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BERKLEY W R CORP – 10-K – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
W. R. Berkley Corporation is an insurance holding company that is among the largest commercial lines writers inthe United States and operates worldwide in two segments of the property and casualty business: Insurance and Reinsurance & Monoline Excess. Our decentralized structure provides us with the flexibility to respond quickly and efficiently to local or specific market conditions and to pursue specialty business niches. It also allows us to be closer to our customers in order to better understand their individual needs and risk characteristics. While providing our business units with certain operating autonomy, our structure allows us to capitalize on the benefits of economies of scale through centralized capital, investment, reinsurance, enterprise risk management, and actuarial, financial and corporate legal staff support. The Company's primary sources of revenues and earnings are its insurance operations and its investments. An important part of our strategy is to form new businesses to capitalize on various opportunities. Over the years, the Company has formed numerous businesses that are focused on important parts of the economy in theU.S. , including healthcare, cyber security, energy and agriculture, and on growing international markets, including theAsia-Pacific region ,South America andMexico . The profitability of the Company's insurance business is affected primarily by the adequacy of premium rates. The ultimate adequacy of premium rates is not known with certainty at the time an insurance policy is issued because premiums are determined before claims are reported. The ultimate adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural and other disasters, regulatory measures and court decisions that define and change the extent of coverage and the effects of economic or social inflation on the amount of compensation for injuries or losses. General insurance prices are also influenced by available insurance capacity, i.e., the level of capital employed in the industry, and the industry's willingness to deploy that capital. The Company's profitability is also affected by its investment income and investment gains. The Company's invested assets are invested principally in fixed maturity securities. The return on fixed maturity securities is affected primarily by general interest rates, as well as the credit quality and duration of the securities. Returns available on fixed maturity investments have been at low levels for an extended period. The Company also invests in equity securities, merger arbitrage securities, investment funds, private equity, loans and real estate related assets. The Company's investments in investment funds and its other alternative investments have experienced, and the Company expects to continue to experience, greater fluctuations in investment income. The Company's share of the earnings or losses from investment funds is generally reported on a one-quarter lag in order to facilitate the timely completion of the Company's consolidated financial statements. OnFebruary 23, 2022 , the Company announced that it has entered into an agreement for the sale of a real estate investment consisting of an office building located at52 Lime Street ,London, U.K. (known as "The Scalpel") for £718 million, subject to agreed upon adjustments. The transaction is scheduled to close onMarch 7, 2022 . The Company estimates that it will realize a pretax gain of more than$300 million in the first quarter of 2022, subject to adjustment for final transaction expenses and certain items, including the impact of the foreign exchange rate at the date of the close. The COVID-19 pandemic, including the related impact on theU.S. and global economies, has materially and adversely affected our results of operations. For the year endedDecember 31, 2021 , the Company recorded approximately$58 million for current accident year COVID-19-related losses, net of reinsurance. At the same time, COVID-19 has led to reduced loss frequency in certain lines of business (which has begun to return to pre-pandemic levels as many economies and legal systems have reopened as a result of higher levels of vaccination). The ultimate impact of COVID-19 on the economy and the Company's results of operations, financial position and liquidity is not within the Company's control and remains unclear due to, among other factors, uncertainty in connection with its claims, reserves and reinsurance recoverables. The scope, duration and magnitude of the direct and indirect effects of COVID-19 continue to evolve in ways that are difficult or impossible to anticipate. While many of the potential impacts on the Company have receded as populations have begun to become vaccinated, new variants of the COVID-19 virus, including the "Omicron" variant, and the slowing of vaccination rates among certain populations, continue to create risks to the Company. As a result, the impact of COVID-19 on the Company's results of operations for the year of 2021 is not necessarily indicative of its impact for 2022 or beyond. Despite the effects of COVID-19 to date, the Company's financial position and liquidity improved for the year endedDecember 31, 2021 . 40 --------------------------------------------------------------------------------
Critical Accounting Estimates
The following presents a discussion of accounting policies and estimates
relating to reserves for losses and loss expenses, assumed reinsurance premiums
and other-than-temporary impairments of investments. Management believes these
policies and estimates are the most critical to its operations and require the
most difficult, subjective and complex judgments.
Reserves for Losses and Loss Expenses. To recognize liabilities for unpaid
losses, either known or unknown, insurers establish reserves, which is a balance
sheet account representing estimates of future amounts needed to pay claims and
related expenses with respect to insured events which have occurred. Estimates
and assumptions relating to reserves for losses and loss expenses are based on
complex and subjective judgments, often including the interplay of specific
uncertainties with related accounting and actuarial measurements. Such estimates
are also susceptible to change as significant periods of time may elapse between
the occurrence of an insured loss, the report of the loss to the insurer, the
ultimate determination of the cost of the loss and the insurer's payment of that
loss.
In general, when a claim is reported, claims personnel establish a "case
reserve" for the estimated amount of the ultimate payment based upon known
information about the claim at that time. The estimate represents an informed
judgment based on general reserving practices and reflects the experience and
knowledge of the claims personnel regarding the nature and value of the specific
type of claim. Reserves are also established on an aggregate basis to provide
for losses incurred but not reported ("IBNR") to the insurer, potential
inadequacy of case reserves and the estimated expenses of settling claims,
including legal and other fees and general expenses of administrating the claims
adjustment process. Reserves are established based upon the then current legal
interpretation of coverage provided.
In examining reserve adequacy, several factors are considered in estimating the
ultimate economic value of losses. These factors include, among other things,
historical data, legal developments, changes in social attitudes and economic
conditions, including the effects of inflation. The actuarial process relies on
the basic assumption that past experience, adjusted judgmentally for the effects
of current developments and anticipated trends, is an appropriate basis for
predicting future outcomes. Reserve amounts are based on management's informed
estimates and judgments using currently available data. As additional experience
and other data become available and are reviewed, these estimates and judgments
may be revised. This may result in reserve increases or decreases that would be
reflected in our results in periods in which such estimates and assumptions are
changed.
Reserves do not represent a certain calculation of liability. Rather, reserves
represent an estimate of what management expects the ultimate settlement and
claim administration will cost. While the methods for establishing reserves are
well tested over time, the major assumptions about anticipated loss emergence
patterns are subject to uncertainty. These estimates, which generally involve
actuarial projections, are based on management's assessment of facts and
circumstances then known, as well as estimates of trends in claims severity and
frequency, judicial theories of liability and other factors, including the
actions of third parties which are beyond the Company's control. These variables
are affected by external and internal events, such as inflation and economic
volatility, judicial and litigation trends, reinsurance coverage, legislative
changes and claim handling and reserving practices, which make it more difficult
to accurately predict claim costs. The inherent uncertainties of estimating
reserves are greater for certain types of liabilities where long periods of time
elapse before a definitive determination of liability is made. Because setting
reserves is inherently uncertain, the Company cannot provide assurance that its
current reserves will prove adequate in light of subsequent events.
Loss reserves included in the Company's financial statements represent
management's best estimates based upon an actuarially derived point estimate and
other considerations. The Company uses a variety of actuarial techniques and
methods to derive an actuarial point estimate for each business. These methods
include paid loss development, incurred loss development, paid and incurred
Bornhuetter-Ferguson methods and frequency and severity methods. In
circumstances where one actuarial method is considered more credible than the
others, that method is used to set the point estimate. For example, the paid
loss and incurred loss development methods rely on historical paid and incurred
loss data. For new lines of business, where there is insufficient history of
paid and incurred claims data, or in circumstances where there have been
significant changes in claim practices, the paid and incurred loss development
methods would be less credible than other actuarial methods. The actuarial point
estimate may also be based on a judgmental weighting of estimates produced from
each of the methods considered. Industry loss experience is used to supplement
the Company's own data in selecting "tail factors" and in areas where the
Company's own data is limited. The actuarial data is analyzed by line of
business, coverage and accident or policy year, as appropriate, for each
business.
The establishment of the actuarially derived loss reserve point estimate also
includes consideration of qualitative factors that may affect the ultimate
losses. These qualitative considerations include, among others, the impact of
re-underwriting initiatives, changes in the mix of business, changes in
distribution sources and changes in policy terms and conditions. Examples of
changes in terms and conditions that can have a significant impact on reserve
levels are the use of aggregate policy limits, the expansion of coverage
exclusions, whether or not defense costs are within policy limits, and changes
in deductibles and attachment points.
