Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

W. R. Berkley Corporation is an insurance holding company that is among the largest commercial lines writers in the United States and operates in three business segments: Insurance-Domestic, Insurance-International and Reinsurance-Global. Our decentralized structure provides us with the flexibility to respond quickly and efficiently to local or specific market conditions and to pursue specialty business niches. It also allows us to be closer to our customers in order to better understand their individual needs and risk characteristics. While providing our business units with certain operating autonomy, our structure allows us to capitalize on the benefits of economies of scale through centralized capital, investment, reinsurance and enterprise risk management, and actuarial, financial and corporate legal staff support. The Company’s primary sources of revenues and earnings are its insurance operations and its investments.

An important part of our strategy is to form new operating units to capitalize on various business opportunities. Since 2006, the Company formed 24 new operating units that are focused on important parts of the economy in the U.S., including healthcare, energy and agriculture, and on growing international markets, including Scandinavia, Australia, the Asia-Pacific region and South America.

The profitability of the Company’s insurance business is affected primarily by the adequacy of premium rates. The ultimate adequacy of premium rates is not known with certainty at the time an insurance policy is issued because premiums are determined before claims are reported. The ultimate adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural and other disasters, regulatory measures and court decisions that define and change the extent of coverage and the effects of economic inflation on the amount of compensation for injuries or losses. General insurance prices are also influenced by available insurance capacity, i.e., the level of statutory capital and surplus employed in the industry, and the industry’s willingness to deploy that capital.

From 2005 through 2010, the property casualty insurance market was very competitive and insurance rates decreased across most business lines. Although prices have generally increased since the beginning of 2011, current market price levels for certain lines of business remain below the prices required for the Company to achieve its long-term return objectives. Part of the Company's strategy is to selectively reduce its business in areas where it believes returns are not adequate. Price changes are reflected in the Company’s results over time as premiums are earned.

The Company’s profitability is also affected by its investment income and investment gains. The Company’s invested assets, which are derived from its own capital and cash flow from its insurance business, are invested principally in fixed maturity securities. The return on fixed maturity securities is affected primarily by general interest rates, as well as the credit quality and duration of the securities. Returns available on fixed maturity investments are at historically low levels. The Company's investment income has been negatively impacted by the low fixed maturity investment returns, and will be further impacted if investment returns remain at this level.

The Company also invests in equity securities, merger arbitrage, private equity investments, investment funds, loans receivable and real estate. The Company's investments in investment funds have experienced, and the Company expects to continue to experience, greater fluctuations in investment income.

Critical Accounting Estimates

The following presents a discussion of accounting policies and estimates relating to reserves for losses and loss expenses, assumed premiums and other-than-temporary impairments of investments. Management believes these policies and estimates are the most critical to its operations and require the most difficult, subjective and complex judgments.

Reserves for Losses and Loss Expenses. To recognize liabilities for unpaid losses, either known or unknown, insurers establish reserves, which is a balance sheet account representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred. Estimates and assumptions relating to reserves for losses and loss expenses are based on complex and subjective judgments, often including the interplay of specific uncertainties with related accounting and actuarial measurements. Such estimates are also susceptible to change as significant periods of time may elapse between the occurrence of an insured loss, the report of the loss to the insurer, the ultimate determination of the cost of the loss and the insurer’s payment of that loss.

In general, when a claim is reported, claims personnel establish a “case reserve” for the estimated amount of the ultimate payment based upon known information about the claim at that time. The estimate represents an informed judgment based on general reserving practices and reflects the experience and knowledge of the claims personnel regarding the nature

and value of the specific type of claim. Reserves are also established on an aggregate basis to provide for losses incurred but not reported (“IBNR”) to the insurer, potential inadequacy of case reserves and the estimated expenses of settling claims, including legal and other fees and general expenses of administrating the claims adjustment process. Reserves are established based upon the then current legal interpretation of coverage provided.

In examining reserve adequacy, several factors are considered in estimating the ultimate economic value of losses. These factors include, among other things, historical data, legal developments, changes in social attitudes and economic conditions, including the effects of inflation. The actuarial process relies on the basic assumption that past experience, adjusted judgmentally for the effects of current developments and anticipated trends, is an appropriate basis for predicting future outcomes. Reserve amounts are based on management’s informed estimates and judgments using currently available data. As additional experience and other data become available and are reviewed, these estimates and judgments may be revised. This may result in reserve increases or decreases that would be reflected in our results in periods in which such estimates and assumptions are changed.

Reserves do not represent an exact calculation of liability. Rather, reserves represent an estimate of what management expects the ultimate settlement and claim administration will cost. While the methods for establishing reserves are well tested over time, some of the major assumptions about anticipated loss emergence patterns are subject to unanticipated fluctuation. These estimates, which generally involve actuarial projections, are based on management’s assessment of facts and circumstances then known, as well as estimates of trends in claims severity and frequency, judicial theories of liability and other factors, including the actions of third parties which are beyond the Company’s control. These variables are affected by external and internal events, such as inflation and economic volatility, judicial and litigation trends, reinsurance coverage, legislative changes and claim handling and reserving practices, which make it more difficult to accurately predict claim costs. The inherent uncertainties of estimating reserves are greater for certain types of liabilities where long periods of time elapse before a definitive determination of liability is made. Because setting reserves is inherently uncertain, the Company cannot provide assurance that its current reserves will prove adequate in light of subsequent events.

Loss reserves included in the Company’s financial statements represent management’s best estimates based upon an actuarially derived point estimate and other considerations. The Company uses a variety of actuarial techniques and methods to derive an actuarial point estimate for each operating unit. These methods include paid loss development, incurred loss development, paid and incurred Bornhuetter-Ferguson methods and frequency and severity methods. In circumstances where one actuarial method is considered more credible than the others, that method is used to set the point estimate. For example, the paid loss and incurred loss development methods rely on historical paid and incurred loss data. For new lines of business, where there is insufficient history of paid and incurred claims data, or in circumstances where there have been significant changes in claim practices, the paid and incurred loss development methods would be less credible than other actuarial methods. The actuarial point estimate may also be based on a judgmental weighting of estimates produced from each of the methods considered. Industry loss experience is used to supplement the Company’s own data in selecting “tail factors” and in areas where the Company’s own data is limited. The actuarial data is analyzed by line of business, coverage and accident or policy year, as appropriate, for each operating unit.

The establishment of the actuarially derived loss reserve point estimate also includes consideration of qualitative factors that may affect the ultimate losses. These qualitative considerations include, among others, the impact of re-underwriting initiatives, changes in the mix of business, changes in distribution sources and changes in policy terms and conditions. Examples of changes in terms and conditions that can have a significant impact on reserve levels are the use of aggregate policy limits, the expansion of coverage exclusions, whether or not defense costs are within policy limits, and changes in deductibles and attachment points.

The key assumptions used to arrive at the best estimate of loss reserves are the expected loss ratios, rate of loss cost inflation, and reported and paid loss emergence patterns. Expected loss ratios represent management’s expectation of losses at the time the business is written, before any actual claims experience has emerged. This expectation is a significant determinant of the estimate of loss reserves for recently written business where there is little paid or incurred loss data to consider. Expected loss ratios are generally derived from historical loss ratios adjusted for the impact of rate changes, loss cost trends and known changes in the type of risks underwritten. Expected loss ratios are estimated for each key line of business within each operating unit. Expected loss cost inflation is particularly important for the long-tail lines, such as excess casualty, and claims with a high medical component, such as workers’ compensation. Reported and paid loss emergence patterns are used to project current reported or paid loss amounts to their ultimate settlement value. Loss development factors are based on the historical emergence patterns of paid and incurred losses, and are derived from the Company’s own experience and industry data. The paid loss emergence pattern is also significant to excess and assumed workers’ compensation reserves because those reserves are discounted to their estimated present value based upon such estimated payout patterns. Management believes the estimates and assumptions it makes in the reserving process provide the best estimate of the ultimate cost of settling claims and related expenses with respect to insured events which have occurred; however, different assumptions and variables could lead to significantly different reserve estimates.

Loss frequency and severity are measures of loss activity that are considered in determining the key assumptions described in our discussion of loss and loss expense reserves, including expected loss ratios, rate of loss cost inflation and reported and paid loss emergence patterns. Loss frequency is a measure of the number of claims per unit of insured exposure, and loss severity is a measure of the average size of claims. Factors affecting loss frequency include the effectiveness of loss controls and safety programs and changes in economic activity or weather patterns. Factors affecting loss severity include changes in policy limits, retentions, rate of inflation and judicial interpretations.

