W.R. BERKLEY CORPORATION Overview
W. R. Berkley Corporation is an insurance holding company that is among the largest commercial lines writers inthe United States and operates worldwide in two segments of the property and casualty business: Insurance and Reinsurance & Monoline Excess. Our decentralized structure provides us with the flexibility to respond quickly and efficiently to local or specific market conditions and to pursue specialty business niches. It also allows us to be closer to our customers in order to better understand their individual needs and risk characteristics. While providing our business units with certain operating autonomy, our structure allows us to capitalize on the benefits of economies of scale through centralized capital, investment, reinsurance, enterprise risk management, and actuarial, financial and corporate legal staff support. The Company's primary sources of revenues and earnings are its insurance operations and its investments. An important part of our strategy is to form new operating units to capitalize on various business opportunities. Over the years, the Company has formed numerous operating units that are focused on important parts of the economy in theU.S. , including healthcare, cyber security, energy and agriculture, and on growing international markets, including theAsia-Pacific region ,South America andMexico . The profitability of the Company's insurance business is affected primarily by the adequacy of premium rates. The ultimate adequacy of premium rates is not known with certainty at the time an insurance policy is issued because premiums are determined before claims are reported. The ultimate adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural and other disasters, regulatory measures and court decisions that define and change the extent of coverage and the effects of economic inflation on the amount of compensation for injuries or losses. General insurance prices are also influenced by available insurance capacity, i.e., the level of capital employed in the industry, and the industry's willingness to deploy that capital. The Company's profitability is also affected by its investment income and investment gains. The Company's invested assets are invested principally in fixed maturity securities. The return on fixed maturity securities is affected primarily by general interest rates, as well as the credit quality and duration of the securities. Returns available on fixed maturity investments have been at low levels for an extended period. The Company also invests in equity securities, merger arbitrage securities, investment funds, private equity, loans and real estate related assets. The Company's investments in investment funds and its other alternative investments have experienced, and the Company expects to continue to experience, greater fluctuations in investment income. The Company's share of the earnings or losses from investment funds is generally reported on a one-quarter lag in order to facilitate the timely completion of the Company's consolidated financial statements. The COVID-19 pandemic, including the related impact on theU.S. and global economies, has adversely affected our results of operations. For the nine months endedSeptember 30, 2021 , the Company recorded approximately$46 million for current accident year COVID-19-related losses, net of reinsurance. At the same time, COVID-19 has led to reduced loss frequency in certain lines of business (which has begun a return to pre-pandemic levels as many economies and legal systems have reopened as a result of populations becoming vaccinated). The ultimate impact of COVID-19 on the economy and the Company's results of operations, financial position and liquidity is not within the Company's control and unclear due to, among other factors, uncertainty in connection with its claims, reserves and reinsurance recoverables. The scope, duration and magnitude of the direct and indirect effects of COVID-19 continue to evolve in ways that are difficult or impossible to anticipate. While many of the potential impacts on the Company have receded as populations have begun to become vaccinated, new variants of the COVID-19 virus, including the "Delta" variant, and the slowing of vaccination rates among certain populations, continue to create risks to the Company. As a result, the impact of COVID-19 on the Company's results of operations for the nine months of 2021 is not necessarily indicative of its impact for the remainder of 2021 or beyond. Despite the effects of COVID-19 to date, the Company's financial position and liquidity improved for the nine months endedSeptember 30, 2021 .
Critical Accounting Estimates
The following presents a discussion of accounting policies and estimates
relating to reserves for losses and loss expenses, assumed premiums and
allowance for expected credit losses on investments. Management believes these
policies and estimates are the most critical to its operations and require the
most difficult, subjective and complex judgments.
Reserves for Losses and Loss Expenses. To recognize liabilities for unpaid
losses, either known or unknown, insurers establish reserves, which is a balance
sheet account representing estimates of future amounts needed to pay claims and
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related expenses with respect to insured events which have occurred. Estimates
and assumptions relating to reserves for losses and loss expenses are based on
complex and subjective judgments, often including the interplay of specific
uncertainties with related accounting and actuarial measurements. Such estimates
are also susceptible to change as significant periods of time may elapse between
the occurrence of an insured loss, the report of the loss to the insurer, the
ultimate determination of the cost of the loss and the insurer's payment of that
loss.
In general, when a claim is reported, claims personnel establish a "case
reserve" for the estimated amount of the ultimate payment based upon known
information about the claim at that time. The estimate represents an informed
judgment based on general reserving practices and reflects the experience and
knowledge of the claims personnel regarding the nature and value of the specific
type of claim. Reserves are also established on an aggregate basis to provide
for losses incurred but not reported ("IBNR") to the insurer, potential
inadequacy of case reserves and the estimated expenses of settling claims,
including legal and other fees and general expenses of administrating the claims
adjustment process. Reserves are established based upon the then current legal
interpretation of coverage provided.
In examining reserve adequacy, several factors are considered in estimating
the ultimate economic value of losses. These factors include, among other
things, historical data, legal developments, changes in social attitudes and
economic conditions, including the effects of inflation. The actuarial process
relies on the basic assumption that past experience, adjusted judgmentally for
the effects of current developments and anticipated trends, is an appropriate
basis for predicting future outcomes. Reserve amounts are based on management's
informed estimates and judgments using currently available data. As additional
experience and other data become available and are reviewed, these estimates and
judgments may be revised. This may result in reserve increases or decreases that
would be reflected in our results in periods in which such estimates and
assumptions are changed.
Reserves do not represent an exact calculation of liability. Rather, reserves
represent an estimate of what management expects the ultimate settlement and
claim administration will cost. While the methods for establishing reserves are
well tested over time, some of the major assumptions about anticipated loss
emergence patterns are subject to uncertainty. These estimates, which generally
involve actuarial projections, are based on management's assessment of facts and
circumstances then known, as well as estimates of trends in claims severity and
frequency, judicial theories of liability and other factors, including the
actions of third parties which are beyond the Company's control. These variables
are affected by external and internal events, such as inflation and economic
volatility, judicial and litigation trends, reinsurance coverage, legislative
changes and claim handling and reserving practices, which make it more difficult
to accurately predict claim costs. The inherent uncertainties of estimating
reserves are greater for certain types of liabilities where long periods of time
elapse before a definitive determination of liability is made. Because setting
reserves is inherently uncertain, the Company cannot provide assurance that its
current reserves will prove adequate in light of subsequent events.
Loss reserves included in the Company's financial statements represent
management's best estimates based upon an actuarially derived point estimate and
other considerations. The Company uses a variety of actuarial techniques and
methods to derive an actuarial point estimate for each operating unit. These
methods include paid loss development, incurred loss development, paid and
incurred Bornhuetter-Ferguson methods and frequency and severity methods. In
circumstances where one actuarial method is considered more credible than the
others, that method is used to set the point estimate. For example, the paid
loss and incurred loss development methods rely on historical paid and incurred
loss data. For new lines of business, where there is insufficient history of
paid and incurred claims data, or in circumstances where there have been
significant changes in claim practices, the paid and incurred loss development
methods would be less credible than other actuarial methods. The actuarial point
estimate may also be based on a judgmental weighting of estimates produced from
each of the methods considered. Industry loss experience is used to supplement
the Company's own data in selecting "tail factors" and in areas where the
Company's own data is limited. The actuarial data is analyzed by line of
business, coverage and accident or policy year, as appropriate, for each
operating unit.
The establishment of the actuarially derived loss reserve point estimate also
includes consideration of qualitative factors that may affect the ultimate
losses. These qualitative considerations include, among others, the impact of
re-underwriting initiatives, changes in the mix of business, changes in
distribution sources and changes in policy terms and conditions. Examples of
changes in terms and conditions that can have a significant impact on reserve
levels are the use of aggregate policy limits, the expansion of coverage
exclusions, whether or not defense costs are within policy limits, and changes
in deductibles and attachment points.
The key assumptions used to arrive at the best estimate of loss reserves are
the expected loss ratios, rate of loss cost inflation, and reported and paid
loss emergence patterns. Expected loss ratios represent management's expectation
of losses at the time the business is written, before any actual claims
experience has emerged. This expectation is a significant determinant of the
estimate of loss reserves for recently written business where there is little
paid or incurred loss data to consider. Expected loss ratios are generally
derived from historical loss ratios adjusted for the impact of rate changes,
loss cost trends and known
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changes in the type of risks underwritten. Expected loss ratios are estimated
for each key line of business within each operating unit. Expected loss cost
inflation is particularly important for the long-tail lines, such as excess
casualty, and claims with a high medical component, such as workers'
compensation. Reported and paid loss emergence patterns are used to project
current reported or paid loss amounts to their ultimate settlement value. Loss
development factors are based on the historical emergence patterns of paid and
incurred losses, and are derived from the Company's own experience and industry
data. The paid loss emergence pattern is also significant to excess and assumed
workers' compensation reserves because those reserves are discounted to their
estimated present value based upon such estimated payout patterns. Management
believes the estimates and assumptions it makes in the reserving process provide
the best estimate of the ultimate cost of settling claims and related expenses
with respect to insured events which have occurred; however, different
assumptions and variables could lead to significantly different reserve
estimates.
