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. A portion of the Company's fixed maturity securities include investments in collateralized loan obligations with exposure to a diverse group of industries. As ofSeptember 30, 2020 , approximately 97% of the Company's collateralized loan obligation portfolio has an average rating of "AA" or higher. As a result, the Company believes that its collateralized loan obligation portfolio is well-positioned despite the current market environment. 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. EffectiveJanuary 1, 2020 , the Company adopted new accounting standard ASU 2016-13 Financial Instruments - Credit Losses. Refer to Note 3 in the financial statements for further information on the accounting guidance and impact of its adoption on the Company's results and financial position. The ongoing COVID-19 pandemic, including the related impact on theU.S. and global economies, has materially and adversely affected our results of operations. For the nine months endedSeptember 30, 2020 , the Company recorded approximately$143 million for COVID-19-related losses, net of reinsurance, and reinstatement premiums of approximately$18 million . The ultimate impact of COVID-19 on the economy and on the Company's results of operations, financial position and liquidity is uncertain and not within the Company's control. 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. In addition, because COVID-19 did not begin to affect the Company's operations and financial position until late in the first quarter of 2020, its impact on the Company's first nine months of 2020 is not necessarily indicative of its impact for the remainder of 2020 or beyond. Despite the effects of COVID-19 to date, the Company's financial position and liquidity improved commencing in the second quarter. The impact of the COVID-19 pandemic on our results of operations, financial position and liquidity is expected to include, among others: Adverse Legislative and Regulatory Action. Legislative and regulatory initiatives taken or that may be taken in response to COVID-19, such as those that seek to retroactively mandate or provide a presumption of coverage for losses which our insurance policies would not otherwise cover and were not priced to cover, may adversely affect us, particularly in our workers' compensation and property coverages businesses. 32 -------------------------------------------------------------------------------- Claim Losses Related to COVID-19 May Exceed Reserves. Given the great uncertainties associated with COVID-19 and its impact and the limited information upon which our current assumptions and assessments have been made, our reserves and underlying estimated level of claim losses and costs arising from COVID-19 may materially change. Claim Losses and Adjustment Expenses May Increase. As the effects of COVID-19 on industry practices and economic, legal, judicial, social and other environmental conditions continue to evolve, unexpected and unintended issues related to claims and coverages may emerge (including in the area of property coverages where physical damage requirements and communicable disease exclusions are currently being challenged). Reinsurance. Reinsurers may dispute the applicability of reinsurance to COVID-19 related losses (including the application of reinsurance reinstatements) and, as a result, our reinsurers may refuse to pay reinsurance recoverables related thereto or they may not pay them on a timely basis. In addition, we may be unable to renew our current reinsurance coverages or purchase new coverages with respect to certain exposures under our policies, including COVID-19-related exposures. Premium Volumes May Be Negatively Impacted. Reduced economic activity relating to the COVID-19 pandemic will likely decrease demand for our insurance products and services. In addition, we may alter our view on the insurance coverages that are appropriate to offer in various jurisdictions, which could further negatively impact our premium volumes. Investments. Further disruptions in global financial markets due to the continuing impact of COVID-19 could cause us to incur additional unrealized and/or realized investment losses, including impairments in our fixed income portfolio and other investments. Credit Risk. As credit risk is generally a function of the economy, we face greater credit risk from our policyholders, independent agents and brokers in connection with the payment and remittance of premiums as a result of the economic conditions caused by COVID-19. Similarly, our credit risk related to the reimbursement of deductibles from policyholders and in connection with reinsurance recoverables has increased. Operational Disruptions and Costs. Our operations could be disrupted if key members of our senior management or a significant percentage of our workforce or the workforce of our agents, brokers, suppliers or other third party service providers are unable to continue to work because of illness, government directives or otherwise. In response to the COVID-19 pandemic, we have implemented remote working policies which have resulted in disruptions to our business routines, heightened risk to cybersecurity attacks and data security incidents and a greater dependency on internet and telecommunication access and capabilities.
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
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
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--------------------------------------------------------------------------------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 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
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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 2019:
(In thousands) Frequency (+/-)
Severity (+/-) 1% 5% 10%
1% $ 81,566 $ 245,508 $ 450,437
5% 245,508 415,944 628,988
10% 450,437 628,988 852,178
Our net reserves for losses and loss expenses of approximately $11.4 billion
as of September 30, 2020 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 $2.6 billion , or 23%, of the Company's net loss reserves as of
September 30, 2020 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.