Another factor affecting estimates of loss frequency and severity is the loss reporting lag, which is the period of time between the occurrence of a loss and the date the loss is reported to the Company. The length of the loss reporting lag affects our ability to accurately predict loss frequency (loss frequencies are more predictable for lines with short reporting lags) as well as the amount of reserves needed for incurred but not reported losses (less IBNR is required for lines with short reporting lags). As a result, loss reserves for lines with short reporting lags are likely to have less variation from initial loss estimates. For lines with short reporting lags, which include commercial automobile, primary workers’ compensation, other liability (claims-made) and property business, the key assumption is the loss emergence pattern used to project ultimate loss estimates from known losses paid or reported to date. For lines of business with long reporting lags, which include other liability (occurrence), products liability, excess workers’ compensation and liability reinsurance, the key assumption is the expected loss ratio since there is often little paid or incurred loss data to consider. Historically, the Company has experienced less variation from its initial loss estimates for lines of businesses with short reporting lags than for lines of business with long reporting lags.

The key assumptions used in calculating the most recent estimate of the loss reserves are reviewed each quarter and adjusted, to the extent necessary, to reflect historical changes, current trends and other factors observed. If the actual level of loss frequency and severity are higher or lower than expected, the ultimate losses will be different than management’s estimate. The following table reflects the impact of changes (which could be favorable or unfavorable) in frequency and severity, relative to our assumptions, on our loss estimate for claims occurring in 2013:

(In thousands)	Frequency (+/-)
Severity (+/-)	1%				5%				10%
1%	$	64,750			$	194,893			$	357,572
5%	194,893				330,191				499,313
10%	357,572				499,313				676,488

Our net reserves for losses and loss expenses of approximately $8.7 billion as of December 31, 2013 relate to multiple accident years. Therefore, the impact of changes in frequency or severity for more than one accident year could be higher or lower than the amounts reflected above.

Approximately $1.6 billion, or 18%, of the Company’s net loss reserves as of December 31, 2013 relate to the Reinsurance-Global segment. There is a higher degree of uncertainty and greater variability regarding estimates of assumed loss reserves because those estimates are based, in part, upon information received from ceding companies. If information received from ceding companies is not timely or correct, the Company’s estimate of ultimate losses may not be accurate. Furthermore, due to delayed reporting of claim information by ceding companies, the claim settlement tail for assumed reinsurance is extended. Management considers the impact of delayed reporting in its selection of assumed loss development factors.

Information received from ceding companies is used to set initial expected loss ratios, to establish case reserves and to estimate reserves for incurred but not reported losses on assumed reinsurance business. This information, which is generally provided through reinsurance intermediaries, is gathered through the underwriting process and from periodic claim reports and other correspondence with ceding companies. The Company performs underwriting and claim audits of selected ceding companies to determine the accuracy and completeness of information provided to the Company. The information received from the ceding companies is supplemented by the Company’s own loss development experience with similar lines of business as well as industry loss trends and loss development benchmarks.

Following is a summary of the Company’s reserves for losses and loss expenses by business segment as of December 31, 2013 and 2012:

(In thousands)	2013				2012
Insurance-Domestic	$	6,493,401			$	6,297,773
Insurance-International	592,709				540,769
Reinsurance-Global	1,597,687				1,573,309
Net reserves for losses and loss expenses	8,683,797				8,411,851
Ceded reserves for losses and loss expenses	1,397,144				1,339,235
Gross reserves for losses and loss expenses	$	10,080,941			$	9,751,086

Following is a summary of the Company’s net reserves for losses and loss expenses by major line of business as of December 31, 2013 and 2012:

(In thousands)	Reported Case Reserves				Incurred But Not Reported				Total
December 31, 2013
Other liability	$	937,168			$	1,852,779			$	2,789,947
Workers’ compensation (1)	1,462,849				1,206,244				2,669,093
Professional liability	320,579				344,232				664,811
Commercial automobile	267,701				205,404				473,105
Short-tail lines	258,459				230,696				489,155
Total primary	3,246,756				3,839,355				7,086,111
Reinsurance (1)	679,108				918,578				1,597,686
Total	$	3,925,864			$	4,757,933			$	8,683,797
December 31, 2012
Other liability	$	922,568			$	1,863,465			$	2,786,033
Workers’ compensation (1)	1,427,599				1,114,340				2,541,939
Professional liability	271,854				312,811				584,665
Commercial automobile	275,322				204,900				480,222
Short-tail lines	240,411				205,272				445,683
Total primary	3,137,754				3,700,788				6,838,542
Reinsurance (1)	626,962				946,347				1,573,309
Total	$	3,764,716			$	4,647,135			$	8,411,851

(1) Reserves for excess and assumed workers’ compensation business are net of an aggregate net discount of $837 million and $867 million as of December 31, 2013 and 2012, respectively.

The Company evaluates reserves for losses and loss adjustment expenses on a quarterly basis. Changes in estimates of prior year losses are reported when such changes are made. The changes in prior year loss reserve estimates are generally the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as additional information becomes known regarding individual claims and aggregate claim trends. Certain of the Company's insurance and reinsurance contracts are retrospectively rated, whereby the Company collects more or less premiums based on the level of loss activity. For those contracts, changes in loss and loss adjustment expenses for prior years may be fully or partially offset by additional or return premiums. Net prior year development (i.e, the sum of prior year reserve changes and prior year earned premiums changes) for each of the three years ended December 31, 2013 are as follows:

(In thousands)	2013				2012				2011
Decrease in prior year loss reserves	$	78,810			$	99,343			$	180,585
Increase in prior year earned premiums	19,046				3,228				697
Net favorable prior year development	$	97,856			$	102,571			$	181,282

Favorable prior year development was $98 million in 2013 compared with $103 in 2012 and $181 in 2011.

Favorable development in 2013 was primarily attributable to accident years 2006 through 2012 and included favorable development of $39 million for other liability business, $32 million for reinsurance assumed liability business, $22 million for workers’ compensation, $18 million for commercial property and $24 million for other lines of business. The favorable development in 2013 was largely driven by loss cost trends, which were more favorable than originally anticipated. In particular, loss frequency trends have been more favorable than expected for excess & surplus lines casualty business, workers' compensation and excess of loss professional and other liability business.

The 2013 favorable development was partially offset by unfavorable development of $23 million for commercial automobile business and $14 million for products liability business. Commercial automobile development was driven by large losses for long-haul trucking business in 2011 and 2012. Product liability development stemmed from completed operations losses associated with construction projects in accident years prior to 2009.

Favorable reserve development in 2012 was primarily attributable improved claim frequency (i.e., number of reported claims per unit of exposure), especially in the for excess and surplus casualty business. In addition, standard commercial lines business and reinsurance business experienced better than expected reported losses. The improvement was related primarily to accident years 2008 through 2010.

Favorable reserve development in 2011 was primarily attributable excess and surplus casualty, commercial multi-peril and reinsurance business and was concentrated in accident years 2007 through 2009.

Reserve Discount - The Company discounts its liabilities for excess and assumed workers’ compensation business because of the long period of time over which losses are paid. Discounting is intended to appropriately match losses and loss expenses to income earned on investment securities supporting the liabilities. The expected losses and loss expense payout pattern subject to discounting was derived from the Company’s loss payout experience. For non-proportional business, reserves for losses and loss expenses have been discounted using risk-free discount rates determined by reference to the U.S. Treasury yield curve. For proportional business, reserves for losses and loss expenses have been discounted at the statutory rate of 2.2%. As of December 31, 2013, the aggregate blended discount rates ranged from 2.1% to 6.5%, with a weighted average discount rate of 4.1%. The aggregate net discount, after reflecting the effects of ceded reinsurance, was $837 million and $867 million as of December 31, 2013 and December 31, 2012, respectively.

