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ALLEGHANY CORP /DE – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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"Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Quantitative and Qualitative Disclosures About Market Risk" contain disclosures which are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements include all statements that do not relate solely to historical or current facts, and can be identified by the use of words such as "may," "will," "expect," "project," "estimate," "anticipate," "plan," "believe," "potential," "should," "continue" or the negative versions of those words or other comparable words. These forward-looking statements are based upon our current plans or expectations and are subject to a number of uncertainties and risks that could significantly affect current plans, anticipated actions and our future financial condition and results. These statements are not guarantees of future performance, and we have no specific intention to update these statements. The uncertainties and risks include, but are not limited to,
ā¢ significant weather-related or other natural or human-made catastrophes and
disasters;
ā¢ the cyclical nature of the property and casualty insurance industry;
ā¢ changes in market prices of our significant equity investments and changes
in value of our debt securities portfolio;
ā¢ adverse loss development for events insured by our insurance operating
units in either the current year or prior year; ā¢ the long-tail and potentially volatile nature of certain casualty lines of
business written by our insurance operating units; ā¢ the cost and availability of reinsurance; ā¢ exposure to terrorist acts;
ā¢ the willingness and ability of our insurance operating units' reinsurers to
pay reinsurance recoverables owed to our insurance operating units; ā¢ changes in the ratings assigned to our insurance operating units; ā¢ claims development and the process of estimating reserves; ā¢ legal and regulatory changes, including the new federal financial
regulatory reform of the insurance industry mandated by the Dodd-Frank Act;
ā¢ the uncertain nature of damage theories and loss amounts; and
ā¢ increases in the levels of risk retention by our insurance operating units.
Additional risks and uncertainties include general economic and political conditions, including the effects of a prolonged U.S. or global economic downturn or recession; changes in costs; variations in political, economic or other factors; risks relating to conducting operations in a competitive environment; effects of acquisition and disposition activities, inflation rates, or recessionary or expansive trends; changes in interest rates; extended labor disruptions, civil unrest, or other external factors over which we have no control; and changes in our plans, strategies, objectives, expectations, or intentions, which may happen at any time at our discretion. As a consequence, current plans, anticipated actions, and future financial condition and results may differ from those expressed in any forward-looking statements made by us or on our behalf. Critical Accounting Estimates Loss and LAE Overview. Each of our insurance operating units establishes reserves on its balance sheet for unpaid loss and LAE related to its property and casualty insurance and surety contracts. As of any balance sheet date, historically there have been claims that have not yet been reported, and some claims may not be reported for many years after the date a loss occurs. As a result of this historical pattern, the liability for unpaid loss and LAE includes significant estimates for IBNR. Additionally, reported claims are in various stages of the settlement process. Each claim is settled individually based upon its merits, and certain claims may take years to settle, 42
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especially if legal action is involved. As a result, the liabilities for unpaid loss and LAE include significant judgments, assumptions and estimates made by management relating to the actual ultimate losses that will arise from the claims. Due to the inherent uncertainties in the process of establishing these liabilities, the actual ultimate loss from a claim is likely to differ, perhaps materially, from the liability initially recorded and could be material to the results of our operations. The accounting policies that our insurance operating units use in connection with the establishment of these liabilities include critical accounting estimates. As noted above, as of any balance sheet date, not all claims that have occurred have been reported to our insurance operating units, and if reported may not have been settled. The time period between the occurrence of a loss and the time it is settled by the insurer is referred to as the "claim tail." Property claims usually have a fairly short claim tail and, absent claim litigation, are reported and settled within no more than a few years of the date they occur. For short-tail lines, loss reserves consist primarily of reserves for reported claims. The process of recording quarterly and annual liabilities for unpaid loss and LAE for short-tail lines is primarily focused on maintaining an appropriate reserve level for reported claims and IBNR, rather than determining an expected loss ratio for the current business. Specifically, we assess the reserve adequacy of IBNR in light of such factors as the current levels of reserves for reported claims and expectations with respect to reporting lags, historical data, legal developments, and economic conditions, including the effects of inflation. As ofDecember 31, 2011 , the amount of IBNR for short-tail claims represented approximately 1.3 percent, or$29.7 million , of our total gross loss and LAE liabilities of$2.3 billion . In conformity with GAAP, our insurance operating units are not permitted to establish IBNR reserves for catastrophe losses that have not occurred. Therefore, losses related to a significant catastrophe, or accumulation of catastrophes, in any reporting period could have a material, negative impact on our results during that period. Our insurance operating units provide coverage on both a claims-made and occurrence basis. Claims-made policies generally require that claims occur and be reported during the coverage period of the policy. Occurrence policies allow claims which occur during a policy's coverage period to be reported after the coverage period, and as a result, these claims can have a very long claim tail, occasionally extending for decades. Casualty claims can have a very long claim tail, in certain situations extending for many years. In addition, casualty claims are more susceptible to litigation and the legal environment and can be significantly affected by changing contract interpretations, all of which contribute to extending the claim tail. For long-tail casualty lines of business, estimation of ultimate liabilities for unpaid loss and LAE is a more complex process and depends on a number of factors, including the line and volume of the business involved. For these reasons, AIHL's insurance operating units will generally use actuarial projections in setting reserves for all casualty lines of business. Although we are unable at this time to determine whether additional reserves, which could have a material impact upon our financial condition, results of operations, and cash flows, may be necessary in the future, we believe that the reserves for unpaid loss and LAE established by our insurance operating units are adequate as ofDecember 31, 2011 . Methodologies and Assumptions. Our insurance operating units use a variety of techniques that employ significant judgments and assumptions to establish the liabilities for unpaid loss and LAE recorded at the balance sheet date. These techniques include detailed statistical analyses of past claim reporting, settlement activity, claim frequency, internal loss experience, changes in pricing or coverages and severity data when sufficient information exists to lend statistical credibility to the analyses. More subjective techniques are used when statistical data is insufficient or unavailable. These liabilities also reflect implicit or explicit assumptions regarding the potential effects of future inflation, judicial decisions, changes in laws and recent trends in such factors, as well as a number of actuarial assumptions that vary across our insurance operating units and across lines of business. This data is analyzed by line of business, coverage and accident year, as appropriate. Our loss reserve review processes use actuarial methods that vary by insurance operating unit and line of business and produce point estimates for each class of business. The actuarial methods used by our insurance operating units include the following methods:
ā¢ Reported Loss Development Method: a reported loss development pattern is
calculated based on historical loss development data, and this pattern is
then used to project the latest evaluation of cumulative reported losses
for each accident year to ultimate levels; 43
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ā¢ Paid Development Method: a paid loss development pattern is calculated
based on historical development data, and this pattern is then used to
project the latest evaluation of cumulative paid losses for each accident
year to ultimate levels; ā¢ Expected Loss Ratio Method: expected loss ratios are applied to premiums
earned, based on historical company experience, or historical insurance
industry results when company experience is deemed not to be sufficient; and
ā¢ Bornhuetter-Ferguson Method: the results from the Expected Loss Ratio
Method are essentially blended with either the
Method or the Paid Development Method.
The primary assumptions used by our insurance operating units include the following:
ā¢ Expected loss ratios represent management's expectation of losses, in
relation to earned premium, at the time business is written, before any
actual claims experience has emerged. This expectation is a significant
determinant of the estimate of loss reserves for recently written business
where there is little paid or incurred loss data to consider. Expected loss
ratios are generally derived from historical loss ratios adjusted for the
impact of rate changes, loss cost trends and known changes in the type of
risks underwritten.
ā¢ Rate of loss cost inflation (or deflation) represents management's
expectation of the inflation associated with the costs we may incur in the
future to settle claims. Expected loss cost inflation is particularly
important for claims with a substantial medical component, such as workers'
compensation. ā¢ Reported and paid loss emergence patterns represent management's
expectation of how losses will be reported and ultimately paid in the future based on the historical emergence patterns of reported and paid
losses and are derived from past experience of our insurance operating
units, modified for current trends. These emergence patterns are used to
project current reported or paid loss amounts to their ultimate settlement
value.
Each of the above actuarial assumptions may also incorporate data from the insurance industry as a whole, or peer companies writing substantially similar insurance coverages, in the absence of sufficiently credible internally-derived historical information. Data from external sources may be used to set expectations, as well as assumptions regarding loss frequency or severity relative to an exposure unit or claim, among other actuarial parameters. Assumptions regarding the application or composition of peer group or industry reserving parameters require substantial judgment. The use of data from external sources was most significant for PCC as ofDecember 31, 2011 . Sensitivity. Loss frequency and severity are measures of loss activity that are considered in determining the key assumptions described above. Loss frequency is a measure of the number of claims per unit of insured exposure, and loss severity is a measure of the average size of claims. Factors affecting loss frequency include the effectiveness of loss controls and safety programs and changes in economic conditions or weather patterns. Factors affecting loss severity include changes in policy limits, retentions, rate of inflation and judicial interpretations. Another factor affecting estimates of loss frequency and severity is the loss reporting lag, which is the period of time between the occurrence of a loss and the date the loss is reported to our insurance operating units. The length of the loss reporting lag affects our ability to accurately predict loss frequency (loss frequencies are more predictable for lines with short reporting lags), as well as the amount of reserves needed for IBNR. If the actual level of loss frequency and severity is higher or lower than expected, the ultimate losses will be different than management's estimates. A small percentage change in an estimate can result in a material effect on our reported earnings. The following table reflects the impact of changes, which could be favorable or unfavorable, in frequency and severity on our loss estimates for claims occurring in 2011 (dollars in millions): Frequency Severity 1.0% 5.0% 10.0% 1.0% $ 8.8 $ 26.5 $ 48.6 5.0% $ 26.5 $ 44.9 $ 67.9 10.0% $ 48.6 $ 67.9 $ 92.0 44
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Our net reserves for loss and LAE of$1.5 billion as ofDecember 31, 2011 relate to multiple accident years. Therefore, the impact of changes in frequency or severity for more than one accident year could be higher or lower than the amounts reflected above. We believe the above analysis provides a reasonable benchmark for sensitivity as we believe it is within historical variation for our reserves. Currently, none of the scenarios is believed to be more likely than the other. See Note 1(j) and Note 6 to the Consolidated Financial Statements set forth in Item 8 of this Form 10-K Report for additional information on our loss and LAE. PriorYear Development . Our insurance operating units continually evaluate the potential for changes, both positive and negative, in their estimates of their loss and LAE liabilities and use the results of these evaluations to adjust both recorded liabilities and underwriting criteria. With respect to liabilities for unpaid loss and LAE established in prior years, these liabilities are periodically analyzed and their expected ultimate cost adjusted, where necessary, to reflect positive or negative development in loss experience and new information, including, for certain catastrophic events, revised industry estimates of the magnitude of a catastrophe. Adjustments to previously recorded liabilities for unpaid loss and LAE, both positive and negative, are reflected in our financial results in the periods in which these adjustments are made and are referred to as prior year reserve development. Each ofRSUI , CATA and PCC adjusted its prior year loss and LAE reserve estimate during 2011 and 2010 based on current information that differed from previous assumptions made at the time such loss and LAE reserves were previously estimated. These reserve (decreases) increases to prior year net reserves are summarized as follows (in millions): 2011 2010RSUI : Net casualty reserve (releases) $ (56.2 ) $ (33.9 ) Property and other, net (3.3 ) (9.3 ) $ (59.5 ) $ (43.2 ) CATA: Net insurance reserve increases (releases) $ 5.0 $ (0.4 ) Reinsurance assumed reserve release - (3.5 ) $ 5.0 $ (3.9 ) PCC: Net workers' compensation increases $ 28.4 $ 12.5 All other, net 0.3 0.9 $ 28.7 $ 13.4 Total incurred related to prior years $ (25.8 ) $ (33.7 )
The more significant prior year adjustments affecting 2011 and 2010 are summarized as follows:
ā¢ For RSUI, loss and LAE for 2011 reflect a net
accident year casualty loss reserves, compared with a net
release of prior accident year casualty loss reserves during 2010. The $56.2
million release relates primarily to the umbrella/excess, general liability
and professional liability lines of business, primarily for the 2003 through
2008 accident years, and reflects favorable loss emergence, compared with
loss emergence patterns assumed in earlier periods for such lines of
business. Specifically, cumulative losses for such lines of business, which
include both loss payments and case reserves, in respect of prior accident
years were expected to be higher through the balance sheet date than the
actual cumulative losses through that date. The amount of lower cumulative
losses, expressed as a percentage of carried loss and LAE reserves at the beginning of the year, was 2.3 percent. Such reduction did not impact the assumptions used in estimatingRSUI's loss and LAE liabilities for its general liability and professional liability lines of business earned in 2011. Such reserve releases were partially offset by an increase in loss
reserves in the D&O liability line of business in the 2011 third quarter,
primarily reflecting adverse legal developments associated with a large
claim from the 2007 accident year. Such increase did not impact the
assumptions used in estimating
liability line of business earned in 2011.
