UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

For the quarterly period ended June 30, 2018

or

For the transition period from              to

Commission file number 0-15886

 

The Navigators Group, Inc.

(Exact name of registrant as specified in its charter)

 

 

(203) 905-6090

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report.)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    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 the definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check One):

 

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  ☒

The number of common shares outstanding as of July 27, 2018 was 29,765,245.

 

 

 

 

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THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

INDEX

Contents

 

 

 

 

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PART I. FINANCIAL INFORMATION

 

Item 1.  Financial Statements

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

 

See accompanying Notes to Interim Consolidated Financial Statements.

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THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

 

 

 

See accompanying Notes to Interim Consolidated Financial Statements.

 

 

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THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

 

 

.

 

 

See accompanying Notes to Interim Consolidated Financial Statements

 

 

 

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THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (Unaudited)

 

 

 

See accompanying Notes to Interim Consolidated Financial Statements.

 

 

 

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THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

 

 

See accompanying Notes to Interim Consolidated Financial Statements.

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THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

Notes to Interim Consolidated Financial Statements (Unaudited)

 

 

NOTE 1.  ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Unless the context requires otherwise, the terms “we,” “us,” “our” or “our Company” are used to mean The Navigators Group, Inc., a Delaware holding company established in 1982, and its subsidiaries. The term “Parent Company” is used to mean The Navigators Group, Inc. without its subsidiaries.

Organization

We are an international insurance company with a long-standing area of specialization in Marine insurance. We also offer Property and Casualty (“P&C”) insurance, primarily general liability coverage and umbrella & excess liability coverage to commercial enterprises through our Primary and Excess Casualty divisions. We have also developed niches in Professional Liability insurance, through our Directors & Officers (“D&O”) and Errors & Omissions (“E&O”) divisions, as well as assumed reinsurance products.

We operate through various wholly-owned insurance and service companies. Our subsidiaries domiciled in the United States (“U.S.”) include two insurance companies, Navigators Insurance Company (“NIC”) and Navigators Specialty Insurance Company (“NSIC”), as well as our U.S. underwriting agency, Navigators Management Company (“NMC”). NIC includes a branch in the United Kingdom (“U.K”). We also have operations domiciled in the U.K., Hong Kong and Europe. Navigators International Insurance Company Ltd. (“NIIC”), Navigators Management (U.K.) Ltd. (“NMUK”) and Navigators Underwriting Ltd. (“NUL”) are domiciled in the U.K. and NUL includes European branches. Navigators Underwriting Agency Ltd. (“NUAL”), a Lloyd’s of London (“Lloyd’s”) underwriting agency, manages and provides the capital, through Navigators Corporate Underwriters Ltd. (“NCUL”), for our Lloyd’s Syndicate 1221 (the “Syndicate”), and is also domiciled in the U.K. We control 100% of the Syndicate’s stamp capacity.

On June 7, 2018, we acquired 100% ownership interest in Bracht, Deckers & Mackelbert NV, an insurance underwriting agency organized under the laws of Belgium (“BDM”) and Assurances Continentales – Continentale Verzekeringen NV, an insurance company licensed under the laws of Belgium (“ASCO”). The acquisition is being accounted for in accordance with Accounting Standards Codification (“ASC”) 805, “Business Combinations.” Refer to Note 2. Business Combinations and Note 6. Goodwill and Intangible Assets for further information regarding the acquisition.

 

Basis of Presentation

The Consolidated Balance Sheet at June 30, 2018 and the Consolidated Statements of Income, Comprehensive Income, Stockholders’ Equity and Cash Flows for the periods ended June 30, 2018 and 2017 are unaudited. The Balance Sheet at December 31, 2017 is derived from our audited Financial Statements. The accompanying Interim Consolidated Financial Statements reflect all adjustments, which, in the opinion of management, are necessary to fairly present the results of our Company for the interim periods presented on the basis of U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the U.S. Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. All significant intercompany transactions and balances have been eliminated in consolidation. The preparation of these Financial Statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the Financial Statements and the reported revenues and expenses during the reporting periods. The results of operations for any interim period are not necessarily indicative of results for the full year. The Interim Consolidated Financial Statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2017. Certain amounts for the prior period have been reclassified to conform with the current period presentation.

Income Taxes

On December 22, 2017, the 2017 Tax Cuts and Jobs Act (the “Tax Act”) was enacted into law and the new legislation contained several key tax provisions that affected us, including a one-time mandatory Deemed Repatriation Transition Tax (“Transition Tax”) on accumulated foreign earnings and a reduction of the corporate income tax rate to 21% effective January 1, 2018, among others. We were required to recognize the effect of the tax law changes in the period of enactment, such as determining the Transition Tax, re-measuring our U.S. deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), Income Tax Accounting Implications of the Tax Act, which allowed us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. During the fourth quarter of 2017, we made a reasonable estimate of the effects on our deferred tax balances and in relation to the Transition Tax. During the first half of 2018, we did not make any changes to this estimate; however we continue to gather additional information to more precisely compute these income tax impacts.  We expect to complete our analysis within the measurement period in accordance with SAB 118.

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The interim income tax provision has been computed based on our estimated annual Effective Tax Rate, which represents our best estimate on a year to date basis for the interim period. As a result, the tax provision for a given quarter equals the difference between the provision recorded cumulatively year to date less the amount recorded cumulatively as of the end of the prior interim period. Our Effective Tax Rate for the quarter differs from the federal tax rate of 21% primarily due to tax-exempt investment income, the dividends received deduction and an excess tax benefit related to the vesting of stock compensation at fair market value.

 

Short-Term Investments Reclassifications

Cash and overseas deposits that were misclassified within Short-Term Investments were reclassified representing an immaterial correction. Cash of $20.5 million as of December 31, 2017 was reclassified from Short-Term Investments to Cash and Cash Equivalents. Overseas deposits of $28.8 million as of December 31, 2017 were reclassified from Short-Term Investments to Other Invested Assets. The reclassification of cash within Short-Term Investments to Cash and Cash Equivalents impacted the Statement of Cash Flows for the six months ended June 30, 2017 by increasing Net Cash Used in Investing Activities by $4.8 million.

New Accounting Standards Adopted in 2018

Revenue From Contracts With Customers

Effective January 1, 2018, our Company adopted ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)”. This guidance affects any contracts with customers to transfer goods or services or for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example, insurance contracts are not in scope of the new guidance). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Our Company generates an insignificant amount of fee income that is within the scope of this guidance and was not materially impacted by the adoption of this guidance. The adoption of this guidance did not have a material impact on our results of operations, financial condition or liquidity.

 

Classification and Measurement of Financial Instruments

Effective January 1, 2018, our Company adopted ASU 2016-01 “Financial Instruments – Overall (Subtopic 825-10) – Recognition and Measurement of Financial Assets and Financial Liabilities”. This guidance requires equity investments (except those accounted for under the equity method of accounting, investments that are consolidated or those that meet a practicability exception) to be measured at fair value with changes in fair value recognized in net income, simplifies the impairment assessment of equity investments without readily determinable values by requiring a qualitative assessment to identify impairment, eliminates the requirement to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost, requires the use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes, requires separate presentation in other comprehensive income of the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the organization has elected to measure the liabilities in accordance with the fair value option, requires the separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and clarifies that the reporting organization should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the organization’s other deferred tax assets.

As of January 1, 2018, the adoption of this guidance resulted in a $7.7 million net after-tax increase to Retained Earnings with a corresponding decrease to Accumulated Other Comprehensive Income (Loss), resulting in no change to our Total Stockholders’ Equity. This adjustment reflects the cumulative effect adjustment to reclassify Net Unrealized Gain on Investments in Accumulated Other Comprehensive Income (Loss) for available-for-sale Equity Securities to Retained Earnings upon adoption. Upon the adoption of this guidance, Equity Securities have been measured at fair value with changes in fair value recognized in Net Income through Net Unrealized Gains (Losses) on Equity Securities at Fair Value. The other aspects of this guidance only impacted disclosure or did not apply to our Company and therefore did not impact our results of operations, financial condition or liquidity.

 

Cash Flows

Effective January 1, 2018, our Company adopted ASU 2016-15, “Statement of Cash Flows (Topic 230) – Classification of Certain Cash Receipts and Cash Payments” which addresses diversity in practice in how eight specific cash receipts and cash payments should be presented and classified on the statement of cash flows. The adoption of this guidance did not impact our results of operations, financial condition or liquidity.

 

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Effective January 1, 2018, our Company adopted ASU 2016-18, “Statement of Cash Flows (Topic 230) – Restricted Cash” which addresses diversity in practice in the classification and presentation of changes in restricted cash on the statement of cash flows. This guidance requires a statement of cash flows to explain the change during the period in the total of cash, cash equivalents, restricted cash and restricted cash equivalents. Transfers between cash and cash equivalents and restricted cash and restricted cash equivalents will no longer be presented on the statement of cash flows. To assist in meeting the requirements of this guidance to provide a reconciliation from the Statement of Cash Flows to the Balance Sheet, upon adoption of this guidance our Company added new accounts titled “Cash and Cash Equivalents” and “Restricted Cash and Cash Equivalents” and reclassified amounts previously held in Short-Term Investments to these accounts for all periods presented. This resulted in the reclassification of $71.3 million of restricted and unrestricted cash and cash equivalent balances as of December 31, 2017. This guidance was adopted on a retrospective basis. Prior to the adoption of this guidance, restricted and unrestricted cash and cash equivalent balances included in the Short-Term Investments account had been presented as a cash flow provided by (used in) investing activities. Consequently, the Statement of Cash Flows for the six months ended June 30, 2017 includes a revision to increase “Net Cash Used in Investing Activities” by $18.1 million.

 

Income Taxes

Effective January 1, 2018, our Company adopted ASU 2016-16, “Income Taxes (Topic 740) – Intra-Entity Transfers of Assets Other than Inventory” that requires companies to account for the income tax effects of intercompany transfers of assets other than inventory when the transfer occurs. The adoption of this guidance did not impact our results of operations, financial condition or liquidity.

 

Definition of a Business

Effective January 1, 2018, our Company adopted ASU 2017-01, “Clarifying the Definition of a Business” that provides guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This guidance will be applied to transactions prospectively. The adoption of this guidance did not impact our results of operations, financial condition or liquidity.

 

Tax Reform Reclassification from Other Comprehensive Income

Effective January 1, 2018, our Company early adopted ASU 2018-02, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income” that permits entities to reclassify tax effects stranded in accumulated other comprehensive income as a result of tax reform to retained earnings. The total impact of the remeasurement and other adjustments was reflected in 2017 income from continuing operations, regardless of where deferred taxes were originally recorded. As of January 1, 2018, the adoption of this guidance resulted in a one-time reclassification of $2.8 million, decreasing Retained Earnings and increasing Accumulated Other Comprehensive Income (Loss) primarily from the remeasurement of deferred tax assets and liabilities associated with unrealized gains and losses on investments and currency translation adjustments using the 21% corporate tax rate. 

