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EX-32 - EX-32 - ENDURANCE SPECIALTY HOLDINGS LTD | enhexhibit32q13312017.htm |
EX-31.2 - EX-31.2 - ENDURANCE SPECIALTY HOLDINGS LTD | enhexhibit312q13312017.htm |
EX-31.1 - EX-31.1 - ENDURANCE SPECIALTY HOLDINGS LTD | enhexhibit311q13312017.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
ý | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
for the period ended March 31, 2017,
or
¨ | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
Commission file number 1-31599
ENDURANCE SPECIALTY HOLDINGS LTD.
(Exact Name of Registrant as Specified in Its Charter)
Bermuda | 98-0392908 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
Waterloo House
100 Pitts Bay Road
Pembroke HM 08, Bermuda
(Address of principal executive offices,
including postal code)
Registrant's Telephone Number, Including Area Code: (441) 278-0400
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of "accelerated filer", "large accelerated filer", "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | ý | Accelerated filer | ¨ | |||
Non-accelerated filer | ¨ | Smaller reporting company | ¨ | |||
Emerging growth company | ¨ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Description of Class | Common Shares Outstanding as of May 10, 2017 | |
Ordinary Shares - $1.00 par value | 30,000 |
INDEX
Page | |
1
Cautionary Statement Regarding Forward-Looking Statements
Some of the statements under "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Quarterly Report on Form 10-Q may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 ("PSLRA"). The PSLRA provides a "safe harbor" for forward-looking statements. These forward-looking statements reflect our current views with respect to us specifically and the insurance and reinsurance business generally, investments, capital markets and the general economic environments in which we operate. Statements which include the words "expect," "intend," "plan," "believe," "project," "anticipate," "seek," "will," and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the PSLRA or otherwise.
All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements. We believe that these factors include, but are not limited to, the following:
• | the effects of competitors' pricing policies, and of changes in laws and regulations on competition, industry consolidation and development of competing financial products; |
• | greater frequency or severity of claims and loss activity, including as a result of natural or man-made catastrophic events or as a result of changing climate conditions, than our underwriting, reserving or investment practices have anticipated; |
• | changes in market conditions in the agriculture industry, which may vary depending upon demand for agricultural products, weather, commodity prices, natural disasters, technological advances in agricultural practices, changes in U.S. and foreign legislation and policies related to agricultural products and producers; |
• | termination of or changes in the terms of the U.S. multiple peril crop insurance program and termination or changes to the U.S. farm bill, including modifications to the Standard Reinsurance Agreement put in place by the Risk Management Agency of the U.S. Department of Agriculture; |
• | decreased demand for property and casualty insurance or reinsurance or increased competition due to an increase in capacity of property and casualty insurers and reinsurers; |
• | changes in the availability, cost or quality of reinsurance or retrocessional coverage; |
• | the inability to renew business previously underwritten or acquired; |
• | the inability to obtain or maintain financial strength or claims-paying ratings by one or more of our subsidiaries; |
• | our ability to effectively integrate acquired operations and to continue to expand our business; |
• | uncertainties in our reserving process, including the potential for adverse development of our loss reserves or failure of our loss limitation methods; |
• | the ability of the counterparty institutions with which we conduct business to continue to meet their obligations to us; |
• | the failure or delay of the Florida Hurricane Catastrophe Fund or private market participants in Florida to promptly pay claims, particularly following a large windstorm or of multiple smaller storms; |
• | our continued ability to comply with applicable financial standards and restrictive covenants, the breach of which could trigger significant collateral or prepayment obligations; |
• | Endurance Specialty Holdings Ltd. ("Endurance Holdings") or Endurance Specialty Insurance Ltd. ("Endurance Bermuda") becomes subject to income taxes in jurisdictions outside of Bermuda; |
• | changes in tax regulations or laws applicable to us, our subsidiaries, brokers or customers; |
• | state, federal and foreign regulations that impede our ability to charge adequate rates and efficiently allocate capital; |
• | changes in insurance regulations in the U.S. or other jurisdictions in which we operate, including the implementation of Solvency II by the European Commission; |
• | the impact of the United Kingdom's June 2016 referendum on European Union membership and the potential withdrawal of the United Kingdom from the European Union; |
• | reduced acceptance of our existing or new products and services; |
2
• | loss of business provided by any one of a few brokers on whom we depend for a large portion of our revenue, and our exposure to the credit risk of our brokers; |
• | actions by our competitors, many of which are larger or have greater financial resources than we do; |
• | assessments by states for high risk or otherwise uninsured individuals; |
• | the impact of acts of terrorism and acts of war; |
• | the effects of terrorist related insurance legislation and laws; |
• | the inability to retain key personnel; |
• | political stability of Bermuda or other countries in which we operate; |
• | changes in the political environment of certain countries in which we operate or underwrite business; |
• | changes in accounting regulation, policies or practices; |
• | our investment performance; |
• | the valuation of our invested assets and the determination of impairments of those assets, if any; |
• | the breach of our investment guidelines or the inability of those guidelines to mitigate investment risk; |
• | the need for additional capital in the future which may not be available or only available on unfavorable terms; |
• | the ability to maintain the availability of our systems and safeguard the security of our data in the event of a disaster or other unanticipated event; |
• | risks relating to the acquisition of the Company by Sompo Holdings, Inc. ("Sompo"), including risks that our future financial performance may differ from projections, risks relating to integration challenges and costs, and loss of business; and |
• | changes in general economic conditions and/or industry specific conditions, including inflation or deflation, foreign currency exchange rates, interest rates, and other factors. |
The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in Endurance Holdings' Annual Report on Form 10-K for the fiscal year ended December 31, 2016, including the risk factors set forth in Item 1A. Risk Factors thereof. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.
3
ENDURANCE SPECIALTY HOLDINGS LTD.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands of United States dollars, except share amounts)
MARCH 31, 2017 | DECEMBER 31, 2016 | ||||||
(UNAUDITED) | |||||||
ASSETS | |||||||
Investments | |||||||
Fixed maturity investments, trading at fair value (amortized cost: $2,382,280 and $2,727,271 at March 31, 2017 and December 31, 2016, respectively) | $ | 2,397,307 | $ | 2,740,055 | |||
Fixed maturity investments, available for sale at fair value (amortized cost: $3,929,611 and $3,538,227 at March 31, 2017 and December 31, 2016, respectively) | 3,967,360 | 3,572,766 | |||||
Short-term investments, trading at fair value (amortized cost: $53,075 and $330,305 at March 31, 2017 and December 31, 2016, respectively) | 52,967 | 330,199 | |||||
Short-term investments, available for sale at fair value (amortized cost: $39,891 and $78,506 at March 31, 2017 and December 31, 2016, respectively) | 39,881 | 78,505 | |||||
Equity securities, trading at fair value (cost: $182 and $16,094 at March 31, 2017 and December 31, 2016, respectively) | 202 | 16,056 | |||||
Equity securities, available for sale at fair value (cost: $479,649 and $461,684 at March 31, 2017 and December 31, 2016, respectively) | 529,938 | 485,085 | |||||
Other investments | 569,706 | 588,308 | |||||
Total investments | 7,557,361 | 7,810,974 | |||||
Cash and cash equivalents | 1,332,167 | 1,149,541 | |||||
Premiums receivable, net | 2,266,004 | 1,657,752 | |||||
Insurance and reinsurance balances receivable | 110,020 | 110,183 | |||||
Deferred acquisition costs | 331,503 | 276,639 | |||||
Prepaid reinsurance premiums | 1,087,710 | 711,695 | |||||
Reinsurance recoverable on unpaid losses | 1,277,467 | 1,213,129 | |||||
Reinsurance recoverable on paid losses | 351,423 | 273,789 | |||||
Accrued investment income | 32,104 | 35,853 | |||||
Goodwill and intangible assets | 452,445 | 468,374 | |||||
Deferred tax asset | 85,814 | 71,802 | |||||
Net receivable on sales of investments | 121,571 | 54,620 | |||||
Other assets | 377,593 | 288,510 | |||||
Total assets | $ | 15,383,182 | $ | 14,122,861 | |||
LIABILITIES | |||||||
Reserve for losses and loss expenses | $ | 4,834,969 | $ | 4,905,138 | |||
Reserve for unearned premiums | 2,844,125 | 1,994,676 | |||||
Reinsurance balances payable | 1,027,488 | 784,162 | |||||
Debt | 705,437 | 705,292 | |||||
Net payable on purchases of investments | 241,123 | 181,337 | |||||
Deferred tax liability | 12,539 | 13,074 | |||||
Other liabilities | 521,122 | 397,049 | |||||
Total liabilities | 10,186,803 | 8,980,728 | |||||
Commitments and contingent liabilities | |||||||
SHAREHOLDERS' EQUITY | |||||||
Preferred shares, total liquidation preference $230,000 (2016 - $230,000) | 9 | 9 | |||||
Common shares, ordinary - 30,000 issued and outstanding (2016 - 67,627,901) | 30 | 67,628 | |||||
Additional paid-in capital | 2,063,537 | 1,961,917 | |||||
Accumulated other comprehensive loss | (22,930 | ) | (58,749 | ) | |||
Retained earnings | 2,895,618 | 2,911,634 | |||||
Total shareholders' equity available to Endurance Holdings | 4,936,264 | 4,882,439 | |||||
Non-controlling interests | 260,115 | 259,694 | |||||
Total shareholders' equity | 5,196,379 | 5,142,133 | |||||
Total liabilities and shareholders' equity | $ | 15,383,182 | $ | 14,122,861 |
4
ENDURANCE SPECIALTY HOLDINGS LTD.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(In thousands of United States dollars, except share and per share amounts)
THREE MONTHS ENDED MARCH 31, | |||||||
2017 | 2016 | ||||||
Revenues | |||||||
Gross premiums written | $ | 1,778,861 | $ | 1,611,677 | |||
Ceded premiums written | (759,212 | ) | (672,835 | ) | |||
Net premiums written | 1,019,649 | 938,842 | |||||
Change in unearned premiums | (472,617 | ) | (385,651 | ) | |||
Net premiums earned | 547,032 | 553,191 | |||||
Net investment income | 52,850 | 11,181 | |||||
Net realized and unrealized gains | 4,093 | 13,787 | |||||
Net impairment losses recognized in earnings | (430 | ) | (623 | ) | |||
Other underwriting loss | (5,892 | ) | (2,444 | ) | |||
Total revenues | 597,653 | 575,092 | |||||
Expenses | |||||||
Net losses and loss expenses | 301,313 | 243,328 | |||||
Acquisition expenses | 119,124 | 103,842 | |||||
General and administrative expenses | 73,957 | 72,225 | |||||
Corporate expenses | 70,367 | 11,771 | |||||
Amortization of intangibles | 15,934 | 21,374 | |||||
Net foreign exchange gains | (1,157 | ) | (11,729 | ) | |||
Interest expense | 10,788 | 10,870 | |||||
Total expenses | 590,326 | 451,681 | |||||
Income before income taxes | 7,327 | 123,411 | |||||
Income tax benefit | 19,056 | 1,233 | |||||
Net income | 26,383 | 124,644 | |||||
Net income attributable to non-controlling interests | (6,955 | ) | (9,063 | ) | |||
Net income available to Endurance Holdings | 19,428 | 115,581 | |||||
Preferred dividends | (3,651 | ) | (9,203 | ) | |||
Net income available to Endurance Holdings' common and participating common shareholders | $ | 15,777 | $ | 106,378 | |||
Comprehensive income | |||||||
Net income | $ | 26,383 | $ | 124,644 | |||
Other comprehensive income | |||||||
Net unrealized holding gains on investments arising during the period (net of other-than-temporary impairment losses recognized in other comprehensive income, reclassification adjustment and applicable deferred income taxes of $514 and ($6,881) for the three months ended March 31, 2017 and 2016, respectively) | 30,108 | 57,758 | |||||
Foreign currency translation adjustments | 5,689 | (12,318 | ) | ||||
Reclassification adjustment for net losses on derivative designated as cash flow hedge included in net income | 22 | 22 | |||||
Other comprehensive income | 35,819 | 45,462 | |||||
Comprehensive income | 62,202 | 170,106 | |||||
Comprehensive income attributable to non-controlling interests | (6,955 | ) | (9,063 | ) | |||
Comprehensive income attributable to Endurance Holdings | $ | 55,247 | $ | 161,043 | |||
Per share data | |||||||
Dividend per common share | $ | 0.38 | $ | 0.38 |
5
ENDURANCE SPECIALTY HOLDINGS LTD.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN
SHAREHOLDERS' EQUITY
(In thousands of United States dollars)
THREE MONTHS ENDED MARCH 31, | |||||||
2017 | 2016 | ||||||
Preferred shares | |||||||
Balance, beginning and end of period | 9 | 9,209 | |||||
Common shares | |||||||
Balance, beginning of period | 67,628 | 66,798 | |||||
Issuance of common shares, net of forfeitures | (113 | ) | 552 | ||||
Cancellation of common shares | (67,485 | ) | — | ||||
Balance, end of period | 30 | 67,350 | |||||
Additional paid-in capital | |||||||
Balance, beginning of period | 1,961,917 | 2,145,836 | |||||
Issuance of common shares, net of forfeitures | 136 | 1,055 | |||||
Cancellation of common shares | 67,485 | — | |||||
Settlement of equity awards | (13,606 | ) | (10,735 | ) | |||
Stock-based compensation expense | 41,816 | 10,015 | |||||
Reclassification due to ASU 2016-09 | 5,789 | — | |||||
Balance, end of period | 2,063,537 | 2,146,171 | |||||
Accumulated other comprehensive loss | |||||||
Cumulative foreign currency translation adjustments: | |||||||
Balance, beginning of period | (118,642 | ) | (32,318 | ) | |||
Foreign currency translation adjustments | 5,689 | (12,318 | ) | ||||
Balance, end of period | (112,953 | ) | (44,636 | ) | |||
Unrealized holding gains on investments, net of deferred taxes: | |||||||
Balance, beginning of period | 61,483 | (12,638 | ) | ||||
Net unrealized holding gains arising during the period, net of other-than-temporary impairment losses and reclassification adjustment | 30,108 | 57,758 | |||||
Balance, end of period | 91,591 | 45,120 | |||||
Accumulated derivative loss on cash flow hedging instruments: | |||||||
Balance, beginning of period | (1,590 | ) | (1,678 | ) | |||
Net change from current period hedging transactions, net of reclassification adjustment | 22 | 22 | |||||
Balance, end of period | (1,568 | ) | (1,656 | ) | |||
Total accumulated other comprehensive loss | (22,930 | ) | (1,172 | ) | |||
Retained earnings | |||||||
Balance, beginning of period | 2,911,634 | 2,681,053 | |||||
Reclassification due to ASU 2016-09 | (5,789 | ) | — | ||||
Net income | 26,383 | 124,644 | |||||
Net income attributable to non-controlling interests | (6,955 | ) | (9,063 | ) | |||
Dividends on preferred shares | (3,651 | ) | (9,203 | ) | |||
Dividends on common shares | (26,004 | ) | (25,632 | ) | |||
Balance, end of period | 2,895,618 | 2,761,799 | |||||
Total shareholders' equity available to Endurance Holdings | 4,936,264 | 4,983,357 | |||||
Non-controlling interests | 260,115 | 258,259 | |||||
Total shareholders' equity | $ | 5,196,379 | $ | 5,241,616 |
See accompanying notes to unaudited condensed consolidated financial statements.
6
ENDURANCE SPECIALTY HOLDINGS LTD.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of United States dollars)
THREE MONTHS ENDED MARCH 31, | |||||||
2017 | 2016 | ||||||
Cash flows used in operating activities | |||||||
Net income | $ | 26,383 | $ | 124,644 | |||
Adjustments to reconcile net income to net cash used in operating activities: | |||||||
Amortization of net premium on investments | 9,714 | 10,460 | |||||
Amortization of other intangibles and depreciation | 22,554 | 26,880 | |||||
Net realized and unrealized gains | (4,093 | ) | (13,787 | ) | |||
Net impairment losses recognized in earnings | 430 | 623 | |||||
Deferred taxes | (14,033 | ) | (1,842 | ) | |||
Stock-based compensation expense | 41,816 | 10,015 | |||||
Equity in (earnings) losses of other investments | (13,078 | ) | 28,257 | ||||
Change in: | |||||||
Premiums receivable, net | (608,252 | ) | (524,440 | ) | |||
Insurance and reinsurance balances receivable | 163 | (1,445 | ) | ||||
Deferred acquisition costs | (54,864 | ) | (66,153 | ) | |||
Prepaid reinsurance premiums | (376,015 | ) | (392,694 | ) | |||
Reinsurance recoverable on unpaid losses | (64,338 | ) | (27,649 | ) | |||
Reinsurance recoverable on paid losses | (77,634 | ) | (42,925 | ) | |||
Accrued investment income | 3,749 | 657 | |||||
Other assets | (23,552 | ) | 10,312 | ||||
Reserve for losses and loss expenses | (70,169 | ) | (52,226 | ) | |||
Reserve for unearned premiums | 849,449 | 776,257 | |||||
Reinsurance balances payable | 243,326 | 194,044 | |||||
Other liabilities | (34,856 | ) | (89,372 | ) | |||
Net cash flows used in operating activities | (143,300 | ) | (30,384 | ) | |||
Cash flows provided by investing activities | |||||||
Proceeds from sales and maturities of trading investments | 731,116 | 753,987 | |||||
Proceeds from sales and maturities of available for sale investments | 916,256 | 964,133 | |||||
Proceeds from the redemption of other investments | 38,873 | 86,713 | |||||
Purchases of trading investments | (219,134 | ) | (780,573 | ) | |||
Purchases of available for sale investments | (1,163,339 | ) | (852,752 | ) | |||
Purchases of other investments | (7,074 | ) | (39,162 | ) | |||
Net settlements of other assets and other liabilities | (27,203 | ) | 860 | ||||
Purchases of fixed assets | (4,284 | ) | (2,385 | ) | |||
Net cash paid upon subsidiary acquisition | (5 | ) | (3 | ) | |||
Net cash flows provided by investing activities | 265,206 | 130,818 | |||||
Cash flows provided by (used in) financing activities | |||||||
Issuance of common shares | 30 | 566 | |||||
Net distributions to non-controlling interests | (4,778 | ) | (16,859 | ) | |||
Settlement of equity awards | (13,606 | ) | (10,735 | ) | |||
Received from Sompo for settlement of equity awards | 101,778 | — | |||||
Offering and registration costs paid | — | (258 | ) | ||||
Proceeds from issuance of debt | — | 178 | |||||
Repayments of debt | (7 | ) | (13,199 | ) | |||
Dividends on preferred shares | (3,651 | ) | (9,203 | ) | |||
Dividends on common shares | (25,973 | ) | (25,578 | ) | |||
Net cash flows provided by (used in) financing activities | 53,793 | (75,088 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents | 6,927 | 9,637 | |||||
Net increase in cash and cash equivalents | 182,626 | 34,983 | |||||
Cash and cash equivalents, beginning of period | 1,149,541 | 1,177,750 | |||||
Cash and cash equivalents, end of period | $ | 1,332,167 | $ | 1,212,733 |
7
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
1. | General |
Endurance Specialty Holdings Ltd. ("Endurance Holdings" and together with its subsidiaries, the "Company") was organized as a Bermuda holding company on June 27, 2002. Endurance Holdings writes specialty lines of insurance and reinsurance on a global basis through its wholly-owned operating subsidiaries.