ForRSUI , the$33.9 million net release of prior accident year casualty loss reserves in 2010 consisted of a$41.4 million reserve release, partially offset by a$7.5 million reserve increase. The$41.4 million reserve 45
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release relates primarily to the general liability and professional liability lines of business primarily for the 2003 through 2007 accident years and reflects favorable loss emergence, compared with loss emergence patterns assumed in earlier periods for such lines of business. The$7.5 million reserve increase in loss reserves related to an increase in estimated ultimate 2007 accident year losses for the D&O liability line of business, reflecting, in part, unfavorable loss emergence on certain sub-prime mortgage industry claims.
ā¢ For RSUI, loss and LAE for 2011 and 2010 also include a net
primarily related to a re-estimation of case and IBNR reserves in the
property line of business. For 2011, the net
primarily reflects significant net reserve releases in non-catastrophe
property reserves and unallocated LAE, partially offset by reserve increases
related to prior year catastrophes. For 2010, the net
release primarily reflects significant net reserve releases in
non-catastrophe property reserves, partially offset by a
reserve increase related to prior year catastrophes. Of the
third quarter 2008 hurricanes, and
2010 and related to the third quarter 2005 hurricanes.
ā¢ For CATA, loss and LAE for 2011 reflect a net
accident year loss reserves (related primarily to the casualty lines of
business), compared with a
reserves during 2010 (related primarily to the surety lines of business).
The
in reserves related to certain specialty property and casualty classes of
business through a program administrator in connection with a program where
notice of termination of such program has been given ("Terminated Program
Business"), partially offset by a$9.6 million of net reserve release in certain of CATA's casualty lines of business. The reserve increase in the
Terminated Program Business reflects unfavorable loss emergence, primarily
in the 2009 and 2010 accident years, compared with loss emergence patterns
assumed in earlier periods for such business. The net
of prior accident year loss reserves did not impact the assumptions used in
estimating CATA's loss and LAE liabilities for business earned in 2011.
ā¢ For CATA, loss and LAE for 2010 reflect a
reflecting favorable loss emergence for asbestos and environmental
impairment claims that arose from reinsurance assumed by a subsidiary of
CATA between 1969 and 1976, based on a reserve study that was completed in
the 2010 second quarter.
ā¢ For PCC, loss and LAE for 2011 reflect a
accident year workers' compensation loss reserves, compared with a
loss reserves during 2010. Of the
recorded in the 2011 second quarter and$13.4 million was recorded in the 2011 fourth quarter, as follows (in millions): Three months ended: Twelve months ended June 30, 2011 December 31, 2011 December 31, 2011
Adverse claims emergence $ 10.0 $ 4.2 $ 14.2 Increases in allocated LAE 3.0 6.4 9.4 Increases in unallocated LAE - 2.8 2.8 Decrease in ceded loss and LAE reserves 2.0 - 2.0 $ 15.0 $ 13.4 $ 28.4 PCC's adverse claims emergence related to an unanticipated increase in medical claims emergence and an absence of anticipated favorable indemnity claims emergence. PCC had anticipated favorable indemnity claims emergence based upon prior claims development experience which indicated that injured workers would be returning to work, curtailing lost wage costs. PCC believes the weakCalifornia employment environment has hindered the ability of injured workers to return to work and indirectly influenced indemnity claims. Increases in allocated and unallocated LAE reserves primarily reflect increased use of outside counsel to assist in the settlement process and higher litigation costs caused by recent Workers' Compensation Appeals Board decisions. The decrease in ceded loss and LAE reserves was based on a 46
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second quarter 2011 review of reinsurance coverage estimates, which also resulted in a
For PCC, the$12.5 million increase in loss and LAE for 2010 relates primarily to a decrease in ceded loss and LAE reserves based on a fourth quarter 2010 review of reinsurance coverage estimates, and to a lesser extent, an increase in unallocated LAE reserves, which also resulted in a$5.0 million decrease in ceded premiums earned, thereby increasing net premiums earned in 2010. Asbestos and Environmental Impairment Reserves. Our reserve for unpaid loss and LAE includes$13.7 million of gross and net reserves as ofDecember 31, 2011 for asbestos and environmental impairment claims that arose from reinsurance of certain general liability and commercial multiple peril coverages assumed by Capitol Indemnity between 1969 and 1976. Reserves for asbestos and environmental impairment claims cannot be estimated with traditional loss reserving techniques because of uncertainties that are greater than those associated with other types of claims. Factors contributing to these uncertainties include a lack of historical data, the significant periods of time that often elapse between the occurrence of an insured loss and the reporting of that loss to the ceding company and the reinsurer, uncertainty as to the number and identity of insureds with potential exposure to these risks, unresolved legal issues regarding policy coverage, and the extent and timing of any such contractual liability. Loss reserve estimates for these asbestos and environmental impairment exposures include case reserves, which also reflect reserves for legal and other LAE and IBNR reserves. IBNR reserves are determined based upon CATA's historic general liability exposure base and policy language, asbestos liability law, judicial settlements of asbestos liabilities, previous environmental impairment loss experience, the assessment of current trends of environmental law and environmental cleanup costs. For both asbestos and environmental impairment reinsurance claims, CATA establishes case reserves by receiving case reserve amounts from its ceding companies and verifies these amounts against reinsurance contract terms, analyzing from the first dollar of loss incurred by the primary insurer. In establishing the liability for asbestos and environmental impairment claims, CATA considers facts currently known and the current state of the applicable law and coverage litigation. Additionally, ceding companies often report potential losses on a precautionary basis to protect their rights under the reinsurance arrangement, which generally calls for prompt notice to the reinsurer. Ceding companies, at the time they report potential losses, advise CATA of the ceding companies' current estimate of the extent of the loss. CATA's claims department reviews each of the precautionary claims notices and, based upon current information, assesses the likelihood of loss to CATA. This assessment is one of the factors used in determining the adequacy of the recorded asbestos and environmental impairment reserves. Although we are unable at this time to determine whether additional reserves, which could have a material impact upon our results of operations, may be necessary in the future, we believe that CATA's asbestos and environmental impairment reserves are adequate as ofDecember 31, 2011 . Additional information regarding asbestos and environmental impairment claims can be found on pages 21 and 22 this Form 10-K Report. Reinsurance. Recoverables recorded with respect to claims ceded by our insurance operating units to reinsurers under reinsurance contracts are predicated in large part on the estimates for unpaid losses and, therefore, are also subject to a significant degree of uncertainty. In addition to the factors cited above, reinsurance recoverables may prove uncollectible if the reinsurer is unable to perform under the contract. Reinsurance contracts purchased by our insurance operating units do not relieve them of their obligations to their own policyholders. Additional information regarding the use of, and risks related to, the use of reinsurance by our insurance operating units can be found on pages 23 through 25 and page 33 of this Form 10-K Report. Also see Note 1(e) and Note 5 to the Consolidated Financial Statements set forth in Item 8 of this Form 10-K Report for additional information on our reinsurance recoverables.
Investments Impairment
We hold our equity and debt securities as available-for-sale, and as such, these securities are recorded at fair value. We continually monitor the difference between cost and the estimated fair value of our investments, which involves uncertainty as to whether declines in value are temporary in nature. If a decline in the value of a particular investment is deemed temporary, we record the decline as an unrealized loss in stockholders' equity. If the decline is deemed to be other than temporary, we write its cost-basis down to the fair value of the investment and record an other-than-temporary impairment loss on our statement of earnings, regardless of whether we 47
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continue to hold the applicable security. In addition, under GAAP, any portion of such decline that relates to debt securities that is believed to arise from factors other than credit is recorded as a component of other comprehensive income. Management's assessment of a decline in value initially involves an evaluation of all securities that are in an unrealized loss position, regardless of the duration or severity of the loss, as of the applicable balance sheet date. Such initial review consists primarily of assessing whether:
(i) there has been a negative news event with respect to the issuer of any
such security that could indicate the existence of an other-than-temporary
impairment;
(ii) we have the ability and intent to hold an equity security for a period of
time sufficient to allow for an anticipated recovery (generally considered to be less than one year from the balance sheet date); and
(iii) it is more likely than not that we will sell a debt security before
recovery of its amortized cost basis.
To the extent that an equity security in an unrealized loss position is not impaired based on the initial review described above, we then further evaluate such equity security and deem it to be other-than-temporarily impaired if its decline in fair value has existed for twelve months or more or if its decline in fair value from its cost is greater than 50 percent, absent compelling evidence to the contrary.
We then evaluate all remaining equity securities that are in an unrealized loss position the cost of which:
(i) exceeds their fair value by 20 percent or more as of the balance sheet
date; or
(ii) has exceeded fair value continuously for six (6) months or more preceding
the balance sheet date.
This evaluation takes into account quantitative and qualitative factors in determining whether such securities are other-than-temporarily impaired including:
(i) market valuation metrics associated with the equity security (e.g., dividend yield and price-to-earnings ratio);
(ii) current views on the equity security, as expressed by either our internal
stock analysts and/or by independent stock analysts or rating agencies;
and
(iii) discrete credit or news events associated with a specific company, such
as negative news releases and rating agency downgrades with respect to
the issuer of the investment.
To the extent that a debt security that is in an unrealized loss position is not impaired based on the initial review described above, and absent an intent to sell, we will consider a debt security to be impaired when we believe it to be probable that we will not be able to collect all amounts due under the security's contractual terms. We may ultimately record a realized loss after having originally concluded that the decline in value was temporary. Risks and uncertainties are inherent in the methodology we use to assess other-than-temporary declines in value. Risks and uncertainties could include, but are not limited to, incorrect assumptions about financial condition, liquidity or future prospects, inadequacy of any underlying collateral, and unfavorable changes in economic conditions or social trends, interest rates or credit ratings. See Note 1(b) and Note 3 to the Consolidated Financial Statements set forth in Item 8 of this Form 10-K Report for additional information on our investments and investment impairments.
Goodwill and Other Intangible Assets
Our consolidated balance sheet as ofDecember 31, 2011 includes goodwill and other intangible assets, net of amortization, of$139.0 million , and related toRSUI and CATA. This amount has been recorded as a result of business acquisitions. Other intangible assets that are not deemed to have an indefinite useful life are amortized over their estimated useful lives. Goodwill and other intangible assets deemed to have an indefinite useful life are tested annually in the fourth quarter of every calendar year for impairment and at such other times upon the occurrence of certain events. We also evaluate goodwill and other intangible assets whenever events and changes in circumstances suggest that the carrying amount may not be recoverable. A significant amount of judgment is 48
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required in performing goodwill and other intangible asset impairment tests. These tests include estimating the fair value of our operating units and other intangible assets. With respect to goodwill, we compare the estimated fair value of our operating units with their respective carrying amounts including goodwill. Under GAAP, fair value refers to the amount for which the entire operating unit may be bought or sold. Our methods for estimating operating unit values include asset and liability fair values and other valuation techniques, such as discounted cash flows and multiples of earnings or revenues. All of these methods involve significant estimates and assumptions. We recorded a pre-tax, non-cash impairment charge of$11.2 million in 2009, which is classified as a net realized capital loss on our consolidated statement of earnings for the year endedDecember 31, 2009 . The$11.2 million pre-tax, non-cash impairment charge represents the entire carrying value of PCC's trade names, originally determined to have indefinite useful lives, renewal rights, distribution rights and database development, net of accumulated amortization. The impairment charge was due primarily to PCC's determination inJune 2009 that it was unable to write business at rates it deemed adequate due to the state of theCalifornia workers' compensation market. As a result, PCC ceased soliciting new or renewal business on a direct basis commencingAugust 1, 2009 and took corresponding expense reduction steps, including staff reductions, in light of such determination. In addition, immaterial accruals were established related to terminated employee severance payments and other charges.
See Note 1(h), Note 1(o) and Note 4 to the Consolidated Financial Statements set forth in Item 8 of this Form 10-K Report for additional information on our goodwill and other intangible assets.
Deferred Taxes
We file a consolidated federal income tax return with our subsidiaries. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. As ofDecember 31, 2011 , a net deferred tax asset of$81.0 million was recorded, which included a valuation allowance of$15.2 million for certain deferred state tax assets which we believe may not be realized. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. This determination is based upon a review of anticipated future earnings as well as all available evidence, both positive and negative.
