10-Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 ____________________________________
Form 10-Q
(Mark One)
  þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 31, 2016
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to              
Commission file number: 001-32938
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
(Exact Name of Registrant as Specified in Its Charter)
Switzerland
98-0681223
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification No.)
Gubelstrasse 24, Park Tower, 15th Floor, 6300 Zug, Switzerland
(Address of Principal Executive Offices and Zip Code)

41-41-768-1080
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company ¨
 
 
(Do not check if a smaller reporting company)            
                                                     
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
As of April 11, 2016, 89,660,448 common shares were outstanding.


Table of Contents

TABLE OF CONTENTS
PART I
 
 
 
 
Item 1.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II
 
 
 
 
Item 1.        
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 
 
 
 

-i-

Table of Contents

PART I
FINANCIAL INFORMATION
Item 1.
Financial Statements.
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
as of March 31, 2016 and December 31, 2015
(Expressed in millions, except share and per share amounts)
 
As of
 
As of
 
March 31,
2016
 
December 31,
2015
ASSETS:
 
 
 
Fixed maturity investments trading, at fair value (amortized cost: 2016: $7,595.1; 2015: $7,290.6)
$
7,568.1

 
$
7,201.5

Equity securities trading, at fair value (cost: 2016: $209.4; 2015: $395.3)
202.0

 
403.0

Other invested assets
940.3

 
966.7

Total investments
8,710.4

 
8,571.2

Cash and cash equivalents
772.0

 
608.0

Restricted cash
87.4

 
60.6

Insurance balances receivable
885.4

 
745.9

Funds held
353.2

 
640.8

Prepaid reinsurance
380.3

 
392.3

Reinsurance recoverable
1,512.0

 
1,480.0

Reinsurance recoverable on paid losses
82.7

 
96.4

Accrued investment income
40.1

 
38.3

Net deferred acquisition costs
186.9

 
165.2

Goodwill
389.7

 
388.1

Intangible assets
115.7

 
116.6

Balances receivable on sale of investments
24.6

 
36.9

Net deferred tax assets
25.0

 
24.4

Other assets
162.6

 
147.2

Total assets
$
13,728.0

 
$
13,511.9

LIABILITIES:
 
 
 
Reserve for losses and loss expenses
$
6,575.1

 
$
6,456.2

Unearned premiums
1,796.9

 
1,683.3

Reinsurance balances payable
221.6

 
214.4

Balances due on purchases of investments
148.0

 
125.1

Senior notes:
 
 
 
Principal amount
1,300.0

 
1,300.0

Less unamortized discount and debt issuance costs
6.7

 
7.1

Senior notes, net
1,293.3

 
1,292.9

Other long-term debt
23.3

 
23.0

Accounts payable and accrued liabilities
134.4

 
184.5

Total liabilities
$
10,192.6

 
$
9,979.4

SHAREHOLDERS’ EQUITY:
 
 
 
Common shares: 2016 and 2015: par value CHF 4.10 per share (2016: 94,062,342; 2015: 95,523,230 shares issued and 2016: 89,840,448; 2015: 90,959,635 shares outstanding)
375.1

 
386.7

Treasury shares, at cost (2016: 4,221,894; 2015: 4,563,595)
(146.3
)
 
(155.1
)
Accumulated other comprehensive loss
(6.2
)
 
(9.3
)
Retained earnings
3,312.8

 
3,310.2

Total shareholders’ equity
3,535.4

 
3,532.5

Total liabilities and shareholders’ equity
$
13,728.0

 
$
13,511.9

See accompanying notes to the consolidated financial statements.

1

Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
for the three months ended March 31, 2016 and 2015
(Expressed in millions, except share and per share amounts)
 
 
Three Months Ended 
 March 31,
 
2016
 
2015
REVENUES:
 
 
 
Gross premiums written
$
863.5

 
$
880.6

Premiums ceded
(159.5
)
 
(108.1
)
Net premiums written
704.0

 
772.5

Change in unearned premiums
(123.9
)
 
(204.0
)
Net premiums earned
580.1

 
568.5

Net investment income
53.3

 
44.6

Net realized investment gains
18.9

 
45.0

Other income
0.6

 
0.9

Total revenue
652.9

 
659.0

EXPENSES:
 
 
 
Net losses and loss expenses
372.4

 
325.2

Acquisition costs
88.3

 
78.7

General and administrative expenses
96.4

 
97.1

Other expense
1.1

 
1.8

Amortization of intangible assets
2.5

 
0.6

Interest expense
20.0

 
14.4

Foreign exchange (gain) loss
(3.0
)
 
9.9

Total expenses
577.7

 
527.7

Income before income taxes
75.2

 
131.3

Income tax expense
1.1

 
6.9

NET INCOME
74.1

 
124.4

Other comprehensive income: foreign currency translation adjustment
3.1

 

COMPREHENSIVE INCOME
$
77.2

 
$
124.4

PER SHARE DATA:
 
 
 
Basic earnings per share
$
0.82

 
$
1.30

Diluted earnings per share
$
0.81

 
$
1.27

Weighted average common shares outstanding
90,254,512

 
95,935,551

Weighted average common shares and common share equivalents outstanding
91,559,225

 
97,577,029

Dividends paid per share
$
0.260

 
$
0.225

See accompanying notes to the consolidated financial statements.

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
for the three months ended March 31, 2016 and 2015
(Expressed in millions)
 
 
Share
Capital
 
Treasury
Shares
 
Accumulated
Other
Comprehensive
Loss
 
Retained
Earnings
 
Total
December 31, 2015
$
386.7

 
$
(155.1
)
 
$
(9.3
)
 
$
3,310.2

 
$
3,532.5

Net income

 

 

 
74.1

 
74.1

Dividends

 

 

 
(23.4
)
 
(23.4
)
Stock compensation

 
8.8

 

 
(9.7
)
 
(0.9
)
Share repurchases

 
(50.0
)
 

 

 
(50.0
)
Shares canceled
(11.6
)
 
50.0

 

 
(38.4
)
 

Foreign currency translation adjustment

 

 
3.1

 

 
3.1

March 31, 2016
$
375.1

 
$
(146.3
)
 
$
(6.2
)
 
$
3,312.8

 
$
3,535.4

 
 
 
 
 
 
 
 
 
 
December 31, 2014
$
408.0

 
$
(143.1
)
 
$

 
$
3,513.3

 
$
3,778.2

Net income

 

 

 
124.4

 
124.4

Dividends

 

 

 
(21.5
)
 
(21.5
)
Stock compensation

 
12.3

 

 
(13.4
)
 
(1.1
)
Share repurchases

 
(50.9
)
 

 

 
(50.9
)
Shares canceled
(1.9
)
 
19.4

 

 
(17.5
)
 

March 31, 2015
$
406.1

 
$
(162.3
)
 
$

 
$
3,585.3

 
$
3,829.1

 See accompanying notes to the consolidated financial statements.

