10-Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 ____________________________________
Form 10-Q
(Mark One)
  þ
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              
Commission file number: 001-32938
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
(Exact Name of Registrant as Specified in Its Charter)
Switzerland
98-0681223
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification No.)
Gubelstrasse 24, Park Tower, 15th Floor, 6300 Zug, Switzerland
(Address of Principal Executive Offices and Zip Code)

41-41-768-1080
(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 þ No ¨

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

Large accelerated filer þ
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company ¨
(Do not check if a 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 þ
As of October 12, 2015, 90,911,888 common shares were outstanding.


Table of Contents

TABLE OF CONTENTS
PART I
 
 
 
 
Item 1.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II
 
 
 
 
Item 1.        
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 
 
 
 

-i-

Table of Contents

PART I
FINANCIAL INFORMATION
Item 1.
Financial Statements.
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
as of September 30, 2015 and December 31, 2014
(Expressed in thousands, except share and per share amounts)
 
September 30,
2015
 
December 31,
2014
ASSETS:
 
 
 
Fixed maturity investments trading, at fair value (amortized cost: 2015: $6,555,748; 2014: $6,035,240)
$
6,546,993

 
$
6,069,010

Equity securities trading, at fair value (cost: 2015: $668,061; 2014: $791,206)
663,390

 
844,163

Other invested assets
969,427

 
955,509

Total investments
8,179,810

 
7,868,682

Cash and cash equivalents
603,810

 
589,339

Restricted cash
159,863

 
80,971

Insurance balances receivable
905,401

 
664,815

Funds held
443,670

 
724,021

Prepaid reinsurance
387,269

 
360,732

Reinsurance recoverable
1,449,832

 
1,340,256

Reinsurance recoverable on paid losses
117,110

 
86,075

Accrued investment income
32,673

 
28,456

Net deferred acquisition costs
201,313

 
151,546

Goodwill
354,781

 
278,258

Intangible assets
130,612

 
46,298

Balances receivable on sale of investments
29,461

 
47,149

Net deferred tax assets
27,268

 
33,615

Other assets
174,706

 
121,350

Total assets
$
13,197,579

 
$
12,421,563

LIABILITIES:
 
 
 
Reserve for losses and loss expenses
$
6,436,579

 
$
5,881,165

Unearned premiums
1,835,527

 
1,555,313

Reinsurance balances payable
260,225

 
180,060

Balances due on purchases of investments
108,337

 
5,428

Senior notes
799,043

 
798,802

Other long-term debt
23,328

 
19,213

Dividends payable
23,637

 
21,669

Accounts payable and accrued liabilities
155,498

 
181,622

Total liabilities
$
9,642,174

 
$
8,643,272

SHAREHOLDERS’ EQUITY:
 
 
 
Common shares: 2015 and 2014: par value CHF 4.10 per share (2015: 95,523,230; 2014: 100,775,256 shares issued and 2015: 90,911,888; 2014: 96,195,482 shares outstanding)
$
386,702

 
$
408,020

Treasury shares, at cost (2015: 4,611,342; 2014: 4,579,774)
(156,281
)
 
(143,075
)
Accumulated other comprehensive loss

(4,265
)
 

Retained earnings
3,329,249

 
3,513,346

Total shareholders’ equity
3,555,405

 
3,778,291

Total liabilities and shareholders’ equity
$
13,197,579

 
$
12,421,563

See accompanying notes to the consolidated financial statements.

1

Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
for the three and nine months ended September 30, 2015 and 2014
(Expressed in thousands, except share and per share amounts)
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
REVENUES:
 
 
 
 
 
 
 
Gross premiums written
$
754,062

 
$
707,884

 
$
2,460,646

 
$
2,369,682

Premiums ceded
(147,070
)
 
(139,142
)
 
(477,457
)
 
(475,402
)
Net premiums written
606,992

 
568,742

 
1,983,189

 
1,894,280

Change in unearned premiums
43,661

 
(27,005
)
 
(117,612
)
 
(285,011
)
Net premiums earned
650,653

 
541,737

 
1,865,577

 
1,609,269

Net investment income
45,667

 
43,412

 
132,978

 
127,824

Net realized investment (losses) gains
(113,626
)
 
(35,136
)
 
(88,783
)
 
104,286

Other income
735

 
1,032

 
2,513

 
1,032

Total revenue
583,429

 
551,045

 
1,912,285

 
1,842,411

EXPENSES:
 
 
 
 
 
 
 
Net losses and loss expenses
416,881

 
336,090

 
1,173,578

 
926,231

Acquisition costs
100,101

 
72,403

 
279,418

 
214,404

General and administrative expenses
105,798

 
88,294

 
311,299

 
264,822

Other expense
1,245

 
6,575

 
4,303

 
6,575

Amortization of intangible assets
2,639

 
633

 
6,091

 
1,900

Interest expense
14,469

 
14,325

 
43,272

 
43,451

Foreign exchange (gain) loss
(793
)
 
278

 
10,369

 
978

Total expenses
640,340

 
518,598

 
1,828,330

 
1,458,361

(Loss) income before income taxes
(56,911
)
 
32,447

 
83,955

 
384,050

Income tax (benefit) expense
(5,281
)
 
1,532

 
1,771

 
24,300

NET (LOSS) INCOME
(51,630
)
 
30,915

 
82,184

 
359,750

Other comprehensive loss: foreign currency translation adjustment, net of tax
(993
)
 

 
(4,265
)
 

COMPREHENSIVE (LOSS) INCOME
$
(52,623
)
 
$
30,915

 
$
77,919

 
$
359,750

PER SHARE DATA
 
 
 
 
 
 
 
Basic (loss) earnings per share
$
(0.57
)
 
$
0.32

 
$
0.88

 
$
3.67

Diluted (loss) earnings per share
$
(0.57
)
 
$
0.31

 
$
0.87

 
$
3.60

Weighted average common shares outstanding
90,882,511

 
96,458,231

 
93,068,088

 
97,926,378

Weighted average common shares and common share equivalents outstanding
90,882,511

 
98,444,238

 
94,724,980

 
99,965,296

Dividends paid per share
$
0.26

 
$
0.225

 
$
0.71

 
$
0.559


See accompanying notes to the consolidated financial statements.

2

Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
for the nine months ended September 30, 2015 and 2014
(Expressed in thousands)
 
 
Share
Capital
 
Treasury
Shares
 
Accumulated Other Comprehensive Loss
 
Retained
Earnings
 
Total
December 31, 2014
$
408,020

 
$
(143,075
)
 
$

 
$
3,513,346

 
$
3,778,291

Net income

 

 

 
82,184

 
82,184

Dividends

 

 

 
(68,751
)
 
(68,751
)
Stock compensation

 
18,363

 

 
(5,116
)
 
13,247

Share repurchases

 
(245,301
)
 

 

 
(245,301
)
Shares canceled
(21,318
)
 
213,732

 

 
(192,414
)
 

Foreign currency translation adjustment




(4,265
)


 
(4,265
)
September 30, 2015
$
386,702

 
$
(156,281
)
 
$
(4,265
)
 
$
3,329,249

 
$
3,555,405

 
 
 
 
 
 
 
 
 
 
December 31, 2013
$
418,988

 
$
(79,992
)
 
$

 
$
3,180,830

 
$
3,519,826

Net income

 

 

 
359,750

 
359,750

Dividends

 

 

 
(60,017
)
 
(60,017
)
Stock compensation

 
17,235

 

 
1,333

 
18,568

Share repurchases

 
(164,528
)
 

 

 
(164,528
)
Shares canceled
(10,998
)
 
92,652

 

 
(81,654
)
 

September 30, 2014
$
407,990

 
$
(134,633
)
 
$

 
$
3,400,242

 
$
3,673,599

 
See accompanying notes to the consolidated financial statements.