Loss frequency and severity are measures of loss activity that are considered
in determining the key assumptions described in our discussion of loss and loss
expense reserves, including expected loss ratios, rate of loss cost inflation
and reported and paid loss emergence patterns. Loss frequency is a measure of
the number of claims per unit of insured exposure, and loss severity is a
measure of the average size of claims. Factors affecting loss frequency include
the effectiveness of loss controls and safety programs and changes in economic
activity or weather patterns. Factors affecting loss severity include changes in
policy limits, retentions, rate of inflation and judicial interpretations.
Another factor affecting estimates of loss frequency and severity is the loss
reporting lag, which is the period of time between the occurrence of a loss and
the date the loss is reported to the Company. The length of the loss reporting
lag affects our ability to accurately predict loss frequency (loss frequencies
are more predictable for lines with short reporting lags) as well as the amount
of reserves needed for incurred but not reported losses (less IBNR is required
for lines with short reporting lags). As a result, loss reserves for lines with
short reporting lags are likely to have less variation from initial loss
estimates. For lines with short reporting lags, which include commercial
automobile, primary workers' compensation, other liability (claims-made) and
property business, the key assumption is the loss emergence pattern used to
project ultimate loss estimates from known losses paid or reported to date. For
lines of business with long reporting lags, which include other liability
(occurrence), products liability, excess workers' compensation and liability
reinsurance, the key assumption is the expected loss ratio since there is often
little paid or incurred loss data to consider. Historically, the Company has
experienced less variation from its initial loss estimates for lines of
businesses with short reporting lags than for lines of business with long
reporting lags.
The key assumptions used in calculating the most recent estimate of the loss
reserves are reviewed each quarter and adjusted, to the extent necessary, to
reflect the latest reported loss data, current trends and other factors
observed. If the actual level of loss frequency and severity are higher or lower
than expected, the ultimate losses will be different than management's estimate.
The following table reflects the impact of changes (which could be favorable or
unfavorable) in frequency and severity, relative to our assumptions, on our loss
estimate for claims occurring in 2020:
(In thousands) Frequency (+/-)
Severity (+/-) 1% 5% 10%
1% $ 89,102 $ 268,193 $ 492,056
5% 268,193 454,376 687,105
10% 492,056 687,105 930,917
Our net reserves for losses and loss expenses of approximately $12.5 billion
as of September 30, 2021 relate to multiple accident years. Therefore, the
impact of changes in frequency or severity for more than one accident year could
be higher or lower than the amounts reflected above. The impact of such changes
would likely be manifested gradually over the course of many years, as the
magnitude of the changes became evident.
Approximately $2.7 billion , or 22%, of the Company's net loss reserves as of
September 30, 2021 relate to the Reinsurance & Monoline Excess segment. There is
a higher degree of uncertainty and greater variability regarding estimates of
excess workers' compensation and assumed reinsurance loss reserves. In the case
of excess workers' compensation, our policies generally attach at $1 million or
higher. The claims which reach our layer therefore tend to involve the most
serious injuries and many remain open for the lifetime of the claimant, which
extends the claim settlement tail. These claims also occur less frequently but
tend to be larger than primary claims, which increases claim variability. In the
case of assumed reinsurance our loss reserve estimates are based, in part, upon
information received from ceding companies. If information received from ceding
companies is not timely or correct, the Company's estimate of ultimate losses
may not be accurate. Furthermore, due to delayed reporting of claim information
by ceding companies, the claim settlement tail for assumed reinsurance is also
extended. Management considers the impact of delayed reporting and the extended
tail in its selection of loss development factors for these lines of business.
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Information received from ceding companies is used to set initial expected
loss ratios, to establish case reserves and to estimate reserves for incurred
but not reported losses on assumed reinsurance business. This information, which
is generally provided through reinsurance intermediaries, is gathered through
the underwriting process and from periodic claim reports and other
correspondence with ceding companies. The Company performs underwriting and
claim audits of selected ceding companies to determine the accuracy and
completeness of information provided to the Company. The information received
from the ceding companies is supplemented by the Company's own loss development
experience with similar lines of business as well as industry loss trends and
loss development benchmarks.
Following is a summary of the Company's reserves for losses and loss expenses
by business segment:
September 30, December 31,
(In thousands) 2021 2020
Insurance $ 9,758,754 $ 9,034,969
Reinsurance & Monoline Excess 2,722,375 2,585,424
Net reserves for losses and loss expenses 12,481,129 11,620,393
Ceded reserves for losses and loss expenses 2,438,447 2,164,037
Gross reserves for losses and loss expenses
Following is a summary of the Company's net reserves for losses and loss expenses by major line of business:
Reported Case Incurred But Total
(In thousands) Reserves Not Reported
September 30, 2021
Other liability $ 1,692,098 $ 3,079,753 $ 4,771,851
Workers' compensation (1) 1,001,955 918,438 1,920,393
Professional liability 450,592 1,049,223 1,499,815
Commercial automobile 473,821 416,273 890,094
Short-tail lines (2) 317,863 358,738 676,601
Total Insurance 3,936,329 5,822,425 9,758,754Reinsurance & Monoline Excess (1) (3) 1,490,320 1,232,055
2,722,375
Total $ 5,426,649 $ 7,054,480 $ 12,481,129
December 31, 2020
Other liability $ 1,534,514 $ 2,864,760 $ 4,399,274
Workers' compensation (1) 977,035 873,072 1,850,107
Professional liability 414,104 875,163 1,289,267
Commercial automobile 442,975 398,688 841,663
Short-tail lines (2) 295,313 359,345 654,658
Total Insurance 3,663,941 5,371,028 9,034,969Reinsurance & Monoline Excess (1) (3) 1,442,099 1,143,325
2,585,424
Total $ 5,106,040 $ 6,514,353 $ 11,620,393
___________
(1) Reserves for workers' compensation and Reinsurance & Monoline Excess are net
of an aggregate net discount of $462 million and $483 million as of
September 30, 2021 and December 31, 2020 , respectively.
(2) Short-tail lines include commercial multi-peril (non-liability), inland
marine, accident and health, fidelity and surety, boiler and machinery and other
lines.
(3) Reinsurance & Monoline Excess includes property and casualty reinsurance, as
well as operations that solely retain risk on an excess basis.
The Company evaluates reserves for losses and loss adjustment expenses on a
quarterly basis. Changes in estimates of prior year losses are reported when
such changes are made. The changes in prior year loss reserve estimates are
generally the result of ongoing analysis of recent loss development trends.
Original estimates are increased or decreased as additional information becomes
known regarding individual claims and aggregate claim trends.
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Certain of the Company's insurance and reinsurance contracts are
retrospectively rated, whereby the Company collects more or less premiums based
on the level of loss activity. For those contracts, changes in loss and loss
adjustment expenses for prior years may be fully or partially offset by
additional or return premiums.
Net prior year development (i.e., the sum of prior year reserve changes and
prior year earned premiums changes) for the nine months ended September 30, 2021
and 2020 are as follows:
(In thousands) 2021 2020
Net increase in prior year loss reserves $ (1,552) $ (849)
Increase in prior year earned premiums 6,918 12,869
Net favorable prior year development $ 5,366 $ 12,020
The COVID-19 global pandemic has impacted, and may further impact, the Company's
results through its effect on claim frequency and severity. Loss cost trends
have been impacted and may be further impacted by COVID-19-related claims in
certain lines of business. Losses incurred from COVID-19-related claims have
been offset, to a certain extent, by lower claim frequency in certain lines of
our businesses; however, as the economy and legal systems have reopened, the
benefit of lower claim frequency has begun to abate. Although as populations
have continued to be vaccinated against the virus and the effects of the
pandemic have receded in many jurisdictions, most particularly the United
States , it remains too early to determine the ultimate net impact of COVID-19 on
the Company. New variants of the COVID-19 virus, including the "Delta" variant,
and the slowing of vaccination rates among certain populations continue to
create risks with respect to loss costs and the potential for renewed impact of
the other effects of COVID-19 associated with economic conditions, inflation,
and social distancing and work from home rules.
Most of the COVID-19-related claims reported to the Company to date involve
certain short-tailed lines of business, including contingency and event
cancellation, business interruption, and film production delay. The Company has
also received COVID-19-related claims for longer-tailed casualty lines of
business such as workers' compensation and other liability; however, the
estimated incurred loss impact for these reported claims are not material at
this time. Given the continuing uncertainty regarding the pandemic's
pervasiveness, the future impact that the pandemic may have on claim frequency
and severity remains uncertain at this time.
