Form 10-K
Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

Form 10-K

 

 

(Mark One)

 

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

For the fiscal year ended December 31, 2013

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.)

Lindenstrasse 8 6340 Baar Zug, Switzerland

(Address of Principal Executive Offices and Zip Code)

41-41-768-1080

(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Shares, par value CHF 12.30 per share

  New York Stock Exchange, Inc.

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  þ        No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨        No  þ

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨

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 Act).     Yes  ¨        No  þ

The aggregate market value of voting and non-voting common shares held by non-affiliates of the registrant as of June 28, 2013 (the last business day of the registrant’s most recently completed second fiscal quarter) was approximately $3.0 billion based on the closing sale price of the registrant’s common shares on the New York Stock Exchange on that date.

As of February 10, 2014, 33,239,969 common shares were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A with respect to the annual general meeting of the shareholders of the registrant scheduled to be held on May 1, 2014 is incorporated in Part III of this Form 10-K.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

        

Page

 
PART I   

ITEM 1.

  Business      1   

ITEM 1A.

  Risk Factors      23   

ITEM 1B.

  Unresolved Staff Comments      42   

ITEM 2.

  Properties      49   

ITEM 3.

  Legal Proceedings      49   

ITEM 4.

  Mine Safety Disclosures      49   
PART II   

ITEM 5.

  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      50   

ITEM 6.

  Selected Financial Data      53   

ITEM 7.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      55   

ITEM 7A.

  Quantitative and Qualitative Disclosures About Market Risk      109   

ITEM 8.

  Financial Statements and Supplementary Data      113   

ITEM 9.

  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      113   

ITEM 9A.

  Controls and Procedures      113   

ITEM 9B.

  Other Information      115   
PART III   

ITEM 10.

  Directors, Executive Officers and Corporate Governance      115   

ITEM 11.

  Executive Compensation      115   

ITEM 12.

  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      115   

ITEM 13.

  Certain Relationships and Related Transactions, and Director Independence      115   

ITEM 14.

  Principal Accountant Fees and Services      115   
PART IV   

ITEM 15.

  Exhibits and Financial Statement Schedules      115   

SIGNATURES

     116   

EXHIBITS

     E-1   

CONSOLIDATED FINANCIAL STATEMENTS

     F-1   


Table of Contents

PART I

References in this Annual Report on Form 10-K to the terms “we,” “us,” “our,” “the company” or other similar terms mean the consolidated operations of Allied World Assurance Company Holdings, AG, a Swiss holding company, and our consolidated subsidiaries, unless the context requires otherwise. References in this Form 10-K to the terms “Allied World Switzerland” or “Holdings” means only Allied World Assurance Company Holdings, AG. References to our “insurance subsidiaries” may include our reinsurance subsidiaries. References in this Form 10-K to $ are to the lawful currency of the United States and to CHF are to the lawful currency of Switzerland. References in this Form 10-K to Holdings’ “common shares” means its registered voting shares. For your convenience, we have included a glossary beginning on page 43 of selected insurance and reinsurance terms.

 

Item 1. Business

Overview

We are a Swiss-based insurance and reinsurance holding company whose subsidiaries underwrite a diverse portfolio of property and casualty lines of business through offices located in Bermuda, Canada, Hong Kong, Ireland, Singapore, Switzerland, the United Kingdom and the United States. For the year ended December 31, 2013, our U.S. insurance segment accounted for 42.5%, our international insurance segment accounted for 23.4% and our reinsurance segment accounted for 34.1% of our total gross premiums written of $2,738.7 million. As of December 31, 2013, we had $11.9 billion of total assets and $3.5 billion of shareholders’ equity.

We were formed in Bermuda in 2001 and have continued to maintain significant insurance and reinsurance operations there following our parent company’s redomestication to Switzerland in December 2010. During the years since our formation, we have steadily expanded our geographic reach and now operate from 17 offices located in eight different countries. Our European operations commenced with the opening of our Dublin office in 2002 and our London branch opened during the following year. In 2010, we received approval from Lloyd’s to establish a syndicate. Our Lloyd’s Syndicate 2232 commenced underwriting in June 2010. More recently, we have further expanded in Europe with the opening of a branch in Zug, Switzerland in 2008 and the chartering of a Swiss-domiciled insurance and reinsurance company in 2011.

Our presence in the United States commenced with the acquisition of two inactive U.S. insurance companies in 2002. Since then, we have greatly expanded our North American business, acquiring a privately held reinsurance company in early 2008 and a public professional liability carrier, Darwin Professional Underwriters, Inc. and its subsidiaries (collectively, “DPUI”), later that same year. We currently operate from 11 U.S. offices in nine states, including our most recently opened U.S. office in Miami from which we service reinsurance accounts in Latin America and the Caribbean. Several years ago we became licensed in a number of Canadian provinces, and we opened our newest North American branch in Toronto in July 2013.

Our growing presence in the Asia Pacific region began with the opening of Allied World Assurance Company, Ltd branches in Hong Kong and Singapore in 2009, and expanded with our license to write reinsurance business in Labuan, a Malaysian financial center. In July 2010, we received approval from the Monetary Authority of Singapore and Lloyd’s Asia to operate a service company, Capita 2232 Services Pte Ltd. On behalf of Syndicate 2232, the service company offers a broad range of insurance and reinsurance treaty products from Singapore, including property, casualty and specialty lines, to clients in the Asia Pacific, Middle East and Africa regions. In September 2012, Allied World Reinsurance Management Company received approval to act as a Lloyd’s coverholder to underwrite Latin American and Caribbean treaty business from our Miami office on behalf of Syndicate 2232.

Available Information

We maintain a website at www.awac.com. The information on our website is not incorporated by reference in this Annual Report on Form 10-K.

We make available, free of charge through our website, our financial information, including the information contained in our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on

 

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Form 8-K filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the U.S. Securities and Exchange Commission (the “SEC”). We also make available, free of charge through our website, our Audit Committee Charter, Compensation Committee Charter, Investment Committee Charter, Nominating & Corporate Governance Committee Charter, Enterprise Risk Committee Charter, Corporate Governance Guidelines, Code of Ethics for CEO and Senior Financial Officers and Code of Business Conduct and Ethics. Such information is also available in print for any shareholder who sends a request to Allied World Assurance Company Holdings, AG, Lindenstrasse 8, 6340 Baar, Zug, Switzerland, attention: Wayne H. Datz, Corporate Secretary, or via e-mail to secretary@awac.com. Reports and other information we file with the SEC may also be viewed at the SEC’s website at www.sec.gov or viewed or obtained at the SEC Public Reference Room at 100 F Street, N.E., Washington, DC 20549. Information on the operation of the SEC Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.

Our Strategy

Our business objective is to generate attractive returns on equity and book value per share growth for our shareholders. We seek to achieve this objective by executing the following strategies:

 

   

Capitalize on profitable underwriting opportunities. Our experienced management and underwriting teams are positioned to locate and identify business with attractive risk/reward characteristics. We pursue a strategy that emphasizes profitability, not market share. Key elements of this strategy are prudent risk selection, appropriate pricing and adjusting our business mix to remain flexible and opportunistic. We seek ways to take advantage of underwriting opportunities that we believe will be profitable.

 

   

Exercise underwriting and risk management discipline. We believe we exercise underwriting and risk management discipline by: (i) maintaining a diverse spread of risk across product lines and geographic zones, (ii) managing our aggregate property catastrophe exposure through the application of sophisticated modeling tools, (iii) monitoring our exposures on non-property catastrophe coverages, (iv) adhering to underwriting guidelines across our business lines and (v) fostering a culture that focuses on enterprise risk management and strong internal controls.

 

   

Employ a diversified investment strategy. We believe that we follow a diversified investment strategy designed to emphasize the preservation of capital, provide adequate liquidity for the prompt payment of claims, as well as generate returns for our shareholders. Our investment portfolio consists primarily of investment-grade, fixed-maturity securities of short-to medium-term duration.

Our premium revenues are generated by operations conducted from our corporate headquarters in Switzerland and our other offices worldwide. For information concerning our gross premiums written by geographic location of underwriting office, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Comparison of Years Ended December 31, 2013 and 2012” and “— Comparison of Years Ended December 31, 2012 and 2011.”

Our Operating Segments

We have three business segments: U.S. insurance, international insurance and reinsurance. These segments and their respective lines of business and products may, at times, be subject to different underwriting cycles. We modify our product strategy as market conditions change and new opportunities emerge by developing new products, targeting new industry classes or de-emphasizing existing lines. Our diverse underwriting skills and flexibility allow us to concentrate on the business lines where we expect to generate the greatest returns. Financial data relating to our three segments is included in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in our consolidated financial statements included in this report.

 

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The gross premiums written in each segment for the years ended December 31, 2013, 2012 and 2011 were as follows:

 

     Year Ended
December 31, 2013
    Year Ended
December 31, 2012
    Year Ended
December 31, 2011
 
     Amount      % of Total     Amount      % of Total     Amount      % of Total  
     ($ in millions)  

U.S. insurance

   $ 1,163.1         42.5   $ 993.9         42.7   $ 838.6         43.3

International insurance

     641.8         23.4     575.1         24.7     530.4         27.3

Reinsurance

     933.8         34.1     760.3         32.6     570.5         29.4
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 2,738.7         100.0   $ 2,329.3         100.0   $ 1,939.5         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

U.S. Insurance Segment

General

The U.S. insurance segment is comprised of our direct insurance operations in the United States and our Canada branch office in Toronto that opened in 2013. Within this segment we provide an increasingly diverse range of specialty liability products, with a particular emphasis on coverages for healthcare and professional liability risks. Additionally, we offer a selection of direct general casualty insurance and general property insurance products. We generally write small- and middle-market, non-Fortune 1000 accounts domiciled in North America, including public entities, private companies and non-profit organizations. Our underwriters are spread among our locations in the United States and Canada, because we believe it is important to be physically present in the major insurance markets where we compete for business. We believe that in recent years we have become a significant writer of primary professional liability and other specialty liability coverage for small firms, and we intend to continue to seek attractive opportunities in the U.S. market.

The table below illustrates the breakdown of the company’s U.S. direct insurance gross premiums written by line of business for the year ended December 31, 2013.

 

     Year Ended
December 31, 2013
 
     Amount      % of Total  
     ($ in millions)  

General casualty

   $ 366.7         31.5

Professional liability

     259.0         22.3

Healthcare

     184.0         15.8

Programs

     138.1         11.9

General property

     96.0         8.3

Other(1)

     119.3         10.2
  

 

 

    

 

 

 
   $ 1,163.1         100.0
  

 

 

    

 

 

 

 

(1) Includes our inland marine, environmental, mergers and acquisitions, primary construction and surety lines of business.

Products and Customer Base

Our casualty operations in the United States and Canada focus on insuring specialty liability risks, such as professional liability, environmental liability, product liability, healthcare liability, and commercial general liability risks. Professional liability products include policies covering directors and officers, employment practices and fiduciary liability insurance. We also offer errors and omissions liability policies designed for a variety of service providers, including law firms, technology companies, insurance companies, insurance agents and brokers, and municipalities. In addition, we provide both primary and excess liability and other casualty coverages to the healthcare industry, including hospitals and hospital systems, managed care organizations, accountable care organizations and other medical service providers.

 

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We regularly assess our product mix, and we evaluate new products and markets where we believe our underwriting and service will allow us to differentiate our offerings. For example, several years ago, we entered the environmental liability business by developing policies that cover the pollution and related liability exposures of general contractors, tank installers, remediation contractors and others. More recently, we have introduced new products for mergers and acquisitions liability, privacy and technology-related liability and, in 2013, we commenced writing surety.

With respect to general casualty products, we provide both primary and excess capacity, and our focus is on complex liability risks in a variety of industries including construction, real estate, public entities, retailers, manufacturing, transportation, and finance and insurance services. We also offer comprehensive insurance to contractors and their employees working outside of the United States on contracts for agencies of the U.S. government or foreign operations of U.S. companies.

Our U.S. property insurance operations provide direct coverage of physical property and business interruption coverage for commercial property risks. During 2011, we also commenced writing inland marine business. We write solely commercial coverages and concentrate on primary risk layers of insurance (as opposed to excess layers), offering meaningful but limited capacity in these layers. This means that we are typically part of the first group of insurers that cover a loss up to a specified limit. We offer general property products from our underwriting platforms in the United States, and cover risks for retail chains, real estate, manufacturers, hotels and casinos, and municipalities.

We contract with third-party agencies to underwrite a variety of professional liability, excess casualty and primary general liability programs. We generally retain responsibility for administration of program claims, although we have opted to outsource the claims handling in selected programs. Before delegating underwriting authority, we consider the integrity, experience and reputation of each program administrator, as well as the availability of reinsurance and the potential profitability of the business. Once a program is established, we conduct regular ongoing reviews and audits of the administrator. To help align interests, we seek to set up incentive-based compensation as a component of their fees, which encourages better long-term underwriting results.

For more information concerning our gross premiums written by line of business in our U.S. insurance segment, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — U.S. Insurance Segment — Comparison of Years Ended December 31, 2013 and 2012” and “— Comparison of Years Ended December 31, 2012 and 2011.”

Distribution

Within our U.S. insurance segment, insurance policies are placed through a network of over 350 insurance intermediaries, including excess and surplus lines wholesalers and regional and national retail brokerage firms. Marsh & McLennan Companies, Inc. (“Marsh”) accounted for 10.2% of gross premiums written in the U. S. insurance segment during 2013.

International Insurance Segment

General

The international insurance segment includes our direct insurance operations in Bermuda, Europe and Asia. Our Bermuda operations underwrite primarily larger, Fortune 1000 casualty and property risks for accounts domiciled in North America. Our European offices have tended to focus on mid-sized to large European and multi-national companies domiciled outside of North America, and in recent years have diversified into products for smaller commercial clients. In addition, Syndicate 2232 offers select product lines including international property, general casualty and professional liability, targeted at key territories such as countries in Latin America and the Asia Pacific region. The international insurance segment also encompasses our offices in Asia that underwrite a variety of primary and excess professional liability lines and general casualty and healthcare insurance products. Our staff in the international insurance segment is spread among our locations in Bermuda, Europe and Asia because we believe it is important that our underwriters be physically present in the major insurance markets around the world where we compete for business.

 

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The table below illustrates the breakdown of the company’s international insurance gross premiums written by line of business for the year ended December 31, 2013.

 

     Year Ended
December 31, 2013
 
     Amount      % of Total  
     ($ in millions)  

Professional liability

   $ 201.0         31.3

General property

     165.2         25.7

General casualty

     134.5         21.0

Healthcare

     82.1         12.8

Aviation

     30.5         4.8

Other(1)

     28.5         4.4
  

 

 

    

 

 

 
   $ 641.8         100.0
  

 

 

    

 

 

 

 

(1) Includes our trade credit line of business.

Products and Customer Base

Within our international insurance segment we provide general casualty products as well as professional liability, errors & omissions, employment practices and fiduciary liability insurance, and healthcare liability products. Our general casualty focus is on complex risks in a variety of industries, including manufacturing, energy, chemicals, transportation, real estate, consumer products, medical and healthcare services, and construction. With respect to specialty risks, we offer a diverse mix of coverages for commercial entities such as law firms, technology companies, financial institutions, insurance companies and brokers, manufacturing and energy, and engineering and construction firms. Our healthcare underwriters provide risk transfer products to numerous healthcare institutions, such as hospitals, managed care organizations and healthcare systems. In addition to primary policies, we provide excess capacity and focus on higher excess layers. Our international insurance segment utilizes significant gross limit capacity.

We offer general property products from our underwriting platforms in Bermuda and Europe. Our international property insurance operations provide direct coverage of physical property and business interruption coverage for commercial property risks and mining risks. We write solely commercial coverages and focus on the insurance of the primary risk layer. The types of commercial property risks we cover include retail chains, real estate, manufacturers, hotels and casinos. In addition, through a program we created, we offer short- and medium-term trade credit insurance for clients that export primarily to and from Latin America and the Caribbean. In 2013, we introduced new coverages for employers’ liability and aviation lines of business.

We have contracted with third-party agencies to underwrite a variety of programs including professional liability, healthcare, casualty, property, marine and aviation products. We generally have opted to outsource the claims handling in these programs. Before delegating underwriting authority, we consider the integrity, experience and reputation of each program administrator, as well as the availability of reinsurance and the potential profitability of the business. Once a program is established, we conduct regular ongoing reviews and audits of the administrator. To help align interests, we seek to set up incentive-based compensation as a component of their fees, which encourages better long-term underwriting results.

For more information on our gross premiums written by line of business in our international insurance segment, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — International Insurance Segment — Comparison of Years Ended December 31, 2013 and 2012” and “— Comparison of Years Ended December 31, 2012 and 2011.”

Distribution

With regard to our international insurance segment, we utilize our relationships with insurance intermediaries as our principal method for obtaining business. Our international insurance segment maintains

 

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significant relationships with Marsh, Aon plc (“Aon”) and Willis Group Holdings (“Willis”), which accounted for 31.0%, 24.1% and 11.3%, respectively, of our gross premiums written in this segment during 2013.

Reinsurance Segment

General

Our reinsurance segment includes the reinsurance of property, general casualty, professional liability, specialty lines and property catastrophe coverages written by other insurance companies. In order to diversify our portfolio and complement our direct insurance business, we presently write reinsurance on both a treaty and a facultative basis, targeting several niche markets including professional liability lines, specialty casualty, property for U.S. regional insurers, accident and health, marine, aerospace and crop risks. Overall, we strive to diversify our reinsurance portfolio through the appropriate combination of business lines, ceding source, geography and contract configuration. Our primary customer focus is on highly-rated carriers with proven underwriting skills and dependable operating models.

We determine appropriate pricing either by using pricing models built or approved by our actuarial staff or by relying on established pricing set by one of our pricing actuaries for a specific treaty. Pricing models are generally used for facultative reinsurance, property catastrophe reinsurance, property per risk reinsurance, workers compensation and personal accident catastrophe reinsurance. Other types of reinsurance rely on actuarially-established pricing. On a written basis, our business mix is more heavily weighted to reinsurance during the first three months of the year. Our reinsurance segment operates from our offices in Bermuda, London, Miami, New York, Singapore and Switzerland.

The table below illustrates the breakdown of the company’s reinsurance gross premiums written by line of business for the year ended December 31, 2013.

 

     Year Ended
December 31, 2013
 
     Amount      % of Total  
     ($ in millions)  

Property

   $ 460.0         49.3

Casualty

     274.4         29.4

Specialty

     199.4         21.3
  

 

 

    

 

 

 
   $ 933.8         100.0
  

 

 

    

 

 

 

Product Lines and Customer Base

Property, casualty and specialty reinsurance is the principal source of revenue for this segment. The insurers we reinsure range from single state to nationwide insurers located in the United States as well as specialty carriers or the specialty divisions of standard lines carriers. For our international treaty unit, our clients include multi-national insurers, single territory insurers, niche carriers and Lloyd’s syndicates. We focus on niche programs and coverages, frequently sourced from excess and surplus lines insurers. For a number of years, we have utilized our Zug branch as a base from which to offer property, general casualty and professional liability products throughout Europe, business which is now being written by Allied World Assurance Company, AG, our Swiss licensed insurance and reinsurance company. Syndicate 2232 also offers international treaty reinsurance. Singapore serves as the hub for our reinsurance operations in Asia for all classes of treaty reinsurance business for the region. In the United States we have continued to add depth and diversity to our reinsurance platform. In 2012, our Miami operations received approval to act as a Lloyd’s coverholder to underwrite treaty business in Latin America and the Caribbean on behalf of Syndicate 2232. We target a portfolio of well-rated companies that are highly knowledgeable in their product lines, have the financial resources to execute their business plans and are committed to underwriting discipline throughout the underwriting cycle.