Significant Accounting Policies

There were no notable changes in our significant accounting policies subsequent to our Annual Report on Form 10-K for the year ended December 31, 2017, with the exception of changes related to the adoption of ASU 2016-01 and ASU 2016-18 impacting the following accounting policies:

 

Cash and Cash Equivalents and Restricted Cash and Cash Equivalents

Cash includes cash on hand and demand deposits with banks. Cash Equivalents include highly liquid investments with original maturities of three months or less including money-market funds. Restricted Cash and Cash Equivalents primarily relates to funds that are held to support regulatory and contractual obligations.

 

Investments

Fixed Maturities held by our Company were carried at fair value and classified as available-for-sale. Available-for-sale securities are debt securities not classified as either held-to-maturity securities or trading securities and are reported at fair value, with unrealized gains and losses excluded from earnings and reported in Accumulated Other Comprehensive Income (“AOCI”) as a separate component of Stockholders’ Equity. Fixed Maturities include bonds, mortgage-backed and asset-backed securities, and redeemable preferred stocks.  

Upon adoption of ASU 2016-01 on January 1, 2018, Equity Securities held by our Company were carried at fair value with any changes in fair value recognized in Net Income through the Net Unrealized Gains (Losses) on Equity Securities at Fair Value account. Prior to the adoption of ASU 2016-01, Equity Securities were carried at fair value and classified as available-for-sale. For our policy on Equity Securities classified as available-for-sale, refer to Note 1 within our Annual Report on Form 10-K for the year ended December 31, 2017. Equity Securities consist of common stock, exchange traded funds, mutual funds and preferred stock.

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Other Invested Assets consist of investments our Company made in certain strategic companies which are accounted for using the equity method of accounting and overseas deposits which are carried at fair value.

For our investments applying the equity method, these investments are initially recorded at cost and are subsequently adjusted based on our Company’s proportionate share of the net income or loss of the companies.  Changes in the carrying value of such investments are recorded in Other Income. In applying the equity method, we use the most recently available financial information provided by the companies which is generally three months prior to the end of the reporting period.

Overseas deposits include private funds held by the Syndicate and invested according to local regulatory requirements. The compositions of the overseas deposits vary and the deposits are based on the portfolio level reporting that is provided by Lloyd’s. The fair values of these overseas deposits were measured using the net asset value practical expedient and therefore have not been categorized within the fair value hierarchy. Changes in the fair value of the Overseas deposits are recorded in Net Investment Income.

Short-Term Investments are carried at fair value. Short-Term Investments have maturities greater than three months but less than one year from the purchase date.

All prices for our Fixed Maturities, Equity Securities and Short-Term Investments are classified as Level 1, Level 2 or Level 3 under the fair value hierarchy, as defined in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification 820 (“ASC 820”).  

Premiums and discounts on Fixed Maturities are amortized into interest income over the life of the security using the interest method.  For Mortgage-Backed and Asset-Backed Securities, anticipated prepayments and expected maturities are utilized in applying the interest rate method.  An effective yield is calculated based on projected principal cash flows at the time of original purchase.  The effective yield is used to amortize the purchase price of the security over the security’s expected life.  Book values are adjusted to reflect the amortization of premium or accretion of discount on a monthly basis. The projected principal cash flows are based on certain prepayment assumptions, which are generated using a prepayment model.  The prepayment model uses a number of factors to estimate prepayment activity including the current levels of interest rates (refinancing incentive), time of year (seasonality), economic activity (including housing turnover) and term and age of the underlying collateral (burnout, seasoning).  Prepayment assumptions associated with the Mortgage-Backed and Asset-Backed Securities are reviewed on a periodic basis.  When changes in prepayment assumptions are deemed necessary as the result of actual prepayments differing from anticipated prepayments, securities are revalued based upon the new prepayment assumptions utilizing the retrospective adjustment method, whereby the effective yield is recalculated to reflect actual payments to date and anticipated future payments.  The investment in such securities is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the security.  Such adjustments, if any, are included in Net Investment Income for the current period.

Realized Gains and Losses on sales of investments are recognized when the related trades are executed and are determined on the basis of the specific identification method.

 

Impairment of Invested Assets

Management regularly reviews our Fixed Maturities portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of securities.

Our Company reviews the magnitude of a security’s unrealized loss compared to its cost/amortized cost and the length of time that the security has been impaired to determine if an unrealized loss is other-than-temporary. If warranted as a result of conditions relating to a particular security, our Company will also review securities with declines in fair value resulting from a headline news event involving the issuer, a headline news event involving the asset class, the advice of our external asset managers, or economic events that may impact the issuer to determine if an unrealized loss is other-than-temporary. The depth of analysis performed is dependent upon the nature and magnitude of the indicators of other-than-temporary impairment present in regards to each impaired security.

Our Company assesses the underlying fundamentals of each issuer to determine if there is a change in the amount or timing of expected cash flows. Management compares the amortized cost basis to the present value of the revised cash flows using the historical book yield to determine the credit loss portion of impairment which is recognized in earnings. All non-credit losses where we have the intent and ability to hold the security until recovery are recognized as changes in Other than Temporary Impairment (“OTTI”) losses within AOCI.

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Specifically for structured Fixed Maturities, our Company analyzes projections provided by our investment managers with respect to an expected principal loss under a range of scenarios and utilizes the most likely outcomes. The analysis relies on actual collateral performance measures such as default rate, prepayment rate and loss severity. These assumptions are applied throughout the remaining term of the deal, incorporating the transaction structure and priority of payments, to generate loss adjusted cash flows. Results of the analysis will indicate whether the security is expected ultimately to incur a loss or whether there is a material impact on yield due to either a projected loss or a change in cash flow timing. A break-even default rate is also calculated. A comparison of the break-even default rate to the actual default rate provides an indication of the level of cushion or coverage to the first dollar principal loss. For securities in which a tranche loss is present and the net present value of loss adjusted cash flows is less than book value, credit impairment is recognized in earnings. The output data also includes a number of additional metrics such as average life remaining, original and current credit support, over 60 day delinquency and security rating. The significant inputs used to measure the amount of credit loss recognized in earnings are actual delinquency rates, default probability, severity and prepayment assumptions.

Projected losses are a function of both loss severity and probability of default, which differ based on property type, vintage and the stress of the collateral.

For our policy on evaluating Equity Securities for impairment prior to the adoption of ASU 2016-01 on January 1, 2018, refer to Note 1 within our Annual Report on Form 10-K for the year ended December 31, 2017.

 

NOTE 2.  BUSINESS COMBINATIONS

 

On June 7, 2018 (the “acquisition date”), our Company acquired 100% ownership interest in BDM and ASCO. Our Company also acquired in this transaction a wholly-owned subsidiary of ASCO, Canal Re S.A., a reinsurance company licensed under the laws of the Grand Duchy of Luxembourg (“Canal Re”). The acquisition of all three of these entities will be referred to as (the “Acquisition”). The Acquisition was undertaken as part of our Company’s strategy of expanding to more brokers and insureds across Europe and reinforces our Company’s presence in the European Union’s single market. We anticipate that this will enable our Company to better serve its European clients after Brexit, and will also provide an opportunity for BDM and ASCO to reach a wider European audience.

 

Our Company paid a purchase price of EUR 35.0 million in cash at the acquisition date (which was approximately $40.5 million based on the exchange rate as of June 30, 2018). Additionally, our Company will be reimbursed up to EUR 5.0 million (which is approximately $5.8 million based on the exchange rate as of June 30, 2018) in the event of adverse development of claims incurred prior to December 31, 2016 as measured on December 31, 2019. This reimbursement was valued at $nil as of the acquisition date and June 30, 2018.

 

The purchase price was allocated to the assets acquired and liabilities assumed of BDM and ASCO based on estimated fair values as of the acquisition date and our Company recognized goodwill of $11.3 million.

 

Our Company identified finite lived intangible assets of $7.9 million, including customer relationships, the value of business acquired (“VOBA”), broker networks and trade name. These finite lived intangible assets will be amortized over a weighted average period of 12 years.

 

Our Company identified indefinite lived intangible assets of $2.5 million, related to ASCO’s European licenses.

 

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The fair value of the assets acquired and liabilities assumed and the allocation of the purchase price on the acquisition date are summarized in the table below:

 

 

Significant Fair Value Adjustments were as follows:

The business combination accounting is subject to change if additional information that existed as of the balance sheet date, but was not available, later becomes available within the measurement period, which cannot exceed twelve months from the acquisition date. The acquisition date fair values of the assets acquired and liabilities assumed, including Reserves for Losses and LAE, Deferred Income Tax and Identifiable Intangible Assets, as well as the related estimated useful lives, are provisional and may be subject to adjustments, which may impact the amounts recorded for assets acquired and liabilities assumed as well as the goodwill.

 

The amount of revenue and earnings of BDM and ASCO since the acquisition date has been immaterial.

 

NOTE 3.  SEGMENT INFORMATION

We report our results of operations consistent with the manner in which our Chief Operating Decision Maker reviews the business to assess performance through our reporting segments: U.S. Insurance, International Insurance (“Int’l Insurance”), Global Reinsurance (“GlobalRe”) and Corporate. 

We classify our business into three underwriting segments: U.S. Insurance, Int’l Insurance and GlobalRe.  Both the U.S. Insurance and Int’l Insurance reporting segments are each comprised of three operating segments: Marine, P&C and Professional Liability. The underwriting results of the acquired business from BDM and ASCO are included in the Int’l Insurance reporting segment, with no new operating segments resulting from the acquisition.

We evaluate the performance of each of the underwriting segments based on underwriting results.  Underwriting results are measured based on Underwriting Profit or Loss and the related Combined Ratio, which are both measures of underwriting profitability.   Underwriting Profit (Loss) is calculated from Net Earned Premiums less the sum of Net Losses and Loss Adjustment Expenses (“LAE”), Commission Expenses, Other Operating Expenses and Other Underwriting Income (Expense).  The Combined Ratio is derived by dividing the sum of Net Losses and LAE, Commission Expenses, Other Operating Expenses and Other Underwriting

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Income (Expense) by Net Earned Premiums.  A Combined Ratio of less than 100% indicates an Underwriting Profit and greater than 100% indicates an Underwriting Loss.  Our underwriting performance is evaluated separately from the rest of our operations.  

The performance of our investment portfolios, our liquidity and capital resource needs, our foreign currency exposure and our tax planning strategies are evaluated on a consolidated basis within our Corporate segment. We do not allocate our assets by underwriting segment as we evaluate the underwriting results of these segments separately from the results of our investments portfolio.

Financial data by segment for the three and six months ended June 30, 2018 and 2017 was as follows:

 

 

 

 

 

 

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Revenue by operating segment for the three and six months ended June 30, 2018 and 2017 was as follows:

 

 

 

 

 

 

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NOTE 4.  INVESTMENTS

The following tables set forth our Company’s Available-For-Sale Investments as of June 30, 2018 and December 31, 2017 and include Other-Than-Temporary-Impairment (“OTTI”) securities recognized within Accumulated Other Comprehensive Income (“AOCI”):

 

 

 

 

 

 

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The following table sets forth our Company’s Equity Securities at fair value as of June 30, 2018:

 

 

 

Our Company made investments in certain companies, which are reported as Other Invested Assets on the Consolidated Balance Sheet and accounted for using the equity method.  In applying the equity method, these investments were initially recorded at cost and subsequently adjusted based on our Company’s proportionate share of the net income or loss of the investments. Our initial purchase price for these investments was $2.0 million with a current carrying value of $1.7 million at June 30, 2018 and  December 31, 2017, as reflected on our Consolidated Balance Sheet.  