Assumed Reinsurance Premiums. The Company estimates the amount of assumed reinsurance premiums that it will receive under treaty reinsurance agreements at the inception of the contracts. These premium estimates are revised as the actual amount of assumed premiums is reported to the Company by the ceding companies. As estimates of assumed premiums are made or revised, the related amount of earned premiums, commissions and incurred losses associated with those premiums are recorded. Estimated assumed premiums receivable were approximately $57 million and $73 million at December 31, 2013 and December 31, 2012, respectively. The assumed premium estimates are based upon terms set forth in reinsurance agreements, information received from ceding companies during the underwriting and negotiation of agreements, reports received from ceding companies and discussions and correspondence with reinsurance intermediaries. The Company also considers its own view of market conditions, economic trends and experience with similar lines of business. These premium estimates represent management’s best estimate of the ultimate amount of premiums to be received under its assumed reinsurance agreements.

Other-Than-Temporary Impairments (OTTI) of Investments. The cost of securities is adjusted where appropriate to include a provision for decline in value which is considered to be other-than-temporary. An other-than-temporary decline is considered to occur in investments where there has been a sustained reduction in fair value and where the Company does not expect the fair value to recover prior to the time of sale or maturity. Since equity securities do not have a contractual cash flow or maturity, the Company considers whether the price of an equity security is expected to recover within a reasonable period of time.

The Company classifies its fixed maturity securities and preferred stocks by credit rating, primarily based on ratings assigned by credit rating agencies. For purposes of classifying securities with different ratings, the Company uses the lower rating if two ratings were assigned and the middle rating if three ratings were assigned, unless the Company’s own analysis indicates that the lower rating is more appropriate. Securities that are not rated by a rating agency are evaluated and classified by the Company on a case-by-case basis.

Fixed Maturity Securities – For securities that we intend to sell or, more likely than not, would be required to sell, a decline in value below amortized cost is considered to be OTTI. The amount of OTTI is equal to the difference between amortized cost and fair value at the balance sheet date. For securities that we do not intend to sell or expect to be required to sell, a decline in value below amortized cost is considered to be an OTTI if we do not expect to recover the entire amortized cost basis of a security (i.e., the present value of cash flows expected to be collected is less than the amortized cost basis of the security).

The portion of the decline in value considered to be a credit loss (i.e., the difference between the present value of cash flows expected to be collected and the amortized cost basis of the security) is recognized in earnings. The portion of the decline in value not considered to be a credit loss (i.e., the difference in the present value of cash flows expected to be collected and the fair value of the security) is recognized in other comprehensive income.

Impairment assessments for structured securities, including mortgage-backed securities and asset-backed securities, collateralized debt obligations and corporate debt, are generally evaluated based on the performance of the underlying collateral under various economic and default scenarios that may involve subjective judgments and estimates by management. Modeling these securities involves various factors, such as projected default rates, the nature and realizable value of the collateral, if any, the ability of the issuer to make scheduled payments, historical performance and other relevant economic and performance factors. If an OTTI determination is made, a discounted cash flow analysis is used to ascertain the amount of the credit impairment.

The following table provides a summary of fixed maturity securities in an unrealized loss position as of December 31, 2013:

(Dollars in thousands)	Number of Securities			Aggregate Fair Value				Unrealized Loss
Unrealized loss less than 20% of amortized cost	501			$	3,380,725			$	103,240
Unrealized loss of 20% or greater of amortized cost:
Six months to less than nine months	1			1,039				269
Nine months to less than twelve months	1			886				242
Twelve months and longer	7			25,266				7,383
Total	510			$	3,407,916			$	111,134

A summary of the Company’s non-investment grade fixed maturity securities that were in an unrealized loss position at December 31, 2013 is presented in the table below.

(Dollars in thousands)	Number of Securities			Aggregate Fair Value				Unrealized Loss
Mortgage-backed securities	13			$	66,658			$	3,748
Corporate	9			31,579				1,005
Foreign government	2			23,603				844
Total	24			$	121,840			$	5,597

The Company has evaluated its fixed maturity securities in an unrealized loss position and believes the unrealized loss is due primarily to temporary market and sector-related factors rather than to issuer-specific factors. None of these securities are delinquent or in default under financial covenants. Based on its assessment of these issuers, the Company expects them to continue to meet their contractual payment obligations as they become due and does not consider any of these securities to be OTTI.

Preferred Stocks – At December 31, 2013, there were three preferred stocks in an unrealized loss position, with an aggregate fair value of $33 million and a gross unrealized loss of $6 million. None of these preferred stocks are rated non-investment grade and none are delinquent or in default. Management believes the unrealized losses are due primarily to market and sector related factors and does not consider these to be OTTI.

Common Stocks – At December 31, 2013, there were no common stocks in an unrealized loss position.

Loans Receivable – The Company monitors the performance of its loans receivable, including current market conditions for each loan and the ability to collect principal and interest. For loans where the Company determines it is probable that the contractual terms will not be met, an analysis is performed and a valuation reserve is established, if necessary, with a charge to earnings. Loans receivable are reported net of a valuation reserve of $2 million and $6 million at December 31, 2013 and 2012, respectively.

The Company monitors the performance of its loans receivable and assesses the ability of each borrower to pay principal and interest based upon loan structure, underlying property values, cash flow and related financial and operating performance

of the property and market conditions. Loans receivable with a potential for default are further assessed using discounted cash flow analysis and comparable cost and sales methodologies, if appropriate.

Fair Value Measurements. The Company’s fixed maturity and equity securities available for sale and its trading account securities are carried at fair value. Fair value is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” The Company utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for similar assets in active markets. Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs may only be used to measure fair value to the extent that observable inputs are not available. The fair value of the vast majority of the Company’s portfolio is based on observable data (other than quoted prices) and, accordingly, is classified as Level 2.

In classifying particular financial securities in the fair value hierarchy, the Company uses its judgment to determine whether the market for a security is active and whether significant pricing inputs are observable. The Company determines the existence of an active market by assessing whether transactions occur with sufficient frequency and volume to provide reliable pricing information. The Company determines whether inputs are observable based on the use of such information by pricing services and external investment managers, the uninterrupted availability of such inputs, the need to make significant adjustments to such inputs and the volatility of such inputs over time. If the market for a security is determined to be inactive or if significant inputs used to price a security are determined to be unobservable, the security is categorized in Level 3 of the fair value hierarchy.

Because many fixed maturity securities do not trade on a daily basis, the Company utilizes pricing models and processes which may include benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Market inputs used to evaluate securities include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. Quoted prices are often unavailable for recently issued securities that are infrequently traded or securities that are only traded in private transactions. For publicly traded securities for which quoted prices are unavailable, the Company determines fair value based on independent broker quotations and other observable market data. For securities traded only in private negotiations, the Company determines fair value based primarily on the cost of such securities, which is adjusted to reflect prices of recent placements of securities of the same issuer, financial data, projections and business developments of the issuer and other relevant information.

The following is a summary of pricing sources for the Company's fixed maturity securities available for sale as of December 31, 2013:

(In thousands)	Carrying Value				Percent of Total
Pricing source:
Independent pricing services	$	10,372,057			90.0	%
Syndicate manager	79,602				0.7
Directly by the Company based on:
Observable data	1,021,001				8.9
Cash flow model	42,864				0.4
Total	$	11,515,524			100.0	%

Independent pricing services - The vast majority of the Company’s fixed maturity securities available for sale were priced by independent pricing services (generally one U.S. pricing service plus additional pricing services with respect to a limited number of foreign securities held by the Company). The prices provided by the independent pricing services are generally based on observable market data in active markets (e.g., broker quotes and prices observed for comparable securities). The determination of whether markets are active or inactive is based upon the volume and level of activity for a particular asset class. The Company reviews the prices provided by pricing services for reasonableness based upon current trading levels for similar securities. If the prices appear unusual to the Company, they are re-examined and the value is either confirmed or revised. In addition, the Company periodically performs independent price tests of a sample of securities to ensure proper valuation and to verify our understanding of how securities are priced. As of December 31, 2013, the Company did not make any adjustments to the prices provided by the pricing services. Based upon the Company’s review of the methodologies used by the independent pricing services, these securities were classified as Level 2.

Syndicate manager – The Company has a 15% participation in a Lloyd’s syndicate, and the Company’s share of the securities owned by the syndicate is priced by the syndicate’s manager. The majority of the securities are liquid, short duration

fixed maturity securities. The Company reviews the syndicate manager’s pricing methodology and audited financial statements and holds discussions with the syndicate manager as necessary to confirm its understanding and agreement with security prices. Based upon the Company’s review of the methodologies used by the syndicate manager, these securities were classified as Level 2.