In addition, as part of its collateralized reinsurance and third party asset management operations, Endurance Holdings and Endurance Specialty Insurance Ltd. ("Endurance Bermuda") together own 33.3% of Blue Capital Reinsurance Holdings Ltd. ("BCRH")'s common shares, and Endurance Bermuda owns 28.0% of Blue Capital Global Reinsurance Fund Limited ("BCGR")'s ordinary shares.
BCRH is a Bermuda-based exempted limited liability holding company managed by Blue Capital Management Ltd. ("BCML"), a wholly-owned subsidiary of the Company. BCRH provides fully-collateralized property catastrophe reinsurance and invests in various insurance-linked securities through its wholly-owned Bermuda-based subsidiaries, Blue Capital Re. Ltd. ("Blue Capital Re") and Blue Capital Re ILS Ltd. ("Blue Capital Re ILS"). BCRH's shares are listed on the New York Stock Exchange and the Bermuda Stock Exchange.
BCGR is a closed-ended mutual fund incorporated in Bermuda and managed by BCML. BCGR serves as the feeder fund for the Blue Capital Global Reinsurance SA-I cell (the "BCGR Cell"). BCGR's shares are listed on the Specialist Fund Market of the London Stock Exchange and on the Bermuda Stock Exchange.
On October 5, 2016, the Company entered into an agreement and plan of merger (the "Merger Agreement") for the acquisition of 100% of the outstanding ordinary shares of the Company by Sompo Holdings, Inc. ("Sompo") for $93.00 per share in cash (the "Merger"). The Merger was approved by each company's Board of Directors and the Company's ordinary and preferred shareholders at a special general meeting.
On March 28, 2017, Sompo completed its acquisition of the Company following receipt of all shareholder and regulatory approvals. Pursuant to the terms of the Merger Agreement, Endurance Holdings ordinary shares ceased trading on the New York Stock Exchange ("NYSE") and each Endurance Holdings issued and outstanding ordinary share was canceled and converted into the right to receive $93.00 per share. The Company's 6.35% Non-Cumulative Preferred Shares, Series C (the "Series C Preferred Shares") continue to be traded on the NYSE following the close of the transaction.
Under the terms of the Merger Agreement, the aggregate consideration for the Merger was $6,288.7 million in cash. The purchase was financed by Sompo from existing sources of liquidity and supplementary facilities. In connection with the acquisition by Sompo, the Company incurred transaction expenses of $56.2 million for the three months ended March 31, 2017, related primarily to equity compensation expenses, professional fees and investment banking fees. These expenses have been reported as a component of corporate expenses.
2. | Summary of significant accounting policies |
The accompanying consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States ("U.S. GAAP") for interim financial information and with the instructions to the Quarterly Report on Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Results for the three months ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. The consolidated financial statements include the accounts of Endurance Holdings, its wholly-owned subsidiaries, and BCRH and the BCGR Cell. All intercompany transactions and balances have been eliminated in consolidation. Management is required to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. Actual results could differ from those estimates. Among other matters, significant estimates and assumptions are used to record premiums written and ceded, to record the fair value of investments and to record reserves for losses and loss expenses and contingencies. Estimates and assumptions are periodically reviewed and the effects of revisions are recorded in the consolidated financial statements in the period that they are determined to be necessary.
The balance sheet at December 31, 2016 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements. These consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial statements and notes
8
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
2. | Summary of significant accounting policies, cont'd. |
thereto for the year ended December 31, 2016 contained in Endurance Holdings' Annual Report on Form 10-K for the fiscal year ended December 31, 2016 (the "2016 Form 10-K").
Certain comparative information has been reclassified to conform to current year presentation.
There were no material changes in the Company's significant accounting and reporting policies subsequent to the filing of the 2016 Form 10-K.
Recent accounting pronouncements
In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-09, "Improvements to Employee Share-Based Payment Accounting" ("ASU 2016-09"). ASU 2016-09 changes how companies account for certain aspects of share-based payments to employees. Entities are required to recognize the income tax effects of awards in the income statement when the awards vest or are settled. The guidance also changes employers' accounting for an employee's use of shares to satisfy the employer's statutory income tax withholding obligation, and accounting for forfeitures. ASU 2016-09 was effective for public business entities for annual and interim periods beginning after December 15, 2016. Early adoption was permitted. The Company adopted ASU 2016-09 effective January 1, 2017. The adoption of this guidance resulted in a reduction of $5.8 million to opening retained earnings and a corresponding increase to opening additional paid-in capital. The adoption of this guidance did not have a material impact on the Company's Unaudited Condensed Consolidated Statements of Income and Comprehensive Income and Unaudited Condensed Consolidated Statements of Cash Flows.
In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350)" ("ASU 2017-04"). ASU 2017-04 simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under ASU 2017-04, an entity would perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. ASU 2017-04 is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted. The Company is currently evaluating the impact of this guidance on its Unaudited Condensed Consolidated Financial Statements.
3. | Investments |
Composition of Net Investment Income and of Invested Assets
The components of net investment income for the three months ended March 31, 2017 and 2016 are as follows:
Three Months Ended March 31, | |||||||
2017 | 2016 | ||||||
Fixed income investments | $ | 41,726 | $ | 38,400 | |||
Equity securities | 1,957 | 3,847 | |||||
Other investments | 13,078 | (28,257 | ) | ||||
Cash and cash equivalents | 625 | 1,047 | |||||
$ | 57,386 | $ | 15,037 | ||||
Investment expenses | (4,536 | ) | (3,856 | ) | |||
Net investment income | $ | 52,850 | $ | 11,181 |
9
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
3. | Investments, cont'd. |
Contractual maturities of the Company's fixed maturity and short-term investments are shown below as of March 31, 2017 and December 31, 2016. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
March 31, 2017 | December 31, 2016 | ||||||||||||||
Amortized Cost | Fair Value | Amortized Cost | Fair Value | ||||||||||||
Due within one year | $ | 298,437 | $ | 298,369 | $ | 617,655 | $ | 617,462 | |||||||
Due after one year through five years | 2,167,758 | 2,188,242 | 2,170,111 | 2,187,173 | |||||||||||
Due after five years through ten years | 886,477 | 895,874 | 887,775 | 896,388 | |||||||||||
Due after ten years | 59,155 | 61,938 | 55,400 | 58,449 | |||||||||||
Residential mortgage-backed securities | 1,452,746 | 1,463,232 | 1,448,917 | 1,461,286 | |||||||||||
Commercial mortgage-backed securities | 625,162 | 626,851 | 615,730 | 618,848 | |||||||||||
Collateralized loan and debt obligations | 406,111 | 412,236 | 369,126 | 371,256 | |||||||||||
Asset-backed securities | 509,011 | 510,773 | 509,595 | 510,663 | |||||||||||
Total | $ | 6,404,857 | $ | 6,457,515 | $ | 6,674,309 | $ | 6,721,525 |
The following table summarizes the fair value of the fixed maturity investments, short-term investments and equity securities classified as trading at March 31, 2017 and December 31, 2016.
March 31, 2017 | December 31, 2016 | |||||||
Fixed maturity investments | ||||||||
U.S. government and agencies securities | $ | 412,572 | $ | 551,055 | ||||
U.S. state and municipal securities | 2,627 | 6,006 | ||||||
Foreign government securities | 110,730 | 110,088 | ||||||
Government guaranteed corporate securities | 2,618 | 2,959 | ||||||
Corporate securities | 958,677 | 1,051,200 | ||||||
Residential mortgage-backed securities | 425,734 | 483,444 | ||||||
Commercial mortgage-backed securities | 144,730 | 164,237 | ||||||
Collateralized loan and debt obligations | 115,074 | 98,924 | ||||||
Asset-backed securities | 224,545 | 272,142 | ||||||
Total fixed maturity investments | 2,397,307 | 2,740,055 | ||||||
Short-term investments | 52,967 | 330,199 | ||||||
Total fixed income investments | $ | 2,450,274 | $ | 3,070,254 | ||||
Equity securities | ||||||||
Equity investments | $ | 202 | $ | 16,056 | ||||
Total equity securities | $ | 202 | $ | 16,056 |
In addition to the Company's fixed maturity, short-term and equity securities, the Company invests in other investments. At March 31, 2017 and December 31, 2016, the Company had invested, net of capital returned, a total of $445.1 million and $470.3 million, respectively, in other investments. At March 31, 2017 and December 31, 2016, the carrying value of other investments was $569.7 million and $588.3 million, respectively.
10
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
3. | Investments, cont'd. |
The following table summarizes the composition, unfunded commitments and redemption restrictions of other investments as of March 31, 2017 and December 31, 2016:
March 31, 2017 | Market Value | Unfunded Commitments | Ineligible for Redemption over next 12 months | |||||||||
Hedge funds | $ | 457,595 | $ | — | $ | 89,444 | ||||||
Private investment funds | 81,550 | 86,220 | 81,550 | |||||||||
Other investment funds | 30,561 | — | 31,093 | |||||||||
Total | $ | 569,706 | $ | 86,220 | $ | 202,087 |
December 31, 2016 | Market Value | Unfunded Commitments | Ineligible for Redemption in 2017 | |||||||||
Hedge funds | $ | 482,865 | $ | — | $ | 85,963 | ||||||
Private investment funds | 76,451 | 92,214 | 76,451 | |||||||||
Other investment funds | 28,992 | — | 27,518 | |||||||||
Total | $ | 588,308 | $ | 92,214 | $ | 189,932 |
Hedge funds – The redemption frequency of the hedge funds in which the Company invests range from monthly to biennially with notice periods from 30 to 180 days. Over one year, it is estimated that the Company can liquidate approximately 80.5% of its hedge fund portfolio, with the remainder over the following two years.
Private investment funds – The Company generally has no right to redeem its interest in any private investment fund in advance of dissolution of the applicable partnership. Instead, the nature of these investments is that distributions are received by the Company in connection with the liquidation of or distribution of earnings from the underlying assets of the applicable limited partnership. It is estimated that the majority of the underlying assets of the limited partnerships would liquidate over 5 to 10 years from inception of the limited partnership. A secondary market, with unpredictable liquidity, exists for limited partner interests in private equity funds.
Other investment funds – Other investment funds includes funds on deposit with Lloyd's of London ("Lloyd's"), which are restricted, and the Company's investment in BCGR, which represents the net asset or liability of the Company's investment in BCGR that has not been deployed into the BCGR cell.
Net Realized and Unrealized Gains
Realized gains and losses are recognized in earnings using the first in, first out method. The analysis of gross realized gains and losses, net unrealized gains on trading securities, and the change in the fair value of investment-related derivative financial instruments for the three months ended March 31, 2017 and 2016 is as follows:
Three Months Ended March 31, | |||||||
2017 | 2016 | ||||||
Gross realized gains on investment sales | $ | 8,169 | $ | 9,856 | |||
Gross realized losses on investment sales | (7,899 | ) | (11,195 | ) | |||
Net unrealized gains on trading securities | 7,490 | 14,796 | |||||
Change in fair value of investment-related derivative financial instruments(1) | (3,667 | ) | 330 | ||||
Net realized and unrealized gains | $ | 4,093 | $ | 13,787 |
(1) | For additional information on the Company's derivative financial instruments, see Note 7, Derivatives. |
11
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
3. | Investments, cont'd. |
Unrealized Gains and Losses
The Company classifies some of its investments in fixed maturity investments, short-term investments and equity securities as available for sale. The amortized cost, fair value and related gross unrealized gains and losses on the Company's securities classified as available for sale at March 31, 2017 and December 31, 2016 are as follows:
March 31, 2017 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||
Fixed maturity investments | ||||||||||||||||
U.S. government and agencies securities | $ | 545,642 | $ | 3,905 | $ | (1,616 | ) | $ | 547,931 | |||||||
U.S. state and municipal securities | 14,568 | 845 | (94 | ) | 15,319 | |||||||||||
Foreign government securities | 76,397 | 1,211 | (796 | ) | 76,812 | |||||||||||
Government guaranteed corporate securities | 764 | — | (1 | ) | 763 | |||||||||||
Corporate securities | 1,205,017 | 24,752 | (6,243 | ) | 1,223,526 | |||||||||||
Residential mortgage-backed securities | 1,027,938 | 19,523 | (9,963 | ) | 1,037,498 | |||||||||||
Commercial mortgage-backed securities | 480,197 | 7,686 | (5,762 | ) | 482,121 | |||||||||||
Collateralized loan and debt obligations | 294,667 | 2,639 | (144 | ) | 297,162 | |||||||||||
Asset-backed securities | 284,421 | 2,577 | (770 | ) | 286,228 | |||||||||||
Total fixed maturity investments | 3,929,611 | 63,138 | (25,389 | ) | 3,967,360 | |||||||||||
Short-term investments | 39,891 | — | (10 | ) | 39,881 | |||||||||||
Total fixed income investments | $ | 3,969,502 | $ | 63,138 | $ | (25,399 | ) | $ | 4,007,241 | |||||||
Equity securities | ||||||||||||||||
Equity investments | $ | 479,524 | $ | 50,559 | $ | (271 | ) | $ | 529,812 | |||||||
Preferred equity investments | 125 | 1 | — | 126 | ||||||||||||
Total equity securities | $ | 479,649 | $ | 50,560 | $ | (271 | ) | $ | 529,938 |
December 31, 2016 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||
Fixed maturity investments | ||||||||||||||||
U.S. government and agencies securities | $ | 449,638 | $ | 3,981 | $ | (2,792 | ) | $ | 450,827 | |||||||
U.S. state and municipal securities | 11,560 | 945 | (154 | ) | 12,351 | |||||||||||
Foreign government securities | 68,539 | 2,236 | (1,944 | ) | 68,831 | |||||||||||
Government guaranteed corporate securities | 912 | 46 | — | 958 | ||||||||||||
Corporate securities | 1,078,756 | 26,481 | (8,744 | ) | 1,096,493 | |||||||||||
Residential mortgage-backed securities | 968,273 | 21,032 | (11,463 | ) | 977,842 | |||||||||||
Commercial mortgage-backed securities | 452,011 | 8,790 | (6,190 | ) | 454,611 | |||||||||||
Collateralized loan and debt obligations | 271,361 | 1,644 | (673 | ) | 272,332 | |||||||||||
Asset-backed securities | 237,177 | 2,242 | (898 | ) | 238,521 | |||||||||||
Total fixed maturity investments | 3,538,227 | 67,397 | (32,858 | ) | 3,572,766 | |||||||||||
Short-term investments | 78,506 | 1 | (2 | ) | 78,505 | |||||||||||
Total fixed income investments | $ | 3,616,733 | $ | 67,398 | $ | (32,860 | ) | $ | 3,651,271 | |||||||
Equity securities | ||||||||||||||||
Equity investments | $ | 461,509 | $ | 27,948 | $ | (4,545 | ) | $ | 484,912 | |||||||
Preferred equity investments | 175 | — | (2 | ) | 173 | |||||||||||
Total equity securities | $ | 461,684 | $ | 27,948 | $ | (4,547 | ) | $ | 485,085 |
12
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
3. | Investments, cont'd. |
The following tables summarize, for all available for sale securities in an unrealized loss position at March 31, 2017 and December 31, 2016, the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position.
Less than 12 months | 12 months or greater | Total | ||||||||||||||||||||||
March 31, 2017 | Unrealized Losses(1) | Fair Value | Unrealized Losses(1) | Fair Value | Unrealized Losses(1) | Fair Value | ||||||||||||||||||
Fixed maturity investments | ||||||||||||||||||||||||
U.S. government and agencies securities | $ | (1,615 | ) | $ | 240,131 | $ | (1 | ) | $ | 248 | $ | (1,616 | ) | $ | 240,379 | |||||||||
U.S. state and municipal securities | (91 | ) | 7,702 | (3 | ) | 2,058 | (94 | ) | 9,760 | |||||||||||||||
Foreign government securities | (207 | ) | 22,247 | (589 | ) | 2,780 | (796 | ) | 25,027 | |||||||||||||||
Government guaranteed corporate securities | (1 | ) | 763 | — | — | (1 | ) | 763 | ||||||||||||||||
Corporate securities | (5,269 | ) | 344,120 | (974 | ) | 7,106 | (6,243 | ) | 351,226 | |||||||||||||||
Residential mortgage-backed securities | (8,720 | ) | 522,225 | (1,243 | ) | 29,538 | (9,963 | ) | 551,763 | |||||||||||||||
Commercial mortgage-backed securities | (2,807 | ) | 151,647 | (2,955 | ) | 58,708 | (5,762 | ) | 210,355 | |||||||||||||||
Collateralized loan and debt obligations | (97 | ) | 63,336 | (47 | ) | 17,611 | (144 | ) | 80,947 | |||||||||||||||
Asset-backed securities | (596 | ) | 106,552 | (174 | ) | 34,553 | (770 | ) | 141,105 | |||||||||||||||
Total fixed maturity investments | (19,403 | ) | 1,458,723 | (5,986 | ) | 152,602 | (25,389 | ) | 1,611,325 | |||||||||||||||
Short-term investments | (10 | ) | 35,230 | — | — | (10 | ) | 35,230 | ||||||||||||||||
Total fixed income investments | $ | (19,413 | ) | $ | 1,493,953 | $ | (5,986 | ) | $ | 152,602 | $ | (25,399 | ) | $ | 1,646,555 | |||||||||
Equity securities | ||||||||||||||||||||||||
Equity investments | $ | (56 | ) | $ | 2,473 | $ | (215 | ) | $ | 3,884 | $ | (271 | ) | $ | 6,357 | |||||||||
Total equity securities | $ | (56 | ) | $ | 2,473 | $ | (215 | ) | $ | 3,884 | $ | (271 | ) | $ | 6,357 |
(1) | Gross unrealized losses include unrealized losses on non-OTTI and non-credit OTTI securities recognized in accumulated other comprehensive loss at March 31, 2017. |
As of March 31, 2017, 1,015 available for sale securities were in an unrealized loss position aggregating $25.7 million. Of those, 184 securities with aggregated unrealized losses of $6.2 million had been in a continuous unrealized loss position for twelve months or greater.