 

Other Invested Assets also includes overseas deposits with a fair value of $36.6 million at June 30, 2018 and $28.8 million at December 31, 2017.  The overseas deposits consist of investments in private funds which are managed centrally by The Corporation of Lloyds in support of all Lloyd’s market participants. The funds consist of fixed income securities, bank deposits, and cash invested in local markets which are intended to fulfill regulatory deposit requirements in worldwide jurisdictions. Our Company’s ability to withdraw from the funds is restricted by an annual and quarterly funding and release process managed by Lloyd’s in conjunction with Syndicate 1221’s capital requirements in various jurisdictions.

As of June 30, 2018 and December 31, 2017, our Company did not have a concentration of greater than 5% of invested assets in a single non-government backed issuer.

As of June 30, 2018 and December 31, 2017, Fixed Maturities for which Non-Credit OTTI was previously recognized and included in AOCI were in a Net Unrealized Gain position of $0.4 million and $0.5 million, respectively.

The fair value of our Company’s Fixed Maturities investment portfolio may fluctuate significantly in response to various factors such as changes in interest rates, investment quality ratings, foreign exchange rates and credit spreads. Our Company does not have the intent to sell nor is it more likely than not that it will have to sell Fixed Maturities in unrealized loss positions that are not other-than-temporarily impaired before recovery. For structured securities, default probability and severity assumptions differ based on property type, vintage and the stress of the collateral. Our Company does not intend to sell, and it is more likely than not that our Company will not be required to sell, these securities before the recovery of the amortized cost basis. Our Company may realize investment losses to the extent our liquidity needs require the disposition of Fixed Maturity securities in unfavorable interest rate, liquidity or credit spread environments. Significant changes in the factors our Company considers when evaluating investments for impairment losses could result in a significant change in impairment losses reported in the Consolidated Financial Statements.

The contractual maturity dates for Fixed Maturities categorized by the number of years until maturity as of June 30, 2018 are shown in the following table:

 

 

Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Prepayment assumptions associated with the Mortgage-Backed and Asset-Backed Securities are reviewed on a periodic basis. When changes in prepayment assumptions are deemed necessary as the result of actual prepayments differing from anticipated prepayments, securities are revalued based upon the new prepayment assumptions utilizing the retrospective accounting method. Due to the periodic repayment of principal, our Mortgage-Backed and Asset-Backed Securities are estimated to have an effective maturity of approximately 5.3 years.

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The following tables summarize all Available-For-Sale securities in a gross unrealized loss position as of June 30, 2018 and December 31, 2017, showing the aggregate fair value and gross unrealized loss by the length of time those securities have continuously been in a gross unrealized loss position:

 

 

 

 

 

Our Company analyzes impaired securities quarterly to determine if any impairments are other-than-temporary.  The above securities with unrealized losses are deemed to be temporarily impaired based on our evaluation.

 

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As of June 30, 2018, there were 753 Fixed Maturities in an unrealized loss position. As of December 31, 2017, there were 454 Fixed Maturities and 22 Equity Securities in an unrealized loss position. As of June 30, 2018, the gross unrealized loss for the greater than 12 months category consists primarily of Agency Residential Mortgage-Backed Securities and Corporate Exposures principally due to an increase in interest rates and spread widening. The gross unrealized loss for the less than 12 months category for the period ended June 30, 2018 consists primarily of Corporate Exposures due to spread widening.  As of December 31, 2017, the gross unrealized loss for the greater than 12 month category consists primarily of Agency Residential Mortgage-Backed Securities and Corporate Exposures and is mostly due to an increase in interest rates since the time of purchase.  The gross unrealized loss for the less than 12 months category for the period ended December 31, 2017 consists primarily of Corporate Bonds and Preferred Stocks, which are reported in Equity Securities, due to an increase in interest rates since time of purchase, as well as Foreign Government Bonds due to an unfavorable exchange rate movement in our Canadian portfolio.

As of June 30, 2018 and December 31, 2017, the largest unrealized loss by a non-government backed issuer in the investment portfolio was $1.7 million and $0.7 million, respectively.

Our Company’s ability to hold securities is supported by sufficient cash flow from our operations and from maturities within our investment portfolio in order to meet our claims payments and other disbursement obligations arising from our underwriting operations without selling such investments.  With respect to securities where the decline in value is determined to be temporary and the security’s value is not written down, a subsequent decision may be made to sell that security and realize a loss.  Subsequent decisions on security sales are made within the context of overall risk monitoring, changing information and market conditions.  

Upon adoption of ASU 2016-01 as of January 1, 2018, changes in the fair value of Equity Securities are recognized through Net Income. Our Company did not have any credit related OTTI losses during the three months ended June 30, 2018 or 2017. Our Company did not have any credit related OTTI losses during the six months ended June 30, 2018. Our Company had two credit related OTTI losses of $1.1 million in the equity portfolio during the six months ended June 30, 2017.    

As of June 30, 2018 and 2017, the cumulative amounts related to our Company’s credit loss portion of the OTTI losses on Fixed Maturities was $2.4 million.  There were no changes to the cumulative amounts of our Company’s credit loss portion of OTTI for the three and six months ended June 30, 2018 and 2017.

 

 

 

Our Company’s Net Investment Income was derived from the following sources:

 

 

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Realized Gains and Losses on Investments Sold, excluding net OTTI losses recognized in earnings, for the periods indicated, were as follows:

 

 

 

The following table presents the portion of Net Unrealized Gains (Losses) recognized during the three and six months ended June 30, 2018, that relates to Equity Securities held as of June 30, 2018:

 

 

NOTE 5.  FAIR VALUE MEASUREMENT

The fair value of our financial instruments is determined based on the following fair value hierarchy:

Level 1 – Quoted prices for identical instruments in active markets.  Examples are listed equities and fixed income securities traded on an exchange.  U.S. Treasury securities are reported as Level 1 and are valued based on unadjusted quoted prices for identical assets in active markets that our Company can access.

Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.  Examples are Asset-Backed and Mortgage-Backed Securities that are similar to other Asset-Backed or Mortgage-Backed Securities observed in the market. U.S. Government Agency Securities are reported as Level 2 and are valued using yields and spreads that are observable in active markets.

Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.  An example would be a private placement with minimal liquidity.

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The following tables present, for each of the fair value hierarchy levels as defined by the accounting guidance for fair value measurements described above, our Company’s Fixed Maturities and Equity Securities by asset class that are measured at fair value on a recurring basis, as well as the fair value of the 5.75% Senior Notes due October 15, 2023 (the “Senior Notes”) carried at amortized cost as of June 30, 2018 and December 31, 2017:

 

 

 

Other Financial assets and liabilities including Cash, Premium Receivable, Reinsurance Recoverable and Reinsurance Balances Payable are carried at cost, which approximates fair value.  Our Company has Overseas deposits in Other Invested Assets of $36.6 million and $28.8 million at June 30, 2018 and December 2017, respectively, which is measured at fair value using the net asset value (“NAV”) as a practical expedient.

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Our Company did not have any transfers between Level 1 and Level 2 classifications for the three and six months ended June 30, 2018 and 2017.   

As of June 30, 2018, our Company did not have any Level 3 assets.

 

NOTE 6.  GOODWILL AND INTANGIBLE ASSETS

 

Goodwill

 

The following table shows an analysis of goodwill by reporting segment:

 

 

The goodwill acquired primarily relates to expected synergies from combining operations of BDM and ASCO and is not expected to be deductible for tax purposes. The fair values of the assets acquired and liabilities assumed may be subject to adjustments, which may impact the amount recorded for goodwill.

 

Intangibles

 

The gross carrying value and weighted average amortization period of intangible assets by type at June 30, 2018 was as follows:

 

 

The aggregate amortization expense since the acquisition date of BDM and ASCO has been immaterial.

 

The fair values of the intangible assets acquired may be subject to adjustments, which may impact the amounts recorded.

 

The estimated remaining amortization expense for the finite-lived intangible assets is as follows:

 

 

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NOTE 7.  LOSS RESERVES

We establish reserves for the estimated unpaid ultimate liability for losses and LAE under the terms of our policies and agreements.  The determination of Reserves for Losses and LAE is partially dependent upon the receipt of information from agents and brokers.  Reserves include estimates for both claims that have been reported and for those that have been incurred but not reported (“IBNR”), and include estimates of expenses associated with processing and settling these claims.  Reserves are recorded in Reserves for Losses and LAE in the Consolidated Balance Sheets.  Our estimates and judgements may be revised as additional experience and other data become available and are reviewed, as new or improved methodologies are developed, or as laws change. Frequency/severity analyses are also performed for certain books of business.  To the extent that reserves are found deficient or redundant, a strengthening or release is recognized as a charge or credit to earnings.

The following table summarizes our Company’s Reserves for Losses and LAE activity for the six months ended June 30, 2018 and 2017:

 

 

For the six months ended June 30, 2018, our Incurred Losses and LAE increased $35.8 million as compared to the same period in 2017, primarily due to growth in Net Earned Premium over the prior year.

 

In addition, we incurred $3.3 million of net prior AY reserve strengthening for the six months ended June 30, 2018 due to net unfavorable non-catastrophe related loss emergence of $11.8 million primarily within our Int’l and U.S. Insurance reporting segments, partially offset by net catastrophe loss releases $8.5 million primarily related to Hurricanes Harvey, Irma and Maria (the “Hurricane events”) and the Puebla, Mexico Earthquake that occurred in the third quarter of 2017. This compared to $15.1 million of net prior AY reserve strengthening for the same period in 2017 related to unfavorable loss emergence within our Int’l Insurance and GlobalRe reporting segments.

For the six months ended June 30, 2018, our Losses and LAE Payments increased $28.5 million as compared to the same period in 2017, primarily due to increased claim payments associated with the catastrophe activity occurring in the third quarter of 2017.

Our June 30, 2018 Net Reserves for Losses and LAE includes estimated amounts for numerous catastrophe events. We caution that the magnitude and complexity of losses arising from these events inherently increases the level of uncertainty and therefore the level of management judgment involved in arriving at our estimated Net Reserves for Losses and LAE. As a result, our actual losses for these events may ultimately differ materially from our current estimates.

 

NOTE 8. CEDED REINSURANCE

As of June 30, 2018, the credit quality distribution of our Company’s Reinsurance recoverable of $1.1 billion for ceded paid losses, ceded unpaid losses and LAE, and ceded unearned premiums based on insurer financial strength ratings from A.M. Best or S&P was not significantly different from the credit quality distribution as of December 31, 2017.    

Our allowance for uncollectible reinsurance was $12.6  million as of June 30, 2018 and December 31, 2017.

As of June 30, 2018, the list of our 10 largest reinsurers measured by the amount of Reinsurance recoverable for ceded losses and LAE and ceded unearned premium, together with the reinsurance recoverable and collateral, was similar to the list as of December 31, 2017.

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NOTE 9.  DEBT

During the first quarter of 2018, the Company reclassified certain overseas deposits from Short-Term Investments to Other Invested Assets. Refer to Note 1. Organization & Summary of Significant Accounting Policies. Although the nature of the investments did not change, this reclassification caused the Company to exceed a covenant of our Club Facility that sets a limitation on other investments as a percentage of total investments.  Our Company has received a waiver of compliance with respect to this covenant, which was subsequently amended to increase the percentage of other investments permitted. As of June 30, 2018, our Company was in compliance with all covenants for our Club Facility, Senior Notes, Australian Facility and Bilateral Facility.

