Document
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, 2016
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 24, 2016, 86,998,341 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, 2016 and December 31, 2015
(Expressed in millions of United States dollars, except share and per share amounts)
 
September 30,
2016
 
December 31,
2015
ASSETS:
 
 
 
Fixed maturity investments trading, at fair value (amortized cost: 2016: $7,311.5; 2015: $7,290.6)
$
7,327.3

 
$
7,201.5

Equity securities trading, at fair value (cost: 2016: $208.0; 2015: $395.3)
216.1

 
403.0

Other invested assets
941.7

 
966.7

Total investments
8,485.1

 
8,571.2

Cash and cash equivalents
773.8

 
608.0

Restricted cash
98.9

 
60.6

Insurance balances receivable
893.3

 
745.9

Funds held
263.9

 
640.8

Prepaid reinsurance
448.7

 
392.3

Reinsurance recoverable
1,550.7

 
1,480.0

Reinsurance recoverable on paid losses
129.1

 
96.4

Accrued investment income
37.2

 
38.3

Net deferred acquisition costs
157.7

 
165.2

Goodwill
392.8

 
388.1

Intangible assets
111.1

 
116.6

Balances receivable on sale of investments
20.3

 
36.9

Net deferred tax assets
26.3

 
24.4

Other assets
153.5

 
147.2

Total assets
$
13,542.4

 
$
13,511.9

LIABILITIES:
 
 
 
Reserve for losses and loss expenses
$
6,665.8

 
$
6,456.2

Unearned premiums
1,785.2

 
1,683.3

Reinsurance balances payable
258.4

 
214.4

Balances due on purchases of investments
242.4

 
125.1

Senior notes:
 
 
 
Principal amount
800.0

 
1,300.0

Less unamortized discount and debt issuance costs
6.0

 
7.1

Senior notes, net of unamortized discount and debt issuance costs
794.0

 
1,292.9

Other long-term debt
23.3

 
23.0

Accounts payable and accrued liabilities
157.4

 
184.5

Total liabilities
$
9,926.5

 
$
9,979.4

SHAREHOLDERS’ EQUITY:
 
 
 
Common shares: 2016 and 2015: par value CHF 4.10 per share (2016: 93,586,418; 2015: 95,523,230 shares issued and 2016: 86,974,284; 2015: 90,959,635 shares outstanding)
$
378.8

 
$
386.7

Treasury shares, at cost (2016: 6,612,134; 2015: 4,563,595)
(237.0
)
 
(155.1
)
Accumulated other comprehensive loss
(5.4
)
 
(9.3
)
Retained earnings
3,479.5

 
3,310.2

Total shareholders’ equity
3,615.9

 
3,532.5

Total liabilities and shareholders’ equity
$
13,542.4

 
$
13,511.9

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, 2016 and 2015
(Expressed in millions of United States dollars, except share and per share amounts)
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
REVENUES:
 
 
 
 
 
 
 
Gross premiums written
$
730.2

 
$
754.1

 
$
2,394.1

 
$
2,460.6

Premiums ceded
(201.9
)
 
(147.1
)
 
(583.6
)
 
(477.4
)
Net premiums written
528.3

 
607.0

 
1,810.5

 
1,983.2

Change in unearned premiums
55.7

 
43.7

 
(43.4
)
 
(117.6
)
Net premiums earned
584.0

 
650.7

 
1,767.1

 
1,865.6

Net investment income
50.6

 
45.7

 
159.7

 
133.0

Net realized investment gains (losses)

10.7

 
(113.6
)
 
104.0

 
(88.8
)
Other income
1.8

 
0.7

 
7.6

 
2.5

Total revenue
647.1

 
583.5

 
2,038.4

 
1,912.3

EXPENSES:
 
 
 
 
 
 
 
Net losses and loss expenses
376.3

 
416.9

 
1,114.1

 
1,173.6

Acquisition costs
82.0

 
100.1

 
257.7

 
279.4

General and administrative expenses
104.2

 
105.8

 
305.3

 
311.3

Other expense
2.2

 
1.3

 
5.0

 
4.3

Amortization of intangible assets
2.5

 
2.6

 
7.5

 
6.1

Interest expense
13.5

 
14.5

 
53.3

 
43.2

Foreign exchange loss (gain)
1.0

 
(0.8
)
 
(4.9
)
 
10.4

Total expenses
581.7

 
640.4

 
1,738.0

 
1,828.3

Income (loss) before income taxes
65.4

 
(56.9
)
 