See Note 1(i) and Note 8 to the Consolidated Financial Statements set forth in Item 8 of this Form 10-K Report for additional information on our deferred taxes.
In addition to the policies described above which contain critical accounting estimates, our other accounting policies are described in Note 1 to the Consolidated Financial Statements set forth in Item 8 of this Form 10-K Report. The accounting policies described in Note 1 require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities but do not meet the level of materiality required for a determination that the accounting policy includes critical accounting estimates. On an ongoing basis, we evaluate our estimates, including those related to the value of long-lived assets, deferred acquisition costs, incentive compensation, pension benefits and contingencies and litigation. Our estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Our actual results may differ from these estimates under different assumptions or conditions.
Consolidated Results of Operations
Overview
We are engaged, through AIHL and its subsidiaries, primarily in the property and casualty and surety insurance business. We also own and manage land in theSacramento, California region through our subsidiaryAlleghany Properties and seek out strategic investments and conduct other activities at the parent level. Primarily 49
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through our wholly-owned subsidiary,Alleghany Capital Partners , we manage our public equity investments, including those held by our insurance operating units, as well as conduct equity investment and non-insurance acquisition research. Strategic investments currently include an approximately 33 percent stake in Homesite, a national, full-service, mono-line provider of homeowners insurance, and an approximately 38 percent stake in ORX, a regional gas and oil exploration and production company. Our primary sources of revenues and earnings are our insurance operations and investments. The profitability of our insurance operating units, and as a result, our profitability, is primarily impacted by the adequacy of premium rates, level of catastrophe losses, investment returns, intensity of competition and the cost of reinsurance. The adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural disasters, regulatory measures and court decisions that define and expand the extent of coverage, and the effects of economic inflation on the amount of compensation due for injuries or losses. The ultimate adequacy of premium rates is not known with certainty at the time property and casualty insurance policies are issued because premiums are determined before claims are reported. Catastrophe losses, or the absence thereof, have had a significant impact on our results. For example,RSUI's pre-tax catastrophe losses, net of reinsurance, were$74.3 million in 2011,$31.0 million in 2010,$6.7 million in 2009 and$97.9 million in 2008. Catastrophe losses in 2011 primarily reflect net losses from severe weather, particularly tornados, in the southeastern and midwestern U.S. in April andMay 2011 , as well as from Hurricane Irene, which affected the east coast of the U.S. inAugust 2011 . Catastrophe losses in 2011 also include assumed catastrophe losses from international insurance carriers. Catastrophe losses in 2008 primarily reflect net losses from 2008 third quarter Hurricanes Ike, Gustav and Dolly. The incidence and severity of catastrophes in any short period of time are inherently unpredictable. Catastrophes can cause losses in a variety of our property and casualty lines of business, and most of our past catastrophe-related claims have resulted from severe hurricanes. Longer-term natural catastrophe trends may be changing due to climate change, a phenomenon that has been associated with extreme weather events linked to rising temperatures, and includes effects on global weather patterns, sea, land and air temperatures, sea levels, rain and snow. Climate change, to the extent it produces rising temperatures and changes in weather patterns, could impact the frequency or severity of weather events such as hurricanes. To the extent climate change increases the frequency and severity of such weather events, our insurance operating units, particularlyRSUI , may face increased claims, particularly with respect to properties located in coastal areas. Our insurance operating units take certain measures to mitigate against the frequency and severity of such events by giving consideration to these risks in their underwriting and pricing decisions and through the purchase of reinsurance. As ofDecember 31, 2011 , we had consolidated total investments of approximately$4.8 billion , of which$2.7 billion was invested in debt securities and$0.9 billion was invested in equity securities,$1.1 billion was invested in short-term investments and$0.1 billion was invested in other invested assets. Net realized capital gains, other-than-temporary impairment losses and net investment income related to such investment assets are subject to market conditions and management investment decisions and as a result can have a significant impact on our results. Net realized capital gains were$127.1 million in 2011, compared with$97.4 million in 2010 and$320.4 million in 2009, and other-than-temporary impairment losses were$3.6 million in 2011, compared with$12.3 million in 2010 and$85.9 million in 2009. The profitability of our insurance operating units is also impacted by competition generally and price competition in particular. Historically, the performance of the property and casualty insurance industry has tended to fluctuate in cyclical periods of price competition and excess underwriting capacity followed by periods of high premium rates and shortages of underwriting capacity. Although an individual insurance company's performance is dependent on its own specific business characteristics, the profitability of most property and casualty insurance companies tends to follow this cyclical market pattern. In the past few years, our insurance operating units have faced increasing competition as a result of an increased flow of capital into the insurance industry, with both new entrants and existing insurers seeking to gain market share. This resulted in decreased premium rates and less favorable contract terms and conditions. In particular,RSUI and CATA's specialty lines of business increasingly encountered competition from the standard market. Although we continue to see a competitive property and casualty insurance market, we continue to be cautiously optimistic about the prospect for improvements, particularly in property insurance and workers' compensation pricing. 50
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As part of their overall risk and capacity management strategy, our insurance operating units purchase reinsurance for certain amounts of risk underwritten by them, especially catastrophe risks. The reinsurance programs purchased by our insurance operating units are generally subject to annual renewal. Market conditions beyond the control of our insurance operating units determine the availability and cost of the reinsurance protection they purchase, which may affect the level of business written and thus their profitability. The following table summarizes our consolidated revenues, costs and expenses and earnings. 2011 2010 2009 (in millions) Revenues Net premiums earned $ 747.6 $ 768.1 $ 845.0 Net investment income 108.9 125.0 101.9 Net realized capital gains 127.1 97.4 320.4 Other than temporary impairment losses (3.6 ) (12.3 ) (85.9 ) Other income 1.8 7.2 3.0 Total revenues $ 981.8 $ 985.4 $ 1,184.4 Costs and expenses Loss and loss adjustment expenses $ 430.0 $ 377.9 $ 442.1 Commissions, brokerage and other underwriting expenses 268.1 259.3 273.7 Other operating expenses 34.5 37.2 45.6 Corporate administration 41.0 28.9 26.9 Interest expense 17.4 4.7 0.7 Total costs and expenses $ 791.0 $ 708.0 $ 789.0 Earnings before income taxes $ 190.8 $ 277.4 $ 395.4 Income taxes 47.5 78.9 124.4 Net earnings $ 143.3 $ 198.5 $ 271.0 Revenues: AIHL $ 941.8 $ 978.2 $ 996.9 Corporate activities* 40.0 7.2 187.5 Earnings (loss) before income taxes: AIHL $ 214.0 $ 306.6 $ 237.6 Corporate activities* (23.2 ) (29.2 ) 157.8
* Corporate activities consist of
Homesite and ORX and corporate activities at the parent level.
Our earnings before income taxes in 2011 decreased from 2010, primarily reflecting higher loss and LAE, lower net premiums earned and lower net investment income, partially offset by higher net realized capital gains. The increase in loss and LAE primarily reflects a$28.4 million increase in PCC's prior year reserves and higher catastrophe and other large property losses atRSUI in the 2011 period, partially offset by a higher net release of prior year casualty reserves byRSUI . The decrease in net premiums earned reflects the impact of continuing competition at CATA, as well as a reduction in net premiums written in certain specialty classes of business by CATA. The decrease in net investment income is due primarily to an increase in catastrophe losses related to our investment in Homesite, partially offset by higher dividend income. Our earnings before income taxes in 2010 decreased from 2009, primarily reflecting lower net realized capital gains and, to a lesser extent, a decline in net premiums earned, partially offset by lower other-than-temporary impairment losses and loss and LAE. The decrease in net realized capital gains primarily reflects the absence of sales of common stock ofBurlington Northern Santa Fe Corporation , or "Burlington Northern," in 2010, which were significant in 2009. The decrease in net premiums earned and loss and LAE in 2010 compared with 2009 reflects the impact of continuing competition atRSUI , as well as PCC's determination inJune 2009 to cease soliciting new and renewal business on a direct basis commencingAugust 1, 2009 . The decrease in other-than-temporary impairment losses was due to improvements in U.S. equity market conditions since the 2009 first 51
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quarter when we incurred substantial losses primarily related to a significant deterioration of U.S. equity and, to a lesser extent, residential housing market conditions. The effective income tax rate on earnings before income taxes was 24.9 percent in 2011, 28.4 percent in 2010 and 31.5 percent in 2009. The lower effective tax rate in 2011 primarily reflects the impact of higher dividends received deductions and lower pre-tax earnings in 2011, partially offset by the absence of a foreign tax benefit which was significant in 2010. The lower effective income tax rate in 2010 compared with 2009 primarily reflects the recognition of a permanent tax benefit in the 2010 first quarter. This permanent tax benefit related to a finalization of our unused foreign tax credits arising from our prior ownership ofWorld Minerals, Inc. which was sold onJuly 14, 2005 . The lower effective income tax rate in 2010 compared with 2009 also reflects increased tax benefits associated with dividends and tax-exempt income. 52
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AIHL Operating Results
AIHL Operating Unit Pre-Tax Results RSUI CATA PCC AIHL (in millions, except ratios) 2011 Gross premiums written $ 986.5 $ 150.4 $ 4.1 $ 1,141.0 Net premiums written 627.9 141.6 5.2 774.7 Net premiums earned (1) $ 593.8 $ 149.3 $ 4.5 $ 747.6 Loss and loss adjustment expenses 315.2 83.3 31.5 430.0 Commission, brokerage and other underwriting expenses (2) 170.8 72.7 24.6 268.1 Underwriting profit (loss) (3) $ 107.8 $ (6.7 )
$ (51.6 )
Net investment income (1) 117.4 Net realized capital gains (1) 79.7 Other than temporary impairment losses (1) (3.6 ) Other income (1) 0.7 Other expenses (2) 29.7 Earnings before income taxes $ 214.0 Loss ratio (4) 53.1 % 55.7 % 701.0 % 57.5 % Expense ratio (5) 28.8 % 48.7 % 547.1 % 35.9 % Combined ratio (6) 81.9 % 104.4 % 1248.1 % 93.4 % 2010 Gross premiums written $ 933.6 $ 168.9 $ 1.5 $ 1,104.0 Net premiums written 570.7 159.0 6.5 736.2 Net premiums earned (1) $ 593.6 $ 164.3 $ 10.2 $ 768.1 Loss and loss adjustment expenses 271.0 89.4 17.5 377.9 Commission, brokerage and other underwriting expenses (2) 162.7 73.4 23.2 259.3 Underwriting profit (loss) (3) $ 159.9 $ 1.5
$ (30.5 )
Net investment income (1) 128.9 Net realized capital gains (1) 92.9 Other than temporary impairment losses (1) (12.3 ) Other income (1) 0.6 Other expenses (2) 34.4 Earnings before income taxes $ 306.6 Loss ratio (4) 45.7 % 54.4 % 170.9 % 49.2 % Expense ratio (5) 27.4 % 44.7 % 226.7 % 33.8 % Combined ratio (6) 73.1 % 99.1 % 397.6 % 83.0 % 2009 Gross premiums written $ 1,033.4 $ 174.6 $ 51.1 $ 1,259.1 Net premiums written 621.1 165.3 44.4 830.8 Net premiums earned (1) $ 633.4 $ 166.7 $ 44.9 $ 845.0 Loss and loss adjustment expenses 274.3 81.6 86.2 442.1 Commission, brokerage and other underwriting expenses (2) 169.3 75.0 29.4 273.7 Underwriting profit (loss) (3) $ 189.8 $ 10.1
$ (70.7 )
Net investment income (1) 116.7 Net realized capital gains (1) 119.8 Other than temporary impairment losses (1) (85.9 ) Other income (1) 1.3 Other expenses (2) 43.5 Earnings before income taxes $ 237.6 Loss ratio (4) 43.3 % 48.9 % 192.2 % 52.3 % Expense ratio (5) 26.7 % 45.0 % 65.4 % 32.4 % Combined ratio (6) 70.0 % 93.9 % 257.6 % 84.7 %
(1) Represent components of total revenues.
(2) Commission, brokerage and other underwriting expenses represent commission
and brokerage expenses and that portion of salaries, administration and other
operating expenses attributable primarily to underwriting activities, whereas
the remainder constitutes other expenses. 53
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Table of Contents (3) Represents net premiums earned less loss and LAE and commissions, brokerage
and other underwriting expenses, all as determined in accordance with GAAP,
and does not include net investment income, net realized capital gains,
other-than-temporary impairment losses, other income or other expenses.