13
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
3. | Investments, cont'd. |
Less than 12 months | 12 months or greater | Total | ||||||||||||||||||||||
December 31, 2016 | Unrealized Losses(1) | Fair Value | Unrealized Losses(1) | Fair Value | Unrealized Losses(1) | Fair Value | ||||||||||||||||||
Fixed maturity investments | ||||||||||||||||||||||||
U.S. government and agencies securities | $ | (2,791 | ) | $ | 289,012 | $ | (1 | ) | $ | 248 | $ | (2,792 | ) | $ | 289,260 | |||||||||
U.S. state and municipal securities | (152 | ) | 5,288 | (2 | ) | 2,143 | (154 | ) | 7,431 | |||||||||||||||
Foreign government securities | (446 | ) | 15,717 | (1,498 | ) | 5,973 | (1,944 | ) | 21,690 | |||||||||||||||
Corporate securities | (7,512 | ) | 448,643 | (1,232 | ) | 11,897 | (8,744 | ) | 460,540 | |||||||||||||||
Residential mortgage-backed securities | (10,082 | ) | 521,167 | (1,381 | ) | 31,835 | (11,463 | ) | 553,002 | |||||||||||||||
Commercial mortgage-backed securities | (3,453 | ) | 174,144 | (2,737 | ) | 76,694 | (6,190 | ) | 250,838 | |||||||||||||||
Collateralized loan and debt obligations | (223 | ) | 50,194 | (450 | ) | 81,043 | (673 | ) | 131,237 | |||||||||||||||
Asset-backed securities | (539 | ) | 64,109 | (359 | ) | 39,770 | (898 | ) | 103,879 | |||||||||||||||
Total fixed maturity investments | (25,198 | ) | 1,568,274 | (7,660 | ) | 249,603 | (32,858 | ) | 1,817,877 | |||||||||||||||
Short-term investments | (2 | ) | 4,691 | — | — | (2 | ) | 4,691 | ||||||||||||||||
Total fixed income investments | $ | (25,200 | ) | $ | 1,572,965 | $ | (7,660 | ) | $ | 249,603 | $ | (32,860 | ) | $ | 1,822,568 | |||||||||
Equity securities | ||||||||||||||||||||||||
Equity investments | $ | (2,855 | ) | $ | 71,509 | $ | (1,690 | ) | $ | 17,408 | $ | (4,545 | ) | $ | 88,917 | |||||||||
Preferred equity investments | (2 | ) | 123 | — | — | (2 | ) | 123 | ||||||||||||||||
Total equity securities | $ | (2,857 | ) | $ | 71,632 | $ | (1,690 | ) | $ | 17,408 | $ | (4,547 | ) | $ | 89,040 |
(1) | Gross unrealized losses include unrealized losses on non-OTTI and non-credit OTTI securities recognized in accumulated other comprehensive loss at December 31, 2016. |
As of December 31, 2016, 1,090 available for sale securities were in an unrealized loss position aggregating $37.4 million. Of those, 218 securities with aggregated unrealized losses of $9.4 million had been in a continuous unrealized loss position for twelve months or greater.
The decrease in gross unrealized losses on the Company's available for sale fixed income investments at March 31, 2017 compared to December 31, 2016 was primarily due to tightening credit spreads during the three months ended March 31, 2017. At March 31, 2017, the Company did not have the intent to sell any of the remaining fixed income investments in an unrealized loss position and determined that it was unlikely that the Company would be required to sell those securities in an unrealized loss position. During the three months ended March 31, 2017, the Company impaired certain fixed maturity investments and equity securities and therefore recognized in earnings total other-than-temporary impairments of $0.4 million for the three months ended March 31, 2017. As of March 31, 2017, the Company did not have the intent to sell any of the remaining equity securities in an unrealized loss position.
Other Investments
The Company is involved in the normal course of business with variable interest entities ("VIEs") as a passive investor in residential and commercial mortgage-backed securities and through its interests in various other investments that are structured as limited partnerships considered to be third party VIEs. The Company determines whether it is the primary beneficiary of an entity subject to consolidation based on a qualitative assessment of the VIE's capital structure, contractual terms, nature of the VIE's operations and purpose and the Company's relative exposure to the related risks of the VIE on the date it becomes initially involved in the VIE. The Company determined that it was not the primary beneficiary for any of these investments as of March 31, 2017. The Company believes its exposure to loss with respect to these investments is generally limited to the investment carrying amounts reported in the Company's Condensed Consolidated Balance Sheets and any unfunded investment commitments.
14
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
3. | Investments, cont'd. |
Collateralized Reinsurance Entities
As of March 31, 2017, Endurance Holdings and Endurance Bermuda together owned 33.3% of BCRH's common shares. BCRH is considered a VIE under U.S. GAAP due to service agreements for investment management, underwriting and insurance management and administrative services between BCRH and BCML, and the economic penalty to terminate the service agreements by BCRH. The Company has determined that it is BCRH's primary beneficiary due to its ability to direct the activities of BCRH through BCML along with its economic interest in BCRH. As a result, the Company fully consolidates the assets, liabilities and operations of BCRH and its subsidiaries within its Unaudited Condensed Consolidated Financial Statements. The interests in BCRH and its subsidiaries that the Company fully consolidates that are attributable to third-party investors are reported within the Company's Unaudited Condensed Consolidated Financial Statements as non-controlling interests. BCRH's shareholder rights do not include redemption features within the control of the third party shareholders. The Company reassesses its VIE determination with respect to BCRH on an ongoing basis.
As of March 31, 2017, Endurance Bermuda owned 28.0% of BCGR's ordinary shares. BCGR is considered a "voting interest entity" under U.S. GAAP and, because the Company owns less than 50% of its outstanding ordinary shares, the Company does not consolidate BCGR's assets, liabilities or operations within its Unaudited Condensed Consolidated Financial Statements. However, the BCGR Cell and Blue Water Re Ltd. ("Blue Water Re"), the Company's wholly-owned Bermuda-based special purpose insurance company, are considered VIEs under U.S. GAAP due to service agreements for investment management, underwriting and insurance management and administrative services between Blue Water Re and BCML. The Company has determined that it is the primary beneficiary of these entities due to its ability to direct the activities of Blue Water Re and the BCGR Cell along with its economic interest in these entities. Therefore, as funds held in BCGR are invested in the BCGR Cell, and ultimately into Blue Water Re, they are included in the Company's Unaudited Condensed Consolidated Financial Statements. Conversely, as funds previously invested by BCGR and the BCGR Cell into Blue Water Re are returned to BCGR, they are no longer included in the Company's Unaudited Condensed Consolidated Financial Statements. The interests in the BCGR Cell and Blue Water Re that the Company fully consolidates that are attributable to third-party investors are reported within the Company's Unaudited Condensed Consolidated Financial Statements as non-controlling interests. BCGR's shareholder rights do not include redemption features within the control of the third party shareholders. The Company reassesses its VIE determinations with respect to the BCGR Cell and Blue Water Re on an ongoing basis.
The following table summarizes the movements in the non-redeemable non-controlling interests balance during the three months ended March 31, 2017 and 2016:
Three Months Ended March 31, | ||||||||
2017 | 2016 | |||||||
Non-controlling interests, beginning of period | $ | 259,694 | $ | 267,810 | ||||
Income attributable to third-party investments in the BCGR Cell | 4,195 | 5,741 | ||||||
Income attributable to third-party investments in BCRH | 2,760 | 3,322 | ||||||
Net income attributable to non-controlling interests | 6,955 | 9,063 | ||||||
Net preferred share redemptions attributable to third-party investments in the BCGR Cell(1) | (1,402 | ) | (9,623 | ) | ||||
Net investments attributable to third-parties in BCRH | 92 | 16 | ||||||
Net change in third-party investments in non-controlling interests | (1,310 | ) | (9,607 | ) | ||||
Dividends declared by BCRH attributable to non-controlling interests | (5,224 | ) | (9,007 | ) | ||||
Non-controlling interests, end of period | $ | 260,115 | $ | 258,259 |
(1) The redemption from the BCGR Cell during the three months ended March 31, 2017 and 2016 was required to fund expenses, repay debt and fund dividends by BCGR.
15
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
4. | Fair value measurement |
The Company determines the fair value of its fixed maturity investments, short-term investments, equity securities, debt, and other assets and liabilities in accordance with current accounting guidance, which defines fair value and establishes a fair value hierarchy based on inputs to the various valuation techniques used for each fair value measurement. The Company determines the estimated fair value of each individual security utilizing the highest level inputs available. Valuation inputs by security type may include the following:
• | Government and agencies fixed maturity securities – These securities are generally priced by pricing services or index providers. The pricing services or index providers may use current market trades for securities with similar quality, maturity and coupon. If no such trades are available, the pricing service typically uses analytical models which may incorporate option adjusted spreads, daily interest rate data and market/sector news. The Company generally classifies the fair values of government and agencies securities in Level 2. Current issue U.S. government securities are generally valued based on Level 1 inputs, which use the market approach valuation technique. |
• | Government guaranteed corporate fixed maturity securities – These securities are generally priced by pricing services or index providers. The pricing service or index providers may use current market trades for securities with similar quality, maturity and coupon. If no such trades are available, the pricing service typically uses analytical spread models which may incorporate inputs from the U.S. treasury curve or LIBOR. The Company generally classifies the fair values of its government guaranteed corporate securities in Level 2. |
• | Corporate fixed maturity securities – These securities are generally priced by pricing services or index providers. The pricing services or index providers typically use discounted cash flow models that incorporate benchmark curves for treasury, swap and high issuance credits. Credit spreads are developed from current market observations for like or similar securities. The Company generally classifies the fair values of its corporate securities in Level 2. The Company uses models that include unobservable inputs to price its corporate bank loan portfolio. As such, the fair values of the corporate bank loans are generally classified in Level 3. |
• | Equity securities – These securities are generally priced by pricing services or index providers. Depending on the type of underlying equity security or equity fund, the securities are priced by pricing services or index providers based on quoted market prices in active markets or through a discounted cash flow model that incorporates benchmark curves for treasury, swap and credits for like or similar securities. The Company generally classifies the fair values of its equity securities in Level 1 or 2. |
• | Structured securities including agency and non-agency, residential and commercial mortgage-backed securities, asset-backed securities and collateralized loan and debt obligations – These securities are generally priced by broker/dealers. Broker/dealers may use current market trades for securities with similar qualities. If no such trades are available, inputs such as bid and offer, prepayment speeds, the U.S. treasury curve, swap curve and cash settlement may be used in a discounted cash flow model to determine the fair value of a security. The Company generally classifies the fair values of its structured securities in Level 2. |
• | Other assets and liabilities – A portion of other assets and liabilities are composed of a variety of derivative instruments used to enhance the efficiency of the investment portfolio and economically hedge certain risks. These instruments are generally priced by pricing services, broker/dealers and/or recent trading activity. The market value approach valuation technique is used to estimate the fair value for these derivatives based on significant observable market inputs. Certain derivative instruments are priced by pricing services based on quoted market prices in active markets. These derivative instruments are generally classified in Level 1. Other derivative instruments are priced using industry valuation models and are considered Level 2, as the inputs to the valuation model are based on observable market inputs. Also included in this line item are proprietary, non-exchange traded derivative-based risk management products primarily used to address weather and energy risks. The trading market for these weather and energy derivatives are generally linked to energy and agriculture commodities, weather and other natural phenomena. In instances where market prices are not available, the Company uses industry or internally developed valuation techniques such as spread option, Black Scholes, quanto and simulation modeling to determine fair value and classifies these in Level 3. These models may reference prices for similar instruments. |
• | Debt – Outstanding debt consists of the Company's 7.0% Senior Notes due July 15, 2034, the 4.7% Senior Notes due October 15, 2022 (together, the "Senior Notes") and the Trust Preferred Securities. The fair values of the Senior Notes |
16
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
4. | Fair value measurement, cont'd. |
were obtained from a third party pricing service and pricing was based on the spread above the risk-free yield curve. The fair values of the Trust Preferred Securities were based on the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As these spreads and the yields for the risk-free yield curve are observable market inputs, the fair values of the Senior Notes and the Trust Preferred Securities are classified in Level 2.
The carrying values of cash and cash equivalents, accrued investment income, other investments, net receivable on sales of investments, net payable on purchases of investments and other financial instruments not described above approximated their fair values at March 31, 2017 and December 31, 2016.
Transfers between levels are assumed to occur at the end of each period.
The following table sets forth the Company's fixed maturity investments, equity securities, short-term investments, other assets and liabilities and debt categorized by the level within the hierarchy in which the fair value measurements fall at March 31, 2017:
Fair Value Measurements at March 31, 2017 | |||||||||||||||
Total at March 31, 2017 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
Assets | |||||||||||||||
Fixed maturity investments | |||||||||||||||
U.S. government and agencies securities | $ | 960,503 | $ | 23,292 | $ | 937,211 | $ | — | |||||||
U.S. state and municipal securities | 17,946 | — | 17,946 | — | |||||||||||
Foreign government securities | 187,542 | — | 187,542 | — | |||||||||||
Government guaranteed corporate securities | 3,381 | — | 3,381 | — | |||||||||||
Corporate securities | 2,182,203 | — | 1,994,513 | 187,690 | |||||||||||
Residential mortgage-backed securities | 1,463,232 | — | 1,463,232 | — | |||||||||||
Commercial mortgage-backed securities | 626,851 | — | 626,851 | — | |||||||||||
Collateralized loan and debt obligations | 412,236 | — | 412,236 | — | |||||||||||
Asset-backed securities | 510,773 | — | 510,773 | — | |||||||||||
Total fixed maturity investments | 6,364,667 | 23,292 | 6,153,685 | 187,690 | |||||||||||
Equity securities | |||||||||||||||
Equity investments | 530,014 | 190,659 | 339,355 | — | |||||||||||
Preferred equity investments | 126 | — | 126 | — | |||||||||||
Total equity securities | 530,140 | 190,659 | 339,481 | — | |||||||||||
Short-term investments | 92,848 | — | 92,848 | — | |||||||||||
Other assets (see Note 7) | 235,276 | 1,945 | 190,571 | 42,760 | |||||||||||
Total assets | $ | 7,222,931 | $ | 215,896 | $ | 6,776,585 | $ | 230,450 | |||||||
Liabilities | |||||||||||||||
Other liabilities (see Note 7) | $ | 136,617 | $ | 334 | $ | 98,406 | $ | 37,877 | |||||||
Debt | 810,494 | — | 810,494 | — | |||||||||||
Total liabilities | $ | 947,111 | $ | 334 | $ | 908,900 | $ | 37,877 |
During the three months ended March 31, 2017, no securities were transferred into or out of Level 3. No securities were transferred between Level 3 and Level 2 during the period.
During the three months ended March 31, 2016, $3.6 million of primarily of corporate securities were transferred into Level 3 as no observable inputs were available. $5.0 million of primarily corporate securities were transferred out of Level 3 into Level 2 during the period.
17
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
4. | Fair value measurement, cont'd. |
The following table sets forth the Company's fixed maturity investments, equity securities, short-term investments, other assets and liabilities and debt categorized by the level within the hierarchy in which the fair value measurements fall at December 31, 2016:
Fair Value Measurements at December 31, 2016 | |||||||||||||||
Total at December 31, 2016 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
Assets | |||||||||||||||
Fixed maturity investments | |||||||||||||||
U.S. government and agencies securities | $ | 1,001,882 | $ | 51,827 | $ | 950,055 | $ | — | |||||||
U.S. state and municipal securities | 18,357 | — | 18,357 | — | |||||||||||
Foreign government securities | 178,919 | — | 178,919 | — | |||||||||||
Government guaranteed corporate securities | 3,917 | — | 3,917 | — | |||||||||||
Corporate securities | 2,147,693 | — | 1,968,056 | 179,637 | |||||||||||
Residential mortgage-backed securities | 1,461,286 | — | 1,461,286 | — | |||||||||||
Commercial mortgage-backed securities | 618,848 | — | 618,848 | — | |||||||||||
Collateralized loan and debt obligations | 371,256 | — | 371,256 | — | |||||||||||
Asset-backed securities | 510,663 | — | 510,663 | — | |||||||||||
Total fixed maturity investments | 6,312,821 | 51,827 | 6,081,357 | 179,637 | |||||||||||
Equity securities | |||||||||||||||
Equity investments | 500,968 | 184,251 | 316,717 | — | |||||||||||
Preferred equity investments | 173 | — | 173 | — | |||||||||||
Total equity securities | 501,141 | 184,251 | 316,890 | — | |||||||||||
Short-term investments | 408,704 | — | 408,654 | 50 | |||||||||||
Other assets (see Note 7) | 166,716 | 1,953 | 123,681 | 41,082 | |||||||||||
Total assets | $ | 7,389,382 | $ | 238,031 | $ | 6,930,582 | $ | 220,769 | |||||||
Liabilities | |||||||||||||||
Other liabilities (see Note 7) | $ | 84,069 | $ | 2,772 | $ | 55,051 | $ | 26,246 | |||||||
Debt | 770,704 | — | 770,704 | — | |||||||||||
Total liabilities | $ | 854,773 | $ | 2,772 | $ | 825,755 | $ | 26,246 |
Level 3 assets represented 3.2% and 3.0% of the Company's total fair valued assets at March 31, 2017 and December 31, 2016, respectively. At March 31, 2017 and December 31, 2016, Level 3 securities were primarily comprised of corporate securities and weather derivatives. There were no material changes in the Company's valuation techniques for the three months ended March 31, 2017.
Other assets and other liabilities measured at fair value at March 31, 2017 included Level 3 assets of $42.8 million (December 31, 2016 - $41.1 million) and liabilities of $37.9 million (December 31, 2016 - $26.2 million) related to proprietary, non-exchange traded derivative-based risk management products used in the Company's weather risk management business, and hedging and trading activities related to these risks. In instances where market prices are not available, the Company may use industry or internally developed valuation techniques such as historical analysis and simulation modeling to determine fair value and are considered Level 3.
Observable and unobservable inputs to these valuation techniques vary by contract requirements and commodity type, are validated using market-based or independently sourced parameters where applicable and may typically include the following:
•Observable inputs: contract price, notional, option strike, term to expiry, interest rate, contractual limits,
temperature, rainfall, windspeed, wave height, snow fall, cyclone category;
18
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
4. | Fair value measurement, cont'd. |
•Unobservable inputs: correlation, composite weather variable; and
•Both observable and unobservable: forward commodity price.
