Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2015

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from                      to                     

001-34809

Commission File Number

GLOBAL INDEMNITY PLC

(Exact name of registrant as specified in its charter)

 

Ireland   98-0664891

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

25/28 NORTH WALL QUAY

DUBLIN 1

IRELAND

(Address of principal executive office, including zip code)

353 (0) 1 649 2000

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.:

 

Large accelerated filer   ¨;    Accelerated filer   x;
Non-accelerated filer   ¨;    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of November 3, 2015, the registrant had outstanding 13,671,818 A Ordinary Shares and 12,061,370 B Ordinary Shares.


Table of Contents

TABLE OF CONTENTS

 

          Page  
   PART I – FINANCIAL INFORMATION   

Item 1.

  

Financial Statements:

  
  

Consolidated Balance Sheets

  
  

As of September 30, 2015 (Unaudited) and December 31, 2014

     2   
  

Consolidated Statements of Operations

  
  

Quarters and Nine Months Ended September 30, 2015 (Unaudited) and September 30, 2014 (Unaudited)

     3   
  

Consolidated Statements of Comprehensive Income

  
  

Quarters and Nine Months Ended September 30, 2015 (Unaudited) and September 30, 2014 (Unaudited)

     4   
  

Consolidated Statements of Changes in Shareholders’ Equity

  
  

Nine Months Ended September 30, 2015 (Unaudited) and Year Ended December 31, 2014

     5   
  

Consolidated Statements of Cash Flows

  
  

Nine Months Ended September 30, 2015 (Unaudited) and September 30, 2014 (Unaudited)

     6   
  

Notes to Consolidated Financial Statements (Unaudited)

     7   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     41   

Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

     74   

Item 4.

  

Controls and Procedures

     74   
   PART II – OTHER INFORMATION   

Item 1.

  

Legal Proceedings

     75   

Item 1A.

  

Risk Factors

     75   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     76   

Item 3.

  

Defaults Upon Senior Securities

     76   

Item 4.

  

Mine Safety Disclosures

     76   

Item 5.

  

Other Information

     76   

Item 6.

  

Exhibits

     77   

Signature

     78   

 

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Table of Contents

PART I – FINANCIAL INFORMATION

Item  1. Financial Statements

GLOBAL INDEMNITY PLC

Consolidated Balance Sheets

(In thousands, except share amounts)

 

     (Unaudited)
September 30, 2015
    December 31, 2014  
ASSETS     

Fixed maturities:

    

Available for sale, at fair value (amortized cost: $1,539,192 and $1,272,948)

   $ 1,548,885      $ 1,283,475   

Equity securities:

    

Available for sale, at fair value (cost: $99,257 and $99,297)

     106,666        122,048   

Other invested assets:

    

Available for sale, at fair value (cost: $31,137 and $33,174)

     33,555        33,663   
  

 

 

   

 

 

 

Total investments

     1,689,106        1,439,186   

Cash and cash equivalents

     146,686        58,823   

Restricted cash

     —          113,696   

Premiums receivable, net

     95,438        56,586   

Reinsurance receivables, net

     134,187        125,718   

Funds held by ceding insurers

     24,523        25,176   

Federal income taxes receivable

     5,187        3,139   

Deferred federal income taxes

     35,809        20,250   

Deferred acquisition costs

     57,398        25,238   

Intangible assets

     26,417        17,636   

Goodwill

     6,936        4,820   

Prepaid reinsurance premiums

     39,150        4,725   

Receivable for securities sold

     —          60   

Other assets

     57,782        34,980   
  

 

 

   

 

 

 

Total assets

   $ 2,318,619      $ 1,930,033   
  

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Liabilities:

    

Unpaid losses and loss adjustment expenses

   $ 729,509      $ 675,472   

Unearned premiums

     297,657        120,815   

Ceded balances payable

     4,110        2,800   

Contingent commissions

     14,397        12,985   

Debt

     292,144        174,673   

Payable for securities

     4,126        —     

Other liabilities

     54,964        34,998   
  

 

 

   

 

 

 

Total liabilities

     1,396,907        1,021,743   
  

 

 

   

 

 

 

Commitments and contingencies (Note 11)

     —          —     

Shareholders’ equity:

    

Ordinary shares, $0.0001 par value, 900,000,000 ordinary shares authorized; A ordinary shares issued: 16,748,528 and 16,331,577, respectively; A ordinary shares outstanding: 13,671,818 and 13,266,762 , respectively; B ordinary shares issued and outstanding: 12,061,370 and 12,061,370, respectively

     3        3   

Additional paid-in capital

     529,319        519,590   

Accumulated other comprehensive income, net of taxes

     13,245        23,384   

Retained earnings

     480,882        466,717   

A ordinary shares in treasury, at cost: 3,076,710 and 3,064,815 shares, respectively

     (101,737     (101,404
  

 

 

   

 

 

 

Total shareholders’ equity

     921,712        908,290   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 2,318,619      $ 1,930,033   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

GLOBAL INDEMNITY PLC

Consolidated Statements of Operations

(In thousands, except shares and per share data)

 

     (Unaudited)
Quarters Ended September 30,
    (Unaudited)
Nine Months Ended September 30,
 
     2015     2014     2015     2014  

Revenues:

        

Gross premiums written

   $ 150,148      $ 67,098      $ 459,532      $ 227,200   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums written

   $ 122,497      $ 63,262      $ 394,606      $ 212,495   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

   $ 124,707      $ 68,028      $ 380,921      $ 201,589   

Net investment income

     8,852        6,527        26,234        22,488   

Net realized investment gains (losses):

        

Other than temporary impairment losses on investments

     (4,641     (6     (6,879     (68

Other net realized investment gains (losses)

     (6,137     1,164        (337     40,294   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net realized investment gains (losses)

     (10,778     1,158        (7,216     40,226   

Other income

     1,279        126        2,408        449   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     124,060        75,839        402,347        264,752   

Losses and Expenses:

        

Net losses and loss adjustment expenses

     77,691        36,654        226,870        113,496   

Acquisition costs and other underwriting expenses

     50,934        27,458        150,118        81,114   

Corporate and other operating expenses

     3,567        3,481        19,441        9,614   

Interest expense

     1,595        118        2,635        628   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     (9,727     8,128        3,283        59,900   

Income tax expense (benefit)

     (5,981     (1,633     (10,882     8,108   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (3,746   $ 9,761      $ 14,165      $ 51,792   
  

 

 

   

 

 

   

 

 

   

 

 

 

Per share data:

        

Net income (loss)

        

Basic

   $ (0.15   $ 0.39      $ 0.56      $ 2.06   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (0.15   $ 0.39      $ 0.55      $ 2.05   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average number of shares outstanding

        

Basic

     25,463,994        25,137,531        25,452,991        25,126,684   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     25,704,931        25,334,716        25,684,931        25,323,187   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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GLOBAL INDEMNITY PLC

Consolidated Statements of Comprehensive Income

(In thousands)

 

     (Unaudited)
Quarters Ended September 30,
    (Unaudited)
Nine Months Ended September 30,
 
     2015     2014     2015     2014  

Net income (loss)

   $ (3,746   $ 9,761      $ 14,165      $ 51,792   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss), net of taxes:

        

Unrealized holding gains (losses)

     (9,078     (7,293     (9,808     6,476   

Portion of other-than-temporary impairment losses recognized in other comprehensive income (loss)

     (1     (1     (1     (4

Reclassification adjustment for (gains) losses included in net income

     2,199        (1,524     (517     (35,312

Unrealized foreign currency translation gains (losses)

     23        (229     187        (234
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss), net of taxes

     (6,857     (9,047     (10,139     (29,074
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss), net of taxes

   $ (10,603   $ 714      $ 4,026      $ 22,718   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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GLOBAL INDEMNITY PLC

Consolidated Statements of Changes in Shareholders’ Equity

(In thousands, except share amounts)

 

     (Unaudited)
Nine Months Ended
September 30, 2015
    Year Ended
December 31, 2014
 

Number of A ordinary shares issued:

    

Number at beginning of period

     16,331,577        16,200,406   

Ordinary shares issued under share incentive plans

     121,812        94,563   

Ordinary shares issued to directors

     27,437        36,608   

Ordinary shares issued in connection with American Reliable acquisition

     267,702        —     
  

 

 

   

 

 

 

Number at end of period

     16,748,528        16,331,577   
  

 

 

   

 

 

 

Number of B ordinary shares issued:

    

Number at beginning and end of period

     12,061,370        12,061,370   
  

 

 

   

 

 

 

Par value of A ordinary shares:

    

Balance at beginning and end of period

   $ 2      $ 2   
  

 

 

   

 

 

 

Par value of B ordinary shares:

    

Balance at beginning and end of period

   $ 1      $ 1   
  

 

 

   

 

 

 

Additional paid-in capital:

    

Balance at beginning of period

   $ 519,590      $ 516,653   

Share compensation plans

     9,671        2,900   

Tax benefit on share-based compensation expense

     58        37   
  

 

 

   

 

 

 

Balance at end of period

   $ 529,319      $ 519,590   
  

 

 

   

 

 

 

Accumulated other comprehensive income, net of deferred income tax:

    

Balance at beginning of period

   $ 23,384      $ 54,028   

Other comprehensive income (loss):

    

Change in unrealized holding gains (losses)

     (10,319     (30,299

Change in other than temporary impairment losses recognized in other comprehensive income

     (7     (4

Unrealized foreign currency translation gains (losses)

     187        (341
  

 

 

   

 

 

 

Other comprehensive income (loss)

     (10,139     (30,644
  

 

 

   

 

 

 

Balance at end of period

   $ 13,245      $ 23,384   
  

 

 

   

 

 

 

Retained earnings:

    

Balance at beginning of period

   $ 466,717      $ 403,861   

Net income

     14,165        62,856   
  

 

 

   

 

 

 

Balance at end of period

   $ 480,882      $ 466,717   
  

 

 

   

 

 

 

Number of Treasury Shares:

    

Number at beginning of period

     3,064,815        3,059,371   

A ordinary shares purchased

     11,895        5,444   
  

 

 

   

 

 

 

Number at end of period

     3,076,710        3,064,815   
  

 

 

   

 

 

 

Treasury Shares, at cost:

    

Balance at beginning of period

   $ (101,404   $ (101,265

A ordinary shares purchased, at cost

     (333     (139
  

 

 

   

 

 

 

Balance at end of period

   $ (101,737   $ (101,404
  

 

 

   

 

 

 

Total shareholders’ equity

   $ 921,712      $ 908,290   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

GLOBAL INDEMNITY PLC

Consolidated Statements of Cash Flows

(In thousands)

 

     (Unaudited)
Nine Months Ended September 30,
 
     2015     2014  

Cash flows from operating activities:

    

Net income

   $ 14,165      $ 51,792   

Adjustments to reconcile net income to net cash used for operating activities:

    

Amortization of value of business acquired

     22,823        —     

Amortization and depreciation

     3,761        2,649   

Amortization of debt issuance costs

     16        —     

Restricted stock and stock option expense

     9,671        2,236   

Deferred federal income taxes

     (8,984     1,964   

Amortization of bond premium and discount, net

     10,557        5,701   

Net realized investment gain

     7,216        (40,226

Equity in the earnings of a partnership

     (1,448     —     

Changes in:

    

Premiums receivable, net

     18,971        (12,323

Reinsurance receivables, net

     5,373        19,694   

Funds held by ceding insurers

     661        (5,100

Unpaid losses and loss adjustment expenses

     (35,452     (39,535

Unearned premiums

     4,608        11,169   

Ceded balances payable

     (11,909     (1,027

Other assets and liabilities, net

     (13,199     317   

Contingent commissions

     (2,909     (166

Federal income tax receivable/payable

     (2,048     (28

Deferred acquisition costs, net

     (32,160     (3,913

Prepaid reinsurance premiums

     9,081        (265
  

 

 

   

 

 

 

Net cash used for operating activities

     (1,206     (7,061
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Cash release from escrow for business acquisition

     113,696        —     

Acquisition of business, net of cash acquired

     (92,336     —     

Proceeds from sale of fixed maturities

     290,580        350,179   

Proceeds from sale of equity securities

     34,161        181,203   

Proceeds from sale of preferred stock

     1,540        —     

Proceeds from maturity of fixed maturities

     146,870        66,281   

Proceeds from limited partnership distribution

     4,287        —     

Proceeds from other invested assets

     —          12   

Amounts paid in connection with derivatives

     (7,072     (13,182

Purchases of fixed maturities

     (485,153     (525,935

Purchases of equity securities

     (32,434     (34,033

Purchases of other invested assets

     (2,250     (18,475
  

 

 

   

 

 

 

Net cash provided by (used for) investing activities

     (28,111     6,050   
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net borrowings (repayments) under margin borrowing facilities

     21,114        (37,726

Proceeds from issuance of subordinated notes

     100,000        —     

Debt issuance cost

     (3,659     —     

Tax benefit on share-based compensation expense

     58        —     

Purchase of A ordinary shares

     (333     (139
  

 

 

   

 

 

 

Net cash provided by (used for) financing activities

     117,180        (37,865
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     87,863        (38,876

Cash and cash equivalents at beginning of period

     58,823        105,492   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 146,686      $ 66,616   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

GLOBAL INDEMNITY PLC

 

1. Principles of Consolidation and Basis of Presentation

Global Indemnity plc (“Global Indemnity” or “the Company”) was incorporated on March 9, 2010 and is domiciled in Ireland. Global Indemnity replaced the Company’s predecessor, United America Indemnity, Ltd., as the ultimate parent company as a result of a re-domestication transaction in July, 2010. The Company’s A ordinary shares are publicly traded on the NASDAQ Global Select Market under the trading symbol “GBLI.”

Starting in the 1st quarter of 2015, the Company manages its business through three business segments: Commercial Lines, managed in Bala Cynwyd, offers specialty property and casualty products designed for product lines such as Small Business Binding Authority, Property Brokerage, and Programs; Personal Lines, managed in Scottsdale, AZ, offers specialty personal lines and agricultural coverage; and Reinsurance Operations, managed in Bermuda, provides reinsurance solutions through brokers and primary writers including insurance and reinsurance companies. The Commercial Lines and Personal Lines segments comprise the Company’s U.S. Insurance Operations. See Note 14 for additional information regarding segments.

The interim consolidated financial statements are unaudited, but have been prepared in conformity with United States of America generally accepted accounting principles (“GAAP”), which differs in certain respects from those principles followed in reports to insurance regulatory authorities. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

The unaudited consolidated financial statements include all adjustments that are, in the opinion of management, of a normal recurring nature and are necessary for a fair statement of results for the interim periods. Results of operations for the quarters and nine months ended September 30, 2015 and 2014 are not necessarily indicative of the results of a full year. The accompanying notes to the unaudited consolidated financial statements should be read in conjunction with the notes to the consolidated financial statements contained in the Company’s 2014 Annual Report on Form 10-K.

The consolidated financial statements include the accounts of Global Indemnity and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

2. Acquisition

On January 1, 2015, Global Indemnity Group, Inc., a subsidiary of the Company, acquired 100% of the voting equity interest of American Reliable Insurance Company (“American Reliable”) from American Bankers Insurance Group, Inc. by paying $113.7 million in cash and assuming $283.3 million of customary insurance related liabilities, obligations, and mandates. Per the American Reliable Stock Purchase Agreement “Stock Purchase Agreement”), the ultimate purchase price is subject to (i) accounting procedures that were performed in 2015 to determine GAAP book value and (ii) indemnification on future development on recorded loss and loss adjustment expenses as of December 31, 2014. In accordance with the Stock Purchase Agreement, on the third calendar year following the calendar year of the closing, if loss and loss adjustment expenses for accident years 2014 and prior are lower than recorded unpaid loss and loss adjustment expenses as of December 31, 2014, Global Indemnity Group, Inc. will pay the variance to American Bankers Group, Inc. Conversely, if loss and loss adjustment expenses for accident years 2014 and prior exceed recorded unpaid loss and loss adjustment expenses as of December 31, 2014, American Bankers Group, Inc. will pay the variance to Global Indemnity Group, Inc. The Company’s current estimate of the purchase price, based on available financial information, is approximately $99.8 million.

The results of American Reliable’s operations have been included in the Company’s consolidated financial statements since the date of the acquisition on January 1, 2015.

The purchase of American Reliable expanded Global Indemnity’s product offerings. American Reliable is a specialty company that distributes personal lines products written on an admitted basis that are unusual and harder to place. It complements Global Indemnity’s existing US Insurance Operations that primarily distribute commercial lines products on an excess and surplus lines basis.

American Reliable is domiciled in Arizona and as such is subject to its state insurance department regulations.

 

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Table of Contents

GLOBAL INDEMNITY PLC

 

For the quarter and nine months ended September 30, 2015, American Reliable had total revenues of $63.5 million and $196.1 million, respectively, and pre-tax loss of $11.2 million and $8.5 million, respectively. These amounts are included in the Company’s results of operations for the quarter and nine months ended September 30, 2015.

The following table presents the Company’s unaudited pro forma consolidated results of operations for the quarters and nine months ended September 30, 2015 and 2014 as if the acquisition had occurred on January 1, 2014 instead of January 1, 2015.

 

     Pro Forma  
     Quarters Ended September 30,      Nine Months Ended September 30,  
(Dollars in thousands except per share data)    2015      2014      2015      2014  

Total Revenue

   $ 124,060       $ 141,902       $ 402,347       $ 462,164   

Net Income (Loss)

   $ (3,746    $ 13,782       $ 19,560       $ 57,224   

Net Income (Loss) per share (diluted)

   $ ( 0.15    $ 0.54       $ 0.76       $ 2.24   

The pro forma results were calculated by applying the Company’s accounting policies and adjusting the result of American Reliable to reflect (i) impact of intercompany reinsurance with Global Indemnity Reinsurance Company, Ltd. (“Global Indemnity Reinsurance”), (ii) the impact on interest expense resulting from changes to the Company’s capital structure in connection with the acquisition, (iii) impact on investment income from the acquisition date adjustments to fair value of investments, (iv) impact on underwriting expenses from the acquisition date adjustments to fair value of deferred acquisition costs and intangible assets, (v) impact of excluding transaction costs related to the acquisition and (vi) the tax effects of the above adjustments.

The pro forma results do not include any anticipated cost synergies or other effects of the integration of American Reliable. Such pro forma amounts are not indicative of the results that actually would have occurred had the acquisition been completed on January 1, 2014, nor are they indicative of the future operating results of the combined company.