3

Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
for the nine months ended September 30, 2015 and 2014
(Expressed in thousands)

 
Nine Months Ended 
 September 30,
 
2015
 
2014
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
 
 
 
Net income
$
82,184

 
$
359,750

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
Net realized gains on sales of investments
(41,185
)
 
(118,640
)
Mark to market adjustments
112,421

 
(5,634
)
Stock compensation expense
11,805

 
10,822

Undistributed loss of equity method investments
19,244

 
10,452

Changes in:
 
 
 
Reserve for losses and loss expenses, net of reinsurance recoverables
188,835

 
171,229

Unearned premiums, net of prepaid reinsurance
113,380

 
285,012

Insurance balances receivable
(123,175
)
 
(256,993
)
Funds held
280,351

 
226,727

Reinsurance balances payable
40,354

 
30,405

Reinsurance recoverable on paid losses
(31,035
)
 
(3,634
)
Net deferred acquisition costs
(10,901
)
 
(45,166
)
Net deferred tax assets
(10,141
)
 
(3,511
)
Accounts payable and accrued liabilities
(39,046
)
 
4,473

Other items, net
(1,705
)
 
4,441

Net cash provided by operating activities
591,386

 
669,733

CASH FLOWS USED IN INVESTING ACTIVITIES:
 
 
 
Purchases of trading securities
(3,962,283
)
 
(5,608,594
)
Purchases of other invested assets
(110,851
)
 
(242,227
)
Sales of trading securities
3,888,416

 
5,500,176

Sales of other invested assets
160,253

 
243,123

Purchases of fixed assets
(23,798
)
 
(14,490
)
Change in restricted cash
(78,892
)
 
(29,565
)
Net cash paid for acquisitions
(141,503
)
 
(2,565
)
Net cash used in investing activities
(268,658
)
 
(154,142
)
CASH FLOWS USED IN FINANCING ACTIVITIES:
 
 
 
Dividends paid
(66,784
)
 
(55,064
)
Proceeds from the exercise of stock options
9,184

 
7,640

Share repurchases
(246,443
)
 
(166,207
)
Proceeds from other long-term debt
4,003

 

Repayment of other long-term debt
(154
)
 

Net cash used in financing activities
(300,194
)
 
(213,631
)
Effect of exchange rate changes on foreign currency cash
(8,063
)
 
(2,626
)
NET INCREASE IN CASH AND CASH EQUIVALENTS
14,471

 
299,334

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
589,339

 
531,936

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
603,810

 
$
831,270

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for income taxes
$
2,213

 
$
18,052

Cash paid for interest expense
$
45,750

 
$
45,750

See accompanying notes to the consolidated financial statements.

4

Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)
1. GENERAL

Allied World Assurance Company Holdings, AG, a Swiss holding company (“Allied World Switzerland”), through its wholly-owned subsidiaries (collectively, the “Company”), provides property and casualty insurance and reinsurance on a worldwide basis. References to “$” are to the lawful currency of the United States and to “CHF” are to the lawful currency of Switzerland.

During the fourth quarter of 2014, the Company reorganized how it manages its business, and as a result it realigned its executive management team and changed its reportable segments to correspond to the reorganization. The Company's Bermuda insurance operations, except for the trade credit line of business, which had previously been included in the international insurance segment, was combined with the U.S. insurance segment, with the new segment renamed the “North American Insurance” segment. The remaining direct insurance operations of the international insurance segment were renamed the “Global Markets Insurance” segment. The Reinsurance segment remained unchanged. The newly created segments are included in Note 12 and prior periods have been recast to conform to the new presentation.


2. BASIS OF PREPARATION AND CONSOLIDATION

These unaudited condensed consolidated financial statements include the accounts of the Company and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with Article 10 of Regulation S-X as promulgated by the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments that are normal and recurring in nature and necessary for a fair presentation of financial position and results of operations as of the end of and for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for a full year.

The preparation of financial statements in conformity with U.S. 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The significant estimates reflected in the Company’s financial statements, include, but are not limited to:

The premium estimates for certain reinsurance agreements,
Recoverability of deferred acquisition costs,
The reserve for outstanding losses and loss expenses,
Valuation of ceded reinsurance recoverables,
Determination of impairment of goodwill and other intangible assets, and
Valuation of financial instruments.

Intercompany accounts and transactions have been eliminated on consolidation and all entities meeting consolidation requirements have been included in the unaudited condensed consolidated financial statements.

These unaudited condensed consolidated financial statements, including these notes, should be read in conjunction with the Company’s audited consolidated financial statements, and related notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.
3. NEW ACCOUNTING PRONOUNCEMENTS
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2014-09, “Revenue from Contracts with Customers" (“ASU 2014-09”). ASU 2014-09 provides a framework, through a five-step process, for recognizing revenue from customers, improves comparability and consistency of recognizing revenue across entities, industries, jurisdictions and capital markets, and requires enhanced disclosures. Certain contracts with customers are specifically excluded from the scope of ASU 2014-09, including, among others, insurance contracts accounted for under