 

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Our property reinsurance treaties protect insurers who write residential, commercial and industrial accounts in North America, Europe, Asia and Latin America, with our predominant exposure being North America. We also write Euro-centric business, including Lloyd’s syndicates and Continental European companies, and are expanding our capabilities in Asia and Latin America. We emphasize monoline, per risk accounts, which are structured as either quota share or excess-of-loss reinsurance. Monoline reinsurance applies to one kind of coverage, and per risk reinsurance coverage applies to a particular risk (for example a building and its contents), rather than on a per accident, event or aggregate basis. We selectively write industry loss warranties where we believe market opportunities justify the risks.

Our casualty reinsurance business consists of general casualty and professional liability lines and writes both treaty and facultative business. Our general casualty treaties cover working layer, intermediate layer and catastrophe exposures. We sell both quota share and excess-of-loss reinsurance. We principally underwrite general liability, auto liability and commercial excess and umbrella liability for both admitted and non-admitted companies. Our general casualty facultative business is principally comprised of lower-attachment, individual-risk reinsurance covering automobile liability, general liability and workers compensation risks for many of the largest U.S. property-casualty and surplus lines insurers. Our professional liability treaties cover several products, primarily directors’ and officers’ liability, but also attorneys’ malpractice, medical malpractice, miscellaneous professional classes and transactional risk liability. The complex exposures undertaken by this unit demand highly technical underwriting and pricing analysis.

For our specialty reinsurance business, we underwrite on a global basis crop, marine and aviation, and other specialty lines of business, including accident and health business with an emphasis on catastrophe personal accident programs and workers compensation catastrophe business.

For more information on our gross premiums written by line of business in our reinsurance segment, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Reinsurance Segment — Comparison of Years Ended December 31, 2013 and 2012” and “— Comparison of Years Ended December 31, 2012 and 2011.”

Distribution

Due to a number of factors, including transactional size and complexity, the distribution infrastructure of the reinsurance marketplace is characterized by relatively few intermediary firms. As a result, we have close business relationships with a small number of reinsurance intermediaries, and our business during 2013 was primarily with affiliates of Marsh, Aon and Willis accounting for 42.1%, 24.8% and 15.2%, respectively, of total gross premiums written in this segment during 2013. Due to the substantial percentage of premiums produced in our reinsurance segment by the top three intermediaries, the loss of business from any one of them could have a material adverse effect on our business.

Security Arrangements

Allied World Assurance Company, Ltd, our Bermuda insurance and reinsurance company, is not admitted as an insurer nor is it accredited as a reinsurer in any jurisdiction in the United States, although it is qualified as an “eligible” or “certified” reinsurer in several U.S. states. Except in states where it has qualified as an eligible or certified reinsurer, Allied World Assurance Company, Ltd is generally required to post collateral security with respect to any reinsurance liabilities it assumes from ceding insurers domiciled in the United States in order for these cedents to obtain credit on their U.S. statutory financial statements with respect to insurance liabilities ceded by them. Under applicable statutory provisions, the security arrangements may be in the form of letters of credit, reinsurance trusts maintained by trustees or funds-withheld arrangements where assets are held by the ceding company. For a description of the security arrangements used by us, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Pledged Assets.”

 

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Enterprise Risk Management

General

While the assumption of risk is inherent in our business, we believe we have developed a strong risk management culture that is fostered and maintained by our senior management. Our enterprise risk management (“ERM”) consists of numerous processes and controls that have been designed by our senior management, with oversight by our Board of Directors, including through its Enterprise Risk Committee, and implemented by employees across our organization. One key element of our ERM is our economic capital model. Utilizing this modeling framework, we review the relative interaction between risks impacting us from underwriting through investment risks. Our ERM supports our firm-wide decision making process by aiming to provide reliable and timely risk information. Our primary ERM objectives are to:

 

   

protect our capital position,

 

   

ensure that our assumed risks (individually and in the aggregate) are within our firm-wide risk appetite,

 

   

maximize our risk-adjusted returns on capital, and

 

   

manage our earnings volatility.

We have identified the following six major categories of risk within our business:

Underwriting risk:   Encompasses risks associated with entering into insurance and reinsurance transactions and includes frequency and severity assessments, pricing adequacy issues and exposures posed by new products. For more information concerning our management of underwriting risk, see “Underwriting Risk Management” below.

Catastrophe and Aggregate Accumulation risk:   Addresses the organization’s exposure to natural catastrophes, such as windstorms, earthquakes or floods, particularly with regard to managing the concentration of exposed insurance limits within coastal or other areas that are more prone to severe catastrophic events. For more information concerning our management of catastrophe risk, see “Underwriting Risk Management” below.

Reserving risk:   The risks associated with overestimating or underestimating required reserves is a significant risk for any company that writes long-tail casualty business.

Investment risk:   Addresses risks of market volatility and losses associated with individual investments and investment classes, as well as overall portfolio risk associated with decisions as to asset mix, geographic risk, duration and liquidity.

Reinsurance risk:   The ceding of policies we write to other reinsurers is a principal risk management activity, and it requires careful monitoring of the concentration of our reinsured exposures and the creditworthiness of the reinsurers to which we cede business.

Operational risk:   Encompasses a wide range of risks related to our operations, including: corporate governance, claims settlement processes, regulatory compliance, employment practices and IT exposures (including disaster recovery, cyber-security and business continuity planning).

Our risk governance structure includes committees comprised of senior underwriting, actuarial, finance, legal, investment and operations staff that identify, monitor and help manage each of these risks. Our management-based Risk Management Committee, chaired by our Chief Risk Officer, focuses primarily on identifying correlations among our primary categories of risk, developing metrics to assess our overall risk position, performing an annual risk assessment and reviewing continually factors that may impact our organizational risk. This risk governance structure is complemented by our internal audit department, which assesses the adequacy and effectiveness of our internal control systems and coordinates risk-based audits and compliance reviews and other specific initiatives to evaluate and address risk within targeted areas of our business as well as our risk-mitigation efforts. Our ERM is a dynamic process, with periodic updates being made to reflect organizational processes and the recalibration of our models, as well as staying current with changes within our industry and the global economic environment.

 

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Our management’s internal ERM efforts are overseen by our Board of Directors, primarily through its Enterprise Risk Committee. This committee, comprised of independent directors, is charged with reviewing and recommending to the Board of Directors our overall firm-wide risk appetite as well as overseeing management’s compliance therewith. Our Enterprise Risk Committee reviews our risk management methodologies, standards, tolerances and risk strategies, and assesses whether management is addressing risk issues in a timely and appropriate manner. Our Audit Committee, Investment Committee and Compensation Committee also oversee aspects of our financial, investment and compensation risks, respectively. Internal controls and ERM can provide a reasonable but not absolute assurance that our control objectives will be met. The possibility of material financial loss remains in spite of our ERM efforts.

Underwriting Risk Management

Underwriting insurance and reinsurance coverage, which is our primary business activity, entails the assumption of risk. Therefore, protecting corporate assets from an unexpected level of loss related to underwriting activities is a major area of focus. We emphasize careful risk selection by evaluating a potential insured’s risk management practices, loss history and adequacy of retention. Other factors that go into the effective management of underwriting risk may differ depending on the line of business involved and the type of account being insured or reinsured.

In our direct insurance casualty products, we strive to write diverse business across a variety of product lines and industry classes, and we review business concentrations on a regular basis with the objective of creating balanced portfolios. By maintaining a balanced casualty portfolio, we believe we are less vulnerable to adverse market changes in any one product or industry. In addition, because of the large limits we often deploy for casualty business written in the U.S. insurance segment and the international insurance segment, we utilize both facultative and treaty reinsurance to reduce our net exposure. For more information on the reinsurance we purchase for the casualty business written in the U.S. insurance and international insurance segments, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Ceded Reinsurance.”

In our direct insurance property products, we have historically managed our property catastrophe exposure by closely monitoring our policy limits and utilizing complex risk models that analyze the locations covered by each insurance policy enabling us to obtain a more accurate assessment of our property catastrophe exposure. In addition to our continued focus on aggregate limits and modeled probable maximum loss, we have implemented a gross exposed policy limits approach that focuses on exposures in catastrophe-prone geographic zones and takes into consideration flood severity, demand surge and business interruption exposures for each critical area. We closely monitor our gross accumulations in each zone and restrict our gross exposed policy limits in each critical property catastrophe zone to an amount consistent with our probable maximum loss. Subsequent to a catastrophic event, we reassess our risk appetite and risk tolerances to ensure they are aligned with our capital preservation targets. Additionally, for our direct property, workers compensation, accident and health catastrophe and property reinsurance business, we seek to manage our risk exposure so that our probable maximum losses for a single catastrophe event, after all applicable reinsurance, in any “one-in-250-year” event does not exceed approximately 20% of our total capital.

Before we review the specifics of any proposal in our reinsurance segment, we consider the attributes of the client, including the experience and reputation of its management and its risk management strategy. We also examine the level of shareholders’ equity, industry ratings, length of incorporation, duration of business model, portfolio profitability, types of exposures and the extent of its liabilities. To identify, manage and monitor accumulations of exposures from potential property catastrophes, we employ industry-recognized software. Our underwriters, actuaries and claims personnel collaborate throughout the reinsurance underwriting process. For property proposals, we also obtain information on the nature of the perils to be included and the policy information on locations to be covered under the reinsurance contract. If a program meets our underwriting criteria, we then assess the adequacy of its proposed pricing, terms and conditions, and its potential impact on our profit targets and risk objectives.

 

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Competition

Competition in the insurance and reinsurance industry is substantial with market participants competing on the basis of many factors, including premium rates, policy terms and conditions, financial strength ratings assigned by independent rating agencies, service quality, claims handling service and expertise, and reputation and experience in the risks underwritten. We compete with major U.S. and non-U.S. companies, some of which have longer operating histories, more capital and/or higher ratings than we do, as well as greater marketing, management and business resources.

In addition, risk-linked securities, derivatives, captive companies and other alternative risk transfer vehicles, many of which are offered by entities other than insurance and reinsurance companies, compete with us. The availability of these non-traditional products could reduce the demand for both traditional insurance and reinsurance products.

Financial Strength Ratings

Ratings are an important factor in establishing the competitive position of insurance and reinsurance companies. A.M. Best, Moody’s, Standard & Poor’s and Fitch Ratings have each developed a rating system to provide an opinion of an insurer’s or reinsurer’s financial strength and ability to meet ongoing obligations to its policyholders. Each rating reflects the rating agency’s opinion of the capitalization, management and sponsorship of the entity to which it relates, and is neither an evaluation directed to investors in our common shares nor a recommendation to buy, sell or hold our common shares. A.M. Best ratings currently range from “A++” (Superior) to “F” (In Liquidation) and include 15 separate ratings categories. Moody’s maintains a letter scale rating system ranging from “Aaa” (Exceptional) to “C” (Lowest-rated) and includes 21 separate ratings categories. Standard & Poor’s maintains a letter scale rating system ranging from “AAA” (Extremely Strong) to “R” (under regulatory supervision) and includes 22 separate ratings categories. Fitch Ratings maintains a letter scale rating system ranging from “AAA” (Extremely Strong”) to “C” (Distressed) and includes 19 separate ratings categories. Our principal operating subsidiaries and their respective ratings from each rating agency are provided in the table below. These ratings are subject to periodic review, and may be revised upward, downward or revoked, at the sole discretion of the rating agencies.

 

Subsidiary

  Rated “A”
(Excellent) from
A.M. Best(1)
    Rated “A2”
(Good)  from
Moody’s(2)
    Rated  “A”
(Strong) from
Standard & Poor’s(3)
    Rated  “A”
(Strong) from
Fitch Ratings(4)
 

Allied World Assurance Company, Ltd

    X        X        X        X   

Allied World Assurance Company (U.S.) Inc.

    X        X        X        X   

Allied World National Assurance Company

    X        X        X        X   

Allied World Insurance Company

    X        X        X        X   

Darwin National Assurance Company

    X                        

Darwin Select Insurance Company

    X                        

Allied World Assurance Company, AG

                  X (5)        

Allied World Assurance Company (Europe) Limited

    X               X          

 

(1) Third highest of 15 available ratings from A.M. Best.

 

(2) Sixth highest of 21 available ratings from Moody’s.

 

(3) Sixth highest of 22 available ratings from Standard & Poor’s.

 

(4) Fifth highest of 19 available ratings from Fitch Ratings.

 

(5) This credit rating reflects the benefit of the unconditional guarantee provided by Allied World Assurance Company, Ltd, whereby it guarantees all of the obligations under the insurance policies and reinsurance contracts of Allied World Assurance Company, AG where such obligations have become due and payable in accordance with their terms.

In addition to the above-named subsidiaries, we underwrite through our Lloyd’s Syndicate 2232. All Lloyd’s syndicates benefit from Lloyd’s central resources, including Lloyd’s brand, its network of global licenses

 

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and the central fund. As all of Lloyd’s policies are ultimately backed by this common security, a single market rating can be applied. A.M. Best has assigned Lloyd’s a financial strength rating of “A” (Excellent) and Standard & Poor’s and Fitch Ratings have assigned Lloyd’s a financial strength rating of “A+” (Strong).

Reserve for Losses and Loss Expenses

We are required by applicable insurance laws and regulations in the countries in which we operate and accounting principles generally accepted in the United States (“U.S. GAAP”) to establish loss reserves to cover our estimated liability for the payment of all losses and loss expenses incurred with respect to premiums earned on the policies and treaties that we write. These reserves are balance sheet liabilities representing estimates of losses and loss expenses we are required to pay for insured or reinsured claims that have occurred as of or before the balance sheet date. It is our policy to establish these losses and loss expense reserves using prudent actuarial methods after reviewing all information known to us as of the date they are recorded. For more specific information concerning the statistical and actuarial methods we use to estimate ultimate expected losses and loss expenses, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Reserve for Losses and Loss Expenses.”

The following tables show the development of gross and net reserves for losses and loss expenses, respectively. The tables do not present accident or policy year development data. Each table begins by showing the original year-end reserves recorded at the balance sheet date for each of the years presented (“as originally estimated”). This represents the estimated amounts of losses and loss expenses arising in all prior years that are unpaid at the balance sheet date, including reserves for losses incurred but not reported (“IBNR”). The re-estimated liabilities reflect additional information regarding claims incurred prior to the end of the preceding financial year. A (redundancy) or deficiency arises when the re-estimation of reserves recorded at the end of each prior year is (less than) or greater than its estimation at the preceding year-end. The cumulative (redundancies) or deficiencies represent cumulative differences between the original reserves and the currently re-estimated liabilities over all prior years. Annual changes in the estimates are reflected in the consolidated statement of operations and comprehensive income for each year, as the liabilities are re-estimated.

 

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The lower sections of the tables show the portions of the original reserves that were paid (claims paid) as of the end of subsequent years. This section of each table provides an indication of the portion of the re-estimated liability that is settled and is unlikely to develop in the future. For our quota share treaty reinsurance business, we have estimated the allocation of claims paid to applicable years based on a review of large losses and earned premium percentages.

Development of Reserve for Losses and Loss Expenses Cumulative Deficiency (Redundancy)

Gross Losses

 

    Year Ended December 31,  
    2003     2004     2005     2006     2007     2008(1)     2009     2010     2011     2012     2013  
    ($ in millions)  

As Originally Estimated:

  $ 1,062.1      $ 2,084.3      $ 3,543.8      $ 3,900.5      $ 4,307.6      $ 4,576.8      $ 4,761.8      $ 4,879.2      $ 5,225.1      $ 5,645.5      $ 5,766.5   

Liability Re-estimated as of:

                     

One Year Later

    981.7        1,961.2        3,403.3        3,622.7        3,484.9        4,290.3        4,329.3        4,557.8        4,991.2        5,375.6     

Two Years Later

    899.2        1,873.6        3,249.3        3,247.9        3,149.3        3,877.8        3,975.2        4,246.5        4,707.7       

Three Years Later

    845.2        1,733.7        2,894.5        2,911.3        2,791.1        3,576.8        3,670.3        3,953.8         

Four Years Later

    810.2        1,513.7        2,558.6        2,605.8        2,533.6        3,295.7        3,446.4           

Five Years Later

    704.7        1,306.2        2,315.9        2,432.6        2,300.1        3,101.7             

Six Years Later

    626.8        1,235.6        2,190.5        2,314.2        2,184.3               

Seven Years Later

    619.9        1,207.7        2,168.5        2,263.0                 

Eight Years Later

    618.2        1,199.7        2,151.4                   

Nine Years Later

    618.6        1,197.1                     

Ten Years Later

    630.0                       

Cumulative (Redundancy)

    (432.1     (887.2     (1,392.4     (1,637.5     (2,123.3     (1,475.1     (1,315.4     (925.4     (517.4     (269.9  

Cumulative Claims Paid as of:

                     

One Year Later

    138.8        374.6        718.3        560.2        583.4        574.8        634.5        656.6        852.1        1,112.6     

Two Years Later

    237.9        574.4        1,154.9        1,002.5        943.9        1,089.5        1,036.2        1,242.1        1,577.0       

Three Years Later

    301.3        726.0        1,521.6        1,252.9        1,311.4        1,391.3        1,408.0        1,671.5         

Four Years Later

    372.2        842.9        1,662.8        1,531.9        1,469.3        1,680.7        1,737.2           

Five Years Later

    425.4        910.4        1,829.0        1,622.5        1,634.5        1,904.4             

Six Years Later

    456.7        972.0        1,864.9        1,705.9        1,789.1               

Seven Years Later

    478.1        994.8        1,916.9        1,810.5                 

Eight Years Later

    499.5        1,031.9        1,995.1                   

Nine Years Later

    514.8        1,071.9                     

Ten Years Later

    548.0                       

 

(1) Reserve for losses and loss expenses includes the reserves for losses and loss expenses of Finial Insurance Company (now renamed Allied World Insurance Company), which we acquired in February 2008, and DPUI, which we acquired in October 2008.

 

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Development of Reserve for Losses and Loss Expenses Cumulative Deficiency (Redundancy)

Gross Losses

 

     Year Ended December 31,  
     2003     2004     2005     2006     2007     2008(1)     2009     2010     2011     2012  

Liability Re-estimated as of:

  

One Year Later

     92     94     96     93     81     94     91     93     96     95

Two Years Later

     85     90     92     83     73     85     83     87     90  

Three Years Later

     80     83     82     75     65     78     77     81    

Four Years Later

     76     73     72     67     59     72     72      

Five Years Later

     66     63     65     62     53     68        

Six Years Later

     59     59     62     59     51          

Seven Years Later

     58     58     61     58            

Eight Years Later

     58     58     61              

Nine Years Later

     58     57                

Ten Years Later

     59                  

Cumulative (Redundancy)

     (41 %)      (43 %)      (39 %)      (42 %)      (49 %)      (32 %)      (28 %)      (19 %)      (10 %)      (5 %) 
Gross Loss and Loss Expense Cumulative Paid as a Percentage of Originally Estimated Liability   

Cumulative Claims Paid as of:

                    

One Year Later

     13     18     20     14     14     13     13     13     16     20

Two Years Later

     22     28     33     26     22     24     22     25     30  

Three Years Later

     28     35     43     32     30     30     30     34    

Four Years Later

     35     40     47     39     34     37     36      

Five Years Later

     40     44     52     42     38     42        

Six Years Later

     43     47     53     44     42          

Seven Years Later

     45     48     54     46            

Eight Years Later

     47     50     56              

Nine Years Later

     48     51                

Ten Years Later

     52                  

 

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Development of Reserve for Losses and Loss Expenses Cumulative Deficiency (Redundancy)

Losses Net of Reinsurance

 

    Year Ended December 31,  
    2003     2004     2005     2006     2007     2008(1)     2009     2010     2011     2012     2013  
    ($ in millions)  

As Originally Estimated:

  $ 967.3      $ 1,809.6      $ 2,826.9      $ 3,211.4      $ 3,624.9      $ 3,688.5      $ 3,841.8      $ 3,951.6      $ 4,222.2      $ 4,504.4      $ 4,532.0   

Liability Re-estimated as of:

                     

One Year Later

    887.9        1,760.5        2,662.7        2,978.3        3,312.2        3,440.5        3,528.4        3,698.1        4,051.9        4,324.1     

Two Years Later

    833.5        1,655.7        2,551.9        2,699.6        3,032.1        3,128.3        3,256.0        3,474.3        3,855.7       

Three Years Later

    774.0        1,551.1        2,281.0        2,417.0        2,742.5        2,882.6        3,020.0        3,271.5         

Four Years Later

    746.4        1,354.0        1,986.8        2,152.2        2,518.5        2,655.7        2,854.8           

Five Years Later

    648.5        1,162.3        1,776.5        1,997.0        2,326.5        2,516.9             

Six Years Later

    574.8        1,098.7        1,663.6        1,896.0        2,240.0               

Seven Years Later

    568.3        1,075.3        1,644.2        1,857.4                 

Eight Years Later

    567.0        1,067.1        1,630.6                   

Nine Years Later

    567.8        1,067.2                     

Ten Years Later

    579.7                       

Cumulative (Redundancy)

    (387.6     (742.4     (1,196.3     (1,354.0     (1,384.9     (1,171.6     (987.0     (680.1     (366.5     (180.3  

Cumulative Claims Paid as of:

                     

One Year Later

    133.3        306.9        461.3        377.3        415.2        415.9        498.1        542.6        743.8        974.0     

Two Years Later

    214.9        482.0        759.3        699.0        681.3        811.7        843.7        1,050.8        1,365.8       

Three Years Later

    272.0        624.9        990.5        884.1        964.8        1,069.3        1,171.5        1,430.2         

Four Years Later

    342.9        733.3        1,090.7        1,094.0        1,100.0        1,318.8        1,458.2           

Five Years Later

    407.7        783.1        1,220.0        1,167.6        1,244.9        1,515.5             

Six Years Later

    426.4        833.9        1,248.3        1,241.5        1,379.9               

Seven Years Later

    440.8        851.3        1,293.1        1,335.9                 

Eight Years Later

    455.3        883.2        1,362.9                   

Nine Years Later

    467.3        917.7                     

Ten Years Later

    496.4                       

 

(1) Reserve for losses and loss expenses net includes the reserves for losses and loss expenses of Finial Insurance Company (now renamed Allied World Insurance Company), which we acquired in February 2008, and DPUI, which we acquired in October 2008.