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) 2020 2019
Insurance $ 8,800,434 $ 8,193,381
Reinsurance & Monoline Excess 2,590,630 2,504,617
Net reserves for losses and loss expenses 11,391,064 10,697,998
Ceded reserves for losses and loss expenses 2,068,295 1,885,251
Gross reserves for losses and loss expenses
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--------------------------------------------------------------------------------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, 2020
Other liability $ 1,495,595 $ 2,754,905 $ 4,250,500
Workers' compensation (1) 956,982 905,652 1,862,634
Professional liability 417,451 824,648 1,242,099
Commercial automobile 427,154 355,200 782,354
Short-tail lines (2) 303,236 359,611 662,847
Total Insurance 3,600,418 5,200,016 8,800,434Reinsurance & Monoline Excess (1) (3) 1,454,609 1,136,021
2,590,630
Total $ 5,055,027 $ 6,336,037 $ 11,391,064
December 31, 2019
Other liability $ 1,421,378 $ 2,522,957 $ 3,944,335
Workers' compensation (1) 918,619 964,102 1,882,721
Professional liability 399,411 713,433 1,112,844
Commercial automobile 412,036 300,339 712,375
Short-tail lines (2) 271,192 269,914 541,106
Total Insurance 3,422,636 4,770,745 8,193,381Reinsurance & Monoline Excess (1) (3) 1,469,363 1,035,254
2,504,617
Total $ 4,891,999 $ 5,805,999 $ 10,697,998
___________
(1) Reserves for workers' compensation and Reinsurance & Monoline Excess are net
of an aggregate net discount of $490 million and $530 million as of
September 30, 2020 and December 31, 2019 , 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.
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, 2020
and 2019 are as follows:
(In thousands) 2020 2019
Net increase in prior year loss reserves
Increase in prior year earned premiums 12,869 39,567
Net favorable prior year development $ 12,020 $ 17,227
The ongoing COVID-19 global pandemic has impacted, and will likely continue to
impact, the Company's results through its effect on claim frequency and
severity. Loss cost trends have been impacted and will likely be further
impacted by COVID-19-related claims in certain lines of business, as well as by
other effects of COVID-19 associated with economic conditions, inflation, and
social distancing and work from home rules, for example. Although it is still
too early to determine the net impact, it appears that the losses incurred due
to COVID-19-related claims are being offset, to a certain extent, by lower claim
frequency in certain lines of our businesses, including commercial auto,
workers' compensation, and other
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liability. However, given the continuing nature of the pandemic, the impact of
COVID-19 could ultimately increase or decrease overall loss cost trends and is
likely to have differing impacts on the Company's different lines of business.
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
expects additional claims to be reported for these lines of business. 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 appears to be
modest at this time. Given the continuing uncertainty regarding the pandemic's
pervasiveness and the time needed to develop widespread treatments and vaccines,
and the related economic impacts, the future impact that the pandemic may have
on claim frequency and severity remains uncertain at this time. In workers'
compensation, for example, nearly two-thirds of the states have enacted rules,
legislation or administrative orders creating a presumption that certain
"essential" workers who contract COVID-19 did so through the course of their
employment. Several other states are considering similar actions, including
varying the definition of "essential" workers. While the ultimate impact of
these presumptions are unknown at this time, the Company believes that such
state actions will likely increase workers' compensation claims with respect to
workers deemed "essential," although this impact may be partially offset by
lower workers' compensation claim frequency with respect to non-essential
workers.
The Company has estimated the potential COVID-19 impact to its workers'
compensation, contingency and event cancellation, and other lines of business
under a number of possible scenarios; however, due to COVID-19's evolving impact
and the still limited amount of available data, there remains a high degree of
uncertainty around the Company's COVID-19 reserves. In addition, several states
(and international jurisdictions), through regulation, legislation and/or
judicial action, continue to seek to expand policy coverage terms beyond the
policy's intended coverage, including, for example, but not limited to, property
coverages, where there are attempts to extend business interruption coverage
where there is no physical damage or loss to property, and attempts to disregard
policy exclusions for communicable disease. Accordingly, losses arising from
these actions, and the other factors described above, could exceed the Company's
reserves established for those related policies.
For the nine months ended September 30, 2020 , the Company has recognized losses
for COVID-19-related claims activity, net of reinsurance, of approximately $143
million , of which $121 million relates to the Insurance segment and $22 million
relates to the Reinsurance & Monoline Excess segment. Of the $143 million of
COVID-19-related losses, $69 million are reported losses and $74 million is
booked as IBNR.
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.
During the nine months ended September 30, 2019 , favorable prior year
development (net of additional and return premiums) of $17 million included $18
million of favorable development for the Insurance segment, offset by $1 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 general liability, professional
liability, and commercial auto liability business. The favorable workers'
compensation development was mainly attributable to accident years 2014 through
2018, and reflects a continuation of the benign loss cost trends experienced
during recent years, particularly the favorable claim frequency trends (i.e.,
number of reported claims per unit of exposure). The adverse general liability
development was mainly related to accident years 2015 through 2017 and was
driven by a higher than expected number of large losses being reported in the
period. The adverse professional liability development was mainly from accident
years 2013 through 2016 and was driven by an increased
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frequency of large losses relating to lawyers professional and directors and
officers liability. The adverse commercial auto liability development was
primarily related to accident years 2015 through 2018 (with most in 2018), and
was driven by a higher than expected number of large losses.