300.4

 
84.0

Income tax (benefit) expense
(3.2
)
 
(5.3
)
 
4.3

 
1.8

NET INCOME (LOSS)
68.6

 
(51.6
)
 
296.1

 
82.2

Other comprehensive gain (loss): foreign currency translation adjustment
0.6

 
(1.0
)
 
3.9

 
(4.3
)
COMPREHENSIVE INCOME (LOSS)
$
69.2

 
$
(52.6
)
 
$
300.0

 
$
77.9

PER SHARE DATA
 
 
 
 
 
 
 
Basic earnings (loss) per share
$
0.79

 
$
(0.57
)
 
$
3.34

 
$
0.88

Diluted earnings (loss) per share
$
0.77

 
$
(0.57
)
 
$
3.29

 
$
0.87

Weighted average common shares outstanding
87,102,290

 
90,882,511

 
88,691,983

 
93,068,088

Weighted average common shares and common share equivalents outstanding
88,603,101

 
90,882,511

 
90,113,606

 
94,724,980

Dividends paid per share
$
0.26

 
$
0.26

 
$
0.78

 
$
0.71


See accompanying notes to the consolidated financial statements.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
for the nine months ended September 30, 2016 and 2015
(Expressed in millions of United States dollars)
 
 
Share
Capital
 
Treasury
Shares
 
Accumulated Other Comprehensive Loss
 
Retained
Earnings
 
Total
December 31, 2015
$
386.7

 
$
(155.1
)
 
$
(9.3
)
 
$
3,310.2

 
$
3,532.5

Net income

 

 

 
296.1

 
296.1

Dividends

 

 

 
(68.8
)
 
(68.8
)
Stock compensation

 
17.6

 

 
0.8

 
18.4

Share repurchases

 
(166.2
)
 

 

 
(166.2
)
Shares canceled
(7.9
)
 
66.7

 

 
(58.8
)
 

Foreign currency translation adjustment




3.9



 
3.9

September 30, 2016
$
378.8

 
$
(237.0
)
 
$
(5.4
)
 
$
3,479.5

 
$
3,615.9

 
 
 
 
 
 
 
 
 
 
December 31, 2014
$
408.0

 
$
(143.1
)
 
$

 
$
3,513.4

 
$
3,778.3

Net income

 

 

 
82.2

 
82.2

Dividends

 

 

 
(68.8
)
 
(68.8
)
Stock compensation

 
18.4

 

 
(5.1
)
 
13.3

Share repurchases

 
(245.3
)
 

 

 
(245.3
)
Shares canceled
(21.3
)
 
213.7

 

 
(192.4
)
 

Foreign currency translation adjustment

 

 
(4.3
)
 

 
(4.3
)
September 30, 2015
$
386.7

 
$
(156.3
)
 
$
(4.3
)
 
$
3,329.3

 
$
3,555.4

 
See accompanying notes to the consolidated financial statements.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
for the nine months ended September 30, 2016 and 2015
(Expressed in millions of United States dollars)

 
Nine Months Ended 
 September 30,
 
2016
 
2015
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
 
 
 
Net income
$
296.1

 
$
82.2

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
Net realized gains on sales of investments
(37.7
)
 
(41.2
)
Mark to market adjustments
(91.1
)
 
112.4

Stock compensation expense
13.4

 
11.8

Undistributed income of equity method investments
22.2

 
19.2

Changes in:
 
 
 
Reserve for losses and loss expenses, net of reinsurance recoverables
138.9

 
188.8

Unearned premiums, net of prepaid reinsurance
45.5

 
113.4

Insurance balances receivable
(148.8
)
 
(123.2
)
Funds held
376.9

 
280.4

Reinsurance balances payable
44.1

 
40.4

Reinsurance recoverable on paid losses
(32.6
)
 
(31.0
)
Net deferred acquisition costs
7.5

 
(10.9
)
Net deferred tax assets
(1.9
)
 
(10.1
)
Accounts payable and accrued liabilities
(28.2
)
 
(39.0
)
Other items, net
15.2

 
(1.7
)
Net cash provided by operating activities
619.5

 
591.5

CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
 
 
 
Purchases of trading securities
(4,322.6
)
 
(3,962.3
)
Purchases of other invested assets
(58.5
)
 
(110.9
)
Sales of trading securities
4,595.8

 
3,888.4

Sales of other invested assets
99.2

 
160.3

Purchases of fixed assets
(3.1
)
 
(23.8
)
Change in restricted cash
(38.2
)
 