 

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Development of Reserve for Losses and Loss Expenses Cumulative Deficiency (Redundancy)

Losses Net of Reinsurance

 

     Year Ended December 31,  
     2003     2004     2005     2006     2007     2008(1)     2009     2010     2011     2012  

Liability Re-estimated as of:

  

One Year Later

     92     97     94     93     91     93     92     94     96     96

Two Years Later

     86     91     90     84     84     85     85     88     91  

Three Years Later

     80     86     81     75     76     78     79     83    

Four Years Later

     77     75     70     67     69     72     74      

Five Years Later

     67     64     63     62     64     68        

Six Years Later

     59     61     59     59     62          

Seven Years Later

     59     59     58     58            

Eight Years Later

     59     59     58              

Nine Years Later

     59     59                

Ten Years Later

     60                  

Cumulative (Redundancy)

     (40 %)      (41 %)      (42 %)      (42 %)      (38 %)      (32 %)      (26 %)      (17 %)      (9 %)      (4 %) 
Net Loss and Loss Expense Cumulative Paid as a Percentage of Originally Estimated Liability   

Cumulative Claims Paid as of:

                    

One Year Later

     14     17     16     12     11     11     13     14     18     22

Two Years Later

     22     27     27     22     19     22     22     27     32  

Three Years Later

     28     35     35     28     27     29     30     36    

Four Years Later

     35     41     39     34     30     36     38      

Five Years Later

     42     43     43     36     34     41        

Six Years Later

     44     46     44     39     38          

Seven Years Later

     46     47     46     42            

Eight Years Later

     47     49     48              

Nine Years Later

     48     51                

Ten Years Later

     51                  

 

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Losses Net of Reinsurance

The table below is a reconciliation of the beginning and ending liability for unpaid losses and loss expenses for the years ended December 31, 2013, 2012 and 2011. Losses incurred and paid are reflected net of reinsurance recoveries.

 

     Year Ended December 31,  
     2013     2012     2011  
     ($ in millions)  

Net reserves for losses and loss expenses, January 1

   $ 4,504.4      $ 4,222.2      $ 3,951.6   

Incurred related to:

      

Commutation of variable rated reinsurance contracts

                   11.5   

Current year non-catastrophe

     1,290.0        1,130.0        909.0   

Current year property catastrophe

     13.5        179.6        292.2   

Prior year

     (180.3     (170.3     (253.5
  

 

 

   

 

 

   

 

 

 

Total incurred

     1,123.2        1,139.3        959.2   
  

 

 

   

 

 

   

 

 

 

Paid related to:

      

Current year non-catastrophe

     115.6        99.1        72.1   

Current year property catastrophe

            18.1        70.1   

Prior year

     974.0        743.8        542.6   
  

 

 

   

 

 

   

 

 

 

Total paid

     1,089.6        861.0        684.8   

Foreign exchange revaluation

     (6.0     3.9        (3.8
  

 

 

   

 

 

   

 

 

 

Net reserve for losses and loss expenses, December 31

     4,532.0        4,504.4        4,222.2   

Losses and loss expenses recoverable

     1,234.5        1,141.1        1,002.9   
  

 

 

   

 

 

   

 

 

 

Reserve for losses and loss expenses, December 31

   $ 5,766.5      $ 5,645.5      $ 5,225.1   
  

 

 

   

 

 

   

 

 

 

Investments

Investment Strategy and Guidelines

We believe that we follow a diversified investment strategy designed to emphasize the preservation of our invested assets, and provide adequate liquidity for the prompt payment of claims as well as attractive returns for our shareholders. To help ensure adequate liquidity for payment of claims, we take into account the maturity and duration of our investment portfolio and our general liability profile. In making investment decisions, we consider the impact of various catastrophic events to which we may be exposed. As of December 31, 2013, investment grade, fixed-maturity securities and cash and cash equivalents, represented 73% of our total investments and cash and cash equivalents, with the remainder invested in non-investment grade securities and loans, equities, hedge funds and other alternative investments. Our current Investment Policy Statement contains restrictions on the maximum amount of our investment portfolio that may be invested in alternative investments (such as hedge funds and private equity vehicles) as well as a minimum amount that must be maintained in investment grade fixed income securities and cash. Allied World Financial Services, Ltd and Allied World Financial Services, Inc. invest in nonpublic entities that we believe will complement our core insurance and reinsurance operations and diversify our revenues. These investments do not and are not expected to represent a material part of the company’s total investment portfolio.

In an effort to meet business needs and mitigate risks, our investment guidelines provide restrictions on our portfolio’s composition, including limits on the type of issuer, sector limits, credit quality limits, portfolio duration, limits on the amount of investments in approved countries and permissible security types. We may direct our investment managers to invest some of the investment portfolio in currencies other than the U.S. dollar based on the business we have written, the currency in which our loss reserves are denominated on our books or regulatory requirements.

 

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Our investment performance is subject to a variety of risks, including risks related to general economic conditions, market volatility, interest rate fluctuations, liquidity risk and credit and default risk. Investment guideline restrictions have been established in an effort to minimize the effect of these risks but may not always be effective due to factors beyond our control. Interest rates are highly sensitive to many factors, including governmental monetary and fiscal policies, domestic and international economic and political conditions and other factors beyond our control. A significant increase in interest rates could result in significant losses, realized or unrealized, in the value of our investment portfolio. Similarly, given our portfolio’s exposure to credit assets, a significant increase in credit spreads could result in significant losses to our investment portfolio. Additionally, with respect to some of our investments, we are subject to prepayment and therefore reinvestment risk. Alternative investments, such as our hedge fund and private equity investments, subject us to restrictions on sale, transfer and redemption, which may limit our ability to withdraw funds or realize gains on such investments for some period of time after our initial investment. The values of, and returns on, such investments may also be more volatile.

Investment Committee and Investment Managers

The Investment Committee of our Board of Directors approves an Investment Policy Statement that contains investment guidelines and supervises our investment activity. The Investment Committee regularly monitors our overall investment results and compliance with investment objectives and guidelines, and ultimately reports our overall investment results to the Board of Directors.

For several asset classes we have engaged outside investment managers to provide us with certain discretionary investment management services. We have agreed to pay investment management fees based on the market values of the investments in the portfolio. The fees, which vary depending on the amount of assets under management, are included as a deduction to net investment income. These investment management agreements may generally be terminated by either party upon 30 days prior written notice.

Our Portfolio

Composition as of December 31, 2013

As of December 31, 2013, we had total investments and cash and cash equivalents of $8.4 billion, including restricted cash, fixed-maturity securities, equity securities, hedge fund, private equity investments and other securities. The average credit quality of our investments is rated AA- by Standard & Poor’s and Aa3 by Moody’s. Short-term instruments must be rated a minimum of A-1, F-1 or P-1 by Standard & Poor’s, Moody’s or Fitch. The target duration range is 1.00 to 4.25 years. The portfolio has a total return rather than income orientation. The average duration of our investment portfolio was 2.4 years as of December 31, 2013.

 

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The following table shows the types of securities in our portfolio, their fair market values, average rating and portfolio percentage as of December 31, 2013.

 

     Fair Value      Average
Rating
(S&P)
     Portfolio
Percentage
 
     ($ in millions)  

Type of Investment

        

Cash and cash equivalents

   $ 681.3         AAA         8.1

U.S. government securities

     1,370.1         AA+         16.3

U.S. government agencies

     306.7         AA+         3.7

Non-U.S. government and government agencies

     191.8         AA+         2.3

State, municipalities and political subdivisions

     231.6         AA         2.8

Mortgage-backed securities:

        

Agency mortgage-backed securities

     725.5         AA+         8.6

Non-agency residential mortgage-backed securities

     54.7         BBB+         0.7

Non-agency mortgage-backed securities (non-investment grade strategy)

     221.1         B-         2.6

Commercial mortgage-backed securities

     291.2         AA+         3.5
  

 

 

       

 

 

 

Total mortgage-backed securities

     1,292.5            15.4

Corporate securities:

        

Financial institutions

     958.8         A         11.4

Industrials

     1,174.0         BBB         14.0

Utilities

     69.4         BBB         0.8
  

 

 

       

 

 

 

Total corporate securities

     2,202.2            26.2

Asset-backed securities:

        

Credit card receivables

     20.9         AAA         0.2

Automobile loan receivables

     18.5         AAA         0.2

Student loan receivables

     151.5         AA+         1.8

Collateralized loan obligations

     251.2         AA-         3.0

Other

     63.7         AA+         0.8
  

 

 

       

 

 

 

Total asset-backed securities

     505.8            6.0

Other invested assets:

        

Private equity funds

     216.8         N/A         2.6

Hedge funds

     515.3         N/A         6.1

Other private securities

     147.3         N/A         1.8

High yield loan fund

     32.0         N/A         0.4
  

 

 

       

 

 

 

Total other invested assets

     911.4            10.9

Equity securities

     699.8         N/A         8.3
  

 

 

       

 

 

 

Total investment portfolio

   $ 8,393.2            100.0
  

 

 

       

 

 

 

For more information on the securities in our investment portfolio, please see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Fair Value of Financial Instruments”.

 

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Ratings as of December 31, 2013

The investment ratings (provided by Standard & Poor’s and Moody’s) for fixed-maturity securities held as of December 31, 2013 and the percentage of our total fixed-maturity securities they represented on that date were as follows:

 

     Fair Value      Percentage
of Total
Fair Value
 
     ($ in millions)  

Ratings

     

U.S. government and government agencies

   $ 1,676.8         27.5

AAA/Aaa

     755.4         12.4

AA/Aa

     1,458.4         23.9

A/A

     1,022.3         16.8

BBB/Bbb

     533.2         8.7

BB/Bb

     195.7         3.2

B/B

     329.3         5.4

CCC+ and below

     129.7         2.1
  

 

 

    

 

 

 

Total

   $ 6,100.8         100.0
  

 

 

    

 

 

 

Maturity Distribution as of December 31, 2013

The maturity distribution for our fixed-maturity securities held as of December 31, 2013 was as follows:

 

     Fair Value      Percentage
of Total
Fair Value
 
     ($ in millions)  

Maturity

     

Due within one year

   $ 838.8         13.7

Due after one year through five years

     2,698.8         44.2

Due after five years through ten years

     697.8         11.5

Due after ten years

     67.0         1.1

Mortgage-backed

     1,292.5         21.2

Asset-backed

     505.9         8.3
  

 

 

    

 

 

 

Total

   $ 6,100.8         100.0
  

 

 

    

 

 

 

Investment Returns for the Year Ended December 31, 2013

Our investment returns for year ended December 31, 2013 ($ in millions):

 

Net investment income

   $ 157.6   

Net realized investment gains

     59.5   
  

 

 

 

Total net investment return

   $ 217.1   
  

 

 

 

Total financial statement portfolio return(1)

     2.6

Effective annualized yield(2)

     1.9

 

(1) Total financial statement portfolio return for our investment portfolio is calculated by dividing total net investment return by the average of the beginning and ending market values of our invested assets adjusted for external cash flows.

 

(2) Effective annualized yield is calculated by dividing net investment income by the average balance of aggregate invested assets, on an amortized cost basis.

 

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Our Principal Operating Subsidiaries

Allied World Assurance Company, Ltd is a registered Class 4 Bermuda insurance and reinsurance company that began operations in November 2001. It carries on business from its offices in Bermuda and from branch offices licensed in Hong Kong and Singapore, as well as under its license from Labuan. Allied World Assurance Company (Europe) Limited was incorporated as a wholly-owned subsidiary of Allied World Assurance Holdings (Ireland) Ltd and has been approved to carry on business in the E.U. from its office in Dublin, Ireland since October 2002 and from a branch office in London, England since May 2003 and a branch office in Zug, Switzerland since October 2008. Since its formation, Allied World Assurance Company (Europe) Limited has written business primarily originating from Dublin, Ireland, the United Kingdom and Continental Europe. We include the reinsurance business produced by Allied World Assurance Company (Europe) Limited in our international insurance segment (other than reinsurance business written through its Swiss branch office) even though the majority of coverages are structured as facultative reinsurance. Allied World Assurance Company, AG is a direct subsidiary of Holdings which was formed in Switzerland in May 2010 and licensed by the Swiss Financial Market Supervisory Authority (“FINMA”) to write insurance and reinsurance from our office in Zug, Switzerland and approved to operate a branch from our office in Bermuda.

We write direct insurance in the United States primarily through four subsidiaries, Allied World Assurance Company (U.S.) Inc. and Allied World National Assurance Company, which we acquired in July 2002, and Darwin National Assurance Company and Darwin Select Insurance Company, which we acquired in October 2008. These companies are authorized or eligible to write insurance on both a surplus lines and admitted basis throughout the United States. In February 2008, we also acquired a fully licensed subsidiary which we operated as Allied World Reinsurance Company until late 2012, when it was renamed Allied World Insurance Company. It offers primarily reinsurance, although it also writes direct insurance. Lastly, Allied World Reinsurance Management Company was formed in Delaware in February 2012. It is licensed to write as a managing general underwriter for our U.S. reinsurance business.

The activities of AWAC Services Company (Bermuda), Ltd, AWAC Services Company (Ireland) Limited and AWAC Services Company are limited to providing certain administrative services to various subsidiaries of Holdings. During 2010, we formed a new subsidiary, 2232 Services Limited, in the United Kingdom in order to administratively support the operations of Syndicate 2232 at Lloyd’s. Allied World Financial Services, Ltd and Allied World Financial Services, Inc. were incorporated in Bermuda and Delaware, respectively, during 2012 to engage in investment transactions intended to complement our core property and casualty business.

Our Employees

As of February 3, 2014, we had a total of 940 full-time employees. We believe that our employee relations are good. No employees are subject to collective bargaining agreements.

Regulatory Matters

General

Our insurance and reinsurance subsidiaries must comply with many laws and regulations in the countries where we operate and where we sell our products. Compliance obligations are increasing in most jurisdictions as the focus on insurance regulatory controls has escalated in recent years, with particular emphasis on regulation of solvency, risk management and controls.

Group Supervision

The Bermuda Monetary Authority (“BMA”) acts as the group supervisor for Allied World Assurance Company, Ltd, our lead insurance and reinsurance subsidiary which has been named the “designated insurer” for group supervisory purposes. In accordance with the Group Supervisory and Insurance Group Solvency Rules effective in January 2012, Allied World Assurance Company, Ltd is required to prepare and submit annual group U.S. GAAP financial statements, annual group statutory financial statements, annual group statutory financial and capital returns, and unaudited quarterly returns.

 

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Bermuda

As a Bermuda company, Allied World Assurance Company, Ltd is subject to the Bermuda Insurance Act 1978 (the “Insurance Act”) and is registered as a Class 4 insurer with the BMA. The Insurance Act imposes solvency and liquidity standards as well as auditing and reporting requirements on Bermuda insurers and reinsurers, and it empowers the BMA to supervise and investigate the affairs of these companies. There are a number of remedial actions the BMA can take to protect the public interest if it determines that a Bermuda company may become insolvent or that a breach of the Insurance Act or of a registration condition has or is about to occur.

In addition to maintaining a principal office in Bermuda and appointing specified officers, the following are some significant aspects of the Bermuda regulatory framework:

Solvency and Capital Standards.    Allied World Assurance Company, Ltd must maintain a minimum solvency margin and hold available statutory capital and surplus equal to or exceeding its enhanced capital requirement and target capital level as determined by the BMA under the Bermuda Solvency Capital Requirement model (the “BSCR model”). The BSCR model is a risk-based capital model that establishes an enhanced capital requirement and total capital level by taking into account risk characteristics specific to an insurer’s business. Allied World Assurance Company, Ltd is required to maintain a minimum solvency margin that is equal to the greatest of (1) $100,000,000, (2) 50% of net premiums written, (3) 15% of net losses and loss expense reserves and (4) 25% of its enhanced group capital requirement.

Eligible Capital and Liquidity.    Allied World Assurance Company, Ltd must disclose the makeup of its capital under a “three-tiered capital system,” under which capital instruments are classified as either basic or ancillary capital, and then classified into one of three tiers based on “loss absorbency” characteristics. The maximum of tier 1, 2 and 3 capital that may be used to support a company’s minimum solvency margin, enhanced capital requirement and target capital level are determined in accordance with BMA rules. In addition, minimum liquidity must be maintained at a ratio at least equal to the value of relevant assets at not less than 75% of the amount of relevant liabilities.

Dividends.    Allied World Assurance Company, Ltd is prohibited from declaring or paying a dividend during any financial year if it is, or would be after such dividend, in breach of its minimum solvency margin, minimum liquidity ratio or enhanced capital requirements. It must also receive BMA approval prior to declaring or paying within any financial year dividends of more than 25% of its total statutory capital and surplus or reducing its total statutory capital by 15%. Additionally, under the Companies Act, no Bermuda company may pay a dividend if such company has reasonable grounds for believing that it is, or would after the payment be, unable to pay its liabilities as they become due, or that the realizable value of its assets would thereby be less than its liabilities.

Code of Conduct.    Allied World Assurance Company, Ltd must comply with the Insurance Code of Conduct which prescribes the duties, standards, procedures and sound business principles with which all companies registered under the Insurance Act must comply.

Change of Control.    The BMA also requires written notification from any person who, directly or indirectly, becomes a holder of at least 10% of the voting shares of Allied World Assurance Company, Ltd or its parents within stipulated period after becoming such a holder. The BMA may object to such a person if determined to be not fit and proper to be such a holder or it may require the shareholder to reduce its holdings or voting rights.