5

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


Accounting Standard Codification 944, Financial Services - Insurance. With the issuance of ASU 2015-14, this standard will be effective on January 1, 2018 with retrospective adoption required for the comparative periods. The Company is currently assessing the impact the adoption of ASU 2014-09 will have on future financial statements and related disclosures.
In February 2015, the FASB issued Accounting Standards Update 2015-02, “Amendments to the Consolidation Analysis” (“ASU 2015-02”). ASU 2015-02 amends certain aspects of the consolidation guidance in U.S. GAAP. In particular, it will modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (“VIEs”) or voting interest entities and also eliminates the presumption that a general partner should consolidate a limited partnership, if certain conditions are met. The new guidance will also affect the consolidation analysis of the Company's interests in VIEs, particularly those that have fee arrangements and related party relationships. ASU 2015-02 is effective on January 1, 2016 and adoption is required retrospectively either through a modified retrospective approach by recording a cumulative-effect adjustment to shareholders' equity as of the beginning of the year of adoption or retrospectively for all comparative periods. The Company has determined that the adoption of ASU 2015-02 will result in several of its limited partnership interests meeting the criteria of being considered VIEs. None of the limited partnership interests that will be considered VIE's will be consolidated as the Company is not considered the primary beneficiary. As a result, the Company does not expect any financial statement impact due to the adoption of ASU 2015-02 other than additional disclosures related to the Company's interests in VIEs.
In May 2015, the FASB issued Accounting Standards Update 2015-07, “Fair Value Measurements (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)” (“ASU 2015-07”). ASU 2015-07 removes the requirement to categorize within the fair value hierarchy investments for which fair value is measured using the net asset value per share practical expedient. The Company has applied the net asset value per share practical expedient to all of its private equity and hedge funds in determining fair value. The Company early adopted ASU 2015-07 during the quarter ended June 30, 2015, and as a result removed the fair value category for its investments that are measured using the net asset value per share practical expedient that is disclosed in Note 7.
In May 2015, the FASB issued Accounting Standards Update 2015-09, “Financial Services - Insurance (Topic 944): Disclosures about Short-Duration Contracts” (“ASU 2015-09”). ASU 2015-09 provides enhanced disclosures, on an annual basis, related to the reserve for losses and loss expenses. The enhanced disclosures required by ASU 2015-09 include (1) net incurred and paid claims development information by accident year, (2) a reconciliation of incurred and paid claims development information to the aggregate carrying amount of the reserve for losses and loss expenses, (3) for each accident year presented of incurred claims development information, the total of reserves for incurred but not reported (IBNR), including expected development on reported claims, included in the reserve for losses and loss expenses and a description of the reserving methodologies and changes to the reserving methodologies, and (4) for each accident year presented of incurred claims development information, quantitative information about claims frequency, as well as a description of methodologies used for determining claim frequency information. ASU 2015-09 is effective for annual periods beginning after December 15, 2015, and as such the disclosures will first be presented in the Company's Annual Report on Form 10-K for the year ended December 31, 2016. The Company is currently assessing the impact the adoption of ASU 2015-09 will have on future disclosures.
In September 2015, the FASB issued Accounting Standards Update 2015-16, “Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments” (“ASU 2015-16”). ASU 2015-16 requires an acquirer in a business combination to recognize adjustments to the provisional amounts identified during the measurement period in the reporting period in which the adjustment amounts are determined. The acquirer is also required to either present separately on the face of the income statement or disclose in the notes to the financial statements the portion of the amounts recorded in the current-period earnings by line item that would have been recorded in previous periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. Under current U.S. GAAP, the acquirer is required to retrospectively adjust provisional amounts recognized at the acquisition date with a corresponding adjustment to goodwill. ASU 2015-16 is effective for annual periods beginning after December 31, 2015, with early application permitted, and shall apply to adjustments to provisional amounts that occur after the effective date. The Company is currently assessing the impact the adoption of ASU 2014-09 will have on future financial statements and related disclosures.



6

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


4. ACQUISITIONS

a) Hong Kong and Singapore Branches of Royal & Sun Alliance Insurance plc

On April 1, 2015, the Company completed its acquisitions of certain assets and assumed certain liabilities of the Hong Kong and Singapore operations of Royal & Sun Alliance Insurance plc (“RSA”) to further expand its international insurance operations. The assets acquired and liabilities assumed constituted a business, and as such the Company accounted for the acquisitions of the RSA branches under the acquisition method in accordance with U.S. GAAP. The initial cash consideration for the branches was $193,889. There were post-closing adjustments based on the net asset value of the acquired branches at the date of acquisitions that resulted in a decrease in the initial consideration of $31,160. The post-closing adjustments are still being agreed upon with RSA and as such the assets acquired and liabilities assumed are still preliminary and will be adjusted during the measurement period. In addition, completion of the valuation of the assets acquired and liabilities assumed is currently in process and will be finalized during the measurement period. To date, the Company has incurred a total of $8,948 in acquisition related expenses, mostly related to advisory, legal and valuation services rendered, which were recorded in “other expense” in the unaudited condensed consolidated statements of operations and comprehensive income (“consolidated income statements”).

The following table summarizes the consideration paid for the Hong Kong and Singapore branches of RSA and the preliminary amounts of the assets acquired and liabilities assumed at the acquisition date.
Consideration:
 
Fair Value
Cash for initial consideration
 
$
193,889

Receivable for post-closing adjustments
 
(31,160
)
Fair value of consideration transferred
 
162,729

 
 
 
Recognized amounts of identifiable assets acquired and liabilities assumed:
 
 
Fixed maturity investments
 
245,997

Cash and cash equivalents
 
46,853

Insurance balances receivable
 
113,922

Prepaid reinsurance
 
17,491

Reinsurance recoverable
 
57,350

Value of business acquired

37,104

Intangible assets
 
90,600

Other assets
 
10,041

Reserve for losses and loss expenses
 
(310,198
)
Unearned premiums
 
(150,530
)
Reinsurance balances payable
 
(35,734
)
Net deferred tax liabilities
 
(16,488
)
Accounts payable and accrued liabilities
 
(19,918
)
Total identifiable net assets acquired
 
86,490

 
 
 
Goodwill
 
76,239

Total net assets acquired
 
$
162,729

Of the $76,239 of goodwill acquired, $52,427 and $23,812 related to the Singapore and Hong Kong branches, respectively. All of the goodwill has been allocated to the Global Markets Insurance segment as all of the results of the international insurance operations are included in that segment and the expected synergies from these acquisitions are to be realized in that segment.
The Company recognized identifiable finite lived intangible assets, including an intangible asset for the value of businesses acquired (“VOBA”), which will be amortized over a weighted average period of 12 years. The following is a breakdown of the

7

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


intangible assets acquired.
 
 
Singapore
 Branch
 
Estimated Useful Life
 
Hong Kong Branch
 
Estimated Useful Life
 
Total
VOBA
 
$
19,845

 
2 years
 
$
17,259

 
1.5 years
 
$
37,104

Customer renewals
 
8,600

 
4 years
 
6,800

 
7 years
 
15,400

Distribution channels
 
48,500

 
18 years
 
26,700

 
18 years
 
75,200

 
 
$
76,945

 
 
 
$
50,759

 
 
 
$
127,704

The following is an explanation of identifiable finite lived intangible assets acquired:
VOBA: Represents the difference between the expected future losses and expenses and the associated unearned premium reserve. This intangible asset will be amortized consistent with how the associated unearned premiums will be earned and will be recorded in “acquisition costs” in the consolidated income statements.
Customer renewals: The value of inforce policies renewing taking into consideration the net cash flows generated from these renewals. The amortization expense for this intangible asset will be recorded in “amortization of intangible assets” in the consolidated income statements.
Distribution channels: The value of access to contractual and non-contractual relationships (e.g., brokers and affinity relationships) taking into consideration the net cash flows generated from these relationships. The amortization expense for this intangible asset will be recorded in “amortization of intangible assets” in the consolidated income statements.

The following summarizes the results of the Hong Kong and Singapore branches that have been included in the Company’s consolidated income statement since the acquisitions closed on April 1, 2015.
 
 
From April 1, 2015 to September 30, 2015
Total revenue
 
$
103,265

Net loss
 
$
(14,788
)
The following unaudited pro forma information presents the combined results of the Company and the acquired Hong Kong and Singapore RSA branches for the nine months ended September 30, 2015 and 2014, with pro forma adjustments related to the acquisition method of accounting as if the acquisitions had been consummated as of January 1, 2014, which is the beginning of the earliest period presented. This unaudited pro forma information is not necessarily indicative of what would have occurred had the acquisitions and related transactions been made on the dates indicated, or of future results of the Company.
 