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
for the three months ended March 31, 2016 and 2015
(Expressed in millions)
 
Three Months Ended 
 March 31,
 
2016
 
2015
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
 
 
 
Net income
$
74.1

 
$
124.4

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
Net realized gains on sales of investments
(12.0
)
 
(32.5
)
Mark to market adjustments
(27.1
)
 
(22.7
)
Stock compensation expense
3.9

 
4.0

Undistributed income of equity method investments
9.2

 
9.8

Changes in:
 
 
 
Reserve for losses and loss expenses, net of reinsurance recoverables
86.9

 
13.9

Unearned premiums, net of prepaid reinsurance
125.5

 
204.0

Insurance balances receivable
(139.5
)
 
(108.6
)
Reinsurance recoverable on paid losses
13.8

 
(21.0
)
Funds held
287.7

 
244.1

Reinsurance balances payable
7.3

 
4.3

Net deferred acquisition costs
(21.7
)
 
(35.7
)
Net deferred tax assets
(0.6
)
 
3.7

Accounts payable and accrued liabilities
(50.1
)
 
(75.0
)
Other items, net
(9.9
)
 
5.0

Net cash provided by operating activities
347.5

 
317.7

CASH FLOWS USED IN INVESTING ACTIVITIES:
 
 
 
Purchases of trading securities
(1,530.0
)
 
(1,723.4
)
Purchases of other invested assets
(8.1
)
 
(233.3
)
Sales of trading securities
1,414.6

 
1,561.9

Sales of other invested assets
38.7

 
56.5

Purchases of fixed assets
(0.6
)
 
(8.4
)
Net cash paid on acquisition

 
(3.5
)
Change in restricted cash
(26.8
)
 
31.0

Net cash used in investing activities
(112.2
)
 
(319.2
)
CASH FLOWS USED IN FINANCING ACTIVITIES:
 
 
 
Dividends paid
(23.4
)
 
(21.7
)
Proceeds from the exercise of stock options
0.4

 
4.2

Repayment of other long-term debt

(0.1
)
 

Share repurchases
(50.0
)
 
(50.3
)
Net cash used in financing activities
(73.1
)
 
(67.8
)
Effect of exchange rate changes on foreign currency cash
1.8

 
(5.0
)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
164.0

 
(74.3
)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
608.0

 
589.3

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
772.0

 
$
515.0

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for income taxes
$
1.0

 
$
0.7

Cash paid for interest expense
$
18.8

 
$
18.8

See accompanying notes to the consolidated financial statements.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)
1. GENERAL

Allied World Assurance Company Holdings, AG, a Swiss holding company (“Allied World Switzerland”), through its wholly-owned subsidiaries (collectively, the “Company”), is a global provider of a diversified portfolio of property and casualty insurance and reinsurance. References to “$” are to the lawful currency of the United States and to “CHF” are to the lawful currency of Switzerland.

2. BASIS OF PREPARATION AND CONSOLIDATION

These unaudited condensed consolidated financial statements include the accounts of the Company and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with Article 10 of Regulation S-X as promulgated by the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments that are normal and recurring in nature and necessary for a fair presentation of financial position and results of operations as of the end of and for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for a full year.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The significant estimates reflected in the Company’s financial statements, include, but are not limited to:

The premium estimates for certain reinsurance agreements,
Recoverability of deferred acquisition costs,
The reserve for outstanding losses and loss expenses,
Valuation of ceded reinsurance recoverables,
Determination of impairment of goodwill and other intangible assets, and
Valuation of financial instruments.

Intercompany accounts and transactions have been eliminated on consolidation and all entities meeting consolidation requirements have been included in the unaudited condensed consolidated financial statements.

These unaudited condensed consolidated financial statements, including these notes, should be read in conjunction with the Company’s audited consolidated financial statements, and related notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
3. NEW ACCOUNTING PRONOUNCEMENTS
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”). ASU 2014-09 provides a framework, through a five-step process, for recognizing revenue from customers, improves comparability and consistency of recognizing revenue across entities, industries, jurisdictions and capital markets, and requires enhanced disclosures. Certain contracts with customers are specifically excluded from the scope of ASU 2014-09, including, among others, insurance contracts accounted for under Accounting Standard Codification 944, Financial Services - Insurance. ASU 2014-09 is effective on January 1, 2017 with retrospective adoption required for the comparative periods. With the issuance of ASU 2015-14, this standard will be effective on January 1, 2018 with retrospective adoption required for the comparative periods. The Company is currently assessing the impact the adoption of ASU 2014-09 will have on future financial statements and related disclosures.
In May 2015, the FASB issued Accounting Standards Update 2015-09, “Financial Services - Insurance (Topic 944): Disclosures about Short-Duration Contracts” (“ASU 2015-09”). ASU 2015-09 provides enhanced disclosures, on an annual basis, related to the reserve for losses and loss expenses. The enhanced disclosures required by ASU 2015-09 include (1) net incurred and paid claims development information by accident year, (2) a reconciliation of incurred and paid claims development information to the aggregate carrying amount of the reserve for losses and loss expenses, (3) for each accident

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)


year presented of incurred claims development information, the total of reserves for losses incurred but not reported (IBNR), including expected development on reported claims, included in the reserve for losses and loss expenses and a description of the reserving methodologies and changes to the reserving methodologies, and (4) for each accident year presented of incurred claims development information, quantitative information about claims frequency, as well as a description of methodologies used for determining claim frequency information. ASU 2015-09 is effective for annual periods beginning after December 15, 2015, and as such the disclosures will first be presented in the Company's Annual Report on Form 10-K for the year ended December 31, 2016. The Company is currently assessing the impact the adoption of ASU 2015-09 will have on future disclosures.
In January 2016, the FASB issued Accounting Standards Update 2016-01, “Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”). ASU 2016-01 changes current U.S. GAAP for public entities by requiring the following, among others: (1) equity securities, except those accounted for under the equity method of accounting, to be measured at fair value with changes in fair value recognized in net income; (2) the use of the exit price when measuring fair value of financial instruments for disclosure purposes; (3) an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value; and (4) separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or notes to the financial statements. ASU 2016-01 is effective for annual periods beginning after January 1, 2018, including interim periods. Early application is permitted. The Company is currently assessing the impact the adoption of ASU 2016-01 will have on future financial statements and disclosures.
In February 2016, the FASB issued Accounting Standards Update 2016-02, “Leases” (“ASU 2016-02”). ASU 2016-02 changes current U.S. GAAP for lessees to recognize lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous GAAP. ASU 2016-02 is effective for annual periods beginning after January 1, 2019, including interim periods. Early application is permitted. The Company is currently assessing the impact the adoption of ASU 2016-02 will have on future financial statements and disclosures.
In March 2016, the FASB issued Accounting Standards Update 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). ASU 2016-09 modifies U.S. GAAP by requiring the following, among others: (1) all excess tax benefits and tax deficiencies are to be recognized as income tax expense or benefit on the income statement (excess tax benefits are recognized regardless of whether the benefit reduces taxes payable in the current period); (2) excess tax benefits are to be classified along with other income tax cash flows as an operating activity in the statement of cash flows; (3) in the area of forfeitures, an entity can still follow the current U.S. GAAP practice of making an entity-wide accounting policy election to estimate the number of awards that are expected to vest or may instead account for forfeitures when they occur; and (4) classification as a financing activity in the statement of cash flows of cash paid by an employer to the taxing authorities when directly withholding shares for tax withholding purposes. ASU 2016-09 is effective for annual periods beginning after January 1, 2017, including interim periods. Early application is permitted. The Company is currently assessing the impact the adoption of ASU 2016-09 will have on future financial statements and disclosures.



