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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
The following is a discussion and analysis of our results of operations and financial condition. It should be read in conjunction with the Consolidated Financial Statements and accompanying notes thereto presented under ITEM 8, “Financial Statements and Supplementary Data”.
Industry Conditions.
The worldwide reinsurance and insurance businesses are highly competitive, as well as cyclical by product and market. As such, financial results tend to fluctuate with periods of constrained availability, higher rates and stronger profits followed by periods of abundant capacity, lower rates and constrained profitability. Competition in the types of reinsurance and insurance business that we underwrite is based on many factors, including the perceived overall financial strength of the reinsurer or insurer, ratings of the reinsurer or insurer by A.M. Best and/or Standard & Poor’s, underwriting expertise, the jurisdictions where the reinsurer or insurer is licensed or otherwise authorized, capacity and coverages offered, premiums charged, other terms and conditions of the reinsurance and insurance business offered, services offered, speed of claims payment and reputation and experience in lines written. Furthermore, the market impact from these competitive factors related to reinsurance and insurance is generally not consistent across lines of business, domestic and international geographical areas and distribution channels.
We compete in the U.S., Bermuda and international reinsurance and insurance markets with numerous global competitors. Our competitors include independent reinsurance and insurance companies, subsidiaries or affiliates of established worldwide insurance companies, reinsurance departments of certain insurance companies, domestic and international underwriting operations, including underwriting syndicates at Lloyd’s of London and certain government sponsored risk transfer vehicles. Some of these competitors have greater financial resources than we do and have established long term and continuing business relationships, which can be a significant competitive advantage. In addition, the lack of strong barriers to entry into the reinsurance business and recently, the securitization of reinsurance and insurance risks through capital markets provide additional sources of potential reinsurance and insurance capacity and competition.
Worldwide insurance and reinsurance market conditions historically have been competitive. Generally, there was ample insurance and reinsurance capacity relative to demand, as well as, additional capital from the capital markets through insurance linked financial instruments. These financial instruments such as side cars, catastrophe bonds and collateralized reinsurance funds, provided capital markets with access to insurance and reinsurance risk exposure. The capital markets demand for these products was being primarily driven by a low interest environment and the desire to achieve greater risk diversification and potentially higher returns on their investments. This increased competition was generally having a negative impact on rates, terms and conditions; however, the impact varies widely by market and coverage.
The industry continues to deal with the impacts of a global pandemic, COVID-19. Globally, many countries mandated that their citizens remain at home and many non-essential businesses have continued to be physically closed. We activated our operational resiliency plan across our global footprint and all of our critical operations are functioning effectively from remote locations. We continue to service and meet the needs of our clients while ensuring the safety and health of our employees and customers.
The pandemic has caused significant volatility in the global financial markets. Interest rates plummeted, credit spreads widened and the equity markets lost value. We saw our fixed maturity and equity portfolios decline in value resulting in realized and unrealized investment losses in our March 31, 2020 financial statements. However, the financial markets rebounded during the remaining quarters of 2020 and we recognized after-tax realized gains of $389.4 million and unrealized gains of $667.7 million in our financial statements for these three quarters. Nevertheless, the lack of business activity may lead to an increase in bankruptcies and corresponding credit losses.
There will also be a negative impact on future industry underwriting results. With the closing of non-essential businesses, there has been a significant decline in business activity. To the extent that premiums are based on business activity, there will be a decline in premium volume. Incurred losses from the pandemic will be impacted by the duration of the event and will vary by line of business and geographical location. For the full year 2020, our underwriting results include $511.1 million of estimated losses related to the pandemic.
Many regulators had issued moratoriums on the cancellation of policies for the non-payment of premiums and also on non-renewals. We are complying with the various regulatory requests for accommodations to policyholders during this difficult period. The moratoriums combined with the forced closure of businesses may lead to an increase in uncollectible premium expense.
Prior to the pandemic, there was a growing industry consensus that there was some firming of (re)insurance rates for the areas impacted by the recent catastrophes. The increased frequency of catastrophe losses in 2020 appears to be further pressuring the increase of rates. Rates also appear to be firming in some of the casualty lines of business, particularly in the casualty lines that had seen significant losses such as excess casualty and directors’ and officers’ liability. Other casualty lines are experiencing modest rate increase, while some lines such as workers’ compensation were experiencing softer market conditions. It is too early to tell what will be the impact on pricing conditions but it is likely to change depending on the line of business and geography.
While we are unable to predict the full impact the pandemic will have on the insurance industry as it continues to have a negative impact on the global economy, we are well positioned to continue to service our clients. Our capital position remains a source of strength, with high quality invested assets, significant liquidity and a low operating expense ratio. Our diversified global platform with its broad mix of products, distribution and geography is resilient.
Financial Summary.
We monitor and evaluate our overall performance based upon financial results. The following table displays a summary of the consolidated net income (loss), ratios and shareholders’ equity for the periods indicated.
| Years Ended December 31, | Percentage Increase/(Decrease) | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | 2020 | 2019 | 2018 | 2020/2019 | 2019/2018 | |||||||
| Gross written premiums | $ | 10,482.4 | $ | 9,133.4 | $ | 8,475.2 | 14.8% | 7.8% | ||||
| Net written premiums | 9,117.0 | 7,824.4 | 7,414.4 | 16.5% | 5.5% | |||||||
| REVENUES: | ||||||||||||
| Premiums earned | $ | 8,681.5 | $ | 7,403.7 | $ | 6,931.7 | 17.3% | 6.8% | ||||
| Net investment income | 642.5 | 647.1 | 581.2 | (0.7)% | 11.3% | |||||||
| Net realized capital gains (losses) | 267.6 | 185.0 | (127.1) | 44.7% | NM | |||||||
| Other income (expense) | 6.5 | (4.6) | (24.3) | (39.2)% | (81.1)% | |||||||
| Total revenues | 9,598.1 | 8,231.2 | 7,361.5 | 16.6% | 11.8% | |||||||
| CLAIMS AND EXPENSES: | ||||||||||||
| Incurred losses and loss adjustment expenses | 6,550.8 | 4,922.9 | 5,651.4 | 33.1% | (12.9)% | |||||||
| Commission, brokerage, taxes and fees | 1,873.3 | 1,703.7 | 1,519.0 | 10.0% | 12.2% | |||||||
| Other underwriting expenses | 511.2 | 440.9 | 371.5 | 16.0% | 18.7% | |||||||
| Corporate expenses | 41.1 | 33.0 | 30.7 | 24.7% | 7.5% | |||||||
| Interest, fees and bond issue cost amortization expense | 36.3 | 31.7 | 31.0 | 14.6% | 2.1% | |||||||
| Total claims and expenses | 9,012.8 | 7,132.2 | 7,603.7 | 26.4% | (6.2)% | |||||||
| INCOME (LOSS) BEFORE TAXES | 585.3 | 1,099.0 | (242.2) | (46.7)% | NM | |||||||
| Income tax expense (benefit) | 71.2 | 89.5 | (331.2) | (20.5)% | NM | |||||||
| NET INCOME (LOSS) | $ | 514.2 | $ | 1,009.5 | $ | 89.0 | (49.1)% | NM | ||||
| RATIOS: | Point Change | |||||||||||
| Loss ratio | 75.5% | 66.5% | 81.5% | 9.0 | (15.0) | |||||||
| Commission and brokerage ratio | 21.6% | 23.0% | 21.9% | (1.4) | 1.1 | |||||||
| Other underwriting expense ratio | 5.8% | 6.0% | 5.4% | (0.2) | 0.6 | |||||||
| Combined ratio | 102.9% | 95.5% | 108.8% | 7.4 | (13.3) | |||||||
| At December 31, | Percentage Increase/(Decrease) | |||||||||||
| (Dollars in millions, except per share amounts) | 2020 | 2019 | 2018 | 2020/2019 | 2019/2018 | |||||||
| Balance sheet data: | ||||||||||||
| Total investments and cash | $ | 25,461.6 | $ | 20,748.5 | $ | 18,433.1 | 22.7% | 12.6% | ||||
| Total assets | 32,788.4 | 27,324.1 | 24,751.0 | 20.0% | 10.4% | |||||||
| Loss and loss adjustment expense reserves | 16,399.0 | 13,611.3 | 13,119.1 | 20.5% | 3.8% | |||||||
| Total debt | 1,910.4 | 633.8 | 633.6 | 201.4% | 0.0% | |||||||
| Total liabilities | 23,062.2 | 18,191.1 | 16,890.2 | 26.8% | 7.7% | |||||||
| Shareholders' equity | 9,726.2 | 9,132.9 | 7,860.8 | 6.5% | 16.2% | |||||||
| Book value per share | 243.25 | 223.85 | 193.37 | 8.7% | 15.8% | |||||||
| (NM, not meaningful) | ||||||||||||
| (Some amounts may not reconcile due to rounding.) |
Revenues.
Premiums. Gross written premiums increased by 14.8% to $10,482.4 million in 2020, compared to $9,133.4 million in 2019, reflecting a $925.8 million, or 14.6%, increase in our reinsurance business and a $423.2 million, or 15.2%, increase in our insurance business. The increase in reinsurance premiums was mainly due to increases in property pro rata business, casualty excess of loss writings and property catastrophe excess of loss business, partially offset by a $35.9 million negative impact from the movement of foreign exchange rates. The rise in insurance premiums was primarily due to increases in specialty casualty business, property business and professional liability business. Net written premiums increased by 16.5% to $9,117.0 million in 2020, compared to $7,824.4 million in 2019. This change is consistent with the change in gross written premiums. Premiums earned increased by 17.3% to $8,681.5 million in 2020, compared to $7,403.7 million in 2019. The change in premiums earned relative to net written premiums is the result of timing; premiums are earned ratably over the coverage period whereas written premiums are recorded at the initiation of the coverage period.
Gross written premiums increased by 7.8% to $9,133.4 million in 2019, compared to $8,475.2 million in 2018, reflecting a $526.9 million, or 23.4%, increase in our insurance business and a $131.3 million, or 2.1%, increase in our reinsurance business. The rise in insurance premiums was primarily due to increases in many lines of business, including casualty, energy, accident and health and business written through the Lloyd’s Syndicate. The increase in reinsurance premiums was mainly due to increases in treaty casualty writings and mortgage business, partially offset by a decline in treaty property business, including lower reinstatement premiums, and a $55.5 million negative impact from the movement of foreign exchange rates. Net written premiums increased by 5.5% to $7,824.4 million in 2019, compared to $7,414.4 million in 2018. This change is consistent with the change in gross written premiums. Premiums earned increased by 6.8% to $7,403.7 million in 2019, compared to $6,931.7 million in 2018. The change in premiums earned relative to net written premiums is the result of timing; premiums are earned ratably over the coverage period whereas written premiums are recorded at the initiation of the coverage period.
Net Investment Income. Net investment income decreased by 0.7% to $642.5 million in 2020 compared with investment income of $647.1 million in 2019. Net pre-tax investment income, as a percentage of average invested assets, was 2.9% in 2020 compared to 3.3% in 2019. The decreases in both income and yield were primarily the result of lower income from short term investments primarily due to lower interest rates resulting from the market impacts of COVID-19, partially offset by an increase in limited partnership income and higher income from the growing fixed income portfolio.
Net investment income increased by 11.3% to $647.1 million in 2019 compared with investment income of $581.2 million in 2018. Net pre-tax investment income, as a percentage of average invested assets, was 3.3% in 2019 compared to 3.2% in 2018. The increases in both income and yield were primarily the result of higher income from our growing fixed maturity portfolio and higher income from our limited partnerships, partially offset by lower dividend income from our equity portfolio.
Net Realized Capital Gains (Losses). Net realized capital gains were $267.6 million and $185.0 million in 2020 and 2019, respectively, and net realized capital losses were $127.1 million in 2018. The net realized capital gains of $267.6 million in 2020 were comprised of $280.4 million of net gains from fair value re-measurements, partially offset by $11.1 million of net realized capital losses from sales of investments, and $1.7 million of net allowances for credit losses. The net realized capital gains of $185.0 million in 2019 were comprised of $167.0 million of net gains from fair value re-measurements and $38.9 million of net realized capital gains from sales of investments, partially offset by $20.9 million of other-than-temporary impairments. The net realized capital losses of $127.1 million in 2018 were comprised of $67.3 million of net losses from fair value re-measurements, $51.7 million of net realized capital losses from sales of investments and $8.1 million of other-than-temporary impairments.
Other Income (Expense). We recorded other income of $6.5 million in 2020 and other expense of $4.6 million and $24.3 million in 2019 and 2018, respectively. The changes were primarily the result of fluctuations in foreign currency exchange rates, income related to Mt. Logan Re, changes in value of equity put option
contracts and changes in deferred gains related to any retroactive reinsurance transactions. We recognized foreign currency exchange expense of $7.3 million in 2020, foreign currency exchange expense of $13.4 million in 2019 and foreign currency exchange income of $2.4 million in 2018.
Claims and Expenses.
