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
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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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

   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     $ (1,128,846   $ 534,154  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized gains on investments arising during the period net of applicable deferred income tax expense of $81

                   150              150  

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

                   (13,249            (13,249
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive loss

                   (13,099            (13,099
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

COMPREHENSIVE INCOME (LOSS)

   $ 534,154     $ 536,479     $ 579,268     $ (1,128,846   $ 521,055  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nine 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

   $      $      $ 1,061,523     $      $ 1,061,523  

Net investment income

     51       25       150,383              150,459  

Net realized investment gains

                   (21,555            (21,555

Other income — termination fee

     35,000                            35,000  

Net losses and loss expenses

                   (745,811            (745,811

Acquisition costs

                   (120,733            (120,733

General and administrative expenses

     (7,919     (5,141     (188,104            (201,164

Amortization of intangible assets

                   (2,300            (2,300

Interest expense

            (41,235                   (41,235

Foreign exchange gain (loss)

     11       (1,131     (2,588            (3,708

Income tax (expense) benefit

     (2,730            (16,298            (19,028

Equity in earnings of consolidated subsidiaries

     67,035       114,243              (181,278       
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME (LOSS)

   $ 91,448     $ 66,761     $ 114,517     $ (181,278   $ 91,448  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized gains on investments arising during the period net of applicable deferred income tax expense of $3,051

                   5,656              5,656  

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

                   (44,995            (44,995
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive loss

                   (39,339            (39,339
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

COMPREHENSIVE INCOME (LOSS)

   $ 91,448     $ 66,761     $ 75,178     $ (181,278   $ 52,109  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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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)

 

Unaudited Condensed Consolidating Cash Flows:

 

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
 

CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES

   $ 162,141     $ 687      $ 336,824     $       $ 499,652  
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:

            

Purchases trading securities

                    (6,328,719             (6,328,719

Purchases of other invested assets

                    (52,578             (52,578

Sales of available for sale securities

                    215,318               215,318  

Sales of trading securities

                    5,778,138               5,778,138  

Sales of other invested assets

                    110,429               110,429  

Other

                    33,644               33,644  
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Net cash provided by (used in) investing activities

                    (243,768             (243,768
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:

            

Partial par value reduction

     (54,721                            (54,721

Proceeds from the exercise of stock options

     9,104                              9,104  

Share repurchases

     (204,746                            (204,746
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Net cash provided by (used in) financing activities

     (250,363                            (250,363
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     (88,222     687        93,056               5,521  

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

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

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

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

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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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)

 

Nine 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
 

CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:

   $ 34,318     $ (52,678   $ 510,550     $       $ 492,190  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:

           

Purchases of available for sale securities

                   (727             (727

Purchases of trading securities

                   (5,555,249             (5,555,249

Purchases of other invested assets

                   (265,720             (265,720

Sales of available for sale securities

                   627,392               627,392  

Sales of trading securities

                   4,841,580               4,841,580  

Sales of other invested assets

                   40,129               40,129  

Other

     (4,496            59,824               55,328  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net cash provided by (used in) investing activities

     (4,496            (252,771             (257,267
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:

           

Partial par value reduction

     (14,295                           (14,295

Proceeds from the exercise of stock options

     5,317                             5,317  

Share repurchases

     (60,000                           (60,000

Repurchase of founder warrants

            (53,620                    (53,620

Other

     (391     (820     1,211                 
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net cash provided by (used in) financing activities

     (69,369     (54,440     1,211               (122,598
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     (39,547     (107,118     258,990               112,325  

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     138,488       125,663       492,844               756,995  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 98,941     $ 18,545     $ 751,834     $       $ 869,320  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

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Table of Contents

Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q. References in this Form 10-Q to the terms “we,” “us,” “our,” “the company” or other similar terms mean the consolidated operations of Allied World Assurance Company Holdings, AG, a Swiss holding company, and our consolidated subsidiaries, unless the context requires otherwise. References in this Form 10-Q to the term “Allied World Switzerland” or “Holdings” means only Allied World Assurance Company Holdings, AG. References to “Allied World Bermuda” mean only Allied World Assurance Company Holdings, Ltd, a Bermuda holding company. References to “our insurance subsidiaries” may include our reinsurance subsidiaries. References in this Form 10-Q to $ are to the lawful currency of the United States and to CHF are to the lawful currency of Switzerland. References in this Form 10-Q to Holdings’ “common shares” mean its registered voting shares.

Note on Forward-Looking Statement

This Form 10-Q and other publicly available documents may include, and our officers and representatives may from time to time make, projections concerning financial information and statements concerning future economic performance and events, plans and objectives relating to management, operations, products and services, and assumptions underlying these projections and statements. These projections and statements are forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995 and are not historical facts but instead represent only our belief regarding future events, many of which, by their nature, are inherently uncertain and outside our control. These projections and statements may address, among other things, our strategy for growth, product development, financial results and reserves. Actual results and financial condition may differ, possibly materially, from these projections and statements and therefore you should not place undue reliance on them. Factors that could cause our actual results to differ, possibly materially, from those in the specific projections and statements are discussed throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations and in “Risk Factors” in Item 1A. of Part I of our 2011 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on February 29, 2012 (the “2011 Form 10-K”). We are under no obligation (and expressly disclaim any such obligation) to update or revise any forward-looking statement that may be made from time to time, whether as a result of new information, future developments or otherwise.

Overview

Our Business

We write a diversified portfolio of property and casualty insurance and reinsurance internationally through our subsidiaries and branches based in Bermuda, Europe, Hong Kong, Singapore and the United States as well as our Lloyd’s Syndicate 2232. We manage our business through three operating segments: U.S. insurance, international insurance and reinsurance. As of September 30, 2012, we had approximately $12.3 billion of total assets, $3.4 billion of total shareholders’ equity and $4.2 billion of total capital, which includes shareholders’ equity and senior notes.

During the three months ended September 30, 2012, we continued to experience rate increases on property lines that had experienced significant loss activity in the prior year. We also continued to see rate improvement during the quarter on some of our casualty lines of business in certain jurisdictions. We believe that there are opportunities where certain products have attractive premium rates and that the expanded breadth of our operations allows us to target those classes of business. Given these trends, we continue to be selective in the insurance policies and reinsurance contracts we underwrite. Our consolidated gross premiums written increased by $61.7 million, or 13.9%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. Our net income was $219.6 million for the three months ended September 30, 2012 compared to a net loss of $11.0 million for the three months ended September 30, 2011, representing a $230.6 million increase. The increase was due to net realized investment gains that increased by $280.6 million for the three months ended September 30, 2012 compared to the same period in 2011. This was partially offset by the non-recurring $35.0 million termination fee recognized in the three months ended September 30, 2011 that related to our previously announced Transatlantic Holdings, Inc. (“Transatlantic”) merger agreement. In addition, we recognized $40.0 million of crop reinsurance losses in the three months ended September 30, 2012.

Our consolidated gross premiums written increased by $309.2 million, or 20.3%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. Our net income increased by $442.7 million to $534.2 million compared to the nine months ended September 30, 2011. The increase was due to net realized investment gains that increased by $313.6 million for the nine months ended September 30, 2012 compared to the same period in 2011, combined with lower net losses and loss

 

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Table of Contents

expenses. The nine months ended September 30, 2011 included $233.1 million of property catastrophe losses for the Asia-Pacific catastrophes, Midwestern U.S. storms and Hurricane Irene. This was partially offset by the non-recurring $35.0 million termination fee recognized in the nine months ended September 30, 2011 that related to the previously announced Transatlantic merger agreement. In addition, we recognized $40.0 million of crop reinsurance losses in the nine months ended September 30, 2012.

Financial Highlights

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2012     2011     2012     2011  
     ($ in millions except share, per share and percentage data)  

Gross premiums written

   $ 504.4     $ 442.7     $ 1,832.2     $ 1,523.0  

Net income (loss)

     219.6       (11.0     534.2       91.5  

Operating income

     79.2       86.2       258.0       89.0  

Basic earnings per share:

        

Net income (loss)

   $ 6.16     $ (0.29   $ 14.68     $ 2.40  

Operating income

   $ 2.22     $ 2.26     $ 7.09     $ 2.34  

Diluted earnings per share:

        

Net income (loss)

   $ 6.00     $ (0.29   $ 14.28     $ 2.30  

Operating income

   $ 2.16     $ 2.19     $ 6.90     $ 2.24  

Weighted average common shares outstanding:

        

Basic

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

Diluted

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

Basic book value per common share

   $ 97.05     $ 78.73     $ 97.05     $ 78.73  

Diluted book value per common share

   $ 93.82     $ 75.82     $ 93.82     $ 75.82  

Annualized return on average equity (ROAE), net income (loss)

     26.2     (1.5 %)      21.7     4.1

Annualized ROAE, operating income

     9.4     11.5     10.5     4.0

Non-GAAP Financial Measures

In presenting the company’s results, management has included and discussed certain non-GAAP financial measures, as such term is defined in Item 10(e) of Regulation S-K promulgated by the SEC. Management believes that these non-GAAP measures, which may be defined differently by other companies, better explain the company’s results of operations in a manner that allows for a more complete understanding of the underlying trends in the company’s business. However, these measures should not be viewed as a substitute for those determined in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).

Operating income & operating income per share

Operating income is an internal performance measure used in the management of our operations and represents after-tax operational results excluding, as applicable, net realized investment gains or losses, net impairment charges recognized in earnings, net foreign exchange gain or loss, impairment of intangible assets and other non-recurring items. We exclude net realized investment gains or losses, net impairment charges recognized in earnings, net foreign exchange gain or loss and any other non-recurring items from our calculation of operating income because these amounts are heavily influenced by and fluctuate in part according to the availability of market opportunities and other factors. We have excluded from our operating income the $35.0 million termination fee we received from Transatlantic as this is a non-recurring item. In addition to presenting net income determined in accordance with U.S. GAAP, we believe that showing operating income enables investors, analysts, rating agencies and other users of our financial information to more easily analyze our results of operations and our underlying business performance. Operating income should not be viewed as a substitute for U.S. GAAP net income. The following is a reconciliation of operating income to its most closely related U.S. GAAP measure, net income.

 

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Table of Contents
     Three Months Ended September 30,     Nine Months Ended September 30,  
     2012     2011     2012     2011  
     ($ in millions, except share, per share and percentage data)  

Net income (loss)

   $ 219.6     $ (11.0   $ 534.2     $ 91.5  

Add after tax effect of:

        

Net realized investment (gains) losses

     (141.4     126.5       (276.1     26.1  

Other income — termination fee

            (32.3            (32.3

Foreign exchange loss (gain)

     1.0       3.0       (0.1     3.7  
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

   $ 79.2     $ 86.2     $ 258.0     $ 89.0  
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic per share data:

        

Net income (loss)

   $ 6.16     $ (0.29   $ 14.68     $ 2.40  

Add after tax effect of:

        

Net realized investment (gains) losses

     (3.97     3.32       (7.59     0.69  

Other income — termination fee

            (0.85            (0.85

Foreign exchange gain

     0.03       0.08              0.10  
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

   $ 2.22     $ 2.26     $ 7.09     $ 2.34  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted per share data:

        

Net income (loss)

   $ 6.00     $ (0.29   $ 14.28     $ 2.30  

Add after tax effect of:

        

Net realized investment (gains) losses

     (3.86     3.21       (7.38     0.66  

Other income — termination fee

            (0.82            (0.81

Foreign exchange gain

     0.02       0.09              0.09  
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

   $ 2.16     $ 2.19     $ 6.90     $ 2.24  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted book value per share

We have included diluted book value per share because it takes into account the effect of dilutive securities; therefore, we believe it is an important measure of calculating shareholder returns.

 

     As of September 30,  
     2012     2011  
     ($ in millions, except share and
per share data)
 

Price per share at period end

   $ 77.25     $ 53.71  

Total shareholders’ equity

   $ 3,435.8     $ 3,003.1  

Basic common shares outstanding

     35,402,558       38,145,557  

Add:

    

Unvested restricted share units

     179,986       256,672  

Performance based equity awards

     508,130       898,014  

Employee share purchase plan

     5,925       1,215  

Dilutive options/warrants outstanding

     1,306,837       1,107,305  

Weighted average exercise price per share

   $ 46.14     $ 38.80  

Deduct:

    

Options bought back via treasury method

     (780,502     (799,914
  

 

 

   

 

 

 

Common shares and common share equivalents outstanding

     36,622,934       39,608,849  

Basic book value per common share

   $ 97.05     $ 78.73  

Diluted book value per common share

   $ 93.82     $ 75.82  

 

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Table of Contents

Annualized return on average equity

Annualized return on average shareholders’ equity (“ROAE”) is calculated using average equity, excluding the average after tax unrealized gains or losses on investments. We present ROAE as a measure that is commonly recognized as a standard of performance by investors, analysts, rating agencies and other users of our financial information.

Annualized operating return on average shareholders’ equity is calculated using operating income and average shareholders’ equity, excluding the average after tax unrealized gains or losses on investments.

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  
     ($ in millions except percentage data)  

Opening shareholders’ equity

   $ 3,283.9     $ 3,044.4     $ 3,149.0     $ 3,075.8  

Deduct: accumulated other comprehensive income

     (1.4     (23.1     (14.5     (57.1
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted opening shareholders’ equity

   $ 3,282.5     $ 3,021.3     $ 3,134.5     $ 3,018.7  

Closing shareholders’ equity

   $ 3,435.8     $ 3,003.1     $ 3,435.8     $ 3,003.1  

Deduct: accumulated other comprehensive income

     (1.4     (17.8     (1.4     (17.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted closing shareholders’ equity

   $ 3,434.4     $ 2,985.3     $ 3,434.4     $ 2,985.3  

Average shareholders’ equity

   $ 3,358.4     $ 3,003.3     $ 3,284.5     $ 3,002.0  

Net income (loss) available to shareholders

   $ 219.6     $ (11.0   $ 534.2     $ 91.4  

Annualized return on average shareholders’ equity — net income (loss) available to shareholders

     26.2     (1.5 %)      21.7     4.1
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income available to shareholders

   $ 79.2     $ 86.2     $ 258.0     $ 89.0  

Annualized return on average shareholders’ equity — operating income available to shareholders

     9.4     11.5     10.5     4.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Relevant Factors

Revenues

We derive our revenues primarily from premiums on our insurance policies and reinsurance contracts, net of any reinsurance or retrocessional coverage purchased. Insurance and reinsurance premiums are a function of the amounts and types of policies and contracts we write, as well as prevailing market prices. Our prices are determined before our ultimate costs, which may extend far into the future, are known. In addition, our revenues include income generated from our investment portfolio, consisting of net investment income and net realized investment gains or losses. Investment income is principally derived from interest and dividends earned on investments, partially offset by investment management expenses and fees paid to our custodian bank. Net realized investment gains or losses include gains or losses from the sale of investments, as well as the change in the fair value of investments that we mark-to-market through net income.

