Form 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: September 30, 2012

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

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

Lindenstrasse 8

6340 Baar

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 November 5, 2012, 35,242,967 common shares were outstanding.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

PART I    FINANCIAL INFORMATION   

Item 1.

 

Financial Statements

     1   

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     31   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     66   

Item 4.

 

Controls and Procedures

     69   
PART II   

Item 1.

 

Legal Proceedings

     69   

Item 1A.

 

Risk Factors

     69   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     70   

Item 3.

 

Defaults Upon Senior Securities

     70   

Item 4.

 

Mine Safety Disclosures

     70   

Item 5.

 

Other Information

     70   

Item 6.

 

Exhibits

     71   

SIGNATURES

     72   

EXHIBIT INDEX

  

 

-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 September 30, 2012 and December 31, 2011

(Expressed in thousands of United States dollars, except share and per share amounts)

 

     As of
September 30,
2012
    As of
December 31,
2011
 

ASSETS:

    

Fixed maturity investments available for sale, at fair value (amortized cost: 2012: $26,954; 2011: $226,397)

   $ 29,085     $ 244,016  

Fixed maturity investments trading, at fair value (amortized cost: 2012: $6,934,821; 2011: $6,207,991)

     7,125,860       6,254,686  

Equity securities trading, at fair value (cost: 2012: $436,983; 2011: $356,370)

     490,418       367,483  

Other invested assets trading, at fair value

     564,702       540,409  
  

 

 

   

 

 

 

Total investments

     8,210,065       7,406,594  

Cash and cash equivalents

     639,517       633,996  

Restricted cash

     46,923       82,608  

Insurance balances receivable

     754,978       652,158  

Prepaid reinsurance

     262,163       226,721  

Reinsurance recoverable

     1,077,522       1,002,919  

Accrued investment income

     32,348       38,263  

Net deferred acquisition costs

     127,527       100,334  

Goodwill

     268,376       268,376  

Intangible assets

     51,998       53,898  

Balances receivable on sale of investments

     756,570       580,443  

Net deferred tax assets

     23,185       22,646  

Other assets

     60,817       53,202  
  

 

 

   

 

 

 

Total assets

   $ 12,311,989     $ 11,122,158  
  

 

 

   

 

 

 

LIABILITIES:

    

Reserve for losses and loss expenses

   $ 5,450,787     $ 5,225,143  

Unearned premiums

     1,316,399       1,078,412  

Reinsurance balances payable

     120,432       124,539  

Balances due on purchases of investments

     1,075,069       616,728  

Senior notes

     798,147       797,949  

Dividends payable

            14,302  

Accounts payable and accrued liabilities

     115,369       116,063  
  

 

 

   

 

 

 

Total liabilities

   $ 8,876,203     $ 7,973,136  
  

 

 

   

 

 

 

SHAREHOLDERS’ EQUITY:

    

Common shares: 2012: par value CHF 12.98 per share and 2011: par value CHF 14.03 per share (2012: 37,083,742; 2011: 40,003,642 shares issued and 2012: 35,402,558; 2011: 37,742,131 shares outstanding)

     477,246       557,153  

Additional paid-in capital

            78,225  

Treasury shares, at cost (2012: 1,681,184; 2011: 2,261,511)

     (120,944     (136,590

Retained earnings

     3,078,099       2,635,750  

Accumulated other comprehensive income: net unrealized gains on investments, net of tax

     1,385       14,484  
  

 

 

   

 

 

 

Total shareholders’ equity

     3,435,786       3,149,022  
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 12,311,989     $ 11,122,158  
  

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

for the three and nine months ended September 30, 2012 and 2011

(Expressed in thousands of United States dollars, except share and per share amounts)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

REVENUES:

        

Gross premiums written

   $ 504,420     $ 442,698     $ 1,832,219     $ 1,522,984  

Premiums ceded

     (112,883     (92,438     (357,019     (296,050
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums written

     391,537       350,260       1,475,200       1,226,934  

Change in unearned premiums

     49,480       21,080       (202,546     (165,411
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

     441,017       371,340       1,272,654       1,061,523  

Net investment income

     39,121       47,883       128,781       150,459  

Net realized investment gains (losses)

     149,813       (130,809     292,057       (21,555

Other income — termination fee

            35,000              35,000  
  

 

 

   

 

 

   

 

 

   

 

 

 
     629,951       323,414       1,693,492       1,225,427  
  

 

 

   

 

 

   

 

 

   

 

 

 

EXPENSES:

        

Net losses and loss expenses

     258,948       205,546       724,530       745,811  

Acquisition costs

     51,086       39,680       149,812       120,733  

General and administrative expenses

     78,572       66,007       222,917       201,164  

Amortization of intangible assets

     633       767       1,900       2,300  

Interest expense

     13,822       13,748       41,579       41,235  

Foreign exchange loss (gain)

     1,023       2,966       (77     3,708  
  

 

 

   

 

 

   

 

 

   

 

 

 
     404,084       328,714       1,140,661       1,114,951  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     225,867       (5,300     552,831       110,476  

Income tax expense

     6,220       5,672       18,677       19,028  
  

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME (LOSS)

     219,647       (10,972     534,154       91,448  
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive loss:

        

Unrealized (losses) gains on investments arising during the period net of applicable deferred income tax benefit (expense) for the three months ended September 30, 2012: $15; 2011:($5,476) and nine months ended September 30, 2012:($81); 2011: ($3,051)

     (29     20       150       5,656  

Reclassification adjustment for net realized investment gains included in net income (loss), net of applicable income tax

            (5,319     (13,249     (44,995
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive loss

     (29     (5,299     (13,099     (39,339
  

 

 

   

 

 

   

 

 

   

 

 

 

COMPREHENSIVE INCOME (LOSS)

   $ 219,618     $ (16,271   $ 521,055     $ 52,109  
  

 

 

   

 

 

   

 

 

   

 

 

 

PER SHARE DATA

        

Basic earnings (loss) per share

   $ 6.16     $ (0.29   $ 14.68     $ 2.40  

Diluted earnings (loss) per share

   $ 6.00     $ (0.29   $ 14.28     $ 2.30  

Weighted average common shares outstanding

     35,652,768       38,110,368       36,379,514       38,078,116  

Weighted average common shares and common share equivalents outstanding

     36,616,734       38,110,368       37,393,093       39,759,780  

Dividends paid per share

   $ 0.750     $ 0.375     $ 1.500     $ 0.375  

See accompanying notes to the consolidated financial statements.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

for the nine months ended September 30, 2012 and 2011

(Expressed in thousands of United States dollars)

 

     Share
Capital
    Additional
Paid-in
Capital
    Treasury
Shares
    Accumulated
Other
Comprehensive
Income
    Retained
Earnings
    Total  

December 31, 2011

   $ 557,153     $ 78,225     $ (136,590   $ 14,484     $ 2,635,750     $ 3,149,022  

Net income

                                 534,154       534,154  

Dividends — par value reduction

     (40,419                                 (40,419

Other comprehensive loss

                          (13,099            (13,099

Stock compensation

            (23,050     36,226                     13,176  

Share repurchases

                   (207,048                   (207,048

Shares cancelled

     (39,488     (55,175     186,468              (91,805       
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

September 30, 2012

   $ 477,246     $      $ (120,944   $ 1,385     $ 3,078,099     $ 3,435,786  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2010

   $ 600,055     $ 170,239     $ (112,811   $ 57,135     $ 2,361,202     $ 3,075,820  

Net income

                                 91,448       91,448  

Dividends — par value reduction

     (28,600                                 (28,600

Other comprehensive loss

                          (39,339            (39,339

Stock compensation

            (42,822     60,187                     17,365  

Share repurchase

                   (60,000                   (60,000

Repurchase of founder warrants

            (53,620                          (53,620
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