The Company's weather curves are determined by taking the average payouts for each transaction within its portfolio utilizing detrended historical weather measurements. The Company's commodity curves are determined using historical market data scaled to currently observed market prices. The range of each unobservable input could vary based on the specific commodity, including, but not limited to natural gas, electricity, crude, liquids, temperature or precipitation. Due to the diversity of the portfolio, the range of unobservable inputs could be wide-spread as reflected in the below table on quantitative information. The unobservable inputs are validated at each reporting period and are only changed when corroborated by evidence such as similar market transactions, third-party pricing services and/or broker or dealer quotations or other empirical market data.
Changes in any or all of the unobservable inputs listed above may contribute positively or negatively to the overall portfolio fair value depending upon the underlying position. In general, movements in weather curves are the largest contributing factor that impacts fair value.
Below is a summary of quantitative information regarding the significant inputs used in determining the fair value of the net weather and energy related derivative assets classified in Level 3 that are measured at fair value on a recurring basis at March 31, 2017 and December 31, 2016:
March 31, 2017 | |||||||||||||||
Fair Value (Level 3) | Valuation Techniques | Inputs | Range | ||||||||||||
Low | High | ||||||||||||||
(Commodity curve in U.S. dollars in thousands) | |||||||||||||||
Net weather and energy related derivative assets | $ | 4,883 | Historical Analysis and Simulation | Correlation | 0 | 1 | |||||||||
Temperature | -15F | 115F | |||||||||||||
Composite weather variable | -25 deg. | 45 deg. | |||||||||||||
Rainfall | 0" | 2" | |||||||||||||
Windspeed | 0.01 m/s | 25 m/s | |||||||||||||
Wave height | 0 m | 25 m | |||||||||||||
Commodity curve | $ | (1 | ) | $ | 14 |
December 31, 2016 | |||||||||||||||
Fair Value (Level 3) | Valuation Techniques | Inputs | Range | ||||||||||||
Low | High | ||||||||||||||
(Commodity curve in U.S. dollars in thousands) | |||||||||||||||
Net weather and energy related derivative assets | $ | 14,836 | Historical Analysis and Simulation | Correlation | 0 | 1 | |||||||||
Temperature | -15F | 115F | |||||||||||||
Composite weather variable | -25 deg. | 45 deg. | |||||||||||||
Rainfall | 0" | 2" | |||||||||||||
Windspeed | 0.01 m/s | 25 m/s | |||||||||||||
Wave height | 0 m | 25 m | |||||||||||||
Commodity curve | $ | (1 | ) | $ | 14 |
19
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
4. | Fair value measurement, cont'd. |
The following tables present a reconciliation of the beginning and ending balances for all assets and liabilities measured at fair value on a recurring basis using Level 3 inputs during the three months ended March 31, 2017 and 2016:
Three Months Ended March 31, 2017 | |||||||||||||||
Fixed maturity investments | Other assets | Total assets | Other liabilities | ||||||||||||
Level 3, beginning of period | $ | 179,687 | $ | 41,082 | $ | 220,769 | $ | (26,246 | ) | ||||||
Total realized and unrealized gains and losses included in earnings | (95 | ) | — | (95 | ) | — | |||||||||
Total income and losses included in other underwriting loss | — | 1,237 | 1,237 | (5,335 | ) | ||||||||||
Change in unrealized gains and losses included in other comprehensive income | — | — | — | — | |||||||||||
Purchases | 27,068 | — | 27,068 | — | |||||||||||
Issues | — | 4,687 | 4,687 | (6,518 | ) | ||||||||||
Sales | (18,970 | ) | — | (18,970 | ) | — | |||||||||
Settlements | — | (4,246 | ) | (4,246 | ) | 222 | |||||||||
Transfers into Level 3 | — | — | — | — | |||||||||||
Transfers out of Level 3 | — | — | — | — | |||||||||||
Level 3, end of period | $ | 187,690 | $ | 42,760 | $ | 230,450 | $ | (37,877 | ) | ||||||
Three Months Ended March 31, 2016 | |||||||||||||||
Fixed maturity investments | Other assets | Total assets | Other liabilities | ||||||||||||
Level 3, beginning of period | $ | 112,453 | $ | 41,503 | $ | 153,956 | $ | (42,029 | ) | ||||||
Total realized and unrealized gains and losses included in earnings | (864 | ) | — | (864 | ) | — | |||||||||
Total income and losses included in other underwriting loss | — | (144 | ) | (144 | ) | (533 | ) | ||||||||
Change in unrealized gains and losses included in other comprehensive income | 415 | — | 415 | — | |||||||||||
Purchases | 671 | — | 671 | — | |||||||||||
Issues | — | 2,692 | 2,692 | (4,093 | ) | ||||||||||
Sales | (2,469 | ) | — | (2,469 | ) | — | |||||||||
Settlements | — | (14,080 | ) | (14,080 | ) | 16,236 | |||||||||
Transfers into Level 3 | 3,629 | — | 3,629 | — | |||||||||||
Transfers out of Level 3 | (5,034 | ) | — | (5,034 | ) | — | |||||||||
Level 3, end of period | $ | 108,801 | $ | 29,971 | $ | 138,772 | $ | (30,419 | ) |
20
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
5. Reserve for losses and loss expenses
Activity in the reserve for losses and loss expenses for the three months ended March 31, 2017 and 2016 is summarized as follows:
Three Months Ended March 31, | ||||||||
2017 | 2016 | |||||||
Gross reserve for losses and loss expenses, beginning of period | $ | 4,905,138 | $ | 4,510,415 | ||||
Reinsurance recoverable on unpaid losses | 1,213,129 | 907,944 | ||||||
Net reserve for losses and loss expenses, beginning of period | 3,692,009 | 3,602,471 | ||||||
Incurred related to: | ||||||||
Current year | 335,119 | 304,437 | ||||||
Prior years | (33,806 | ) | (61,109 | ) | ||||
Total incurred | 301,313 | 243,328 | ||||||
Paid related to: | ||||||||
Current year | (12,386 | ) | (7,051 | ) | ||||
Prior years | (439,208 | ) | (333,227 | ) | ||||
Total paid | (451,594 | ) | (340,278 | ) | ||||
Foreign currency translation and other | 15,774 | 17,075 | ||||||
Net reserve for losses and loss expenses, end of period | 3,557,502 | 3,522,596 | ||||||
Reinsurance recoverable on unpaid losses | 1,277,467 | 935,593 | ||||||
Gross reserve for losses and loss expenses, end of period | $ | 4,834,969 | $ | 4,458,189 |
During the three months ended March 31, 2017, the Company's estimated ultimate losses for prior accident years were reduced by $33.8 million (2016 - $61.1 million) due to lower claims emergence than originally estimated by the Company. During the three months ended March 31, 2017, the Company experienced favorable reserve development of $22.7 million across all lines of business in the Reinsurance segment and $11.1 million of favorable development across all lines of business in the Insurance segment. During the three months ended March 31, 2016, the Company experienced favorable development of $37.9 million across all lines of business in the Reinsurance segment and $23.2 million of favorable development across all lines of business in the Insurance segment.
Reserves for losses and loss expenses are based in part upon the estimation of losses resulting from catastrophic events. Estimation of these losses and loss expenses are based upon the Company's historical claims experience and is inherently difficult because of the Company's short operating history and the possible severity of catastrophe claims. Therefore, the Company uses both proprietary and commercially available models, as well as historical reinsurance industry catastrophe claims experience in addition to its own historical data for purposes of evaluating trends and providing an estimate of ultimate claims costs.
A significant portion of the Company's contracts and policies cover excess layers for high severity exposures. Underwriting results and ultimate claims payments for this type of coverage are therefore not typically reported to the Company until later in the contract and policy lives. As a result, the level of losses reported to date is not necessarily indicative of expected future results.
21
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
6. | Accumulated other comprehensive loss |
The following tables present the changes in accumulated other comprehensive loss balances by component for the three months ended March 31, 2017 and 2016:
For the Three Months Ended March 31, 2017 | |||||||||||||||
Losses on cash flow hedges | Unrealized gains on available for sale securities | Foreign currency translation adjustments | Total | ||||||||||||
Beginning balance | $ | (1,590 | ) | $ | 61,483 | $ | (118,642 | ) | $ | (58,749 | ) | ||||
Other comprehensive income before reclassifications | — | 28,897 | 5,689 | 34,586 | |||||||||||
Amounts reclassified from accumulated other comprehensive loss(1) | 22 | 1,211 | — | 1,233 | |||||||||||
Net current period other comprehensive income | 22 | 30,108 | 5,689 | 35,819 | |||||||||||
Ending balance | $ | (1,568 | ) | $ | 91,591 | $ | (112,953 | ) | $ | (22,930 | ) |
(1)All amounts are net of tax.
For the Three Months Ended March 31, 2016 | |||||||||||||||
Losses on cash flow hedges | Unrealized gains on available for sale securities | Foreign currency translation adjustments | Total | ||||||||||||
Beginning balance | $ | (1,678 | ) | (12,638 | ) | $ | (32,318 | ) | $ | (46,634 | ) | ||||
Other comprehensive income before reclassifications | — | 55,494 | (12,318 | ) | 43,176 | ||||||||||
Amounts reclassified from accumulated other comprehensive loss(1) | 22 | 2,264 | — | 2,286 | |||||||||||
Net current period other comprehensive income | 22 | 57,758 | (12,318 | ) | 45,462 | ||||||||||
Ending balance | $ | (1,656 | ) | $ | 45,120 | $ | (44,636 | ) | $ | (1,172 | ) |
(1)All amounts are net of tax.
22
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
6. | Accumulated other comprehensive loss, cont'd. |
The following tables present the significant items reclassified out of accumulated other comprehensive loss during the three months ended March 31, 2017 and 2016:
Three Months Ended March 31, 2017 | ||||||
Details about accumulated other comprehensive loss components | Amount reclassified from accumulated other comprehensive loss | Affected line item in the Unaudited Condensed Consolidated Statements of Income and Comprehensive Income | ||||
Losses on cash flow hedges - Debt | $ | 22 | Interest expense | |||
22 | Total before income taxes | |||||
— | Income tax expense | |||||
$ | 22 | Total net of income taxes | ||||
Unrealized losses on available for sale securities | $ | 680 | Net realized losses on available for sale securities | |||
430 | Net impairment losses recognized in earnings | |||||
1,110 | Total before income taxes | |||||
101 | Income tax expense | |||||
$ | 1,211 | Total net of income taxes | ||||
Three Months Ended March 31, 2016 | ||||||
Details about accumulated other comprehensive loss components | Amount reclassified from accumulated other comprehensive loss | Affected line item in the Unaudited Condensed Consolidated Statements of Income and Comprehensive Income | ||||
Losses on cash flow hedges - Debt | $ | 22 | Interest expense | |||
22 | Total before income taxes | |||||
— | Income tax expense | |||||
$ | 22 | Total net of income taxes | ||||
Unrealized losses on available for sale securities | $ | 1,877 | Net realized losses on available for sale securities | |||
623 | Net impairment losses recognized in earnings | |||||
2,500 | Total before income taxes | |||||
(236 | ) | Income tax benefit | ||||
$ | 2,264 | Total net of income taxes |
7. | Derivatives |
The Company regularly transacts in certain derivative-based weather risk management products primarily to address weather and energy risks on behalf of third parties. The markets for these derivatives are generally linked to energy and agriculture commodities, weather and other natural phenomena. Generally, the Company's current portfolio of such derivative contracts is of short duration and such contracts are predominantly seasonal in nature. The Company also invests a portion of its investments with third party investment managers with investment guidelines that permit the use of derivative instruments. The Company may enter derivative transactions directly or as part of strategies employed by its external investment managers.
The Company's derivative instruments are recorded in the Condensed Consolidated Balance Sheets at fair value, with changes in fair value and gains and losses recognized in net realized and unrealized gains, net foreign exchange gains and other underwriting loss in the Unaudited Condensed Consolidated Statements of Income and Comprehensive Income.
23
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
7. | Derivatives, cont'd. |
The Company's derivatives are not designated as hedges under current accounting guidance.
The Company's objectives for holding these derivatives are as follows:
Interest Rate Futures, Swaps, Swaptions and Options - to manage exposure to interest rate risk, which can include increasing or decreasing its exposure to this risk through modification of the portfolio composition and duration.
Industry Loss Warranty ("ILW") Swaps - to manage underwriting risk. The Company has entered into ILW swap contracts which provide reinsurance-like protection to the Company for specific loss events associated with certain lines of its business. The Company has also sold ILW protection, which provides reinsurance-like protection to third parties for specific loss events.
Foreign Exchange Forwards, Futures and Options - as part of overall currency risk management and investment strategies.
Credit Default Swaps - to manage market exposures. The Company may assume or economically hedge credit risk through credit default swaps to replicate or hedge investment positions. The original term of these credit default swaps is generally five years or less.
To-Be-Announced Mortgage-backed Securities ("TBAs") - to enhance investment performance and as part of overall investment strategy. TBAs represent commitments to purchase or sell a future issuance of agency mortgage-backed securities. For the period between purchase of a TBA and issuance of the underlying securities, the Company’s position is accounted for as a derivative.
Energy and Weather Contracts – to address weather and energy risks. The Company may purchase or sell contracts with financial settlements based on the performance of an index linked to a quantifiable weather element, such as temperature, precipitation, snowfall or windspeed, and structures with multiple risk triggers indexed to a quantifiable weather element and a weather sensitive commodity price, such as temperature and electrical power or natural gas. Generally, the Company's current portfolio of energy and weather derivative contracts is of comparably short duration and such contracts are predominantly seasonal in nature.
LIBOR Swap – to establish future net cash flows in connection with the Trust Preferred Securities for the five-year period beginning March 30, 2012 as if these securities bore interest at a fixed rate of 4.905%.
Loss Development Cover – as part of the sale of Montpelier U.S. Insurance Company ("MUSIC") to Selective Insurance Group, Inc. ("Selective"), Montpelier Reinsurance Ltd. ("Montpelier Re", now Endurance Bermuda) entered into a loss development cover with MUSIC which ensures that MUSIC's reserve for losses and loss expenses relating to retained business written on or prior to December 31, 2011 remains adequate. Under the loss development cover, any future adverse development associated with such retained reserves will be protected by Endurance Bermuda and any future favorable development associated with such retained reserves will benefit Endurance Bermuda.
24
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
7. | Derivatives, cont'd. |
The fair values and the related notional values of derivatives at March 31, 2017 and December 31, 2016 are shown below.
March 31, 2017 | December 31, 2016 | ||||||||||||||
Fair Value | Notional Principal Amount | Fair Value | Notional Principal Amount | ||||||||||||
Derivatives recorded in other assets | |||||||||||||||
Foreign exchange forward contracts | $ | 357 | $ | 29,396 | $ | 629 | $ | 34,630 | |||||||
Credit default swaps | 197 | 3,150 | 266 | 5,450 | |||||||||||
Interest rate swaps | 426 | 8,200 | 374 | 7,000 | |||||||||||
Interest rate futures | 47 | 4,008 | — | — | |||||||||||
ILWs | 14 | 10,000 | 1,010 | 20,000 | |||||||||||
TBAs | 189,530 | 185,000 | 121,402 | 120,300 | |||||||||||
Energy and weather contracts | 44,705 | 75,060 | 43,035 | 101,436 | |||||||||||
Total recorded in other assets | $ | 235,276 | $ | 166,716 | |||||||||||
Derivatives recorded in other liabilities | |||||||||||||||
Foreign exchange forward contracts | $ | 246 | $ | 31,728 | $ | 1,204 | $ | 32,080 | |||||||
Credit default swaps | 221 | 2,756 | 21 | 2,744 | |||||||||||
Interest rate swaps | 59 | 1,100 | 59 | 1,100 | |||||||||||
Interest rate swaptions | — | — | 34 | 5,400 | |||||||||||
Interest rate futures | 2,969 | 28,476 | — | — | |||||||||||
ILWs | — | — | 184 | 14,209 | |||||||||||
LIBOR swap | — | 100,000 | 27 | 100,000 | |||||||||||
TBAs | 92,272 | 90,300 | 50,704 | 50,400 | |||||||||||
Loss development cover | 2,639 | 24,451 | 2,818 | 24,451 | |||||||||||
Energy and weather contracts | 38,211 | 121,419 | 29,018 | 162,900 | |||||||||||
Total recorded in other liabilities | $ | 136,617 | $ | 84,069 | |||||||||||
Net derivative asset | $ | 98,659 | $ | 82,647 |
At March 31, 2017, the Company's derivative assets of $235.2 million (December 31, 2016 - $166.7 million) and liabilities of $133.6 million (December 31, 2016 - $84.1 million) are subject to master netting agreements, which provide for the ability to settle the derivative asset and liability with each counterparty on a net basis. Interest rate futures are not subject to master netting agreements. At March 31, 2017 and December 31, 2016, the Company's derivative instruments were recorded on a gross basis in the Condensed Consolidated Balance Sheets.
At March 31, 2017, the Company held $5.2 million (December 31, 2016 - nil) of reverse repurchase agreements. These agreements were fully collateralized, were generally outstanding for a short period of time and were presented as part of cash and cash equivalents in the Condensed Consolidated Balance Sheets. The required collateral for these agreements was either cash or U.S. treasury securities at a minimum rate of 102% of the principal amount. Upon maturity, the Company received the principal and interest income.
25
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
7. | Derivatives, cont'd. |
The gains and losses on the Unaudited Condensed Consolidated Statements of Income and Comprehensive Income for derivatives for the three months ended March 31, 2017 and 2016 were as follows:
Three Months Ended March 31, | |||||||
2017 | 2016 | ||||||
Total losses included in net foreign exchange gains from foreign exchange forward contracts | $ | (300 | ) | $ | (538 | ) | |
Interest rate futures | (2,961 | ) | (282 | ) | |||
Credit default swaps | 88 | 30 | |||||
Interest rate swaps | 47 | (51 | ) | ||||
Interest rate swaptions | — | (13 | ) | ||||
ILWs | (812 | ) | 304 | ||||
LIBOR swap | 26 | (144 | ) | ||||
TBAs | (55 | ) | 486 | ||||
Total (losses) gains included in net realized and unrealized gains | (3,667 | ) | 330 | ||||
Energy and weather contracts | (4,790 | ) | (715 | ) | |||
Loss development cover | (14 | ) | (867 | ) | |||
Total losses included in other underwriting loss | (4,804 | ) | (1,582 | ) | |||
Total losses from derivatives | $ | (8,771 | ) | $ | (1,790 | ) |
8. | Stock-based employee compensation and other stock plans |
The Company had a stock-based employee compensation plan, which provided the Company with the ability to grant options to purchase the Company's ordinary shares, share appreciation rights, restricted shares, restricted share units, share bonuses and other equity incentive awards to key employees. The Company recognizes forfeitures of awards as they occur. In accordance with the Company's stock-based employee compensation plan and the Merger Agreement, all of the Company's share-based awards fully vested and were acquired by Sompo upon the acquisition of the Company on March 28, 2017. These awards were settled in cash to employees in April 2017.