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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)


4. INVESTMENTS

a) Trading Securities

Securities accounted for at fair value with changes in fair value recognized in the unaudited condensed consolidated statements of operations and comprehensive income (“consolidated income statements”) by category are as follows:
 
March 31, 2016
 
December 31, 2015
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
U.S. government and government agencies
$
1,528.0

 
$
1,521.0

 
$
1,434.0

 
$
1,437.9

Non-U.S. government and government agencies
531.4

 
532.3

 
556.8

 
579.2

States, municipalities and political subdivisions
412.9

 
397.6

 
413.5

 
396.0

Corporate debt:
 
 
 
 

 

Financial institutions
1,369.7

 
1,354.2

 
1,275.4

 
1,277.3

Industrials
1,435.6

 
1,440.7

 
1,308.1

 
1,345.6

Utilities
130.6

 
134.9

 
118.9

 
125.4

Mortgage-backed:


 


 


 


Agency mortgage-backed
786.0

 
773.0

 
751.8

 
745.4

Non-agency residential mortgage-backed
30.7

 
29.5

 
34.0

 
32.4

Commercial mortgage-backed
564.8

 
604.6

 
582.8

 
600.1

Asset-backed
778.4

 
807.3

 
726.2

 
751.1

Total fixed maturity investments, trading
$
7,568.1

 
$
7,595.1

 
$
7,201.5

 
$
7,290.6

 
March 31, 2016
 
December 31, 2015
 
Fair Value
 
Original Cost
 
Fair Value
 
Original Cost
Equity securities
$
202.0

 
$
209.4

 
$
403.0

 
$
395.3

Other invested assets
817.0

 
762.7

 
840.2

 
770.9

 
$
1,018.9

 
$
972.1

 
$
1,243.2

 
$
1,166.2


Other invested assets, included in the table above, include investments in private equity funds, hedge funds and a high yield loan fund that are accounted for at fair value, but exclude other private securities described below in Note 4(b) that are accounted for using the equity method of accounting.


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)


b) Other Invested Assets

Details regarding the carrying value, redemption characteristics and unfunded investment commitments of the other invested assets portfolio as of March 31, 2016 and December 31, 2015 were as follows:
Investment Type
Carrying Value as of March 31, 2016
 
Investments
with
Redemption
Restrictions
 
Estimated
Remaining
Restriction
Period
 
Investments
without
Redemption
Restrictions
 
Redemption
Frequency
(1)
 
Redemption
Notice
Period
(1)
 
Unfunded
Commitments
Private equity
$
240.1

 
$
240.1

 
1 - 7 Years
 
$

 
 
 
 
 
$
223.4

Levered credit
209.6

 
209.6

 
4 - 10 Years
 

 
 
 
 
 
217.1

Distressed
5.2

 
5.2

 
2 Years
 

 
 
 
 
 
3.8

Real estate

 

 
7 - 9 Years
 

 
 
 
 
 
250.0

Total private equity
454.9

 
454.9

 
 
 

 
 
 
 
 
694.3

Distressed
216.2

 
56.5

 
2 Years
 
159.7

 
Monthly
 
90 Days
 

Equity long/short
58.8

 

 

 
58.8

 
Quarterly
 
45 Days
 

Relative value credit
87.1

 

 
 
 
87.1

 
Quarterly
 
60 Days
 

Total hedge funds
362.1

 
56.5

 
 
 
305.6

 
 
 
 
 

Total other invested assets at fair value
817.0

 
511.4

 
 
 
305.6

 
 
 
 
 
694.3

Other private securities
123.3

 

 
 
 
123.3

 
 
 
 
 

Total other invested assets
$
940.3

 
$
511.4

 
 
 
$
428.9

 
 
 
 
 
$
694.3


Investment Type
Carrying Value as of December 31, 2015
 
Investments
with
Redemption
Restrictions
 
Estimated
Remaining
Restriction
Period
 
Investments
without
Redemption
Restrictions
 
Redemption
Frequency
(1)
 
Redemption
Notice
Period
(1)
 
Unfunded
Commitments
Private equity (primary and secondary)
$
236.4

 
$
236.4

 
1 - 7 Years
 
$

 
 
 
 
 
$
231.0

Levered credit
205.9

 
205.9

 
4 - 8 Years
 

 
 
 
 
 
179.0

Distressed
5.1

 
5.1

 
2 Years
 

 
 
 
 
 
3.8

Real estate

 

 
7 - 9 Years
 

 
 
 
 
 
200.0

Total private equity
447.4

 
447.4

 
 
 

 
 
 
 
 
613.8

Distressed
215.6

 
54.6

 
2 Years
 
161.0

 
Monthly
 
90 Days
 

Equity long/short
58.0

 

 
 
 
58.0

 
Quarterly
 
45 Days
 

Relative value credit
105.4

 

 
 
 
105.4

 
Quarterly
 
60 Days
 

Total hedge funds
379.0

 
54.6

 
 
 
324.4

 
 
 
 
 

High yield loan fund
13.8

 

 
 
 
13.8

 
Monthly
 
30 Days
 

Total other invested assets at fair value
840.2

 
502.0

 
 
 
338.2

 
 
 
 
 
613.8

Other private securities
126.5

 

 
 
 
126.5

 
 
 
 
 

Total other invested assets
$
966.7

 
$
502.0

 
 
 
$
464.7

 
 
 
 
 
$
613.8

_______________________
(1) 
The redemption frequency and notice periods only apply to the investments without redemption restrictions. Some or all of these investments may be subject to a gate as described below.

In general, the Company has invested in hedge funds that require at least 30 days’ notice of redemption and may be redeemed on a monthly, quarterly, semi-annual, annual or longer basis, depending on the fund. Certain hedge funds have lock-up periods ranging from one to three years from initial investment. A lock-up period refers to the initial amount of time an investor is contractually required to invest before having the ability to redeem. Funds that provide for periodic redemptions may, depending on the funds’ governing documents, have the ability to deny or delay a redemption request, called a “gate.” The

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)


fund may implement this restriction because the aggregate amount of redemption requests as of a particular date exceeds a specified level, generally ranging from 15% to 25% of the fund’s net assets. The gate is a method for executing an orderly redemption process to reduce the possibility of adversely affecting investors in the fund. Typically, the imposition of a gate delays a portion of the requested redemption, with the remaining portion settled in cash sometime after the redemption date. Certain funds may impose a redemption fee on early redemptions. Interests in private equity funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

The following describes each investment type:

Private equity (primary and secondary): Primary equity includes funds that may invest in companies and general partnership interests, as well as direct investments. Secondary funds buy limited partnership interests from existing limited partners of primary private equity funds. As owners of private equity, funds may seek liquidity by selling their existing interests, plus any remaining commitment, to secondary market participants. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the funds.
Levered credit (including mezzanine debt): Levered credit funds invest across the capital structures of upper middle market and middle market companies in connection with leveraged buyouts, mergers and acquisitions, recapitalizations, growth financings, refinancings and other corporate purposes. The most common position in the capital structure of mezzanine funds will be between the senior secured debt holder and the equity; however, the funds in which we are invested may include secured debt, subordinated debt, preferred stock and/or private equity. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the funds.
Distressed funds: In distressed debt investing, managers take positions in the debt of companies experiencing significant financial difficulties, including bankruptcy, or in certain positions of the capital structure of structured securities. The manager relies on the fundamental analysis of these securities, including the claims on the assets and the likely return to bondholders. Certain funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.
Real estate funds: Private real estate funds invest directly (through debt and equity) in commercial real estate (multifamily, industrial, office, student housing and retail) as well as residential property.  Real estate managers have diversified portfolios that generally follow core, core-plus, value-added or opportunistic strategies.  These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.
Equity long/short funds: In equity long/short funds, managers take long positions in companies they deem to be undervalued and short positions in companies they deem to be overvalued. Long/short managers may invest in countries, regions or sectors and vary by their use of leverage and by their targeted net long position.
Relative value credit funds: These funds seek to take exposure to credit-sensitive securities, long and/or short, based upon credit analysis of issuers and securities and credit market views.
High yield loan fund: A long-only private mutual fund that invests in high yield fixed income securities.
Other private securities: These securities mostly include strategic non-controlling minority investments in private asset management companies and other insurance related investments that are accounted for using the equity method of accounting.

