TMCnet News
ALLIED WORLD ASSURANCE CO HOLDINGS, AG - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q. References in this Form 10-Q to the terms "we," "us," "our," the "Company" or other similar terms mean the consolidated operations of Allied World Assurance Company Holdings, AG, a Swiss holding company, and our consolidated subsidiaries, unless the context requires otherwise. References in this Form 10-Q to the term "Allied World Switzerland" or "Holdings" means only Allied World Assurance Company Holdings, AG. References to "Allied World Bermuda" mean only Allied World Assurance Company Holdings, Ltd, a Bermuda holding company. References to "our insurance subsidiaries" may include our reinsurance subsidiaries. References in this Form 10-Q to $ are to the lawful currency of the United States and to CHF are to the lawful currency of Switzerland. References in this Form 10-Q to Holdings' "common shares" mean its registered voting shares. Note on Forward-Looking Statement This Form 10-Q and other publicly available documents may include, and our officers and representatives may from time to time make, projections concerning financial information and statements concerning future economic performance and events, plans and objectives relating to management, operations, products and services, and assumptions underlying these projections and statements. These projections and statements are forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995 and are not historical facts but instead represent only our belief regarding future events, many of which, by their nature, are inherently uncertain and outside our control. These projections and statements may address, among other things, our strategy for growth, product development, financial results and reserves. Actual results and financial condition may differ, possibly materially, from these projections and statements and therefore you should not place undue reliance on them. Factors that could cause our actual results to differ, possibly materially, from those in the specific projections and statements are discussed throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations and in "Risk Factors" in Item 1A. of Part I of our 2013 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission ("SEC") on February 18, 2014 (the "2013 Form 10-K"). We are under no obligation (and expressly disclaim any such obligation) to update or revise any forward-looking statement that may be made from time to time, whether as a result of new information, future developments or otherwise. OverviewOur Business We write a diversified portfolio of property and casualty insurance and reinsurance internationally through our subsidiaries and branches based in Bermuda, Canada, Europe, Hong Kong, Singapore, and the United States as well as our Lloyd's Syndicate 2232. We manage our business through three operating segments: U.S. insurance, international insurance and reinsurance. As of March 31, 2014, we had approximately $12.3 billion of total assets, $3.6 billion of total shareholders' equity and $4.4 billion of total capital, which includes shareholders' equity and senior notes. During the three months ended March 31, 2014, we continued to grow our business, in particular in the United States and Europe, as we entered new lines of business and added scale to our existing lines of business. We experienced positive rate improvements in certain lines of business, such as general casualty, primary casualty and professional liability in our U.S. insurance segment. However, we did experience negative rate changes in our general property line of business in both our U.S. insurance and international insurance segments, as well as negative rate changes in our European casualty lines of business in the international insurance segment. As a result, our consolidated gross premiums written increased by $64.3 million, or 7.7%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. Overall our combined ratio is lower by 5.2 percentage points, driven by benign property loss activity during the quarter and lower expenses primarily driven by lower employee stock-based compensation. Each of our operating segments reported higher underwriting income and lower combined ratios during the three months ended March 31, 2014 compared to the three months ended March 31, 2013. Also during the quarter, we received approval from Lloyd's, the Prudential Regulation Authority and the Financial Conduct Authority to establish our own Lloyd's managing agent, Allied World Managing Agency Limited, effective April 1, 2014, to manage Allied World's syndicate 2232. Our net income increased by $18.0 million to $177.0 million compared to the three months ended March 31, 2013. The increase was primarily due to the higher underwriting income reported by each of our operating segments partially offset by lower total investment return and higher income tax expense. 28-------------------------------------------------------------------------------- Table of Contents Financial Highlights Three Months Ended March 31, 2014 2013 ($ in millions except share, per share and percentage data) Gross premiums written $ 901.4 $ 837.1 Net income 177.0 159.0 Operating income 129.9 84.2 Basic earnings per share: Net income $ 5.33 $ 4.59 Operating income $ 3.91 $ 2.43 Diluted earnings per share: Net income $ 5.23 $ 4.49 Operating income $ 3.84 $ 2.38 Weighted average common shares outstanding: Basic 33,181,729 34,613,606 Diluted 33,861,554 35,431,843 Basic book value per common share $ 109.90 $ 99.11 Diluted book value per common share $ 107.05 $ 96.50 Annualized return on average equity (ROAE), net income 19.8 % 18.8 % Annualized ROAE, operating income 14.6 % 10.0 % Non-GAAP Financial Measures In presenting the company's results, management has included and discussed certain non-GAAP financial measures, as such term is defined in Item 10(e) of Regulation S-K promulgated by the SEC. Management believes that these non-GAAP measures, which may be defined differently by other companies, better explain the company's results of operations in a manner that allows for a more complete understanding of the underlying trends in the company's business. However, these measures should not be viewed as a substitute for those determined in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). Operating income and operating income per share Operating income is an internal performance measure used in the management of our operations and represents after-tax operational results excluding, as applicable, net realized investment gains or losses, net foreign exchange gain or loss, and other non-recurring items. We exclude net realized investment gains or losses, net foreign exchange gain or loss and any other non-recurring items from our calculation of operating income because these amounts are heavily influenced by and fluctuate in part according to the availability of market opportunities and other factors. In addition to presenting net income determined in accordance with U.S. GAAP, we believe that showing operating income enables investors, analysts, rating agencies and other users of our financial information to more easily analyze our results of operations and our underlying business performance. Operating income should not be viewed as a substitute for U.S. GAAP net income. 