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The key assumptions used to arrive at the best estimate of loss reserves are the
expected loss ratios, rate of loss cost inflation, and reported and paid loss
emergence patterns. Expected loss ratios represent management's expectation of
losses at the time the business is priced and 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. Expected
loss ratios are estimated for each key line of business within each business.
Expected loss cost inflation is particularly important for the long-tail lines,
such as excess casualty, and claims with a high medical component, such as
workers' compensation. Reported and paid loss emergence patterns are used to
project current reported or paid loss amounts to their ultimate settlement
value. Loss development factors are based on the historical emergence patterns
of paid and incurred losses, and are derived from the Company's own experience
and industry data. The paid loss emergence pattern is also significant to excess
and assumed workers' compensation reserves because those reserves are discounted
to their estimated present value based upon such estimated payout patterns.
Management believes the estimates and assumptions it makes in the reserving
process provide the best estimate of the ultimate cost of settling claims and
related expenses with respect to insured events which have occurred; however,
different assumptions and variables could lead to significantly different
reserve estimates.
Loss frequency and severity are measures of loss activity that are considered in
determining the key assumptions described in our discussion of loss and loss
expense reserves, including expected loss ratios, rate of loss cost inflation
and reported and paid loss emergence patterns. 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
activity 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 the Company. 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 incurred but not reported losses (less IBNR is required
for lines with short reporting lags). As a result, loss reserves for lines with
short reporting lags are likely to have less variation from initial loss
estimates. For lines with short reporting lags, which include commercial
automobile, primary workers' compensation, other liability (claims-made) and
property business, the key assumption is the loss emergence pattern used to
project ultimate loss estimates from known losses paid or reported to date. For
lines of business with long reporting lags, which include other liability
(occurrence), products liability, excess workers' compensation and liability
reinsurance, the key assumption is the expected loss ratio since there is often
little paid or incurred loss data to consider. Historically, the Company has
experienced less variation from its initial loss estimates for lines of
businesses with short reporting lags than for lines of business with long
reporting lags.
The key assumptions used in calculating the most recent estimate of the loss
reserves are reviewed each quarter and adjusted, to the extent necessary, to
reflect the latest reported loss data, current trends and other factors
observed. If the actual level of loss frequency and severity are higher or lower
than expected, the ultimate losses will be different than management's estimate.
The following table reflects the impact of changes (which could be favorable or
unfavorable) in frequency and severity, relative to our assumptions, on our loss
estimate for claims occurring in 2021:
(In thousands) Frequency (+/-)
Severity (+/-) 1% 5% 10%
1% $ 98,916 $ 297,732 $ 546,252
5% 297,732 504,422 762,785
10% 546,252 762,785 1,033,450
Our net reserves for losses and loss expenses of approximately $12.8 billion as
of December 31, 2021 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. The impact of such changes would
likely be manifested gradually over the course of many years, as the magnitude
of the changes became evident.
Approximately $2.8 billion , or 22%, of the Company's net loss reserves as of
December 31, 2021 relate to the Reinsurance & Monoline Excess segment. There is
a higher degree of uncertainty and greater variability regarding estimates of
excess workers' compensation and assumed reinsurance loss reserves. In the case
of excess workers' compensation, our policies generally attach at $1 million or
higher. The claims which reach our layer therefore tend to involve the most
serious injuries and many remain open for the lifetime of the claimant, which
extends the claim settlement tail. These claims also occur less frequently but
tend to be larger than primary claims, which increases claim variability. In the
case of assumed reinsurance our loss reserve estimates are based, in part, upon
information received from ceding companies. If information received from ceding
companies is not timely or correct, the Company's estimate of ultimate losses
may not be accurate. Furthermore, due to
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delayed reporting of claim information by ceding companies, the claim settlement
tail for assumed reinsurance is also extended. Management considers the impact
of delayed reporting and the extended tail in its selection of loss development
factors for these lines of business.
Information received from ceding companies is used to set initial expected loss
ratios, to establish case reserves and to estimate reserves for incurred but not
reported losses on assumed reinsurance business. This information, which is
generally provided through reinsurance intermediaries, is gathered through the
underwriting process and from periodic claim reports and other correspondence
with ceding companies. The Company performs underwriting and claim audits of
selected ceding companies to determine the accuracy and completeness of
information provided to the Company. The information received from the ceding
companies is supplemented by the Company's own loss development experience with
similar lines of business as well as industry loss trends and loss development
benchmarks.
Following is a summary of the Company's reserves for losses and loss expenses by
business segment as of
(In thousands) 2021 2020 Insurance$ 10,060,420 $ 9,034,969 Reinsurance & Monoline Excess 2,787,942 2,585,424 Net reserves for losses and loss expenses 12,848,362 11,620,393 Ceded reserves for losses and loss expenses 2,542,526 2,164,037 Gross reserves for losses and loss expenses$ 15,390,888 $ 13,784,430
Following is a summary of the Company's net reserves for losses and loss
expenses by major line of business as of
Reported Case Incurred But
(In thousands) Reserves Not Reported Total
December 31, 2021
Other liability $ 1,724,907 $ 3,319,665 $ 5,044,572
Workers' compensation (1) 1,016,014 903,448 1,919,462
Professional liability 468,680 1,019,344 1,488,024
Commercial automobile 504,821 424,382 929,203
Short-tail lines (2) 322,917 356,242 679,159
Total Insurance 4,037,339 6,023,081 10,060,420
Reinsurance & Monoline Excess (1) (3) 1,475,623 1,312,319
2,787,942 Total$ 5,512,962 $ 7,335,400 $ 12,848,362 December 31, 2020 Other liability$ 1,534,514 $ 2,968,428 $ 4,502,942 Workers' compensation (1) 977,035 873,072 1,850,107 Professional liability 414,104 771,495 1,185,599 Commercial automobile 442,975 398,688 841,663 Short-tail lines (2) 295,313 359,345 654,658Total Insurance 3,663,941 5,371,028 9,034,969
Reinsurance & Monoline Excess (1) (3) 1,442,099 1,143,325
2,585,424 Total$ 5,106,040 $ 6,514,353 $ 11,620,393 ____________________ (1)Reserves for excess and assumed workers' compensation business are net of an aggregate net discount of$452 million and$483 million as ofDecember 31, 2021 and 2020, respectively.
(2)Short-tail lines include commercial multi-peril (non-liability), inland
marine, accident and health, fidelity and surety, boiler and machinery and other
lines.
(3)Reinsurance & Monoline Excess includes property and casualty reinsurance as
well as operations that solely retain risk on an excess basis.
43 -------------------------------------------------------------------------------- The Company evaluates reserves for losses and loss expenses on a quarterly basis. Changes in estimates of prior year losses are reported when such changes are made. The changes in prior year loss reserve estimates are generally the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as additional information becomes known regarding individual claims and aggregate claim trends. Certain of the Company's insurance and reinsurance contracts are retrospectively rated, whereby the Company collects more or less premiums based on the level of loss activity. For those contracts, changes in loss and loss expenses for prior years may be fully or partially offset by additional or return premiums.
Net prior year development (i.e, the sum of prior year reserve changes and prior
year earned premiums changes) for each of the last three years ended
(In thousands) 2021 2020 2019 Increase in prior year loss reserves$ (863) $ (627) $ (34,079) Increase in prior year earned premiums 7,510 16,807 53,511 Net favorable prior year development$ 6,647 $ 16,180 $ 19,432 The COVID-19 global pandemic has impacted, and may further impact, the Company's results through its effect on claim frequency and severity. Loss cost trends have been impacted and may be further impacted by COVID-19-related claims in certain lines of business. Losses incurred from COVID-19-related claims have been offset, to a certain extent, by lower claim frequency in certain lines of our businesses; however, as the economy and legal systems have reopened, the benefit of lower claim frequency has begun to abate. Although as populations have continued to be vaccinated against the virus and the effects of the pandemic have receded in many jurisdictions, most particularlythe United States , it remains too early to determine the ultimate net impact of COVID-19 on the Company. New variants of the COVID-19 virus, including the "Omicron" variant, and the slowing of vaccination rates among certain populations continue to create risks with respect to loss costs and the potential for renewed impact of the other effects of COVID-19 associated with economic conditions, inflation, and social distancing and work from home rules. Most of the COVID-19-related claims reported to the Company to date involve certain short-tailed lines of business, including contingency and event cancellation, business interruption, and film production delay. The Company has also received COVID-19-related claims for longer-tailed casualty lines of business such as workers' compensation and other liability; however, the estimated incurred loss impact for these reported claims are not material at this time. Given the continuing uncertainty regarding the pandemic's pervasiveness, the future impact that the pandemic may have on claim frequency and severity remains uncertain at this time. The Company has estimated the potential COVID-19 impact to its contingency and event cancellation, workers' compensation, and other lines of business under a number of possible scenarios; however, due to COVID-19's continued evolving impact, there remains a high degree of uncertainty around the Company's COVID-19 reserves. In addition, should the pandemic continue or worsen as a result of new COVID-19 variants or otherwise, governments in the jurisdictions where we operate may renew their efforts to expand policy coverage terms beyond the policy's intended coverage. Accordingly, losses arising from these actions, and the other factors described above, could exceed the Company's reserves established for those related policies. As ofDecember 31, 2021 , the Company had recognized losses for COVID-19-related claims activity, net of reinsurance, of approximately$274 million , of which$233 million relates to the Insurance segment and$41 million relates to the Reinsurance & Monoline Excess segment. Such$274 million of COVID-19-related losses included$239 million of reported losses and$35 million of IBNR. For the year endedDecember 31, 2021 , the Company recognized current accident year losses for COVID-19-related claims activity, net of reinsurance, of approximately$58 million , of which$54 million relates to the Insurance segment and$4 million relates to the Reinsurance & Monoline Excess segment.