Incurred Losses and Loss Adjustment Expenses. The following table presents our incurred losses and loss adjustment expenses (“LAE”) for the periods indicated.
| Years Ended December 31, | |||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Current | Ratio %/ | Prior | Ratio %/ | Total | Ratio %/ | ||||||||||||
| (Dollars in millions) | Year | Pt Change | Years | Pt Change | Incurred | Pt Change | |||||||||||
| 2020 | |||||||||||||||||
| Attritional | $ | 5,724.4 | 66.0% | $ | 401.4 | 4.7% | $ | 6,125.8 | 70.7% | ||||||||
| Catastrophes | 425.0 | 4.9% | — | —% | 425.0 | 4.9% | |||||||||||
| Total segment | $ | 6,149.4 | 70.9% | $ | 401.4 | 4.7% | $ | 6,550.8 | 75.5% | ||||||||
| 2019 | |||||||||||||||||
| Attritional | $ | 4,441.0 | 60.0% | $ | (93.6) | (1.3)% | $ | 4,347.4 | 58.7% | ||||||||
| Catastrophes | 545.5 | 7.4% | 30.0 | 0.4% | 575.5 | 7.8% | |||||||||||
| Total segment | $ | 4,986.5 | 67.4% | $ | (63.6) | (0.9)% | $ | 4,922.9 | 66.5% | ||||||||
| 2018 | |||||||||||||||||
| Attritional | $ | 4,025.4 | 58.0% | $ | (174.1) | (2.5)% | $ | 3,851.2 | 55.5% | ||||||||
| Catastrophes | 1,239.0 | 17.9% | 561.2 | 8.1% | 1,800.2 | 26.0% | |||||||||||
| Total segment | $ | 5,264.3 | 75.9% | $ | 387.1 | 5.6% | $ | 5,651.4 | 81.5% | ||||||||
| Variance 2020/2019 | |||||||||||||||||
| Attritional | $ | 1,283.4 | 6.0 | pts | $ | 495.0 | 6.0 | pts | $ | 1,778.4 | 12.0 | pts | |||||
| Catastrophes | (120.5) | (2.5) | pts | (30.0) | (0.4) | pts | (150.5) | (2.9) | pts | ||||||||
| Total segment | $ | 1,162.9 | 3.5 | pts | $ | 465.0 | 5.6 | pts | $ | 1,627.9 | 9.0 | pts | |||||
| Variance 2019/2018 | |||||||||||||||||
| Attritional | $ | 415.6 | 2.0 | pts | $ | 80.6 | 1.2 | pts | $ | 496.2 | 3.2 | pts | |||||
| Catastrophes | (693.5) | (10.5) | pts | (531.2) | (7.7) | pts | (1,224.7) | (18.2) | pts | ||||||||
| Total segment | $ | (277.9) | (8.5) | pts | $ | (450.6) | (6.5) | pts | $ | (728.5) | (15.0) | pts | |||||
| (Some amounts may not reconcile due to rounding.) |
Incurred losses and LAE increased by 33.1% to $6,550.8 million in 2020, compared to $4,922.9 million in 2019, primarily due to a rise of $1,283.4 million in current year attritional losses, mainly due to $511.1 million of losses related to the COVID-19 pandemic and the impact of the increase in premiums earned, as well as $495.0 million of less favorable development on prior years attritional losses in 2020, which primarily resulted from $400.0 of reserve strengthening in the fourth quarter of 2020 associated with higher ultimate loss estimates for long-tail casualty business in the reinsurance segment for accident years 2015 to 2018, notably general liability, professional lines and auto liability. The reserve charge also includes actions on non-CAT property lines, primarily for the 2017 to 2019 accident years and driven by a few large losses to aggregate programs. The increase was partially offset by a decrease of $120.5 million in current year catastrophe losses. The current year catastrophe losses of $425.0 million in 2020 related to Hurricane Laura ($124.0 million), the Northern California wildfires ($44.1 million), Hurricane Zeta ($40.0 million), Hurricane Sally ($32.8 million), the California Glass wildfire ($29.5 million), Nashville tornadoes ($22.9 million), the Derecho storms ($20.5 million), Hurricane Isaias ($20.0 million), Hurricane Delta ($20.0 million), the Oregon wildfires ($17.0 million), the Calgary storms in Canada ($14.7 million), the 2020 U.S. civil unrest ($14.5 million), the Queensland Hailstorm ($10.0 million), the 2020 Australia fires ($8.2 million) and the Australia East Coast Storm ($6.8 million). The $545.5 million of current year catastrophe losses in 2019 related to Typhoon Hagibis ($200.0 million), Hurricane Dorian ($170.9
million), Typhoon Faxai ($124.3 million), Townsville Monsoon ($25.3 million), and the Dallas tornadoes ($25.0 million).
Incurred losses and LAE decreased by 12.9% to $4,922.9 million in 2019, compared to $5,651.4 million in 2018, primarily due to a decrease in current year catastrophe losses of $693.5 million and $531.2 million less of unfavorable development on prior years catastrophe losses in 2019 compared to 2018. These decreases were partially offset by an increase of $415.6 million in current year attritional losses, mainly due to the impact of the increase in premiums earned and changes in the mix of business, and $80.6 million less of favorable development on prior years attritional losses in 2019 compared to 2018. The current year catastrophe losses of $545.5 million in 2019 are outlined above. The $1,239.0 million of current year catastrophe losses in 2018 related to Hurricane Michael ($462.0 million), Camp wildfire ($322.0 million), Woolsey wildfire ($154.0 million), Typhoon Jebi ($80.0 million), Hurricane Florence ($73.8 million), Cyclone Mekunu ($43.7 million), Typhoon Trami ($25.0 million), Australia Hailstorm ($25.0 million), other 2018 California wildfires ($24.6 million), Japan floods ($20.5 million) and the U.S. winter storms ($8.4 million).
Commission, Brokerage, Taxes and Fees. Commission, brokerage, taxes and fees increased by 10.0% to $1,873.3 million for the year ended December 31, 2020 compared to $1,703.7 million for the year ended December 31, 2019. The changes were primarily due to the impact of the increases in premiums earned and changes in the mix of business.
Commission, brokerage, taxes and fees increased by 12.2% to $1,703.7 million for the year ended December 31, 2019 compared to $1,519.0 million for the year ended December 31, 2018. The changes were primarily due to the impact of the increases in premiums earned, higher contingent commissions and changes in the mix of business.
Other Underwriting Expenses. Other underwriting expenses were $511.2 million, $440.9 million and $371.5 million in 2020, 2019 and 2018, respectively. The increases in other underwriting expenses were mainly due to the impact of the increases in premiums earned and costs incurred to support the continued expansion of the insurance business.
Corporate Expenses. Corporate expenses, which are general operating expenses that are not allocated to segments, were $41.1 million, $33.0 million and $30.7 million for the years ended December 31, 2020, 2019 and 2017, respectively. The increase from 2019 to 2020 was mainly due to costs associated with the relocation of our U.S. corporate offices and higher compensation expenses.
Interest, Fees and Bond Issue Cost Amortization Expense. Interest, fees and other bond amortization expense was $36.3 million, $31.7 million and $31.0 million in 2020, 2019 and 2018, respectively. The changes in expense were primarily due to the movements in the floating interest rate related to the long term subordinated notes, which is reset quarterly per the note agreement. The floating rate was 2.6% as of December 31, 2020. The increase from 2019 to 2020 was also related to the interest expense on the $1,000.0 million senior note issuance in October 2020.
Income Tax Expense (Benefit). We had income tax expense of $71.2 million in 2020, $89.5 million in 2019, and an income tax benefit of $331.2 million in 2018. Income tax expense is primarily a function of the geographic location of the Company’s pre-tax income and the statutory tax rates in those jurisdictions. The effective tax rate (“ETR”) is primarily affected by tax-exempt investment income, foreign tax credits and dividends. Variations in the ETR generally result from changes in the relative levels of pre-tax income, including the impact of catastrophe losses and net capital gains (losses), among jurisdictions with different tax rates. The change in income tax expense was primarily due to the increase in incurred losses, including from COVID 19 reserves and a reserve charge from 2019 to 2020.
The Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, enacted on March 27, 2020, provided that U.S. companies could carryback for five years net operating losses incurred in 2018, 2019 and/or 2020. This
beneficial tax provision in the CARES Act enabled the Company to carryback its significant 2018 net operating losses to prior tax years with higher effective tax rates of 35% versus 21% in 2018 and later years. As a result, the Company was able to record a net income tax benefit from the five-year carryback of $32.5 million and obtain federal income tax cash refunds of $182.5 million including interest in 2020.
During 2018, the Company completed its accounting for the TCJA in accordance with SEC Staff Accounting Bulletin 118, including interpretation of the additional guidance issued by the IRS and U.S. Department of the Treasury, and recognized an income tax benefit of $28.4 million primarily related to the 2017 tax return to tax provision true-up recorded in 2018.
Net Income (Loss).
Our net income was $514.2 million, $1,009.5 million and $89.0 million in 2020, 2019 and 2018, respectively. The changes were primarily driven by the financial component fluctuations explained above.
Ratios.
Our combined ratio increased by 7.4 points to 102.9% in 2020, compared to 95.5% in 2019. The loss ratio component increased 9.0 points in 2020 over the same period last year mainly due $511.1 million of losses related to the COVID-19 pandemic in 2020. The commission and brokerage ratio components decreased to 21.6% in 2020 compared to 23.0% in 2019 mainly due to the impact of lower reinstatement premiums in 2020 and changes in the mix of business. The other underwriting expense ratios decreased to 5.8% in 2020 compared to 6.0% in 2019 mainly due to the impact of higher earned premiums in 2020 compared to 2019.
Our combined ratio decreased by 13.3 points to 95.5% in 2019, compared to 108.8% in 2018. The loss ratio component decreased 15.0 points in 2019 over the same period last year mainly due to lower catastrophe losses in 2019 compared to 2018 and less unfavorable development on prior years catastrophe losses. The commission and brokerage ratio components increased to 23.0% in 2019 compared to 21.9% in 2018 mainly due to the impact of lower reinstatement premiums in 2019 and changes in the mix of business. The other underwriting expense ratios increased to 6.0% in 2019 compared to 5.4% in 2018 mainly due to higher variable compensation in 2019 compared to 2018.
Shareholders’ Equity.
Shareholders’ equity increased by $593.3 million to $9,726.2 million at December 31, 2020 from $9,132.9 million at December 31, 2019, principally as a result of $514.2 million of net income, $419.7 million of unrealized appreciation on investments net of tax, $86.3 million of net foreign currency translation adjustments, $25.6 million of share-based compensation transactions and $0.7 million of net benefit plan obligation adjustments, net of tax, partially offset by $249.1 million of shareholder dividends and the repurchase of 970,892 common shares for $200.0 million and $4.2 million of cumulative adjustment from the adoption of ASU 2016-13.
Shareholders’ equity increased by $1,272.1 million to $9,132.9 million at December 31, 2019 from $7,860.8 million at December 31, 2018, principally as a result of $1,009.5 million of net income, $483.8 million of unrealized appreciation on investments net of tax, $30.9 million of share-based compensation transactions and $14.0 million of net foreign currency translation adjustments, partially offset by $234.3 million of shareholder dividends, the repurchase of 114,633 common shares for $24.6 million and $7.1 million of net benefit plan obligation adjustments, net of tax.
Consolidated Investment Results
Net Investment Income.
Net investment income decreased by 0.7% to $642.5 million in 2020 compared with investment income of $647.1 million in 2019. The decrease was primarily due to lower income from short term investments primarily due to lower interest rates resulting from the market impacts of COVID-19, partially offset by an increase in limited partnership income and higher income from the growing fixed income portfolio.
Net investment income increased by 11.3% to $647.1 million in 2019 compared with investment income of $581.2 million in 2018. The increase was primarily due to higher income from our growing fixed maturity portfolio and an increase in limited partnership income, partially offset by lower dividend income from our equity portfolio.
The following table shows the components of net investment income for the periods indicated.
| Years Ended December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | 2020 | 2019 | 2018 | |||||
| Fixed maturities | $ | 542.4 | $ | 520.3 | $ | 465.8 | ||
| Equity securities | 18.8 | 19.5 | 25.3 | |||||
| Short-term investments and cash | 5.0 | 17.6 | 14.4 | |||||
| Other invested assets | ||||||||
| Limited partnerships | 112.9 | 105.8 | 93.3 | |||||
| Other | 1.7 | 14.1 | 17.0 | |||||
| Gross investment income before adjustments | 680.7 | 677.3 | 615.8 | |||||
| Funds held interest income (expense) | 12.8 | 13.3 | 6.3 | |||||
| Future policy benefit reserve income (expense) | (1.2) | (1.4) | (1.4) | |||||
| Gross investment income | 692.2 | 689.2 | 620.7 | |||||
| Investment expenses | (49.8) | (42.1) | (39.5) | |||||
| Net investment income | $ | 642.5 | $ | 647.1 | $ | 581.2 | ||
| (Some amounts may not reconcile due to rounding.) |
The following tables show a comparison of various investment yields for the periods indicated.
| 2020 | 2019 | 2018 | ||||||
|---|---|---|---|---|---|---|---|---|
| Imbedded pre-tax yield of cash and invested assets at December 31 | 3.0 | % | 3.4 | % | 3.4 | % | ||
| Imbedded after-tax yield of cash and invested assets at December 31 | 2.6 | % | 3.0 | % | 3.0 | % | ||
| Annualized pre-tax yield on average cash and invested assets | 2.9 | % | 3.3 | % | 3.2 | % | ||
| Annualized after-tax yield on average cash and invested assets | 2.5 | % | 2.9 | % | 2.8 | % |
| 2020 | 2019 | 2018 | ||||||
|---|---|---|---|---|---|---|---|---|
| Fixed income portfolio total return | 6.3 | % | 6.2 | % | 1.3 | % | ||
| Barclay's Capital - U.S. aggregate index | 7.5 | % | 8.7 | % | - | % | ||
| Common equity portfolio total return | 26.7 | % | 23.8 | % | (5.2) | % | ||
| S&P 500 index | 18.4 | % | 31.5 | % | (4.4) | % | ||
| Other invested asset portfolio total return | 8.3 | % | 9.9 | % | 11.1 | % |
The pre-tax equivalent total return for the bond portfolio was approximately 5.3%, 6.3% and 2.9%, respectively, in 2020, 2019 and 2018. The pre-tax equivalent return adjusts the yield on tax-exempt bonds to the fully taxable equivalent.
Our fixed income and equity portfolios have different compositions than the benchmark indexes. Our fixed income portfolios have a shorter duration because we align our investment portfolio with our liabilities. We also hold foreign securities to match our foreign liabilities while the index is comprised of only U.S. securities. Our equity portfolios reflect an emphasis on dividend yield and growth equities, while the index is comprised of the largest 500 equities by market capitalization.
Net Realized Capital Gains (Losses).