29-------------------------------------------------------------------------------- Table of Contents The following is a reconciliation of operating income to its most closely related U.S. GAAP measure, net income. Three Months Ended March 31, 2014 2013 ($ inmillions, except share, per share and percentage data) Net income $ 177.0 $ 159.0 Add after tax effect of: Net realized investment (gains) losses (47.2 ) (77.3 ) Foreign exchange loss (gain) 0.1 2.5 Operating income $ 129.9 $ 84.2 Basic per share data: Net income $ 5.33 $ 4.59 Add after tax effect of: Net realized investment (gains) losses (1.42 ) (2.23 ) Foreign exchange loss (gain) - 0.07 Operating income $ 3.91 $ 2.43 Diluted per share data: Net income $ 5.23 $ 4.49 Add after tax effect of: Net realized investment (gains) losses (1.39 ) (2.18 ) Foreign exchange loss (gain) - 0.07 Operating income $ 3.84 $ 2.38 Diluted book value per share We have included diluted book value per share because it takes into account the effect of dilutive securities; therefore, we believe it is an important measure of calculating shareholder returns. As of March 31, 2014 2013 ($ in millions, except share and per share data) Price per share at period end $ 103.19 $ 92.72 Total shareholders' equity $ 3,616.7 $ 3,432.0 Basic common shares outstanding 32,908,821 34,626,361 Add: Unvested restricted stock units 174,415 91,159 Performance-based equity awards 207,092 272,062 Employee share purchase plan 5,572 5,616 Dilutive stock options outstanding 920,101 1,166,137 Weighted average exercise price per share $ 48.33 $ 47.34 Deduct: Options bought back via treasury method (430,938 ) (595,451 ) Common shares and common share equivalents outstanding 33,785,063 35,565,884 Basic book value per common share $ 109.90 $ 99.11 Diluted book value per common share $ 107.05 $ 96.50 30-------------------------------------------------------------------------------- Table of Contents Annualized return on average equity Annualized return on average shareholders' equity ("ROAE") is calculated using average shareholders' equity. We present ROAE as a measure that is commonly recognized as a standard of performance by investors, analysts, rating agencies and other users of our financial information. Annualized operating return on average shareholders' equity is calculated using operating income and average shareholders' equity. Three Months Ended March 31, 2014 2013 ($ in millions except percentage data) Opening shareholders' equity $ 3,519.8 $ 3,326.3 Closing shareholders' equity $ 3,616.7 $ 3,432.0 Average shareholders' equity $ 3,568.3 $ 3,379.1 Net income available to shareholders $ 177.0 $ 159.0 Annualized return on average shareholders' equity - net income available to shareholders 19.8 % 18.8 % Operating income available to shareholders $ 129.9 $ 84.2 Annualized return on average shareholders' equity - operating income available to shareholders 14.6 % 10.0 % Relevant Factors Revenues We derive our revenues primarily from premiums on our insurance policies and reinsurance contracts, net of any reinsurance or retrocessional coverage purchased. Insurance and reinsurance premiums are a function of the amounts and types of policies and contracts we write, as well as prevailing market prices. Our prices are determined before our ultimate costs, which may extend far into the future, are known. In addition, our revenues include income generated from our investment portfolio, consisting of net investment income and net realized investment gains or losses. Investment income is principally derived from interest and dividends earned on investments, as well as distributed and undistributed income from equity method investments, partially offset by investment management expenses and fees paid to our custodian bank. Net realized investment gains or losses include gains or losses from the sale of investments, as well as the change in the fair value of investments that we mark-to-market through net income. Expenses Our expenses consist largely of net losses and loss expenses, acquisition costs and general and administrative expenses. Net losses and loss expenses incurred are comprised of three main components: • losses paid, which are actual cash payments to insureds and reinsureds, net of recoveries from reinsurers; • outstanding loss or case reserves, which represent management's best estimate of the likely settlement amount for known claims, less the portion that can be recovered from reinsurers; and • reserves for losses incurred but not reported, or "IBNR", which are reserves (in addition to case reserves) established by us that we believe are needed for the future settlement of claims. The portion recoverable from reinsurers is deducted from the gross estimated loss. Acquisition costs are comprised of commissions, brokerage fees, insurance taxes and other acquisition related costs such as profit commissions. Commissions and brokerage fees are usually calculated as a percentage of premiums and depend on the market and line of business. Acquisition costs are reported after (1) deducting commissions received on ceded reinsurance, (2) deducting the part of deferred acquisition costs relating to the successful acquisition of new and renewal insurance and reinsurance contracts and (3) including the amortization of previously deferred acquisition costs. 31-------------------------------------------------------------------------------- Table of Contents General and administrative expenses include personnel expenses including stock-based compensation expense, rent expense, professional fees, information technology costs and other general operating expenses. Ratios Management measures results for each segment on the basis of the "loss and loss expense ratio," "acquisition cost ratio," "general and administrative expense ratio," "expense ratio" and the "combined ratio." Because we do not manage our assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments. General and administrative expenses are allocated to segments based on various factors, including staff count and each segment's proportional share of gross premiums written. The loss and loss expense ratio is derived by dividing net losses and loss expenses by net premiums earned. The acquisition cost ratio is derived by dividing acquisition costs by net premiums earned. The general and administrative expense ratio is derived by dividing general and administrative expenses by net premiums earned. The expense ratio is the sum of the acquisition cost ratio and the general and administrative expense ratio. The combined ratio is the sum of the loss and loss expense ratio, the acquisition cost ratio and the general and administrative expense ratio. Critical Accounting Policies It is important to understand our accounting policies in order to understand our financial position and results of operations. Our unaudited condensed consolidated financial statements reflect determinations that are inherently subjective in nature and require management to make assumptions and best estimates to determine the reported values. If events or other factors cause actual results to differ materially from management's underlying assumptions or estimates, there could be a material adverse effect on our financial condition or results of operations. We believe that some of the more critical judgments in the areas of accounting estimates and assumptions that affect our financial condition and results of operations are related to reserves for losses and loss expenses, reinsurance recoverables, premiums and acquisition costs, valuation of financial instruments and goodwill and other intangible asset impairment valuation. For a detailed discussion of our critical accounting policies, please refer to our 2013 Form 10-K. There were no material changes in the application of our critical accounting estimates subsequent to that report. 32-------------------------------------------------------------------------------- Table of Contents Results of OperationsThe following table sets forth our selected consolidated statement of operations data for each of the periods indicated. Three Months Ended March 31, 2014 2013 ($ in millions) Revenues Gross premiums written $ 901.4 $ 837.1 Net premiums written $ 771.6 $ 695.1 Net premiums earned $ 530.3 $ 463.2 Net investment income 47.6 33.4Net realized investment gains (losses) 54.2 79.6 $ 632.1 $ 576.2 Expenses Net losses and loss expenses $ 275.3 $ 255.1 Acquisition costs 67.7 56.7 General and administrative expenses 80.3 82.7 Amortization of intangible assets 0.6 0.6 Interest expense 14.6 14.1 Foreign exchange loss 0.1 2.6 $ 438.6 $ 411.8 Income before income taxes 193.5 164.4 Income tax expense 16.5 5.4 Net income $ 177.0 $ 159.0 Ratios Loss and loss expense ratio 51.9 % 55.1 % Acquisition cost ratio 12.8 % 12.2 % General and administrative expense ratio 15.2 % 17.8 % Expense ratio 28.0 % 30.0 % Combined ratio 79.9 % 85.1 % Comparison of Three Months Ended March 31, 2014 and 2013 Premiums Gross premiums written increased by $64.3 million, or 7.7%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The overall increase in gross premiums written was primarily the result of the following: • U.S. insurance: Gross premiums written increased by $13.9 million, or 