Favorable prior year development (net of additional and return premiums) was
Insurance - Reserves for the Insurance segment developed favorably by$20 million in 2021 (net of additional and return premiums). The overall favorable development in 2021 was attributable to favorable development on the 2020 accident year, partially offset by adverse development on the 2016 through 2019 accident years. The favorable development on the 2020 accident year was largely concentrated in the commercial auto liability and other liability lines of business, including commercial multi-peril liability. During 2020 the Company achieved larger rate increases in these lines of business than were contemplated in its budget and in its initial loss ratio selections. The Company also experienced significantly lower reported claim frequency in these lines in 2020 relative to historical averages, and lower 44 -------------------------------------------------------------------------------- reported incurred losses relative to its expectations. We believe that the lower claim frequency and lower reported incurred losses were caused by the impacts of the COVID-19 pandemic, for example, lockdowns, reduced driving and traffic, work from home, and court closures. However, due to the uncertainty regarding the ultimate impacts of the pandemic on accident year 2020 incurred losses, the Company elected not to react to these lower reported trends during 2020. As more information became available and the 2020 accident year continued to mature, during 2021 the Company started to recognize favorable accident year 2020 development in response to the continuing favorable reported loss experience relative to its expectations. The adverse development on the 2016 through 2019 accident years is concentrated largely in the other liability line of business, including commercial multi-peril liability, but is also seen to a lesser extent in commercial auto liability. The adverse development for these accident years is driven by a higher than expected number of large losses reported, and particularly impacted the directors and officers liability, lawyers professional liability, and excess and surplus lines casualty classes of business. We also believe that increased social inflation is contributing to the increased number of large losses, for example, higher jury awards on cases which go to trial, and the corresponding higher demands from plaintiffs and higher values required to reach settlement on cases which do not go to trial. Reinsurance & Monoline Excess - Reserves for the Reinsurance & Monoline Excess segment developed unfavorably by$13 million in 2021. The unfavorable development in the segment was driven by the non-proportional reinsurance assumed liability and other liability lines of business, related primarily to accident years 2017 through 2019, and was partially offset by favorable development in excess workers' compensation business which was spread across many prior accident years. The unfavorable non-proportional reinsurance assumed liability and other liability development was associated with ourU.S. andU.K. assumed reinsurance business, and related primarily to accounts insuring construction projects and professional liability exposures.
Favorable prior year development (net of additional and return premiums) was
million
Insurance - Reserves for the Insurance segment developed favorably by$24 million in 2020 (net of additional and return premiums). Continuing the pattern seen in recent years, the overall favorable development in 2020 resulted from more significant favorable development on workers' compensation business, which was partially offset by unfavorable development on professional liability, including excess professional liability For workers' compensation, the favorable development was spread across almost all prior accident years, including prior to 2011, but was most significant in accident years 2016 through 2019. The favorable workers' compensation development reflects a continuation of the benign loss cost trends experienced during recent years, particularly the favorable claim frequency trends (i.e., number of reported claims per unit of exposure). The long term trend of declining workers' compensation frequency can be attributable to improved workplace safety. Loss severity trends were also aided by our continued investment in claims handling initiatives such as medical case management services and vendor savings through usage of preferred provider networks and pharmacy benefit managers. Reported workers' compensation losses in 2020 continued to be below our expectations at most of our businesses, and were below the assumptions underlying our initial loss ratio picks and our previous reserve estimates for most prior accident years. For professional liability business, unfavorable development was driven mainly by large losses reported in the directors and officers ("D&O"), lawyers professional and excess hospital professional liability lines of business. For these lines of business, we continue to see an increase in the number of large losses reported and a lengthening of the reporting "tail" beyond historical levels. We believe a contributing cause is rising social inflation in the form of, for example, higher jury awards on cases that go to trial, and the corresponding higher demands from plaintiffs and higher values required to reach settlement on cases that do not go to trial. The unfavorable development for professional liability affected mainly accident years 2016 through 2018. Reinsurance & Monoline Excess - Reserves for the Reinsurance & Monoline Excess segment developed unfavorably by$8 million in 2020. The unfavorable development in the segment was driven by non-proportional assumed liability business written in both theU.S. andU.K. , and was partially offset by favorable development on excess workers' compensation business. The unfavorable non-proportional assumed liability development was concentrated in accident years 2014 through 2018, and related primarily to accounts insuring construction projects and professional liability exposures.
Favorable prior year development (net of additional and return premiums) was
million
Insurance - Reserves for the Insurance segment developed favorably by$21 million in 2019 (net of additional and return premiums). This overall favorable development resulted from more significant favorable development on workers' compensation business, which was partially offset by unfavorable development on professional liability and general liability business. 45 -------------------------------------------------------------------------------- For workers' compensation, the favorable development was spread across many accident years, including prior to 2010, but was most significant in accident years 2014 through 2018, and particularly 2017 and 2018. The favorable workers' compensation development reflects a continuation during 2019 of the benign loss cost trends experienced during recent years, particularly the favorable claim frequency trends (i.e., number of reported claims per unit of exposure). The long term trend of declining workers' compensation frequency can be attributable to improved workplace safety. Loss severity trends were also aided by our continued investment in claims handling initiatives such as medical case management services and vendor savings through usage of preferred provider networks and pharmacy benefit managers. Our initial loss ratio "picks" for this line of business over the past few accident years have contemplated an increase in loss cost trends and reflect decreasing premium rates in the marketplace; reported workers' compensation losses in 2019 continued to be below our expectations at most of our operating units, and were below the assumptions underlying our initial loss ratio picks and our previous reserve estimates. For professional liability business, the unfavorable development was driven mainly by an increase in the number of large losses reported in the lawyers professional liability and directors and officers ("D&O") liability lines of business. Many of the lawyers large losses involved claims made against insured law firms relating to work performed on matters stemming from the 2008 financial crisis. These claims affected mainly accident years 2013 through 2016. In addition, for both of these lines of business, we have seen evidence of social inflation in the form of higher jury awards on cases that go to trial, and corresponding higher demands from plaintiffs and higher values required to reach settlement on cases that do not go to trial. The unfavorable development for D&O affected mainly accident years 2014 through 2017. For general liability business, most of the unfavorable development emanated from our excess and surplus lines (E&S) businesses, and was driven by an increase in the number of large losses reported. Many of these large losses were from construction and contracting classes of business, which have also been impacted by social inflation. The general liability unfavorable development impacted mainly accident years 2015 through 2018. Reinsurance & Monoline Excess - Reserves for the Reinsurance & Monoline Excess segment developed unfavorably by$2 million in 2019. The unfavorable development in the segment was driven by non-proportional assumed liability business in both theU.S. andU.K. , and was largely offset by favorable development on excess workers' compensation business. The unfavorable non-proportional assumed liability development was concentrated in accident years 2015 through 2018, and included an adjustment for the Ogden discount rate in theU.K. Reserve Discount. The Company discounts its liabilities for certain workers' compensation reserves. The amount of workers' compensation reserves that were discounted was$1,387 million and$1,655 million atDecember 31, 2021 and 2020, respectively. The aggregate net discount for those reserves, after reflecting the effects of ceded reinsurance, was$452 million and$483 million atDecember 31, 2021 and 2020, respectively. AtDecember 31, 2021 , discount rates by year ranged from 0.7% to 6.5%, with a weighted average discount rate of 3.4%. Substantially all discounted workers' compensation reserves (97% of total discounted reserves atDecember 31, 2021 ) are excess workers' compensation reserves. In order to properly match loss expenses with income earned on investment securities supporting the liabilities, reserves for excess workers' compensation business are discounted using risk-free discount rates determined by reference to theU.S. Treasury yield curve. These rates are determined annually based on the weighted average rate for the period. Once established, no adjustments are made to the discount rate for that period, and any increases or decreases in loss reserves in subsequent years are discounted at the same rate, without regard to when any such adjustments are recognized. The expected loss and loss expense payout patterns subject to discounting are derived from the Company's loss payout experience. The Company also discounts reserves for certain other long-duration workers' compensation reserves (representing approximately 3% of total discounted reserves atDecember 31, 2021 ), including reserves for quota share reinsurance and reserves related to losses regarding occupational lung disease. These reserves are discounted at statutory rates prescribed or permitted by theDepartment of Insurance of the State of Delaware . Assumed Reinsurance Premiums. The Company estimates the amount of assumed reinsurance premiums that it will receive under treaty reinsurance agreements at the inception of the contracts. These premium estimates are revised as the actual amount of assumed premiums is reported to the Company by the ceding companies. As estimates of assumed premiums are made or revised, the related amount of earned premiums, commissions and incurred losses associated with those premiums are recorded. Estimated assumed premiums receivable were approximately$60 million and$44 million atDecember 31, 2021 and 2020, respectively. The assumed premium estimates are based upon terms set forth in reinsurance agreements, information received from ceding companies during the underwriting and negotiation of agreements, reports received from ceding companies and discussions and correspondence with reinsurance intermediaries. The Company also considers its own view of market conditions, economic trends and experience with similar lines of business. These premium estimates represent management's best estimate of the ultimate amount of premiums to be received under its assumed reinsurance agreements. 46
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Allowance for Expected Credit Losses on Investments.