Reserve Discount. The Company discounts its liabilities for certain workers'
compensation reserves. The amount of workers' compensation reserves that were
discounted was $1,650 million and $1,731 million at September 30, 2020 and
December 31, 2019 , respectively. The aggregate net discount for those reserves,
after reflecting the effects of ceded reinsurance, was $490 million and $530
million at September 30, 2020 and December 31, 2019 , respectively. At
September 30, 2020 , discount rates by year ranged from 0.7% to 6.5%, with a
weighted average discount rate of 3.6%.
Substantially all of the workers' compensation discount (97% of total
discounted reserves at September 30, 2020 ) 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, 2020 ), 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
$44 million at September 30, 2020 and $43 million at December 31, 2019 . 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.
Allowance for Expected Credit Losses on Investments.
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- 38 --------------------------------------------------------------------------------
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, 2020 is presented in the table below: Number of Aggregate ($ in thousands) Securities Fair Value Gross Unrealized Loss Foreign government 22$ 91,413 $ 45,247 Corporate 13 28,816 6,343 Mortgage-backed securities 8 1,659 34 Total 43$ 121,888 $ 51,624 As ofSeptember 30, 2020 , the Company has recorded an allowance for expected credit losses on fixed maturity securities of$3 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$6 million and$2 million as ofSeptember 30, 2020 andDecember 31, 2019 , 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 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. 39 --------------------------------------------------------------------------------
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
42,383 0.3
Directly by the Company based on:
Observable data 139,362 1.0
Total $ 13,820,529 100.0 %
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, 2020 , the Company did not make any adjustments to
the prices provided by the pricing services. Based upon the Company's review of
the methodologies used by the independent pricing services, these securities
were classified as Level 2.
Syndicate manager - The Company has a 15% participation in a Lloyd's
syndicate, and the Company's share of the securities owned by the syndicate is
priced by the syndicate's manager. The majority of the securities are liquid,
short duration fixed maturity securities. The Company reviews the syndicate
manager's pricing methodology and audited financial statements and holds
discussions with the syndicate manager as necessary to confirm its understanding
and agreement with security prices. Based upon the Company's review of the
methodologies used by the syndicate manager, these securities were classified as
Level 2.
Observable data - If independent pricing is not available, the Company prices
the securities directly. Prices are based on observable market data where
available, including current trading levels for similar securities and
non-binding quotations from brokers. The Company generally requests two or more
quotes. If more than one quote is received, the Company sets a price within the
range of quotes received based on its assessment of the credibility of the quote
and its own evaluation of the security. The Company generally does not adjust
quotes obtained from brokers. Since these securities were priced based on
observable data, they were classified as Level 2.
Cash flow model - If the above methodologies are not available, the Company
prices securities using a discounted cash flow model based upon assumptions as
to prevailing credit spreads, interest rates and interest rate volatility, time
to maturity and subordination levels. Discount rates are adjusted to reflect
illiquidity where appropriate. These securities were classified as Level 3.
40
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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 premiums earned), expense ratios (underwriting expenses expressed as a percentage of 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, 2020 and 2019. 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) 2020 2019 Insurance: Gross premiums written$ 5,841,328 $ 5,565,862 Net premiums written 4,754,791 4,601,077 Net premiums earned 4,481,092 4,396,071 Loss ratio 65.5 % 62.3 % Expense ratio 30.6 % 31.3 % GAAP combined ratio 96.1 % 93.6 % Reinsurance & Monoline Excess: Gross premiums written$ 784,835 $ 663,279 Net premiums written 710,189 601,894 Net premiums earned 636,161 520,436 Loss ratio 66.5 % 61.6 % Expense ratio 32.1 % 35.2 % GAAP combined ratio 98.6 % 96.8 % Consolidated: Gross premiums written$ 6,626,163 $ 6,229,141 Net premiums written 5,464,980 5,202,971 Net premiums earned 5,117,253 4,916,507 Loss ratio 65.6 % 62.2 % Expense ratio 30.8 % 31.7 % GAAP combined ratio 96.4 % 93.9 % 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, 2020 and 2019: (In thousands, except per share data) 2020 2019 Net income to common stockholders$ 218,520 $ 562,638 Weighted average diluted shares 189,515 193,557 Net income per diluted share$ 1.15 $ 2.91 The Company reported net income to common stockholders of$219 million in 2020 compared to$563 million in 2019. The$344 million decrease in net income was primarily due to an after-tax decrease in net investment gains of$161 million (primarily resulting from disruption in global financial markets related to COVID-19), an after-tax decrease in underwriting income of$88 million primarily from COVID-19-related losses and other catastrophe losses, an after-tax decrease in net investment income of$83 million primarily due to less income from investment funds, reduced investment yields in fixed maturity securities and repositioning a larger portion of the investment portfolio to cash and cash equivalents, an increase in tax expense of$27 million due to a change in the effective tax rate, an after-tax decrease in foreign currency gains of$4 million , an after-tax decrease in profits from non-insurance businesses of$2 million , and an after-tax decrease in other income of$1 million , partially offset by an after-tax decrease in corporate expenses of$11 million , an after-tax increase in profit from insurance service businesses of$7 million and an after-tax decrease in interest expense of$4 million . The number of weighted average diluted shares decreased by approximately 4 million for 2020 compared to 2019 mainly reflecting shares repurchased in 2020. 41 -------------------------------------------------------------------------------- Premiums. Gross premiums written were$6,626 million in 2020, an increase of 6% from$6,229 million in 2019. The increase was due to a$275 million increase in the Insurance segment and a$122 million increase in the Reinsurance & Monoline Excess segment. Approximately 79.0% of premiums expiring in 2020 were renewed, and 79.9% of premiums expiring in 2019 were renewed.