5.4%. The increase in gross premiums written was primarily due to $10.4 million of new business growth from new lines of business and new insureds during the three months ended March 31, 2014 compared to the three months ended March 31, 2013, as well as premium rate increases across most lines of business. This was particularly evident in our general casualty, programs, inland marine and environmental lines of business that had an overall increase in gross premiums written of $26.2 million. This growth was partially offset by the non-renewal of business, particularly in our healthcare line of business, that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions); • International insurance: Gross premiums written increased by $5.9 million, or 4.6%. The increase was primarily due to continued growth from new initiatives and new lines of business. Our new aviation and marine cargo business contributed $4.4 million of gross premiums written during the current quarter. The professional liability line of business grew by $4.5 million on new business writings in European errors and omissions ("E&O") and mergers and 33-------------------------------------------------------------------------------- Table of Contents acquisitions classes of business. This growth was partially offset by the general casualty line of business, which decreased by $3.9 million compared to the prior period, due to $3.5 million of non-recurring business in 2013; and • Reinsurance: Gross premiums written increased by $44.5 million, or 9.8%. The increase was driven primarily by new business and increased renewals across several major product lines and the timing of renewals that were renewed during the current quarter but were previously bound subsequent to the quarter ended March 31, 2013. In our property reinsurance lines of business, we had increased premiums of approximately $15.5 million from our collateralized property catastrophe reinsurance program through Aeolus Re, Ltd. ("Aeolus Re"), as well as growth of $17.7 million from our U.S. property reinsurance operations. In our specialty lines of business, our crop reinsurance line of business increased gross premiums written by $13.8 million primarily due to increases on renewals, timing of renewals and new business. Partially offsetting these increases in gross premiums written were non-renewals of certain treaties, particularly in our casualty reinsurance line of business, either due to poor terms and conditions or the cedents not renewing their reinsurance or finding other reinsurance alternatives, and net downward premium adjustments on inforce treaties. The table below illustrates our gross premiums written by underwriter location for each of the periods indicated. Three Months Ended March 31, Dollar Percentage 2014 2013 Change Change ($ in millions) United States $ 520.8 $ 478.4 $ 42.4 8.9 % Bermuda 229.6 228.7 0.9 0.4 % Europe 103.3 86.5 16.8 19.4 % Asia 46.9 43.5 3.4 7.8 % Canada 0.8 - 0.8 n/a $ 901.4 $ 837.1 $ 64.3 7.7 % Net premiums written increased by $76.5 million, or 11.0%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The increase in net premiums written was due to the increase in gross premiums written and non-renewing our collaterlized retrocessional catastrophe cover in our reinsurance segment, which reduced ceded premiums written and therefore increased net premiums written. These increases were partially offset by new reinsurance treaties in support of the aviation, marine cargo, primary construction and small- to medium-sized enterprise lines of business entered into during the three months ended March 31, 2014 that we did not have in place during the three months ended March 31, 2013 and recognizing annual ceded premiums written at the inception of treaties that have contractual minimum premiums. Previously, we recognized ceded premiums written on these agreements based on the actual premiums ceded each quarter. This change resulted in the acceleration of ceded premiums written of $4.9 million in our international insurance segment to this quarter, but had no impact on net premiums earned. The difference between gross and net premiums written is the cost to us of purchasing reinsurance coverage, including the cost of property catastrophe reinsurance coverage. We ceded 14.4% of gross premiums written for the three months ended March 31, 2014 compared to 17.0% for the same period in 2013. The decrease was primarily due to the non-renewal of the collaterlized retrocessional catastrophe cover in our reinsurance segment, which reduced the ratio by 3.1 percentage points. Net premiums earned increased by $67.1 million, or 14.5%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013 as a result of higher premiums earned in each of our operating segments. We evaluate our business by segment, distinguishing between U.S. insurance, international insurance and reinsurance. The following table illustrates the mix of our business on both a gross premiums written and net premiums earned basis. Gross Premiums Written Net Premiums Earned Three Months Ended Three Months Ended March 31, March 31, 2014 2013 2014 2013 U.S. insurance 29.9 % 30.5 % 40.0 % 40.7 % International insurance 14.9 % 15.4 % 16.7 % 18.2 % Reinsurance 55.2 % 54.1 % 43.3 % 41.1 % Total 100.0 % 100.0 % 100.0 % 100.0 % 34-------------------------------------------------------------------------------- Table of Contents Gross premiums written by our reinsurance segment typically accounts for the largest portion of gross premiums written during the first quarter of a calendar year as many reinsurance contracts have January 1st renewal dates. Net Investment Income Net investment income increased by $14.2 million, or 42.5%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The increase was due to higher income across most asset classes such as our fixed maturity investments, our equity method investments owned through Allied World Financial Services, Inc. and our hedge fund and private equity investments. We reported $7.4 million of earnings from our equity method investments during the three months ended March 31, 2014, whereas we did not report any earnings during the comparative prior period. The earnings from our equity method investments can fluctuate from period to period based on the performance of each equity method investment and the seasonality of their results, and as such the current period earnings may not be indicative of the performance in future periods. The annualized period book yield of the investment portfolio for the three months ended March 31, 2014 and 2013 was 2.3% and 1.6%, respectively. As of March 31, 2014, we held 11.5% of our total investments and cash equivalents in other invested assets compared to 9.7% as of March 31, 2013. Investment management expenses of $3.8 million and $4.3 million were incurred during the three months ended March 31, 2014 and 2013, respectively. The decrease of $0.5 million, or 11.8%, was due to better terms with our investment portfolio managers. As of March 31, 2014, approximately 89.6% of our fixed income investments consisted of investment grade securities. As of March 31, 2014 and December 31, 2013, the average credit rating of our fixed income portfolio was AA- as rated by Standard & Poor's. Realized Investment Gains (Losses) Net realized investment gains (losses) were comprised of the following: Three Months Ended March 31, 2014 2013 ($ in millions) Net realized gains (losses) on sale: Fixed maturity investments, trading $ 7.5 $ 21.9 Equity securities, trading 36.2 9.8 Other invested assets: hedge funds and private equity, trading 6.4 5.6 Total net realized gains on sale 50.1 37.3 Net realized and unrealized losses on derivatives (12.9 ) (1.0 ) Mark-to-market gains (losses): Fixed maturity investments, trading 22.5 (16.5 ) Equity securities, trading (21.6 ) 33.0 Other invested assets: hedge funds and private equity, trading 16.2 26.8 Total mark-to-market gains 17.1 43.3 Net realized investment gains $ 54.3 $ 79.6 The total return of our investment portfolio was 1.2% and 1.3% for the three months ended March 31, 2014 and 2013, respectively. The slight decrease in total return is primarily due to lower stock price appreciation of our equity securities during the three months ended March 31, 2014 compared to three months ended March 31, 2013 partially offset by gains in our fixed maturity investments portfolio. The increased realized and unrealized losses on derivatives was a result of entering into contracts to hedge against rising interest rates, however, market interest rates decreased during the quarter, generating a loss on derivatives. 