Fixed Maturity Securities - For fixed maturity securities in an unrealized loss position where the Company intends to sell, or it is more likely than not that it will be required to sell the security before recovery in value, the amortized cost basis is written down to fair value through net investment gains (losses). For fixed maturity securities in an unrealized loss position where the Company does not intend to sell, or it is more likely than not that it will not be required to sell the security before recovery in value, the Company evaluates whether the decline in fair value has resulted from credit losses or all other factors (non-credit factors). In making this assessment, the Company considers the extent to which fair value is less than amortized cost, changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, an allowance for expected credit losses is recorded for the credit loss through net investment gains (losses), limited by the amount that the fair value is less than the amortized cost basis. EffectiveJanuary 1, 2020 , the allowance is adjusted for any change in expected credit losses and subsequent recoveries through net investment gains (losses). The impairment related to non-credit factors is recognized in other comprehensive income (loss) . The Company's credit assessment of allowance for expected credit losses uses a third party model for available for sale and held to maturity securities, as well as loans receivable. The allowance for expected credit losses is generally based on the performance of the underlying collateral under various economic and default scenarios that involve subjective judgments and estimates by management. Modeling these securities involves various factors, such as projected default rates, the nature and realizable value of the collateral, if any, the ability of the issuer to make scheduled payments, historical performance and other relevant economic and performance factors. A discounted cash flow analysis is used to ascertain the amount of the allowance for expected credit losses, if any. In general, the model reverts to the rating-level long-term average marginal default rates based on 10 years of historical data, beyond the forecast period. For other inputs, the model in most cases reverts to the baseline long-term assumptions linearly over 5 years beyond the forecast period. The long-term assumptions are based on the historical averages. The Company classifies its fixed maturity securities by credit rating, primarily based on ratings assigned by credit rating agencies. For purposes of classifying securities with different ratings, the Company uses the average of the credit ratings assigned, unless in limited situations the Company's own analysis indicates an internal rating is more appropriate. Securities that are not rated by a rating agency are evaluated and classified by the Company on a case-by-case basis. A summary of the Company's non-investment grade fixed maturity securities that were in an unrealized loss position atDecember 31, 2021 is presented in the table below. Number of Aggregate Unrealized ($ in thousands) Securities Fair Value Loss Foreign government 38$ 130,621 $ 38,849 Corporate 8 26,903 1,644 Mortgage-backed securities 4 210 13 Asset-backed securities 2 154 14 State and municipal 1 14,594 411 Total 53$ 172,482 $ 40,931 As ofDecember 31, 2021 , the Company has recorded an allowance for expected credit losses on fixed maturity securities of$23 million . The Company has evaluated the remaining fixed maturity securities in an unrealized loss position and believes the unrealized losses are due primarily to temporary market and sector-related factors rather than to issuer-specific factors. None of these securities are delinquent or in default under financial covenants. Based on its assessment of these issuers, the Company expects them to continue to meet their contractual payment obligations as they become due. Loans Receivable - For loans receivable, the Company estimates an allowance for expected credit losses based on relevant information about past events, including historical loss experience, current conditions and forecasts that affect the expected collectability of the amortized cost of the financial asset. The allowance for expected credit losses is presented as a reduction to amortized cost of the financial asset in the consolidated balance sheet and changes to the estimate for expected credit losses are recognized through net investment gains (losses). Loans receivable are reported net of an allowance for expected credit losses of$2 million and$5 million as ofDecember 31, 2021 and 2020, respectively. Fair Value Measurements. The Company's fixed maturity available for sale securities, equity securities, and its trading account securities are carried at fair value. Fair value is defined as "the price that would be received to sell an asset or 47 -------------------------------------------------------------------------------- paid to transfer a liability in an orderly transaction between market participants at the measurement date". The Company utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for similar assets in active markets. Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs may only be used to measure fair value to the extent that observable inputs are not available. The fair value of the vast majority of the Company's portfolio is based on observable data (other than quoted prices) and, accordingly, is classified as Level 2. In classifying particular financial securities in the fair value hierarchy, the Company uses its judgment to determine whether the market for a security is active and whether significant pricing inputs are observable. The Company determines the existence of an active market by assessing whether transactions occur with sufficient frequency and volume to provide reliable pricing information. The Company determines whether inputs are observable based on the use of such information by pricing services and external investment managers, the uninterrupted availability of such inputs, the need to make significant adjustments to such inputs and the volatility of such inputs over time. If the market for a security is determined to be inactive or if significant inputs used to price a security are determined to be unobservable, the security is categorized in Level 3 of the fair value hierarchy. Because many fixed maturity securities do not trade on a daily basis, the Company utilizes pricing models and processes which may include benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Market inputs used to evaluate securities include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. Quoted prices are often unavailable for recently issued securities that are infrequently traded or securities that are only traded in private transactions. For publicly traded securities for which quoted prices are unavailable, the Company determines fair value based on independent broker quotations and other observable market data. For securities traded only in private negotiations, the Company determines fair value based primarily on the cost of such securities, which is adjusted to reflect prices of recent placements of securities of the same issuer, financial data, projections and business developments of the issuer and other relevant information.