Expenses

Our expenses consist largely of net losses and loss expenses, acquisition costs and general and administrative expenses. Net losses and loss expenses incurred are comprised of three main components:

 

   

losses paid, which are actual cash payments to insureds and reinsureds, net of recoveries from reinsurers;

 

   

outstanding loss or case reserves, which represent management’s best estimate of the likely settlement amount for known claims, less the portion that can be recovered from reinsurers; and

 

   

reserves for losses incurred but not reported, or “IBNR”, which are reserves (in addition to case reserves) established by us that we believe are needed for the future settlement of claims. The portion recoverable from reinsurers is deducted from the gross estimated loss.

 

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Acquisition costs are comprised of commissions, brokerage fees and insurance taxes. Commissions and brokerage fees are usually calculated as a percentage of premiums and depend on the market and line of business. Acquisition costs are reported after (1) deducting commissions received on ceded reinsurance, (2) deducting the part of acquisition costs relating to unearned premiums and (3) including the amortization of previously deferred acquisition costs.

General and administrative expenses include personnel expenses including stock-based compensation expense, rent expense, professional fees, information technology costs and other general operating expenses.

Ratios

Management measures results for each segment on the basis of the “loss and loss expense ratio,” “acquisition cost ratio,” “general and administrative expense ratio,” “expense ratio” and the “combined ratio.” Because we do not manage our 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. The loss and loss expense ratio is derived by dividing net losses and loss expenses by net premiums earned. The acquisition cost ratio is derived by dividing acquisition costs by net premiums earned. The general and administrative expense ratio is derived by dividing general and administrative expenses by net premiums earned. The expense ratio is the sum of the acquisition cost ratio and the general and administrative expense ratio. The combined ratio is the sum of the loss and loss expense ratio, the acquisition cost ratio and the general and administrative expense ratio.

Critical Accounting Policies

It is important to understand our accounting policies in order to understand our financial position and results of operations. Our unaudited condensed consolidated financial statements reflect determinations that are inherently subjective in nature and require management to make assumptions and best estimates to determine the reported values. If events or other factors cause actual results to differ materially from management’s underlying assumptions or estimates, there could be a material adverse effect on our financial condition or results of operations. We believe that some of the more critical judgments in the areas of accounting estimates and assumptions that affect our financial condition and results of operations are related to reserves for losses and loss expenses, reinsurance recoverables, premiums and acquisition costs, valuation of financial instruments and goodwill and other intangible asset impairment valuation. For a detailed discussion of our critical accounting policies, please refer to our 2011 Form 10-K. There were no material changes in the application of our critical accounting estimates subsequent to that report.

 

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Results of Operations

The following table sets forth our selected consolidated statement of operations data for each of the periods indicated.

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  
     ($ in millions)  

Revenues

        

Gross premiums written

   $ 504.4     $ 442.7     $ 1,832.2     $ 1,523.0  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums written

   $ 391.5     $ 350.3     $ 1,475.2     $ 1,226.9  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

   $ 441.0     $ 371.3     $ 1,272.7     $ 1,061.5  

Net investment income

     39.1       47.9       128.8       150.5  

Net realized investments gains (losses)

     149.8       (130.8     292.0       (21.6

Other income — termination fee

            35.0              35.0  
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 629.9     $ 323.4     $ 1,693.5     $ 1,225.4  
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

        

Net losses and loss expenses

   $ 258.9     $ 205.5     $ 724.5     $ 745.8  

Acquisition costs

     51.1       39.7       149.8       120.7  

General and administrative expenses

     78.6       66.0       223.0       201.2  

Amortization of intangible assets

     0.6       0.8       1.9       2.3  

Interest expense

     13.8       13.7       41.6       41.2  

Foreign exchange loss (gain)

     1.0       3.0       (0.1     3.7  
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 404.0     $ 328.7     $ 1,140.7     $ 1,114.9  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     225.9       (5.3     552.8       110.5  

Income tax expense

     6.3       5.7       18.6       19.0  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 219.6     $ (11.0   $ 534.2     $ 91.5  
  

 

 

   

 

 

   

 

 

   

 

 

 

Ratios

        

Loss and loss expense ratio

     58.7     55.4     56.9     70.3

Acquisition cost ratio

     11.6     10.7     11.8     11.4

General and administrative expense ratio

     17.8     17.8     17.5     19.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Expense ratio

     29.4     28.5     29.3     30.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Combined ratio

     88.1     83.9     86.2     100.7
  

 

 

   

 

 

   

 

 

   

 

 

 

Comparison of Three Months Ended September 30, 2012 and 2011

Premiums

Gross premiums written increased by $61.7 million, or 13.9%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The overall increase in gross premiums written was primarily the result of the following:

 

   

Gross premiums written in our U.S. insurance segment increased by $61.6 million, or 30.6%. The increase in gross premiums written was primarily due to increased new business and premium rate increases in most lines of business. Growth from new products introduced in 2012, such as mergers and acquisitions and primary construction, and new programs also contributed to the increase for the quarter. This growth was partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and continued competition;

 

   

Gross premiums written in our international insurance segment increased by $11.7 million, or 10.7%. We saw continued growth from new products, specifically trade credit which grew $7.6 million, and general casualty, which grew by $7.2 million with strong new business writings. This growth was partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and continued competition; and

 

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Gross premiums written in our reinsurance segment decreased by $11.6 million, or 8.8%. The decrease in gross premiums written was primarily due to changes in the timing of renewals and downward premium estimates on our crop reinsurance business. This was combined with the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and continued competition.

The table below illustrates our gross premiums written by geographic location for each of the periods indicated.

 

     Three Months Ended September 30,      Dollar     Percentage  
     2012      2011      Change     Change  
            ($ in millions)               

United States

   $   312.9      $ 245.7      $ 67.2       27.4

Bermuda

     108.9        113.7        (4.8     (4.2 %) 

Europe

     46.8        47.6        (0.8     (1.7 %) 

Singapore

     31.9        33.2        (1.3     (3.9 %) 

Hong Kong

     3.9        2.5        1.4       56.0
  

 

 

    

 

 

    

 

 

   
   $ 504.4      $ 442.7      $ 61.7       13.9
  

 

 

    

 

 

    

 

 

   

Net premiums written increased by $41.2 million, or 11.8%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The increase in net premiums written was due to the increase in gross premiums written. The difference between gross and net premiums written is the cost to us of purchasing reinsurance coverage, including the cost of property catastrophe reinsurance coverage. We ceded 22.4% of gross premiums written for the three months ended September 30, 2012 compared to 20.9% for the same period in 2011. The increase was due to the change in our mix of business with a lower proportion of our premiums from our reinsurance segment, where we retain substantially all premiums written.

Net premiums earned increased by $69.7 million, or 18.8%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011 as a result of higher net premiums written in 2012 and 2011.

We evaluate our business by segment, distinguishing between U.S. insurance, international insurance and reinsurance. The following table illustrates the mix of our business on both a gross premiums written and net premiums earned basis.

 

     Gross  Premiums
Written
    Net Premiums
Earned
 
     Three Months Ended September 30,     Three Months Ended September 30,  
     2012     2011     2012     2011  

U.S. insurance

     52.2     45.5     39.5     40.5

International insurance

     24.0     24.8     19.3     21.6

Reinsurance

     23.8     29.7     41.2     37.9
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     100.0     100.0     100.0     100.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Investment Income

Net investment income decreased by $8.8 million, or 18.4%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The decrease was due to lower yields on our fixed maturity investments as well as an increased allocation to other invested assets that contribute to our total return but carry little or no current yield. The annualized period book yield of the investment portfolio for the three months ended September 30, 2012 and 2011 was 1.9% and 2.4%, respectively.

As of September 30, 2012, we held 21.1% of our total investments and cash equivalents in U.S. government or government agency securities, compared to 13.1% as of September 30, 2011. Our average duration decreased to 1.9 years as of September 30, 2012 compared to 2.1 years as of September 30, 2011.

Investment management expenses of $3.7 million and $3.6 million were incurred during the three months ended September 30, 2012 and 2011, respectively. The increase in investment management expenses was primarily due to the increase in the size of our investment portfolio, as well as expenses from higher expense asset classes. Investment expenses have decreased to $3.7 million from

 

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$4.4 million in the first quarter of 2012 as we have renegotiated investment management agreements with our investment advisors, or changed advisors, to manage our expenses.

As of September 30, 2012, approximately 90.4% of our fixed income investments consisted of investment grade securities. As of September 30, 2012 and December 31, 2011, the average credit rating of our fixed income portfolio was AA- as rated by Standard & Poor’s and Aa3 as rated by Moody’s.

Realized Investment Gains (Losses)

Net realized investment gains (losses) were comprised of the following:

 

     Three Months  Ended
September 30,
 
     2012     2011  
     ($ in millions)  

Gross realized gains on sale of invested assets

   $ 27.2     $ 44.7  

Gross realized losses on sale of invested assets

     (6.7     (10.6
  

 

 

   

 

 

 

Net realized gains on sale of invested assets

     20.5       34.1  

Net realized and unrealized losses on derivatives

     (1.0     (43.3

Mark-to-market changes:

    

Debt securities, trading

     99.8       (46.1

Other invested assets and equity securities

     30.4       (75.5
  

 

 

   

 

 

 

Total mark-to-market changes

     130.2       (121.6
  

 

 

   

 

 

 

Net realized investment gains (losses)

   $ 149.7     $ (130.8
  

 

 

   

 

 

 

During the three months ended September 30, 2012 and 2011, we did not recognize any net impairment charges. The total return of our investment portfolio was 2.2% and (1.1)% for the three months ended September 30, 2012 and 2011, respectively.

The investment portfolio return for the three months ended September 30, 2012 benefited from the favorable financial, economic and business environment during the quarter and the absence of significant market events. Equity markets performed well, with the S&P 500 up over 5% during the quarter. Fixed income securities also benefited from the benign quarter combined with the U.S. Federal Reserve’s announcement of a third round of quantitative easing, resulting in spreads tightening during the quarter.

The investment portfolio return for the three months ended September 30, 2011 was negatively impacted by the credit downgrade of the U.S. Treasury and related securities in early August 2011 and the economic and political turmoil surrounding European sovereign and bank credit risk. The combination of these and other events caused investors to seek safe havens in specific sovereign risks, such as the U.S., Switzerland, Germany and Japan, while selling riskier asset classes, such as equities, corporate bonds and mortgage bonds, and driving down prices.

Other Income

The other income of $35.0 million for the three months ended September 30, 2011 represented a termination fee from our previously announced merger agreement with Transatlantic. There was no other income for the three months ended September 30, 2012.

Net Losses and Loss Expenses

Net losses and loss expenses increased by $53.4 million, or 26.0%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The loss and loss expense ratio increased by 3.3 percentage points for the same period. The increase in net loss and loss expenses was due to growth in net premiums earned and lower net favorable prior year reserve development. In addition, for the three months ended September 30, 2012, we recorded approximately $40.0 million of crop reinsurance-related losses and loss expenses related to drought conditions across much of the United States. This amount is in addition to our anticipated losses and loss expenses prior to the onset of the drought. This was partially offset by significantly lower

 

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catastrophe losses for the three months ended September 30, 2012 compared to the same period in 2011 when we recognized estimated losses from Hurricane Irene, Asia-Pacific catastrophes and Midwestern U.S. storms of $33.5 million.

Excluding the prior year reserve development and property catastrophe losses, the loss and loss expense ratios would have been 70.3% and 61.8% for the three months ended September 30, 2012 and 2011, respectively. The increase was due to the $40.0 million in crop reinsurance losses for the three months ended September 30, 2012 that increased the loss and loss expense ratio by 9.1 percentage points.

 

     Three Months Ended
September 30, 2012
    Three Months Ended
September 30, 2011
    Dollar     Change in
Percentage
 
     Amount     % of  NPE(1)     Amount     % of  NPE(1)     Change     Points  
                 ($ in millions)                    

Non-catastrophe

   $ 310.1       70.3    $ 233.6       61.8    $ 76.5       8.5  Pts 

Property catastrophe

     5.0       1.1       33.5       7.6       (28.5     (6.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Current period

     315.1       71.4       267.1       69.4       48.0       2.0   

Prior period

     (56.2     (12.7     (61.6     (14.0     5.4       1.3   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net losses and loss expenses

   $ 258.9       58.7   $ 205.5       55.4    $ 53.4       3.3  Pts 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) “NPE” means net premiums earned.

We recorded net favorable reserve development related to prior years of $56.2 million during the three months ended September 30, 2012 compared to net favorable reserve development of $61.6 million for the three months ended September 30, 2011, as shown in the tables below.

 

     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Three Months Ended September 30, 2012  
     2002     2003     2004     2005     2006     2007     2008     2009     2010     2011     Total  
     ($ in millions)  

U.S. insurance

   $ (0.5   $ 0.6     $      $ (1.7   $ (7.1   $ (6.0   $ (2.7   $ 1.7     $ 4.4     $ 3.1     $ (8.2

International insurance

            (1.0     (2.7     9.9       (15.5     (12.7     (8.9     (1.9     (0.8     (5.4     (39.0

Reinsurance

     (0.3     (0.7     (0.2     2.8       (1.7     (6.7     (2.4     (0.8     7.5       (6.5     (9.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ (0.8   $ (1.1   $ (2.9   $ 11.0     $ (24.3   $ (25.4   $ (14.0   $ (1.0   $ 11.1     $ (8.8   $ (56.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The unfavorable reserve development in our U.S. insurance segment for loss years 2009 to 2011 was primarily due to adverse development on a program that commenced writing in 2008 and was terminated during 2011. The unfavorable reserve development in our international insurance segment for the 2005 loss year was primarily due to two product liability claims within our general casualty line of business. The unfavorable reserve development in our reinsurance segment for the 2010 loss year was primarily due to adverse emergence on certain classes of U.S. casualty business.

The following table shows the net favorable reserve development by loss year for each of our segments for the three months ended September 30, 2011.

 

     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Three Months Ended September 30, 2011  
     2002     2003     2004     2005     2006     2007     2008     2009     2010     Total  
     ($ in millions)  

U.S. insurance

   $ (0.1   $ (0.7   $ (1.1   $ (6.8   $ (1.8   $ (4.4   $ (2.7   $ (2.0   $ (2.3   $ (21.9

International insurance

     (0.2     9.2       (3.6     (4.8     (11.3     (8.1     (6.8     (0.5     6.2       (19.9

Reinsurance

     0.3       (0.4     (3.1     (4.6     (3.1     (9.7     0.3       (0.1     0.6       (19.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $      $ 8.1     $ (7.8   $ (16.2   $ (16.2   $ (22.2   $ (9.2   $ (2.6   $ 4.5     $ (61.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The unfavorable reserve development in our international insurance segment for the 2003 loss year was primarily due to a directors and officers claim within our professional liability line of business related to a securities fraud class action suit.

 

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The following table shows the components of net losses and loss expenses for each of the periods indicated.