A summary of option activity, including options held by employees, during the quarter ended March 31, 2017 is presented below:
For the Three Months Ended March 31, 2017 | |||||||
Options Outstanding | Number of Options | Weighted Average Exercise Price | |||||
Beginning of period | 160,000 | $ | 48.20 | ||||
Granted | — | — | |||||
Settled on close of acquisition of the Company by Sompo | (160,000 | ) | 48.20 | ||||
Forfeited | — | — | |||||
Outstanding, end of period | — | $ | — |
26
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
8. | Stock-based employee compensation and other stock plans, cont'd. |
No options were granted or expired during the quarters ended March 31, 2017 and 2016. 160,000 options vested and were settled during the quarter ended March 31, 2017 (2016 - nil). For the quarter ended March 31, 2017, compensation costs recognized in earnings for all options totaled $0.4 million (2016 - $0.3 million), of which $0.3 million was related to the vesting of options upon the acquisition of the Company by Sompo. At March 31, 2017, there were no (2016 - $0.7 million) compensation costs not yet recognized related to unvested stock options.
A summary of the restricted share and restricted share unit activity during the quarter ended March 31, 2017 is presented below:
Number of Shares/Units | |||
Unvested, beginning of period | 1,466,716 | ||
Granted | — | ||
Settled prior to acquisition of the Company by Sompo | (430,129 | ) | |
Vested on close of acquisition of the Company by Sompo | (1,033,476 | ) | |
Forfeited | (3,111 | ) | |
Unvested, end of period | — |
During the quarter ended March 31, 2017, the Company granted no (2016 – 560,172) restricted shares and restricted share units. The restricted shares and restricted share units granted during the quarter ended March 31, 2016 had weighted average grant date fair values of $33.3 million. During the quarter ended March 31, 2017, the aggregate fair value of restricted shares and restricted share units that vested was $120.9 million (2016 - $33.0 million). For the quarter ended March 31, 2017, compensation costs recognized in earnings for all restricted shares and restricted share units were $41.4 million (2016 - $9.7 million), of which $34.1 million was related to the vesting of restricted shares and restricted share units upon the acquisition of the Company by Sompo. At March 31, 2017, there were no (2016 - $46.3 million) compensation costs not yet recognized related to unvested restricted shares and restricted share units.
Employee Share Purchase Plan
The Company also had an Employee Share Purchase Plan ("ESPP") under which employees of Endurance Holdings and certain of its subsidiaries were able to purchase the Company's ordinary shares. As a result of signing the Merger Agreement with Sompo, the ESPP was suspended as of January 1, 2017 and was terminated upon the closing of the acquisition by Sompo on March 28, 2017. For the three months ended March 31, 2017, total expenses related to the Company's ESPP were nil (2016 - $0.1 million).
9. | Segment reporting |
The determination of the Company's business segments is based on how the Company monitors the performance of its underwriting operations. The Company has two reportable business segments, Insurance and Reinsurance, which are comprised of the following lines of business:
Insurance segment lines of business
•Agriculture
•Casualty and other specialty
•Professional lines
•Property, marine/energy and aviation
Reinsurance segment lines of business
•Catastrophe
•Property
•Casualty
•Professional lines
•Specialty
27
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
9. | Segment reporting, cont'd. |
Management measures Insurance and Reinsurance segment results on the basis of the combined ratio, which is obtained by dividing the sum of the net losses and loss expenses, acquisition expenses and general and administrative expenses by net premiums earned. When purchased within a single line of business, ceded reinsurance and recoveries are accounted for within that line of business. When purchased across multiple lines of business, ceded reinsurance and recoveries are allocated to the lines of business in proportion to the related risks assumed. The Company does not manage its assets by segment; accordingly, investment income and total assets are not allocated to the individual business segments. General and administrative expenses incurred by the segments are allocated directly. Remaining general and administrative expenses not incurred by the segments are classified as corporate expenses and are not allocated to the individual business segments. Ceded reinsurance and recoveries are recorded within the business segment to which they apply.
The following table provides a summary of segment revenues and results for the three months ended March 31, 2017 and the reserve for losses and loss expenses as of March 31, 2017:
Three Months Ended March 31, 2017 | ||||||||||||
Insurance | Reinsurance | Total | ||||||||||
Revenues | ||||||||||||
Gross premiums written | $ | 989,897 | $ | 788,964 | $ | 1,778,861 | ||||||
Ceded premiums written | (543,132 | ) | (216,080 | ) | (759,212 | ) | ||||||
Net premiums written | 446,765 | 572,884 | 1,019,649 | |||||||||
Net premiums earned | 224,650 | 322,382 | 547,032 | |||||||||
Other underwriting loss | — | (5,892 | ) | (5,892 | ) | |||||||
224,650 | 316,490 | 541,140 | ||||||||||
Expenses | ||||||||||||
Net losses and loss expenses | 149,218 | 152,095 | 301,313 | |||||||||
Acquisition expenses | 41,119 | 78,005 | 119,124 | |||||||||
General and administrative expenses | 48,114 | 25,843 | 73,957 | |||||||||
238,451 | 255,943 | 494,394 | ||||||||||
Underwriting (loss) income | $ | (13,801 | ) | $ | 60,547 | 46,746 | ||||||
Net investment income | 52,850 | |||||||||||
Corporate expenses | (70,367 | ) | ||||||||||
Net foreign exchange gains | 1,157 | |||||||||||
Net realized and unrealized gains | 4,093 | |||||||||||
Net impairment losses recognized in earnings | (430 | ) | ||||||||||
Amortization of intangibles | (15,934 | ) | ||||||||||
Interest expense | (10,788 | ) | ||||||||||
Income before income taxes | $ | 7,327 | ||||||||||
Net loss ratio | 66.4 | % | 47.2 | % | 55.0 | % | ||||||
Acquisition expense ratio | 18.3 | % | 24.2 | % | 21.8 | % | ||||||
General and administrative expense ratio | 21.4 | % | 8.0 | % | 26.4 | % | (1) | |||||
Combined ratio | 106.1 | % | 79.4 | % | 103.2 | % | ||||||
Reserve for losses and loss expenses | $ | 2,716,325 | $ | 2,118,644 | $ | 4,834,969 |
(1) Total general and administrative expense ratio includes general and administrative expenses and corporate expenses.
28
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
9. | Segment reporting, cont'd. |
The following table provides a summary of segment revenues and results for the three months ended March 31, 2016 and the reserve for losses and loss expenses as of March 31, 2016:
Three Months Ended March 31, 2016 | ||||||||||||
Insurance | Reinsurance | Total | ||||||||||
Revenues | ||||||||||||
Gross premiums written | $ | 835,117 | $ | 776,560 | $ | 1,611,677 | ||||||
Ceded premiums written | (464,173 | ) | (208,662 | ) | (672,835 | ) | ||||||
Net premiums written | 370,944 | 567,898 | 938,842 | |||||||||
Net premiums earned | 219,569 | 333,622 | 553,191 | |||||||||
Other underwriting loss | — | (2,444 | ) | (2,444 | ) | |||||||
219,569 | 331,178 | 550,747 | ||||||||||
Expenses | ||||||||||||
Net losses and loss expenses | 126,132 | 117,196 | 243,328 | |||||||||
Acquisition expenses | 30,358 | 73,484 | 103,842 | |||||||||
General and administrative expenses | 38,429 | 33,796 | 72,225 | |||||||||
194,919 | 224,476 | 419,395 | ||||||||||
Underwriting income | $ | 24,650 | $ | 106,702 | 131,352 | |||||||
Net investment income | 11,181 | |||||||||||
Corporate expenses | (11,771 | ) | ||||||||||
Net foreign exchange gains | 11,729 | |||||||||||
Net realized and unrealized gains | 13,787 | |||||||||||
Net impairment losses recognized in earnings | (623 | ) | ||||||||||
Amortization of intangibles | (21,374 | ) | ||||||||||
Interest expense | (10,870 | ) | ||||||||||
Income before income taxes | $ | 123,411 | ||||||||||
Net loss ratio | 57.5 | % | 35.2 | % | 43.9 | % | ||||||
Acquisition expense ratio | 13.8 | % | 22.0 | % | 18.8 | % | ||||||
General and administrative expense ratio | 17.5 | % | 10.1 | % | 15.2 | % | (1) | |||||
Combined ratio | 88.8 | % | 67.3 | % | 77.9 | % | ||||||
Reserve for losses and loss expenses | $ | 2,422,960 | $ | 2,035,229 | $ | 4,458,189 |
(1) Total general and administrative expense ratio includes general and administrative expenses and corporate expenses.
29
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
9. | Segment reporting, cont'd. |
The following table provides gross and net premiums written by line of business for the three months ended March 31, 2017 and 2016:
Gross premiums written | Net premiums written | Gross premiums written | Net premiums written | ||||||||||||
Business Segment | 2017 | 2017 | 2016 | 2016 | |||||||||||
Insurance | |||||||||||||||
Agriculture | $ | 545,041 | $ | 264,343 | $ | 496,216 | $ | 208,627 | |||||||
Casualty and other specialty | 196,585 | 82,752 | 138,255 | 63,497 | |||||||||||
Professional lines | 99,886 | 45,953 | 77,415 | 43,334 | |||||||||||
Property, marine/energy and aviation | 148,385 | 53,717 | 123,231 | 55,486 | |||||||||||
Total Insurance | 989,897 | 446,765 | 835,117 | 370,944 | |||||||||||
Reinsurance | |||||||||||||||
Catastrophe | 207,473 | 98,191 | 200,830 | 88,868 | |||||||||||
Property | 143,149 | 123,417 | 156,466 | 150,056 | |||||||||||
Casualty | 63,932 | 63,869 | 98,720 | 98,719 | |||||||||||
Professional lines | 78,040 | 76,539 | 48,549 | 48,220 | |||||||||||
Specialty | 296,370 | 210,868 | 271,995 | 182,035 | |||||||||||
Total Reinsurance | 788,964 | 572,884 | 776,560 | 567,898 | |||||||||||
Total | $ | 1,778,861 | $ | 1,019,649 | $ | 1,611,677 | $ | 938,842 |
10. | Commitments and contingencies |
Concentrations of credit risk. The Company's reinsurance recoverables on paid and unpaid losses at March 31, 2017 and December 31, 2016 amounted to $1,628.9 million and $1,486.9 million, respectively. At March 31, 2017, substantially all reinsurance recoverables on paid and unpaid losses were due from the U.S. government or from reinsurers rated A- or better by A.M. Best Company, Inc. or Standard & Poor's Corporation. At March 31, 2017 and December 31, 2016, the Company held collateral of $501.3 million and $493.3 million, respectively, related to its ceded reinsurance agreements.
Major production sources. The following table shows the percentage of gross premiums written generated through the Company's largest brokers for the three months ended March 31, 2017 and 2016, respectively:
Broker | 2017 | 2016 | ||||
Marsh & McLennan Companies, Inc. | 15.7 | % | 19.1 | % | ||
Aon Benfield | 14.0 | % | 13.4 | % | ||
Willis Companies | 7.8 | % | 8.9 | % | ||
Total of largest brokers | 37.5 | % | 41.4 | % |
Letters of credit. As of March 31, 2017, the Company had issued letters of credit of $224.4 million (December 31, 2016 – $222.3 million) under its credit facilities and letter of credit reimbursement agreements in favor of certain ceding companies to collateralize obligations.
Investment commitments. As of March 31, 2017 and December 31, 2016, the Company had pledged cash and cash equivalents and fixed maturity investments of $105.7 million and $106.8 million, respectively, in favor of certain ceding companies to collateralize obligations. As of March 31, 2017 and December 31, 2016, the Company had also pledged $248.3 million and $252.2 million of its cash and fixed maturity investments as required to meet collateral obligations for $224.4 million and $222.3 million, respectively, in letters of credit outstanding under its credit facilities and letter of credit reimbursement agreements. In addition, as of March 31, 2017 and December 31, 2016, cash and fixed maturity investments with fair values of $207.6 million and $207.8 million were on deposit with U.S. state regulators, respectively.
30
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
10. | Commitments and contingencies, cont'd. |
The Company is subject to certain commitments with respect to other investments at March 31, 2017 and December 31, 2016. See Note 3, Investments.
Investment assets held in trust. Blue Water Re and Blue Water Re II do not operate with a financial strength rating and, instead, fully collateralize their reinsurance obligations through cash and cash equivalents held in trust funds established by Blue Water Re and Blue Water Re II (the "Blue Water Trusts") for the benefit of ceding companies. As of March 31, 2017, the fair value of the assets held in the Blue Water Trusts was $391.1 million (December 31, 2016 - $427.8 million), which met the minimum value required on that date.
As of March 31, 2017, Blue Capital Re had pledged $181.9 million (December 31, 2016 - $191.4 million) of its cash and cash equivalents to trust accounts established for the benefit of Blue Water Re.
Blue Capital Re ILS fully collateralizes its insurance-linked security obligations through cash and cash equivalents held in trust funds established by Blue Capital Re ILS (the "Blue Capital Re ILS Trusts") for the benefit of third parties. As of March 31, 2017, the fair value of the assets held in the Blue Capital Re ILS Trusts was $3.1 million (December 31, 2016 - $3.3 million), which met the minimum value required on that date.
During 2015, Endurance Bermuda established a multi-beneficiary reinsurance trust (the "Endurance Reinsurance Trust") domiciled in Delaware. The Endurance Reinsurance Trust was established as a means of providing statutory credit to Endurance Bermuda's U.S. cedants. As of March 31, 2017, the fair value of the investments held in the Endurance Reinsurance Trust exceeded $768.3 million (December 31, 2016 - $783.9 million), the minimum value required on that date.
During 2015, Endurance Bermuda also established a second multi-beneficiary reinsurance trust domiciled in Delaware as a means of providing statutory credit to Endurance Bermuda's U.S. cedants in connection with a reduction in collateral requirements in certain states (the "Reduced Collateral Trust"). As of March 31, 2017, the fair value of the assets held in the Reduced Collateral Trust exceeded $25.1 million (December 31, 2016 - $16.4 million), the minimum value required on that date.
Endurance Bermuda is party to a reinsurance trust (the "MUSIC Trust"). The MUSIC Trust was established as a means of providing statutory credit to MUSIC in support of the business retained in connection with the 2011 sale by Montpelier Re of MUSIC. As of March 31, 2017, the fair value of the assets held in the MUSIC Trust was $24.9 million (December 31, 2016 - $24.6 million), the minimum value required on that date.
Endurance Bermuda is party to a Lloyd's Deposit Trust Deed (the "Lloyd's Capital Trust") in order to meet Endurance Corporate Capital Limited ("ECCL")'s ongoing funds at Lloyd's ("FAL") requirements. The minimum value of cash and investments held by the Lloyd’s Capital Trust is subject to approval by Lloyd's and is based on ECCL's Solvency Capital Requirement, which is used to determine the required amount of FAL. As of March 31, 2017, the fair value of cash and investments held in the Lloyd's Capital Trust was $324.2 million (December 31, 2016 - $323.6 million), which met the minimum value required on that date.
Premiums received by Syndicate 5151 are required to be received into the Lloyd's Premiums Trust Funds (the "Premiums Trust Funds"). Under the Premiums Trust Funds' deeds, assets may only be used for the payment of claims and valid expenses for a stated period of time. As of March 31, 2017, the fair value of all assets held in the Premiums Trust Funds was $178.4 million (December 31, 2016 - $184.1 million).
The Company's investment assets held in trust appear on the Company's Condensed Consolidated Balance Sheets as cash and cash equivalents, fixed maturity investments and accrued investment income, as appropriate.
Lloyd's New Central Fund. The Lloyd's New Central Fund is available to satisfy claims if a member of Lloyd's is unable to meet its obligations to policyholders. The Lloyd's New Central Fund is funded by an annual levy imposed on members, which is determined annually by Lloyd's as a percentage of each member's gross written premiums (2017 - 0.35%; 2016 - 0.35%). In addition, the Council of Lloyd's has power to call on members to make an additional contribution to the Lloyd's New Central Fund of up to 3.0% of their underwriting capacity each year should it decide that such additional contributions are necessary. The Company currently estimates that its 2017 obligation to the Lloyd's New Central Fund will be approximately $1.5 million (2016 - $1.1 million) and accrues for this obligation ratably throughout the year on a quarterly basis.
31
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
10. | Commitments and contingencies, cont'd. |
Lloyd's also imposes other charges on its members and the syndicates on which they participate, including an annual subscription charge (2017 - 0.40%; 2016 - 0.45%), a market modernization levy (2017- 0.9%; 2016 - 0.1%) and an overseas business charge, levied as a percentage of gross international premiums (defined as business outside the U.K. and the Channel Islands), with the percentage depending on the type of business written. Lloyd's also has power to impose additional charges under Lloyd's Powers of Charging Byelaw. The Company currently estimates that its 2017 obligation to Lloyd's for such charges will be approximately $2.1 million (2016 - $1.8 million) and accrues for this obligation ratably throughout the year on a quarterly basis.
BCRH Credit Facility. The Company, through a wholly-owned subsidiary, is party to an unsecured $20.0 million credit facility agreement with BCRH (the "BCRH Credit Facility"). As of March 31, 2017, BCRH had no outstanding borrowings under the BCRH Credit Facility (2016 - nil).
BCGR Credit Facility. The Company, through a wholly-owned subsidiary, is party to an unsecured $20.0 million credit facility agreement with BCGR (the "BCGR Credit Facility"). As of March 31, 2017, BCGR had no outstanding borrowings under the BCGR Credit Facility (2016 - nil).
Reinsurance commitments. In the ordinary course of business, the Company periodically enters into reinsurance agreements that include terms that could require the Company to collateralize certain of its obligations.
Employment agreements. The Company has entered into employment agreements with certain officers that provide for incentive awards, executive benefits and severance payments under certain circumstances.
Operating leases. The Company leases office space and office equipment under operating leases. Future minimum lease commitments at March 31, 2017 are as follows:
Twelve months ended March 31, | Amount | |||
2018 | $ | 16,295 | ||
2019 | 21,872 | |||
2020 | 22,549 | |||
2021 | 21,228 | |||
2022 | 17,909 | |||
2023 and thereafter | 99,741 | |||
$ | 199,594 |
Total net lease expense under operating leases for the three months ended March 31, 2017 was $3.4 million (2016 – $3.3 million).