The following table presents the composition of our net realized capital gains (losses) for the periods indicated.
| Years Ended December 31, | 2020/2019 | 2019/2018 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | 2020 | 2019 | 2018 | Variance | Variance | |||||||||
| Gains (losses) from sales: | ||||||||||||||
| Fixed maturity securities, market value: | ||||||||||||||
| Gains | $ | 79.6 | $ | 63.4 | $ | 34.0 | $ | 16.2 | $ | 29.4 | ||||
| Losses | (81.8) | (35.3) | (55.7) | (46.5) | 20.4 | |||||||||
| Total | (2.2) | 28.1 | (21.7) | (30.3) | 49.8 | |||||||||
| Fixed maturity securities, fair value: | ||||||||||||||
| Gains | — | 0.4 | — | (0.4) | 0.4 | |||||||||
| Losses | (2.9) | - | (1.8) | (2.9) | 1.8 | |||||||||
| Total | (2.9) | 0.4 | (1.8) | (3.3) | 2.2 | |||||||||
| Equity securities, fair value: | ||||||||||||||
| Gains | 37.4 | 14.3 | 31.7 | 23.1 | (17.4) | |||||||||
| Losses | (46.4) | (10.1) | (61.7) | (36.3) | 51.6 | |||||||||
| Total | (9.0) | 4.1 | (30.0) | (13.1) | 34.1 | |||||||||
| Other Invested Assets | ||||||||||||||
| Gains | 7.7 | 6.8 | 1.8 | 0.9 | 5.0 | |||||||||
| Losses | (6.0) | (0.8) | — | (5.3) | (0.7) | |||||||||
| Total | 1.7 | 6.0 | 1.8 | (4.4) | 4.3 | |||||||||
| Short Term Investments | ||||||||||||||
| Gains | 1.3 | — | — | 1.3 | — | |||||||||
| Losses | - | — | — | - | — | |||||||||
| Total | 1.3 | — | — | 1.3 | — | |||||||||
| Total net realized capital gains (losses) from sales: | ||||||||||||||
| Gains | 126.1 | 84.9 | 67.5 | 41.2 | 17.4 | |||||||||
| Losses | (137.1) | (46.1) | (119.2) | (91.0) | 73.1 | |||||||||
| Total | (11.1) | 38.9 | (51.7) | (49.9) | 90.6 | |||||||||
| Allowance for credit losses: | (1.7) | — | — | (1.7) | — | |||||||||
| Other-than-temporary impairments: | — | (20.9) | (8.1) | 20.9 | (12.8) | |||||||||
| Gains (losses) from fair value adjustments: | ||||||||||||||
| Fixed maturities, fair value | 1.9 | 1.8 | 1.5 | 0.1 | 0.3 | |||||||||
| Equity securities, fair value | 278.5 | 165.2 | (68.8) | 113.3 | 234.0 | |||||||||
| Total | 280.4 | 167.0 | (67.3) | 113.4 | 234.3 | |||||||||
| Total net realized capital gains (losses) | $ | 267.6 | $ | 185.0 | $ | (127.1) | $ | 82.7 | $ | 312.1 | ||||
| (Some amounts may not reconcile due to rounding.) |
Net realized capital gains were $267.6 million and $185.0 million in 2020 and 2019, respectively, and net realized capital losses were $127.1 million in 2018. The net realized capital gains of $267.6 million in 2020 were comprised of $280.4 million of net gains from fair value re-measurements, partially offset by $11.1 million of net realized capital losses from sales of investments and $1.7 million of net allowances for credit losses. In 2019, we recorded $167.0 million of net gains from fair value re-measurements and $38.9 million of net realized capital gains from sales of investments, partially offset by $20.9 million of other-than-temporary impairments. In 2018,
we recorded $67.3 million of net losses from fair value re-measurements, $51.7 million of net realized capital losses from sales of investments and $8.1 million of other-than-temporary impairments. The fixed maturity and equity sales during these years related primarily to adjusting the portfolios for overall market changes and individual credit shifts.
Segment Results.
The Reinsurance operation writes worldwide property and casualty reinsurance and specialty lines of business, on both a treaty and facultative basis, through reinsurance brokers, as well as directly with ceding companies. Business is written in the U.S., Bermuda, and Ireland offices, as well as, through branches in Canada, Singapore and the United Kingdom. The Insurance operation writes property and casualty insurance directly and through brokers, surplus lines brokers and general agents within the U.S., Canada and Europe through its offices in the U.S., Canada, Ireland and a branch located in Zurich.
These segments are managed independently, but conform with corporate guidelines with respect to pricing, risk management, control of aggregate catastrophe exposures, capital, investments and support operations. Management generally monitors and evaluates the financial performance of these operating segments based upon their underwriting results.
Underwriting results include earned premium less losses and loss adjustment expenses (“LAE”) incurred, commission and brokerage expenses and other underwriting expenses. We measure our underwriting results using ratios, in particular loss, commission and brokerage and other underwriting expense ratios, which, respectively, divide incurred losses, commissions and brokerage and other underwriting expenses by premiums earned.
The Company does not maintain separate balance sheet data for its operating segments. Accordingly, the Company does not review and evaluate the financial results of its operating segments based upon balance sheet data.
Our loss and LAE reserves are management’s best estimate of our ultimate liability for unpaid claims. We re-evaluate our estimates on an ongoing basis, including all prior period reserves, taking into consideration all available information and, in particular, recently reported loss claim experience and trends related to prior periods. Such re-evaluations are recorded in incurred losses in the period in which re-evaluation is made.
The following discusses the underwriting results for each of our segments for the periods indicated.
Reinsurance.
The following table presents the underwriting results and ratios for the Reinsurance segment for the periods indicated.
| Years Ended December 31, | 2020/2019 | 2019/2018 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | 2020 | 2019 | 2018 | Variance | % Change | Variance | % Change | |||||||||||
| Gross written premiums | $ | 7,281.7 | $ | 6,355.9 | $ | 6,224.6 | $ | 925.8 | 14.6% | $ | 131.3 | 2.1% | ||||||
| Net written premiums | 6,767.6 | 5,732.3 | 5,706.5 | 1,035.3 | 18.1% | 25.8 | 0.5% | |||||||||||
| Premiums earned | $ | 6,466.1 | $ | 5,491.3 | $ | 5,293.1 | $ | 974.8 | 17.8% | $ | 198.2 | 3.7% | ||||||
| Incurred losses and LAE | 4,933.4 | 3,675.2 | 4,585.6 | 1,258.2 | 34.2% | (910.4) | (19.9)% | |||||||||||
| Commission and brokerage | 1,552.4 | 1,400.2 | 1,251.6 | 152.1 | 10.9% | 148.6 | 11.9% | |||||||||||
| Other underwriting expenses | 175.7 | 160.8 | 142.9 | 14.9 | 9.3% | 17.9 | 12.5% | |||||||||||
| Underwriting gain (loss) | $ | (195.4) | $ | 255.0 | $ | (687.0) | $ | (450.4) | (176.6)% | $ | 942.1 | (137.1)% | ||||||
| Point Chg | Point Chg | |||||||||||||||||
| Loss ratio | 76.3% | 67.0% | 86.6% | 9.3 | (19.6) | |||||||||||||
| Commission and brokerage ratio | 24.0% | 25.5% | 23.6% | (1.5) | 1.9 | |||||||||||||
| Other underwriting expense ratio | 2.7% | 2.9% | 2.8% | (0.2) | 0.1 | |||||||||||||
| Combined ratio | 103.0% | 95.4% | 113.0% | 7.6 | (17.6) | |||||||||||||
| (NM, not meaningful) | ||||||||||||||||||
| (Some amounts may not reconcile due to rounding.) |
Premiums. Gross written premiums increased by 14.6% to $7,281.7 million in 2020 from $6,355.9 million in 2019, primarily due to increases in property pro rata business, casualty excess of loss writings and property catastrophe excess of loss business, partially offset by a $35.9 million negative impact from the movement of foreign exchange rates. Net written premiums increased by 18.1% to $6,767.6 million in 2020 compared to $5,732.3 million in 2019. The difference between the change in gross written premiums compared to the change in net written premiums was primarily due to varying utilization of reinsurance. Premiums earned increased by 17.8% to $6,466.1 million in 2020, compared to $5,491.3 million in 2019. The change in premiums earned relative to net written premiums is primarily the result of timing; premiums are earned ratably over the coverage period whereas written premiums are recorded at the initiation of the coverage period.
Gross written premiums increased by 2.1% to $6,355.9 million in 2019 from $6,244.6 million in 2018, primarily due to increases in treaty casualty writings and mortgage business, partially offset by a decline in treaty property business, including lower reinstatement premiums, and a $55.5 million negative impact from the movement of foreign exchange rates. Net written premiums increased by 0.5% to $5,732.3 million in 2019 compared to $5,706.5 million in 2018 which is consistent with the change in gross written premiums. Premiums earned increased by 3.7% to $5,491.3 million in 2019, compared to $5,293.1 million in 2018. The change in premiums earned relative to net written premiums is primarily the result of timing; premiums are earned ratably over the coverage period whereas written premiums are recorded at the initiation of the coverage period.
Incurred Losses and LAE. The following table presents the incurred losses and LAE for the Reinsurance segment for the periods indicated.
| Years Ended December 31, | |||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Current | Ratio %/ | Prior | Ratio %/ | Total | Ratio %/ | ||||||||||||
| (Dollars in millions) | Year | Pt Change | Years | Pt Change | Incurred | Pt Change | |||||||||||
| 2020 | |||||||||||||||||
| Attritional | $ | 4,179.5 | 64.6% | $ | 396.9 | 6.1% | $ | 4,576.4 | 70.7% | ||||||||
| Catastrophes | 357.0 | 5.5% | — | —% | 357.0 | 5.5% | |||||||||||
| Total segment | $ | 4,536.5 | 70.1% | $ | 396.9 | 6.1% | $ | 4,933.4 | 76.3% | ||||||||
| 2019 | |||||||||||||||||
| Attritional | $ | 3,177.5 | 57.9% | $ | (77.2) | (1.4)% | $ | 3,100.4 | 56.5% | ||||||||
| Catastrophes | 541.5 | 9.9% | 33.4 | 0.6% | 574.8 | 10.5% | |||||||||||
| Total segment | $ | 3,719.0 | 67.8% | $ | (43.8) | (0.8)% | $ | 3,675.2 | 67.0% | ||||||||
| 2018 | |||||||||||||||||
| Attritional | $ | 2,940.6 | 55.5% | $ | (121.9) | (2.3)% | $ | 2,818.7 | 53.2% | ||||||||
| Catastrophes | 1,195.9 | 22.6% | 571.1 | 10.8% | 1,766.9 | 33.4% | |||||||||||
| Total segment | $ | 4,136.4 | 78.1% | $ | 449.2 | 8.5% | $ | 4,585.6 | 86.6% | ||||||||
| Variance 2020/2019 | |||||||||||||||||
| Attritional | $ | 1,002.0 | 6.7 | pts | $ | 474.1 | 7.5 | pts | $ | 1,476.0 | 14.2 | pts | |||||
| Catastrophes | (184.5) | (4.4) | pts | (33.4) | (0.6) | pts | (217.8) | (5.0) | pts | ||||||||
| Total segment | $ | 817.5 | 2.3 | pts | $ | 440.7 | 6.9 | pts | $ | 1,258.2 | 9.3 | pts | |||||
| Variance 2019/2018 | |||||||||||||||||
| Attritional | $ | 236.9 | 2.4 | pts | $ | 44.7 | 0.9 | pts | $ | 281.7 | 3.3 | pts | |||||
| Catastrophes | (654.4) | (12.7) | pts | (537.7) | (10.2) | pts | (1,192.1) | (22.9) | pts | ||||||||
| Total segment | $ | (417.5) | (10.3) | pts | $ | (493.0) | (9.3) | pts | $ | (910.4) | (19.6) | pts | |||||
| (Some amounts may not reconcile due to rounding.) |
Incurred losses increased by 34.2% to $4,933.4 million in 2020, compared to $3,675.2 million in 2019. The increase was primarily due to an increase of $1,002.0 million in current year attritional losses, mainly related to $407.1 million of losses from the COVID-19 pandemic and the impact of the increase in premiums earned, as well as $474.1 million of more development on prior years attritional losses in 2020 compared to 2019 primarily resulted from $400.0 of reserve strengthening in the fourth quarter of 2020 associated with higher ultimate loss estimates for long-tail casualty business for accident years 2015 to 2018, notably general liability, professional lines and auto liability. The reserve charge also includes actions on non-CAT property lines, primarily for the 2017 to 2019 accident years and driven by a few large losses to aggregate programs. The increase was partially offset by a decline of $184.5 million in current year catastrophe losses and $33.4 million of less development on prior years catastrophe losses. The current year catastrophe losses of $357.0 million in 2020 related primarily to Hurricane Laura ($105.5 million), the Northern California wildfires ($44.1 million), Hurricane Zeta ($32.0 million), the California Glass wildfire ($29.5 million), Hurricane Delta ($18.0 million), Hurricane Isaias ($17.8 million), the Nashville tornadoes ($17.5 million), the Derecho storms ($17.5 million), the Oregon wildfires ($17.0 million), Hurricane Sally ($16.9 million), the Calgary storms in Canada ($12.2 million), the Queensland hailstorm ($10.0 million), the Australia fires ($8.2 million), the Australia East Coast storm ($6.8 million), and the 2020 U.S. Civil Unrest ($4.1 million). The $541.5 million of current year catastrophe losses in 2019 related primarily to Typhoon Hagibis ($200.0 million), Hurricane Dorian ($166.9 million), Typhoon Faxai ($124.3 million), the 2019 Townsville Monsoon ($25.3 million) and the Dallas tornadoes ($25.0 million).
Incurred losses decreased by 19.9% to $3,675.2 million in 2019, compared to 4,585.6 million in 2018. The decrease was primarily due to a decrease of $654.4 million in current year catastrophe losses and an improvement of $537.7 million on development of prior years catastrophe losses, partially offset by an increase
of $236.9 million in current year attritional losses, mainly due to the impact of changes in the mix of business, primarily writing more treaty casualty. The current year catastrophe losses of $541.5 million in 2019 are outlined above. The $1,195.9 million of current year catastrophe losses in 2018 related primarily to Hurricane Michael ($438.0 million), Camp wildfire ($322.0 million), Woolsey wildfire ($154.0 million), Typhoon Jebi ($80.0 million), Hurricane Florence ($64.3 million), Cyclone Mekunu ($43.7 million), Typhoon Trami ($25.0 million), Australia hailstorm ($24.0 million), other 2018 California wildfires ($23.1 million) and Japan floods ($5.5 million).
Segment Expenses. Commission and brokerage expense increased by 10.9% to $1,552.4 million in 2020 compared to $1,400.2 million in 2019. The increase was mainly due to the impact of the increase in premiums earned and changes in the mix of business. Segment other underwriting expenses increased to $175.7 million in 2020 from $160.8 million in 2019. The increase was mainly due to changes in the mix of business and the impact of the increase in premiums earned.
Commission and brokerage expense increased by 11.9% to $1,400.2 million in 2019 compared to $1,251.6 million in 2018. The increases are mainly due to the impact of the increases in premiums earned, higher contingent commission, changes in the mix of business towards additional pro rata business and significantly higher reinstatement premiums in 2018 which have no commission charge. Segment other underwriting expenses increased to $160.8 million in 2019 from $142.9 million in 2018. The increases were mainly due to changes in the mix of business and the impact of the increase in premiums earned.
Insurance.