September 30, 2011

   $ 571,455     $ 73,797     $ (112,624   $ 17,796     $ 2,452,650     $ 3,003,074  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

for the nine months ended September 30, 2012 and 2011

(Expressed in thousands of United States dollars)

 

     Nine Months Ended
September 30,
 
     2012     2011  

CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:

    

Net income

   $ 534,154     $ 91,448  

Adjustments to reconcile net income to cash provided by operating activities:

    

Net realized gains on sales of investments

     (63,625     (78,001

Mark to market adjustments

     (225,425     61,912  

Stock compensation expense

     13,118       16,917  

Changes in:

    

Reserve for losses and loss expenses, net of reinsurance recoverables

     151,041       284,310  

Unearned premiums, net of prepaid reinsurance

     202,545       165,412  

Insurance balances receivable

     (102,820     (77,343

Reinsurance balances payable

     (4,107     (4,269

Net deferred acquisition costs

     (27,193     (18,267

Net deferred tax assets

     1,850       (4,081

Accounts payable and accrued liabilities

     (2,996     7,564  

Other items, net

     23,677       45,903  
  

 

 

   

 

 

 

Net cash provided by operating activities

     500,219       491,505  
  

 

 

   

 

 

 

CASH FLOWS USED IN INVESTING ACTIVITIES:

    

Purchases of available for sale securities

            (727

Purchases of trading securities

     (6,328,719     (5,555,249

Purchases of other invested assets

     (52,578     (265,720

Sales of available for sale securities

     215,318       627,392  

Sales of trading securities

     5,778,138       4,841,580  

Sales of other invested assets

     110,429       40,129  

Purchases of fixed assets

     (2,041     (7,792

Change in restricted cash

     35,685       63,120  
  

 

 

   

 

 

 

Net cash used in investing activities

     (243,768     (257,267
  

 

 

   

 

 

 

CASH FLOWS USED IN FINANCING ACTIVITIES:

    

Dividends paid — partial par value reduction

     (54,721     (14,295

Proceeds from the exercise of stock options

     9,104       5,317  

Share repurchases

     (204,746     (60,000

Repurchase of founder warrants

            (53,620
  

 

 

   

 

 

 

Net cash used in financing activities

     (250,363     (122,598
  

 

 

   

 

 

 

Effect of exchange rate changes on foreign currency cash

     (567     685  

NET INCREASE IN CASH AND CASH EQUIVALENTS

     5,521       112,325  

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     633,996       756,995  
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 639,517     $ 869,320  
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

    

— Cash paid for income taxes

   $ 18,912     $ 6,294  

— Cash paid for interest expense

   $ 45,750     $ 45,750  

See accompanying notes to the consolidated financial statements.

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, 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”), provides property and casualty insurance and reinsurance on a worldwide basis through operations in Bermuda, the United States, Europe, Hong Kong and Singapore.

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 consolidation.

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, 2011.

3. NEW ACCOUNTING PRONOUNCEMENTS

In October 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-26, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (“ASU 2010-26”). ASU 2010-26 clarifies what costs associated with acquiring or renewing insurance contracts can be deferred and amortized over the coverage period. Under the revised guidance of ASU 2010-26, incremental direct costs that result directly from and are essential to the insurance contract and would not have been incurred had the insurance contract not been written are costs that may be capitalized, including costs relating to activities specifically performed by the Company such as underwriting, policy issuance and processing. The Company adopted ASU 2010-26 retrospectively on January 1, 2012. The adoption of ASU 2010-26 did not have an impact on consolidated shareholders’ equity or net income as the Company had not previously capitalized costs that did not meet the requirement for capitalization of the revised standard.

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

In May 2011, the FASB issued ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU 2011-04”). ASU 2011-04 provides a consistent meaning for the term “fair value” between the FASB and International Accounting Standards Board and establishes common requirements for measuring and disclosing information related thereto. The Company adopted ASU 2011-04 prospectively on January 1, 2012. The adoption of ASU 2011-04 did not have an impact on consolidated shareholders’ equity or net income or the Company’s fair value measurements. Refer to Note 6 for the Company’s related disclosures.

In June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity, requires consecutive presentation of the statement of net income and other comprehensive income, and requires the presentation of reclassification adjustments on the face of the financial statements from other comprehensive income to net income. In December 2011, ASU 2011-05 was updated by ASU 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05” (“ASU 2011-12”) to defer the presentation requirements of reclassification adjustments required by ASU 2011-05. The Company adopted ASU 2011-05 on January 1, 2012. The adoption of ASU 2011-05 and the related updates from ASU 2011-12 did not have an impact on the presentation of the financial statements.

In September 2011, the FASB issued ASU 2011-08, “Testing Goodwill for Impairment” (“ASU 2011-08”). ASU 2011-08 simplifies how goodwill is tested for impairment by permitting entities to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The results of the qualitative assessment will determine if an entity needs to proceed with the two-step goodwill impairment test. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The Company adopted ASU 2011-08 on January 1, 2012. The adoption of ASU 2011-08 did not have an impact on consolidated shareholders’ equity or net income.

In July 2012, the FASB issued ASU 2012-02, “Testing Indefinite-Lived Intangible Assets for Impairment” (“ASU 2012-02”). ASU 2012-02 modifies both annual and interim impairment testing and allows the inclusion of qualitative factors in the assessment of whether a quantitative impairment test is necessary. When an entity’s qualitative assessment reveals that indefinite-lived intangible asset impairment is more likely than not, the entity must perform the quantitative impairment test. The amendments did not change the existing accounting guidance on how this impairment test is performed. ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012 and early adoption is permitted. The Company has not elected early adoption. The Company does not expect the adoption of this guidance to have an impact on its consolidated shareholders’ equity or net income.

4. INVESTMENTS

a) Available for Sale Securities

The amortized cost, gross unrealized gains, gross unrealized losses and fair value of the Company’s available for sale investments by category are as follows:

 

     Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
    Fair Value  

September 30, 2012

          

U.S. Government and Government agencies

   $ 26,954      $ 2,131      $      $ 29,085  
  

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed maturity investments, available for sale

   $ 26,954      $ 2,131      $      $ 29,085  
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2011

          

U.S. Government and Government agencies

   $ 31,309      $ 2,321      $      $ 33,630  

States, municipalities and political subdivisions

     29,128        4,351               33,479  

Corporate debt:

          

Financial institutions

     17,431        348        (292     17,487  

Industrials

     73,539        4,268               77,807  

Utilities

     74,990        6,623               81,613  
  

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed maturity investments, available for sale

   $ 226,397      $ 17,911      $ (292   $ 244,016  
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

b) 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 (loss) (“consolidated income statements”) by category are as follows:

 

     September 30, 2012      December 31, 2011  
     Fair Value      Amortized Cost      Fair Value      Amortized Cost  

U.S. Government and Government agencies

   $ 1,849,492      $ 1,831,521      $ 1,278,265      $ 1,263,948  

Non-U.S. Government and Government agencies

     309,471        297,424        256,756        251,784  

States, municipalities and political subdivisions

     41,542        40,327        133,902        128,633  

Corporate debt:

           

Financial institutions

     1,031,764        997,781        1,161,904        1,174,308  

Industrials

     1,145,621        1,128,154        987,006        974,731  

Utilities

     59,802        57,622        105,564        103,262  

Residential mortgage-backed:

           

Non-agency residential

     337,662        287,354        302,827        314,077  

Agency residential

     1,606,201        1,568,320        1,183,893        1,156,913  

Commercial mortgage-backed

     308,094        294,901        331,371        326,697  

Asset-backed

     436,211        431,417        513,198        513,638  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturity investments, trading

   $ 7,125,860      $ 6,934,821      $ 6,254,686      $ 6,207,991  
  

 

 

    

 

 

    

 

 

    

 

 