Legal proceedings. The Company is party to various legal proceedings generally arising in the normal course of its business. While any proceeding contains an element of uncertainty, the Company does not believe that the eventual outcome of any litigation or arbitration proceeding to which it is presently a party could have a material adverse effect on its financial condition or business. Pursuant to the Company's insurance and reinsurance agreements, disputes are generally required to be settled by arbitration.
11. | Related party transactions |
On March 28, 2017, Sompo completed its acquisition of 100% of the outstanding ordinary shares of the Company. The Company has entered into assumed and ceded reinsurance arrangements with certain subsidiaries and affiliates of Sompo.
32
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
11. | Related party transactions, cont'd. |
The following table presents the impact of the related party reinsurance arrangements in the Company's Unaudited Condensed Consolidated Balance Sheet at March 31, 2017:
2017 | |||
Premiums receivable | 2,326 | ||
Deferred acquisition costs | 1,188 | ||
Prepaid reinsurance premiums | 10,728 | ||
Reinsurance recoverable on unpaid losses | 11,120 | ||
Reinsurance recoverable on paid losses | 2,672 | ||
Reserve for losses and loss expenses | 12,717 | ||
Reserve for unearned premiums | 4,297 | ||
Reinsurance balances payable | 792 |
33
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion and analysis of the financial condition and results of operations for the three months ended March 31, 2017 of Endurance Specialty Holdings Ltd. ("Endurance Holdings") and its wholly-owned subsidiaries (collectively, the "Company"). This discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and related notes contained in this Quarterly Report on Form 10-Q (this "Form 10-Q") as well as the audited consolidated financial statements and related notes for the fiscal year ended December 31, 2016, the discussions of critical accounting policies and the qualitative and quantitative disclosure about market risk contained in Endurance Holdings' Annual Report on Form 10-K for the fiscal year ended December 31, 2016 (the "2016 Form 10-K").
Some of the information contained in this discussion and analysis or set forth elsewhere in this Form 10-Q, including information with respect to the Company's plans and strategy for its business, includes forward-looking statements that involve risk and uncertainties. Please see the section "Cautionary Statement Regarding Forward-Looking Statements" for more information on factors that could cause actual results to differ materially from the results described in or implied by any forward-looking statements contained in this discussion and analysis. You should review the "Risk Factors" set forth in the 2016 Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained herein.
Overview
Endurance Holdings was organized as a Bermuda holding company on June 27, 2002 and writes specialty lines of property and casualty insurance and reinsurance on a global basis through its operating subsidiaries. The Company seeks to create a portfolio of specialty lines of business that are profitable and have limited correlation with one another. The Company's portfolio of specialty lines of business is organized into two business segments, Insurance and Reinsurance.
In the Insurance segment, the Company writes agriculture, casualty and other specialty, professional lines, and property, marine/energy and aviation insurance. In the Reinsurance segment, the Company writes catastrophe, property, casualty, professional lines and specialty reinsurance.
The Company's Insurance and Reinsurance segments both include property related coverages, which provide insurance or reinsurance of an insurable interest in tangible property for property loss, damage or loss of use. In addition, the Company's Insurance and Reinsurance segments include various casualty insurance and reinsurance coverages, which are primarily concerned with the losses caused by injuries to third parties, i.e., not the insured, or to property owned by third parties and the legal liability imposed on the insured resulting from such injuries.
As part of its collateralized reinsurance and third party asset management operations, Endurance Holdings and Endurance Specialty Insurance Ltd. ("Endurance Bermuda") together own 33.3% of Blue Capital Reinsurance Holdings Ltd. ("BCRH")'s common shares, and Endurance Bermuda owns 28.0% of Blue Capital Global Reinsurance Fund Limited ("BCGR")'s ordinary shares.
BCRH is a Bermuda-based exempted limited liability holding company managed by a subsidiary of the Company. BCRH provides fully-collateralized property catastrophe reinsurance and invests in various insurance-linked securities through its wholly-owned Bermuda-based subsidiaries, Blue Capital Re. Ltd. and Blue Capital Re ILS Ltd. Blue Capital Re Ltd. is a Class 3A insurer licensed under the Bermuda Insurance Act. BCRH's shares are listed on the New York Stock Exchange and the Bermuda Stock Exchange.
BCGR is a closed-ended mutual fund incorporated in Bermuda and managed by a subsidiary of the Company. BCGR serves as the feeder fund for the Blue Capital Global Reinsurance SA-I cell. BCGR's shares are listed on the Specialist Fund Market of the London Stock Exchange and on the Bermuda Stock Exchange.
On October 5, 2016, the Company entered into an agreement and plan of merger (the "Merger Agreement") for the acquisition of 100% of the outstanding ordinary shares of the Company by Sompo Holdings, Inc. ("Sompo") for $93.00 per share in cash (the "Merger"). The Merger was approved by each company's Board of Directors and the Company's ordinary and preferred shareholders at a special general meeting.
On March 28, 2017, Sompo completed its acquisition of the Company following receipt of all shareholder and regulatory approvals. Pursuant to the terms of the Merger Agreement, Endurance Holdings ordinary shares ceased trading on the New York Stock Exchange ("NYSE") and each Endurance Holdings issued and outstanding ordinary share was canceled and converted into the right to receive $93.00 per share. The Company's 6.35% Non-Cumulative Preferred Shares, Series C (the "Series C Preferred Shares") continue to be traded on the NYSE following the close of the transaction.
Under the terms of the Merger Agreement, the aggregate consideration for the Merger was $6,288.7 million in cash. The purchase was financed by Sompo from existing sources of liquidity and supplementary facilities. In connection with the acquisition by Sompo, the Company incurred transaction expenses of $56.2 million for the three months ended
34
March 31, 2017, related primarily to equity compensation expenses, professional fees and investment banking fees. These expenses have been reported as a component of corporate expenses.
Application of Critical Accounting Estimates
The Company's unaudited condensed consolidated financial statements are based on the selection of accounting policies and application of significant accounting estimates which require management to make significant estimates and assumptions. The Company believes that some of the more critical judgments in the areas of accounting estimates and assumptions that affect its financial condition and results of operations are related to the recognition of premiums written and ceded, reserves for losses and loss expenses, other-than-temporary impairments within the investment portfolio and fair value measurements of certain portions of the investment portfolio. There were no material changes in the application of the Company's critical accounting estimates. Management has discussed the application of these critical accounting estimates with the Company's Board of Directors and the Audit Committee of the Board of Directors. For a detailed discussion of the Company's critical accounting estimates, please refer to the 2016 Form 10-K and the Notes to the Unaudited Condensed Consolidated Financial Statements in this Form 10-Q.
Consolidated Results of Operations – For the Three Months Ended March 31, 2017 and 2016
Results of operations for the three months ended March 31, 2017 and 2016 were as follows:
Three Months Ended March 31, | ||||||||||
2017 | 2016 | Change(1) | ||||||||
(U.S. dollars in thousands, except for ratios) | ||||||||||
Revenues | ||||||||||
Gross premiums written | $ | 1,778,861 | $ | 1,611,677 | 10.4 | % | ||||
Ceded premiums written | (759,212 | ) | (672,835 | ) | 12.8 | % | ||||
Net premiums written | 1,019,649 | 938,842 | 8.6 | % | ||||||
Net premiums earned | 547,032 | 553,191 | (1.1 | )% | ||||||
Net investment income | 52,850 | 11,181 | 372.7 | % | ||||||
Net realized and unrealized gains | 4,093 | 13,787 | (70.3 | )% | ||||||
Net impairment losses recognized in earnings | (430 | ) | (623 | ) | (31.0 | )% | ||||
Other underwriting loss | (5,892 | ) | (2,444 | ) | 141.1 | % | ||||
Total revenues | 597,653 | 575,092 | 3.9 | % | ||||||
Expenses | ||||||||||
Net losses and loss expenses | 301,313 | 243,328 | 23.8 | % | ||||||
Acquisition expenses | 119,124 | 103,842 | 14.7 | % | ||||||
General and administrative expenses | 73,957 | 72,225 | 2.4 | % | ||||||
Corporate expenses | 70,367 | 11,771 | 497.8 | % | ||||||
Amortization of intangibles | 15,934 | 21,374 | (25.5 | )% | ||||||
Net foreign exchange gains | (1,157 | ) | (11,729 | ) | (90.1 | )% | ||||
Interest expense | 10,788 | 10,870 | (0.8 | )% | ||||||
Income tax benefit | (19,056 | ) | (1,233 | ) | NM(2) | |||||
Net income | 26,383 | 124,644 | (78.8 | )% | ||||||
Net income attributable to non-controlling interests | (6,955 | ) | (9,063 | ) | (23.3 | )% | ||||
Preferred dividends | (3,651 | ) | (9,203 | ) | (60.3 | )% | ||||
Net income available to Endurance Holdings' common and participating common shareholders | $ | 15,777 | $ | 106,378 | (85.2 | )% | ||||
Net loss ratio | 55.0 | % | 43.9 | % | 11.1 | |||||
Acquisition expense ratio | 21.8 | % | 18.8 | % | 3.0 | |||||
General and administrative expense ratio(3) | 26.4 | % | 15.2 | % | 11.2 | |||||
Combined ratio | 103.2 | % | 77.9 | % | 25.3 |
(1) | With respect to ratios, changes show increase or decrease in percentage points. |
(2) | Not meaningful. |
(3) | General and administrative expense ratio includes general and administrative expenses and corporate expenses. |
35
Premiums
Gross premiums written in the three months ended March 31, 2017 were $1,778.9 million, an increase of $167.2 million, or 10.4%, compared to the same period in 2016. Net premiums written in the three months ended March 31, 2017 were $1,019.6 million, an increase of $80.8 million, or 8.6% compared to the same period in 2016. The increase in gross premiums written were driven by the following factors:
• | An increase in gross premiums written in the agriculture line of business in the Insurance segment primarily due to higher commodity prices; |
• | An increase in gross premiums written in the property, marine/energy and aviation, professional lines and casualty and other specialty lines of business in the Insurance segment due primarily to business generated by new underwriting teams in the U.S. and the U.K.; |
• | An increase in gross premiums written in the catastrophe line of business in the Reinsurance segment due to new international business, partially offset by rate declines and non-renewal of policies that no longer met profitability targets; |
• | A decrease in gross premiums written in the property line of business in the Reinsurance segment due to non-renewal of policies that no longer met profitability targets; |
• | A decline in gross premiums written in the casualty line of business in the Reinsurance segment due to the timing of renewal for a large eighteen month international contract and non-renewal of policies that no longer met profitability targets; |
• | An increase in gross premiums written in the professional lines of business in the Reinsurance segment due to increases in signed lines; and |
• | An increase in gross premiums written in the specialty line of business in the Reinsurance segment due to new surety business written and increased renewals in the surety and engineering businesses, partially offset by non-renewal of policies that no longer met profitability targets. |
Ceded premiums written increased 12.8% during the quarter ended March 31, 2017 as compared to the same period in 2016. In the Insurance segment, increased gross premiums written resulted in increased ceded premiums under the whole account quota share treaty covering the entire Insurance segment's business, combined with additional purchases of facultative and excess of loss reinsurance in the property, marine/energy and aviation line of business. In the Reinsurance segment, ceded premiums written increased primarily due to growth in gross written premiums ceded under existing quota share treaties, combined with additional purchases of facultative reinsurance in the property line of business.
Net premiums earned for the three months ended March 31, 2017 were $547.0 million, a decrease of $6.2 million, or 1.1%, from the first quarter of 2016 due to the increase in ceded premiums, partially offset by the increase in gross premiums written.
Net Investment Income
The Company's net investment income of $52.9 million increased by 372.7%, or $41.7 million, for the quarter ended March 31, 2017 as compared to the same period in 2016. This increase resulted primarily from the Company's other investments. Net investment income during the first quarter of 2017 included net mark to market gains of $13.1 million on other investments as compared to mark to market losses of $28.3 million in the first quarter of 2016. Investment expenses, including investment management fees, for the three months ended March 31, 2017 were $4.5 million compared to $3.9 million for the same period in 2016.
During the first quarter of 2017, the yield on the benchmark three year U.S. Treasury bond fluctuated within a 30 basis point range, with a high of 1.69% and a low of 1.39%. Trading activity in the Company's trading and available for sale portfolios during the first quarter included reductions in short-term investments and U.S. government and agencies securities, and increased allocations to corporate securities, collateralized loan and debt obligations, equity securities, residential and commercial mortgage-backed securities and foreign government securities. The duration of fixed income investments increased to 3.13 years at March 31, 2017 from 3.04 years at December 31, 2016.
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Net Realized and Unrealized Gains
The Company's investment portfolio is actively managed to generate attractive economic returns and income. Movements in financial markets and interest rates influence the timing and recognition of net realized investment gains and losses as the portfolio is adjusted and rebalanced. Proceeds from sales and maturities of investments classified as trading and available for sale during the three months ended March 31, 2017 were $1,647.4 million compared to $1,718.1 million during the same period a year ago. Net realized and unrealized gains decreased during the three months ended March 31, 2017 compared to the same period in 2016 due to lower unrealized gains on trading securities and increased losses on investment-related derivative financial instruments.
Gross realized investment gains and losses, net unrealized gains on trading securities and the change in the fair value of investment-related derivative financial instruments for the three months ended March 31, 2017 and 2016 were as follows:
Three Months Ended March 31, | |||||||
2017 | 2016 | ||||||
(U.S. dollars in thousands) | |||||||
Gross realized gains on investment sales | $ | 8,169 | $ | 9,856 | |||
Gross realized losses on investment sales | (7,899 | ) | (11,195 | ) | |||
Net unrealized gains on trading securities | 7,490 | 14,796 | |||||
Change in fair value of investment-related derivative financial instruments | (3,667 | ) | 330 | ||||
Net realized and unrealized gains | $ | 4,093 | $ | 13,787 |
Net Foreign Exchange Gains
For the three months ended March 31, 2017, the Company re-measured its monetary assets and liabilities denominated in foreign currencies, which resulted in a net foreign exchange gain of $1.2 million compared to a net foreign exchange gain of $11.7 million for the same period of 2016. The current period net foreign exchange gain partly resulted from the disposal of available for sale investments and the recognition of realized foreign exchange losses in net income from accumulated other comprehensive loss. Additionally, the U.S. dollar weakening modestly against other key currencies during the period resulted in the upward revaluation of net liability positions across the business which offset the recorded gains. In the prior year, the net foreign exchange gain resulted from the U.S. dollar and British Sterling generally weakening against other key currencies during the period resulting in the upward revaluation of net asset positions in those currencies.
Net Losses and Loss Expenses
The Company's net loss ratio for the three months ended March 31, 2017 increased compared to the same period in 2016 due primarily to an increase in the current accident year loss ratio in the Insurance segment and a decrease in favorable prior year loss reserve development in the current quarter.
Favorable prior year loss reserve development was $33.8 million for the first quarter of 2017, which decreased the net loss ratio by 6.2 percentage points, compared to $61.1 million during the same period in 2016, which decreased the net loss ratio by 11.0 percentage points. In the first quarter of 2017, prior year loss reserves emerged favorably across all lines of business in the Insurance and Reinsurance segments.
The Company participates in lines of business where claims may not be reported for many years. Accordingly, management does not believe that reported claims are the only valid means for estimating ultimate obligations. Ultimate losses and loss expenses may differ materially from the amounts recorded in the Company's unaudited consolidated financial statements. These estimates are reviewed regularly and, as experience develops and new information becomes known, the reserves are adjusted as necessary. Reserve adjustments, if any, are recorded in earnings in the period in which they are determined. The overall loss reserves were established by the Company's actuaries and reflect management's best estimate of ultimate losses. See "Reserve for Losses and Loss Expenses" below for further discussion.
Acquisition Expenses
The acquisition expense ratio for the three months ended March 31, 2017 was higher than the same period in 2016. For the three months ended March 31, 2016, the addition of earned premiums from the Company's acquisition of Montpelier, which had no associated acquisition costs, decreased the acquisition expense ratio for that period.
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General and Administrative Expenses and Corporate Expenses
The Company's general and administrative expense ratio for the first quarter of 2017 increased by 11.2 percentage points compared to the same period in 2016 primarily due to transaction costs associated with the Company's acquisition by Sompo, which are included in corporate expenses. Excluding these transaction costs, general and administrative and corporate expenses increased due to an increase in personnel costs, partially offset by increased ceding commission reimbursements as a result of increased ceded premiums. At March 31, 2017, the Company had a total of 1,269 employees compared to 1,148 employees at March 31, 2016.
Income Tax Benefit
The Company recorded an income tax benefit for the quarter ended March 31, 2017 of $19.1 million compared to an income tax benefit of $1.2 million for the quarter ended March 31, 2016. The income tax benefit in 2017 resulted from an increase in net operating loss carryforwards primarily from transaction costs associated with the Company's acquisition by Sompo for which no valuation allowance was recorded.
Net Income
The Company generated net income of $26.4 million in the three months ended March 31, 2017 compared to net income of $124.6 million in the same period of 2016. The decrease in net income in the current period primarily resulted from increased corporate expenses, net losses and loss expenses, acquisition expenses, decreased net foreign exchange gain and net realized and unrealized gains, partially offset by increased net investment income and income tax benefit, decreased amortization expense and lower preferred dividends.
Net Income Attributable to Non-controlling Interests
The Company's net income attributable to non-controlling interests was $7.0 million in the three months ended March 31, 2017 compared to $9.1 million in the same period of 2016. At March 31, 2017, Endurance Holdings and Endurance Bermuda together owned 33.3% of BCRH's common shares and Endurance Bermuda owned 28.0% of BCGR's ordinary shares. Net income attributable to non-controlling interests relates to the share of the Company's net income attributable to the BCRH common shares and BCGR ordinary shares that are not owned by the Company.
Reserve for Losses and Loss Expenses
As of March 31, 2017, the Company had accrued losses and loss expense reserves of $4.8 billion (December 31, 2016 - $4.9 billion). This amount represents management's best estimate of the ultimate liability for payment of losses and loss expenses related to loss events. During the three months ended March 31, 2017 and 2016, the Company's net paid losses and loss expenses were $451.6 million and $340.3 million, respectively.
As more fully described under "Reserving Process" in the Company's Management's Discussion and Analysis of Financial Condition and Results of Operations in the 2016 Form 10-K, the Company incorporates a variety of actuarial methods and judgments in its reserving process. Two key inputs in the various actuarial methods employed by the Company are initial expected loss ratios and expected loss reporting patterns. These key inputs impact the potential variability in the estimate of the reserve for losses and loss expenses and are applicable to each of the Company's business segments. The Company's loss and loss expense reserves consider and reflect, in part, deviations resulting from differences between expected loss and actual loss reporting as well as judgments relating to the weights applied to the reserve levels indicated by the actuarial methods. Expected loss reporting patterns are based upon internal and external historical data and assumptions regarding claims reporting trends over a period of time that extends beyond the Company's own operating history.