 

     Three Months
Ended September 30,
    Dollar  
     2012      2011     Change  
     ($ in millions)  

Net losses paid

   $ 195.8      $ 194.5     $ 1.3  

Net change in reported case reserves

     4.9        (10.4     15.3  

Net change in IBNR

     58.2        21.4       36.8  
  

 

 

    

 

 

   

 

 

 

Net losses and loss expenses

   $ 258.9      $ 205.5     $ 53.4  
  

 

 

    

 

 

   

 

 

 

The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables.

 

     Three Months Ended
September 30,
 
     2012     2011  
     ($ in millions)  

Net reserves for losses and loss expenses, July 1

   $ 4,303.9     $ 4,237.4  

Incurred related to:

    

Current period non-catastrophe

     310.1       233.6  

Current period property catastrophe

     5.0       33.5  

Prior period

     (56.2     (61.6
  

 

 

   

 

 

 

Total incurred

     258.9       205.5  
  

 

 

   

 

 

 

Paid related to:

    

Current period non-catastrophe

     16.3       18.1  

Current period property catastrophe

            25.6  

Prior period

     179.5       150.8  
  

 

 

   

 

 

 

Total paid

     195.8       194.5  

Foreign exchange revaluation

     6.3       (12.5
  

 

 

   

 

 

 

Net reserve for losses and loss expenses, September 30

     4,373.3       4,235.9  

Losses and loss expenses recoverable

     1,077.5       1,009.6  
  

 

 

   

 

 

 

Reserve for losses and loss expenses, September 30

   $ 5,450.8     $ 5,245.5  
  

 

 

   

 

 

 

Acquisition Costs

Acquisition costs increased by $11.4 million, or 28.7%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The increase in acquisition costs was primarily due to the increase in net premiums earned. Acquisition costs as a percentage of net premiums earned were 11.6% for the three months ended September 30, 2012 compared to 10.7% for the same period in 2011. In 2011 we recognized a reduction in profit commission of $2.4 million on our reinsurance business due to declining profitability resulting from loss activity. This decreased the acquisition cost ratio by 0.6 percentage points in 2011.

General and Administrative Expenses

General and administrative expenses increased by $12.6 million, or 19.1%, for the three months ended September 30, 2012 compared to the same period in 2011. The increase in general and administrative expenses was primarily due to increased salary and related costs as average headcount increased by 13% to support our continued growth, combined with an increase in performance-based incentive compensation expense during the quarter as profitability exceeded target levels. During the same period in 2011, we recorded a reduction in expenses due to lower performance-based incentive compensation as profitability was below target and for reimbursement of our merger-related expenses by Transatlantic.

Our general and administrative expense ratio was 17.8% for the three months ended September 30, 2012 and 2011.

 

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The expense ratio is the sum of the acquisition cost ratio and the general and administrative expense ratio. Our expense ratio was 29.4% for the three months ended September 30, 2012 compared to 28.5% for the three months ended September 30, 2011. The increase was due to the 0.9 percentage point increase in the acquisition cost ratio, as discussed above.

Amortization of Intangible Assets

The amortization of intangible assets decreased by $0.2 million, or 25.0%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The decrease is due to certain intangible assets that were fully amortized during 2011.

Interest Expense

Interest expense increased by $0.1 million, or 0.7%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011.

Net Income

Net income for the three months ended September 30, 2012 was $219.6 million compared to a net loss of $11.0 million for the three months ended September 30, 2011. The $230.6 million increase was primarily the result of realized investment gains of $149.8 million for the three months ended September 30, 2012 compared to realized investment losses of $130.8 million for the same period in 2011.

Comparison of Nine Months Ended September 30, 2012 and 2011

Premiums

Gross premiums written increased by $309.2 million, or 20.3%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The overall increase in gross premiums written was primarily the result of the following:

 

   

Gross premiums written in our U.S. insurance increased by $121.7 million, or 19.9%. The increase in gross premiums written was primarily due to increased new business across most lines, combined with premium rate increases in most lines of business and growth from new products introduced since 2010. This growth was partially offset by non-recurring business, the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and continued competition;

 

   

Gross premiums written in our international insurance segment increased by $19.0 million, or 4.8%, primarily as a result of increased premiums from new products, specifically our trade credit and small to mid-sized enterprise (“SME”) insurance products, and premium rate increases in select lines of business. This growth was partially offset by non-recurring business, the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and continued competition; and

 

   

Gross premiums written in our reinsurance segment increased by $168.5 million, or 32.9%. The increase in gross premiums written was primarily due to new business, both from new products and new regions, increased participations on renewing business and premium rate increases. This growth was partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and continued competition.

 

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The table below illustrates our gross premiums written by geographic location for each of the periods indicated.

 

     Nine Months Ended September 30,      Dollar      Percentage  
     2012      2011      Change      Change  
            ($ in millions)                

United States

   $ 1,051.4      $ 821.5      $ 229.9        28.0

Bermuda

     484.3        462.0        22.3        4.8

Europe

     182.2        169.9        12.3        7.2

Singapore

     101.2        58.8        42.4        72.1

Hong Kong

     13.1        10.8        2.3        21.3
  

 

 

    

 

 

    

 

 

    
   $ 1,832.2      $ 1,523.0      $ 309.2        20.3
  

 

 

    

 

 

    

 

 

    

Net premiums written increased by $248.3 million, or 20.2%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The increase in net premiums written was due to the increase in gross premiums written. The difference between gross and net premiums written is the cost to us of purchasing reinsurance coverage, including the cost of property catastrophe reinsurance coverage. We ceded 19.5% of gross premiums written for the nine months ended September 30, 2012 compared to 19.4% for the same period in 2011.

Net premiums earned increased by $211.2 million, or 19.9%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 as a result of higher net premiums written in 2011 and 2012.

We evaluate our business by segment, distinguishing between U.S. insurance, international insurance and reinsurance. The following table illustrates the mix of our business on both a gross premiums written and net premiums earned basis.

 

     Gross  Premiums
Written
    Net Premiums
Earned
 
     Nine Months Ended September 30,     Nine Months Ended September 30,  
     2012     2011     2012     2011  

U.S. insurance

     40.1     40.2     38.5     40.6

International insurance

     22.8     26.2     19.5     22.3

Reinsurance

     37.1     33.6     42.0     37.1
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     100.0     100.0     100.0     100.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Investment Income

Net investment income decreased by $21.7 million, or 14.4%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The decrease was due to lower yields on our fixed maturity investments as well as an increased allocation to other invested assets, which contribute to our total return but carry little or no current yield. The annualized period book yield of the investment portfolio for the nine months ended September 30, 2012 and 2011 was 2.1% and 2.6%, respectively.

As of September 30, 2012, we held 21.1% of our total investments and cash equivalents in U.S. government or government agency securities, compared to 15.8% as of September 30, 2011. Our average duration decreased to 1.9 years as of September 30, 2012 compared to 2.1 years as of September 30, 2011.

Investment management expenses of $12.0 million and $10.2 million were incurred during the nine months ended September 30, 2012 and 2011, respectively. The increase in investment management expenses was primarily due to the increase in the size of our investment portfolio, as well as expenses from higher expense asset classes.

 

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Realized Investment Gains

Net realized investment gains were comprised of the following:

 

     Nine Months Ended
September 30,
 
     2012     2011  
     ($ in millions)  

Gross realized gains on sale of invested assets

   $ 119.2     $ 122.8  

Gross realized losses on sale of invested assets

     (43.4     (35.9
  

 

 

   

 

 

 

Net realized gains on sale of invested assets

     75.8       86.9  

Net realized and unrealized losses on derivatives

     (0.2     (58.8

Mark-to-market changes:

    

Debt securities, trading

     144.0       (0.7

Other invested assets and equity securities

     72.4       (48.9
  

 

 

   

 

 

 

Total mark-to-market changes

     216.4       (49.6
  

 

 

   

 

 

 

Net realized investment gains (losses)

   $ 292.0     $ (21.5
  

 

 

   

 

 

 

During the nine months ended September 30, 2012 and 2011, we did not recognize any net impairment charges. The total return of our investment portfolio was 4.9% and 1.1% for the nine months ended September 30, 2012 and 2011, respectively.

Other Income

The other income of $35.0 million for the nine months ended September 30, 2011 represented a termination fee from our previously announced merger agreement with Transatlantic. There was no other income for the nine months ended September 30, 2012.

Net Losses and Loss Expenses

Net losses and loss expenses decreased by $21.3 million, or 2.9%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The loss and loss expense ratio decreased by 13.4 percentage points for the same period. The decrease in net loss and loss expenses was due to significantly lower catastrophe losses for the nine months ended September 30, 2012 compared to the same period in 2011, when we recognized estimated losses from Asia-Pacific catastrophes, Midwestern U.S. storms and Hurricane Irene of $233.1 million. This was partially offset by lower net favorable prior year reserve development.

Excluding the prior year reserve development, property catastrophe losses and the impact of the commutation, the loss and loss expense ratios would have been 67.3% and 63.1% for the nine months ended September 30, 2012 and 2011, respectively. The increase was due to the $40.0 million in crop reinsurance losses for the nine months ended September 30, 2012 that increased the loss and loss expense ratio by 3.1 percentage points.

 

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     Nine Months Ended
September 30, 2012
    Nine Months Ended
September 30, 2011
    Dollar
Change
    Change in
Percentage

Points
 
     Amount     % of NPE     Amount     % of  NPE(2)      
                 ($ in millions)                    

Non-catastrophe

   $ 857.1       67.3   $ 662.3       63.1   $ 194.8       4.2  Pts 

Property catastrophe

     5.0       0.4       233.1       22.2       (228.1     (21.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Current period

     862.1       67.7       895.4       85.3       (33.3     (17.6

Prior period

     (137.6     (10.8     (161.1     (15.4     23.5       4.6   

Impact of commutation(1)

                   11.5       0.4       (11.5     (0.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net losses and loss expenses

   $ 724.5       56.9   $ 745.8       70.3   $ (21.3     (13.4 )Pts 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Reflects the impact of the commutation of prior year contracts in the nine months ended September 30, 2011, which increased prior year net losses and loss expenses by $11.5 million and increased net premiums earned by $12.4 million.
(2) Current period and prior period losses as a % of NPE are calculated excluding the effect of the commutation on net premiums.

We recorded net favorable reserve development related to prior years of $137.6 million during the nine months ended September 30, 2012 compared to net favorable reserve development of $161.1 million for the nine months ended September 30, 2011, as shown in the tables below.

 

     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Nine Months Ended September 30, 2012  
     2002     2003     2004     2005     2006     2007     2008     2009     2010     2011      Total  
     ($ in millions)  

U.S. insurance

   $ (0.6   $ 0.6     $ (1.2   $ (5.5   $ (17.5   $ (24.4   $ (1.6   $ (3.6   $ 13.7     $ 18.5      $ (21.6

International insurance

     5.7       (3.4     (8.5     (0.6     (43.8     (30.1     (14.3     (3.7     (7.4     17.7        (88.4

Reinsurance

     (0.2     (0.0     (1.0     (4.8     (8.7     (18.2     (4.0     1.1       6.2       2.0        (27.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 
   $ 4.9     $ (2.8   $ (10.7   $ (10.9   $ (70.0   $ (72.7   $ (19.9   $ (6.2   $ 12.5     $ 38.2      $ (137.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

The net favorable reserve development is a result of actual loss emergence being lower than anticipated. The unfavorable reserve development in our U.S. insurance segment for the 2010 and 2011 loss years was primarily due to adverse development on a program that commenced writing in 2008 and was terminated during 2011. We also experienced adverse development for the 2011 loss year for certain errors and omissions products. The unfavorable reserve development in our international insurance segment for loss year 2011 was due to adverse development on an individual claim, estimated to reach our full limit of $20.0 million, net of reinsurance.

The following table shows the net favorable reserve development by loss year for each of our segments for the nine months ended September 30, 2011.

 

     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Nine Months Ended September 30, 2011  
     2002     2003     2004     2005     2006     2007     2008     2009     2010     Total  
     ($ in millions)  

U.S. insurance

   $ (0.2   $ (2.2   $ (4.5   $ (19.5   $ 22.0     $ (6.5   $ (3.5   $ (2.3   $ 6.8     $ (9.9

International insurance

     1.0       5.2       (4.6     (28.3     (25.6     (29.9     3.4       (7.8     26.1       (60.5

Reinsurance

     (0.3     (3.3     (7.0     (29.3     (15.4     (16.8     (2.7     (9.6     (6.3     (90.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ 0.5     $ (0.3   $ (16.1   $ (77.1   $ (19.0   $ (53.2   $ (2.8   $ (19.7   $ 26.6     $ (161.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The unfavorable reserve development of $22.0 million in our U.S. insurance segment for the 2006 loss year was primarily due to directors and officers claims within our professional liability line of business related to a class action suit filed against a number of private equity firms alleging collusion. The unfavorable reserve development in our international insurance segment for the 2010 loss year was primarily due to a casualty claim emanating from an oil field services risk.

 

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Table of Contents

The following table shows the components of net losses and loss expenses for each of the periods indicated.

 

     Nine Months Ended
September 30,
     Dollar  
     2012      2011      Change  
            ($ in millions)         

Net losses paid

   $ 578.1      $ 459.3      $ 118.8  

Net change in reported case reserves

     51.9        218.4        (166.5

Net change in IBNR

     94.5        68.1        26.4  
  

 

 

    

 

 

    

 

 

 

Net losses and loss expenses

   $ 724.5      $ 745.8      $ (21.3
  

 

 

    

 

 

    

 

 

 

The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables

 

     Nine Months Ended
September 30,
 
     2012     2011  
     ($ in millions)  

Net reserves for losses and loss expenses, January 1

   $ 4,222.2     $ 3,951.6  

Incurred related to:

    

Commutation of variable rated reinsurance contracts

            11.5  

Current period non-catastrophe

     857.1       662.3  

Current period property catastrophe

     5.0       233.1  

Prior period

     (137.6     (161.1
  

 

 

   

 

 

 

Total incurred

     724.5       745.8  
  

 

 

   

 

 

 

Paid related to:

    

Current period non-catastrophe

     36.1       29.2  

Current period property catastrophe

            35.8  

Prior period

     542.0       394.3  
  

 

 

   

 

 

 

Total paid

     578.1       459.3  

Foreign exchange revaluation

     4.7       (2.2
  

 

 

   

 

 

 

Net reserve for losses and loss expenses, September 30

     4,373.3       4,235.9  

Losses and loss expenses recoverable

     1,077.5       1,009.6  
  

 

 

   

 

 

 

Reserve for losses and loss expenses, September 30

   $ 5,450.8     $ 5,245.5  
  

 

 

   

 

 

 

Acquisition Costs

Acquisition costs increased by $29.1 million, or 24.1%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The increase in acquisition costs was primarily due to the increase in net premiums earned. Acquisition costs as a percentage of net premiums earned were 11.8% for the nine months ended September 30, 2012 compared to 11.4% for the same period in 2011. The increase is due to the growth in our reinsurance segment, which has a higher acquisition cost ratio.