NOTE 10.  COMMITMENTS AND CONTINGENCIES

In 2013, the State of Connecticut (“the State”) awarded our Company up to $11.5 million ($8.0 million in loans and $3.5 million in grants) to move our corporate headquarters to Stamford, Connecticut.  The loan is non-interest bearing, has a term of 10 years and is subject to forgiveness based on our compliance with certain conditions set forth in the agreement with the State.  The amount of the loan to be received is dependent on our Company reaching certain milestones for creation of new jobs over a five-year period, and the funds are to be used to offset certain equipment purchases, facility costs, training of employees and other eligible project-related costs.  As of June 30, 2018, our Company has received $11.5 million of the award ($8.0 million in loans and $3.5 million of the grant) and earned a loan forgiveness credit of $7.0 million with the State. Our Company is recognizing the amount of loan and grants received over the period in which offsetting expenses are recognized. Our Company recognized $0.4 million and $0.7 million of the incentive for the three and six months ended June 30, 2018, respectively. As of June 30, 2018 and December 31, 2017, our Company has deferred revenue of $5.3 million and $4.4 million, respectively, which is included in Other Liabilities on the Consolidated Balance Sheets.

On February 16, 2017, our Company entered into a guarantee, pursuant to which it guaranteed all of the liabilities and obligations of NIIC (the “Guarantee”). The Guarantee will remain effective until all of such liabilities and obligations are discharged, and in the event that our Company does not meet its obligations under the Guarantee, any person who is covered by an insurance policy, certificate of coverage or reinsurance contract issued by NIIC will be a third party beneficiary under the Guarantee.  Our Company’s obligations under the Guarantee may be terminated by providing twelve months prior written notice to NIIC. However the obligations of our Company under the Guarantee terminate immediately in the event that (i) the majority of the outstanding voting capital stock in NIIC is sold to any non-affiliated entity; (ii) A.M. Best has confirmed that NIIC will receive the same financial strength rating as NIC or NSIC, without the benefit of the Guarantee; or (iii) NIIC withdraws its request to be rated by A.M. Best, provided that NIIC has not been downgraded within the prior twelve months.

In the ordinary course of conducting business, our Parent Company’s subsidiaries are involved in various legal proceedings. Most of these proceedings consist of claims litigation involving our Parent Company’s subsidiaries as either: (a) liability insurers defending or providing indemnity for third party claims brought against insureds or (b) insurers defending first party coverage claims brought against them. In general, our Company believes we have valid defenses to these cases. Our Company’s management believes that the ultimate liability, if any, with respect to these legal proceedings, after consideration of provisions made for potential losses and cost of defense, will not be material to our Company’s Consolidated Balance Sheets, Statements of Income and Statements of Cash Flows.

 

NOTE 11.  STOCK-BASED COMPENSATION

Stock-based compensation granted under our Company’s stock plans is expensed in tranches over the vesting period. Non-performance based grants generally vest equally over a three or four-year period. Performance units generally cliff vest three years after they are granted. Each performance unit and restricted stock unit represents a contingent right to receive one share of Common Stock as of the vesting date. Such Common Stock may be subject to forfeiture for the payment of any required tax withholding.

 

The activity related to our Company's restricted stock unit awards was as follows:

 

 

 

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The activity related to our Company's performance-based equity awards was as follows:

 

 

NOTE 12. STOCKHOLDERS’ EQUITY

On May 10, 2018 our Board of Directors declared a cash dividend of $0.07 per share that was paid on June 29, 2018. 

The declaration and amount of any future dividend will be at the discretion of the Board of Directors, and will depend upon many factors, including financial condition, results of operations, business requirements, regulatory and legal constraints and other factors the Board of Directors deems relevant.

 

 

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

FORWARD-LOOKING STATEMENTS

Some of the statements in this Quarterly Report on Form 10-Q are “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact included in or incorporated by reference in this Quarterly Report are forward-looking statements.  Whenever used in this report, the words “estimate,” “expect,” “believe,” “may,” “will,” “intend,” “continue” or similar expressions or their negative are intended to identify such forward-looking statements.  Forward-looking statements are derived from information that we currently have and assumptions that we make, and are subject to a number of risks and uncertainties, including those described in the “Risk Factors” section of our 2017 Annual Report on Form 10-K.  We operate in a competitive environment, with new risks emerging from time to time. We cannot assure you that anticipated results will be achieved, since actual results may differ materially because of both known and unknown risks and uncertainties which we face.

In light of these risks, uncertainties and assumptions, any forward-looking events discussed in this Form 10-Q may not occur, and we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of their respective dates.

U.S. GAAP and Non-GAAP Financial Performance Metrics

Throughout this Quarterly Report, we present our operations in the way we believe will be most meaningful, useful and transparent to anyone using this financial information to evaluate our performance. In addition to the presentation of Net Income, Book Value, Book Value per Share, Net Losses and LAE Reserves and Combined Ratio, we show certain non-GAAP financial measures as defined in Regulation G that we believe are valuable in managing our business and drawing comparisons to our peers. These non-GAAP measures are Net Operating Earnings and Underwriting Profit (Loss).

The following is a list of GAAP and non-GAAP measures found throughout this report with their definitions, relationships to GAAP measures and explanations of their importance to our operations:

Book Value and Book Value Per Share

Book Value is equivalent to Stockholders’ Equity and Book Value per Share is calculated by dividing Stockholders’ Equity by the number of outstanding shares at the end of the interim period.

Net Losses and LAE Reserves

Reserves for Losses and LAE, as shown in the liabilities section of our Consolidated Balance Sheets, represents the total gross obligations to claimants for both estimates of known claims and estimates for IBNR claims. The related asset item, Reinsurance Recoverable on Unpaid Losses and LAE, is the estimate of both known claims and IBNR that we expect to recover from reinsurers. The net of these two items is generally referred to as Net Losses and LAE Reserves and is commonly used in our disclosures regarding the process of establishing these various estimated amounts.

Combined Ratio

The Combined Ratio is a common insurance industry measure of profitability for any underwriting operation and is calculated in three components. First, the Loss Ratio is represented by Net Losses and LAE divided by Net Earned Premiums. The second component is the Commission Expense Ratio, which is Commission Expenses divided by Net Earned Premiums. The third component is the Other Operating Expense Ratio, which reflects the sum of Other Operating Expenses and Other Underwriting Income (Expense), divided by Net Earned Premiums. All items included in these components of the Combined Ratio are presented in our GAAP Consolidated Financial Statements. The sum of the Loss, Commission Expense and Other Operating Expense Ratios is the Combined Ratio. The difference between the Combined Ratio and 100% reflects the rate of Underwriting Profit (Loss). For example, a Combined Ratio of 85% implies that for every $100 of premium we earn, we record $15 of Underwriting Profit.

Net Operating Earnings

Net Operating Earnings is a “non-GAAP financial measure” as defined in Regulation G. Net Operating Earnings is comprised of Net Income excluding After-Tax Total Net Realized and Unrealized Gains (Losses), After-Tax Foreign Exchange Gains (Losses) and the Net Gain on Disposition of Product Line recognized in our Consolidated Statements of Income. We believe that this presentation reflects the underlying fundamentals of our business.

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A reconciliation of Net Income (the nearest GAAP financial measure) to Net Operating Earnings can be found in Item 2, Results of Operations. We believe this presentation enhances the understanding of our results of operations by highlighting the underlying profitability of our business and enables investors and other users of our financial information to analyze underlying business performance in a manner similar to management. We also believe this measure follows industry practice and, therefore facilitates comparison of our performance with our peer group.

Underwriting Profit (Loss)

Underwriting Profit (Loss) represents one measure of the pre-tax profitability of our insurance operations and is derived by subtracting the following from Net Earned Premiums: Net Losses and LAE Incurred, Commission Expenses, Other Operating Expenses and Other Underwriting Income (Expense). This information is available in total and by segment in Note 3 – Segment Information in the Interim Consolidated Financial Statements. The nearest comparable GAAP measure is Income Before Income Taxes which, in addition to Net Underwriting Profit (Loss), includes Net Investment Income, Total Net Realized and Unrealized Gains (Losses) recognized in our Consolidated Statements of Income, Interest Expense and Other Income (Loss). While this measure is presented in the footnotes to the Interim Consolidated Financial Statements, it is considered a “non-GAAP financial measure” as defined in Regulation G when presented elsewhere on a consolidated basis.

A reconciliation of total Net Underwriting Profit (Loss) and its components to Income Before Income Taxes (the nearest GAAP financial measure) can be found in Item 1, Note 3 to the Interim Consolidated Financial Statements and in Item 2, Segment Results. We believe that presentation of Net Underwriting Profit (Loss) provides investors with an enhanced understanding of our results of operations, by highlighting the underlying pre-tax profitability of our underwriting activities.

Overview

The discussion and analysis of our financial condition and results of operations contained herein should be read in conjunction with our 2017 Annual Report on Form 10-K in its entirety as well as the statements under “Forward-Looking Statements” and the Interim Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q for a complete description of events, trends, uncertainties, risks and critical accounting estimates affecting us.

Unless the context requires otherwise, the terms “we,” “us,”  “our” or “our Company” are used to mean The Navigators Group, Inc., a Delaware holding company established in 1982, and its subsidiaries. The term “Parent Company” is used to mean The Navigators Group, Inc. without its subsidiaries.

We are an international insurance company with a long-standing area of specialization in Marine insurance. We also offer P&C insurance, primarily general liability coverage and umbrella & excess liability coverage to commercial enterprises through our Primary and Excess Casualty divisions. We have also developed niches in Professional Liability insurance, through our D&O and E&O divisions, as well as assumed reinsurance products.

On February 7, 2018, certain wholly owned subsidiaries of our Company entered into a Renewal Rights Agreement with Thomas Miller Specialty Underwriting Agency Limited and Thomas Miller & Co Limited (collectively “Thomas Miller”), pursuant to which Thomas Miller agreed to acquire the renewal rights to our Company’s fixed-premium protection and indemnity business. During the first quarter of 2018, our Company recorded a gain from this transaction. Our Company agreed to continue to underwrite such business from February 8, 2018 through an end date of August 31, 2018, which was originally June 30, 2018, while all transitional arrangements are put in place, but will cede 100% of such business through a quota share agreement. After August 31, 2018 this business will renew through Thomas Miller. Our Company will remain responsible for all losses occurring prior to February 8, 2018 on such business, and our Company will continue to participate in the protection and indemnity market primarily through reinsurance of mutual clubs via our Lloyd’s of London (“Lloyd’s”) syndicate, Syndicate 1221.