Unconsolidated Variable Interest Entities

As a result of the adoption of Accounting Standards Update 2015-02, “Amendments to the Consolidation Analysis”, which became effective January 1, 2016, certain limited partnership investments and similar legal entity investments were considered variable interest entities (“VIE's”) as there were no substantive kick-out or other participating rights. These VIE's will not be consolidated because the Company has determined it is not considered the primary beneficiary, as it does not have both the power to direct the activities that most significantly impact the economic performance of the entity and the obligation to absorb losses of the entity that could be potentially significant to the VIE or the right to receive benefits from the entity that could be potentially significant. As such, the Company continues to record its interests in these entities at fair value, with changes in fair value recorded in the consolidated income statements. The Company's interests in these entities are recorded in “other invested assets” in the unaudited condensed consolidated balance sheets (“consolidated balance sheets”). The Company's maximum

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)


exposure to loss in these entities, which is the sum of the carrying value and the unfunded commitment, was $867.6 million as of March 31, 2016.
 
c) Net Investment Income
 
Three Months Ended 
 March 31,
 
2016
 
2015
Fixed maturity investments
$
48.0

 
$
36.2

Equity securities
1.8

 
3.6

Other invested assets: hedge funds and private equity
4.7

 
8.4

Other invested assets: other private securities
3.1

 
0.9

Cash and cash equivalents
0.5

 
0.5

Expenses
(4.8
)
 
(5.0
)
Net investment income
$
53.3

 
$
44.6


d) Components of Realized Gains and Losses
 
Three Months Ended 
 March 31,
 
2016
 
2015
Gross realized gains on sale of invested assets
$
54.0

 
$
45.3

Gross realized losses on sale of invested assets
(41.9
)
 
(13.0
)
Net realized and unrealized losses on derivatives
(22.9
)
 
(11.6
)
Mark-to-market gains (losses):
 
 
 
Fixed maturity investments, trading
62.3

 
25.5

Equity securities, trading
(15.1
)
 
5.4

Other invested assets, trading
(17.5
)
 
(6.6
)
Net realized investment gains
$
18.9

 
$
45.0


e) Pledged Assets

As of March 31, 2016 and December 31, 2015, $2,703.4 million and $2,748.9 million, respectively, of cash and cash equivalents and investments were deposited, pledged or held in trust accounts in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions, insurance laws and other contract provisions.

In addition, as of March 31, 2016 and December 31, 2015, a further $631.8 million and $579.3 million, respectively, of cash and cash equivalents and investments were pledged as collateral for the Company’s letter of credit facilities. See Note 11(g) to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 for details on the Company’s credit facilities.



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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)


5. DERIVATIVE INSTRUMENTS

As of March 31, 2016 and December 31, 2015, none of the Company’s derivatives were designated as hedges for accounting purposes. The following table summarizes information on the location and amounts of derivative fair values on the consolidated balance sheets:
 
 
March 31, 2016
 
December 31, 2015
 
Asset
Derivative 
Notional
Amount
 
Asset
Derivative 
Fair Value 
 
Liability
Derivative 
Notional
Amount
 
Liability
Derivative 
Fair Value
 
Asset
Derivative 
Notional
Amount
 
Asset
Derivative 
Fair Value
 
Liability
Derivative 
Notional
Amount
 
Liability
Derivative
Fair Value 
Foreign exchange contracts
$
0.1

 
$

 
$
201.3

 
$
5.5

 
$
41.1

 
$
0.1

 
$
244.8

 
$
3.0

Interest rate swaps

 

 
219.2

 
0.5

 

 

 
328.2

 
0.5

Total derivatives
$
0.1

 
$

 
$
420.5

 
$
6.0

 
$
41.1

 
$
0.1

 
$
573.0

 
$
3.5


Derivative assets and derivative liabilities are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

The following table provides the net realized and unrealized gains (losses) on derivatives not designated as hedges recorded on the consolidated income statements:
 
Three Months Ended 
 March 31,
 
2016
 
2015
Foreign exchange contracts
$
2.3

 
$
(7.4
)
Total included in foreign exchange (gain) loss
2.3

 
(7.4
)
Foreign exchange contracts
(14.9
)
 
1.1

Interest rate swaps and futures
(8.0
)
 
(12.7
)
Total included in net realized investment gains
(22.9
)
 
(11.6
)
Total realized and unrealized losses on derivatives
$
(20.6
)
 
$
(19.0
)

Derivative Instruments Not Designated as Hedging Instruments

The Company is exposed to foreign currency risk in its investment portfolio. Accordingly, the fair values of the Company’s investment portfolio are partially influenced by the change in foreign exchange rates. These foreign currency hedging activities have not been designated as specific hedges for financial reporting purposes.

The Company’s insurance and reinsurance subsidiaries and branches operate in various foreign countries and consequently the Company’s underwriting portfolio is exposed to foreign currency risk. The Company manages foreign currency risk by seeking to match liabilities under the insurance policies and reinsurance contracts that it writes and that are payable in foreign currencies with cash and investments that are denominated in such currencies. When necessary, the Company may also use derivatives to economically hedge un-matched foreign currency exposures, specifically forward contracts and currency options.

The Company also purchases and sells interest rate future and interest rate swap contracts to actively manage the duration and yield curve positioning of its fixed income portfolio. Interest rate futures and interest rate swaps can efficiently increase or decrease the overall duration of the portfolio. Additionally, interest rate futures and interest rate swaps can be utilized to obtain the desired position along the yield curve in order to protect against certain future yield curve shapes.

The Company also purchases options to actively manage its equity portfolio.



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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)


6. FAIR VALUE OF FINANCIAL INSTRUMENTS

In accordance with U.S. GAAP, 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. There is a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement date, with quoted market prices being the highest level (Level 1) and unobservable inputs being the lowest level (Level 3). A fair value measurement will fall within the level of the hierarchy based on the input that is significant to determining such measurement. The three levels are defined as follows:
 
Level 1: Observable inputs to the valuation methodology that are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2: Observable inputs to the valuation methodology other than quoted market prices (unadjusted) for identical assets or liabilities in active markets. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical assets in markets that are not active and inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
Level 3: Inputs to the valuation methodology that are unobservable for the asset or liability.