Observable data – If independent pricing is not available, the Company prices the securities directly. Prices are based on observable market data where available, including current trading levels for similar securities and non-binding quotations from brokers. The Company generally requests two or more quotes. If more than one quote is received, the Company sets a price within the range of quotes received based on its assessment of the credibility of the quote and its own evaluation of the security. The Company generally does not adjust quotes obtained from brokers. Since these securities were priced based on observable data, they were classified as Level 2.

Cash flow model – If the above methodologies are not available, the Company prices securities using a discounted cash flow model based upon assumptions as to prevailing credit spreads, interest rates and interest rate volatility, time to maturity and subordination levels. Discount rates are adjusted to reflect illiquidity where appropriate. These securities were classified as Level 3.

Results of Operations for the Years Ended December 31, 2013 and 2012

Business Segment Results

Following is a summary of gross and net premiums written, net premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of net premiums earned), expense ratios (underwriting expenses expressed as a percentage of net premiums earned) and GAAP combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the years ended December 31, 2013 and 2012. The GAAP combined ratio represents a measure of underwriting profitability, excluding investment income. A GAAP combined ratio in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit.

(In thousands)	2013				2012
Insurance-Domestic
Gross premiums written	$	4,803,753			$	4,261,165
Net premiums written	3,994,387				3,569,883
Net premiums earned	3,782,416				3,417,022
Loss ratio	61.3		%		63.5		%
Expense ratio	32.7				32.5
GAAP combined ratio	94.0				96.0
Insurance-International
Gross premiums written	$	898,776			$	802,057
Net premiums written	756,185				664,459
Net premiums earned	723,151				631,841
Loss ratio	59.4		%		59.7		%
Expense ratio	39.0				40.2
GAAP combined ratio	98.4				99.9
Reinsurance-Global
Gross premiums written	$	808,562			$	716,657
Net premiums written	749,601				664,197
Net premiums earned	720,970				624,653
Loss ratio	62.2		%		64.3		%
Expense ratio	34.8				36.3
GAAP combined ratio	97.0				100.6
Consolidated
Gross premiums written	$	6,511,091			$	5,779,879
Net premiums written	5,500,173				4,898,539
Net premiums earned	5,226,537				4,673,516
Loss ratio	61.2		%		63.1		%
Expense ratio	33.9				34.1
GAAP combined ratio	95.1				97.2

Net Income to Common Stockholders. The following table presents the Company’s net income to common stockholders and net income per diluted share for the years ended December 31, 2013 and 2012.

(In thousands, except per share data)	2013				2012
Net income to common stockholders	$	499,925			$	510,592
Weighted average diluted shares	140,743				143,315
Net income per diluted share	$	3.55			$	3.56

The Company reported net income of $500 million in 2013 compared to $511 million in 2012. The 2% decrease in net income was primarily due to decreases in after-tax net investment gains of $63 million and after-tax net investment income of $31 million, largely offset by an increase in after-tax underwriting income of $82 million. The number of weighted average diluted shares decreased as a result of the Company’s repurchases of its common stock in 2013 and 2012.

Premiums. Gross premiums written were $6,511 million in 2013, an increase of 13% from $5,780 million in 2012. The growth was due to a combination of rate increases and increased exposures, including expansion into new geographic and product markets. Approximately 76% of policies expiring in 2013 were renewed, compared with a 78% renewal retention rate for policies expiring in 2012.

Average renewal premium rates (adjusted for change in exposures) increased 2.7% in 2011, 6.8% in 2012 and 6.5% in 2013. However, overall loss costs are also increasing, and current market price levels for certain lines of business remain below the prices required for the Company to achieve its long-term return objectives.

A summary of gross premiums written in 2013 compared with 2012 by line of business within each business segment follows:

•	Insurance-Domestic gross premiums increased 13% to $4,804 million in 2013 from $4,261 million in 2012. Gross premiums increased $247 million (19%) for other liability, $155 million (14%) for workers' compensation, $56 million (6%) for short-tail lines, $50 million (15%) for professional liability and $35 million (7%) for commercial auto.

•	Insurance-International gross premiums increased 12% to $899 million in 2013 from $802 million in 2012. Gross premiums increased $69 million (17%) for short-tail lines, $36 million (62%) for other liability, $2 million (3%) for workers' compensation and decreased $5 million (4%) for professional liability and $5 million (3%) for commercial auto.

•	Reinsurance-Global gross premiums increased 13% to $809 million in 2013 from $717 million in 2012. Gross premiums written increased $51 million (11%) for casualty lines and $41 million (17%) for property lines.

Net premiums written were $5,500 million in 2013, an increase of 12% from $4,899 million in 2012. Ceded reinsurance premiums as a percentage of gross written premiums were 16% in 2013 and 15% in 2012. The increase in the percentage of business ceded was due to changes in the reinsurance terms and costs.

Premiums earned increased 12% to $5,227 million in 2013 from $4,674 million in 2012. Insurance premiums (including the impact of rate changes) are generally earned evenly over the policy term, and accordingly we expect recent rate increases will be earned over the upcoming quarters. Premiums earned in 2013 are related to business written during both 2013 and 2012. Audit premiums were $120 million in 2013 compared with $89 million in 2012.

Net Investment Income. Following is a summary of net investment income for the years ended December 31, 2013 and 2012:

	Amount								Average Annualized Yield
(In thousands)	2013				2012				2013			2012
Fixed maturity securities, including cash and cash equivalents and loans receivable	$	442,287			$	479,035			3.5	%		3.7	%
Investment funds	67,712				77,015				8.0			11.4
Arbitrage trading account	20,431				8,286				4.2			2.8
Real estate	12,498				12,097				2.0			3.0
Equity securities available for sale	11,380				16,419				3.8			4.4
Gross investment income	554,308				592,852				3.7			4.1
Investment expenses	(10,017		)		(6,089		)
Total	$	544,291			$	586,763			3.7	%		4.0	%

Net investment income decreased 7% to $544 million in 2013 from $587 million in 2012 primarily due to a decrease in income from fixed maturity securities. The average annualized yield for fixed maturity securities declined from 3.7% to 3.5% due to lower long-term reinvestment yields available in the market and to a shortening of the average duration of the fixed maturity portfolio from 3.4 years at December 31, 2012 to 3.3 years at December 31, 2013. Average invested assets, at cost (including cash and cash equivalents) were $14.8 billion in 2013 and $14.5 billion in 2012.

Insurance Service Fees. The Company is a servicing carrier of workers' compensation assigned risk plans for 20 states and provides insurance program management services to self-insureds, captives, governmental entities, risk retention groups, and insurance companies. Service fees were $108 million in 2013, up from $103 million in 2012, primarily as a result of an increase in fees from assigned risk plans.

Net Realized Gains on Investment Sales. The Company buys and sells securities on a regular basis in order to maximize its total return on investments. Decisions to sell securities are based on management’s view of the underlying fundamentals of specific securities as well as management’s expectations regarding interest rates, credit spreads, currency values and general economic conditions. Net realized gains on investment sales were $128 million in 2013 compared with $201 million in 2012.

Other-Than-Temporary Impairments. The cost of securities is adjusted where appropriate to include a provision for a decline in value that is considered to be other-than-temporary. Other-than-temporary impairments were $6 million in 2013 and $5 million in 2012.

For loans where the Company determines it is probable that the contractual terms will not be met, an analysis is performed and a valuation reserve is established, if necessary, with a charge to earnings. In 2012, the valuation allowance for mortgage loans decreased by $14 million. There was no change to the valuation allowance in 2013.

Revenues from Wholly-Owned Investees. Revenues from wholly-owned investees were derived from aviation-related businesses that provide services to the general aviation market, including fuel and line service, aircraft sales and maintenance, avionics and engineering services and parts fabrication. Revenues from wholly-owned investees increased to $408 million in 2013 from $247 million in 2012, primarily as a result of the acquisition of an aircraft equipment supplier in January 2013.