 

On June 7, 2018 (the “acquisition date”), the Company acquired 100% ownership interest in Bracht, Deckers & Mackelbert NV, an insurance underwriting agency organized under the laws of Belgium (“BDM”), and Assurances Continentales – Continentale Verzekeringen NV, an insurance company licensed under the laws of Belgium (“ASCO”). The Company also acquired in this transaction a wholly-owned subsidiary of ASCO, Canal Re S.A., a reinsurance company licensed under the laws of the Grand Duchy of Luxembourg (“Canal Re”). The acquisition of all three of these entities will be referred to as (the “Acquisition”). The Acquisition was undertaken as part of the Company’s strategy of expanding to more brokers and insured across Europe and reinforces the Company’s presence in the European Union’s single market. We anticipate that this will enable the Company to better serve its European clients after Brexit, and will also provide opportunity for BDM and ASCO to reach a wider European audience.

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Financial Highlights – Selected Indicators

 

 

 

Our revenue is primarily comprised of premiums and investment income. Cash flow is generated from premiums collected and investment income received less paid losses and loss expenses, commission and administrative expenses as well as the timing of reinsurance receipts and payments. Our products are distributed through multiple channels, utilizing global, national and regional retail and wholesale insurance brokers.

We report our results of operations consistent with the manner in which our Chief Operating Decision Maker reviews the business to assess performance by our four reportable segments: U.S. Insurance, Int’l Insurance, GlobalRe and Corporate.  

 

 

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Results of Operations

The following table presents a summary of our consolidated financial results for the three and six months ended June 30, 2018 and 2017:

 

 

 

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The following tables calculate our Net Operating Earnings for the three and six months ended June 30, 2018 and 2017:

 

 

 

 

 

 

 

 

Underwriting Profit

Quarter to Date Variance

Underwriting Profit was $13.3 million for the three months ended June 30, 2018 increasing $5.5 million from the same period in 2017. This increase was driven by the impact of growth in Net Earned Premiums across all of our reporting segments, as well as a $6.7 million decrease in Net Prior Accident Year Reserve Strengthening for the three months ended June 30, 2018 compared to the same period in 2017. Although Commission Expenses increased for the three months ended June 30, 2018 compared to the same period in 2017, this increase in conjunction with growth in Net Earned Premium caused a lower Commission Expense Ratio resulting in an additional contribution to Underwriting Profit period over period. These increases to Underwriting Profit were partially offset by an increase in Other Operating Expenses primarily due to an increase in employee expenses, professional service fees and information technology costs associated with new business initiatives and expansion of our global platform, as well as the impact of foreign exchange rates. Also partially offsetting the increases to Underwriting Profit was an increase in the Net Current Accident Year Losses and LAE Ratio.

Year to Date Variance

Underwriting Profit was $32.7 million for the six months ended June 30, 2018 increasing $14.8 million from the same period in 2017. This increase was driven by the impact of growth in Net Earned Premiums across all of our reporting segments, as well as an $11.8 million decrease in Net Prior Accident Year Reserve Strengthening for the six months ended June 30, 2018 compared to the same period in 2017. These increases to Underwriting Profit were partially offset by an increase in Other Operating Expenses primarily due to an increase in employee expenses, professional service fees and information technology costs associated with new business

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initiatives and expansion of our global platform, as well as the impact of foreign exchange rates. Also partially offsetting the increases to Underwriting Profit was an increase in the Net Current Accident Year Losses and LAE Ratio. While Commission Expenses increased for the six months ended June 30, 2018 compared to the same period in 2017, this was in line with Net Earned Premium growth resulting in relatively consistent ratios period over period.

For more detail on Underwriting Profit (Loss), see the U.S. Insurance, Int’l Insurance and GlobalRe reporting segment results sections included herein.

A major component of our Underwriting Profit (Loss) is Net Losses and LAE.  The following table presents the current and prior accident year (“AY”) changes in our Net Losses and LAE Ratio for the three and six months ended June 30, 2018 and 2017:

 

 

 

Quarter to Date Variance

 

For the three months ended June 30, 2018, our Reported Net Losses and LAE Ratio decreased 1.0 points as compared to the same period in 2017 driven by:

Prior Year Reserve Development

For the three months ended June 30, 2018, our Net Prior AY Losses and LAE Ratio decreased 2.3 points as compared to the same period in 2017 driven by:

 

Changes in the Current Accident Year Loss Ratio

For the three months ended June 30, 2018, our Net Current AY losses and LAE Ratio increased 1.3 points as compared to the same period in 2017 primarily driven by unfavorable performance within our Int’l Insurance reporting segment and changes in mix of business, partially offset by a lower level of catastrophe losses within our GlobalRe reporting segment.

Year to Date Variance

 

For the six months ended June 30, 2018, our Reported Net Losses and LAE Ratio decreased 1.3 points as compared to the same period in 2017 driven by:

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Prior Year Reserve Development

For the six months ended June 30, 2018, our Net Prior AY Losses and LAE Ratio decreased 2.1 points as compared to the same period in 2017 driven by:

 

Changes in the Current Accident Year Loss Ratio

For the six months ended June 30, 2018, our Net Current AY losses and LAE Ratio increased 0.8 points as compared to the same period in 2017 attributable to the same drivers as the quarter to date variance.

Net Investment Income

Our Net Investment Income was derived from the following sources:

 

Quarter and Year to Date Variance

The increase in Net Investment Income for the three and six months ended June 30, 2018 as compared to the same period in the prior year was due to growth of invested assets in the Fixed Maturities portfolio. The annualized pre-tax yield, excluding Total Net Realized and Unrealized Gains and Losses recognized in our Results of Operations, for the three months ended June 30, 2018 and 2017 was 2.8%. The annualized pre-tax yield, excluding Total Net Realized and Unrealized Gains and Losses recognized in our Results of Operations, for the six months ended June 30, 2018 was 2.8%, compared to 2.7% for the same period in 2017.

As part of our overall investment strategy, we seek to build a tax efficient investment portfolio by maintaining an allocation of tax- exempt municipal bonds. The tax-exempt portion of our Fixed Maturities portfolio was 17.6% at June 30, 2018 as compared to 19.5% at June 30, 2017. Additionally, substantially all of our equity portfolio is invested in tax efficient securities which qualify for the dividends received deduction. The tax equivalent yield for the three months ended June 30, 2018 and 2017 was 3.0% and 3.2%, respectively. The tax equivalent yield for the six months ended June 30, 2018 and 2017 was 3.0% and 3.1%, respectively. The decrease in the tax equivalent yield is due to the Tax Cuts and Jobs Act enacted on December 22, 2017 (the “Tax Act”), which resulted in lower tax benefits associated with the tax exempt portions of our investment portfolio.

OTTI Losses Recognized in Earnings

Quarter and Year to Date Variance

Our Company had no credit related OTTI losses during the three months ended June 30, 2018 and 2017. Our Company had no credit related OTTI losses during the six months ended June 30, 2018. Our Company had two credit related OTTI losses of $1.1 million in our equity portfolio during the six months ended June 30, 2017.  Upon the adoption of ASU 2016-01 as of January 1, 2018, changes in the fair value of Equity Securities are now recognized in Net Income.

 

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Net Realized Gains and Losses on Investments Sold

Net Realized Gains and Losses on Investments Sold, excluding OTTI Losses Recognized in Earnings, for the periods indicated were as follows:

 

Quarter and Year to Date Variance

 

Net Realized Gains and Losses are generated as part of the normal ongoing management of our investment portfolio. Net Realized Gains of $1.8 million for the three months ended June 30, 2018 are primarily due to the sale of Municipal Bonds as we re-evaluate this asset class in light of the tax changes enacted as part of the Tax Act in 2017.  To a lesser extent, realized gains are driven by sales of Preferred Stocks within our Equity portfolio. Net Realized Gains of $3.0 million for the six months ended June 30, 2018 are primarily due to the sale of Municipal Bond and Corporate Exposures. Net Realized Gains of $1.7 million and $2.7 million for the three and six months ended June 30, 2017, respectively, are primarily due to the sale of Common Equity Securities, partially offset by foreign currency losses on our Canadian denominated Foreign Government Bonds

Net Unrealized Gains and Losses on Investments at Fair Value through Net Income

Quarter and Year to Date Variance

For the three and six months ended June 30, 2018, our Company had $1.3 million of net unrealized gains and $1.9 million of net unrealized losses, respectively, on our Equity Securities, which were recognized in Net Income pursuant to ASU 2016-01, which we adopted effective January 1, 2018.

Interest Expense

Quarter and Year to Date Variance

Interest Expense was $3.9 million and $7.7 million for the three and six months ended June 30, 2018, respectively, relating to our $265.0 million principal amount of the Senior Notes.  The effective interest rate related to the Senior Notes, based on the proceeds net of discount and all issuance costs, is approximately 5.86%.

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Other Income (Loss)

Quarter to Date Variance

Other Income (Loss) for the three months ended June 30, 2018 was $2.6 million compared to $(0.4) million for the same period in 2017. The Other Income for the three months ended June 30, 2018 was attributable to net realized and unrealized foreign exchange gains driven by the re-measurement of net insurance related liabilities impacted by the strengthening of the U.S. Dollar against the Great British pound, Euro and Canadian Dollar.

Year to Date Variance

Other Income for the six months ended June 30, 2018 was $2.5 million compared to $0.6 million for the same period in 2017. The Other Income for the six months ended June 30, 2018 was attributable to revenue from the sale of renewal rights for our Company’s fixed-premium protection and indemnity business during the first quarter as well as net realized and unrealized foreign exchange gains driven by the re-measurement of net insurance related liabilities impacted by the strengthening of the U.S. Dollar against the Great British pound, Euro and Canadian Dollar.

Income Taxes

Quarter and Year to Date Variance

We recorded an Effective Tax Rate of 19.3% and 18.1% for the three and six months ended June 30, 2018, respectively, compared to 25.4% and 26.0% for the same periods in 2017. The decrease of 6.1 points and 7.9 points for the three and six months ended June 30, 2018, respectively, is mostly driven by the benefit of the lowered statutory tax rate from 35% in 2017 to 21% in 2018 under the Tax Act. The income tax provision has been computed based on our estimated interim annual Effective Tax Rate incorporating discrete items. Our Effective Tax Rate for the quarter and year-to-date differs from the federal tax rate of 21% primarily due to tax-exempt investment income, the dividends received deduction, and an excess tax benefit related to the vesting of stock compensation at fair market value.

 

Segment Results

The following tables summarize our Consolidated Financial Results by reporting segment for the three and six months ended June 30, 2018 and 2017:

 

 

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U.S. Insurance

The following tables summarize our Underwriting Profit (Loss) by operating segment for our U.S. Insurance reporting segment for the three and six months ended June 30, 2018 and 2017:

 

 

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Gross Written Premiums

Quarter to Date Variance

Gross Written Premiums increased $31.3 million for the three months ended June 30, 2018 as compared to the same period in 2017, driven by a $30.5 million and $3.7 million increase in our P&C and Professional Liability operating segments, respectively, partially offset by a decrease in our Marine operating segment of $2.9 million.

The decrease in our Marine operating segment was driven by a decrease in our Craft product due to nonrenewal of an underperforming program, offset by an increase in our Inland Marine product due to new business and an increased level of renewals.

The increase in our P&C operating segment was mainly driven by increases in our Excess Casualty, Auto and Other P&C divisions. The increase in our Excess Casualty division was mostly driven by an increased level of renewals, new business, and improved rates. New business production drove increases in our Property product within our Other P&C division as well as our Auto division

The increase in our Professional Liability operating segment was primarily due to increased rates, new business and an increased level of renewals.