The Company is still in the process of valuing the assets acquired and liabilities assumed. As a result, the allocation of the acquisition consideration is subject to change. The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of the acquisition as of September 30, 2015 compared to June 30, 2015 along with changes in estimates made during the quarter.

 

     As of         
(Dollars in thousands)    September 30, 2015      June 30, 2015      Change  

ASSETS:

        

Investments

   $ 226,458       $ 226,458       $ —     

Cash and cash equivalents

     21,360         21,360         —     

Premiums receivables, net

     25,941         25,941         —     

Accounts receivable

     11,311         17,129         (5,818

Reinsurance receivables

     13,842         12,723         1,119   

Prepaid reinsurance premiums

     43,506         43,506         —     

Intangible assets

     32,000         32,000         —     

Deferred federal income taxes

     1,139         1,246         (107

Other assets

     6,550         6,550         —     
  

 

 

    

 

 

    

 

 

 

Total assets

     382,107         386,913         (4,806
  

 

 

    

 

 

    

 

 

 

LIABILITIES:

        

Unearned premiums

     172,234         172,234         —     

Unpaid losses and loss adjustment expenses

     89,489         88,370         1,119   

Reinsurance balances payable

     13,219         13,219         —     

Contingent commissions

     3,876         3,876         —     

Other liabilities

     5,608         5,685         (77
  

 

 

    

 

 

    

 

 

 

Total liabilities

     284,426         283,384         1,042   
  

 

 

    

 

 

    

 

 

 

Estimated fair value of net assets acquired

     97,681         103,529         (5,848

Purchase price

     99,797         105,843         6,046   
  

 

 

    

 

 

    

 

 

 

Goodwill

   $ 2,116       $ 2,314       $ (198
  

 

 

    

 

 

    

 

 

 

Pursuant to the Stock Purchase Agreement, the Company and American Bankers Group, Inc. have performed procedures to finalize the closing balance sheet for purposes of determining the purchase price. However, the Company and American Bankers Group, Inc. were unable to come to an agreement on the carrying value of unpaid loss and loss adjustment expense reserves. As a result, the Company entered into a dispute resolution with American Bankers Group, Inc. for the carried

 

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amount of unpaid loss and loss adjustment reserves as of the acquisition date. This dispute resolution is consistent with the Stock Purchase Agreement that includes indemnification to both the Company and American Bankers Group, Inc. on future development on recorded loss and loss adjustment expenses as of December 31, 2014. On the third calendar year following the acquisition date of January 1, 2015, if loss and loss adjustment expenses for accident years 2014 and prior are lower than recorded unpaid loss and loss adjustment expenses as of December 31, 2014, Global Indemnity Group, Inc. will pay the variance plus interest of 5% compounding semi-annually to American Bankers Group, Inc. Conversely, if loss and loss adjustment expenses for accident years 2014 and prior exceed recorded unpaid loss and loss adjustment expenses as of December 31, 2014, American Bankers Group, Inc. will pay the variance plus interest of 5% compounding semi-annually to Global Indemnity Group, Inc.

As a result of the structure of this dispute resolution on unpaid loss and loss adjustment expenses, American Reliable’s accounts receivable declined by $5.8 million for amounts due from American Bankers Group, Inc. and Global Indemnity Group, Inc.’s accounts receivable due from American Bankers Group, Inc. increased by $6.5 million. This consolidated net increase in accounts receivable due from American Bankers Group, Inc. of $0.7 million is related to accrued interest on the anticipated indemnification of unpaid loss and loss adjustment expense reserves.

The transaction is being accounted for using the purchase method of accounting. The assets and liabilities acquired by the Company were adjusted to estimated fair value. The $2.1 million excess of cash and acquisition cost over the estimated fair value of assets acquired was recognized as goodwill. Under the purchase method of accounting, goodwill is not amortized but is tested for impairment at least annually.

Goodwill of $2.1 million, arising from the acquisition, consists largely of the synergies and economies of scales expected from combining the operations of Global Indemnity and American Reliable. The Company has determined that the goodwill of $2.1 million will be assigned to the Personal Lines segment. There is no tax goodwill.

An identification and valuation of intangible assets was performed that resulted in the recognition of intangible assets of $32.0 million with values assigned as follows:

 

(Dollars in thousands)

Description

   Useful Life    Amount  

State insurance licenses

   Indefinite    $ 5,000   

Value of business acquired

   < 1 year      25,500   

Agent relationships

   10 years      900   

Trade name

   7 - 8 years      600   
     

 

 

 
      $ 32,000   
     

 

 

 

Intangible assets arising from the acquisition will be deductible for income tax purposes over 15 years.

The following table presents details of the Company’s intangible assets arising from the American Reliable acquisition as of September 30, 2015:

 

(Dollars in thousands)

Description

   Useful Life    Cost      Accumulated
Amortization
     Net Value  

State insurance licenses

   Indefinite    $ 5,000       $ —         $ 5,000   

Value of business acquired

   < 1 year      25,500         22,823         2,677   

Agent relationships

   10 years      900         67         833   

Trade name

   7 - 8 years      600         64         536   
     

 

 

    

 

 

    

 

 

 
      $ 32,000       $ 22,954       $ 9,046   
     

 

 

    

 

 

    

 

 

 

Amortization related to the Company’s definite lived intangible assets resulting from American Reliable acquisition was $4.1 million and $23.0 million for the quarter and nine months ended September 30, 2015.

 

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The Company expects that amortization expense for the next five years related to the American Reliable acquisition will be as follows:

 

(Dollars in thousands)       

October 1, 2015 to September 30, 2016

   $ 2,853   

October 1, 2016 to September 30, 2017

     176   

October 1, 2017 to September 30, 2018

     176   

October 1, 2018 to September 30, 2019

     176   

October 1, 2019 to September 30, 2020

     176   

The fair value, gross contractual amounts due, and contractual cash flows not expected to be collected of acquired receivables are as follows:

 

(Dollars in thousands)    Fair
Value
     Gross
Contractual
Amounts Due
     Contractual
cash flows not
expected to be
collected
 

Premium receivables

   $ 25,941       $ 26,896       $ 955   

Accounts receivable

     11,311         11,311         —     

Reinsurance receivables

     12,723         12,723         —     

In connection with the acquisition, the Company agreed to pay to Fox Paine & Company, LLC (“Fox Paine”) an investment banking fee of 3% of the amount paid plus the additional capital required to operate American Reliable on a standalone basis and a $1.5 million investment advisory fee, which in the aggregate, totaled $6.5 million. This amount is included in corporate and other operating expenses on the Company’s Consolidated Statements of Operations during the nine months ended September 30, 2015. As payment for these fees, 267,702 A ordinary shares of Global Indemnity were issued under the Global Indemnity plc Share Incentive Plan in May, 2015. These shares will be registered but cannot be sold until the earlier of five years or a change of control. See Note 12 for additional information on the Global Indemnity plc Share Incentive Plan.

Additional costs, mainly professional fees, of $5.1 million were incurred in connection with the acquisition of American Reliable. Of this amount, $3.3 million was recorded as corporate and other operating expenses on the Company’s Consolidated Statements of Operations during the year ended December 31, 2014 and $1.8 million was recorded as corporate and other operating expenses on the Company’s Consolidated Statements of Operation during the nine months ended September 30, 2015.

During the nine months ended September 30, 2015, the Company paid approximately $1.6 million in employee compensation related cost, which were related to periods prior to the Acquisition. These costs were accrued by American Reliable and were included in the fair value of net assets acquired by Global Indemnity Group, Inc. on January 1, 2015.

 

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Geographic Concentration

The following table sets forth the geographic distribution of American Reliable’s gross premiums written, excluding business that is ceded under a 100% quota share reinsurance agreement to American Bankers Insurance Company of Florida, for the year ended December 31, 2014:

 

     Year Ended December 31,
2014
 
(Dollars in thousands)    Amount      Percent  

Texas

   $ 32,760         12.3

California

     25,556         9.6   

North Carolina

     23,040         8.7   

Arizona

     17,722         6.7   

Louisiana

     17,522         6.6   

New York

     13,408         5.0   

Florida

     12,361         4.6   

Oklahoma

     9,977         3.7   

Georgia

     8,768         3.3   

New Jersey

     6,925         2.6   
  

 

 

    

 

 

 

Subtotal

     168,039         63.1   

All other states

     98,264         36.9   
  

 

 

    

 

 

 

Total

   $ 266,303         100.0
  

 

 

    

 

 

 

Marketing and Distribution

American Reliable distributes its insurance products primarily through a group of approximately 290 general and specialty agents and 332 retail agents in Arizona and New Mexico. Of the Company’s non-affiliated general and specialty agents, the top five accounted for 23.9% of American Reliable’s gross premiums written for the year ended December 31, 2014. One agency represented 6.8% of American Reliable’s gross premiums written for the year ended December 31, 2014. There is no agency which accounted for more than 10.0% of American Reliable’s revenue for the year ended December 31, 2014.

Dividend Limitations

The maximum amount of dividends, which can be paid by Arizona domiciled insurance companies without prior approval of the Insurance Commissioner, is subject to certain regulatory restrictions relating to statutory surplus. Specifically, an insurance company may pay dividends equal to the lesser of net income or 10% of its statutory surplus without specific approval from the Insurance Commissioner. At December 31, 2014, the maximum dividend, which may be distributed without approval in 2015, is zero. Dividends in excess of this amount are considered extraordinary.

Reinsurance

As a result of the acquisition, the following reinsurance treaties were entered into:

Earthquake Property Catastrophe Excess of Loss – Effective January 1, 2015, the Company purchased an earthquake property catastrophe excess of loss treaty which provides occurrence coverage for earthquake catastrophe losses of $30 million in excess of $5 million for American Reliable property business. This treaty provides for one full reinstatement of coverage at 100% additional premium as to time and pro rata as to amount of limit reinstated. This treaty was cancelled on May 31, 2015 and rolled into a new combined master catastrophe treaty which was effective June 1, 2015.

American Reliable Property Per Risk Excess of Loss – Effective January 1, 2015, American Reliable renewed its property per risk excess of loss treaty covering business underwritten by American Reliable. This treaty provides coverage in two layers: $1 million per risk in excess of $1 million per risk, and $3 million per risk in excess of $2 million per risk. The first layer is subject to a $2 million limit of liability for all risks involved in one loss occurrence, and the second layer is subject to a $6 million limit for all risks involved in one loss occurrence.

100% Ceded Quota Share to American Bankers – Effective December 1, 2014, American Reliable entered into four treaties to cede 100% of its liabilities related to certain businesses to American Bankers Insurance Company that were not included in the acquisition of American Reliable. For the quarter and nine months ended September 30, 2015, American Reliable recorded ceded written premiums of $18.7 million and $41.7 million, respectively, and ceded earned premiums of $13.3 million and $50.8 million, respectively, to American Bankers Insurance Company.

 

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100% Assumed Quota Share from American Bankers – Effective December 1, 2014, American Reliable entered into two treaties to assume 100% of its liabilities from various insurers owned by Assurant, Inc. for business included in the acquisition but not written directly by American Reliable. For the quarter and nine months ended September 30, 2015, American Reliable recorded assumed written premiums of $21.4 million and $69.3 million, respectively, and assumed earned premiums of $22.8 million and $69.8 million, respectively, from insurance companies owned by Assurant, Inc.

The effect of reinsurance on premiums written and earned by American Reliable is as follows:

 

(Dollars in thousands)    Written      Earned  

For the quarter ended September 30, 2015:

     

Direct business

   $   65,824       $   57,825   

Reinsurance assumed

     21,525         22,927   

Reinsurance ceded

     24,047         18,620   
  

 

 

    

 

 

 

Net premiums

   $   63,302       $   62,132   
  

 

 

    

 

 

 

 

(Dollars in thousands)    Written      Earned  

For the nine months ended September 30, 2015:

     

Direct business

   $ 179,979       $ 182,851   

Reinsurance assumed

     69,585         70,120   

Reinsurance ceded

     52,779         61,499   
  

 

 

    

 

 

 

Net premiums

   $ 196,785       $ 191,472   
  

 

 

    

 

 

 

Commitments

As a result of the acquisition, the Company assumed operating leases related to the operations of American Reliable. Rental expense under these operating leases was $0.3 million and $0.8 million for the quarter and nine months ended September 30, 2015, respectively. At September 30, 2015, future minimum cash payments under non-cancelable operating leases related to the operations of American Reliable were as follows:

 

(Dollars in thousands)       

October 1, 2015 to September 30, 2016

   $ 1,032   

October 1, 2016 to September 30, 2017

     941   

October 1, 2017 to September 30, 2018

     937   

October 1, 2018 to September 30, 2019

     143   
  

 

 

 

Total

   $ 3,053   
  

 

 

 

At the time of the acquisition, one of the Company’s policy administration systems was under development. In April, 2015, the Company entered into an agreement with an unrelated third party to build out a rate, quote, bind and issue application for the Company’s agriculture products. This project has an estimated cost of approximately $2.6 million plus reimbursable travel and related expenses.

 

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3. Investments

The amortized cost and estimated fair value of investments were as follows as of September 30, 2015 and December 31, 2014:

 

(Dollars in thousands)    Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
     Other than
temporary
impairments
recognized
in AOCI (1)
 

As of September 30, 2015

             

Fixed maturities:

             

U.S. treasury and agency obligations

   $ 95,312       $ 1,972       $ (9   $ 97,275       $  —     

Obligations of states and political subdivisions

     232,532         3,538         (670     235,400         —     

Mortgage-backed securities

     185,359         3,203         (159     188,403         —     

Asset-backed securities

     278,059         1,391         (616     278,834         (10

Commercial mortgage-backed securities

     160,829         74         (827     160,076         —     

Corporate bonds

     459,840         2,526         (1,072     461,294         —     

Foreign corporate bonds

     127,261         573         (231     127,603         —     
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed maturities

     1,539,192         13,277         (3,584     1,548,885         (10

Common stock

     99,257         12,359         (4,950     106,666         —     

Other invested assets

     31,137         2,418         —          33,555         —     
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,669,586       $ 28,054       $ (8,534   $ 1,689,106       $ (10
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Represents the total amount of other than temporary impairment losses relating to factors other than credit losses recognized in accumulated other comprehensive income (“AOCI”).

 

(Dollars in thousands)    Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
     Other than
temporary
impairments
recognized
in AOCI (2)
 

As of December 31, 2014

             

Fixed maturities:

             

U.S. treasury and agency obligations

   $ 78,569       $ 2,281       $ (83   $ 80,767       $  —     

Obligations of states and political subdivisions

     188,452         3,718         (697     191,473         —     

Mortgage-backed securities

     205,814         3,709         (764     208,759         (4

Asset-backed securities

     177,853         713         (303     178,263         (13

Commercial mortgage-backed securities

     133,984         21         (847     133,158         —     

Corporate bonds

     380,704         3,421         (709     383,416         —     

Foreign corporate bonds

     107,572         625         (558     107,639         —     
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed maturities

     1,272,948         14,488         (3,961     1,283,475         (17

Common stock

     99,297         25,689         (2,938     122,048         —     

Other invested assets

     33,174         489         —          33,663         —     
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,405,419       $ 40,666       $ (6,899   $ 1,439,186       $ (17
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

(2) Represents the total amount of other than temporary impairment losses relating to factors other than credit losses recognized in accumulated other comprehensive income (“AOCI”).

Excluding U.S. treasuries and agency bonds, the Company did not hold any debt or equity investments in a single issuer that was in excess of 4% of shareholders’ equity at September 30, 2015 or December 31, 2014.

 

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The amortized cost and estimated fair value of the Company’s fixed maturities portfolio classified as available for sale at September 30, 2015, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

(Dollars in thousands)    Amortized
Cost
     Estimated
Fair Value
 

Due in one year or less

   $ 142,231       $ 143,283   

Due in one year through five years

     701,239         705,430   

Due in five years through ten years

     49,986         50,812   

Due in ten years through fifteen years

     3,799         4,277   

Due after fifteen years

     17,690         17,770   

Mortgage-backed securities

     185,359         188,403   

Asset-backed securities

     278,059         278,834   

Commercial mortgage-backed securities

     160,829         160,076   
  

 

 

    

 

 

 

Total

   $ 1,539,192       $ 1,548,885   
  

 

 

    

 

 

 

The following table contains an analysis of the Company’s securities with gross unrealized losses, categorized by the period that the securities were in a continuous loss position as of September 30, 2015:

 

     Less than 12 months     12 months or longer (1)     Total  
(Dollars in thousands)    Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
 

Fixed maturities:

               

U.S. treasury and agency obligations

   $  —         $  —        $ 3,413       $ (9   $ 3,413       $ (9

Obligations of states and political subdivisions

     43,194         (573     9,510         (97     52,704         (670

Mortgage-backed securities

     23,004         (114     255         (45     23,259         (159

Asset-backed securities

     107,361         (588     4,531         (28     111,892         (616

Commercial mortgage-backed securities

     110,702         (687     15,453         (140     126,155         (827

Corporate bonds

     145,181         (1,051     2,974         (21     148,155         (1,072

Foreign corporate bonds

     42,441         (231     —           —          42,441         (231
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed maturities

     471,883         (3,244     36,136         (340     508,019         (3,584

Common stock

     38,128         (4,950     —           —          38,128         (4,950
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 510,011       $ (8,194   $ 36,136       $ (340   $ 546,147       $ (8,534
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Fixed maturities in a gross unrealized loss position for twelve months or longer are primarily comprised of non-credit losses on investment grade securities where management does not intend to sell, and it is more likely than not that the Company will not be forced to sell the security before recovery. The Company has analyzed these securities and has determined that they are not other than temporarily impaired.

The following table contains an analysis of the Company’s securities with gross unrealized losses, categorized by the period that the securities were in a continuous loss position as of December 31, 2014:

 

     Less than 12 months     12 months or longer (1)     Total  
(Dollars in thousands)    Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
 

Fixed maturities:

               

U.S. treasury and agency obligations

   $ 11,728       $ (9   $ 3,343       $ (74   $ 15,071       $ (83

Obligations of states and political subdivisions

     28,684         (314     28,061         (383     56,745         (697

Mortgage-backed securities

     2,818         (7     51,203         (757     54,021         (764

Asset-backed securities

     92,123         (283     1,683         (20     93,806         (303

Commercial mortgage-backed securities

     92,664         (525     26,280         (322     118,944         (847

Corporate bonds

     144,505         (656     3,216         (53     147,721         (709

Foreign corporate bonds

     60,518         (558     —           —          60,518         (558
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed maturities

     433,040         (2,352     113,786         (1,609     546,826         (3,961

Common stock

     20,002         (2,808     1,577         (130     21,579         (2,938
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 453,042       $ (5,160   $ 115,363       $ (1,739   $ 568,405       $ (6,899
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Fixed maturities in a gross unrealized loss position for twelve months or longer are primarily comprised of non-credit losses on investment grade securities where management does not intend to sell, and it is more likely than not that the Company will not be forced to sell the security before recovery. The Company has analyzed these securities and has determined that they are not other than temporarily impaired.