(78.9
)
Net cash paid for acquisitions
(1.2
)
 
(141.5
)
Net cash provided by (used in) investing activities
271.4

 
(268.7
)
CASH FLOWS USED IN FINANCING ACTIVITIES:
 
 
 
Dividends paid
(68.8
)
 
(66.8
)
Proceeds from the exercise of stock options
7.7

 
9.2

Repayment of senior notes
(500.0
)
 

Share repurchases
(165.7
)
 
(246.4
)
Proceeds from other long-term debt

 
4.0

Repayment of other long-term debt
(0.2
)
 
(0.2
)
Net cash used in financing activities
(727.0
)
 
(300.2
)
Effect of exchange rate changes on foreign currency cash
1.9

 
(8.1
)
NET INCREASE IN CASH AND CASH EQUIVALENTS
165.8

 
14.5

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
608.0

 
589.3

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
773.8

 
$
603.8

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for income taxes
$
2.3

 
$
2.2

Cash paid for interest expense
$
56.6

 
$
45.8

See accompanying notes to the consolidated financial statements.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions of United States dollars, 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”), is a global provider of a diversified portfolio of property and casualty insurance and reinsurance. References to “$” are to the lawful currency of the United States and to “CHF” are to the lawful currency of Switzerland.

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. To facilitate comparison of information across periods, certain reclassifications have been made to prior year amounts to conform to the current year's presentation.

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, 2015.
3. NEW ACCOUNTING PRONOUNCEMENTS
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“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 Accounting Standard Codification 944, Financial Services - Insurance. ASU 2014-09 is effective on January 1, 2017 with retrospective adoption required for the comparative periods. With the issuance of Accounting Standards Update 2015-14, “Revenue from Contracts with Customers (Topic 606) - Deferral of the Effective Date”, 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.

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


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 losses 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 preparing the disclosures required by ASU 2015-09.
In January 2016, the FASB issued Accounting Standards Update 2016-01, “Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”). ASU 2016-01 changes current U.S. GAAP for public entities by requiring the following, among others: (1) equity securities, except those accounted for under the equity method of accounting, to be measured at fair value with changes in fair value recognized in net income; (2) the use of the exit price when measuring fair value of financial instruments for disclosure purposes; (3) an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value; and (4) separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or notes to the financial statements. ASU 2016-01 is effective for annual periods beginning after January 1, 2018, including interim periods. Early application is permitted. The Company is currently assessing the impact the adoption of ASU 2016-01 will have on future financial statements and disclosures.
In February 2016, the FASB issued Accounting Standards Update 2016-02, “Leases” (“ASU 2016-02”). ASU 2016-02 changes current U.S. GAAP for lessees to recognize lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous GAAP. ASU 2016-02 is effective for annual periods beginning after January 1, 2019, including interim periods. Early application is permitted. The Company is currently assessing the impact the adoption of ASU 2016-02 will have on future financial statements and disclosures.
In March 2016, the FASB issued Accounting Standards Update 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). ASU 2016-09 modifies U.S. GAAP by requiring the following, among others: (1) all excess tax benefits and tax deficiencies are to be recognized as income tax expense or benefit on the income statement (excess tax benefits are recognized regardless of whether the benefit reduces taxes payable in the current period); (2) excess tax benefits are to be classified along with other income tax cash flows as an operating activity in the statement of cash flows; (3) in the area of forfeitures, an entity can still follow the current U.S. GAAP practice of making an entity-wide accounting policy election to estimate the number of awards that are expected to vest or may instead account for forfeitures when they occur; and (4) classification as a financing activity in the statement of cash flows of cash paid by an employer to the taxing authorities when directly withholding shares for tax withholding purposes. ASU 2016-09 is effective for annual periods beginning after January 1, 2017, including interim periods. Although early adoption is permitted, the Company will not early adopt ASU 2016-09. The Company is currently assessing the impact the adoption of ASU 2016-09 will have on future financial statements and disclosures.
In June 2016, the FASB issued Accounting Standards Update 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”). ASU 2016-13 modifies U.S. GAAP related to the recognition of credit losses by replacing the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 would apply to financial assets such as loans, debt securities, trade receivables, off-balance sheet credit exposures, reinsurance receivables, and other financial assets that have the contractual right to receive cash. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amount. The Company's invested assets are measured at fair value through net income, and therefore those invested assets would not be impacted by the adoption of ASU 2016-13. The Company has other financial assets, such as reinsurance receivables, that could be impacted by the adoption of ASU 2016-13. ASU 2016-13 is effective for annual periods beginning after January 1, 2020, including interim periods. The Company is currently assessing the impact the adoption of ASU 2016-13 will have on future financial statements and disclosures.