Average renewal premium rates for our U.S. Insurance reporting segment for the three months ended June 30, 2018 increased 3.4% compared to the same period in 2017, driven by increases of 4.5%, 1.3% and 0.2% within our P&C, Professional Liability and Marine operating segments, respectively.

Year to Date Variance

Gross Written Premiums increased $33.6 million for the six months ended June 30, 2018 as compared to the same period in 2017, driven by a $28.1 million and $7.6 million increase in our P&C and Professional Liability operating segments, respectively, partially offset by a decrease in our Marine operating segment of $2.1 million.

The decrease in our Marine operating segment was driven by a decrease in our Craft product due to nonrenewal of an underperforming program. This decrease was partially offset by an increase in our Marine Liability product due to the timing of renewals and rate improvement as well as an increase in our Inland Marine product driven by new business and an increased level of renewals.

The increase in our P&C operating segment was driven by increases in our Other P&C, Auto, Excess Casualty, and Environmental divisions, partially offset by a decrease in our Primary Casualty division. New business production and increased renewal rates drove increases in our Property product within our Other P&C division as well as our Auto division. The increase in our Excess Casualty division was attributable to new business and improved rates on renewals for our Commercial Retail Excess Casualty product,

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partially offset by a decrease in premium for our Specialty Wholesale Excess Casualty product due to two large non-recurring construction projects coverage accounts written in the first quarter of 2017. The increase in our Environmental division was attributable to an increased level of renewals including the renewal of multi-year contracts not available for renewal in the prior year. The decrease in our Primary Casualty division was related to the nonrenewal of underperforming accounts.

The increase in our Professional Liability operating segment was attributable to the same drivers as the quarter to date variance.

Average renewal premium rates for our U.S. Insurance reporting segment for the six months ended June 30, 2018 increased 3.1% compared to the same period in 2017, driven by increases of 3.8%, 1.7% and 1.5% within our P&C, Professional Liability and Marine operating segments, respectively.

Ceded Written Premiums

Quarter to Date Variances

Ceded Written Premiums were $76.1 million, resulting in a retention ratio of 73.6% of Net Written Premiums to Gross Written Premiums, for the three months ended June 30, 2018 compared to $73.9 million, resulting in a retention ratio of 71.3%, for the same period in 2017. The increase in the retention ratio was driven by our Marine and P&C operating segments, partially offset by a decrease in the retention ratio for our Professional Liability operating segment.

The increase in our Marine operating segment’s retention ratio was primarily driven by a reduction in proportional reinsurance in our Craft product related to business that was not renewed which had proportional cessions, partially offset by an increase in quota share cessions on our Fishing Vessels product in 2018.

The increase in our P&C operating segment’s retention ratio was primarily the result of additional reinsurance on our Property product impacting the second quarter of 2017.

The decrease in our Professional Liability operating segment’s retention ratio for the three months ended June 30, 2018 was primarily the result of an excess of loss increased ceded premium estimate on our E&O division in the second quarter of 2017. This decrease was partially offset by a reduction in proportional reinsurance coverage that supports our D&O division.

Year to Date Variances

Ceded Written Premiums were $142.7 million, resulting in a retention ratio of 73.0%, for the six months ended June 30, 2018 compared to $135.3 million, resulting in a retention ratio of 72.6%, for the same period in 2017. The increase in the retention ratio was driven by our Marine and Professional Liability operating segments, partially offset by a decrease in the retention ratio for our P&C operating segment.

The increase in our Marine operating segment’s retention ratio was attributable to the same drivers as the quarter to date variance.

The decrease in our P&C operating segment’s retention ratio was primarily the result of changes in the mix of business within this operating segment.

The increase in our Professional Liability operating segment’s retention ratio was primarily attributable to a reduction in proportional reinsurance coverage that supports our D&O division.

Net Earned Premiums

Quarter and Year to Date Variances

Net Earned Premiums increased $12.7 million and $21.6 million for the three and six months ended June 30, 2018, respectively, as compared to the same periods in 2017 driven by growth in our P&C operating segment and recent reductions in the level of proportional reinsurance within our Professional Liability operating segment. These increases in Net Earned Premiums were partially offset by a reduction in the amount of premiums written in our Marine operating segment as well as the impact of increased proportional reinsurance on our Property product within the P&C operating segment.

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Net Losses and LAE

The Net Losses and LAE reserves as of June 30, 2018 and December 31, 2017 were as follows:

 

 

The following tables present the current and prior accident year changes in our Net Losses and LAE Ratio for the three and six months ended June 30, 2018 and 2017:

 

 

 

Quarter to Date Variance

 

For the three months ended June 30, 2018, our Net Losses and LAE Ratio decreased 0.8 points as compared to the same period in 2017 driven by:

Prior Year Reserve Development

For the three months ended June 30, 2018, our Net Prior AY Losses and LAE Ratio decreased 1.4 points as compared to the same period in 2017 primarily driven by:

The above decrease in our Net Prior AY Loss and LAE Ratio was partially offset by:

 

Changes in the Current Accident Year Loss Ratio

For the three months ended June 30, 2018, our Net Current AY Losses and LAE Ratio increased 0.6 points as compared to the same period in 2017, primarily driven by increases in our P&C and Marine operating segments due to unfavorable performance within certain key products, partially offset by changes in product mix and favorable performance within our Professional Liability operating segment.

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Year to Date Variance

 

For the six months ended June 30, 2018, our Net Losses and LAE Ratio increased 1.4 points as compared to the same period in 2017 driven by:

Prior Year Reserve Development

For the six months ended June 30, 2018, our Net Prior AY Losses and LAE Ratio increased 0.8 points as compared to the same period in 2017 primarily driven by:

 

 

The above increases in our Net Prior AY Loss and LAE Ratio were partially offset by:

Changes in the Current Accident Year Loss Ratio

For the six months ended June 30, 2018, our Net Current AY Losses and LAE Ratio increased 0.6 points as compared to the same period in 2017, attributable to the same drivers as the quarter to date variance.

Commission Expenses

Quarter and Year to Date Variances

Our Commission Expense Ratio for the three and six months ended June 30, 2018 decreased 0.9 points and 0.6 points as compared to the same periods in 2017, mostly driven by our Marine and P&C operating segments, partially offset by an increase in our Professional Liability operating segment.

Our Marine operating segment’s Commission Expense Ratio decreased due to lower gross commission rates on certain product lines, changes in the mix of business, and greater ceded profit commission income.

Our P&C operating segment’s Commission Expense Ratio decreased primarily due changes in the mix of business with an increase in Property business which generates greater ceding commission income related to a large proportional reinsurance program.

Our Professional Liability operating segment’s Commission Expense Ratio increased due to the reduction in proportional reinsurance and the related ceding commission benefits primarily within our D&O division.

Other Operating Expenses

Quarter and Year to Date Variances

Other Operating Expenses for the three and six months ended June 30, 2018 increased $5.3 million and $8.8 million, respectively, as compared to the same periods in 2017, primarily due to an increase in costs associated with new business initiatives including applicable support and information technology expenses as well as higher professional service fees.

 

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Int’l Insurance

The following tables summarize our Underwriting Profit (Loss) by operating segment for our Int’l Insurance reporting segment for the three and six months ended June 30, 2018 and 2017: 

 

 

 

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Gross Written Premiums

Quarter to Date Variance

Gross Written Premiums increased $1.3 million for the three months ended June 30, 2018 compared to the same period in 2017, driven by an increase in our Professional Liability operating segment of $10.3 million, partially offset by decreases in our Marine operating segment of $8.9 million.

The decrease in our Marine operating segment was driven by decreases in our Hull, Transport, Marine Liability, Cargo, and Specie products. The decrease in our Hull product was primarily related to the timing of certain construction driven contracts and non-renewals. The decrease in our Transport and Marine Liability products was primarily driven by declined renewals of several large binding authorities. The decrease in our Cargo product was related to remedial actions on certain accounts. The decrease in our Specie product was related to timing and non-renewals.

Gross Written Premiums remained relatively consistent in our P&C operating segment as declines in our Property division were offset by increases in our General Liability, Energy & Engineering and Political Violence & Terrorism divisions driven by new business production. The decrease in our Property division was related to strategic actions taken to exit our International and North American Property businesses in 2017.

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The increase in our Professional Liability operating segment was primarily driven by rate improvement and growth in new business across all divisions within this operating segment.

Average renewal premium rates for our Int’l Insurance reporting segment for the three months ended June 30, 2018 increased 2.7% compared to the same period in 2017, driven by increases of 5.0%, 2.0% and 0.8% in our P&C, Professional Liability and Marine operating segments, respectively.

Year to Date Variance

Gross Written Premiums decreased $12.7 million for the six months ended June 30, 2018 compared to the same period in 2017, driven by decreases in our Marine and P&C operating segments of $21.2 million and $6.5 million, respectively, partially offset by an increase in our Professional Liability operating segment of $15.1 million.

The decrease in our Marine operating segment was due to decreases in our Transport, Protection & Indemnity, Marine Liability, and Hull products. The decreases in our Transport, Marine Liability, and Hull products were attributable to the same drivers as the quarter to date variances. The decrease in our Protection & Indemnity product was driven by timing of renewals and policy cancellations associated with decision to sell the renewal rights to our fixed-premium protection and indemnity business.

The decrease in our P&C operating segment was attributable to the same drivers as the quarter to date variance.

The increase in our Professional Liability operating segment was attributable to the same drivers as the quarter to date variance.

Average renewal premium rates for our Int’l Insurance reporting segment for the six months ended June 30, 2018 increased 2.9% compared to the same period in 2017, driven by increases of 4.6%, 2.4% and 1.4% in our P&C, Marine and Professional Liability operating segments, respectively.

Ceded Written Premiums

Quarter and Year to Date Variance

Ceded Written Premiums were $39.9 million, resulting in a retention ratio of 69.9% of Net Written Premiums to Gross Written Premiums, and $68.8 million, resulting in a retention ratio of 73.6%, for the three and six months ended June 30, 2018, respectively. This compares to $43.8 million, resulting in a retention ratio of 66.6%, and $90.4 million, resulting in a retention ratio of 66.9%, for the three and six months ended June 30, 2017, respectively. The increase in the retention ratio was driven by our P&C and Professional Liability operating segments. The P&C operating segment’s increase was driven by 2017 strategic actions to exit our Property division, thereby ceding 100% of our North American business, which is now in the latter stages of run-off, as well as an increase in our Energy & Engineering division’s retention ratio due to a reduction in quota share reinsurance during the second quarter of 2018. The increase in our Professional Liability operating segment’s retention ratio was attributable to lower facultative and excess of loss reinsurance costs. These increases to the retention ratio were partially offset by a decrease in the retention ratio of our Marine operating segment largely driven by our renewal rights agreement with Thomas Miller Specialty in 2018 that included a 100% cession of our fixed-premium protection and indemnity business.

Net Earned Premiums

Quarter and Year to Date Variances

Net Earned Premiums increased $10.0 million and $19.1 million for the three and six months ended June 30, 2018, as compared to the same periods in 2017 driven by growth in our Professional Liability operating segment across all divisions, partially offset by the strategic actions to exit our Property division and decreased production in our Marine operating segment including the impact of our renewal rights agreement with Thomas Miller Specialty.