The following table presents the underwriting results and ratios for the Insurance segment for the periods indicated.
| Years Ended December 31, | 2020/2019 | 2019/2018 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | 2020 | 2019 | 2018 | Variance | % Change | Variance | % Change | |||||||||||
| Gross written premiums | $ | 3,200.6 | $ | 2,777.5 | $ | 2,250.6 | $ | 423.2 | 15.2% | $ | 526.9 | 23.4% | ||||||
| Net written premiums | 2,349.4 | 2,092.2 | 1,708.0 | 257.3 | 12.3% | 384.2 | 22.5% | |||||||||||
| Premiums earned | $ | 2,215.4 | $ | 1,912.4 | $ | 1,638.6 | $ | 303.0 | 15.8% | $ | 273.8 | 16.7% | ||||||
| Incurred losses and LAE | 1,617.4 | 1,247.7 | 1,065.8 | 369.7 | 29.6% | 181.9 | 17.1% | |||||||||||
| Commission and brokerage | 320.9 | 303.5 | 267.4 | 17.4 | 5.7% | 36.1 | 13.5% | |||||||||||
| Other underwriting expenses | 335.5 | 280.1 | 228.7 | 55.4 | 19.8% | 51.4 | 22.5% | |||||||||||
| Underwriting gain (loss) | $ | (58.4) | $ | 81.1 | $ | 76.7 | $ | (139.5) | (172.0)% | $ | 4.4 | 5.8% | ||||||
| Point Chg | Point Chg | |||||||||||||||||
| Loss ratio | 73.0% | 65.2% | 65.0% | 7.8 | 0.2 | |||||||||||||
| Commission and brokerage ratio | 14.5% | 15.9% | 16.3% | (1.4) | (0.4) | |||||||||||||
| Other underwriting expense ratio | 15.1% | 14.7% | 14.0% | 0.4 | 0.7 | |||||||||||||
| Combined ratio | 102.6% | 95.8% | 95.3% | 6.8 | 0.5 | |||||||||||||
| (Some amounts may not reconcile due to rounding.) |
Premiums. Gross written premiums increased by 15.2% to $3,200.6 million in 2020 compared to $2,777.5 million in 2019. This rise was related to increases in specialty casualty business, property business and professional liability business. Net written premiums increased by 12.3% to $2,349.4 million in 2020 compared to $2,092.2 million in 2019. The difference between the change in gross written premiums compared to the change in net written premiums is primarily due to varying utilization of reinsurance. Premiums earned increased 15.8% to $2,215.4 million in 2019 compared to $1,912.4 million in 2019. The change in premiums earned relative to net written premiums is the result of timing; premiums are earned ratably over the coverage period whereas written premiums are recorded at the initiation of the coverage period.
Gross written premiums increased by 23.4% to $2,777.5 million in 2019 compared to $2,250.6 million in 2018. This increase was related to most lines of business including casualty, energy, accident and health and premiums written through the Lloyd’s Syndicate. Net written premiums increased by 22.5% to $2,092.2 million in 2019 compared to $1,708.0 million in 2018, which is consistent with the change in gross written premiums. Premiums earned increased 16.7% to $1,912.4 million in 2019 compared to $1,638.6 million in 2018. The change in premiums earned relative to net written premiums is the result of timing; premiums are earned ratably over the coverage period whereas written premiums are recorded at the initiation of the coverage period.
Incurred Losses and LAE. The following table presents the incurred losses and LAE for the Insurance segment for the periods indicated.
| Years Ended December 31, | |||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Current | Ratio %/ | Prior | Ratio %/ | Total | Ratio %/ | ||||||||||||
| (Dollars in millions) | Year | Pt Change | Years | Pt Change | Incurred | Pt Change | |||||||||||
| 2020 | |||||||||||||||||
| Attritional | $ | 1,544.9 | 69.7% | $ | 4.5 | 0.2% | $ | 1,549.4 | 69.9% | ||||||||
| Catastrophes | 68.0 | 3.1% | — | —% | 68.0 | 3.1% | |||||||||||
| Total segment | $ | 1,612.9 | 72.8% | $ | 4.5 | 0.2% | $ | 1,617.4 | 73.0% | ||||||||
| 2019 | |||||||||||||||||
| Attritional | $ | 1,263.4 | 66.1% | $ | (16.4) | (0.9)% | $ | 1,247.0 | 65.2% | ||||||||
| Catastrophes | 4.0 | 0.2% | (3.4) | (0.2)% | 0.7 | 0.0% | |||||||||||
| Total segment | $ | 1,267.5 | 66.3% | $ | (19.8) | (1.1)% | $ | 1,247.7 | 65.2% | ||||||||
| 2018 | |||||||||||||||||
| Attritional | $ | 1,084.8 | 66.2% | $ | (52.2) | (3.2)% | $ | 1,032.6 | 63.0% | ||||||||
| Catastrophes | 43.1 | 2.6% | (9.9) | (0.6)% | 33.2 | 2.0% | |||||||||||
| Total segment | $ | 1,127.9 | 68.8% | $ | (62.1) | (3.8)% | $ | 1,065.8 | 65.0% | ||||||||
| Variance 2020/2019 | |||||||||||||||||
| Attritional | $ | 281.5 | 3.6 | pts | $ | 20.9 | 1.1 | pts | $ | 302.4 | 4.7 | pts | |||||
| Catastrophes | 64.0 | 2.9 | pts | 3.4 | 0.2 | pts | 67.3 | 3.1 | pts | ||||||||
| Total segment | $ | 345.4 | 6.5 | pts | $ | 24.3 | 1.3 | pts | $ | 369.7 | 7.8 | pts | |||||
| Variance 2019/2018 | |||||||||||||||||
| Attritional | $ | 178.6 | (0.1) | pts | $ | 35.8 | 2.3 | pts | $ | 214.5 | 2.2 | pts | |||||
| Catastrophes | (39.1) | (2.4) | pts | 6.5 | 0.4 | pts | (32.6) | (2.0) | pts | ||||||||
| Total segment | $ | 139.6 | (2.5) | pts | $ | 42.3 | 2.7 | pts | $ | 181.9 | 0.2 | pts | |||||
| (Some amounts may not reconcile due to rounding.) |
Incurred losses and LAE increased by 29.6% to $1,617.4 million in 2020 compared to $1,247.7 million in 2019. The increase was mainly due to a rise of $281.5 million in current year attritional losses, primarily related to $104.0 million of losses from the COVID-19 pandemic and the impact of the increase in premiums earned, as well as an increase of $64.0 million in current year catastrophe losses. The current year catastrophe losses of $68.0 million in 2020 related to Hurricane Laura ($18.5 million), Hurricane Sally ($15.9 million), the 2020 U.S. Civil Unrest ($10.4 million), Hurricane Zeta ($8.0 million), the Nashville tornadoes ($5.5 million), the Derecho storms ($3.0 million), the Calgary storms in Canada ($2.5 million), Hurricane Isaias ($2.2 million) and Hurricane Delta ($2.0 million). The $4.0 million of current year catastrophe losses in 2019 related primarily to Hurricane Dorian ($4.0 million).
Incurred losses and LAE increased by 17.1% to $1,247.7 million in 2019 compared to $1,065.8 million in 2018, mainly due to an increase of $178.6 million in current year attritional losses, related to the impact of the increase in premiums earned and $35.8 million less of favorable development on prior years attritional losses. These impacts were partially offset by a decrease of $39.1 million in current year catastrophe losses. The
current year catastrophe losses of $4.0 million in 2019 are outlined above. The $43.1 million of current year catastrophe losses in 2018 related primarily to Hurricane Michael ($24.0 million), Hurricane Florence ($9.5 million), the U.S. winter storms ($7.1 million), other 2018 California wildfires ($1.5 million) and Australia hailstorm ($1.0 million).
Segment Expenses. Commission and brokerage increased by 5.7% to $320.9 million in 2020 compared to $303.5 million in 2019. The increase in 2019 was mainly due to the impact of the increase in premiums earned. Segment other underwriting expenses increased to $335.5 million in 2020 compared to $280.1 million in 2019. The increase was mainly due to the impact of the increase in premiums earned and increased expenses related to the continued build out of the insurance business.
Commission and brokerage increased by 13.5% to $303.5 million in 2019 compared to $267.4 million in 2018. The increase in 2019 was mainly due to the impact of the increase in premiums earned. Segment other underwriting expenses increased to $280.1 million in 2019 compared to $228.7 million in 2018. The increase was mainly due to the impact of the increase in premiums earned and increased expenses related to the continued build out of the insurance business.
Critical Accounting Policies
The following is a summary of the critical accounting policies related to accounting estimates that (1) require management to make assumptions about highly uncertain matters and (2) could materially impact the consolidated financial statements if management made different assumptions.
Loss and LAE Reserves. Our most critical accounting policy is the determination of our loss and LAE reserves. We maintain reserves equal to our estimated ultimate liability for losses and LAE for reported and unreported claims for our insurance and reinsurance businesses. Because reserves are based on estimates of ultimate losses and LAE by underwriting or accident year, we use a variety of statistical and actuarial techniques to monitor reserve adequacy over time, evaluate new information as it becomes known and adjust reserves whenever an adjustment appears warranted. We consider many factors when setting reserves including: (1) our exposure base and projected ultimate premiums earned; (2) our expected loss ratios by product and class of business, which are developed collaboratively by underwriters and actuaries; (3) actuarial methodologies and assumptions which analyze our loss reporting and payment experience, reports from ceding companies and historical trends, such as reserving patterns, loss payments and product mix; (4) current legal interpretations of coverage and liability; and (5) economic conditions. Our insurance and reinsurance loss and LAE reserves represent management’s best estimate of our ultimate liability. Actual losses and LAE ultimately paid may deviate, perhaps substantially, from such reserves. Our net income (loss) will be impacted in a period in which the change in estimated ultimate losses and LAE is recorded. See also ITEM 8, “Financial Statements and Supplementary Data” - Note 1 of Notes to the Consolidated Financial Statements.
It is more difficult to accurately estimate loss reserves for reinsurance liabilities than for insurance liabilities. At December 31, 2020, we had reinsurance reserves of $12,034.2 million, of which $217.7 million were loss reserves for A&E liabilities, and insurance loss reserves of $4,364.8 million. A detailed discussion of additional considerations related to A&E exposures follows later in this section.
The detailed data required to evaluate ultimate losses for our insurance business is accumulated from our underwriting and claim systems. Reserving for reinsurance requires evaluation of loss information received from ceding companies. Ceding companies report losses to us in many forms dependent on the type of contract and the agreed or contractual reporting requirements. Generally, proportional/quota share contracts require the submission of a monthly/quarterly account, which includes premium and loss activity for the period with corresponding reserves as established by the ceding company. This information is recorded into our records. For certain proportional contracts, we may require a detailed loss report for claims that exceed a certain dollar threshold or relate to a particular type of loss. Excess of loss and facultative contracts generally require individual loss reporting with precautionary notices provided when a loss reaches a significant
percentage of the attachment point of the contract or when certain causes of loss or types of injury occur. Our experienced claims staff handles individual loss reports and supporting claim information. Based on our evaluation of a claim, we may establish additional case reserves (ACRs) in addition to the case reserves reported by the ceding company. To ensure ceding companies are submitting required and accurate data, the Underwriting, Claim, Reinsurance Accounting and Internal Audit departments of the Company perform various reviews of our ceding companies, particularly larger ceding companies, including on-site audits.
We sort both our reinsurance and insurance reserves into exposure groupings for actuarial analysis. We assign our business to exposure groupings so that the underlying exposures have reasonably homogeneous loss development characteristics and are large enough to facilitate credible estimation of ultimate losses. We periodically review our exposure groupings and we may change our groupings over time as our business changes. We currently use over 200 exposure groupings to develop our reserve estimates. One of the key selection characteristics for the exposure groupings is the historical duration of the claims settlement process. Business in which claims are reported and settled relatively quickly are commonly referred to as short tail lines, principally property lines. On the other hand, casualty claims tend to take longer to be reported and settled and casualty lines are generally referred to as long tail lines. Our estimates of ultimate losses for shorter tail lines, with the exception of loss estimates for large catastrophic events, generally exhibit less volatility than those for the longer tail lines.
We use similar actuarial methodologies, such as expected loss ratio, chain ladder reserving methods and Borhuetter Ferguson, supplemented by judgment where appropriate, to estimate our ultimate losses and LAE for each exposure group. Although we use similar actuarial methodologies for both short tail and long tail lines, the faster reporting of experience for the short tail lines allows us to have greater confidence in our estimates of ultimate losses for short tail lines at an earlier stage than for long tail lines. As a result, we utilize, as well, exposure-based methods to estimate our ultimate losses for longer tail lines, especially for immature accident years. For both short and long tail lines, we supplement these general approaches with analytically based judgments. We cannot estimate losses from widespread catastrophic events, such as hurricanes and earthquakes, using traditional actuarial methods. We estimate losses for these types of events based on information derived from catastrophe models, quantitative and qualitative exposure analyses, reports and communications from ceding companies and development patterns for historically similar events. Due to the inherent uncertainty in estimating such losses, these estimates are subject to variability, which increases with the severity and complexity of the underlying event.
Our key actuarial assumptions contain no explicit provisions for reserve uncertainty nor do we supplement the actuarially determined reserves for uncertainty.
Our carried reserves at each reporting date are management’s best estimate of ultimate unpaid losses and LAE at that date. We complete detailed reserve studies for each exposure group annually for our reinsurance and insurance operations. The completed annual reinsurance reserve studies are “rolled forward” for each accounting period until the subsequent reserve study is completed. Analyzing the roll-forward process involves comparing actual reported losses to expected losses based on the most recent reserve study. We analyze significant variances between actual and expected losses and also consider recent market, underwriting and management criteria to determine management’s best estimate of ultimate unpaid losses and LAE. As a result of these additional factors, in some instances the selected reserve level may be higher or lower than the actuarial indicated estimate.
Given the inherent variability in our loss reserves, we have developed an estimated range of possible gross reserve levels. A table of ranges by segment, accompanied by commentary on potential and historical variability, is included in “Financial Condition - Loss and LAE Reserves”. The ranges are statistically developed using the exposure groups used in the reserve estimation process and aggregated to the segment level. For each exposure group, our actuaries calculate a range for each accident year based principally on two variables. The first is the historical changes in losses and LAE incurred but not reported (“IBNR”) for each accident year over time; the second is volatility of each accident year’s held reserves related to estimated ultimate losses, also
over time. Both are measured at various ages from the end of the accident year through the final payout of the year’s losses. Ranges are developed for the exposure groups using statistical methods to adjust for diversification; the ranges for the exposure groups are aggregated to the segment level, likewise, with an adjustment for diversification. Our estimates of our reserve variability may not be comparable to those of other companies because there are no consistently applied actuarial or accounting standards governing such presentations. Our recorded reserves reflect our best point estimate of our liabilities and our actuarial methodologies focus on developing such point estimates. We calculate the ranges subsequently, based on the historical variability of such reserves.