Losses and Loss Expenses. Losses and loss expenses increased to $3,197 million in 2013 from $2,948 million in 2012. The consolidated loss ratio was 61.2% in 2013 and 63.1% in 2012. Catastrophe losses, net of reinsurance recoveries and reinstatement premiums, were $65 million in 2013 compared with $80 million in 2012, a decrease of 0.5 loss ratio points. Favorable prior year reserve development (net of premium offsets) was $98 million in 2013 compared with $103 million in 2012, a difference of 0.3 loss ratio points. The loss ratio excluding catastrophe losses and prior year reserve development decreased 1.8 points to 61.8% in 2013 from 63.6% in 2012. A summary of loss ratios in 2013 compared with 2012 by business segment follows:

•

Insurance-Domestic - The loss ratio of 61.3% in 2013 was 2.2 points lower than the loss ratio of 63.5% in 2012. Catastrophe losses were $38 million in 2013 compared with $43 million in 2012, a decrease of 0.2 loss ratio points. Favorable prior year reserve development was $71 million in 2013 compared with $66 million in 2012. The loss ratio excluding catastrophe losses and prior year reserve development decreased 2.0 points to 62.2% in 2013 from 64.2% in 2012.

•

Insurance-International - The loss ratio of 59.4% in 2013 was 0.3 points lower than the loss ratio of 59.7% in 2012. Catastrophe losses were $11 million in 2013 compared with $14 million in 2012, a decrease of 0.6 loss ratio points. Adverse prior year reserve development was $12 million in 2013 compared with none in 2012, a difference of 1.7 loss ratio points. The loss ratio excluding catastrophe losses and prior year reserve development decreased 1.4 points to 56.1% in 2013 from 57.5% in 2012.

•

Reinsurance-Global - The loss ratio of 62.2% in 2013 was 2.1 points lower than the loss ratio of 64.3% in 2012. Catastrophe losses were $16 million in 2013 compared with $23 million in 2012, a decrease of 1.4 loss ratio points. Favorable prior year reserve development was $46 million in 2013 compared with $37 million in 2012, a difference of 0.4 loss ratio points. The loss ratio excluding catastrophe losses and prior year reserve development decreased 1.1 points to 65.4% in 2013 from 66.5% in 2012.

Other Operating Costs and Expenses. Following is a summary of other operating costs and expenses:

(In thousands)	2013				2012
Underwriting expenses	$	1,771,128			$	1,592,746
Service expenses	88,662				84,986
Net foreign currency gains	(10,120		)		(6,092		)
Debt extinguishment costs	6,709				—
Other costs and expenses	144,305				127,983
Total	$	2,000,684			$	1,799,623

Underwriting expenses are comprised of commissions paid to agents and brokers, premium taxes and other assessments and internal underwriting costs. Underwriting expenses increased 11% compared with an increase in net premiums earned of 12%. The expense ratio (underwriting expenses expressed as a percentage of premiums earned) was 33.9% in 2013 and 34.1% in 2012. We expect our expense ratio to further improve if insurance prices continue to increase at current levels.

Service expenses, which represent the costs associated with the fee-based businesses, increased 4% to $89 million. The increase was due to an increase in general and administrative expenses related to fee-based business.

Net foreign currency gains of $10 million in 2013 (compared with $6 million in 2012) resulted from transactions denominated in a currency other than the operating unit’s functional currency.

Debt extinguishment costs of $7 million in 2013 related to the prepayment of subordinated debentures that were due in 2045 and were prepaid in May 2013.

Other costs and expenses represent general and administrative expenses of the parent company and other expenses not allocated to business segments, including the cost of certain long-term incentive plans. Other costs and expenses increased to $144 million in 2013 from $128 million in 2012 due primarily to an increase in compensation costs.

Expenses from Wholly-Owned Investees. Expenses from wholly-owned investees represent costs associated with aviation-related businesses that include cost of goods sold related to aircraft and other sales, labor and equipment costs related to repairs and other services and general and administrative expenses. Expenses from wholly-owned investees were $389 million in 2013 compared to $247 million in 2012, primarily as a result of the acquisition of an aircraft equipment supplier in January 2013.

Interest Expense. Interest expense was $123 million in 2013 compared with $126 million in 2012. The Company issued $350 million of 4.625% senior notes in March 2012 and repaid $200 million of 5.875% senior notes that matured in February 2013. In May 2013, the Company issued $350 million of 5.625% subordinated debentures due 2053 and prepaid $250 million of 6.750% subordinated debentures that were due in 2045.

Income Taxes. The effective income tax rate was 28% in 2013 compared to 27% in 2012. The effective income tax rate differs from the federal income tax rate of 35% primarily because of tax-exempt investment income. Tax exempt investment income comprised a lower portion of the 2013 pre-tax income and as such had a lesser impact on the effective tax rate for 2013 compared with 2012.

The Company has not provided U.S. deferred income taxes on the undistributed earnings of approximately $103 million of its non-U.S. subsidiaries since these earnings are intended to be permanently reinvested in the non-U.S. subsidiaries. However, in the future, if such earnings were distributed to the Company, taxes of approximately $9 million, assuming all tax credits are realized, would be payable on such undistributed earnings and would be reflected in the tax provision for the year in which these earnings are no longer intended to be permanently reinvested in the foreign subsidiary.

Results of Operations for the Years Ended December 31, 2012 and 2011

Following is a summary of gross and net premiums written, net premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of net premiums earned), expense ratios (underwriting expenses expressed as a percentage of net premiums earned) and GAAP combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the years ended December 31, 2012 and 2011. The GAAP combined ratio represents a measure of underwriting profitability, excluding investment income. A GAAP combined ratio in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit.

(In thousands)	2012				2011
Insurance-Domestic
Gross premiums written	$	4,261,165			$	3,794,862
Net premiums written	3,569,883				3,238,120
Net premiums earned	3,417,022				3,121,281
Loss ratio	63.5		%		64.9		%
Expense ratio	32.5				32.6
GAAP combined ratio	96.0				97.5
Insurance-International
Gross premiums written	$	802,057			$	681,424
Net premiums written	664,459				551,910
Net premiums earned	631,841				508,509
Loss ratio	59.7		%		57.4		%
Expense ratio	40.2				42.7
GAAP combined ratio	99.9				100.1
Reinsurance-Global
Gross premiums written	$	716,657			$	601,027
Net premiums written	664,197				567,338
Net premiums earned	624,653				531,077
Loss ratio	64.3		%		64.3		%
Expense ratio	36.3				38.0
GAAP combined ratio	100.6				102.3
Consolidated
Gross premiums written	$	5,779,879			$	5,077,313
Net premiums written	4,898,539				4,357,368
Net premiums earned	4,673,516				4,160,867
Loss ratio	63.1		%		63.9		%
Expense ratio	34.1				34.6
GAAP combined ratio	97.2				98.5

Net Income to Common Stockholders. The following table presents the Company’s net income to common stockholders and net income per diluted share for the years ended December 31, 2012 and 2011.

(In thousands, except per share data)	2012				2011
Net income to common stockholders	$	510,592			$	391,211
Weighted average diluted shares	143,315				145,672
Net income per diluted share	$	3.56			$	2.69

The Company reported net income of $511 million in 2012 compared to $391 million in 2011. The increase in net income was primarily due to an increase in after-tax net investment gains of $55 million, an increase in after-tax underwriting income of $44 million and an increase in after-tax net investment income of $36 million. The number of weighted average diluted shares decreased as a result of the Company’s repurchases of its common stock in 2012 and 2011.

Premiums. Gross premiums written were $5,780 million in 2012, an increase of 14% from $5,077 million in 2011. The growth was due to a combination of rate increases and increased exposures, including expansion into new geographic and product markets. Approximately 78.3% of policies expiring in 2012 were renewed, compared with a 80.1% renewal retention rate for policies expiring in 2011. The average rate (i.e., average premium adjusted for change in exposures) for policies that renewed in 2012 increased 6.4%. Audit premiums were $89 million in 2012 compared with $53 million in 2011.

From 2005 through 2010, the property casualty insurance market was highly competitive and insurance rates decreased across most business lines. Prices began to increase in 2011, and the rate of increase accelerated in 2012. However, overall loss costs are also generally increasing, and current market price levels for certain lines of business remain below the prices required for the Company to achieve its long-term return objectives. A summary of gross premiums written in 2012 compared with 2011 by line of business within each business segment follows:

•	Insurance-Domestic premiums increased 12% to $4,261 million in 2012 from $3,795 million in 2011. Gross premiums increased $184 million (19%) for workers' compensation, $125 million (11%) for other liability, $107 million (12%) for short-tail lines, $31 million (10%) for professional liability and $19 million (4%) for commercial auto.