35-------------------------------------------------------------------------------- Table of Contents Net Losses and Loss Expenses Net losses and loss expenses increased by $20.2 million, or 7.9%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The following is a breakdown of the loss and loss expense ratio for the three months ended March 31, 2014 and 2013: Three Months Ended Three Months Ended Change in March 31, 2014 March 31, 2013 Dollar Percentage Amount % of NPE (1) Amount % of NPE (1) Change Points ($ in millions) Non-catastrophe $ 324.2 61.1 % $ 299.2 64.6 % $ 25.0 (3.5 ) Property catastrophe - - - - - - Current period 324.2 61.1 299.2 64.6 25.0 (3.5 ) Prior period (48.9 ) (9.2 ) (44.1 ) (9.5 ) (4.8 ) 0.3 Net losses and loss expenses $ 275.3 51.9 % $ 255.1 55.1 % $ 20.2 (3.2 ) ________________________ (1) "NPE" means net premiums earned. Current year non-catastrophe losses and loss expenses The increase in the current year non-catastrophe losses and loss expenses was primarily due to the overall growth of our operations. The reduction in the current year non-catastrophe losses and loss expenses ratio was primarily due to lower reported loss activity in our property lines of business during the three months ended March 31, 2014 compared to the three months March 31, 2013, and an increase to the loss adjustment expense reserve during the three months ended March 31, 2013 that did not occur during the three months ended March 31, 2014, which reduced the current year non-catastrophe loss and loss adjustment expense ratio by 1.7 percentage points. Current year property catastrophe losses and loss expenses During the three months ended March 31, 2014 and March 31, 2013, we did not incur any property catastrophe losses. Prior year losses and loss expenses We recorded net favorable reserve development related to prior years of $48.9 million during the three months ended March 31, 2014 compared to net favorable reserve development of $44.1 million for the three months ended March 31, 2013, as shown in the tables below. (Favorable) and Unfavorable Loss Reserve Development by Loss Year For the Three Months Ended March 31, 2014 2004 and Prior 2005 2006 2007 2008 2009 2010 2011 2012 2013 Total ($ in millions) U.S. insurance $ (3.1 ) $ - $ - $ 0.2 $ (0.5 ) $ (0.3 ) $ (0.1 ) $ 4.5 $ 0.1 $ - $ 0.8 International insurance 3.9 (2.3 ) (2.6 ) (17.8 ) (5.8 ) (5.8 ) (4.4 ) (5.0 ) (1.4 ) 11.8 (29.4 ) Reinsurance (1.4 ) 0.8 (1.4 ) (2.1 ) (1.7 ) 0.2 1.5 0.2 (2.1 ) (14.3 ) (20.3 ) $ (0.6 ) $ (1.5 ) $ (4.0 ) $ (19.7 ) $ (8.0 ) $ (5.9 ) $ (3.0 ) $ (0.3 ) $ (3.4 ) $ (2.5 ) $ (48.9 ) The net unfavorable prior year reserve development in the U.S. insurance segment for the 2011 loss year was in our healthcare line of business and was due to adverse development on several claims above our previous expectations in the managed care E&O class of business and higher than expected loss frequency in the medical malpractice class of business. The favorable prior year reserve development in the international insurance segment for the 2007 loss year was due to favorable reserve development on an individual professional liability claim and the unfavorable reserve development for the 2013 loss year was due to a single claim in our healthcare line of business. The net favorable prior year reserve development in our reinsurance segment for the 2013 loss year was primarily due to benign property loss activity, and therefore reported losses were less than our expectations. 36-------------------------------------------------------------------------------- Table of Contents The following table shows the net favorable reserve development by loss year for each of our segments for the three months ended March 31, 2013. (Favorable) and Unfavorable Loss Reserve Development by Loss Year For the Three Months Ended March 31, 2013 2003 and Prior 2004 2005 2006 2007 2008 2009 2010 2011 2012 Total ($ in millions) U.S. insurance $ (0.1 ) $ (1.2 ) $ (2.1 ) $ (1.5 ) $ (6.9 ) $ (3.7 ) $ (2.7 ) $ (0.1 ) $ 4.5 $ 24.3 $ 10.5 International insurance (0.5 ) 2.7 (7.2 ) (6.0 ) (2.8 ) (7.1 ) 3.6 (2.5 ) (7.6 ) (2.3 ) (29.7 ) Reinsurance 0.5 (0.1 ) (2.1 ) (0.2 ) (2.2 ) (3.0 ) (1.0 ) (2.2 ) (5.5 ) (9.1 ) (24.9 ) $ (0.1 ) $ 1.4 $ (11.4 ) $ (7.7 ) $ (11.9 ) $ (13.8 ) $ (0.1 ) $ (4.8 ) $ (8.6 ) $ 12.9 $ (44.1 ) The unfavorable reserve development for the 2011 and 2012 loss years for our U.S. insurance segment was due to higher than expected loss emergence, primarily in our private/not for profit directors' and officers' ("D&O"), healthcare D&O and E&O products. The healthcare D&O emergence was largely driven by two large claims, both in excess of $3 million. The emergence in the E&O and private/not for profit D&O is due to higher than expected loss frequency. The following table shows the components of net losses and loss expenses for each of the periods indicated. Three Months Ended March 31, Dollar 2014 2013 Change ($ in millions) Net losses paid $ 232.3 $ 244.6 $ (12.3 ) Net change in reported case reserves (51.1 ) 9.0 (60.1 ) Net change in IBNR 94.1 1.5 92.6 Net losses and loss expenses $ 275.3 $ 255.1 $ 20.2 The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables. Three Months Ended March 31, 2014 2013 ($ in millions) Net reserves for losses and loss expenses, January 1 $ 4,532.0 $ 4,504.4 Incurred related to: Current period non-catastrophe 324.2 299.2 Prior period (48.9 ) (44.1 ) Total incurred 275.3 255.1 Paid related to: Current period non-catastrophe 3.7 3.5 Prior period 228.6 241.1 Total paid 232.3 244.6 Foreign exchange revaluation 1.3 (5.2 ) Net reserve for losses and loss expenses, March 31 4,576.3 4,509.7 Losses and loss expenses recoverable 1,280.5 1,163.5 Reserve for losses and loss expenses, March 31 $ 5,856.8 $ 5,673.2 37-------------------------------------------------------------------------------- Table of Contents Acquisition Costs Acquisition costs increased by $11.0 million, or 19.4%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The increase in acquisition costs was due to the growth in premiums and related acquisition costs. Acquisition costs as a percentage of net premiums earned were 12.8% for the three months ended March 31, 2014 compared to 12.2% for the same period in 2013. The higher acquisition cost ratio is driven from our U.S. insurance segment. General and Administrative Expenses General and administrative expenses decreased by $2.4 million, or 2.9%, for the three months ended March 31, 2014 compared to the same period in 2013. Our general and administrative expense ratio was 15.2% and 17.8% for the three months ended March 31, 2014 and 2013, respectively. The decrease in general and administrative expenses was primarily due to lower stock-based compensation partially offset by higher salary related costs due to higher headcount as our average headcount increased by 15%. We have granted cash equivalent restricted stock units and performance-based equity awards to certain key employees, and we measure the value of each award at the period ending share price. Changes in our share price are recognized as increases or decreases in our compensation expense ratably over the service period. Our share price decreased 9% for the three months ended March 31, 2014, compared to a 18% increase for the same period in 2013. Amortization of Intangible Assets The amortization of intangible assets was unchanged for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. Interest Expense Interest expense increased by $0.5 million, or 3.5%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013 reflecting increased letter of credit facility charges. Net Income Net income for the three months ended March 31, 2014 was $177.0 million compared to net income of $159.0 million for the three months ended March 31, 2013. The $18.0 million increase was primarily the result of higher underwriting income from each of our operating segments. Income tax expense for the three months ended March 31, 2014 increased