General and Administrative Expenses

General and administrative expenses increased by $21.8 million, or 10.8%, for the nine months ended September 30, 2012 compared to the same period in September 30, 2011. The increase in general and administrative expenses was primarily due to increased salary and related costs as average headcount increased by 9% to support our continued growth, combined with increased stock compensation expense resulting from the 22.8% increase in our share price during the nine months ended September 30, 2012 and higher performance-based compensation expense as profitability has exceeded target levels.

 

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Our general and administrative expense ratio was 17.5% for the nine months ended September 30, 2012 compared to 19.0% for the nine months ended September 30, 2011. The decrease was due to the growth in net premiums earned being greater than the increase in expenses.

The expense ratio is the sum of the acquisition cost ratio and the general and administrative expense ratio. Our expense ratio was 29.3% for the nine months ended September 30, 2012 compared to 30.4% for the nine months ended September 30, 2011. The decrease was primarily due to the 1.5 percentage point decrease in the general and administrative expense ratio, as discussed above.

Amortization of Intangible Assets

The amortization of intangible assets decreased by $0.4 million, or 17.4%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The decrease is due to certain intangible assets that were fully amortized during 2011.

Interest Expense

Interest expense increased by $0.4 million, or 1.0%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The increase was due to fees associated with the termination of our $400 million unsecured credit facility on June 7, 2012.

Net Income

Net income for the nine months ended September 30, 2012 was $534.2 million compared to $91.5 million for the nine months ended September 30, 2011. The $442.7 million increase was primarily the result of the lower net loss and loss expense ratio due to significantly lower property catastrophe losses in 2012 compared to 2011. The nine months ended September 30, 2011 included $233.1 million of property catastrophe losses for the Asia-Pacific catastrophes, Midwestern U.S. storms and Hurricane Irene. This was combined with realized investment gains of $292.1 million for the nine months ended September 30, 2012 compared to realized investment losses of $21.6 million for the same period in 2011.

Underwriting Results by Operating Segments

Our company is organized into three operating segments:

U.S. Insurance Segment. The U.S. insurance segment includes our 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.

International Insurance Segment. The international insurance segment includes our 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 our Bermuda office and non-North American domiciled accounts from our European, Singapore and Hong Kong offices.

Reinsurance Segment. Our reinsurance segment has operations in Bermuda, Europe, Singapore and the United States. This segment includes the reinsurance of property, general casualty, professional liability, specialty lines and property catastrophe coverages written by insurance companies. We presently write reinsurance on both a treaty and a facultative basis, targeting several niche reinsurance markets.

 

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Table of Contents

U.S. Insurance Segment

The following table summarizes the underwriting results and associated ratios for the U.S. insurance segment for each of the periods indicated.

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  
     ($ in millions)  

Revenues

        

Gross premiums written

   $ 263.1     $ 201.5     $ 733.3     $ 611.6  

Net premiums written

     200.8       157.3       551.3       470.1  

Net premiums earned

     174.0       150.5       490.1       431.8  

Expenses

        

Net losses and loss expenses

   $ 109.1     $ 85.7     $ 309.9     $ 294.2  

Acquisition costs

     22.7       19.5       63.9       56.5  

General and administrative expenses

     37.4       29.0       103.2       91.0  

Underwriting income (loss)

     4.8       16.3       13.1       (9.9

Ratios

        

Loss and loss expense ratio

     62.7     57.0     63.2     68.1

Acquisition cost ratio

     13.0     13.0     13.0     13.1

General and administrative expense ratio

     21.5     19.2     21.0     21.1
  

 

 

   

 

 

   

 

 

   

 

 

 

Expense ratio

     34.5     32.2     34.0     34.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Combined ratio

     97.2     89.2     97.2     102.3
  

 

 

   

 

 

   

 

 

   

 

 

 

Comparison of Three Months Ended September 30, 2012 and 2011

Premiums. Gross premiums written increased by $61.6 million, or 30.6%, for the three months ended September 30, 2012 compared to the same period in 2011. The increase in gross premiums written was primarily due to new business across most lines that added $92.0 million during the quarter combined with premium rate increases in most lines of business. Growth from new products introduced in 2012, such as mergers and acquisitions and primary construction, contributed $3.6 million for the quarter. This growth was partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and continued competition.

The table below illustrates our gross premiums written by line of business for each of the periods indicated.

 

     Three Months Ended September 30,      Dollar      Percentage  
     2012      2011      Change      Change  
            ($ in millions)                

General casualty

   $ 77.9      $ 54.6      $ 23.3        42.7

Professional liability

     66.4        57.0        9.4        16.5

Healthcare

     52.3        42.1        10.2        24.2

Programs

     32.2        26.6        5.6        21.1

Other *

     18.6        6.3        12.3        195.2

General property

     15.7        14.9        0.8        5.4
  

 

 

    

 

 

    

 

 

    
   $ 263.1      $ 201.5      $ 61.6        30.6
  

 

 

    

 

 

    

 

 

    

 

* Includes our inland marine, environmental and mergers and acquisitions lines of business

Net premiums written increased by $43.5 million, or 27.7%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The increase in net premiums written was primarily due to higher gross premiums written. We ceded 23.7% of gross premiums written for the three months ended September 30, 2012 compared to 21.9% for the same period in

 

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2011. The increase in the cession percentage was due to increased reinsurance placement in our excess casualty book and increased writings in other lines with higher cession percentages.

Net premiums earned increased by $23.5 million, or 15.6%, for the three months ended September 30, 2012 compared to the same period in 2011. The increase was primarily due to the growth of our U.S. insurance operations during 2011 and 2012.

Net losses and loss expenses. Net losses and loss expenses increased by $23.4 million, or 27.3%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The loss and loss expense ratio increased by 5.7 percentage points for the same period. The increase in net losses and loss expenses was primarily due to growth in the U.S. insurance segment combined with lower favorable prior year reserve development. We recognized estimated losses from catastrophes of $1.7 million from Hurricane Isaac for the three months ended September 30, 2012. We recognized estimated losses from catastrophes of $3.5 million related to Hurricane Irene and the Midwestern U.S. storms for the three months ended September 30, 2011. Excluding the prior year reserve development and property catastrophe losses, the loss and loss expense ratios would have been 66.4% and 69.3% for the three months ended September 30, 2012 and 2011, respectively.

 

     Three Months Ended
September 30, 2012
    Three Months Ended
September 30, 2011
    Dollar     Change in
Percentage
 
     Amount     % of NPE     Amount     % of NPE     Change     Points  
                 ($ in millions)                    

Non-catastrophe

   $ 115.6       66.4   $ 104.1       69.3   $ 11.5       (2.9 )Pts 

Property catastrophe

     1.7       1.0       3.5       2.3       (1.8     (1.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Current period

     117.3       67.4       107.6       71.6       9.7       (4.2

Prior period

     (8.2     (4.7     (21.9     (14.6     13.7       9.9   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net losses and loss expenses

   $ 109.1       62.7   $ 85.7       57.0   $ 23.4       5.7 Pts 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Overall, our U.S. insurance segment recorded net favorable reserve development of $8.2 million during the three months ended September 30, 2012 compared to net favorable reserve development of $21.9 million for the three months ended September 30, 2011, as shown in the tables below.

 

     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Three Months Ended September 30, 2012  
     2002     2003     2004     2005     2006     2007     2008     2009     2010     2011     Total  
     ($ in millions)  

Professional liability

   $ (0.5   $ (0.5   $ (1.4   $ (0.8   $ (0.9   $ (3.3   $ (1.1   $ (1.5   $ (1.6   $ (0.4   $ (12.0

General casualty

            (0.3     (0.6     (0.2     (3.9     (0.2     (1.4     (0.2                   (6.8

Healthcare

            1.4       1.7       (0.7     (1.5     (1.6     (0.8     (0.1     (0.4     (0.7     (2.7

General property

                   0.3              (0.1                          (0.1     (0.1       

Programs

                                 (0.7     (0.9     0.6       3.5       6.5       4.3       13.3  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ (0.5   $ 0.6     $ (0.0   $ (1.7   $ (7.1   $ (6.0   $ (2.7   $ 1.7     $ 4.4     $ 3.1     $ (8.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The unfavorable reserve development for loss years 2009 to 2011 was due to continued adverse development on a program that commenced writing in 2008 and was terminated during 2011. This program continues to experience unfavorable loss emergence and during the quarter we performed a detailed review of all open claims as part of our reserve review. This was partially offset by favorable development on our active programs.

 

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     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Three Months Ended September 30, 2011  
     2002     2003     2004     2005     2006     2007     2008     2009     2010     Total  
     ($ in millions)  

Professional liability

   $      $ (0.1   $ (0.1   $ (0.6   $ (0.4   $ (2.3   $ (0.5   $ (1.3   $      $ (5.3

General casualty

            (0.2     (0.3     (5.8            1.0                     0.4       (4.9

Healthcare

     (0.1     (0.4     (0.5     (0.2     (1.1     (0.5     (1.6            (1.0     (5.4

General property

                   (0.2     0.1              (1.1            (0.6     (1.8     (3.6

Programs

                          (0.3     (0.3     (1.5     (0.6     (0.1     0.1       (2.7

Other

                                                                      
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ (0.1   $ (0.7   $ (1.1   $ (6.8   $ (1.8   $ (4.4   $ (2.7   $ (2.0   $ (2.3   $ (21.9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Acquisition costs. Acquisition costs increased by $3.2 million, or 16.4%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The increase was primarily caused by increased net premiums earned. The acquisition cost ratio was 13.0% for the three months ended September 30, 2012 and 2011.

General and administrative expenses. General and administrative expenses increased by $8.4 million, or 29.0%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The increase was due to the continued growth of the U.S. insurance operations, combined with higher performance-based incentive compensation expense due to improved profitability in 2012 compared to 2011. As a result, the general and administrative ratio increased to 21.5% for the three months ended September 30, 2012 from 19.2% for the same period in 2011.

Comparison of Nine Months Ended September 30, 2012 and 2011

Premiums. Gross premiums written increased by $121.7 million, or 19.9%, for the nine months ended September 30, 2012 compared to the same period in 2011. The increase in gross premiums written was primarily due to new business across most lines that added $241.0 million during the nine months ended September 30, 2012, combined with premium rate increases in most lines of business. Growth from new products introduced in 2012, such as mergers and acquisitions and primary construction, contributed a further $4.9 million for the period. This growth was partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and continued competition.

The table below illustrates our gross premiums written by line of business for each of the periods indicated.

 

     Nine Months Ended
September 30,
     Dollar      Percentage  
     2012      2011      Change      Change  
            ($ in millions)                

General casualty

   $ 204.6      $ 152.1      $ 52.5        34.5

Professional liability

     192.3        170.8        21.5        12.6

Healthcare

     145.6        137.7        7.9        5.7

Programs

     81.1        66.8        14.3        21.4

General property

     71.3        61.4        9.9        16.1

Other*

     38.4        22.8        15.6        68.4
  

 

 

    

 

 

    

 

 

    
   $ 733.3      $ 611.6      $ 121.7        19.9
  

 

 

    

 

 

    

 

 

    

 

* Includes our inland marine, environmental and mergers and acquisitions lines of business

Net premiums written increased by $81.2 million, or 17.3%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The increase in net premiums written was primarily due to higher gross premiums written, partially offset by the impact of the commutation of prior year contracts in 2011. The nine months ended September 30, 2011 included a $12.4 million reduction in premiums ceded due to the commutation of certain variable-rated reinsurance contracts that had swing-rated provisions. We ceded 24.8% of gross premiums written for the nine months ended September 30, 2012 compared to 23.1% for the same period in 2011. The increase in the cession percentage was due to the impact of the commutation on the prior year.

 

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Net premiums earned increased by $58.3 million, or 13.5%, for the nine months ended September 30, 2012 compared to the same period in 2011. The increase was primarily due to the growth of our U.S. insurance operations during 2012 and 2011, partially offset by the $12.4 million impact of the commutation of prior year contracts in 2011, which was fully earned.

Net losses and loss expenses. Net losses and loss expenses increased by $15.7 million, or 5.3%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The loss and loss expense ratio decreased by 4.9 percentage points for the same period. The increase in net losses and loss expenses was primarily due to growth in the U.S. insurance segment, partially offset by higher favorable prior year reserve development in 2012 and the $11.5 million impact of the commutation of prior year contracts in 2011. We recognized estimated losses from catastrophes of $1.7 million from Hurricane Isaac for the nine months ended September 30, 2012, compared to $8.5 million related to Asia-Pacific catastrophes, Midwestern U.S. storms and Hurricane Irene for the same period in 2011. Excluding the prior year reserve development, property catastrophe losses and the impact of the commutation, the loss and loss expense ratios would have been 67.3% and 67.7% for the nine months ended September 30, 2012 and 2011, respectively.

 

     Nine Months Ended
September 30, 2012
    Nine Months Ended
September 30, 2011
    Dollar
Change
    Change in
Percentage

Points
 
     Amount     % of NPE     Amount     % of NPE (2)      
     ($ in millions)        

Non-catastrophe

   $ 329.8       67.3   $ 284.1       67.7   $ 45.7       (0.4 )Pts 

Property catastrophe

     1.7       0.3       8.5       2.0       (6.8     (1.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Current period

     331.5       67.6       292.6       69.7       38.9       (2.1

Prior period

     (21.6     (4.4     (9.9     (2.4     (11.7     (2.0

Impact of commutation (1)

                   11.5       0.8       (11.5     (0.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net losses and loss expenses

   $ 309.9       63.2   $ 294.2       68.1   $ 15.7       (4.9 )Pts 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Reflects the impact of the commutation of prior year contracts in the nine months ended September 30, 2011, which increased prior year net losses and loss expenses by $11.5 million and increased net premiums earned by $12.4 million.
(2) Current period and prior period losses as a % of NPE are calculated excluding the effect of the commutation on net premiums earned.

Overall, our U.S. insurance segment recorded net favorable reserve development of $21.6 million during the nine months ended September 30, 2012 compared to net favorable reserve development of $9.9 million for the nine months ended September 30, 2011, as shown in the tables below.

 

     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Nine Months Ended September 30, 2012  
     2002     2003     2004     2005     2006     2007     2008     2009     2010     2011     Total  
     ($ in millions)  

Professional liability

   $ (0.5   $ (0.5   $ (1.5   $ (1.1   $ (0.8   $ (18.4   $ (1.2   $ (4.3   $ (2.5   $ 9.8     $ (21.0

General casualty

     (0.1     (0.6     0.3       (0.8     (12.0     (0.3     (2.4     (0.6     (0.1            (16.6

Healthcare

            1.7       (1.0     (3.3     (3.8     (4.4     0.3       (1.8     3.1       (0.2     (9.4

Other

                                                                    (0.2     (0.2

General property

                   1.0       (0.3     (0.1     (0.2     1.7       (0.4     (0.6     1.0       2.1  

Programs

                                 (0.8     (1.1            3.5       13.8       8.1       23.5  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ (0.6   $ 0.6     $ (1.2   $ (5.5   $ (17.5   $ (24.4   $ (1.6   $ (3.6   $ 13.7     $ 18.5     $ (21.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The unfavorable reserve development for the 2010 and 2011 loss years was primarily due to adverse development on a program that commenced writing in 2008 and was terminated during 2011. This was partially offset by favorable development on our active programs. We also experienced adverse development for the 2011 loss year for certain errors and omissions products.