•	Insurance-International gross premiums increased 18% to $802 million in 2012 from $681 million in 2011. Gross premiums increased $115 million (41%) for short-tail lines, $10 million (7%) for commercial auto, $8 million (11%) for workers' compensation and $1 million (1%) for professional liability and decreased $13 million (18%) for other liability.

•	Reinsurance-Global gross premiums increased 19% to $717 million in 2012 from $601 million in 2011. Gross premiums written increased $62 million (35%) for casualty business and $54 million (13%) for property lines.

Net premiums written were $4,899 million in 2012, an increase of 12% from $4,357 million in 2011. Ceded reinsurance premiums as a percentage of gross written premiums were 15% in 2012 and 14% in 2011. The increase in the percentage of business ceded was due to changes in the reinsurance terms and costs.

Premiums earned increased 12% to $4,674 million in 2012 from $4,161 million in 2011. Insurance premiums (including the impact of rate changes) are generally earned evenly over the policy term, and accordingly we expect to recognize recent rate increases over the upcoming quarters. Premiums earned in 2012 are related to business written during both 2012 and 2011.

Net Investment Income. Following is a summary of net investment income for the years ended December 31, 2012 and 2011:

	Amount								Average Annualized Yield
(In thousands)	2012				2011				2012			2011
Fixed maturity securities, including cash and cash equivalents and loans receivable	$	479,035			$	483,905			3.7	%		4.0	%
Investment funds	77,015				9,452				11.4			1.6
Equity securities available for sale	16,419				12,416				4.4			3.5
Real estate	12,097				7,471				3.0			4.3
Arbitrage trading account	8,286				16,576				2.8			4.9
Gross investment income	592,852				529,820				4.1			3.9
Investment expenses	(6,089		)		(3,469		)
Total	$	586,763			$	526,351			4.0			3.9

Net investment income increased 12% to $587 million in 2012 from $526 million in 2011. The increase in investment income was primarily due to an increase in income from energy and real estate funds (investment funds are reported on a one quarter lag). The average annualized yield for fixed maturity securities declined from 4.0% to 3.7% due to lower long-term reinvestment yields available in the market. Average invested assets, at cost (including cash and cash equivalents) were $14.5 billion in 2012 and $13.6 billion in 2011.

Insurance Service Fees. The Company is a servicing carrier of workers' compensation assigned risk plans for 20 states and provides insurance program management services to self-insureds, captives, governmental entities, risk retention groups, and insurance companies. Service fees were $103 million in 2012, up from $93 million in 2011, primarily as a result of an increase in fees from assigned risk plans.

Net Realized Gains on Investment Sales. The Company buys and sells securities on a regular basis in order to maximize its total return on investments. Decisions to sell securities are based on management’s view of the underlying fundamentals of specific securities as well as management’s expectations regarding interest rates, credit spreads, currency values and general economic conditions. Net realized gains on investment sales were $201 million in 2012 compared with $126 million in 2011. Investment gains in 2012 were related primarily to the sale of a private equity investment and equity securities.

Other-Than-Temporary Impairments. The cost of securities is adjusted where appropriate to include a provision for a decline in value that is considered to be other-than-temporary. Other-than-temporary impairments were $5 million in 2012 compared with $0.4 million in 2011.

For loans where the Company determines it is probable that the contractual terms will not be met, an analysis is performed and a valuation reserve is established, if necessary, with a charge to earnings. In 2012, the valuation allowance for mortgage loans decreased by $14 million.

Revenues from Wholly-Owned Investees. Revenues from wholly-owned investees were derived from aviation-related businesses that provide services to the general aviation market, including fuel and line service, aircraft sales and maintenance, avionics and engineering services and parts fabrication. Revenues from wholly-owned investees decreased to $247 million in 2012 from $249 million in 2011, primarily as a result of lower aircraft sales.

Losses and Loss Expenses. Losses and loss expenses increased to $2,948 million in 2012 from $2,658 million in 2011. The consolidated loss ratio was 63.1% in 2012 and 63.9% in 2011. Catastrophe losses, net of reinsurance recoveries and reinstatement premiums, were $80 million in 2012 compared with $153 million in 2011, a decrease of 2.0 loss ratio points. Favorable prior year reserve development was $103 million in 2012 compared with $182 million in 2011, a difference of 2.2 loss ratio points. The loss ratio excluding catastrophe losses and prior year reserve development decreased 1.0 point to 63.6% in 2012 from 64.6% in 2011. A summary of loss ratios in 2012 compared with 2011 by business segment follows:

•

Insurance-Domestic - The loss ratio of 63.5% in 2012 was 1.4 points lower than the loss ratio of 64.9% in 2011. Catastrophe losses were $43 million in 2012 compared with $104 million in 2011, a decrease of 2.1 loss ratio points. Favorable prior year reserve development was $66 million in 2012 compared with $146 million in 2011, a difference of 2.7 loss ratio points. The loss ratio excluding catastrophe losses and prior year reserve development decreased 2.0 points to 64.2% in 2012 from 66.2% in 2011.

•

Insurance-International - The loss ratio of 59.7% in 2012 was 2.3 points higher than the loss ratio of 57.4% in 2011. Catastrophe losses were $14 million in 2012 and in 2011, a decrease of 0.5 loss ratio points. There was no prior year reserve development in 2012 compared with favorable reserve development of $10 million in 2011, a difference of 2.0 loss ratio points. The loss ratio excluding catastrophe losses and prior year reserve development increased 0.8 points to 57.5% in 2012 from 56.7% in 2011.

•

Reinsurance-Global - The loss ratio was 64.3% in 2012 and 2011. Catastrophe losses were $23 million in 2012 compared with $35 million in 2011, a decrease of 2.9 loss ratio points. Favorable prior year reserve development was $37 million in 2012 compared with $26 million in 2011, a difference of 1.0 loss ratio point. The loss ratio excluding catastrophe losses and prior year reserve development increased 3.9 points to 66.5% in 2012 from 62.6% in 2011.

Other Operating Costs and Expenses. Following is a summary of other operating costs and expenses:

(In thousands)	2012				2011
Underwriting expenses	$	1,592,746			$	1,438,129
Service expenses	84,986				75,231
Net foreign currency gains	(6,092		)		(1,884		)
Other costs and expenses	127,983				115,050
Total	$	1,799,623			$	1,626,526

Underwriting expenses are comprised of commissions paid to agents and brokers, premium taxes and other assessments and internal underwriting costs. Underwriting expenses increased 11% compared with an increase in net premiums earned of 12%. The expense ratio (underwriting expenses expressed as a percentage of premiums earned) was 34.1% in 2012 and 34.6% in 2011.

Service expenses, which represent the costs associated with the fee-based businesses, increased 13% to $85 million. The increase was due to an increase in general and administrative expenses related to fee-based business.

Net foreign currency gains of $6 million (compared with $2 million in 2011) resulted from transactions denominated in a currency other than the operating unit’s functional currency.

Other costs and expenses were $128 million in 2012 compared with $115 million in 2011. Other costs and expenses represent general and administrative expenses of the parent company and other expenses not allocated to business segments, including the cost of certain long-term incentive plans.

Expenses from Wholly-Owned Investees. Expenses from wholly-owned investees represent costs associated with aviation-related businesses that include cost of goods sold related to aircraft and other sales, labor and equipment costs related to repairs and other services and general and administrative expenses. Expenses from wholly-owned investees were $247 million in 2012 compared to $245 million in 2011.

Interest Expense. Interest expense was $126 million in 2012 compared with $113 million in 2011 due to the issuance of $350 million of 4.625% senior notes in March 2012.

Income Taxes. The effective income tax rate was 27% in 2012 compared to 24% in 2011. The effective income tax rate differs from the federal income tax rate of 35% primarily because of tax-exempt investment income. Tax exempt investment income comprised a lower portion of the 2012 pre-tax income and as such had a lesser impact on the effective tax rate for 2012 compared with 2011.

The Company has not provided U.S. deferred income taxes on the undistributed earnings of approximately $98 million of its non-U.S. subsidiaries since these earnings are intended to be permanently reinvested in the non-U.S. subsidiaries. However, in the future, if such earnings were distributed to the Company, taxes of approximately $8 million, assuming all tax credits are realized, would be payable on such undistributed earnings and would be reflected in the tax provision for the year in which these earnings are no longer intended to be permanently reinvested in the foreign subsidiary.