by $11.1 million compared to the three months ended March 31, 2013. The increase in income tax expense was primarily due to higher taxable income in our U.S. operations. Underwriting Results by Operating SegmentsOur company is organized into three operating segments: U.S. Insurance Segment. The U.S. insurance segment includes our direct specialty insurance operations in the United States and Canada. This segment provides both direct property and specialty casualty insurance primarily to non-Fortune 1000 North American domiciled accounts. International Insurance Segment. The international insurance segment includes our direct insurance operations in Bermuda, Europe, Singapore, Labuan and Hong Kong. This segment provides both direct property and casualty insurance primarily to Fortune 1000 North American domiciled accounts from our Bermuda office and direct property and specialty casualty to our non-North American domiciled accounts from our European, Singapore and Hong Kong offices. Reinsurance Segment. Our reinsurance segment has operations in Bermuda, Europe, Singapore and the United States. This segment includes the reinsurance of property, general casualty, professional liability, specialty lines and property catastrophe coverages written by insurance companies. We presently write reinsurance on both a treaty and a facultative basis, targeting several niche reinsurance markets. 38-------------------------------------------------------------------------------- Table of Contents U.S. Insurance Segment The following table summarizes the underwriting results and associated ratios for the U.S. insurance segment for each of the periods indicated. Three Months Ended March 31, 2014 2013 ($ in millions) Revenues Gross premiums written $ 269.9 $ 256.0 Net premiums written 202.7 192.3 Net premiums earned 212.1 188.4 Expenses Net losses and loss expenses $ 142.0 $ 133.3 Acquisition costs 27.5 23.1 General and administrative expenses 37.4 39.6 Underwriting income (loss) $ 5.2 $ (7.6 ) Ratios Loss and loss expense ratio 66.9 % 70.8 % Acquisition cost ratio 13.0 % 12.3 % General and administrative expense ratio 17.6 % 21.0 % Expense ratio 30.6 % 33.3 % Combined ratio 97.5 % 104.1 % Comparison of Three Months Ended March 31, 2014 and 2013 Premiums. Gross premiums written increased by $13.9 million, or 5.4%, for the three months ended March 31, 2014 compared to the same period in 2013. The increase in gross premiums written was primarily due to $10.4 million of new business growth from new lines of business and new insureds during the three months ended March 31, 2014 compared to the three months ended March 31, 2013, as well as premium rate increases across most lines of business. This was particularly evident in our general casualty, programs, inland marine and environmental lines of business that had an overall increase in gross premiums written of $26.2 million. This growth was partially offset by the non-renewal of business, particularly in our healthcare line of business, that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions). The table below illustrates our gross premiums written by line of business for each of the periods indicated. Three Months Ended March 31, Dollar Percentage 2014 2013 Change Change ($ in millions) General casualty $ 79.2 $ 66.9 $ 12.3 18.4 % Professional liability 62.2 63.1 (0.9 ) (1.4 )% Programs 39.0 32.9 6.1 18.5 % Healthcare 34.4 53.5 (19.1 ) (35.7 )% General property 19.0 19.7 (0.7 ) (3.6 )% Inland marine 12.1 8.0 4.1 51.3 % Environmental 10.3 6.6 3.7 56.1 % Other* 13.7 5.4 8.3 153.7 % $ 269.9 $ 256.0 $ 13.9 5.4 % ________________________* Includes our primary construction, mergers and acquisitions and surety lines of business. 39-------------------------------------------------------------------------------- Table of Contents Net premiums written increased by $10.4 million, or 5.4%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013 consistent with the increase in gross premiums written. We ceded 24.9% of gross premiums written for the three months ended March 31, 2014 and March 31, 2013. Net premiums earned increased by $23.7 million, or 12.6%, for the three months ended March 31, 2014 compared to the same period in 2013. The increase was due to the continued growth of our U.S. insurance operations during 2013 and into 2014. Net losses and loss expenses. Net losses and loss expenses increased by $8.7 million, or 6.5%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The following is a breakdown of the loss and loss expense ratio for the three months ended March 31, 2014 and 2013: Three Months Ended Three Months Ended Change in March 31, 2014 March 31, 2013 Dollar Percentage Amount % of NPE Amount % of NPE Change Points ($ in millions) Non-catastrophe $ 141.2 66.5 % $ 122.8 65.2 % $ 18.4 1.3 Pts Property catastrophe - - - - - - Current period 141.2 66.5 122.8 65.2 18.4 1.3 Prior period 0.8 0.4 10.5 5.6 (9.7 ) (5.2 ) Net losses and loss expenses $ 142.0 66.9 % $ 133.3 70.8 % $ 8.7 (3.9) Pts Current year non-catastrophe losses and loss expenses The increase in the current year non-catastrophe losses and loss expenses was primarily due to growth of the business, while the increase in the current year non-catastrophe losses and loss expense ratio was primarily due to mix of business and increased loss adjustment expenses across several lines of business. Current year property catastrophe losses and loss expenses During the three months ended March 31, 2014 and March 31, 2013, we did not incur any property catastrophe losses. Prior year losses and loss expenses Overall, our U.S. insurance segment recorded net unfavorable reserve development of $0.8 million during the three months ended March 31, 2014 compared to net unfavorable reserve development of $10.5 million for the three months ended March 31, 2013, as shown in the tables below. (Favorable) and Unfavorable Loss Reserve Development by Loss Year For the Three Months Ended March 31, 2014 2004 and Prior 2005 2006 2007 2008 2009 2010 2011 2012 2013 Total ($ in millions) General casualty $ (2.9 ) $ - $ - $ (0.5 ) $ (2.3 ) $ 0.3 $ (0.1 ) $ 2.0 $ - $ - $ (3.5 ) Programs - - - 1.0 1.6 (3.0 ) - (1.0 ) (0.2 ) - (1.6 ) Healthcare (0.2 ) - - (0.3 ) 0.2 2.0 - 4.3 1.8 - 7.8 Professional liability - - - - - 0.4 - (0.5 ) (1.2 ) - (1.3 ) Inland Marine - - - - - - - (0.3 ) (0.3 ) - (0.6 ) $ (3.1 ) $ - $ - $ 0.2 $ (0.5 ) $ (0.3 ) $ (0.1 ) $ 4.5 $ 0.1 $ - $ 0.8 The net unfavorable prior year reserve development in the healthcare lines of business is due to adverse development on several claims above our previous expectations in the managed care E&O class of business and higher than expected loss frequency in the medical malpractice class of business. 40-------------------------------------------------------------------------------- Table of Contents (Favorable) and Unfavorable Loss Reserve Development by Loss Year For the Three Months Ended March 31, 2013 2003 and Prior 2004 2005 2006 2007 2008 2009 2010 2011 2012 Total ($ in millions) General casualty $ - $ (0.4 ) $ (0.3 ) $ - $ (3.3 ) $ (1.7 ) $ (0.2 ) $ - $ 1.2 $ - $ (4.7 ) Programs - - - - (1.6 ) 0.1 (0.6 ) (0.9 ) (0.4 ) 1.4 (2.0 ) General property - - - - - - (1.4 ) 2.3 (0.1 ) 2.0 2.8 Healthcare (0.1 ) (0.3 ) (0.9 ) (1.0 ) (0.8 ) (2.6 ) 0.1 (0.6 ) 3.0 6.8 3.6 Professional liability - (0.5 ) (0.9 ) (0.5 ) (1.2 ) 0.5 (0.6 ) (0.9 ) 0.8 13.3 10.0 Other - - - - - - - - - 0.8 0.8 $ (0.1 ) $ (1.2 ) $ (2.1 ) $ (1.5 ) $ (6.9 ) $ (3.7 ) $ (2.7 ) $ (0.1 ) $ 4.5 $ 24.3 $ 10.5 The unfavorable reserve development for the 2011 and 2012 loss years was due to higher than expected loss emergence, primarily in our private/not for profit D&O, healthcare D&O and E&O products. The healthcare D&O emergence was largely driven by two large claims, both in excess of $3 million. The emergence in the E&O and private/not for profit D&O is due to higher than expected loss frequency. Acquisition costs. Acquisition costs increased by $4.4 million, or 19.0%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The increase was driven by the growth in premiums and higher commission and brokerage rates compared to last year due to changes in the mix of business and higher rates charged by brokers. The acquisition cost ratio was 13.0% and 12.3% for the three months ended March 31, 2014 and 2013, respectively, due to the mix of business and higher rates discussed above. General and administrative expenses. General and administrative expenses decreased by $2.2 million, or 5.6%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The decrease was primarily due to lower stock-based compensation expense partially offset by higher salary related costs as we continue to grow our U.S. insurance operations. The general and administrative expense ratio decreased to 17.6% for the three months ended March 31, 2014 from 21.0% for the same period in 2013, reflecting lower expenses and higher net premiums earned. 