Underwriting profit does not replace net earnings determined in accordance
with GAAP as a measure of profitability; rather, we believe that underwriting
profit, which does not include net investment income, net realized capital
gains, other-than-temporary impairment losses, other income or other
expenses, enhances the understanding of AIHL's insurance operating units'
operating results by highlighting net earnings attributable to their
underwriting performance. With the addition of net investment income, net
realized capital gains, other-than-temporary impairment losses, other income
and other expenses, reported pre-tax net earnings (a GAAP measure) may show a
profit despite an underlying underwriting loss. Where underwriting losses
persist over extended periods, an insurance company's ability to continue as
an ongoing concern may be at risk. Therefore, we view underwriting profit as
an important measure in the overall evaluation of performance.
(4) Loss and LAE divided by net premiums earned, all as determined in accordance
with GAAP.
(5) Commission, brokerage and other underwriting expenses divided by net premiums
earned, all as determined in accordance with GAAP.
(6) The sum of the loss ratio and expense ratio, all as determined in accordance
with GAAP, representing the percentage of each premium dollar an insurance
company has to spend on loss and LAE, and commission, brokerage and other
underwriting expenses.
Discussion of individual AIHL operating unit results follows, and AIHL investment results are discussed below under "AIHL Investment Results."
The increase in gross premiums written byRSUI in 2011 from 2010 primarily reflects the impact of assumed premium writings from international insurance carriers, and, to a lesser extent, growth in binding authority business. Such increases were partially offset by the impact of reduced exposures ofRSUI's customers and continuing competition in certain ofRSUI's casualty lines of business. The slight increase inRSUI's net premiums earned in 2011 from 2010 primarily reflects the impact of a recent increase in gross premiums written, largely offset by the impact of lower gross premiums written during the third and fourth quarters of 2010 and the first quarter of 2011 as compared with gross premiums written in the third and fourth quarters of 2009 and the first quarter of 2010. The decrease in gross premiums written byRSUI in 2010 from 2009 primarily reflects the impact of reduced exposures ofRSUI's customers and continuing and increasing competition, particularly inRSUI's property, umbrella/excess and general liability lines of business, partially offset by growth inRSUI's binding authority business.RSUI's net premiums earned decreased in 2010 from 2009 primarily due to the decline in gross premiums written, partially offset by a decrease in ceded premiums written associated primarily withRSUI's property line of business. The increase in loss and LAE in 2011 from 2010 primarily reflects the impact of higher catastrophe and other large property losses, partially offset by the impact of higher releases of prior accident year reserves in 2011 (as further described below). Catastrophe losses, net of reinsurance, were$74.3 million in 2011, compared with$31.0 million in 2010. Catastrophe losses in 2011 primarily reflect net losses from severe weather, particularly tornados, in the southeastern and midwestern U.S. in April andMay 2011 , as well as from Hurricane Irene, which affected the east coast of the U.S. inAugust 2011 . Catastrophe losses in 2011 also include assumed catastrophe losses from international insurance carriers. In addition,RSUI incurred a net$14.4 million property loss arising from the magnitude 5.8 earthquake that occurred inNorthern Virginia inAugust 2011 . This earthquake was not classified as a catastrophic event by the property and casualty industry. The decrease in loss and LAE in 2010 from 2009 primarily reflects the impact of lower net premiums earned and lower non-catastrophe property losses incurred, partially offset by$31.0 million of catastrophe losses 54
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in 2010, compared with$6.7 million of catastrophe losses in 2009. The decrease in loss and LAE in 2010 from 2009 also reflects modestly lower net releases of prior accident year loss reserves in 2010 (as further described below). ForRSUI , loss and LAE for 2011 reflect a net$56.2 million release of prior accident year casualty loss reserves, compared with a net$33.9 million release during 2010 and a net$38.4 million release during 2009. The$56.2 million release relates primarily to the umbrella/excess, general liability and professional liability lines of business, primarily for the 2003 through 2008 accident years, and reflects favorable loss emergence, compared with loss emergence patterns assumed in earlier periods for such lines of business. Such reserve releases were partially offset by an increase in loss reserves in the D&O liability line of business in the 2011 third quarter, primarily reflecting adverse legal developments associated with a large claim from the 2007 accident year. The$33.9 million net release of prior year casualty loss reserves in 2010 consisted of a$41.4 million reserve release, partially offset by a$7.5 million reserve increase. The$41.4 million reserve release during 2010 and the net$38.4 million reserve release during 2009 primarily reflect favorable loss emergence compared with loss emergence patterns assumed in earlier periods. Loss and LAE in 2010 also reflect increases in prior accident year property loss reserves of$5.3 million related to 2008 third quarter hurricanes and$11.0 million related to 2005 third quarter hurricanes. Loss and LAE in 2009 also reflects a net$9.9 million release of prior accident year property loss reserves related to 2008 third quarter hurricanes. The increase in commissions, brokerage and other underwriting expenses in 2011 compared with 2010 is due primarily to growth in the binding authority business, which incurs higher commission and other underwriting expenses than other lines of business. The decrease in commissions, brokerage and other underwriting expenses in 2010 compared with 2009 primarily reflects the net effect of lower premium volumes described above, which caused premium taxes, commissions and related acquisition costs to decline. The decrease inRSUI's underwriting profit in 2011 from 2010 primarily reflects an increase in loss and LAE. The decrease inRSUI's underwriting profit in 2010 from 2009 primarily reflects a decrease in net premiums earned, partially offset by the decrease in loss and LAE. Additional information regardingRSUI's use of reinsurance and risks related to reinsurance recoverables can be found on pages 23 through 25 and page 33 of this Form 10-K Report. Additional information regardingRSUI's prior year reserve adjustments and releases can be found on pages 45 and 46 of this Form 10-K Report.
Although we continue to see a competitive property and casualty insurance market, we continue to be cautiously optimistic about the prospect for improvements, particularly in property insurance pricing.
CATA
The decrease in gross premiums written by CATA in 2011 from 2010 primarily reflects continuing price competition in CATA's property and casualty lines of business, including in excess and surplus markets, partially offset by higher gross premiums written in CATA's commercial surety line of business. The decrease in CATA's property and casualty lines of business also reflects reduced writings associated with CATA's Terminated Program Business. CATA's net premiums earned decreased in 2011 from 2010 primarily reflecting the decrease in gross premiums written. The decrease in CATA's gross premiums written and net premiums earned in 2010 from 2009 primarily reflects price competition in CATA's property and casualty lines of business, partially offset by higher gross premiums written and net premiums earned in CATA's commercial surety and miscellaneous errors and omissions liability lines of business. 55
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The decrease in loss and LAE in 2011 from 2010 primarily reflects the impact of lower net premiums earned, partially offset by the impact of a net reserve increase of prior accident year loss reserves in 2011 compared with a net reserve release in 2010 (as further described below). The increase in loss and LAE in 2010 from 2009 primarily reflects a lower amount of prior year reserve releases in 2010 compared with 2009 (as further described below), and to a lesser extent, higher property and workers' compensation claims. For CATA, loss and LAE for 2011 reflect a net$5.0 million increase of prior accident year loss reserves (related primarily to the casualty lines of business), compared with a$3.9 million release of prior accident year loss reserves during 2010 and a$10.7 million release of prior accident year loss reserves during 2009. The$5.0 million net reserve increase was due primarily to a$14.6 million increase in reserves related to CATA's Terminated Program Business, partially offset by a$9.6 million net reserve release in certain of CATA's casualty lines of business. The$3.9 million release in 2010 includes$3.5 million reserve release reflecting favorable loss emergence for asbestos and environmental impairment claims that arose from reinsurance assumed by a subsidiary of CATA between 1969 and 1976, based on a reserve study that was completed in the 2010 second quarter. The$10.7 million reserve release in 2009 primarily reflects favorable emergence in the casualty and surety lines of business. The decrease in net premiums earned, partially offset by the decrease in loss and LAE, was the primary cause of the decrease in CATA's underwriting profit in 2011 from 2010. The increase in loss and LAE was the primary cause for the decrease in CATA's underwriting profit in 2010 from 2009.
Additional information regarding CATA's prior year reserve releases can be found on pages 45 and 46 of this Form 10-K Report.
PCC
CommencingAugust 1, 2009 , PCC ceased soliciting new or renewal business on a direct basis due to its determination that it was unable to write business at rates it deemed adequate due to the difficult state of theCalifornia workers' compensation market and took corresponding expense reduction steps, including staff reductions, in light of such determination. PCC also took steps to emerge as a brokerage carrier at such time as it determines rates are adequate. In 2011, PCC began writing a modest amount of new business through brokers. PCC reported underwriting losses of$51.6 million ,$30.5 million and$70.7 million in 2011, 2010 and 2009, respectively. The underwriting losses primarily reflect an absence of premiums earned for the reasons described above (particularly with respect to the 2011 and 2010), combined with PCC's ongoing staffing and related expenses. The underwriting losses also reflect the impact of increases of prior accident year loss reserves in each period (as further described below). For PCC, loss and LAE for 2011 reflect a$28.4 million increase of prior accident year workers' compensation loss reserves, compared with a$12.5 million reserve increase of prior accident year workers' compensation loss reserves during 2010. Of the$28.4 million increase,$15.0 million was recorded in the 2011 second quarter and$13.4 million was recorded in the 2011 fourth quarter, as follows (in millions): Three months ended: Twelve months ended June 30, 2011 December 31, 2011 December 31, 2011
Adverse claims emergence $10.0 $4.2 $14.2 Increases in allocated LAE 3.0 6.4 9.4 Increases in unallocated LAE - 2.8 2.8 Decrease in ceded loss and LAE reserves 2.0 - 2.0 $15.0 $13.4 $28.4 PCC's adverse claims emergence relates to an unanticipated increase in medical claims emergence and an absence of anticipated favorable indemnity claims emergence. PCC had anticipated favorable indemnity claims emergence based upon prior claims development experience which indicated that injured workers would be returning to work, curtailing lost wage costs. PCC believes the weakCalifornia employment environment has hindered the ability of injured workers to return to work and indirectly influenced indemnity claims. The 56
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increases in allocated and unallocated LAE reserves primarily reflect increased use of outside counsel to assist in the settlement process and higher litigation costs caused by recent Workers' Compensation Appeals Board decisions. The decrease in ceded loss and LAE reserves was based on a second quarter 2011 review of reinsurance coverage estimates, which also resulted in a$1.1 million decrease in ceded premiums earned, thereby increasing net premiums earned in the 2011 second quarter. The$12.5 million reserve increase in loss and LAE for 2010 relates primarily to a decrease in ceded loss and LAE reserves based on a fourth quarter 2010 review of reinsurance coverage estimates and, to a lesser extent, an increase in unallocated LAE reserves, which also resulted in a$5.0 million decrease in ceded premiums earned, thereby increasing net premiums earned in 2010. The$26.5 million reserve increase during 2009 primarily reflects a significant acceleration in claims emergence and higher than anticipated increases in industry-wide severity, as well as the estimated impact of judicial decisions by the Workers' Compensation Appeals Board. Such decisions related to permanent disability determinations that have materially weakened prior workers' compensation reforms instrumental in reducing medical and disability costs in earlier years. Such increases impacted the assumptions used in estimating PCC's loss and LAE liabilities for business earned in 2009, causing an increase of the current accident year reserves of$8.0 million in 2009. TheCalifornia Department of Insurance , or the "CDI," is responsible for periodic financial and market conduct examinations ofCalifornia -domiciled insurance companies. InSeptember 2010 , the CDI issued a financial examination report of PCIC for the period fromJuly 1, 2004 throughDecember 31, 2008 . As part of its work for such financial examination report, the CDI produced an actuarial report, or the "Actuarial Report," for the years endedDecember 31, 2009 and 2008. The Actuarial Report included an estimate of loss and LAE reserves on a statutory basis of accounting that was higher than that recorded by PCIC at such dates. We believed that PCIC's reserves for unpaid loss and LAE were adequate, and the CDI did not require PCIC to currently or retroactively increase its carried reserves to the estimates included in the Actuarial Report. AIHL did, however, contribute$40.0 million of capital to PCC onSeptember 27, 2010 , and these funds were used by PCIC to increase its workers' compensation deposit, which is required to be maintained by PCIC underCalifornia workers' compensation regulations, to a level consistent with the estimated loss and LAE reserves included in the Actuarial Report. To the extent that PCIC's actual loss experience is less than the CDI's final estimate of PCIC's loss and LAE reserves, over time such additional workers' compensation deposit funds will be released back to PCIC.
Additional information regarding PCC's reserve increases can be found on pages 46 through 47 of this Form 10-K Report.
AIHL Investment Results
Following is information relating to AIHL's investment results.