 

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The Company regularly performs various analytical valuation procedures with respect to its investments, including reviewing each fixed maturity security in an unrealized loss position to assess whether the security is a candidate for credit loss. Specifically, the Company considers credit rating, market price, and issuer specific financial information, among other factors, to assess the likelihood of collection of all principal and interest as contractually due. Securities for which the Company determines that a credit loss is likely are subjected to further analysis through discounted cash flow testing to estimate the credit loss to be recognized in earnings, if any. The specific methodologies and significant assumptions used by asset class are discussed below. Upon identification of such securities and periodically thereafter, a detailed review is performed to determine whether the decline is considered other than temporary. This review includes an analysis of several factors, including but not limited to, the credit ratings and cash flows of the securities and the magnitude and length of time that the fair value of such securities is below cost.

For fixed maturities, the factors considered in reaching the conclusion that a decline below cost is other than temporary include, among others, whether:

 

  (1) the issuer is in financial distress;

 

  (2) the investment is secured;

 

  (3) a significant credit rating action occurred;

 

  (4) scheduled interest payments were delayed or missed;

 

  (5) changes in laws or regulations have affected an issuer or industry;

 

  (6) the investment has an unrealized loss and was identified by the Company’s investment manager as an investment to be sold before recovery or maturity; and

 

  (7) the investment failed cash flow projection testing to determine if anticipated principal and interest payments will be realized.

According to accounting guidance for debt securities in an unrealized loss position, the Company is required to assess whether it has the intent to sell the debt security or more likely than not will be required to sell the debt security before the anticipated recovery. If either of these conditions is met, the Company must recognize an other than temporary impairment with the entire unrealized loss being recorded through earnings. For debt securities in an unrealized loss position not meeting these conditions, the Company assesses whether the impairment of a security is other than temporary. If the impairment is deemed to be other than temporary, the Company must separate the other than temporary impairment into two components: the amount representing the credit loss and the amount related to all other factors, such as changes in interest rates. The credit loss represents the portion of the amortized book value in excess of the net present value of the projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. The credit loss component of the other than temporary impairment is recorded through earnings, whereas the amount relating to factors other than credit losses is recorded in other comprehensive income, net of taxes.

For equity securities, management carefully reviews all securities with unrealized losses to determine if a security should be impaired and further focuses on securities that have either:

 

  (1) persisted with unrealized losses for more than twelve consecutive months or

 

  (2) the value of the investment has been 20% or more below cost for six continuous months or more.

The amount of any write-down, including those that are deemed to be other than temporary, is included in earnings as a realized loss in the period in which the impairment arose.

The following is a description, by asset type, of the methodology and significant inputs that the Company used to measure the amount of credit loss recognized in earnings, if any:

U.S. treasury and agency obligations – As of September 30, 2015, gross unrealized losses related to U.S. treasury and agency obligations were $0.009 million. All unrealized losses have been in an unrealized loss position for twelve months or greater and are rated AA+. Macroeconomic and market analysis is conducted in evaluating these securities. The analysis is driven by moderate interest rate anticipation, yield curve management, and security selection.

Obligations of states and political subdivisions – As of September 30, 2015, gross unrealized losses related to obligations of states and political subdivisions were $0.670 million. Of this amount, $0.097 million have been in an unrealized loss position for twelve months or greater and are rated A or better. All factors that influence performance of the municipal bond

 

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market are considered in evaluating these securities. The aforementioned factors include investor expectations, supply and demand patterns, and current versus historical yield and spread relationships. The analysis relies on the output of fixed income credit analysts, as well as dedicated municipal bond analysts who perform extensive in-house fundamental analysis on each issuer, regardless of their rating by the major agencies.

Mortgage-backed securities (“MBS”) – As of September 30, 2015, gross unrealized losses related to mortgage-backed securities were $0.159 million. Of this amount, $0.045 million have been in an unrealized loss position for twelve months or greater and are rated CC. Mortgage-backed securities are modeled to project principal losses under downside, base, and upside scenarios for the economy and home prices. The primary assumption that drives the security and loan level modeling is the Home Price Index (“HPI”) projection. The model first projects HPI at the national level, then at the zip-code level based on the historical relationship between the individual zip code HPI and the national HPI. The model utilizes loan level data and borrower characteristics including FICO score, geographic location, original and current loan size, loan age, mortgage rate and type (fixed rate / interest-only / adjustable rate mortgage), issuer / originator, residential type (owner occupied / investor property), dwelling type (single family / multi-family), loan purpose, level of documentation, and delinquency status as inputs. The model also includes the explicit treatment of silent second liens, utilization of loan modification history, and the application of roll rate adjustments.

Asset-backed securities (“ABS”) – As of September 30, 2015, gross unrealized losses related to asset backed securities were $0.616 million. Of this amount, $0.028 million has been in an unrealized loss position for 12 months or greater and are rated AAA. The weighted average credit enhancement for the Company’s asset backed portfolio is 21.9. This represents the percentage of pool losses that can occur before an asset backed security will incur its first dollar of principal losses. Every ABS transaction is analyzed on a stand-alone basis. This analysis involves a thorough review of the collateral, prepayment, and structural risk in each transaction. Additionally, the analysis includes an in-depth credit analysis of the originator and servicer of the collateral. The analysis projects an expected loss for a deal given a set of assumptions specific to the asset type. These assumptions are used to calculate at what level of losses the deal will incur its first dollar of principal loss. The major assumptions used to calculate this ratio are loss severities, recovery lags, and no advances on principal and interest.

Commercial mortgage-backed securities (“CMBS”) – As of September 30, 2015, gross unrealized losses related to the CMBS portfolio were $0.827 million. Of this amount, $0.140 million have been in an unrealized loss position for twelve months or greater, of which, 81.0% are rated AA- or better. The weighted average credit enhancement for the Company’s CMBS portfolio is 35.7. This represents the percentage of pool losses that can occur before a mortgage-backed security will incur its first dollar of principal loss. For the Company’s CMBS portfolio, a loan level analysis is utilized where every underlying CMBS loan is re-underwritten based on a set of assumptions reflecting expectations for the future path of the economy. In the analysis, the focus is centered on stressing the significant variables that influence commercial loan defaults and collateral losses in CMBS deals. These variables include: (1) a projected drop in occupancies; (2) capitalization rates that vary by property type and are forecasted to return to more normalized levels as the capital markets repair and capital begins to flow again; and (3) property value stress testing using projected property performance and projected capitalization rates. Term risk is triggered if the projected debt service coverage rate falls below 1x. Balloon risk is triggered if a property’s projected performance does not satisfy new tighter mortgage standards.

Corporate bonds – As of September 30, 2015, gross unrealized losses related to corporate bonds were $1.072 million. Of this amount, $0.021 million have been in an unrealized loss position for twelve months or greater and are rated BBB or better. The analysis for this sector includes maintaining detailed financial models that include a projection of each issuer’s future financial performance, including prospective debt servicing capabilities, capital structure composition, and the value of the collateral. The analysis incorporates the macroeconomic environment, industry conditions in which the issuer operates, the issuer’s current competitive position, its vulnerability to changes in the competitive and regulatory environment, issuer liquidity, issuer commitment to bondholders, issuer creditworthiness, and asset protection. Part of the process also includes running downside scenarios to evaluate the expected likelihood of default as well as potential losses in the event of default.

Foreign bonds – As of September 30, 2015, gross unrealized losses related to foreign bonds were $0.231 million. All unrealized losses have been in an unrealized loss position for less than twelve months. For this sector, detailed financial models are maintained that include a projection of each issuer’s future financial performance, including prospective debt servicing capabilities, capital structure composition, and the value of the collateral. The analysis incorporates the macroeconomic environment, industry conditions in which the issuer operates, the issuer’s current competitive position, its vulnerability to changes in the competitive and regulatory environment, issuer liquidity, issuer commitment to bondholders, issuer creditworthiness, and asset protection. Part of the process also includes running downside scenarios to evaluate the expected likelihood of default as well as potential losses in the event of default.

 

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Common stock – As of September 30, 2015, gross unrealized losses related to common stock were $4.950 million. All unrealized losses have been in an unrealized loss position for less than 12 months. To determine if an other than temporary impairment of an equity security has occurred, the Company considers, among other things, the severity and duration of the decline in fair value of the equity security. The Company also examines other factors to determine if the equity security could recover its value in a reasonable period of time.

The Company recorded the following other than temporary impairments (“OTTI”) on its investment portfolio for the quarters and nine months ended September 30, 2015 and 2014:

 

     Quarters Ended September 30,      Nine Months Ended September 30,  
(Dollars in thousands)    2015      2014      2015      2014  

Fixed maturities:

           

OTTI losses, gross

   $ —         $ (6    $ (23    $ (31

Portion of loss recognized in other comprehensive income (pre-tax)

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Net impairment losses on fixed maturities recognized in earnings

     —           (6      (23      (31

Equity securities

     (4,641      —           (6,856      (37
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ (4,641    $ (6    $ (6,879    $ (68
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table is an analysis of the credit losses recognized in earnings on fixed maturities held by the Company for the quarters and nine months ended September 30, 2015 and 2014 for which a portion of the OTTI loss was recognized in other comprehensive income.

 

     Quarters Ended September 30,      Nine Months Ended September 30,  
(Dollars in thousands)    2015      2014      2015      2014  

Balance at beginning of period

   $ 31       $ 50       $ 50       $ 54   

Additions where no OTTI was previously recorded

     —           —           —           —     

Additions where an OTTI was previously recorded

     —           —           —           —     

Reductions for securities for which the company intends to sell or more likely than not will be required to sell before recovery

     —           —           —           —     

Reductions reflecting increases in expected cash flows to be collected

     —           —           —           —     

Reductions for securities sold during the period

     —           —           (19      (4
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 31       $ 50       $ 31       $ 50   
  

 

 

    

 

 

    

 

 

    

 

 

 

Accumulated Other Comprehensive Income, Net of Tax

Accumulated other comprehensive income, net of tax, as of September 30, 2015 and December 31, 2014 was as follows:

 

(Dollars in thousands)    September 30,
2015
     December 31,
2014
 

Net unrealized gains from:

     

Fixed maturities

   $ 9,693       $ 10,527   

Common stock

     7,409         22,751   

Other

     970         369   

Deferred taxes

     (4,827      (10,263
  

 

 

    

 

 

 

Accumulated other comprehensive income, net of tax

   $ 13,245       $ 23,384   
  

 

 

    

 

 

 

 

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The following tables present the changes in accumulated other comprehensive income, net of tax, by component for the quarters and nine months ended September 30, 2015 and 2014:

 

Quarter Ended September 30, 2015

(Dollars in thousands)

   Unrealized Gains
and Losses on
Available for
Sale Securities,
Net of Tax
     Foreign Currency
Items, Net of Tax
     Accumulated Other
Comprehensive
Income, Net of Tax
 

Beginning balance

   $ 20,201       $ (99)       $ 20,102   

Other comprehensive income (loss) before reclassification

     (9,009      (47      (9,056

Amounts reclassified from accumulated other comprehensive income (loss)

     2,129         70         2,199   
  

 

 

    

 

 

    

 

 

 

Other comprehensive income (loss)

     (6,880      23         (6,857
  

 

 

    

 

 

    

 

 

 

Ending balance

   $ 13,321       $ (76    $ 13,245   
  

 

 

    

 

 

    

 

 

 

 

Quarter Ended September 30, 2014

(Dollars in thousands)

   Unrealized Gains
and Losses on
Available for
Sale Securities,
Net of Tax
     Foreign Currency
Items, Net of Tax
     Accumulated Other
Comprehensive
Income, Net of Tax
 

Beginning balance

   $ 33,928       $ 73       $ 34,001   

Other comprehensive income (loss) before reclassification

     (7,295      (228      (7,523

Amounts reclassified from accumulated other comprehensive income (loss)

     (1,523      (1      (1,524
  

 

 

    

 

 

    

 

 

 

Other comprehensive income (loss)

     (8,818      (229      (9,047
  

 

 

    

 

 

    

 

 

 

Ending balance

   $ 25,110       $ (156    $ 24,954   
  

 

 

    

 

 

    

 

 

 

 

Nine Months Ended September 30, 2015

(Dollars in thousands)

   Unrealized Gains
and Losses on
Available for
Sale Securities,
Net of Tax
     Foreign Currency
Items, Net of Tax
     Accumulated Other
Comprehensive
Income, Net of Tax
 

Beginning balance

   $ 23,647       $ (263)       $ 23,384   

Other comprehensive income (loss) before reclassification

     (9,413      (209      (9,622

Amounts reclassified from accumulated other comprehensive income (loss)

     (913      396         (517
  

 

 

    

 

 

    

 

 

 

Other comprehensive income (loss)

     (10,326      187         (10,139
  

 

 

    

 

 

    

 

 

 

Ending balance

   $ 13,321       $ (76    $ 13,245   
  

 

 

    

 

 

    

 

 

 

 

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Nine Months Ended September 30, 2014

(Dollars in thousands)

   Unrealized Gains
and Losses on
Available for
Sale Securities,
Net of Tax
     Foreign Currency
Items, Net of Tax
     Accumulated Other
Comprehensive
Income, Net of Tax
 

Beginning balance

   $ 53,950       $ 78       $ 54,028   

Other comprehensive income (loss) before reclassification

     6,396         (158      6,238   

Amounts reclassified from accumulated other comprehensive income (loss)

     (35,236      (76      (35,312
  

 

 

    

 

 

    

 

 

 

Other comprehensive income (loss)

     (28,840      (234      (29,074
  

 

 

    

 

 

    

 

 

 

Ending balance

   $ 25,110       $ (156    $ 24,954   
  

 

 

    

 

 

    

 

 

 

The reclassifications out of accumulated other comprehensive income for the quarters and nine months ended September 30, 2015 and 2014 were as follows:

 

          Amounts Reclassified from
Accumulated Other
Comprehensive Income
 
          Quarters Ended September 30,  

(Dollars in thousands)

Details about Accumulated Other Comprehensive
Income Components

  

Affected Line Item in the

Consolidated Statements of

Operations

   2015      2014  

Unrealized gains and losses on available for sale securities

   Other net realized investment (gains)    $ (2,042    $ (2,355
   Other than temporary impairment losses on investments      4,641         6   
     

 

 

    

 

 

 
   Total before tax      2,599         (2,349
   Income tax expense (benefit)      (470      826   
     

 

 

    

 

 

 
   Net of tax    $ 2,129       $ (1,523
     

 

 

    

 

 

 

Foreign Currency Items

   Other net realized investment (gains) losses    $ 108       $ (1
   Income tax (benefit)      (38      —     
     

 

 

    

 

 

 
   Net of tax    $ 70       $ (1
     

 

 

    

 

 

 

Total reclassifications

   Net of tax    $ 2,199       $ (1,524
     

 

 

    

 

 

 

 

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          Amounts Reclassified from
Accumulated Other
Comprehensive Income
 
          Nine Months Ended September 30,  

(Dollars in thousands)

Details about Accumulated Other Comprehensive
Income Components

  

Affected Line Item in the

Consolidated Statements of

Operations

   2015      2014  

Unrealized gains and losses on available for sale securities

   Other net realized investment (gains)    $ (9,168    $ (53,729
   Other than temporary impairment losses on investments      6,879         68   
     

 

 

    

 

 

 
   Total before tax      (2,289      (53,661
   Income tax expense      1,376         18,425   
     

 

 

    

 

 

 
   Net of tax    $ (913    $ (35,236
     

 

 

    

 

 

 

Foreign Currency Items

   Other net realized investment (gains) losses    $ 609       $ (117
   Income tax expense (benefit)      (213      41   
     

 

 

    

 

 

 
   Net of tax    $ 396       $ (76
     

 

 

    

 

 

 

Total reclassifications

   Net of tax    $ (517    $ (35,312
     

 

 

    

 

 

 

Net Realized Investment Gains (Losses)

Net realized gains and losses on investments are determined based on the specific identification method.

The components of net realized investment gains (losses) for the quarters and nine months ended September 30, 2015 and 2014 were as follows:

 

     Quarters Ended September 30,      Nine Months Ended September 30,  
(Dollars in thousands)    2015      2014      2015      2014  

Fixed maturities:

           

Gross realized gains

   $ 110       $ 262       $ 1,589       $ 2,651   

Gross realized losses

     (1,451      (471      (1,692      (697
  

 

 

    

 

 

    

 

 

    

 

 

 

Net realized gains/ (losses)

     (1,341      (209      (103      1,954   
  

 

 

    

 

 

    

 

 

    

 

 

 

Common stock:

           

Gross realized gains

     3,494         2,559         9,418         52,434   

Gross realized losses

     (4,860      —           (7,731      (610
  

 

 

    

 

 

    

 

 

    

 

 

 

Net realized gains/ (losses)

     (1,366      2,559         1,687         51,824   
  

 

 

    

 

 

    

 

 

    

 

 

 

Preferred stock:

           

Gross realized gains

     —           —           96         —     

Gross realized losses

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Net realized gains

     —           —           96         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Derivatives:

           

Gross realized gains

     —           147         —           —     

Gross realized losses

     (8,071      (1,339      (8,896      (13,552
  

 

 

    

 

 

    

 

 

    

 

 

 

Net realized (losses)

     (8,071      (1,192      (8,896      (13,552
  

 

 

    

 

 

    

 

 

    

 

 

 

Total net realized investment gains/ (losses)

   $ (10,778    $ 1,158       $ (7,216    $ 40,226   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The proceeds from sales of available-for-sale securities resulting in net realized investment gains (losses) for the nine months ended September 30, 2015 and 2014 were as follows:

 

     Nine Months Ended
September 30,
 
(Dollars in thousands)    2015      2014  

Fixed maturities

   $ 290,580       $ 350,179   

Equity securities

     34,161         181,203   

Preferred stock

     1,540         —     

Net Investment Income

The sources of net investment income for the quarters and nine months ended September 30, 2015 and 2014 were as follows:

 

     Quarters Ended
September 30,
     Nine Months Ended
September 30,
 
(Dollars in thousands)    2015      2014      2015      2014  

Fixed maturities

   $ 8,673       $ 6,791       $ 24,709       $ 20,843   

Equity securities

     703         780         2,419         4,861   

Cash and cash equivalents

     32         14         59         42   

Other invested assets

     193         —           1,535         87   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment income

     9,601         7,585         28,722         25,833   

Investment expense

     (749      (1,058      (2,488      (3,345
  

 

 

    

 

 

    

 

 

    

 

 

 

Net investment income

   $ 8,852       $ 6,527       $ 26,234       $ 22,488   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company’s total investment return on a pre-tax basis for the quarters and nine months ended September 30, 2015 and 2014 were as follows:

 

     Quarters Ended September 30,     Nine Months Ended September 30,  
(Dollars in thousands)    2015     2014     2015     2014  

Net investment income

   $ 8,852      $ 6,527      $ 26,234      $ 22,488   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized investment gains (losses)

     (10,778     1,158        (7,216     40,226   

Change in unrealized holding gains and losses

     (10,420     (11,876     (15,575     (43,650
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized and unrealized investment returns

     (21,198     (10,718     (22,791     (3,424
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment return

   $ (12,346   $ (4,191   $ 3,443      $ 19,064   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment return % (1)

     (0.7 %)      (0.3 %)      0.2     1.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Average investment portfolio (2)

   $ 1,800,993      $ 1,558,501      $ 1,788,777      $ 1,541,336   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Not annualized.

