013 compared to 2012. Ceding Commission. The ceding commission earned during the three months endedJune 30, 2013 and 2012 was$15.4 million and$12.9 million , respectively. The ceding commission increased period over period as result of an increase in net earned premium, as the segment received its allocation of ceding commission for its proportionate share of our overall policy acquisition expense. Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased$28.0 million , or 58.5%, to$75.8 million for the three months endedJune 30, 2013 , compared to$47.8 million for the three months endedJune 30, 2012 . Our loss ratio for the segment for the three months endedJune 30, 2013 increased to 68.5% from 67.5% for the three months endedJune 30, 2012 . The increase in the loss ratio in the three months endedJune 30, 2013 resulted primarily from higher current accident year selected ultimate losses as compared to selected ultimate losses from prior years. Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased$8.8 million , or 25.2%, to$43.8 million from$35.0 million for the three months endedJune 30, 2013 and 2012, respectively. The expense ratio decreased to 25.6% for the three months endedJune 30, 2013 from 31.1% for the three months endedJune 30, 2012 . The decrease in the expense ratio resulted both from a change in business mix and economies of scale. During the three months endedJune 30, 2013 , a higher percentage of gross written premium was attributable to workers' compensation business, which has lower policy acquisition expenses than other types of business written in this segment. Net Earned Premiums less Expense Included in Combined Ratio (Underwriting Income). Net earned premiums less expenses included in combined ratio increased$5.5 million , or 565.3%, to$6.5 million from$1.0 million for the three months endedJune 30, 2013 and 2012, respectively. The increase of$5.5 million resulted primarily from a decrease in expense ratio in the three months endedJune 30, 2013 compared to the three months endedJune 30, 2012 , partially offset by an increase in the loss ratio in the same period.
Specialty Program Segment Results of Operations for Six Months Ended
Gross Written Premium. Gross premium increased$156.4 million , or 69.0%, to$382.9 million from$226.5 million for the six months endedJune 30, 2013 and 2012, respectively. The segment benefited from growth in new programs and existing programs, including both workers' compensation programs and commercial package policy programs. Additionally, the segment benefited from new programs, particularly workers' compensation programs, which accounted for 41.5% of the total increase in gross written premium in the first six months of 2013. Net Written Premium. Net written premium increased$90.1 million , or 58.0%, to$245.5 million from$155.4 million for the six months endedJune 30, 2013 and 2012, respectively. The increase in net written premium resulted from an increase in gross written premium for the six months endedJune 30, 2013 compared to for the six months endedJune 30, 2012 , partially offset by a lower retention of gross written premium during 2013 compared to 2012. Our overall retention rate for the segment was 64.1% and 68.6% for the six months endedJune 30, 2013 and 2012, respectively. 58 -------------------------------------------------------------------------------- Net Earned Premium. Net earned premium increased$91.7 million , or 70.3%, to$222.2 million from$130.5 million for the six months endedJune 30, 2013 and 2012, respectively. As premiums written earn ratably over an annual period, the increase in net premium earned resulted from higher net written premium for 2013 compared to 2012. Ceding Commission. The ceding commission earned during the six months endedJune 30, 2013 and 2012 was$37.2 million and$24.9 million , respectively. The ceding commission increased period over period as result of an increase in net earned premium, as the segment received its allocation of ceding commission for its proportionate share of our overall policy acquisition expense. Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased$63.4 million , or 72.0%, to$151.4 million for the six months endedJune 30, 2013 , compared to$88.0 million for the six months endedJune 30, 2012 . Our loss ratio for the segment for the six months endedJune 30, 2013 increased to 68.1% from 67.4% for the six months endedJune 30, 2012 . The increase in the loss ratio in the six months endedJune 30, 2013 resulted primarily from higher current accident year selected ultimate losses as compared to selected ultimate losses from prior years. Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased$29.2 million , or 45.0%, to$94.1 million from$64.9 million for the six months endedJune 30, 2013 and 2012, respectively. The expense ratio decreased to 25.6% for the six months endedJune 30, 2013 from 30.7% for the six months endedJune 30, 2012 . The decrease in the expense ratio resulted both from a change in business mix and economies of scale. During the six months endedJune 30, 2013 , a higher percentage of gross written premium was attributable to workers' compensation business, which has lower policy acquisition expenses than other types of business written in this segment. Net Earned Premiums less Expenses Included in Combined Ratio (Underwriting Income). Net earned premiums less expenses included in combined ratio increased$11.4 million , or 465.1%, to$13.9 million from$2.5 million for the six months endedJune 30, 2013 and 2012, respectively. The increase of$11.4 million resulted primarily from a decrease in the expense ratio in 2013 compared to 2012.