Ireland

Following its merger with Allied World Assurance Company (Reinsurance) Limited in November 2013, Allied World Assurance Company (Europe) Limited is authorized as a non-life insurance and reinsurance undertaking regulated by the Central Bank of Ireland (“CBI”) pursuant to the Irish Insurance Acts and Central Bank Acts, as well as statutory instruments relating to insurance made or adopted after the European Communities Acts. In addition, the Third Non-Life Directive of the European Union established a common framework for the authorization and regulation of non-life insurance undertakings within the E.U., permitting

 

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non-life insurance undertakings authorized in one member state to operate in other member states either directly from the home state (on a freedom to provide services basis) or through local branches (by way of permanent establishment). Allied World Assurance Company (Europe) Limited operates branch offices in the United Kingdom and Switzerland and operates on a freedom to provide services basis in other European Union member states.

United States

Our U.S. insurance and reinsurance subsidiaries are admitted or surplus lines eligible in all 50 states and the District of Columbia. Allied World Insurance Company is domiciled in New Hampshire and is the lead U.S. subsidiary for regulatory purposes. Allied World Assurance Company (U.S.) Inc. and Darwin National Assurance Company are each domiciled in Delaware. Darwin Select Insurance Company and Vantapro Specialty Insurance Company are each Arkansas-domiciled.

The regulation of U.S. insurance and reinsurance companies varies by state. Generally, states regulate insurance holding companies to assure the fairness of inter-affiliate transactions, the propriety of dividends paid to corporate parents and the benefits of any proposed change-of-control transaction. States also regulate insurer solvency, accounting matters and risk management, as well as a range of operational matters including: authorized lines of business, permitted investments, policy forms and premium rates, maximum single policy risks, adequacy of reserves for losses and unearned premiums and maintenance of in-state deposits for the benefit of policyholders. To monitor compliance, state departments conduct periodic examinations of the market conduct and financial fitness of insurance companies and require the filing of annual and other reports relating to the financial condition of companies and other matters.

Several of our U.S. companies serve primarily the excess and surplus lines markets and, as such, are subject to somewhat reduced regulation and reporting requirements in the jurisdictions in which they write surplus lines insurance. These companies are generally exempt from form and rate pre-approval requirements and from state guaranty fund laws and involuntary pool participation

Guaranty Fund Assessments and Involuntary Pools.    Virtually all states require admitted insurers to participate in various forms of guaranty associations in order to bear a portion of the losses to insureds caused by the insolvency of other insurers. Assessments are generally between 1% and 2% of the annual premiums written. Many states also require participation in assigned risk pools involving workers compensation and automobile insurance.

Risk-Based Capital.    U.S. insurers are subject to risk-based capital (or “RBC”) guidelines that provide a method to measure the total adjusted capital (statutory capital and surplus plus other adjustments) taking into account the specific risk characteristics of the company’s investments and products. The guidelines establish capital requirements for four categories: asset risk, insurance risk, interest rate risk and business risk. As of December 31, 2013, we believe all of our U.S. subsidiaries had RBC in excess of amounts requiring company or regulatory action.

Lloyd’s

Syndicate 2232 is licensed by Lloyd’s to underwrite certain lines of insurance and reinsurance business. As the Syndicate’s sole corporate member, Allied World Capital (Europe) Limited must comply with Lloyd’s bye laws and the Financial and Services and Markets Act 2000 (“FSMA”). Lloyd’s has various powers and duties under the FSMA and the Lloyd’s Acts to regulate its members’ operations, including minimum solvency standards and requirements as to member management and control. In addition to establishing the capital required to support a syndicate’s annual underwriting capacity (referred to as the “funds at Lloyd’s”), Lloyd’s has discretion to call or assess up to 3% of a member’s underwriting capacity in any one year as a Central Fund contribution.

Our business plan (including the maximum underwriting capacity) for Syndicate 2232 requires annual approval by Lloyd’s. Lloyd’s may require changes to the business plan and may also require additional capital to support an approved business plan. Prior to the closure of any underwriting year, “funds at Lloyd’s” cannot

 

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typically be reduced without the consent of Lloyd’s, and such consent will usually be considered only where a member has surplus “funds at Lloyd’s”. Lloyd’s approval is also required before any person can acquire control of a Lloyd’s managing agent or Lloyd’s corporate member.

Lloyd’s worldwide insurance and reinsurance business is subject to various laws, regulations, treaties and policies of the E.U. as well as each jurisdiction in which it operates. Material changes in governmental requirements or laws could have an adverse effect on Lloyd’s and its member companies, including Allied World Capital (Europe) Limited.

Switzerland

Allied World Assurance Company, AG was licensed by FINMA in 2011 to carry on insurance and reinsurance business in specific non-life lines in Switzerland. It must comply with Swiss insurance supervisory laws under regulations and guidance issued by FINMA, and it is currently required to satisfy capital and solvency requirements, based on two independent methodologies: the E.U.’s Solvency I (solvency margin calculated by applying defined percentages to a base and comparing coverage in terms of the company’s admissible funds against the required solvency margin) and the Swiss Solvency Test (“SST”), which is similar in nature to the methodology to be applied under the E.U.’s Solvency II regime.

In addition to quantitative risk measures, FINMA requires full qualitative governance and control of risk in the firm, including: fitness, propriety and competence of the directors and senior management, observance of ethical standards, objective and appropriate remuneration procedures, management of conflicts of interests, the institution of a compliance function, independence and adequate resourcing of control functions (including the responsible actuary, the risk management function and the internal audit function). Insurance companies are required to implement documented procedures for risk management and internal control.

Other

Allied World Assurance Company, Ltd received regulatory approval to operate branch offices in Hong Kong, Singapore and Labuan, the Malaysian financial district, in March 2009, December 2009 and July 2011, respectively. Also, in connection with the opening in 2012 of a Miami office to service primarily markets in Latin America and the Caribbean, Allied World Insurance Company, Ltd has become registered as a foreign reinsurer in a number of Latin American countries. Darwin National Assurance Company became licensed by the Canadian Office of the Supervisor of Financial Institutions in 2011, in preparation for the opening of its Toronto branch office in 2013.

 

Item 1A. Risk Factors.

Factors that could cause our actual results to differ materially from those in the forward-looking statements contained in this Annual Report on Form 10-K and other documents we file with the SEC include the following:

Risks Related to Our Company

Downgrades or the revocation of our financial strength ratings would affect our standing among brokers and customers and may cause our premiums and earnings to decrease significantly.

Financial strength ratings are important to the competitive position of insurance and reinsurance companies and are subject to periodic revision at the sole discretion of the rating agency. It is therefore possible that the future ratings of one or more of our insurance subsidiaries will not be maintained at current levels. For the financial strength rating of each of our principal operating subsidiaries, please see Item 1. “Business — Our Financial Strength Ratings”.

If any of our insurance subsidiaries’ ratings were revised downward, our competitive position in the insurance and reinsurance industry would likely suffer. That could in turn cause substantial loss of revenue, as some portion of our business would likely move to competitors with higher financial strength ratings. Additionally, reinsurance contracts often contain terms that allow the ceding company to cancel its contract or to

 

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demand additional security if the reinsurer is downgraded below an A- by either A.M. Best or Standard & Poor’s. Any such decision to cancel or demand security would typically depend on the reason for and the extent of the downgrade, the prevailing market conditions and the pricing and availability of replacement reinsurance coverage. Such ratings-related cancellations and/or additional security requirements could materially affect our financial condition and our future operations, resulting in premium returns, the commutation of reserves and the costs of adding collateral. Moreover, if required to do so due to a ratings downgrade, our U.S. reinsurance operations may not have sufficient liquidity to post security as stipulated in such reinsurance contracts.

All Lloyd’s syndicates benefit from Lloyd’s central resources, including the Lloyd’s brand, its network of global licenses and the central fund. Due to the resources potentially available through the Lloyd’s structure, Syndicate 2232 benefits from Lloyd’s high financial strength ratings. Syndicate 2232 would be adversely affected if the Lloyd’s ratings were downgraded from their present levels.

Actual claims may exceed our reserves for losses and loss expenses.

Our success depends on our ability to accurately assess the risks associated with the businesses we insure and reinsure. We establish loss reserves to cover the expected losses and loss expenses with respect to the policies we write, but such reserves represent estimates only and not exact calculations of liability. These estimates are based on actuarial projections and on our assessment of currently available data, including trends in claims severity and frequency, emerging judicial theories of liability and other factors. Loss reserve estimates are refined as experience develops and as claims are reported and resolved. Establishing an appropriate level of loss reserves is an inherently uncertain process. It is therefore possible that our reserves at any given time will prove to be inadequate.

If we conclude that actual losses and loss expenses exceed our expectations and the reserves reflected in our financial statements, we will be required to increase our reserves to reflect our changed expectations. This could cause a material increase in our liabilities and a reduction in our profitability, including operating losses and a reduction of capital. (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reserve for Losses and Loss Expenses” for a discussion of overall changes in reserves during 2012 and 2013.) We have estimated our net losses from catastrophes based on actuarial analyses of claims information received to date, industry modeling and discussions with individual insureds and reinsureds. Accordingly, actual losses may vary from those estimated and will be adjusted in the period in which further information becomes available.

We may experience significant losses and financial volatility due to natural and man-made catastrophes.

We have substantial exposure to losses arising out of natural disasters and man-made catastrophes. Natural disasters include a wide variety of destructive events including earthquakes, hurricanes, tsunamis, volcanic eruptions, tornadoes, droughts and floods among others. Man-made disasters can often be as costly as natural catastrophes and include events such as oil spills and similar environmental disasters, industrial explosions, acts of terrorism, nuclear accidents, political instability and global pandemics. Although the incidence and severity of such events are inherently difficult to predict, the international distribution of our business may subject us to a wider array of catastrophe exposure than similarly-situated carriers that do not have our geographic scope. Additionally, our growing book of international trade credit and political risk insurance exposes us to risks associated with global and regional economic upheaval, sovereign debt concerns and political unrest to a higher degree than other carriers.

The loss experience of catastrophe insurers and reinsurers has historically been characterized as low frequency but high severity in nature. Large scale climate change could increase both the frequency and severity of our loss costs associated with property damage and business interruption due to storms, floods and other weather-related events. Over the long term, climate change could impair our ability to predict the costs associated with future weather events and could also give rise to new environmental liability claims in the energy, manufacturing and other industries we serve. In terms of severity, a combination of inflation-impacted property values and denser concentrations of insured properties have increased the overall severity of catastrophe losses to the industry in recent years, and we expect this trend to continue.

 

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We use industry-recognized catastrophe risk modeling programs to help us quantify our aggregate exposure to any one event. The accuracy of any such model’s predictions is largely dependent on the accuracy and quality of the data provided in the underwriting process and the judgments of our employees and other industry professionals. No model can anticipate every potential peril or catastrophic loss event, and it is particularly difficult for a model to anticipate losses that have not been experienced as a result of prior catastrophes. In addition, there is a possibility that loss reserves established for past catastrophes will be inadequate to cover losses. U.S. GAAP does not permit insurers and reinsurers to reserve for a catastrophe until it occurs, so claims from these events could cause substantial volatility in our financial results for any fiscal period.

Losses from catastrophic events could have a material adverse effect on our financial condition and could also result in downward revisions to our financial strength ratings from the various rating agencies that cover us. Accordingly, we remain exposed to unanticipated contingencies related to natural disasters and man-made catastrophes which could have a material adverse effect on our results of operations.

We may be adversely impacted by inflation due to the long-tail nature of our business.

A significant portion of our business is in long-tail lines (i.e., business lines in which the adjustment and payment of policy claims may not occur until several years after the policy expires). Long-tail insurance lines are inherently more susceptible than short-tail lines to the effects of inflation, because premiums are established long before the ultimate amounts of loss and loss adjustment expense are known. Although we consider inflation’s impact on our ultimate loss and loss adjustment expenses when we set premium rates, our premiums may not fully account for the actual effect of inflation, which would result in our underpricing the risks that we insure and reinsure. If inflation causes our claims costs to exceed the reserves established when policies were written or the claims initially received, the resulting increase to reserves in later periods would decrease such periods’ net income and could have a material adverse effect on financial condition and results of operations.

The failure of any of the loss limitation methods we employ could have a material adverse effect on our financial condition or results of operations.

We seek to limit our loss exposure by, among other things: adhering to limits restrictions on policies written in defined geographical zones and on limits exposed to any single client; adjusting the client’s retained risk levels where appropriate; establishing per-risk and per-occurrence limitations for each event; establishing underwriting guidelines which cover every insurance program written; and purchasing reinsurance. In addition, many of our direct liability insurance policies include maximum aggregate limitations. We cannot assure you that any of these loss limitation methods will be effective. In particular, geographic zone limitations involve significant underwriting judgments, including the determination of the areas of the zones and whether a policy falls within particular zone limits. Also, disputes relating to coverage conditions and choice of legal forum may arise, with the result that provisions of our policies designed to limit our risks may not be enforceable in the manner we intend. For the forgoing reasons, one or more catastrophes or other events could result in claims and expenses that substantially exceed our expectations and could have a material adverse effect on our results of operations.

Turmoil in the U.S. and international financial markets could harm our business, liquidity and financial condition, and our share price.

U.S. debt ceiling and budget deficit concerns, together with adverse sovereign debt conditions in Europe, have increased the possibility of further economic slowdowns. These conditions, including the possibility of a prolonged recession, may adversely affect various aspects of our business, including the demand for and claims made under our products, our counterparty credit risk and the ability of our customers, counterparties and others to establish or maintain their relationships with us. Increased volatility in the U.S. and other securities markets may also adversely affect our ability to access and efficiently use internal and external capital resources, our investment performance and our share price.

 

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We depend on a small number of brokers for a large portion of our revenues. The loss of business provided by any one of them could adversely affect us.

We market our insurance and reinsurance products worldwide through insurance and reinsurance brokers. For the year ended December 31, 2013, our top three brokers were Marsh, Aon (including Benfield Group) and Willis, and they represented approximately 26%, 18% and 12%, respectively, of our total gross premiums. Loss of all or a substantial portion of the business produced by any one of those brokers could have a material adverse effect on our financial condition, results of operations and business.

Our reliance on brokers, program administrators and third-party claims adjusters subjects us to risk.

We transact business through intermediaries, frequently paying insured or reinsured claims through brokers, program administrators or third-party claims adjustment services. If such an intermediary were to fail to pass such a payment through to the claimant or policyholder, we would remain liable for the deficiency because of local laws or contractual obligations. Likewise, when a customer pays its policy premium to a broker or program administrator for further remittance to us, that premium is generally considered to have been paid and the client is no longer liable for such amount even if we do not actually receive the premium. Consequently, we assume a degree of credit risk associated with the intermediaries we use with respect to our insurance and reinsurance business.

In addition, we write a portion of our insurance business under contracts pursuant to which we authorize program administrators to underwrite and bind business on our behalf, within guidelines we prescribe. We rely on controls incorporated in program administration agreements, as well as on the administrator’s internal controls, to limit the risks insured only to those within the prescribed parameters. However, our controls and monitoring efforts may be ineffective, permitting one or more program administrators to exceed underwriting authority and cause us to insure risks outside the agreed upon guidelines. To the extent such administrators exceed their authorities or otherwise breach their obligations to us, our financial condition or results of operations could be materially adversely affected.

We may be unable to purchase reinsurance for our own account on commercially acceptable terms or to collect under any reinsurance we have purchased.

We acquire reinsurance purchased for our own account to mitigate the effects of large or multiple losses on our financial condition. From time to time, market conditions have limited, and in some cases prevented, insurers and reinsurers from obtaining the reinsurance they consider adequate for their business needs. We may be unable to purchase reinsurance in the areas and for the amounts required or desired. Even if reinsurance is generally available, we may not be able to negotiate terms that we deem appropriate or acceptable or to obtain coverage from entities with satisfactory financial resources.

In addition, uncertainty within the financial markets may adversely affect our reinsurers’ and retrocessionaires’ ability to meet their obligations to us. The inability or refusal of such parties to make payments under a reinsurance or retrocession agreement with us could have a material adverse effect on our financial condition and results of operations because we remain liable to the insureds under the corresponding coverages written by us.

Our investment performance may adversely affect our financial performance and ability to conduct business.

Because we derive substantial income from invested assets, our operating results depend in significant part on the performance of our investment portfolio. Volatile conditions in the U.S. and international financial markets have in the past adversely affected our investment portfolio, and such conditions could occur again. Depending on market conditions, we could incur additional losses in future periods which could have a material adverse effect on our financial condition, results of operations and business.

Our investment performance is subject to a variety of risks, including risks related to general economic conditions, market volatility, interest rate fluctuations, lack of liquidity, credit downgrades, default risk and, in

 

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some cases, pre-payment or reinvestment risk. In addition, while we strive to maintain an investment portfolio with instruments rated highly by the recognized rating agencies, there are no assurances that these high ratings will be maintained over time. During the recent past, companies with highly-rated debt have filed for bankruptcy. The assignment of a high credit rating does not preclude the potential for the risk of default on any investment instrument.

Our current Investment Policy Statement permits a limited amount of our investment portfolio to be invested in alternative assets (such as hedge funds and private equity). As a result, we may be subject to redemption restrictions which limit our ability to withdraw funds or realize gains or losses on such investments for some period of time after our initial investment. The values of, and returns on, such investments are also likely to be more volatile than those of our non-alternative portfolio. In addition, investments in hedge funds may involve certain other risks, including the limited operating history of a fund as well as risks associated with the strategies employed by the managers of the fund.

Because losses arising from our insurance or reinsurance business may not flow in a regular or predictable fashion, our liquidity needs could be substantial and may arise at any time. To the extent we are unsuccessful in managing our investment portfolio within the context of our expected liabilities, we may be forced to liquidate our investments at times and prices that are not optimal, or we may have difficulty in liquidating some of our alternative investments due to restrictions on sales, transfers and redemptions noted above. This could have a material adverse effect on the performance of our investment portfolio. If either our need for liquidity or our general liability profile unexpectedly changes, we may not be successful in continuing to structure our investment portfolio in its current manner. In addition, investment losses could significantly decrease our book value, thereby affecting our ability to conduct business.

A material increase in interest rates and/or credit spread levels could result in significant losses in the fair value of our investment portfolio.

Our investment portfolio is comprised largely of fixed-rate instruments the returns on which may be adversely affected by fluctuations in interest rates. Investment income on rate-sensitive securities is generally reduced during sustained lower interest rate periods, as higher-yielding fixed income securities are called by the issuers, or mature or are sold, and their proceeds must be reinvested at lower rates. Conversely, during periods of rising interest rates prices of fixed income securities tend to fall and the ability to realize gains upon their sale is reduced. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control.

We may be unable to effectively mitigate our interest rate sensitivity with the result that a rise in interest rates could result in significant losses, realized or unrealized, in the fair value of our investment portfolio. Such losses could have a material adverse effect on our financial condition and results of operations. Additionally, changes in the credit spread (the difference in the percentage yield) between U.S. Treasury securities and non-U.S. Treasury securities may negatively impact our investment portfolio as we may not be able to effectively mitigate credit spread sensitivity. In particular, a significant increase in credit spreads could result in significant losses, realized or unrealized, in the fair value of our investment portfolio and, consequently, could have a material adverse effect on our financial condition and results of operations.

In addition, our investment portfolio includes material amounts of U.S. government agency and non-agency commercial and residential mortgage-backed securities. (See “Business — Investments: Type of Investment”.) When interest rates decline, mortgage prepayments generally increase and mortgage-backed securities are generally prepaid more quickly, requiring us to reinvest the proceeds at the then current market rates. When interest rates rise, mortgage-backed securities may have lower levels of prepayments, extending their maturity and duration, thereby negatively impacting the security’s price.

Our non-agency commercial and residential mortgage-backed securities are subject to delinquencies, defaults and losses on the underlying mortgage loans. While many of the factors that led to such delinquencies, defaults and losses in the past have moderated in recent years, further deterioration is possible. Delinquencies, defaults and losses with regard to non-agency residential mortgage-backed securities are driven in part by residential property values. A decline or an extended flattening in property values may result in increased

 

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delinquencies, defaults and losses on residential mortgage loans generally, especially with respect to second homes and investor properties, and with respect to any residential mortgage loans where the aggregate loan amounts (including any subordinate loans) are close to or greater than the related property values. This would negatively impact the value of our securities.