Differences between actual reported losses and expected losses are anticipated to occur in any individual period and such deviations may influence future initial expected loss ratios and/or expected loss reporting patterns as the recent actual experience becomes part of the historical data utilized as part of the ongoing reserve estimation process. The Company has demonstrated the impact of changes in the speed of the loss reporting patterns, as well as changes in the expected loss ratios, within the tables under the heading "Potential Variability in Reserves for Losses and Loss Expenses" in the Company's Management's Discussion and Analysis of Financial Condition and Results of Operations in the 2016 Form 10-K.
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Losses and loss expenses for the three months ended March 31, 2017 are summarized as follows:
Incurred related to: | |||||||||||
Three Months Ended March 31, 2017 | Current year | Prior years | Total incurred losses | ||||||||
(U.S. dollars in thousands) | |||||||||||
Insurance: | |||||||||||
Agriculture | $ | 32,023 | $ | (4,646 | ) | $ | 27,377 | ||||
Casualty and other specialty | 55,494 | (5,726 | ) | 49,768 | |||||||
Professional lines | 26,196 | (294 | ) | 25,902 | |||||||
Property, marine/energy and aviation | 46,574 | (403 | ) | 46,171 | |||||||
Total Insurance | 160,287 | (11,069 | ) | 149,218 | |||||||
Reinsurance: | |||||||||||
Catastrophe | 19,421 | (971 | ) | 18,450 | |||||||
Property | 29,912 | (3,075 | ) | 26,837 | |||||||
Casualty | 41,299 | (7,145 | ) | 34,154 | |||||||
Professional lines | 39,348 | (4,636 | ) | 34,712 | |||||||
Specialty | 44,852 | (6,910 | ) | 37,942 | |||||||
Total Reinsurance | 174,832 | (22,737 | ) | 152,095 | |||||||
Totals | $ | 335,119 | $ | (33,806 | ) | $ | 301,313 |
Losses and loss expenses for the three months ended March 31, 2017 included $33.8 million in favorable development of reserves relating to prior accident years. The favorable loss reserve development experienced during the three months ended March 31, 2017 benefited the Company's reported net loss ratio by approximately 6.2 percentage points. This net reduction in estimated losses for prior accident years reflects lower than expected claims emergence for the three months ended March 31, 2017 in all lines of business within the Insurance and Reinsurance segments.
For the three months ended March 31, 2017, the Company did not materially alter the key inputs utilized to establish reserve for losses and loss expenses (initial expected loss ratios and loss reporting patterns) related to prior years for the insurance and reinsurance segments as the variances in reported losses for those segments were within the range of possible results anticipated by the Company.
Losses and loss expenses for the three months ended March 31, 2016 are summarized as follows:
Incurred related to: | |||||||||||
Three Months Ended March 31, 2016 | Current year | Prior years | Total incurred losses | ||||||||
(U.S. dollars in thousands) | |||||||||||
Insurance: | |||||||||||
Agriculture | $ | 31,316 | $ | (13,265 | ) | $ | 18,051 | ||||
Casualty and other specialty | 43,653 | (7,138 | ) | 36,515 | |||||||
Professional lines | 25,464 | (187 | ) | 25,277 | |||||||
Property, marine/energy and aviation | 48,875 | (2,586 | ) | 46,289 | |||||||
Total Insurance | 149,308 | (23,176 | ) | 126,132 | |||||||
Reinsurance: | |||||||||||
Catastrophe | 5,873 | (15,465 | ) | (9,592 | ) | ||||||
Property | 42,852 | (3,565 | ) | 39,287 | |||||||
Casualty | 29,139 | (5,674 | ) | 23,465 | |||||||
Professional lines | 38,210 | (3,619 | ) | 34,591 | |||||||
Specialty | 39,055 | (9,610 | ) | 29,445 | |||||||
Total Reinsurance | 155,129 | (37,933 | ) | 117,196 | |||||||
Totals | $ | 304,437 | $ | (61,109 | ) | $ | 243,328 |
Losses and loss expenses for the three months ended March 31, 2016 included $61.1 million in favorable development of reserves relating to prior accident years. The favorable loss reserve development experienced during the three months ended March 31, 2016 benefited the Company's reported net loss ratio by approximately 11.0 percentage points. This
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net reduction in estimated losses for prior accident years reflects lower than expected claims emergence for the three months ended March 31, 2016 in all lines of business within the Insurance and Reinsurance segments.
For the three months ended March 31, 2016, the Company did not materially alter the two key inputs utilized to establish its reserve for losses and loss expenses (initial expected loss ratios and loss reporting patterns) for business related to prior years for the insurance and reinsurance segments as the variances in reported losses for those segments were within the range of possible results anticipated by the Company.
Insurance
Agriculture. For the three months ended March 31, 2017, the Company recorded favorable loss emergence due to lower than anticipated multi-peril crop insurance claims settlements for the 2016 crop year. For the three months ended March 31, 2016, the Company recorded favorable loss emergence due to lower than anticipated multi-peril crop insurance claims settlements for the 2015 crop year.
Casualty and other specialty. For the three months ended March 31, 2017, the Company recorded favorable loss emergence within this line of business primarily due to lower than expected claims activity, particularly within the Bermuda healthcare business, which was partially offset by unfavorable development on the Company's surety business. For the three months ended March 31, 2016, the Company recorded favorable loss emergence within this line of business primarily due to lower than expected claims activity, particularly within the Bermuda excess casualty business.
Professional lines. For the three months ended March 31, 2017 and 2016, ultimate losses for prior years in the Company's professional lines insurance were relatively stable as reported loss activity was in line with expectations.
Property, marine/energy and aviation. For the three months ended March 31, 2017, the modest favorable loss emergence within the property, marine/energy and aviation line of business was primarily due to lower than expected reported claims emergence within the Company's U.K. energy business, mostly offset by unfavorable development in the Company's inland marine, aviation and property businesses. For the three months ended March 31, 2016, the favorable loss emergence within the property, marine/energy and aviation line of business was primarily due to lower than expected claims emergence within the property business.
Reinsurance
Catastrophe. For the three months ended March 31, 2017 and 2016, the Company recorded favorable loss emergence within this line of business primarily due to lower than expected claims activity within the U.S. property catastrophe businesses.
Property. For the three months ended March 31, 2017 and 2016, the Company recorded favorable loss emergence in the property line of business primarily due to lower than expected claims activity within the property treaty business.
Casualty. For the three months ended March 31, 2017 and 2016, the Company recorded favorable loss emergence within this line of business primarily due to lower than expected claims activity for business written by the Bermuda operation.
Professional lines. For the three months ended March 31, 2017 and 2016, the Company recorded favorable loss emergence within this line of business primarily due to lower than expected claims emergence in prior accident years.
Specialty. For the three months ended March 31, 2017, the Company recorded favorable loss emergence within this line of business primarily due to lower than expected claims activity within the marine, aerospace, and surety businesses. For the three months ended March 31, 2016, the Company recorded favorable loss emergence within this line of business primarily due to lower than expected claims activity within the marine, trade credit and political risk business.
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The total reserves for losses and loss expenses recorded on the Company's balance sheet were comprised of the following at March 31, 2017:
Case Reserves | IBNR Reserves | Reserve for losses and loss expenses | |||||||||
(U.S. dollars in thousands) | |||||||||||
Insurance: | |||||||||||
Agriculture | $ | 61,593 | $ | 108,308 | $ | 169,901 | |||||
Casualty and other specialty | 282,827 | 1,089,309 | 1,372,136 | ||||||||
Professional lines | 138,631 | 579,832 | 718,463 | ||||||||
Property, marine/energy and aviation | 280,809 | 175,016 | 455,825 | ||||||||
Total Insurance | 763,860 | 1,952,465 | 2,716,325 | ||||||||
Reinsurance: | |||||||||||
Catastrophe | 145,405 | 64,767 | 210,172 | ||||||||
Property | 213,883 | 93,770 | 307,653 | ||||||||
Casualty | 241,453 | 489,571 | 731,024 | ||||||||
Professional lines | 97,194 | 346,313 | 443,507 | ||||||||
Specialty | 160,685 | 265,603 | 426,288 | ||||||||
Total Reinsurance | 858,620 | 1,260,024 | 2,118,644 | ||||||||
Totals | $ | 1,622,480 | $ | 3,212,489 | $ | 4,834,969 |
The total reserves for losses and loss expenses recorded on the Company's balance sheet were comprised of the following at December 31, 2016:
Case Reserves | IBNR Reserves | Reserve for losses and loss expenses | |||||||||
(U.S. dollars in thousands) | |||||||||||
Insurance: | |||||||||||
Agriculture | $ | 195,981 | $ | 51,906 | $ | 247,887 | |||||
Casualty and other specialty | 299,684 | 1,072,560 | 1,372,244 | ||||||||
Professional lines | 155,631 | 555,743 | 711,374 | ||||||||
Property, marine/energy and aviation | 295,430 | 172,054 | 467,484 | ||||||||
Total Insurance | 946,726 | 1,852,263 | 2,798,989 | ||||||||
Reinsurance: | |||||||||||
Catastrophe | 150,408 | 59,436 | 209,844 | ||||||||
Property | 220,223 | 100,122 | 320,345 | ||||||||
Casualty | 233,374 | 499,459 | 732,833 | ||||||||
Professional lines | 87,138 | 338,034 | 425,172 | ||||||||
Specialty | 153,581 | 264,374 | 417,955 | ||||||||
Total Reinsurance | 844,724 | 1,261,425 | 2,106,149 | ||||||||
Totals | $ | 1,791,450 | $ | 3,113,688 | $ | 4,905,138 |
Underwriting Results by Business Segments
The determination of the Company's business segments is based on the manner in which management monitors the performance of the Company's underwriting operations. As a result, we report two business segments – Insurance and Reinsurance.
Management measures the Company's results on the basis of the combined ratio, which is obtained by dividing the sum of the losses and loss expenses, acquisition expenses and general and administrative expenses by net premiums earned. The Company's historic combined ratios may not be indicative of future underwriting performance. When purchased within a single line of business, ceded reinsurance and recoveries are accounted for within that line of business. When purchased across multiple lines of business, ceded reinsurance and recoveries are allocated to the lines of business in proportion to the related risks assumed. The Company does not manage its assets by business segment; accordingly, investment income and total assets are not allocated to the individual business segments. General and administrative expenses incurred by the business segments are allocated directly. Remaining general and administrative expenses not incurred by the business segments are classified as corporate expenses and are not allocated to the individual business segments. Ceded reinsurance and recoveries are recorded within the business segment to which they apply.
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Insurance
The following table summarizes the underwriting results and associated ratios for the Company's Insurance segment for the three months ended March 31, 2017 and 2016.
Three Months Ended March 31, | |||||||
2017 | 2016 | ||||||
(U.S. dollars in thousands, except for ratios) | |||||||
Revenues | |||||||
Gross premiums written | $ | 989,897 | $ | 835,117 | |||
Ceded premiums written | (543,132 | ) | (464,173 | ) | |||
Net premiums written | 446,765 | 370,944 | |||||
Net premiums earned | 224,650 | 219,569 | |||||
Expenses | |||||||
Losses and loss expenses | 149,218 | 126,132 | |||||
Acquisition expenses | 41,119 | 30,358 | |||||
General and administrative expenses | 48,114 | 38,429 | |||||
238,451 | 194,919 | ||||||
Underwriting (loss) income | $ | (13,801 | ) | $ | 24,650 | ||
Net loss ratio | 66.4 | % | 57.5 | % | |||
Acquisition expense ratio | 18.3 | % | 13.8 | % | |||
General and administrative expense ratio | 21.4 | % | 17.5 | % | |||
Combined ratio | 106.1 | % | 88.8 | % |
Premiums. Gross premiums written for the three months ended March 31, 2017 in the Insurance segment increased by 18.5% over the same period in 2016. Gross and net premiums written for each line of business in the Insurance segment were as follows:
Three Months Ended March 31, | |||||||||||||||
2017 | 2016 | ||||||||||||||
Gross Premiums Written | Net Premiums Written | Gross Premiums Written | Net Premiums Written | ||||||||||||
(U.S. dollars in thousands) | |||||||||||||||
Agriculture | $ | 545,041 | $ | 264,343 | $ | 496,216 | $ | 208,627 | |||||||
Casualty and other specialty | 196,585 | 82,752 | 138,255 | 63,497 | |||||||||||
Professional lines | 99,886 | 45,953 | 77,415 | 43,334 | |||||||||||
Property, marine/energy and aviation | 148,385 | 53,717 | 123,231 | 55,486 | |||||||||||
Total | $ | 989,897 | $ | 446,765 | $ | 835,117 | $ | 370,944 |
The movements in the gross premiums written in the Insurance segment for the three months ended March 31, 2017 compared to the same periods in 2016 were primarily due to the following factors:
• | An increase in gross premiums written in the agriculture line of business primarily due to higher commodity prices; and |
• | An increase in gross premiums written in the property, marine/energy and aviation, professional lines and casualty and other specialty lines of business due primarily to business generated by new underwriting teams in the U.S. and the U.K. |
Ceded premiums written increased during the three months ended March 31, 2017 as compared to the same period in 2016. Increased gross premiums written resulted in increased ceded premiums under the whole account quota share treaty covering the entire Insurance segment's business, combined with additional purchases of facultative and excess of loss reinsurance in the property, marine/energy and aviation line of business.
Net premiums earned by the Company in the Insurance segment increased in the three months ended March 31, 2017 compared to the same periods in 2016. The increase was a result of growth in gross premiums written partially offset by increased ceded premiums across the segment.
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Losses and Loss Expenses. The net loss ratio in the Company's Insurance segment increased by 8.9 percentage points for the three months ended March 31, 2017 compared to the same period in 2016. The increase in the net loss ratio for the three months ended March 31, 2017 was primarily due to lower levels of favorable prior year reserve development in the agriculture line of business and increased loss activity in the casualty, other specialty, and property, marine/energy and aviation lines of business. Partially offsetting these increases was a lower net loss ratio in the professional lines business.
During the three months ended March 31, 2017, the Company's previously estimated losses and loss expense reserves for the Insurance segment for prior accident years were reduced by $11.1 million which decreased the net loss ratio by 4.9 percentage points as compared to a reduction of $23.2 million that decreased the net loss ratio by 10.6 percentage points for the three months ended March 31, 2016. Lower levels of favorable prior year loss reserve development in the three months ended March 31, 2017 compared to 2016 was experienced mainly in the agriculture line of business.
Acquisition Expenses. The acquisition expense ratio in the Insurance segment in the three months ended March 31, 2017 increased compared to the same period in 2016. For the three months ended March 31, 2016, the addition of earned premiums from the Company's acquisition of Montpelier, which had no associated acquisition costs, decreased the acquisition expense ratio for that period.
General and Administrative Expenses. The general and administrative expense ratio in the Insurance segment in the three months ended March 31, 2017 increased compared to the same period in 2016 due to an increase in personnel costs associated with the addition of new underwriting teams and additional employees, partially offset by increased ceding commission reimbursements as a result of additional purchases of reinsurance.
Reinsurance
The following table summarizes the underwriting results and associated ratios for the Company's Reinsurance business segment for the three months ended March 31, 2017 and 2016.
Three Months Ended March 31, | |||||||
2017 | 2016 | ||||||
(U.S. dollars in thousands, except for ratios) | |||||||
Revenues | |||||||
Gross premiums written | $ | 788,964 | $ | 776,560 | |||
Ceded premiums written | (216,080 | ) | (208,662 | ) | |||
Net premiums written | 572,884 | 567,898 | |||||
Net premiums earned | 322,382 | 333,622 | |||||
Other underwriting loss | (5,892 | ) | (2,444 | ) | |||
316,490 | 331,178 | ||||||
Expenses | |||||||
Losses and loss expenses | 152,095 | 117,196 | |||||
Acquisition expenses | 78,005 | 73,484 | |||||
General and administrative expenses | 25,843 | 33,796 | |||||
255,943 | 224,476 | ||||||
Underwriting income | $ | 60,547 | $ | 106,702 | |||
Net loss ratio | 47.2 | % | 35.2 | % | |||
Acquisition expense ratio | 24.2 | % | 22.0 | % | |||
General and administrative expense ratio | 8.0 | % | 10.1 | % | |||
Combined ratio | 79.4 | % | 67.3 | % |
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Premiums. In the three months ended March 31, 2017, net premiums written in the Reinsurance segment increased by 0.9% over the same periods in 2016. Gross and net premiums written for each line of business in the Reinsurance segment for the three months ended March 31, 2017 and 2016 were as follows:
Three Months Ended March 31, | |||||||||||||||
2017 | 2016 | ||||||||||||||
Gross Premiums Written | Net Premiums Written | Gross Premiums Written | Net Premiums Written | ||||||||||||
(U.S. dollars in thousands) | |||||||||||||||
Catastrophe | $ | 207,473 | $ | 98,191 | $ | 200,830 | $ | 88,868 | |||||||
Property | 143,149 | 123,417 | 156,466 | 150,056 | |||||||||||
Casualty | 63,932 | 63,869 | 98,720 | 98,719 | |||||||||||
Professional lines | 78,040 | 76,539 | 48,549 | 48,220 | |||||||||||
Specialty | 296,370 | 210,868 | 271,995 | 182,035 | |||||||||||
Total | $ | 788,964 | $ | 572,884 | $ | 776,560 | $ | 567,898 |
The movements in gross premiums written in the Reinsurance segment for the three months ended March 31, 2017 compared to the same periods in 2016 were primarily due to the following factors:
• | An increase in gross premiums written in the catastrophe line of business due to new international business, partially offset by rate declines and non-renewal of policies that no longer met profitability targets; |
• | A decrease in gross premiums written in the property line of business due to non-renewal of policies that no longer met profitability targets; |
• | A decline in gross premiums written in the casualty line of business due to the timing of renewal for a large eighteen month international contract and non-renewal of policies that no longer met profitability targets; |
• | An increase in gross premiums written in the professional lines of business due to increases in signed lines; and |
• | An increase in gross premiums written in the specialty line of business due to new surety business written and increased renewals in the surety and engineering business, partially offset by non-renewal of policies that no longer met profitability targets. |
Ceded premiums written increased in the three months ended March 31, 2017 as compared to the same period in 2016. Ceded premiums written increased primarily due to the growth in gross premiums written, combined with additional purchases of facultative reinsurance in the property line of business.