 
Nine Months Ended September 30, 2015
 
Nine Months Ended September 30, 2014
Total revenue
 
$
1,960,185

 
$
2,010,308

Net income
 
$
70,633

 
$
362,143

b) Acquisition of Labuan branch of RSA

On April 30, 2015, the Company also acquired the assets and assumed the liabilities of the Labuan operations of RSA for consideration of one British pound sterling. The Company recorded goodwill of $1,396 related to this acquisition. The goodwill has been allocated to the Global Markets Insurance segment.
c) Acquisition of Latin American Underwriters Holdings, Ltd.
In January 2015, the Company acquired Latin American Underwriters Holdings Ltd. (“LAU”) for cash consideration of $5,105. LAU had previously underwritten trade credit insurance and political risk coverages solely for the Company since 2010. As part of the acquisition, the Company recorded goodwill of $2,467 and customer relationship intangibles of $3,610, which have a five-year useful life. The goodwill has been allocated to the Global Markets Insurance segment. The Company also recorded $1,000 of contingent consideration related to certain earn-out payments. During the three months ended

8

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


September 30, 2015, it was determined that LAU will not achieve any of the earn-out payments. As a result, the Company reduced the fair value of the contingent consideration to zero with the corresponding gain recorded as a reduction in “general and administrative expenses” in the consolidated income statements.
5. INVESTMENTS

a) Trading Securities

Securities accounted for at fair value with changes in fair value recognized in the consolidated income statements by category are as follows:
 
September 30, 2015
 
December 31, 2014
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
U.S. government and government agencies
$
1,287,749

 
$
1,283,085

 
$
1,610,502

 
$
1,610,880

Non-U.S. government and government agencies
427,096

 
449,572

 
188,199

 
196,332

States, municipalities and political subdivisions
422,007

 
410,052

 
170,567

 
165,615

Corporate debt:
 
 
 
 
 
 
 
Financial institutions
1,052,636

 
1,049,451

 
1,024,667

 
1,018,777

Industrials
1,256,975

 
1,276,413

 
1,029,729

 
1,037,820

Utilities
118,167

 
120,856

 
110,997

 
111,599

Mortgage-backed
1,302,678

 
1,273,349

 
1,263,517

 
1,219,712

Asset-backed
679,685

 
692,970

 
670,832

 
674,505

Total fixed maturity investments
$
6,546,993

 
$
6,555,748

 
$
6,069,010

 
$
6,035,240

 
September 30, 2015
 
December 31, 2014
 
Fair Value
 
Original Cost
 
Fair Value
 
Original Cost
Equity securities
$
663,390

 
$
668,061

 
$
844,163

 
$
791,206

Other invested assets
845,167

 
762,792

 
812,543

 
725,069

 
$
1,508,557

 
$
1,430,853

 
$
1,656,706

 
$
1,516,275


Other invested assets, included in the table above, include investments in private equity funds, hedge funds and a high yield loan fund that are accounted for at fair value, but excludes other private securities described below in Note 5(b) that are accounted for using the equity method of accounting.


9

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


b) Other Invested Assets

Details regarding the carrying value, redemption characteristics and unfunded investment commitments of the other invested assets portfolio as of September 30, 2015 and December 31, 2014 were as follows:

Investment Type
Carrying Value as of September 30, 2015
 
Investments
with
Redemption
Restrictions
 
Estimated
Remaining
Restriction
Period
 
Investments
without
Redemption
Restrictions
 
Redemption
Frequency
(1)
 
Redemption
Notice
Period
(1)
 
Unfunded
Commitments
Private equity
$
221,862

 
$
221,862

 
2 - 8 Years
 
$

 
 
 
 
 
$
251,874

Mezzanine debt
194,512

 
194,512

 
5 - 9 Years
 

 
 
 
 
 
166,476

Distressed
5,845

 
5,845

 
3 Years
 

 
 
 
 
 
5,591

Real estate

 

 
9 Years
 

 
 
 
 
 
200,000

Total private equity
422,219

 
422,219

 
 
 

 
 
 
 
 
623,941

Distressed
216,993

 
47,775

 
2 Years
 
169,218

 
Monthly
 
60 Days
 

Equity long/short
58,655

 

 

 
58,655

 
Quarterly
 
45 Days
 

Relative value credit
119,100

 

 
 
 
119,100

 
Quarterly
 
60 Days
 

Total hedge funds
394,748

 
47,775

 
 
 
346,973

 
 
 
 
 

High yield loan fund
28,200

 

 
 
 
28,200

 
Monthly
 
30 Days
 

Total other invested assets at fair value
845,167

 
469,994

 
 
 
375,173

 
 
 
 
 
623,941

Other private securities
124,260

 

 
 
 
124,260

 
 
 
 
 

Total other invested assets
$
969,427

 
$
469,994

 
 
 
$
499,433

 
 
 
 
 
$
623,941

Investment Type
Carrying Value as of December 31, 2014
 
Investments
with
Redemption
Restrictions
 
Estimated
Remaining
Restriction
Period
 
Investments
without
Redemption
Restrictions
 
Redemption
Frequency
(1)
 
Redemption
Notice
Period
(1)
 
Unfunded
Commitments
Private equity
$
184,576

 
$
184,576

 
2 - 8 Years
 
$

 
 
 
 
 
$
223,802

Mezzanine debt
166,905

 
166,905

 
5 - 9 Years
 

 
 
 
 
 
204,232

Distressed
5,869

 
5,869

 
3 Years
 

 
 
 
 
 
5,180

Real estate

 

 
9 Years
 

 
 
 
 
 
50,000

Total private equity
357,350

 
357,350

 
 
 

 
 
 
 
 
483,214

Distressed
170,169

 
170,169

 

 

 
Based on net asset value
 
60 Days
 

Equity long/short
84,198

 

 
 
 
84,198

 
Quarterly
 
30 - 60 Days
 

Multi-strategy
51,507

 

 
 
 
51,507

 
Quarterly
 
45 - 90 Days
 

Relative value credit
119,156

 

 
 
 
119,156

 
Quarterly
 
60 Days
 

Total hedge funds
425,030

 
170,169

 
 
 
254,861

 
 
 
 
 

High yield loan fund
30,163

 

 
 
 
30,163

 
Monthly
 
30 Days
 

Total other invested assets at fair value
812,543

 
527,519

 
 
 
285,024

 
 
 
 
 
483,214

Other private securities
142,966

 

 
 
 
142,966

 
 
 
 
 

Total other invested assets
$
955,509

 
$
527,519

 
 
 
$
427,990

 
 
 
 
 
$
483,214

(1) 
The redemption frequency and notice periods only apply to the investments without redemption restrictions. Some or all of these investments may be subject to a gate as described below.

