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13: R2 Consolidated Balance Sheets Consolidated Balance HTML 121K
Sheets
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16: R5 Consolidated Statements of Comprehensive Income HTML 50K
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Position (Securities in an Unrealized Loss
Position) (Details)
28: R17 General HTML 29K
29: R18 Per Share Data HTML 39K
30: R19 Recent Accounting Pronouncements and Accounting HTML 40K
Policies
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32: R21 Investments in Equity Securities HTML 346K
33: R22 Arbitrage Trading Account HTML 29K
34: R23 Investment Funds HTML 56K
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Position
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Policies (Policies)
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(Exact name of registrant as specified in its charter)
iDelaware
i22-1867895
(State
or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
i475 Steamboat Road
iGreenwich
iConnecticut
i06830
(Address
of principal executive offices)
(Zip Code)
i(203)
i629-3000
(Registrant’s
telephone number, including area code)
None
Former name, former address and former fiscal year, if changed since last report.
Securities registered pursuant to Section 12(b) of the Act:
Title
Trading Symbol
Name
iCommon Stock, par value $.20 per share
iWRB
iNew
York Stock Exchange
i5.625% Subordinated Debentures due 2053
iWRB-PB
iNew
York Stock Exchange
i5.90% Subordinated Debentures due 2056
iWRB-PC
iNew
York Stock Exchange
i5.75% Subordinated Debentures due 2056
iWRB-PD
iNew
York Stock Exchange
i5.70% Subordinated Debentures due 2058
iWRB-PE
iNew
York Stock Exchange
i5.10% Subordinated Debentures due 2059
iWRB-PF
iNew
York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. iYes☒
No ☐
1
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). iYes☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
iLarge
accelerated filer
☒
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
i☐
Emerging
growth company
i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i☐ No ☒
Number of shares of common stock, $.20 par value, outstanding as of July 29, 2020: i178,003,807
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(1) iGeneral
The unaudited consolidated financial statements, which include the accounts of W. R. Berkley Corporation and its subsidiaries (the “Company”), have been prepared on the basis of U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, they do not include all the information and notes required by GAAP for annual financial statements. The unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring items, which are necessary to present fairly the Company’s financial position and results of operations on a basis consistent with the prior audited consolidated financial statements. Operating results for interim periods are not necessarily indicative
of the results that may be expected for the year. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the revenues and expenses reflected during the reporting period. For further information related to areas of judgment and estimates and other information necessary to understand the Company’s financial position and results of operations, refer to the audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31,
2019.
The income tax provision has been computed based on the Company’s estimated annual effective tax rate. The effective income tax rate differs from the federal income tax rate of i21% principally because foreign jurisdictions were limited on the utilization of losses at different tax rates, which was partially offset by tax-exempt investment income and tax benefits
related to equity-based compensation.
(2) iiPer
Share Data/
The Company presents both basic and diluted net income per share (“EPS”) amounts. Basic EPS is calculated by dividing net income by the weighted average number of common shares outstanding during the period (including i7,575,168 and
i7,389,781 common shares held in a grantor trust as of June 30, 2020 and 2019, respectively). The common shares held in the grantor trust are for delivery upon settlement of vested but mandatorily deferred restricted stock units ("RSUs"). Shares held by the grantor trust do not affect diluted shares outstanding since the shares deliverable under vested RSUs were already included in diluted shares outstanding. Diluted
EPS is based upon the weighted average number of basic and common equivalent shares outstanding during the period and is calculated using the treasury stock method for stock incentive plans. Common equivalent shares are excluded from the computation in periods in which they have an anti-dilutive effect.
iThe weighted average number of common shares used in the computation of basic and diluted earnings per share was as follows:
For
the Three Months Ended June 30,
For the Six Months Ended June 30,
(In thousands)
2020
2019
2020
2019
Basic
i185,979
i190,512
i188,133
i190,456
Diluted
i187,862
i193,059
i190,078
i192,804
(3) iiRecent
Accounting Pronouncements and Accounting Policies/
Recently adopted accounting pronouncements:
In June 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-13, Financial Instruments - Credit Losses, which amended the accounting guidance for credit losses on financial instruments. The updated guidance amended the current other-than-temporary impairment model for available for sale debt securities by requiring the recognition of impairments relating to expected credit losses through an allowance account and limits the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. This
guidance also applies a new current expected credit loss model for determining credit-related impairments for financial instruments measured at amortized cost, such as reinsurance recoverables. The updated guidance was effective for reporting periods beginning after December 15, 2019.
The adoption of this guidance on January 1, 2020 resulted in the recognition of an allowance for expected credit losses in connection with operating assets (premiums and fees receivable and due from reinsurers) of $ii5.7/
million (net of tax) and a corresponding cumulative effect adjustment that decreased common stockholders' equity. Certain investments (primarily fixed
6
maturity securities available for sale) established an allowance for expected credit loss of $i24.8 million (net of tax), with a cumulative effect adjustment decreasing retained earnings by $i24.8
million (net of tax) and increasing accumulated other comprehensive (loss) income ("AOCI") by $i25.0 million (net of tax), resulting in $i0.2
million net impact to total common stockholders' equity.
All other accounting and reporting standards that have become effective in 2020 were either not applicable to the Company or their adoption did not have a material impact on the Company.
Accounting and reporting standards that are not yet effective:
All recently issued but not yet effective accounting and reporting standards are either not applicable to the Company or are not expected to have a material impact on the Company.
Accounting
policies:
The following accounting policies have been updated to reflect the Company's adoption of Financial Instruments - Credit Losses as described above.
Revenue recognition (related to premiums and fees receivable)
Insurance premiums are recognized as written at the inception of the policy. Reinsurance premiums are estimated based upon information received from ceding companies, and subsequent differences from such estimates are recorded in the period they are determined. Insurance and reinsurance premiums are primarily earned on a pro rata basis over the policy term. Fees for services are earned over the period that the services are provided. Premiums and fees receivable are reported net of an allowance for expected credit losses with the allowance
being estimated based on current and future expected conditions, historical loss data and specific identification of collectability concerns where applicable. Changes in the allowance are reported within other operating costs and expenses.
Reinsurance ceded (related to due from reinsurers)
The unearned portion of premiums ceded to reinsurers is reported as prepaid reinsurance premiums and earned ratably over the policy term. The estimated amounts of reinsurance recoverable on unpaid losses are reported as due from reinsurers. To the extent any reinsurer does not meet its obligations under reinsurance agreements, the Company must discharge its liability. Amounts due from reinsurers are reflected net of funds held where the right of offset is present. The
Company has provided an allowance for expected credit losses for estimated uncollectible reinsurance. The allowance is estimated based on the composition of the recoverable balance, considering reinsurer credit ratings, collateral received from financial institutions and funds withheld arrangements, length of collection periods, probability of default methodology, and specific identification of collectability concerns. Changes in the allowance are reported within losses and loss expenses.
Investments
For available for sale 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. For available
for sale 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, limited by the amount that the fair value is less than the amortized cost basis. The allowance is adjusted for any change in expected credit losses and subsequent recoveries through net investment gains. The impairment related to non-credit factors is recognized in other comprehensive income.
For financial assets carried at amortized cost, which includes held to maturity securities and 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.
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
7
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 reports accrued investment income separately from fixed maturity securities,
and has elected not to measure an allowance for expected credit losses for accrued investment income. Accrued investment income is written off through net investment income at the time the issuer of the bond defaults or is expected to default on payments.
8
(4) iConsolidated
Statements of Comprehensive Income
iThe following table presents the components of the changes in accumulated other comprehensive (loss) income ("AOCI"):
Other
comprehensive income (loss) before reclassifications
i118,475
(i14,492)
i103,983
Amounts
reclassified from AOCI
i174
i—
i174
Other
comprehensive income (loss)
i118,649
(i14,492)
i104,157
Unrealized
investment loss related to noncontrolling interest
i30
i—
i30
Ending
balance
$
i152,915
$
(i413,711)
$
(i260,796)
Amounts
reclassified from AOCI
Pre-tax
$
i220
(1)
$
i—
$
i220
Tax
effect
(i46)
(2)
i—
(i46)
After-tax
amounts reclassified
$
i174
$
i—
$
i174
Other
comprehensive income (loss)
Pre-tax
$
i147,072
$
(i14,492)
$
i132,580
Tax
effect
(i28,423)
i—
(i28,423)
Other
comprehensive income (loss)
$
i118,649
$
(i14,492)
$
i104,157
____________
(1)
Net investment gains (losses) in the consolidated statements of income.
(2) Income tax expense in the consolidated statements of income.
(5) iStatements of Cash Flows
Interest payments were $i73,056,000
and $i77,672,000 for the six months ended June 30, 2020 and 2019, respectively. iNo income tax was paid
for the six months ended June 30, 2020 and $i82,800,000 was paid for the six months ended June 30, 2019.
(1)
Represents the amount of impairment that has resulted from credit-related factors. The change in the allowance for expected credit losses, excluding the cumulative effect adjustment resulting from changes in accounting principles, is recognized in the consolidated statements of income. Amount excludes unrealized losses relating to non-credit factors.
The
following table presents the rollforward of the allowance for expected credit losses for held to maturity securities for the six months ended June 30, 2020:
Cumulative
effect adjustment resulting from changes in accounting principles
i69
Provision for expected credit losses
i879
Allowance
for expected credit losses at June 30, 2020
$
i948
The following table presents the rollforward of the allowance for expected credit losses for held to maturity securities for the three months ended June 30, 2020:
State
and Municipal
(In thousands)
Allowance for expected credit losses at April 1, 2020
$
i107
Provision for expected credit losses
i841
Allowance
for expected credit losses at June 30, 2020
$
i948
/
12
i
The
following table presents the rollforward of the allowance for expected credit losses for available for sale securities for the six months ended June 30, 2020:
Cumulative
effect adjustment resulting from changes in accounting principles
i35,645
i—
i35,645
Expected
credit losses on securities for which credit losses were not previously recorded
i12,494
i6,797
i19,291
Expected
credit losses on securities for which credit losses were previously recorded
i547
(i3,758)
(i3,211)
Reduction
due to disposals
(i3,917)
(i2,315)
(i6,232)
Allowance
for expected credit losses at June 30, 2020
$
i44,769
$
i724
$
i45,493
The
following table presents the rollforward of the allowance for expected credit losses for available for sale securities for the three months ended June 30, 2020:
Foreign Government
Corporate
Total
(In thousands)
Allowance
for expected credit losses at April 1, 2020
$
i60,920
$
i6,436
$
i67,356
Expected
credit losses on securities for which credit losses were not previously recorded
i—
i361
i361
Expected
credit losses on securities for which credit losses were previously recorded
(i15,822)
(i3,758)
(i19,580)
Reduction
due to disposals
(i329)
(i2,315)
(i2,644)
Allowance
for expected credit losses at June 30, 2020
$
i44,769
$
i724
$
i45,493
/
During
the six months ended June 30, 2020, the Company increased the allowance for expected credit losses utilizing its credit loss assessment process and inputs used in its credit loss model, primarily due to the negative impact to the financial markets caused by COVID-19. As a result, the Company recognized an initial allowance for expected credit losses on securities that previously did not have an allowance, and increased the allowance for expected credit losses on existing securities due to higher default rate and lower recovery rate assumptions. Improved market pricing and credit ratings at June 30, 2020 compared to March 31, 2020 led to a decrease in the allowance
for expected credit losses during the three months ended June 30, 2020.
iThe amortized cost and fair value of fixed maturity securities at June 30, 2020, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because certain issuers may have the right to call or prepay obligations.