Years Ended December 31, 2011 2010 2009 (in millions) Net investment income $ 117.4 $ 128.9 $ 116.7 Net realized capital gains $ 79.7 $ 92.9 $
132.1 *
Other than temporary impairment losses $ (3.6 ) $ (12.3 ) $ (85.9 )
* Excludes a non-cash impairment charge in 2009 related to the intangible assets
associated with our acquisition of PCC which was classified as a net realized
capital loss in our consolidated statements of earnings (see Note 4(a) to the
Consolidated Financial Statements set forth in Item 8 of this Form 10-K
Report).
Net Investment Income. The decrease in AIHL's net investment income in 2011 from 2010 is due principally to the impact of ongoing negative cash flow at PCC and dividends paid to Alleghany, partially offset by higher dividend income. In addition, the decrease in AIHL's net investment income in 2011 as compared with 2010 reflects the absence of equity-method partnership income in 2011, as such partnerships were dissolved in the 2010 third quarter. 57
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The increase in AIHL's net investment income in 2010 from 2009 is due principally to higher dividend income resulting from a higher allocation of AIHL's investment portfolio to equity securities during 2010 compared with 2009.
Approximate yields of AIHL's debt securities for 2011, 2010 and 2009 are as follows (in millions, except for percentages):
Pre-Tax After-Tax Net Net Average Investment Investment Effective After-Tax
Year Investments (1) Income(2) Income(3) Yield(4) Yield(5) 2011 $ 2,649.7 $ 99.0 $ 77.1 3.7 % 2.9 % 2010 $ 2,887.3 $ 102.1 $ 80.2 3.5 % 2.8 % 2009 $ 2,858.4 $ 104.7 $ 83.9 3.7 % 2.9 %
(1) Average of amortized cost of debt securities portfolio at beginning and end
of period.
(2) After investment expenses, excluding net realized gains and
other-than-temporary impairment losses.
(3) Pre-tax net investment income less income taxes.
(4) Pre-tax net investment income for the period divided by average investments
for the same period.
(5) After-tax net investment income for the period divided by average investments
for the same period.
Net Realized Capital Gains. Net realized capital gains in 2011, 2010 and 2009 relate primarily to sales of equity securities in the energy sector, some of which had their cost basis reduced in earlier periods for the recognition of unrealized losses through other-than-temporary impairment losses, particularly in 2009. Other-Than-Temporary Impairment Losses. Other-than-temporary impairment losses reflect impairment charges related to unrealized losses that were deemed to be other than temporary and, as such, are required to be charged against earnings. Other-than-temporary impairment losses for 2011 reflect$3.6 million of unrealized losses that were deemed to be other than temporary and, as such, were required to be charged against earnings. Of the$3.6 million ,$3.1 million related to equity security holdings (primarily in the materials and financial services sectors), and$0.5 million related to debt security holdings (all of which were deemed to be credit-related). The determination that unrealized losses on such securities were other than temporary was primarily based on the severity of the declines in fair value of such securities relative to their cost as of the balance sheet date. Of the$12.3 million of other-than-temporary impairment losses in 2010,$11.1 million related to equity security holdings (primarily in the energy sector) and$1.2 million related to debt security holdings (all of which were deemed to be credit-related). The determination that unrealized losses on such securities were other than temporary was primarily based on the severity and duration of the declines in fair value of such securities relative to their cost as of the balance sheet date. Of the$85.9 million of other-than-temporary impairment losses in 2009,$57.6 million related to equity security holdings in the energy sector,$16.5 million related to equity security holdings in various other sectors and$11.8 million related to debt security holdings (all of which were deemed to be credit-related). The determination that unrealized losses on such securities were other than temporary in 2009 was primarily based on the severity of the declines in fair value of such securities relative to cost as of the balance sheet date. Such severe declines were primarily related to a significant deterioration of U.S. equity market conditions during the latter part of 2008 and the first quarter of 2009, which abated somewhat in the remainder of 2009.
After adjusting the cost basis of securities for the recognition of other-than-temporary impairment losses, the gross unrealized investment losses for debt and equity securities as of
ā¢ the duration of time and the relative magnitude to which fair values of
these investments has been below cost was not indicative of an
other-than-temporary impairment loss (for example, no equity security was
in a continuous unrealized loss position for twelve months or more as ofDecember 31, 2011 ); 58
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ā¢ the absence of compelling evidence that would cause us to call into
question the financial condition or near-term prospects of the issuer of
the investment; and ā¢ our ability and intent to hold the investment for a period of time
sufficient to allow for any anticipated recovery.
See Note 3 to the Consolidated Financial Statements set forth in Item 8 of this Form 10-K Report for further details concerning gross unrealized investment losses for debt and equity securities as of
Corporate Activities Operating Results
The following table summarizes corporate activities' results for 2011, 2010 and 2009 (in millions): Years Ended December 31, 2011 2010 2009 Net investment income $ (8.5 ) $ (3.9 ) $ (14.8 ) Net realized capital gains 47.5 4.5
200.6
Other than temporary impairment losses - - - Other income 1.0 6.6 1.7 Total revenues $ 40.0 $ 7.2 $ 187.5
Corporate administration and other expenses 45.9 31.4
29.1
Interest expense 17.3 5.0
0.6
(Losses) earnings before income taxes $ (23.2 ) $ (29.2 )
The decrease in losses in 2011 from 2010 primarily reflects higher net realized capital gains, partially offset by higher corporate administration and other expenses, higher interest expenses, lower other income and higher negative net investment income. Net realized capital gains in 2011 primarily reflects net realized capital gains from the sale of equity securities, primarily common stock of Exxon Mobil Corporation in the fourth quarter of 2011. The proceeds from such sales were reinvested in short-term securities and cash, and will be used to fund Alleghany's cash consideration in connection with the pending merger with Transatlantic, which is expected to close in the first quarter of 2012. The higher corporate administration and other expenses is due primarily to$19.3 million of due diligence, legal, investment bank and other costs incurred in the 2011 fourth quarter related to the pending merger with Transatlantic, partially offset by lower incentive compensation and pension accruals. The higher interest expenses are due to our Senior Notes, which were issued onSeptember 20, 2010 . The lower other income in 2011 reflects the absence of a non-recurring gain fromAlleghany Properties that existed in 2010. As further explained below, the increase in negative net investment income is due primarily to higher catastrophe losses related to our investment in Homesite, partially offset by higher dividend income and higher interest income. Higher interest income reflects the investment of the proceeds from our Senior Notes and dividends received from subsidiaries. For more information on the merger, see Note 2 to the Consolidated Financial Statements set forth in Item 8 of this Form 10-K Report. Corporate activities reported a loss before income taxes in 2010 compared with earnings before income taxes in 2009, primarily reflecting lower net realized capital gains which were not sufficient to offset corporate administration, interest and other expenses. The lower net realized capital gains primarily reflects the absence of sales of common stock of Burlington Northern in 2010, which were significant in 2009. As further explained below, negative net investment income in 2009 primarily reflects losses related to our investment in ORX.
Net investment income for Corporate activities includes our equity share of (losses) earnings in Homesite and ORX, as follows (in millions):
2011 2010 2009 Homesite $ (20.2 ) $ (3.2 ) $ (1.1 ) ORX (1.6 ) (2.0 ) (21.9 )
Interest, dividends and other - net 13.3 1.3 8.2
Net investment income $ (8.5 ) $ (3.9 ) $ (14.8 ) 59
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Homesite losses in 2011 primarily reflect the impact of increased homeowners insurance claims from severe weather, particularly tornados, in the southeastern and midwestern U.S. in April andMay 2011 , as well as from Hurricane Irene, which affected the east coast of the U.S. inAugust 2011 . Homesite losses in 2011 also reflect a tax valuation adjustment that Homesite recorded in the fourth quarter of 2011. Homesite losses in 2010 and 2009 primarily reflect the impact of increased homeowners insurance claims from severe weather and ongoing purchase accounting adjustments.
The
Reserve Review Process
AIHL's insurance operating units analyze, at least quarterly, liabilities for unpaid loss and LAE established in prior years and adjust their expected ultimate cost, where necessary, to reflect positive or negative development in loss experience and new information, including, for certain catastrophic events, revised industry estimates of the magnitude of a catastrophe. Adjustments to previously recorded liabilities for unpaid loss and LAE, both positive and negative, are reflected in our financial results in the periods in which these adjustments are made and are referred to as prior year reserve development. The following table presents the reserves established in connection with the loss and LAE of AIHL's insurance operating units on a gross and net basis by line of business. These reserve amounts represent the accumulation of estimates of ultimate loss (including for IBNR) and LAE. Workers' All Property Casualty(1) CMP(2) Surety Comp(3) Other(4) Total (in millions) 2011 Gross loss and LAE reserves $ 192.4 $ 1,844.0 $ 58.9 $ 21.1 $ 167.5 $ 29.1 $ 2,313.0 Reinsurance recoverables on unpaid losses (62.3 ) (741.7 ) (0.3 ) (0.1 ) (12.0 ) (15.4 ) (831.8 ) Net loss and LAE reserves $ 130.1 $ 1,102.3 $ 58.6 $ 21.0 $ 155.5 $ 13.7 $ 1,481.2 2010 Gross loss and LAE reserves $ 150.1 $ 1,883.6 $ 58.9 $ 17.1 $ 186.7 $ 32.3 $ 2,328.7 Reinsurance recoverables on unpaid losses (52.0 ) (765.2 ) (1.0 ) (0.1 ) (10.9 ) (18.2 ) (847.4 ) Net loss and LAE reserves $ 98.1 $ 1,118.4 $ 57.9 $ 17.0 $ 175.8 $ 14.1 $ 1,481.3 2009
Gross loss and LAE reserves
(104.5 ) (799.5 )
(0.2 ) (0.1 ) (20.2 ) (23.2 ) (947.7 )
Net loss and LAE reserves $ 144.6 $ 1,102.9 $ 63.4 $ 17.9 $ 225.7 $ 18.8 $ 1,573.3
(1) Primarily consists of umbrella/excess, D&O liability, professional liability
and general liability.
(2) Commercial multiple peril.
(3) Workers' compensation amounts include PCC, net of purchase accounting
adjustments (see Note 4(a) to the Consolidated Financial Statements set forth
in Item 8 of this Form 10-K Report). Such adjustments include a minor
reduction of gross and net loss and LAE for acquisition date discounting, as
required under purchase accounting. Workers' compensation amounts also include minor balances from CATA.
(4) Primarily consists of loss and LAE reserves for terminated lines of business
and loss reserves acquired in connection with prior acquisitions for which
the sellers provided loss reserve guarantees. The loss and LAE reserves are
ceded 100 percent to the sellers. Additional information regarding the loss
reserve guarantees can be found in Note 5(c) to the Consolidated Financial
Statements set forth in Item 8 of this 10-K Report. 60
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Changes in Loss and LAE Reserves between
Gross Reserves. Gross loss and LAE reserves as ofDecember 31, 2011 decreased slightly fromDecember 31, 2010 , primarily reflecting reserve decreases in the casualty and workers' compensation lines of business, largely offset by reserve increases in the property lines of business. The decrease in the casualty gross loss and LAE reserves primarily reflects the impact of releases in gross loss and LAE reserves byRSUI during 2011 related to prior accident years, partially offset by the impact of increases in gross loss and LAE reserves by CATA during 2011 related to prior accident years. The decrease in workers' compensation gross loss and LAE reserves primarily reflects the impact of PCC ceasing to solicit new or renewal business on a direct basis commencingAugust 1, 2009 , partially offset by an increase in gross loss and LAE reserves by PCC as ofJune 30, 2011 andDecember 31, 2011 related to prior accident years. The increase in property gross loss and LAE reserves is due to increases in case reserves related primarily to significant catastrophe and other large losses incurred in 2011, partially offset by claim payments made byRSUI in 2011 related to catastrophe losses in prior years. Such claim payments causedRSUI to reduce its case reserves from prior accident years, primarily related to 2008 third quarter hurricane losses. Net Reserves. Net loss and LAE reserves as ofDecember 31, 2011 were essentially unchanged fromDecember 31, 2010 , primarily reflecting reserve decreases in the casualty and workers' compensation lines of business and offsetting reserve increases in the property lines of business. The decrease in the casualty net loss and LAE reserves primarily reflects the impact of releases in net loss and LAE reserves byRSUI during 2011 related to prior accident years, partially offset by the impact of increases in net loss and LAE reserves by CATA during 2011 related to prior accident years. The decrease in workers' compensation net loss and LAE reserves primarily reflects the impact of PCC ceasing to solicit new or renewal business on a direct basis commencingAugust 1, 2009 , partially offset by an increase in net loss and LAE reserves by PCC as ofJune 30, 2011 andDecember 31, 2011 related to prior accident years. The increase in property net loss and LAE reserves is due to increases in case reserves related primarily to significant catastrophe and other large losses incurred in 2011, partially offset by claim payments made byRSUI in 2011 related to catastrophe losses in prior years. Such claim payments causedRSUI to reduce its case reserves from prior accident years, primarily related to 2008 third quarter hurricane losses, after reflecting any applicable ceded reinsurance.