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


In August 2016, the FASB issued Accounting Standards Update 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”). ASU 2016-15 clarifies the classification of receipts and payments in the statement of cash flows. ASU 2016-15 provides guidance related to (1) settlement and payment of zero coupon debt instruments, (2) contingent consideration, (3) proceeds from settlement of insurance claims, (4) proceeds from settlement of corporate and bank owned life insurance policies, (5) distributions from equity method investees, (6) cash receipts from beneficial interests obtained by a transferor, and (7) general guidelines for cash receipts and payments that have more than one aspect of classification. ASU 2016-15 is effective for annual periods beginning after December 15, 2017, including interim periods. Early adoption is permitted. The Company is currently assessing the impact the adoption of ASU 2016-15 will have on future financial statements and disclosures.

4. INVESTMENTS

a) Trading Securities

Securities accounted for at fair value with changes in fair value recognized in the unaudited condensed consolidated statements of operations and comprehensive income (the “consolidated income statements”) by category are as follows:
 
September 30, 2016
 
December 31, 2015
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
U.S. government and government agencies
$
1,471.2

 
$
1,466.1

 
$
1,434.0

 
$
1,438.0

Non-U.S. government and government agencies
488.1

 
498.2

 
556.8

 
579.2

States, municipalities and political subdivisions
480.8

 
460.3

 
413.5

 
396.0

Corporate debt:
 
 
 
 
 
 
 
Financial institutions
1,084.2

 
1,066.8

 
1,275.4

 
1,277.3

Industrials
1,372.5

 
1,353.5

 
1,308.1

 
1,345.6

Utilities
138.4

 
136.2

 
118.9

 
125.4

Mortgage-backed
 
 
 
 
 
 
 
Agency mortgage-backed
845.9

 
831.0

 
751.8

 
745.5

Non-agency residential mortgage-backed
22.6

 
21.5

 
34.0

 
32.4

Commercial mortgage-backed
631.8

 
671.3

 
582.8

 
600.1

Asset-backed
791.8

 
806.6

 
726.2

 
751.1

Total fixed maturity investments
$
7,327.3

 
$
7,311.5

 
$
7,201.5

 
$
7,290.6

 
September 30, 2016
 
December 31, 2015
 
Fair Value
 
Original Cost
 
Fair Value
 
Original Cost
Equity securities
$
216.1

 
$
208.0

 
$
403.0

 
$
395.3

Other invested assets
827.1

 
770.7

 
840.2

 
770.9

 
$
1,043.2

 
$
978.7

 
$
1,243.2

 
$
1,166.2


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 4(b) that are accounted for using the equity method of accounting.


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions of United States dollars, 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, 2016 and December 31, 2015 were as follows:

Investment Type
Carrying Value as of September 30, 2016
 
Investments
with
Redemption
Restrictions
 
Estimated
Remaining
Restriction
Period
 
Investments
without
Redemption
Restrictions
 
Redemption
Frequency
(1)
 
Redemption
Notice
Period
(1)
 
Unfunded
Commitments
Private equity
$
248.1

 
$
248.1

 
1 - 7 Years
 
$

 
 
 
 
 
$
221.8

Levered credit
221.0

 
221.0

 
4 - 8 Years
 

 
 
 
 
 
195.1

Real estate
21.4

 
21.4

 
7 - 9 Years
 

 
 
 
 
 
189.3

Distressed
5.1

 
5.1

 
2 Years
 

 
 
 
 
 
3.8

Total private equity
495.6

 
495.6

 
 
 

 
 
 
 
 
610.0

Distressed
173.9

 

 
 
 
173.9

 
Monthly
 
90 Days
 

Relative value credit
82.6

 

 
 
 
82.6

 
Quarterly
 
60 Days
 

Equity long/short
64.8

 

 
 
 
64.8

 
Quarterly
 
45 Days
 

Fund of funds
10.2

 

 
 
 
10.2

 
Annual
 
60 Days
 

Total hedge funds
331.5

 

 
 
 
331.5

 
 
 
 
 

Total other invested assets at fair value
827.1

 
495.6

 
 
 
331.5

 
 
 
 
 
610.0

Other private securities
114.6

 

 
 
 
114.6

 
 
 
 
 

Total other invested assets
$
941.7

 
$
495.6

 
 