Net Losses and LAE

The Net Losses and LAE Reserves as of June 30, 2018 and December 31, 2017 were as follows:

 

 

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The following tables present the current and prior accident year changes in our Net Losses and LAE Ratio for the three and six months ended June 30, 2018 and 2017:

 

 

 

Quarter to Date Variance

 

For the three months ended June 30, 2018, our Reported Net Losses and LAE Ratio increased 3.1 points as compared to the same period in 2017 driven by:

Prior Year Reserve Development

For the three months ended June 30, 2018, our Net Prior AY Losses and LAE Ratio decreased 2.2 points as compared to the same period in 2017 primarily driven by:

 

 

The above decreases in our Net Prior AY Loss and LAE Ratio were partially offset by:

 

Changes in the Current Accident Year Loss Ratio

For the three months ended June 30, 2018, our Net Current AY Losses and LAE Ratio increased 5.3 points as compared to the same period in 2017, primarily driven by unfavorable performance within certain key products within the Marine and Professional Liability operating segments, as well as increases in all three operating segments due to changes in the mix of business.

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Year to Date Variance

 

For the six months ended June 30, 2018, our Reported Net Losses and LAE Ratio decreased 4.0 points as compared to the same period in 2017 driven by:

Prior Year Reserve Development

For the six months ended June 30, 2018, our Net Prior AY Losses and LAE Ratio decreased 6.3 points as compared to the same period in 2017 primarily driven by:

 

 

The above decreases in our Net Prior AY Loss and LAE Ratio were partially offset by:

 

Changes in the Current Accident Year Loss Ratio

For the six months ended June 30, 2018, our Net Current AY Losses and LAE Ratio increased 2.3 points as compared to the same period in 2017 attributable to the same drivers as the quarter to date variance.

Commission Expenses

Quarter and Year to Date Variances

Our Commission Expense Ratio for the three and six months ended June 30, 2018 decreased 1.5 points and 1.6 points, respectively, as compared to the same periods in 2017, driven by our P&C operating segment, reflecting reduced acquisition costs within our Energy & Engineering division due to a favorable adjustment to a prior underwriting year gross commission estimate and reductions in profit commission expense, as compared to the prior periods.

Other Operating Expenses

Quarter and Year to Date Variances

Other Operating Expenses for the three and six months ended June 30, 2018 increased $0.8 million and $1.5 million, respectively, as compared to the same periods in 2017 primarily due to increased professional fees, including expenses relating to the acquisition of BDM and ASCO, and the impact of foreign exchange rates. An increase in Net Earned Premiums resulted in the Other Operating Expense Ratio decreasing by 2.2 points and 1.9 points for the three and six months ended June 30, 2018, respectively, as compared to the same periods in 2017.

 

 

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GlobalRe

The following tables summarize our Underwriting Profit for our GlobalRe reporting segment for the three and six months ended June 30, 2018 and 2017:

 

 

 

 

Gross Written Premiums

Quarter To Date Variance

Gross Written Premiums increased $12.4 million for the three months ended June 30, 2018, compared to the same period in 2017, primarily due to increases in our P&C, Agriculture, Specialty Casualty, and Surety products, driven by new business and increased renewals, partially offset by a decrease in our Accident & Health product. In addition to new business and increased renewals, our P&C and Agriculture products were also impacted by increased premium estimates and the timing of renewals, and the increases in our Specialty Casualty and Surety products were partially offset by a decrease in premium estimates on prior year contracts. The decrease in our Accident & Health product was driven by renewal timing and decreased premium estimates, partially offset by an increase in renewal business.

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Year To Date Variance

Gross Written Premiums increased $69.0 million for the six months ended June 30, 2018, compared to the same period in 2017, primarily due to increases in our Accident & Health, P&C, Specialty Casualty, and Surety products. Our Accident & Health product increased by $41.7 million, primarily driven by new business and increased renewals. The increase for our P&C product was attributable to the same drivers as the quarter to date variance. The increase in our Specialty Casualty product was due to timing largely related to inception date changes on two contracts, new business, and increased renewals. The increase in our Surety product was driven by increased lines, underlying program growth on renewals, and increased premium estimates primarily on prior year contracts.

Ceded Written Premiums

Quarter To Date Variances

Ceded Written Premiums were $1.9 million, resulting in a retention ratio of 97.5% of Net Written Premiums to Gross Written Premiums, for the three months ended June 30, 2018 compared to $1.2 million, resulting in a retention ratio of 98.1%, for the same period in 2017. The decrease in the retention ratio was primarily driven by additional ceded coverage purchased on our P&C products during the quarter and an increase in ceded RRPs relating to our P&C products.

Year To Date Variances

Ceded Written Premiums were $8.4 million, resulting in a retention ratio of 95.9%, for the six months ended June 30, 2018 compared to $6.3 million, resulting in a retention ratio of 95.3%, for the same period in 2017. The increase in the retention ratio was primarily driven by changes in the mix of business with proportionately more Accident & Health premium, which had 100% retention, partially offset by additional ceded coverage purchased on our P&C products during the quarter and an increase in ceded RRPs relating to our P&C products.

Net Earned Premiums

Quarter and Year To Date Variances

Net Earned Premiums for the three and six months ended June 30, 2018 increased $14.6 million and $33.0 million, respectively, as compared to the same periods in 2017, primarily due to growth in our Accident & Health, P&C, and Specialty Casualty products.

Net Losses and LAE

The Net Losses and LAE Reserves as of June 30, 2018 and December 31, 2017 were as follows:

 

 

The following tables present the current and prior accident year changes in our Net Losses and LAE Ratio for the three and six months ended June 30, 2018 and 2017:

 

 

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Quarter To Date Variance

 

For the three months ended June 30, 2018, our Reported Net Losses and LAE Ratio decreased 7.8 points as compared to the same period in 2017 driven by:

Prior Year Reserve Development

For the three months ended June 30, 2018, our Net Prior AY Losses and LAE Ratio decreased 6.3 points as compared to the same period in 2017 primarily driven by:

Changes in the Current Accident Year Loss Ratio

For the three months ended June 30, 2018, our Net Current AY Losses and LAE Ratio decreased 1.5 points as compared to the same period in 2017, primarily driven by catastrophe losses attributable to weather-related events during the three months ended June 30, 2017, partially offset by changes in the mix of business with an increase in Net Earned Premiums related to our Accident & Health and Specialty Casualty products, which carries a higher loss ratio.

Year To Date Variance

 

For the six months ended June 30, 2018, our Reported Net Losses and LAE Ratio decreased 4.2 points as compared to the same period in 2017 driven by:

Prior Year Reserve Development

For the six months ended June 30, 2018, our Net Prior AY Losses and LAE Ratio decreased 4.9 points as compared to the same period in 2017 primarily driven by:

Changes in the Current Accident Year Loss Ratio

For the six months ended June 30, 2018, our Net Current AY Losses and LAE Ratio increased 0.7 points as compared to the same period in 2017, primarily driven by changes in the mix of business with an increase in Net Earned Premiums related to our Accident & Health and Specialty Casualty products, which carries a higher loss ratio, partially offset by catastrophe losses attributable to weather-related events during the six months ended June 30, 2017.

Commission Expenses

Quarter and Year To Date Variances

Our Commission Expense Ratio for the three and six months ended June 30, 2018 increased 2.1 points and 2.2 points, respectively, as compared to the same periods in 2017, primarily due to changes in the mix of business with more proportional Accident & Health and Specialty Casualty premium earned with higher Commission Expense Ratios as well as a greater profit commission expense over prior year.

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Other Operating Expenses

Quarter and Year To Date Variances

Other Operating Expenses for the three and six months ended June 30, 2018 increased $1.3 million and $1.4 million, respectively, as compared to the same periods in 2017, primarily due to costs associated with new business initiatives including increased employee expenses and premium taxes on our Latin America business. An increase in Net Earned Premiums resulted in the Other Operating Expense Ratio decreasing by 0.4 points and 2.2 points for the three and six months ended June 30, 2018, respectively, as compared to the same periods in 2017.

 

Capital Resources and Liquidity

Capital Resources

Our capital resources consist of funds deployed or available to be deployed to support our business operations.  As of June 30, 2018 and December 31, 2017, our capital resources were as follows:

 

 

As part of our capital management program, we may seek to raise additional capital or may seek to return capital to our stockholders through share repurchases, cash dividends or other methods (or a combination of such methods).  Any such determination will be at the discretion of our Parent Company’s Board of Directors and will be dependent upon our profits, financial requirements and other factors, including legal restrictions, rating agency requirements, credit facility limitations and such other factors as our Board of Directors deems relevant.

We primarily rely upon dividends from our subsidiaries to meet our Parent Company’s obligations, which mostly consist of semi-annual (April and October) interest payments of $7.6 million on the Senior Notes. In the second quarter of 2018 NIC paid a dividend of $41.0 million to our Parent Company, related to the funding of the acquisition of BDM and ASCO. As described in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2017, we continue to believe that the dividend capacity of our subsidiaries will provide our Parent Company with sufficient liquidity for the foreseeable future.

Senior Notes and Credit Facility

As of June 30, 2018, letters of credit with an aggregate face amount of 24.0 million Australian Dollars were outstanding under the credit facility with Barclays Bank PLC that we entered into on November 4, 2016 and amended on October 30, 2017 (the “Australian Facility”).

As of June 30, 2018, letters of credit with an aggregate face amount of $140.0 million and £60.0 million were outstanding under the credit facility with ING Bank N.V., London Branch, individually and as administrative agent for a syndicate of lenders, that we entered into on November 7, 2016 (the “Club Facility”), and we had an aggregate of $1.2 million of cash collateral posted.  

As of June 30, 2018, letters of credit with an aggregate face amount of $25.0 million were outstanding under the credit facility with ING Bank N.V., London Branch, that we entered into on November 20, 2015 and amended on November 7, 2016 (the “Bilateral Facility”).

During the first quarter of 2018, the Company reclassified certain overseas deposits from Short-Term Investments to Other Invested Assets. Refer to Note 1. Organization & Summary of Significant Accounting Policies in the Notes to Interim Consolidated Financial Statements. Although the nature of the investments did not change, this reclassification caused the Company to exceed a covenant of our Club Facility that sets a limitation on other investments as a percentage of total investments.  Our Company received a waiver of compliance with respect to this covenant, which was subsequently amended to increase the percentage of other investments permitted. As of June 30, 2018, our Company was in compliance with all covenants for our Club Facility, Senior Notes, Australian Facility and Bilateral Facility.

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Shelf Registration

We generally maintain the ability to issue certain classes of debt and equity securities via a universal shelf registration statement filed with the SEC, which is renewed every three years. The shelf registration provides us the means to access the debt and equity markets relatively quickly. Our current shelf registration, which was filed on April 13, 2018, with the SEC expires in 2021. This report is not an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any state in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of such state.

Consolidated Cash Flows

We believe that the cash flow generated by the operating activities of our subsidiaries will provide sufficient funds for us to meet our liquidity needs over the next twelve months.  Beyond the next twelve months, cash flow available to us may be influenced by a variety of factors, including general economic conditions and conditions in the insurance and reinsurance markets, as well as fluctuations from year to year in claims experience.