The Company has estimated the potential COVID-19 impact to its contingency and
event cancellation, workers' compensation, and other lines of business under a
number of possible scenarios; however, due to COVID-19's continued evolving
impact, there remains a high degree of uncertainty around the Company's COVID-19
reserves. In addition, should the pandemic continue or worsen as a result of new
COVID-19 variants or otherwise, governments in the jurisdictions where we
operate may renew their efforts to expand policy coverage terms beyond the
policy's intended coverage. Accordingly, losses arising from these actions, and
the other factors described above, could exceed the Company's reserves
established for those related policies.
As of September 30, 2021 , the Company had recognized losses for COVID-19-related
claims activity, net of reinsurance, of approximately $256 million , of which
$220 million relates to the Insurance segment and $36 million relates to the
Reinsurance & Monoline Excess segment. Such $256 million of COVID-19-related
losses included $219 million of reported losses and $37 million of IBNR. For the
nine months ended September 30, 2021 , the Company recognized current accident
year losses for COVID-19-related claims activity, net of reinsurance, of
approximately $46 million , of which $43 million relates to the Insurance segment
and $3 million relates to the Reinsurance & Monoline Excess segment.
During the nine months ended September 30, 2021 , favorable prior year
development (net of additional and return premiums) of $5 million included $8
million of favorable development for the Insurance segment, partially offset by
$3 million of adverse development for the Reinsurance & Monoline Excess segment.
The overall favorable development for the Insurance segment was primarily
attributable to favorable development on the 2020 accident year, partially
offset by adverse development on the 2016 through 2019 accident years. The
favorable development on the 2020 accident year was largely concentrated in the
commercial auto liability and other liability lines of business including
commercial multi-peril liability. During 2020 the Company achieved larger rate
increases in these lines of business than were contemplated in our budget and in
our initial loss ratio selections. The Company also experienced significantly
lower reported claim frequency in these lines in 2020 relative to historical
averages, and lower reported incurred losses relative to our expectations. We
believe that the lower claim frequency and lower reported incurred losses were
caused by the impacts of the COVID-19 pandemic, for example, lockdowns, reduced
driving and traffic, work from home, and court closures. However, due to the
uncertainty regarding the ultimate impacts of the pandemic on accident year 2020
incurred losses, the Company elected not to react to these lower reported trends
during 2020. As more information becomes available and the 2020 accident year
continues to mature, during 2021 we have started to recognize favorable accident
year 2020 development in response to the continuing favorable reported loss
experience relative to our expectations. The adverse development on the 2016
through 2019 accident years is concentrated largely in the other liability line
of business including commercial multi-peril
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liability, but is also seen to a lesser extent in commercial auto liability. The
adverse development on these years is driven by a higher than expected number of
large losses reported, and particularly impacted the directors and officers
liability and excess and surplus lines casualty classes of business. We also
believe that increased social inflation is contributing to the increased number
of large losses.
The overall adverse development for the Reinsurance & Monoline Excess segment
was driven by adverse development in the other liability and non-proportional
reinsurance assumed liability lines of business, related primarily to accident
years 2017 through 2019, partially offset by favorable development in excess
workers' compensation which was spread across many prior accident years. The
adverse development was driven by higher than expected reported losses on excess
of loss treaties written in the U.S. and U.K.
During the nine months ended September 30, 2020 , favorable prior year
development (net of additional and return premiums) of $12 million included $19
million of favorable development for the Insurance segment, partially offset by
$7 million of adverse development for the Reinsurance & Monoline Excess segment.
The overall favorable development for the Insurance segment was primarily
attributable to favorable development on workers' compensation business,
partially offset by adverse development on professional liability business. The
favorable workers' compensation development was spread across many prior
accident years, including prior to 2010, but was especially significant in
accident year 2019. The favorable workers' compensation development reflects a
continuation of the benign loss cost trends experienced during recent years,
particularly the favorable claim frequency trends. Our ongoing workers'
compensation claims management efforts, including active medical case management
and use of networks and specialty vendors to control medical and pharmaceutical
benefit costs, have also added to the favorable workers' compensation prior year
development. The adverse professional liability development was mainly
concentrated in accident years 2016 through 2018 and was largely driven by
higher than expected large losses being reported in the directors and officers
and lawyers professional liability lines of business.
The adverse development for the Reinsurance & Monoline Excess segment was mainly
driven by non-proportional reinsurance assumed liability business written in the
U.K. for accident years 2016 through 2018, partially offset by favorable
development on excess workers' compensation business. The adverse development
was driven by a greater than expected number of reported large losses.
Reserve Discount. The Company discounts its liabilities for certain workers'
compensation reserves. The amount of workers' compensation reserves that were
discounted was $1,395 million and $1,655 million at September 30, 2021 and
December 31, 2020 , respectively. The aggregate net discount for those reserves,
after reflecting the effects of ceded reinsurance, was $462 million and $483
million at September 30, 2021 and December 31, 2020 , respectively. At
September 30, 2021 , discount rates by year ranged from 0.7% to 6.5%, with a
weighted average discount rate of 3.4%.
Substantially all of the workers' compensation discount (97% of total
discounted reserves at September 30, 2021 ) relates to excess workers'
compensation reserves. In order to properly match loss expenses with income
earned on investment securities supporting the liabilities, reserves for excess
workers' compensation business are discounted using risk-free discount rates
determined by reference to the U.S. Treasury yield curve. These rates are
determined annually based on the weighted average rate for the period. Once
established, no adjustments are made to the discount rate for that period, and
any increases or decreases in loss reserves in subsequent years are discounted
at the same rate, without regard to when any such adjustments are recognized.
The expected loss and loss expense payout patterns subject to discounting are
derived from the Company's loss payout experience.
The Company also discounts reserves for certain other long-duration workers'
compensation reserves (representing approximately 3% of total discounted
reserves at September 30, 2021 ), including reserves for quota share reinsurance
and reserves related to losses regarding occupational lung disease. These
reserves are discounted at statutory rates permitted by the Department of
Insurance of the State of Delaware .
Assumed Reinsurance Premiums. The Company estimates the amount of assumed
reinsurance premiums that it will receive under treaty reinsurance agreements at
the inception of the contracts. These premium estimates are revised as the
actual amount of assumed premiums is reported to the Company by the ceding
companies. As estimates of assumed premiums are made or revised, the related
amount of earned premiums, commissions and incurred losses associated with those
premiums are recorded. Estimated assumed premiums receivable were approximately
$61 million at September 30, 2021 and $44 million at December 31, 2020 . The
assumed premium estimates are based upon terms set forth in reinsurance
agreements, information received from ceding companies during the underwriting
and negotiation of agreements, reports received from ceding companies and
discussions and correspondence with reinsurance intermediaries. The Company also
considers its own view of market conditions, economic trends and experience with
similar lines of business. These premium estimates represent management's best
estimate of the ultimate amount of premiums to be received under its assumed
reinsurance agreements.