 
$
446.1

 
 
 
 
 
$
610.0

Investment Type
Carrying Value as of December 31, 2015
 
Investments
with
Redemption
Restrictions
 
Estimated
Remaining
Restriction
Period
 
Investments
without
Redemption
Restrictions
 
Redemption
Frequency
(1)
 
Redemption
Notice
Period
(1)
 
Unfunded
Commitments
Private equity
$
236.4

 
$
236.4

 
1 - 7 Years
 
$

 
 
 
 
 
$
231.0

Levered credit
205.9

 
205.9

 
4 - 8 Years
 

 
 
 
 
 
179.0

Distressed
5.1

 
5.1

 
2 Years
 

 
 
 
 
 
3.8

Real estate

 

 
7 - 9 Years
 

 
 
 
 
 
200.0

Total private equity
447.4

 
447.4

 
 
 

 
 
 
 
 
613.8

Distressed
215.6

 
54.6

 
2 Years
 
161.0

 
Monthly
 
90 Days
 

Equity long/short
58.0

 

 
 
 
58.0

 
Quarterly
 
45 Days
 

Relative value credit
105.4

 

 
 
 
105.4

 
Quarterly
 
60 Days
 

Total hedge funds
379.0

 
54.6

 
 
 
324.4

 
 
 
 
 

High yield loan fund
13.8

 

 
 
 
13.8

 
Monthly
 
30 Days
 

Total other invested assets at fair value
840.2

 
502.0

 
 
 
338.2

 
 
 
 
 
613.8

Other private securities
126.5

 

 
 
 
126.5

 
 
 
 
 

Total other invested assets
$
966.7

 
$
502.0

 
 
 
$
464.7

 
 
 
 
 
$
613.8

(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 investor is contractually required to invest before having the ability to redeem. Funds that provide for periodic redemptions

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions of United States dollars, except share, per share, percentage and ratio information)


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 if 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 (primary and secondary): Primary equity funds include funds that may invest in companies and general partnership interests, as well as direct investments. Secondary funds buy limited partnership interests from existing limited partners of primary private equity funds. As owners of private equity, funds may seek liquidity by selling their existing interests, 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 funds.
Levered credit (including mezzanine debt): Levered credit funds invest across the capital structures of upper middle market and middle market companies in connection with leveraged buyouts, mergers and acquisitions, recapitalizations, growth financings, refinancings and other corporate purposes. The most common position in the capital structure of mezzanine funds will be between the senior secured debt holder and the equity; however, the funds in which we are invested 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 funds.
Real estate funds: Private real estate funds invest directly (through debt and equity) in commercial real estate (multifamily, industrial, office, student housing and retail) as well as residential property.  Real estate managers have diversified portfolios that generally follow core, core-plus, value-added or opportunistic strategies.  These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the funds.
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 funds.
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.
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.
Fund of funds: Fund of funds allocate assets among multiple investment managers unaffiliated with the fund of funds sponsor employing a variety of proprietary investment strategies. Fund of funds strategies will invest in a portfolio of funds that primarily pursue the following investment strategies: equity, macro, event driven and credit.
Other private securities: These securities mostly 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.
High yield loan fund: A long-only private mutual fund that invests in high yield fixed income securities.

Unconsolidated Variable Interest Entities

As a result of the adoption of Accounting Standards Update 2015-02, “Amendments to the Consolidation Analysis”, which became effective January 1, 2016, certain limited partnership investments and similar legal entity investments were considered variable interest entities (“VIEs”) as there were no substantive kick-out or other participating rights. These VIEs will not be consolidated because the Company has determined it is not considered the primary beneficiary, as it does not have both the power to direct the activities that most significantly impact the economic performance of the entity and the obligation to absorb

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions of United States dollars, except share, per share, percentage and ratio information)


losses of the entity that could be potentially significant to the VIE or the right to receive benefits from the entity that could be potentially significant. As such, the Company continues to record its interests in these entities at fair value, with changes in fair value recorded in the consolidated income statements. The Company's interests in these entities are recorded in “other invested assets” in the unaudited condensed consolidated balance sheets (“consolidated balance sheets”). The Company's maximum exposure to loss in these entities, which is the sum of the carrying value and the unfunded commitment, was $982.6 million as of September 30, 2016.

c) Net Investment Income
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Fixed maturity investments
$
46.4