Average renewal premium rates for insurance and facultative reinsurance increased 10.7% in 2020 when adjusted for changes in exposures, and increased 13.0% excluding workers' compensation.
A summary of gross premiums written in 2020 compared with 2019 by line of business within each business segment follows: •Insurance - gross premiums increased 5% to$5,841 million in 2020 from$5,566 million in 2019. Gross premiums increased$195 million (10%) for other liability,$121 million (17%) for professional liability,$79 million (6%) for short-tail lines, and$34 million (5%) for commercial auto, and decreased$153 million (15%) for workers' compensation. •Reinsurance & Monoline Excess - gross premiums increased 18% to$785 million in 2020 from$663 million in 2019. Gross premiums increased$79 million (22%) for casualty reinsurance,$27 million (19%) for property reinsurance and$16 million (10%) for monoline excess. Net premiums written were$5,465 million in 2020, an increase of 5% from$5,203 million in 2019. Ceded reinsurance premiums as a percentage of gross written premiums were 18% in 2020 and 16% in 2019. The cession rate increased primarily because of reinstatement premiums associated with COVID-19 related claims activity. Premiums earned increased 4% to$5,117 million in 2020 from$4,917 million in 2019. 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 2020 are related to business written during both 2020 and 2019. Audit premiums were$111 million in 2020 compared with$149 million in 2019.
Net Investment Income. Following is a summary of net investment income for the
nine months ended
Average Annualized
Amount Yield
($ in thousands) 2020 2019 2020 2019
Fixed maturity securities, including cash and
cash equivalents and loans receivable $ 330,941 $ 386,978 2.9 % 3.5 %
Investment funds 1,260 77,284 0.1 7.5
Arbitrage trading account 51,985 26,184 12.4 8.0
Real estate 18,807 17,468 1.2 1.1
Equity securities 6,194 3,984 2.4 2.1
Gross investment income 409,187 511,898 2.8 3.6
Investment expenses (6,343) (3,619) - -
Total $ 402,844 $ 508,279 2.7 % 3.5 %
Net investment income decreased 21% to $403 million in 2020 from $508 million
in 2019 due primarily to a $76 million decrease in income from investment funds
(as a result of the impact of the disruption in global financial markets
associated with COVID-19 during 2020), a $56 million decrease in income from
fixed maturity securities mainly driven by lower investment yields and
repositioning a larger portion of the investment portfolio to cash and cash
equivalents, and a $2 million increase in investment expense, partially offset
by a $26 million increase from the arbitrage trading account, a $1 million
increase in real estate and a $2 million increase from equity securities. 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 $19.8 billion in 2020 and $19.1 billion in 2019.
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
decreased to $67 million in 2020 from $71 million in 2019. The decrease is
primarily due to a reduction of assigned risk plan business.
42
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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
realized and unrealized losses on investments were $89 million in 2020 compared
with net gains of $144 million in 2019. The losses of $89 million in 2020
reflect net realized losses on investments of $27 million and an increase in
unrealized losses on equity securities of $62 million driven by the disruption
in global financial markets associated with COVID-19 during the first nine
months of 2020. In 2019, the gains of $144 million reflected net realized gains
on investment sales of $28 million and an increase in unrealized gains on equity
securities of $116 million .
Change in Allowance for Expected Credit Losses on Investments. Effective January
1, 2020 , the Company adopted accounting guidance for credit losses on financial
instruments. The cumulative effective adjustment from the change in accounting
principle was $25 million after-tax, which decreased opening retained earnings
and increased AOCI. 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, 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 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 $257 million
in 2020 and $283 million in 2019. The decrease mainly relates to a reduction in
revenues from the aviation-related businesses impacted by COVID-19.
Losses and Loss Expenses. Losses and loss expenses increased to $3,357 million
in 2020 from $3,059 million in 2019. The consolidated loss ratio was 65.6% in
2020 and 62.2% in 2019. Catastrophe losses, net of reinsurance recoveries, were
$297 million (including losses of approximately $143 million related to
COVID-19) in 2020 and $70 million in 2019. Favorable prior year reserve
development (net of premium offsets) was $12 million in 2020 and $17 million in
2019. The loss ratio excluding catastrophe losses and prior year reserve
development was 60.0% in 2020 and 61.2% in 2019.