Personal Lines Reinsurance Segment Results of Operations for the Three and Six Months Ended
Three Months Ended June 30, Six Months Ended June 30, (Amounts in Thousands) 2013 2012 2013 2012 Gross written premium$ 28,975 $ 28,823 $ 59,627 $ 59,432 Net written premium 28,975 28,823 59,627 59,432 Change in unearned premium 438 (872 ) (1,452 ) (5,019 ) Net earned premium 29,413 27,951 58,175 54,413 Loss and loss adjustment expense (19,872 ) (18,028 ) (39,273 ) (35,096 ) Acquisition costs and other underwriting expenses (8,983 ) (8,525 ) (17,743 ) (16,596 ) (28,855 ) (26,553 ) (57,016 ) (51,692 ) Underwriting income $ 558$ 1,398 $ 1,159 $ 2,721 Key measures: Net loss ratio 67.6 % 64.5 % 67.5 % 64.5 % Net expense ratio 30.5 % 30.5 % 30.5 % 30.5 % Net combined ratio 98.1 % 95.0 % 98.0 % 95.0 % 59
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Personal Lines Reinsurance Segment Results of Operations for the Three Months Ended
We assumed$29.0 million and$28.8 million of premium from the insurance companies ofGMAC Insurance Holdings, Inc. (the "GMACI Insurers") for the three months endedJune 30, 2013 and 2012, respectively. As the GMACI premium in the three months endedJune 30, 2013 compared toJune 30, 2012 was essentially unchanged, our assumed premium was also unchanged. Net earned premium increased 5.2% in the second quarter of 2013 compared to the second quarter of 2012 due to the earning cycle of assumed written premium in 2012. Loss and loss adjustment expense increased 10.2% for the three months endedJune 30, 2013 compared to the same period in 2012 and increased proportionally with net earned premium, as well as experiencing higher ultimate losses in 2013 compared to 2012. The net expense ratio in the second quarter of 2013 was flat compared to second quarter of 2012.
Personal Lines Reinsurance Segment Results of Operations for the Six Months Ended
We assumed$59.6 million and$59.4 million of premium from the GMACI Insurers for the six months endedJune 30, 2013 and 2012, respectively. As the GMACI premium in the six months endedJune 30, 2013 compared toJune 30, 2012 was essentially unchanged, our assumed premium was also unchanged. Net earned premium increased 7.0% in the six months endedJune 30, 2013 compared to the same period in 2012 due to the earning cycle of assumed written premium in 2012. Loss and loss adjustment expense increased 12.0% for the six months endedJune 30, 2013 compared to the same period in 2012 and increased proportionally with net earned premium, as well as experiencing higher ultimate losses in 2013 compared to 2012. The net expense ratio in the six months endedJune 30, 2013 was flat compared to the same period in 2012.
Liquidity and Capital Resources
Our principal sources of operating funds are premiums, service and fee income, investment income and proceeds from sales and maturities of investments. Our primary uses of operating funds include payments of claims and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash primarily in fixed maturity and equity securities. We forecast claim payments based on our historical trends. We seek to manage the funding of claim payments by actively managing available cash and forecasting cash flows on short-term and long-term bases. Cash payments for claims were$437 million and$368 million in the six months endedJune 30, 2013 and 2012, respectively. We expect that projected cash flow from operations will provide us sufficient liquidity to fund our anticipated growth, by providing capital to increase the surplus of our insurance subsidiaries, as well as for payment of claims and operating expenses, payment of interest and principal on debt facilities and other holding company expenses for at least the next twelve months. However, if our growth attributable to potential acquisitions, internally generated growth or a combination of these, exceeds our projections, we may have to raise additional capital sooner to support our growth. If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements and, as a result, our business, financial condition and results of operation could be adversely affected.