 

(2) Average of total cash and invested assets, net of receivable/payable for securities purchased and sold, as of the beginning and end of the period.

Insurance Enhanced Asset Backed and Credit Securities

As of September 30, 2015, the Company held insurance enhanced asset backed and credit securities with a market value of approximately $45.5 million. Approximately $19.0 million of these securities were tax free municipal bonds, which represented approximately 1.0% of the Company’s total cash and invested assets, net of payable/receivable for securities purchased and sold. These securities had an average rating of “A+.” Approximately $8.3 million of these bonds are pre-refunded with U.S. treasury securities, of which $0.1 million are backed by financial guarantors, meaning that funds have been set aside in escrow to satisfy the future interest and principal obligations of the bond. Of the remaining $10.7 million of insurance enhanced municipal bonds, $0.5 million would have carried a lower credit rating had they not been insured.

 

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The following table provides a breakdown of the ratings for these municipal bonds with and without insurance.

 

(Dollars in thousands)   

Ratings

with

    

Ratings

without

 
Rating    Insurance      Insurance  

AA

   $ 511       $ —     

BB

     —           511   
  

 

 

    

 

 

 

Total

   $ 511       $ 511   
  

 

 

    

 

 

 

A summary of the Company’s insurance enhanced municipal bonds that are backed by financial guarantors, including the pre-refunded bonds that are escrowed in U.S. government obligations, as of September 30, 2015, is as follows:

 

(Dollars in thousands)

Financial Guarantor

   Total      Pre-refunded
Securities
     Government
Guaranteed
Securities
     Exposure Net
of Pre-refunded
& Government
Guaranteed

Securities
 

Ambac Financial Group

   $ 1,686       $ 136       $ —         $ 1,550   

Assured Guaranty Corporation

     3,661         —           —           3,661   

Municipal Bond Insurance Association

     4,920         —           —           4,920   

Gov’t National Housing Association

     553         —           553         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total backed by financial guarantors

     10,820         136         553         10,131   

Other credit enhanced municipal bonds

     8,185         8,185         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 19,005       $ 8,321       $ 553       $ 10,131   
  

 

 

    

 

 

    

 

 

    

 

 

 

In addition to the tax-free municipal bonds, the Company held $26.5 million of insurance enhanced asset-backed and taxable municipal bonds, which represented approximately 1.4% of the Company’s total invested assets, net of receivable/payable for securities purchased and sold. The financial guarantors of the Company’s $26.5 million of insurance enhanced asset-backed and taxable municipal securities include Municipal Bond Insurance Association ($8.4 million), Ambac Financial Group ($1.4 million), Assured Guaranty Corporation ($14.5 million), Financial Guaranty Insurance Group ($0.2 million) and Build America Mutual ($2.0 million).

The Company had no direct investments in the entities that have provided financial guarantees or other credit support to any security held by the Company at September 30, 2015.

Bonds Held on Deposit

Certain cash balances, cash equivalents, equity securities and bonds available for sale were deposited with various governmental authorities in accordance with statutory requirements, were held as collateral pursuant to borrowing arrangements, or were held in trust pursuant to intercompany reinsurance agreements. The fair values were as follows as of September 30, 2015 and December 31, 2014:

 

     Estimated Fair Value  
(Dollars in thousands)    September 30,
2015
     December 31,
2014
 

On deposit with governmental authorities

   $ 39,763       $ 32,790   

Intercompany trusts held for the benefit of U.S. policyholders

     555,859         495,301   

Held in trust pursuant to third party requirements

     69,153         95,828   

Letter of credit held for third party requirements

     6,112         9,340   

Securities held as collateral for borrowing arrangements (1)

     248,486         222,809   
  

 

 

    

 

 

 

Total

   $ 919,373       $ 856,068   
  

 

 

    

 

 

 

 

(1) Amount required to collateralize margin borrowing facilities.

4. Derivative Instruments

Interest rate swaps are used by the Company primarily to reduce risks from changes in interest rates. Under the terms of the interest rate swaps, the Company agrees with another party to exchange, at specified intervals, the difference between fixed rate and floating rate interest amounts as calculated by reference to an agreed notional amount.

 

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The Company accounts for the interest rate swaps as non-hedge instruments and recognizes the fair value of the interest rate swaps in other assets or other liabilities on the consolidated balance sheets with the changes in fair value recognized as net realized investment gains (losses) in the consolidated statement of operations. The estimated fair value of the interest rate swaps, which is primarily derived from the forward interest rate curve, is based on the valuation received from a third party financial institution.

The following table summarizes information on the location and the gross amount of the derivatives’ fair value on the consolidated balance sheets as of September 30, 2015 and December 31, 2014:

 

(Dollars in thousands)           September 30, 2015     December 31, 2014  

Derivatives Not Designated as Hedging

Instruments under ASC 815

   Balance Sheet
Location
     Notional
Amount
     Fair
Value
    Notional
Amount
     Fair
Value
 

Interest rate swap agreements

     Other liabilities       $ 200,000       $ (18,522   $ 200,000       $ (13,675

The following table summarizes the net gains and losses included in the consolidated statement of operations for changes in the fair value of the derivatives and the periodic net interest settlements under the derivatives for the quarters and nine months ended September 30, 2015 and 2014:

 

     Quarters Ended September 30,     Nine Months Ended September 30,  
(Dollars in thousands)   

Statement of Operations Line

   2015     2014     2015     2014  

Interest rate swap agreements

   Net realized investment gain(losses)    $ (8,071   $ (1,192   $ (8,896   $ (13,552

As of September 30, 2015, the Company is due receivables of $4.8 million for collateral posted and $18.8 million for margin calls made in connection with the interest rate swaps. These amounts are included in other assets on the consolidated balance sheets.

5. Fair Value Measurements

The accounting standards related to fair value measurements define fair value, establish a framework for measuring fair value, outline a fair value hierarchy based on inputs used to measure fair value, and enhance disclosure requirements for fair value measurements. These standards do not change existing guidance as to whether or not an instrument is carried at fair value. The Company has determined that its fair value measurements are in accordance with the requirements of these accounting standards.

The Company’s invested assets and derivative instruments are carried at their fair value and are categorized based upon a fair value hierarchy:

 

    Level 1—inputs utilize quoted prices (unadjusted) in active markets for identical assets that the Company has the ability to access at the measurement date.

 

    Level 2—inputs utilize other than quoted prices included in Level 1 that are observable for similar assets, either directly or indirectly.

 

    Level 3—inputs are unobservable for the asset, and include situations where there is little, if any, market activity for the asset.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset.

Both observable and unobservable inputs may be used to determine the fair value of positions that the Company has classified within the Level 3 category. As a result, the unrealized gains and losses for invested assets within the Level 3 category presented in the tables below may include changes in fair value that are attributed to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long-dated volatilities) inputs.

 

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The following table presents information about the Company’s invested assets and derivative instruments measured at fair value on a recurring basis as of September 30, 2015 and December 31, 2014, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.

 

As of September 30, 2015    Fair Value Measurements  
(Dollars in thousands)    Level 1      Level 2      Level 3      Total  

Assets:

           

Fixed maturities:

           

U.S. treasury and agency obligations

   $ 91,341       $ 5,934       $  —         $ 97,275   

Obligations of states and political subdivisions

     —           235,400         —           235,400   

Mortgage-backed securities

     —           188,403         —           188,403   

Commercial mortgage-backed securities

     —           160,076         —           160,076   

Asset-backed securities

     —           278,834         —           278,834   

Corporate bonds

     —           461,294         —           461,294   

Foreign corporate bonds

     —           127,603         —           127,603   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities

     91,341         1,457,544         —           1,548,885   

Common stock

     106,666         —           —           106,666   

Other invested assets

     —           —           33,555         33,555   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured at fair value

   $ 198,007       $ 1,457,544       $ 33,555       $ 1,689,106   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

           

Derivative instruments

   $ —         $ 18,522       $ —         $ 18,522   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities measured at fair value

   $ —         $ 18,522       $ —         $ 18,522   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

As of December 31, 2014    Fair Value Measurements  
(Dollars in thousands)    Level 1      Level 2      Level 3      Total  

Assets:

           

Fixed maturities:

           

U.S. treasury and agency obligations

   $ 74,765       $ 6,002       $  —         $ 80,767   

Obligations of states and political subdivisions

     —           191,473         —           191,473   

Mortgage-backed securities

     —           208,759         —           208,759   

Commercial mortgage-backed securities

     —           133,158         —           133,158   

Asset-backed securities

     —           178,263         —           178,263   

Corporate bonds

     —           383,416         —           383,416   

Foreign corporate bonds

     —           107,639         —           107,639   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities

     74,765         1,208,710         —           1,283,475   

Common stock

     122,048         —           —           122,048   

Other invested assets

     —           —           33,663         33,663   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured at fair value

   $ 196,813       $ 1,208,710       $ 33,663       $ 1,439,186   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

           

Derivative instruments

   $ —         $ 13,675       $ —         $ 13,675   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities measured at fair value

   $ —         $ 13,675       $ —         $ 13,675   
  

 

 

    

 

 

    

 

 

    

 

 

 

The securities classified as Level 1 in the above table consist of U.S. Treasuries and equity securities actively traded on an exchange.

The securities classified as Level 2 in the above table consist primarily of fixed maturity securities and derivative instruments. Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, security prices are derived through recent reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information. If there are no recent reported trades, matrix or model processes are used to develop a security price where future cash flow expectations are developed based upon collateral performance and discounted at an estimated market rate. Included in the pricing of asset-backed securities, collateralized mortgage obligations, and mortgage-backed securities are estimates of the rate of future prepayments of principal over the remaining life of the securities. Such estimates are derived based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral. The estimated fair value of the interest rate swaps is obtained from a third party financial institution who utilizes observable inputs such as the forward interest rate curve.

 

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For the Company’s material debt arrangements, the current fair value of the Company’s debt was as follows:

 

(Dollars in thousands)    Carrying Value      Fair Value  

Margin Borrowing Facilities

   $ 195,787       $ 195,787   

7.75% Subordinated Notes due 2045 (1)

     96,357         90,117   
  

 

 

    

 

 

 

Total

   $ 292,144       $ 285,904   
  

 

 

    

 

 

 

 

(1) As of September 30, 2015, the carrying value and fair value of the 7.75% Subordinated Notes due 2045 are net of unamortized debt issuance cost of $3.6 million.

The fair value of the margin borrowing facilities approximates its carrying value due to the facilities being due on demand. The 7.75% subordinated notes due 2045 are publicly traded instruments and are classified as Level 1 in the fair value hierarchy.

There were no transfers between Level 1 and Level 2 during the quarters and nine months ended September 30, 2015 or 2014.

The following table presents changes in Level 3 investments measured at fair value on a recurring basis for the quarters and nine months ended September 30, 2015 and 2014:

 

     Quarters Ended September 30,      Nine Months Ended September 30,  
(Dollars in thousands)    2015      2014      2015      2014  

Beginning balance

   $ 31,176       $ 15,034       $ 33,663       $ 3,489   

Total gains (losses) (realized / unrealized):

           

Included in accumulated other comprehensive income (loss)

     23         (404      481         (834

Investment Income:

           

Equity in Limited Partnership

     106         —           1,448         —     

Purchases

     2,250         6,500         2,250         18,475   

Distributions

     —           (12      (4,287      (12
  

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance

   $ 33,555       $ 21,118       $ 33,555       $ 21,118   
  

 

 

    

 

 

    

 

 

    

 

 

 

The investments classified as Level 3 in the above table relate to investments in limited partnerships. The Company does not have access to daily valuations; therefore, the estimated fair values of the limited partnerships are measured utilizing net asset value, typically on a quarter lag, as a practical expedient for the limited partnerships.

The Company uses the equity method to account for an investment in a limited partnership where its ownership interest exceeds 3%. The equity method of accounting for an investment in a limited partnership requires changes in fair market value to be reflected in the income statement. The Company records the changes in fair market value for investments in limited partnerships accounted for under the equity method to investment income. The change in fair market value included in investment income for this limited partnership was $0.1 million during the quarter ended September 30, 2015 and $1.4 million during the year ended September 30, 2015.

 

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Fair Value of Alternative Investments

Included in “Other invested assets” in the fair value hierarchy at September 30, 2015 and December 31, 2014 are limited liability partnerships measured at fair value. The following table provides the fair value and future funding commitments related to these investments at September 30, 2015 and December 31, 2014.

 

     September 30, 2015      December 31, 2014  
(Dollars in thousands)    Fair Value      Future
Funding
Commitment
     Fair Value      Future
Funding
Commitment
 

Equity Fund, LP (1)

   $ 3,348       $ 2,391       $ 3,401       $ 2,436   

Real Estate Fund, LP (2)

     —           —           —           —     

European Non-Performing Loan Fund, LP (3)

     30,207         21,314         30,262         20,064   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 33,555       $ 23,705       $ 33,663       $ 22,500   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) This limited partnership invests in companies from various business sectors whereby the partnership has acquired control of the operating business as a lead or organizing investor. The Company does not have the ability to sell or transfer its limited partnership interest without consent from the general partner. The Company does not have the contractual option to redeem its limited partnership interest but receives distributions based on the liquidation of the underlying assets. The Company anticipates its interest in this partnership to be redeemed during the 4th quarter of 2015.
(2) This limited partnership invests in real estate assets through a combination of direct or indirect investments in partnerships, limited liability companies, mortgage loans, and lines of credit. The Company does not have the contractual option to redeem its limited partnership interest but receives distributions based on the liquidation of the underlying assets. The Company does not have the ability to sell or transfer its limited partnership interest without consent from the general partner. The Company continues to hold an investment in this limited partnership and has written the fair value down to zero.
(3) This limited partnership invests in distressed securities and assets through senior and subordinated, secured and unsecured debt and equity, in both public and private large-cap and middle-market companies. The Company does not have the ability to sell or transfer its limited partnership interest without consent from the general partner. The Company does not have the contractual option to redeem its limited partnership interest but receives distributions based on the liquidation of the underlying assets. Based on the terms of the partnership agreement, the Company anticipates its interest in this partnership to be redeemed in 2020.

Pricing

The Company’s pricing vendors provide prices for all investment categories except for investments in limited partnerships which are measured utilizing net asset values as a practical expedient. Two vendors provide prices for equity and fixed maturity securities.

The following is a description of the valuation methodologies used by the Company’s pricing vendors for investment securities carried at fair value:

 

    Equity prices are received from all primary and secondary exchanges.

 

    Corporate and agency bonds are evaluated by utilizing a multi-dimensional relational model. For bonds with early redemption options, an option adjusted spread model is utilized. Both asset classes use standard inputs and incorporate security set up, defined sector breakdown, benchmark yields, apply base spreads, yield to maturity, and adjust for corporate actions.

 

    Data from commercial vendors is aggregated with market information, then converted into a prepayment/spread/LIBOR curve model used for commercial mortgage obligations (“CMO”). CMOs are categorized with mortgage-backed securities in the tables listed above. For ABS’s, data derived from market information along with trustee and servicer reports is converted into spreads to interpolated swap yield curve. For both asset classes, evaluations utilize standard inputs plus new issue data, monthly payment information, and collateral performance. The evaluated pricing models incorporate discount rates, loan level information, prepayment speeds, treasury benchmarks, and LIBOR and swap curves.

 

    For municipals, a multi-dimensional relational model is used to evaluate securities within this asset class. The evaluated pricing models for this asset class incorporate security set-up, benchmark yields, apply base spreads, yield to worst or market convention, ratings updates, prepayment schedules and adjustments for material events notices.

 

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    U.S. treasuries are evaluated by obtaining feeds from a number of live data sources including active market makers and inter-dealer brokers.

 

    For MBSs, a matrix model correlation to TBA (a forward MBS trade) or benchmarking is utilized to value a security.

The Company performs certain procedures to validate whether the pricing information received from the pricing vendor is reasonable, to ensure that the fair value determination is consistent with accounting guidance, and to ensure that its assets are properly classified in the fair value hierarchy. The Company’s procedures include, but are not limited to:

 

    Reviewing periodic reports provided by the Investment Manager that provide information regarding rating changes and securities placed on watch. This procedure allows the Company to understand why a particular security’s market value may have changed.

 

    Understanding and periodically evaluating the various pricing methods and procedures used by the Company’s pricing vendor to ensure that investments are properly classified within the fair value hierarchy.

 

    On a quarterly basis, the Company corroborates investment security prices received from its pricing vendor by obtaining pricing from a second pricing vendor for a sample of securities.

During the quarters and nine months ended September 30, 2015 and 2014, the Company has not adjusted quotes or prices obtained from the pricing vendor.

6. Income Taxes

The statutory income tax rates of the countries where the Company does business are 35% in the United States, 0% in Bermuda, 0% in the Cayman Islands, 0% in Gibraltar, 29.22% in the Duchy of Luxembourg, and 25% on non-trading income, 33% on capital gains and 12.5% on trading income in the Republic of Ireland. The statutory income tax rate of each country is applied against the expected annual taxable income of the Company in each country to estimate the annual income tax expense. Generally, during interim periods, the Company will divide total estimated annual income tax expense by total estimated annual pre-tax income to determine the expected annual income tax rate used to compute the income tax provision. The expected annual income tax rate is then applied against interim pre-tax income, excluding net realized gains and losses and limited partnership distributions, and that amount is then added to the actual income taxes on net realized gains and losses, discrete items and limited partnership distributions. However, when there is significant volatility in the expected effective tax rate, the Company records its actual income tax provision in lieu of the estimated effective income tax rate. In 2015, the Company recorded its income tax provision using a discrete period computation because a reliable estimate of an effective tax rate could not be made.