 
     September 30, 2012      December 31, 2011  
     Fair Value      Original Cost      Fair Value      Original Cost  

Equity securities

   $ 490,418      $ 436,983      $ 367,483      $ 356,370  

Other invested assets (1)

     564,702        520,233        540,409        529,851  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 1,055,120      $ 957,216      $ 907,892      $ 886,221  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Within the Company’s financial statements and footnotes “other invested assets” include the Company’s investments in both hedge funds and private equity funds.

c) Contractual Maturity Dates

The contractual maturity dates of available for sale fixed maturity investments are as follows:

 

     September 30, 2012  
     Amortized Cost      Fair Value  

Due within one year

   $ 6,477      $ 6,515  

Due after one year through five years

     16,408        17,534  

Due after five years through ten years

     1,073        1,181  

Due after ten years

     2,996        3,855  
  

 

 

    

 

 

 
   $ 26,954      $ 29,085  
  

 

 

    

 

 

 

Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.

d) Other Invested Assets

Included in other invested assets are the Company’s hedge fund and private equity investments. As of the balance sheet date, the Company held interests in 23 funds with a total fair value of $564,702, which comprised 6.4% of the total fair value of its investments and cash and cash equivalents. The fair values of these assets have been estimated using the net asset value per share of the funds.

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 1 to 3 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 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 that allows for redemption requests to be

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

executed in an orderly fashion 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.

Details regarding the redemption characteristics of the other invested assets portfolio and the Company’s unfunded investment commitments as of September 30, 2012 were as follows:

 

Fund Type

   Fair Value as of
September 30, 2012
     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)

   $ 87,241      $ 87,241        4 - 10 Years       $             $ 158,129  

Mezzanine debt

     27,444        27,444        10 Years                       89,000  

Distressed

     9,510        9,510        <6 Years                       8,800  
  

 

 

    

 

 

       

 

 

          

 

 

 

Total private equity

     124,195        124,195                         255,929  
  

 

 

    

 

 

       

 

 

          

 

 

 

Distressed

     42,248        212        <2 Years         42,036        Quarterly         45 - 65 Days           

Equity long/short

     170,023                   170,023        Quarterly         30 - 60 Days           

Multi-strategy

     140,141        26,956        <2 Years         113,185        Quarterly         45 - 90 Days           

Global macro

     19,246                   19,246        Monthly         3 Days           

Event driven

     68,849                   68,849        Annual         45 - 60 Days           
  

 

 

    

 

 

       

 

 

          

 

 

 

Total hedge funds

     440,507        27,168           413,339                
  

 

 

    

 

 

       

 

 

          

 

 

 

Total other invested assets

   $ 564,702      $ 151,363         $ 413,339            $ 255,929  
  

 

 

    

 

 

       

 

 

          

 

 

 

 

(1) The redemption frequency and notice periods only apply to the investments without redemption restrictions.

 

   

Private equity funds: Primary funds may invest in companies and general partnership interests. Secondary funds buy limited partnership interests from existing limited partners of primary private equity funds. As owners of private equity funds seek liquidity, they can sell their existing investments, 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 fund.

 

   

Mezzanine debt funds: Mezzanine debt funds primarily focus on providing capital to upper middle market and middle market companies, and private equity sponsors, in connection with leveraged buyouts, mergers and acquisitions, recapitalizations, growth financings and other corporate transactions. The most common position in the capital structure will be between the senior secured debt holder and the equity; however, the funds will utilize a flexible approach when structuring investments, which 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 fund.

 

   

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.

 

   

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.

 

   

Multi-strategy funds: These funds may utilize many strategies employed by specialized funds including distressed investing, equity long/short, merger arbitrage, convertible arbitrage, fixed income arbitrage and macro trading.

 

   

Global macro funds: These funds focus on a top-down analysis of global markets as influenced by major political and economic trends or events. Global macro managers develop investment strategies that aim to forecast movements in interest rates, fund flows, political changes and other wide-ranging systematic factors. The portfolios of these funds can include long or short positions in equities, fixed-income, currencies and commodities in the form of cash or derivatives instruments.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

   

Event driven funds: Event driven strategies seek to deploy capital into specific securities whose returns are affected by a specific event that affects the value of one or more securities of a company. Returns for such securities are linked primarily to the specific outcome of the events and not by the overall direction of the bond or stock markets. Examples could include mergers and acquisitions (arbitrage), corporate restructurings and spin-offs, and capital structure arbitrage.

e) Net Investment Income

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Fixed maturity investments

   $ 36,778     $ 47,877     $ 120,883     $ 149,471  

Equity securities and other invested assets

     5,375       3,397       18,093       10,608  

Cash and cash equivalents

     640       166       1,797       611  

Expenses

     (3,672     (3,557     (11,992     (10,231
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income

   $ 39,121     $ 47,883     $ 128,781     $ 150,459  
  

 

 

   

 

 

   

 

 

   

 

 

 

f) Components of Realized Gains and Losses

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Gross realized gains on sale of invested assets

   $ 27,210     $ 44,674     $ 119,154     $ 122,842  

Gross realized losses on sale of invested assets

     (6,686     (10,634     (43,355     (35,896

Net realized and unrealized losses on derivatives

     (962     (43,285     (192     (58,821

Mark-to-market changes:

        

Debt securities, trading

     99,821       (46,078     144,024       (742

Equity securities and other invested assets

     30,430       (75,486     72,426       (48,938
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized investment gains (losses)

   $ 149,813     $ (130,809   $ 292,057     $ (21,555
  

 

 

   

 

 

   

 

 

   

 

 

 

Proceeds from sale of available for sale securities

   $ 1,000     $ 60,043     $ 214,716     $ 606,234  

g) Pledged Assets

As of September 30, 2012 and December 31, 2011, $2,076,294 and $2,029,138, 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 and insurance laws.

In addition, as of September 30, 2012 and December 31, 2011, a further $1,047,023 and $1,044,236, respectively, of cash and cash equivalents and investments were pledged as collateral for the Company’s letter of credit facility. See Note 11 to these Condensed Consolidated Financial Statements and Note 9 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 for details on the credit facility.

h) Analysis of Unrealized Losses

The following table summarizes the market value of those available for sale investments in an unrealized loss position for periods less than and greater than 12 months:

 

     September 30, 2012      December 31, 2011  
     Gross Fair
Value
     Unrealized
Loss
     Gross Fair
Value
     Unrealized
Loss
 

Less than 12 months

           

Corporate debt:

           

Financial institutions

   $       $       $ 9,440      $ (292
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturity investments, available for sale

   $       $       $ 9,440      $ (292
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

As of September 30, 2012 and December 31, 2011, there were nil and three securities, respectively, in an unrealized loss position.

i) Other-than-temporary impairment charges

Following the Company’s review of the securities in the investment portfolio during the three and nine months ended September 30, 2012 and 2011, no securities were considered to be other-than-temporarily impaired.

5. DERIVATIVE INSTRUMENTS

As of September 30, 2012 and December 31, 2011, none of the Company’s derivatives were designated as hedges. The following table summarizes information on the location and amounts of derivative fair values in the unaudited condensed consolidated balance sheets (“consolidated balance sheets”):

 

     September 30, 2012      December 31, 2011  
     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
 

Derivatives not designated as hedging instruments

  

Put options (1)

   $       $       $       $       $ 4,461      $ 336      $       $   

Foreign exchange contracts (2)

     95,884        2,436        181,612        3,103        91,162        2,030        339,533        8,934  

Interest rate futures (2)

     428,200        1,561        76,900        2,082        680,650        977        292,000        3,467  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total derivatives

   $ 524,084      $ 3,997      $ 258,512      $ 5,185      $ 776,273      $ 3,343      $ 631,533      $ 12,401  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Asset and liability derivatives relating to the put options are classified within “equity securities trading, at fair value” on the consolidated balance sheets.