(In
thousands)
Amortized Cost (1)
Fair Value
Due in one year or less
$
i852,249
$
i832,105
Due
after one year through five years
i5,021,482
i5,151,442
Due
after five years through ten years
i3,148,884
i3,297,837
Due
after ten years
i2,863,378
i2,844,608
Mortgage-backed
securities
i1,132,437
i1,170,406
Total
$
i13,018,430
$
i13,296,398
________________
(1)
Amortized cost is reduced by the allowance for expected credit losses of $i948 thousand related to held to maturity securities.
At June 30, 2020 and December 31, 2019, there were no investments that exceeded 10% of common stockholders' equity, other than investments in United States government and government agency securities.
At June 30, 2020 and December 31, 2019, the fair and carrying values of the arbitrage trading account were $i581 million and $i401
million, respectively. The primary focus of the trading account is merger arbitrage. Merger arbitrage is the business of investing in the securities of publicly held companies which are the targets in announced tender offers and mergers. Arbitrage investing differs from other types of investing in its focus on transactions and events believed likely to bring about a change in value over a relatively short time period (usually four months or less).
The Company uses put options and call options in order to mitigate the impact of potential changes in market conditions on the merger arbitrage trading account. These options are reported at fair value. As of June 30, 2020, the fair value of long option contracts
outstanding was $i202 thousand (notional amount of $i5.2 million) and the fair value of short option contracts
outstanding was $i88 thousand (notional amount of $i3.9 million). Other than with respect to the use of these trading account securities, the
Company does not make use of derivatives.
(9) iNet Investment Income
iNet
investment income consisted of the following:
For the Three Months Ended June 30,
For the Six Months Ended June 30,
(In
thousands)
2020
2019
2020
2019
Investment income (losses) earned on:
Fixed maturity securities, including cash and cash equivalents and loans receivable
$
i105,843
$
i128,903
$
i233,861
$
i261,022
Investment
funds
(i57,552)
i46,840
(i16,975)
i58,251
Arbitrage
trading account
i31,304
i7,199
i32,442
i17,784
Real
estate
i5,045
i5,174
i11,141
i9,481
Equity
securities
i2,726
i1,303
i4,288
i2,591
Gross
investment income
i87,366
i189,419
i264,757
i349,129
Investment
expense
(i1,935)
(i1,086)
(i4,563)
(i2,542)
Net
investment income
$
i85,431
$
i188,333
$
i260,194
$
i346,587
14
(10)
iInvestment Funds
The Company evaluates whether it is an investor in a variable interest entity ("VIE"). Such entities do not have sufficient equity at risk to finance their activities without additional subordinated financial support, or the equity investors, as a group, do not have the characteristics of a controlling financial interest (primary beneficiary). The
Company determines whether it is the primary beneficiary of an entity subject to consolidation based on a qualitative assessment of the VIE's capital structure, contractual terms, nature of the VIE's operations and purpose, and the Company's relative exposure to the related risks of the VIE on the date it becomes initially involved in the VIE and on an ongoing basis. The Company is not the primary beneficiary in any of its investment funds, and accordingly, carries its interests in investment funds under the equity method of accounting.
The Company’s maximum exposure to loss with respect to these investments is limited to the carrying amount reported on the
Company’s consolidated balance sheet and its unfunded commitments, which were $i145 million as of June 30, 2020.
iInvestment
funds consisted of the following:
Carrying Value as of
Income (Loss) from Investment Funds
June
30,
December 31,
For the Six Months Ended June 30,
(In thousands)
2020
2019
2020
2019
Real estate
$
i313,781
$
i412,275
$
i4,021
$
i13,078
Financial
services
i345,175
i280,705
(i6,881)
i23,297
Energy
i129,031
i156,869
(i20,968)
(i6,422)
Transportation
i142,840
i147,034
(i4,627)
i9,536
Other
funds
i228,410
i216,652
i11,480
i18,762
Total
$
i1,159,237
$
i1,213,535
$
(i16,975)
$
i58,251
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. Accordingly, losses from investment funds for the second quarter of 2020 reflects the adverse impact from the disruption in global financial markets associated with COVID-19 during the first quarter of 2020.
(11) iReal
Estate
iInvestment in real estate represents directly owned property held for investment, as follows:
Carrying Value
June
30,
December 31,
(In thousands)
2020
2019
Properties in operation
$
i1,623,579
$
i1,351,249
Properties
under development
i449,193
i754,701
Total
$
i2,072,772
$
i2,105,950
As
of June 30, 2020, properties in operation included a long-term ground lease in Washington, D.C., a hotel in Memphis, Tennessee, two office complexes in New York City, office buildings in West Palm Beach and Palm Beach, Florida, an office building in London, and the completed portion of a mixed-use project in Washington D.C.. Properties in operation are net of accumulated depreciation and amortization of $i72,036,000 and $i59,832,000
as of June 30, 2020 and December 31, 2019, respectively. Related depreciation expense was $i13,776,000 and $i8,931,000
for the six months ended June 30, 2020 and 2019, respectively. Future minimum rental income expected on operating leases relating to properties in operation is $i39,127,419 in 2020, $i81,060,656
in 2021, $i81,637,432 in 2022, $i75,278,181 in 2023, $i73,040,940
in 2024, $i69,300,988 in 2025 and $i660,961,934 thereafter.
The
Company borrowed $i101,750,000 through a non-recourse loan secured by the West Palm Beach office building in 2018. The loan matures in November 2028 and carries a fixed interest rate of i4.21%.
The carrying value does not reflect the outstanding financing, which is reflected within senior notes and other debt on the Company's consolidated balance sheet.
A mixed-use project in Washington, D.C. has been under development in 2020 and 2019, with the completed portion reported in properties in operation as of June 30, 2020.
Amortized cost (net of allowance for expected credit losses):
Real estate loans
$
i49,770
$
i58,541
Commercial
loans
i32,364
i33,258
Total
$
i82,134
$
i91,799
Fair
value:
Real estate loans
$
i54,088
$
i59,853
Commercial
loans
i32,364
i34,760
Total
$
i86,452
$
i94,613
The
real estate loans are secured by commercial real estate primarily located in New York. These loans generally earn interest at floating LIBOR-based interest rates and have maturities (inclusive of extension options) through August 2025. The commercial loans are with small business owners who have secured the related financing with the assets of the business. Commercial loans primarily earn interest on a fixed basis and have varying maturities generally not exceeding i10 years.
Cumulative
effect adjustment resulting from changes in accounting principles
(i905)
i548
(i357)
Provision
for expected credit losses
i3,721
i3,209
i6,930
Allowance
for expected credit losses at June 30, 2020
$
i4,318
$
i4,401
$
i8,719
The
following table presents the rollforward of the allowance for expected credit losses for loans receivable for the three months ended June 30, 2020:
Real Estate Loans
Commercial Loans
Total
(In thousands)
Allowance
for expected credit losses at April 1, 2020
$
i1,435
$
i2,493
$
i3,928
Provision
for expected credit losses
i2,883
i1,908
i4,791
Allowance
for expected credit losses at June 30, 2020
$
i4,318
$
i4,401
$
i8,719
/
The
Company monitors the performance of its loans receivable and assesses the ability of the borrower to pay principal and interest based upon loan structure, underlying property values, cash flow and related financial and operating performance of the property and market conditions.
In evaluating the real estate loans, the Company considers their credit quality indicators, including loan to value ratios, which compare the outstanding loan amount to the estimated value of the property, the borrower’s financial condition and performance with respect to loan terms, the position in the capital structure, the overall leverage in the capital structure and other market conditions.
16
(13) iNet
Investment Gains (Losses)
iNet investment gains (losses) are as follows:
For
the Three Months Ended June 30,
For the Six Months Ended June 30,
(In thousands)
2020
2019
2020
2019
Net investment gains (losses):
Fixed
maturity securities:
Gains
$
i14,844
$
i3,157
$
i19,775
$
i8,403
Losses
(i9,234)
(i3,377)
(i14,081)
(i6,895)
Equity
securities (1):
Net realized gains (losses) on investment sales
i5,727
(i6)
i5,727
i23,339
Change
in unrealized gains (losses)
i61,914
i69,418
(i92,552)
i111,496
Investment
funds
i913
i41
i31,096
i58
Real
estate (2)
(i7,137)
i3,021
(i7,824)
i5,767
Loans
receivable
i—
i—
i—
(i970)
Other
(i5,374)
i1,320
(i23,773)
i1,028
Net
realized and unrealized gains (losses) on investments in earnings before allowance for expected credit losses
i61,653
i73,574
(i81,632)
i142,226
Change
in allowance for expected credit losses on investments (3):
Fixed maturity securities
i21,023
i—
(i10,727)
i—
Loans
receivable
(i4,791)
i—
(i6,930)
i—
Change
in allowance for expected credit losses on investments
i16,232
i—
(i17,657)
i—
Net
investment gains (losses)
i77,885
i73,574
(i99,289)
i142,226
Income
tax (expense) benefit
(i18,098)
(i15,451)
i22,476
(i29,867)
After-tax
net investment gains (losses)
$
i59,787
$
i58,123
$
(i76,813)
$
i112,359
Change
in unrealized investment gains on available for sale securities:
Fixed maturity securities without allowance for expected credit losses
$
i369,615
$
i146,629
$
i43,199
$
i321,123
Fixed
maturity securities with allowance for expected credit losses
i23,450
i81
i24,991
i12
Investment
funds
i4,212
i5,762
(i3,434)
i7,552
Other
(i1,653)
(i5,401)
(i1,979)
(i12,356)
Total
change in unrealized investment gains
i395,624
i147,071
i62,777
i316,331
Income
tax expense
(i76,899)
(i28,422)
(i3,034)
(i71,907)
Noncontrolling
interests
(i1)
i30
i1
(i18)
After-tax
change in unrealized investment gains of available for sale securities
$
i318,724
$
i118,679
$
i59,744
$
i244,406
______________________
(1)
The net realized gains or losses on investment sales represent the total gains or losses from the purchase dates of the equity securities. The change in unrealized gains consists of two components: (i) the reversal of the gain or loss recognized in previous periods on equity securities sold and (ii) the change in unrealized gain or loss resulting from mark-to-market adjustments on equity securities still held.
(2) For the three and six months ended June 30, 2020, net investment losses on real estate includes an allowance of $ii8/ million.
(3)
The inclusion of the allowance for expected credit losses on investments commenced January 1, 2020 due to the adoption of ASU 2016-13. See Note 3 for more details.
17
(14) iFixed
Maturity Securities in an Unrealized Loss Position
iThe following tables summarize all fixed maturity securities in an unrealized loss position at June 30, 2020 and December 31, 2019 by the length of time those securities have been continuously in an unrealized loss position:
Substantially
all of the securities in an unrealized loss position are rated investment grade, except for the securities in the foreign government classification. In general, fair value in all classifications were negatively affected by market disruptions caused by COVID-19. A significant amount of the unrealized loss on foreign government securities is the result of changes in currency exchange rates.
iA
summary of the Company’s non-investment grade fixed maturity securities that were in an unrealized loss position at June 30, 2020 is presented in the table below:
($ in thousands)
Number of Securities
Aggregate Fair Value
Gross Unrealized
Loss
Foreign government
i14
$
i52,126
$
i32,429
Corporate
i18
i47,404
i9,320
Mortgage-backed
securities
i12
i6,348
i340
Asset-backed
securities
i2
i279
i6
Total
i46
$
i106,157
$
i42,095
For
fixed maturity securities that management does not intend to sell or to be required to sell, the portion of the decline in value that is considered to be due to credit factors is recognized in earnings, and the portion of the decline in value that is considered to be due to non-credit factors is recognized in other comprehensive income.
The Company has evaluated its 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.
18
(15)iFair Value Measurements
The
Company’s fixed maturity available for sale securities, equity securities and its arbitrage trading account securities are carried at fair value. Fair value is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”The Company utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, as follows:
Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
Level 2 - Quoted
prices for similar assets or valuations based on inputs that are observable.