Asbestos and Environmental Exposures. We continue to receive claims under expired insurance and reinsurance contracts asserting injuries and/or damages relating to or resulting from environmental pollution and hazardous substances, including asbestos. Environmental claims typically assert liability for (a) the mitigation or remediation of environmental contamination or (b) bodily injury or property damage caused by the release of hazardous substances into the land, air or water. Asbestos claims typically assert liability for bodily injury from exposure to asbestos or for property damage resulting from asbestos or products containing asbestos.
Our reserves include an estimate of our ultimate liability for A&E claims. Our A&E liabilities emanate from Everest Re’s assumed reinsurance business. Liabilities related to Mt. McKinley’s direct business, which had been ceded to Bermuda Re previously, were retroceded to an affiliate of Clearwater Insurance Company in 2015, concurrent with the sale of Mt. McKinley to Clearwater Insurance Company. There are significant uncertainties surrounding our estimates of our potential losses from A&E claims. Among the uncertainties are: (a) potentially long waiting periods between exposure and manifestation of any bodily injury or property damage; (b) difficulty in identifying sources of asbestos or environmental contamination; (c) difficulty in properly allocating responsibility and/or liability for asbestos or environmental damage; (d) changes in underlying laws and judicial interpretation of those laws; (e) the potential for an asbestos or environmental claim to involve many insurance providers over many policy periods; (f) questions concerning interpretation and application of insurance and reinsurance coverage; and (g) uncertainty regarding the number and identity of insureds with potential asbestos or environmental exposure.
Due to the uncertainties discussed above, the ultimate losses attributable to A&E, and particularly asbestos, may be subject to more variability than are non-A&E reserves and such variation could have a material adverse effect on our financial condition, results of operations and/or cash flows. See also ITEM 8, “Financial Statements and Supplementary Data” - Notes 1 and 3 of Notes to the Consolidated Financial Statements.
Reinsurance Receivables. We have purchased reinsurance to reduce our exposure to adverse claim experience, large claims and catastrophic loss occurrences. Our ceded reinsurance provides for recovery from reinsurers of a portion of losses and loss expenses under certain circumstances. Such reinsurance does not relieve us of our obligation to our policyholders. In the event our reinsurers are unable to meet their obligations under these agreements or are able to successfully challenge losses ceded by us under the contracts, we will not be able to realize the full value of the reinsurance receivable balance. In some cases, we may hold full or partial collateral for the receivable, including letters of credit, trust assets and cash. Additionally, creditworthy foreign reinsurers of business written in the U.S., as well as capital markets’ reinsurance mechanisms, are generally required to secure their obligations. We have established reserves for uncollectible balances based on our assessment of the collectability of the outstanding balances. The allowance for uncollectible reinsurance reflects management’s best estimate of reinsurance cessions that may be uncollectible in the future due to reinsurers’ unwillingness or inability to pay. The allowance for uncollectible reinsurance comprises an allowance and an allowance for disputed balances. Based on this analysis, the Company may adjust the allowance for uncollectible reinsurance or charge off reinsurer balances that are determined to be uncollectible.
The allowance is estimated as the amount of reinsurance receivable exposed to loss multiplied by estimated factors for the probability of default. The probability of default is assigned based on each reinsurer's credit rating, or a rating is estimated if no external rating is available. Credit ratings are reviewed and updated at least
annually. The probability of default factors are historical insurer and reinsurer defaults for liabilities with similar durations to the reinsured liabilities as estimated through multiple economic cycles. Credit ratings are forward-looking and consider a variety of economic outcomes. The Company's evaluation of the required allowance for reinsurance receivable considers the current economic environment as well as macroeconomic scenarios.
As of December 31, 2020, and 2019, the reserve for uncollectible balances was $17.2 million and $15.0 million, respectively. Actual uncollectible amounts may vary, perhaps substantially, from such reserves, impacting income (loss) in the period in which the change in reserves is made. See also ITEM 8, “Financial Statements and Supplementary Data” - Note 11 of Notes to the Consolidated Financial Statements and “Financial Condition – Reinsurance Receivables” below.
Premiums Written and Earned. Premiums written by us are earned ratably over the coverage periods of the related insurance and reinsurance contracts. We establish unearned premium reserves to cover the unexpired portion of each contract. Such reserves, for assumed reinsurance, are computed using pro rata methods based on statistical data received from ceding companies. Premiums earned, and the related costs, which have not yet been reported to us, are estimated and accrued. Because of the inherent lag in the reporting of written and earned premiums by our ceding companies, we use standard accepted actuarial methodologies to estimate earned but not reported premium at each financial reporting date. These earned but not reported premiums are combined with reported earned premiums to comprise our total premiums earned for determination of our incurred losses and loss and LAE reserves. Commission expense and incurred losses related to the change in earned but not reported premium are included in current period company and segment financial results. See also ITEM 8, “Financial Statements and Supplementary Data” - Note 1 of Notes to the Consolidated Financial Statements.
The following table displays the estimated components of net earned but not reported premiums by segment for the periods indicated.
| At December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | 2020 | 2019 | 2018 | |||||
| Reinsurance | $ | 1,774.4 | $ | 1,424.5 | $ | 1,362.9 | ||
| Insurance | — | — | — | |||||
| Total | $ | 1,774.4 | $ | 1,424.5 | $ | 1,362.9 | ||
| (Some amounts may not reconcile due to rounding.) |
Investment Valuation. Our fixed income investments are classified for accounting purposes as available for sale and are carried at market value or fair value in our consolidated balance sheets. Our equity securities are all carried at fair value, as of January 1, 2018, due to the adoption of ASU 2016-01. Most securities we own are traded on national exchanges where market values are readily available. Some of our commercial mortgage-backed securities (“CMBS”) are valued using cash flow models and risk-adjusted discount rates. We hold some privately placed securities, less than 7% of the portfolio, that are either valued by investment advisors or the Company. In some instances, values provided by an investment advisor are supported with opinions from qualified independent third parties. The Company has procedures in place to review the values received from its investment advisors. At December 31, 2020 and 2019, our investment portfolio included $1,764.5 million and $1,510.6 million, respectively, of limited partnership investments whose values are reported pursuant to the equity method of accounting. We carry these investments at values provided by the managements of the limited partnerships and due to inherent reporting lags, the carrying values are based on values with “as of” dates from one month to one quarter prior to our financial statement date.
At December 31, 2020, we had unrealized gains, net of tax, of $724.2 million compared to unrealized gains, net of tax, of $304.4 million at December 31, 2019. Gains and losses from market fluctuations for investments held at market value are reflected as comprehensive income (loss) in the consolidated balance sheets. Gains and losses from market fluctuations for investments held at fair value are reflected as net realized capital gains and
losses in the consolidated statements of operations and comprehensive income (loss). Market value declines for the fixed income portfolio, which are considered credit related, are reflected in our consolidated statements of operations and comprehensive income (loss), as realized capital losses. We consider many factors when determining whether a market value decline is credit related, including: (1) we have no intent to sell and, more likely than not, will not be required to sell prior to recovery, (2) the length of time the market value has been below book value, (3) the credit strength of the issuer, (4) the issuer’s market sector, (5) the length of time to maturity and (6) for asset-backed securities, changes in prepayments, credit enhancements and underlying default rates. If management’s assessments change in the future, we may ultimately record a realized loss after management originally concluded that the decline in value was temporary. See also ITEM 8, “Financial Statements and Supplementary Data” - Note 1 of Notes to the Consolidated Financial Statements.
Financial Condition
Cash and Invested Assets. Aggregate invested assets, including cash and short-term investments, were $25,461.6 million at December 31, 2020, an increase of $4,713.1 million compared to $20,748.5 million at December 31, 2019. This increase was primarily the result of $2,873.6 million of cash flows from operations, $979.4 million of proceeds from the issuance of senior notes, $465.2 million of pre-tax unrealized appreciation, $310.0 million of proceeds from Federal Home Loan Bank (“FHLB”) borrowings, $239.9 million in fair value re-measurements, $194.6 million of unsettled securities, $180.0 million due to fluctuations in foreign currencies and $103.8 million in equity adjustments of our limited partnership investments, partially offset by $249.1 million paid out in dividends to shareholders and repurchases of 1.0 million common shares for $200.0 million.
Our principal investment objectives are to ensure funds are available to meet our insurance and reinsurance obligations and to maximize after-tax investment income while maintaining a high quality diversified investment portfolio. Considering these objectives, we view our investment portfolio as having two components: 1) the investments needed to satisfy outstanding liabilities (our core fixed maturities portfolio) and 2) investments funded by our shareholders’ equity.
For the portion needed to satisfy global outstanding liabilities, we generally invest in fixed maturities with an average credit quality of Aa3. This global fixed maturity securities portfolio is externally managed by independent, professional investment managers using portfolio guidelines approved by internal management.
Over the past several years, we have expanded the allocation of our investments funded by shareholders’ equity to include: 1) a greater percentage of publicly traded equity securities, 2) emerging market fixed maturities through mutual fund structures, as well as individual holdings, 3) high yield fixed maturities, 4) bank and private loan securities and 5) private equity limited partnership investments. The objective of this portfolio diversification is to enhance the risk-adjusted total return of the investment portfolio by allocating a prudent portion of the portfolio to higher return asset classes. We limit our allocation to these asset classes because of 1) the potential for volatility in their values and 2) the impact of these investments on regulatory and rating agency capital adequacy models. We use investment managers experienced in these markets and adjust our allocation to these investments based upon market conditions. At December 31, 2020, the market value of investments in these investment market sectors, carried at both market and fair value, approximated 76% of shareholders’ equity.
The Company’s limited partnership investments are comprised of limited partnerships that invest in private equities. Generally, the limited partnerships are reported on a quarter lag. We receive annual audited financial statements for all of the limited partnerships which are prepared using fair value accounting in accordance with FASB guidance. For the quarterly reports, the Company’s staff performs reviews of the financial reports for any unusual changes in carrying value. If the Company becomes aware of a significant decline in value during the lag reporting period, the loss will be recorded in the period in which the Company identifies the decline.
The tables below summarize the composition and characteristics of our investment portfolio as of the dates indicated.
| At December 31, | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | 2020 | 2019 | |||||||||
| Fixed maturities, market value | $ | 20,040.2 | 78.7% | $ | 16,824.9 | 81.1% | |||||
| Fixed maturities, fair value | — | —% | 5.8 | - | |||||||
| Equity securities, fair value | 1,472.2 | 5.8% | 931.5 | 4.5% | |||||||
| Short-term investments | 1,135.0 | 4.5% | 414.7 | 2.0% | |||||||
| Other invested assets | 2,012.6 | 7.9% | 1,763.5 | 8.5% | |||||||
| Cash | 801.7 | 3.1% | 808.0 | 3.9% | |||||||
| Total investments and cash | $ | 25,461.6 | 100.0% | $ | 20,748.5 | 100.0% | |||||
| (Some amounts may not reconcile due to rounding.) |
| At December 31, | ||||
|---|---|---|---|---|
| 2020 | 2019 | |||
| Fixed income portfolio duration (years) | 3.6 | 3.5 | ||
| Fixed income composite credit quality | Aa3 | A1 | ||
| Imbedded end of period yield, pre-tax | 3.0% | 3.4% | ||
| Imbedded end of period yield, after-tax | 2.6% | 3.0% |
Reinsurance Receivables.
Reinsurance receivables for both paid and recoverable on unpaid losses totaled $1,994.6 million at December 31, 2020 and $1,763.5 million at December 31, 2019. At December 31, 2020, $699.7 million, or 35.1%, was receivable from Mt. Logan Re collateralized segregated accounts and $211.6 million, or 10.6%, was receivable from Munich Re. No other retrocessionaire accounted for more than 5% of our receivables.
Loss and LAE Reserves. Gross loss and LAE reserves totaled $16,399.0 million and $13,611.3 million at December 31, 2020 and 2019, respectively.
The following tables summarize gross outstanding loss and LAE reserves by segment, classified by case reserves and IBNR reserves, for the periods indicated.
| At December 31, 2020 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Case | IBNR | Total | % of | ||||||||
| (Dollars in millions) | Reserves | Reserves | Reserves | Total | |||||||
| Reinsurance | $ | 5,092.7 | $ | 6,723.8 | $ | 11,816.5 | 72.1% | ||||
| Insurance | 1,282.1 | 3,082.6 | 4,364.8 | 26.6% | |||||||
| Total excluding A&E | 6,374.8 | 9,806.4 | 16,181.3 | 98.7% | |||||||
| A&E | 184.0 | 33.8 | 217.7 | 1.3% | |||||||
| Total including A&E | $ | 6,558.8 | $ | 9,840.2 | $ | 16,399.0 | 100.0% | ||||
| (Some amounts may not reconcile due to rounding.) |
| At December 31, 2019 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Case | IBNR | Total | % of | ||||||||
| (Dollars in millions) | Reserves | Reserves | Reserves | Total | |||||||
| Reinsurance | $ | 5,050.5 | $ | 4,839.4 | $ | 9,889.9 | 72.7% | ||||
| Insurance | 1,090.4 | 2,373.2 | 3,463.6 | 25.4% | |||||||
| Total excluding A&E | 6,140.9 | 7,212.5 | 13,353.4 | 98.1% | |||||||
| A&E | 203.4 | 54.5 | 257.9 | 1.9% | |||||||
| Total including A&E | $ | 6,344.3 | $ | 7,267.0 | $ | 13,611.3 | 100.0% | ||||
| (Some amounts may not reconcile due to rounding.) |
Changes in premiums earned and business mix, reserve re-estimations, catastrophe losses and changes in catastrophe loss reserves and claim settlement activity all impact loss and LAE reserves by segment and in total.
Our loss and LAE reserves represent management’s best estimate of our ultimate liability for unpaid claims. We continuously re-evaluate our reserves, including re-estimates of prior period reserves, taking into consideration all available information and, in particular, newly reported loss and claim experience. Changes in reserves resulting from such re-evaluations are reflected in incurred losses in the period when the re-evaluation is made. Our analytical methods and processes operate at multiple levels including individual contracts, groupings of like contracts, classes and lines of business, internal business units, segments, legal entities, and in the aggregate. In order to set appropriate reserves, we make qualitative and quantitative analyses and judgments at these various levels. Additionally, the attribution of reserves, changes in reserves and incurred losses among accident years requires qualitative and quantitative adjustments and allocations at these various levels. We utilize actuarial science, business expertise and management judgment in a manner intended to ensure the accuracy and consistency of our reserving practices. Nevertheless, our reserves are estimates, which are subject to variation, which may be significant.