 

(2) All other asset and liability derivatives 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 losses on derivatives not designated as hedges recorded in the consolidated income statements:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Foreign exchange contracts

   $ (676   $ (8,075   $ (96   $ (5,474
  

 

 

   

 

 

   

 

 

   

 

 

 

Total included in foreign exchange (loss) gain

     (676     (8,075     (96     (5,474
  

 

 

   

 

 

   

 

 

   

 

 

 

Put options

                   (336       

Foreign exchange contracts

     (2,751     (5,343     (641     (4,620

Interest rate futures

     1,789       (37,942     785       (54,201
  

 

 

   

 

 

   

 

 

   

 

 

 

Total included in net realized investment gains

     (962     (43,285     (192     (58,821
  

 

 

   

 

 

   

 

 

   

 

 

 

Total realized and unrealized losses on derivatives

   $ (1,638   $ (51,360   $ (288   $ (64,295
  

 

 

   

 

 

   

 

 

   

 

 

 

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. The Company entered into foreign currency forward contracts to manage the effect of this foreign currency risk. These foreign currency hedging activities have not been designated as specific hedges for financial reporting purposes.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

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

The Company purchases options to actively manage the Company’s equity portfolio.

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.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

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:

 

                   Fair value measurement using:  

September 30, 2012

   Carrying
amount
     Total fair value      Quoted prices in
active markets for
identical assets

(Level 1)
     Significant other
observable inputs

(Level 2)
     Significant
unobservable
inputs

(Level 3)
 

Available for sale securities:

              

U.S. Government and Government agencies

   $ 29,085      $ 29,085      $ 29,085      $       $   
  

 

 

    

 

 

          

Total available for sale fixed maturity investments

     29,085        29,085           
  

 

 

    

 

 

          

Trading securities:

              

U.S. Government and Government agencies

   $ 1,849,492      $ 1,849,492      $ 1,458,504      $ 390,988      $   

Non-U.S. Government and Government agencies

     309,471        309,471                309,471          

States, municipalities and political subdivisions

     41,542        41,542                41,542          

Corporate debt

     2,237,187        2,237,187                2,237,187          

Mortgage-backed

     2,251,957        2,251,957                2,082,687        169,270  

Asset-backed

     436,211        436,211                360,444        75,767  
  

 

 

    

 

 

          

Total trading fixed maturity investments

     7,125,860        7,125,860           
  

 

 

    

 

 

          

Total fixed maturity investments

     7,154,945        7,154,945           
  

 

 

    

 

 

          

Equity securities

     490,418        490,418        490,418                  

Other invested assets

     564,702        564,702                        564,702  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 8,210,065      $ 8,210,065      $ 1,978,007      $ 5,422,319      $ 809,739  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Derivative assets: (1)

              

Foreign exchange contracts

   $ 2,436      $ 2,436      $       $ 2,436      $   

Interest rate futures

     1,561        1,561                1,561          
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Derivative liabilities: (1)

              

Foreign exchange contracts

   $ 3,103      $ 3,103      $       $ 3,103      $   

Interest rate futures

     2,082        2,082                2,082          
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Senior notes

   $ 798,147      $ 914,816      $       $ 914,816      $   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Asset and liability derivatives relating to foreign exchange contracts and interest rate futures are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

                   Fair value measurement using:  

December 31, 2011

   Carrying
amount
     Total fair value      Quoted prices in
active  markets for
identical assets
(Level 1)
     Significant other
observable inputs

(Level 2)
     Significant
unobservable
inputs

(Level 3)
 

Available for sale securities:

              

U.S. Government and Government agencies

   $ 33,630      $ 33,630      $ 33,630      $       $   

States, municipalities and political subdivisions

     33,479        33,479                33,479          

Corporate debt

     176,907        176,907                176,907          
  

 

 

    

 

 

          

Total available for sale fixed maturity investments

     244,016        244,016           
  

 

 

    

 

 

          

Trading securities:

              

U.S. Government and Government agencies

   $ 1,278,265      $ 1,278,265      $ 1,054,003      $ 224,262      $   

Non-U.S. Government and Government agencies

     256,756        256,756                256,756          

States, municipalities and political subdivisions

     133,902        133,902                133,902          

Corporate debt

     2,254,474        2,254,474                2,254,474          

Mortgage-backed

     1,818,091        1,818,091                1,568,887        249,204  

Asset-backed

     513,198        513,198                418,453        94,745  
  

 

 

    

 

 

          

Total trading fixed maturity investments

     6,254,686        6,254,686           
  

 

 

    

 

 

          

Total fixed maturity investments

     6,498,702        6,498,702           
  

 

 

    

 

 

          

Equity securities

     367,483        367,483        367,483                  

Other invested assets

     540,409        540,409                        540,409  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 7,406,594      $ 7,406,594      $ 1,455,116      $ 5,067,120      $ 884,358  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Derivative assets: (1)

              

Foreign exchange contracts

   $ 2,030      $ 2,030      $       $ 2,030      $   

Interest rate futures

     977        977                977          
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Derivative liabilities: (1)

              

Foreign exchange contracts

   $ 8,934      $ 8,934      $       $ 8,934      $   

Interest rate futures

     3,467        3,467                3,467          
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Senior notes

   $ 797,949      $ 872,731      $       $ 872,731      $   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Asset and liability derivatives relating to foreign exchange contracts and interest rate futures 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.

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

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

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.

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 corporations that are diversified across a wide range of issuers and industries. The fair values of corporate bonds that are short-term are priced using spread above the London Interbank Offered Rate yield curve, and the fair value of corporate bonds 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 bonds are observable market inputs, the fair values of corporate bonds 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 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: The fair value of the equity securities are priced from market exchanges and therefore included in the Level 1 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 net asset value of the funds as reported by the fund manager that the Company believes is an unobservable input, and as such, the fair values of those funds are included in the Level 3 fair value hierarchy.

Derivative instruments: The fair value of foreign exchange contracts and interest rate futures 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. As of September 30, 2012, the 7.50% Senior Notes and 5.50% Senior Notes (each as defined in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011) were traded at 117.1% and 109.7% of their principal amount, providing an effective yield of 2.8% and 4.1%, respectively. The fair value of the senior notes is 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 thousands of United States dollars, except share, per share, percentage and ratio information)

 

The following is a reconciliation of the beginning and ending balance of financial instruments using significant unobservable inputs (Level 3):

 

    

Fair value measurement using significant

unobservable inputs (Level 3):

 
     Other invested assets     Mortgage-backed     Asset-backed  

Three Months Ended September 30, 2012

      

Opening balance

   $ 520,890     $ 157,959     $ 117,586  

Realized and unrealized gains included in net income

     11,871       4,855       988  

Purchases

     34,800       40,481       7,466  

Sales

     (2,859     (48,728     (7,326

Transfers into Level 3 from Level 2

            14,730       12,495  

Transfers out of Level 3 into Level 2(1)

            (27     (55,442
  

 

 

   

 

 

   

 

 

 

Ending balance

   $ 564,702     $ 169,270     $ 75,767  
  

 

 

   

 

 

   

 

 

 

Three Months Ended September 30, 2011

      

Opening balance

   $ 562,267     $ 216,660     $ 113,310  

Realized and unrealized (losses) gains included in net income

     (34,729     1,876       (1,374

Purchases

     29,553       46,077       328  

Sales

     (5,017     (7,021     (5,708

Transfers into Level 3 from Level 2

            18,170       1,351  

Transfers out of Level 3 into Level 2(1)

            (28,299     (12,300
  

 

 

   

 

 

   

 

 

 

Ending balance

   $ 552,074     $ 247,463     $ 95,607  
  

 

 

   

 

 

   

 

 

 

 

    

Fair value measurement using significant

unobservable inputs (Level 3):