Level 3 - Estimates of fair value based on internal pricing methodologies using unobservable inputs. Unobservable inputs are only used to measure fair value to the extent that observable inputs are not available.
Substantially all of the Company’s fixed maturity securities were priced by independent pricing services. The prices provided by the independent pricing services are estimated based on observable market data in active markets utilizing pricing models and processes, which may include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, sector groupings, matrix pricing and reference data. The pricing services may
prioritize inputs differently on any given day for any security based on market conditions, and not all inputs are available for each security evaluation on any given day. The pricing services used by the Company have indicated that they will only produce an estimate of fair value if objectively verifiable information is available. 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 and periodically performs independent price tests of a sample of securities to ensure proper valuation.
If prices from independent pricing services are not available for fixed maturity securities, the
Company estimates the fair value. For Level 2 securities, the Company utilizes pricing models and processes which may include benchmark yields, sector groupings, matrix pricing, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, bids, offers and reference data. Where broker quotes are used, the Company generally requests two or more quotes and 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 received from brokers. 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 projections, credit quality and business developments of the issuer and other relevant information.
For Level 3 securities, the Company generally uses a discounted cash flow model to estimate the fair value of fixed maturity securities. The cash flow models are based upon assumptions as to prevailing credit spreads, interest rate and interest rate volatility, time to maturity and subordination levels. Projected cash flows are discounted at rates that are adjusted to reflect illiquidity, where appropriate.
19
iThe
following tables present the assets and liabilities measured at fair value on a recurring basis as of June 30, 2020 and December 31, 2019 by level:
Total
fixed maturity securities available for sale
i14,102,278
i—
i14,102,278
i—
Equity
securities:
Common stocks
i166,805
i157,752
i—
i9,053
Preferred
stocks
i313,815
i—
i307,310
i6,505
Total
equity securities
i480,620
i157,752
i307,310
i15,558
Arbitrage
trading account
i400,809
i381,061
i19,748
i—
Total
$
i14,983,707
$
i538,813
$
i14,429,336
$
i15,558
Liabilities:
Trading
account securities sold but not yet purchased
$
i36,143
$
i36,143
$
i—
$
i—
20
iThe
following tables summarize changes in Level 3 assets and liabilities for the six months ended June 30, 2020 and for the year ended December 31, 2019:
Trading
account securities sold but not yet purchased
$
i793
$
i133
$
i—
$
i—
$
i7,609
$
(i8,535)
$
i—
$
i—
$
i—
For
the quarter ended June 30, 2020, there were no securities transferred into or out of Level 3. For the year ended December 31, 2019, there were two common stocks transferred into Level 3 in the arbitrage trading account where publicly traded prices were no longer available, and both were sold by year end.
21
(16) iReserves
for Loss and Loss Expenses
The Company's reserves for losses and loss expenses are comprised of case reserves and incurred but not reported liabilities ("IBNR"). When a claim is reported, a case reserve is established for the estimated ultimate payment based upon known information about the claim. As more information about the claim becomes available over time, case reserves are adjusted up or down as appropriate. Reserves are also established on an aggregate basis to provide for IBNR liabilities and expected loss reserve development on reported claims.
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 operating unit. 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. 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” 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 operating unit.
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.
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 operating unit. 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.
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.
22
iThe
table below provides a reconciliation of the beginning and ending reserve balances:
June 30,
(In thousands)
2020
2019
Net
reserves at beginning of period
$
i10,697,998
$
i10,248,883
Cumulative
effect adjustment resulting from changes in accounting principles
i5,927
i—
Restated
net reserves at beginning of period
i10,703,925
i10,248,883
Net
provision for losses and loss expenses:
Claims occurring during the current year (1)
i2,222,671
i1,980,138
Increase
in estimates for claims occurring in prior years (2) (3)
i2,050
i16,764
Loss
reserve discount accretion
i17,658
i20,577
Total
i2,242,379
i2,017,479
Net
payments for claims:
Current year
i289,154
i548,589
Prior
years
i1,545,471
i1,200,906
Total
i1,834,625
i1,749,495
Foreign
currency translation
(i45,572)
(i2,228)
Net
reserves at end of period
i11,066,107
i10,514,639
Ceded
reserves at end of period
i2,022,797
i1,805,639
Gross
reserves at end of period
$
i13,088,904
$
i12,320,278
_______________________________________
(1) Claims
occurring during the current year are net of loss reserve discounts of $i5 million and $i11 million for the six months ended June
30, 2020 and 2019, respectively.
(2) The change in estimates for claims occurring in prior years is net of loss reserve discount. On an undiscounted basis, the estimates for claims occurring in prior years decreased by $i8 million and increased by $i9
million for the six months ended June 30, 2020 and 2019, respectively.
(3) For certain retrospectively rated insurance policies and reinsurance agreements, reserve development is offset by additional or return premiums. Favorable development, net of additional and return premiums, was $i7
million and $i14 million for the six months ended June 30, 2020 and 2019, respectively.
The ongoing COVID-19 global pandemic has impacted, and will likely continue to impact, the
Company’s results through its effect on claim frequency and severity. Loss cost trends have been impacted and will likely be further impacted by COVID-19-related claims in certain lines of business, as well as by other effects of COVID-19 associated with economic conditions, inflation, and social distancing and work from home rules, for example. Although it is still too early to determine, to date, it appears that the losses incurred due to COVID-19-related claims have been partially offset by lower claim frequency in certain lines of our businesses, including commercial auto. However, given the continuing nature of the pandemic, the impact of COVID-19 could ultimately increase or decrease overall loss cost trends and is likely to have differing impacts on the Company's different lines of business. For certain lines of business, such as contingency and event cancellation, the
Company has received reported claims related to COVID-19, and it expects additional claims to be reported in the future. The Company has also received claims for other short-tailed lines related to business interruption and film production delays. Further, for workers’ compensation, nearly one-third of the states have enacted rules, legislation or administrative orders creating a presumption that certain “essential” workers who contract COVID-19 did so through the course of their employment. Several other states are considering similar actions, including with varying definitions of “essential” workers. While the ultimate impact of these presumptions are unknown at this time, the Company believes that
such state actions will likely increase workers’ compensation claims with respect to workers deemed “essential,” although this impact may be partially offset by lower workers’ compensation claim frequency with respect to non-essential workers.
The Company has estimated the potential COVID-19 impact to its workers’ compensation, contingency and event cancellation, and other lines of business under a number of possible scenarios, however, due to COVID-19’s evolving impact and the limited amount of available data, there is a high degree of uncertainty around the Company’s COVID-19 reserves. In addition, several states (and international jurisdictions), through regulation, legislation and/or judicial action, continue to seek to expand policy coverage terms
beyond the policy’s intended coverage, including, for example, but not limited to, property coverages, where there are attempts to extend business interruption coverage where there is no physical damage or loss to property, and attempts to disregard policy exclusions for communicable disease. Accordingly, losses arising from these actions, and the other factors described above, could exceed the Company’s reserves established for those related policies.
For the six months ended June 30, 2020, the Company has recognized losses for COVID-19-related claims activity, net of reinsurance, of approximately $i143
million, of which $i102 million relates to the Insurance segment and $i41
million
23
relates to the Reinsurance & Monoline Excess segment. Of the $i143 million of COVID-19-related losses, $i37 million
are reported losses and $i106 million is booked as IBNR.
During the six months ended June 30, 2020, favorable prior year development (net of additional and return premiums) of $i7.0
million included $i11.9 million of favorable development for the Insurance segment, partially offset by $i4.9
million of adverse development for the Reinsurance & Monoline Excess segment.
The overall favorable development for the Insurance segment was primarily attributable to favorable development on workers’ compensation business, partially offset by adverse development on professional liability business. The favorable workers’ compensation development was spread across many accident years, including prior to 2010, but was especially significant in accident year 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). Our ongoing workers’ compensation claims management efforts, including active medical case management and use of networks and specialty vendors to control medical and pharmaceutical benefit costs, have also added to the favorable
workers’ compensation prior year development. The adverse professional liability development was concentrated in accident years 2016 through 2018 and predominately resulted from a greater than expected number of large losses being reported in the period in two niches of our professional liability business.
The adverse development for the Reinsurance & Monoline Excess segment was mainly driven by non-proportional reinsurance assumed liability business written in the U.K., primarily from accident years 2014 through 2018. The development was driven by a greater than expected number of reported large losses during the period.
During the six months ended June 30, 2019, favorable prior year development (net of additional and return premiums) of $i13.6
million included $i17.2 million of favorable development for the Insurance segment, offset by $i3.6
million of adverse development for the Reinsurance & Monoline Excess segment.
The overall favorable development for the Insurance segment was primarily attributable to favorable development on workers’ compensation business, partially offset by adverse development on other liability business, commercial auto liability business, and medical malpractice business. The favorable workers’compensation development was spread across many accident years, including prior to 2009, but was most significant in accident years 2015 through 2018. 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 adverse other liability development was mainly related to accident years 2014 through 2016. It was driven by a higher than expected number of large losses
being reported in the period, including both general liability and professional liability losses. The adverse commercial auto liability development was primarily related to accident year 2018, and was driven by a greater than expected number of large losses during the period. The adverse medical malpractice development was primarily related to accident years 2013 through 2016, and stemmed from a discontinued book of business at one of our operating units.
The adverse development for the Reinsurance & Monoline Excess segment was mainly driven by U.S. casualty facultative business from accident years 2009 and prior related to construction projects.
24
(17) Fair
Value of Financial Instruments
iThe following table presents the carrying amounts and estimated fair values of the Company’s financial instruments:
Trading
account receivables from brokers and clearing organizations
i254,230
i254,230
i423,543
i423,543
Due
from broker
i993
i993
i—
i—
Liabilities:
Due
to broker
i—
i—
i27,116
i27,116
Trading
account securities sold but not yet purchased
i20,814
i20,814
i36,143
i36,143
Subordinated
debentures
i1,199,198
i1,219,704
i1,198,704
i1,274,088
Senior
notes and other debt
i1,725,449
i1,935,507
i1,427,575
i1,582,290
The
estimated fair values of the Company’s fixed maturity securities, equity securities and arbitrage trading account securities are based on various valuation techniques that rely on fair value measurements as described in Note 15. The fair value of loans receivable are estimated by using current institutional purchaser yield requirements for loans with similar credit characteristics, which is considered a Level 2 input. The fair value of the senior notes and other debt and the subordinated debentures is based on spreads for similar securities, which is considered a Level 2 input.