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Fixed Maturity Securities - For fixed maturity securities in an unrealized loss position where the Company intends to sell, or it is more likely than not that it will be required to sell the security before recovery in value, the amortized cost basis is written down to fair value through net investment gains (losses). For fixed maturity securities in an unrealized loss position where the Company does not intend to sell, or it is more likely than not that it will not be required to sell the security before recovery in value, the Company evaluates whether the decline in fair value has resulted from credit losses or all other factors (non-credit factors). In making this assessment, the Company considers the extent to which fair value is less than amortized cost, changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, an allowance for expected credit losses is recorded for the credit loss through net investment gains (losses), limited by the amount that the fair value is less than the amortized cost basis. EffectiveJanuary 1, 2020 , the allowance is adjusted for any change in expected credit losses and subsequent recoveries through net investment gains (losses). The impairment related to non-credit factors is recognized in other comprehensive income (loss). The Company's credit assessment of allowance for expected credit losses uses a third party model for available for sale and held to maturity securities, as well as loans receivable. The allowance for expected credit losses is generally based on the performance of the underlying collateral under various economic and default scenarios that involve subjective judgments and estimates by management. Modeling these securities involves various factors, such as projected default rates, the nature and realizable value of the collateral, if any, the ability of the issuer to make scheduled payments, historical performance and other relevant economic and performance factors. A discounted cash flow analysis is used to ascertain the amount of the allowance for expected credit losses, if any. In general, the model reverts to the rating-level long-term average marginal default rates based on 10 years of historical data, beyond the forecast period. For other inputs, the model in most cases reverts to the baseline long-term assumptions linearly over 5 years beyond the forecast period. The long-term assumptions are based on the historical averages. The Company classifies its fixed maturity securities by credit rating, primarily based on ratings assigned by credit rating agencies. For purposes of classifying securities with different ratings, the Company uses the average of the credit ratings assigned, unless in limited situations the Company's own analysis indicates an internal rating is more appropriate. Securities that are not rated by a rating agency are evaluated and classified by the Company on a case-by-case basis. A summary of the Company's non-investment grade fixed maturity securities that were in an unrealized loss position atSeptember 30, 2021 is presented in the table below: Number of Aggregate ($ in thousands) Securities Fair Value Gross Unrealized Loss Foreign government 31$ 119,141 $ 32,048 Corporate 13 49,623 1,879 State and municipal 2 39,693 335 Mortgage-backed 4 249 16 Asset-backed 1 94 3 Total 51$ 208,800 $ 34,281 As ofSeptember 30, 2021 , the Company has recorded an allowance for expected credit losses on fixed maturity securities of$17 million . The Company has evaluated the remaining fixed maturity securities in an unrealized loss position and believes the unrealized losses are due primarily to temporary market and sector-related factors rather than to issuer-specific factors. None of these securities are delinquent or in default under financial covenants. Based on its assessment of these issuers, the Company expects them to continue to meet their contractual payment obligations as they become due. Loans Receivable - For loans receivable, the Company estimates an allowance for expected credit losses based on relevant information about past events, including historical loss experience, current conditions and forecasts that affect the expected collectability of the amortized cost of the financial asset. The allowance for expected credit losses is presented as a reduction to amortized cost of the financial asset in the consolidated balance sheet and changes to the estimate for expected credit losses are recognized through net investment gains (losses). Loans receivable are reported net of an allowance for expected credit losses of$2 million and$5 million as ofSeptember 30, 2021 andDecember 31, 2020 , respectively.
Fair Value Measurements. The Company's fixed maturity available for sale securities, equity securities, and its arbitrage trading account securities are carried at fair value. Fair value is defined as "the price that would be received to sell an
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asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date." The Company utilizes a fair value
hierarchy that prioritizes the inputs to valuation techniques used to measure
fair value into three broad levels. Level 1 inputs are quoted prices
(unadjusted) in active markets for identical assets or liabilities that the
reporting entity has the ability to access at the measurement date. Level 2
inputs are inputs other than quoted prices included within Level 1 that are
observable for similar assets in active markets. Level 3 inputs are unobservable
inputs for the asset or liability. Unobservable inputs may only be used to
measure fair value to the extent that observable inputs are not available. The
fair value of the vast majority of the Company's portfolio is based on
observable data (other than quoted prices) and, accordingly, is classified as
Level 2.
In classifying particular financial securities in the fair value hierarchy,
the Company uses its judgment to determine whether the market for a security is
active and whether significant pricing inputs are observable. The Company
determines the existence of an active market by assessing whether transactions
occur with sufficient frequency and volume to provide reliable pricing
information. The Company determines whether inputs are observable based on the
use of such information by pricing services and external investment managers,
the uninterrupted availability of such inputs, the need to make significant
adjustments to such inputs and the volatility of such inputs over time. If the
market for a security is determined to be inactive or if significant inputs used
to price a security are determined to be unobservable, the security is
categorized in Level 3 of the fair value hierarchy.
Because many fixed maturity securities do not trade on a daily basis, the
Company utilizes pricing models and processes which may include benchmark
curves, benchmarking of like securities, sector groupings and matrix pricing.
Market inputs used to evaluate securities include benchmark yields, reported
trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark
securities, bids, offers and reference data. Quoted prices are often unavailable
for recently issued securities that are infrequently traded or securities that
are only traded in private transactions. For publicly traded securities for
which quoted prices are unavailable, the Company determines fair value based on
independent broker quotations and other observable market data. For securities
traded only in private negotiations, the Company determines fair value based
primarily on the cost of such securities, which is adjusted to reflect prices of
recent placements of securities of the same issuer, financial data, projections
and business developments of the issuer and other relevant information.
The following is a summary of pricing sources for the Company's fixed maturity
securities available for sale as of
Carrying Percent
($ in thousands) Value of Total
Pricing source:
Independent pricing services
49,600 0.3
Directly by the Company based on:
Observable data 269,004 1.7
Total $ 15,999,361 100.0 %
Independent pricing services - Substantially all of the Company's fixed
maturity securities available for sale were priced by independent pricing
services (generally one U.S. pricing service plus additional pricing services
with respect to a limited number of foreign securities held by the Company). The
prices provided by the independent pricing services are generally based on
observable market data in active markets (e.g., broker quotes and prices
observed for comparable securities). The determination of whether markets are
active or inactive is based upon the volume and level of activity for a
particular asset class. The Company reviews the prices provided by pricing
services for reasonableness based upon current trading levels for similar
securities. If the prices appear unusual to the Company, they are re-examined
and the value is either confirmed or revised. In addition, the Company
periodically performs independent price tests of a sample of securities to
ensure proper valuation and to verify our understanding of how securities are
priced. As of September 30, 2021 , the Company did not make any adjustments to
the prices provided by the pricing services. Based upon the Company's review of
the methodologies used by the independent pricing services, these securities
were classified as Level 2.
Syndicate manager - The Company has a 15% participation in a Lloyd's
syndicate, and the Company's share of the securities owned by the syndicate is
priced by the syndicate's manager. The majority of the securities are liquid,
short duration fixed maturity securities. The Company reviews the syndicate
manager's pricing methodology and audited financial statements and holds
discussions with the syndicate manager as necessary to confirm its understanding
and agreement with security prices. Based upon the Company's review of the
methodologies used by the syndicate manager, these securities were classified as
Level 2.
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Observable data - If independent pricing is not available, the Company prices
the securities directly. Prices are based on observable market data where
available, including current trading levels for similar securities and
non-binding quotations from brokers. The Company generally requests two or more
quotes. If more than one quote is received, the Company sets a price within the
range of quotes received based on its assessment of the credibility of the quote
and its own evaluation of the security. The Company generally does not adjust
quotes obtained from brokers. Since these securities were priced based on
observable data, they were classified as Level 2.
Cash flow model - If the above methodologies are not available, the Company
prices securities using a discounted cash flow model based upon assumptions as
to prevailing credit spreads, interest rates and interest rate volatility, time
to maturity and subordination levels. Discount rates are adjusted to reflect
illiquidity where appropriate. These securities were classified as Level 3.
39
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Results of Operations for the Nine Months Ended
Following is a summary of gross and net premiums written, net premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of net premiums earned), expense ratios (underwriting expenses expressed as a percentage of net premiums earned) and GAAP combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the nine months endedSeptember 30, 2021 and 2020. The GAAP combined ratio represents a measure of underwriting profitability, excluding investment income. A GAAP combined ratio in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit. ($ in thousands) 2021 2020 Insurance: Gross premiums written$ 7,008,617 $ 5,841,328 Net premiums written 5,741,229 4,754,791 Net premiums earned 5,151,253 4,481,092 Loss ratio 61.4 % 65.5 % Expense ratio 28.5 % 30.6 % GAAP combined ratio 89.9 % 96.1 % Reinsurance & Monoline Excess: Gross premiums written$ 924,829 $ 784,835 Net premiums written 846,128 710,189 Net premiums earned 751,345 636,161 Loss ratio 61.5 % 66.5 % Expense ratio 30.1 % 32.1 % GAAP combined ratio 91.6 % 98.6 % Consolidated: Gross premiums written$ 7,933,446 $ 6,626,163 Net premiums written 6,587,357 5,464,980 Net premiums earned 5,902,598 5,117,253 Loss ratio 61.4 % 65.6 % Expense ratio 28.7 % 30.8 % GAAP combined ratio 90.1 % 96.4 % Net Income to Common Stockholders. The following table presents the Company's net income to common stockholders and net income per diluted share for the nine months endedSeptember 30, 2021 and 2020: (In thousands, except per share data) 2021 2020 Net income to common stockholders$ 728,060 $ 218,520 Weighted average diluted shares 187,060 189,515 Net income per diluted share$ 3.89 $ 1.15 The Company reported net income to common stockholders of$728 million in 2021 compared to$219 million in 2020. The$509 million increase in net income was primarily due to an after-tax increase in underwriting income of$316 million mainly due to the growth in premium rates and exposure as well as reductions in loss ratio partly due to lower catastrophe losses and in expense ratio driven by net earned premium growth outpacing expense growth, an after-tax increase in net investment gains of$110 million primarily due to sale of real estate assets, an after-tax increase in net investment income of$82 million primarily due to investment funds, a reduction of$22 million in tax expense due to a change in the effective tax rate, an after-tax increase in profits from non-insurance businesses of$6 million , an after-tax savings from interest expenses of$4 million due to early refinancings, an after-tax increase in profit from insurance service businesses of$2 million and a less than$1 million after-tax increase in other income, partially offset by an after-tax increase in corporate expenses of$23 million which includes an after-tax debt extinguishment expense of$9 million on debt redeemed and increased incentive compensation costs, an after-tax increase of$7 million in minority interest and an after-tax decrease in foreign currency gains of$4 million . The number of weighted average diluted shares decreased by 2.5 million for 2021 compared to 2020 mainly reflecting shares repurchased in 2020 and 2021. 40 -------------------------------------------------------------------------------- Premiums. Gross premiums written were$7,933 million in 2021, an increase of 20% from$6,626 million in 2020. The increase was due to a$1,167 million increase in the Insurance segment and a$140 million increase in the Reinsurance & Monoline Excess segment. Approximately 82% of premiums expiring in 2021 were renewed, and 79% of premiums expiring in 2020 were renewed.