 
$
42.8

 
$
143.3

 
$
120.3

Equity securities
1.1

 
3.1

 
4.4

 
11.5

Other invested assets: hedge funds and private equity
5.9

 
3.4

 
18.2

 
16.3

Other invested assets: other private securities
1.0

 
1.8

 
5.7

 
(1.1
)
Cash and cash equivalents
0.7

 
0.3

 
2.0

 
1.2

Expenses
(4.5
)
 
(5.7
)
 
(13.9
)
 
(15.2
)
Net investment income
$
50.6

 
$
45.7

 
$
159.7

 
$
133.0


The loss from “other invested assets: other private securities” for the nine months ended September 30, 2015 included an other-than-temporary impairment of $6.3 million 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,
 
2016
 
2015
 
2016
 
2015
Gross realized gains on sale of invested assets
$
23.2

 
$
18.7

 
$
123.3

 
$
100.1

Gross realized losses on sale of invested assets
(16.5
)
 
(34.7
)
 
(85.3
)
 
(57.8
)
Net realized and unrealized losses on derivatives
(1.0
)
 
(19.9
)
 
(23.9
)
 
(17.6
)
Mark-to-market gains (losses):
 
 
 
 
 
 
 
Fixed maturity investments, trading
(9.4
)
 
(15.3
)
 
108.3

 
(42.5
)
Equity securities, trading
11.1

 
(62.8
)
 
(3.1
)
 
(57.8
)
Other invested assets, trading
3.3

 
0.4

 
(15.3
)
 
(13.2
)
Net realized investment gains (losses)
$
10.7

 
$
(113.6
)
 
$
104.0

 
$
(88.8
)

e) Pledged Assets

As of September 30, 2016 and December 31, 2015, $2,717.3 million and $2,748.9 million, 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, 2016 and December 31, 2015, a further $572.8 million and $579.3 million, respectively, of cash and cash equivalents and investments were pledged as collateral for the Company’s letter of credit facilities.

In June 2016, the Company entered into a $200.0 million committed unsecured credit facility with a syndication of lenders (the “Credit Agreement”). The Credit Agreement provides for a $200.0 million five-year senior unsecured revolving credit facility (the “Facility”) for the making of revolving loans and short-term swingline loans. The aggregate commitment of $200.0 million under the Facility may be increased by up to $150.0 million upon the Company's request and upon the agreement of one

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions of United States dollars, except share, per share, percentage and ratio information)


or more lenders or additional lenders. The Facility replaces the four-year senior secured credit facility under the Amended and Restated Credit Agreement, dated as of June 7, 2012.

In addition, see Note 11(g) to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 for further details on the Company’s credit facilities.

5. DERIVATIVE INSTRUMENTS

As of September 30, 2016 and December 31, 2015, 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 consolidated balance sheets:
 
 
September 30, 2016
 
December 31, 2015
 
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
$
4.6

 
$

 
$
202.2

 
$
2.2

 
$
41.1

 
$
0.1

 
$
244.8

 
$
3.0

Interest rate swaps

 

 

 

 

 

 
328.2

 
0.5

Total derivatives
$
4.6

 
$

 
$
202.2

 
$
2.2

 
$
41.1

 
$
0.1

 
$
573.0

 
$
3.5


Derivative assets and derivative liabilities are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets. As of September 30, 2016, all open interest rate swap contracts were closed out.

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,
 
2016
 
2015
 
2016
 
2015
Foreign exchange contracts
$
(0.1
)
 
$
0.2

 
$
1.0

 
$
(6.0
)
Total included in foreign exchange (loss) gain
(0.1
)
 
0.2

 
1.0

 
(6.0
)
Foreign exchange contracts

 
0.1

 
(15.3
)
 
0.9

Interest rate futures and swaps
(1.0
)
 
(20.0
)
 
(8.6
)
 
(18.5
)
Total included in net realized investment losses
(1.0
)
 
(19.9
)
 
(23.9
)
 
(17.6
)
Total realized and unrealized losses on derivatives
$
(1.1
)
 
$
(19.7
)
 
$
(22.9
)
 
$
(23.6
)

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.