Our investment portfolio includes below investment-grade securities that have a higher degree of credit or default risk, which could result in significant losses in the fair value of our investment portfolio.

Our investment portfolio consists primarily of investment grade, fixed maturity securities. However, we invest a smaller portion of the portfolio in below investment-grade securities. (See “Business — Investments: Ratings as of December 31, 2013”.) Additionally, we have recently made investment commitments involving private equity funds and hedge funds. These securities and fund investments, on which we expect to receive higher investment returns, also expose us to a higher degree of credit risk and counterparty default risk. They are also likely to be less liquid in times of economic weakness or market disruptions. During such periods we could experience default losses in our portfolio, which could have a material adverse effect on our financial condition and results of operations.

The valuation of our investments may include methodologies, estimations and assumptions that are subject to differing interpretations and could result in changes to investment valuations that may materially adversely affect our financial condition or results of operations.

During periods of market disruptions, it may be difficult to value certain of our securities if trading becomes less frequent or market data becomes less observable. In addition, certain asset classes which normally trade in active markets with significant observable data may become less liquid during times of financial turmoil. In such cases, the valuation of a greater number of securities in our investment portfolio may require more subjectivity and management judgment. Valuations that are derived from inputs which are less observable or that require greater estimation could result in value determinations that differ materially from the values at which the investments may be ultimately sold. Further, rapidly changing and unpredictable credit and equity market conditions could materially affect the valuation of securities as reported within our consolidated financial statements and the period-to-period changes in value could vary significantly. Decreases in value could have a material adverse effect on our financial condition and results of operations.

We may be adversely affected by fluctuations in currency exchange rates.

A meaningful portion of our insurance and reinsurance contracts are denominated in a currency other than the U.S. dollar, which is the functional currency of all our operating subsidiaries. In addition, we maintain a portion of our investments and liabilities in currencies other than the U.S. dollar. Assets in non-U.S. currencies are generally converted into U.S. dollars at the time of receipt, while liabilities incurred in a non-U.S. currency are carried on our books in the original currency until converted to U.S. dollars at the time of payment. We incur foreign currency exchange gains or losses as we ultimately receive premiums and settle claims in foreign currencies. Among the currencies creating foreign exchange risk for us are the Australian dollar, the Canadian dollar, the British pound sterling and the Euro.

To the extent that we do not adequately hedge our foreign currency risk or our hedges prove ineffective, the impact of a movement in foreign currency exchange rates could adversely affect our financial condition or results of operations. In recent years, the European sovereign debt crisis and related restructuring efforts may have increased the risk of exchange rate volatility.

We may require additional capital in the future that may not be available to us on commercially favorable terms or may require shareholder approval.

Our future capital requirements depend on many factors, including our ability to write new business and to establish premium rates and reserves at levels sufficient to cover losses. To the extent that the funds we receive from insurance premiums and investment income are insufficient to fund our requirements, we may need to raise additional funds through financings or liquidating assets. Financial market volatility in recent years has created

 

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uncertainty in the equity and credit markets, and such uncertainty could affect the ability of insurers and reinsurers to raise additional capital in the public or private markets. Any future financing, if available at all, may be on terms that are not favorable to us. In the case of equity financing, shareholder dilution could result, and the securities issued may have rights, preferences and privileges that are senior or otherwise superior to those of our common shares.

In addition, Swiss law generally prevents us from issuing shares below par value. Therefore, if a need to raise common equity capital arose at a time when the trading price of our shares was below par value, we would need to obtain shareholder approval to decrease the par value of our shares, a requirement that would entail filing a proxy statement with the SEC and convening a meeting of shareholders, which could delay capital raising plans. Further, there is no assurance that we would be able to obtain such shareholder approval. Lastly, a reduction in our shares’ par value may decrease our ability to pay dividends as a repayment of share capital which is not subject to Swiss withholding tax. See “Risks Related to Taxation- We may not be able to make distributions or repurchase shares without subjecting you to Swiss withholding tax”.

Our shareholders are empowered to authorize share capital that can be issued by the Board of Directors without shareholder approval. Under Swiss law and our Articles of Association, this authorization is limited to 20% of our existing registered share capital and must be renewed by the shareholders every two years. Additionally, subject to specified exceptions described in our Articles of Association, Swiss law grants preemptive rights to existing shareholders and provides less flexibility than many U.S. states’ laws in the various terms that can attach to different classes of shares. For example, we will not be able to issue preferred stock without the approval of a majority of the votes cast at a shareholder meeting.

There may be situations where the additional restrictions which Swiss laws and our Articles of Association impose on capital management flexibility could have a material adverse effect on our ability to effectively manage our capital and could also adversely impact our shareholders.

Our business could be adversely affected if we lose any member of our management team or are unable to attract and retain our personnel.

Our success depends in substantial part on our ability to attract and retain the highly qualified employees who have the experience and knowledge necessary to generate and service our business. We rely substantially on the services of our executive management team. If we were to lose the services of any member of our executive management team, our business could be adversely affected. An inability to attract and retain other talented personnel could impede implementation of our business strategy, materially and adversely affecting our business. We currently have written employment agreements with our Chief Executive Officer, Chief Financial Officer, Chief Investment Officer, General Counsel, Chief Actuary and certain other members of our executive management team; however, these agreements will likely need to be revised in light of the New Swiss Regulations discussed below. We do not maintain key man life insurance policies for any of our employees.

Recent changes to Swiss law regarding executive compensation and corporate governance could adversely affect our ability to retain members of our management team or our Board of Directors and our ability to compete for talented employees with other insurance and reinsurance companies domiciled outside of Switzerland.

Recent changes in Swiss law (the “Swiss Ordinance”) became effective as of January 1, 2014, subject to an extended transition period for some requirements. These changes will, among other things, require a binding shareholder approval for the compensation received by our management team and Board of Directors; require our shareholders to approve numerous amendments to our Articles of Association, including approving our compensation practices; prohibit severance payments; restrict the terms of provisions in existing and any future employment agreements; and subject our Board of Directors to criminal sanctions in certain cases for violations of the Swiss Ordinance.

There is significant competition for executive and board talent in the insurance and reinsurance industry, and we compete for such persons with companies that are regulated by the laws of jurisdictions that may provide greater flexibility than Switzerland in terms of compensation and corporate governance practices. The provisions

 

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of the Swiss Ordinance may adversely affect our ability to retain members of our management team and our Board of Directors as well as to compete for talented employees with other insurance and reinsurance companies domiciled outside of Switzerland, all of which could adversely affect our business.

Employee error and misconduct may be difficult to detect and prevent and could adversely affect our business, results of operations and financial condition.

We may experience losses from, among other things, fraud, errors, failure to document transactions properly or to obtain proper internal authorization or failure to comply with regulatory or legal requirements. In particular, one or more of our employees, officers or agents may violate our internal policies concerning compliance with the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act of 2010 or the anti-bribery laws in other countries. Such violations could entail severe penalties for improper payments for the purpose of obtaining or retaining business or gaining a commercial advantage. It is not always possible to deter or prevent employee misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Losses related to employee error or misconduct could adversely affect our financial condition, results of operations and business.

If we experience difficulties with our information technology and telecommunications systems and/or data security, our ability to conduct our business might be adversely affected.

We rely heavily on the successful, uninterrupted functioning of our information technology (“IT”) and telecommunications systems. Our ongoing business and continued expansion are highly dependent upon our ability to perform, efficiently and without interruption, necessary business functions. A prolonged failure of our IT and/or telecommunication systems or the termination of certain of our third-party software licenses could materially impact our ability to write and service our business or perform other necessary actuarial, legal, financial and administrative functions. Computer viruses, hackers and other external hazards, as well as internal exposures such as potentially dishonest employees, could expose our IT and data systems to security breaches that may result in liability to us, cause our data to be corrupted and cause us to commit resources, management time and money to prevent or correct security breaches. Some of our key business partners rely on our systems for critical underwriting and administration functions, and interruption and/or failure of these systems could cause significant liability to them. If we do not maintain adequate IT and telecommunications systems, we could experience adverse consequences, including inadequate information on which to base critical decisions, the loss of existing customers, difficulty in attracting new customers, litigation exposures and increased administrative expenses. As a result, our ability to conduct our business might be adversely affected.

The integration of acquired companies, the growth of operations through new lines of business, the expansion into new geographic regions and/or the entering into joint ventures may expose us to operational risks.

Acquisitions involve numerous risks, including operational, strategic and financial risks such as potential liabilities associated with the acquired business. We may experience difficulties in integrating an acquired company, which could adversely affect the acquired company’s performance or prevent us from realizing anticipated synergies, cost savings and operational efficiencies. Our existing businesses could also be negatively impacted by acquisitions. Expanding our lines of business, expanding our geographic reach and entering into joint ventures or partnerships also involve operational, strategic and financial risks, including retaining qualified management and implementing satisfactory budgetary, financial and operational controls. Our failure to manage successfully these risks may adversely affect our financial condition, results of operations or business, or we may not realize any of the intended benefits.

Risks Related to the Insurance and Reinsurance Business

The insurance and reinsurance business is historically cyclical, with periods of excess underwriting capacity and unfavorable premium rates and policy terms.

Insurers and reinsurers tend to experience significant cyclicality in operating results due to fluctuating levels of competition and underwriting capacity, catastrophic events, general economic conditions and other factors. The supply of insurance and reinsurance is related to prevailing prices, the level of insured losses and the amount

 

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of industry surplus which, in turn, responds to changes in the investment returns earned by insurers and reinsurers. Catastrophic events, which are inherently unpredictable, can affect the subsequently prevailing market prices for certain products. As a result of these factors, the insurance and reinsurance business historically has been characterized by periods of intense competition on price and policy terms (due to excessive underwriting capacity) as well as periods when capacity shortages permit favorable premium rates and policy terms. Increased supply of insurance and reinsurance may have adverse consequences for us, including fewer policies and contracts written, lower premium rates, increased expenses for customer acquisition and retention and less favorable policy terms and conditions.

Increased competition in the insurance and reinsurance markets in which we operate could adversely impact our operating margins.

The insurance and reinsurance industry is highly competitive, and many of our competitors in the U.S. and international markets have greater financial, marketing and management resources than we do. We also compete with new companies that continue to be formed to enter the insurance and reinsurance markets.

In addition, risk-linked securities and other non-traditional risk transfer mechanisms are being offered by non-insurance entities, and the availability of such products could reduce the demand for traditional insurance and reinsurance. New competition arising from these developments could result in fewer contracts written, lower premium rates, increased expenses for customer acquisition and retention and less favorable policy terms and conditions, which could have a material adverse effect on our growth, financial condition or results of operations.

For our reinsurance business, ceding companies may fail to accurately assess the risks they underwrite which may lead us to inaccurately assess the risks we assume.

Reinsurance underwriting success depends in part on the policies, procedures and expertise of the ceding companies making the original underwriting decisions. Underwriting is a matter of judgment, and we face the risk that the ceding companies may fail to accurately assess the risks they underwrite, which, in turn, may lead us to inaccurately assess the risks we assume as reinsurance. If this occurs, the premiums that are ceded to us may not adequately compensate us and we could face significant losses on these reinsurance contracts.

The effects of emerging claims and coverage issues on our business are uncertain.

As legal, judicial, social and other conditions change, unexpected and unintended issues may adversely affect our business, either by extending coverage beyond underwriting intent or by increasing the number or size of claims. Such changes may not become apparent until sometime after we have issued insurance or reinsurance contracts that are affected by the changes. Consequently, the full extent of liability under our insurance and reinsurance contracts may not be known for many years after a contract is issued. Examples of emerging claims and coverage issues include:

 

   

larger defense costs, settlements and jury awards in cases involving professionals and corporate directors and officers covered by professional liability and directors and officers liability insurance; and

 

   

a trend of plaintiffs targeting property and casualty insurers in class action litigation related to claims handling, insurance sales practices and other practices related to the conduct of our business.

The availability and cost of reinsurance security arrangements may materially impact our ability to provide reinsurance from Bermuda to insurers domiciled in the United States.

Allied World Assurance Company, Ltd, our Bermuda insurance and reinsurance company, is not accredited as a reinsurer in any U.S. jurisdiction. As a result of its non-accredited status, it is generally required to post collateral with respect to reinsurance liabilities it assumes in order that its U.S.-domiciled cedents may obtain full credit on their statutory financial statements with respect to the reinsurance liabilities due from Allied World Assurance Company, Ltd. Such collateral may be in the form of letters of credit, reinsurance trusts or funds-withheld arrangements where assets are held by the ceding company. Allied World Assurance Company, Ltd uses trust accounts and has access to up to $1.45 billion in letters of credit under two letter of credit facilities.

 

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Access to our existing letter of credit facilities depends on our compliance with agreed-upon covenants and on the ability of the banks to meet their commitments. Our $1 billion letter of credit facility with Citibank Europe plc is on an uncommitted basis, which means the bank has agreed to offer us up to $1 billion in letters of credit, but they are not contractually obligated for that full amount. Our $450 million syndicated letter of credit facility expires in June 2016. If such facilities are not sufficient or drawable or if Allied World Assurance Company, Ltd is unable to renew either facility or to arrange for trust accounts or other types of security on commercially acceptable terms, the amount of reinsurance it is able to provide to U.S.-domiciled insurers may be reduced, which could have a material adverse effect on our business and results of operations.

Risks Related to Laws and Regulations Applicable to Us

Compliance with the legal and regulatory requirements to our insurance subsidiaries are subject is expensive. Any failure to comply could have a material adverse effect on our business.

We must comply with numerous laws and regulations applicable to insurance or reinsurance companies, both in the jurisdictions where our subsidiaries are organized and also where they sell their insurance and reinsurance products. (See “Business — Regulatory Matters”.) In general, and particularly for offshore insurers and reinsurers, our industry has been subjected to increased regulatory scrutiny over the past decade. Recent U.S. Congressional initiatives (as yet unadopted) have looked toward increased regulation of the domestic insurance industry. The impact of changes in laws and regulations on our future operations could be substantial, and the cost of complying with new legal requirements could have a material adverse effect on our business.

Our subsidiaries may not always be able to obtain or maintain necessary licenses, authorizations or accreditations, or they may be unable to fully comply with or gain exemption from laws and regulations applicable to them. An inability to comply with applicable laws or regulations could restrict our business in jurisdictions where we now operate or where we plan to operate. In addition, noncompliance with applicable laws could result in fines or other sanctions, any of which could have a material adverse effect on our business.

Our Bermuda operating company could become subject to regulation in the United States.

Allied World Assurance Company, Ltd, our Bermuda operating company is not admitted as an insurer, nor accredited as a reinsurer, in any jurisdiction in the United States. However, a majority of its gross premiums written each year is derived from policies or treaties with entities domiciled in the United States. Each state in the United States regulates the sale of insurance and reinsurance by foreign insurers. Allied World Assurance Company, Ltd conducts its business through its Bermuda office and maintains no office and no personnel in the United States. While we believe our Bermuda subsidiary is not violating any state law or regulation, we cannot be certain that inquiries or challenges to our insurance and reinsurance activities will not be raised in the future. If Allied World Assurance Company, Ltd were to become subject to any laws of this type in the future, we could be unable to comply with the requirements of those laws which could materially affect the amount of business done by our Bermuda subsidiary with U.S. domiciled policyholders.

We may become subject to additional Swiss regulation.

The BMA currently exercises group supervisory authority over our insurance companies. (See “Business — Regulatory Matters — Group Supervision”). In 2009, we received non-binding written confirmation from the Swiss regulator, FINMA, that it will not subject us to group supervision based primarily on the fact that most of our senior management do not reside in Switzerland. We cannot assure you that our future business needs may not require us to have a greater management presence in Switzerland or that FINMA will not otherwise determine to exercise group supervision over us. If subjected to group supervision by FINMA, there could be additional costs and administrative obligations as well as a substantial impact on our organizational and operational flexibility.

 

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Our holding company structure and regulatory and other constraints affect our ability to pay dividends and make other payments.

Allied World Switzerland, our ultimate parent company, is a holding company that has no substantial operations of its own nor any significant assets other than its ownership of its direct and indirect subsidiaries. Dividends and other permitted distributions from subsidiaries are expected to be the sole source of funds for Allied World Switzerland to meet any ongoing cash requirements and to pay any dividends to shareholders. In addition, we have insurance subsidiaries that are the parent companies for other insurance subsidiaries, such that dividends will be subject to multiple layers of the regulations discussed below, as funds are distributed to our ultimate parent company. The inability of our insurance subsidiaries to pay dividends in an amount sufficient to enable Allied World Switzerland to meet its cash requirements could have a material adverse effect on our business, our ability to transfer capital from one subsidiary to another and our ability to declare and pay dividends to our shareholders. Furthermore, Allied World Bermuda has senior notes outstanding and an inability of any of its insurance subsidiaries to pay dividends could impact its ability to make payments on the outstanding senior notes, which could have a material adverse effect on our business.

Swiss Law

Under Swiss law, dividends may be paid out only if we have sufficient distributable profits from previous fiscal years or if we have legal reserves, each as presented on Holdings’ audited statutory financial statements. Payments out of the share capital (in other words, the aggregate par value of our share capital) in the form of dividends are not allowed; however, payments out of share capital may be made by way of a capital reduction to achieve a similar result as the payment of dividends. The affirmative vote of shareholders holding a majority of the votes cast at a shareholder meeting must approve reserve reclassifications and distributions of dividends; our Board of Directors cannot itself authorize the dividend. Under Swiss law, upon satisfaction of all legal requirements, we will be required to submit an application to the Swiss Commercial Register to register each applicable par value reduction. Without effective registration of the appropriate documentation with the Swiss Commercial Register, we will not be able to proceed with the payment of any installment of such dividend. We cannot assure you that the Swiss Commercial Register will approve the registration of any applicable par value reduction.

Under Swiss law, if our general capital reserves amount to less than 20% of the share capital recorded in the Swiss Commercial Register (i.e., 20% of the aggregate par value of our capital), then at least 5% of our annual profit must be retained as general reserves. In addition, Swiss law requires that we create a special reserve on Holdings’ audited statutory financial statements in the amount of the purchase price of common shares we or any of our subsidiaries repurchases, which amount may not be used for dividends.

Swiss companies generally must maintain separate audited statutory financial statements for the purpose of, among other things, determining the amounts available for the return of capital to shareholders, including by way of a distribution of dividends. Amounts available for the return of capital as indicated on Holdings’ audited statutory financial statements may be materially different from amounts reflected in our consolidated U.S. GAAP financial statements. Our auditor must confirm that a dividend proposal made to shareholders complies with Swiss law and our Articles of Association.

We are required under Swiss law to declare any dividends and other capital distributions in Swiss francs. We have made and intend to continue to make any dividend payments to holders of our common shares in U.S. dollars. Continental Stock Transfer & Trust Company, our transfer agent, will be responsible for paying the U.S. dollars to registered holders of our common shares, less amounts subject to withholding for taxes. As a result, shareholders may be exposed to fluctuations in the U.S. dollar-Swiss franc exchange rate between the date used for purposes of calculating the Swiss franc amount of any proposed dividend or par value reduction and the relevant payment date.

Bermuda Law

Without BMA approval, Allied World Assurance Company, Ltd is prohibited from paying dividends of more than 25% of its total statutory capital and surplus (as shown in its previous year-end statutory balance

 

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sheet) and may not pay any dividend if it failed to meet minimum solvency and liquidity criteria as of the prior year-end. Further, reduction of total statutory capital by 15% or more would require the prior approval of the BMA. In addition, Bermuda corporate law prohibits declaration or payment of a dividend whenever there are reasonable grounds for believing that (i) the company is, or would after the payment be, unable to pay liabilities as they become due; or (ii) the realizable value of the company’s assets would thereby be less than the aggregate of its liabilities, its issued share capital and its share premium accounts.