The following table shows the fair value of the Company’s financial instruments and where in the fair value hierarchy the fair value measurements are included as of the dates indicated below:
March 31, 2016
 
Carrying
Amount
 
Total
Fair Value
 
Level 1
 
Level 2
 
Level 3
Fixed maturity investments:
 
 
 
 
 
 
 
 
 
 
U.S. government and government agencies
 
$
1,528.0

 
$
1,528.0

 
$
1,485.5

 
$
42.5

 
$

Non-U.S. government and government agencies
 
531.4

 
531.4

 

 
531.4

 

States, municipalities and political subdivisions
 
412.9

 
412.9

 

 
412.9

 

Corporate debt:
 


 


 
 
 
 
 
 
Financial Institutions
 
1,369.7

 
1,369.7

 

 
1,369.7

 

Industrials
 
1,435.6

 
1,435.6

 

 
1,435.6

 

Utilities
 
130.6

 
130.6

 

 
130.6

 

Mortgage-backed:
 


 


 
 
 
 
 
 
Agency mortgage-backed
 
786.0

 
786.0

 

 
644.9

 
141.1

Non-agency residential mortgage-backed
 
30.7

 
30.7

 

 
25.7

 
5.0

Commercial mortgage-backed
 
564.8

 
564.8

 

 
564.8

 

Asset-backed
 
778.4

 
778.4

 

 
714.8

 
63.6

Total fixed maturity investments
 
7,568.1

 
7,568.1

 
1,485.5

 
5,872.9

 
209.7

Equity securities
 
202.0

 
202.0

 
202.0

 

 

Other invested assets(1)
 
817.0

 
817.0

 

 

 

Total investments
 
$
8,587.1

 
$
8,587.1

 
$
1,687.5

 
$
5,872.9

 
$
209.7

Derivative liabilities:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
5.5

 
$
5.5

 
$

 
$
5.5

 
$

Interest rate swaps
 
0.5

 
0.5

 

 
0.5

 

Senior notes
 
$
1,293.3

 
$
1,350.7

 
$

 
$
1,350.7

 
$

Other long-term debt
 
$
23.3

 
$
29.5

 
$

 
$
29.5

 
$


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)


December 31, 2015
 
Carrying
Amount
 
Total
Fair Value
 
Level 1
 
Level 2
 
Level 3
Fixed maturity investments:
 
 
 
 
 
 
 
 
 
 
U.S. government and government agencies
 
$
1,434.0

 
$
1,434.0

 
$
1,396.4

 
$
37.6

 
$

Non-U.S. government and government agencies
 
556.8

 
556.8

 

 
556.8

 

States, municipalities and political subdivisions
 
413.5

 
413.5

 

 
413.5

 

Corporate debt:
 


 


 
 
 
 
 
 
Financial Institutions
 
1,275.4

 
1,275.4

 

 
1,275.4

 

Industrials
 
1,308.1

 
1,308.1

 

 
1,308.1

 

Utilities
 
118.9

 
118.9

 

 
118.9

 

Mortgage-backed:
 


 


 
 
 
 
 
 
Agency mortgage-backed
 
751.9

 
751.9

 

 
650.8

 
101.1

Non-agency residential mortgage-backed
 
34.0

 
34.0

 

 
29.0

 
5.0

Commercial Mortgage Backed
 
582.8

 
582.8

 

 
582.8

 

Asset-backed
 
726.2

 
726.2

 

 
663.2

 
63.0

Total fixed maturity investments
 
7,201.6

 
7,201.6

 
1,396.4

 
5,636.1

 
169.1

Equity securities
 
403.0

 
403.0

 
403.0

 

 

Other invested assets(1)
 
840.2

 
840.2

 

 

 

Total investments
 
$
8,444.8

 
$
8,444.8

 
$
1,799.4

 
$
5,636.1

 
$
169.1

Derivative assets:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
0.1

 
$
0.1

 
$

 
$
0.1

 
$

Derivative liabilities:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
3.0

 
$
3.0

 
$

 
$
3.0

 
$

Interest rate swaps
 
$
0.5

 
$
0.5

 
$

 
$
0.5

 
$

Senior notes
 
$
1,292.9

 
$
1,337.9

 
$

 
$
1,337.9

 
$

Other long-term debt
 
$
23.0

 
$
27.7

 
$

 
$
27.7

 
$

(1) In accordance with U.S. GAAP, other invested assets, excluding other private securities, are measured at fair value using the net asset value per share (or its equivalent) practical expedient and have not been classified in the fair value hierarchy.

“Other invested assets” exclude other private securities that the Company did not measure at fair value, but are accounted for using the equity method of accounting. Derivative assets and derivative liabilities relating to foreign exchange contracts and interest rate swaps are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

The following describes the valuation techniques used by the Company to determine the fair value of financial instruments held as of the balance sheet date.

Fair Value of Financial Instruments

U.S. government and government agencies: Comprised primarily of bonds issued by the U.S. Treasury, the Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association. The fair values of the Company’s U.S. government securities are based on quoted market prices in active markets and are included in the Level 1 fair value hierarchy. The Company believes the market for U.S. Treasury securities is an actively traded market given the high level of daily trading volume. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are included in the Level 2 fair value hierarchy.

Non-U.S. government and government agencies: Comprised of fixed income obligations of non-U.S. governmental entities. The fair values of these securities are based on prices obtained from international indices and are included in the Level 2 fair value hierarchy.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)



States, municipalities and political subdivisions: Comprised of fixed income obligations of U.S. domiciled state and municipality entities. The fair values of these securities are based on prices obtained from the new issue market, and are included in the Level 2 fair value hierarchy.

Corporate debt: Comprised of bonds issued by or loan obligations of corporations that are diversified across a wide range of issuers and industries. The fair values of corporate debt that are short-term are priced using spread above the LIBOR yield curve, and the fair values of corporate debt that are long-term are priced using the spread above the risk-free yield curve. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price corporate debt are observable market inputs, the fair values of corporate debt are included in the Level 2 fair value hierarchy.

Mortgage-backed: Primarily comprised of residential and commercial mortgages originated by both U.S. government agencies (such as the Federal National Mortgage Association) and non-U.S. government agencies. The fair values of mortgage-backed securities originated by U.S. government agencies and non-U.S. government agencies are based on a pricing model that incorporates prepayment speeds and spreads to determine the appropriate average life of mortgage-backed securities. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the mortgage-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the mortgage-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

Asset-backed: Principally comprised of bonds backed by pools of automobile loan receivables, home equity loans, credit card receivables and collateralized loan obligations originated by a variety of financial institutions. The fair values of asset-backed securities are priced using prepayment speed and spread inputs that are sourced from the new issue market or broker-dealer quotes. As the significant inputs used to price the asset-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the asset-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

Equity securities: Comprised of U.S. and foreign common and preferred stocks and mutual funds. Equities are generally included in the Level 1 fair value hierarchy as prices are obtained from market exchanges in active markets. Non-U.S. mutual funds where the net asset value (“NAV”) is not provided on a daily basis are included in the Level 3 fair value hierarchy.

Other invested assets: Comprised of funds invested in a range of diversified strategies. In accordance with U.S. GAAP, the fair values of the funds are based on the NAV of the funds as reported by the fund manager.

Derivative instruments: The fair value of foreign exchange contracts and interest rate futures and swaps are priced from quoted market prices for similar exchange-traded derivatives and pricing valuation models that utilize independent market data inputs. The fair value of derivatives are included in the Level 2 fair value hierarchy.

Senior notes: The fair value of the senior notes is based on reported trades. The fair value of the senior notes is included in the Level 2 fair value hierarchy.