Net premiums earned by the Company in the Reinsurance segment for the three months ended March 31, 2017 decreased compared to net premiums earned during the same period in 2016 as the net premiums earned for the three months ended March 31, 2016 included the earning of premiums acquired in the Montpelier acquisition.
Other Underwriting Loss. Other underwriting loss increased for the three months ended March 31, 2017. The increase in other underwriting loss was primarily due to decreased income from the Company's weather derivative products for the period.
Losses and Loss Expenses. The net loss ratio in the Company's Reinsurance segment for the three months ended March 31, 2017 increased compared to the same period in 2016. The increase in the net loss ratio for the three months ended March 31, 2017 was across all lines of business due to higher than expected loss activity.
The Company recorded $22.7 million of favorable prior year loss reserve development in the three months ended March 31, 2017, which benefited the net loss ratios by 7.1 percentage points compared to $37.9 million in the three months ended March 31, 2016, which benefited the net loss ratios by 11.4 percentage points. Favorable reserve development in the three months ended March 31, 2017 was lower than the same period in 2016, primarily in the catastrophe line of business.
Acquisition Expenses. The Company's acquisition expense ratio in the Reinsurance segment for the three months ended March 31, 2017 was higher than the same period in 2016. For the three months ended March 31, 2016, the addition of earned premiums from the Company's acquisition of Montpelier, which had no associated acquisition costs, decreased the acquisition expense ratio for that period.
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General and Administrative Expenses. The general and administrative expense ratio in the Reinsurance segment for the three months ended March 31, 2017 decreased compared to the same period in 2016 due to lower personnel costs.
Liquidity and Capital Resources
Endurance Holdings is a holding company that does not have any significant operations or assets other than its ownership of the shares of its direct and indirect subsidiaries. Endurance Holdings relies primarily on dividends and other permitted distributions from its subsidiaries to pay its operating expenses, interest on debt and dividends, if any, on its ordinary shares, and its 6.35% Non-Cumulative Preferred Shares, Series C ("Series C Preferred Shares"). There are restrictions on the payment of dividends by the Company's operating subsidiaries to Endurance Holdings, which are described in more detail below.
Ability of Subsidiaries to Pay Dividends. The ability of Endurance Bermuda to pay dividends is dependent on its ability to meet the requirements of applicable Bermuda law and regulations. Under Bermuda law, Endurance Bermuda may not declare or pay a dividend if there are reasonable grounds for believing that Endurance Bermuda is, or would after the payment be, unable to pay its liabilities as they become due, or the realizable value of Endurance Bermuda's assets would thereby be less than the aggregate of its liabilities and its issued share capital and share premium accounts. Further, Endurance Bermuda, as a regulated insurance company in Bermuda, is subject to additional regulatory restrictions on the payment of dividends or distributions. As of March 31, 2017, Endurance Bermuda could pay a dividend or return additional paid-in capital totaling approximately $1,077.7 million (December 31, 2016 – $1,109.3 million) without prior regulatory approval based upon the Bermuda insurance and corporate regulations. At March 31, 2017, Endurance Holdings has loaned Endurance Bermuda $613.5 million, which remains outstanding and is callable on demand.
Each of the Company's U.S. operating subsidiaries, except American Agri-Business Insurance Company ("American Agri-Business") is subject to regulation by the State of Delaware Department of Insurance. American Agri-Business is subject to regulation by the Texas Department of Insurance. Dividends for each U.S. operating subsidiary are limited to the greater of 10% of policyholders' surplus or statutory net income, excluding realized capital gains. In addition, dividends may only be declared or distributed out of earned surplus. At December 31, 2016, none of the Company's U.S. operating subsidiaries, except American Agri-Business, had earned surplus; therefore, these companies are precluded from declaring or distributing dividends at March 31, 2017 without the prior approval of the applicable insurance regulator. At March 31, 2017, American Agri-Business could pay dividends of $3.3 million with notice to the Texas Department of Insurance. In addition, any dividends paid by Endurance American, Endurance American Specialty and Endurance Risk Solutions would be subject to the dividend limitation of their respective parent insurance companies.
Under the jurisdiction of the United Kingdom's Prudential Regulation Authority ("PRA") and the Financial Conduct Authority ("FCA"), Endurance Worldwide Insurance Limited ("Endurance U.K.") must maintain a margin of solvency at all times, which is determined based on the type and amount of insurance business written. The PRA regulatory requirements impose no explicit restrictions on Endurance U.K.'s ability to pay a dividend, but Endurance U.K. would have to notify the PRA 28 days prior to any proposed dividend payment. Dividends may only be distributed from profits available for distributions. At March 31, 2017, Endurance U.K. had $52.1 million (December 31, 2016 - nil) retained profits available for distributions.
Endurance Corporate Capital Limited, Syndicate 5151 and Endurance at Lloyd's Limited ("Endurance at Lloyd's") are subject to oversight by the Council of Lloyd's. Endurance at Lloyd's is also subject to regulation by the PRA and the FCA. Underwriting capacity of a member of Lloyd's must be supported by providing a deposit in the form of cash, securities or letters of credit, which are referred to as Funds at Lloyd's ("FAL"). The amount of FAL required is determined by the Economic Capital Assessment ("ECA"), together with any deficit funding requirements. The ECA, which is determined by Lloyd's, is based on Syndicate 5151's solvency and capital requirement as calculated through its internal model and the latest approved business plan. At March 31, 2017, the fair value of the FAL posted for Syndicate 5151 at March 31, 2017 was $324.2 million (December 31, 2016 - $323.6 million). At March 31, 2017, Endurance Corporate Capital Limited did not have assets available for distribution.
Cash and Invested Assets. The Company's aggregate invested assets, including fixed maturity investments, short-term investments, equity securities, other investments, cash and cash equivalents and pending securities transactions, as of March 31, 2017 totaled $8.8 billion compared to aggregate invested assets of $8.8 billion as of December 31, 2016.
At March 31, 2017, the Company's available for sale investments had gross unrealized gains of $113.7 million and gross unrealized losses of $25.7 million compared to gross unrealized gains of $95.3 million and gross unrealized losses of $37.4 million at December 31, 2016. The decrease in gross unrealized losses on the Company's available for sale investments at March 31, 2017 compared to December 31, 2016 was primarily due to tightening credit spreads. The Company did not have the intent to sell any of its fixed income investments in an unrealized loss position and determined that it was unlikely that the Company would be required to sell securities in an unrealized loss position at March 31, 2017. During the
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three months ended March 31, 2017, the Company impaired certain fixed maturity investments and equity securities and therefore recognized in earnings total other-than-temporary impairments of $0.4 million (2016 - $0.6 million) for the three months ended March 31, 2017.
The Company's aggregate direct exposure to the indebtedness and equity securities of those countries whose currency is the Euro or whose sovereign debt rating is below AAA (except the U.S.) was $809.9 million at March 31, 2017, compared to $763.7 million at December 31, 2016.
Cash Flows
Three Months Ended March 31, | |||||||
2017 | 2016 | ||||||
(U.S. dollars in thousands) | |||||||
Net cash flows used in operating activities | $ | (143,300 | ) | $ | (30,384 | ) | |
Net cash flows provided by investing activities | 265,206 | 130,818 | |||||
Net cash flows provided by (used in) financing activities | 53,793 | (75,088 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents | 6,927 | 9,637 | |||||
Net increase in cash and cash equivalents | 182,626 | 34,983 | |||||
Cash and cash equivalents, beginning of period | 1,149,541 | 1,177,750 | |||||
Cash and cash equivalents, end of period | $ | 1,332,167 | $ | 1,212,733 |
Cash flows used in operating activities in the three months ended March 31, 2017 increased compared to the same period in 2016 from higher levels of gross loss payments cash and ceded premium payments.
Investing activity cash flows reflect the Company's active management of its investment portfolio to generate attractive economic returns and income. Movements in financial markets and interest rates influence the timing of investment sales and purchases. The increase in cash flows provided by investing activities in 2017 is primarily due to decreased purchases of trading and available for sale investments and other investments, partially offset by higher proceeds from sales and maturities on trading and available for sale investments compared to 2016.
The cash flows provided by (used in) financing activities in the three months ended March 31, 2017 were higher than in the same period in 2016 as a result of the receipt of cash from Sompo to settle the Company's share-based awards with employees in April 2017, lower dividends paid, debt repayments and net distributions to non-controlling interest, offset by higher settlements of equity awards.
Foreign exchange rate changes had a positive impact on the cash balances of the Company in the three months ended March 31, 2017 had a positive impact on the cash balances of the Company as the U.S. dollar generally weakened against most key currencies in the period resulting in an increase in the reported value of holdings in those currencies. Foreign exchange rate changes in the three months ended March 31, 2016 had a positive impact on the cash balances of the Company as the U.S. dollar and British Sterling generally weakened against most key currencies in the period resulting in an increase in the reported value of holdings in those currencies.
As of March 31, 2017 and December 31, 2016, the Company had pledged cash and cash equivalents and fixed maturity investments of $105.7 million and $106.8 million, respectively, in favor of certain ceding companies to collateralize obligations. As of March 31, 2017 and December 31, 2016, the Company had also pledged $248.3 million and $252.2 million of its cash and fixed maturity investments to meet collateral obligations for $224.4 million and $222.3 million, respectively, in letters of credit outstanding under its Credit Facility (as defined below) and LOC Agreements (as defined below). In addition, at March 31, 2017 and December 31, 2016, cash and fixed maturity investments with fair values of $207.6 million and $207.8 million were on deposit with U.S. state regulators, respectively.
Credit Facilities. On March 23, 2016, the Company and certain designated subsidiaries of the Company entered into a $450.0 million five-year letter of credit facility with JPMorgan Chase Bank, N.A. ("JPMorgan") as administrative agent ("Credit Facility"). As of March 31, 2017, there were letters of credit outstanding under the Credit Facility of $199.2 million (December 31, 2016 – $199.8 million). The Credit Facility does not provide for revolving or term loans.
The Company is party to certain uncommitted letter of credit reimbursement agreements ("LOC Agreements") that allow for the issuance of letters of credit in a variety of currencies, including U.S. dollars. The fees paid under the LOC Agreements depend on the amount of the outstanding letters of credit and vary from 0.30% to 0.45% on the principal amount of letters of credit outstanding to a fee negotiated at the time of issuance of the individual letters of credit. The total amount of letters of credit outstanding under the LOC Agreements as of March 31, 2017 was $25.2 million (December 31, 2016 - $22.5 million).
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BCRH Credit Facility. The Company, through a wholly-owned subsidiary, is party to an unsecured $20.0 million credit facility agreement with BCRH (the "BCRH Credit Facility"). As of March 31, 2017, BCRH had no outstanding borrowings under the BCRH Credit Facility (December 31, 2016 - nil).
BCGR Credit Facility. The Company, through a wholly-owned subsidiary, is party to an unsecured $20.0 million credit facility agreement with BCGR (the "BCGR Credit Facility"). As of March 31, 2017, BCGR had no outstanding borrowings under the BCGR Credit Facility (December 31, 2016 - nil).
On June 1, 2016, Endurance redeemed all 9,200,000 shares outstanding of its 7.5% Non-Cumulative Preferred Shares, Series B (the "Series B Preferred Shares") at a redemption price of $25.00 per share plus unpaid dividends.
Historically, the operating subsidiaries of the Company have generated sufficient cash flows to meet all of their obligations. Because of the inherent volatility of the business written by the Company, the seasonality in the timing of payments by ceding companies, the irregular timing of loss payments, the impact of a change in interest rates on the Company's investment returns as well as seasonality in coupon payment dates for fixed maturity investments, cash flows from the Company's operating activities may vary significantly between periods. The Company expects to generate positive operating cash flows through 2017, absent the occurrence of additional significant loss events. In the event that paid losses accelerate beyond the ability to fund such payments from operating cash flows, the Company would use its cash balances available, liquidate a portion of its investment portfolio, or arrange for additional financing. There can be no assurance that the Company will be successful in executing these strategies.
Off-Balance Sheet Arrangements
Certain of the Company's ongoing obligations to Selective Insurance Group, Inc. in connection with the sale of Montpelier U.S. Insurance Company constitute off-balance sheet arrangements. Excluding these specific transactions, as of March 31, 2017, the Company was not party to any off-balance sheet arrangements, as defined by Item 303(a)(4) of Regulation S-K, to which an entity unconsolidated with the Company is a party that management believes is reasonably likely to have a current or future effect on the Company's financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that the Company believes is material to investors.
Currency and Foreign Exchange
The Company's functional currencies are U.S. dollars for its U.S., Bermuda and Lloyd's operations, and British Sterling for Endurance U.K. The reporting currency for all operations is U.S. dollars. The Company maintains a portion of its investments and liabilities in currencies other than the U.S. dollar. Endurance U.K. and Endurance Corporate Capital Limited are subject to risk-based capital charges under Solvency II. Depending on the profile of the Company's liabilities, each of the Company's operating subsidiaries hold some of their respective assets in currencies corresponding to the currencies of its liabilities in accordance with the Company's asset and liability management policy and in order to limit currency risk. The Company may, from time to time, experience gains or losses resulting from fluctuations in the values of foreign currencies, which could have a material adverse effect on the Company's results of operations.
Assets and liabilities of foreign operations whose functional currency is not the U.S. dollar are translated at exchange rates in effect at the balance sheet date. Revenues and expenses of such foreign operations are translated at average exchange rates during the year. The effect of the translation adjustments for foreign operations is included in accumulated other comprehensive loss.
Other monetary assets and liabilities denominated in foreign currencies are revalued at the exchange rates in effect at the balance sheet date with the resulting foreign exchange gains and losses included in earnings. Revenues and expenses denominated in foreign currencies are translated at the prevailing exchange rate on the transaction date.
Effects of Inflation
The effects of inflation could cause the severity of claims to rise in the future. The Company's estimates for losses and loss expenses include assumptions about future payments for settlement of claims and claims handling expenses, such as medical treatments and litigation costs. To the extent inflation causes these costs to increase above reserves established for these claims, the Company will be required to increase the reserve for losses and loss expenses with a corresponding reduction in its earnings in the period in which the deficiency is identified. In addition, inflation could lead to higher interest rates causing the current unrealized gain position on the Company's fixed income portfolio to decrease or become an unrealized loss position. In response, the Company may choose to hold its fixed income investments to maturity, which would result in the unrealized gains or losses largely amortizing through net investment income.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes in market risk from the information provided under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations - Quantitative and Qualitative Information about Market Risk" included in the Company's 2016 Form 10-K.
Item 4. Controls and Procedures
a) Disclosure Controls and Procedures. The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.
(b) Internal Control Over Financial Reporting. There have not been any changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the Company's first fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
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PART II
OTHER INFORMATION
Item 1. Legal Proceedings
We are party to various legal proceedings generally arising in the normal course of our business. While any proceeding contains an element of uncertainty, we do not believe that the eventual outcome of any litigation or arbitration proceeding to which we are presently a party could have a material adverse effect on our financial condition or business. Pursuant to our insurance and reinsurance agreements, disputes are generally required to be finally settled by arbitration.
Item 1A. Risk Factors
There have been no material changes to the risk factors disclosed in Item 1A. Risk Factors in our 2016 Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
ISSUER PURCHASES OF EQUITY SECURITIES | |||||||||||
Period | (a) Total Number of Shares Purchased(1) | (b) Average Price Paid per Share | (c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(1) (2) | (d) Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs(1) (2) | |||||||
January 1, 2017 - January 31, 2017 | — | $ | — | — | 5,000,000 | ||||||
February 1, 2017 - February 28, 2017 | — | $ | — | — | 5,000,000 | ||||||
March 1, 2017 - March 31, 2017 | — | $ | — | — | 5,000,000 | ||||||
Total | — | $ | — | — | 5,000,000 |
(1) | Ordinary shares or share equivalents. |
(2) | At its meeting on February 25, 2016, the Board of Directors of the Company authorized the repurchase of up to a total of 5,000,000 ordinary shares and share equivalents through February 28, 2018, superseding all previous authorizations. This repurchase authorization terminated upon closing of the acquisition of the Company by Sompo on March 28, 2017. |
Item 3. Defaults Upon Senior Securities
None
Item 4. Mine Safety Disclosures
Not applicable
Item 5. Other Information
None
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Item 6. | Exhibits |
(a) The following sets forth those exhibits filed pursuant to Item 601 of Regulation S-K:
Exhibit Number | Description | |
2.1 | Agreement and Plan of Merger, dated as of October 5, 2016, by and among Endurance Specialty Holdings Ltd., Sompo Holdings, Inc. and Volcano International Limited. Incorporated herein by reference to Exhibit 2.1 to the Current Report on Form 8-K filed on October 5, 2016. | |
2.2 | Amendment No. 1 to Agreement and Plan of Merger, dated as of December 1, 2016, by and among Endurance Specialty Holdings Ltd., Sompo Holdings, Inc. and Volcano International Limited. Incorporated herein by reference to Exhibit 2.1 to the Current Report on Form 8-K filed on December 2, 2016. | |
3.1 | Altered Memorandum of Association. Incorporated herein by reference to Exhibit 3.1 to the Current Report on Form 8-K filed on March 28, 2017. | |
3.2 | Amended and Restated Bye-laws. Incorporated herein by reference to Exhibit 3.2 to the Current Report on Form 8-K filed on March 28, 2017. | |
10.1 | First Amendment, Waiver and Consent, dated March 17, 2017, by and among Endurance Specialty Holdings Ltd., as parent borrower, each designated subsidiary borrower party thereto, JPMorgan Chase Bank, N.A., as administrative agent, Deutsche Bank Trust Company Americas, as collateral agent, and the lending institutions party thereto. Incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K filed on March 21, 2017. | |
31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act. | |
31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act. | |
32 | Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
101 | Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Condensed Consolidated Balance Sheets as at March 31, 2017 (unaudited) and December 31, 2016; (ii) the Unaudited Condensed Consolidated Statements of Income and Comprehensive Income for the three months ended March 31, 2017 and 2016; (iii) the Unaudited Condensed Consolidated Statements of Changes in Shareholders' Equity for the three months ended March 31, 2017 and 2016; (iv) the Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and 2016; and (v) the Notes to the Unaudited Condensed Consolidated Financial Statements. |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ENDURANCE SPECIALTY HOLDINGS LTD. | |||||
Date: | May 10, 2017 | By: | /s/ John R. Charman | ||
John R. Charman | |||||
Chief Executive Officer | |||||
Date: | May 10, 2017 | By: | /s/ Michael J. McGuire | ||
Michael J. McGuire | |||||
Chief Financial Officer (Principal Financial Officer) |
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