 

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The Company’s income before income taxes from its non-U.S. subsidiaries and U.S. subsidiaries, including the results of the quota share and stop-loss agreements between Global Indemnity Reinsurance and the Insurance Operations, for the quarters and nine months ended September 30, 2015 and 2014 were as follows:

 

Quarter Ended September 30, 2015:

(Dollars in thousands)

   Non-U.S.
Subsidiaries
     U.S.
Subsidiaries
     Eliminations      Total  

Revenues:

           

Gross premiums written

   $   67,543       $ 140,268       $   (57,663    $ 150,148   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net premiums written

   $ 67,534       $ 54,963       $ —         $ 122,497   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net premiums earned

   $ 70,532       $ 54,175       $ —         $ 124,707   

Net investment income

     10,644         4,783         (6,575      8,852   

Net realized investment losses

     (1,256      (9,522      —           (10,778

Other income

     (11      1,290         —           1,279   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     79,909         50,726         (6,575      124,060   

Losses and Expenses:

           

Net losses and loss adjustment expenses

     39,849         37,842         —           77,691   

Acquisition costs and other underwriting expenses

     30,504         20,430         —           50,934   

Corporate and other operating expenses

     1,648         1,919         —           3,567   

Interest expense

     1,501         6,669         (6,575      1,595   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

   $ 6,407       $ (16,134    $ —         $ (9,727
  

 

 

    

 

 

    

 

 

    

 

 

 

 

Quarter Ended September 30, 2014:

(Dollars in thousands)

   Non-U.S.
Subsidiaries
     U.S.
Subsidiaries
     Eliminations      Total  

Revenues:

           

Gross premiums written

   $ 38,387       $   56,491       $   (27,780    $ 67,098   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net premiums written

   $ 38,366       $ 24,896       $ —         $ 63,262   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net premiums earned

   $ 43,238       $ 24,790       $ —         $   68,028   

Net investment income

     7,713         3,655         (4,841      6,527   

Net realized investment gains (losses)

     (10      1,168         —           1,158   

Other income (loss)

     (38      164         —           126   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     50,903         29,777         (4,841      75,839   

Losses and Expenses:

           

Net losses and loss adjustment expenses

     18,939         17,715         —           36,654   

Acquisition costs and other underwriting expenses

     17,762         9,696         —           27,458   

Corporate and other operating expenses

     1,156         2,325         —           3,481   

Interest expense

     193         4,766         (4,841      118   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before income taxes

   $   12,853       $ (4,725    $ —         $ 8,128   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

Nine Months Ended September 30, 2015:

(Dollars in thousands)

   Non-U.S.
Subsidiaries
     U.S.
Subsidiaries
     Eliminations      Total  

Revenues:

           

Gross premiums written

   $ 289,940       $ 411,310       $ (241,718    $ 459,532   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net premiums written

   $ 289,892       $ 104,714       $ —         $ 394,606   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net premiums earned

   $ 214,667       $ 166,254       $ —         $ 380,921   

Net investment income

     32,146         13,594         (19,506      26,234   

Net realized investment losses

     (1,643      (5,573      —           (7,216

Other income (loss)

     (77      2,485         —           2,408   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     245,093         176,760         (19,506      402,347   

Losses and Expenses:

           

Net losses and loss adjustment expenses

     115,654         111,216         —           226,870   

Acquisition costs and other underwriting expenses

     92,368         57,750         —           150,118   

Corporate and other operating expenses

     3,395         16,046         —           19,441   

Interest expense

     2,325         19,816         (19,506      2,635   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

   $ 31,351       $ (28,068    $ —         $ 3,283   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Nine Months Ended September 30, 2014:

(Dollars in thousands)

   Non-U.S.
Subsidiaries
     U.S.
Subsidiaries
     Eliminations      Total  

Revenues:

           

Gross premiums written

   $ 139,714       $ 170,038       $   (82,552    $ 227,200   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net premiums written

   $ 138,677       $ 73,818       $ —         $ 212,495   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net premiums earned

   $ 126,551       $ 75,038       $ —         $ 201,589   

Net investment income

     22,947         13,980         (14,439      22,488   

Net realized investment gains

     1,017         39,209         —           40,226   

Other income (loss)

     (41      490         —           449   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     150,474         128,717         (14,439      264,752   

Losses and Expenses:

           

Net losses and loss adjustment expenses

     51,818         61,678         —           113,496   

Acquisition costs and other underwriting expenses

     52,637         28,477         —           81,114   

Corporate and other operating expenses

     4,034         5,580         —           9,614   

Interest expense

     647         14,420         (14,439      628   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before income taxes

   $ 41,338       $ 18,562       $ —         $ 59,900   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table summarizes the components of income tax expense (benefit):

 

     Quarters Ended September 30,      Nine Months Ended September 30,  
(Dollars in thousands)    2015      2014      2015      2014  

Current income tax expense:

           

Foreign

   $ 67       $ 39       $ 228       $ 164   

U.S. Federal

     (579      (1,571      (2,126      5,980   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total current income tax expense (benefit)

     (512      (1,532      (1,898      6,144   
  

 

 

    

 

 

    

 

 

    

 

 

 

Deferred income tax expense (benefit):

           

U.S. Federal

     (5,469      (101      (8,984      1,964   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total deferred income tax expense (benefit)

     (5,469      (101      (8,984      1,964   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total income tax expense (benefit)

   $ (5,981    $ (1,633    $ (10,882    $ 8,108   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table summarizes the differences between the tax provision for financial statement purposes and the expected tax provision at the weighted average tax rate:

 

     Quarters Ended September 30,  
     2015     2014  
(Dollars in thousands)    Amount      % of Pre-
Tax Income
    Amount      % of Pre-
Tax Income
 

Expected tax provision at weighted average rate

   $ (5,580      (57.4 %)    $ (1,614      (19.9 %) 

Adjustments:

          

Tax exempt interest

     (107      (1.1     (120      (1.5

Dividend exclusion

     (175      (1.8     (229      (2.8

Effective tax rate adjustment

     —           0.0        288         3.5   

Other

     (119      (1.2     42         0.6   
  

 

 

    

 

 

   

 

 

    

 

 

 

Actual tax on continuing operations

   $ (5,981      (61.5 %)    $ (1,633      (20.1 %) 
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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The effective income tax benefit rate for the quarter ended September 30, 2015 was 61.5%, compared to an effective income tax benefit rate of 20.1%, for the quarter ended September 30, 2014. The increase in the effective tax benefit rate is primarily due to capital losses in the quarter ended September 30, 2015. Taxes were computed using a discrete period computation because a reliable estimate of an effective tax rate could not be made.

 

     Nine Months Ended September 30,  
     2015     2014  
(Dollars in thousands)    Amount      % of Pre-
Tax Income
    Amount      % of Pre-
Tax Income
 

Expected tax provision at weighted average rate

   $ (9,595      (292.3 %)    $ 6,649         11.1

Adjustments:

          

Tax exempt interest

     (326      (9.9     (490      (0.8

Dividend exclusion

     (588      (17.9     (1,186      (2.0

Effective tax rate adjustment

     —           0.0        2,600         4.3   

Other

     (373      (11.4     535         0.9   
  

 

 

    

 

 

   

 

 

    

 

 

 

Actual tax on continuing operations

   $ (10,882      (331.5 %)    $ 8,108         13.5
  

 

 

    

 

 

   

 

 

    

 

 

 

The effective income tax benefit rate for the nine months ended September 30, 2015 was 331.5%, compared to an effective income tax expense rate of 13.5% for the nine months ended September 30, 2014. The decrease in the effective tax rate is primarily due to expenses related to the acquisition of American Reliable Insurance Company in 2015 and large capital gains in 2014. Taxes were computed using a discrete period computation because a reliable estimate of an effective tax rate could not be made.

The tax effects of temporary differences that give rise to significant portions of the net deferred tax assets at September 30, 2015 and December 31, 2014 are presented below:

 

(Dollars in thousands)    September 30,
2015
     December 31,
2014
 

Deferred tax assets:

     

Discounted unpaid losses and loss adjustment expenses

   $ 8,739       $ 7,492   

Unearned premiums

     8,117         3,409   

Alternative minimum tax credit carryover

     10,587         10,473   

Net operating loss carryforward

     6,264         —     

Partnership K1 basis differences

     245         145   

Capital gain on derivative instruments

     6,483         4,786   

Investment impairments

     2,709         379   

Stock options

     2,578         2,048   

Deferred acquisition costs

     149         187   

Stat-to-GAAP reinsurance reserve

     1,364         1,424   

Intercompany transfers

     1,738         1,919   

Depreciation and amortization

     93         —     

Other

     4,115         3,050   
  

 

 

    

 

 

 

Total deferred tax assets

     53,181         35,312   
  

 

 

    

 

 

 

Deferred tax liabilities:

     

PGAAP adjustment for American Reliable

     6,095         —     

Intangible assets

     4,615         3,220   

Unrealized gain on securities available-for-sale and investments in limited partnerships included in accumulated other comprehensive income

     4,827         10,263   

Investment basis differences

     1,066         692   

Depreciation and amortization

     —           16   

Other

     769         871   
  

 

 

    

 

 

 

Total deferred tax liabilities

     17,372         15,062   
  

 

 

    

 

 

 

Total net deferred tax assets

   $ 35,809       $ 20,250   
  

 

 

    

 

 

 

Management believes it is more likely than not that the deferred tax assets will be fully utilized in future years. As a result, the Company has not recorded a valuation allowance at September 30, 2015 and December 31, 2014.

 

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The Company has an alternative minimum tax credit carry forward of $10.6 million and $10.5 million as of September 30, 2015 and December 31, 2014, respectively, which can be carried forward indefinitely. The company has a net operating loss (“NOL”) carryforward of $6.3 million as of September 30, 2015. The company has no NOL carryforward as of December 31, 2014.

7. Liability for Unpaid Losses and Loss Adjustment Expenses

Activity in the liability for unpaid losses and loss adjustment expenses is summarized as follows:

 

     Quarters Ended September 30,      Nine Months Ended September 30,  
(Dollars in thousands)    2015      2014      2015      2014  

Balance at beginning of period

   $ 769,299       $ 754,595       $ 675,472       $ 779,466   

Less: Ceded reinsurance receivables

     138,497         178,998         123,201         192,491   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net balance at beginning of period

     630,802         575,597         552,271         586,975   

Purchased reserves, gross

     1,119         —           89,489         —     

Less: Purchased reserves ceded

     (1,119      —           (12,800      —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Purchased reserves, net

     —           —           76,689         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Incurred losses and loss adjustment expenses related to:

           

Current year

     86,203         36,501         244,041         119,464   

Prior years

     (8,512      153         (17,171      (5,969
  

 

 

    

 

 

    

 

 

    

 

 

 

Total incurred losses and loss adjustment expenses

     77,691         36,654         226,870         113,495   
  

 

 

    

 

 

    

 

 

    

 

 

 

Paid losses and loss adjustment expenses related to:

           

Current year

     53,512         15,480         113,573         39,472   

Prior years

     56,385         28,704         143,661         92,931   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total paid losses and loss adjustment expenses

     109,897         44,184         257,234         132,403   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net balance at end of period

     598,596         568,067         598,596         568,067   

Plus: Ceded reinsurance receivables

     130,913         171,864         130,913         171,864   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 729,509       $ 739,931       $ 729,509       $ 739,931   
  

 

 

    

 

 

    

 

 

    

 

 

 

When analyzing loss reserves and prior year development, the Company considers many factors, including the frequency and severity of claims, loss trends, case reserve settlements that may have resulted in significant development, and any other additional or pertinent factors that may impact reserve estimates.

In the third quarter of 2015, the Company decreased its prior accident year loss reserves by $8.5 million, which consisted of a $7.3 million decrease related to Commercial Lines and a $1.2 million decrease related to Reinsurance Operations.

The $7.3 million decrease related to Commercial Lines primarily consisted of the following:

 

    Professional: A $3.5 million decrease in aggregate primarily related to better than anticipated loss emergence in accident years 2006 through 2012.

 

    General Liability: A $3.8 million decrease in aggregate primarily related to accident years 1999 through 2013 primarily due to better than anticipated frequency and severity in construction defect.

The $1.2 million decrease in aggregate related to Reinsurance Operations was primarily due to improved results reported by the Company’s cedants on property catastrophe contracts for accident years 2009 to 2013.

In the third quarter of 2014, the Company increased its prior accident year loss reserves by $0.2 million, which consisted of a $0.02 million increase related to Commercial Lines and a $0.1 million increase related to Reinsurance Operations.

The $0.02 million increase related to Commercial Lines primarily consisted of the following:

 

    General Liability: A $5.4 million increase primarily due to higher than anticipated loss emergence in recent accident years.

 

    Professional: A $6.4 million reduction is primarily due to lower than expected severity from accident years 2007 through 2011.

 

    Property: A $0.5 million increase primarily due to increased severity in accident years 2011 through 2013.

 

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    Asbestos: $0.2 million increase primarily related to accident years prior to 1990 due to recent development on several claims.

 

    Other: A $0.3 million increase primarily due to accident years 2011 through 2013.

The $0.1 million increase related to Reinsurance Operations primarily consisted of the following:

 

    Property: A $3.4 million reduction is due to less catastrophe losses than anticipated primarily from accident year 2013.

 

    Commercial Auto: A $0.5 million increase due to increased severity primarily from accident years 2009 and 2010.

 

    Marine: A $3.0 million increase is primarily related to increased severity on accident years 2011 and 2012. These treaties are in runoff. Several claims have recently settled for amounts higher than expected.

In the first nine months of 2015, the Company decreased its prior accident year loss reserves by $17.2 million, which consisted of a $12.9 million decrease related to Commercial Lines and a $4.3 million decrease related to Reinsurance Operations.

The $12.9 million decrease related to Commercial Lines primarily consisted of the following:

 

    Property: A $0.8 million decrease in aggregate primary related to better than anticipated loss emergence in the 2011 through 2014 accident years.

 

    Umbrella: $0.3 million decrease primarily related to accident years 2003 through 2005 as a result of better than anticipated loss emergence.

 

    Professional: $6.4 million decrease in aggregate primarily related to better than anticipated frequency in accident years 2006 through 2012.

 

    General Liability: A $5.7 million decrease in aggregate primarily related to accident years prior to 2013 due to better than anticipated frequency and severity in construction defect.

The $4.3 million decrease in aggregate related to Reinsurance Operations was primarily due to improved results reported by the Company’s cedants on property contracts for accident years 2009 through 2014.

In the first nine months of 2014, the Company reduced its prior accident year loss reserves by $6.0 million, which consisted of a $5.0 million decrease related to Commercial Lines and a $1.0 million decrease related to Reinsurance Operations.

The $5.0 million decrease related to Commercial Lines primarily consisted of the following:

 

    Property: A $0.7 million increase primarily due to increased severity in accident years 2007, 2012, and 2013.

 

    General Liability: A $5.3 million increase primarily due to higher than anticipated loss emergence in recent accident years.

 

    Professional: A $18.1 million reduction due to lower than expected severity primarily from accident years 2007 through 2011.

 

    Asbestos: $7.1 million increase primarily related to accident years prior to 1990 due to recent development on several claims.

The $1.0 million decrease related to Reinsurance Operations primarily consisted of the following:

 

    Property: A $4.7 million reduction driven by less catastrophe losses than anticipated primarily from accident years 2012 and 2013.

 

    Marine: A $3.0 million increase primarily related to increased severity from accident years 2011 and 2012. These treaties are in runoff. Several claims have recently settled for amounts higher than expected.

 

    Commercial Auto: $0.7 million increase is primarily due to increased severity primarily from accident years 2009 and 2010.

 

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8. Debt

The Company’s outstanding debt consisted of the following at September 30, 2015 and December 31, 2014:

 

(Dollars in thousands)    September 30, 2015      December 31, 2014  

Margin Borrowing Facilities

   $ 195,787       $ 174,673   

7.75% Subordinated Notes due 2045

     96,357         —     
  

 

 

    

 

 

 

Total

   $ 292,144       $ 174,673   
  

 

 

    

 

 

 

Margin Borrowing Facilities

The amount outstanding on the Company’s margin borrowing facilities was $195.8 million and $174.7 million as of September 30, 2015 and December 31, 2014, respectively. The borrowing rate for each facility is tied to LIBOR and is currently approximately 1% as of September 30, 2015. These facilities are due on demand. The borrowings are subject to maintenance margin, which is a minimum account balance that must be maintained. A decline in market conditions could require an additional deposit of collateral. As of September 30, 2015, approximately $248.5 million in securities were deposited as collateral to support the borrowing.

The Company recorded interest expense of approximately $0.5 million and $0.1 million during the quarter ended September 30, 2015 and 2014, respectively, and $1.6 million and $0.5 million during the nine months ended September 30, 2015 and 2014, respectively, related to the Margin Borrowing Facilities.

7.75% Subordinated Notes due 2045

On August 12, 2015, the Company issued $100.0 million in aggregate principal amount of its 2045 Subordinated Notes through an underwritten public offering.

The notes bear interest at an annual rate equal to 7.75%, payable quarterly in arrears on February 15, May 15, August 15, and November 15 of each year, commencing November 15, 2015. The notes mature on August 15, 2045. The Company has the right to redeem the notes in $25 increments, in whole or in part, on and after August 15, 2020, or on any interest payments date thereafter, at a redemption price equal to 100% of the principal amount of the notes being redeemed plus accrued and unpaid interest to, but not including, the date of redemption.

The notes are subordinated unsecured obligations and rank (i) senior to the Company’s existing and future capital stock, (ii) senior in right of payment to future junior subordinated debt, (iii) equally in right of payment with any unsecured, subordinated debt that the Company incurs in the future that ranks equally with the notes, and (iv) subordinate in right of payment to any of the Company’s existing and future senior debt. In addition, the notes are structurally subordinated to all existing and future indebtedness, liabilities and other obligations of the Company’s subsidiaries.

The Company incurred $3.6 million in deferred issuance costs associated with the notes, which is being amortized over the term of the notes. Interest expense, including amortization of deferred issuance costs, recognized on the notes was $1.1 million during both the quarter and nine months ended September 30, 2015.