Changes in Loss and LAE Reserves between
Gross Reserves. Gross loss and LAE reserves as ofDecember 31, 2010 decreased fromDecember 31, 2009 due primarily to reserve decreases in property and workers' compensation lines of business. The decrease in property gross loss and LAE reserves is mainly due to loss payments made byRSUI on hurricane related losses incurred in prior years. The decrease in workers' compensation gross loss and LAE reserves primarily reflects the impact of PCC's decision inJune 2009 to cease soliciting new or renewal business on a direct basis commencingAugust 1, 2009 . Net Reserves. Net loss and LAE reserves as ofDecember 31, 2010 decreased slightly fromDecember 31, 2009 due primarily to reserve decreases in the workers' compensation and property lines of business, partially offset by a modest reserve increase in the casualty line of business. The decrease in workers' compensation net loss and LAE reserves primarily reflects the impact of PCC's decision inJune 2009 to cease soliciting new or renewal business on a direct basis commencingAugust 1, 2009 . This decrease was partially offset by a$12.5 million increase of prior accident year workers' compensation net loss reserves recorded by PCC related primarily to a decrease in ceded loss and LAE based on a fourth quarter 2010 review of reinsurance coverage estimates, and to a lesser extent, an increase in unallocated LAE reserves. The decrease in property net loss and LAE reserves was mainly due to loss payments made byRSUI on hurricane related losses incurred in prior years, net of corresponding decreases in reinsurance recoverables on unpaid losses. The increase in the casualty line of business relates primarily to modest increases at CATA due to growth in certain specialty classes and its miscellaneous errors and omissions liability line of business.
Additional information regarding
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Reinsurance Recoverables
As ofDecember 31, 2011 , AIHL had total reinsurance recoverables of$852.8 million , consisting of$831.8 million of ceded outstanding loss and LAE and$21.0 million of recoverables on paid losses.RSUI's reinsurance recoverables totaled$759.8 million of AIHL's$852.8 million . The reinsurance purchased by AIHL's insurance operating units does not relieve them from their obligations to their policyholders, and therefore, the financial strength of their reinsurers is important.AIHL's Reinsurance Security Committee , which includes certain of our officers and the chief financial officer of each of AIHL's operating units and which manages the use of reinsurance by such operating units, has determined that reinsurers with a rating of A (Excellent) or higher have an ability to meet their ongoing obligations at a level that is acceptable to us.
Information regarding concentration of AIHL's reinsurance recoverables as of
Reinsurer(1) Rating(2) Dollar Amount Percentage Swiss Re A+(Superior) $ 152.1 17.8 % Platinum Underwriters Holdings, Ltd. A (Excellent) 95.3 11.2 % PartnerRe Ltd. A+(Superior) 89.3 10.5 % All other reinsurers 516.1 60.5 % Total (3) $ 852.8 100.0 %
(1) Reinsurance recoverables reflect amounts due from one or more reinsurance
subsidiaries of the listed company.
(2) Represents the
subsidiaries from which the reinsurance recoverable is due.
(3) Approximately 99.0 percent of AIHL's reinsurance recoverables balance as of
strength rating of A (Excellent) or higher.
As ofDecember 31, 2011 , AIHL also had fully collateralized reinsurance recoverables of$66.8 million due fromDarwin , now a subsidiary of AWAC. TheA.M. Best financial strength rating ofDarwin was A (Excellent) as ofDecember 31, 2011 . AIHL had no allowance for uncollectible reinsurance as ofDecember 31, 2011 . Financial Condition Parent Level General. In general, we follow a policy of maintaining a relatively liquid financial condition at the parent company. This policy has permitted us to expand our operations through internal growth at our subsidiaries and through acquisitions of, or substantial investments in, operating companies. As ofDecember 31, 2011 , we held marketable securities and cash of$534.6 million at the parent company and$700.3 million at AIHL, which totaled$1,234.9 million . We anticipate that we will use an estimated$846.7 million of these assets to fund cash commitments we made in connection with the merger. We currently believe that we have and will have adequate internally generated funds, cash resources and unused credit facilities to provide for the currently foreseeable needs of our business, and we had no material commitments for capital expenditures as ofDecember 31, 2011 . Stockholders' equity increased to approximately$2.93 billion as ofDecember 31, 2011 , compared with approximately$2.91 billion as ofDecember 31, 2010 , representing an increase of 0.6 percent. The increase in stockholders' equity primarily reflects net earnings in 2011, partially offset by the repurchase of our common stock pursuant to our share repurchase program described below. Debt. OnSeptember 20, 2010 , we issued$300.0 million of Senior Notes dueSeptember 15, 2020 . The Senior Notes are unsecured and unsubordinated general obligations of Alleghany as the parent company. Interest is payable semi-annually onMarch 15 andSeptember 15 of each year. The terms of the Senior Notes permit redemption prior to their maturity. The indenture under which the Senior Notes were issued contains covenants that impose conditions on our ability to create liens on the capital stock of AIHL orRSUI or to engage in sales of the capital stock of AIHL orRSUI . The Senior Notes were issued at a discount of approximately 99.63 percent, 62
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resulting in proceeds before underwriting discount, commissions and other expenses of$298.9 million , and an effective yield of approximately 5.67 percent. Approximately$2.8 million of underwriting discount, commissions and other expenses was recorded as deferred charges, which are amortized over the life of the Senior Notes. Credit Agreement. OnSeptember 9, 2010 , we entered into the Credit Agreement, and a related security agreement, or the "Security Agreement," with a bank syndicate. The Credit Agreement provides for a two tranche revolving credit facility in an aggregate principal amount of up to$100.0 million , or the "Commitments," consisting of (i) a secured credit facility, or "Tranche A," subject to a borrowing base as set forth in the Credit Agreement, in an aggregate principal amount of up to$50.0 million and (ii) an unsecured credit facility, or "Tranche B," in an aggregate principal amount of up to$50.0 million . The Commitments under the Credit Agreement are scheduled to terminate onSeptember 9, 2013 , or the "Maturity Date," unless earlier terminated. Borrowings under the Credit Agreement are available for working capital and general corporate purposes. Alternate Base Rate Borrowings under the Credit Agreement bear interest at (x) the greatest of (a) the administrative agent's prime rate, (b) the federal funds rate plus 0.5 percent or (c) an adjusted London Interbank Overnight, or "LIBO," rate for a one month interest period on such day plus 1 percent, plus (y) a specified margin (currently 0 basis points for Tranche A and 125 basis points for Tranche B). Eurodollar Borrowings under the Credit Agreement bear interest at the Adjusted LIBO Rate for the interest period in effect plus a specified margin (currently 75 basis points for Tranche A and 225 basis points for Tranche B). The Credit Agreement requires that all loans be repaid in full no later than the Maturity Date. The Credit Agreement also requires us to pay a Commitment Fee each quarter in a range of between one fifth and one-half of one percent per annum, based upon ourMoody's Rating and S&P Ratings Services , on the daily unused amount of the Commitments of the relevant Tranche. The Credit Agreement contains representations, warranties and covenants customary for bank loan facilities of this nature. In this regard, the Credit Agreement requires us to, among other things, (i) maintain a consolidated net worth of not less than the sum of (x) approximately$2.0 billion plus (y) 50 percent of our cumulative consolidated net income earned in each fiscal quarter (if positive) commencing onSeptember 30, 2010 and (ii) maintain a ratio of consolidated total indebtedness to consolidated capital as of the end of each fiscal quarter of not greater than 0.25 to 1.0. Additionally, the Credit Agreement contains various negative covenants with which we must comply, including, but not limited to, limitations respecting the creation of liens on any property or asset; the incurrence of indebtedness; mergers, consolidations, liquidations and dissolutions; change of business; sales of assets; transactions with affiliates; and other provisions customary in similar types of agreements. In addition, at any time when a default has occurred and is continuing or would result therefrom, the Credit Agreement proscribes our ability to declare or pay, or permit certain of our subsidiaries to declare or pay, any dividend on, or make any payment on account of, or set apart assets for a sinking or other analogous fund for, the purchase, redemption, defeasance, retirement or acquisition of, any of our stock or any such subsidiaries. Under the Credit Agreement, an Event of Default is defined as (i) a failure to pay any principal or interest on any of the loans or any fee or any other amount payable under the Credit Agreement or any other loan document within designated time periods; (ii) a breach of any representation or warranty made in the Credit Agreement or any other loan document; (iii) a failure to comply with certain specified covenants, conditions or agreements in the Credit Agreement; (iv) a failure to comply with any other conditions, covenants or agreements in the Credit Agreement or any other loan document within thirty days after knowledge or written notice of such failure; (v) a failure by us or any subsidiary to pay any indebtedness, other than loans under the Credit Agreement, or any obligation in respect of our or any subsidiary's hedging agreements in an aggregate amount exceeding$25.0 million , or "Material Indebtedness," when due or payable; (vi) any event or condition occurs that results in the acceleration of the maturity of Material Indebtedness or which enables or permits the holder of such Material Indebtedness to cause the acceleration of such indebtedness, except for secured indebtedness that becomes due as a result of the voluntary sale or transfer of the property or assets securing such indebtedness; (vii) the occurrence of certain involuntary or voluntary bankruptcy, insolvency or reorganization events relating to us or any of our 63
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material subsidiaries; (viii) the rendering of certain money judgments against us or any of our subsidiaries in an aggregate amount in excess of$25.0 million ; (ix) a failure by us or certain affiliates to pay any material amounts to thePension Benefit Guaranty Corporation or to an employee pension benefit plan or the institution of an enforcement proceeding under ERISA (as defined in the Credit Agreement), the occurrence of certain ERISA events which would reasonably be expected to have a material adverse effect, or the occurrence of certain material events under ERISA covered plans; (x) the failure of any lien created by any of the security documents to constitute an enforceable first priority perfected lien on all of the collateral encumbered thereby; or (xi) the occurrence of certain events constituting a Change of Control relating to us. If an Event of Default occurs, then, to the extent permitted in the Credit Agreement, the Lenders may, as applicable, terminate the Commitments, accelerate the repayment of any outstanding loans and exercise all rights and remedies available to such Lenders under the Credit Agreement, the Security Agreement and related documents and applicable law, including, without limitation, exercising rights and remedies with respect to the collateral for the benefit of the Tranche A Lenders. In the case of an Event of Default that exists due to the occurrence of certain involuntary or voluntary bankruptcy, insolvency or reorganization events relating to us, the Commitments will automatically terminate and the repayment of any outstanding loans shall be automatically accelerated. The Security Agreement secures all of our obligations relating to the Tranche A Loans under the Credit Agreement, and grants to a collateral agent for the Lenders, or "Collateral Agent," a continuing first priority lien on and security interest in, and assigns to the Collateral Agent (for the ratable benefit of the Lenders) as collateral security, all of our right, title and interest in and to: (i) all cash, securities, shares of stock, investment property, financial assets, equity interests, instruments and general intangibles which are from time to time held in or credited to a certain account, or the "Account," maintained with the Collateral Agent, (ii) the Account itself, and (iii) all rights to which we now or hereafter become entitled by reason of our interest in any of the previously described collateral, and all security entitlements related to the Account and the financial assets credited to the Account, and the additions to, accessions to, substitutions of, products or proceeds of any or all of the foregoing.
There were no borrowings under the Credit Agreement during 2010 or 2011.