Average renewal premium rates for insurance and facultative reinsurance increased 9.5% in 2021 when adjusted for changes in exposures, and increased 10.8% excluding workers' compensation.
A summary of gross premiums written in 2021 compared with 2020 by line of business within each business segment follows: •Insurance - gross premiums increased 20% to$7,009 million in 2021 from$5,841 million in 2020. Gross premiums increased$410 million (20%) for other liability,$376 million (45%) for professional liability,$186 million (27%) for commercial auto,$175 million (13%) for short-tail lines and$21 million (2%) for workers' compensation. •Reinsurance & Monoline Excess - gross premiums increased 18% to$925 million in 2021 from$785 million in 2020. Gross premiums increased$111 million (25%) for casualty reinsurance,$27 million (16%) for monoline excess and$2 million (1%) for property reinsurance.
Net premiums written were
Premiums earned increased 15% to$5,903 million in 2021 from$5,117 million in 2020. Insurance premiums (including the impact of rate changes) are generally earned evenly over the policy term, and accordingly, recent rate increases will be earned over the upcoming quarters. Premiums earned in 2021 are related to business written during both 2021 and 2020. Audit premiums were$138 million in 2021 compared with$111 million in 2020.
Net Investment Income. Following is a summary of net investment income for the
nine months ended
Average Annualized
Amount Yield
($ in thousands) 2021 2020 2021 2020
Fixed maturity securities, including cash and
cash equivalents and loans receivable $ 284,704 $ 330,941 2.2 % 2.9 %
Investment funds 169,538 1,260 16.5 0.1
Arbitrage trading account 30,176 51,985 6.5 12.4
Equity securities 21,854 6,194 5.0 2.4
Real estate 5,517 18,807 0.4 1.2
Gross investment income 511,789 409,187 3.1 2.8
Investment expenses (5,174) (6,343) - -
Total $ 506,615 $ 402,844 3.1 % 2.7 %
Net investment income increased 26% to $507 million in 2021 from $403 million
in 2020 due primarily to a $168 million increase in income from investment funds
primarily from financial services and transportation funds, a $16 million
increase from equity securities and a $1 million decrease in investment expense,
partially offset by a $46 million decrease in income from fixed maturity
securities mainly driven by lower investment yields, a $22 million decrease from
the arbitrage trading account and a $13 million decrease in real estate. The
Company shortened the duration of its fixed maturity security portfolio, thereby
reducing the potential impact of mark-to-market on the portfolio and positioning
the Company to react quickly to changes in the current interest rate
environment. Average invested assets, at cost (including cash and cash
equivalents), were $21.9 billion in 2021 and $19.8 billion in 2020.
Insurance Service Fees. The Company earns fees from an insurance distribution
business, a third-party administrator and as a servicing carrier of workers'
compensation assigned risk plans for certain states. Insurance service fees
increased to $70 million in 2021 from $67 million in 2020, mainly due to the
business recovery from the pandemic.
Net Realized and Unrealized Gains (Losses) on Investments. The Company buys
and sells securities and other investment assets on a regular basis in order to
maximize its total return on investments. Decisions to sell securities and other
investment assets are based on management's view of the underlying fundamentals
of specific investments as well as management's expectations regarding interest
rates, credit spreads, currency values and general economic conditions. Net
41
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realized and unrealized gains on investments were $89 million in 2021 compared
with net losses of $89 million in 2020. The gains of $89 million in 2021 reflect
net realized gains on investments of $151 million (primarily due to the sale of
certain real estate assets and the disposition of an investment fund) partially
offset by unrealized losses on equity securities of $62 million . In 2020, the
net losses of $89 million reflected net realized losses on investment sales of
$27 million and an increase in unrealized losses on equity securities of $62
million , which was primarily due to market disruptions as a result of COVID-19.
Change in Allowance for Expected Credit Losses on Investments. Based on credit
factors, the allowance for expected credit losses is increased or decreased
depending on the percentage of unrealized loss relative to amortized cost by
security, changes in rating of the security by a rating agency, and adverse
conditions specifically related to the security, among other factors. For the
nine months ended September 30, 2021 , the pre-tax change in allowance for
expected credit losses on investments increased by $11 million ($9 million
after-tax), which is reflected in net investment gains (losses), primarily
related to foreign government securities which did not previously have an
allowance. For the nine months ended September 30, 2020 , the pre-tax change in
allowance for expected credit losses on investments decreased by $29 million
($23 million after-tax), which is reflected in net investment gains (losses)
primarily due to the disposition of securities which previously had an allowance
recorded.
Revenues from Non-Insurance Businesses. Revenues from non-insurance businesses
were derived from businesses engaged in the distribution of promotional
merchandise, world-wide textile solutions and aviation-related businesses that
provide services to aviation markets, including (i) the distribution,
manufacturing, repair and overhaul of aircraft parts and components, (ii) the
sale of new and used aircraft, and (iii) avionics, fuel, maintenance, storage
and charter services. Revenues from non-insurance businesses were $317 million
in 2021 and $257 million in 2020. The increase mainly relates to the business
recovery from COVID-19 on aviation-related and textile businesses.
Losses and Loss Expenses. Losses and loss expenses increased to $3,624 million
in 2021 from $3,357 million in 2020. The consolidated loss ratio was 61.4% in
2021 and 65.6% in 2020. Catastrophe losses, net of reinsurance recoveries, were
$154 million (including current accident year losses of approximately $46
million related to COVID-19) in 2021 and $297 million (including losses of
approximately $143 million related to COVID-19) in 2020. Favorable prior year
reserve development (net of premium offsets) was $5 million in 2021 and $12
million in 2020. The loss ratio excluding catastrophe losses and prior year
reserve development was 58.9% in 2021 and 60.0% in 2020.
A summary of loss ratios in 2021 compared with 2020 by business segment
follows:
•Insurance - The loss ratio was 61.4% in 2021 and 65.5% in 2020. Catastrophe
losses were $109 million in 2021 compared with $245 million in 2020. The Company
reflected a best estimate (net of reinsurance) based upon available information
for current accident year COVID-19-related losses of approximately $43 million ,
primarily related to contingency and event cancellation coverage. Favorable
prior year reserve development was $8 million in 2021 and $19 million in 2020.
The loss ratio excluding catastrophe losses and prior year reserve development
decreased 0.9 points to 59.5% in 2021 from 60.4% in 2020.
•Reinsurance & Monoline Excess - The loss ratio was 61.5% in 2021 and 66.5% in
2020. Catastrophe losses were $45 million in 2021 compared with $53 million in
2020. The Company reflected a best estimate (net of reinsurance) based upon
available information for current accident year COVID-19-related losses of
approximately $3 million , primarily related to excess workers' compensation.
Adverse prior year reserve development was $3 million in 2021 and $7 million in
2020. The loss ratio excluding catastrophe losses and prior year reserve
development decreased 2.1 points to 55.1% in 2021 from 57.2% in 2020.
Other Operating Costs and Expenses. Following is a summary of other operating
costs and expenses:
($ in thousands) 2021 2020
Policy acquisition and insurance operating expenses$ 1,694,548 $ 1,574,507 Insurance service expenses 63,817 64,029 Net foreign currency gains (19,216) (23,845) Debt extinguishment costs 11,521 - Other costs and expenses 156,350 138,451 Total$ 1,907,020 $ 1,753,142 Policy acquisition and insurance operating expenses are comprised of commissions paid to agents and brokers, premium taxes and other assessments and internal underwriting costs. Policy acquisition and insurance operating expenses increased 8% and net premiums earned increased 15% from 2020. The expense ratio (underwriting expenses expressed as a percentage of net premiums earned) was 28.7% in 2021 and 30.8% in 2020. The improvement is primarily attributable to higher 42 -------------------------------------------------------------------------------- net premiums earned outpacing compensation expense growth and lower travel and entertainment expenses due to the global pandemic. However, to the extent our net premiums earned decrease or travel and entertainment expenses increase, due to the impact of the COVID-19 pandemic or otherwise, our expense ratio would be expected to increase.