The following table is summary of our statement of cash flows:
Six Months Ended June 30, (Amounts in Thousands) 2013 2012 Cash and cash equivalents provided by (used in): Operating activities$ 496,603 $ 224,501 Investing activities (538,726 ) (338,882 ) Financing activities 80,242 64,578 Net cash provided by operating activities for the six months endedJune 30, 2013 increased compared to cash provided by operating activities in the six months endedJune 30, 2012 . The increase in cash provided from operations resulted primarily from an increase in gross written premium written in 2013 compared to 2012. Net cash used in investing activities was approximately$539 million during the six months endedJune 30, 2013 and consisted primarily of approximately$342 million for the net purchase of fixed maturity and equity securities, approximately$85 million for restricted cash, approximately$73 million for acquisitions, approximately$23 million for capital expenditures and approximately$19 million for the acquisition of and premium payments for life settlement contracts. Net cash used in investing activities was$339 million for the six months endedJune 30, 2012 and consisted of approximately$284 million for the net purchase of fixed maturity and equity securities, approximately$24 million for the acquisition of and premium payments for life settlement contracts, an increase in restricted cash of$22 million and capital expenditures of approximately$15 million . 60 -------------------------------------------------------------------------------- Net cash provided by financing activities was approximately$80 million for the six months endedJune 30, 2013 compared to net cash provided by financing activities of approximately$65 million during the six months endedJune 30, 2012 . In 2013, we received approximately$111 million of net proceeds from a preferred share offering and approximately$6 million from non-controlling interest capital contributions to certain subsidiaries, which was partially offset by payments of approximately$10 million of dividends and approximately$30 million to settle repurchase agreements. During the six months endedJune 30, 2012 , cash provided by financing activities primarily included debt proceeds of approximately$25 million , non-controlling interest capital contributions to one of our subsidiaries of approximately$10 million and borrowings from securities sold under agreements to repurchase of$40 million , partially offset by cash dividend payments of approximately$11 million and note payments of approximately$8 million .
Other Material Changes in Financial Position
(Amounts in thousands) June 30, 2013 December 31, 2012 Assets: Fixed maturities, available for sale$ 2,730,830 $ 2,065,226 Prepaid reinsurance premium 928,613 754,844 Liabilities: Loss and loss expense reserve$ 3,065,792 $ 2,426,400 Unearned premium 2,385,190 1,773,593 Accrued expenses and other current liabilities 758,061
406,447
The increase in fixed maturities, available for sale and accrued expenses and other current liabilities fromDecember 31, 2012 toJune 30, 2013 related to certain assets and liabilities assumed from the acquisition of Car Care, Sequoia and FNIC. The increase in prepaid reinsurance premium between periods related to higher cessions of premium during the first six months of 2013. The increase in loss and loss expense reserve, unearned premium related to an increase in gross written premium during the six months endedJune 30, 2013 compared to 2012, as well as the assumption of these liabilities associated with the acquisitions of Car Care, Sequoia and MIHC. Preferred Stock OnJune 10, 2013 , we issued 4,600,000 shares of 6.75% Non-Cumulative Preferred Stock. Dividends on the Series A Preferred Stock when, as and if declared by our Board of Directors or a duly authorized committee of the Board will accrue and be payable on the liquidation preference amount, on a non-cumulative basis, quarterly in arrears on the 15th day of March, June, September and December of each year (each, a "dividend payment date"), commencing onSeptember 15, 2013 , at an annual rate of 6.75%. Dividends on the Series A Preferred Stock are not cumulative. Accordingly, in the event dividends are not declared on the Series A Preferred Stock for payment on any dividend payment date, then those dividends will not accumulate and will not be payable. If we have not declared a dividend before the dividend payment date for any dividend period, we will have no obligation to pay dividends for that dividend period, whether or not dividends on the Series A Preferred Stock are declared for any future dividend payment.