Preferred Stock. OnJune 23, 2006 , we completed an offering of 1,132,000 shares of 5.75% Mandatory Convertible Preferred Stock, or the "Preferred Stock," at a public offering price of$264.60 per share, resulting in net proceeds of$290.4 million . OnJune 15, 2009 , all outstanding shares of Preferred Stock were mandatorily converted into shares of our common stock. Each outstanding share of Preferred Stock was automatically converted into 1.0139 shares of our common stock based on the arithmetic average of the daily volume-weighted average price per share of our common stock for each of the 20 consecutive trading days ending onJune 10, 2009 , or$260.9733 per share. We issued 698,009 shares of our common stock for the 688,621 shares of Preferred Stock that were outstanding at the date of the mandatory conversion. All of the foregoing per share data has not been adjusted for subsequent Alleghany common stock dividends. Capital Contributions. From time to time, we make capital contributions to our subsidiaries when third-party financing may not be attractive or available. In 2010, we made a capital contribution of$40.0 million to provide capital support to PCIC in connection with an increase in its workers' compensation deposit, which is required to be maintained by PCIC underCalifornia workers' compensation regulations. In 2007, we made a capital contribution of$50.0 million to provide additional capital support to PCC in connection with AIHL's acquisition of PCC. We expect that we will continue to make capital contributions to our subsidiaries from time to time in the future for similar or other purposes. Common Stock and Preferred Stock Repurchases. InFebruary 2008 , our Board of Directors authorized the repurchase of shares of our common stock, at such times and at prices as management determined advisable, up to an aggregate of$300.0 million . InNovember 2008 , the authorization to repurchase our common stock was expanded to include repurchases of Preferred Stock. As ofDecember 31, 2010 , this program had been fully utilized. InJuly 2010 , in anticipation of such full utilization, our Board of Directors authorized the repurchase of additional shares of our common stock, at such times and at prices as management may determine advisable, up to an aggregate of$300.0 million , upon such full utilization. Such share repurchase program was terminated upon the entry into the merger agreement with Transatlantic inNovember 2011 . 64
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During 2011, we repurchased an aggregate of 399,568 shares of our common stock in the open market for$120.3 million , at an average price per share of$301.14 . During 2010, we repurchased an aggregate of 285,056 shares of our common stock in the open market for$83.1 million , at an average price per share of$291.64 . During 2009, we repurchased an aggregate of 295,463 shares of our common stock in the open market for$75.9 million , at an average price per share of$256.73 . Prior to the mandatory conversion date ofJune 15, 2009 , we repurchased an aggregate of 442,998 shares of Preferred Stock in the open market for$117.4 million , at an average price per share of$264.92 . All of the foregoing per share and average price data has not been adjusted for subsequent Alleghany common stock dividends.
As of
Dividends. We have declared stock dividends in lieu of cash dividends every year since 1987 except 1998 when our wholly-owned subsidiary,Chicago Title Corporation , was spun off to our stockholders. These stock dividends have helped to conserve our financial strength and, in particular, the liquid assets available to finance internal growth and operating company acquisitions and investments. In light of the pending merger with Transatlantic, our Board of Directors determined not to declare a stock dividend for 2012. Dividends from Subsidiaries. As ofDecember 31, 2011 , approximately$835.3 million of the equity of all of our subsidiaries was available for dividends or advances to us at the parent level. AIHL's insurance operating units are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid by them without prior approval of insurance regulatory authorities. Of the aggregate total equity of our insurance operating units as ofDecember 31, 2011 of$1.85 billion , a maximum of$35.9 million was available for dividends without prior approval of the applicable insurance regulatory authorities. These limitations have not affected our ability to meet our obligations. In 2011,RSUI paid AIHL a cash dividend of$100.0 million and CATA paid AIHL a cash dividend of$15.0 million . In 2010,RSUI paid AIHL a cash dividend of$100.0 million and CATA paid AIHL a cash dividend of$25.0 million . In 2009,RSUI paid AIHL a cash dividend of$150.0 million and CATA paid AIHL a cash dividend of$15.0 million . Contractual Obligations. We have certain obligations to make future payments under contracts and credit-related financial instruments and commitments. As ofDecember 31, 2011 , certain long-term aggregate contractual obligations and credit-related financial commitments were as follows (in millions): More than More than 1 Year 3 Years Within but Within but Within More than Contractual Obligations Total 1 Year 3 Years 5 Years 5 Years Operating lease obligations $ 65.6 $ 10.0 $ 20.1 $ 14.6 $ 20.9 Investments 26.4 6.8 9.8 9.8 - Senior Notes 299.0 - - - 299.0 Interest on Senior Notes 147.9 16.9 34.0 34.0 63.0 Loss and LAE 2,313.0 556.4 795.1 408.2 553.3 Merger Agreement* 846.7 846.7 - - - Other long-term liabilities reflected on our consolidated balance sheet under GAAP** 144.4 57.9 40.2 12.2 34.1 Total $ 3,843.0 $ 1,494.7 $ 899.2 $ 478.8 $ 970.3
* Represents cash commitments we made in connection with the pending merger
with Transatlantic, consisting of
to Transatlantic shareholders upon consummation of the merger, as well as
payable to our investment bankers (see Note 2 to the Consolidated Financial
Statements set forth in Item 8 of this Form 10-K Report for further details).
The merger is expected to close in the first quarter of 2012.
** Other long-term liabilities primarily reflect employee pension obligations,
certain retired executive pension obligations and obligations under certain
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Our insurance operating units have obligations to make certain payments for loss and LAE pursuant to insurance policies they issue. These future payments are reflected as reserves on our consolidated financial statements. With respect to loss and LAE, there is typically no minimum contractual commitment associated with insurance contracts, and the timing and ultimate amount of actual claims related to these reserves is uncertain. Additional information regarding reserves for loss and LAE, including information regarding the timing of payments of these expenses, can be found on pages 19 through 22, pages 30 and 31, pages 42 through 47 and pages 60 and 61 of this Form 10-K Report. Off-Balance Sheet Arrangements. In late 2010,Alleghany Properties commenced making investments in threeCalifornia low income housing tax credit limited liability companies. The investments each took the form of a limited partnership interest in separate limited liability companies organized and managed by a third party real estate developer.Alleghany Properties expects that its investment in the limited liability companies will last for approximately 10 years. The developer is the general partner and retains the residual interest in the underlying real estate properties. The limited liability companies are consolidated by the third party real estate developer for accounting purposes. Funding for each low income housing project is provided principally byAlleghany Properties and various government-sponsored loans secured by the assets of the limited liability companies. As ofDecember 31, 2011 ,Alleghany Properties invested a cumulative$4.5 million in the three limited liability companies, and is committed to invest an additional$1.7 million .
Subsidiaries
Financial strength is also a high priority of our subsidiaries, whose assets stand behind their financial commitments to their customers and vendors. We believe that our subsidiaries have and will have adequate internally generated funds, cash resources, and unused credit facilities to provide for the currently foreseeable needs of their businesses. Our subsidiaries have no material commitments for capital expenditures. AIHL. The obligations and cash outflow of AIHL's insurance operating units include claim settlements, administrative expenses and purchases of investments. In addition to premium collections, cash inflow is obtained from interest and dividend income and maturities and sales of investments. Because cash inflow from premiums is received in advance of cash outflow required to settle claims, AIHL's insurance operating units accumulate funds which they invest pending the need for liquidity. As an insurance company's cash needs can be unpredictable due to the uncertainty of the claims settlement process, AIHL's portfolio, which includes those of its insurance operating units, is composed primarily of debt securities and short-term investments to ensure the availability of funds and maintain a sufficient amount of liquid securities. As ofDecember 31, 2011 , investments and cash represented 74.6 percent of the assets of AIHL and its insurance operating units. As ofDecember 31, 2011 , AIHL had total unpaid loss and LAE of approximately$2.3 billion and total reinsurance recoverables of$852.8 million , consisting of$831.8 million of ceded outstanding loss and LAE and$21.0 million of recoverables on paid losses. As ofDecember 31, 2011 , AIHL's investment securities portfolio had a fair market value of approximately$4.1 billion and consisted primarily of high quality debt securities. Additional information regarding AIHL's investment portfolio and the credit quality of AIHL's debt securities portfolio can be found on pages 66 through 71 of this Form 10-K Report.Alleghany Properties . As ofDecember 31, 2011 ,Alleghany Properties held properties having a total book value of$19.9 million (excluding$4.5 million invested in threeCalifornia low income housing tax credit limited liability companies), compared with$19.9 million as ofDecember 31, 2010 and$19.8 million as ofDecember 31, 2009 . These properties and loans had a total book value of$90.1 million as ofOctober 31, 1994 , the dateAlleghany Properties purchased the assets. The capital needs ofAlleghany Properties consist primarily of various development costs relating to its owned land and corporate administration. Adequate funds to provide for the currently foreseeable needs of its business are expected to be generated by sales and, if needed, capital contributions by us.
Investment Strategy. Our investment strategy seeks to preserve principal and maintain liquidity while trying to maximize our risk-adjusted, after-tax rate of return. Investment decisions are guided mainly by the nature and 66
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timing of expected liability payouts, management's forecast of cash flows and the possibility of unexpected cash demands, for example, to satisfy claims due to catastrophe losses. Our consolidated investment portfolio currently consists mainly of highly rated and liquid debt securities and equity securities listed on national securities exchanges. The overall debt securities portfolio credit quality is measured using the lower of either Standard & Poor's or Moody's rating. In this regard, the overall weighted-average credit quality rating of our debt securities portfolio as ofDecember 31, 2011 was AA, with 16.3 percent of our consolidated debt securities portfolio invested in securities with the highest rating (Aaa/AAA), 63.0 percent invested in securities with the second highest rating (Aa/AA) and only 1.1 percent had either no rating or a rating below investment grade (below Baa3 / BBB-). The overall weighted-average credit quality rating of our debt securities portfolio was reduced from AA+ as ofDecember 31, 2010 to AA as ofDecember 31, 2011 as a result of Standard and Poor's downgrade of its long-term assessment of U.S. sovereign debt to AA+ from AAA onAugust 5, 2011 , as well as the subsequent downgrade of U.S. agency and other debt backed by theU.S. Government . Although many of our debt securities, which consist predominantly of states, municipalities and political subdivision bonds, are insured by third-party financial guaranty insurance companies, the impact of such insurance was not significant to the debt securities credit quality rating as ofDecember 31, 2011 . As ofDecember 31, 2011 , we had$83.5 million of foreign bonds, none of which were sovereign obligations ofPortugal ,Ireland</location>, Italy ,Greece orSpain . Our debt securities portfolio has been designed to enable management to react to investment opportunities created by changing interest rates, prepayments, tax and credit considerations or other factors, or to circumstances that could result in a mismatch between the desired duration of debt securities and the duration of liabilities, and, as such, is classified as available for sale. We produced positive cash flow in the three-year period endingDecember 31, 2011 . Our positive cash flow from operations reduces the need to liquidate portions of our debt securities portfolio to pay for current claims of our insurance operating units. This positive cash flow also permits us, as attractive investment opportunities arise, to make investments in debt securities that have a longer duration than our liabilities. When attractive investment opportunities do not arise, we may maintain higher proportions of shorter duration debt securities to preserve our capital resources. Effective duration measures a portfolio's sensitivity to change in interest rates; a change within a range of plus or minus 1 percent in interest rates would be expected to result in an inverse change of approximately 4.1 percent in the fair market value of our debt securities portfolio. In this regard, as ofDecember 31, 2011 , our debt securities portfolio had an effective duration of approximately 4.0 years, with approximately$0.7 billion , or 26.4 percent, of our debt securities portfolio in securities with maturities of five years or less and$1.1 billion of short-term investments. See Note 3 to the Consolidated Financial Statements set forth in Item 8 of this Form 10-K Report for further details concerning the contractual maturities of our consolidated debt securities portfolio. We may modestly increase the proportion of our debt securities portfolio held in securities with maturities of more than five years should the yields of these securities provide, in our judgment, sufficient compensation for their increased risk. We do not believe that this strategy would reduce our ability, as necessary, to meet ongoing claim payments or to respond to significant catastrophe losses. In the event paid losses accelerate beyond the ability of our insurance operating units to fund these paid losses from current cash balances, current operating cash flow, coupon receipts and security maturities, we would need to liquidate a portion of our investment portfolio, make capital contributions to our insurance operating units, and/or arrange for financing. Strains on liquidity could result from:
ā¢ the occurrence of several significant catastrophic events in a relatively
short period of time;
ā¢ the sale of investments into a depressed marketplace to fund these paid
losses;
ā¢ the uncollectibility of reinsurance recoverables on these paid losses;
ā¢ the significant decrease in the value of collateral supporting reinsurance
recoverables; or ā¢ a significant reduction in our net premium collections.
We may, from time to time, make significant investments in the common stock of a public company, subject to limitations imposed by applicable regulations. Although the vast majority of our investment holdings are
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denominated in U.S. dollars, investments may be made in other currency denominations depending upon investment opportunities in those currencies, or as may be required by regulation or law.