U.S. and Irish Law

A U.S. insurance company may not pay an “extraordinary” dividend unless the applicable insurance regulator has approved (or not objected) to such action upon its receipt of 30-day prior notice. In general, an “extraordinary” dividend is defined as a dividend that, together with other dividends made within the preceding 12 months, exceeds the greater (or, in some jurisdictions, the lesser) of: (a) 10% of the insurer’s statutory surplus as of the immediately prior year end; or (b) or the statutory net income during the prior calendar year. Regulators could also prohibit the payment of ordinary dividends by our U.S. insurance subsidiaries (or other payments, such as under a tax sharing agreements or for employee or other services) if they determine that such payment could be adverse to such subsidiaries’ policyholders. In Ireland, the CBI must consent to any action by Allied World Assurance Company (Europe) Limited to reduce the level of its capital, to pay any dividend, to make any inter-company loan or which would cause it to fall below a minimum solvency margin. These rules and regulations may have the effect of restricting the ability of these companies to declare and pay dividends.

Effectiveness of the Affordable Care Act in the United States could have a material impact on our business.

Our U.S. insurance segment and our international insurance segment derive substantial revenues from healthcare liability underwriting, that is, insuring professionals and institutions that participate in the U.S. healthcare delivery infrastructure. Much of the U.S. healthcare reform legislation, the Affordable Care Act, becomes effective in 2014 and is likely to effect far-reaching changes in the healthcare delivery system and cost reimbursement structure in the United States. Such changes could negatively impact our healthcare liability business. Additionally, future healthcare proposals could include tort reform provisions under which plaintiffs would be restricted in their ability to bring suit against healthcare providers, which could negatively impact the demand for our healthcare liability products. While the impact of this healthcare legislation or future healthcare proposals on our business is difficult to predict, any material changes in how healthcare providers insure their malpractice liability risks could have a material adverse effect on our results of operations.

Legislative and regulatory initiatives, such as the Dodd-Frank Act in the United States and Solvency II in Europe, could adversely affect our business.

The 2010 Dodd Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) effected sweeping changes to financial services regulation in the United States, including the establishment of a Federal Insurance Office (“FIO”). In December 2013, the FIO issued a report to Congress on recommendations for modernizing regulation of the U.S. insurance industry. The report recommended that in certain respects, and in the short term, the U.S. system of insurance regulation can be modernized through state-based improvements combined with certain federal actions. The report identified areas for direct federal involvement in international standard setting, FIO participation in supervisory colleges which monitor the regulation of large national and internationally active insurance groups and federal pursuit of international “covered agreements” to afford nationally uniform treatment of reinsurance collateral requirements. The report also made several recommendations for state reform of insurance regulation including changes to the state regulation of insurance company solvency, group supervision and corporate governance. The potential impact on our business as a result of the Dodd-Frank Act and the FIO’s current and future recommendations remain unclear; however our financial results could be adversely affected if the FIO’s report results in the creation of federal insurance regulations that constrain our business opportunities or reduce investment flexibility.

In addition to federal developments, the insurance and reinsurance industry is also subject to heavy regulatory scrutiny by state governments and by an increasing number of international authorities. Government regulators are generally concerned with the protection of policyholders to the exclusion of other constituencies,

 

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including shareholders. Authorities in the United States and worldwide show increasing concerns about the potential risks posed by the insurance industry as a whole and about its risks to commercial and financial systems, and these concerns may result in increased regulatory intervention. Some state legislatures have considered or enacted laws that increase regulation of insurance and reinsurance companies and holding companies. Moreover, the National Association of the Insurance Commissioners regularly reexamines and recommends enhancements to existing laws and regulations.

For example, we could be adversely affected by proposals to:

 

   

provide governmental insurance or reinsurance capacity in markets we target;

 

   

require greater participation in industry risk pools and guaranty associations;

 

   

expand the scope of mandated coverage terms under insurance policies;

 

   

revise laws and regulations under which we operate, including a potential change to U.S. tax laws to disallow or limit the current tax deduction for reinsurance premiums paid by our U.S. subsidiaries to our Bermuda insurance subsidiary for reinsurance protections it provides to our U.S. subsidiaries; or

 

   

disproportionately benefit the companies of one country over those of another.

With respect to international measures, the 2009 E.U. directive concerning the capital adequacy, risk management and regulatory reporting for insurers and reinsurers (“Solvency II”) may affect our insurance businesses. In September 2013, the European Insurance and Occupational Pensions Authority (“EIOPA”) published final guidelines for Solvency II preparations, which set out EIOPA’s proposal for the phased introduction of specific Solvency II requirements covering systems of governance, forward looking assessment of the undertaker’s own risk, submission of information to national authorities, and the pre-application of internal models. Full implementation of the Solvency II requirements is currently anticipated at the beginning of 2016, and compliance with its capital and solvency margin requirements may lead to an increase of the capital required by our E.U. domiciled insurer. Solvency II provides for the supervision of insurers and reinsurers on both a solo (entity level) and group basis. (See Item 1. “Business—Regulatory Matters-Group Supervision”.) In respect of our non-E.U. subsidiaries engaging in E.U. insurance or reinsurance business, should the regulatory regime in which they are operating not be deemed equivalent to that established within the E.U. pursuant to Solvency II, additional capital requirements may be imposed in order that such companies may continue to insure or reinsure E.U. domiciled risk/cedents.

We are unable to predict the future impact on our operations of changes in the laws and regulations to which we are or may become subject. Moreover, our exposure to potential regulatory initiatives could be heightened by the fact that our principal insurance subsidiary is domiciled in Bermuda. For example, as a small jurisdiction, Bermuda may be disadvantaged in participating in global or cross-border regulatory matters as compared with larger jurisdictions such as the United States or the leading E.U. countries. In addition, Bermuda is currently an overseas territory of the United Kingdom but may consider changes to such status in the future. These changes could adversely affect Bermuda’s position with respect to its regulatory initiatives, which could adversely impact us commercially.

Changes in current accounting practices and future pronouncements may materially impact our reported financial results.

Developments in accounting practices, for example a convergence of U.S. GAAP with International Financial Reporting Standards, or IFRS, may require considerable additional expense to comply with, particularly if we are required to prepare information relating to prior periods for comparison purposes or to apply the new requirements retroactively. The impact of changes in current accounting practices and future pronouncements cannot be predicted, but may affect the results of our operations, including among other things, the calculation of net income.

 

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Risks Related to Ownership of Our Common Shares

Future sales of our common shares may adversely affect the market price.

As of February 3, 2014, we had 33,284,136 common shares outstanding. Up to an additional 1,278,386 common shares may be issuable upon the vesting and exercise of outstanding stock options, restricted stock units (“RSUs”) and performance-based equity awards. We have filed registration statements on Form S-8 under the Securities Act of 1933, as amended (the “Securities Act”) to register common shares issued or reserved for issuance under our equity incentive plans and our Amended and Restated Employee Share Purchase Plan, and additional share registrations may occur in the future. Subject to the exercise of issued and outstanding stock options, shares registered under the registration statements on Form S-8 will be available for sale to the public. We cannot predict what effect, if any, future sales of our common shares, or the availability of common shares for future sale, will have on the market price of our common shares. Sales of substantial amounts of our common shares in the public market, or the perception that such sales might occur, could depress the shares’ market price and may make it more difficult for you to sell your shares at a time and price that you deem appropriate.

Our Articles of Association contain restrictions on voting, ownership and transfers of our common shares.

Our Articles of Association generally provide that shareholders have one vote for each common share held by them and are entitled to vote at all meetings of shareholders. However, the voting rights exercisable by a shareholder may be limited so that certain persons or groups are not deemed to hold 10% or more of the voting power conferred by our common shares. These provisions could reduce the voting power of some shareholders who would not otherwise be subject to the limitation by virtue of their direct share ownership. Our Board of Directors may refuse to register any holder of shares as a shareholder with voting rights based on certain grounds, including if the holder would, directly or indirectly, formally, constructively or beneficially own (as described in Articles 8 and 14 of our Articles of Association) or otherwise control voting rights with respect to 10% or more of our registered share capital recorded in the Swiss Commercial Register. In addition, our Board of Directors shall reject entry of a holder of voting shares as a shareholder with voting rights in the share register or shall decide on such holder’s deregistration when the acquirer or shareholder upon request does not expressly state that it has acquired or holds the voting shares for its own account and benefit. Furthermore, our Board of Directors may cancel, with retroactive application, the registration of a shareholder with voting rights if the initial registration was on the basis of false information in the shareholder’s application. Shareholders registered without voting rights may not participate in or vote at our shareholders meetings, but will be entitled to dividends, preemptive rights and liquidation proceeds. Only shareholders that are registered as shareholders with voting rights on the relevant record date are permitted to participate in and vote at a shareholders meeting.

Anti-takeover provisions in our Articles of Association could impede an attempt to replace or remove our directors, which could diminish the value of our common shares.

Our Articles of Association currently make it difficult to replace directors even if the shareholders consider it beneficial to do so, and they could also delay or prevent a change of control that shareholders might consider favorable. For example, these provisions may prevent a shareholder from receiving the benefit from any premium over the market price offered by a bidder in a potential takeover. Such provisions can adversely affect the prevailing market price of our shares if viewed as discouraging management changes and/or takeover attempts.

The following Articles, among others, could have such an effect: reduced voting power for shareholders owning 10% or more of our total shares; and discretion by our directors to decline registration of a shareholder as a shareholder-with-voting-rights to the extent such shareholder owns or otherwise controls (alone or together with others) 10% of our total voting rights or if such shareholder refuses to confirm to us that it has acquired the voting shares for its own account and benefit.

Moreover, our Board of Directors has the power until May 3, 2014 to issue a number of voting shares up to 20% of our share capital registered in the Swiss Commercial Register and to limit or withdraw the preemptive rights of the existing shareholders in various circumstances.

 

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As a shareholder of our company, you may have greater difficulties in protecting your interests than as a shareholder of a U.S. corporation.

Swiss law differs in material respects from laws generally applicable to U.S. corporations and their shareholders. Together with our Articles of Association, these Swiss law differences may result in your having greater difficulties protecting your interests as a shareholder of our company than you would as a shareholder of a U.S. corporation. Among other things, such differences impact the ability to void transactions involving an interested director as well as the ability to hold an interested director accountable for benefits realized in a transaction with our company. Also affected by Swiss law are what approvals may be required for business combinations by our company with a large shareholder or a wholly-owned subsidiary, what rights a shareholder has to enforce specified provisions of Swiss corporate law or our Articles of Association, shareholder rights to bring class action and derivative lawsuits and the circumstances under which we may indemnify our directors and officers.

Furthermore, certain of our directors and officers reside outside the United States, and all or a substantial portion of our assets and the assets of such persons are located in jurisdictions outside the United States. As such, it may be difficult or impossible to effect service of process within the United States upon Holdings or upon its non-U.S. management or to recover against us or them on judgments of U.S. courts, including judgments predicated upon civil liability provisions of the U.S. federal securities laws.

We have been advised by Swiss counsel, that there is doubt as to whether the courts in Switzerland would enforce judgments of U.S. courts obtained in actions against us or our directors and officers, predicated upon the civil liability provisions of the U.S. federal securities laws or original actions brought in Switzerland against us or such persons predicated solely upon U.S. federal securities laws. Further, we have been advised by Swiss counsel that there is no treaty in effect between the United States and Switzerland providing for the enforcement of judgments of U.S. courts. Some remedies available under the laws of U.S. jurisdictions, including some remedies available under the U.S. federal securities laws, may not be allowed in Swiss courts as contrary to that jurisdiction’s public policy. Because judgments of U.S. courts are not automatically enforceable in Switzerland, it may be difficult for investors to recover against us based upon such judgments.

There are regulatory limitations on the ownership and transfer of our common shares.

Regulatory constraints may make it difficult for persons or groups to acquire a large block of our common shares, if such ownership is viewed as indirect control over our operating insurance subsidiaries. The BMA must approve all issuances and transfers of securities of Bermuda exempted companies. Before any person acquires 10% or more of the voting shares, either directly or indirectly, of any of our U.S. insurance subsidiaries, that shareholder must file an acquisition statement with and obtain prior approval from the domiciliary insurance commissioner of the respective company. Similar provisions apply to our Lloyd’s corporate member.

Risks Related to Taxation

U.S. taxation of our non-U.S. companies could materially adversely affect our financial condition and results of operations.

We believe that our non-U.S. companies, including our Swiss, Bermuda and Irish companies, have operated and will operate their respective businesses in a manner that will not cause them to be subject to U.S. tax (other than certain U.S. federal excise and withholding taxes) on the basis that none of them are engaged in a U.S. trade or business. However, there are no definitive standards under current law as to those activities that constitute a U.S. trade or business and the determination of whether a non-U.S. company is engaged in a U.S. trade or business is inherently factual. Therefore, we cannot assure you that the U.S. Internal Revenue Service (the “IRS”) will not contend that a non-U.S. company is engaged in a U.S. trade or business. If any of the non-U.S. companies is engaged in a U.S. trade or business and does not qualify for benefits under the applicable income tax treaty, such company may be subject to U.S. federal income taxation at regular corporate rates on its premium income from U.S. sources and investment income that is effectively connected with its U.S. trade or business. In addition, a U.S. federal branch profits tax at the rate of 30% may be imposed on the earnings and

 

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profits attributable to such income. All of the premium income from U.S. sources and a significant portion of investment income of such company, as computed under Section 842 of the Code, requiring that a foreign company carrying on a U.S. insurance or reinsurance business have a certain minimum amount of effectively connected net investment income, determined in accordance with a formula that depends, in part, on the amount of U.S. risks insured or reinsured by such company, may be subject to U.S. federal income and branch profits taxes.

If Allied World Assurance Company, Ltd, our Bermuda insurance subsidiary, or any Bermuda insurance subsidiary we form or acquire in the future is engaged in a U.S. trade or business and qualifies for benefits under the United States-Bermuda tax treaty, U.S. federal income taxation of such subsidiary will depend on whether (i) it maintains a U.S. permanent establishment and (ii) the relief from taxation under the treaty generally applies to non-premium income. We believe that our Bermuda insurance subsidiary has operated and will continue to operate its business in a manner that will not cause it to maintain a U.S. permanent establishment. However, the determination of whether an insurance company maintains a U.S. permanent establishment is inherently factual. Therefore, we cannot assure you that the IRS will not successfully assert that our Bermuda insurance subsidiary maintains a U.S. permanent establishment. In such case, our Bermuda insurance subsidiary will be subject to U.S. federal income tax at regular corporate rates and branch profit tax at the rate of 30% with respect to its income attributable to the permanent establishment. Furthermore, although the provisions of the treaty clearly apply to premium income, it is uncertain whether they generally apply to other income of a Bermuda insurance company. Therefore, if a Bermuda insurance subsidiary of our company qualifies for benefits under the treaty and does not maintain a U.S. permanent establishment but is engaged in a U.S. trade or business, and the treaty is interpreted not to apply to income other than premium income, such subsidiary will be subject to U.S. federal income and branch profits taxes on its investment and other non-premium income as described in the preceding paragraph. In addition, a Bermuda subsidiary will qualify for benefits under the treaty only if more than 50% of its shares are beneficially owned, directly or indirectly, by individuals who are Bermuda residents or U.S. citizens or residents. Our Bermuda subsidiaries may not be able to continually satisfy such beneficial ownership test or be able to establish it to the satisfaction of the IRS.

If any of our Swiss or Irish companies are engaged in a U.S. trade or business and qualify for benefits under the relevant income tax treaty with the United States, U.S. federal income taxation of such company will depend on whether it maintains a U.S. permanent establishment. We believe that each such company has operated and will continue to operate its business in a manner that will not cause it to maintain a U.S. permanent establishment. However, the determination of whether a non-U.S. company maintains a U.S. permanent establishment is inherently factual. Therefore, we cannot assure you that the IRS will not successfully assert that any of such companies maintains a U.S. permanent establishment. In such case, the company will be subject to U.S. federal income tax at regular corporate rates and branch profits tax at the rate of 5% with respect to its income attributable to the permanent establishment.

U.S. federal income tax, if imposed, will be based on effectively connected or attributable income of a non-U.S. company computed in a manner generally analogous to that applied to the income of a U.S. corporation, except that all deductions and credits claimed by a non-U.S. company in a taxable year can be disallowed if the company does not file a U.S. federal income tax return for such year. Penalties may be assessed for failure to file such return. None of our non-U.S. companies filed U.S. federal income tax returns for the 2002 and 2001 taxable years. However, we have filed protective U.S. federal income tax returns on a timely basis for each non-U.S. company for subsequent years in order to preserve our right to claim tax deductions and credits in such years if any of such companies is determined to be subject to U.S. federal income tax.

If any of our non-U.S. companies is subject to such U.S. federal taxation, our financial condition and results of operations could be materially adversely affected.

Our U.S. subsidiaries may be subject to additional U.S. taxes in connection with our interaffiliate arrangements.

Our U.S. subsidiaries reinsure a significant portion of their insurance policies with Allied World Assurance Company, Ltd. While we believe that the terms of these reinsurance arrangements are arm’s length, we cannot

 

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assure you that the IRS will not successfully assert that the payments made by the U.S. subsidiaries with respect to such arrangements exceed arm’s length amounts. In such case, our U.S. subsidiaries will be treated as realizing additional income that may be subject to additional U.S. income tax, possibly with interest and penalties. Such excess amount may also be deemed to have been distributed as dividends to the indirect parent of the U.S. subsidiaries, Allied World Assurance Holdings (Ireland) Ltd, in which case this deemed dividend will also be subject to a U.S. federal withholding tax of 5%, assuming that the parent is eligible for benefits under the United States-Ireland income tax treaty (or a withholding tax of 30% if the parent is not so eligible). If any of these U.S. taxes are imposed, our financial condition and results of operations could be materially adversely affected. In addition, if legislation is enacted in the U.S. that limits or eliminates our ability to enter into interaffiliate arrangements, our financial condition or results of operations could be materially adversely affected.

We may not be able to make distributions or repurchase shares without subjecting you to Swiss withholding tax.

If we are not successful in our efforts to make distributions, if any, through a reduction of par value or pay dividends out of legal reserves, then any dividends paid by us will generally be subject to a Swiss federal withholding tax at a rate of 35%. The withholding tax must be withheld from the gross distribution and paid to the Swiss Federal Tax Administration. A U.S. holder that qualifies for benefits under the Convention between the United States of America and the Swiss Confederation for the Avoidance of Double Taxation with Respect to Taxes on Income may apply for a refund of the tax withheld in excess of the 15% treaty rate (or in excess of the 5% reduced treaty rate for qualifying corporate shareholders with at least 10% participation in our voting shares, or for a full refund in case of qualified pension funds). Payment of a capital distribution in the form of a par value reduction or out of legal reserves is not subject to Swiss withholding tax. However, there can be no assurance that our shareholders will approve such dividends, that we will be able to meet the other legal requirements, or that Swiss withholding rules will not be changed in the future. In addition, over the long term, the amount of par value available for us to use for par value reductions or out of legal reserves will be limited. If we are unable to make a distribution through a reduction in par value or pay a dividend out of legal reserves, we may not be able to make distributions without subjecting you to Swiss withholding taxes.

The repurchase of our shares to be held in treasury will generally not be subject to Swiss withholding tax. However, under Swiss law, we are generally prohibited from holding in treasury an aggregate amount of voting shares and non-voting shares in excess of 10% of our aggregate share capital, which could limit our ability to repurchase our shares in the future.

You may be subject to U.S. income taxation with respect to income of our non-U.S. companies and ordinary income characterization of gains on disposition of our shares under the controlled foreign corporation (“CFC”) rules.

Generally, each “United States shareholder” of a CFC will be subject to (i) U.S. federal income taxation on its ratable share of the CFC’s subpart F income, even if the earnings attributable to such income are not distributed, provided that such “United States shareholder” holds directly or through non-U.S. entities shares of the CFC; and (ii) potential ordinary income characterization of gains from the sale or exchange of the directly owned shares of the non-U.S. corporation. For these purposes, any U.S. person who owns directly, through non-U.S. entities, or under applicable constructive ownership rules, 10% or more of the total combined voting power of all classes of stock of any non-U.S. company will be considered to be a “United States shareholder.” An insurance company is classified as a CFC only if its “United States shareholders” own 25% or more of the vote or value of its stock. Although our non-U.S. companies may be or become CFCs, for the following reasons we believe it is unlikely that any U.S. person holding our shares directly, or through non-U.S. entities, would be subject to tax as a “United States shareholder.”