Service expenses, which represent the costs associated with the fee-based
businesses, were
Net foreign currency gains result from transactions denominated in a currency other than a company's operating functional currency. Net foreign currency gains were$19 million in 2021 compared to$24 million in 2020. The reduction in gains is primarily related to less weakening of the Argentine Peso andU.K. sterling compared to theU.S. dollar in 2021 versus 2020. Debt extinguishment costs of$12 million related to the redemption of$400 million of subordinated debentures in March andJune 2021 that were due in 2056. Other costs and expenses represent general and administrative expenses of the parent company and other expenses not allocated to business segments, including the cost of certain long-term incentive plans and new business ventures. Other costs and expenses increased to$156 million in 2021 from$138 million in 2020, primarily due to the increase in performance-based compensation costs in 2021. Expenses from Non-Insurance Businesses. Expenses from non-insurance businesses represent costs associated with businesses engaged in the distribution of promotional merchandise, world-wide textile solutions and aviation-related businesses that include (i) cost of goods sold related to aircraft and products sold and services provided, and (ii) general and administrative expenses. Expenses from non-insurance businesses were$308 million in 2021 compared to$256 million in 2020. The increase mainly relates to the business recovery from COVID-19 on aviation-related and textile businesses. Interest Expense. Interest expense was$110 million in 2021 and$115 million in 2020. InMay 2020 , the Company issued$300 million aggregate principal amount of 4.00% senior notes due 2050. InSeptember 2020 , the Company issued an additional$170 million aggregate principal amount of 4.00% senior notes due 2050 and$250 million aggregate principal amount of 4.25% subordinated debentures due 2060 and repaid$300 million aggregate principal amount of 5.375% senior notes at maturity. InOctober 2020 , the Company redeemed$350 million aggregate principal amount of 5.625% subordinated debentures due 2053. InFebruary 2021 , the Company issued$300 million aggregate principal amount of 4.125% subordinated debenture due 2061. InMarch 2021 , the Company issued$400 million aggregate principal amount of 3.55% senior notes due 2052 and redeemed its$110 million aggregate principal amount of 5.90% subordinated debentures due 2056. InJune 2021 , the Company redeemed the$290 million aggregate principal amount of its 5.75% subordinated debentures due 2056. InSeptember 2021 , the Company issued$350 million aggregate principal amount of 3.15% senior notes due 2061. The redemptions resulted in debt extinguishment costs of$12 million during the nine months endedSeptember 30, 2021 . Additionally in the second quarter of 2021, the Company sold a real estate asset which resulted in a$102 million reduction of the Company's non-recourse debt that was supporting the property. The redemption of debentures and issuance of additional debentures in 2021, as described below in "Liquidity and Capital Resources -- Debt," are expected to decrease interest expense in 2021 and forward. Income Taxes. The effective income tax rate was 20.6% in 2021 and 27.8% in 2020. For the nine months endedSeptember 30, 2021 , the effective income tax rate differs from the federal income tax rate of 21% principally because of tax-exempt investment income and tax benefits related to equity-based compensation, which was partially offset by state and foreign income taxes. The increased effective income tax rate for the nine months endedSeptember 30, 2020 was principally because utilization of losses in certain foreign jurisdictions was limited.
The Company has not provided
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Results of Operations for the Three Months Ended
Following is a summary of gross and net premiums written, net premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of net premiums earned), expense ratios (underwriting expenses expressed as a percentage of net premiums earned) and GAAP combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the three months endedSeptember 30, 2021 and 2020. The GAAP combined ratio represents a measure of underwriting profitability, excluding investment income. A GAAP combined ratio in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit. ($ in thousands) 2021 2020 Insurance: Gross premiums written$ 2,446,758 $ 1,981,816 Net premiums written 2,007,194 1,628,316 Net premiums earned 1,819,071 1,531,093 Loss ratio 61.4 % 64.4 % Expense ratio 27.9 % 29.7 % GAAP combined ratio 89.3 % 94.1 % Reinsurance & Monoline Excess: Gross premiums written$ 340,740 $ 280,729 Net premiums written 317,945 251,000 Net premiums earned 261,947 217,828 Loss ratio 69.3 % 59.1 % Expense ratio 29.1 % 31.2 % GAAP combined ratio 98.4 % 90.3 % Consolidated: Gross premiums written$ 2,787,499 $ 2,262,545 Net premiums written 2,325,138 1,879,316 Net premiums earned 2,081,018 1,748,921 Loss ratio 62.4 % 63.7 % Expense ratio 28.0 % 30.0 % GAAP combined ratio 90.4 % 93.7 % Net Income to Common Stockholders. The following table presents the Company's net income to common stockholders and net income per diluted share for the three months endedSeptember 30, 2021 and 2020: (In thousands, except per share data) 2021 2020 Net income to common stockholders$ 261,297 $ 151,678 Weighted average diluted shares 186,742 187,717 Net income per diluted share$ 1.40 $ 0.81 The Company reported net income to common stockholders of$261 million in 2021 compared to$152 million in 2020. The$109 million increase in net income was primarily due to an after-tax increase in underwriting income of$71 million mainly due to the growth in premium rates and exposure, an after-tax increase in net investment income of$30 million primarily due to investment funds, an after-tax increase in foreign currency gains of$14 million as theU.S. dollar strengthened against other major currencies during the quarter, a reduction of$14 million in tax expense due to a change in the effective tax rate, an after-tax saving on interest expense of$4 million due to early refinancings, an after-tax increase in profits from non-insurance businesses of$2 million and a$1 million after-tax increase in other income, partially offset by an after-tax reduction in net investment gains of$16 million , an after-tax increase in corporate expenses of$6 million and an after-tax increase of$5 million in minority interest. The number of weighted average diluted shares decreased by approximately one million for 2021 compared to 2020 mainly reflecting shares repurchased in 2020 and 2021. 44 -------------------------------------------------------------------------------- Premiums. Gross premiums written were$2,787 million in 2021, an increase of 23% from$2,263 million in 2020. The increase was due to a$465 million increase in the Insurance segment and a$59 million increase in the Reinsurance & Monoline Excess segment. Approximately 81.7% of premiums expiring in 2021 were renewed, and 78.5% of premiums expiring in 2020 were renewed.
Average renewal premium rates for insurance and facultative reinsurance increased 8.8% in 2021 when adjusted for changes in exposures, and increased 10.1% excluding workers' compensation.
A summary of gross premiums written in 2021 compared with 2020 by line of business within each business segment follows: •Insurance - gross premiums increased 23% to$2,447 million in 2021 from$1,982 million in 2020. Gross premiums increased$162 million (23%) for other liability,$142 million (47%) for professional liability,$74 million (16%) for short-tail lines,$67 million (27%) for commercial auto and$20 million (8%) for workers' compensation. •Reinsurance & Monoline Excess - gross premiums increased 21% to$340 million in 2021 from$281 million in 2020. Gross premiums increased$54 million (36%) for casualty reinsurance and$6 million (10%) for monoline excess, partially offset by a$1 million (1%) reduction for property reinsurance.
Net premiums written were
Premiums earned increased 19% to$2,081 million in 2021 from$1,749 million in 2020. Insurance premiums (including the impact of rate changes) are generally earned evenly over the policy term, and accordingly, recent rate increases will be earned over the upcoming quarters. Premiums earned in 2021 are related to business written during both 2021 and 2020. Audit premiums were$54 million in 2021 compared with$27 million in 2020.
Net Investment Income. Following is a summary of net investment income for the
three months ended
Average Annualized
Amount Yield
($ in thousands) 2021 2020 2021 2020
Fixed maturity securities, including cash and
cash equivalents and loans receivable $ 93,031 $ 97,080 2.1 % 2.5 %
Investment funds 69,292 18,235 19.9 6.2
Arbitrage trading account 7,187 19,543 3.8 13.8
Equity securities 8,462 1,907 5.0 2.2
Real estate 3,485 7,666 0.8 1.5
Gross investment income 181,457 144,430 3.2 2.9
Investment expenses (1,606) (1,780) - -
Total $ 179,851 $ 142,650 3.2 % 2.8 %
Net investment income increased 26% to $180 million in 2021 from $143 million
in 2020 due primarily to a $51 million increase in income from investment funds
primarily from financial services and transportation funds and a $6 million
increase from equity securities, partially offset by a $12 million decrease from
the arbitrage trading account, a $4 million decrease in income from fixed
maturity securities mainly driven by lower investment yields and a $4 million
decrease in real estate. The Company shortened the duration of its fixed
maturity security portfolio, thereby reducing the potential impact of
mark-to-market on the portfolio and positioning the Company to react quickly to
changes in the current interest rate environment. Average invested assets, at
cost (including cash and cash equivalents), were $22.5 billion in 2021 and $20.3
billion in 2020.