41-------------------------------------------------------------------------------- Table of Contents International Insurance Segment The following table summarizes the underwriting results and associated ratios for the international insurance segment for each of the periods indicated. Three Months Ended March 31, 2014 2013 ($ in millions) Revenues Gross premiums written $ 134.4 $ 128.5 Net premiums written 75.5 77.7 Net premiums earned 88.4 84.2 Expenses Net losses and loss expenses $ 23.6 $ 28.9 Acquisition costs (0.9 ) (0.8 ) General and administrative expenses 24.8 24.8 Underwriting income $ 40.9 $ 31.3 Ratios Loss and loss expense ratio 26.7 % 34.4 % Acquisition cost ratio (1.1 )% (1.0 )% General and administrative expense ratio 28.0 % 29.4 % Expense ratio 26.9 % 28.4 % Combined ratio 53.6 % 62.8 % Comparison of Three Months Ended March 31, 2014 and 2013 Premiums. Gross premiums written increased by $5.9 million, or 4.6%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The increase was primarily due to continued growth from new initiatives and new lines of business. Our new aviation and marine cargo business contributed $4.4 million of gross premiums written during the current quarter. The professional liability line of business grew $4.5 million on new business writings in European E&O and mergers and acquisitions classes of business. This growth was partially offset by the general casualty line of business, which decreased by $3.9 million compared to the prior period, due to $3.5 million of non-recurring business in 2013. The table below illustrates our gross premiums written by underwriter location for our international insurance operations. Three Months Ended March 31, Dollar Percentage 2014 2013 Change Change ($ in millions) Bermuda $ 79.9 $ 85.2 $ (5.3 ) (6.2 )% Europe 49.0 37.6 11.4 30.3 % Asia 5.5 5.7 (0.2 ) (3.5 )% $ 134.4 $ 128.5 $ 5.9 4.6 % 42-------------------------------------------------------------------------------- Table of Contents The table below illustrates our gross premiums written by line of business for each of the periods indicated. Three Months Ended March 31, Dollar Percentage 2014 2013 Change Change ($ in millions) Professional liability $ 37.6 $ 33.1 $ 4.5 13.6 % General property 36.6 38.7 (2.1 ) (5.4 )% Healthcare 27.2 26.5 0.7 2.6 % General casualty 20.1 24.0 (3.9 ) (16.3 )% Trade credit 8.5 6.2 2.3 37.1 % Aviation 2.9 - 2.9 n/a Other* 1.5 - 1.5 n/a $ 134.4 $ 128.5 $ 5.9 4.6 % ________________________* Includes our marine cargo line of business. Net premiums written decreased by $2.2 million, or 2.8%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The decrease in net premiums written was due to higher ceded premiums. We ceded 43.8% of gross premiums written for the three months ended March 31, 2014 compared to 39.5% for the three months ended March 31, 2013. The increase was primarily due to ceded premiums written of $6.1 million from new reinsurance contracts for our aviation, marine cargo and small-to medium-sized enterprise lines of business that were in place during the three months ended March 31, 2014 but were not in place during the three months ended March 31, 2013. Included in the $6.1 million of additional ceded premium was $4.9 million of ceded premiums written due to recognizing annual ceded premiums written at the inception of the treaty rather than ratably over the contract period for those reinsurance contracts where there is a contractual minimum premium. Net premiums earned increased by $4.2 million, or 5.0%, primarily due to higher net premiums written during 2013. Net losses and loss expenses. Net losses and loss expenses decreased by $5.3 million, or 18.3%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The following is a breakdown of the loss and loss expense ratio for the three months ended March 31, 2014 and 2013: Three Months Ended Three Months Ended Change in March 31, 2014 March 31, 2013 Dollar Percentage Amount % of NPE Amount % of NPE Change Points ($ in millions) Non-catastrophe $ 53.0 59.9 % $ 58.6 69.7 % $ (5.6 ) (9.8) Pts Property catastrophe - - - - - - Current period 53.0 59.9 58.6 69.7 (5.6 ) (9.8 ) Prior period (29.4 ) (33.2 ) (29.7 ) (35.3 ) 0.3 2.1 Net losses and loss expenses $ 23.6 26.7 % $ 28.9 34.4 % $ (5.3 ) (7.7) Pts Current year non-catastrophe losses and loss expenses The decrease in the current year non-catastrophe losses and loss expenses and related ratio was primarily due to an increase to the loss adjustment expense reserve during the three months ended March 31, 2013 that did not occur during the three months ended March 31, 2014, which reduced the current year non-catastrophe loss and loss adjustment expense reserve by 9.7 percentage points. Current year property catastrophe losses and loss expenses During the three months ended March 31, 2014 and March 31, 2013, we did not incur any property catastrophe losses. 43-------------------------------------------------------------------------------- Table of Contents Prior year losses and loss expenses Overall, our international insurance segment recorded net favorable reserve development of $29.4 million during the three months ended March 31, 2014 compared to net favorable reserve development of $29.7 million for the three months ended March 31, 2013, as shown in the tables below. (Favorable) and Unfavorable Loss Reserve Development by Loss Year For the Three Months Ended March 31, 2014 2004 and Prior 2005 2006 2007 2008 2009 2010 2011 2012 2013 Total ($ in millions) General casualty $ 4.4 $ (0.7 ) $ (1.3 ) $ (2.1 ) $ (4.1 ) $ (2.7 ) $ (4.7 ) $ (0.1 ) $ - $ - $ (11.3 ) General property (0.3 ) 0.3 (0.1 ) (1.0 ) (0.3 ) (0.5 ) 0.5 (3.2 ) (2.3 ) (4.2 ) (11.1 ) Professional liability (0.2 ) (0.9 ) (0.3 ) (13.7 ) (0.6 ) (2.6 ) (0.1 ) (0.4 ) (0.1 ) - (18.9 ) Healthcare - (1.0 ) (0.9 ) (1.0 ) (0.8 ) - - (0.3 ) - 16.0 12.0 Trade Credit - - - - - - (0.1 ) (1.0 ) 1.0 - (0.1 ) $ 3.9 $ (2.3 ) $ (2.6 ) $ (17.8 ) $ (5.8 ) $ (5.8 ) $ (4.4 ) $ (5.0 ) $ (1.4 ) $ 11.8 $ (29.4 ) The unfavorable prior year reserve development in the healthcare line of business for the 2013 loss year related to a single claim. The favorable prior year reserve development in the professional liability line of business for the 2007 loss year was primarily due to favorable reserve development on an individual claim. (Favorable) and Unfavorable Loss Reserve Development by Loss Year For the Three Months Ended March 31, 2013 2003 and Prior 2004 2005 2006 2007 2008 2009 2010 2011 2012 Total ($ in millions) General casualty $ (0.3 ) $ 3.1 $ (5.6 ) $ (3.4 ) $ (6.3 ) $ (2.7 ) $ (2.9 ) $ (0.2 ) $ 0.2 $ 0.9 $ (17.2 ) General property - - - (0.4 ) 0.3 (0.6 ) 0.2 (1.3 ) (7.9 ) (3.2 ) (12.9 ) Professional liability (0.1 ) (0.3 ) (1.2 ) (1.5 ) (5.4 ) 0.3 (0.4 ) (0.3 ) - - (8.9 ) Healthcare (0.1 ) (0.1 ) (0.4 ) (0.7 ) 8.6 (4.1 ) 6.7 (0.7 ) 0.1 - 9.3 $ (0.5 ) $ 2.7 $ (7.2 ) $ (6.0 ) $ (2.8 ) $ (7.1 ) $ 3.6 $ (2.5 ) $ (7.6 ) $ (2.3 ) $ (29.7 ) Acquisition costs. Acquisition costs decreased by $0.1 million, or 12.5%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The acquisition cost ratio was negative 1.1% for the three months ended March 31, 2014 and negative 1.0% for the three months ended March 31, 2013. The negative cost represents ceding commissions received on ceded premiums, that have been earned, in excess of the brokerage fees and commissions paid on gross premiums written, that have been amortized. The ceding commission income also covers costs that are expensed as incurred. The higher negative acquisition cost ratio is primarily due to additional ceding commission income earned on the new aviation reinsurance contracts and increased ceding commission income on certain renewals. General and administrative expenses. General and administrative expenses were unchanged for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. While the total general and administrative expenses were unchanged, we did have increased salary and related costs as we continue to grow our international operations, however this was offset by lower stock-based compensation expense. The general and administrative expense ratio was 28.0% and 29.4% for the three months ended March 31, 2014 and 2013, respectively. The decrease in the general and administrative expense ratio was due to higher growth in net premiums earned relative to expenses. 