We believe that we have adequately managed our cash flow requirements related to reinsurance recoveries from their positive cash flows and the use of available short-term funds when applicable.  However, there can be no assurances that we will be able to continue to adequately manage such recoveries in the future or that collection disputes or reinsurer insolvencies will not arise that could materially increase the collection time lags or result in recoverable write-offs causing additional incurred losses and liquidity constraints to our Company.  The payment of gross claims and related collections from reinsurers with respect to large losses could significantly impact our liquidity needs.  However, in general, we expect to collect our paid reinsurance recoverables under the terms described above.

Net Cash Provided by Operating Activities was $82.7 million for the six months ended June 30, 2018 compared to $72.9 million for the same period in 2017. Operating cash flow increased from the prior year due to additional premium collections resulting from the growth of our business, higher investment income collected as a result of the growth in assets under management, and lower operating expense payments resulting from smaller incentive compensation payments in 2018 as compared with 2017. The growth in operating cash flows was partially offset by increased claim payments in 2018, as compared with 2017, associated with the catastrophe loss activity occurring in the third quarter of 2017.

Net Cash Used in Investing Activities was $8.2 million for the six months ended June 30, 2018 compared to $77.9 million for the same period in 2017. The decrease in cash used in investing activities is due in part to a temporary increase in cash equivalents at June 30, 2018 as we await investment opportunities and hold cash equivalents for unsettled trades at the end of the quarter. Additionally, investing cash flows for the six months ended June 30, 2018 were impacted by cash acquired resulting from the Acquisition as discussed in Note 2. Business Combinations. The cash inflow from the sale of Fixed Maturities to fund the Acquisition was offset by the cash outflow to purchase the subsidiaries.

Net Cash Used in Financing Activities was $11.0 million for the six months ended June 30, 2018 compared to $15.1 million for the same period in 2017. The decrease in cash used in financing activities is primarily related to reduced tax withholding payments on vested stock compensation in 2018 as compared with 2017.

 

Investments

Our investment portfolio is invested primarily in publicly traded, investment grade, fixed income securities with an average credit quality of “AA-/Aa3” as rated by S&P or Moody’s.  As of June 30, 2018, our portfolio had a duration of 3.5 years.  Management periodically projects cash flow of the investment portfolio and other sources in order to maintain the appropriate levels of liquidity in an effort to ensure our ability to satisfy claims.  

As of June 30, 2018 and December 31, 2017, all Fixed Maturities Securities were classified as Available-For-Sale. Upon adoption of the FASB’s ASU 2016-01 as of January 1, 2018, our Equity Securities have been measured at fair value with changes in fair value recognized through Net Income. Prior to the adoption of ASU 2016-01, our Equity Securities were classified as Available-For-Sale with change in fair value recognized through Accumulated Other Comprehensive Income.

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The portfolio is externally managed by independent, professional investment managers and is broadly diversified across geographies, sectors, and issuers. The primary objectives are to maximize total investment return in the context of preserving and enhancing stockholder value and the statutory surplus of our regulated insurance companies.  As part of our overall investment strategy, we seek to build a tax efficient investment portfolio by maintaining an allocation to tax-exempt municipal bonds. The tax-exempt portion of our Fixed Maturities portfolio at June 30, 2018 was 17.6% compared to 22.4% at December 31, 2017.  Additionally, substantially all of our equity portfolio is invested in tax efficient securities which qualify for the dividends received deduction.  The investments are subject to the oversight of the respective insurance companies’ Boards of Directors and the Finance Committee of our Parent Company’s Board of Directors.

We are a specialty insurance company and periods of moderate economic recession or inflation tend not to have a significant direct effect on underwriting operations.  They do, however, impact our investment portfolio.  A decrease in interest rates will tend to decrease our yield and have a positive effect on the fair value of our invested assets.  An increase in interest rates will tend to increase our yield and have a negative effect on the fair value of our invested assets.

The following table summarizes the composition of our investments at fair value:

 

 

Fixed Maturities decreased from December 31, 2017 due to an increase in interest rates and spread widening which impacted our longer dated municipal securities as well as certain corporate exposures.  To a lesser extent, proceeds from the sale of Treasury bonds were used to fund the Acquisition as well as reinvested into equity mutual funds tracking broad market indices.  The increase in common stocks is due to the equity portfolio of ASCO and Canal Re, which was acquired as part of the purchase of these entities, as well as the purchase of passively managed equity mutual funds.  Furthermore, certain short dated municipal securities were sold due to technical market factors with proceeds reinvested in cash equivalents.

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The following table sets forth the amount of our Fixed Maturities as of June 30, 2018 by S&P credit rating or, if an S&P rating is not available, the equivalent Moody’s rating. The total rating is the weighted average quality rating for the Fixed Maturities portfolio as a whole.

 

 

The following table sets forth the composition of the non-government guaranteed Fixed Maturities categorized by asset class and generally equivalent S&P and Moody’s ratings (not all securities in our portfolio are rated by both S&P and Moody’s) as of June 30, 2018:

 

 

The following table sets forth our U.S. Treasury Bonds, Agency Bonds and Foreign Government Bonds, as well as our State, Municipality and Political Subdivision bond holdings by type:

 

 

As of June 30, 2018, we own $27.0 million of municipal securities, which are credit enhanced by various financial guarantors that have an average underlying credit rating of A+.  

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The following table sets forth our Agency Residential Mortgage-Backed Securities (“ARMBS”) issued by the Government National Mortgage Association (“GNMA”), Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”) and the quality category (Prime, Alternative A-paper (“Alt-A”), and Other Non-Agency) for Residential Mortgage-Backed Securities (“RMBS”) as of June 30, 2018:

 

 

We analyze our Mortgage-Backed Securities by credit quality of the underlying collateral distinguishing between the securities issued by FNMA, FHLMC and GNMA, which are federal government sponsored entities, and non-agency backed securities broken out by Prime, Alt-A,  and Other Non-Agency collateral. The securities issued by FNMA and FHLMC are the obligations of each respective entity. The U.S. Department of the Treasury has agreed to provide support to FNMA and FHLMC under a Preferred Stock Purchase Agreement by committing to make quarterly payments to these enterprises, if needed, to maintain a zero net worth.

Prime collateral consists of mortgages or other collateral from the most creditworthy borrowers. Alt-A collateral consists of mortgages or other collateral from borrowers, which have a risk potential greater than Prime but less than subprime. The subprime collateral consists of mortgages or other collateral from borrowers with low credit ratings. We have no exposure to subprime RMBS at June 30, 2018. Prime, subprime and Alt-A categories are as defined by S&P.

Details of the collateral of our Asset-Backed Securities portfolio as of June 30, 2018 are presented below:

 

 

Details of our Corporate Exposures portfolio as of June 30, 2018 are presented below:

 

 

As of June 30, 2018, the fair value of securities issued in foreign countries was $324.7 million, with an amortized cost of $330.6 million, representing 10.0% of our total Fixed Maturities and Equity Securities. Our largest exposure is Canada with a total of $141.9 million followed by the United Kingdom with a total of $37.9 million.

Our Company did not have gross unrealized investment losses where the fair value was less than 80% of amortized cost as of June 30, 2018.

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Our Company did not have any credit related OTTI losses during the three months ended June 30, 2018 or 2017. Our Company did not have any credit related OTTI losses during the six months ended June 30, 2018. Our Company had two credit related OTTI losses of $1.1 million in the equity portfolio during the six months ended June 30, 2017.

The fair value of our investment portfolio may fluctuate significantly in response to various factors such as changes in interest rates, investment quality ratings, equity prices, foreign exchange rates and credit spreads. We do not have the intent to sell nor is it more likely than not that we will have to sell Fixed Maturities in unrealized loss positions that are not other-than-temporarily impaired before recovery. For structured securities, default probability and severity assumptions differ based on property type, vintage and the stress of the collateral. We do not intend to sell any of these securities and it is more likely than not that we will not be required to sell these securities before the recovery of the amortized cost basis. Upon adoption of ASU-2016-01 as of January 1, 2018, the changes in the fair value of Equity Securities is recognized through Net Income. We may realize investment losses to the extent our liquidity needs require the disposition of Fixed Maturity securities in unfavorable interest rate, liquidity or credit spread environments. Significant changes in the factors we consider when evaluating investments for impairment losses could result in a significant change in impairment losses reported in the Consolidated Financial Statements.

 

Critical Accounting Estimates

Our Company’s Annual Report on Form 10-K for the year ended December 31, 2017 discloses our critical accounting estimates (refer to Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Estimates).

We believe the items that require the most subjective and complex estimates involve the reporting of:

We believe that the critical accounting estimates discussion in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2017 continues to describe the significant estimates and judgements included in the preparation of our Consolidated Financial Statements.

 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Refer to Item 7A included in our Company’s 2017 Annual Report on Form 10-K. There have been no material changes to this item since December 31, 2017.

Item 4. Controls and Procedures

 

On June 7, 2018 we acquired Bracht, Deckers & Mackelbert NV (“BDM”), a specialty underwriting agency, and its affiliated insurance company, Assurances Continentales – Continentale Verzekeringen NV (“ASCO”). SEC guidance permits management to omit an assessment of an acquired business’ internal control over financial reporting from management’s assessment of internal control over financial reporting for a period not to exceed one year from the date of the acquisition. Accordingly, we have not yet included BDM and ASCO in our assessment of the effectiveness of our disclosure controls and procedures and internal control over financial reporting as of June 30, 2018. For the three months ended June 30, 2018, BDM and ASCO accounted for $nil of our total net revenue, and as of June 30, 2018 had total assets of $113.4 million.

 

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We have commenced certain transformation initiatives to automate, centralize and simplify our business processes and systems. These are long-term initiatives that we believe will enhance our internal control over financial reporting due to increased automation and integration of related processes. The commencement of these initiatives has not materially affected our internal control over financial reporting, however, we will continue to monitor and evaluate the effectiveness of our internal control over financial reporting throughout the transformation.

 

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PART II - OTHER INFORMATION

Item 1. Legal Proceedings

In the ordinary course of conducting business, our subsidiaries are involved in various legal proceedings, either indirectly as insurers for parties or directly as defendants. Most of these proceedings consist of claims litigation involving our subsidiaries as either: (a) liability insurers defending or providing indemnity for third party claims brought against insureds or (b) insurers defending first party coverage claims brought against us. Our Company accounts for such activity through the establishment of unpaid losses and LAE reserves. Our Company’s management believes that our ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and cost of defense, will not be material to the consolidated financial condition, results of operations, or cash flows of our Company.

Our subsidiaries are also occasionally involved with other legal actions, some of which assert claims for substantial amounts. These actions include claims asserting extra contractual obligations, such as claims involving allegations of bad faith in the handling of claims or the underwriting of policies. In general, our Company believes we have valid defenses to these cases. Our Company’s management expects that the ultimate liability, if any, with respect to such extra-contractual matters will not be material to our consolidated financial position. Nonetheless, given the large or indeterminate amounts sought in certain of these matters, and the inherent unpredictability of litigation, an adverse outcome in such matters could, from time to time, have a material adverse outcome on our consolidated results of operations or cash flows in a particular fiscal quarter or year.

 

 

Item 1A. Risk Factors

There have been no material changes from the risk factors as previously disclosed in our Company’s 2017 Annual Report on Form 10-K.

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

None

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

 

 

 

 

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Signatures

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

 

 

 

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