Other long-term debt: Comprised of the mortgage and credit facility associated with the purchase of office space in Switzerland. The fair value of the other long-term debt is based on the value of the debt using current interest rates. The fair value of the other long-term debt is included in the Level 2 fair value hierarchy.

Non-recurring Fair Value of Financial Instruments

The Company measures the fair value of certain assets on a non-recurring basis, generally quarterly, annually, or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. These assets include investments accounted for using the equity method, goodwill and intangible assets. The Company uses a variety of techniques to measure the fair value of these assets when appropriate, such as discounted expected future cash flows or market multiple models.


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)


Investments accounted for using the equity method: When the Company determines that the carrying value of these assets may not be recoverable, the Company records the assets at fair value with the loss recognized in income. In such cases, the Company measures the fair value of these assets using the techniques discussed above.

Goodwill and intangible assets: The Company tests goodwill and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable, but at least annually for goodwill and indefinite-lived intangibles. When the Company determines that goodwill and indefinite-lived intangible assets may be impaired, the Company uses techniques, including discounted expected future cash flows and market multiple models, to measure fair value.

Rollforward of Level 3 Financial Instruments

The following is a reconciliation of the beginning and ending balance of financial instruments using significant unobservable inputs (Level 3):
Three Months Ended March 31, 2016
Agency MBS
 
Non-agency RMBS
 
CMBS
 
Total Mortgage-backed
 
Asset-backed
 
Equities
Opening balance
$
101.1

 
$
5.0

 
$

 
$
106.1

 
$
63.0

 
$

Realized and unrealized gains (losses) included in net income
1.6

 
0.1

 

 
1.7

 
(0.8
)
 

Purchases
40.4

 

 

 
40.4

 
9.0

 

Sales
(3.6
)
 
(0.1
)
 

 
(3.7
)
 
(2.1
)
 

Transfers into Level 3 from Level 2
1.6

 

 

 
1.6

 
9.9

 

Transfers out of Level 3 into Level 2 (1)

 

 

 

 
(15.4
)
 

Ending balance
$
141.1

 
$
5.0

 
$

 
$
146.1

 
$
63.6

 
$

Three Months Ended March 31, 2015
 
 
 
 
 
 
 
 
 
 
 
Opening balance
$
180.1

 
$

 
$
1.7

 
$
181.8

 
$
55.4

 
$
43.3

Realized and unrealized gains (losses) included in net income
1.3

 

 
0.1

 
1.4

 
0.4

 
5.4

Purchases
18.3

 

 
1.8

 
20.1

 
25.3

 

Sales
(67.0
)
 

 
(3.6
)
 
(70.6
)
 
(2.7
)
 

Transfers into Level 3 from Level 2

 

 

 

 
43.6

 

Transfers out of Level 3 into Level 2 (1)

 

 

 

 
(29.1
)
 

Ending balance
$
132.7

 
$

 
$

 
$
132.7

 
$
92.9

 
$
48.7

_______________________ 
(1)
Transfers out of Level 3 are primarily attributable to the availability of market observable information.

The Company attempts to verify the significant inputs used by broker-dealers in determining the fair value of the securities priced by them. If the Company could not obtain sufficient information to determine if the broker-dealers were using significant observable inputs, then such securities have been transferred to the Level 3 fair value hierarchy. The Company believes the prices obtained from the broker-dealers are the best estimate of fair value of the securities being priced as the broker-dealers are typically involved in the initial pricing of the security, and the Company has compared the price per the broker-dealer to other pricing sources and noted no material differences. The Company recognizes transfers between levels at the end of the reporting period. There were no transfers between Level 1 and Level 2 during the period.

The Company’s external investment accounting service provider receives prices from internationally recognized independent pricing services to measure the fair values of its fixed maturity investments. Pricing sources are evaluated and selected in a manner to ensure that the most reliable sources are used. The Company uses a pricing service ranking to consistently select the most appropriate pricing service in instances where it receives multiple quotes on the same security. The Company obtains multiple quotes for the majority of its securities. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. Each pricing service has its own

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)


proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing service uses observable market inputs, including, but not limited to, reported trades, benchmark yields, broker-dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value.

All of the Company’s securities classified as Level 3 are valued based on unadjusted broker-dealer quotes. This includes less liquid securities such as lower quality asset-backed securities, commercial mortgage-backed securities and residential mortgage-backed securities. The primary valuation inputs include monthly payment information, the probability of default, loss severity rates and estimated prepayment rates. Significant changes in these inputs in isolation would result in a significantly lower or higher fair value measurement. In general, a change in the assumption of the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity in an event of default and prepayment rates.

The Company records the unadjusted price provided and validates this price through a process that includes, but is not limited to, monthly and/or quarterly: (i) comparison of prices between two independent sources, with significant differences requiring additional price sources; (ii) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to their target benchmark, with significant differences identified and investigated); (iii) evaluation of methodologies used by external parties to calculate fair value, including a review of the inputs used for pricing; (iv) comparing the price to the Company’s knowledge of the current investment market; and (v) back-testing, which includes randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates from the pricing service. In addition to internal controls, management relies on the effectiveness of the valuation controls in place at the Company’s external investment accounting service provider (supported by a Statement on Standards for Attestation Engagements No. 16 report) in conjunction with regular discussion and analysis of the investment portfolio’s structure and performance.

7. RESERVE FOR LOSSES AND LOSS EXPENSES

The reserve for losses and loss expenses consists of the following:
 
March 31,
2016
 
December 31,
2015
Outstanding loss reserves
$
1,710.3

 
$
1,678.5

Reserves for losses incurred but not reported
4,864.8

 
4,777.7

Reserve for losses and loss expenses
$
6,575.1

 
$
6,456.2


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)


The table below is a reconciliation of the beginning and ending liability for unpaid losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables.
 
Three Months Ended 
 March 31,
 
2016
 
2015
Gross liability at beginning of period
$
6,456.2

 
$
5,881.2

Reinsurance recoverable at beginning of period
(1,480.0
)
 
(1,340.3
)
Net liability at beginning of period
4,976.2

 
4,540.9

Net losses incurred related to:
 
 
 
Current year
397.8

 
388.8

Prior years
(25.4
)
 
(63.6
)
Total incurred
372.4

 
325.2

Net paid losses related to:
 
 
 
Current year
6.7

 
6.6

Prior years
282.5

 
293.1

Total paid
289.2

 
299.7

Foreign exchange revaluation and other
3.7

 
(11.6
)
Net liability at end of period
5,063.1

 
4,554.8

Reinsurance recoverable at end of period
1,512.0

 
1,350.3

Gross liability at end of period
$
6,575.1

 
$
5,905.1


For the three months ended March 31, 2016, the Company recorded net favorable prior year reserve development in each of its operating segments primarily due to actual loss emergence being lower than initially expected. The net favorable prior year reserve development in the North American Insurance segment was primarily related to the professional liability and programs lines of business, partially offset by net unfavorable prior year reserve development in the casualty line of business. The net favorable reserve development in the Global Markets Insurance segment was primarily related to the other specialty line of business partially offset by unfavorable reserve development in the professional liability and casualty lines of business. The net favorable prior year reserve development in the Reinsurance segment was primarily related to the property reinsurance and specialty reinsurance lines of business partially offset by net unfavorable prior year reserve development in the casualty reinsurance line of business.