A summary of loss ratios in 2020 compared with 2019 by business segment
follows:
•Insurance - The loss ratio was 65.5% in 2020 and 62.3% in 2019. Catastrophe
losses were $245 million in 2020 compared with $54 million in 2019. The Company
reflected a best estimate (net of reinsurance) based upon available information
for COVID-19-related losses of approximately $121 million , which was included in
catastrophe losses and primarily related to contingency and event cancellation
coverage, workers' compensation and short-tail lines. Favorable prior year
reserve development was $19 million in 2020 and $18 million in 2019. The loss
ratio excluding catastrophe losses and prior year reserve development decreased
1.1 points to 60.4% in 2020 from 61.5% in 2019.
•Reinsurance & Monoline Excess - The loss ratio was 66.5% in 2020 and 61.6% in
2019. Catastrophe losses were $53 million in 2020 compared with $16 million in
2019. The Company reflected a best estimate (net of reinsurance) based upon
available information for COVID-19-related losses of approximately $22 million ,
which was included in catastrophe losses and primarily related to excess
workers' compensation and short-tail lines. Adverse prior year reserve
development was $7 million in 2020 and $1 million in 2019. The loss ratio
excluding catastrophe losses and prior year reserve development decreased 1.1
points to 57.2% in 2020 from 58.3% in 2019.
Other Operating Costs and Expenses. Following is a summary of other operating
costs and expenses:
($ in thousands) 2020 2019
Policy acquisition and insurance operating expenses$ 1,574,507 $ 1,560,350 Insurance service expenses 64,029 77,513 Net foreign currency gains (23,845) (29,084) Other costs and expenses 138,451 152,182 Total$ 1,753,142 $ 1,760,961 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 1% and net premiums earned increased 4% from 2019. The expense ratio (underwriting expenses expressed as a 43 -------------------------------------------------------------------------------- percentage of premiums earned) was 30.8% in 2020 and 31.7% in 2019. The improvement is primarily attributable to higher net premiums earned and lower travel and entertainment expenses due to the global pandemic. However, to the extent our net premiums earned decrease, 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, decreased to
Net foreign currency gains result from transactions denominated in a currency other than a company's operating functional currency. Net foreign currency gains were$24 million in 2020 compared to gains of$29 million in 2019, mainly resulting from the continued strengthening of theU.S. dollar in relation to the Argentine peso andU.K sterling in 2020. 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 decreased to$138 million in 2020 from$152 million in 2019, primarily due to a reduction in non-recurring performance-based compensation costs which occurred in 2019. 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$256 million in 2020 compared to$280 million in 2019. The decrease mainly relates to a reduction of aviation-related business impacted by COVID-19 in 2020. Interest Expense. Interest expense was$115 million in 2020 compared with$120 million in 2019. During 2019, the Company repaid at maturity$489 million aggregate principal amount of senior notes and other debt. InDecember 2019 , the Company issued$300 million aggregate principal amount of 5.10% subordinated debentures due 2059. 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 issued$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. Accordingly, the timing of the debt repayments in 2019 and 2020 and issuances in 2019 and 2020 led to the decrease in interest expense for the nine months endedSeptember 30, 2020 compared to 2019. InOctober 2020 , the Company redeemed$350 million aggregate principal amount of 5.625% subordinated debentures due 2053, which we expect will lead to a debt extinguishment charge of pre-tax$8 million in the fourth quarter. Income Taxes. The effective income tax rate was 27.8% in 2020 and 20.1% in 2019. The effective income tax rate differs from the federal income tax rate of 21% principally because the utilization of losses in certain foreign jurisdictions was limited, which was partially offset by tax-exempt investment income and tax benefits related to equity-based compensation. The Company has not providedU.S. deferred income taxes on the undistributed earnings of approximately$107 million of its non-U.S. subsidiaries since these earnings are intended to be permanently reinvested in the non-U.S. subsidiaries. In the future, if such earnings were distributed the Company projects that the incremental tax, if any, will be immaterial. 44
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Results of Operations for the Three Months Ended
Following is a summary of gross and net premiums written, net premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of premiums earned), expense ratios (underwriting expenses expressed as a percentage of premiums earned) and GAAP combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the three months endedSeptember 30, 2020 and 2019. The GAAP combined ratio represents a measure of underwriting profitability, excluding investment income. A GAAP combined ratio in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit. ($ in thousands) 2020 2019 Insurance: Gross premiums written$ 1,981,816 $ 1,850,012 Net premiums written 1,628,316 1,529,113 Net premiums earned 1,531,093 1,493,854 Loss ratio 64.4 % 61.8 % Expense ratio 29.7 % 31.2 % GAAP combined ratio 94.1 % 93.0 % Reinsurance & Monoline Excess: Gross premiums written$ 280,729 $ 243,038 Net premiums written 251,000 220,793 Net premiums earned 217,828 182,956 Loss ratio 59.1 % 64.6 % Expense ratio 31.2 % 33.7 % GAAP combined ratio 90.3 % 98.3 % Consolidated: Gross premiums written$ 2,262,545 $ 2,093,050 Net premiums written 1,879,316 1,749,906 Net premiums earned 1,748,921 1,676,810 Loss ratio 63.7 % 62.1 % Expense ratio 30.0 % 31.5 % GAAP combined ratio 93.7 % 93.6 % 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, 2020 and 2019: (In thousands, except per share data) 2020 2019 Net income to common stockholders$ 151,678 $ 165,208 Weighted average diluted shares 187,717 193,589 Net income per diluted share$ 0.81 $ 0.85 The Company reported net income to common stockholders of$152 million in 2020 compared to$165 million in 2019. The$13 million decrease in net income was primarily due to an after-tax increase in foreign currency losses of$22 million from the weakeningU.S. dollar compared to certain currencies, an increase of$15 million in tax expense due to a change in the effective tax rate, an after-tax decrease in net investment income of$15 million mainly from reduced investment yields in fixed maturity securities and repositioning a larger portion of the investment portfolio to cash and cash equivalents, and an after-tax increase in interest expense of$1 million , partially offset by an after-tax increase in net investment gains of$29 million mainly due to unrealized gains related to equity securities, an after-tax decrease in corporate expenses of$4 million , an after-tax increase in underwriting income of$3 million , an after-tax increase in profit from insurance service businesses of$2 million , and an after-tax increase in profits from non-insurance businesses of$2 million . The number of weighted average diluted shares was reduced by approximately 6 million for the three months endedSeptember 30, 2020 , mainly due to the repurchase of common shares in 2020, compared to the three months endedSeptember 30, 2019 . 45 -------------------------------------------------------------------------------- Premiums. Gross premiums written were$2,263 million in 2020, an increase of 8% from$2,093 million in 2019. The increase was due to a$132 million increase in the Insurance segment and a$38 million increase in the Reinsurance & Monoline Excess segment. Approximately 78.5% of premiums expiring in 2020 were renewed, and 79.7% of premiums expiring in 2019 were renewed.
Average renewal premium rates for insurance and facultative reinsurance increased 12.1% in 2020 when adjusted for changes in exposures, and increased 14.5% excluding workers' compensation.
A summary of gross premiums written in 2020 compared with 2019 by line of business within each business segment follows: •Insurance - gross premiums increased 7% to$1,982 million in 2020 from$1,850 million in 2019. Gross premiums increased$69 million (11%) for other liability,$51 million (21%) for professional liability,$35 million (17%) for commercial auto, and$25 million (6%) for short-tail lines, and decreased$48 million (16%) for workers' compensation. •Reinsurance & Monoline Excess - gross premiums increased 16% to$281 million in 2020 from$243 million in 2019. Gross premiums increased$14 million (29%) for property reinsurance,$13 million (22%) for monoline excess, and$11 million (8%) for casualty reinsurance. Net premiums written were$1,879 million in 2020, a 7% increase from$1,750 million in 2019. Ceded reinsurance premiums as a percentage of gross written premiums were 17% in 2020 and 16% in 2019. Premiums earned increased 4% to$1,749 million in 2020 from$1,677 million in 2019. 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 2020 are related to business written during both 2020 and 2019. Audit premiums were$27 million in 2020 and$49 million in 2019.
Net Investment Income. Following is a summary of net investment income for the
three months ended
Average Annualized
Amount Yield
($ in thousands) 2020 2019 2020 2019
Fixed maturity securities, including cash and
cash equivalents and loans receivable $ 97,080 $ 125,957 2.5 % 3.4 %
Investment funds 18,235 19,033 6.2 5.7
Arbitrage trading account 19,543 8,400 13.8 7.1
Real estate 7,666 7,987 1.5 1.5
Equity securities 1,907 1,392 2.2 2.1
Gross investment income 144,430 162,769 2.9 3.4
Investment expenses (1,780) (1,077) - -
Total $ 142,650 $ 161,692 2.8 % 3.4 %
Net investment income decreased 12% to $143 million in 2020 from $162 million
in 2019 due primarily to a $29 million decrease in fixed maturity securities as
a result of lower investment yields and repositioning a larger portion of the
investment portfolio to cash and cash equivalents and a $1 million decrease in
income from investment funds, partially offset by a $11 million increase from
the arbitrage trading account. The Company has maintained a shortened duration
of its fixed maturity security portfolio that has reduced the potential impact
of mark-to-market on the portfolio and positioned the Company to react quickly
to changes in the current interest rate environment. Average invested assets, at
cost (including cash and cash equivalents), were $20.3 billion in 2020 and $19.2
billion in 2019.
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
decreased to $22 million in 2020 from $24 million in 2019. 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
46
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realized and unrealized losses on investments were $8 million in 2020 compared
with gains of $1 million in 2019. The losses of $8 million in 2020 reflected net
realized losses on investments of $39 million and an increase in unrealized
gains on equity securities of $31 million . In 2019, the gains of $1 million
reflected net realized gains on investment sales of $3 million and an increase
in unrealized gains on equity securities of $4 million .
Change in Allowance for Expected Credit Losses on Investments. Effective January
1, 2020 , the Company adopted accounting guidance for credit losses on financial
instruments. The cumulative effective adjustment from the change in accounting
principle was $25 million after-tax, which decreased opening retained earnings
and increased AOCI. 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, 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 $87 million in
2020 and $102 million in 2019. The decrease mainly relates to reduction in
revenues from the aviation-related businesses impacted by COVID-19.