(18) iPremiums
and Reinsurance Related Information
i
The following is a summary of insurance and reinsurance financial information:
For
the Three Months Ended June 30,
For the Six Months Ended June 30,
(In thousands)
2020
2019
2020
2019
Written
premiums:
Direct
$
i1,892,359
$
i1,883,032
$
i3,856,848
$
i3,712,847
Assumed
i239,887
i206,828
i506,769
i423,243
Ceded
(i392,428)
(i346,396)
(i777,953)
(i683,025)
Total
net premiums written
$
i1,739,818
$
i1,743,464
$
i3,585,664
$
i3,453,065
Earned
premiums:
Direct
$
i1,804,844
$
i1,773,437
$
i3,634,558
$
i3,497,047
Assumed
i232,996
i198,661
i461,210
i386,852
Ceded
(i360,925)
(i325,257)
(i727,435)
(i644,202)
Total
net premiums earned
$
i1,676,915
$
i1,646,841
$
i3,368,333
$
i3,239,697
Ceded
losses and loss expenses incurred
$
i232,873
$
i239,267
$
i468,055
$
i412,314
Ceded
commissions earned
$
i85,593
$
i73,092
$
i166,638
$
i144,109
/
iThe
following table presents the rollforward of the allowance for expected credit losses for premiums and fees receivable for the six months ended June 30, 2020:
Cumulative
effect adjustment resulting from changes in accounting principles
i1,270
Provision for expected credit losses
i1,013
Allowance
for expected credit losses at June 30, 2020
$
i22,106
25
The following table presents the rollforward of the allowance
for expected credit losses for premiums and fees receivable for the three months ended June 30, 2020:
(In thousands)
Allowance for expected credit losses at April 1, 2020
$
i21,524
Provision
for expected credit losses
i582
Allowance for expected credit losses at June 30, 2020
$
i22,106
The
Company reinsures a portion of its insurance exposures in order to reduce its net liability on individual risks and catastrophe losses. The Company also cedes premiums to state assigned risk plans and captive insurance companies. Estimated amounts due from reinsurers are reported net of an allowance for expected credit losses. iThe following table presents the rollforward of the allowance for expected credit losses associated with due
from reinsurers for the six months ended June 30, 2020:
Cumulative
effect adjustment resulting from changes in accounting principles
i5,927
Provision for expected credit losses
i558
Allowance
for expected credit losses at June 30, 2020
$
i7,175
The following table presents the rollforward of the allowance for expected credit losses associated with due from reinsurers for the three months ended June 30, 2020:
(In
thousands)
Allowance for expected credit losses at April 1, 2020
$
i6,800
Provision for expected credit losses
i375
Allowance
for expected credit losses at June 30, 2020
$
i7,175
(19) iRestricted
Stock Units
Pursuant to its stock incentive plan, the Company may issue restricted stock units ("RSUs") to employees of the Company and its subsidiaries. The RSUs generally vest three to ifive
years from the award date and are subject to other vesting and forfeiture provisions contained in the award agreement. RSUs are expensed pro-ratably over the vesting period. RSU expenses were $i23 million and $i25
million for the six months ended June 30, 2020 and 2019, respectively. iA summary of RSUs issued in the six months ended June 30, 2020 and 2019 follows:
($
in thousands)
Units
Fair Value
2020
i724
$
i57
2019
i5,141
$
i308
(20) iLitigation
and Contingent Liabilities
In the ordinary course of business, the Company is subject to disputes, litigation and arbitration arising from its insurance and reinsurance businesses. These matters are generally related to insurance and reinsurance claims and are considered in the establishment of loss and loss expense reserves. In addition, the Company may also become involved in legal actions which seek extra-contractual damages, punitive damages or penalties, including claims alleging bad faith in handling of insurance claims. The Company expects its ultimate liability with respect to such matters will not be material to its financial condition. However, adverse outcomes
on such matters are possible, from time to time, and could be material to the Company’s results of operations in any particular financial reporting period.
26
(21) iLeases
Lessees
are required to recognize a right-of-use asset and a lease liability for leases with terms of more than 12 months on the balance sheet. All leases disclosed within this footnote are classified as operating leases. Recognized right-of-use asset and lease liability are reported within other assets and other liabilities, respectively, in the consolidated balance sheet. Lease expense is reported in other operating costs and expenses in the consolidated statement of income and accounted for on a straight-line basis over the lease term.
To determine the discount rate used to calculate present value of future minimum lease payments, the Company uses its incremental borrowing rate during the lease commencement period in line with the respective lease duration. In certain cases, the
Company has the option to renew the lease. Lease renewal future payments are included in the present value of the future minimum lease payments when the Company determines it is reasonably certain to renew.
The main leases entered into by the Company are for office space used by the Company’s operating units across the world. Additionally, the Company, to a lesser extent, has equipment leases mainly for office equipment. iFurther
information relating to operating lease expense and other operating lease information are as follows:
For the Three Months Ended June 30,
For the Six Months Ended June 30,
(In
thousands)
2020
2019
2020
2019
Leases:
Lease cost
$
i10,878
$
i10,680
$
i22,114
$
i22,235
Cash
paid for amounts included in the measurement of lease liabilities reported in operating cash flows
$
i11,479
$
i11,132
$
i22,309
$
i22,789
Right-of-use
assets obtained in exchange for new lease liabilities
$
i2,682
$
i2,918
$
i4,294
$
i7,884
i
As
of June 30,
($ in thousands)
2020
2019
Right-of-use assets
$
i180,011
$
i179,984
Lease
liabilities
$
i219,444
$
i209,107
Weighted-average
remaining lease term
i6.8 years
i6.6 years
Weighted-average
discount rate
i5.94
%
i5.97
%
/
i
Contractual
maturities of the Company’s future minimum lease payments are as follows:
The Company’s reportable segments include the following itwo business segments, plus a corporate segment:
•Insurance - predominantly commercial insurance business, including excess and surplus lines, admitted lines and specialty personal lines throughout the United States, as well as insurance business in the United Kingdom,
Continental Europe, South America, Canada, Mexico, Scandinavia, Asia and Australia.
•Reinsurance & Monoline Excess - reinsurance business on a facultative and treaty basis, primarily in the United States, the United Kingdom, Continental Europe, Australia, the Asia-Pacific Region and South Africa, as well as operations that solely retain risk on an excess basis.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Income tax expense and benefits are calculated based upon the Company's overall effective tax rate.
Summary financial information about the
Company's reporting segments is presented in the following tables. Income (loss) before income taxes by segment includes allocated investment income. Identifiable assets by segment are those assets used in or allocated to the operation of each segment.
(1)
Certain amounts included in earned premiums of each segment are related to inter-segment transactions.
(2) Revenues for Insurance from foreign countries for the three months ended June 30, 2020 and 2019 were $i149 million and $i179
million, respectively, and for the six months ended June 30, 2020 and 2019 were $i317 million and $i349 million, respectively. Revenues for
Reinsurance & Monoline Excess from foreign countries for the three months ended June 30, 2020 and 2019 were $i65 million and $i62 million,
respectively, and for the six months ended June 30, 2020 and 2019 were $i134 million and $i121 million, respectively.
(3)
Corporate, other and eliminations represent corporate revenues and expenses that are not allocated to business segments.
iNet
premiums earned by major line of business are as follows:
For the Three Months Ended June 30,
For the Six Months Ended June 30,
(In
thousands)
2020
2019
2020
2019
Insurance:
Other liability
$
i544,465
$
i505,621
$
i1,091,594
$
i996,282
Short-tail
lines (1)
i295,968
i305,852
i591,446
i594,943
Workers'
compensation
i278,699
i330,510
i580,299
i657,186
Commercial
automobile
i190,335
i188,278
i379,978
i369,203
Professional
liability
i155,577
i144,923
i306,682
i284,604
Total
Insurance
i1,465,044
i1,475,184
i2,949,999
i2,902,218
Reinsurance
& Monoline Excess:
Casualty reinsurance
i130,459
i95,109
i253,190
i185,939
Monoline
excess (2)
i41,062
i39,400
i83,224
i78,381
Property
reinsurance
i40,350
i37,148
i81,920
i73,159
Total
Reinsurance & Monoline Excess
i211,871
i171,657
i418,334
i337,479
Total
$
i1,676,915
$
i1,646,841
$
i3,368,333
$
i3,239,697
______________
(1)
Short-tail lines include commercial multi-peril (non-liability), inland marine, accident and health, fidelity and surety, boiler and machinery and other lines.
(2) Monoline excess includes operations that solely retain risk on an excess basis.
30
SAFE HARBOR STATEMENT
This is a “Safe Harbor” Statement under the Private Securities Litigation Reform Act of 1995. Any forward-looking statements contained herein, including statements related to our outlook for the
industry and for our performance for the year 2020 and beyond, are based upon the Company’s historical performance and on current plans, estimates and expectations. The inclusion of this forward-looking information should not be regarded as a representation by us or any other person that the future plans, estimates or expectations contemplated by us will be achieved. They are subject to various risks and uncertainties, including but not limited to: the ongoing COVID-19 pandemic, including the related impact on the U.S. and global economies; the cyclical nature of the property casualty industry; the impact of significant competition, including new alternative entrants to the industry; the long-tail and potentially volatile nature of the insurance and reinsurance business; product demand and pricing; claims development and the process of estimating reserves; investment risks, including those
of our portfolio of fixed maturity securities and investments in equity securities, including investments in financial institutions, municipal bonds, mortgage-backed securities, loans receivable, investment funds, including real estate, merger arbitrage, energy related and private equity investments; the effects of emerging claim and coverage issues; the uncertain nature of damage theories and loss amounts; natural and man-made catastrophic losses, including as a result of terrorist activities, epidemics or pandemics, such as COVID-19; the impact of climate change, which may increase the frequency and severity of catastrophe events; general economic and market activities, including inflation, interest rates, and volatility in the credit and capital markets; the impact of the conditions in the financial markets and the global economy, and the potential effect of legislative, regulatory, accounting or other initiatives taken in response, on our results and financial condition;
foreign currency and political risks (including those associated with the United Kingdom's withdrawal from the European Union, or "Brexit") relating to our international operations; our ability to attract and retain key personnel and qualified employees; continued availability of capital and financing; the success of our new ventures or acquisitions and the availability of other opportunities; the availability of reinsurance; our retention under the Terrorism Risk Insurance Program Reauthorization Act of 2015; the ability or willingness of our reinsurers to pay reinsurance recoverables owed to us; other legislative and regulatory developments, including those related to business practices in the insurance industry; credit risk related to our policyholders, independent agents and brokers; changes in the ratings assigned to us or our insurance company subsidiaries by rating
agencies; the availability of dividends from our insurance company subsidiaries; potential difficulties with technology and/or cyber security issues; the effectiveness of our controls to ensure compliance with guidelines, policies and legal and regulatory standards; and other risks detailed from time to time in the Company’s filings with the Securities and Exchange Commission.
These risks and uncertainties could cause our actual results for the year 2020 and beyond to differ materially from those expressed in any forward-looking statement we make. Any projections of growth in our revenues would not necessarily result in commensurate levels of earnings. Our future financial performance is dependent upon factors
discussed in our Annual Report on Form 10-K, elsewhere in this Form 10-Q and our other SEC filings. Forward-looking statements speak only as of the date on which they are made. Except to the extent required by applicable laws, the Company does not undertake any obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise.
31
Item 2. 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 in the 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 operating units to capitalize on various business opportunities. Over the years, the Company has formed numerous operating units that are focused on important parts of the economy in the U.S., including healthcare, cyber security, energy and agriculture, and on growing international markets, including the Asia-Pacific region, South America and Mexico.
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 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. A portion of the Company’s fixed maturity securities include investments in collateralized loan obligations with exposure to a diverse group of industries. As of June 30, 2020, approximately 97% of the Company’s collateralized loan obligation portfolio has an average rating of “AA” or higher. As a result, the Company believes that its collateralized loan obligation portfolio is well-positioned despite the current market environment.
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.
Effective January
1, 2020, the Company adopted new accounting standard ASU 2016-13 Financial Instruments - Credit Losses. Refer to Note 3 in the financial statements for further information on the accounting guidance and impact of its adoption on the Company's results and financial position.
The ongoing COVID-19 pandemic, including the related impact on the U.S. and global economies, has materially and adversely affected our results of operations. For the six months ended June 30, 2020, the Company recorded approximately $143 million for COVID-19-related losses, net of reinsurance, and reinstatement premiums of approximately $21 million. The ultimate
impact of COVID-19 on the economy and on the Company’s results of operations, financial position and liquidity is uncertain and not within the Company’s control. 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. In addition, because COVID-19 did not begin to affect the Company's operations and financial position until late in the first quarter of 2020, its impact on the Company’s first six months of 2020 is not necessarily indicative of its impact for the remainder of 2020 or beyond. Despite the effects of COVID-19 to date, the
Company’s financial position and liquidity improved during the second quarter.