In general, the Company has invested in hedge funds that require at least 30 days’ notice of redemption and may be redeemed on a monthly, quarterly, semi-annual, annual or longer basis, depending on the fund. Certain hedge funds have lock-up periods ranging from one to three years from initial investment. A lock-up period refers to the initial amount of time an

10

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


investor is contractually required to invest before having the ability to redeem. Funds that provide for periodic redemptions may, depending on the funds’ governing documents, have the ability to deny or delay a redemption request, called a “gate.” The fund may implement this restriction because the aggregate amount of redemption requests as of a particular date exceeds a specified level, generally ranging from 15% to 25% of the fund’s net assets. The gate is a method for executing an orderly redemption process to reduce the possibility of adversely affecting investors in the fund. Typically, the imposition of a gate delays a portion of the requested redemption, with the remaining portion settled in cash sometime after the redemption date. Certain funds may impose a redemption fee on early redemptions. Interests in private equity funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

The following describes each investment type:

Private equity funds: Primary funds may invest in companies and general partnership interests. Secondary funds buy limited partnership interests from existing limited partners of primary private equity funds. As owners of private equity funds seek liquidity, they can sell their existing investments, plus any remaining commitment, to secondary market participants. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.
Mezzanine debt funds: Mezzanine debt funds primarily focus on providing capital to upper middle market and middle market companies and private equity sponsors, in connection with leveraged buyouts, mergers and acquisitions, recapitalizations, growth financings and other corporate transactions. The most common position in the capital structure will be between the senior secured debt holder and the equity; however, the funds will utilize a flexible approach when structuring investments, which may include secured debt, subordinated debt, preferred stock and/or private equity. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.
Distressed funds: In distressed debt investing, managers take positions in the debt of companies experiencing significant financial difficulties, including bankruptcy, or in certain positions of the capital structure of structured securities. The manager relies on the fundamental analysis of these securities, including the claims on the assets and the likely return to bondholders. Certain funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.
Real estate funds: Private real estate funds invest directly in, and lend to commercial real estate (multifamily units, industrial buildings, office spaces and retail stores) and some residential property.  Real estate managers have diversified portfolios that generally follow core, core-plus, value-added, opportunistic or real estate debt strategies.  These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.
Equity long/short funds: In equity long/short funds, managers take long positions in companies they deem to be undervalued and short positions in companies they deem to be overvalued. Long/short managers may invest in countries, regions or sectors and vary by their use of leverage and by their targeted net long position.
Relative value credit funds: These funds seek to take exposure to credit-sensitive securities, long and/or short, based upon credit analysis of issuers and securities and credit market views.
Multi-strategy funds: These funds may utilize many strategies employed by specialized funds, including distressed investing, equity long/short, merger arbitrage, convertible arbitrage, fixed income arbitrage and macro trading.
High yield loan fund: A long-only private mutual fund that invests in high yield fixed income securities.
Other private securities: These securities include strategic non-controlling minority investments in private asset management companies and other insurance related investments that are accounted for using the equity method of accounting.











11

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


c) Net Investment Income
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Fixed maturity investments
$
42,801

 
$
38,762

 
$
120,264

 
$
110,998

Equity securities
3,115

 
3,711

 
11,540

 
12,876

Other invested assets: hedge funds and private equity
3,342

 
2,249

 
16,305

 
8,767

Other invested assets: other private securities
1,804

 
3,292

 
(1,119
)
 
7,291

Cash and cash equivalents
277

 
552

 
1,178

 
1,562

Expenses
(5,672
)
 
(5,154
)
 
(15,190
)
 
(13,670
)
Net investment income
$
45,667

 
$
43,412

 
$
132,978

 
$
127,824


The loss from other invested assets: other private securities for the nine months ended September 30, 2015 included an other-than-temporary impairment of $6,261 related to one of the Company's equity method investments. The Company recorded the other-than-temporary impairment as the fair value of this investment was below its carrying value.

d) Components of Realized Gains and Losses

 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Gross realized gains on sale of invested assets
$
18,694

 
$
28,773

 
$
100,060

 
$
146,780

Gross realized losses on sale of invested assets
(34,735
)
 
(9,955
)
 
(57,798
)
 
(26,228
)
Net realized and unrealized (losses) gains on derivatives
(19,905
)
 
2,171

 
(17,616
)
 
(24,469
)
Mark-to-market (losses) gains:
 
 
 
 
 
 
 
Fixed maturity investments, trading
(15,270
)
 
(40,843
)
 
(42,441
)
 
18,039

Equity securities, trading
(62,853
)
 
(8,479
)
 
(57,761
)
 
(8,768
)
Other invested assets, trading
443

 
(6,803
)
 
(13,227
)
 
(1,068
)
Net realized investment (losses) gains
$
(113,626
)
 
$
(35,136
)
 
$
(88,783
)
 
$
104,286


e) Pledged Assets

As of September 30, 2015 and December 31, 2014, $2,975,115 and $3,585,792, respectively, of cash and cash equivalents and investments were deposited, pledged or held in trust accounts in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions, insurance laws and other contract provisions.

In addition, as of September 30, 2015 and December 31, 2014, a further $570,363 and $571,750, respectively, of cash and cash equivalents and investments were pledged as collateral for the Company’s letter of credit facilities. See Note 10(f) to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 for details on the Company’s credit facilities.



12

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


6. DERIVATIVE INSTRUMENTS

As of September 30, 2015 and December 31, 2014, none of the Company’s derivatives were designated as hedges for accounting purposes. The following table summarizes information on the location and amounts of derivative fair values on the unaudited condensed consolidated balance sheets (“consolidated balance sheets”):
 
 
September 30, 2015
 
December 31, 2014
 
Asset
Derivative 
Notional
Amount
 
Asset
Derivative 
Fair Value 
 
Liability
Derivative 
Notional
Amount
 
Liability
Derivative 
Fair Value
 
Asset
Derivative 
Notional
Amount
 
Asset
Derivative 
Fair Value
 
Liability
Derivative 
Notional
Amount
 
Liability
Derivative
Fair Value 
Foreign exchange contracts
$
4,331

 
$
28

 
$
890

 
$
9

 
$
33,875

 
$
1,274

 
$
167,376

 
$
991

Interest rate swaps
547,000

 
330

 

 

 

 

 
571,500

 
683

Total derivatives
$
551,331

 
$
358

 
$
890

 
$
9

 
$
33,875

 
$
1,274

 
$
738,876

 
$
1,674


Derivative assets and derivative liabilities are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

The following table provides the net realized and unrealized gains (losses) on derivatives not designated as hedges recorded on the consolidated income statements:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Foreign exchange contracts
$
183

 
$
1,886

 
$
(5,975
)
 
$
(580
)
Total included in foreign exchange loss
183

 
1,886

 
(5,975
)
 
(580
)
Foreign exchange contracts
134

 
1,701

 
928

 
857

Interest rate futures and swaps
(20,039
)
 
470

 
(18,544
)
 
(25,326
)
Total included in net realized investment gains (losses)
(19,905
)
 
2,171

 
(17,616
)
 
(24,469
)
Total realized and unrealized gains (losses) on derivatives
$
(19,722
)
 
$
4,057

 
$
(23,591
)
 
$
(25,049
)

Derivative Instruments Not Designated as Hedging Instruments

The Company is exposed to foreign currency risk in its investment portfolio. Accordingly, the fair values of the Company’s investment portfolio are partially influenced by the change in foreign exchange rates. These foreign currency hedging activities have not been designated as specific hedges for financial reporting purposes.

The Company’s insurance and reinsurance subsidiaries and branches operate in various foreign countries and consequently the Company’s underwriting portfolio is exposed to foreign currency risk. The Company manages foreign currency risk by seeking to match liabilities under the insurance policies and reinsurance contracts that it writes and that are payable in foreign currencies with cash and investments that are denominated in such currencies. When necessary, the Company may also use derivatives to economically hedge un-matched foreign currency exposures, specifically forward contracts and currency options.