 
     Other invested assets     Mortgage-backed     Asset-backed  

Nine Months Ended September 30, 2012

      

Opening balance

   $ 540,409     $ 249,204     $ 94,745  

Realized and unrealized gains included in net income

     26,753       10,951       1,643  

Purchases

     52,578       50,302       32,573  

Sales

     (55,038     (124,940     (57,325

Transfers into Level 3 from Level 2

            18,461       15,835  

Transfers out of Level 3 into Level 2 (1)

            (34,708     (11,704
  

 

 

   

 

 

   

 

 

 

Ending balance

   $ 564,702     $ 169,270     $ 75,767  
  

 

 

   

 

 

   

 

 

 

Nine Months Ended September 30, 2011

      

Opening balance

   $ 347,632     $ 172,558     $ 48,707  

Realized and unrealized (losses) gains included in net income

     (22,236     5,103       (788

Purchases

     274,893       108,681       115,745  

Sales

     (48,215     (50,308     (8,933

Transfers into Level 3 from Level 2

            104,255       34,152  

Transfers out of Level 3 into Level 2 (1)

            (92,826     (93,276
  

 

 

   

 

 

   

 

 

 

Ending balance

   $ 552,074     $ 247,463     $ 95,607  
  

 

 

   

 

 

   

 

 

 

 

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

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio 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, 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 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 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, other than investments in other invested assets, 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:

 

     September 30,
2012
     December 31,
2011
 

Outstanding loss reserves

   $ 1,430,923      $ 1,366,466  

Reserves for losses incurred but not reported

     4,019,864        3,858,677  
  

 

 

    

 

 

 

Reserve for losses and loss expenses

   $ 5,450,787      $ 5,225,143  
  

 

 

    

 

 

 

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, 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
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Gross liability at beginning of period

   $ 5,377,518     $ 5,251,304     $ 5,225,143     $ 4,879,188  

Reinsurance recoverable at beginning of period

     (1,073,612     (1,013,951     (1,002,919     (927,588
  

 

 

   

 

 

   

 

 

   

 

 

 

Net liability at beginning of period

     4,303,906       4,237,353       4,222,224       3,951,600  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net losses incurred related to:

        

Commutation of variable-rated reinsurance contracts

                          11,529  

Current year

     315,102       267,070       862,088       895,386  

Prior years

     (56,154     (61,524     (137,558     (161,104
  

 

 

   

 

 

   

 

 

   

 

 

 

Total incurred

     258,948       205,546       724,530       745,811  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net paid losses related to:

        

Current year

     16,323       43,723       36,163       65,002  

Prior years

     179,666       150,767       542,077       394,363  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total paid

     195,989       194,490       578,240       459,365  
  

 

 

   

 

 

   

 

 

   

 

 

 

Foreign exchange revaluation

     6,400       (12,499     4,751       (2,136
  

 

 

   

 

 

   

 

 

   

 

 

 

Net liability at end of period

     4,373,265       4,235,910       4,373,265       4,235,910  

Reinsurance recoverable at end of period

     1,077,522       1,009,643       1,077,522       1,009,643  
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross liability at end of period

   $ 5,450,787     $ 5,245,553     $ 5,450,787     $ 5,245,553  
  

 

 

   

 

 

   

 

 

   

 

 

 

For the three months ended September 30, 2012, the Company had net favorable reserve development in each of its segments due to actual loss emergence being lower than initially expected. The majority of the net favorable reserve development was recognized by each segment in the 2006 through 2008 loss years across most lines of business.

For the nine months ended September 30, 2012, the Company had net favorable reserve development in each of its segments due to actual loss emergence being lower than initially expected. The majority of the net favorable reserve development was recognized by each segment in the 2004 through 2008 loss years. The Company had net unfavorable reserve development in its U.S. insurance segment in the 2010 and 2011 loss years, primarily due to higher than expected losses on a terminated program, and in its international insurance segment in the 2011 loss year, primarily due to an individual full-limit general casualty claim.

During the nine months ended September 30, 2011, the Company commuted certain variable-rated reinsurance contracts that have swing-rated provisions, reducing ceded losses by $11,529 in accordance with the terms of the contracts, resulting in a net gain of $865.

For the three months ended September 30, 2011, the Company had net favorable reserve development in each of its segments due to actual loss emergence being lower than the initial expected. The majority of the net favorable reserve development was recognized in each segment in the 2004 through 2007 loss years related to the general casualty and professional liability insurance and reinsurance lines of business and the healthcare insurance line of business.

For the nine months ended September 30, 2011, the Company had net favorable reserve development in each of its segments due to actual loss emergence being lower than the initial expected. The majority of the net favorable reserve development was recognized in the international insurance and reinsurance segments in the 2004 through 2007 loss years related to the general casualty and professional liability insurance and reinsurance lines of business and the healthcare insurance line of business.

While the Company has experienced favorable 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.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

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 the taxable equity of Allied World Switzerland in Switzerland. Allied World 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 the United Kingdom, Ireland, Switzerland, Hong Kong and Singapore. To the best of the Company’s knowledge, there are no income tax examinations pending by any 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 January 2012.

9. SHAREHOLDERS’ EQUITY

a) Authorized shares

The issued share capital consists of the following:

 

     September 30,
2012
     December 31,
2011
 

Common shares issued and fully paid, 2012: CHF 12.98 per share; 2011: CHF 14.03 per share

     37,083,742        40,003,642  
  

 

 

    

 

 

 

Share capital at end of period

   $ 477,246      $ 557,153  
  

 

 

    

 

 

 

 

     Nine Months  Ended
September 30, 2012
 

Shares issued at beginning of period

     40,003,642  

Shares cancelled

     (2,919,900
  

 

 

 

Total shares issued at end of period

     37,083,742  
  

 

 

 

Treasury shares issued at beginning of period

     2,261,511  

Shares repurchased

     2,942,085  

Shares issued out of treasury

     (602,512

Shares cancelled

     (2,919,900
  

 

 

 

Total treasury shares at end of period

     1,681,184  
  

 

 

 

Total shares outstanding at end of period

     35,402,558  
  

 

 

 

As of September 30, 2012, there were issued and outstanding 35,402,558 voting common shares and nil non-voting common shares.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

Effective July 30, 2012, the Company cancelled 2,326,900 voting shares and 173,100 non-voting shares held in treasury, upon completing a required filing with the Swiss Commercial Register in Zug. During the three months ended September 30, 2012, a further 419,900 voting shares repurchased and designated for cancellation were constructively retired and cancelled.

As of September 30, 2012, Allied World Switzerland’s articles of association authorized its board of directors to increase the share capital by a maximum amount of 20% of the share capital registered in the commercial register up to CHF 97,359 or 7,500,728 voting shares, and create conditional capital of 5,200,000 voting shares.

b) Share Warrants

In conjunction with the private placement offering at the formation of Allied World Bermuda, Allied World Bermuda granted warrant agreements to certain founding shareholders to acquire up to 5,500,000 common shares at an exercise price of $34.20 per share. These warrants were exercisable in certain limited conditions, including a public offering of common shares. All warrants granted were repurchased by the Company.

In February 2011, the Company repurchased the last outstanding warrant owned by American International Group, Inc. (“AIG”) in a privately negotiated transaction. The warrant entitled AIG to purchase 2,000,000 of the Company’s common shares for $34.20 per share. The Company repurchased the warrant for an aggregate purchase price of $53,620. The repurchase of the warrant was recognized as a reduction in “additional paid-in capital” on the consolidated balance sheets. The repurchase was executed separately from the share repurchase program discussed in Note 9(d) below. After this repurchase, AIG has no warrants remaining and no other disclosed equity interest in the Company.

c) Dividends

Under Swiss law, distributions to shareholders may be paid only if the Company has sufficient distributable profits from previous fiscal years, or if the Company has freely distributable reserves, each as presented on the audited stand-alone statutory balance sheet. Distributions to shareholders out of the share and participation capital may be made by way of a capital reduction in the form of a reduction to par value to achieve a similar result as the payment of a dividend.