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions of United States dollars, except share, per share, percentage and ratio information)


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

6. 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 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, 2016
 
Carrying
Amount
 
Total
Fair Value
 
Level 1
 
Level 2
 
Level 3
ASSETS:
 
 
 
 
 
 
 
 
 
 
Fixed maturity investments:
 
 
 
 
 
 
 
 
 
 
U.S. government and government agencies
 
$
1,471.2

 
$
1,471.2

 
$
1,429.4

 
$
41.8

 
$

Non-U.S. government and government agencies
 
488.1

 
488.1

 

 
488.1

 

States, municipalities and political subdivisions
 
480.8

 
480.8

 

 
480.8

 

Corporate debt
 


 


 
 
 
 
 
 
Financial institutions
 
1,084.2

 
1,084.2

 

 
1,080.7

 
3.5

Industrials
 
1,372.5

 
1,372.5

 

 
1,371.7

 
0.8

Utilities
 
138.4

 
138.4

 

 
138.4

 

Mortgage-backed
 


 


 
 
 
 
 
 
Agency mortgage-backed
 
845.9

 
845.9

 

 
558.3

 
287.6

Non-agency residential mortgage-backed
 
22.6

 
22.6

 

 
22.6

 

Commercial mortgage-backed
 
631.8

 
631.8

 

 
630.6

 
1.2

Asset-backed
 
791.8

 
791.8

 

 
728.1

 
63.7

Total fixed maturity investments
 
7,327.3

 
7,327.3

 
1,429.4

 
5,541.1

 
356.8

Equity securities
 
216.1

 
216.1

 
216.1

 

 

Other invested assets (1)
 
827.1

 
827.1

 

 

 

Total investments
 
$
8,370.5

 
$
8,370.5

 
$
1,645.5

 
$
5,541.1

 
$
356.8

LIABILITIES:
 
 
 
 
 
 
 
 
 
 
Derivative liabilities:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
2.2

 
$
2.2

 
$

 
$
2.2

 
$

Senior notes
 
$
794.0

 
$
850.5

 
$

 
$
850.5

 
$

Other long-term debt
 
$
23.3

 
$
30.0

 
$

 
$
30.0

 
$


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions of United States dollars, except share, per share, percentage and ratio information)


December 31, 2015
 
Carrying
Amount
 
Total
Fair Value
 
Level 1
 
Level 2
 
Level 3
ASSETS:
 
 
 
 
 
 
 
 
 
 
Fixed maturity investments:
 
 
 
 
 
 
 
 
 
 
U.S. government and government agencies
 
$
1,434.0

 
$
1,434.0

 
$
1,396.4

 
$
37.6

 
$

Non-U.S. government and government agencies
 
556.8

 
556.8

 

 
556.8

 

States, municipalities and political subdivisions
 
413.5

 
413.5

 

 
413.5

 

Corporate debt
 


 


 


 


 


Financial institutions
 
1,275.4

 
1,275.4

 

 
1,275.4

 

Industrials
 
1,308.1

 
1,308.1

 

 
1,308.1

 

Utilities
 
118.9

 
118.9

 

 
118.9

 

Mortgage-backed
 


 


 


 


 


Agency mortgage-backed
 
751.8

 
751.8

 

 
645.7

 
106.1

Non-agency residential mortgage-backed
 
34.0

 
34.0

 

 
34.0

 

Commercial mortgage-backed
 
582.8

 
582.8

 

 
582.8

 

Asset-backed
 
726.2

 
726.2

 

 
663.2

 
63.0

Total fixed maturity investments
 
7,201.5

 
7,201.5

 
1,396.4

 
5,636.0

 
169.1

Equity securities
 
403.0

 
403.0

 
403.0

 

 

Other invested assets (1)
 
840.2

 
840.2

 

 

 

Total investments
 
$
8,444.7

 
$
8,444.7

 
$
1,799.4

 
$
5,636.0

 
$
169.1

Derivative assets:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
0.1

 
$
0.1

 
$

 
$
0.1

 
$

LIABILITIES:
 
 
 
 
 
 
 
 
 
 
Derivative liabilities:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
3.0

 
$
3.0

 
$

 
$
3.0

 
$

Interest rate swaps
 
$
0.5

 
$
0.5

 
$

 
$
0.5

 
$

Senior notes
 
$
1,292.9

 
$
1,337.9

 
$

 
$
1,337.9

 
$

Other long-term debt
 
$
23.0

 
$
27.7

 
$

 
$
27.7

 
$


(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.

“Other invested assets” exclude other private securities that the Company did not measure at fair value, but are accounted for using the equity method of accounting. Derivative assets and derivative liabilities relating to foreign exchange contracts and interest rate swaps are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

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.

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.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions of United States dollars, except share, per share, percentage and ratio information)



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 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, unless the significant inputs used to price the corporate debt 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.

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 (“MBS”) 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 MBS. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the MBS 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 MBS 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 U.S. and foreign 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 (the “NAV”) 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 NAV 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.