There can be no assurance that reserves for, and losses from, claim obligations will not increase in the future, possibly by a material amount. However, we believe that our existing reserves and reserving methodologies lessen the probability that any such increase would have a material adverse effect on our financial condition, results of operations or cash flows.
We have included ranges for loss reserve estimates determined by our actuaries, which have been developed through a combination of objective and subjective criteria. Our presentation of this information may not be directly comparable to similar presentations of other companies as there are no consistently applied actuarial or accounting standards governing such presentations. Our recorded reserves are an aggregation of our best point estimates for approximately 200 reserve groups and reflect our best point estimate of our liabilities. Our actuarial methodologies develop point estimates rather than ranges and the ranges are developed subsequently based upon historical and prospective variability measures.
The following table below represents the reserve levels and ranges for each of our business segments for the period indicated.
| Outstanding Reserves and Ranges By Segment (1) | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| At December 31, 2020 | ||||||||||||||
| As | Low | Low | High | High | ||||||||||
| (Dollars in millions) | Reported | Range % (2) | Range (2) | Range % (2) | Range (2) | |||||||||
| Gross Reserves By Segment | ||||||||||||||
| Reinsurance | $ | 11,816.5 | -11.9% | $ | 10,408.1 | 11.9% | $ | 13,224.9 | ||||||
| Insurance | 4,364.8 | -13.7% | 3,765.4 | 13.7% | 4,964.1 | |||||||||
| Total Gross Reserves (excluding A&E) | 16,181.3 | -11.0% | 14,409.2 | 11.0% | 17,953.3 | |||||||||
| A&E (All Segments) | 217.7 | -13.7% | 187.9 | 13.7% | 247.6 | |||||||||
| Total Gross Reserves | $ | 16,399.0 | -10.9% | 14,613.4 | 10.9% | 18,184.6 | ||||||||
| (Some amounts may not reconcile due to rounding.) |
(1) There can be no assurance that reserves will not ultimately exceed the indicated ranges requiring additional income (loss) statement expense.
(2) Although totals are displayed for both the low and high range amounts, it should be noted that statistically the range of the total is not equal to the sum of the ranges of the segments.
Depending on the specific segment, the range derived for the loss reserves, excluding reserves for A&E exposures, ranges from minus 11.9% to minus 13.7% for the low range and from plus 11.9% to plus 13.7% for the high range. Both the higher and lower ranges are associated with the Insurance segment. The size of the range is dependent upon the level of confidence associated with the outcome. Within each range, management’s best estimate of loss reserves is based upon the point estimate derived by our actuaries in detailed reserve studies. Such ranges are necessarily subjective due to the lack of generally accepted actuarial standards with respect to their development. For the above presentation, we have assumed what we believe is a reasonable confidence level but note that there can be no assurance that our claim obligations will not vary outside of these ranges
Additional losses, including those relating to latent injuries, and other exposures, which are as yet unrecognized, the type or magnitude of which cannot be foreseen by us or the reinsurance and insurance industry generally, may emerge in the future. Such future emergence, to the extent not covered by existing retrocessional contracts, could have material adverse effects on our future financial condition, results of operations and cash flows.
Asbestos and Environmental Exposures. A&E exposures represent a separate exposure group for monitoring and evaluating reserve adequacy. The following table summarizes the outstanding loss reserves with respect to A&E reserves on both a gross and net of retrocessions basis for the periods indicated.
| Years Ended December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | 2020 | 2019 | 2018 | |||||
| Gross reserves | $ | 219.3 | $ | 257.9 | $ | 347.5 | ||
| Reinsurance receivable | (21.1) | (29.2) | (86.0) | |||||
| Net reserves | $ | 198.3 | $ | 228.7 | $ | 261.5 | ||
| (Some amounts may not reconcile due to rounding.) |
With respect to asbestos only, at December 31, 2020, we had net asbestos loss reserves of $194.1 million, or 97.9%, of total net A&E reserves, all of which was for assumed business.
In 2015, we sold Mt. McKinley to Clearwater Insurance Company. Concurrently with the closing, we entered into a retrocession treaty with an affiliate of Clearwater. Per the retrocession treaty, we retroceded 100% of the liabilities associated with certain Mt. McKinley policies, which had been reinsured by Bermuda Re. As
consideration for entering into the retrocession treaty, Bermuda Re transferred cash of $140.3 million, an amount equal to the net loss reserves as of the closing date. Of the $140.3 million of net loss reserves retroceded, $100.5 million were related to A&E business. The maximum liability retroceded under the retrocession treaty will be $440.3 million, equal to the retrocession payment plus $300.0 million. We will retain liability for any amounts exceeding the maximum liability retroceded under the retrocession treaty.
On December 20, 2019, the retrocession treaty was amended and included a partial commutation. As a result of this amendment and partial commutation, gross A&E reserves and correspondingly reinsurance receivable were reduced by $43.4 million. In addition, the maximum liability permitted to be retroceded increased to $450.3 million.
Ultimate loss projections for A&E liabilities cannot be accomplished using standard actuarial techniques. We believe that our A&E reserves represent management’s best estimate of the ultimate liability; however, there can be no assurance that ultimate loss payments will not exceed such reserves, perhaps by a significant amount.
Industry analysts use the “survival ratio” to compare the A&E reserves among companies with such liabilities. The survival ratio is typically calculated by dividing a company’s current net reserves by the three year average of annual paid losses. Hence, the survival ratio equals the number of years that it would take to exhaust the current reserves if future loss payments were to continue at historical levels. Using this measurement, our net three year asbestos survival ratio was 5.2 years at December 31, 2020. These metrics can be skewed by individual large settlements occurring in the prior three years and therefore, may not be indicative of the timing of future payments.
Shareholders’ Equity. Our shareholders’ equity increased to $9,726.2 million as of December 31, 2020 from $9,132.9 million as of December 31, 2019. This increase was the result of $514.2 million of net income, $419.7 million of unrealized appreciation on investments net of tax, $86.3 million of net foreign currency translation adjustments, $25.6 million of share-based compensation transactions and $0.7 million of net benefit plan obligation adjustments, net of tax, partially offset by $249.1 million of shareholder dividends, the repurchase of 970,892 common shares for $200.0 million and $4.2 million of cumulative adjustment from the adoption of ASU 2016-13.
Our shareholders’ equity increased to $9,132.9 million as of December 31, 2019 from $7,860.8 million as of December 31, 2018. This increase was the result of $1,009.5 million of net income, $483.8 million of unrealized appreciation on investments net of tax, $30.9 million of share-based compensation transactions and $14.0 million of net foreign currency translation adjustments, partially offset by $234.3 million of shareholder dividends, the repurchase of 114,633 common shares for $24.6 million and $7.1 million of net benefit plan obligation adjustments, net of tax.
Liquidity and Capital Resources
Capital. Shareholders’ equity at December 31, 2020 and December 31, 2019 was $9,726.2 million and $9,132.9 million, respectively. Management’s objective in managing capital is to ensure its overall capital level, as well as the capital levels of its operating subsidiaries, exceed the amounts required by regulators, the amount needed to support our current financial strength ratings from rating agencies and our own economic capital models. The Company’s capital has historically exceeded these benchmark levels.
Our two main operating companies Bermuda Re and Everest Re are regulated by the Bermuda Monetary Authority (“BMA”) and the State of Delaware, Department of Insurance, respectively. Both regulatory bodies have their own capital adequacy models based on statutory capital as opposed to GAAP basis equity. Failure to meet the required statutory capital levels could result in various regulatory restrictions, including business activity and the payment of dividends to their parent companies.
The regulatory targeted capital and the actual statutory capital for Bermuda Re and Everest Re were as follows:
| Bermuda Re (1) | Everest Re (2) | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| At December 31, | At December 31, | |||||||||||
| (Dollars in millions) | 2020 (3) | 2019 (3) | 2020 | 2019 | ||||||||
| Regulatory targeted capital | $ | - | $ | 2,061.1 | $ | 2,489.8 | $ | 2,001.2 | ||||
| Actual capital | $ | 2,944.5 | $ | 3,197.4 | $ | 5,276.0 | $ | 3,739.1 |
(1) Regulatory targeted capital represents the target capital level from the applicable year's BSCR calculation.
(2) Regulatory targeted capital represents 200% of the RBC authorized control level calculation for the applicable year.
(3) The 2020 BSCR calculation is not yet due to be completed; however, the Company anticipates that Bermuda Re's December 31, 2020 actual capital will exceed the targeted capital level.
Our financial strength ratings as determined by A.M. Best, Standard & Poor’s and Moody’s are important as they provide our customers and investors with an independent assessment of our financial strength using a rating scale that provides for relative comparisons. We continue to possess significant financial flexibility and access to debt and equity markets as a result of our financial strength, as evidenced by the financial strength ratings as assigned by independent rating agencies. See also ITEM 1, Business – “Financial Strength Ratings”.
We maintain our own economic capital models to monitor and project our overall capital, as well as, the capital at our operating subsidiaries. A key input to the economic models is projected income and this input is continually compared to actual results, which may require a change in the capital strategy.
In 2020, we repurchased 970,892 shares for $200.0 million in the open market and paid $249.1 million in dividends to adjust our capital position and enhance long term expected returns to our shareholders. During 2019, we repurchased 114,633 shares for $24.6 million in the open market and paid $234.3 million in dividends. We may at times enter into a Rule 10b5-1 repurchase plan agreement to facilitate the repurchase of shares. On May 22, 2020, our existing Board authorization to purchase up to 30 million of our shares was amended to authorize the purchase of up to 32 million shares. As of December 31, 2020, we had repurchased 29.6 million shares under this authorization.
We also repurchased $13.2 million of our long-term subordinated notes in 2020. We recognized a realized gain of $2.5 million on the repurchase. We may continue, from time to time, to seek to retire portions of our outstanding debt securities through cash repurchases, in open-market purchases, privately negotiated transactions or otherwise. Such repurchases, if any, will be subject to and depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved in any such transactions, individually or in the aggregate, may be material.
On October 7, 2020, we issued an additional $1,000.0 million of 30 year senior notes with an interest coupon rate of 3.5%. These senior notes will mature on October 15, 2050 and will pay interest semi-annually.
Liquidity. Our liquidity requirements are generally met from positive cash flow from operations. Positive cash flow results from reinsurance and insurance premiums being collected prior to disbursements for claims, which disbursements generally take place over an extended period after the collection of premiums, sometimes a period of many years. Collected premiums are generally invested, prior to their use in such disbursements, and investment income provides additional funding for loss payments. Our net cash flows from operating activities were $2,873.6 million, $1,852.0 million and $610.1 million for the years ended December 31, 2020, 2019 and 2018, respectively. Additionally, these cash flows reflected net tax recoveries of $169.7 million, $148.6 million and $65.1 million in for the years ended December 31, 2020, 2019 and 2018, respectively, as well as net catastrophe loss payments of $661.5 million, $868.8 million, and $1,125.9 million for the years ended December 31, 2020, 2019 and 2018, respectively.
If disbursements for claims and benefits, policy acquisition costs and other operating expenses were to exceed premium inflows, cash flow from reinsurance and insurance operations would be negative. The effect on cash
flow from insurance operations would be partially offset by cash flow from investment income. Additionally, cash inflows from investment maturities and dispositions, both short-term investments and longer term maturities are available to supplement other operating cash flows.
As the timing of payments for claims and benefits cannot be predicted with certainty, we maintain portfolios of long term invested assets with varying maturities, along with short-term investments that provide additional liquidity for payment of claims. At December 31, 2020 and December 31, 2019, we held cash and short-term investments of $1,936.6 million and $1,222.7 million, respectively. Our short-term investments are generally readily marketable and can be converted to cash. In addition to these cash and short-term investments, at December 31, 2020, we had $1,374.7 million of available for sale fixed maturity securities maturing within one year or less, $6,774.8 million maturing within one to five years and $6,061.7 million maturing after five years. Our $1,472.2 million of equity securities are comprised primarily of publicly traded securities that can be easily liquidated. We believe that these fixed maturity and equity securities, in conjunction with the short-term investments and positive cash flow from operations, provide ample sources of liquidity for the expected payment of losses in the near future. We do not anticipate selling a significant amount of securities or using available credit facilities to pay losses and LAE but have the ability to do so. Sales of securities might result in realized capital gains or losses. At December 31, 2020 we had $816.9 million of net pre-tax unrealized appreciation related to fixed maturity securities, comprised of $941.7 million of pre-tax unrealized appreciation and $124.8 million of pre-tax unrealized depreciation.
Management generally expects annual positive cash flow from operations, which reflects the strength of overall pricing. However, given the recent set of catastrophic events, cash flow from operations may decline and could become negative in the near term as significant claim payments are made related to the catastrophes. However, as indicated above, the Company has ample liquidity to settle its catastrophe claims.
In addition to our cash flows from operations and liquid investments, we also have multiple credit facilities that provide up to $200.0 million of unsecured revolving credit for liquidity and letters of credit but more importantly provide for up to $600.0 million and £52.2 million of collateralized standby letters of credit to support business written by our Bermuda operating subsidiaries.
Effective May 26, 2016, Group, Bermuda Re and Everest International entered into a five year, $800.0 million senior credit facility with a syndicate of lenders, which amended and restated in its entirety the June 22, 2012, four year, $800.0 million senior credit facility. Both the May 26, 2016 and June 22, 2012 senior credit facilities, which have similar terms, are referred to as the “Group Credit Facility”. Wells Fargo Corporation (“Wells Fargo Bank”) is the administrative agent for the Group Credit Facility, which consists of two tranches. Tranche one provides up to $200.0 million of unsecured revolving credit for liquidity and general corporate purposes, and for the issuance of unsecured standby letters of credit. The interest on the revolving loans shall, at the Company’s option, be either (1) the Base Rate (as defined below) or (2) an adjusted London Interbank Offered Rate (“LIBOR”) plus a margin. The Base Rate is the higher of (a) the prime commercial lending rate established by Wells Fargo Bank, (b) the Federal Funds Rate plus 0.5% per annum or (c) the one month LIBOR Rate plus 1.0% per annum. The amount of margin and the fees payable for the Group Credit Facility depends on Group’s senior unsecured debt rating. Tranche two exclusively provides up to $600.0 million for the issuance of standby letters of credit on a collateralized basis.