First, although certain of our principal U.S. shareholders previously owned 10% or more of our common shares, no such shareholder currently owns more than 10%. We will be classified as a CFC only if United States shareholders own 25% or more of our stock; one United States shareholder alone will not be subject to tax on subpart F income unless that shareholder owns 25% or more of our stock or there is at least one other United States shareholder that in combination with the first United States shareholder owns 25% or more of our common

 

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stock. Second, our Articles of Association provide that no individual or legal entity may, directly or through Constructive Ownership (as defined in Article 14 of our Articles of Association) or otherwise control voting rights with respect to 10% or more of our registered share capital recorded in the Swiss Commercial Register and authorize our Board of Directors to refuse to register holders of shares as shareholders with voting rights under certain circumstances. We cannot assure you, however, that the provisions of the Articles of Association referenced in this paragraph will operate as intended or that we will be otherwise successful in preventing a U.S. person from exceeding, or being deemed to exceed, these voting limitations. Accordingly, U.S. persons who hold our shares directly or through non-U.S. entities should consider the possible application of the CFC rules.

You may be subject to U.S. income taxation under the related person insurance income (“RPII”) rules.

Our non-U.S. insurance and reinsurance subsidiaries may currently insure and reinsure and may continue to insure and reinsure directly or indirectly certain of our U.S. shareholders and persons related to such shareholders. We believe that U.S. persons that hold our shares directly or through non-U.S. entities will not be subject to U.S. federal income taxation with respect to the income realized in connection with such insurance and reinsurance prior to distribution of earnings attributable to such income either on the basis (i) that RPII, determined on a gross basis, realized by each non-U.S. insurance and reinsurance subsidiary will be less than 20% of its gross insurance income in each taxable year; or (ii) that at all times during the year U.S. insureds hold less than 20% of the combined voting power of all classes of our shares entitled to vote and hold less than 20% of the total value of our shares. However, the identity of all of our shareholders, as well as some of the factors that determine the extent of RPII in any period, may be beyond our knowledge or control. For example, we may be considered to insure indirectly the risk of our shareholder if an unrelated company that insured such risk in the first instance reinsures such risk with us. Therefore, we cannot assure you that we will be successful in keeping the RPII realized by the non-U.S. insurance and reinsurance subsidiaries or the ownership of us by U.S. insureds below the 20% limit in each taxable year. Furthermore, even if we are successful in keeping the RPII or the ownership of us by U.S. insureds below the 20% limit, we cannot assure you that we will be able to establish that fact to the satisfaction of the U.S. tax authorities. If we are unable to establish that the RPII of any non-U.S. insurance or reinsurance subsidiary is less than 20% of that subsidiary’s gross insurance income in any taxable year, and no other exception from the RPII rules applies, each U.S. person who owns our shares, directly or through non-U.S. entities, on the last day of the taxable year will be generally required to include in its income for U.S. federal income tax purposes that person’s ratable share of that subsidiary’s RPII for the taxable year, determined as if that RPII were distributed proportionately to U.S. holders at that date, regardless of whether that income was actually distributed.

The RPII rules provide that if a holder who is a U.S. person disposes of shares in a foreign insurance corporation that has RPII (even if the amount of RPII is less than 20% of the corporation’s gross insurance income and the ownership of us by U.S. insureds is below 20%) and in which U.S. persons own 25% or more of the shares, any gain from the disposition will generally be treated as a dividend to the extent of the holder’s share of the corporation’s undistributed earnings and profits that were accumulated during the period that the holder owned the shares (whether or not those earnings and profits are attributable to RPII). In addition, such a shareholder will be required to comply with specified reporting requirements, regardless of the amount of shares owned. These rules should not apply to dispositions of our shares because Allied World Assurance Company Holdings, AG is not itself directly engaged in the insurance business and these rules appear to apply only in the case of shares of corporations that are directly engaged in the insurance business. We cannot assure you, however, that the IRS will interpret these rules in this manner or that the proposed regulations addressing the RPII rules will not be promulgated in final form in a manner that would cause these rules to apply to dispositions of our shares.

U.S. tax-exempt entities may recognize unrelated business taxable income (“UBTI”).

A U.S. tax-exempt entity holding our shares generally will not be subject to U.S. federal income tax with respect to dividends and gains on our shares, provided that such entity does not purchase our shares with borrowed funds. However, if a U.S. tax-exempt entity realizes income with respect to our shares under the CFC or RPII rules, as discussed above, such entity will be generally subject to U.S. federal income tax with respect to

 

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such income as UBTI. Accordingly, U.S. tax-exempt entities that are potential investors in our shares should consider the possible application of the CFC and RPII rules.

You may be subject to additional U.S. federal income taxation with respect to distributions on and gains on dispositions of our shares under the passive foreign investment company (“PFIC”) rules.

We believe that U.S. persons holding our shares should not be subject to additional U.S. federal income taxation with respect to distributions on and gains on dispositions of shares under the PFIC rules. We expect that our insurance subsidiaries will be predominantly engaged in, and derive their income from the active conduct of, an insurance business and will not hold reserves in excess of reasonable needs of their business, and therefore qualify for the insurance exception from the PFIC rules. However, the determination of the nature of such business and the reasonableness of such reserves is inherently factual. Furthermore, we cannot assure you, as to what positions the IRS or a court might take in the future regarding the application of the PFIC rules to us. Therefore, we cannot assure you that we will not be considered to be a PFIC. If we are considered to be a PFIC, U.S. persons holding our shares could be subject to additional U.S. federal income taxation on distributions on and gains on dispositions of shares. Accordingly, each U.S. person who is considering an investment in our shares should consult his or her tax advisor as to the effects of the PFIC rules.

Our non-U.K. companies and/or non-Irish companies may become subject to U.K. tax or Irish tax, respectively, which may have a material adverse effect on our results of operations.

Two of our subsidiaries, Allied World Capital (Europe) Limited and 2232 Services Limited, are incorporated in the United Kingdom and, are therefore, subject to tax in the United Kingdom. None of our other companies should be treated as being resident in the United Kingdom for corporation tax purposes unless the central management and control of any such company is exercised in the United Kingdom. The concept of central management and control is indicative of the highest level of control of a company, which is wholly a question of fact. Each of our companies currently intend to manage our affairs so that none of our other companies are resident in the United Kingdom for tax purposes.

A non-U.K. resident company will only be subject to U.K. corporation tax if it carries on a trade in the United Kingdom through a permanent establishment in the United Kingdom. Such a company is, in broad terms, taxable on the profits and gains attributable to the U.K. permanent establishment. Each of our companies, other than Allied World Assurance Company (Europe) Limited (which has an established branch in the United Kingdom), currently intend to operate in such a manner so as not to carry on a trade through a permanent establishment in the United Kingdom. The Allied World Assurance Company (Europe) Limited branch in London constitutes a permanent establishment and the profits attributable to such permanent establishment are subject to U.K. corporation tax. The United Kingdom has no income tax treaty with Bermuda.

In some circumstances companies neither resident in the United Kingdom nor entitled to the protection afforded by a double tax treaty between the United Kingdom and their residency jurisdiction may be exposed to U.K. income tax (other than by deduction or withholding) on income arising in the United Kingdom. However, each of our companies currently operates in such a manner that we expect none to fall within the charge to income tax in the United Kingdom (other than by deduction or withholding) in this respect.

Companies resident in Ireland are generally subject to Irish corporation tax on their worldwide income and capital gains. Other than Allied World Assurance Company (Europe) Limited, AWAC Services Company (Ireland) Limited and Allied World Assurance Holdings (Ireland) Ltd (our “Irish companies”), no Holdings subsidiary should be treated as being resident in Ireland unless the central management and control of any such company is exercised in Ireland. The concept of central management and control is indicative of the highest level of control of a company, and is wholly a question of fact. Our subsidiary companies, other than the Irish companies, currently intend to operate in a manner such that central management and control of each is exercised outside of Ireland. Nevertheless, because central management and control is a question of fact to be determined based on a number of different factors, the Irish Revenue Commissioners might contend successfully that the central management and control of any of our companies is exercised in Ireland, which would subject such company to Irish corporation tax on worldwide income and capital gains.

 

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The trading income of a company not resident in Ireland for Irish tax purposes can also be subject to Irish corporation tax if it carries on a trade through a branch or agency in Ireland. Each of our companies currently intend to operate in a manner such that no company carries on a trade through a branch or agency in Ireland. Nevertheless, because neither case law nor Irish legislation definitively defines the activities that constitute trading in Ireland through a branch or agency, the Irish Revenue Commissioners might contend successfully that any of our companies, other than our Irish companies, is trading through a branch or agency in Ireland. Should this occur, such companies will be subject to Irish corporation tax on profits attributable to that branch or agency.

If any subsidiary, other than our U.K. resident or Irish companies were treated as being resident in the United Kingdom or Ireland, respectively, for corporate tax purposes, or were treated as carrying on a trade in the United Kingdom or Ireland through a branch agency or of having a permanent establishment in such country, results of operations and your investment could be materially adversely affected.

If corporate tax rates in Ireland increase, our business and financial results could be adversely affected.

Trading income derived from the insurance and reinsurance businesses carried on in Ireland by our Irish companies is generally taxed in Ireland at a rate of 12.5%. Over the past number of years, various E.U. Member States have, from time to time, called for harmonization of corporate tax rates within the E.U. Ireland, along with other member states, has consistently resisted any movement towards standardized corporate tax rates in the E.U. The Government of Ireland has also made clear its commitment to retain the 12.5% rate of corporation tax until at least the year 2025. Should, however, tax laws in Ireland change so as to increase the general corporation tax rate in Ireland, our results of operations could be materially adversely affected.

If investments held by our Irish companies are determined not to be integral to the insurance and reinsurance businesses carried on by those companies, additional Irish tax could be imposed and our business and financial results could be adversely affected.

Based on administrative practice, taxable income derived from investments made by our Irish companies is generally taxed in Ireland at the rate of 12.5% on the grounds that such investments either form part of the permanent capital required by regulatory authorities, or are otherwise integral to the insurance and reinsurance businesses carried on by those companies. Our Irish companies intend to operate in such a manner so that the level of investments held by such companies does not exceed the amount that is integral to the insurance and reinsurance businesses carried on by our Irish companies. If, however, investment income earned by our Irish companies exceeds these thresholds, or if the administrative practice of the Irish Revenue Commissioners changes, Irish corporation tax could apply to such investment income at a higher rate (currently 25%) instead of the general 12.5% rate, and our results of operations could be materially adversely affected.

 

Item 1B. Unresolved Staff Comments.

None.

 

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GLOSSARY OF SELECTED INSURANCE AND OTHER TERMS

 

Admitted insurer

An insurer that is licensed or authorized to write insurance in a particular state; to be distinguished from an insurer eligible to write excess and surplus lines insurance on risks located within a jurisdiction.

 

Assumed reinsurance

That portion of a risk that a reinsurer accepts from an insurer in return for a stated premium.

 

Attachment point

The loss point of which an insurance or reinsurance policy becomes operative and below which any losses are retained by either the insured or other insurers or reinsurers, as the case may be.

 

Acquisition costs

Comprised of commissions, brokerage fees and insurance taxes. Commissions and brokerage fees are usually calculated as a percentage of premiums and depend on the market and line of business. Acquisition costs are reported after (1) deducting commissions received on ceded reinsurance, (2) deducting the part of acquisition costs relating to unearned premiums and (3) including the amortization of previously deferred acquisition costs.

 

Acquisition cost ratio

Calculated by dividing “acquisition costs” by “net premiums earned”.

 

Capacity

The maximum percentage of surplus, or the dollar amount of exposure, that an insurer or reinsurer is willing or able to place at risk. Capacity may apply to a single risk, a program, a line of business or an entire portfolio of business. Capacity may be constrained by legal restrictions, corporate restrictions or indirect restrictions.

 

Case reserves

Loss reserves, established with respect to specific, individual reported claims.

 

Casualty lines

Insurance that is primarily concerned with losses due to injuries to persons and liability imposed on the insured for such injury or for damage to the property of others.

 

Catastrophe exposure or event

A severe loss, typically involving multiple claimants. Common perils include earthquakes, hurricanes, tsunamis, hailstorms, severe winter weather, floods, fires, tornadoes, explosions and other natural or man-made disasters. Catastrophe losses may also arise from acts of war, acts of terrorism and political instability.

 

Catastrophe reinsurance

A form of excess-of-loss reinsurance that, subject to a specified limit, indemnifies the ceding company for the amount of loss in excess of a specified retention with respect to an accumulation of losses resulting from a catastrophic event. The actual reinsurance document is called a “catastrophe cover.” These reinsurance contracts are typically designed to cover property insurance losses but can be written to cover other types of insurance losses such as workers’ compensation policies.

 

Cede, cedent, ceding company

When an insurer transfers some or all of its risk to a reinsurer, it “cedes” business and is referred to as the “ceding company” or “cedent.”

 

Combined ratio

Calculated as the sum of the “loss and loss expense ratio”, the “acquisition cost ratio” and the “general and administrative expense ratio”.

 

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Commercial coverage

Insurance products that are sold to entities and individuals in their business or professional capacity, and which are intended for other than the insured’s personal or household use.

 

Coverholder

A Lloyd’s approved service company that is authorized to enter into policies or contracts of insurance and reinsurance to be underwritten by the Lloyd’s syndicate in accordance with the terms of a binding authority or service company agreement.

 

Deductible

The amount of exposure an insured retains on any one risk or group of risks. The term may apply to an insurance policy, where the insured is an individual or business, or a reinsurance contract, where the insured is an insurance company. See “Retention.”

 

Direct insurance

Insurance sold by an insurer that contracts directly with the insured, as distinguished from reinsurance.

 

Directors and officers liability

Insurance that covers liability for corporate directors and officers for wrongful acts, subject to applicable exclusions, terms and conditions of the policy.

 

Earned premiums or Premiums earned

That portion of premiums written that applies to the expired portion of the policy term. Earned premiums are recognized as revenues under both statutory accounting practice and U.S. GAAP.

 

Employment practices liability insurance

Insurance that primarily provides liability coverage to organizations and their employees for losses arising from acts of discrimination, harassment and retaliation against current and prospective employees of the organization.

 

Errors and omissions insurance

Insurance that provides liability coverage for claims arising from professional negligence or malpractice, subject to applicable exclusions, terms and conditions of the policy.

 

Excess and surplus lines

A risk or a part of a risk for which there is no insurance market available among admitted insurers; or insurance written by non-admitted insurance companies to cover such risks.

 

Excess layer

Insurance to cover losses in one or more layers above a certain amount with losses below that amount usually covered by the insured’s primary policy and its self-insured retention.

 

Excess-of-loss reinsurance

Reinsurance that indemnifies the insured against all or a specified portion of losses over a specified amount or “retention.”

 

Exclusions

Provisions in an insurance or reinsurance policy excluding certain risks or otherwise limiting the scope of coverage.

 

Expense ratio

Calculated by adding the “acquisition cost ratio” and the “general and administrative cost ratio”.

 

Exposure

The possibility of loss. A unit of measure of the amount of risk a company assumes.

 

Facultative reinsurance

The reinsurance of all or a portion of the insurance provided by a single policy. Each policy reinsured is separately negotiated.

 

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Fiduciary liability insurance

Insurance that primarily provides liability coverage to fiduciaries of employee benefit and welfare plans for losses arising from the breach of any fiduciary duty owed to plan beneficiaries.

 

Frequency

The number of claims occurring during a specified period of time.

 

General and administrative expense ratio

Calculated by dividing “general and administrative expenses” by “net premiums earned”.

 

General casualty

Insurance that is primarily concerned with losses due to injuries to persons and liability imposed on the insured for such injury or for damage to the property of others.

 

Gross premiums written

Total premiums for insurance and reinsurance written during a given period.

 

Healthcare liability or Healthcare lines

Insurance coverage, often referred to as medical malpractice insurance, which addresses liability risks of doctors, surgeons, nurses, other healthcare professionals and the institutions (hospitals, clinics) in which they practice.

 

Incurred but not reported (“IBNR”) reserves

Reserves established by us for claims that have occurred but have not yet been reported to us as well as for changes in the values of claims that have been reported to us but are not yet settled.

 

In-force

Policies that have not expired or been terminated and for which the insurer remains on risk as of a given date.

 

Limits

The maximum amount that an insurer or reinsurer will insure or reinsure for a specified risk, a portfolio of risks or on a single insured entity. The term also refers to the maximum amount of benefit payable for a given claim or occurrence.

 

Loss development

The difference between the original loss as initially reserved by an insurer or reinsurer and its subsequent evaluation at a later date or at the time of its closure. Loss development occurs because of inflation and time lags between the occurrence of claims and the time they are actually reported to an insurer or reinsurer. To account for these increases, a “loss development factor” or multiplier is usually applied to a claim or group of claims in an effort to more accurately project the ultimate amount that will be paid.

 

Losses incurred

The total losses and loss adjustment expenses paid, plus the change in loss and loss adjustment expense reserves, including IBNR, sustained by an insurance or reinsurance company under its insurance policies or other insurance or reinsurance contracts.

 

Losses and loss expense ratio

Calculated by dividing net “losses and loss expenses” by “net premiums earned”.

 

Losses and loss expenses

“Losses” are an occurrence that is the basis for submission or payment of a claim. Losses may be covered, limited or excluded from coverage, depending on the terms of the insurance policy or other insurance or reinsurance contracts. “Loss expenses” are the expenses incurred by an insurance or reinsurance company in settling a loss.

 

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Loss reserves

Liabilities established by insurers and reinsurers to reflect the estimated cost of claims incurred that the insurer or reinsurer will ultimately be required to pay. Reserves are established for losses and for loss expenses, and consist of case reserves and IBNR reserves. As the term is used in this Form 10-K, “loss reserves” is meant to include reserves for both losses and for loss expenses.

 

Loss year

The year to which a claim is attributed based upon the terms in the underlying policy or contract. All years referred to are years ending December 31.

 

Net premiums earned

The portion of net premiums written during or prior to a given period that was recognized as income during such period.

 

Net premiums written

Gross premiums written, less premiums ceded to reinsurers.

 

Paid losses

Claim amounts paid to insureds or ceding companies.

 

Per occurrence limitations

The maximum amount recoverable under an insurance or reinsurance policy as a result of any one event, regardless of the number of claims.

 

Primary insurance

Insurance that absorbs the losses immediately above the insured’s retention layer. A primary insurer will pay up to a certain dollar amount of losses over the insured’s retention, at which point a higher layer excess insurer will be liable for additional losses. The coverage terms of a primary insurance layer typically assume an element of regular loss frequency.

 

Probable maximum loss

An estimate of the loss on any given insurance policy or group of policies at some pre-defined probability of occurrence. The probability of occurrence is usually expressed in terms of the number of years between loss events of that size (e.g., 1 in 100 years or 1 in 200 years).

 

Producer

A licensed professional, often referred to as an insurance agent, insurance broker or intermediary, who acts as intermediary between the insurance carrier and the insured or reinsured (as the case may be).

 

Product liability

Insurance that provides coverage to manufacturer and/or distributors of tangible goods against liability for personal injury caused if such products are unsafe or defective.

 

Professional liability

Insurance that provides liability coverage to directors and officers, attorneys, doctors, accountants and other professionals who offer services to the general public and claim expertise in a particular area greater than the ordinary layperson for their negligence or malfeasance.

 

Property catastrophe coverage

In reinsurance, coverage that protects the ceding company against accumulated losses in excess of a stipulated sum that arise from a catastrophic event such as an earthquake, fire or windstorm. “Catastrophe loss” generally refers to the total loss of an insurer arising out of a single catastrophic event.

 

Quota share reinsurance

A proportional reinsurance treaty in which the ceding company cedes an agreed-on percentage of every risk it insures that falls within a class or classes of business subject to the treaty.