The following is a summary of pricing sources for the Company's fixed maturity
securities available for sale as of
Carrying Percent
(In thousands) Value of Total
Pricing source:
Independent pricing services
Syndicate manager
54,508 0.3 Directly by the Company based on: Observable data 212,747 1.3 Total$ 16,528,692 100.0 % Independent pricing services - Substantially all of the Company's fixed maturity securities available for sale were priced by independent pricing services (generally oneU.S. pricing service plus additional pricing services with respect to a limited number of foreign securities held by the Company). The prices provided by the independent pricing services are generally based on observable market data in active markets (e.g., broker quotes and prices observed for comparable securities). The determination of whether markets are active or inactive is based upon the volume and level of activity for a particular asset class. The Company reviews the prices provided by pricing services for reasonableness based upon current trading levels for similar securities. If the prices appear unusual to the Company, they are re-examined and the value is either confirmed or revised. In addition, the Company periodically performs independent price tests of a sample of securities to ensure proper valuation and to verify our understanding of how securities are priced. As ofDecember 31, 2021 , the Company did not make any adjustments to the prices provided by the pricing services. Based upon the Company's review of the methodologies used by the independent pricing services, these securities were classified as Level 2. Syndicate manager - The Company has a 15% participation in a Lloyd's syndicate, and the Company's share of the securities owned by the syndicate is priced by the syndicate's manager. The majority of the securities are liquid, short duration fixed maturity securities. The Company reviews the syndicate manager's pricing methodology and audited financial statements and holds discussions with the syndicate manager as necessary to confirm its understanding and agreement with security prices. Based upon the Company's review of the methodologies used by the syndicate manager, these securities were classified as Level 2. 48 -------------------------------------------------------------------------------- Observable data - If independent pricing is not available, the Company prices the securities directly. Prices are based on observable market data where available, including current trading levels for similar securities and non-binding quotations from brokers. The Company generally requests two or more quotes. If more than one quote is received, the Company sets a price within the range of quotes received based on its assessment of the credibility of the quote and its own evaluation of the security. The Company generally does not adjust quotes obtained from brokers. Since these securities were priced based on observable data, they were classified as Level 2. Cash flow model - If the above methodologies are not available, the Company prices securities using a discounted cash flow model based upon assumptions as to prevailing credit spreads, interest rates and interest rate volatility, time to maturity and subordination levels. Discount rates are adjusted to reflect illiquidity where appropriate. These securities were classified as Level 3. 49 --------------------------------------------------------------------------------
Results of Operations for the Years Ended
Business Segment Results
Following is a summary of gross and net premiums written, net premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of net premiums earned), expense ratios (underwriting expenses expressed as a percentage of net premiums earned) and GAAP combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the years endedDecember 31, 2021 and 2020. The GAAP combined ratio represents a measure of underwriting profitability, excluding investment income. A GAAP combined ratio in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit. (In thousands) 2021 2020 Insurance Gross premiums written$ 9,471,667 $ 7,837,496 Net premiums written 7,743,814 6,347,101 Net premiums earned 7,077,708 6,067,669 Loss ratio 61.1 % 64.9 % Expense ratio 28.3 30.3 GAAP combined ratio 89.4 95.2 Reinsurance & Monoline Excess Gross premiums written$ 1,228,467 $ 1,010,151 Net premiums written 1,119,053 915,336 Net premiums earned 1,028,323 863,174 Loss ratio 61.0 % 61.3 % Expense ratio 29.7 31.8 GAAP combined ratio 90.7 93.1 Consolidated Gross premiums written$ 10,700,134 $ 8,847,647 Net premiums written 8,862,867 7,262,437 Net premiums earned 8,106,031 6,930,843 Loss ratio 61.1 % 64.5 % Expense ratio 28.5 30.4 GAAP combined ratio 89.6 94.9 Net Income to Common Stockholders. The following table presents the Company's net income to common stockholders and net income per diluted share for the years endedDecember 31, 2021 and 2020. (In thousands, except per share data) 2021 2020
Net income to common stockholders
Weighted average diluted shares
186,499 188,763 Net income per diluted share$ 5.48 $ 2.81 The Company reported net income of$1,022 million in 2021 compared to$531 million in 2020. The$491 million increase in net income was primarily due to an after-tax increase in underwriting income of$397 million mainly due to the growth in premium rates and exposure as well as reductions in loss ratio partly due to lower catastrophe losses and in expense ratio driven by net earned premium growth outpacing expense growth, an after-tax increase in net investment income of$71 million primarily due to investment funds, a reduction of$33 million in tax expense due to a change in the effective tax rate, an after-tax increase in foreign currency gains of$21 million , an after-tax increase in profits from non-insurance businesses of$9 million due to sales rebounding from the pandemic, an after-tax increase in profit from insurance service businesses of$4 million , and an after-tax reduction in interest expenses of$3 million due to early refinancings, partially offset by an after-tax increase in corporate expenses of$31 million mainly due to increased incentive compensation costs, an after-tax reduction in net investment gains of$10 million primarily due to the sale of real estate in 2020 and an after-tax increase of$6 million in minority interest. The number of weighted average diluted shares decreased by 2.3 million for 2021 compared to 2020 mainly reflecting shares repurchased in 2020 and 2021. Premiums. Gross premiums written were$10,700 million in 2021, an increase of 21% from$8,848 million in 2020. The increase was due to the growth in the Insurance segment of$1,634 million and$218 million in the Reinsurance & Monoline Excess segment. Approximately 82% of premiums expiring in 2021 were renewed, and 79% of premiums expiring in 50 --------------------------------------------------------------------------------
2020 were renewed.
Average renewal premium rates for insurance and facultative reinsurance
increased 9.1% in 2021 and 11.3% in 2020, when adjusted for changes in
exposures. Average renewal premium rates for insurance and facultative
reinsurance excluding workers' compensation increased 10.4% in 2021 and 13.6% in
2020, when adjusted for changes in exposures.
A summary of gross premiums written in 2021 compared with 2020 by line of business within each business segment follows: •Insurance gross premiums increased 21% to$9,472 million in 2021 from$7,837 million in 2020. Gross premiums increased$557 million (20%) for other liability,$497 million (42%) for professional liability,$272 million (15%) for short-tail lines,$261 million (28%) for commercial auto, and$48 million (4%) for workers' compensation. •Reinsurance & Monoline Excess gross premiums increased 22% to$1,228 million in 2021 from$1,010 million in 2020. Gross premiums written increased$173 million (29%) for casualty lines,$33 million (17%) for monoline excess, and$12 million (5%) for property lines. Net premiums written were$8,863 million in 2021, an increase of 22% from$7,262 million in 2020. Ceded reinsurance premiums as a percentage of gross written premiums were 17% in 2021 and 18% in 2020. Premiums earned increased 17% to$8,106 million in 2021 from$6,931 million in 2020. Insurance premiums (including the impact of rate changes) are generally earned evenly over the policy term, and accordingly recent rate increases will be earned over the upcoming quarters. Premiums earned in 2021 are related to business written during both 2021 and 2020. Audit premiums were$195 million in 2021 compared with$128 million in 2020.
Net Investment Income. Following is a summary of net investment income for the
years ended
Average Annualized
Amount Yield
(In thousands) 2021 2020 2021 2020
Fixed maturity securities, including cash and
cash equivalents and loans receivable $ 382,001 $ 426,563 2.2 % 2.7 %
Investment funds 220,014 54,253 15.8 4.5
Arbitrage trading account 37,676 77,931 5.3 14.6
Real estate 7,703 24,027 0.4 1.2
Equity securities 32,020 10,172 5.0 2.7
Gross investment income 679,414 592,946 3.1 3.0
Investment expenses (7,796) (9,125) - -
Total $ 671,618 $ 583,821 3.0 % 2.9 %
Net investment income increased 15% to $672 million in 2021 from $584 million in
2020 primarily due to a $166 million increase in income from investment funds, a
$22 million increase in equity securities and an $1 million reduction in
investment expenses, partially offset by a $45 million reduction in income from
fixed maturity securities driven by lower investment yields, a $40 million
reduction in arbitrage trading account and a $16 million reduction from real
estate. Investment funds are reported on a one quarter lag. The average
annualized yield for fixed maturity securities was 2.2% in 2021 and 2.7% in
2020. The effective duration of the fixed maturity portfolio was 2.4 years at
both December 31, 2021 and 2020. The Company maintained the shortened duration
of its fixed maturity security portfolio, thereby reducing the potential impact
of mark-to-market on the portfolio and positioning the Company to react quickly
to changes in the current interest rate environment. Average invested assets, at
cost (including cash and cash equivalents), were $22.2 billion in 2021 and $20.0
billion in 2020.
Insurance Service Fees. The Company earns fees from an insurance distribution
business, a third-party administrator, and as a servicing carrier of workers'
compensation assigned risk plans for certain states. Insurance service fees
increased to $94 million in 2021 from $89 million in 2020.
Net Realized and Unrealized Gains on Investments. The Company buys and sells
securities and other investment assets on a regular basis in order to maximize
its total return on investments. Decisions to sell securities and other
investment assets are based on management's view of the underlying fundamentals
of specific investments as well as management's expectations regarding interest
rates, credit spreads, currency values and general economic conditions. Net
realized and unrealized gains on investments were $107 million in 2021 compared
with $74 million in 2020. In 2021, the gains reflected net realized gains on
investments of $145 million were partially offset by a change in unrealized
losses on equity securities of $38 million . In 2020,
51
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the gains reflected net realized gains on investments of $99 million , primarily
including the sale of a building for a gain of $105 million , partially offset by
an increase in unrealized losses on equity securities of $25 million .