 

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     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Nine Months Ended September 30, 2011  
     2002     2003     2004     2005     2006     2007     2008     2009     2010     Total  
     ($ in millions)  

Professional liability

   $      $ (0.1   $ (0.2   $ (1.9   $ 23.7     $ (4.6   $      $ (4.1   $ 7.0     $ 19.8  

General casualty

     0.1       (0.7     (1.6     (16.9            1.0              0.1       0.4       (17.6

Healthcare

     (0.3     (1.4     (2.3     0.1       (1.4     0.2       (3.3     1.2       (1.9     (9.1

General property

                   (0.4     (0.6            (1.1     (0.4     (0.6     (0.3     (3.4

Programs

                          (0.2     (0.3     (2.0     0.2       1.1       1.6       0.4  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ (0.2   $ (2.2   $ (4.5   $ (19.5   $ 22.0     $ (6.5   $ (3.5   $ (2.3   $ 6.8     $ (9.9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The unfavorable reserve development of $22.0 million for the 2006 loss year was primarily due to directors and officers claims within our professional liability line of business related to a class action suit filed against a number of private equity firms alleging collusion.

Acquisition costs. Acquisition costs increased by $7.4 million, or 13.1%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The increase was primarily caused by increased net premiums earned. The acquisition cost ratio decreased slightly to 13.0% for the nine months ended September 30, 2012 from 13.1% for the same period in 2011.

General and administrative expenses. General and administrative expenses increased by $12.2 million, or 13.4%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, due to the continued growth of our U.S. insurance operations. The general and administrative expense ratio decreased slightly to 21.0% for the nine months ended September 30, 2012 from 21.1% in the same period in 2011 as a result of our increased net premiums earned.

 

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International Insurance Segment

The following table summarizes the underwriting results and associated ratios for the international insurance segment for each of the periods indicated.

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  
     ($ in millions)  

Revenues

        

Gross premiums written

   $ 121.3     $ 109.6     $ 418.5     $ 399.5  

Net premiums written

     71.1       61.4       255.1       245.3  

Net premiums earned

     85.3       80.2       247.8       236.4  

Expenses

        

Net losses and loss expenses

   $ 15.1     $ 43.7     $ 75.4     $ 186.9  

Acquisition costs

     (0.3     (0.3     (1.4     (2.9

General and administrative expenses

     22.9       21.5       67.0       62.9  

Underwriting income (loss)

     47.6       15.3       106.8       (10.5

Ratios

        

Loss and loss expense ratio

     17.7     54.5     30.4     79.1

Acquisition cost ratio

     (0.3 %)      (0.4 %)      (0.6 %)      (1.2 %) 

General and administrative expense ratio

     26.9     26.9     27.0     26.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Expense ratio

     26.6     26.5     26.4     25.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Combined ratio

     44.3     81.0     56.8     104.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Comparison of Three Months Ended September 30, 2012 and 2011

Premiums. Gross premiums written increased by $11.7 million, or 10.7%, for the three months ended September 30, 2012 compared to the same period in 2011. The increase was primarily a result of new business and premium rate increases in select lines of business. We saw continued growth from new products, specifically trade credit which grew $7.6 million, and general casualty, which grew by $7.2 million with strong new business writings. However, this increase was partially offset by decreases in other lines due to the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions), continued competition and a reduction in limits deployed for the international general property line of business, which decreased $5.7 million.

The table below illustrates our gross premiums written by line of business for each of the periods indicated.

 

     Three Months Ended September 30,      Dollar     Percentage  
     2012      2011      Change     Change  
     ($ in millions)        

Professional liability

   $ 37.8      $ 38.9      $ (1.1     (2.8 %) 

General casualty

     32.6        25.5        7.1       27.8

General property

     22.2        24.4        (2.2     (9.0 %) 

Healthcare

     17.8        17.4        0.4       2.3

Other *

     10.9        3.4        7.5       220.6
  

 

 

    

 

 

    

 

 

   
   $ 121.3      $ 109.6      $ 11.7       10.7
  

 

 

    

 

 

    

 

 

   

 

* Includes our trade credit line of business

Net premiums written increased by $9.7 million, or 15.8%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. Net premiums written increased primarily due to an increase in gross premiums written. We ceded to reinsurers 41.4% of gross premiums written for the three months ended September 30, 2012 compared to 44.0% for the three

 

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months ended September 30, 2011. The decrease was due to the change in mix of business, combined with the reduction in catastrophe cover ceded premiums as we increased our retentions.

Net premiums earned increased by $5.1 million, or 6.4%, primarily due to higher net premiums written in the latter half of 2011 and the nine months ended September 30, 2012.

Net losses and loss expenses. Net losses and loss expenses decreased by $28.6 million, or 65.4%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The loss and loss expense ratio decreased by 36.8 percentage points for the same period. The decrease in net losses and loss expenses was primarily due to lower catastrophe losses in 2012 of $2.3 million for Hurricane Isaac, compared to the same period in 2011, which included $10.5 million in catastrophe losses related to Hurricane Irene and the Midwestern U.S. storms. This was combined with higher net favorable prior year reserve development in 2012 compared to the same period in 2011. Excluding the prior year reserve development and property catastrophe losses, the loss and loss expense ratios would have been 60.7% and 66.2% for the three months ended September 30, 2012 and 2011, respectively. The decrease is due to the change in mix of business combined with the reduction in catastrophe cover ceded premiums and benign loss experience on short-tail lines of business.

 

     Three Months Ended
September 30, 2012
    Three Months Ended
September 30, 2011
    Dollar     Change in
Percentage
 
     Amount     % of NPE     Amount     % of NPE     Change     Points  
     ($ in millions)        

Non-catastrophe

   $ 51.8       60.7   $ 53.1       66.2   $ (1.3     (5.5 )Pts 

Property catastrophe

     2.3       2.7       10.5       13.1       (8.2     (10.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Current period

     54.1       63.4       63.6       79.3       (9.5     (15.9

Prior period

     (39.0     (45.7     (19.9     (24.8     (19.1     (20.9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net losses and loss expenses

   $ 15.1       17.7   $ 43.7       54.5   $ (28.6     (36.8 )Pts 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Overall, our international insurance segment recorded net favorable reserve development of $39.0 million during the three months ended September 30, 2012 compared to net favorable reserve development of $19.9 million for the three months ended September 30, 2011, as shown in the tables below.

 

     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Three Months Ended September 30, 2012  
     2002      2003     2004     2005     2006     2007     2008     2009     2010     2011     Total  
     ($ in millions)  

General property

   $       $      $ 0.6     $ (0.1   $ 1.3     $ (0.5   $      $ (0.3   $ (0.8   $ (5.4   $ (5.2

Professional liability

                    (0.5     (1.9     (12.5     (2.0     (4.1                          (21.0

General casualty

             (0.8     (2.6     12.8       (3.5     (9.5     (1.1     (1.6                   (6.3

Healthcare

             (0.2     (0.2     (0.9     (0.8     (0.7     (3.7                          (6.5
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $       $ (1.0   $ (2.7   $ 9.9     $ (15.5   $ (12.7   $ (8.9   $ (1.9   $ (0.8   $ (5.4   $ (39.0
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The unfavorable reserve development for the 2005 loss year was primarily due to two product liability claims within our general casualty line of business.

 

     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Three Months Ended September 30, 2011  
     2002     2003     2004     2005     2006     2007     2008     2009     2010      Total  
     ($ in millions)  

Professional liability

   $      $ 9.7     $ (1.2   $ (2.7   $ (2.4   $ (5.1   $ (1.5   $      $       $ (3.2

Healthcare

            0.5       (0.5     (0.5     (0.5     (3.1            0.1               (4.0

General casualty

     (0.2     (1.0     (1.2     (1.7     (8.2     (1.0     (3.3                    (16.6

General property

                   (0.7     0.1       (0.2     1.1       (2.0     (0.6     6.2        3.9  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 
   $ (0.2   $ 9.2     $ (3.6   $ (4.8   $ (11.3   $ (8.1   $ (6.8   $ (0.5   $ 6.2      $ (19.9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

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The unfavorable reserve development for the 2003 loss year was primarily due to a directors and officers claim within our professional liability line of business related to a securities fraud class action suit.

Acquisition costs. Acquisition costs were unchanged for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The negative cost represents ceding commissions received on ceded premiums in excess of the brokerage fees and commissions paid on gross premiums written. The acquisition cost ratio was negative 0.3% for the three months ended September 30, 2012 compared to negative 0.4% for the three months ended September 30, 2011.

General and administrative expenses. General and administrative expenses increased by $1.4 million, or 6.5%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The increase in general and administrative expenses was primarily due to increased salary and related costs incurred as we continue to expand internationally, combined with higher incentive compensation due to increased profitability. The general and administrative expense ratio was 26.9% for the three months ended September 30, 2012 and 2011.

Comparison of Nine Months Ended September 30, 2012 and 2011

Premiums. Gross premiums written increased by $19.0 million, or 4.8%, for the nine months ended September 30, 2012 compared to the same period in 2011. The increase was primarily a result of new business, including $15.3 million from new products, specifically our trade credit and SME insurance products, growth in Asia and premium rate increases in select lines of business. However, this increase was partially offset by decreases in other lines due to the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions), continued competition and a reduction in limits deployed for the international general property line of business.

The table below illustrates our gross premiums written by line of business for each of the periods indicated.

 

     Nine Months Ended September 30,      Dollar
Change
    Percentage
Change
 
     2012      2011       
     ($ in millions)        

Professional liability

   $ 121.6      $ 116.0      $ 5.6       4.8

General property

     120.2        124.9        (4.7     (3.8 %) 

General casualty

     97.5        94.2        3.3       3.5

Healthcare

     58.1        57.3        0.8       1.4

Other *

     21.1        7.1        14.0       197.2
  

 

 

    

 

 

    

 

 

   
   $ 418.5      $ 399.5      $ 19.0       4.8
  

 

 

    

 

 

    

 

 

   

 

* Includes our trade credit line of business

Net premiums written increased by $9.8 million, or 4.0%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. We ceded to reinsurers 39.0% of gross premiums written for the nine months ended September 30, 2012 compared to 38.6% for the nine months ended September 30, 2011.

Net premiums earned increased by $11.4 million, or 4.8%, primarily due to higher net premiums written in the latter half of 2011 and for the nine months ended September 30, 2012.

Net losses and loss expenses. Net losses and loss expenses decreased by $111.5 million, or 59.7%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The loss and loss expense ratio decreased by 48.7 percentage points for the same period. The decrease in net losses and loss expenses was primarily due to significantly lower catastrophe losses in 2012 of $2.3 million for Hurricane Isaac, compared to the same period in 2011, which included $84.1 million in catastrophe losses related to Asia-Pacific catastrophes, Midwestern U.S. storms and Hurricane Irene. This was combined with higher net favorable prior year reserve development in 2012 compared to the same period in 2011. Excluding the prior year reserve development and property catastrophe losses, the loss and loss expense ratios would have been 65.2% and 69.1% for the nine months ended September 30, 2012 and 2011, respectively. The decrease is due to the change in mix of business combined with the reduction in catastrophe cover ceded premiums and benign loss experience on short-tail lines of business.

 

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     Nine Months Ended     Nine Months Ended           Change in  
     September 30, 2012     September 30, 2011     Dollar     Percentage  
     Amount     % of NPE     Amount     % of NPE     Change     Points  
     ($ in millions)        

Non-catastrophe

   $ 161.5       65.2   $ 163.3       69.1   $ (1.8     (3.9 )Pts 

Property catastrophe

     2.3       0.9       84.1       35.6       (81.8     (34.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Current period

     163.8       66.1       247.4       104.7       (83.6     (38.6

Prior period

     (88.4     (35.7     (60.5     (25.6     (27.9     (10.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net losses and loss expenses

   $ 75.4       30.4   $ 186.9       79.1   $ (111.5     (48.7 )Pts 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Overall, our international insurance segment recorded net favorable reserve development of $88.4 million during the nine months ended September 30, 2012 compared to net favorable reserve development of $60.5 million for the nine months ended September 30, 2011, as shown in the tables below.

 

     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Nine Months Ended September 30, 2012  
     2002     2003     2004     2005     2006     2007     2008     2009     2010     2011     Total  
     ($ in millions)  

Professional liability

   $      $ (0.2   $ (2.8   $ (5.0   $ (27.6   $ (9.2   $ 2.9     $      $      $      $ (41.9

Healthcare

     (0.1     (0.8     (0.8     (2.0     (1.6     (4.8     (6.3                          (16.4

General casualty

     5.8       (2.4     (5.7     8.0       (14.9     (16.7     (8.7     (1.6            20.0       (16.2

General property

                   0.8       (1.6     0.3       0.6       (2.2     (2.1     (7.4     (2.3     (13.9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ 5.7     $ (3.4   $ (8.5   $ (0.6   $ (43.8   $ (30.1   $ (14.3   $ (3.7   $ (7.4   $ 17.7     $ (88.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The net favorable reserve development for loss years 2003 to 2010 is a result of actual loss emergence being lower than anticipated. The unfavorable reserve development in our general casualty line for loss year 2011 was due to adverse development on an individual claim, estimated to reach our full limit of $20.0 million, net of reinsurance.

 

     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Nine Months Ended September 30, 2011  
     2002     2003     2004     2005     2006     2007     2008     2009     2010      Total  
     ($ in millions)  

Professional liability

   $ 2.0     $ 8.6     $ (5.1   $ (10.4   $ (12.4   $ (9.2   $ 21.5     $      $       $ (5.0

Healthcare

     (0.1            (1.4     (1.5     (9.3     (7.1            0.1               (19.3

General casualty

     (0.9     (3.4     3.3       (14.2     (4.0     (13.1     (3.3     7.2       22.5        (5.9

General property

                   (1.4     (2.2     0.1       (0.5     (14.8     (15.1     3.6        (30.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 
   $ 1.0     $ 5.2     $ (4.6   $ (28.3   $ (25.6   $ (29.9   $ 3.4     $ (7.8   $ 26.1      $ (60.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

The unfavorable reserve development for the 2010 loss year was primarily due to a casualty claim emanating from an oil field services risk.

Acquisition costs. Acquisition costs increased by $1.5 million, or 51.7%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The negative cost represents ceding commissions received on ceded premiums in excess of the brokerage fees and commissions paid on gross premiums written. The acquisition cost ratio was negative 0.6% for the nine months ended September 30, 2012 and negative 1.2% for the nine months ended September 30, 2011.

General and administrative expenses. General and administrative expenses increased by $4.1 million, or 6.5%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The increase in general and administrative expenses was primarily due to increased salary and related costs incurred as we continue to expand internationally, combined with higher incentive compensation due to increased profitability. The general and administrative expense ratios for the nine months ended September 30, 2012 and 2011 were 27.0% and 26.6%, respectively. The increase was due to higher expenses, partially offset by higher net premiums earned.