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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions of United States dollars, except share, per share, percentage and ratio information)


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.

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, 2016
MBS
 
CMBS
 
Total mortgage-backed
 
Asset-backed
 
Equities
 
Corporate debt - financial
 
Corporate debt - industrial
Opening balance
$
138.2

 
$

 
$
138.2

 
$
62.3

 
$

 
$

 
$

Realized and unrealized gains (losses) included in net income (loss)
0.9

 

 
0.9

 
1.7

 

 

 

Purchases
178.0

 

 
178.0

 
6.6

 

 

 

Sales
(19.4
)
 

 
(19.4
)
 
(5.5
)
 

 

 

Transfers into Level 3 from Level 2
0.3

 
1.2

 
1.5

 

 

 
3.5

 
0.8

Transfers out of Level 3 into Level 2 (1)
(10.4
)
 

 
(10.4
)
 
(1.4
)
 

 

 

Ending balance
$
287.6

 
$
1.2

 
$
288.8

 
$
63.7

 
$

 
$
3.5

 
$
0.8

Three Months Ended September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
Opening balance
$
96.5

 
$
3.1

 
$
99.6

 
$
83.9

 
$
57.8

 
$

 
$

Realized and unrealized gains (losses) included in net income (loss)
0.8

 

 
0.8

 
(2.5
)
 
(11.0
)
 

 

Purchases
9.7

 

 
9.7

 
0.1

 

 

 

Sales
(6.5
)
 
(2.9
)
 
(9.4
)
 
(7.9
)
 
(20.0
)
 

 

Transfers into Level 3 from Level 2
3.1

 

 
3.1

 
0.6

 

 

 

Transfers out of Level 3 into Level 2 (1)

 
(0.2
)
 
(0.2
)
 
(16.7
)
 

 

 

Ending balance
$
103.6

 
$

 
$
103.6

 
$
57.5

 
$
26.8

 
$

 
$


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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions of United States dollars, except share, per share, percentage and ratio information)


Nine Months Ended September 30, 2016
MBS
 
CMBS
 
Total mortgage-backed
 
Asset-backed
 
Equities
 
Corporate debt - financial
 
Corporate debt - industrial
Opening balance
$
106.1

 
$

 
$
106.1

 
$
63.0

 
$

 
$

 
$

Realized and unrealized gains (losses) included in net income (loss)
3.4

 

 
3.4

 
2.5

 

 

 

Purchases
216.4

 

 
216.4

 
18.4

 

 
1.5

 

Sales
(29.7
)
 

 
(29.7
)
 
(10.4
)
 

 

 

Transfers into Level 3 from Level 2
1.8

 
1.2

 
3.0

 
8.0

 

 
2.0

 
0.8

Transfers out of Level 3 into Level 2 (1)
(10.4
)
 

 
(10.4
)
 
(17.8
)
 

 

 

Ending balance
$
287.6

 
$
1.2

 
$
288.8

 
$
63.7

 
$

 
$
3.5

 
$
0.8

Nine Months Ended September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
Opening balance
$
180.1

 
$
1.7

 
$
181.8

 
$
55.5

 
$
43.3

 
$

 
$

Realized and unrealized gains (losses) included in net income (loss)
(0.1
)
 
0.1

 

 
(3.0
)
 
3.5

 

 

Purchases
14.8

 
1.8

 
16.6

 
7.0

 

 

 

Sales
(91.2
)
 
(3.6
)
 
(94.8
)
 
(20.2
)
 
(20.0
)
 

 

Transfers into Level 3 from Level 2

 

 

 
41.2

 

 

 

Transfers out of Level 3 into Level 2 (1)

 

 

 
(23.0
)
 

 

 

Ending balance
$
103.6

 
$

 
$
103.6

 
$
57.5

 
$
26.8

 
$

 
$


(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.

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

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in millions of United States dollars, except share, per share, percentage and ratio information)


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.

7. RESERVE FOR LOSSES AND LOSS EXPENSES

The reserve for losses and loss expenses consists of the following:
 
September 30,
2016
 
December 31,
2015
Outstanding loss reserves
$
1,751.0

 
$
1,678.5

Reserves for losses incurred but not reported
4,914.8

 
4,777.7

Reserve for losses and loss expenses
$
6,665.8

 
$
6,456.2


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,
 
2016
 
2015
 
2016
 
2015
Gross liability at beginning of period
$
6,623.2

 
$
6,363.9

 
$
6,456.2