The following tables represent the amounts recorded for the margin borrowing facilities and 7.75% subordinated notes as of September 30, 2015 and December 31, 2014:

 

     September 30, 2015  
     Outstanding
Principal
     Unamortized
Debt Issuance
Costs
     Net
Carrying
Amount
 

Margin Borrowing Facilities

   $ 195,787       $ —         $ 195,787   

7.75% Subordinated Notes due 2045

     100,000         (3,643      96,357   
  

 

 

    

 

 

    

 

 

 
   $ 295,787       $ (3,643    $ 292,144   
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents

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     December 31, 2014  
     Outstanding
Principal
     Unamortized
Debt Issuance
Costs
     Net
Carrying
Amount
 

Margin Borrowing Facilities

   $ 174,673       $ —         $ 174,673   

7.75% Subordinated Notes due 2045

     —           —           —     
  

 

 

    

 

 

    

 

 

 
   $ 174,673       $ —         $ 174,673   
  

 

 

    

 

 

    

 

 

 

9. Shareholders’ Equity

Repurchases of the Company’s A ordinary shares

No shares were repurchased during the quarters ended September 30, 2015 and 2014. During the nine months ended September 30, 2015 and 2014, the Company repurchased 11,895 share and 5,444 shares, respectively, with an average price paid of $28.03 per share and $ 25.46 per share, respectively.

Please see Note 11 of the notes to the consolidated financial statements in Item 8 Part II of the Company’s 2014 Annual Report on Form 10-K for more information on the Company’s repurchase program.

10. Related Party Transactions

Fox Paine & Company

As of September 30, 2015, Fox Paine beneficially owned shares having approximately 93% of the Company’s total outstanding voting power. Fox Paine has the right to appoint a number of the Company’s Directors equal in aggregate to the pro rata percentage of the voting shares of the Company beneficially held by Fox Paine for so long as Fox Paine holds an aggregate of 25% or more of the voting power in the Company. Fox Paine controls the election of all of the Company’s Directors due to its controlling share ownership. The Company’s Chairman is a member of Fox Paine. The Company relies on Fox Paine to provide management services and other services related to the operations of the Company.

At September 30, 2015 and December 31, 2014, Global Indemnity Reinsurance was a limited partner in Fox Paine Capital Fund, II, which is managed by Fox Paine. This investment was originally made by United National Insurance Company in June 2000 and pre-dates the September 5, 2003 acquisition by Fox Paine of Wind River Investment Corporation, which was the predecessor holding company for United National Insurance Company. The Company’s investment in this limited partnership was valued at $3.3 million and $3.4 million at September 30, 2015 and December 31, 2014, respectively. At September 30, 2015, the Company had an unfunded capital commitment of $2.4 million to the partnership. There were no distributions received from the limited partnership during the third quarter of 2015 or 2014. During the nine months ended September 30, 2015, the Company received a distribution of $0.8 million. There were no distributions received from the limited partnership during the nine months ended September 30, 2014.

The Company relies on Fox Paine to provide management services and other services related to the operations of the Company. The Company incurred management fees of $0.4 million and $0.5 million during the quarters ended September 30, 2015 and 2014, respectively, and $1.4 million and $1.5 million during the nine months ended September 30, 2015 and 2014, respectively, as part of the annual management fee paid to Fox Paine. As of September 30, 2015 and December 31, 2014, unpaid management fees, which were included in other liabilities on the consolidated balance sheets, were $2.1 million and $0.6 million, respectively.

In connection with the acquisition, the Company agreed to pay to Fox Paine an investment banking fee of 3% of the amount paid plus the additional capital required to operate American Reliable on a standalone basis and a $1.5 million investment advisory fee, which in the aggregate, totaled $6.5 million. This amount is included in corporate and other operating expenses on the Company’s Consolidated Statements of Operations during the nine months ended September 30, 2015. As payment for these fees, 267,702 A ordinary shares of Global Indemnity were issued under the Global Indemnity plc Share Incentive Plan in May, 2015. These shares will be registered but cannot be sold until the earlier of five years or a change of control. See Note 12 for additional information on the Global Indemnity plc Share Incentive Plan.

 

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Cozen O’Connor

The Company incurred $0.2 million and $0.02 million for legal services rendered by Cozen O’Connor during the quarters ended September 30, 2015 and 2014, respectively. The Company incurred $0.6 million and $0.1 million for legal services rendered by Cozen O’Connor during the nine months ended September 30, 2015 and 2014, respectively. Stephen A. Cozen, the chairman of Cozen O’Connor, is a member of the Company’s Board of Directors.

Crystal & Company

The Company incurred brokerage fees with Crystal & Company, an insurance broker, of $0.1 million during each of the quarters ended September 30, 2015 and 2014 and $0.2 million during each of the nine months ended September 30, 2015 and 2014. James W. Crystal, the chairman and chief executive officer of Crystal & Company, is a member of the Company’s Board of Directors.

Hiscox Insurance Company (Bermuda) Ltd.

Global Indemnity Reinsurance was a participant in two reinsurance agreements with Hiscox Insurance Company (Bermuda) Ltd. (“Hiscox Bermuda”) while Steve Green, the President of Global Indemnity Reinsurance, was a member of Hiscox Bermuda’s Board of Directors. Steve Green was a member of Hiscox Bermuda’s Board of Directors until May, 2014. The Company estimated that the following earned premium and incurred losses related to these agreements have been assumed by Global Indemnity Reinsurance from Hiscox Bermuda:

 

     Quarters Ended September 30,  
(Dollars in thousands)    2015      2014  

Assumed earned premium

   $ 47       $ 1,823   

Assumed losses and loss adjustment expenses

     (167      504   
     Nine Months Ended September 30,  
(Dollars in thousands)    2015      2014  

Assumed earned premium

   $ 2,294       $ 4,639   

Assumed losses and loss adjustment expenses

     476         1,349   

Net balances due to Global Indemnity Reinsurance under this agreement are as follows:

 

(Dollars in thousands)    September 30,
2015
     December 31,
2014
 

Net receivable (payable) balance

   $ (61    $ 2,897   

11. Commitments and Contingencies

Legal Proceedings

The Company is, from time to time, involved in various legal proceedings in the ordinary course of business. The Company maintains insurance and reinsurance coverage for such risks in amounts that it considers adequate. However, there can be no assurance that the insurance and reinsurance coverage that the Company maintains is sufficient or will be available in adequate amounts or at a reasonable cost. The Company does not believe that the resolution of any currently pending legal proceedings, either individually or taken as a whole, will have a material adverse effect on its business, results of operations, cash flows, or financial condition.

There is a greater potential for disputes with reinsurers who are in runoff. Some of the Company’s reinsurers’ have operations that are in runoff, and therefore, the Company closely monitors those relationships. The Company anticipates that, similar to the rest of the insurance and reinsurance industry, it will continue to be subject to litigation and arbitration proceedings in the ordinary course of business.

 

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Commitments

During 2014, the Company entered into a $50 million commitment to purchase an alternative investment vehicle which is comprised of European non-performing loans. As of September 30, 2015, the Company has funded $28.7 million of this commitment leaving $21.3 million as unfunded.

At September 30, 2015, the Company had an unfunded capital commitment of $2.4 million related to its investment in Fox Paine Capital Fund, II. See Note 10 for additional information on the Company’s investment in Fox Paine Capital Fund, II.

12. Share-Based Compensation Plans

Options

No stock options were awarded during the quarters ended September 30, 2015 and 2014. No unvested stock options were forfeited during the quarter ended September 30, 2015. Unvested stock options of 75,000 were forfeited during the quarter ended September 30, 2014.

During the nine months ended September 30, 2015, the company awarded 200,000 time based options with a strike price of $28.37 per share which vest one third on each of December 31, 2015, December 31, 2016, and December 31, 2017. During the nine months ended September 30, 2014, the company awarded 25,000 time based options with a strike price of $24.00 per share which vest in February, 2017. Unvested stock options of 75,000, which include the 25,000 shares issued during the nine months ended September 30, 2014, were forfeited during the nine months ended September 30, 2014.

Restricted Shares

No restricted shares were issued to employees during the quarter ended September 30, 2015 and 2014.

During the nine months ended September 30, 2015, the Company issued 138,507 A ordinary shares, with a weighted average grant date value of $28.37 per share, to key employees under the Plan.

Of the shares issued during the nine months ended September 30, 2015, 10,574 were issued to the Company’s Chief Executive Officer and vest 33 1/3 on each subsequent anniversary date of the grant for a period of three years subject to an accident year true-up of bonus year underwriting results as of the third anniversary of the grant and an additional 44,058 were issued to the Company’s Chief Executive Officer and other key employees which vest 100% on January 1, 2018. The remaining 83,875 shares were issued to key employees and will vest as follows:

 

    16.5%, 16.5%, and 17.0% of the granted stock vest on the first, second, and third anniversary of the grant, respectively.

 

    50% of granted stock vests 100% on the anniversary of the third year subject to accident year true-up of bonus year underwriting results and are subject to Board approval.

During the nine months ended September 30, 2014, the Company issued 95,694 A ordinary shares, with a weighted average grant date value of $25.37 per share, to key employees under the 2014 Plan. Of the shares issued in 2014, 11,857 were granted to the Company’s Chief Executive Officer and vest 33 1/3 on each subsequent anniversary date of the grant for a period of three years subject to an accident year true-up of bonus year underwriting results as of the third anniversary of the grant. 5,671 were issued to a key employee and vest 33 1/3% on each subsequent anniversary date of the award for a period of three years. The remaining 78,166 shares were issued to key employees and will vest as follows:

 

    16.5%, 16.5%, and 17.0% of the granted stock vest on the first, second, and third anniversary of the grant, respectively.

 

    50% of granted stock vests 100% on the anniversary of the third year subject to accident year true-up of bonus year underwriting results and are subject to Board approval.

 

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During the quarters ended September 30, 2015 and 2014, the Company issued 9,392 and 9,498 A ordinary shares, respectively, at a weighted average grant date value of $26.17 and $25.23 per share, respectively, to non-employee directors of the Company under the Plan. During the nine months ended September 30, 2015 and 2014, the Company issued 27,437 and 27,676 A ordinary shares, respectively, at a weighted average grant date value of $27.31 and $25.84 per share, respectively, to non-employee directors of the Company under the Plan. All of the shares issued to non-employee directors of the Company in 2015 and 2014 were fully vested but subject to certain restrictions. An additional 18,838 A ordinary shares were granted to non-employee directors on June 11, 2014. These shares were issued to non-employee directors prior to January 1, 2014 on the condition that the shareholders approve the Company’s revised share incentive plan at the Company’s 2014 annual shareholder meeting which occurred on June 11, 2014.

13. Earnings Per Share

Earnings per share have been computed using the weighted average number of ordinary shares and ordinary share equivalents outstanding during the period.

The following table sets forth the computation of basic and diluted earnings per share:

 

(Dollars in thousands,    Quarters Ended September 30,      Nine Months Ended September 30,  
except share and per share data)    2015      2014      2015      2014  

Net income (loss)

   $ (3,746    $ 9,761       $ 14,165       $ 51,792   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic earnings per share:

           

Weighted average shares outstanding – basic

     25,463,994         25,137,531         25,452,991         25,126,684   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss) per share

   $ (0.15    $ 0.39       $ 0.56       $ 2.06   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted earnings per share:

           

Weighted average shares outstanding – diluted

     25,704,931         25,334,716         25,684,931         25,323,187   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss) per share

   $ (0.15    $ 0.39       $ 0.55       $ 2.05   
  

 

 

    

 

 

    

 

 

    

 

 

 

A reconciliation of weighted average shares for basic earnings per share to weighted average shares for diluted earnings per share is as follows:

 

     Quarters Ended September 30,      Nine Months Ended September 30,  
     2015      2014      2015      2014  

Weighted average shares for basic earnings per share

     25,463,994         25,137,531         25,452,991         25,126,684   

Non-vested restricted stock

     138,261         89,114         128,942         88,710   

Options

     102,676         108,071         102,998         107,793   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares for diluted earnings per share

     25,704,931         25,334,716         25,684,931         25,323,187   
  

 

 

    

 

 

    

 

 

    

 

 

 

The weighted average shares outstanding used to determine dilutive earnings per share for the quarters ended September 30, 2015 and 2014 do not include 512,500 and 12,500 options, respectively, which were deemed to be anti-dilutive. The weighted average shares outstanding used to determine dilutive earnings per share for the nine months ended September 30, 2015 and 2014 do not include 512,500 and 12,500 options, respectively, which were deemed to be anti-dilutive.

The following table summarizes options which are deemed to be anti-dilutive at September 30, 2015:

 

Grant Date

   Expiration Date    Outstanding
Options
     Strike Price  

February 9, 2014

   February 10, 2024      300,000         32.38   

January 1, 2015

   January 1, 2025      200,000         28.37   

November 2, 2005 (1)

   November 3, 2015      12,500         37.70   
     

 

 

    
        512,500      
     

 

 

    

 

(1) Represents anti-dilutive options at September 30, 2014.

 

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14. Segment Information

The acquisition of American Reliable has impacted the way the Company manages and analyzes its operating results. The business acquired from American Reliable is considered to be a separate segment, Personal Lines. The Company now manages its business through three business segments: Commercial Lines, managed in Bala Cynwyd, PA, offers specialty property and casualty products designed for product lines such as Small Business Binding Authority, Property Brokerage, and Programs; Personal Lines, managed in Scottsdale, AZ, offers specialty personal lines and agricultural coverage; and Reinsurance Operations, managed in Bermuda, provides reinsurance solutions through brokers and primary writers including insurance and reinsurance companies.

The following are tabulations of business segment information for the quarters and nine months ended September 30, 2015 and 2014.

 

Quarter Ended September 30, 2015:

(Dollars in thousands)

   Commercial
Lines (1)
    Personal
Lines (1)
    Reinsurance
Operations (2)
    Total  

Revenues:

        

Gross premiums written

   $ 52,920      $ 87,349      $ 9,879      $ 150,148   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums written

   $ 49,325      $ 63,302      $ 9,870      $ 122,497   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

   $ 48,916      $ 62,132      $ 13,659      $ 124,707   

Other income (loss)

     102        1,188        (11     1,279   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     49,018        63,320        13,648        125,986   
  

 

 

   

 

 

   

 

 

   

 

 

 

Losses and Expenses:

        

Net losses and loss adjustment expenses

     22,832        48,899        5,960        77,691   

Acquisition costs and other underwriting expenses

     20,686 (3)      25,779 (4)      4,469        50,934   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from segments

   $ 5,500      $ (11,358   $ 3,219      $ (2,639
  

 

 

   

 

 

   

 

 

   

Unallocated Items:

        

Net investment income

           8,852   

Net realized investment losses

           (10,778

Corporate and other operating expenses

           (3,567

Interest expense

           (1,595
        

 

 

 

Income before income taxes

           (9,727

Income tax benefit

           5,981   
        

 

 

 

Net income

           (3,746
        

 

 

 

Total assets

   $ 1,005,435      $ 572,807      $ 740,377 (5)    $ 2,318,619   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes business ceded to the Company’s Reinsurance Operations.
(2) External business only, excluding business assumed from affiliates.
(3) Includes federal excise tax of $258 relating to cessions from Commercial Lines to Reinsurance Operations.
(4) Includes federal excise tax of $310 relating to cessions from Personal Lines to Reinsurance Operations.
(5) Comprised of Global Indemnity Reinsurance’s total assets less its investment in subsidiaries.

 

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Quarter Ended September 30, 2014:

(Dollars in thousands)

   Commercial
Lines (1)
    Reinsurance
Operations (2)
    Total  

Revenues:

      

Gross premiums written

   $ 56,489      $ 10,609      $ 67,098   
  

 

 

   

 

 

   

 

 

 

Net premiums written

   $ 52,674      $ 10,588      $ 63,262   
  

 

 

   

 

 

   

 

 

 

Net premiums earned

   $ 52,462      $ 15,566      $ 68,028   

Other income (loss)

     164        (38     126   
  

 

 

   

 

 

   

 

 

 

Total revenues

     52,626        15,528        68,154   

Losses and Expenses:

      

Net losses and loss adjustment expenses

     29,575        7,079        36,654   

Acquisition costs and other underwriting expenses

     21,790 (3)      5,668        27,458   
  

 

 

   

 

 

   

 

 

 

Income (loss) from segments

   $ 1,261      $ 2,781        4,042   
  

 

 

   

 

 

   

Unallocated Items:

      

Net investment income

         6,527   

Net realized investment gains

         1,158   

Corporate and other operating expenses

         (3,481

Interest expense

         (118
      

 

 

 

Income before income taxes

         8,128   

Income tax expense

         1,633   
      

 

 

 

Net income

       $ 9,761   
      

 

 

 

Total assets

   $ 1,229,463      $ 650,352 (4)    $ 1,879,815   
  

 

 

   

 

 

   

 

 

 

 

(1) Includes business ceded to the Company’s Reinsurance Operations.
(2) External business only, excluding business assumed from affiliates.
(3) Includes federal excise tax of $277 relating to cessions from Commercial Lines to Reinsurance Operations.
(4) Comprised of Global Indemnity Reinsurance’s total assets less its investment in subsidiaries.

 

Nine Months Ended September 30, 2015:

(Dollars in thousands)

   Commercial
Lines (1)
    Personal
Lines (1)
    Reinsurance
Operations (2)
    Total  

Revenues:

        

Gross premiums written

   $ 161,746      $ 249,564      $ 48,222      $ 459,532   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums written

   $ 149,647      $ 196,785      $ 48,174      $ 394,606   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

   $ 149,244      $ 191,472      $ 40,205      $ 380,921   

Other income (loss)

     420        2,065        (77     2,408   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     149,664        193,537        40,128        383,329   
  

 

 

   

 

 

   

 

 

   

 

 

 

Losses and Expenses:

        

Net losses and loss adjustment expenses

     82,474        129,997        14,399        226,870   

Acquisition costs and other underwriting expenses

     61,317 (3)      74,590 (4)      14,211        150,118   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from segments

   $ 5,873      $ (11,050   $ 11,518      $ 6,341   
  

 

 

   

 

 

   

 

 

   

Unallocated Items:

        

Net investment income

           26,234   

Net realized investment losses

           (7,216

Corporate and other operating expenses

           (19,441

Interest expense

           (2,635
        

 

 

 

Income before income taxes

           3,283   

Income tax benefit

           10,882   
        

 

 

 

Net income

           14,165   
        

 

 

 

Total assets

   $ 1,005,435      $ 572,807      $ 740,377 (5)    $ 2,318,619   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes business ceded to the Company’s Reinsurance Operations.
(2) External business only, excluding business assumed from affiliates.
(3) Includes federal excise tax of $787 relating to cessions from Commercial Lines to Reinsurance Operations.
(4) Includes federal excise tax of $957 relating to cessions from Personal Lines to Reinsurance Operations.
(5) Comprised of Global Indemnity Reinsurance’s total assets less its investment in subsidiaries.