 

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Reinsurance Segment

The following table summarizes the underwriting results and associated ratios for the reinsurance segment for each of the periods indicated.

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  
     ($ in millions)  

Revenues

        

Gross premiums written

   $ 120.0     $ 131.6     $ 680.4     $ 511.9  

Net premiums written

     119.6       131.6       668.8       511.5  

Net premiums earned

     181.7       140.7       534.8       393.3  

Expenses

        

Net losses and loss expenses

   $ 134.7     $ 76.2     $ 339.2     $ 264.7  

Acquisition costs

     28.7       20.5       87.3       67.2  

General and administrative expenses

     18.3       15.5       52.8       47.2  

Underwriting income

            28.5       55.5       14.2  

Ratios

        

Loss and loss expense ratio

     74.1     54.1     63.4     67.3

Acquisition cost ratio

     15.8     14.6     16.3     17.1

General and administrative expense ratio

     10.0     11.0     9.9     12.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Expense ratio

     25.8     25.6     26.2     29.1
  

 

 

   

 

 

   

 

 

   

 

 

 

Combined ratio

     99.9     79.7     89.6     96.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Comparison of Three Months Ended September 30, 2012 and 2011

Premiums. Gross premiums written decreased by $11.6 million, or 8.8%, for the three months ended September 30, 2012 compared to the same period in 2011. The decrease was due to $13.5 million of gross premiums written in the third quarter of 2011 that was written in the second quarter of 2012 as a result of the earlier timing of renewal business, combined with unfavorable premium estimates on our crop reinsurance business of $11.7 million. This was combined with the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and continued competition. This was partially offset by $14.7 million of other favorable premium estimates and growth in our international book of business.

The table below illustrates our gross premiums written by geographic location for our reinsurance operations.

 

     Three Months Ended September 30,      Dollar     Percentage  
     2012      2011      Change     Change  
     ($ in millions)        

United States

   $ 49.7      $ 44.1      $ 5.6       12.7

Bermuda

     26.3        41.1        (14.8     (36.0 %) 

Singapore

     29.9        32.9        (3.0     (9.1 %) 

Europe

     14.1        13.5        0.6       4.4
  

 

 

    

 

 

    

 

 

   
   $ 120.0      $ 131.6      $ (11.6     (8.8 %) 
  

 

 

    

 

 

    

 

 

   

 

56


Table of Contents

The table below illustrates our gross premiums written by line of business for each of the periods indicated.

 

     Three Months Ended
September 30,
     Dollar     Percentage  
     2012     2011      Change     Change  
     ($ in millions)        

Property

   $ 59.4     $ 66.1      $ (6.7     (10.1 %) 

Casualty

     60.7       56.0        4.7       8.4

Specialty

     (0.1     9.5        (9.6     (101.1 %) 
  

 

 

   

 

 

    

 

 

   
   $ 120.0     $ 131.6      $ (11.6     (8.8 %) 
  

 

 

   

 

 

    

 

 

   

Net premiums written decreased by $12.0 million, or 9.1%, consistent with the decrease in gross premiums written.

Net premiums earned increased by $41.0 million, or 29.1%, as a result of the increase in net premiums written during the year ended December 31, 2011 and the nine months ended September 30, 2012. Premiums related to our reinsurance business earn at a slower rate than those related to our direct insurance business. Direct insurance premiums typically earn ratably over the term of a policy. Reinsurance premiums under a quota share reinsurance contract are typically earned over the same period as the underlying policies, or risks, covered by the contract. As a result, the earning pattern of a quota share reinsurance contract may extend up to 24 months, reflecting the inception dates of the underlying policies. Property catastrophe premiums, crop reinsurance premiums and premiums for other treaties written on a losses occurring basis generally earn ratably over the term of the reinsurance contract.

Net losses and loss expenses. Net losses and loss expenses increased by $58.5 million, or 76.8%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The loss and loss expense ratio increased by 20.0 percentage points for the same period. The increase in net losses and loss expenses was due to growth in net premiums earned and lower prior year net favorable reserve development for the three months ended September 30, 2012 compared to the same period in 2011. In addition, for the three months ended September 30, 2012, we recorded $40.0 million of crop reinsurance-related losses and loss expenses related to drought conditions across much of the United States. This amount is in addition to our anticipated losses and loss expenses for this line of business prior to the onset of drought. This was partially offset by lower catastrophe losses in 2012 compared to the same period in 2011, which included $19.5 million for Hurricane Irene, the Asia-Pacific catastrophes and Midwestern U.S. storms.

Excluding the prior year reserve development and property catastrophe losses, the loss and loss expense ratios would have been 78.5% and 54.3% for the three months ended September 30, 2012 and 2011, respectively. The increase was due to the $40.0 million in crop reinsurance losses for the three months ended September 30, 2012 that increased the loss and loss expense ratio by 22.0 percentage points.

 

     Three Months Ended
September 30, 2012
    Three Months Ended
September 30, 2011
    Dollar     Change in
Percentage
 
     Amount     % of NPE     Amount     % of NPE     Change     Points  
     ($ in millions)        

Non-catastrophe

   $ 142.7       78.5   $ 76.5       54.3   $ 66.2       24.2  Pts 

Property catastrophe

     1.0       0.6       19.5       13.9       (18.5     (13.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Current period

     143.7       79.1       96.0       68.2       47.7       10.9   

Prior period

     (9.0     (5.0     (19.8     (14.1     10.8       9.1   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net losses and loss expenses

   $ 134.7       74.1   $ 76.2       54.1   $ 58.5       20.0  Pts 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Overall, our reinsurance segment recorded net favorable reserve development of $9.0 million during the three months ended September 30, 2012 compared to net favorable reserve development of $19.8 million for the three months ended September 30, 2011, as shown in the tables below.

 

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Table of Contents
     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Three Months Ended September 30, 2012  
     2002     2003     2004     2005     2006     2007     2008     2009     2010      2011     Total  
     ($ in millions)  

Property

   $      $ 0.1     $ (0.1   $ 0.2     $ 0.1     $ (2.5   $ (1.5   $ (1.6   $ 0.2      $ (7.4   $ (12.5

Specialty

     (0.1     (0.1     (0.2     (0.3     (0.7     (1.4            0.3       1.1        (1.0     (2.4

Casualty

     (0.2     (0.7     0.1       2.9       (1.1     (2.8     (0.9     0.5       6.2        1.9       5.9  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 
   $ (0.3   $ (0.7   $ (0.2   $ 2.8     $ (1.7   $ (6.7   $ (2.4   $ (0.8   $ 7.5      $ (6.5   $ (9.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

The unfavorable reserve development for the 2010 loss year was primarily due to adverse emergence on certain classes of U.S. casualty business.

 

     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Three Months Ended September 30, 2011  
     2002     2003     2004     2005     2006     2007     2008     2009     2010     Total  
     ($ in millions)  

Property

   $ (0.1   $ (0.2   $ (0.8   $ (0.9   $ (0.4   $ 0.2     $ 0.9     $ 0.1     $ 1.1     $ (0.1

Specialty

                   0.2                                          (0.5     (0.3

Casualty

     0.4       (0.2     (2.5     (3.7     (2.7     (9.9     (0.6     (0.2            (19.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ 0.3     $ (0.4   $ (3.1   $ (4.6   $ (3.1   $ (9.7   $ 0.3     $ (0.1   $ 0.6     $ (19.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Acquisition costs. Acquisition costs increased by $8.2 million, or 40.0%, for the three months ended September 30, 2012 compared to the three months ended 2011, primarily due to the increase in net premiums earned. The acquisition cost ratio was 15.8% for the three months ended September 30, 2012 compared to 14.6% for the three months ended 2011. The increase was primarily due to a reduction in profit commissions recognized in 2011 due to higher loss activity.

General and administrative expenses. General and administrative expenses increased by $2.8 million, or 18.1%, for the three months ended September 30, 2012 compared to the same period in 2011. The increase was due to higher salary and related costs due to higher headcount to support our growing operations, combined with higher incentive compensation due to increased profitability. The general and administrative expense ratios for the three months ended September 30, 2012 and 2011 were 10.0% and 11.0%, respectively, reflecting the higher growth in net premiums earned relative to expenses in 2012.

Comparison of Nine Months Ended September 30, 2012 and 2011

Premiums. Gross premiums written increased by $168.5 million, or 32.9%, for the nine months ended September 30, 2012 compared to the same period in 2011. The increase in gross premiums written was primarily due to new business, from both new products and new regions, as well as increased participations on renewing business combined with premium rate increases. Within our specialty unit, crop reinsurance premiums increased by $47.8 million while marine contributed a further $16.8 million. Our North American property reinsurance business also increased by $40.5 million due to a combination of new business opportunities and premium rate increases. This was partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and continued competition.

The table below illustrates our gross premiums written by geographic location for our reinsurance operations.

 

     Nine Months Ended September 30,      Dollar
Change
     Percentage
Change
 
     2012      2011        
     ($ in millions)         

United States

   $ 318.0      $ 209.9      $ 108.1        51.5

Bermuda

     195.9        193.5        2.4        1.2

Singapore

     97.2        57.8        39.4        68.2

Europe

     69.3        50.7        18.6        36.7
  

 

 

    

 

 

    

 

 

    
   $ 680.4      $ 511.9      $ 168.5        32.9
  

 

 

    

 

 

    

 

 

    

 

58


Table of Contents

The table below illustrates our gross premiums written by line of business for each of the periods indicated.

 

     Nine Months Ended
September 30,
     Dollar      Percentage  
     2012      2011      Change      Change  
     ($ in millions)         

Property

   $ 334.7      $ 249.3      $ 85.4        34.3

Casualty

     209.1        200.8        8.3        4.1

Specialty

     136.6        61.8        74.8        121.0
  

 

 

    

 

 

    

 

 

    
   $ 680.4      $ 511.9      $ 168.5        32.9
  

 

 

    

 

 

    

 

 

    

Net premiums written increased by $157.3 million, or 30.8%, consistent with the increase in gross premiums written.

Net premiums earned increased by $141.5 million, or 36.0%, as a result of the increase in net premiums written during the year ended December 31, 2011 and the nine months ended September 30, 2012.

Net losses and loss expenses. Net losses and loss expenses increased by $74.5 million, or 28.1%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The loss and loss expense ratio decreased by 3.9 percentage points for the same period. The increase in net losses and loss expenses was due to growth in net premiums earned, lower prior year net favorable reserve development for the nine months ended September 30, 2012 compared to the same period in 2011 and the $40.0 million of crop reinsurance-related losses recorded in 2012. This was partially offset by the significantly lower catastrophe losses in 2012 compared to the same period in 2011, which included $121.0 million for Hurricane Irene, the Asia-Pacific catastrophes and Midwestern U.S. storms.

Excluding the prior year reserve development and property catastrophe losses, the loss and loss expense ratios would have been 68.4% and 54.7% for the nine months ended September 30, 2012 and 2011, respectively. The increase was due to the $40.0 million in crop reinsurance losses for the nine months ended September 30, 2012 that increased the loss and loss expense ratio by 7.5 percentage points.

 

     Nine Months Ended
September 30, 2012
    Nine Months Ended
September 30, 2011
    Dollar     Change in
Percentage
 
     Amount     % of NPE     Amount     % of NPE     Change     Points  
     ($ in millions)        

Non-catastrophe

   $ 365.8       68.4   $ 214.9       54.7   $ 150.9       13.7  Pts 

Property catastrophe

     1.0       0.2       140.5       35.7       (139.5     (35.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Current period

     366.8       68.6       355.4       90.4       11.4       (21.8

Prior period

     (27.6     (5.2     (90.7     (23.1     63.1       17.9   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net losses and loss expenses

   $ 339.2       63.4   $ 264.7       67.3   $ 74.5       (3.9 )Pts 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Overall, our reinsurance segment recorded net favorable reserve development of $27.6 million during the nine months ended September 30, 2012 compared to net favorable reserve development of $90.7 million for the nine months ended September 30, 2011, as shown in the tables below.

 

     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Nine Months Ended September 30, 2012  
     2002     2003     2004     2005     2006     2007     2008     2009      2010     2011     Total  
     ($ in millions)  

Specialty

   $ (0.1   $ (0.4   $ (3.4   $ (5.4   $ (2.5   $ (3.6   $ (0.1   $ 0.3      $ 1.1     $ (3.0   $ (17.1

Property

            0.1       (0.9     0.4              (2.4     (1.8     0.4        (1.0     (1.9     (7.1

Casualty

     (0.1     0.3       3.3       0.2       (6.2     (12.2     (2.1     0.4        6.1       6.9       (3.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 
   $ (0.2   $      $ (1.0   $ (4.8   $ (8.7   $ (18.2   $ (4.0   $ 1.1      $ 6.2     $ 2.0     $ (27.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

 

59


Table of Contents
     (Favorable) and Unfavorable Loss Reserve Development by Loss Year  
     For the Nine Months Ended September 30, 2011  
     2002     2003     2004     2005     2006     2007     2008     2009     2010     Total  
     ($ in millions)  

Specialty

   $      $      $      $ 0.1     $      $ (0.8   $ (0.2   $ (5.7   $ (3.8   $ (10.4

Property

     (0.2     (0.9     (1.5     (2.9     (1.4     (3.7     (0.9     (3.7     (5.3     (20.5

Casualty

     (0.1     (2.4     (5.5     (26.5     (14.0     (12.3     (1.6     (0.2     2.8       (59.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ (0.3   $ (3.3   $ (7.0   $ (29.3   $ (15.4   $ (16.8   $ (2.7   $ (9.6   $ (6.3   $ (90.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Acquisition costs. Acquisition costs increased by $20.1 million, or 29.9%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 primarily due to the increase in net premiums earned. The acquisition cost ratio was 16.3% for the nine months ended September 30, 2012, compared to 17.1% for the nine months ended September 30, 2011. The decrease was primarily due to a change in mix of business.

General and administrative expenses. General and administrative expenses increased by $5.6 million, or 11.9%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The increase was due to higher salary and related costs due to higher headcount to support our growing operations, combined with higher incentive compensation due to increased profitability. The general and administrative expense ratios for the nine months ended September 30, 2012 and 2011 were 9.9% and 12.0%, respectively, reflecting the higher growth in net premiums earned relative to expenses in 2012.