44-------------------------------------------------------------------------------- Table of Contents Reinsurance Segment The following table summarizes the underwriting results and associated ratios for the reinsurance segment for each of the periods indicated. Three Months Ended March 31, 2014 2013 ($ in millions) Revenues Gross premiums written $ 497.1 $ 452.6 Net premiums written 493.4 425.1 Net premiums earned 229.8 190.6 Expenses Net losses and loss expenses $ 109.7 $ 92.9 Acquisition costs 41.2 34.4 General and administrative expenses 18.1 18.3 Underwriting income $ 60.8 $ 45.0 Ratios Loss and loss expense ratio 47.7 % 48.8 % Acquisition cost ratio 17.9 % 18.1 % General and administrative expense ratio 7.9 % 9.6 % Expense ratio 25.8 % 27.7 % Combined ratio 73.5 % 76.5 % Comparison of Three Months Ended March 31, 2014 and 2013 Premiums. Gross premiums written increased by $44.5 million, or 9.8%, for the three months ended March 31, 2014 compared to the same period in 2013. The increase was driven primarily by new business and increased renewals across several major product lines and the timing of renewals that were renewed during the current quarter but were previously bound subsequent to the quarter ended March 31, 2013. In our property reinsurance lines of business, we had increased premiums of approximately $15.5 million from our collateralized property catastrophe reinsurance program through Aeolus Re, as well as growth of $17.7 million from our U.S. property reinsurance operations. In our specialty lines of business, our crop reinsurance line of business increased gross premiums written by $13.8 million primarily due to increases on renewals, timing of renewals and new business. Partially offsetting these increases in gross premiums written were non-renewals of certain treaties, particularly in our casualty reinsurance line of business, either due to poor terms and conditions or the cedents not renewing their reinsurance or finding other reinsurance alternatives, and net downward premium adjustments on inforce treaties. The table below illustrates our gross premiums written by underwriter location for our reinsurance operations. Three Months Ended March 31, Dollar Percentage 2014 2013 Change Change ($ in millions) United States $ 251.7 $ 222.4 $ 29.3 13.2 % Bermuda 149.7 143.5 6.2 4.3 % Europe 54.4 49.0 5.4 11.0 % Asia 41.3 37.7 3.6 9.5 % $ 497.1 $ 452.6 $ 44.5 9.8 % The increase in gross premiums written for the U.S. was primarily due to the growth of the property reinsurance and crop reinsurance lines of business. 45-------------------------------------------------------------------------------- Table of Contents The table below illustrates our gross premiums written by line of business for each of the periods indicated. Three Months Ended March 31, Dollar Percentage 2014 2013 Change Change ($ in millions) Property $ 250.5 $ 211.6 $ 38.9 18.4 % Specialty 161.5 143.4 18.1 12.6 % Casualty 85.1 97.6 (12.5 ) (12.8 )% $ 497.1 $ 452.6 $ 44.5 9.8 % Net premiums written increased by $68.3 million, or 16.1%, due the increase in gross premiums written as well as not renewing the collateralized retrocessional catastrophe cover. We decided not to renew the collateralized retrocessional catastrophe cover as we believe our current estimate of probable maximum losses from catastrophes are within acceptable levels. Net premiums earned increased by $39.2 million, or 20.6%, as a result of the increase in net premiums written during 2013 and into 2014, as well as the reduction in ceded earned premium related to the non-renewal of the collateralized retrocessional catastrophe cover. Net losses and loss expenses. Net losses and loss expenses increased by $16.8 million, or 18.1%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The following is a breakdown of the loss and loss expense ratio for the three months ended March 31, 2014 and 2013: Three Months Ended Three Months Ended Change in March 31, 2014 March 31, 2013 Dollar Percentage Amount % of NPE Amount % of NPE Change Points ($ in millions) Non-catastrophe $ 130.0 56.5 % $ 117.8 61.9 % $ 12.2 (5.4 ) Property catastrophe - - - - - - Current period 130.0 56.5 117.8 61.9 12.2 (5.4 ) Prior period (20.3 ) (8.8 ) (24.9 ) (13.1 ) 4.6 4.3 Net losses and loss expenses $ 109.7 47.7 % $ 92.9 48.8 % $ 16.8 (1.1 ) Current year non-catastrophe losses and loss expenses The increase in the current year non-catastrophe losses and loss expenses was primarily due to the growth of the business, while the decrease in the current year non-catastrophe losses and loss expense ratio was primarily due to the mix of business with a greater portion of our business being property reinsurance, which carries a lower losses and loss expense ratio than our other reinsurance lines of business, and lower reported large losses during the three months ended March 31, 2014 compared to the three months ended March 31, 2103. Current year property catastrophe losses and loss expenses During the three months ended March 31, 2014 and March 31, 2013, we did not incur any property catastrophe losses. Prior year losses and loss expenses Overall, our reinsurance segment recorded net favorable reserve development of $20.3 million during the three months ended March 31, 2014 compared to net favorable reserve development of $24.9 million for the three months ended March 31, 2013, as shown in the tables below. 46-------------------------------------------------------------------------------- Table of Contents (Favorable) and Unfavorable Loss Reserve Development by Loss Year For the Three Months Ended March 31, 2014 2004 and Prior 2005 2006 2007 2008 2009 2010 2011 2012 2013 Total ($ in millions) Property $ - $ - $ (0.1 ) $ (0.2 ) $ (0.3 ) $ (0.1 ) $ 0.6 $ (0.7 ) $ (1.7 ) $ (13.7 ) $ (16.2 ) Casualty (1.4 ) 0.6 (1.3 ) (1.9 ) (1.4 ) 0.2 0.8 0.9 0.7 2.2 (0.6 ) Specialty - 0.2 - - - 0.1 0.1 - (1.1 ) (2.8 ) (3.5 ) $ (1.4 ) $ 0.8 $ (1.4 ) $ (2.1 ) $ (1.7 ) $ 0.2 $ 1.5 $ 0.2 $ (2.1 ) $ (14.3 ) $ (20.3 ) The net favorable reserve development in the property reinsurance line of business for the 2013 loss year is due to benign reported loss activity. (Favorable) and Unfavorable Loss Reserve Development by Loss Year For the Three Months Ended March 31, 2013 2003 and Prior 2004 2005 2006 2007 2008 2009 2010 2011 2012 Total ($ in millions) Property $ - $ - $ (1.8 ) $ - $ - $ (0.1 ) $ (0.1 ) $ (2.3 ) $ (7.0 ) $ (12.9 ) $ (24.2 ) Casualty 0.5 (0.1 ) (0.2 ) (0.1 ) (2.2 ) (2.5 ) (0.3 ) 0.2 - - (4.7 ) Specialty - - (0.1 ) (0.1 ) - (0.4 ) (0.6 ) (0.1 ) 1.5 3.8 4.0 $ 0.5 $ (0.1 ) $ (2.1 ) $ (0.2 ) $ (2.2 ) $ (3.0 ) $ (1.0 ) $ (2.2 ) $ (5.5 ) $ (9.1 ) $ (24.9 ) The net favorable reserve development for loss years 2004 to 2012 is a result of actual loss emergence being lower than anticipated. Acquisition costs. Acquisition costs increased by $6.8 million, or 19.8%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The increase was due to the increase in premiums written, as well as increased ceding commission charged by cedents in certain lines of business. The acquisition cost ratio was 17.9% for the three months ended March 31, 2014 compared to 18.1% for the three months ended March 31, 2013. The decrease in the acquisition cost ratio was due to higher earned premium during the current quarter related to the non-renewal of the collateralized retrocessional catastrophe cover partially offset by the increased ceding commission charged by cedents. In the prior period, the collateralized retrocessional catastrophe cover reduced net premiums earned but did not have any offsetting ceding commission income, which caused the acquisition costs ratio to be higher compared to the current quarter. General and administrative expenses. General and administrative expenses decreased by $0.2 million, or 1.1%, for the three months ended March 31, 2014 compared to the same period in 2013. The decrease in general and administrative expenses was primarily due to lower stock-based compensation expense partially offset by higher salary related costs. The general and administrative expense ratios for the three months ended March 31, 2014 and 2013 were 7.9% and 9.6%, respectively, due to lower expenses and higher net premiums earned. 