Insurance Service Fees. The Company earns fees from an insurance distribution
business, a third-party administrator and as a servicing carrier of workers'
compensation assigned risk plans for certain states. Insurance service fees were
$21 million in 2021 and $22 million in 2020. The decrease is primarily due to a
reduction of assigned risk plan business.
Net Realized and Unrealized Gains (Losses) on Investments. The Company buys
and sells securities and other investment assets on a regular basis in order to
maximize its total return on investments. Decisions to sell securities and other
investment assets are based on management's view of the underlying fundamentals
of specific investments as well as management's expectations regarding interest
rates, credit spreads, currency values and general economic conditions. Net
45
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realized and unrealized gains on investments were $17 million in 2021 compared
with net losses of $8 million in 2020. The gains of $17 million in 2021 reflect
net realized gains on investments of $36 million , partially offset by an
increase in unrealized losses on equity securities of $19 million . In 2020, the
losses of $8 million reflected net realized losses on investment sales of $39
million and an increase in unrealized gains on equity securities of $31 million .
Change in Allowance for Expected Credit Losses on Investments. Based on credit
factors, the allowance for expected credit losses is increased or decreased
depending on the percentage of unrealized loss relative to amortized cost by
security, changes in rating of the security by a rating agency, and adverse
conditions specifically related to the security, among other factors. For the
three months ended September 30, 2021 , the pre-tax change in allowance for
expected credit losses on investments decreased by $2 million ($1.6 million
after-tax), which is reflected in net investment gains (losses). For the three
months ended September 30, 2020 , the pre-tax change in allowance for expected
credit losses on investments decreased by $47 million ($37 million after-tax),
which is reflected in net investment gains (losses), primarily due to
disposition of securities which previously had an allowance recorded.
Revenues from Non-Insurance Businesses. Revenues from non-insurance businesses
were derived from businesses engaged in the distribution of promotional
merchandise, world-wide textile solutions and aviation-related businesses that
provide services to aviation markets, including (i) the distribution,
manufacturing, repair and overhaul of aircraft parts and components, (ii) the
sale of new and used aircraft, and (iii) avionics, fuel, maintenance, storage
and charter services. Revenues from non-insurance businesses were $120 million
in 2021 and $87 million in 2020. The increase mainly relates to the business
recovery from COVID-19 on aviation-related and textile businesses.
Losses and Loss Expenses. Losses and loss expenses increased to $1,298 million
in 2021 from $1,115 million in 2020. The consolidated loss ratio was 62.4% in
2021 and 63.7% in 2020. Catastrophe losses, net of reinsurance recoveries, were
$74 million (including current accident year losses of approximately $6 million
related to COVID-19) in 2021 and $73 million (no additional COVID-19-related
losses were recognized in the three months ended September 30, 2020 ) in 2020.
Favorable prior year reserve development (net of premium offsets) was $2 million
in 2021 and $5 million in 2020. The loss ratio excluding catastrophe losses and
prior year reserve development was 58.9% in 2021 and 59.8% in 2020.
A summary of loss ratios in 2021 compared with 2020 by business segment
follows:
•Insurance - The loss ratio was 61.4% in 2021 and 64.4% in 2020. Catastrophe
losses were $39 million in 2021 compared with $74 million in 2020. The Company
reflected a best estimate (net of reinsurance) based upon available information
for current accident year COVID-19-related losses of approximately $5 million ,
primarily related to contingency and event cancellation coverage. Adverse prior
year reserve development was $3 million in 2021 and favorable prior year reserve
development was $7 million in 2020. The loss ratio excluding catastrophe losses
and prior year reserve development decreased 1.0 point to 59.0% in 2021 from
60.0% in 2020.
•Reinsurance & Monoline Excess - The loss ratio was 69.3% in 2021 and 59.1% in
2020. Catastrophe losses were $35 million in 2021 compared with ($1) million in
2020. The Company reflected a best estimate (net of reinsurance) based upon
available information for current accident year COVID-19-related losses of
approximately $1 million , primarily related to excess workers' compensation.
Favorable prior year reserve development was $5 million in 2021 and adverse
prior year reserve development was $2 million in 2020. The loss ratio excluding
catastrophe losses and prior year reserve development decreased 0.8 points to
58.1% in 2021 from 58.9% in 2020.
Other Operating Costs and Expenses. Following is a summary of other operating
costs and expenses:
($ in thousands) 2021 2020
Policy acquisition and insurance operating expenses
Insurance service expenses 21,243 21,034
Net foreign currency (gains) losses (12,497)
5,078
Other costs and expenses 51,235 44,508
Total $ 643,046 $ 593,969
Policy acquisition and insurance operating expenses are comprised of
commissions paid to agents and brokers, premium taxes and other assessments and
internal underwriting costs. Policy acquisition and insurance operating expenses
increased 11% and net premiums earned increased 19% from 2020. The expense ratio
(underwriting expenses expressed as a percentage of premiums earned) was 28.0%
in 2021 and 30.0% in 2020. The improvement is primarily attributable to higher
net premiums earned outpacing compensation expense growth. However, to the
extent our net premiums earned decrease or travel and entertainment expenses
increase, due to the impact of the COVID-19 pandemic or otherwise, our expense
ratio would be expected to increase.
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Service expenses, which represent the costs associated with the fee-based
businesses, were
Net foreign currency gains result from transactions denominated in a currency other than a company's operating functional currency. Net foreign currency gains was$12 million in 2021 compared to losses of$5 million in 2020. The gains in 2021 were driven by the strengtheningU.S. dollar against most major currencies in the third quarter of 2021. Other costs and expenses represent general and administrative expenses of the parent company and other expenses not allocated to business segments, including the cost of certain long-term incentive plans and new business ventures. Other costs and expenses increased to$51 million in 2021 from$45 million in 2020, primarily due to the increase in performance-based compensation costs in 2021. Expenses from Non-Insurance Businesses. Expenses from non-insurance businesses represent costs associated with businesses engaged in the distribution of promotional merchandise, world-wide textile solutions and aviation-related businesses that include (i) cost of goods sold related to aircraft and products sold and services provided, and (ii) general and administrative expenses. Expenses from non-insurance businesses were$115 million in 2021 compared to$85 million in 2020. The increase mainly relates to the business recovery from COVID-19 on aviation-related and textile businesses. Interest Expense. Interest expense was$35 million in 2021 and$40 million 2020. InMay 2020 , the Company issued$300 million aggregate principal amount of 4.00% senior notes due 2050. InSeptember 2020 , the Company issued an additional$170 million aggregate principal amount of 4.00% senior notes due 2050 and$250 million aggregate principal amount of 4.25% subordinated debentures due 2060 and repaid$300 million aggregate principal amount of 5.375% senior notes at maturity. InOctober 2020 , the Company redeemed$350 million aggregate principal amount of 5.625% subordinated debentures due 2053. InFebruary 2021 , the Company issued$300 million aggregate principal amount of 4.125% subordinated debenture due 2061. InMarch 2021 , the Company issued$400 million aggregate principal amount of 3.55% senior notes due 2052 and redeemed its$110 million aggregate principal amount of 5.90% subordinated debentures due 2056. In June, 2021, the Company redeemed the$290 million aggregate principal amount of its 5.75% subordinated debentures due 2056. InSeptember 2021 , the Company issued$350 million aggregate principal amount of 3.15% senior notes due 2061. Additionally in the second quarter of 2021, the Company sold a real estate asset which resulted in a$102 million reduction of the Company's non-recourse debt that was supporting the property. The redemption of debentures and issuance of additional debentures in 2021, as described below in "Liquidity and Capital Resources -- Debt," are expected to decrease interest expense in 2021 and forward. Income Taxes. The effective income tax rate was 19.6% in 2021 and 26.2% in 2020. The effective income tax rate differs from the federal income tax rate of 21% principally because of tax-exempt investment income and tax benefits related to equity-based compensation, which was partially offset by state and foreign income taxes. The increased effective income tax rate for the three months endedSeptember 30, 2020 was principally because the utilization of losses in certain foreign jurisdictions was limited.