Reserves for Losses and Loss Expenses

Reserves for losses and loss expenses by segment were comprised of the following:

 

     U.S. Insurance     International Insurance     Reinsurance     Total  
     Sep. 30,
2012
    Dec. 31,
2011
    Sep. 30,
2012
    Dec. 31,
2011
    Sep. 30,
2012
    Dec. 31,
2011
    Sep. 30,
2012
    Dec. 31,
2011
 
     ($ in millions)  

Case reserves

   $ 461.9     $ 387.6     $ 508.8     $ 522.6     $ 460.2     $ 456.2     $ 1,430.9     $ 1,366.4  

IBNR

     1,345.5       1,274.8       1,700.3       1,726.4       974.1       857.5       4,019.9       3,858.7  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reserve for losses and loss expenses

     1,807.4       1,662.4       2,209.1       2,249.0       1,434.3       1,313.7       5,450.8       5,225.1  

Reinsurance recoverables

     (482.1     (438.3     (594.1     (564.3     (1.3     (0.3     (1,077.5     (1,002.9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net reserve for losses and loss expenses

   $ 1,325.3     $ 1,224.1     $ 1,615.0     $ 1,684.7     $ 1,433.0     $ 1,313.4     $ 4,373.3     $ 4,222.2  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

We participate in certain lines of business where claims may not be reported for many years. Accordingly, management does not solely rely upon reported claims on these lines for estimating ultimate liabilities. We also use statistical and actuarial methods to estimate expected ultimate losses and loss expenses. Loss reserves do not represent an exact calculation of liability. Rather, loss reserves are estimates of what we expect the ultimate resolution and administration of claims will cost. These estimates are based on various factors including underwriters’ expectations about loss experience, actuarial analysis, comparisons with the results of industry benchmarks and loss experience to date. Loss reserve estimates are refined as experience develops and as claims are reported and resolved. Establishing an appropriate level of loss reserves is an inherently uncertain process. Ultimate losses and loss expenses may differ from our reserves, possibly by material amounts.

 

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The following tables provide our ranges of loss and loss expense reserve estimates by business segment as of September 30, 2012:

 

     Reserve for Losses and Loss Expenses
Gross of Reinsurance  Recoverable
 
     Carried
Reserves
     Low
Estimate
     High
Estimate
 
     ($ in millions)  

U.S. insurance

   $ 1,807.4      $ 1,369.0      $ 2,042.4  

International insurance

     2,209.1        1,669.5        2,523.1  

Reinsurance

     1,434.3        1,155.3        1,673.4  

Consolidated (1)

     5,450.8        4,493.4        5,939.5  
        
     Reserve for Losses and Loss Expenses
Net of Reinsurance Recoverable
 
     Carried
Reserves
     Low
Estimate
     High
Estimate
 
     ($ in millions)  

U.S. insurance

   $ 1,325.3      $ 1,009.7      $ 1,514.3  

International insurance

     1,615.0        1,213.9        1,846.1  

Reinsurance

     1,433.0        1,155.6        1,674.2  

Consolidated (1)

     4,373.3        3,621.6        4,792.1  

 

(1) For statistical reasons, it is not appropriate to add together the ranges of each business segment in an effort to determine the low and high range around the consolidated loss reserves.

Our range for each business segment was determined by utilizing multiple actuarial loss reserving methods along with various assumptions of reporting patterns and expected loss ratios by loss year. The various outcomes of these techniques were combined to determine a reasonable range of required loss and loss expense reserves. While we believe our approach to determine the range of loss and loss expense is reasonable, there are no assurances that actual loss experience will be within the ranges of loss and loss expense noted above.

Our selection of the actual carried reserves is generally above the midpoint of the range. We believe that we should be prudent in our reserving practices due to the lengthy reporting patterns and relatively large limits of net liability for any one risk of our direct excess casualty business and of our casualty reinsurance business. Thus, due to this uncertainty regarding estimates for reserve for losses and loss expenses, we have carried our consolidated reserve for losses and loss expenses, net of reinsurance recoverable, above the midpoint of the low and high estimates for the consolidated net losses and loss expenses. We believe that relying on the more prudent actuarial indications is appropriate for these lines of business.

Reinsurance Recoverable

The following table illustrates our reinsurance recoverable as of September 30, 2012 and December 31, 2011:

 

     September 30,
2012
     December 31,
2011
 
     ($ in millions)  

Ceded case reserves

   $ 204.2      $ 196.5  

Ceded IBNR reserves

     873.3        806.4  
  

 

 

    

 

 

 

Reinsurance recoverable

   $ 1,077.5      $ 1,002.9  
  

 

 

    

 

 

 

We remain obligated for amounts ceded in the event our reinsurers do not meet their obligations. Accordingly, we have evaluated the reinsurers that are providing reinsurance protection to us and will continue to monitor their credit ratings and financial stability. We generally have the right to terminate our treaty reinsurance contracts at any time, upon prior written notice to the reinsurer, under specified circumstances, including the assignment to the reinsurer by A.M. Best of a financial strength rating of less than “A-.” Approximately 95% of ceded reserves as of September 30, 2012 were recoverable from reinsurers who had an A.M. Best rating of “A-” or higher.

 

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Liquidity and Capital Resources

Liquidity

Liquidity is a measure of our ability to access sufficient cash flows to meet the short-term and long-term cash requirements of our business operations. The Company believes that its cash flows from operations and investments will provide sufficient liquidity for the foreseeable future.

Holdings is a holding company and transacts no business of its own. Cash flows to Holdings may comprise dividends, advances and loans from its subsidiary companies. Holdings is therefore reliant on receiving dividends and other permitted distributions from its subsidiaries to make dividend payments on its common shares.

Our operating subsidiaries depend upon cash inflows from premium receipts, net of commissions, investment income and proceeds from sales and redemptions of investments. Cash outflows for our operating subsidiaries are in the form of claims payments, reinsurance premium payments, purchase of investments, operating expenses and income tax payments as well as dividend payments to the holding company.

Historically, our operating subsidiaries have generated sufficient cash flows to meet all of their obligations. Because of the inherent volatility of our business, the seasonality in the timing of payments by insureds and cedents, the irregular timing of loss payments, and the impact of a change in interest rates and credit spreads on the investment income as well as seasonality in coupon payment dates for fixed income securities, cash flows from operating activities may vary between periods. In the unlikely event that paid losses exceed operating cash flows in any given period, we would use our cash balances available, or liquidate a portion of our investment portfolio in order to meet our short-term liquidity needs. Our total investments and cash totaled $8.9 billion as of September 30, 2012, the main components of which were investment grade fixed income securities and cash and cash equivalents.

Dividend Restrictions

The jurisdictions in which our operating subsidiaries are licensed to write business impose regulations requiring companies to maintain or meet various defined statutory ratios, including solvency and liquidity requirements. Some jurisdictions also place restrictions on the declaration and payment of dividends and other distributions. See Liquidity and Capital Resources in Item 7 of Part II of the Company’s 2011 Form 10-K.

Cash Flows

 

     Nine Months Ended
September 30,
 
     2012     2011  
     ($ in millions)  

Cash flows provided by operating activities

   $ 500.2     $ 491.5  

Cash flows used in investing activities

     (243.8     (257.3

Cash flows used in financing activities

     (250.4     (122.6

Effect of exchange rate changes on foreign currency cash

     (0.5     0.7  
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     5.5       112.3  

Cash and cash equivalents, beginning of period

     634.0       757.0  
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 639.5     $ 869.3  
  

 

 

   

 

 

 

The increase in cash flows from operations was due to higher premiums collected, net of reinsurance, due to continued growth in 2012. This was partially offset by the $118.8 million increase in paid losses resulting from the growth in operations and the 2011 catastrophe events.

In our casualty lines of business, claims may be reported and settled several years after the coverage period has terminated. As a result, we expect that we will generate significant operating cash flow as we accumulate casualty loss reserves on our balance sheet. In our property lines of business, claims are generally reported and paid within a relatively short period of time and we expect volatility in our operating cash flows as losses are incurred. We expect increases in the amount of expected loss payments in future periods with a resulting decrease in operating cash flow; however, we do not expect loss payments to exceed the premiums generated.

 

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Actual premiums written and collected and losses and loss expenses paid in any period could vary materially from our expectations and could have a significant and adverse effect on operating cash flow.

Cash flows from investing activities consist primarily of proceeds on the sale of investments and payments for investments acquired in addition to changes in restricted cash. The decrease in cash flows used in investing activities reflects net purchases of trading securities as excess cash was invested during the quarter.

Cash flows from financing activities consist primarily of capital raising activities, which include the issuance of common shares or debt, the repurchase of our shares, the payment of dividends and the repayment of debt. The increase in cash flows used in financing activities was due to the $144.7 million increase in share repurchases for the nine months ended September 30, 2012 compared to the same period in 2011. No shares were repurchased in the six months ended September 30, 2011 because of the merger negotiations with Transatlantic Holdings, Inc. However, $53.6 million in founder warrants were repurchased in February 2011. In addition, dividends paid as a partial par value reduction increased $40.4 million as no dividends were paid in the first half of 2011 due to the redomestication of our holding company from Bermuda to Switzerland. During the nine months ended September 30, 2012, we did not utilize the revolving loan available under the Amended Secured Credit Facility (as defined below).

Investments

Our funds are primarily invested in liquid, high-grade fixed income securities. As of September 30, 2012 and December 31, 2011, 90.4% and 92.6%, respectively, of our fixed income portfolio consisted of investment grade securities. The maturity distribution of our fixed income portfolio (on a fair value basis) as of September 30, 2012 and December 31, 2011 was as follows:

 

     September 30,
2012
     December 31,
2011
 
     ($ in millions)  

Due in one year or less

   $ 647.4      $ 661.6  

Due after one year through five years

     3,180.8        2,686.1  

Due after five years through ten years

     571.7        725.5  

Due after ten years

     66.8        94.2  

Mortgage-backed

     2,252.0        1,818.1  

Asset-backed

     436.2        513.2  
  

 

 

    

 

 

 

Total

   $ 7,154.9      $ 6,498.7  
  

 

 

    

 

 

 

We have investments in other invested assets, comprising interests in hedge funds and private equity funds, the market value of which was $564.7 million as of September 30, 2012. Some of these funds have redemption notice requirements. For each of our funds, liquidity is allowed after certain defined periods based on the terms of each fund. See Note 4(d) “Investments — Other Invested Assets” to our unaudited condensed consolidated financial statements for additional details on our other invested assets.

We do not believe that inflation has had a material effect on our consolidated results of operations. The potential exists, after a catastrophe loss, for the development of inflationary pressures in a local economy. The effects of inflation are considered implicitly in pricing. Loss reserves are established to recognize likely loss settlements at the date payment is made. Those reserves inherently recognize the effects of inflation. The actual effects of inflation on our results cannot be accurately known, however, until claims are ultimately resolved.

Pledged Assets

Allied World Assurance Company, Ltd uses trust accounts primarily to meet security requirements for inter-company and certain reinsurance transactions. We also have cash and cash equivalents and investments on deposit with various state or government insurance departments or pledged in favor of ceding companies in order to comply with reinsurance contract provisions and relevant insurance regulations. In addition, Allied World Assurance Company, Ltd currently has access to up to $1.35 billion in letters of credit under two letter of credit facilities, a $900 million uncommitted facility with Citibank Europe plc and a $450 million committed Amended Secured Credit Facility. These facilities are used to provide security to reinsureds and are collateralized by us, at least to the extent of letters of credit outstanding at any given time.

 

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Security arrangements with ceding insurers may subject our assets to security interests or require that a portion of our assets be pledged to, or otherwise held by, third parties. Both of our letter of credit facilities are fully collateralized by assets held in custodial accounts at the Bank of New York Mellon held for the benefit of the banks. Although the investment income derived from our assets while held in trust accrues to our benefit, the investment of these assets is governed by the terms of the letter of credit facilities or the investment regulations of the state or territory of domicile of the ceding insurer, which may be more restrictive than the investment regulations otherwise applicable to us. The restrictions may result in lower investment yields on these assets, which may adversely affect our profitability.

As of September 30, 2012 and December 31, 2011, $2,076.3 million and $2,029.1 million, respectively, of cash and cash equivalents and investments were deposited, pledged or held in escrow 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 $1,047.0 million and $1,044.2 million, respectively, of cash and cash equivalents and investments were pledged as collateral for our credit facilities.

We do not currently anticipate that the restrictions on liquidity resulting from restrictions on the payment of dividends by our subsidiary companies or from assets committed in trust accounts or to collateralize the letter of credit facilities will have a material impact on our ability to carry out our normal business activities, including interest and dividend payments, respectively, on our senior notes (described below) and common shares.

Financial Strength Ratings

Financial strength ratings represent the opinions of rating agencies on our capacity to meet our obligations. In the event of a significant downgrade in ratings, our ability to write business and to access the capital markets could be impacted. Our financial strength ratings as of September 30, 2012 have not changed since December 31, 2011, except that Fitch Ratings has assigned us an insurance financial strength rating of “A+”. See Item 1. “Business” in our 2011 Form 10-K.

Capital Resources

The table below sets forth the capital structure of the Company as of September 30, 2012 and December 31, 2011:

 

     As of
September 30,
2012
     As of
December 31,
2011
 
     ($ in millions)  

Senior notes

   $ 798.1      $ 798.0  

Shareholders’ equity

     3,435.8        3,149.0  
  

 

 

    

 

 

 

Total capitalization

   $ 4,233.9      $ 3,947.0  
  

 

 

    

 

 

 

Share Repurchases

In May 2012, we established a new $500 million share repurchase program. Under the terms of this new share repurchase program, common shares repurchased shall be designated for cancellation and shall be cancelled upon prior shareholder approval.

During the three and nine months ended September 30, 2012, our share repurchases were as follows:

 

     Three Months Ended
September 30,

2012
     Nine Months Ended
September 30,

2012
 

Common shares repurchased

     605,898        2,942,085  

Total cost of shares repurchased

   $ 47,590      $ 207,048  

Average price per share

   $ 78.54      $ 70.37  

 

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We have classified the repurchased shares not designated for cancellation as “treasury shares, at cost” on the consolidated balance sheets. Shares repurchased and designated for cancellation are constructively retired and recorded as a share cancellation.

Long-Term Debt

In July 2006, Allied World Bermuda issued $500.0 million aggregate principal amount of 7.50% senior notes due August 1, 2016, with interest payable August 1 and February 1 each year. Allied World Bermuda can redeem the senior notes prior to maturity, subject to payment of a “make-whole” premium; however, Allied World Bermuda currently has no intention of redeeming the notes.

In November 2010, Allied World Bermuda issued $300.0 million aggregate principal amount of 5.50% senior notes due November 1, 2020, with interest payable May 15 and November 15 each year, commencing May 15, 2011. Allied World Bermuda can redeem the senior notes prior to maturity, subject to payment of a “make-whole” premium; however, Allied World Bermuda currently has no intention of redeeming the notes.

The senior notes issued in 2006 and 2010 have been unconditionally and irrevocably guaranteed for the payment of the principal and interest by Holdings.

Credit Facility

In the normal course of our operations, we enter 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 million four-year secured credit facility (the “Amended Secured Credit Facility”) is with a syndication of lenders and is primarily 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 million. Allied World Bermuda may request that existing lenders under the Amended Secured Credit Facility make additional commitments from time to time, up to $150 million, 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 us to maintain a certain leverage ratio and financial strength rating. We are in compliance with all covenants under the Facility.

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

As of September 30, 2012, we had a combined unused letters of credit capacity of $458.2 million from the Amended Secured Credit Facility and Citibank Europe plc. We believe that this remaining capacity is sufficient to meet our future letter of credit needs.