Investments

As part of its investment strategy, the Company establishes a level of cash and highly liquid short-term and intermediate-term securities that, combined with expected cash flow, it believes is adequate to meet its payment obligations.

The Company also attempts to maintain an appropriate relationship between the average duration of the investment portfolio and the approximate duration of its liabilities (i.e., policy claims and debt obligations). The average duration of the investment portfolio was 3.3 years and 3.4 years at December 31, 2013 and 2012, respectively. The Company’s investment portfolio and investment-related assets as of December 31, 2013 were as follows:

(In thousands)	Carrying Value				Percent of Total
Fixed maturity securities:
U.S. government and government agencies	$	884,859			6	%
State and municipal:
Special revenue	2,142,867				15
State general obligation	757,652				5
Pre-refunded (1)	626,601				4
Corporate backed	430,961				3
Local general obligation	329,132				2
Total state and municipal	4,287,213				29
Mortgage-backed securities:
Agency	993,889				7
Commercial	81,136				1
Residential-Prime	187,871				1
Residential-Alt A	94,280				1
Total mortgage-backed securities	1,357,176				10
Corporate:
Industrial	1,533,935				11
Asset-backed	1,266,386				9
Financial	1,108,048				8
Utilities	194,437				1
Other	104,933				1
Total corporate	4,207,739				30
Foreign government	879,857				6
Total fixed maturity securities	11,616,844				81
Equity securities available for sale:
Common stocks	160,775				1
Preferred stocks	122,563				1
Total equity securities available for sale	283,338				2
Investment funds	1,067,495				7
Real estate	715,242				5
Arbitrage trading account	522,128				3
Loans receivable	343,583				2
Total investments	$	14,548,630			100	%

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(1)	Pre-refunded securities are securities for which an escrow account has been established to fund the remaining payments of principal and interest through maturity. Such escrow accounts are funded almost exclusively with U.S. Treasury and U.S. government agency securities.

Fixed Maturity Securities. The Company’s investment policy with respect to fixed maturity securities is generally to purchase instruments with the expectation of holding them to their maturity. However, management of the available for sale portfolio is considered necessary to maintain an approximate matching of assets and liabilities as well as to adjust the portfolio as a result of changes in financial market conditions and tax considerations.

The Company’s philosophy related to holding or selling fixed maturity securities is based on its objective of maximizing total return. The key factors that management considers in its investment decisions as to whether to hold or sell fixed maturity securities are its view of the underlying fundamentals of specific securities as well as its expectations regarding interest rates, credit spreads and currency values. In a period in which management expects interest rates to rise, the Company may sell longer duration securities in order to mitigate the impact of an interest rate rise on the fair value of the portfolio. Similarly, in a period in which management expects credit spreads to widen, the Company may sell lower quality securities, and in a period in which management expects certain foreign currencies to decline in value, the Company may sell securities denominated in those foreign currencies. The sale of fixed maturity securities in order to achieve the objective of maximizing total return may result in realized gains; however, there is no reason to expect these gains to continue in future periods.

At December 31, 2013, investments in foreign government fixed maturity securities were as follows:

(In thousands)	Carrying Value
Australia	$	256,413
Canada	157,094
United Kingdom	132,549
Argentina	116,062
Germany	67,422
Brazil	53,949
Norway	53,206
Supranational (1)	33,083
Singapore	6,762
Uruguay	3,317
Total	$	879,857

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(1) Supranational represents investments in the North American Development Bank, European Investment Bank and International Bank for Reconstruction & Development.

Equity Securities Available for Sale. Equity securities available for sale primarily represent investments in high-dividend yielding common and preferred stocks issued by large market capitalization companies.

Investment Funds. At December 31, 2013, the carrying value of investment funds was $1,067 million, including investments in real estate funds of $378 million, hedged equity funds of $272 million and investments in energy funds of $155 million. Investment funds are reported on a one-quarter lag.

Real Estate. Real estate is directly owned property held for investment. At December 31, 2013, real estate consists of one office building in operation, two office buildings and a mixed-use project under development and a long-term ground lease.

Arbitrage Trading Account. The arbitrage trading account is comprised of direct investments in arbitrage securities. Merger arbitrage is the business of investing in the securities of publicly held companies that are the targets in announced tender offers and mergers.

Loans Receivable. Loans receivable, which are carried at amortized cost, have an aggregate cost of $344 million and an aggregate fair value of $347 million at December 31, 2013. Amortized cost of these loans is net of a valuation allowance of $2 million as of December 31, 2013. The real estate loans earn interest at floating LIBOR-based interest rates and have maturities (inclusive of extension options) through August 2025. These loans are secured by commercial real estate primarily located in Arizona, California, Hawaii, Illinois, New York and Texas. The commercial loans are with small business owners who have secured the related financing with the assets of the business. These loans generally earn interest on a fixed basis and have varying maturities not exceeding ten years.

Liquidity and Capital Resources

Cash Flow. Cash flow provided from operating activities increased to $820 million in 2013 from $675 million in 2012. The increase in cash flow was due primarily to an increase in cash flow from underwriting activities (premiums collected less losses, loss expenses and underwriting expenses paid) partially offset by an increase in income taxes paid. and a decrease in investment income received. Paid losses as a percent of earned premiums were 55% in 2013 compared with 58.0% in 2012.

As a holding company, the Company derives cash from its subsidiaries in the form of dividends, tax payments and management fees. Maximum amounts of dividends that our insurance companies can pay without regulatory approval are prescribed by statute. During 2014, the maximum amount of dividends which can be paid without regulatory approval is approximately $491 million. The ability of the holding company to service its debt obligations is limited by the ability of its insurance subsidiaries to pay dividends. In the event dividends, tax payments and management fees available to the holding company were inadequate to service its debt obligations, the Company would need to raise capital, sell assets or restructure its debt obligations.

The Company's insurance subsidiaries' principal sources of cash are premiums, investment income, service fees and proceeds from sales and maturities of portfolio investments. The principal uses of cash are payments for claims, taxes, operating expenses and dividends. The Company expects its insurance subsidiaries to fund the payment of losses with cash received from premiums, investment income and fees. The Company generally has targeted an average duration for its investment portfolio that is within one year of the average duration of its liabilities so that portions of its investment portfolio mature throughout the claim cycle and are available for the payment of claims if necessary. In the event operating cash flow and proceeds from maturities and prepayments of fixed income securities are not sufficient to fund claim payments and other cash requirements, the remainder of the Company's cash and investments is available to pay claims and other obligations as they become due. The Company's investment portfolio is highly liquid, with approximately 80% invested in cash, cash equivalents and marketable fixed income securities as of December 31, 2013. If the sale of fixed maturity securities were to become necessary, a realized gain or loss equal to the difference between the cost and sales price of securities sold would be recognized.

Debt. At December 31, 2013, the Company had senior notes, subordinated debentures and other debt outstanding with a carrying value of $2,032 million and a face amount of $2,054 million. The maturities of the outstanding debt are $5 million in 2014, $240 million in 2015, $30 million in 2016, $1 million in 2018, $450 million in 2019, $300 million in 2020, $426 million in 2022, $1 million in 2023, $1 million in 2029, $250 million in 2037 and $350 million in 2053.

The Company issued $350 million of 4.625% senior notes in March 2012 and repaid $200 million of 5.875% senior notes that matured in February 2013. In May 2013, the Company issued $350 million of 5.625% subordinated debentures due 2053 and prepaid $250 million of 6.75% subordinated debentures that were due in 2045.

Equity. The Company repurchased shares 3,924,355, 3,428,175 and 5,218,097 shares of its common stock in 2013, 2012 and 2011, respectively. The aggregate cost of the repurchases was $127 million in 2013, $128 million in 2012 and $157 million in 2011. At December 31, 2013, total common stockholders’ equity was $4.3 billion, common shares outstanding were 132,233,167, and stockholders’ equity per outstanding share was $32.79.

Total Capital. Total capitalization (equity, senior notes and other debt and junior subordinated debentures) was $6.4 billion at December 31, 2013. The percentage of the Company’s capital attributable to senior notes, junior subordinated debentures and other debt was 32% at December 31, 2013 and 33% at December 31, 2012.