Change in Allowance for Expected Credit Losses on Investments. Based on credit
factors, the allowance for expected credit losses is increased or decreased
depending on the percentage of unrealized loss relative to amortized cost by
security, changes in rating of the security by a rating agency, and adverse
conditions specifically related to the security, among other factors. For the
year ended December 31, 2021 , the pre-tax change in allowance for expected
credit losses on investments increased by $16 million ($13 million after-tax),
which is reflected in net investment gains, primarily related to foreign
government securities which did not previously have an allowance. For the year
ended December 31, 2020 , the pre-tax change in allowance for expected credit
losses on investments decreased by $29 million ($23 million after-tax), which is
reflected in net investment gains.
Revenues from Non-Insurance Businesses. Revenues from non-insurance businesses
were derived from businesses engaged in the distribution of promotional
merchandise, world-wide textile solutions, and aviation-related businesses that
provide services to aviation markets, including (i) the distribution,
manufacturing, repair and overhaul of aircraft parts and components, (ii) the
sale of new and used aircraft, and (iii) avionics, fuel, maintenance, storage
and charter services. Revenues from non-insurance businesses were $489 million
in 2021 and $390 million in 2020. The increase mainly relates to the business
recovery from COVID-19 on aviation-related and textile businesses.
Losses and Loss Expenses. Losses and loss expenses increased to $4,954 million
in 2021 from $4,469 million in 2020. The consolidated loss ratio was 61.1% in
2021 and 64.5% in 2020. Catastrophe losses, net of reinsurance recoveries, were
$202 million (including current accident year losses of approximately $58
million related to COVID-19) in 2021 compared with $340 million in 2020
(including losses of approximately $171 million related to COVID-19). Favorable
prior year reserve development (net of premium offsets) was $7 million in 2021
compared with $16 million in 2020. The loss ratio excluding catastrophe losses
and prior year reserve development decreased 1.1 points to 58.7% in 2021 from
59.8% in 2020.
A summary of loss ratios in 2021 compared with 2020 by business segment follows:
•Insurance - The loss ratio of 61.1% in 2021 was 3.8 points lower than the loss ratio of 64.9% in 2020. Catastrophe losses were$150 million in 2021 compared with$307 million in 2020. The Company reflected a best estimate (net of reinsurance) based upon available information for current accident year COVID-19-related losses of approximately$54 million , primarily related to contingency and event cancellation coverage. Favorable prior year reserve development was$20 million in 2021 compared with$24 million in 2020. The loss ratio excluding catastrophe losses and prior year reserve development decreased 0.9 points to 59.3% in 2021 from 60.2% in 2020. •Reinsurance & Monoline Excess - The loss ratio of 61.0% in 2021 was 0.3 points lower than the loss ratio of 61.3% in 2020. Catastrophe losses were$52 million in 2021 compared with$33 million in 2020. The Company reflected a best estimate (net of reinsurance) based upon available information for current accident year COVID-19-related losses of approximately$4 million , primarily related to excess workers' compensation. Adverse prior year reserve development was$13 million in 2021 compared with$8 million in 2020. The loss ratio excluding catastrophe losses and prior year reserve development decreased 1.9 points to 54.7% in 2021 from 56.6% in 2020. Other Operating Costs and Expenses. Following is a summary of other operating costs and expenses: (In thousands) 2021 2020
Policy acquisition and insurance operating expenses
Insurance service expenses
86,003
85,724
Net foreign currency (gains) losses (25,725) 363 Debt extinguishment costs 11,521 8,440 Other costs and expenses 220,744 184,852 Total$ 2,599,270 $ 2,390,392 Policy acquisition and insurance operating expenses are comprised of commissions paid to agents and brokers, premium taxes and other assessments and internal underwriting costs. Policy acquisition and insurance operating expenses increased 9% from 2020, while net premiums earned increased 17% over that period. The expense ratio (policy acquisition and insurance operating expenses expressed as a percentage of premiums earned) was 28.5% in 2021 and 30.4% in 2020. The improvement is primarily attributable to higher net premiums earned outpacing compensation expense growth. However, to the extent our net premiums earned decrease or travel and entertainment expenses increase, due to the impact of the COVID-19 pandemic or otherwise, our expense ratio would be expected to increase. 52 --------------------------------------------------------------------------------
Service expenses, which represent the costs associated with the fee-based
businesses, was
Net foreign currency (gains) losses result from transactions denominated in a currency other than a businesses' functional currency. Net foreign currency gains was$26 million in 2021 compared to losses of$0.4 million in 2020, mainly due toU.S. dollar strengthening in relation to a wide spectrum of currencies in 2021. Debt extinguishment costs of$12 million in 2021 related to the redemption of$400 million of subordinated debentures in March andJune 2021 that were due in 2056. Debt extinguishment costs of$8 million in 2020 related to the redemption of subordinated debentures that were due in 2053. Other costs and expenses represent general and administrative expenses of the parent company and other expenses not allocated to business segments, including the cost of certain long-term incentive plans and new business ventures. Other costs and expenses increased to$221 million in 2021 from$185 million in 2020, primarily due to the increase in performance-based compensation costs in 2021. Expenses from Non-Insurance Businesses. Expenses from non-insurance businesses represent costs associated with businesses engaged in the distribution of promotional merchandise, world-wide textile solutions, and aviation-related businesses that include (i) cost of goods sold related to aircraft and products sold and services provided and (ii) general and administrative expenses. Expenses from non-insurance businesses were$472 million in 2021 compared to$384 million in 2020. The increase mainly relates to the business recovery from COVID-19 on aviation-related and textile businesses. Interest Expense. Interest expense was$147 million in 2021 and$151 million in 2020. InMay 2020 , the Company issued$300 million aggregate principal amount of 4.00% senior notes due 2050. InSeptember 2020 , the Company issued an additional$170 million aggregate principal amount of 4.00% senior notes due 2050 and$250 million aggregate principal amount of 4.25% subordinated debentures due 2060 and repaid$300 million aggregate principal amount of 5.375% senior notes at maturity. InOctober 2020 , the Company redeemed$350 million aggregate principal amount of 5.625% subordinated debentures due 2053. InFebruary 2021 , the Company issued$300 million aggregate principal amount of 4.125% subordinated debentures due 2061. InMarch 2021 , the Company issued$400 million aggregate principal amount of 3.55% senior notes due 2052 and redeemed its$110 million aggregate principal amount of 5.90% subordinated debentures due 2056. InJune 2021 , the Company redeemed the$290 million aggregate principal amount of its 5.75% subordinated debentures due 2056. InSeptember 2021 , the Company issued$350 million aggregate principal amount of 3.15% senior notes due 2061. The redemptions resulted in debt extinguishment costs of$12 million in 2021. Additionally, in the second quarter of 2021, the Company sold a real estate asset which, resulted in a$102 million reduction of the Company's non-recourse debt that was supporting the property.
The redemption of debentures and issuance of additional debentures in 2021
combined with maturities in 2022, as described below in "Liquidity and Capital
Resources -- Debt," are expected to decrease interest expense in 2022 and
forward.
Income Taxes. The effective income tax rate was 19.6% in 2021 and 24.4% in 2020. The effective income tax rate differs from the federal income tax rate of 21% principally driven by tax benefits attributable to tax-exempt investment income and equity-based compensation. See Note 16 of the Consolidated Financial Statements for a reconciliation of the income tax expense and the amounts computed by applying the Federal and foreign income tax rate of 21%.
The Company has not provided
earnings of approximately
these earnings are intended to be permanently reinvested in the non-
subsidiaries. In the future, if such earnings were distributed the Company
projects that the incremental tax, if any, will be immaterial.