The Group Credit Facility requires Group to maintain a debt to capital ratio of not greater than 0.35 to 1 and to maintain a minimum net worth. Minimum net worth is an amount equal to the sum of $5,371.0 million plus 25% of consolidated net income for each of Group’s fiscal quarters, for which statements are available ending on or after March 31, 2016 and for which consolidated net income is positive, plus 25% of any increase in consolidated net worth during such period attributable to the issuance of ordinary and preferred shares, which at December 31, 2020, was $6,391.0 million. As of December 31, 2020, the Company was in compliance with all Group Credit Facility covenants.
At December 31, 2020 and 2019, the Company had no outstanding short-term borrowings from the Group Credit Facility revolving credit line. At December 31, 2020, the Group Credit Facility had $164.2 million outstanding letters of credit under tranche one and $589.7 million outstanding letters of credit under tranche two. At December 31, 2019, the Group Credit Facility had $33.7 million outstanding letters of credit under tranche one and $589.7 million outstanding letters of credit under tranche two.
Effective May 12, 2020, Everest International amended its credit facility with Lloyds Bank plc (“Everest International Credit Facility”). The current amendment of the Everest International Credit Facility provides up to £52.2 million for the issuance of standby letters of credit on a collateralized basis. The Company pays a commitment fee of 0.1% per annum on the average daily amount of the remainder of (1) the aggregate amount available under the facility and (2) the aggregate amount of drawings outstanding under the facility. The Company pays a credit commission fee of 0.35% per annum on drawings outstanding under the facility.
The Everest International Credit Facility requires Group to maintain a debt to capital ratio of not greater than 0.35 to 1 and to maintain a minimum net worth. Minimum net worth is an amount equal to the sum of $6,393.0 million (70% of consolidated net worth as of December 31, 2019), plus 25% of consolidated net income for each of Group’s fiscal quarters, for which statements are available ending on or after January 1, 2020 and for which net income is positive, plus 25% of any increase in consolidated net worth of Group during such period attributable to the issuance of ordinary and preferred shares, which at December 31, 2020, was $6,528.0 million. As of December 31, 2020, the Company was in compliance with all Everest International Credit Facility requirements.
At December 31, 2020 and 2019, Everest International Credit Facility had £52.2 million and £47.0 outstanding letters of credit, respectively.
Costs incurred in connection with the Group Credit Facility and Everest International Credit Facility were $0.8 million and $0.4 million for December 31, 2020 and 2019, respectively.
Effective August 15, 2019, Everest Re became a member of the Federal Home Loan Banks (“FHLB”) organization, which allows Everest Re to borrow up to 10% of its statutory admitted assets. As of December 31, 2020, Everest Re had admitted assets of approximately $16,840.7 million which provides borrowing capacity of up to approximately $1,684.1 million. As of December 31, 2020, Everest Re had $310.0 million of outstanding borrowings through its FHLB borrowing capacity. The $310.0 million of collateralized borrowings have interest payable at a rate of 0.35%.
Exposure to Catastrophes. Like other insurance and reinsurance companies, we are exposed to multiple insured losses arising out of a single occurrence, whether a natural event, such as a hurricane or an earthquake, or other catastrophe, such as an explosion at a major factory. A large catastrophic event can be expected to generate insured losses to multiple reinsurance treaties, facultative certificates and direct insurance policies across various lines of business.
We focus on potential losses that could result from any single event, or series of events as part of our evaluation and monitoring of our aggregate exposures to catastrophic events. Accordingly, we employ various techniques to estimate the amount of loss we could sustain from any single catastrophic event or series of events in various geographic areas. These techniques range from deterministic approaches, such as tracking aggregate limits exposed in catastrophe-prone zones and applying reasonable damage factors, to modeled approaches that attempt to scientifically measure catastrophe loss exposure using sophisticated Monte Carlo simulation techniques that forecast frequency and severity of potential losses on a probabilistic basis.
No single computer model or group of models is currently capable of projecting the amount and probability of loss in all global geographic regions in which we conduct business. In addition, the form, quality and granularity of underwriting exposure data furnished by (re)insureds is not uniformly compatible with the data requirements for our licensed models, which adds to the inherent imprecision in the potential loss projections. Further, the
results from multiple models and analytical methods must be combined to estimate potential losses by and across business units. Also, while most models have been updated to incorporate claims information from recent catastrophic events, catastrophe model projections are still inherently imprecise. In addition, uncertainties with respect to future climatic patterns and cycles could add further uncertainty to loss projections from models based on historical data.
Nevertheless, when combined with traditional risk management techniques and sound underwriting judgment, catastrophe models are a useful tool for underwriters to price catastrophe exposed risks and for providing management with quantitative analyses with which to monitor and manage catastrophic risk exposures by zone and across zones for individual and multiple events.
Projected catastrophe losses are generally summarized in terms of the PML. We define PML as our anticipated loss, taking into account contract terms and limits, caused by a single catastrophe affecting a broad contiguous geographic area, such as that caused by a hurricane or earthquake. The PML will vary depending upon the modeled simulated losses and the make-up of the in force book of business. The projected severity levels are described in terms of “return periods”, such as “100-year events” and “250-year events”. For example, a 100-year PML is the estimated loss to the current in-force portfolio from a single event which has a 1% probability of being exceeded in a twelve month period. In other words, it corresponds to a 99% probability that the loss from a single event will fall below the indicated PML. It is important to note that PMLs are estimates. Modeled events are hypothetical events produced by a stochastic model. As a result, there can be no assurance that any actual event will align with the modeled event or that actual losses from events similar to the modeled events will not vary materially from the modeled event PML.
From an enterprise risk management perspective, management sets limits on the levels of catastrophe loss exposure we may underwrite. The limits are revised periodically based on a variety of factors, including but not limited to our financial resources and expected earnings and risk/reward analyses of the business being underwritten.
Management estimates that the projected net economic loss from its largest 100-year event in a given zone represents approximately 6.7% of its December 31, 2020 shareholders’ equity. Economic loss is the PML exposure, net of third party reinsurance, reduced by estimated reinstatement premiums to renew coverage and estimated income taxes. The impact of income taxes on the PML depends on the distribution of the losses by corporate entity, which is also affected by inter-affiliate reinsurance. Management also monitors and controls its largest PMLs at multiple points along the loss distribution curve, such as loss amounts at the 20, 50, 100, 250, 500 and 1,000 year return periods. This process enables management to identify and control exposure accumulations and to integrate such exposures into enterprise risk, underwriting and capital management decisions.
Our catastrophe loss projections, segmented by risk zones, are updated quarterly and reviewed as part of a formal risk management review process.
We believe that our greatest worldwide 1 in 100 year exposure to a single catastrophic event is to a wind event affecting the Southeastern United States, where we estimate we have a PML exposure, net of third party reinsurance, of $925 million. See also table under ITEM 1, “Business - Risk Management of Underwriting and Retrocession Arrangements”.
If such a single catastrophe loss were to occur, management estimates that the economic loss to us would be approximately $648.0 million. The estimate involves multiple variables, including which Everest entity would experience the loss, and as a result there can be no assurance that this amount would not be exceeded.
We may purchase reinsurance to cover specific business written or the potential accumulation or aggregation of exposures across some or all of our operations. Reinsurance purchasing decisions consider both the potential coverage and market conditions including the pricing, terms, conditions, availability and collectability of
coverage, with the aim of securing cost effective protection from financially secure counterparts. The amount of reinsurance purchased has varied over time, reflecting our view of our exposures and the cost of reinsurance.
Information Technology. Everest’s information technology is a key component of its business operations. Information technology systems and services are hosted at public and private cloud service providers across multiple datacenters with processing performed at the office locations of our operating subsidiaries and branches. In addition, our mainframe processing is performed by a third-party vendor at a separate location. We have implemented security procedures, and regularly assess and enhance our security protocols, to ensure that our key business systems are protected, secured and backed up at off-site locations so that they can be restored promptly if necessary. We have business continuity plans and disaster recovery plans along with periodic testing of those plans to ensure we are capable of providing uninterrupted technology services in the event of major systems outages with alternative secure datacenters available in case of broader outages.
Our business operations depend on the proper functioning and availability of our information technology platform, which includes data processing and related electronic communications. We communicate electronically internally and externally with our brokers, program managers, clients, third-party vendors, regulators, and others. These communications and the data we handle may include personal, confidential or proprietary information. We ensure that all our systems, data and electronic transmissions are appropriately protected with the latest technology safeguards and meet regulatory standards.
Despite these safeguards, a significant cyber incident, including system failure, security breach and disruption by malware or other damage could interrupt or delay our operations and possibly our results. This type of incident may result in a violation of applicable data security, privacy, or other laws, damage our reputation, cause a loss of customers or give rise to regulatory scrutiny as well as monetary fines and other penalties. Management is not aware of a cybersecurity incident that has had a material impact on our operations.
Contractual Obligations. The following table shows our contractual obligations for the period indicated.
| Payments due by period | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Less than | More than | |||||||||||||
| (Dollars in millions) | Total | 1 year | 1-3 years | 3-5 years | 5 years | |||||||||
| Senior notes | $ | 1,400.0 | $ | — | $ | — | $ | — | $ | 1,400.0 | ||||
| Long term notes | 225.4 | — | — | — | 225.4 | |||||||||
| Interest expense (1) | 1,796.7 | 60.7 | 121.4 | 121.4 | 1,493.3 | |||||||||
| Employee benefit plans | 51.4 | 2.8 | 4.3 | 4.8 | 39.5 | |||||||||
| Operating lease agreements | 220.9 | 18.5 | 41.2 | 36.9 | 124.3 | |||||||||
| Gross reserve for losses and LAE (2) | 16,399.0 | 5,018.8 | 5,181.2 | 2,485.9 | 3,713.1 | |||||||||
| Total | $ | 20,093.5 | $ | 5,100.8 | $ | 5,348.1 | $ | 2,649.0 | $ | 6,995.6 | ||||
| (Some amounts may not reconcile due to rounding.) |
(1) Interest expense on long term notes is calculated at the variable floating rate of 2.6% as of December 31, 2020.
(2) Loss and LAE reserves represent management’s best estimate of losses from claim and related settlement costs. Both the amounts and timing of such payments are estimates, and the inherent variability of resolving claims as well as changes in market conditions make the timing of cash flows uncertain. Therefore, the ultimate amount and timing of loss and LAE payments could differ from our estimates.
The contractual obligations for senior notes and long term notes are the responsibility of Holdings. We have sufficient cash flow, liquidity, investments and access to capital markets to satisfy these obligations. Holdings generally depends upon dividends from Everest Re, its operating insurance subsidiary for its funding, capital contributions from Group or access to the capital markets. Our various operating insurance and reinsurance subsidiaries have sufficient cash flow, liquidity and investments to settle outstanding reserves for losses and LAE. Management believes that we, and each of our entities, have sufficient financial resources or ready access thereto, to meet all obligations.
Dividends.
During 2020, 2019 and 2018, we declared and paid common shareholder dividends of $249.1 million, $234.3 million and $216.2 million, respectively. As an insurance holding company, we are partially dependent on dividends and other permitted payments from our subsidiaries to pay cash dividends to our shareholders. The payment of dividends to Group by Holdings Ireland and Everest Dublin Holdings is subject to Irish corporate and regulatory restrictions; the payment of dividends to Holdings Ireland by Holdings and to Holdings by Everest Re is subject to Delaware regulatory restrictions; and the payment of dividends to Group by Bermuda Re, Everest International or Mt. Logan Re is subject to Bermuda insurance regulatory restrictions. Management expects that, absent extraordinary catastrophe losses, such restrictions should not affect Everest Re’s ability to declare and pay dividends sufficient to support Holdings’ general corporate needs and that Holdings Ireland, Everest Dublin Holdings, Bermuda Re and Everest International will have the ability to declare and pay dividends sufficient to support Group’s general corporate needs. For the years ended December 31, 2020, 2019 and 2018, Everest Re paid dividends to Holdings of $0.0 million, $300.0 million and $0.0 million, respectively, and EGS paid dividends to Holdings of $0.0 million, $0.0 million and $90.0 million, respectively. For the years ended December 31, 2020, 2019 and 2018, Bermuda Re paid dividends to Group of $650.0 million, $600.0 million and $750.0 million, respectively; Everest International paid dividends to Group of $0.0 million, $0.0 million and $200.0 million, respectively; and Mt. Logan Re paid no dividends to Group. See ITEM 1, “Business – Regulatory Matters – Dividends” and ITEM 8, “Financial Statements and Supplementary Data” - Note 14 of Notes to Consolidated Financial Statements.
Application of Recently Issued Accounting Guidance.
Accounting for Income Taxes. In December 2019, The Financial Accounting Standards Board (“FASB”) issued ASU 2019-12, which provides simplification of existing guidance for income taxes, including the removal of certain exceptions related to recognition of deferred tax liabilities on foreign subsidiaries. The guidance is effective for annual reporting periods beginning after December 15, 2020 and interim periods within that annual reporting period. The Company is currently evaluating the impact of the adoption of ASU 2019-12 on its financial statements.
Accounting for Cloud Computing Arrangement. In August 2018, FASB issued ASU 2018-15, which outlines accounting for implementation costs of a cloud computing arrangement that is a service contract. This guidance requires that implementation costs of a cloud computing arrangement that is a service contract must be capitalized and expensed in accordance with the existing provisions provided in Subtopic 350-40 regarding development of internal use software. In addition, any capitalized implementation costs should be amortized over the term of the hosting arrangement. The guidance is effective for annual reporting periods beginning after December 15, 2019 and interim periods within that annual reporting period. The Company adopted the guidance as of January 1, 2020. The adoption of ASU 2018-15 did not have a material impact on the Company’s financial statements.
Accounting for Long Duration Contracts. In August 2018, FASB issued ASU 2018-12, which discusses changes to the recognition, measurement and presentation of long duration contracts. The main provisions of this guidance address the following: 1) In determining liability for future policy benefits, companies must review cash flow assumptions at least annually and the discount rate assumption at each reporting period date 2) Amortization of deferred acquisition costs has been simplified to be in constant level proportion to either premiums, gross profits or gross margins 3) Disaggregated roll forwards of beginning and ending liabilities for future policy benefits are required. The guidance was originally effective for annual reporting periods beginning after December 15, 2020 and interim periods within that annual reporting period. However, FASB issued ASU 2019-09 in November 2019 and then ASU-2020-11 in November 2021, which ultimately defers the effective date of ASU 2018-12 until annual reporting periods beginning after December 15, 2022. The Company is currently evaluating the impact of the adoption of ASU 2018-12 on its financial statements.