Off-Balance Sheet Arrangements

As of September 30, 2012, we did not have any off-balance sheet arrangements.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

We believe that we are principally exposed to three types of market risk: interest rate risk, credit risk and currency risk.

The fixed income securities in our investment portfolio are subject to interest rate risk and credit risk. Any changes in interest rates and credit spreads have a direct effect on the market values of fixed income securities. As interest rates rise, the market values fall, and vice versa. As credit spreads widen, the market values fall, and vice versa.

In the table below changes in market values as a result of changes in interest rates is determined by calculating hypothetical September 30, 2012 ending prices based on yields adjusted to reflect the hypothetical changes in interest rates, comparing such hypothetical ending prices to actual ending prices, and multiplying the difference by the principal amount of the security. The sensitivity analysis is based on estimates. The estimated changes of our fixed maturity investments and cash and cash equivalents are presented below and actual changes for interest rate shifts could differ significantly.

 

     Interest Rate Shift in Basis Points  
     -200     -100     -50         +50     +100     +200  
     ($ in millions)  

Total market value

   $ 8,038.8     $ 7,953.0     $ 7,906.6     $ 7,841.4     $ 7,767.8     $ 7,690.0     $ 7,520.7  

Market value change from base

     197.4       111.6       65.2              (73.6     (151.4     (320.7

Change in unrealized appreciation/(depreciation)

     2.5     1.4     0.8     0     (0.9 %)      (1.9 %)      (4.1 %) 

In the table below changes in market values as a result of changes in credit spreads are determined by calculating hypothetical September 30, 2012 ending prices adjusted to reflect the hypothetical changes in credit spreads, comparing such hypothetical ending prices to actual ending prices, and multiplying the difference by the principal amount of the security. The sensitivity analysis is based on estimates. The estimated changes of our non-cash, non-U.S. Treasury fixed maturity investments are presented below and actual changes in credit spreads could differ significantly.

 

     Credit Spread Shift in Basis Points  
     -200     -100     -50         +50     +100     +200  
     ($ in millions)  

Total market value

   $ 5,893.7     $ 5,780.5     $ 5,723.9     $ 5,667.4     $ 5,610.8     $ 5,554.2     $ 5,441.0  

Market value change from base

     226.3       113.1       56.5              (56.6     (113.2     (226.4

Change in unrealized appreciation/(depreciation)

     4.0     2.0     1.0     0     (1.0 %)      (2.0 %)      (4.0 %) 

In addition to credit spread risk, our portfolio is also exposed to the risk of securities being downgraded or of issuers defaulting. In an effort to minimize this risk, our investment guidelines have been defined to ensure that the assets held are well diversified and are primarily high-quality securities.

 

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The following table shows the types of securities in our portfolio, their fair market values, average rating and portfolio percentage as of September 30, 2012.

 

     Fair Value
September 30,
2012
     Average
Rating
   Portfolio
Percentage
 
     ($ in millions)              

Cash and cash equivalents

   $ 686.4      AAA      7.7
  

 

 

       

 

 

 

U.S. government securities

   $ 1,487.6      AA+      16.7

U.S. government agencies

     391.0      AA+      4.4

Non-U.S. government and government agencies

     309.5      AA+      3.5

State, municipalities and political subdivisions

     41.5      AA-      0.5

Mortgage-backed securities (“MBS”):

        

Agency MBS

     1,606.2      AA+      18.1

Non-agency Residential MBS

     107.4      A      1.2

Non-agency Residential MBS - Non investment grade

     230.3      CCC      2.6

Commercial MBS

     308.1      AA+      3.4
  

 

 

       

 

 

 

Total mortgage-backed securities

     2,252.0           25.3

Corporate securities:

        

Financials

     1,031.8      A+      11.6

Industrials

     1,145.6      BBB      12.9

Utilities

     59.8      BBB      0.6
  

 

 

       

 

 

 

Total corporate securities

     2,237.2           25.1

Asset-backed securities:

        

Credit cards

     26.1      AAA      0.3

Auto receivables

     34.4      AAA      0.4

Student Loans

     160.0      AA+      1.8

Collateralized loan obligations

     193.7      AA+      2.2

Other

     22.0      AAA      0.2
  

 

 

       

 

 

 

Total asset-backed securities

     436.2           4.9
  

 

 

       

 

 

 

Total fixed income securities

   $ 7,155.0           80.4
  

 

 

       

 

 

 

Private equity

   $ 124.2      N/A      1.4

Hedge funds

     440.5      N/A      5.0

Equities

     490.4      N/A      5.5
  

 

 

       

 

 

 

Total investment portfolio

   $ 8,896.5           100.0
  

 

 

       

 

 

 

As of September 30, 2012, we held $7.2 billion of fixed income securities. Of those assets, approximately 90.4% were rated investment grade (Baa3/BBB- or higher) with the remaining 9.6% rated in the below investment grade category. The average credit quality of the fixed maturity portfolios was AA- by Standard & Poor’s.

Our agency pass-through mortgage-backed securities are exposed to prepayment risk, which occurs when holders of individual mortgages increase the frequency with which they prepay the outstanding principal before the maturity date to refinance at a lower interest rate cost. Given the proportion that these securities comprise of the overall portfolio, and the current interest rate environment and condition of the credit market, prepayment risk is not considered significant at this time.

Our non-agency commercial mortgage-backed securities are subject to the risk of non-payment due to increased levels of delinquencies, defaults and losses on commercial loans that cumulatively create shortfalls beyond the level of subordination in our specific securities. As of September 30, 2012, 31.3% of our non-agency commercial mortgage-backed securities were rated below Aaa/AAA.

As of September 30, 2012, we held investments in other invested assets with a fair value of $564.7 million. Investments in these funds involve certain risks related to, among other things, the illiquid nature of the fund shares, the limited operating history of the

 

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fund, as well as risks associated with the strategies employed by the managers of the funds. The funds’ objectives are generally to seek attractive long-term returns with lower volatility by investing in a range of diversified investment strategies. As our reserves and capital continue to build, we may consider additional investments in these or other alternative investments.

During 2011, concerns about sovereign and corporate credits throughout the European Economic Area became elevated. As of September 30, 2012, our direct exposure to European credit across all of Europe was $751.6 million and is included within “fixed maturity investments trading, at fair value” and “equity securities trading, at fair value” in the consolidated balance sheets. Of that, approximately $222.8 million was invested in debt issued or guaranteed by European nations, $32.7 million was invested in structured products and $496.1 million was invested in debt and equity securities of European corporations (not guaranteed by a sovereign nation) as outlined in the table below. As of September 30, 2012, we had no direct sovereign exposure to Greece, Ireland, Italy, Portugal or Spain.

 

     September 30, 2012  
     Sovereign and
Sovereign
Guaranteed
     Structured
Products
     Corporate Bonds
and Equities
     Total
Exposure
 
     ($ in millions)  

Belgium

   $ 22.0      $       $ 24.6      $ 46.6  

Denmark

     34.9                        34.9  

France

             6.6        61.5        68.1  

Germany

     71.1        2.8        18.4        92.3  

Ireland

                     0.1        0.1  

Italy

                     3.1        3.1  

Luxembourg

                     13.3        13.3  

Netherlands

     39.9                44.8        84.7  

Norway

     12.8                61.9        74.7  

Russia

                     12.3        12.3  

Spain

                     13.2        13.2  

Sweden

                     34.5        34.5  

Switzerland

     10.7                44.3        55.0  

United Kingdom

     31.4        23.3        164.1        218.8  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total exposure

   $ 222.8      $ 32.7      $ 496.1      $ 751.6  
  

 

 

    

 

 

    

 

 

    

 

 

 

The U.S. dollar is our reporting currency and the functional currency of all of our operating subsidiaries. However, we enter into insurance and reinsurance contracts where the premiums receivable and losses payable are denominated in currencies other than the U.S. dollar. In addition, we maintain a portion of our investments and liabilities in currencies other than the U.S. dollar, primarily Euro, British Sterling, Swiss Franc and the Canadian dollar. Receivables in non-U.S. currencies are generally converted into U.S. dollars at the time of receipt. When we incur a liability in a non-U.S. currency, we carry such liability on our books in the original currency. These liabilities are converted from the non-U.S. currency to U.S. dollars at the time of payment. As a result, we have an exposure to foreign currency risk resulting from fluctuations in exchange rates. We utilize a hedging strategy to minimize the potential loss of value caused by currency fluctuations by using foreign currency forward contract derivatives that expire in 90 days from purchase.

As of September 30, 2012 and December 31, 2011, less than 3.6% and 3.1%, respectively, of our total investments and cash and cash equivalents were denominated in currencies other than the U.S. dollar. Of our business written during the nine months ended September 30, 2012 and 2011, approximately 13% and 12%, respectively, was written in currencies other than the U.S. dollar.

 

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Item 4. Controls and Procedures.

In connection with the preparation of this quarterly report, our management has performed an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of September 30, 2012. Disclosure controls and procedures are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by SEC rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow for timely decisions regarding required disclosures. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2012, our company’s disclosure controls and procedures were effective to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by SEC rules and forms and accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow for timely decisions regarding required disclosures.

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide an absolute assurance that all control issues and instances of fraud, if any, within our company have been detected.

No changes were made in our internal controls over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f), during the quarter ended September 30, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II

OTHER INFORMATION

Item 1.     Legal Proceedings.

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.

Item 1A.     Risk Factors.

Our business is subject to a number of risks, including those identified in Item 1A. of Part I of our 2011 Form 10-K, that could have a material adverse effect on our business, results of operations, financial condition and/or liquidity and that could cause our operating results to vary significantly from period to period. There have been no material changes to the risk factors described in our 2011 Form 10-K. The risks described in our 2011 Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also could have a material adverse effect on our business, results of operations, financial condition and/or liquidity.

 

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Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds.

(c) The following table summarizes our repurchases of our common shares during the three months ended September 30, 2012:

 

Period

   Total Number  of
Shares
Purchased
     Average Price
Paid
per Share
     Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
     Maximum Dollar Value
(or Approximate
Dollar Value) of
Shares that May Yet
be Purchased Under
the Plans or Programs
 

July 1 - 31, 2012

     185,998       $ 79.11         185,998       $ 500,000,000   

August 1 - 31, 2012

     229,900         78.39         229,900         481,978,738   

September 1 - 30, 2012

     190,000         78.18         190,000         467,124,363   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     605,898       $ 78.54         605,898       $ 467,124,363  (1) 

 

(1) At the 2012 Annual Shareholder Meeting on May 3, 2012, Holdings’ shareholders approved a new, two-year $500 million share repurchase program. Share repurchases may be effected from time to time through open market purchases, privately negotiated transactions, tender offers or otherwise.

Item 3.     Defaults Upon Senior Securities.

None.

Item 4.     Mine Safety Disclosures.

Not applicable.

Item 5.     Other Information.

None.

 

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Item 6.     Exhibits.

 

Exhibit
Number
 

Description

3.1(1)   Articles of Association of Allied World Assurance Company Holdings, AG, as amended and restated.
3.2(2)   Organizational Regulations of Allied World Assurance Company Holdings, AG, as amended and restated.
10.1(3)†   Form of Indemnification Agreement for Thomas A. Bradley.
31.1   Certification by Chief Executive Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002.
31.2   Certification by Chief Financial Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*   Certification by Chief Executive Officer, as required by Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*   Certification by Chief Financial Officer, as required by Section 906 of the Sarbanes-Oxley Act of 2002.
101.1**   Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011, (ii) the Consolidated Statements of Operations and Comprehensive Income for the three and nine months ended September 30, 2012 and 2011, (iii) the Consolidated Statements of Shareholders’ Equity for the nine months ended September 30, 2012 and 2011, (iv) the Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011 and (v) the Notes to the Consolidated Financial Statements.

 

(1) Incorporated herein by reference to the Current Report on Form 8-K of Allied World Assurance Company Holdings, AG filed with the SEC on September 24, 2012.

 

(2) Incorporated herein by reference to the Current Report on Form 8-K of Allied World Assurance Company Holdings, AG filed with the SEC on August 3, 2012.

 

(3) Incorporated herein by reference to the Current Report on Form 8-K of Allied World Assurance Company Holdings, AG filed with the SEC on December 1, 2010. The Indemnification Agreement, dated as of September 24, 2012, for Thomas A. Bradley is materially identical to the form filed as Exhibit 10.4 thereto.

 

Management contract or compensatory plan, contract or arrangement.

 

* These certifications are being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, chapter 63 of title 18 United States Code) and are not being filed as part of this report.

 

** In accordance with Rule 406T of Regulation S-T, the information in Exhibit 101.1 to this Quarterly Report on Form 10-Q is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act, is deemed not filed for purposes of Section 18 of the Exchange Act and otherwise is not subject to liability under these sections.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
Dated: November 9, 2012     By:   /s/ Scott A. Carmilani
      Name:  Scott A. Carmilani
      Title:    President and Chief Executive Officer
Dated: November 9, 2012     By:   /s/ Thomas A. Bradley
      Name:  Thomas A. Bradley
      Title:    Executive Vice President and Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit
Number
 

Description

3.1(1)   Articles of Association of Allied World Assurance Company Holdings, AG, as amended and restated.
3.2(2)   Organizational Regulations of Allied World Assurance Company Holdings, AG, as amended and restated.
10.1(3)†   Form of Indemnification Agreement for Thomas A. Bradley.
31.1   Certification by Chief Executive Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002.
31.2   Certification by Chief Financial Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*   Certification by Chief Executive Officer, as required by Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*   Certification by Chief Financial Officer, as required by Section 906 of the Sarbanes-Oxley Act of 2002.
101.1**   Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011, (ii) the Consolidated Statements of Operations and Comprehensive Income for the three and nine months ended September 30, 2012 and 2011, (iii) the Consolidated Statements of Shareholders’ Equity for the nine months ended September 30, 2012 and 2011, (iv) the Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011 and (v) the Notes to the Consolidated Financial Statements.

 

(1) Incorporated herein by reference to the Current Report on Form 8-K of Allied World Assurance Company Holdings, AG filed with the SEC on September 24, 2012.

 

(2) Incorporated herein by reference to the Current Report on Form 8-K of Allied World Assurance Company Holdings, AG filed with the SEC on August 3, 2012.

 

(3) Incorporated herein by reference to the Current Report on Form 8-K of Allied World Assurance Company Holdings, AG filed with the SEC on December 1, 2010. The Indemnification Agreement, dated as of September 24, 2012, for Thomas A. Bradley is materially identical to the form filed as Exhibit 10.4 thereto.

 

Management contract or compensatory plan, contract or arrangement.

 

* These certifications are being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, chapter 63 of title 18 United States Code) and are not being filed as part of this report.

 

** In accordance with Rule 406T of Regulation S-T, the information in Exhibit 101.1 to this Quarterly Report on Form 10-Q is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act, is deemed not filed for purposes of Section 18 of the Exchange Act and otherwise is not subject to liability under these sections.