Federal and Foreign Income Taxes

The Company files a consolidated income tax return in the U.S. and foreign tax returns in each of the countries in which it has overseas operations. At December 31, 2013, the Company had a deferred gross tax asset of $431 million (which primarily relates to loss and loss expense reserves and unearned premium reserves) and a gross deferred tax liability of $411 million (which primarily relates to deferred policy acquisition costs and unrealized investment gains). The realization of the deferred tax asset is dependent upon the Company's ability to generate sufficient taxable income in future periods. Based on historical results and the prospects for future operations, management anticipates that it is more likely than not that future taxable income will be sufficient for the realization of this asset.

The Company has not provided U.S. deferred income taxes on the undistributed earnings of approximately $103 million of its non-U.S. subsidiaries since these earnings are intended to be permanently reinvested in the non-U.S. subsidiaries. However, in the future, if such earnings were distributed to the Company, taxes of approximately $9 million, assuming all tax credits are realized, would be payable on such undistributed earnings and would be reflected in the tax provision for the year in which these earnings are no longer intended to be permanently reinvested in the foreign subsidiary.

Reinsurance

The Company follows customary industry practice of reinsuring a portion of its exposures in exchange for paying reinsurers a part of the premiums received on the policies it writes. Reinsurance is purchased by the Company principally to reduce its net liability on individual risks and to protect it against catastrophic losses. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, it does make the assuming reinsurer liable to the insurer to the extent of the reinsurance coverage. The Company monitors the financial condition of its reinsurers and attempts to place its coverages only with substantial and financially sound carriers. Reinsurance coverage and retentions vary depending on the line of business, location of the risk and nature of loss. The Company’s reinsurance purchases include the following:

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Property reinsurance treaties - The Company purchases property reinsurance to reduce its exposure to large individual property losses and catastrophe events. Following is a summary of significant property reinsurance treaties in effect as of January 1, 2014: The Company’s property per risk reinsurance generally covers losses between $2 million and $50 million. The Company’s catastrophe excess of loss reinsurance program provides protection for net losses between $30 million and $205 million for the majority of primary business written by its U.S. companies. The Company has separate catastrophe excess of loss reinsurance for business written through Lloyd’s that provides protection for losses between $20 million and $95 million for events in North America. The Company does not generally purchase significant catastrophe reinsurance for its assumed reinsurance business. The Company’s catastrophe reinsurance agreements are subject to certain limits, exclusions and reinstatement premiums.

•

Casualty reinsurance treaties - The Company purchases casualty reinsurance to reduce its exposure to large individual casualty losses, workers’ compensation catastrophe losses and casualty losses involving multiple claimants or insureds. A significant casualty treaty in effect as of January 1, 2014 provides protection for losses from single events with claims from two or more claimants or insureds. This treaty provides protection for losses between $2.5 million and $65 million for casualty business. For primary workers’ compensation business, coverage is generally in place for losses between $5 million and $125 million. For excess workers’ compensation business, coverage is generally in place for losses between $25 million and $195 million.

•	Facultative reinsurance - The Company also purchases facultative reinsurance on certain individual policies or risks that are in excess of treaty reinsurance capacity.

•	Other reinsurance - Depending on the operating unit, the Company purchases specific additional reinsurance to supplement the above programs.

The Company places most of its significant casualty treaties on a “risk attaching” basis. Under risk attaching treaties, all claims from policies incepting during the period of the reinsurance contract are covered even if they occur after the expiration date of the reinsurance contract. If the Company is unable to renew or replace its existing reinsurance coverage, protection for unexpired policies would remain in place until their expiration. In such case, the Company could revise its underwriting strategy for new business to reflect the absence of reinsurance protection. Property catastrophe and workers’ compensation catastrophe reinsurance is generally placed on a “losses occurring basis,” whereby only claims occurring during the period are covered. If the Company is unable to renew or replace this reinsurance coverage, unexpired policies would not be protected.

Following is a summary of earned premiums and loss and loss expenses ceded to reinsurers for each of the three years ended December 31, 2013:

	Years Ended December 31,
(In thousands)	2013				2012				2011
Earned premiums	$	959,537			$	821,347			$	673,003
Losses and loss expenses	556,108				528,018				458,249

Ceded earned premiums increased 17% in 2013 to $960 million. The increase was higher than the increase in direct and assumed earned premiums of 13% due primarily to growth in assigned risk plan business, which is fully reinsured, and to an increase in ceded premiums for professional liability business. The ceded losses and loss expenses ratio decreased 6.3 points to 58.0% in 2013 from 64.3% in 2012. Ceded loss and loss adjustment expenses in 2012 included $134 million of reinsurance loss recoveries related to Superstorm Sandy.

The following table presents the credit quality of amounts due from reinsurers as of December 31, 2013. Amounts due

from reinsurers are net of reserves for uncollectible reinsurance of $1 million in the aggregate.

(In thousands)
Reinsurer		Rating	(1)		Amount
Amounts due in excess of $25 million:
Munich Re		AA-			$	193,405
Lloyd's of London		A+			117,059
Swiss Re		AA-			104,096
Alleghany Group		A+			96,348
Partner Re		A+			67,116
Axis Capital		A+			65,580
Berkshire Hathaway		A++			53,118
Ace Group		AA-			46,413
Hannover Re Group		AA-			35,607
Everest Re		A+			29,253
Arch Capital Group		A+			25,782
Other reinsurers:
Rated A- or better					157,196
Secured (2)					42,489
All others					31,140
Subtotal					1,064,602
Residual market pools (3)					468,501
Total					$	1,533,103

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(1) S&P rating, or if not rated by S&P, A.M. Best rating.

(2) Secured by letters of credit or other forms of collateral.

(3) Many states require licensed insurers that provide workers' compensation insurance to participate in programs that provide workers' compensation to employers that cannot procure coverage from an insurer on a voluntary basis. Insurers can fulfill this residual market obligation by participating in pools where results are shared by the participating companies. The Company acts as a servicing carrier for workers' compensation pools in 20 states. As a servicing carrier, the Company writes residual market business directly and then cedes 100% of this business to the respective pool. As a servicing carrier, the Company receives fee income for its services. The Company does not retain underwriting risk, and credit risk is limited as ceded balances are jointly shared by all the pool members.

Contractual Obligations

Following is a summary of the Company's contractual obligations as of December 31, 2013:

(In thousands)
Estimated Payments By Periods	2014				2015				2016				2017				2018				Thereafter
Gross reserves for losses	$	2,602,112			$	1,754,738			$	1,324,086			$	967,016			$	694,929			$	3,626,607
Operating lease obligations	42,586				39,218				34,009				29,573				24,437				188,609
Purchase obligations	157,620				6,107				5,238				4,221				4,221				20,950
Junior subordinated debentures	—				—				—				—				—				350,000
Debt maturities	4,997				240,208				29,687				—				—				1,428,785
Interest payments	119,036				111,936				106,467				105,743				105,704				1,082,431
Other long-term liabilities	10,277				64,130				4,168				3,884				3,605				43,510
Total	$	2,936,628			$	2,216,337			$	1,503,655			$	1,110,437			$	832,896			$	6,740,892

The estimated payments for reserves for losses and loss expenses in the above table represent the projected (undiscounted) payments for gross loss and loss expense reserves related to losses incurred as of December 31, 2013. The estimated payments in the above table do not consider payments for losses to be incurred in future periods. These amounts include reserves for reported losses and reserves for incurred but not reported losses. Estimated amounts recoverable from reinsurers are not reflected. The estimated payments by year are based on historical loss payment patterns. The actual payments may differ from the estimated amounts due to changes in ultimate loss reserves and in the timing of the settlement of those reserves. In addition, as of December 31, 2013, the Company had commitments to invest up to $249 million in certain investment funds. These amounts are not included in the above table.

The Company utilizes letters of credit to back certain reinsurance payments and obligations. Outstanding letters of credit were $13 million as of December 31, 2013. The Company has made certain guarantees to state regulators that the statutory capital of certain subsidiaries will be maintained above certain minimum levels.

Off-Balance Sheet Arrangements

An off-balance sheet arrangement is any transaction, agreement or other contractual arrangement involving an unconsolidated entity under which a company has (1) made guarantees, (2) a retained or contingent interest in transferred assets, (3) an obligation under derivative instruments classified as equity or (4) any obligation arising out of a material variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the Company, or that engages in leasing, hedging or research and development arrangements with the Company. The Company has no arrangements of these types that management believes may have a material current or future effect on our financial condition, liquidity or results of operations.