 

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Nine Months Ended September 30, 2014:

(Dollars in thousands)

   Commercial
Lines (1)
    Reinsurance
Operations (2)
    Total  

Revenues:

      

Gross premiums written

   $ 170,037      $ 57,163      $ 227,200   
  

 

 

   

 

 

   

 

 

 

Net premiums written

   $ 156,369        56,126      $ 212,495   
  

 

 

   

 

 

   

 

 

 

Net premiums earned

   $ 158,809      $ 42,780      $ 201,589   

Other income (loss)

     490        (41     449   
  

 

 

   

 

 

   

 

 

 

Total revenues

     159,299        42,739        202,038   

Losses and Expenses:

      

Net losses and loss adjustment expenses

     97,047        16,449        113,496   

Acquisition costs and other underwriting expenses

     66,068 (3)      15,046        81,114   
  

 

 

   

 

 

   

 

 

 

Income (loss) from segments

   $ (3,816   $ 11,244        7,428   
  

 

 

   

 

 

   

Unallocated Items:

      

Net investment income

         22,488   

Net realized investment gains

         40,226   

Corporate and other operating expenses

         (9,614

Interest expense

         (628
      

 

 

 

Income before income taxes

         59,900   

Income tax expense

         (8,108
      

 

 

 

Net income

       $ 51,792   
      

 

 

 

Total assets

   $ 1,229,463      $ 650,352 (4)    $ 1,879,815   
  

 

 

   

 

 

   

 

 

 

 

(1) Includes business ceded to the Company’s Reinsurance Operations.
(2) External business only, excluding business assumed from affiliates.
(3) Includes federal excise tax of $838 relating to cessions from Commercial Lines to Reinsurance Operations.
(4) Comprised of Global Indemnity Reinsurance’s total assets less its investment in subsidiaries.

15. New Accounting Pronouncements

In September, 2015, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance surrounding business combinations. The new guidance requires an acquirer to recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment is determined. It also requires that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. This guidance is effective for public entities for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. This guidance should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this guidance with earlier application permitted for financial statements that have not been issued. This guidance will be applicable to the Company if there is any material adjustments to amounts previously recorded during the measurement period related to the American Reliable acquisition. This guidance may also be applicable to future acquisitions. The Company plans to adopt this guidance in the first quarter of 2016.

In May, 2015, the FASB issued new accounting guidance surrounding investments in certain entities that calculate net asset value per share. The new guidance removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. It also removes the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. This guidance is effective for public business entities for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The Company plans to adopt this guidance in the first quarter of 2016 which will result in the Company’s other invested assets, that are measured utilizing net asset value, being removed from the fair value hierarchy.

In May, 2015, the FASB issued new accounting guidance surrounding short-duration contracts. The new guidance requires additional disclosure surrounding the liability for unpaid claims and claim adjustment expenses. This guidance is effective for public business entities for annual periods beginning after December 15, 2015 and interim periods within annual periods beginning after December 15, 2016. Early adoption is permitted. The Company plans to include these disclosures in its year ended December 31, 2016 financial statements.

 

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In April 2015, the FASB issued new accounting guidance which requires that debt issuance costs be presented in the balance sheet as a direct reduction from the carrying amount of the recognized debt liability, consistent with the treatment of debt discounts or premiums. Amortization of debt issuance costs is to be reported as interest expense. The recognition and measurement guidance for debt issuance costs are not affected by this new guidance. For public entities, the guidance is effective for financial statements issued for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years. Early adoption is permitted. The Company adopted this guidance in the third quarter, 2015.

The Company does not expect any of these four new accounting pronouncements to have a material impact on the Company’s consolidated statements of financial position or results of operations.

16. Subsequent Events

On October 29, 2015, Global Indemnity entered into a redemption agreement with certain affiliates of Fox Paine & Company, LLC and agreed to redeem 8,260,870 of its ordinary shares for $190 million in the aggregate from affiliates of Fox Paine & Company, LLC. Global Indemnity also acquired rights, expiring year end 2019, to redeem an additional 3,376,561 Ordinary Shares for $77,660,903, which amount is subject to an annual 3% increase. The Company is in discussions with affiliates of Fox Paine to acquire rights to redeem a further 1,146,716 ordinary shares on the same terms as the 3,376,561 share redemption rights. After giving effect to the share redemptions and regardless of whether or not the additional redemption rights are exercised, affiliates of Fox Paine will continue to have the ability to cast a majority of votes on matters submitted to Global Indemnity shareholders for approval.

Had the redemption occurred on or prior to September 30, 2015, outstanding shares would have been 17,472,318 as of September 30, 2015.

In connection with the redemption, the Company sold $279.9 million of securities from its consolidated investment portfolio during October, 2015, which resulted in a realized gain of $1.6 million. $102.0 million was used to pay down margin debt, with the remainder being used to fund a portion of the redemption transaction.

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the consolidated financial statements and accompanying notes of Global Indemnity included elsewhere in this report. Some of the information contained in this discussion and analysis or set forth elsewhere in this report, including information with respect to the Company’s plans and strategy, constitutes forward-looking statements that involve risks and uncertainties. Please see “Cautionary Note Regarding Forward-Looking Statements” at the end of this Item 2 for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained herein. For more information regarding the Company’s business and operations, please see the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

Recent Developments

On October 29, 2015, Global Indemnity entered into a redemption agreement with certain affiliates of Fox Paine & Company, LLC and agreed to redeem 8,260,870 of its ordinary shares for $190 million in the aggregate from affiliates of Fox Paine & Company, LLC. Global Indemnity also acquired rights, expiring year end 2019, to redeem an additional 3,376,561 Ordinary Shares for $77,660,903, which amount is subject to an annual 3% increase. The Company is in discussions with affiliates of Fox Paine to acquire rights to redeem a further 1,146,716 ordinary shares on the same terms as the 3,376,561 share redemption rights. After giving effect to the share redemptions and regardless of whether or not the additional redemption rights are exercised, affiliates of Fox Paine will continue to have the ability to cast a majority of votes on matters submitted to Global Indemnity shareholders for approval.

In connection with the redemption, the Company sold $279.9 million of securities from its consolidated investment portfolio during October, 2015, which resulted in a realized gain of $1.6 million. $102.0 million was used to pay down margin debt, with the remainder being used to fund a portion of the redemption transaction.

 

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On August 12, 2015, the Company issued $100.0 million in aggregate principal amount of its 2045 Subordinated Notes through an underwritten public offering. See Note 8 of the notes to the consolidated financial statements in Item 1 of Part I for additional information on this debt issuance.

On June 12, 2015, A.M. Best affirmed the financial strength rating of “A” (Excellent) for Global Indemnity Reinsurance and its U.S. insurance subsidiaries. Global Indemnity Reinsurance and subsidiaries have a financial size category of “XII” with A.M. Best, which represents an adjusted policyholder’s surplus of $1 billion to $1.25 billion.

On January 1, 2015, Global Indemnity Group, Inc. completed its acquisition of American Reliable. The results of American Reliable’s operations are included in the Company’s consolidated financial statements since the date of acquisition on January 1, 2015. The business acquired from American Reliable is considered to be a separate segment, Personal Lines. For additional information related to the acquisition of American Reliable, see Note 2 and Note 14 of the notes to the consolidated financial statements in Item 1 of Part I as well as the “Overview” and “Results of Operations” sections below.

Overview

In connection with the acquisition of American Reliable, the Company reevaluated segment classifications and determined that the Company will operate and manage its business through three business segments: Commercial Lines, Personal Lines, and Reinsurance Operations.

The Company’s Commercial Lines segment distribute property and casualty insurance products through a group of approximately 110 professional general agencies that have limited quoting and binding authority, as well as a number of wholesale insurance brokers who in turn sell the Company’s insurance products to insureds through retail insurance brokers. Commercial Lines operates predominantly in the excess and surplus lines marketplace. The Company manages its Commercial Lines segment via product classifications. These product classifications are: 1) Penn-America, which includes property and general liability products for small commercial businesses distributed through a select network of wholesale general agents with specific binding authority; 2) United National, which includes property, general liability, and professional lines products distributed through program administrators with specific binding authority; and 3) Diamond State, which includes property, casualty, and professional lines products distributed through wholesale brokers and program administrators with specific binding authority.

The Company’s Personal Lines segment, via the American Reliable product classification, offers specialty personal lines and agricultural coverage through general and specialty agents.

The Company’s Reinsurance Operations consisting solely of the operations of Global Indemnity Reinsurance, provides reinsurance solutions through brokers and on a direct basis. In prior years, the Company provided reinsurance solutions through program managers and primary writers, including regional insurance companies. Global Indemnity Reinsurance is a Bermuda based treaty reinsurer for specialty property and casualty insurance and reinsurance companies. Global Indemnity Reinsurance conducts business in Bermuda and is focused on using its capital capacity to write catastrophe-oriented placements and other niche or specialty-focused treaties meeting the Company’s risk tolerance and return thresholds.

The Company derives its revenues primarily from premiums paid on insurance policies that it writes and from income generated by its investment portfolio, net of fees paid for investment management services. The amount of insurance premiums that the Company receives is a function of the amount and type of policies it writes, as well as prevailing market prices.

The Company’s expenses include losses and loss adjustment expenses, acquisition costs and other underwriting expenses, corporate and other operating expenses, interest, investment expenses, and income taxes. Losses and loss adjustment expenses are estimated by management and reflect the Company’s best estimate of ultimate losses and costs arising during the reporting period and revisions of prior period estimates. The Company records its best estimate of losses and loss adjustment expenses based on both internal and external actuarial analyses of the estimated losses the Company expects to incur on the insurance policies it writes. The ultimate losses and loss adjustment expenses will depend on the actual costs to resolve claims. Acquisition costs consist principally of commissions and premium taxes that are typically a percentage of the premiums on the insurance policies the Company writes, net of ceding commissions earned from reinsurers. Other underwriting expenses consist primarily of personnel expenses and general operating expenses. Corporate and other operating expenses are comprised primarily of outside legal fees, other professional and accounting fees, directors’ fees, management fees and salaries and benefits for company personnel whose services relate to the support of corporate activities. Interest expense is primarily comprised of amounts due on outstanding debt.

 

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Critical Accounting Estimates and Policies

The Company’s consolidated financial statements are prepared in conformity with GAAP, which require it to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates and assumptions.

The Company believes that of the Company’s significant accounting policies, the following may involve a higher degree of judgment and estimation.

Liability for Unpaid Losses and Loss Adjustment Expenses

Although variability is inherent in estimates, the Company believes that the liability for unpaid losses and loss adjustment expenses reflects its best estimate for future amounts needed to pay losses and related loss adjustment expenses and the impact of its reinsurance coverage with respect to insured events.

In developing loss and loss adjustment expense (“loss” or “losses”) reserve estimates for the Company’s Insurance Operations, its actuaries perform detailed reserve analyses each quarter. To perform the analysis, the data is organized at a “reserve category” level. Management is responsible for the final determination of loss reserve selections. A reserve category can be a line of business such as commercial automobile liability, or it can be a particular type of claim such as construction defect. The reserves within a reserve category level are characterized as short-tail and long-tail. For long-tail business, it will generally be several years between the time the business is written and the time when all claims are settled. The Company’s long-tail exposures include general liability, professional liability, products liability, commercial automobile liability, and excess and umbrella. Short-tail exposures include property, commercial automobile physical damage, and equine mortality. To manage its insurance operations, the Company differentiates by product classifications, which are Penn-America, United National, Diamond State and American Reliable. For further discussion about the Company’s product classifications, see “General – Business Segments - Insurance Operations” in Item 1 of Part I of the Company’s 2014 Annual Report on Form 10-K. Each of the Company’s product classifications contain both long-tail and short-tail exposures. Every reserve category is analyzed by the Company’s actuaries each quarter. The analyses generally include reviews of losses, gross of reinsurance and net of reinsurance.

Loss reserve estimates for the Company’s Reinsurance Operations are developed by independent, external actuaries at least annually and are regularly monitored by management. Management is responsible for the final determination of loss reserve selections. The data for this analysis is organized by treaty and treaty year. As with the Company’s reserves for its Insurance Operations, reserves for its Reinsurance Operations are characterized as short-tail and long-tail. Long-tail exposures include workers compensation, professional liability, and excess and umbrella liability. Short-tail exposures are primarily catastrophe exposed property and marine accounts. Management reviews each treaty each quarter both gross and net of reinsurance.

In addition to the Company’s internal reserve analysis, independent external actuaries perform a full, detailed review of the Insurance and Reinsurance Operations’ reserves annually. The Company reviews both the internal and external actuarial analyses in determining its reserve position.

The methods used to project ultimate losses for both long-tail and short-tail exposures include, but are not limited to, the following:

 

    Paid Development method;

 

    Incurred Development method;

 

    Expected Loss Ratio method;

 

    Bornhuetter-Ferguson method using premiums and paid loss;

 

    Bornhuetter-Ferguson method using premiums and incurred loss; and

 

    Average Loss method.

 

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The Paid Development method estimates ultimate losses by reviewing paid loss patterns and applying them to accident years with further expected changes in paid loss. Selection of the paid loss pattern requires analysis of several factors including the impact of inflation on claims costs, the rate at which claims professionals make claim payments and close claims, the impact of judicial decisions, the impact of underwriting changes, the impact of large claim payments and other factors. Claim cost inflation itself requires evaluation of changes in the cost of repairing or replacing property, changes in the cost of medical care, changes in the cost of wage replacement, judicial decisions, legislative changes and other factors. Because this method assumes that losses are paid at a consistent rate, changes in any of these factors can impact the results. Since the method does not rely on case reserves, it is not directly influenced by changes in the adequacy of case reserves.

For many reserve categories, paid loss data for recent periods may be too immature or erratic for accurate predictions. This situation often exists for long-tail exposures. In addition, changes in the factors described above may result in inconsistent payment patterns. Finally, estimating the paid loss pattern subsequent to the most mature point available in the data analyzed often involves considerable uncertainty for long-tail reserve categories.

The Incurred Development method is similar to the Paid Development method, but it uses case incurred losses instead of paid losses. Since this method uses more data (case reserves in addition to paid losses) than the Paid Development method, the incurred development patterns may be less variable than paid development patterns. However, selection of the incurred loss pattern requires analysis of all of the factors listed in the description of the Paid Development method. In addition, the inclusion of case reserves can lead to distortions if changes in case reserving practices have taken place and the use of case incurred losses may not eliminate the issues associated with estimating the incurred loss pattern subsequent to the most mature point available.

The Expected Loss Ratio method multiplies premiums by an expected loss ratio to produce ultimate loss estimates for each accident year. This method may be useful if loss development patterns are inconsistent, losses emerge very slowly, or there is relatively little loss history from which to estimate future losses. The selection of the expected loss ratio requires analysis of loss ratios from earlier accident years or pricing studies and analysis of inflationary trends, frequency trends, rate changes, underwriting changes, and other applicable factors.

The Bornhuetter-Ferguson method using premiums and paid losses is a combination of the Paid Development method and the Expected Loss Ratio method. This method normally determines expected loss ratios similar to the method used for the Expected Loss Ratio method and requires analysis of the same factors described above. The method assumes that only future losses will develop at the expected loss ratio level. The percent of paid loss to ultimate loss implied from the Paid Development method is used to determine what percentage of ultimate loss is yet to be paid. The use of the pattern from the Paid Development method requires consideration of all factors listed in the description of the Paid Development method. The estimate of losses yet to be paid is added to current paid losses to estimate the ultimate loss for each year. This method will react very slowly if actual ultimate loss ratios are different from expectations due to changes not accounted for by the expected loss ratio calculation.

The Bornhuetter-Ferguson method using premiums and incurred losses is similar to the Bornhuetter-Ferguson method using premiums and paid losses except that it uses case incurred losses. The use of case incurred losses instead of paid losses can result in development patterns that are less variable than paid development patterns. However, the inclusion of case reserves can lead to distortions if changes in case reserving practices have taken place. The method requires analysis of all the factors that need to be reviewed for the Expected Loss Ratio and Incurred Development methods.

The Average Loss method multiplies a projected number of ultimate claims by an estimated ultimate average loss for each accident year to produce ultimate loss estimates. Since projections of the ultimate number of claims are often less variable than projections of ultimate loss, this method can provide more reliable results for reserve categories where loss development patterns are inconsistent or too variable to be relied on exclusively. In addition, this method can more directly account for changes in coverage that impact the number and size of claims. However, this method can be difficult to apply to situations where very large claims or a substantial number of unusual claims result in volatile average claim sizes. Projecting the ultimate number of claims requires analysis of several factors including the rate at which policyholders report claims to the Company, the impact of judicial decisions, the impact of underwriting changes and other factors. Estimating the ultimate average loss requires analysis of the impact of large losses and claim cost trends based on changes in the cost of repairing or replacing property, changes in the cost of medical care, changes in the cost of wage replacement, judicial decisions, legislative changes and other factors.

 

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For many exposures, especially those that can be considered long-tail, a particular accident year may not have a sufficient volume of paid losses to produce a statistically reliable estimate of ultimate losses. In such a case, the Company’s actuaries typically assign more weight to the Incurred Development method than to the Paid Development method. As claims continue to settle and the volume of paid losses increases, the actuaries may assign additional weight to the Paid Development method. For most of the Company’s reserve categories, even the incurred losses for accident years that are early in the claim settlement process will not be of sufficient volume to produce a reliable estimate of ultimate losses. In these cases, the Company will not assign any weight to the Paid and Incurred Development methods and will use the Bornhuetter-Ferguson and Expected Loss Ratio methods. For short-tail exposures, the Paid and Incurred Development methods can often be relied on sooner primarily because the Company’s history includes a sufficient number of years to cover the entire period over which paid and incurred losses are expected to change. However, the Company may also use the Expected Loss Ratio, Bornhuetter-Ferguson and Average Loss methods for short-tail exposures.