The Company also purchases and sells interest rate future and interest rate swap contracts to actively manage the duration and yield curve positioning of its fixed income portfolio. Interest rate futures and interest rate swaps can efficiently increase or decrease the overall duration of the portfolio. Additionally, interest rate future and interest rate swap contracts can be utilized to obtain the desired position along the yield curve in order to protect against certain future yield curve shapes.

The Company also purchases options to actively manage its equity portfolio.

7. FAIR VALUE OF FINANCIAL INSTRUMENTS

In accordance with U.S. GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. There is a three-level valuation

13

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement date, with quoted market prices being the highest level (Level 1) and unobservable inputs being the lowest level (Level 3). A fair value measurement will fall within the level of the hierarchy based on the input that is significant to determining such measurement. The three levels are defined as follows:
 
Level 1: Observable inputs to the valuation methodology that are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2: Observable inputs to the valuation methodology other than quoted market prices (unadjusted) for identical assets or liabilities in active markets. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical assets in markets that are not active and inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
Level 3: Inputs to the valuation methodology that are unobservable for the asset or liability.

The following table shows the fair value of the Company’s financial instruments and where in the fair value hierarchy the fair value measurements are included as of the dates indicated below:
September 30, 2015
 
Carrying
Amount
 
Total
Fair Value
 
Level 1
 
Level 2
 
Level 3
ASSETS:
 
 
 
 
 
 
 
 
 
 
Fixed maturity investments:
 
 
 
 
 
 
 
 
 
 
U.S. government and government agencies
 
$
1,287,748

 
$
1,287,748

 
$
1,225,745

 
$
62,003

 
$

Non-U.S. government and government agencies
 
427,096

 
427,096

 

 
427,096

 

States, municipalities and political subdivisions
 
422,007

 
422,007

 

 
422,007

 

Corporate debt
 
2,427,779

 
2,427,779

 

 
2,427,779

 

Mortgage-backed
 
1,302,678

 
1,302,678

 

 
1,199,013

 
103,665

Asset-backed
 
679,685

 
679,685

 

 
622,131

 
57,554

Total fixed maturity investments
 
6,546,993

 
6,546,993

 
1,225,745

 
5,160,029

 
161,219

Equity securities
 
663,390

 
663,390

 
636,576

 

 
26,814

Other invested assets (1)
 
845,167

 
845,167

 

 

 

Total investments
 
$
8,055,550

 
$
8,055,550

 
$
1,862,321

 
$
5,160,029

 
$
188,033

Derivative assets:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
28

 
$
28

 
$

 
$
28

 
$

Interest rate swaps
 
330

 
330

 

 
330

 

LIABILITIES:
 
 
 
 
 
 
 
 
 
 
Derivative liabilities:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
9

 
$
9

 
$

 
$
9

 
$

Senior notes
 
$
799,043

 
$
859,307

 
$

 
$
859,307

 
$

Other long-term debt
 
$
23,328

 
$
28,112

 
$

 
$
28,112

 
$


14

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


December 31, 2014
 
Carrying
Amount
 
Total
Fair Value
 
Level 1
 
Level 2
 
Level 3
ASSETS:
 
 
 
 
 
 
 
 
 
 
Fixed maturity investments:
 
 
 
 
 
 
 
 
 
 
U.S. government and government agencies
 
$
1,610,502

 
$
1,610,502

 
$
1,499,347

 
$
111,155

 
$

Non-U.S. government and government agencies
 
188,199

 
188,199

 

 
188,199

 

States, municipalities and political subdivisions
 
170,567

 
170,567

 

 
170,567

 

Corporate debt
 
2,165,393

 
2,165,393

 

 
2,165,393

 

Mortgage-backed
 
1,263,517

 
1,263,517

 

 
1,081,734

 
181,783

Asset-backed
 
670,832

 
670,832

 

 
615,419

 
55,413

Total fixed maturity investments
 
6,069,010

 
6,069,010

 
1,499,347

 
4,332,467

 
237,196

Equity securities
 
844,163

 
844,163

 
800,833

 

 
43,330

Other invested assets (1)
 
812,543

 
812,543

 

 

 

Total investments
 
$
7,725,716

 
$
7,725,716

 
$
2,300,180

 
$
4,332,467

 
$
280,526

Derivative assets:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
1,274

 
$
1,274

 
$

 
$
1,274

 
$

LIABILITIES:
 
 
 
 
 
 
 
 
 
 
Derivative liabilities:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
991

 
$
991

 
$

 
$
991

 
$

Interest rate swaps
 
$
683

 
$
683

 
$

 
$
683

 
$

Senior notes
 
$
798,802

 
$
879,317

 
$

 
$
879,317

 
$

Other long-term debt
 
$
19,213

 
$
22,583

 
$

 
$
22,583

 
$


(1) In accordance with U.S. GAAP, other invested assets, excluding other private securities, are measured at fair value using the net asset value per share (or its equivalent) practical expedient and have not been classified in the fair value hierarchy.

The following describes the valuation techniques used by the Company to determine the fair value of financial instruments held as of the balance sheet date.

Recurring Fair Value of Financial Instruments

U.S. government and government agencies: Comprised primarily of bonds issued by the U.S. Treasury, the Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association. The fair values of the Company’s U.S. government securities are based on quoted market prices in active markets and are included in the Level 1 fair value hierarchy. The Company believes the market for U.S. Treasury securities is an actively traded market given the high level of daily trading volume. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are included in the Level 2 fair value hierarchy.

Non-U.S. government and government agencies: Comprised of fixed income obligations of non-U.S. governmental entities. The fair values of these securities are based on prices obtained from international indices and are included in the Level 2 fair value hierarchy.

States, municipalities and political subdivisions: Comprised of fixed income obligations of U.S.-domiciled state and municipality entities. The fair values of these securities are based on prices obtained from the new issue market, and are included in the Level 2 fair value hierarchy.

Corporate debt: Comprised of bonds issued by or loan obligations of corporations that are diversified across a wide range of issuers and industries. The fair values of corporate debt that are short-term are priced using spread above the LIBOR yield curve, and the fair values of corporate debt that are long-term are priced using the spread above the risk-free yield curve. The

15

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price corporate bonds are observable market inputs, the fair values of corporate debt are included in the Level 2 fair value hierarchy.

Mortgage-backed: Primarily comprised of residential and commercial mortgages originated by both U.S. government agencies (such as the Federal National Mortgage Association) and non-U.S. government agencies. The fair values of mortgage-backed securities originated by U.S. government agencies and non-U.S. government agencies are based on a pricing model that incorporates prepayment speeds and spreads to determine the appropriate average life of mortgage-backed securities. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the mortgage-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the mortgage-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

Asset-backed: Principally comprised of bonds backed by pools of automobile loan receivables, home equity loans, credit card receivables and collateralized loan obligations originated by a variety of financial institutions. The fair values of asset-backed securities are priced using prepayment speed and spread inputs that are sourced from the new issue market or broker-dealer quotes. As the significant inputs used to price the asset-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the asset-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

Equity securities: Comprised of common and preferred stocks and mutual funds. Equities are generally included in the Level 1 fair value hierarchy as prices are obtained from market exchanges in active markets. Non-U.S. mutual funds where the net asset value is not provided on a daily basis are included in the Level 3 fair value hierarchy.

Other invested assets: Comprised of funds invested in a range of diversified strategies. In accordance with U.S. GAAP, the fair values of the funds are based on the net asset value of the funds as reported by the fund manager.