Revolving Credit Agreement
We have a$200 million credit agreement (the "Credit Agreement"), amongJPMorgan Chase Bank, N.A ., as Administrative Agent,KeyBank National Association and SunTrust Bank, as Co-Syndication Agents,Associated Bank, National Association andLloyds Securities Inc. , as Co-Documentation Agents and the various lending institutions party thereto. The credit facility, which matures in 2016, is a revolving credit facility with a letter of credit sublimit of$100 million and an expansion feature not to exceed$100 million . Fees associated with the Credit Agreement were approximately$1.0 million . The Credit Agreement contains certain restrictive covenants customary for facilities of this type (subject to negotiated exceptions and baskets), including restrictions on indebtedness, liens, acquisitions and investments, restricted payments and dispositions. There are also financial covenants that require us to maintain a minimum consolidated net worth, a maximum consolidated leverage ratio, a minimum fixed charge coverage ratio, a minimum risk-based capital and a minimum statutory surplus. We are in compliance with all covenant as ofJune 30, 2013 . 61 -------------------------------------------------------------------------------- As ofJune 30, 2013 , we had no outstanding borrowings under this Credit Agreement. We had outstanding letters of credit in place under this Credit Agreement atJune 30, 2013 for$49.2 million , which reduced the availability for letters of credit to$50.8 million as ofJune 30, 2013 , and the availability under the facility to$150.8 million as ofJune 30, 2013 . Borrowings under the Credit Agreement will bear interest at (x) the greatest of (a) the Administrative Agent's prime rate, (b) the federal funds effective rate plus 0.5 percent or (c) the adjusted LIBO rate for a one month interest period on such day plus 1 percent, plus (y) a margin that is adjusted on the basis of our consolidated leverage ratio. Eurodollar borrowings under the Credit Agreement will bear interest at the adjusted LIBO rate for the interest period in effect plus a margin that is adjusted on the basis of our consolidated leverage ratio. The interest rate on our credit facility as ofJune 30, 2013 was 1.75%. We recorded total interest expense of approximately$1.2 million and$1.0 million for the six months endedJune 30, 2013 and 2012, respectively, under our current and former Credit Agreement. Fees payable by us under the Credit Agreement include a letter of credit participation fee (which is the margin applicable to Eurodollar borrowings and was 1.50% atJune 30, 2013 ), a letter of credit fronting fee with respect to each letter of credit of 0.125% and a commitment fee on the available commitments of the lenders (a range of 0.20% to 0.30% based on our consolidated leverage ratio and was 0.25% atJune 30, 2013 ).
Convertible Senior Notes
InDecember 2011 , we issued$175 million aggregate principal amount of our 5.5% convertible senior notes due 2021 (the "Notes") to certain initial purchasers in a private placement. InJanuary 2012 , we issued an additional$25 million of the Notes to cover the initial purchasers' overallotment option. The Notes bear interest at a rate equal to 5.5% per year, payable semiannually in arrears onJune 15 andDecember 15 of each year, beginningJune 15, 2012 . The Notes will mature onDecember 15, 2021 (the "Maturity Date"), unless earlier purchased by us or converted into shares of our common stock, par value$0.01 per share (the "Common Stock"). Prior toSeptember 15, 2021 , the Notes will be convertible only upon satisfaction of certain conditions, and thereafter, at any time prior to the close of business on the second scheduled trading day immediately preceding the Maturity Date. The conversion rate atJune 30, 2013 is equal to 34.5759 shares of Common Stock per$1,000 principal amount of Notes, which corresponds to a conversion price of approximately$28.92 per share of Common Stock. The conversion rate will be subject to adjustment upon the occurrence of certain events as set forth in the indenture governing the notes. Upon conversion of the Notes, we will, at its election, pay or deliver, as the case may be, cash, shares of Common Stock, or a combination of cash and shares of Common Stock. Upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders of the Notes will have the right to require us to repurchase their Notes for cash, in whole or in part, at 100% of the principal amount of the Notes to be repurchased, plus any accrued and unpaid interest, if any, to, but excluding, the fundamental change purchase date. We separately allocated the proceeds for the issuance of the Notes to a liability component and an equity component, which is the embedded conversion option. The equity component was reported as an adjustment to paid-in-capital, net of tax, and is reflected as an original issue discount ("OID"). The OID of$41.7 million and deferred origination costs relating to the liability component of$4.8 million will be amortized into interest expense over the term of the loan of the Notes. After considering the contractual interest payments and amortization of the original discount, the Notes effective interest rate was 8.57%. Transaction costs of$1.3 million associated with the equity component were netted in paid-in-capital. Interest expense, including amortization of deferred origination costs, recognized on the Notes was$7.2 million and$6.9 million for the six months endedJune 30, 2013 and 2012, respectively.