The impact of the COVID-19 pandemic on our results of operations, financial position and liquidity is expected to include, among others:
Adverse Legislative and Regulatory Action. Legislative and regulatory initiatives taken or that may be taken in response to COVID-19, such as those that seek to retroactively mandate or provide a presumption of coverage for losses which our insurance policies would not otherwise cover and were not priced to cover, may adversely affect us, particularly in our workers’ compensation and property coverages businesses.
32
Claim Losses Related
to COVID-19 May Exceed Reserves. Given the great uncertainties associated with COVID-19 and its impact and the limited information upon which our current assumptions and assessments have been made, our reserves and underlying estimated level of claim losses and costs arising from COVID-19 may materially change.
Claim Losses and Adjustment Expenses May Increase. As the effects of COVID-19 on industry practices and economic, legal, judicial, social and other environmental conditions continue to evolve, unexpected and unintended issues related to claims and coverages may emerge (including in the area of property coverages where physical damage requirements and communicable disease exclusions are currently being challenged).
Reinsurance. Reinsurers may dispute the applicability of reinsurance to COVID-19 related losses
(including the application of reinsurance reinstatements) and, as a result, our reinsurers may refuse to pay reinsurance recoverables related thereto or they may not pay them on a timely basis. In addition, we may be unable to renew our current reinsurance coverages or purchase new coverages with respect to certain exposures under our policies, including COVID-19-related exposures.
Premium Volumes May Be Negatively Impacted. Reduced economic activity relating to the COVID-19 pandemic will likely decrease demand for our insurance products and services. In addition, we may alter our view on the insurance coverages that are appropriate to offer in various jurisdictions, which could further negatively impact our premium volumes.
Investments. Further disruptions in global financial markets due to the continuing impact of COVID-19 could cause
us to incur additional unrealized and/or realized investment losses (beyond the investment fund losses incurred to date), including impairments in our fixed income portfolio and other investments.
Credit Risk. As credit risk is generally a function of the economy, we face greater credit risk from our policyholders, independent agents and brokers in connection with the payment and remittance of premiums as a result of the economic conditions caused by COVID-19. Similarly, our credit risk related to the reimbursement of deductibles from policyholders and in connection with reinsurance recoverables has increased.
Operational Disruptions and Costs. Our operations could be disrupted if key members of our senior management or a significant percentage of our workforce or the workforce of our agents, brokers, suppliers or other third party
service providers are unable to continue to work because of illness, government directives or otherwise. In response to the COVID-19 pandemic, we have implemented remote working policies which have resulted in disruptions to our business routines, heightened risk to cybersecurity attacks and data security incidents and a greater dependency on internet and telecommunication access and capabilities.
For additional information on the risks posed by COVID-19, see “The COVID-19 pandemic has materially and adversely affected our results of operations, and is expected to continue and therefore may materially and adversely affect, our results of operations, financial position and liquidity” included in “Part II-Item 1A-Risk Factors” in this Quarterly Report on Form 10-Q.
Critical
Accounting Estimates
The following presents a discussion of accounting policies and estimates relating to reserves for losses and loss expenses, assumed premiums and allowance for expected credit losses on 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
33
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 an exact 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, some of 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 operating unit. 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 operating unit.
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.
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 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 operating unit. 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.
34
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 2019:
(In
thousands)
Frequency (+/-)
Severity (+/-)
1%
5%
10%
1%
$
81,566
$
245,508
$
450,437
5%
245,508
415,944
628,988
10%
450,437
628,988
852,178
Our
net reserves for losses and loss expenses of approximately $11.1 billion as of June 30, 2020 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 $2.5 billion, or 23%, of the Company’s net loss reserves as of June 30, 2020 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 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.
35
Following is a summary of the Company’s reserves for losses and loss expenses by business segment:
(1)
Reserves for workers’ compensation and Reinsurance & Monoline Excess are net of an aggregate net discount of $506 million and $530 million as of June 30, 2020 and December 31, 2019, 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.
The Company evaluates reserves for losses and loss adjustment 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 adjustment expenses for prior years may be fully or partially
offset by additional or return premiums.
36
Net prior year development (i.e., the sum of prior year reserve changes and prior year earned premiums changes) for the six months ended June 30, 2020 and 2019 are as follows:
(In thousands)
2020
2019
Net
increase in prior year loss reserves
$
(2,050)
$
(16,764)
Increase in prior year earned premiums
9,077
30,323
Net favorable prior year development
$
7,027
$
13,559
The
ongoing COVID-19 global pandemic has impacted, and will likely continue to impact, the Company’s results through its effect on claim frequency and severity. Loss cost trends have been impacted and will likely be further impacted by COVID-19-related claims in certain lines of business, as well as by other effects of COVID-19 associated with economic conditions, inflation, and social distancing and work from home rules, for example. Although it is still too early to determine, to date, it appears that the losses incurred due to COVID-19-related claims have been partially offset by lower claim frequency in certain lines of our businesses, including commercial auto. However, given the continuing nature of the pandemic, the impact of COVID-19 could ultimately increase or decrease overall loss cost trends and is likely to have differing impacts on the
Company's different lines of business. For certain lines of business, such as contingency and event cancellation, the Company has received reported claims related to COVID-19, and it expects additional claims to be reported in the future. The Company has also received claims for other short-tailed lines related to business interruption and film production delays. Further, for workers’ compensation, nearly one-third of the states have enacted rules, legislation or administrative orders creating a presumption that certain “essential” workers who contract COVID-19 did so through the course of their employment. Several other states are considering similar actions, including with varying definitions of “essential”
workers. While the ultimate impact of these presumptions are unknown at this time, the Company believes that such state actions will likely increase workers’ compensation claims with respect to workers deemed “essential,” although this impact may be partially offset by lower workers’ compensation claim frequency with respect to non-essential workers.
The Company has estimated the potential COVID-19 impact to its workers’ compensation, contingency and event cancellation, and other lines of business under a number of possible scenarios, however, due to COVID-19’s evolving impact and the limited amount of available data, there is a high degree of uncertainty around the Company’s
COVID-19 reserves. In addition, several states (and international jurisdictions), through regulation, legislation and/or judicial action, continue to seek to expand policy coverage terms beyond the policy’s intended coverage, including, for example, but not limited to, property coverages, where there are attempts to extend business interruption coverage where there is no physical damage or loss to property, and attempts to disregard policy exclusions for communicable disease. Accordingly, losses arising from these actions, and the other factors described above, could exceed the Company’s reserves established for those related policies.
For the six months ended June 30, 2020, the Company has recognized losses for
COVID-19-related claims activity, net of reinsurance, of approximately $143 million, of which $102 million relates to the Insurance segment and $41 million relates to the Reinsurance & Monoline Excess segment. Of the $143 million of COVID-19-related losses, $37 million are reported losses and $106 million is booked as IBNR.
During the six months ended June 30, 2020, favorable prior year development (net of additional and return premiums) of $7.0 million included $11.9 million of favorable development for the Insurance segment, partially offset by $4.9 million of adverse development for the Reinsurance & Monoline Excess segment.
The overall favorable development for the Insurance segment was primarily attributable to favorable development on workers’ compensation business, partially offset by adverse development on professional
liability business. The favorable workers’ compensation development was spread across many accident years, including prior to 2010, but was especially significant in accident year 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). Our ongoing workers’ compensation claims management efforts, including active medical case management and use of networks and specialty vendors to control medical and pharmaceutical benefit costs, have also added to the favorable workers’ compensation prior year development. The adverse professional liability development was concentrated in accident years 2016 through 2018 and predominately resulted from a greater than expected number of large losses being reported in the period in two niches of our professional liability business.
The
adverse development for the Reinsurance & Monoline Excess segment was mainly driven by non-proportional reinsurance assumed liability business written in the U.K., primarily from accident years 2014 through 2018. The development was driven by a greater than expected number of reported large losses during the period.
During the six months ended June 30, 2019, favorable prior year development (net of additional and return premiums) of $13.6 million included $17.2 million of favorable development for the Insurance segment, offset by $3.6 million of adverse development for the Reinsurance & Monoline Excess segment.
37
The overall favorable development for the
Insurance segment was primarily attributable to favorable development on workers’ compensation business, partially offset by adverse development on other liability business, commercial auto liability business, and medical malpractice business. The favorable workers’compensation development was spread across many accident years, including prior to 2009, but was most significant in accident years 2015 through 2018. 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 adverse other liability development was mainly related to accident years 2014 through 2016. It was driven by a higher than expected number of large losses being reported in the period, including both general liability and professional liability losses. The adverse commercial auto liability development was primarily related
to accident year 2018, and was driven by a greater than expected number of large losses during the period. The adverse medical malpractice development was primarily related to accident years 2013 through 2016, and stemmed from a discontinued book of business at one of our operating units.
The adverse development for the Reinsurance & Monoline Excess segment was mainly driven by U.S. casualty facultative business from accident years 2009 and prior related to construction projects.
Reserve Discount. The Company discounts its liabilities for certain workers’ compensation reserves. The amount of workers’ compensation reserves that were discounted was $1,687 million and $1,731 million at June 30, 2020
and December 31, 2019, respectively. The aggregate net discount for those reserves, after reflecting the effects of ceded reinsurance, was $506 million and $530 million at June 30, 2020 and December 31, 2019, respectively. At June 30, 2020, discount rates by year ranged from 0.7% to 6.5%, with a weighted average discount rate of 3.6%.
Substantially all of the workers’ compensation discount (97% of total discounted reserves at June 30, 2020) relates to 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 the U.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 at June 30, 2020),
including reserves for quota share reinsurance and reserves related to losses regarding occupational lung disease. These reserves are discounted at statutory rates permitted by the Department 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 $44 million at June 30, 2020 and $43 million at December 31, 2019. 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.
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. Effective January 1,
38
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 at June 30, 2020 is presented in the table below:
($
in thousands)
Number of Securities
Aggregate Fair Value
Gross Unrealized Loss
Foreign government
14
$
52,126
$
32,429
Corporate
18
47,404
9,320
Mortgage-backed
securities
12
6,348
340
Asset-backed securities
2
279
6
Total
46
$
106,157
$
42,095
As
of June 30, 2020, the Company has recorded an allowance for expected credit losses on fixed maturity securities of $46 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 $9 million and $2 million as of June 30, 2020 and December 31, 2019, respectively.
Fair Value Measurements.
The Company’s fixed maturity available for sale securities, equity securities, and its arbitrage trading account securities are carried at fair value. Fair value is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”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
39
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 June 30, 2020:
Independent pricing services – Substantially all of the Company’s
fixed maturity securities available for sale were priced by independent pricing services (generally one U.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 of June 30, 2020, 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.
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.