The Company paid the following dividends during the nine months ended September 30, 2012:

 

Dividend Paid    Partial
Par  Value

Reduction
Per Share
     Dividend
Per
Share
     Total
Amount
Paid
 

September 25, 2012(1)

   CHF   0.35      $ 0.375      $ 13,324  

August 6, 2012(1)

   CHF 0.36      $ 0.375      $ 13,394  

April 6, 2012(2)

   CHF 0.34      $ 0.375      $ 13,795  

January 6, 2012(2)

   CHF 0.35      $ 0.375      $ 14,302  

 

(1) On May 3, 2012, the shareholders approved the Company’s proposal to pay cash dividends in the form of a distribution by way of par value reductions. The aggregate reduction amount is expected to be paid to shareholders in four installments of $0.375 per share, with the third installment expected to be paid in December 2012 and the final installment expected to be paid in March 2013.

 

(2) On May 5, 2011, the shareholders approved the Company’s proposal to pay cash dividends in the form of a distribution by way of par value reductions. The aggregate reduction amount was paid to shareholders in quarterly installments of $0.375 per share, with the last of such quarterly dividend payments being made on April 6, 2012.

d) Share Repurchase

In May 2012, the Company established a new share repurchase program in order to repurchase up to $500 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 this new share repurchase program, common shares repurchased shall be designated for cancellation and shall be cancelled upon shareholder approval.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

Shares repurchased by the Company and not designated for cancellation are classified as “Treasury shares, at cost” on the consolidated balance sheets. The Company will issue shares out of treasury principally related to the Company’s employee benefit plans. 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
September 30,
     Nine Months Ended
September 30,
 
     2012      2011      2012      2011  

Common shares repurchased

     605,898                2,942,085        969,163  

Total cost of shares repurchased

   $ 47,590      $       $ 207,048      $ 60,000  

Average price per share

   $ 78.54      $       $ 70.37      $ 61.91  

10. EARNINGS PER SHARE

The following table sets forth the comparison of basic and diluted earnings per share:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012      2011     2012      2011  

Basic earnings (loss) per share:

          

Net income (loss)

   $ 219,647      $ (10,972   $ 534,154      $ 91,448  

Weighted average common shares outstanding

     35,652,768        38,110,368       36,379,514        38,078,116  
  

 

 

    

 

 

   

 

 

    

 

 

 

Basic earnings (loss) per share

   $ 6.16      $ (0.29   $ 14.68      $ 2.40  
  

 

 

    

 

 

   

 

 

    

 

 

 

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012      2011     2012      2011  

Diluted earnings (loss) per share:

          

Net income (loss)

   $ 219,647      $ (10,972   $ 534,154      $ 91,448  

Weighted average common shares outstanding

     35,652,768        38,110,368       36,379,514        38,078,116  

Share equivalents:

          

Warrants and options

     461,373               429,393        413,228  

RSUs and long-term incentive plan (“LTIP”) awards

     501,633               583,226        1,267,221  

Employee stock purchase plan

     960               960        1,215  
  

 

 

    

 

 

   

 

 

    

 

 

 

Weighted average common shares and common share equivalents outstanding — diluted

     36,616,734        38,110,368       37,393,093        39,759,780  
  

 

 

    

 

 

   

 

 

    

 

 

 

Diluted earnings (loss) per share

   $ 6.00      $ (0.29   $ 14.28      $ 2.30  
  

 

 

    

 

 

   

 

 

    

 

 

 

For the three months ended September 30, 2012 a weighted average of 221,008 employee stock options and restricted stock units (“RSUs”) were considered anti-dilutive and were therefore excluded from the calculation of the diluted earnings per share. For the three months ended September 30, 2011, 2,565,428 dilutive securities in the form of employee stock options, RSUs and LTIP awards were considered anti-dilutive as there was a net loss and were therefore excluded from the calculation of the diluted earnings per share.

For the nine months ended September 30, 2012 and 2011, a weighted average of 338,395 and 743,277 employee stock options and RSUs were considered anti-dilutive and were therefore excluded from the calculation of the diluted earnings per share, respectively.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

11. CREDIT AGREEMENTS

In the normal course of its operations, the Company enters into agreements with financial institutions to obtain secured and unsecured credit facilities.

On June 7, 2012, Allied World Bermuda amended its existing secured credit facility. The amended $450,000 four-year secured credit facility (the “Amended Secured Credit Facility”) is primarily used for the issuance of standby letters of credit to support obligations in connection with the insurance and reinsurance business of Allied World Bermuda and its subsidiaries. A portion of the facility may also be used for revolving loans for general corporate and working capital purposes, up to a maximum of $150,000. Allied World Bermuda may request that existing lenders under the Amended Secured Credit Facility make additional commitments from time to time, up to $150,000, subject to approval by the lenders. The Amended Secured Credit Facility contains representations, warranties and covenants customary for similar bank loan facilities, including certain covenants that, among other things, require the Company to maintain a certain leverage ratio and financial strength rating.

On June 7, 2012, upon entering into the Amended Secured Credit Facility, Allied World Bermuda terminated its $400,000 unsecured credit facility.

12. SEGMENT INFORMATION

The determination of reportable segments is based on how senior management 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: U.S. insurance, international insurance and reinsurance. All product lines fall within these classifications.

The U.S. insurance segment includes the Company’s direct specialty insurance operations in the United States. This segment provides both direct property and specialty casualty insurance primarily to non-Fortune 1000 North American domiciled accounts. The international insurance segment includes the Company’s direct insurance operations in Bermuda, Europe, Singapore and Hong Kong. This segment provides both direct property and casualty insurance primarily to Fortune 1000 North American domiciled accounts from the Bermuda office and non-North American domiciled accounts from the European, Singapore and Hong Kong Offices. The reinsurance segment includes the Company’s reinsurance operations in the U.S., Bermuda, Europe and Asia. 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 staff count and each segment’s proportional share of gross premiums written.

Management measures results for each segment on the basis of the “loss and loss expense ratio,” “acquisition cost ratio,” “general and administrative 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 “combined ratio” is the sum of the “loss and loss expense ratio,” the “acquisition cost ratio” and the “general and administrative expense ratio.”

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

The following tables provide a summary of the segment results:

 

Three Months Ended September 30, 2012

   U.S. Insurance     International
Insurance
    Reinsurance     Total  

Gross premiums written

   $ 263,129     $ 121,315     $ 119,976     $ 504,420  

Net premiums written

     200,779       71,199       119,559       391,537  

Net premiums earned

     173,948       85,329       181,740       441,017  

Net losses and loss expenses

     (109,111     (15,099     (134,738     (258,948

Acquisition costs

     (22,696     266       (28,656     (51,086

General and administrative expenses

     (37,388     (22,920     (18,264     (78,572
  

 

 

   

 

 

   

 

 

   

 

 

 

Underwriting income

     4,753       47,576       82       52,411  

Net investment income

           39,121  

Net realized investment gains

           149,813  

Amortization of intangible assets

           (633

Interest expense

           (13,822

Foreign exchange loss

           (1,023
        

 

 

 

Income before income taxes

         $ 225,867  
        

 

 

 

Loss and loss expense ratio

     62.7     17.7     74.1     58.7

Acquisition cost ratio

     13.0     (0.3 %)      15.8     11.6

General and administrative expense ratio

     21.5     26.9     10.0     17.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Combined ratio

     97.2     44.3     99.9     88.1
  

 

 

   

 

 

   

 

 

   

 

 

 

 