Derivative instruments: The fair value of foreign exchange contracts, interest rate futures and interest rate swaps are priced from quoted market prices for similar exchange-traded derivatives and pricing valuation models that utilize independent market data inputs. The fair value of derivatives are included in the Level 2 fair value hierarchy.

Senior notes: The fair value of the senior notes is based on reported trades. The fair value of the senior notes is included in the Level 2 fair value hierarchy.

Other long-term debt: Comprised of the mortgage and credit facility associated with the purchase of office space in Switzerland. The fair value of the other long-term debt is based on the value of the debt using current interest rates. The fair value of the other long-term debt is included in the Level 2 fair value hierarchy.

Non-recurring Fair Value of Financial Instruments

The Company measures the fair value of certain assets on a non-recurring basis, generally quarterly, annually or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. These assets include investments accounted for using the equity method, goodwill and intangible assets. The Company uses a variety of techniques to measure the fair value of these assets when appropriate, as described below:

Investments accounted for using the equity method: When the Company determines that the carrying value of these assets may not be recoverable, the Company records the assets at fair value with the loss recognized in income. In such cases, the Company measures the fair value of these assets using discounted expected future cash flow and market multiple models.

Goodwill and intangible assets: The Company tests goodwill and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable, but at least annually for goodwill and indefinite-lived intangibles. If the Company determines that goodwill and intangible assets may be impaired, the Company uses techniques, including discounted expected future cash flows and market multiple models, to measure fair value.

 

16

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


Rollforward of Level 3 Financial Instruments

The following is a reconciliation of the beginning and ending balance of financial instruments using significant unobservable inputs (Level 3):
Three Months Ended September 30, 2015
Mortgage-backed
 
Asset-backed
 
Equities
Opening balance
$
99,637

 
$
83,908

 
$
57,807

Realized and unrealized gains (losses) included in net (loss) income
808

 
(2,547
)
 
(10,993
)
Purchases
9,666

 
122

 

Sales
(9,390
)
 
(7,892
)
 
(20,000
)
Transfers into Level 3 from Level 2
3,126

 
627

 

Transfers out of Level 3 into Level 2 (1)
(182
)
 
(16,664
)
 

Ending balance
$
103,665

 
$
57,554

 
$
26,814

Three Months Ended September 30, 2014
 
 
 
 
 
Opening balance
$
146,801

 
$
71,232

 
$
34,863

Realized and unrealized gains (losses) included in net (loss) income
(882
)
 
(253
)
 
3,172

Purchases
16,311

 
18,021

 

Sales
(28,761
)
 
(9,970
)
 

Transfers into Level 3 from Level 2
1,628

 
17,863

 

Transfers out of Level 3 into Level 2 (1)
(15,189
)
 
(5,523
)
 

Ending balance
$
119,908

 
$
91,370

 
$
38,035

Nine Months Ended September 30, 2015
Mortgage-backed
 
Asset-backed
 
Equities
Opening balance
$
181,783

 
$
55,413

 
$
43,330

Realized and unrealized gains (losses) included in net (loss) income
27

 
(2,960
)
 
3,484

Purchases
16,657

 
7,011

 

Sales
(94,802
)
 
(20,160
)
 
(20,000
)
Transfers into Level 3 from Level 2

 
41,234

 

Transfers out of Level 3 into Level 2 (1)

 
(22,984
)
 

Ending balance
$
103,665

 
$
57,554

 
$
26,814

Nine Months Ended September 30, 2014
 
 
 
 
 
Opening balance
$
147,338

 
$
93,413

 
$
73,904

Realized and unrealized gains (losses) included in net (loss) income
3,654

 
(659
)
 
(6,572
)
Purchases
34,187

 
35,526

 

Sales
(65,038
)
 
(19,871
)
 
(29,297
)
Transfers into Level 3 from Level 2
1,253

 
13,923

 

Transfers out of Level 3 into Level 2 (1)
(1,486
)
 
(30,962
)
 

Ending balance
$
119,908

 
$
91,370

 
$
38,035


(1) 
Transfers out of Level 3 are primarily attributable to the availability of market observable information.

The Company attempts to verify the significant inputs used by broker-dealers in determining the fair value of the securities priced by them. If the Company could not obtain sufficient information to determine if the broker-dealers were using significant observable inputs, then such securities have been transferred to the Level 3 fair value hierarchy. The Company believes the prices obtained from the broker-dealers are the best estimate of fair value of the securities being priced as the broker-dealers are typically involved in the initial pricing of the security, and the Company has compared the price per the broker-dealer to other pricing sources and noted no material differences. The Company recognizes transfers between levels at the end of the reporting period. There were no transfers between Level 1 and Level 2 during the period.

17

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


The Company’s external investment accounting service provider receives prices from internationally recognized independent pricing services to measure the fair values of its fixed maturity investments. Pricing sources are evaluated and selected in a manner to ensure that the most reliable sources are used. The Company uses a pricing service ranking to consistently select the most appropriate pricing service in instances where it receives multiple quotes on the same security. The Company obtains multiple quotes for the majority of its securities. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. Each pricing service has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing service uses observable market inputs, including, but not limited to, reported trades, benchmark yields, broker-dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value.

All of the Company’s securities classified as Level 3 are valued based on unadjusted broker-dealer quotes. This includes less liquid securities such as lower quality asset-backed securities, commercial mortgage-backed securities and residential mortgage-backed securities. The primary valuation inputs include monthly payment information, the probability of default, loss severity rates and estimated prepayment rates. Significant changes in these inputs in isolation would result in a significantly lower or higher fair value measurement. In general, a change in the assumption of the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity in an event of default and prepayment rates.

The Company records the unadjusted price provided and validates this price through a process that includes, but is not limited to, monthly and/or quarterly: (i) comparison of prices between two independent sources, with significant differences requiring additional price sources; (ii) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to their target benchmark, with significant differences identified and investigated); (iii) evaluation of methodologies used by external parties to calculate fair value, including a review of the inputs used for pricing; (iv) comparing the price to the Company’s knowledge of the current investment market; and (v) back-testing, which includes randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates from the pricing service. In addition to internal controls, management relies on the effectiveness of the valuation controls in place at the Company’s external investment accounting service provider (supported by a Statement on Standards for Attestation Engagements No. 16 report) in conjunction with regular discussion and analysis of the investment portfolio’s structure and performance.