40
Results
of Operations for the Six Months Ended June 30, 2020 and 2019
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 premiums earned), expense ratios (underwriting expenses expressed as a percentage of premiums earned) and GAAP combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the six months ended June 30, 2020 and 2019. 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)
2020
2019
Insurance:
Gross premiums written
$
3,859,511
$
3,715,850
Net
premiums written
3,126,475
3,071,964
Net premiums earned
2,949,999
2,902,218
Loss ratio
66.1
%
62.5
%
Expense ratio
31.0
%
31.4
%
GAAP
combined ratio
97.1
%
93.9
%
Reinsurance & Monoline Excess:
Gross premiums written
$
504,107
$
420,240
Net premiums written
459,189
381,101
Net
premiums earned
418,334
337,479
Loss ratio
70.3
%
60.0
%
Expense ratio
32.6
%
36.0
%
GAAP combined ratio
102.9
%
96.0
%
Consolidated:
Gross
premiums written
$
4,363,618
$
4,136,090
Net premiums written
3,585,664
3,453,065
Net premiums earned
3,368,333
3,239,697
Loss
ratio
66.6
%
62.2
%
Expense ratio
31.2
%
31.9
%
GAAP combined ratio
97.8
%
94.1
%
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 six months ended June 30, 2020 and 2019:
(In thousands, except per share data)
2020
2019
Net income to
common stockholders
$
66,842
$
397,431
Weighted average diluted shares
190,078
192,804
Net income per diluted share
$
0.35
$
2.06
The
Company reported net income to common stockholders of $67 million in 2020 compared to $397 million in 2019. The $330 million decrease in net income was primarily due to an after-tax decrease in net investment gains of $191 million (primarily resulting from disruption in global financial markets related to COVID-19, and the adoption of the new credit loss accounting standard set forth in ASU 2016-13), an after-tax decrease in underwriting income of $91 million primarily from COVID-19-related losses, an after-tax decrease in net investment income of $68 million primarily due to losses from investment funds, reduced investment yields in fixed maturity securities and repositioning a larger portion of the investment portfolio to cash and cash equivalents, an increase in tax expense of $12 million due to a change in the effective tax rate, and an after-tax decrease in profits from non-insurance businesses of $3 million, partially offset by an after-tax increase in foreign
currency gains of $18 million from the strengthening U.S. dollar, an after-tax decrease in corporate expenses of $7 million, an after-tax decrease in interest expense of $5 million, and an after-tax increase in profit from insurance service businesses of $5 million. The number of weighted average diluted shares decreased by approximately 3 million for the the six months ended June 30, 2020 compared to six months ended June 30, 2019 mainly reflecting shares repurchased in the first six months of 2020.
41
Premiums. Gross premiums written were $4,364 million in 2020, an increase of 6% from $4,136 million in 2019.
The increase was due to a $144 million increase in the Insurance segment and a $84 million increase in the Reinsurance & Monoline Excess segment. Approximately 79% of premiums expiring in 2020 were renewed, and 80% of premiums expiring in 2019 were renewed.
Average renewal premium rates for insurance and facultative reinsurance increased 10.0% in 2020 when adjusted for changes in exposures, and increased 12.3% excluding workers' compensation.
A summary of gross premiums written in 2020 compared with 2019 by line of business within each business segment follows:
•Insurance - gross premiums increased 4% to $3,860 million in 2020 from $3,716 million in 2019. Gross premiums increased $126 million (10%) for other liability, $69 million (15%) for professional liability, and $55
million (6%) for short-tail lines, and decreased $104 million (15%) for workers' compensation and $2 million (less than 1%) for commercial auto.
•Reinsurance & Monoline Excess - gross premiums increased 20% to $504 million in 2020 from $420 million in 2019. Gross premiums increased $67 million (30%) for casualty reinsurance, $13 million (14%) for property reinsurance and $4 million (3%) for monoline excess.
Net premiums written were $3,586 million in 2020, an increase of 4% from $3,453 million in 2019. Ceded reinsurance premiums as a percentage of gross written premiums were 18% in 2020 and 17% in 2019. The cession rate increased primarily because of reinstatement premiums associated with COVID-19 related claims activity.
Premiums earned increased 4% to $3,368 million in
2020 from $3,240 million in 2019. 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 2020 are related to business written during both 2020 and 2019. Audit premiums were $83 million in 2020 compared with $100 million in 2019.
Net Investment Income. Following is a summary of net investment income for the six months ended June 30, 2020 and 2019:
Amount
Average Annualized Yield
($
in thousands)
2020
2019
2020
2019
Fixed maturity securities, including cash and cash equivalents and loans receivable
$
233,861
$
261,022
3.1
%
3.5
%
Investment
funds
(16,975)
58,251
(2.8)
8.4
Arbitrage trading account
32,442
17,784
11.6
8.5
Real
estate
11,141
9,481
1.1
0.9
Equity securities
4,288
2,591
2.4
2.1
Gross
investment income
264,757
349,129
2.7
3.7
Investment expenses
(4,563)
(2,542)
—
—
Total
$
260,194
$
346,587
2.7
%
3.6
%
Net
investment income decreased 25% to $260 million in 2020 from $347 million in 2019 due primarily to a $75 million decrease in income from investment funds (as a result of the impact of the disruption in global financial markets associated with COVID-19 during the first quarter of 2020, as investment funds are reported on a one-quarter lag), a $27 million decrease in income from fixed maturity securities mainly driven by lower investment yields and repositioning a larger portion of the investment portfolio to cash and cash equivalents, and a $2 million increase in investment expense, partially offset by a $15 million increase from the arbitrage trading account, a $1 million increase in real estate and a $1 million increase from equity securities. The Company has maintained a shortened duration of its fixed maturity security portfolio. This has reduced the potential impact of mark-to-market
on the portfolio and positioned the Company to react quickly to changes in the current environment. Average invested assets, at cost (including cash and cash equivalents), were $19.5 billion in 2020 and $19.0 billion in 2019.
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 decreased to $46 million in 2020 from $48 million in 2019. The decrease is primarily due to a reduction of assigned risk plan business.
42
Net
Realized and Unrealized Gains (Losses) 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 losses on investments were $82 million in 2020 compared with net gains of $142 million in 2019. The losses of $82 million in 2020 reflect net realized gains on investments of $11 million and an increase in unrealized losses on equity securities of $93 million driven by the disruption in global financial markets associated with COVID-19 during the first six months of 2020. In 2019,
the gains of $142 million reflected net realized gains on investment sales of $31 million and an increase in unrealized gains on equity securities of $111 million.
Change in Allowance for Expected Credit Losses on Investments. Effective January 1, 2020, the Company adopted accounting guidance for credit losses on financial instruments. The cumulative effective adjustment from the change in accounting principle was $25 million after-tax, which decreased opening retained earnings and increased AOCI. 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 six months ended June 30, 2020, the pre-tax change in allowance for expected credit losses on investments increased by $18 million ($14 million after-tax), which is reflected in net investment gains (losses).
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 $169 million in 2020 and $181 million in 2019.
The decrease mainly relates to a reduction in revenues from the aviation-related businesses impacted by COVID-19.
Losses and Loss Expenses. Losses and loss expenses increased to $2,242 million in 2020 from $2,017 million in 2019. The consolidated loss ratio was 66.6% in 2020 and 62.2% in 2019. Catastrophe losses, net of reinsurance recoveries, were $225 million (including losses of approximately $143 million related to COVID-19 primarily comprised of IBNR) in 2020 and $38 million in 2019. Favorable prior year reserve development (net of premium offsets) was $7 million in 2020 and $14 million in 2019. The loss ratio excluding catastrophe losses and prior year reserve development was 60.1% in 2020 and 61.5% in 2019.
A summary of loss ratios in 2020 compared with 2019 by business segment follows:
•Insurance
- The loss ratio was 66.1% in 2020 and 62.5% in 2019. Catastrophe losses were $171 million in 2020 compared with $38 million in 2019. The Company reflected a best estimate (net of reinsurance) based upon available information for COVID-19-related losses of approximately $102 million, which was included in catastrophe losses and primarily related to contingency and event cancellation coverage, workers’ compensation and short-tail lines. Favorable prior year reserve development was $12 million in 2020 and $17 million in 2019. The loss ratio excluding catastrophe losses and prior year reserve development decreased 1.2 points to 60.6% in 2020 from 61.8% in 2019.
•Reinsurance & Monoline Excess - The loss ratio was 70.3% in 2020 and 60.0% in 2019. Catastrophe losses were $54 million in 2020 compared
with $0.1 million in 2019. The Company reflected a best estimate (net of reinsurance) based upon available information for COVID-19-related losses of approximately $41 million, which was included in catastrophe losses and primarily related to excess workers’ compensation and short-tail lines. Adverse prior year reserve development was $5 million in 2020 and $3 million in 2019. The loss ratio excluding catastrophe losses and prior year reserve development decreased 2.7 points to 56.2% in 2020 from 58.9% in 2019.
Other Operating Costs and Expenses. Following is a summary of other operating costs and expenses:
($
in thousands)
2020
2019
Policy acquisition and insurance operating expenses
$
1,051,158
$
1,031,951
Insurance service expenses
42,995
51,343
Net
foreign currency gains
(28,923)
(6,494)
Other costs and expenses
93,943
103,116
Total
$
1,159,173
$
1,179,916
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 2% and net premiums earned increased 4% from 2019. The expense ratio (underwriting expenses expressed as a
43
percentage of premiums earned) was 31.2% in 2020 and 31.9% in 2019. The improvement is primarily attributable to higher net premiums earned and lower travel and entertainment expenses due to the global pandemic. However, to the extent our net premiums earned decrease, due to the impact of the COVID-19 pandemic or otherwise, our expense ratio would be expected to increase.
Service
expenses, which represent the costs associated with the fee-based businesses, decreased to $43 million in 2020 from $51 million in 2019. The decrease is primarily due to a reduction of assigned risk plan business.
Net foreign currency gains result from transactions denominated in a currency other than a company's operating functional currency. Net foreign currency gains were $29 million in 2020 compared to gains of $6 million in 2019, mainly resulting from the continued strengthening of the U.S. dollar in relation to the Argentine peso and U.K sterling in 2020.
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 decreased to $94 million in 2020 from $103 million in
2019, primarily due to a reduction in non-recurring performance-based compensation costs which occurred in 2019.
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 $171 million in 2020 compared to $178 million in 2019. The decrease mainly relates to a reduction of aviation-related business impacted by COVID-19 in 2020.
Interest Expense. Interest expense was $75 million in 2020 compared with $81 million in 2019. During 2019, the
Company repaid at maturity $489 million aggregate principal amount of senior notes and other debt. In December 2019, the Company issued $300 million aggregate principal amount of 5.10% subordinated debentures due 2059. In May 2020, the Company issued $300 million aggregate principal amount of 4.00% senior notes due 2050. Accordingly, the timing of the debt repayment in 2019 and issuance in 2020 led to the decrease in interest expense for the six months ended June 30, 2020 compared to the same period in 2019.
Income Taxes. The effective income tax rate was 31.2% in 2020 and 20.7% in 2019. The effective income tax rate differs from the federal income tax rate of 21% principally because
foreign jurisdictions were limited on the utilization of losses at different tax rates, which was partially offset by tax-exempt investment income and tax benefits related to equity-based compensation.
The Company has not provided U.S. deferred income taxes on the undistributed earnings of approximately $96 million of its non-U.S. subsidiaries since these earnings are intended to be permanently reinvested in the non-U.S. subsidiaries. In the future, if such earnings were distributed the Company projects that the incremental tax, if any, will be immaterial.
44
Results
of Operations for the Three Months Ended June 30, 2020 and 2019
Business Segment Results
Following is a summary of gross and net premiums written, net premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of premiums earned), expense ratios (underwriting expenses expressed as a percentage of premiums earned) and GAAP combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the three months ended June 30, 2020 and 2019. The GAAP combined ratio represents a measure of underwriting profitability, excluding investment income. A GAAP combined ratio in excess of 100 indicates an underwriting loss; a number below
100 indicates an underwriting profit.