Three Months Ended September 30, 2011

   U.S. Insurance     International
Insurance
    Reinsurance     Total  

Gross premiums written

   $ 201,522     $ 109,612     $ 131,564     $ 442,698  

Net premiums written

     157,310       61,386       131,564       350,260  

Net premiums earned

     150,474       80,175       140,691       371,340  

Net losses and loss expenses

     (85,720     (43,666     (76,160     (205,546

Acquisition costs

     (19,549     343       (20,474     (39,680

General and administrative expenses

     (28,945     (21,558     (15,504     (66,007
  

 

 

   

 

 

   

 

 

   

 

 

 

Underwriting income

     16,260       15,294       28,553       60,107  

Net investment income

           47,883  

Net realized investment losses

           (130,809

Other income — termination fee

           35,000  

Amortization of intangible assets

           (767

Interest expense

           (13,748

Foreign exchange loss

           (2,966
        

 

 

 

Loss before income taxes

         $ (5,300
        

 

 

 

Loss and loss expense ratio

     57.0     54.5     54.1     55.4

Acquisition cost ratio

     13.0     (0.4 %)      14.6     10.7

General and administrative expense ratio

     19.2     26.9     11.0     17.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Combined ratio

     89.2     81.0     79.7     83.9
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

Nine Months Ended September 30, 2012

   U.S. Insurance     International
Insurance
    Reinsurance     Total  

Gross premiums written

   $ 733,314     $ 418,498     $ 680,407     $ 1,832,219  

Net premiums written

     551,286       255,150       668,764       1,475,200  

Net premiums earned

     490,091       247,805       534,758       1,272,654  

Net losses and loss expenses

     (309,889     (75,432     (339,209     (724,530

Acquisition costs

     (63,918     1,376       (87,270     (149,812

General and administrative expenses

     (103,162     (66,969     (52,786     (222,917
  

 

 

   

 

 

   

 

 

   

 

 

 

Underwriting income

     13,122       106,780       55,493       175,395  

Net investment income

           128,781  

Net realized investment gains

           292,057  

Amortization of intangible assets

           (1,900

Interest expense

           (41,579

Foreign exchange gain

           77  
        

 

 

 

Income before income taxes

         $ 552,831  
        

 

 

 

Loss and loss expense ratio

     63.2     30.4     63.4     56.9

Acquisition cost ratio

     13.0     (0.6 %)      16.3     11.8

General and administrative expense ratio

     21.0     27.0     9.9     17.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Combined ratio

     97.2     56.8     89.6     86.2
  

 

 

   

 

 

   

 

 

   

 

 

 

 

Nine Months Ended September 30, 2011

   U.S. Insurance     International
Insurance
    Reinsurance     Total  

Gross premiums written

   $ 611,562     $ 399,530     $ 511,892     $ 1,522,984  

Net premiums written

     470,099       245,281       511,554       1,226,934  

Net premiums earned

     431,812       236,421       393,290       1,061,523  

Net losses and loss expenses

     (294,146     (186,932     (264,733     (745,811

Acquisition costs

     (56,527     2,946       (67,152     (120,733

General and administrative expenses

     (90,997     (62,939     (47,228     (201,164
  

 

 

   

 

 

   

 

 

   

 

 

 

Underwriting (loss) income

     (9,858     (10,504     14,177       (6,185

Net investment income

           150,459  

Net realized investment losses

           (21,555

Other income — termination fee

           35,000  

Amortization of intangible assets

           (2,300

Interest expense

           (41,235

Foreign exchange loss

           (3,708
        

 

 

 

Income before income taxes

         $ 110,476  
        

 

 

 

Loss and loss expense ratio

     68.1     79.1     67.3     70.3

Acquisition cost ratio

     13.1     (1.2 %)      17.1     11.4

General and administrative expense ratio

     21.1     26.6     12.0     19.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Combined ratio

     102.3     104.5     96.4     100.7
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

The following table shows an analysis of the Company’s gross premiums written by geographic location of the Company’s subsidiaries. All intercompany premiums have been eliminated.

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012      2011      2012      2011  

United States

   $ 312,807      $ 245,688      $ 1,051,355      $ 821,512  

Bermuda

     108,955        113,671        484,313        461,989  

Europe

     46,836        47,569        182,220        169,857  

Singapore

     31,902        33,252        101,213        58,819  

Hong Kong

     3,920        2,518        13,118        10,807  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total gross premiums written

   $ 504,420      $ 442,698      $ 1,832,219      $ 1,522,984  
  

 

 

    

 

 

    

 

 

    

 

 

 

13. COMMITMENTS AND CONTINGENCIES

In April 2006, a complaint entitled New Cingular Wireless Headquarters, LLC et al. v. Marsh & McLennan Companies, Inc., et al. was filed against numerous brokers and 78 insurers including Allied World Assurance Company, Ltd. Plaintiffs allege that the broker defendants used a variety of illegal schemes and anti-competitive practices that resulted in the plaintiffs either paying more for insurance products or receiving less beneficial terms than the competitive market would have produced. Plaintiffs seek equitable and legal remedies, including injunctive relief, consequential and punitive damages, treble damages and attorneys’ fees. Due to various pending procedural matters, the litigation has not progressed beyond the discovery phase. While it is not possible to predict the outcome of the litigation, the Company does not believe that the outcome will have a material effect on its operations, financial position or cash flow.

The Company, in common with the insurance industry in general, is subject to litigation and arbitration in the normal course of its business. These legal proceedings generally relate to claims asserted by or against the Company in the ordinary course of insurance or reinsurance operations. Estimated amounts payable under these proceedings are included in the reserve for losses and loss expenses in the Company’s consolidated balance sheets. As of September 30, 2012, the Company was not a party to any material legal proceedings arising outside the ordinary course of business that management believes will have a material adverse effect on the Company’s results of operations, financial position or cash flow.

14. OTHER INCOME

On September 15, 2011, the Company reached a mutual agreement with Transatlantic Holdings, Inc. to terminate the previously announced merger agreement. Under the terms of the termination agreement, the Company received an initial termination fee of $35,000, which has been included within “Other income” on the consolidated income statements for the three and nine months ended September 30, 2011. Further to the terms of the termination agreement, the Company received an additional $66,744 in the fourth quarter of 2011.

15. SUBSEQUENT EVENTS

On October 9, 2012, the Company announced plans to expand its asset management business through a strategic partnership between MatlinPatterson Asset Management L.P. (“MatlinPatterson”) and Allied World Financial Services, Ltd (a subsidiary of the Company that was formed in the third quarter 2012 to expand our asset management expertise, invest in strategic business opportunities and diversify the Company’s earnings stream with business relationships that complement the Company’s core property and casualty business). Under the terms of the transaction, the Company will become a minority owner of MatlinPatterson and will provide growth capital for the continued expansion of their asset management platform. Additionally, MatlinPatterson will manage $500 million of the Company’s investment portfolio, over time, in existing and future liquid credit strategies.

In late October, Hurricane Sandy impacted the Mid-Atlantic and Northeast coasts of the United States, ultimately making landfall in New Jersey, with tropical storm force or greater winds. In addition, Hurricane Sandy generated significant storm surge, which contributed to widespread power outages, significant disruptions to travel and devastating flooding throughout a number of states, including New York and New Jersey. The Company is currently assessing its potential claims related to this event, but information as of this filing is not sufficient to arrive at a reasonable estimate.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

16. CONDENSED CONSOLIDATED GUARANTOR FINANCIAL STATEMENTS

The following tables present unaudited condensed consolidating financial information as of September 30, 2012 and December 31, 2011 and for the three and nine months ended September 30, 2012 and 2011 for Allied World Switzerland (the “Parent Guarantor”) and Allied World Bermuda (the “Subsidiary Issuer”). The Subsidiary Issuer is a direct, wholly-owned subsidiary of the Parent Guarantor. Investments in subsidiaries are accounted for by the Parent Guarantor under the equity method for purposes of the supplemental consolidating presentation. Earnings of subsidiaries are reflected in the Parent Guarantor’s investment accounts and earnings. The Parent Guarantor fully and unconditionally guarantees the senior notes issued by the Subsidiary Issuer.