Results of Operations for the Years Ended
For a comparison of the Company's results of operations for the year endedDecember 31, 2020 to the year endedDecember 31, 2019 , see Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2020 , which was filed with theSecurities and Exchange Commission onFebruary 18, 2021 . 53
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Investments
As part of its investment strategy, the Company establishes a level of cash and highly liquid short-term and intermediate-term securities that, combined with expected cash flow, it believes is adequate to meet its payment obligations. Due to the low fixed maturity investment returns, the Company invests in equity securities, merger arbitrage securities, investment funds, private equity, loans and real estate related assets. The Company's investments in investment funds and its other alternative investments have experienced, and the Company expects to continue to experience, greater fluctuations in investment income. The Company also attempts to maintain an appropriate relationship between the effective duration of the investment portfolio and the approximate duration of its liabilities (i.e., policy claims and debt obligations). The effective duration of the investment portfolio was 2.4 years at bothDecember 31, 2021 and 2020. The Company's investment portfolio and investment-related assets as ofDecember 31, 2021 were as follows: Carrying Percent ($ in thousands) Value of Total Fixed maturity securities: U.S. government and government agencies$ 855,343 3.6 % State and municipal: Special revenue 2,092,438 8.8 State general obligation 455,323 1.9 Local general obligation 430,697 1.8 Pre-refunded (1) 222,225 1.0 Corporate backed 172,602 0.7 Total state and municipal 3,373,285 14.2 Mortgage-backed securities: Agency 752,318 3.2 Residential-Prime 186,260 0.8 Commercial 128,756 0.5 Residential-Alt A 5,570 - Total mortgage-backed securities 1,072,904 4.5 Asset-backed securities 4,490,565 18.9 Corporate: Industrial 3,273,163 13.8 Financial 1,763,400 7.4 Utilities 406,302 1.7 Other 152,810 0.7 Total corporate 5,595,675 23.6 Foreign government 1,214,901 5.1 Total fixed maturity securities 16,602,673 69.9 Equity securities available for sale: Common stocks 695,403 2.9 Preferred stocks 245,840 1.1 Total equity securities available for sale 941,243 4.0 Cash and cash equivalents 1,568,843 6.6 Real estate 1,852,508 7.8 Investment funds 1,480,612 6.2 Arbitrage trading account 1,179,606 5.0 Loans receivable 115,172 0.5 Total investments$ 23,740,657 100.0 % ______________ (1)Pre-refunded securities are securities for which an escrow account has been established to fund the remaining payments of principal and interest through maturity. Such escrow accounts are funded almost exclusively withU.S. Treasury andU.S. government agency securities.Fixed Maturity Securities . The Company's investment policy with respect to fixed maturity securities is generally to purchase instruments with the expectation of holding them to their maturity. However, management of the available for sale 54 -------------------------------------------------------------------------------- portfolio is considered necessary to maintain an approximate matching of assets and liabilities as well as to adjust the portfolio as a result of changes in financial market conditions and tax considerations. The Company's philosophy related to holding or selling fixed maturity securities is based on its objective of maximizing total return. The key factors that management considers in its investment decisions as to whether to hold or sell fixed maturity securities are its view of the underlying fundamentals of specific securities as well as its expectations regarding interest rates, credit spreads and currency values. In a period in which management expects interest rates to rise, the Company may sell longer duration securities in order to mitigate the impact of an interest rate rise on the fair value of the portfolio. Similarly, in a period in which management expects credit spreads to widen, the Company may sell lower quality securities, and in a period in which management expects certain foreign currencies to decline in value, the Company may sell securities denominated in those foreign currencies. The sale of fixed maturity securities in order to achieve the objective of maximizing total return may result in realized gains; however, there is no reason to expect these gains to continue in future periods.
and preferred stocks in companies with potential growth opportunities in
different sectors, mainly in the financial institutions and energy sectors.
Investment Funds. AtDecember 31, 2021 , the carrying value of investment funds was$1,481 million , including investments in financial services funds of$432 million , transportation funds of$337 million , other funds of$288 million (which includes a deferred compensation trust asset of$34 million ), real estate funds of$274 million , and energy funds of$150 million . Investment funds are primarily reported on a one-quarter lag. Real Estate. Real estate is directly owned property held for investment. AtDecember 31, 2021 , real estate properties in operation included a long-term ground lease inWashington D.C. , an office complex inNew York City , an office building inLondon , and the completed portion of a mixed-use project inWashington D.C. In addition, part of the previously mentioned mixed-use project inWashington D.C. is under development. The Company expects to fund further development costs for the project with a combination of its own funds and external financing. Arbitrage Trading Account. The arbitrage trading account is comprised of direct investments in arbitrage securities. Merger arbitrage is the business of investing in the securities of publicly held companies that are the targets in announced tender offers and mergers. Loans Receivable. Loans receivable, which are carried at amortized cost (net of allowance for expected credit losses), had an amortized cost of$115 million and an aggregate fair value of$117 million atDecember 31, 2021 . The amortized cost of loans receivable is net of an allowance for expected credit losses of$2 million as ofDecember 31, 2021 . Loans receivable include real estate loans of$89 million that are secured by commercial and residential real estate located primarily inNew York . Real estate loans generally earn interest at fixed or stepped interest rates and have maturities through 2026. Loans receivable include commercial loans of$26 million that are secured by business assets and have fixed interest rates with varying maturities not exceeding 10 years. 55 --------------------------------------------------------------------------------
Liquidity and Capital Resources
Cash Flow. Cash flow provided from operating activities increased to$2,184 million in 2021 from$1,617 million in 2020, primarily due to an increase in premium receipts, net of reinsurance and commissions settled, partially offset by loss and loss expense payments as well as payments to tax authorities. The Company's insurance subsidiaries' principal sources of cash are premiums, investment income, service fees and proceeds from sales and maturities of portfolio investments. The principal uses of cash are payments for claims, taxes, operating expenses and dividends. The Company expects its insurance subsidiaries to fund the payment of losses with cash received from premiums, investment income and fees. The Company generally targets an average duration for its investment portfolio that is within 1.5 years of the average duration of its liabilities so that portions of its investment portfolio mature throughout the claim cycle and are available for the payment of claims if necessary. In the event operating cash flow and proceeds from maturities and prepayments of fixed maturity securities are not sufficient to fund claim payments and other cash requirements, the remainder of the Company's cash and investments is available to pay claims and other obligations as they become due. The Company's investment portfolio is highly liquid, with approximately 76.6% invested in cash, cash equivalents and marketable fixed maturity securities as ofDecember 31, 2021 . If the sale of fixed maturity securities were to become necessary, a realized gain or loss equal to the difference between the cost and sales price of securities sold would be recognized. Debt. AtDecember 31, 2021 , the Company had senior notes, subordinated debentures and other debt outstanding with a carrying value of$3,267 million and a face amount of$3,292 million , including$300 million aggregate principal amount of its 4.125% subordinated debentures due 2061 issued inFebruary 2021 ,$400 million aggregate principal amount of its 3.55% senior notes due 2052 issued inMarch 2021 and$350 million aggregate principal amount of its 3.15% senior notes due 2061 issued inSeptember 2021 . The Company redeemed its$110 million aggregate principal amount of 5.90% subordinated debentures due 2056 onMarch 1, 2021 and its$290 million aggregate principal amount of 5.75% subordinated debentures due 2056 onJune 1, 2021 . Additionally, in the second quarter of 2021, the Company sold a real estate asset which resulted in a$102 million reduction of the Company's non-recourse debt that was supporting the property. The maturities of the outstanding debt are$427 million in 2022,$6 million in 2024,$4 million in 2025,$250 million in 2037,$350 million in 2044,$470 million in 2050,$400 million in 2052,$185 million in 2058,$300 million in 2059,$250 million in 2060, and$650 million in 2061. Equity. AtDecember 31, 2021 , total common stockholders' equity was$6.7 billion , common shares outstanding were 176,780,588 and stockholders' equity per outstanding share was$37.63 . The Company repurchased 1,752,619 and 6,363,301 shares of its common stock in 2021 and 2020, respectively. The aggregate cost of the repurchases was$122 million in 2021 and$346 million in 2020. In 2021, the Board declared regular quarterly cash dividends of$0.12 per share in the first quarter, and$0.13 per share in each of the remaining three quarters, as well as special dividends of$0.50 per share in the second quarter and$1.00 per share in the fourth quarter for a total of$356 million in aggregate dividends in 2021. Total Capital. Total capitalization (equity, debt and subordinated debentures) was$9.9 billion atDecember 31, 2021 . The percentage of the Company's capital attributable to senior notes, subordinated debentures and other debt was 33% and 30% atDecember 31, 2021 and 2020, respectively. Federal and Foreign Income Taxes The Company files a consolidated income tax return in theU.S. and foreign tax returns in each of the countries in which it has overseas operations. AtDecember 31, 2021 , the Company had a gross deferred tax asset of$535 million (which primarily relates to loss and loss expense reserves and unearned premium reserves). The Company also has a$75 million valuation allowance against the gross deferred tax asset and a gross deferred tax liability of$420 million (which primarily relates to deferred policy acquisition costs, and various investment funds) resulting in a net deferred tax asset of$40 million . The realization of this asset is dependent upon the Company's ability to generate sufficient taxable income in future periods. Based on historical results and the prospects for future operations, management anticipates that it is more likely than not that future taxable income will be sufficient for the realization of this asset. 56 --------------------------------------------------------------------------------