Secured Loan Agreement
During 2011, we entered into a seven-year secured loan agreement withBank of America Leasing & Capital, LLC in the aggregate amount of$10.8 million to finance the purchase of an aircraft. The loan bears interest at a fixed rate of 4.45%, requires monthly installment payments of approximately$0.1 million commencing onMarch 25, 2011 and ending onFebruary 25, 2018 , and a balloon payment of$3.2 million at the maturity date. We recorded interest expense of approximately$0.2 million and$0.2 million for the six months endedJune 30, 2013 and 2012 related to this agreement. The loan is secured by an aircraft that our subsidiaries acquired inFebruary 2011 . 62 -------------------------------------------------------------------------------- The agreement contains certain covenants that are similar to our revolving credit facility. Additionally, subsequent toFebruary 25, 2012 , but prior to payment in full, if the outstanding balance of this loan exceeds 90% of the fair value of the aircraft, we are required to pay the lender the entire amount necessary to reduce the outstanding principal balance to be equal to or less than 90% of the fair value of the aircraft. During the three months endedJune 30, 2013 , we paid$0.3 million to reduce the outstanding principal balance to meet these terms. The agreement allows us, under certain conditions, to repay the entire outstanding principal balance of this loan without penalty.
Securities Sold (Purchased) Under Agreements to Repurchase (Sell), at Contract Value
We enter into repurchase agreements and reverse repurchase agreements. The agreements are accounted for as collateralized borrowing transactions and are recorded at contract amounts. In the case of repurchase agreements, we receive cash or securities, which we invest or hold in short term or fixed income securities. As ofJune 30, 2013 , there were$205.2 million principal amount outstanding at interest rates between 0.00% and 0.53%. Interest expense associated with these repurchase agreements for the six months endedJune 30, 2013 was$0.2 million , of which$0.0 million was accrued as ofJune 30, 2013 . We have approximately$266.4 million of collateral pledged in support of these agreements. Additionally, during the three months endedJune 30, 2013 , we closed its reverse repurchase agreement and did not incur any gain or loss as a result of this agreement.
Note Payable - Collateral for Proportionate Share of Reinsurance Obligation
In conjunction with the Reinsurance Agreement betweenAII and Maiden Insurance (see Note 11. "Related Party Transactions"), AII entered into a loan agreement withMaiden Insurance during the fourth quarter of 2007, wherebyMaiden Insurance loaned to AII the amount equal to its quota share of the obligations of the AmTrust Ceding Insurers that AII was then obligated to secure. The loan agreement provides for interest at a rate of LIBOR plus 90 basis points and is payable on a quarterly basis. Each advance under the loan is secured by a promissory note. Advances totaled$168 million as ofJune 30, 2013 andDecember 31, 2012 . EffectiveDecember 31, 2008 ,AII and Maiden Insurance entered into a Reinsurer Trust Assets Collateral agreement wherebyMaiden Insurance is required to provide AII the assets required to secure Maiden's proportionate share of our obligations to our U.S. subsidiaries. The amount of this collateral as ofJune 30, 2013 was approximately$947.6 million . Maiden retains ownership of the collateral in the trust account.
Other Letter of Credit Facilities
We, through one of our subsidiaries, have a secured letter of credit facility withComerica Bank during the 2011. We utilize the letter of credit facility to comply with the deposit requirements of theState of California and theU.S. Department of Labor as security for our obligations to workers' compensation and federalLongshore and Harbor Workers' Compensation Act policyholders. The credit limit is for$75 million and was utilized for$49.6 million as ofJune 30, 2013 . We are required to pay a letter of credit participation fee for each letter of credit in the amount of 0.40%.