Generally, reserves for long-tail lines give more weight to the Expected Loss Ratio method in the more recent immature years. As the accident years mature, weight shifts to the Bornhuetter-Ferguson methods and eventually to the Incurred and/or Paid Development method. Claims related to umbrella business are usually reported later than claims for other long-tail lines. For umbrella business, the shift from the Expected Loss Ratio method to the Bornhuetter-Ferguson methods to the Loss Development method may be more protracted than for most long tailed lines. Reserves for short-tail lines tend to make the shift across methods more quickly than the long tail lines.

For other more complex reserve categories where the above methods may not produce reliable indications, the Company uses additional methods tailored to the characteristics of the specific situation. Such reserve categories include losses from construction defects and asbestos and environmental (“A&E”).

For construction defect losses, the Company’s actuaries organize losses by the year in which they were reported to develop an IBNR provision for development on known cases. To estimate losses from claims that have not been reported (pure IBNR), various extrapolation techniques are applied to the pattern of claims that have been reported to estimate the number of claims yet to be reported. This process requires analysis of several factors including the rate at which policyholders report claims to the Company, the impact of judicial decisions, the impact of underwriting changes and other factors. An average claim size is determined from past experience and applied to the number of unreported claims to estimate reserves for these claims.

Establishing reserves for A&E and other mass tort claims involves considerably more judgment than other types of claims due to, among other things, inconsistent court decisions, an increase in bankruptcy filings as a result of asbestos-related liabilities, and judicial interpretations that often expand theories of recovery and broaden the scope of coverage. The insurance industry continues to receive a substantial number of asbestos-related bodily injury claims, with an increasing focus being directed toward other parties, including installers of products containing asbestos rather than against asbestos manufacturers. This shift has resulted in significant insurance coverage litigation implicating applicable coverage defenses or determinations, if any, including but not limited to, determinations as to whether or not an asbestos-related bodily injury claim is subject to aggregate limits of liability found in most comprehensive general liability policies. The Company continues to closely monitor its asbestos exposure and make adjustments where they are warranted.

In 2009, one of the Company’s insurance companies entered into a settlement agreement to resolve asbestos related coverage litigation related to approximately 3,900 existing asbestos-related bodily injury claims and future claims. The settlement was approved by the Court and a final order was issued in September 2014.

In addition, the Company has exposure to other asbestos related matters. In 2013, three claims were reported on an excess policy that was written in 1985. These claims were settled in April, 2014. Management will continue to monitor the developments of the litigation noted above as well as the new claims that have been reported to determine if any additional financial exposure is present.

Reserve analyses performed by the Company’s internal and external actuaries result in actuarial point estimates. The results of the detailed reserve reviews were summarized and discussed with the Company’s senior management to determine the best estimate of reserves. This group considered many factors in making this decision. The factors included, but were not limited to, the historical pattern and volatility of the actuarial indications, the sensitivity of the actuarial indications to changes in paid and incurred loss patterns, the consistency of claims handling processes, the consistency of case reserving practices, changes in the Company’s pricing and underwriting, and overall pricing and underwriting trends in the insurance market.

 

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Management’s best estimate at September 30, 2015 was recorded as the loss reserve. Management’s best estimate is as of a particular point in time and is based upon known facts, the Company’s actuarial analyses, current law, and the Company’s judgment. This resulted in carried gross and net reserves of $729.5 million and $598.6 million, respectively, as of September 30, 2015. A breakout of the Company’s gross and net reserves, excluding the effects of the Company’s intercompany pooling arrangements and intercompany stop loss and quota share reinsurance agreements, as of September 30, 2015 is as follows:

 

     Gross Reserves  
(Dollars in thousands)    Case      IBNR (1)      Total  

Commercial Lines

   $ 145,388       $ 412,056       $ 557,444   

Personal Lines

     47,330         58,817         106,147   

Reinsurance Operations

     18,608         47,310         65,918   
  

 

 

    

 

 

    

 

 

 

Total

   $ 211,326       $ 518,183       $ 729,509   
  

 

 

    

 

 

    

 

 

 

 

     Net Reserves (2)  
(Dollars in thousands)    Case      IBNR (1)      Total  

Commercial Lines

   $ 109,018       $ 330,265       $ 439,283   

Personal Lines

     41,524         52,218         93,742   

Reinsurance Operations

     18,608         46,963         65,571   
  

 

 

    

 

 

    

 

 

 

Total

   $ 169,150       $ 429,446       $ 598,596   
  

 

 

    

 

 

    

 

 

 

 

(1) Losses incurred but not reported, including the expected future emergence of case reserves.
(2) Does not include reinsurance receivable on paid losses.

The Company continually reviews these estimates and, based on new developments and information, includes adjustments of the estimated ultimate liability in the operating results for the periods in which the adjustments are made. The establishment of loss and loss adjustment expense reserves makes no provision for the possible broadening of coverage by legislative action or judicial interpretation, or the emergence of new types of losses not sufficiently represented in the Company’s historical experience or that cannot yet be quantified or estimated. The Company regularly analyzes its reserves and reviews pricing and reserving methodologies so that future adjustments to prior year reserves can be minimized. However, given the complexity of this process, reserves require continual updates and the ultimate liability may be higher or lower than previously indicated. Changes in estimates for loss and loss adjustment expense reserves are recorded in the period that the change in these estimates is made. See Note 7 of the notes to the consolidated financial statements in Item 1 of Part I of this report for details concerning the changes in the estimate for incurred loss and loss adjustment expenses related to prior accident years.

The detailed reserve analyses that the Company’s internal and external actuaries complete use a variety of generally accepted actuarial methods and techniques to produce a number of estimates of ultimate loss. The Company determines its best estimate of ultimate loss by reviewing the various estimates and assigning weight to each estimate given the characteristics of the reserve category being reviewed. The reserve estimate is the difference between the estimated ultimate loss and the losses paid to date. The difference between the estimated ultimate loss and the case incurred loss (paid loss plus case reserve) is considered to be losses incurred but not reported (“IBNR”). IBNR calculated as such includes a provision for development on known cases (supplemental development) as well as a provision for claims that have occurred but have not yet been reported (pure IBNR).

In light of the many uncertainties associated with establishing the estimates and making the assumptions necessary to establish reserve levels, the Company reviews its reserve estimates on a regular basis and makes adjustments in the period that the need for such adjustments is determined. The anticipated future loss emergence continues to be reflective of historical patterns, and the selected development patterns have not changed significantly from those underlying the Company’s most recent analyses.

The key assumptions fundamental to the reserving process are often different for various reserve categories and accident years. Some of these assumptions are explicit assumptions that are required of a particular method, but most of the assumptions are implicit and cannot be precisely quantified. An example of an explicit assumption is the pattern employed in the Paid Development method. However, the assumed pattern is itself based on several implicit assumptions such as the impact of inflation on medical costs and the rate at which claim professionals close claims. Loss frequency is a measure of the number of claims per unit of insured exposure, and loss severity is a measure of the average size of claims. Each reserve segment has an implicit frequency and severity for each accident year as a result of the various assumptions made.

 

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Previous reserve analyses have resulted in the Company’s identification of information and trends that have caused it to increase or decrease frequency and severity assumptions in prior periods and could lead to the identification of a need for additional material changes in loss and loss adjustment expense reserves, which could materially affect results of operations, equity, business and insurer financial strength and debt ratings. Factors affecting loss frequency include, among other things, the effectiveness of loss controls and safety programs and changes in economic activity or weather patterns. Factors affecting loss severity include, among other things, changes in policy limits and deductibles, rate of inflation and judicial interpretations. Another factor affecting estimates of loss frequency and severity is the loss reporting lag, which is the period of time between the occurrence of a loss and the date the loss is reported to the Company. The length of the loss reporting lag affects the Company’s ability to accurately predict loss frequency (loss frequencies are more predictable for short-tail lines) as well as the amount of reserves needed for IBNR.

If the actual levels of loss frequency and severity are higher or lower than expected, the ultimate losses will be different than management’s best estimate. For most of its reserving classes, the Company believes that frequency can be predicted with greater accuracy than severity. Therefore, the Company believes management’s best estimate is more sensitive to changes in severity than frequency. The following table, which the Company believes reflects a reasonable range of variability around its best estimate based on historical loss experience and management’s judgment, reflects the impact of changes (which could be favorable or unfavorable) in frequency and severity on the Company’s current accident year net loss estimate of $244.0 million for claims occurring during the nine months ended September 30, 2015:

 

(Dollars in thousands)     Severity Change  
           -10%     -5%     0%     5%     10%  

Frequency Change

     -5   $ (35,380   $ (23,790   $ (12,200   $ (610   $ 10,980   
     -3     (30,988     (19,154     (7,320     4,514        16,348   
     -2     (28,792     (16,836     (4,880     7,076        19,032   
     -1     (26,596     (14,518     (2,440     9,638        21,716   
     0     (24,400     (12,200     —          12,200        24,400   
     1     (22,204     (9,882     2,440        14,762        27,084   
     2     (20,008     (7,564     4,880        17,324        29,768   
     3     (17,812     (5,246     7,320        19,886        32,452   
     5     (13,420     (610     12,200        25,010        37,820   

The Company’s net reserves for losses and loss expenses of $598.6 million as of September 30, 2015 relate to multiple accident years. Therefore, the impact of changes in frequency and severity for more than one accident year could be higher or lower than the amounts reflected above.

Recoverability of Reinsurance Receivables

The Company regularly reviews the collectability of its reinsurance receivables and includes adjustments resulting from this review in earnings in the period in which the adjustment arises. A.M. Best ratings, financial history, available collateral and payment history with the reinsurers are several of the factors that the Company considers when judging collectability. Changes in loss reserves can also affect the valuation of reinsurance receivables if the change is related to loss reserves that are ceded to reinsurers. Certain amounts may be uncollectible if the Company’s reinsurers dispute a loss or if the reinsurer is unable to pay. If its reinsurers do not pay, the Company remains legally obligated to pay the loss.

Investments

The carrying amount of the Company’s investments approximates their fair value. The Company regularly performs various analytical valuation procedures with respect to investments, including reviewing each fixed maturity security in an unrealized loss position to determine the amount of unrealized loss related to credit loss and the amount related to all other factors, such as changes in interest rates. The credit loss represents the portion of the amortized book value in excess of the net present value of the projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. The credit loss component of the other than temporary impairment is recorded through earnings, whereas the amount relating to factors other than credit losses are recorded in other comprehensive income, net of taxes. During its review, the Company considers credit rating, market price, and issuer specific financial information, among other factors, to assess the likelihood of collection of all principal and interest as contractually due. Securities for which the Company

 

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determines that a credit loss is likely are subjected to further analysis to estimate the credit loss to be recognized in earnings, if any. See Note 3 of the notes to consolidated financial statements in Item 1 of Part I of this report for the specific methodologies and significant assumptions used by asset class. Upon identification of such securities and periodically thereafter, a detailed review is performed to determine whether the decline is considered other than temporary. This review includes an analysis of several factors, including but not limited to, the credit ratings and cash flows of the securities and the magnitude and length of time that the fair value of such securities is below cost.

For an analysis of the Company’s securities with gross unrealized losses as of September 30, 2015 and December 31, 2014, and for other than temporary impairment losses that the Company recorded for the quarters ended September 30, 2015 and 2014, please see Note 3 of the notes to the consolidated financial statements in Item 1 of Part I of this report.

Fair Value Measurements

The Company categorizes its invested assets and derivative instruments that are accounted for at fair value in the consolidated statements into a fair value hierarchy. The fair value hierarchy is directly related to the amount of subjectivity associated with the inputs utilized to determine the fair value of these assets.

The reported value of financial instruments not carried at fair value, principally cash and cash equivalents and margin borrowing facility, approximates fair value.

See Note 5 of the notes to the consolidated financial statements in Item 1 of Part I of this report for further information about the fair value hierarchy and the Company’s assets that are accounted for at fair value.

Goodwill and Intangible Assets

The Company tests for impairment of goodwill at least annually and more frequently as circumstances warrant in accordance with applicable accounting guidance. Accounting guidance allows for the testing of goodwill for impairment using both qualitative and quantitative factors. Impairment of goodwill is recognized only if the carrying amount of the reporting unit, including goodwill, exceeds the fair value of the reporting unit. The amount of the impairment loss would be equal to the excess carrying value of the goodwill over the implied fair value of the reporting unit goodwill.

Impairment of intangible assets with indefinite useful lives is tested at least annually and more frequently as circumstances warrant in accordance with applicable accounting guidance. Accounting guidance allows for the testing of intangible assets for impairment using both qualitative and quantitative factors. Impairment of indefinite lived intangible assets is recognized only if the carrying amount of the intangible assets exceeds the fair value of said assets. The amount of the impairment loss would be equal to the excess carrying value of the assets over the fair value of said assets.

Intangible assets that are not deemed to have an indefinite useful life are amortized over their estimated useful lives. The carrying amounts of definite lived intangible assets are regularly reviewed for indicators of impairment in accordance with applicable accounting guidance. Impairment is recognized only if the carrying amount of the intangible asset is in excess of its undiscounted projected cash flows. The impairment is measured as the difference between the carrying amount and the estimated fair value of the asset.

Deferred Acquisition Costs

The costs of acquiring new and renewal insurance and reinsurance contracts include commissions, premium taxes and certain other costs that vary with and are directly related to the successful acquisition of new and renewal insurance and reinsurance contracts. The excess of the Company’s costs of acquiring new and renewal insurance and reinsurance contracts over the related ceding commissions earned from reinsurers is capitalized as deferred acquisition costs and amortized over the period in which the related premiums are earned.

In accordance with accounting guidance for insurance enterprises, the method followed in computing such amounts limits them to their estimated realizable value that gives effect to the premium to be earned, related investment income, losses and loss adjustment expenses, and certain other costs expected to be incurred as the premium is earned. A premium deficiency charge is recognized if the sum of expected loss and loss adjustment expenses and unamortized acquisition costs exceeds related unearned premium. This evaluation is done at a product line level in Insurance Operations and at a treaty level in

 

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Reinsurance Operations. Any future expected loss on the related unearned premium is recorded first by impairing the unamortized acquisition costs on the related unearned premium followed by an increase to loss and loss adjustment expense reserves on additional expected loss in excess of unamortized acquisition costs. The Company calculates deferred acquisition costs for Insurance Operations separately by product lines and for its Reinsurance Operations separately for each treaty.

Taxation

The Company provides for income taxes in accordance with applicable accounting guidance. The Company’s deferred tax assets and liabilities primarily result from temporary differences between the amounts recorded in the consolidated financial statements and the tax basis of the Company’s assets and liabilities.

At each balance sheet date, management assesses the need to establish a valuation allowance that reduces deferred tax assets when it is more likely than not that all, or some portion, of the deferred tax assets will not be realized. A valuation allowance would be based on all available information including the Company’s assessment of uncertain tax positions and projections of future taxable income from each tax-paying component in each jurisdiction, principally derived from business plans and available tax planning strategies. There are no valuation allowances as of September 30, 2015 or December 31, 2014. The deferred tax asset balance is analyzed regularly by management. This assessment requires significant judgment and considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of carryforward periods, and tax planning strategies and/or actions. Based on these analyses, the Company has determined that its deferred tax asset is recoverable. Projections of future taxable income incorporate several assumptions of future business and operations that are apt to differ from actual experience. If, in the future, the Company’s assumptions and estimates that resulted in the forecast of future taxable income for each tax-paying component prove to be incorrect, a valuation allowance may be required. This could have a material adverse effect on the Company’s financial condition, results of operations, and liquidity.

On an interim basis, the Company generally records its tax provision using the expected full year effective tax rate. Forecasts which compute taxable income and taxes expected to be incurred in the jurisdictions where the Company does business are prepared several times per year. The effective tax rate is computed by dividing forecasted income tax expense not including tax on net realized investment gains (losses) and discrete items by forecasted pre-tax income not including net realized investment gains (losses) and discrete items. Changes in pre-tax and taxable income in the jurisdictions where the Company does business can change the effective tax rate. To compute the Company’s income tax expense on an interim basis, the Company generally applies its expected full year effective tax rate against its pre-tax income excluding net realized investment gains (losses) and discrete items and then adds actual tax on net realized investment gains (losses) and discrete items to that result. However, when there is significant volatility in the expected tax rate, the Company records its actual income tax provision in lieu of the estimated effective income tax rate.

The Company applies a more likely than not recognition threshold for all tax uncertainties, only allowing the recognition of those tax benefits that have a greater than 50% likelihood of being sustained upon examination by the taxing authorities.

Business Segments

The Company manages its business through three business segments: Personal Lines, Commercial Lines, and Reinsurance Operations.

The Company evaluates the performance of these three segments based on gross and net premiums written, revenues in the form of net premiums earned and expenses in the form of net losses and loss adjustment expenses, acquisition costs, and other underwriting expenses.

For a description of the Company’s segments, see Note 14 of the notes to the consolidated financial statements in Item 1 of Part I.

 

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The following table sets forth an analysis of financial data for the Company’s segments during the periods indicated:

 

(Dollars in thousands)    Quarters Ended September 30,      Nine Months Ended September 30,  
     2015      2014      2015      2014  

Personal Lines premium written:

           

Gross premiums written

   $ 87,349       $ —         $ 249,564       $ —     

Ceded premiums written

     24,047         —           52,779         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Net premiums written

   $ 63,302       $ —         $ 196,785       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Commercial Lines premiums written:

           

Gross premiums written

   $ 52,920       $ 56,489       $ 161,746       $ 170,037   

Ceded premiums written

     3,595         3,815         12,099         13,668   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net premiums written

   $ 49,325       $ 52,674       $ 149,647       $ 156,369   
  

 

 

    

 

 

    

 

 

    

 

 

 

Reinsurance Operations premiums written:

           

Gross premiums written

   $ 9,879       $ 10,609       $ 48,222       $ 57,163   

Ceded premiums written

     9         21         48         1,037   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net premiums written

   $ 9,870       $ 10,588       $ 48,174       $ 56,126   
  

 

 

    

 

 

    

 

 

    

 

 

 

Revenues: (1)

           

Personal Lines

   $ 63,320       $ —         $ 193,537       $ —     

Commercial Lines

     49,018         52,626         149,664         159,299   

Reinsurance Operations

     13,648         15,528         40,128         42,739   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

   $ 125,986       $ 68,154       $ 383,329       $ 202,038   
  

 

 

    

 

 

    

 

 

    

 

 

 

Expenses: (2)

           

Personal Lines (3)

   $ 74,678       $ —         $ 204,587       $ —     

Commercial Lines (4)

     43,518         51,365         143,791         163,115