Losses and Loss Expenses. Losses and loss expenses increased to $1,115 million
in 2020 from $1,041 million in 2019. The consolidated loss ratio was 63.7% in
2020 and 62.1% in 2019. Catastrophe losses, net of reinsurance recoveries, were
$73 million in 2020 compared to $31 million in 2019. No additional
COVID-19-related losses were recognized in the three months ended September 30,
2020 . Favorable prior year reserve development (net of premium offsets) was $5
million in 2020 and $4 million in 2019. The loss ratio excluding catastrophe
losses and prior year reserve development was 59.8% in 2020 and 60.4% in 2019.
A summary of loss ratios in 2020 compared with 2019 by business segment
follows:
•Insurance - The loss ratio was 64.4% in 2020 and 61.8% in 2019. Catastrophe
losses were $74 million in 2020 compared with $15 million in 2019. The increase
in catastrophe losses was attributable to heightened hurricanes, tropical storms
and U.S. wild fires on the west coast. Favorable prior year reserve development
was $7 million in 2020 and $1 million in 2019. The loss ratio excluding
catastrophe losses and prior year reserve development decreased 0.9 points to
60.0% in 2020 from 60.9% in 2019.
•Reinsurance & Monoline Excess - The loss ratio was 59.1% in 2020 and 64.6% in
2019. Catastrophe losses were ($1) million in 2020 compared with $16 million in
2019. The ($1) million was attributable to reclassified COVID-19 related IBNR to
the Insurance segment. Adverse prior year reserve development was $2 million in
2020 compared to favorable prior year reserve development of $3 million in 2019.
The loss ratio excluding catastrophe losses and prior year reserve development
increased 1.6 points to 58.9% in 2020 from 57.3% in 2019.
Other Operating Costs and Expenses. Following is a summary of other operating
costs and expenses:
($ in thousands) 2020 2019
Policy acquisition and insurance operating expenses
Insurance service expenses 21,034 26,171
Net foreign currency losses (gains) 5,078
(22,590)
Other costs and expenses 44,508 49,065
Total $ 593,969 $ 581,045
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
decreased 1% and net premiums earned increased 4% from 2019. The expense ratio
(underwriting expenses expressed as a percentage of premiums earned) was 30.0%
in 2020 and 31.5% in 2019. The improvement is primarily attributable to higher
net premiums earned and lower expenses mainly attributable to reduced travel and
entertainment expenses due to the global pandemic. However, to the extent our
net premiums earned decrease, 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, decreased to
47
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Net foreign currency gains (losses) result from transactions denominated in a
currency other than a company's operating functional currency. Net foreign
currency losses were $5 million in 2020 compared to net foreign currency gains
of $23 million in 2019. The losses in 2020 mainly result from the weakening of
the U.S. dollar in relation to the U.K. sterling, partially offset by the U.S.
dollar strengthening to the Argentine peso.
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 decreased to $45 million in 2020 from $49 million in 2019.
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 $85 million in 2020 compared to $102
million in 2019. The decrease mainly relates to a reduction of the
aviation-related businesses impacted by COVID-19 in 2020.
Interest Expense. Interest expense was $40 million in 2020 compared with $38
million in 2019. During 2019, the Company repaid at maturity $489 million
aggregate principal amount of senior notes and other debt. In December 2019 , the
Company issued $300 million aggregate principal amount of 5.10% subordinated
debentures due 2059. In May 2020 , the Company issued $300 million aggregate
principal amount of 4.00% senior notes due 2050. In September 2020 , the Company
issued an additional $170 million aggregate principal amount of 4.00% senior
notes due 2050 and issued $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. Accordingly, the timing of the debt
repayments in 2019 and 2020 and issuances in 2019 and 2020 led to the increase
in interest expense for the three months ended September 30, 2020 compared to
2019. However, these refinancings of our debt at lower interest rates are
expected to reduce our interest expense. In October 2020 , the Company redeemed
$350 million aggregate principal amount of 5.625% subordinated debentures due
2053, which we expect will lead to a debt extinguishment charge of pre-tax $8
million in the fourth quarter.
Income Taxes. The effective income tax rate was 26.2% in 2020 and 18.6% in
2019. The effective income tax rate differs from the federal income tax rate of
21% principally because the utilization of losses in certain foreign
jurisdictions was limited, which was partially offset by tax-exempt investment
income and tax benefits related to equity-based compensation.
The Company has not provided U.S. deferred income taxes on the undistributed
earnings of approximately $107 million of its non-U.S. subsidiaries since these
earnings are intended to be permanently reinvested in the non-U.S. subsidiaries.
In the future, if such earnings were distributed the Company projects that the
incremental tax, if any, will be immaterial.