The Company has not provided
47
--------------------------------------------------------------------------------Investments
As part of its investment strategy, the Company establishes a level of cash and highly liquid short-term and intermediate-term securities that, combined with expected cash flow, it believes is adequate to meet its payment obligations. Due to the low fixed maturity investment returns, the Company invests in equity securities, merger arbitrage securities, investment funds, private equity, loans and real estate related assets. The Company's investments in investment funds and its other alternative investments have experienced, and the Company expects to continue to experience, greater fluctuations in investment income. The Company also attempts to maintain an appropriate relationship between the average duration of the investment portfolio and the approximate duration of its liabilities (i.e., policy claims and debt obligations). The average duration of the fixed maturity portfolio, including cash and cash equivalents, was 2.3 years atSeptember 30, 2021 and 2.4 years atDecember 31, 2020 . The Company's fixed maturity investment portfolio and investment-related assets as ofSeptember 30, 2021 were as follows: Carrying Percent ($ in thousands) Value of Total Fixed maturity securities: U.S. government and government agencies$ 518,333 2.2 % State and municipal: Special revenue 2,110,271 9.1 State general obligation 447,320 1.9 Local general obligation 431,522 1.9 Pre-refunded (1) 230,840 1.0 Corporate backed 177,916 0.7 Total state and municipal 3,397,869 14.6 Mortgage-backed: Agency 681,798 2.9 Residential-Prime 159,826 0.7 Commercial 130,637 0.6 Residential-Alt A 6,326 - Total mortgage-backed 978,587 4.2 Asset-backed 4,655,555 20.0 Corporate: Industrial 3,132,362 13.5 Financial 1,699,840 7.3 Utilities 418,853 1.8 Other 173,009 0.7 Total corporate 5,424,064 23.3
Foreign government and foreign government agencies 1,098,727 4.7 Total fixed maturity securities
16,073,135 69.0
Equity securities:
Common stocks 609,939 2.6
Preferred stocks 208,799 0.9
Total equity securities 818,738 3.5
Cash and cash equivalents (2) 2,182,020 9.4
Real estate 1,842,400 7.9
Investment funds 1,400,140 6.0
Arbitrage trading account 860,339 3.7
Loans receivable 115,496 0.5
Total investments $ 23,292,268 100.0 %
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48-------------------------------------------------------------------------------- (1) Pre-refunded securities are securities for which an escrow account has been established to fund the remaining payments of principal and interest through maturity. Such escrow accounts are funded almost exclusively withU.S. Treasury andU.S. government agency securities. (2) Cash and cash equivalents includes trading accounts receivable from brokers and clearing organizations, trading account securities sold but not yet purchased and unsettled purchases.Fixed Maturity Securities . The Company's investment policy with respect to fixed maturity securities is generally to purchase instruments with the expectation of holding them to their maturity. However, management of the available for sale portfolio is considered necessary to maintain an approximate matching of assets and liabilities as well as to adjust the portfolio as a result of changes in financial market conditions and tax considerations. The Company's philosophy related to holding or selling fixed maturity securities is based on its objective of maximizing total return. The key factors that management considers in its investment decisions as to whether to hold or sell fixed maturity securities are its view of the underlying fundamentals of specific securities as well as its expectations regarding interest rates, credit spreads and currency values. In a period in which management expects interest rates to rise, the Company may sell longer duration securities in order to mitigate the impact of an interest rate rise on the fair value of the portfolio. Similarly, in a period in which management expects credit spreads to widen, the Company may sell lower quality securities, and in a period in which management expects certain foreign currencies to decline in value, the Company may sell securities denominated in those foreign currencies. The sale of fixed maturity securities in order to achieve the objective of maximizing total return may result in realized gains; however, there is no reason to expect these gains to continue in future periods.Equity Securities . Equity securities primarily represent investments in common and preferred stocks in companies with potential growth opportunities in different sectors, mainly in the financial institutions and energy sectors. Investment Funds. AtSeptember 30, 2021 , the carrying value of investment funds was$1,401 million , including investments in financial services funds of$409 million , transportation funds of$341 million , real estate funds of$263 million , other funds of$238 million and energy funds of$150 million . Investment funds are generally reported on a one-quarter lag. Real Estate. Real estate is directly owned property held for investment. AtSeptember 30, 2021 , real estate properties in operation included a long-term ground lease inWashington D.C. , an office complex inNew York City , an office building inLondon , and the completed portion of a mixed-use project inWashington D.C. In addition, part of the previously mentioned mixed-use project inWashington D.C. is under development. The Company expects to fund further development costs for the project with a combination of its own funds and external financing. Arbitrage Trading Account. The arbitrage trading account is comprised of direct investments in arbitrage securities. Merger arbitrage is the business of investing in the securities of publicly held companies that are the targets in announced tender offers and mergers. Loans Receivable. Loans receivable, which are carried at amortized cost (net of allowance for expected credit losses), had an amortized cost of$115 million and an aggregate fair value of$117 million atSeptember 30, 2021 . The amortized cost of loans receivable is net of an allowance for expected credit losses of$2 million as ofSeptember 30, 2021 . Loans receivable include real estate loans of$89 million that are secured by commercial and residential real estate located primarily inNew York . Real estate loans generally earn interest at fixed or stepped interest rates and have maturities through 2026. Loans receivable include commercial loans of$26 million that are secured by business assets and have fixed interest rates with varying maturities not exceeding 10 years. Market Risk. The fair value of the Company's investments is subject to risks of fluctuations in credit quality and interest rates. The Company uses various models and stress test scenarios to monitor and manage interest rate risk. The Company attempts to manage its interest rate risk by maintaining an appropriate relationship between the effective duration of the investment portfolio and the approximate duration of its liabilities (i.e., policy claims and debt obligations). The effective duration for the fixed maturity portfolio (including cash and cash equivalents) was 2.3 years atSeptember 30, 2021 and 2.4 years atDecember 31, 2020 . In addition, the fair value of the Company's international investments is subject to currency risk. The Company attempts to manage its currency risk by matching its foreign currency assets and liabilities where considered appropriate. 49 --------------------------------------------------------------------------------
Liquidity and Capital Resources
Cash Flow. Cash flow provided from operating activities increased to$1,524 million in the first nine months of 2021 from$1,137 million in the first nine months of 2020, primarily due to an increase in premium receipts, net of reinsurance and commissions settled, partially offset by an increase in tax payments. The Company's insurance subsidiaries' principal sources of cash are premiums, investment income, service fees and proceeds from sales and maturities of portfolio investments. The principal uses of cash are payments for claims, taxes, operating expenses and dividends. The Company expects its insurance subsidiaries to fund the payment of losses with cash received from premiums, investment income and fees. The Company generally targets an average duration for its investment portfolio that is within 1.5 years of the average duration of its liabilities so that portions of its investment portfolio mature throughout the claim cycle and are available for the payment of claims if necessary. In the event operating cash flow and proceeds from maturities and prepayments of fixed income securities are not sufficient to fund claim payments and other cash requirements, the remainder of the Company's cash and investments is available to pay claims and other obligations as they become due. The Company's investment portfolio is highly liquid, with approximately 78.2% invested in cash, cash equivalents and marketable fixed maturity securities as ofSeptember 30, 2021 . If the sale of fixed maturity securities were to become necessary, a realized gain or loss equal to the difference between the cost and sales price of securities sold would be recognized. Debt. AtSeptember 30, 2021 , the Company had senior notes, subordinated debentures and other debt outstanding with a carrying value of$3,266 million and a face amount of$3,292 million , including$300 million aggregate principal amount of its 4.125% subordinated debentures due 2061 issued inFebruary 2021 ,$400 million aggregate principal amount of its 3.55% senior notes due 2052 issued inMarch 2021 and$350 million aggregate principal amount of its 3.15% senior notes due 2061 issued inSeptember 2021 . The Company redeemed its$110 million aggregate principal amount of 5.90% subordinated debentures due 2056 onMarch 1, 2021 and its$290 million aggregate principal amount of 5.75% subordinated debentures due 2056 onJune 1, 2021 . Additionally in the second quarter of 2021, the Company sold a real estate asset which resulted in a$102 million reduction of the Company's non-recourse debt that was supporting the property. The maturities of the outstanding debt are$5 million in 2021,$427 million in 2022,$5 million in 2025,$250 million in 2037,$350 million in 2044,$470 million in 2050,$400 million in 2052,$185 million in 2058,$300 million in 2059,$250 million in 2060, and$650 million in 2061. Equity. AtSeptember 30, 2021 , total common stockholders' equity was$6.6 billion , common shares outstanding were 176,638,884 and stockholders' equity per outstanding share was$37.64 . During the three months endedSeptember 30, 2021 , the Company repurchased 1,287,556 shares of its common stock for$93 million . During the nine months endedSeptember 30, 2021 , the Company repurchased 1,752,619 shares of its common stock for$122 million . In the third quarter of 2021, the board of directors of the Company declared a regular quarterly cash dividend of$0.13 per share. The number of common shares outstanding excludes shares held in a grantor trust established by the Company for delivery upon settlement of vested but mandatorily deferred RSUs. Total Capital. Total capitalization (equity, debt and subordinated debentures) was$9.9 billion atSeptember 30, 2021 . The percentage of the Company's capital attributable to senior notes, subordinated debentures and other debt was 33% atSeptember 30, 2021 and 30% atDecember 31, 2020 .
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