We, through certain subsidiaries, have additional existing stand-by letters of credit with various lenders in the amount of
Reinsurance
Our insurance subsidiaries utilize reinsurance agreements to transfer portions of the underlying risk of the business we write to various affiliated and third-party reinsurance companies. Reinsurance does not discharge or diminish our obligation to pay claims covered by the insurance policies we issue; however, it does permit us to recover certain incurred losses from our reinsurers and our reinsurance recoveries reduce the maximum loss that we may incur as a result of a covered loss event. We believe it is important to ensure that our reinsurance partners are financially strong and they generally carry at least anA.M. Best rating of ''A-'' (Excellent) at the time we enter into our reinsurance agreements. We also enter reinsurance relationships with third-party captives formed by agents and other business partners as a mechanism for sharing risk and profit. The total amount, cost and limits relating to the reinsurance coverage we purchase may vary from year to year based upon a variety of factors, including the availability of quality reinsurance at an acceptable price and the level of risk that we choose to retain for our own account. We have not experienced any significant changes to our reinsurance programs sinceDecember 31, 2012 . For a more detailed description of our reinsurance arrangements, including our reinsurance arrangements withMaiden Insurance Company Ltd. (''Maiden Insurance''), see ''Reinsurance'' in ''Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations'' in our Annual Report on Form 10-K for the year endedDecember 31, 2012 . 63 --------------------------------------------------------------------------------
Investment Portfolio
Our investment portfolio, including cash and cash equivalents but excluding life settlement contracts, other investments and equity investments, increased$796 million , or 30.8%, to$3.4 billion for the six months endedJune 30, 2013 from$2.6 billion as ofDecember 31, 2012 . Our investment portfolio is classified as available-for-sale, as defined by ASC 320, Investments - Debt and Equity Securities. The increase in our investment portfolio during the three months endedJune 30, 2013 related, primarily, to the acquisitions of Car Care, Sequoia and FNIC. Our fixed maturity securities, gross, had a fair value of$2.7 billion and an amortized cost of$2.7 billion as ofJune 30, 2013 . Our equity securities are reported at fair value and totaled$25.9 million with a cost of$24.8 million as ofJune 30, 2013 . Securities sold but not yet purchased represent our obligations to deliver the specified security at the contracted price and thereby create a liability to purchase the security in the market at prevailing rates. We account for sales of securities under repurchase agreements as collateralized borrowing transactions and we record these sales at their contracted amounts.
Our investment portfolio exclusive of life settlement contracts and other investments is summarized in the table below by type of investment:
June 30, 2013 December 31, 2012 Percentage of Percentage of (Amounts in Thousands) Carrying Value Portfolio Carrying Value Portfolio Cash, cash equivalents and restricted cash$ 613,502 18.1 %$ 493,132 19.0 % Time and short-term deposits 15,209 0.4 10,282 0.4 U.S. treasury securities 93,683 2.8 66,192 2.6 U.S. government agencies 8,781 0.3 40,301 1.6 Municipals 439,219 13.0 299,442 11.6 Foreign government 74,354 2.2 - - Commercial mortgage back securities 24,568 0.7 10,200 0.4 Residential mortgage backed securities: Agency backed 512,901 15.2 292,614 11.3 Non-agency backed 7,228 0.2 7,063 0.2 Asset-backed securities 6,937 0.2 - - Corporate bonds 1,563,159 46.1 1,349,414 52.1 Preferred stocks 3,275 0.1 5,184 0.2 Common stocks 22,620 0.7 15,281 0.6$ 3,385,436 100.0 %$ 2,589,105 100.0 %
The table below summarizes the credit quality of our fixed maturity securities as of
June 30, 2013 December 31, 2012 U.S. Treasury 3.4 % 1.9 % AAA 14.0 13.8 AA 31.9 31.2 A 22.8 24.4 BBB, BBB+, BBB- 26.0 27.1 BB, BB+, BB- 1.7 1.6 B, B+, B- 0.1 - Other 0.1 - Total 100.0 % 100.0 % 64
-------------------------------------------------------------------------------- The table below summarizes the average duration by type of fixed maturity as well as detailing the average yield as ofJune 30, 2013 andDecember 31, 2012 : June 30, 2013 December 31, 2012 Average Average Duration Duration Average Yield % in Years Average Yield % in Years U.S. treasury securities 2.21 5.6 2.18 2.4 U.S. government agencies 2.64 1.2 4.14 3.1 Foreign government 2.12 4.4 3.37 5.6 Corporate bonds 3.52 5.3 3.95 5.1 Municipals 3.66 7.5 4.30 6.2 Mortgage and asset backed 2.95 4.7 3.41 2.2
As of