Reinsurance
The Company follows customary industry practice of reinsuring a portion of its exposures in exchange for paying reinsurers a part of the premiums received on the policies it writes. Reinsurance is purchased by the Company principally to reduce its net liability on individual risks and to protect against catastrophic losses. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, it does make the assuming reinsurer liable to the insurer to the extent of the reinsurance coverage. The Company monitors the financial condition of its reinsurers and attempts to place its coverages only with financially sound carriers. Reinsurance coverage and retentions vary depending on the line of business, location of the risk and nature of loss. The Company's reinsurance purchases include the following: •Property reinsurance treaties - The Company purchases property reinsurance to reduce its exposure to large individual property losses and catastrophe events. Following is a summary of significant property reinsurance treaties in effect as ofJanuary 1, 2022 : The Company's property per risk reinsurance generally covers losses between$2.5 million and$65 million . The Company's catastrophe excess of loss reinsurance program provides protection for net losses in excess of between$23.4 million and$40.2 million up to$500 million for the majority ofU.S. business written by its Insurance segment businesses andU.S. and non-U.S. business written by Lloyd's Syndicate, excluding offshore energy; this includes some co-participation in lower layers. The Company's catastrophe reinsurance agreements are subject to certain limits, exclusions and reinstatement premiums. •Casualty reinsurance treaties - The Company purchases casualty reinsurance to reduce its exposure to large individual casualty losses, workers' compensation catastrophe losses and casualty losses involving multiple claimants or insureds for the majority of business written by itsU.S. companies. A significant casualty treaty (casualty catastrophe) in effect as ofJanuary 1, 2022 provides significant protection for losses between$10 million and$75 million from single events with claims involving two or more insurable interests or for systemic events involving multiple insureds and/or policy years. The treaty also covers casualty contingency losses in excess of$5 million and up to$100 million . For losses involving two or more claimants for primary workers' compensation business, coverage is generally in place for losses between$10 million and$550 million . For excess workers' compensation business, such coverage is generally in place for losses between$25 million and$550 million . Our workers' compensation catastrophe reinsurance program is a shared cover for both excess and primary workers' compensation business. •Facultative reinsurance - The Company also purchases facultative reinsurance on certain individual policies or risks that are in excess of treaty reinsurance capacity. •Other reinsurance - Depending on the business, the Company purchases specific additional reinsurance to supplement the above programs. •EffectiveJanuary 1, 2022 , Lifson Re will continue to be a participant on the majority of the Company's reinsurance placements for a 22.5% share of the placed amounts. This pertains to all traditional treaty reinsurance/retrocessional placements for both property and casualty business where there is more than one open market reinsurer participating. Lifson Re has been capitalized with more than$250 million of equity from a small group of sophisticated global investors with long-term investment horizons, including a minority participation by the Company. Lifson Re will participate on a fully collateralized basis. The Company places a number of its casualty treaties on a "risk attaching" basis. Under risk attaching treaties, all claims from policies incepting during the period of the reinsurance contract are covered even if they occur after the expiration date of the reinsurance contract. If the Company is unable to renew or replace its existing reinsurance coverage, protection for unexpired policies would remain in place until their expiration. In such case, the Company could revise its underwriting strategy for new business to reflect the absence of reinsurance protection. The casualty catastrophe treaty highlighted above was purchased on a losses discovered basis. Property catastrophe and workers' compensation catastrophe reinsurance is generally placed on a "losses occurring basis," whereby only claims occurring during the period are covered. If the Company is unable to renew or replace these reinsurance coverages, unexpired policies would not be protected, though we frequently have the option to purchase run-off coverage in our treaties.
Following is a summary of earned premiums and loss and loss expenses ceded to
reinsurers for each of the three years ended
Year Ended December 31,
(In thousands) 2021 2020 2019
Earned premiums $ 1,805,341 $ 1,499,948 $ 1,328,843
Losses and loss expenses 1,236,960 955,630 836,831
Ceded earned premiums increased 20.4% in 2021 to
losses and loss expenses ratio increased 5 points to 69% in 2021 from 64% in
2020.
57 -------------------------------------------------------------------------------- The following table presents the credit quality of amounts due from reinsurers as ofDecember 31, 2021 . Amounts due from reinsurers are net of reserves for uncollectible reinsurance of$1 million in the aggregate. (In thousands) Reinsurer Rating (1) Amount
Amounts due in excess of
Munich Re AA-$ 313,150 Lloyd's of London A+ 308,119 Partner Re A+ 231,251 Alleghany Group A+ 204,699 Swiss Re AA- 203,165Hannover Re Group AA- 167,906 Everest Re A+ 162,432 Renaissance Re A+ 138,408 Berkshire Hathaway AA+ 126,806 Axis Capital A+ 88,938 Liberty Mutual A 85,367 Arch Capital Group A+ 58,156 Korean Re A 55,643 Fairfax Financial A- 43,975Axa Insurance AA- 40,014 Markel Corp Group A 26,737 Sompo Holdings Group A+ 24,220 Helvetia Holdings Group A+ 23,986 Other reinsurers: Rated A- or better 188,195 Secured (2) 200,969 All Others 25,365 Subtotal$ 2,717,501 Residual market pools (3) 213,238 Allowance for expected credit losses (7,713) Total$ 2,923,026 _________________
(1)S&P rating, or if not rated by S&P,
(2)Secured by letters of credit or other forms of collateral.
(3)Many states require licensed insurers that provide workers' compensation
insurance to participate in programs that provide workers' compensation to
employers that cannot procure coverage from an insurer on a voluntary basis.
Insurers can fulfill this residual market obligation by participating in pools
where results are shared by the participating companies. The Company acts as a
servicing carrier for workers' compensation pools in certain states. As a
servicing carrier, the Company writes residual market business directly and then
cedes 100% of this business to the respective pool. As a servicing carrier, the
Company receives fee income for its services. The Company does not retain
underwriting risk, and credit risk is limited as ceded balances are jointly
shared by all the pool members.
58
--------------------------------------------------------------------------------
Contractual Obligations
Following is a summary of the Company's contractual obligations as of
(In thousands) Estimated Payments By Periods 2022 2023 2024 2025 2026
Thereafter
Gross reserves for losses
$
4,079,739
Operating lease obligations 44,962 43,674 37,663 28,109 21,486 68,019 Purchase obligations 137,509 75,875 46,803 46,117 46,538 729 Subordinated debentures - - - - -
1,035,000
Senior notes and other debt 426,503 - 6,078 4,485 - 1,820,000 Interest payments 128,569 123,293 123,293 123,293 123,293 3,212,406 Other long-term liabilities 2,719 2,446 2,188 1,999 1,826 21,421 Total$ 4,817,703 $ 3,107,061 $ 2,365,244 $ 1,780,908 $ 1,306,778 $ 10,237,314 The estimated payments for reserves for losses and loss expenses in the above table represent the projected (undiscounted) payments for gross loss and loss expense reserves related to losses incurred as ofDecember 31, 2021 . The estimated payments in the above table do not consider payments for losses to be incurred in future periods. These amounts include reserves for reported losses and reserves for incurred but not reported losses. Estimated amounts recoverable from reinsurers are not reflected. The estimated payments by year are based on historical loss payment patterns.The actual payments may differ from the estimated amounts due to changes in ultimate loss reserves and in the timing of the settlement of those reserves. In addition, atDecember 31, 2021 , the Company had commitments to invest up to$621 million and$139 million in certain investment funds and real estate construction projects, respectively. These amounts are not included in the above table. The Company utilizes letters of credit to back certain reinsurance payments and obligations. Outstanding letters of credit were$5 million as ofDecember 31, 2021 . The Company has made certain guarantees to state regulators that the statutory capital of certain subsidiaries will be maintained above certain minimum levels.
Off-Balance Sheet Arrangements
An off-balance sheet arrangement is any transaction, agreement or other
contractual arrangement involving an unconsolidated entity under which a company
has (1) made guarantees, (2) a retained or contingent interest in transferred
assets, (3) an obligation under derivative instruments classified as equity or
(4) any obligation arising out of a material variable interest in an
unconsolidated entity that provides financing, liquidity, market risk or credit
risk support to the Company, or that engages in leasing, hedging or research and
development arrangements with the Company. The Company has no arrangements of
these types that management believes may have a material current or future
effect on our financial condition, liquidity or results of operations.
59
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AMBAC FINANCIAL GROUP INC – 10-K – Management's Discussion and Analysis of Financial Condition and Results of Operations
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