For the three months ended March 31, 2015, the Company recorded net favorable prior year reserve development in each of its operating segments due to actual loss emergence being lower than initially expected. The net favorable prior year reserve development in the North American Insurance segment was primarily related to the professional liability and general casualty lines of business, partially offset by net unfavorable prior year reserve development in the healthcare line of business. The Global Markets Insurance segment had favorable prior year reserve development across most major lines of business. The net favorable prior year reserve development in the Reinsurance segment was primarily related to the property reinsurance and casualty reinsurance lines of business partially offset by unfavorable reserve development in the specialty line of business.

While the Company has experienced favorable reserve development in its insurance and reinsurance lines, there is no assurance that conditions and trends that have affected the development of liabilities in the past will continue. It is not appropriate to extrapolate future redundancies based on prior years’ development. The methodology of estimating loss reserves is periodically reviewed to ensure that the key assumptions used in the actuarial models continue to be appropriate.

8. INCOME TAXES

Under Swiss law, a resident company is subject to income tax at the federal, cantonal and communal levels that is levied on net income. Income attributable to permanent establishments or real estate located abroad is excluded from the Swiss tax base. Allied World Switzerland is a holding company and, therefore, is exempt from cantonal and communal income tax. As a result, Allied World Switzerland is subject to Swiss income tax only at the federal level. Allied World Switzerland is a resident of the Canton of Zug and, as such, is subject to an annual cantonal and communal capital tax on its taxable equity. Allied World

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)


Switzerland has a Swiss operating company resident in the Canton of Zug. The operating company is subject to federal, cantonal and communal income tax and to annual cantonal and communal capital tax.

Under current Bermuda law, Allied World Assurance Company Holdings, Ltd (“Allied World Bermuda”) and its Bermuda subsidiaries are not required to pay taxes in Bermuda on either income or capital gains. Allied World Bermuda and Allied World Assurance Company, Ltd have received an assurance from the Bermuda Minister of Finance under the Exempted Undertakings Tax Protection Act 1966 of Bermuda, that in the event of any such taxes being imposed, Allied World Bermuda and Allied World Assurance Company, Ltd will be exempted until March 2035.

Certain subsidiaries of Allied World Switzerland file U.S. federal income tax returns and various U.S. state income tax returns, as well as income tax returns in Canada, Hong Kong, Ireland, Singapore, and the United Kingdom. The U.S. Internal Revenue Service (“IRS”) is currently conducting an audit of the 2012 tax return of the Company's U.S. subsidiaries and the 2014 tax return of the U.S. services company. The Company does not believe there will be any material findings from the 2012 tax return audit. The Company recently received notice of the 2014 tax return audit of the U.S. services company, and as such it is too early to determine if there will be any findings from the audit. To the best of the Company’s knowledge, there are no other examinations pending by any other tax authority.

Management has deemed all material tax positions to have a greater than 50% likelihood of being sustained based on technical merits if challenged. The Company does not expect any material unrecognized tax benefits within 12 months of March 31, 2016.
9. SHAREHOLDERS’ EQUITY

a) Authorized shares

The issued share capital consists of the following:
 
March 31,
2016
 
December 31,
2015
Common shares issued and fully paid, 2016 and 2015: CHF 4.10 per share
94,062,342

 
95,523,230

Share capital at end of period
$
375.1

 
$
386.7

 
Three Months Ended 
 March 31, 2016
Shares issued at beginning of period
95,523,230

Shares canceled
(1,460,888
)
Total shares issued at end of period
94,062,342

Treasury shares issued at beginning of period
4,563,595

Shares repurchased
1,460,888

Shares issued out of treasury
(341,701
)
Shares canceled
(1,460,888
)
Total treasury shares at end of period
4,221,894

Total shares outstanding at end of period
89,840,448


During the three months ended March 31, 2016, 1,460,888 shares repurchased and designated for cancellation were constructively retired and canceled.


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)


b) Dividends

The Company paid the following dividends during the three months ended March 31, 2016:
Dividend Paid
 
Dividend
Per
Share
 
Total
Amount
Paid
March 31, 2016
 
$
0.260

 
$
23.4


On April 30, 2015, the shareholders approved the Company’s proposal to pay cash dividends in the form of a distribution out of general legal reserve from capital contributions. The distribution amount will be paid to shareholders in quarterly installments of $0.26 per share. The installments of the dividend were distributed in July 2015, October 2015, December 2015 and March 2016.

c) Share Repurchases

On May 1, 2014, the shareholders approved a share repurchase program in order for the Company to repurchase up to $500.0 million of its common shares. Repurchases may be effected from time to time through open market purchases, privately negotiated transactions, tender offers or otherwise. The timing, form and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, the Company’s capital position, legal requirements and other factors. Under the terms of the share repurchase program, the first three million of common shares repurchased will remain in treasury and will be used by Allied World Switzerland to satisfy share delivery obligations under its equity-based compensation plans. Any additional common shares repurchased will be designated for cancellation at acquisition and will be canceled upon shareholder approval. Shares repurchased and designated for cancellation are constructively retired and recorded as a share cancellation.

The Company’s share repurchases were as follows:
 
Three Months Ended 
 March 31,
 
2016
 
2015
Common shares repurchased
1,460,888

 
1,271,213

Total cost of shares repurchased
$
50.0

 
$
50.9

Average price per share
$
34.23

 
$
40.08


10. EMPLOYEE BENEFIT PLANS

a) Restricted stock units and performance-based equity awards

Restricted stock units (“RSUs”) vest pro-rata over four years from the date of grant. The compensation expense for the RSUs is based on the fair market value of Allied World Switzerland’s common shares at the date of grant. The Company estimates the expected forfeitures of RSUs at the date of grant and recognizes compensation expense only for those awards that the Company expects to vest. The forfeiture assumption is ultimately adjusted to the actual forfeiture rate.

Performance-based equity awards represent the right to receive a number of common shares in the future, based upon the achievement of established performance criteria during an applicable performance period. Based on the performance goals, the performance-based equity awards granted in 2016, 2015 and 2014 are expensed at 100%, 100% and 75%, respectively, of the fair value of Allied World Switzerland's common shares on the date of grant. The expense is recognized over the performance period.


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)


The activity related to the Company’s RSUs awards is as follows:
 
Three Months Ended March 31, 2016
 
Number of Awards
 
Weighted
Average
Grant Date
Fair Value
Per Share
Outstanding at beginning of period
819,309

 
$
37.33

RSUs granted
689,042

 
31.95

RSUs forfeited
(16,535
)
 
(36.05
)
RSUs fully vested
(248,283
)
 
(36.37
)
Outstanding at end of period
1,243,533

 
$
34.56


The activity related to the Company’s performance-based equity awards is as follows:
 
Three Months Ended March 31, 2016
 
Number of Awards
 
Weighted
Average
Grant Date
Fair Value
Per Share
Outstanding at beginning of period
591,683

 
$
34.78

Performance-based equity awards granted
200,730

 
31.95

Additional awards granted due to achievement of performance criteria
24,979

 
29.24

Performance-based equity awards forfeited
(4,862
)
 
(35.82
)
Performance-based equity awards fully vested
(216,958
)
 
(29.24
)
Outstanding at end of period
595,572

 
$
35.60


b) Cash-equivalent stock awards

As part of the Company’s annual year-end compensation awards, the Company granted both awards classified as equity and cash-equivalent stock awards. The cash-equivalent awards were granted to employees who received RSUs and performance-based equity awards in tandem with stock-based awards. The cash-equivalent RSU awards vest pro-rata over four years from the date of grant. The cash-equivalent performance-based equity awards vest after a three-year performance period. The amount payable per unit awarded will be equal to the price per share of Allied World Switzerland’s common shares, and as such the Company measures the value of an award each reporting period based on the period-ending share price. The effects of changes in the share price at each period-end during the service period are recognized as changes in compensation expense ratably over the service period. The liability is included in “accounts payable and accrued liabilities” in the consolidated balance sheets and changes in the liability are recorded in “general and administrative expenses” in the consolidated income statements.