Quarterly, our Investment Committee ("Committee") evaluates each security that has an unrealized loss as of the end of the subject reporting period for OTTI. We generally consider an investment to be impaired when it has been in a significant unrealized loss position (in excess of 35% of cost if the issuer has a market capitalization of under$1 billion and in excess of 25% of cost if the issuer has a market capitalization of$1 billion or more) for over 24 months. In addition, the Committee uses a set of quantitative and qualitative criteria to review our investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of our investments. The criteria the Committee primarily considers include:
• the current fair value compared to amortized cost;
• the length of time the security's fair value has been below its amortized cost; • specific credit issues related to the issuer such as changes in credit rating, reduction or elimination of dividends or non-payment of scheduled interest payments;
• whether management intends to sell the security and, if not, whether it
is not more than likely than not that the Company will be required to
sell the security before recovery of its amortized cost basis; • the financial condition and near-term prospects of the issuer of the
security, including any specific events that may affect its operations
or earnings; • the occurrence of a discrete credit event resulting in the issuer defaulting on material outstanding obligations or the issuer seeking protection under bankruptcy laws; and
• other items, including company management, media exposure, sponsors,
marketing and advertising agreements, debt restructurings, regulatory
changes, acquisitions and dispositions, pending litigation, distribution agreements and general industry trends. Impairment of investment securities results in a charge to operations when a market decline below cost is deemed to be other-than-temporary. We write down investments immediately that we consider to be impaired based on the above criteria collectively. Based on guidance in FASB ASC 320-10-65, in the event of the decline in fair value of a debt security, a holder of that security that does not intend to sell the debt security and for whom it is not more than likely than not that such holder will be required to sell the debt security before recovery of its amortized cost basis, is required to separate the decline in fair value into (a) the amount representing the credit loss and (b) the amount related to other factors. The amount of total decline in fair value related to the credit loss shall be recognized in earnings as an OTTI with the amount related to other factors recognized in accumulated other comprehensive loss net loss, net of tax. OTTI credit losses result in a permanent reduction of the cost basis of the underlying investment. The determination of OTTI is a subjective process, and different judgments and assumptions could affect the timing of the loss realization.
The impairment charges of our fixed and equity securities for the six months ended
(Amounts in Thousands) 2013 2012 Equity securities $ -$ 1,208 Fixed maturity securities - - $ -$ 1,208 65
--------------------------------------------------------------------------------
During the six months endedJune 30, 2013 , we had no impairment charge of our fixed and equity securities. In addition, during the six months endedJune 30, 2013 , we had$69.8 million of gross unrealized losses, of which$0.7 million related to marketable equity securities and$69.1 million related to fixed maturity securities. Corporate bonds represent 57% of the fair value of our fixed maturities and 62% of the total unrealized losses of our fixed maturities. We own 854 corporate bonds in the industrial, bank and financial and other sectors, which have a fair value of approximately 20%, 34% and 3%, respectively, and 38%, 22% and 3% of total unrealized losses, respectively, of our fixed maturities. We believe that the unrealized losses in these securities are the result, primarily, of general economic conditions and not the condition of the issuers, which we believe are solvent and have the ability to meet their obligations. Therefore, we expect that the market price for these securities should recover within a reasonable time. Additionally, we do not intend to sell the investments and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost basis. Our investment in marketable equity securities consist of investments in preferred and common stock across a wide range of sectors. We evaluated the near-term prospects for recovery of fair value in relation to the severity and duration of the impairment and have determined in each case that the probability of recovery is reasonable and we have the ability and intent to hold these investments until a recovery of fair value. We believe the gross unrealized losses of$0.7 million as ofJune 30, 2013 is not material to our financial position.
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EVEREST RE GROUP LTD – 10-Q – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
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