Unaudited Condensed Consolidating Balance Sheet:

 

As of September 30, 2012

   Allied World
Switzerland
(Parent
Guarantor)
    Allied World
Bermuda
(Subsidiary
Issuer)
    Other Allied
World
Subsidiaries
     Consolidating
Adjustments
    Allied World
Switzerland
Consolidated
 

ASSETS:

           

Investments

   $      $      $ 8,210,065      $      $ 8,210,065  

Cash and cash equivalents

     24,450       9,573       605,494               639,517  

Insurance balances receivable

                   754,978               754,978  

Reinsurance recoverable

                   1,077,522               1,077,522  

Net deferred acquisition costs

                   127,527               127,527  

Goodwill and intangible assets

                   320,374               320,374  

Balances receivable on sale of investments

                   756,570               756,570  

Investments in subsidiaries

     3,427,446       4,716,399               (8,143,845       

Due (to) from subsidiaries

     (4,536     (6,869     11,405                 

Other assets

     1,813       6,450       417,173               425,436  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

   $ 3,449,173     $ 4,725,553     $ 12,281,108      $ (8,143,845   $ 12,311,989  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

LIABILITIES:

           

Reserve for losses and loss expenses

   $      $      $ 5,450,787      $      $ 5,450,787  

Unearned premiums

                   1,316,399               1,316,399  

Reinsurance balances payable

                   120,432               120,432  

Balances due on purchases of investments

                   1,075,069               1,075,069  

Senior notes

            798,147                      798,147  

Other liabilities

     13,387       12,493       89,489               115,369  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities

     13,387       810,640       8,052,176               8,876,203  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total shareholders’ equity

     3,435,786       3,914,913       4,228,932        (8,143,845     3,435,786  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 3,449,173     $ 4,725,553     $ 12,281,108      $ (8,143,845   $ 12,311,989  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

25


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

As of December 31, 2011

   Allied World
Switzerland
(Parent
Guarantor)
    Allied World
Bermuda
(Subsidiary
Issuer)
    Other Allied
World
Subsidiaries
     Consolidating
Adjustments
    Allied World
Switzerland
Consolidated
 

ASSETS:

           

Investments

   $      $      $ 7,406,594      $      $ 7,406,594  

Cash and cash equivalents

     112,672       8,886       512,438               633,996  

Insurance balances receivable

                   652,158               652,158  

Reinsurance recoverable

                   1,002,919               1,002,919  

Net deferred acquisition costs

                   100,334               100,334  

Goodwill and intangible assets

                   322,274               322,274  

Balances receivable on sale of investments

                   580,443               580,443  

Investments in subsidiaries

     3,064,066       3,964,585               (7,028,651       

Due (to) from subsidiaries

     (4,853     (6,769     11,622                 

Other assets

     1,504       6,367       415,569               423,440  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

   $ 3,173,389     $ 3,973,069     $ 11,004,351      $ (7,028,651   $ 11,122,158  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

LIABILITIES:

           

Reserve for losses and loss expenses

   $      $      $ 5,225,143      $      $ 5,225,143  

Unearned premiums

                   1,078,412               1,078,412  

Reinsurance balances payable

                   124,539               124,539  

Balances due on purchases of investments

                   616,728               616,728  

Senior notes

            797,949                      797,949  

Other liabilities

     24,367       17,688       88,310               130,365  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities

     24,367       815,637       7,133,132               7,973,136  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total shareholders’ equity

     3,149,022       3,157,432       3,871,219        (7,028,651     3,149,022  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 3,173,389     $ 3,973,069     $ 11,004,351      $ (7,028,651   $ 11,122,158  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

26


Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

Unaudited Condensed Consolidating Income Statement:

 

Three Months Ended September 30, 2012

   Allied World
Switzerland
(Parent
Guarantor)
    Allied World
Bermuda
(Subsidiary
Issuer)
    Other Allied
World
Subsidiaries
    Consolidating
Adjustments
    Allied World
Switzerland
Consolidated
 

Net premiums earned

   $      $      $ 441,017     $      $ 441,017  

Net investment income

     7       6       39,108              39,121  

Net realized investment losses

                   149,813              149,813  

Net losses and loss expenses

                   (258,948            (258,948

Acquisition costs

                   (51,086            (51,086

General and administrative expenses

     (6,013     (235     (72,324            (78,572

Amortization of intangible assets

                   (633            (633

Interest expense

            (13,822                   (13,822

Foreign exchange gain (loss)

     (206     (83     (734            (1,023

Income tax (expense) benefit

                   (6,220            (6,220

Equity in earnings of consolidated subsidiaries

     225,859       231,471              (457,330       
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME (LOSS)

   $ 219,647     $ 217,337     $ 239,993     $ (457,330   $ 219,647  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized losses on investments arising during the period net of applicable deferred income tax expense of $96

                   (29            (29

Reclassification adjustment for net realized investment gains included in net income, net of applicable income tax

                                   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive loss

                   (29            (29
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

COMPREHENSIVE INCOME (LOSS)

   $ 219,647     $ 217,337     $ 239,964     $ (457,330   $ 219,618  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended September 30, 2011

   Allied World
Switzerland
(Parent
Guarantor)
    Allied World
Bermuda
(Subsidiary
Issuer)
    Other Allied
World
Subsidiaries
    Consolidating
Adjustments
    Allied World
Switzerland
Consolidated
 

Net premiums earned

   $      $      $ 371,340     $      $ 371,340  

Net investment income

     7       3       47,873              47,883  

Net realized investment gains

                   (130,809            (130,809

Other income — termination fee

     35,000                            35,000  

Net losses and loss expenses

                   (205,546            (205,546

Acquisition costs

                   (39,680            (39,680

General and administrative expenses

     (2,110     (913     (62,984            (66,007

Amortization of intangible assets

                   (767            (767

Interest expense

            (13,748                   (13,748

Foreign exchange gain (loss)

     10       (907     (2,069            (2,966

Income tax (expense) benefit

     (2,730            (2,942            (5,672

Equity in earnings of consolidated subsidiaries

     (41,148                            
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME (LOSS)

   $ (10,971   $ (15,565   $ (25,584   $      $ (10,972
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized gains on investments arising during the period net of applicable deferred income tax expense of $1,461

                   20              20  

Reclassification adjustment for net realized investment gains included in net income, net of applicable income tax

                   (5,319            (5,319
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive loss

                   (5,299            (5,299
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

COMPREHENSIVE INCOME (LOSS)

   $ (10,971   $ (15,565   $ (30,883   $      $ (16,271
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

27


Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

Nine Months Ended September 30, 2012

   Allied World
Switzerland
(Parent
Guarantor)
    Allied World
Bermuda
(Subsidiary
Issuer)
    Other Allied
World
Subsidiaries
    Consolidating
Adjustments
    Allied World
Switzerland
Consolidated
 

Net premiums earned

   $      $      $ 1,272,654     $      $ 1,272,654  

Net investment income

     21       17       128,743              128,781  

Net realized investment losses

                   292,057              292,057  

Net losses and loss expenses

                   (724,530            (724,530

Acquisition costs

                   (149,812            (149,812

General and administrative expenses

     (14,247     (2,689     (205,981            (222,917

Amortization of intangible assets

                   (1,900            (1,900

Interest expense

            (41,579                   (41,579

Foreign exchange loss (gain)

     343       (150     (116            77  

Income tax (expense) benefit

     71              (18,748            (18,677

Equity in earnings of consolidated subsidiaries

     547,966       580,880              (1,128,846       
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME (LOSS)

   $ 534,154     $ 536,479     $ 592,367     $