8. RESERVE FOR LOSSES AND LOSS EXPENSES

The reserve for losses and loss expenses consists of the following:
 
September 30,
2015
 
December 31,
2014
Outstanding loss reserves
$
1,707,409

 
$
1,514,051

Reserves for losses incurred but not reported
4,729,170

 
4,367,114

Reserve for losses and loss expenses
$
6,436,579

 
$
5,881,165



18

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


The table below is a reconciliation of the beginning and ending liability for unpaid losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables.
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Gross liability at beginning of period
$
6,363,948

 
$
5,935,678

 
$
5,881,165

 
$
5,766,529

Reinsurance recoverable at beginning of period
(1,433,109
)
 
(1,301,742
)
 
(1,340,256
)
 
(1,234,504
)
Net liability at beginning of period
4,930,839

 
4,633,936

 
4,540,909

 
4,532,025

Acquisition of net reserves for losses and loss expenses

 

 
256,991

 

Net losses incurred related to:
 
 
 
 
 
 
 
Current year
425,473

 
382,970

 
1,267,649

 
1,067,111

Prior years
(8,591
)
 
(46,880
)
 
(94,071
)
 
(140,880
)
Total incurred
416,882

 
336,090

 
1,173,578

 
926,231

Net paid losses related to:
 
 
 
 
 
 
 
Current year
60,828

 
53,596

 
95,388

 
80,401

Prior years
287,840

 
202,626

 
866,770

 
666,555

Total paid
348,668

 
256,222

 
962,158

 
746,956

Foreign exchange revaluation
(12,306
)
 
(10,550
)
 
(22,573
)
 
(8,046
)
Net liability at end of period
4,986,747

 
4,703,254

 
4,986,747

 
4,703,254

Reinsurance recoverable at end of period
1,449,832

 
1,349,009

 
1,449,832

 
1,349,009

Gross liability at end of period
$
6,436,579

 
$
6,052,263

 
$
6,436,579

 
$
6,052,263


The net reserve for losses and loss expenses acquired of $256,991 represents the net reserves acquired from the Hong Kong and Singapore branches of RSA of $252,848 and the net reserves from the Labuan branch of RSA of $4,143.

For the three months ended September 30, 2015, the Company recognized net favorable prior year reserve development primarily due to lower than expected loss emergence across each of its segments. The net favorable prior year reserve development for the North American Insurance segment primarily related to net favorable prior year reserve development in the professional liability line of business, partially offset by unfavorable prior year development in the casualty line of business from the 2012 to 2014 loss years. The net favorable reserve development in the Global Markets Insurance segment was primarily due to net favorable loss reserve development in the professional liability line of business, partially offset by unfavorable prior year reserve development in the specialty and other line of business from the 2013 loss year. The net favorable reserve development in the Reinsurance segment was primarily related to the property and casualty reinsurance lines of business.

For the three months ended September 30, 2014, the Company recognized net favorable prior year reserve development in each of its segments. The net favorable prior year reserve development for the North American Insurance segment primarily related to net favorable prior year reserve development in the professional liability, casualty and programs lines of business, partially offset by unfavorable prior year development in the healthcare line of business mainly from the 2011 to 2013 loss years. The net favorable reserve development in the Global Markets Insurance segment was primarily due to net favorable loss reserve development in the professional liability and general casualty lines of business. The net favorable reserve development in the Reinsurance segment was primarily due to lower than expected loss activity in the property reinsurance line of business for the 2013 loss year.

For the nine months ended September 30, 2015, the Company recognized net favorable prior year reserve development primarily due to lower than expected loss emergence across each of its segments. The net favorable prior year reserve development for the North American Insurance segment primarily related to net favorable prior year reserve development in the professional liability, programs and property lines of business, partially offset by unfavorable prior year development in the healthcare and casualty lines of business mainly from the 2012 and 2013 loss years. The net favorable reserve development in the Global Markets Insurance segment was primarily due to net favorable loss reserve development in the property, professional liability and casualty lines of business, partially offset by unfavorable prior year reserve development in the specialty and other

19

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


line of business from the 2013 loss year. The net favorable reserve development in the Reinsurance segment was primarily related to the property and casualty reinsurance lines of business.

For the nine months ended September 30, 2014, the Company recognized net favorable prior year reserve development in each of its segments. The net favorable prior year reserve development for the North American Insurance segment primarily related to net favorable prior year reserve development in the professional liability, programs and general property lines of business, partially offset by unfavorable prior year development in the healthcare and general casualty lines of business. The net favorable prior year reserve development in the Global Markets Insurance segment was primarily due to net favorable reserve development in the professional liability, general casualty and general property lines of business. The net favorable reserve development in the Reinsurance segment was primarily due to lower than expected loss activity in the property reinsurance line of business for the 2013 loss year.

While the Company at times has experienced favorable reserve development in its insurance and reinsurance lines, there is no assurance that conditions and trends that have affected the development of liabilities in the past will continue. It is not appropriate to extrapolate future redundancies based on prior years’ development. The methodology of estimating loss reserves is periodically reviewed to ensure that the key assumptions used in the actuarial models continue to be appropriate.

9. INCOME TAXES

Under Swiss law, a resident company is subject to income tax at the federal, cantonal and communal levels that is levied on net income. Income attributable to permanent establishments or real estate located abroad is excluded from the Swiss tax base. Allied World Switzerland is a holding company and, therefore, is exempt from cantonal and communal income tax. As a result, Allied World Switzerland is subject to Swiss income tax only at the federal level. Allied World Switzerland is a resident of the Canton of Zug and, as such, is subject to an annual cantonal and communal capital tax on its taxable equity. One of Allied World Switzerland's subsidiaries is a Swiss operating company, which is a resident in the Canton of Zug. The operating company is subject to federal, cantonal and communal income tax and to annual cantonal and communal capital tax.

Under current Bermuda law, Allied World Assurance Company Holdings, Ltd (“Allied World Bermuda”) and its Bermuda subsidiaries are not required to pay taxes in Bermuda on either income or capital gains. Allied World Bermuda and Allied World Assurance Company, Ltd have received an assurance from the Bermuda Minister of Finance under the Exempted Undertakings Tax Protection Act 1966 of Bermuda, that in the event of any such taxes being imposed, Allied World Bermuda and Allied World Assurance Company, Ltd will be exempted until March 2035.

Certain subsidiaries of Allied World Switzerland file U.S. federal income tax returns and various U.S. state income tax returns, as well as income tax returns in Canada, Hong Kong, Ireland, Singapore and the United Kingdom. The U.S. Internal Revenue Service is currently conducting an audit of the 2012 tax return of the Company's U.S. subsidiaries. To the best of the Company’s knowledge, there are no other income tax examinations pending by any other tax authority.

Management has deemed all material tax positions to have a greater than 50% likelihood of being sustained based on technical merits if challenged. The Company does not expect any material unrecognized tax benefits within 12 months of September 30, 2015.
10. SHAREHOLDERS’ EQUITY

a) Authorized shares

The issued share capital consists of the following:
 
September 30,
2015
 
December 31,
2014
Common shares issued and fully paid, 2015 and 2014: CHF 4.10 per share
95,523,230

 
100,775,256

Share capital at end of period
$
386,702

 
$
408,020


20

Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


 
Nine Months Ended September 30, 2015
Shares issued at beginning of period
100,775,256

Shares canceled
(5,252,026
)
Total shares issued at end of period
95,523,230

Treasury shares issued at beginning of period
4,579,774

Shares repurchased
6,047,437

Shares issued out of treasury
(763,843
)
Shares canceled
(5,252,026
)
Total treasury shares at end of period
4,611,342

Total shares outstanding at end of period
90,911,888


During the nine months ended September 30, 2015, 5,252,026 shares repurchased and designated for cancellation were constructively retired and canceled.

b) Dividends

The Company paid the following dividends during the nine months ended September 30, 2015:
Dividend Paid
 
Dividend
Per
Share
 
Total
Amount
Paid
January 2, 2015
 
$
0.225

 
$
21,669

April 2, 2015
 
$
0.225

 
$
21,528

July 2, 2015
 
$
0.260