($ in thousands)
2020
2019
Insurance:
Gross premiums written
$
1,917,702
$
1,905,367
Net
premiums written
1,543,157
1,574,585
Net premiums earned
1,465,044
1,475,184
Loss ratio
67.0
%
62.9
%
Expense ratio
30.7
%
30.9
%
GAAP
combined ratio
97.7
%
93.8
%
Reinsurance & Monoline Excess:
Gross premiums written
$
214,544
$
184,494
Net premiums written
196,661
168,879
Net
premiums earned
211,871
171,657
Loss ratio
72.2
%
59.2
%
Expense ratio
32.9
%
36.0
%
GAAP combined ratio
105.1
%
95.2
%
Consolidated:
Gross
premiums written
$
2,132,246
$
2,089,861
Net premiums written
1,739,818
1,743,464
Net premiums earned
1,676,915
1,646,841
Loss
ratio
67.7
%
62.4
%
Expense ratio
31.0
%
31.5
%
GAAP combined ratio
98.7
%
93.9
%
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 three months ended June 30, 2020 and 2019:
(In thousands, except per share data)
2020
2019
Net income
to common stockholders
$
71,260
$
216,709
Weighted average diluted shares
187,862
193,059
Net income per diluted share
$
0.38
$
1.12
The
Company reported net income to common stockholders of $71 million in 2020 compared to $217 million in 2019. The $146 million decrease in net income was primarily due to an after-tax decrease in net investment income of $81 million mainly from losses from investment funds, reduced investment yields in fixed maturity securities and repositioning a larger portion of the investment portfolio to cash and cash equivalents, an after-tax decrease in underwriting income of $61 million primarily from COVID-19-related losses, an increase of $13 million in tax expense due to a change in the effective tax rate, an after-tax decrease of $2 million in other income, an after-tax decrease in profits from non-insurance businesses of $1 million, and an after-tax increase in corporate expenses of $1 million, partially offset by an after-tax increase in foreign currency gains of $6 million from the strengthening U.S. dollar, an after-tax increase in net investment gains of $3 million,
an after-tax increase in profit from insurance service businesses of $2 million, and an after-tax decrease in interest expense of $2 million. The number of weighted average diluted shares has been reduced by approximately 5 million for the three months ended June 30, 2020 due to the repurchase of common shares in 2020.
Premiums. Gross premiums written were $2,132 million in 2020, an increase of 2% from $2,090 million in 2019. The increase was due to a $12 million increase in the Insurance segment and a $30 million increase in the Reinsurance & Monoline Excess segment. Approximately 78% of premiums expiring in 2020 were renewed, and 81% of premiums expiring in 2019 were renewed.
45
Average
renewal premium rates for insurance and facultative reinsurance increased 10.9% in 2020 when adjusted for changes in exposures, and increased 13.0% excluding workers' compensation.
A summary of gross premiums written in 2020 compared with 2019 by line of business within each business segment follows:
•Insurance - gross premiums increased 1% to $1,918 million in 2020 from $1,905 million in 2019. Gross premiums increased $35 million (14%) for professional liability, $29 million (4%) for other liability, $11 million (2%) for short-tail lines, and $9 million (4%) for commercial auto and decreased $71 million (20%) for workers' compensation.
•Reinsurance & Monoline Excess - gross premiums increased 16% to $215 million in 2020 from $184 million
in 2019. Gross premiums increased $28 million (25%) for casualty reinsurance and $7 million (14%) for property reinsurance and decreased $4 million (16%) for monoline excess.
Net premiums written were $1,740 million in 2020, a less then 1% decrease from $1,743 million in 2019. Ceded reinsurance premiums as a percentage of gross written premiums were 18% in 2020 and 17% in 2019. The cession rate increased primarily because of reinstatement premiums associated with COVID-19 related claims activity.
Premiums earned increased 2% to $1,677 million in 2020 from $1,647 million in 2019. 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 2020 are related to business written during both 2020 and 2019. Audit premiums were
$41 million in 2020 and $58 million in 2019.
Net Investment Income. Following is a summary of net investment income for the three months ended June 30, 2020 and 2019:
Amount
Average Annualized Yield
($
in thousands)
2020
2019
2020
2019
Fixed maturity securities, including cash and cash equivalents and loans receivable
$
105,843
$
128,903
2.7
%
3.4
%
Investment
funds
(57,552)
46,840
(19.4)
13.4
Arbitrage trading account
31,304
7,199
20.6
7.0
Real
estate
5,045
5,174
1.0
1.0
Equity securities
2,726
1,303
3.1
2.1
Gross
investment income
87,366
189,419
1.8
4.0
Investment expenses
(1,935)
(1,086)
—
—
Total
$
85,431
$
188,333
1.7
%
3.9
%
Net
investment income decreased 55% to $85 million in 2020 from $188 million in 2019 due primarily to a $104 million decrease in income from investment funds mainly due to losses from energy funds, financial services funds and transportation funds. Investment funds are generally reported on a one-quarter lag, and accordingly, losses from investment funds for the second quarter of 2020 reflects the adverse impact from the disruption in global financial markets associated with COVID-19 during the first quarter of 2020. In addition to this decrease, there was a $23 million decrease in fixed maturity securities as a result of lower investment yields and repositioning a larger portion of the investment portfolio to cash and cash equivalents and a $1 million decrease in investment expenses, offset by a $24 million increase from the arbitrage trading account and a $1 million increase in equity securities. The
Company has maintained a shortened duration of its fixed maturity security portfolio. This has reduced the potential impact of mark-to-market on the portfolio and positioned the Company to react quickly to changes in the current environment. Average invested assets, at cost (including cash and cash equivalents), were $19.6 billion in 2020 and $19.1 billion in 2019.
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 decreased to $20 million in 2020 from $22 million in 2019. The decrease is primarily due to a reduction of assigned
risk plan business.
Net Realized and Unrealized Gains (Losses) 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 $62 million in 2020 compared with $74 million in 2019. The gains of $62
46
million
in 2020 reflected net realized losses on investments of $261 thousand and an increase in unrealized gains on equity securities of $62 million. In 2019, the gains of $74 million reflected net realized gains on investment sales of $4 million and an increase in unrealized gains on equity securities of $70 million.
Change in Allowance for Expected Credit Losses on Investments. Effective January 1, 2020, the Company adopted accounting guidance for credit losses on financial instruments. The cumulative effective adjustment from the change in accounting principle was $25 million after-tax, which decreased opening retained earnings and increased AOCI. 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 three months ended June 30, 2020, the pre-tax change in allowance for expected credit losses on investments decreased by $16 million ($13 million after-tax), which is reflected in net investment gains (losses).
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 $76 million in 2020 and $89 million in 2019. The decrease mainly relates to reduction in revenues from the aviation-related businesses impacted by COVID-19.
Losses and Loss Expenses. Losses and loss expenses increased to $1,135 million in 2020 from $1,029 million in 2019. The consolidated loss ratio was 67.7% in 2020 and 62.4% in 2019. Catastrophe losses, net of reinsurance recoveries, were $146 million in 2020 (including losses of approximately $86 million related to COVID-19 primarily comprised of IBNR) and $26 million in 2019. Favorable prior year reserve development (net of premium offsets) was $3 million in 2020 and $7 million in 2019. The loss ratio excluding catastrophe losses and prior year reserve development was 59.2% in 2020 and 61.3% in 2019.
A
summary of loss ratios in 2020 compared with 2019 by business segment follows:
•Insurance - The loss ratio was 67.0% in 2020 and 62.9% in 2019. Catastrophe losses were $114 million in 2020 compared with $25 million in 2019. The Company reflected a best estimate (net of reinsurance) based upon available information for COVID-19-related losses of approximately $65 million, which was included in catastrophe losses and primarily related to contingency and event cancellation coverage, workers’ compensation and short-tail lines. Favorable prior year reserve development was $5 million in 2020 and $8 million in 2019. The loss ratio excluding catastrophe losses and prior year reserve development decreased 2.2 points to 59.5% in 2020 from 61.7% in 2019.
•Reinsurance
& Monoline Excess - The loss ratio was 72.2% in 2020 and 59.2% in 2019. Catastrophe losses were $32 million in 2020 compared with $0.1 million in 2019. The Company reflected a best estimate (net of reinsurance) based upon available information for COVID-19-related losses of approximately $21 million, which was included in catastrophe losses and primarily related to excess workers’ compensation and short-tail lines. Adverse prior year reserve development was $2 million in 2020 and $1 million in 2019. The loss ratio excluding catastrophe losses and prior year reserve development decreased 2.3 points to 56.4% in 2020 from 58.7% in 2019.
Other Operating Costs and Expenses. Following is a summary of other operating costs and expenses:
($
in thousands)
2020
2019
Policy acquisition and insurance operating expenses
$
519,234
$
518,160
Insurance service expenses
20,423
25,386
Net
foreign currency (gains) losses
(7,382)
470
Other costs and expenses
48,565
47,812
Total
$
580,840
$
591,828
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 less than 1% and net premiums earned increased 2% from 2019. The expense ratio (underwriting expenses expressed as a percentage of premiums earned) was 31.0% in 2020 and 31.5% in 2019. The improvement is primarily attributable to higher net premiums earned and lower expense growth on a percentage basis mainly attributable to reduced travel and entertainment expenses due to the global pandemic. However, to the extent our net premiums earned decrease, due to the impact of the COVID-19 pandemic or otherwise, our expense ratio would be expected to increase.
Service expenses, which represent the costs associated with the fee-based businesses, decreased to $20 million in 2020 from $25 million
in 2019. The decrease is primarily due to a reduction of assigned risk plan business.
47
Net foreign currency gains (losses) result from transactions denominated in a currency other than a company's operating functional currency. Net foreign currency gains were $7 million in 2020 compared to net losses of $0.5 million in 2019. The gains in 2020 mainly result from the continued strengthening of the U.S. dollar in relation to Argentine peso.
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
$49 million in 2020 from $48 million in 2019.
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 $76 million in 2020 compared to $88 million in 2019. The decrease mainly relates to a reduction of the aviation-related businesses impacted by COVID-19 in 2020.
Interest Expense. Interest expense was $38 million in 2020 compared with $41 million in 2019. During 2019, the
Company repaid at maturity $489 million aggregate principal amount of senior notes and other debt. In December 2019, the Company issued $300 million aggregate principal amount of 5.10% subordinated debentures due 2059. In May 2020, the Company issued $300 million aggregate principal amount of 4.00% senior notes due 2050. Accordingly, the timing of the debt repayment in 2019 and issuance in 2020 led to the decrease in interest expense for the three months ended June 30, 2020 compared to the same period in 2019.
Income Taxes. The effective income tax rate was 32.0% in 2020 and 20.6% in 2019. The effective income tax rate differs from the federal income tax
rate of 21% principally because foreign jurisdictions were limited on the utilization of losses at different tax rates, which was partially offset by tax-exempt investment income and tax benefits related to equity-based compensation.
The Company has not provided U.S. deferred income taxes on the undistributed earnings of approximately $96 million of its non-U.S. subsidiaries since these earnings are intended to be permanently reinvested in the non-U.S. subsidiaries. In the future, if such earnings were distributed the Company projects that the incremental tax, if any, will be
immaterial.
48
Investments
As part of its investment strategy, the Company establishes a level of cash and highly liquid short-term and intermediate-term securities that, combined with expected cash flow, it believes is adequate
to meet its payment obligations. Due to the low fixed maturity investment returns, the Company invests in equity securities, merger arbitrage securities, investment funds, private equity, loans and real estate related assets. The Company's investments in investment funds and its other alternative investments have experienced, and the Company expects to continue to experience, greater fluctuations in investment income.