The activity related to the Company's cash-equivalent RSUs and performance-based awards is as follows:
 
RSUs
 
Performance-based Awards
Three Months Ended March 31, 2016
Number of Awards
 
Weighted Average Grant Date Fair Value
 
Number of Awards
 
Weighted
Average
Grant Date
Fair Value
Per Share
Outstanding at beginning of period
1,277,083

 
$
31.94

 
693,477

 
$
33.25

Granted
167,438

 
31.95

 
50,183

 
31.95

Additional awards granted due to achievement of performance criteria

 

 
37,434

 
29.24

Forfeited
(21,932
)
 
(31.81
)
 
(5,209
)
 
(34.05
)
Fully vested
(581,829
)
 
(29.14
)
 
(325,386
)
 
(29.24
)
Outstanding at end of period
840,760

 
$
33.88

 
450,499

 
$
35.66


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)



c) Total Stock Related Compensation Expense

The following table shows the total stock-related compensation expense relating to the stock options, RSUs and cash equivalent awards:
 
Three Months Ended 
 March 31,
 
2016
 
2015
Stock options
$

 
$
0.3

RSUs and performance-based equity awards
3.9

 
3.7

Cash-equivalent stock awards
(1.9
)
 
12.5

Total
$
2.0

 
$
16.5


11. EARNINGS PER SHARE

The following table sets forth the comparison of basic and diluted earnings per share:
 
Three Months Ended 
 March 31,
 
2016
 
2015
Basic earnings per share:
 
 
 
Net income
$
74.1

 
$
124.4

Weighted average common shares outstanding
90,254,512

 
95,935,551

Basic earnings per share
$
0.82

 
$
1.30

 
Three Months Ended 
 March 31,
 
2016
 
2015
Diluted earnings per share:
 
 
 
Net income
$
74.1

 
$
124.4

Weighted average common shares outstanding
90,254,512

 
95,935,551

Share equivalents:
 
 
 
Stock options
832,747

 
1,116,871

RSUs and performance-based equity awards
451,268

 
509,971

Employee share purchase plan
20,698

 
14,636

Weighted average common shares and common share equivalents outstanding - diluted
91,559,225

 
97,577,029

Diluted earnings per share
$
0.81

 
$
1.27


For the three months ended March 31, 2016 and 2015, a weighted average of 353,679 and 175,175 RSUs, respectively, were considered anti-dilutive and were therefore excluded from the calculation of the diluted earnings per share.

12. SEGMENT INFORMATION

The determination of reportable segments is based on how the Company's chief operating decision maker, the Chief Executive Officer, monitors the Company’s underwriting operations. Management monitors the performance of its direct underwriting operations based on the geographic location of the Company’s offices, the markets and customers served and the type of accounts written. The Company is currently organized into three operating segments: North American Insurance, Global Markets Insurance and Reinsurance. All product lines fall within these classifications.

The North American Insurance segment includes the Company’s specialty insurance operations in the United States, Bermuda and Canada, as well as the Company's claim administration services operation. This segment provides both property and specialty casualty insurance to North American domiciled accounts. The Global Markets Insurance segment includes the

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions, except share, per share, percentage and ratio information)


Company’s insurance operations in Europe and Asia Pacific, which includes offices in Australia, Hong Kong, Labuan, and Singapore. This segment provides both property and casualty insurance primarily to non-North American domiciled accounts. The Reinsurance segment includes the Company’s reinsurance operations in Bermuda, Labuan, London, Singapore, the United States and Zug. This segment provides reinsurance of property, general casualty, professional liability, specialty lines and property catastrophe coverages written by insurance companies. The Company presently writes reinsurance on both a treaty and a facultative basis, targeting several niche reinsurance markets.

Responsibility and accountability for the results of underwriting operations are assigned by major line of business within each segment. Because the Company does not manage its assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments. General and administrative expenses are allocated to segments based on various factors, including expenses directly attributable to individual segments, staff count and each segment’s proportional share of gross premiums written.

The Company measures its segment profit or loss as underwriting income or loss plus other insurance-related income and expenses, which may include the net earnings from our claims administration services operations and other income or expense that is not directly related to our underwriting operations. Management measures results for each segment's underwriting income or loss on the basis of the “loss and loss expense ratio,” “acquisition cost ratio,” “general and administrative expense ratio,” “expense ratio” and the “combined ratio.” The “loss and loss expense ratio” is derived by dividing net losses and loss expenses by net premiums earned. The “acquisition cost ratio” is derived by dividing acquisition costs by net premiums earned. The “general and administrative expense ratio” is derived by dividing general and administrative expenses by net premiums earned. The expense ratio is the sum of the “acquisition cost ratio” and the “general and administrative expense ratio”. The “combined ratio” is the sum of the “loss and loss expense ratio,” the “acquisition cost ratio” and the “general and administrative expense ratio.”

The following tables provide a summary of the segment results:
Three Months Ended March 31, 2016
 
North American
Insurance
 
Global Markets
Insurance
 
Reinsurance
 
Total
Gross premiums written
 
$
379.2

 
$
115.5

 
$
368.8

 
$
863.5

Net premiums written
 
266.2

 
87.6

 
350.2

 
704.0

Net premiums earned
 
316.3

 
94.2

 
169.6

 
580.1

Net losses and loss expenses
 
(216.3
)
 
(67.8
)
 
(88.3
)
 
(372.4
)
Acquisition costs
 
(33.9
)
 
(17.9
)
 
(36.5
)
 
(88.3
)
General and administrative expenses
 
(52.2
)
 
(29.0
)
 
(15.2
)
 
(96.4
)
Underwriting income
 
13.9

 
(20.5
)
 
29.6

 
23.0

Other insurance-related income
 
0.6

 

 

 
0.6

Other insurance-related expenses
 
(0.7
)
 

 
(0.4
)
 
(1.1
)
Segment income
 
13.8

 
(20.5
)
 
29.2

 
22.5

Net investment income
 
 
 
 
 
 
 
53.3

Net realized investment gains
 
 
 
 
 
 
 
18.9

Amortization of intangible assets
 
 
 
 
 
 
 
(2.5
)
Interest expense
 
 
 
 
 
 
 
(20.0
)
Foreign exchange gain
 
 
 
 
 
 
 
3.0

Income before income taxes
 
 
 
 
 
 
 
$
75.2

 
 
 
 
 
 
 
 
 
Loss and loss expense ratio
 
68.4
%
 
72.0
%
 
52.1
%
 
64.2
%
Acquisition cost ratio
 
10.7
%
 
19.0
%