47-------------------------------------------------------------------------------- Table of Contents Reserves for Losses and Loss ExpensesReserves for losses and loss expenses by segment were comprised of the following: U.S. Insurance International Insurance Reinsurance Total Mar 31, Dec 31, Mar 31, Dec 31, Mar 31, Dec 31, Mar 31, Dec 31, 2014 2013 2014 2013 2014 2013 2014 2013 ($ in millions) Case reserves $ 626.6 $ 609.8 $ 386.7 $ 441.0 $ 461.1 $ 470.1 $ 1,474.4 $ 1,520.9 IBNR 1,567.3 1,509.2 1,754.7 1,710.4 1,060.4 1,026.0 4,382.4 4,245.6 Reserve for losses and loss expenses 2,193.9 2,119.0 2,141.4 2,151.4 1,521.5 1,496.1 5,856.8 5,766.5 Reinsurance recoverables (588.1 ) (558.7 ) (683.7 ) (669.6 ) (8.7 ) (6.2 ) (1,280.5 ) (1,234.5 ) Net reserve for losses and loss expenses $ 1,605.8 $ 1,560.3 $ 1,457.7 $ 1,481.8 $ 1,512.8 $ 1,489.9 $ 4,576.3 $ 4,532.0 We participate in certain lines of business where claims may not be reported for many years. Accordingly, management does not solely rely upon reported claims on these lines for estimating ultimate liabilities. We also use statistical and actuarial methods to estimate expected ultimate losses and loss expenses. Loss reserves do not represent an exact calculation of liability. Rather, loss reserves are estimates of what we expect the ultimate resolution and administration of claims will cost. These estimates are based on various factors including underwriters' expectations about loss experience, actuarial analysis, comparisons with the results of industry benchmarks and loss experience to date. Loss reserve estimates are refined as experience develops and as claims are reported and resolved. Establishing an appropriate level of loss reserves is an inherently uncertain process. Ultimate losses and loss expenses may differ from our reserves, possibly by material amounts. The following tables provide our ranges of loss and loss expense reserve estimates by business segment as of March 31, 2014: Reserve for Losses and Loss Expenses Gross of Reinsurance Recoverable Carried Low High Reserves Estimate Estimate ($ in millions) U.S. insurance $ 2,193.9 $ 1,731.9 $ 2,464.8 International insurance 2,141.4 1,648.1 2,369.2 Reinsurance 1,521.5 1,251.8 1,717.2 Consolidated (1) 5,856.8 4,725.8 6,457.2 Reserve for Losses and Loss Expenses Net of Reinsurance Recoverable Carried Low High Reserves Estimate Estimate ($ in millions) U.S. insurance $ 1,605.8 $ 1,269.2 $ 1,838.4 International insurance 1,457.7 1,109.3 1,626.2 Reinsurance 1,512.8 1,242.8 1,705.6 Consolidated (1) 4,576.3 3,703.5 5,088.0 ________________________(1) For statistical reasons, it is not appropriate to add together the ranges of each business segment in an effort to determine the low and high range around the consolidated loss reserves. Our range for each business segment was determined by utilizing multiple actuarial loss reserving methods along with various assumptions of reporting patterns and expected loss ratios by loss year. The various outcomes of these techniques were combined to determine a reasonable range of required loss and loss expense reserves. While we believe our approach to determine the range of loss and loss expense is reasonable, there are no assurances that actual loss experience will be within the ranges of loss and loss expense noted above. 48-------------------------------------------------------------------------------- Table of Contents Our selection of the actual carried reserves is generally above the midpoint of the range. We believe that we should be prudent in our reserving practices due to the lengthy reporting patterns and relatively large limits of net liability for any one risk of our direct excess casualty business and of our casualty reinsurance business. Thus, due to this uncertainty regarding estimates for reserve for losses and loss expenses, we have carried our consolidated reserve for losses and loss expenses, net of reinsurance recoverable, above the midpoint of the low and high estimates for the consolidated net losses and loss expenses. We believe that relying on the more prudent actuarial indications is appropriate for these lines of business. Reinsurance RecoverableThe following table illustrates our reinsurance recoverable as of March 31, 2014 and December 31, 2013: March 31, December 31, 2014 2013 ($ in millions) Ceded case reserves $ 229.2 $ 225.8 Ceded IBNR reserves 1,051.3 1,008.7 Reinsurance recoverable $ 1,280.5 $ 1,234.5 We remain obligated for amounts ceded in the event our reinsurers do not meet their obligations. Accordingly, we have evaluated the reinsurers that are providing reinsurance protection to us and will continue to monitor their credit ratings and financial stability. We generally have the right to terminate our treaty reinsurance contracts at any time, upon prior written notice to the reinsurer, under specified circumstances, including the assignment to the reinsurer by A.M. Best of a financial strength rating of less than "A-." Approximately 99% of ceded reserves as of March 31, 2014 were recoverable from reinsurers who had an A.M. Best rating of "A-" or higher. Liquidity and Capital ResourcesLiquidity Liquidity is a measure of our ability to access sufficient cash flows to meet the short-term and long-term cash requirements of our business operations. The company believes that its cash flows from operations and investments will provide sufficient liquidity for the foreseeable future. Holdings is a holding company and transacts no business of its own. Cash flows to Holdings may comprise dividends, advances and loans from its subsidiary companies. Holdings is therefore reliant on receiving dividends and other permitted distributions from its subsidiaries to make dividend payments on its common shares. Our operating subsidiaries depend upon cash inflows from premium receipts, net of commissions, investment income and proceeds from sales and redemptions of investments. Cash outflows for our operating subsidiaries are in the form of claims payments, net of reinsurance recoveries, reinsurance premium payments, purchase of investments, operating expenses and income tax payments as well as dividend payments to the holding company. Historically, our operating subsidiaries have generated sufficient cash flows to meet all of their obligations. Because of the inherent volatility of our business, the seasonality in the timing of payments by insureds and cedents, the irregular timing of loss payments, and the impact of a change in interest rates and credit spreads on the investment income as well as seasonality in coupon payment dates for fixed income securities, cash flows from operating activities may vary between periods. In the unlikely event that paid losses exceed operating cash flows in any given period, we would use our cash balances available, liquidate a portion of our investment portfolio or borrow under our revolving loan facility (see "Credit Facilities" below) in order to meet our short-term liquidity needs. Our total investments and cash and cash equivalents totaled $8.6 billion as of March 31, 2014, the main components of which were investment grade fixed income securities and cash and cash equivalents. As of March 31, 2014, we held $565.8 million of unrestricted cash and cash equivalents and $942.0 million of fixed income securities with a maturity of less than one year to meet short-term liquidity needs. Our remaining fixed income securities, equity securities and "other invested assets" are available to meet our long-term liquidity needs. 49-------------------------------------------------------------------------------- Table of Contents As of March 31, 2014, we had $150 million available under our revolving loan facility. |