The Company also attempts to maintain an appropriate relationship between the average duration of the investment portfolio and the approximate duration of its liabilities (i.e.,
policy claims and debt obligations). The average duration of the fixed maturity portfolio, including cash and cash equivalents, was 2.4 years at June 30, 2020 down from 2.8 years at December 31, 2019, as the Company repositioned a larger portion of its investment portfolio to cash and cash equivalents. The Company’s fixed maturity investment portfolio and investment-related assets as of June 30, 2020 were as follows:
($
in thousands)
Carrying Value
Percent of Total
Fixed maturity securities:
U.S. government and government agencies
$
693,767
3.5
%
State and municipal:
Special
revenue
2,253,542
11.2
Local general obligation
441,919
2.2
State general obligation
421,765
2.1
Pre-refunded (1)
325,431
1.6
Corporate
backed
232,730
1.2
Total state and municipal
3,675,387
18.3
Mortgage-backed securities:
Agency
622,965
3.1
Residential-Prime
319,371
1.6
Commercial
217,558
1.1
Residential-Alt
A
9,336
—
Total mortgage-backed securities
1,169,230
5.9
Asset-backed securities
3,098,198
15.5
Corporate:
Industrial
1,999,122
10.0
Financial
1,431,704
7.2
Utilities
322,715
1.6
Other
19,040
0.1
Total
corporate
3,772,581
18.9
Foreign government and foreign government agencies
871,922
4.4
Total fixed maturity securities
13,281,085
66.5
Equity
securities:
Preferred stocks
245,297
1.2
Common stocks
116,968
0.6
Total equity securities
362,265
1.8
Cash
and cash equivalents
2,430,826
12.2
Real estate
2,072,772
10.4
Investment funds
1,159,237
5.8
Arbitrage trading
account
580,950
2.9
Loans receivable
82,134
0.4
Total investments
$
19,969,269
100.0
%
________________________
49
(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 with U.S. Treasury and U.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 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.
Equity Securities. Equity securities primarily represent investments in common and preferred stocks in companies with potential growth opportunities in different sectors, mainly in the financial institutions sector.
Investment Funds. At June 30, 2020, the carrying value of investment funds was $1,159 million, including investments in real estate funds of $314 million, financial services funds of $345 million,
energy funds of $129 million, transportation funds of $143 million and other funds of $228 million. Investment funds are generally reported on a one-quarter lag. Accordingly, losses from investment funds for the second quarter of 2020 reflects the adverse impact from the disruption in global financial markets associated with COVID-19 during the first quarter of 2020.
Real Estate. Real estate is directly owned property held for investment. At June 30, 2020, real estate properties in operation included a long-term ground lease in Washington D.C., a hotel in Memphis, Tennessee, two office complexes in New York City, office buildings in West Palm Beach and Palm Beach, Florida, an office building in London, and the completed portion of a mixed-use project in Washington D.C. In addition, part of the previously mentioned mixed-use project in Washington 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, of $82 million and an aggregate fair value of $86 million at June 30, 2020. The amortized cost of loans receivable is net of an allowance for expected credit losses of $9 million
as of June 30, 2020. Loans receivable include real estate loans of $50 million that are secured by commercial real estate located primarily in New York. Real estate loans receivable generally earn interest at floating LIBOR-based interest rates and have maturities (inclusive of extension options) through August 2025. Loans receivable include commercial loans of $32 million that are secured by business assets and have fixed interest rates and floating LIBOR-based interest rates with varying maturities not exceeding 10 years.
Market Risk. The fair value of the Company’s investments is subject to risks of fluctuations in credit quality and interest rates. The Company uses various models and
stress test scenarios to monitor and manage interest rate risk. The Company attempts to manage its interest rate risk by maintaining 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 for the fixed maturity portfolio (including cash and cash equivalents) was 2.4 years at June 30, 2020 down from 2.8 years at December 31, 2019.
In addition, the fair value of the Company’s international investments is subject to currency risk. The Company
attempts to manage its currency risk by matching its foreign currency assets and liabilities where considered appropriate.
50
Liquidity and Capital Resources
Cash Flow. Cash flow provided from operating activities was $580 million in the first six months of 2020 as compared to $403 million from operating activities in the first six months of 2019. The increase is primarily due to a benefit under the Coronavirus Aid, Relief, and Economic Security Act relating to the deferral
of tax payments until July 15, 2020.
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 one year 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 income 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 79% invested in cash, cash equivalents and marketable fixed maturity securities as of June 30, 2020. 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.
At June 30, 2020, the Company held more than $1.5 billion of cash and liquid investments at the holding company.
Debt. At June 30, 2020, the Company had senior notes, subordinated debentures and other debt outstanding with a carrying value of $2,925 million and a face amount of $2,973 million, including $300 million aggregate principal amount of its 4.00% senior notes due 2050
issued in May 2020. The maturities of the outstanding debt are $300 million in 2020, $4 million in 2021, $427 million in 2022, $5 million in 2025, $102 million in 2028, $250 million in 2037, $350 million in 2044, $300 million in 2050, $350 million in 2053, $400 million in 2056, $185 million in 2058 and $300 million in 2059.
Equity. At June 30, 2020, total common stockholders’ equity was $5.8 billion, common shares outstanding were 177,930,502 and stockholders’ equity per outstanding share was $32.60. During the three months ended June 30, 2020, the Company repurchased 1,953,344 shares of its common stock for $96 million. During the six months ended June
30, 2020, the Company repurchased 5,604,103 shares of its common stock for $299 million. The number of common shares outstanding excludes shares held in a grantor trust established by the Company for delivery upon settlement of vested but mandatorily deferred RSUs.
Total Capital. Total capitalization (equity, debt and subordinated debentures) was $8.7 billion at June 30, 2020. The percentage of the Company’s capital attributable to senior notes, subordinated debentures and other debt was 34% at June 30,
2020 and 30% at December 31, 2019.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Reference is made to the information under “Investments - Market Risk” under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-Q.
Item 4.Controls and Procedures
Disclosure
Controls and Procedures.The Company’s management, including its Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of the effectiveness of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-14 as of the end of the period covered by this quarterly report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company has in place effective controls and procedures designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Securities Exchange
Act of 1934, as amended, and the rules thereunder, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Changes in Internal Control over Financial Reporting. During the quarter ended June 30, 2020, there were no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
51
PART
II — OTHER INFORMATION
Item 1.Legal Proceedings
Please see Note 20 to the notes to the interim consolidated financial statements.
Item 1A.Risk Factors
Other than as set forth below, there have been no material changes from the risk factors previously disclosed in the Company’s annual report on Form 10-K for the fiscal year ended December 31,
2019.
The COVID-19 pandemic has materially and adversely affected our results of operations, and is expected to continue and therefore may materially and adversely affect, our results of operations, financial position and liquidity.
The ongoing COVID-19 pandemic, including the related impact on the U.S. and global economies, has materially and adversely affected our results of operations. We expect the pandemic and its impact on our business to continue and potentially even worsen, but we cannot predict the magnitude or duration of its continued impact, particularly given the great uncertainties associated with COVID-19, including regarding the reopening of the U.S. and global economies and the recovery from its devastating economic and other effects. The ultimate impact of COVID-19 on our results of operations, financial position and liquidity is not yet known, and likely will
not be known for some time, but includes the following:
Adverse Legislative and Regulatory Action. Legislative and regulatory initiatives taken or which may be taken in response to COVID-19 may adversely affect us, particularly in our workers’ compensation and property coverages businesses. For example, our business may be subject to, certain initiatives, including, but not limited to: legislative and regulatory action that seeks to retroactively mandate coverage for losses that our insurance policies would not otherwise cover and which were not priced to cover; legislative and regulatory action providing for shifting presumptions with respect to the burdens of proof for “essential” workers on workers’ compensation coverages and varying definitions of “essential” workers; actions prohibiting us from cancelling insurance policies in accordance with our policy terms or non-renewing policies
at their natural expiration; and/or orders to provide premium refunds, grant extended grace periods for premium payments, and provide extended time to pay past due premiums. Any such action would likely increase both our underwriting losses and our expenses and any legal challenges to any such action could take years to resolve.
Claim Losses Related to COVID-19 May Exceed Reserves. As of June 30, 2020, we recorded approximately $143 million for COVID-19-related losses, net of applicable reinsurance, and reinstatement premiums of approximately $21 million. Of the $143 million of COVID-19-related losses, $37 million are reported losses and $106 million is booked as IBNR. Our reserves do not represent an exact calculation of liability, but represent an estimate of what management expects the ultimate settlement and claims administration will cost for claims
that have occurred, whether known or unknown. Given the great uncertainties associated with COVID-19 and its impact and the limited information upon which our current assumptions and assessments have been made, our reserves and the underlying estimated level of claim losses and costs arising from COVID-19 may materially change.
Claim Losses and Adjustment Expenses May Increase. As the effects of COVID-19 on industry practices and economic, legal, judicial, social and other environmental conditions occur, unexpected and unintended issues related to claims and coverages may emerge. These issues may adversely affect our business by extending coverage beyond our underwriting intent (including in the area of property coverages where physical damage requirements and communicable disease exclusions are currently being challenged) or by increasing the number and/or size of claims, each of which could adversely
impact our results.
Reinsurance. We purchase reinsurance in order to transfer part of the risk that we have assumed by writing insurance policies to reinsurance companies in exchange for part of the premium we receive in connection with assuming such risk. Although reinsurance makes the reinsurer contractually liable to us to the extent the risk is transferred to the reinsurer, it does not relieve us of our liability to our policyholders. There may be uncertainty surrounding the availability of reinsurance coverage for COVID-19-related losses as our reinsurers may dispute the applicability of reinsurance to such losses (including the application of reinsurance reinstatements) and, as a result, our reinsurers may refuse to pay reinsurance recoverables related thereto or they may not pay them on a timely basis. In addition, we may be unable to renew our current reinsurance coverages or obtain appropriate
new reinsurance covers with respect to certain exposures under our policies, including COVID-19-related exposures, and therefore our net exposures could increase, or if we are unwilling to bear such increase in net exposure, we may reduce our level of underwriting commitments.
Premium Volumes May Be Negatively Impacted. The demand for insurance is significantly influenced by general economic conditions. Consequently, reduced economic activity relating to the COVID-19 pandemic is likely to decrease demand for our insurance products and services and negatively impact our premium volumes (and, in certain cases, may result in return of premiums due to a decrease in exposures). This may continue for an indefinite period, with the magnitude of the
52
impact
impossible to predict. In addition, as we continue to evaluate the effects of COVID-19 on the insurance coverages we currently offer, our appetite for providing certain coverages in various jurisdictions may change which could further negatively impact our premium volumes. Any such reduction in our premiums would likely cause our expense ratio to rise.
Investments. Further disruptions in global financial markets due to the continuing impact of COVID-19 could cause us to incur additional unrealized and/or realized investment losses (beyond the investment fund losses incurred to date), including impairments in our fixed maturity portfolio and other investments. In addition, the economic uncertainty resulting from COVID-19 may result in a further decline in interest rates, which may negatively impact our net investment income from future investment activity.
Credit
Risk. As credit risk is generally a function of the economy, we face greater credit risk from our policyholders, independent agents and brokers in connection with the payment and remittance of premiums as a result of the economic conditions caused by COVID-19. Similarly, our credit risk related to the reimbursement of deductibles from policyholders and in connection with reinsurance recoverables has increased.
Operational Disruptions and Costs. Our operations could be disrupted if key members of our senior management or a significant percentage of our workforce or the workforce of our agents, brokers, suppliers or other third party service providers are unable to continue to work because of illness, government directives or otherwise. In addition, our agents, brokers, suppliers and other third party service providers, which we rely on for key aspects of our operations, are subject
to risks and uncertainties related to the COVID-19 pandemic, which may interfere with their ability to fulfill their respective commitments and responsibilities to us in a timely manner and in accordance with the agreed-upon terms. In response to the COVID-19 pandemic, we have implemented remote working policies which have resulted in disruptions to our business routines, heightened risk to cybersecurity attacks and data security incidents and a greater dependency on internet and telecommunication access and capabilities.
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds
Set forth below is a summary of
the shares repurchased by the Company during the three months ended June 30, 2020, and the number of shares remaining authorized for purchase by the Company:
Total number of
shares purchased
Average price paid per share
Total number of shares purchased as part of publicly announced plans or programs
Maximum number of shares that may yet be purchased under the plans or programs
Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
53
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