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Investments
As part of its investment strategy, the Company establishes a level of cash and highly liquid short-term and intermediate-term securities that, combined with expected cash flow, it believes is adequate to meet its payment obligations. Due to the low fixed maturity investment returns, the Company invests in equity securities, merger arbitrage securities, investment funds, private equity, loans and real estate related assets. The Company's investments in investment funds and its other alternative investments have experienced, and the Company expects to continue to experience, greater fluctuations in investment income. The Company also attempts to maintain an appropriate relationship between the average duration of the investment portfolio and the approximate duration of its liabilities (i.e., policy claims and debt obligations). The average duration of the fixed maturity portfolio, including cash and cash equivalents, was 2.3 years atSeptember 30, 2020 down from 2.8 years atDecember 31, 2019 , as the Company repositioned a larger portion of its investment portfolio to cash and cash equivalents. The Company's fixed maturity investment portfolio and investment-related assets as ofSeptember 30, 2020 were as follows: Carrying Percent ($ in thousands) Value of Total Fixed maturity securities: U.S. government and government agencies$ 697,432 3.3 % State and municipal: Special revenue 2,305,308 11.0 State general obligation 429,652 2.1 Pre-refunded 285,224 1.4 Corporate backed 232,600 1.1 Local general obligation 438,272 2.1 Total state and municipal 3,691,056 17.7 Mortgage-backed securities: Agency 613,680 2.9 Residential-Prime 260,362 1.2 Commercial 206,025 1.0 Residential-Alt A 9,168 - Total mortgage-backed securities 1,089,235 5.2 Asset-backed securities 3,306,439 15.9 Corporate: Industrial 2,326,598 11.2 Financial 1,524,636 7.3 Utilities 355,619 1.7 Other 32,687 0.2 Total corporate 4,239,540 20.3
Foreign government and foreign government agencies 869,344 4.2 Total fixed maturity securities
13,893,046 66.6
Equity securities:
Preferred stocks 274,445 1.3
Common stocks 160,858 0.8
Total equity securities 435,303 2.1
Cash and cash equivalents 2,571,447 12.3
Real estate 2,106,474 10.1
Investment funds 1,163,707 5.6
Arbitrage trading account 595,727 2.9
Loans receivable 84,771 0.4
Total investments $ 20,850,475 100.0 %
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49-------------------------------------------------------------------------------- (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.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 sector. Investment Funds. AtSeptember 30, 2020 , the carrying value of investment funds was$1,164 million , including investments in real estate funds of$312 million , financial services funds of$352 million , energy funds of$136 million , transportation funds of$144 million and other funds of$220 million . Investment funds are generally reported on a one-quarter lag. Real Estate. Real estate is directly owned property held for investment. AtSeptember 30, 2020 , real estate properties in operation included a long-term ground lease inWashington D.C. , two office complexes inNew York City , office buildings inWest Palm Beach andPalm Beach, Florida , 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, of$85 million and an aggregate fair value of$87 million atSeptember 30, 2020 . The amortized cost of loans receivable is net of an allowance for expected credit losses of$6 million as ofSeptember 30, 2020 . Loans receivable include real estate loans of$52 million that are secured by commercial real estate located primarily inNew York . Real estate loans receivable generally earn interest at floating LIBOR-based interest rates and have maturities (inclusive of extension options) throughAugust 2025 . Loans receivable include commercial loans of$33 million that are secured by business assets and have fixed interest rates and floating LIBOR-based 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, 2020 , down from 2.8 years atDecember 31, 2019 . 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. 50 --------------------------------------------------------------------------------
Liquidity and Capital Resources
Cash Flow. Cash flow provided from operating activities increased to$1,137 million in the first nine months of 2020 from$795 million in the first nine months of 2019, primarily due to an increase in premium receipts, net of reinsurance and commissions settled and the timing of loss and loss expense payments as well as tax payments to tax authorities. 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 79% invested in cash, cash equivalents and marketable fixed maturity securities as ofSeptember 30, 2020 . 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. AtSeptember 30, 2020 , the Company held more than$1.6 billion of cash and liquid investments at the holding company. Debt. AtSeptember 30, 2020 , the Company had senior notes, subordinated debentures and other debt outstanding with a carrying value of$3,073 million and a face amount of$3,099 million , including$300 million aggregate principal amount of its 4.00% senior notes due 2050 issued inMay 2020 as well as$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 issued inSeptember 2020 . The maturities of the outstanding debt are$4 million in 2021,$427 million in 2022,$11 million in 2025,$102 million in 2028,$250 million in 2037,$350 million in 2044,$470 million in 2050,$350 million in 2053 (which was redeemed inOctober 2020 ),$400 million in 2056,$185 million in 2058,$300 million in 2059 and$250 million in 2060. Equity. AtSeptember 30, 2020 , total common stockholders' equity was$6.0 billion , common shares outstanding were 178,217,537 and stockholders' equity per outstanding share was$33.64 . During the three months endedSeptember 30, 2020 , the Company repurchased 216,764 shares of its common stock for$13 million . During the nine months endedSeptember 30, 2020 , the Company repurchased 5,820,867 shares of its common stock for$312 million . 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$9.1 billion atSeptember 30, 2020 . The percentage of the Company's capital attributable to senior notes, subordinated debentures and other debt was 34% atSeptember 30, 2020 and 30% atDecember 31, 2019 .
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