Overview. On a consolidated basis, our invested asset portfolio was approximately$4.8 billion as ofDecember 31, 2011 , an increase of 0.5 percent fromDecember 31, 2010 . The small increase is due primarily to positive cash flow atRSUI , largely offset by repurchases of our common stock pursuant to our share repurchase program, which was terminated in connection with our entry into the merger agreement, and negative cash flow at PCC. Negative cash flow at PCC was a result of PCC ceasing to solicit new or renewal business on a direct basis commencingAugust 1, 2009 . Fair Value. The estimated carrying values and fair values of our consolidated financial instruments as ofDecember 31, 2011 andDecember 31, 2010 were as follows (in millions): December 31, 2011 December 31, 2010 Carrying Fair Carrying Fair Value Value Value Value Assets Investments (excluding equity method investments)* $ 4,670.6 $ 4,670.6 $ 4,622.7 $ 4,622.7 Liabilities Senior Notes $ 299.0 $ 314.8 $ 298.9 $ 291.8
* This table includes available-for-sale investments (securities as well as
partnership investments carried at fair value that are included in other
invested assets). This table excludes investments accounted for using the
equity method (Homesite, ORX and other investments) and certain loans
receivable that are carried at cost, all of which are included in other
invested assets. The fair value of short-term investments approximates
amortized cost. The fair value of all other categories of investments is
discussed below.
GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are not adjusted for transaction costs. In addition, GAAP has a three tiered hierarchy for inputs used in management's determination of fair value of financial instruments that emphasizes the use of observable inputs over the use of unobservable inputs by requiring that the observable inputs be used when available. Observable inputs are market participant assumptions based on market data obtained from sources independent of the reporting entity. Unobservable inputs are the reporting entity's own assumptions about market participant assumptions based on the best information available under the circumstances. In assessing the appropriateness of using observable inputs in making our fair value determinations, we consider whether the market for a particular security is "active" or not based on all the relevant facts and circumstances. For example, we may consider a market to be inactive if there are relatively few recent transactions or if there is a significant decrease in market volume. Furthermore, we consider whether observable transactions are "orderly" or not. We do not consider a transaction to be orderly if there is evidence of a forced liquidation or other distressed condition, and as such, little or no weight is given to that transaction as an indicator of fair value.
The hierarchy is broken down into three levels based on the reliability of inputs as follows:
ā¢ "Level 1" - Valuations are based on unadjusted quoted prices in active
markets for identical, unrestricted assets. Since valuations are based on
quoted prices that are readily and regularly available in an active market, valuation of these assets does not involve any meaningful degree
of judgment. An active market is defined as a market where transactions
for the financial instrument occur with sufficient frequency and volume to
provide pricing information on an ongoing basis. Our Level 1 assets
generally include publicly traded common stocks and debt securities issued
directly by theU.S. Government , where our valuations are based on quoted market prices.
ā¢ "Level 2" - Valuations are based on quoted market prices where such
markets are not deemed to be sufficiently "active." In such circumstances,
additional valuation metrics will be used which involve direct or indirect
observable market inputs. Our Level 2 assets generally include preferred
stocks and debt securities other than debt issued directly by theU.S. Government . Our Level 2 liabilities include 68
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the Senior Notes. Substantially all of the determinations of value in this
category are based on a single quote from third-party dealers and pricing
services. As we generally do not make any adjustments thereto, such quote typically constitutes the sole input in our determination of the fair value of these types of securities. In developing a quote, such third parties will use the terms of the security and market-based inputs. Terms
of the security include coupon, maturity date, and any special provisions
that may, for example, enable the investor, at its election, to redeem the
security prior to its scheduled maturity date. Market-based inputs include
the level of interest rates applicable to comparable securities in the
market place and current credit rating(s) of the security. Such quotes are
generally non-binding. ā¢ "Level 3" - Valuations are based on inputs that are unobservable and
significant to the overall fair value measurement. Valuation under Level 3
generally involves a significant degree of judgment on our part. Our
Level 3 assets are primarily limited to partnership investments. Net asset
value quotes from the third-party general partner of the entity in which
such investments are held, which will often be based on unobservable
market inputs, constitute the primary input in our determination of the fair value of such assets. We validate the reasonableness of our fair value determinations for Level 2 investment securities by testing the methodology of the relevant third-party dealer or pricing service that provides the quotes upon which the fair value determinations are made. We test the methodology by comparing such quotes with prices from executed market trades when such trades occur. We discuss with the relevant third-party dealer or pricing service any identified material discrepancy between the quote derived from its methodology and the executed market trade in order to resolve the discrepancy. We use the quote from the third-party dealer or pricing service unless we determine that the methodology used to produce such quote is not in compliance with GAAP. In addition to such procedures, we also compare the aggregate amount of the fair value for such Level 2 securities with the aggregate fair value provided by a third-party financial institution. Furthermore, we review the reasonableness of our classification of securities within the three-tiered hierarchy to ensure that the classification is consistent with GAAP. 69
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The estimated fair values of our financial instruments as ofDecember 31, 2011 andDecember 31, 2010 allocated among the three levels set forth above were as follows (in millions): Level 1 Level 2 Level 3 Total As ofDecember 31, 2011 Equity securities: Common stock(1) $ 871.0 $ - $ - $ 871.0 Preferred stock - - - - Debt securities: U.S. Government obligations 267.8 - - 267.8 Mortgage and asset-backed securities(2) - 860.5 - 860.5 States, municipalities and political subdivision bonds - 1,113.6
- 1,113.6
Foreign bonds - 83.5 - 83.5 Corporate bonds and other - 354.1 - 354.1 267.8 2,411.7 - 2,679.5 Short-term investments 54.3 1,042.2
- 1,096.5
Other invested assets(3) - - 23.6 23.6 Investments (excluding equity method investments) $ 1,193.1 $ 3,453.9 $ 23.6 $ 4,670.6 Senior Notes $ - $ 314.8 $ - $ 314.8 As ofDecember 31, 2010 Equity securities: Common stock(1) $ 1,500.7 $ - $ - $ 1,500.7 Preferred stock - - - - Debt securities: U.S. Government obligations 307.3 30.5 - 337.8 Mortgage and asset-backed securities(2) - 866.5 - 866.5 States, municipalities and political subdivision bonds - 1,068.5
- 1,068.5
Foreign bonds - 114.2 - 114.2 Corporate bonds and other - 445.4 - 445.4 307.3 2,525.1 - 2.832.4 Short-term investments 86.4 178.4 - 264.8 Other invested assets(3) - - 24.8 24.8 Investments (excluding equity method investments) $ 1,894.4 $ 2,703.5 $ 24.8 $ 4,622.7 Senior Notes $ - $ 291.8 $ - $ 291.8
(1) Of the
related to certain energy sector businesses. Of the
value as of
sector businesses.
(2) Of the
related to residential mortgage-backed securities, or "RMBS,"
related to commercial mortgage-backed securities, or "CMBS," and $218.5
million related to other asset-backed securities. Of the
fair value as of
million related to CMBS and
securities.
(3) Level 3 securities consist of partnership investments. The carrying value of
partnership investments of
primarily to net return of capital during 2011. 70
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Mortgage-and Asset-Backed Securities . As ofDecember 31, 2011 , our mortgage-and asset-backed securities portfolio consisted of the following and was backed by the following types of underlying collateral (in millions): Type of Underlying Collateral Fair Value Average Rating RMBS: guaranteed by FNMA or FHLMC(1) $ 112.8 Aa1 /AA+ RMBS: guaranteed by GNMA(2) 326.3 Aa1 /AA+ RMBS: Alt A 9.0 Aa1 /AA- RMBS: Sub-prime 2.0 Baa2 /AAA All other 410.4 Aa1/AA+ Total $ 860.5 Aa1 /AA+
(1) "FNMA" refers to the Federal National Mortgage Association, and "FHLMC"
refers to the Federal Home Loan Mortgage Corporation.
(2) "GNMA" refers to the
All of our mortgage- and asset-backed securities are current as to principal and interest. Additional information regarding our holdings of securities backed by sub-prime and Alt-A collateral as ofDecember 31, 2011 is as follows (in millions): Gross Gross Weighted Unrealized Unrealized Average
Type of Underlying Collateral Gains Losses
Life Alt-A $ 0.5 $ (0.3 ) 6.5 years Sub-prime $ - $ (0.1 ) 4.4 years
Municipal Bonds. The following table details the top five state exposures of our municipal bond portfolio (in millions):
General Special Total Obligation Revenue Fair Value Texas $ 60.5 $ 41.1 $ 101.6 Massachusetts 4.7 67.5 72.2 New York 4.7 59.2 63.9 Colorado 43.8 18.9 62.7 Illinois 34.5 23.5 58.0 All other 256.9 458.2 715.1 $ 405.1 $ 668.4 $ 1,073.5 Advance refunded /escrowed to maturity bonds
40.1
Total municipal bond portfolio $ 1,113.6 Recent Accounting Standards Recently Adopted InJuly 2010 , theFinancial Accounting Standards Board , or "FASB," issued guidance that provides for additional financial statement disclosure regarding financing receivables, including the credit quality and allowance for credit losses associated with such assets. This guidance is generally effective for interim and annual periods beginning afterDecember 15, 2010 , with certain disclosures effective for interim and annual periods ending on or afterDecember 31, 2010 . We fully adopted this guidance in the 2011 first quarter, and its implementation did not have any impact on our results of operations and financial condition. 71
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Future Application of Accounting Standards
InDecember 2011 , the FASB issued guidance on disclosure requirements related to offsetting arrangements. This guidance provides for additional financial statement disclosure regarding offsetting and related arrangements to enable financial statement users to understand the effect of those arrangements on an entity's financial position. This guidance is effective for interim and annual reporting periods beginning on or afterJanuary 1, 2013 . We will adopt this guidance in the 2013 first quarter, and we do not currently believe that its implementation will have an impact on our results of operations and financial condition. InSeptember 2011 , the FASB issued revised guidance on the testing of goodwill for impairment. This guidance simplifies how an entity tests goodwill for impairment by allowing an entity to first make a qualitative assessment to determine whether it is necessary to perform quantitative testing. Based on the results of such assessment, an entity will no longer be required to perform quantitative testing if it is more likely than not that the fair value of a reporting unit is greater than its carrying value. This guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning afterDecember 15, 2011 , with early adoption permitted. We will adopt this guidance in the 2012 first quarter, and we do not currently believe that its implementation will have an impact on our results of operations and financial condition. InJune 2011 , the FASB issued guidance on the presentation of comprehensive income. This guidance increases the prominence of other comprehensive income in the financial statements and eliminates the current option to report other comprehensive income and its components in the statement of changes in equity, and does not change the items that must be reported in other comprehensive income. This guidance is generally effective for interim and annual periods beginning afterDecember 15, 2011 . We will adopt this guidance in the 2012 first quarter, and we do not currently believe that its implementation will have an impact on our presentation of our financial statements. InMay 2011 , the FASB issued guidance that addresses requirements for measuring fair value. Among other things, this guidance clarifies that the "highest and best use" valuation premise applies only to non-financial assets, and that premiums or discounts should be applied to valuations of an individual asset or liability only when market participants would do so. This guidance also permits measurement of fair value of financial instruments (that are carried at fair value) based on an entity's net exposure to a particular market or credit risk on a net basis if there is evidence that the entity manages its financial instruments in this way. This guidance provides for additional financial statement disclosure regarding fair value measurements, including disclosure involving transfers between categories within the fair value hierarchy, and quantitative and qualitative information about fair value measurements that involve a significant degree of judgment. This guidance is effective for interim and annual periods ending afterDecember 15, 2011 . We will adopt this guidance in the first quarter of 2012, and we do not currently believe its implementation will have a material impact on our results of operations and financial condition. InOctober 2010 , the FASB issued guidance that provides additional clarification for costs associated with acquiring or renewing insurance contracts. This guidance states that only incremental, direct costs associated with the successful acquisition of a new or renewal insurance contract may be capitalized as deferred acquisition costs. Furthermore, such costs: (i) must be essential to the contract transaction; (ii) would not have been incurred had the contract transaction not occurred; and (iii) must be related directly to the acquisition activities involving underwriting, policy issuance and processing, medical and inspection, and sales force contract selling. Advertising costs should be included in deferred acquisition costs only if the capitalization criteria in separate "direct response" advertising guidance within GAAP are met. All other acquisition-related costs and other expenses should be charged to expense as incurred. This guidance is effective for interim and annual periods beginning afterDecember 15, 2011 , with early adoption permitted (but only at the beginning of an entity's annual reporting period). We will adopt this guidance prospectively in the 2012 first quarter, and we do not currently believe that its implementation will have a material impact on our results of operations and financial condition. 72
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TPA Captive Insurance Company, Inc. Earns Financial Stability RatingĀ® of A, Exceptional, from Demotech, Inc.
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