Accounting for Impact on Income Taxes due to Tax Reform. In December 2017, the SEC issued Staff Accounting Bulletin (“SAB”) 118 which provides guidance on the application of FASB Accounting Standards Codification (“ASC”) Topic 740, Income Taxes, due to the enactment of TCJA. SAB 118 became effective upon release. The
Company has adopted the provisions of SAB 118 with respect to measuring the tax effects for the modifications to the determination of tax basis loss reserves. In 2018, the Company recorded adjustments to the amount of tax expense it recorded in 2017 with respect to the TCJA as estimated amounts were finalized, which did not have a material impact on the Company’s financial statements.
Amortization of Bond Premium. In March 2017, FASB issued ASU 2017-08 which outlines guidance on the amortization period for premium on callable debt securities. The new guidance requires that the premium on callable debt securities be amortized through the earliest call date rather than through the maturity date of the callable security. The guidance is effective for annual and interim reporting periods beginning after December 15, 2018. The Company adopted the guidance effective January 1, 2019. The adoption of ASU 2017-08 did not have a material impact on the Company’s financial statements.
Valuation of Financial Instruments. In June 2016, FASB issued ASU 2016-13 (and has subsequently issued related guidance and amendments in ASU 2019-11 and ASU 2019-10 in November 2019) which outline guidance on the valuation of and accounting for assets measured at amortized cost and available for sale debt securities. The new guidance requires the carrying value of assets measured at amortized cost, including reinsurance and premiums receivables to be presented as the net amount expected to be collected on the financial asset (amortized cost less an allowance for credit losses valuation account). The allowance reflects expected credit losses of the financial asset which considers available information using a combination both historical information, current market conditions and reasonable and supportable forecasts. For available-for-sale debt securities, the guidance modified the previous other than temporary impairment model, now requiring an allowance for estimated credit related losses rather than a permanent impairment, which will be limited to the amount by which fair value is below amortized cost. The guidance is effective for annual and interim reporting periods beginning after December 15, 2019. The Company adopted the guidance effective January 1, 2020, on a modified retrospective basis. The adoption resulted in a cumulative reduction of $4,214 thousand in retained earnings, net of tax, which is disclosed separately within the Consolidated Statements of Shareholders’ Equity.
Leases. In February 2016, FASB issued ASU 2016-02 (and subsequently issued ASU 2018-11 in July, 2018) which outline new guidance on the accounting for leases. The new guidance requires the recognition of lease assets and lease liabilities on the balance sheets for most leases that were previously deemed operating leases and required only lease expense presentation in the statements of operations. The guidance is effective for annual and interim reporting periods beginning after December 15, 2018. The Company adopted ASU 2016-02 effective January 1, 2019 and elected to utilize a cumulative-effect adjustment to the opening balance of retained earnings for the year of adoption. Accordingly, the Company’s reporting for the comparative periods prior to adoption continue to be presented in the financial statements in accordance with previous lease accounting guidance. The Company also elected to apply the package of practical expedients applicable to the Company in the updated guidance for transition for leases in effect at adoption. The Company did not elect the hindsight practical expedient to determine the lease term of existing leases (e.g. The Company did not re-assess lease renewals, termination options nor purchase options in determining lease terms). The adoption of the updated guidance resulted in the Company recognizing a right-of-use asset of $69,869 thousand as part of other assets and a lease liability of $77,270 thousand as part of other liabilities in the consolidated balance sheet at the time of adoption, as well as de-recognizing the liability for deferred rent that was required under the previous guidance. The cumulative effect adjustment to the opening balance of retained earnings was zero. The adoption of the updated guidance did not have a material effect on the Company’s results of operations or liquidity.
Recognition and Measurement of Financial Instruments. In January 2016, the FASB issued ASU 2016-01 which outlines revised guidance on the accounting for equity investments. The new guidance states that all equity investments in unconsolidated entities will be measured at fair value, with the change in value being recorded through the income statement rather than being recorded within other comprehensive income. The updated guidance is effective for annual and interim reporting periods beginning after December 15, 2017. The Company adopted the guidance effective January 1, 2018. The adoption of ASU 2016-01 resulted in a
cumulative change adjustment of $1,201 thousand between AOCI and retained earnings, which is disclosed separately within the consolidated statement of changes in shareholders’ equity.
Any issued guidance and pronouncements, other than those directly referenced above, are deemed by the Company to be either not applicable or immaterial to its financial statements.
Market Sensitive Instruments.
The SEC’s Financial Reporting Release #48 requires registrants to clarify and expand upon the existing financial statement disclosure requirements for derivative financial instruments, derivative commodity instruments and other financial instruments (collectively, “market sensitive instruments”). We do not generally enter into market sensitive instruments for trading purposes.
Our current investment strategy seeks to maximize after-tax income through a high quality, diversified, fixed maturity portfolio, while maintaining an adequate level of liquidity. Our mix of investments is adjusted periodically, consistent with our current and projected operating results and market conditions. The fixed maturity securities in the investment portfolio are comprised of non-trading available for sale securities. Additionally, we have invested in equity securities.
The overall investment strategy considers the scope of present and anticipated Company operations. In particular, estimates of the financial impact resulting from non-investment asset and liability transactions, together with our capital structure and other factors, are used to develop a net liability analysis. This analysis includes estimated payout characteristics for which our investments provide liquidity. This analysis is considered in the development of specific investment strategies for asset allocation, duration and credit quality. The change in overall market sensitive risk exposure principally reflects the asset changes that took place during the period.
Interest Rate Risk. Our $25.5 billion investment portfolio at December 31, 2020, is principally comprised of fixed maturity securities, which are generally subject to interest rate risk and some foreign currency exchange rate risk, and some equity securities, which are subject to price fluctuations and some foreign exchange rate risk. The overall economic impact of the foreign exchange risks on the investment portfolio is partially mitigated by changes in the dollar value of foreign currency denominated liabilities and their associated income statement impact.
Interest rate risk is the potential change in value of the fixed maturity securities portfolio, including short-term investments, from a change in market interest rates. In a declining interest rate environment, it includes prepayment risk on the $3,263.2 million of mortgage-backed securities in the $20,040.2 million fixed maturity portfolio. Prepayment risk results from potential accelerated principal payments that shorten the average life and thus the expected yield of the security.
The tables below display the potential impact of market value fluctuations and after-tax unrealized appreciation on our fixed maturity portfolio (including $1,135.0 million of short-term investments) for the period indicated based on upward and downward parallel and immediate 100 and 200 basis point shifts in interest rates. For legal entities with a U.S. dollar functional currency, this modeling was performed on each security individually. To generate appropriate price estimates on mortgage-backed securities, changes in prepayment expectations under different interest rate environments were taken into account. For legal entities with a non-U.S. dollar functional currency, the effective duration of the involved portfolio of securities was used as a proxy for the market value change under the various interest rate change scenarios.
| Impact of Interest Rate Shift in Basis Points | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| At December 31, 2020 | ||||||||||||||
| -200 | -100 | - | 100 | 200 | ||||||||||
| (Dollars in millions) | ||||||||||||||
| Total Market/Fair Value | $ | 22,618.8 | $ | 21,897.0 | $ | 21,175.1 | $ | 20,453.3 | $ | 19,731.4 | ||||
| Market/Fair Value Change from Base (%) | 6.8% | 3.4% | -% | (3.4)% | (6.8)% | |||||||||
| Change in Unrealized Appreciation | ||||||||||||||
| After-tax from Base ($) | $ | 1,264.4 | $ | 632.2 | $ | - | $ | (632.2) | $ | (1,264.4) |
| Impact of Interest Rate Shift in Basis Points | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| At December 31, 2019 | ||||||||||||||
| -200 | -100 | - | 100 | 200 | ||||||||||
| (Dollars in millions) | ||||||||||||||
| Total Market/Fair Value | $ | 18,472.7 | $ | 17,859.1 | $ | 17,245.5 | $ | 16,631.9 | $ | 18,018.3 | ||||
| Market/Fair Value Change from Base (%) | 7.1% | 3.6% | 0.0% | (3.6)% | (7.1)% | |||||||||
| Change in Unrealized Appreciation | ||||||||||||||
| After-tax from Base ($) | $ | 1,088.5 | $ | 544.3 | $ | - | $ | (544.3) | $ | (1,088.5) |
We had $16,399.0 million and $13,611.3 million of gross reserves for losses and LAE as of December 31, 2020 and 2019, respectively. These amounts are recorded at their nominal value, as opposed to present value, which would reflect a discount adjustment to reflect the time value of money. Since losses are paid out over a period of time, the present value of the reserves is less than the nominal value. As interest rates rise, the present value of the reserves decreases and, conversely, as interest rates decline, the present value increases. These movements are the opposite of the interest rate impacts on the fair value of investments. While the difference between present value and nominal value is not reflected in our financial statements, our financial results will include investment income over time from the investment portfolio until the claims are paid. Our loss and loss reserve obligations have an expected duration of approximately 3.2 years, which is reasonably consistent with our fixed income portfolio. If we were to discount our loss and LAE reserves, net of ceded reserves, the discount would be approximately $1.5 billion resulting in a discounted reserve balance of approximately $13.0 billion, representing approximately 61.6% of the value of the fixed maturity investment portfolio funds.
Equity Risk. Equity risk is the potential change in fair and/or market value of the common stock, preferred stock and mutual fund portfolios arising from changing prices. Our equity investments consist of a diversified portfolio of individual securities and mutual funds, which invest principally in high quality common and preferred stocks that are traded on the major exchanges, and mutual fund investments in emerging market debt. The primary objective of the equity portfolio is to obtain greater total return relative to our core bonds over time through market appreciation and income.
The tables below display the impact on fair/market value and after-tax change in fair/market value of a 10% and 20% change in equity prices up and down for the period indicated.
| Impact of Percentage Change in Equity Fair/Market Values | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| At December 31, 2020 | ||||||||||||||
| (Dollars in millions) | -20% | -10% | 0% | 10% | 20% | |||||||||
| Fair/Market Value of the Equity Portfolio | $ | 1,177.8 | $ | 1,325.0 | $ | 1,472.2 | $ | 1,619.5 | $ | 1,766.7 | ||||
| After-tax Change in Fair/Market Value | $ | (234.0) | $ | (117.0) | $ | - | $ | 117.0 | $ | 234.0 |
| Impact of Percentage Change in Equity Fair/Market Values | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| At December 31, 2019 | ||||||||||||||
| (Dollars in millions) | -20% | -10% | 0% | 10% | 20% | |||||||||
| Fair/Market Value of the Equity Portfolio | $ | 745.2 | $ | 838.3 | $ | 931.5 | $ | 1,024.6 | $ | 1,117.7 | ||||
| After-tax Change in Fair/Market Value | $ | (153.6) | $ | (76.8) | $ | - | $ | 76.8 | $ | 153.6 |
Foreign Currency Risk. Foreign currency risk is the potential change in value, income and cash flow arising from adverse changes in foreign currency exchange rates. Each of our non-U.S./Bermuda (“foreign”) operations maintains capital in the currency of the country of its geographic location consistent with local regulatory guidelines. Each foreign operation may conduct business in its local currency, as well as the currency of other countries in which it operates. The primary foreign currency exposures for these foreign operations are the Canadian Dollar, the Singapore Dollar, the British Pound Sterling and the Euro. We mitigate foreign exchange exposure by generally matching the currency and duration of our assets to our corresponding operating liabilities. In accordance with FASB guidance, the impact on the market value of available for sale fixed maturities due to changes in foreign currency exchange rates, in relation to functional currency, is reflected as part of other comprehensive income. Conversely, the impact of changes in foreign currency exchange rates, in relation to functional currency, on other assets and liabilities is reflected through net income as a component of other income (expense). In addition, we translate the assets, liabilities and income of non-U.S. dollar functional currency legal entities to the U.S. dollar. This translation amount is reported as a component of other comprehensive income.
In January 2020, the United Kingdom exited the European Union (commonly referred to as "Brexit"). The Company has a Lloyd’s of London Syndicate and Bermuda Re has a branch operation in the United Kingdom. The nature and extent of the impact of Brexit on regulation, interest rates, currency exchange rates and financial markets is still uncertain and may adversely affect our operations.
The tables below display the potential impact of a parallel and immediate 10% and 20% increase and decrease in foreign exchange rates on the valuation of invested assets subject to foreign currency exposure for the periods indicated. This analysis includes the after-tax impact of translation from transactional currency to functional currency as well as the after-tax impact of translation from functional currency to the U.S. dollar reporting currency.
| Change in Foreign Exchange Rates in Percent | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| At December 31, 2020 | ||||||||||||||
| (Dollars in millions) | -20% | -10% | 0% | 10% | 20% | |||||||||
| Total After-tax Foreign Exchange Exposure | $ | (605.8) | $ | (302.9) | $ | - | $ | 302.9 | $ | 605.8 |
| Change in Foreign Exchange Rates in Percent | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| At December 31, 2019 | ||||||||||||||
| (Dollars in millions) | -20% | -10% | 0% | 10% | 20% | |||||||||
| Total After-tax Foreign Exchange Exposure | $ | (513.2) | $ | (256.6) | $ | - | $ | 256.6 | $ | 513.2 |
Safe Harbor Disclosure.
This report contains forward-looking statements within the meaning of the U.S. federal securities laws. We intend these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in the federal securities laws. In some cases, these statements can be identified by the use of forward-looking words such as “may”, “will”, “should”, “could”, “anticipate”, “estimate”, “expect”, “plan”, “believe”, “predict”, “potential” and “intend”. Forward-looking statements contained in this report include information regarding our reserves for losses and LAE, the impact of the Tax Cut and Jobs Act, the adequacy of capital in relation to regulatory required capital, the adequacy of our provision for uncollectible balances, estimates of our catastrophe exposure, the effects of catastrophic and pandemic events on our financial statements, the ability of Everest Re, Holdings, Holdings Ireland, Dublin Holdings, Bermuda Re and Everest International to pay dividends and the settlement costs of our specialized equity index put option contracts. Forward-looking statements only reflect our expectations and are not guarantees of performance. These statements involve risks, uncertainties and assumptions. Actual events or results may differ materially from our expectations. Important factors that could cause our actual events or results to be materially different from our expectations include those discussed under the caption ITEM 1A, “Risk Factors”. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
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