 

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Reinsurance

The practice whereby one insurer, called the reinsurer, in consideration of a premium paid to that reinsurer, agrees to indemnify another insurer, called the ceding company, for part or all of the liability of the ceding company under one or more policies or contracts of insurance that it has issued.

 

Reserves

Liabilities established by insurers and reinsurers to reflect the estimated cost of claims incurred that the insurer or reinsurer will ultimately be required to pay. Reserves are established for losses and for loss expenses, and consist of case reserves and IBNR reserves. As the term is used in this report, “reserves” are meant to include reserves for both losses and for loss expenses.

 

Retention

The amount of exposure an insured retains on any one risk or group of risks. The term may apply to an insurance policy, where the insured is an individual or business, or a reinsurance contract, where the insured is an insurance company. See “Deductible.”

 

Retrocessional coverage

A transaction whereby a reinsurer cedes to another reinsurer, the retrocessionaire, all or part of the reinsurance that the first reinsurer has assumed. Retrocessional reinsurance does not legally discharge the ceding reinsurer from its liability with respect to its obligations to the reinsured. Reinsurance companies cede risks to retrocessionaires for reasons similar to those that cause insurers to purchase reinsurance: to reduce net liability on individual risks, to protect against catastrophic losses, to stabilize financial ratios and to obtain additional underwriting capacity.

 

Run-off

Liability of an insurance or reinsurance company for existing claims that it expects to pay in the future and for which a loss reserve has been established.

 

Self-insured

A term which describes a risk, or part of a risk, retained by the insured in lieu of transferring the risk to an insurer. A policy deductible or retention feature allows a policyholder to self-insure a portion of an exposure and thereby reduce its risk-transfer costs.

 

Specialty lines

A term used in the insurance and reinsurance industry to describe types of insurance or classes of business that require specialized expertise to underwrite. Insurance and reinsurance for these classes of business is not widely available and is typically purchased from the specialty lines divisions of larger insurance companies or from small specialty lines insurers.

 

Subpart F income

Insurance and reinsurance income (including underwriting and investment income) and foreign personal holding company income (including interest, dividends and other passive investment income).

 

Surplus (or statutory surplus)

As determined under statutory accounting principles, the amount remaining after all liabilities, including loss reserves, are subtracted from all of the “admitted” assets (i.e., those permitted by regulation to be recognized on the statutory balance sheet). Surplus is also referred to as “statutory surplus” or “surplus as regards policyholders” for statutory accounting purposes.

 

Surplus lines

A risk or a part of a risk for which there is no insurance market available among admitted insurers or insurance written by non-admitted insurance companies to cover such risks.

 

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Treaties

Reinsurance contracts under which the ceding company agrees to cede and the reinsurer agrees to assume risks of a particular class or classes of business.

 

Treaty year

The year in which the contract incepts. Exposure from contracts incepting during the current treaty year will potentially affect both the current loss year as well future loss years.

 

Ultimate loss

Total of all expected settlement amounts, whether paid or reserved together with any associated loss adjustment expenses, and is the estimated total amount of loss at the measurement date. For purposes of this Form 10-K, “ultimate loss” is the sum of paid losses, case reserves and IBNR.

 

Underwriter

An employee of an insurance or reinsurance company who examines, accepts or rejects risks and classifies accepted risks in order to charge an appropriate premium for each accepted risk. The underwriter is expected to select business that will produce an average risk of loss no greater than that anticipated for the class of business.

 

Underwriting results

The pre-tax profit or loss experienced by an insurance company that is calculated by deducting net losses and loss expenses, net acquisition costs and general and administration expenses from net premiums earned. This profit or loss calculation includes reinsurance assumed and ceded but excludes investment income.

 

Unearned premium

The portion of premiums written that is allocable to the unexpired portion of the policy term or underlying risk.

 

Working layer

Primary insurance that absorbs the losses immediately above the insured’s retention layer. A working layer insurer will pay up to a certain dollar amount of losses over the insured’s retention, at which point a higher layer excess insurer will be liable for additional losses. The coverage terms of a working layer typically assume an element of loss frequency.

 

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Item 2. Properties.

Our corporate headquarters are located in offices we lease in Switzerland. We also lease space in Bermuda, Canada, England, Hong Kong, Ireland, Singapore and the United States for the operation of our U.S. insurance, international insurance and reinsurance segments. Our leases have remaining terms ranging from approximately seven months to approximately sixteen years in length. We renew and enter into new leases in the ordinary course of business as needed. While we believe that the office space from these leased properties is sufficient for us to conduct our operations for the foreseeable future, we may need to expand into additional facilities to accommodate future growth. For more information on our leasing arrangements, please see Note 15 of the notes to the consolidated financial statements in this Form 10-K.

 

Item 3. Legal Proceedings.

The company, in common with the insurance industry in general, is subject to litigation and arbitration in the normal course of its business. These legal proceedings generally relate to claims asserted by or against the company in the ordinary course of insurance or reinsurance operations. Estimated amounts payable under these proceedings are included in the reserve for losses and loss expenses in the company’s consolidated balance sheets. As of December 31, 2013, the company was not a party to any material legal proceedings arising outside the ordinary course of business that management believes will have a material adverse effect on the company’s results of operations, financial position or cash flow.

 

Item 4. Mine Safety Disclosures.

Not applicable.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Our common shares are publicly traded on the New York Stock Exchange under the symbol “AWH”. The following table sets forth, for the periods indicated, the high and low sales prices per share of our common shares as reported on the New York Stock Exchange Composite Tape.

 

     High      Low  

2013:

     

First quarter

   $ 92.76       $ 79.21   

Second quarter

   $ 94.98       $ 88.00   

Third quarter

   $ 100.00       $ 90.37   

Fourth quarter

   $ 113.28       $ 98.72   

2012:

     

First quarter

   $ 71.34       $ 60.80   

Second quarter

   $ 79.55       $ 67.84   

Third quarter

   $ 80.10       $ 74.32   

Fourth quarter

   $ 84.17       $ 76.12   

On February 3, 2014, the last reported sale price for our common shares was $100.10 per share. At February 3, 2014, there were 28 holders of record of our common shares.

The following dividends were paid during 2013 and 2012:

 

Dividend Paid    Partial Par
Value
Reduction Per
Share
     Dividend
Per
Share
 

October 3, 2013

     N/A          $ 0.500   

July 3, 2013

     N/A          $ 0.500   

March 12, 2013

     CHF         0.34       $ 0.375   

December 18, 2012

     CHF         0.34       $ 0.375   

September 25, 2012

     CHF         0.35       $ 0.375   

August 6, 2012

     CHF         0.36       $ 0.375   

April 6, 2012

     CHF         0.34       $ 0.375   

January 6, 2012

     CHF         0.35       $ 0.375   

At the Annual Shareholder Meeting in May 2012, our shareholders approved the payment of a quarterly cash dividend to shareholders in the form of distributions through par value reductions, each of which were $0.375 per share.

At the Annual Shareholder Meeting in May 2013, our shareholders approved the payment of a quarterly cash dividend to shareholders in four quarterly installments in the form of distributions out of “general legal reserves from capital contributions”, each of which were $0.50 per share. The third dividend was paid in January 2014 and the fourth dividend is anticipated to be paid in April 2014.

The continued declaration and payment of dividends to holders of common shares is expected but will be at the discretion of our Board of Directors and subject to legal, regulatory, financial and other restrictions. Specifically, any future declaration and payment of any cash dividends by the company will:

 

   

depend upon its results of operations, financial condition, cash requirements and other relevant factors;

 

   

be subject to shareholder approval;

 

   

be subject to restrictions contained in our credit facilities and other debt covenants; and

 

   

be subject to other restrictions on dividends imposed by Swiss law.

 

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Under Swiss law, our shareholders have the power to declare dividends without the agreement of the Board of Directors. Consequently, dividends may be declared by resolution of the shareholders even if our Board of Directors and management do not believe it is in the best interest of the company or the shareholders. As a holding company, our principal source of income is dividends or other statutorily permissible payments from our subsidiaries. The ability of our subsidiaries to pay dividends is limited by the applicable laws and regulations of the various countries in which we operate, including Bermuda, the United States and Ireland. See Item 1. “Business — Regulatory Matters,” Item 1A. Risk Factors — Our holding company structure and regulatory and other constraints affect our ability to pay dividends and make other payments,” Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Pledged Assets” and Note 16 of the notes to consolidated financial statements included in this Form 10-K.

Issuer Purchases of Equity Securities

The following table summarizes our repurchases of our common shares during the three months ended December 31, 2013:

 

Period

   Total Number  of
Shares
Purchased
     Average Price
Paid
per Share
     Total Number of
Shares  Purchased as
Part of Publicly
Announced Plans or
Programs
     Maximum Dollar Value
(or Approximate
Dollar Value) of
Shares that May Yet
be Purchased Under
the Plans or Programs
 

October 1 — 31, 2013

     209,652       $ 104.11         209,652       $     265.3 million   

November 1 — 30, 2013

     118,638         110.29         118,638         252.2 million   

December 1 — 31, 2013

     152,021         109.39         152,021         235.5 million   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     480,311       $ 107.31         480,311       $ 235.5 million   

 

(1) At the 2012 Annual Shareholder Meeting on May 3, 2012, Holdings’ shareholders approved a new, two-year $500 million share repurchase program. Share repurchases may be effected from time to time through open market purchases, privately negotiated transactions, tender offers or otherwise.

 

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PERFORMANCE GRAPH

The following information is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to the liabilities of Section 18 of the Exchange Act, and the report shall not be deemed to be incorporated by reference into any prior or subsequent filing by the company under the Securities Act or the Exchange Act.

The following graph shows the cumulative total return, including reinvestment of dividends, on the common shares compared to such return for Standard & Poor’s 500 Composite Stock Price Index (“S&P 500”), and Standard & Poor’s Property & Casualty Insurance Index for the five year period beginning on December 31, 2008 and ending on December 31, 2013, assuming $100 was invested on December 31, 2008. The measurement point on the graph represents the cumulative shareholder return as measured by the last reported sale price on such date during the relevant period.

TOTAL RETURN TO SHAREHOLDERS

(INCLUDES REINVESTMENT OF DIVIDENDS)

 

LOGO

 

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Item 6. Selected Financial Data.

The following table sets forth our summary historical statement of operations data and summary balance sheet data as of and for the years ended December 31, 2013, 2012, 2011, 2010 and 2009. Statement of operations data and balance sheet data are derived from our audited consolidated financial statements, which have been prepared in accordance with U.S. GAAP. These historical results are not necessarily indicative of results to be expected from any future period. For further discussion of this risk see Item 1A. “Risk Factors” in this Form 10-K. You should read the following selected financial data in conjunction with the other information contained in this Form 10-K, including Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8. “Financial Statements and Supplementary Data”.

 

    Year Ended December 31,  
    2013     2012     2011(1)     2010(2)     2009  
    ($ in millions, except per share amounts)  

Summary Statement of Operations Data:

         

Gross premiums written

  $   2,738.7      $   2,329.3      $   1,939.5      $   1,758.4      $   1,696.3   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums written

  $ 2,120.5      $ 1,837.8      $ 1,533.8      $ 1,392.4      $ 1,321.1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

  $ 2,005.8      $ 1,748.9      $ 1,457.0      $ 1,359.5      $ 1,316.9   

Net investment income

    157.6        167.1        195.9        244.1        300.7   

Net realized investment gains

    59.5        306.4        10.1        285.6        126.4   

Net impairment charges recognized in earnings

                         (0.2     (49.6

Other income

                  101.7        0.9        1.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

  $ 2,222.9      $ 2,222.4      $ 1,764.7      $ 1,889.9      $ 1,695.9   

Net losses and loss expenses

    1,123.2        1,139.3        959.2        707.9        604.1   

Total expenses

    1,795.3        1,711.0        1,459.2        1,198.0        1,052.4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

  $ 427.6      $ 511.4      $ 305.5      $ 691.9      $ 643.5   

Income tax expense

    9.8        18.4        31.0        26.9        36.6   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ 417.8      $ 493.0      $ 274.5      $ 665.0      $ 606.9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Per Share Data:

         

Basic earnings per share

  $ 12.23      $ 13.67      $ 7.21      $ 14.30      $ 12.26   

Diluted earnings per share

  $ 11.95      $ 13.30      $ 6.92      $ 13.32      $ 11.67   

Dividends paid per share(3)

  $ 1.375      $ 1.875      $ 0.750      $ 1.050      $ 0.740   

 

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     Year Ended December 31,  
     2013     2012     2011(1)     2010(2)     2009  

Selected Ratios:

          

Loss and loss expense ratio

     56.0     65.1     65.8     52.1     45.9

Acquisition cost ratio

     12.6     11.8     11.5     11.7     11.3

General and administrative expense ratio

     17.6     17.6     18.6     21.1     18.9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Expense ratio

     30.2     29.4     30.1     32.8     30.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Combined ratio

     86.2     94.5     95.9     84.9     76.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     As of December 31,  
     2013     2012     2011(1)     2010(2)     2009  
     ($ in millions)  

Summary Balance Sheet Data:

          

Cash and cash equivalents

   $ 531.9      $ 681.9      $ 634.0      $ 757.0      $ 292.2   

Investments

     7,712.0        7,933.9        7,406.6        7,183.6        7,156.3   

Reinsurance recoverable

     1,234.5        1,141.1        1,002.9        927.6        920.0   

Total assets

     11,945.8        12,029.9        11,122.2        10,427.6        9,653.2   

Reserve for losses and loss expenses

     5,766.5        5,645.5        5,225.1        4,879.2        4,761.8   

Unearned premiums

     1,396.3        1,218.0        1,078.4        962.2        928.6   

Total debt

     798.5        798.2        797.9        797.7        498.9   

Total shareholders’ equity

   $ 3,519.8      $ 3,326.3      $ 3,149.0      $ 3,075.8      $ 3,213.3   

 

(1) Other income for the year ended December 31, 2011 includes termination fees (net of expenses) of $101.7 million related to the termination of the previously announced merger agreement with Transatlantic.

 

(2) Effective July 1, 2010, the Company elected the fair value option for any investment in a beneficial interest in a securitized asset. As a result, the Company elected the fair value option for all of its mortgage-backed and asset-backed securities held as of June 30, 2010. On July 1, 2010, the Company reclassified net unrealized gains of $41.9 million from “accumulated other comprehensive income” to “retained earnings”. As a result of the fair value election, any change in fair value of the mortgage-backed and asset-backed securities is recognized in “net realized investment gains” on the consolidated income statement.

 

(3) A dividend of $0.50 was also paid on January 2, 2014 to shareholders of record on December 24, 2013.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Some of the statements in this Form 10-K include forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995 that involve inherent risks and uncertainties. These statements include in general forward-looking statements both with respect to us and the insurance industry. Statements that are not historical facts, including statements that use terms such as “anticipates,” “believes,” “expects,” “intends,” “plans,” “projects,” “seeks” and “will” and that relate to our plans and objectives for future operations, are forward-looking statements. In light of the risks and uncertainties inherent in all forward-looking statements, the inclusion of such statements in this Form 10-K should not be considered as a representation by us or any other person that our objectives or plans will be achieved. These statements are based on current plans, estimates and expectations. Actual results may differ materially from those projected in such forward-looking statements and therefore you should not place undue reliance on them. Important factors that could cause actual results to differ materially from those in such forward-looking statements are set forth in Item 1A. “Risk Factors” in this Form 10-K. We undertake no obligation to release publicly the results of any future revisions we make to the forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Overview

Our Business

We write a diversified portfolio of property and casualty insurance and reinsurance internationally through our subsidiaries and branches based in Bermuda, Canada, Europe, Hong Kong, Singapore and the United States as well as our Lloyd’s Syndicate 2232. We manage our business through three operating segments: U.S. insurance, international insurance and reinsurance. As of December 31, 2013, we had approximately $11.9 billion of total assets, $3.5 billion of total shareholders’ equity and $4.3 billion of total capital, which includes shareholders’ equity and senior notes.

During the year ended December 31, 2013, we continued to experience rate increases on property lines that had experienced significant loss activity in the prior year. However those rate increases started to flatten or became slightly negative towards the end of the year. We also continued to see rate improvement during the year on some of our casualty lines of business in certain jurisdictions. We believe that there are opportunities where certain products have attractive premium rates and that the expanded breadth of our operations allows us to target those classes of business. During 2013, we entered into several new lines and grew newer lines of business in our direct insurance business such as surety, primary construction, retail property and aviation, and also expanded our property catastrophe reinsurance platform in our reinsurance business.

Our consolidated gross premiums written increased by $409.4 million, or 17.6%, for the year ended December 31, 2013 compared to the year ended December 31, 2012 as each of our operating segments had higher gross premiums written. Our net income decreased by $75.1 million to $417.9 million compared to the year ended December 31, 2012. The decrease was due to lower net realized investment gains of $246.9 million for the year ended December 31, 2013 compared to the same period in 2012, partially offset by an increased profitability in our operations, due to the overall growth of our operations and lower property catastrophe losses during 2013 compared to 2012.

Recent Developments

We reported net income of $137.9 million for the three months ended December 31, 2013 compared to a net loss of $41.1 million for the three months ended December 31, 2012, an increase of $179.0 million.

The increase in net income was due to the following:

 

   

For the three months ended December 31, 2013, we incurred $13.5 million of pre-tax catastrophe-related losses from Typhoon Fitow compared to $166.1 million, net of reinstatement premiums of $9.6 million, of pre-tax catastrophe-related losses for the three months ended December 31, 2012 related to Superstorm Sandy.

 

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Net premiums earned increased $48.3 million due to the continued growth across each operating segment.

 

   

Net investment income increased $8.9 million primarily driven by the additional income from our “other private securities” that we account for under the equity method.

 

   

Net realized investment gains increased by $53.2 million.

Partially offsetting the above increases were the following:

 

   

Current year loss and loss expenses increased $55.9 million primarily due to the growth of our operations and unfavorable reserve development in our U.S. insurance segment.

 

   

General and administrative expenses increased $16.1 million primarily as a result of the increase in our stock price which caused a corresponding increase in the portion of our stock-based compensation that is settled in cash as well as higher salary and related costs due to increased headcount as we continued to expand our operations.

Financial Highlights

 

     Year Ended December 31,  
     2013     2012     2011  
     ($ in millions, except share, per share and percentage data)  

Gross premiums written

   $ 2,738.7      $ 2,329.3      $ 1,939.5   

Net income

     417.9        493.0        274.5   

Operating income

     364.0        202.7        183.7   

Basic earnings per share:

      

Net income

   $ 12.23      $ 13.67      $ 7.21   

Operating income

   $ 10.65      $ 5.62      $ 4.82   

Diluted earnings per share:

      

Net income

   $ 11.95      $ 13.30      $ 6.92   

Operating income

   $ 10.41      $ 5.47      $ 4.63   

Weighted average common shares outstanding:

      

Basic

     34,154,905        36,057,145        38,093,351   

Diluted

     34,955,278        37,069,885        39,667,905   

Basic book value per common share

   $ 105.33      $ 95.59      $ 83.44   

Diluted book value per common share

   $ 102.58      $ 92.59      $ 80.11   

Annualized return on average equity (ROAE), net income

     12.2     15.3     8.9

Annualized ROAE, operating income

     10.6     6.3     6.0

Non-GAAP Financial Measures

In presenting the company’s results, management has included and discussed certain non-GAAP financial measures, as such term is defined in Item 10(e) of Regulation S-K promulgated by the SEC. Management believes that these non-GAAP measures, which may be defined differently by other companies, better explain the Company’s results of operations in a manner that allows for a more complete understanding of the underlying trends in the Company’s business. However, these measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP.

Operating income & operating income per share

Operating income is an internal performance measure used in the management of our operations and represents after-tax operational results excluding, as applicable, net realized investment gains or losses, net foreign exchange gain or loss and other non-recurring items. We exclude net realized investment gains or losses, net foreign exchange gain or loss and other non-recurring items from our calculation of operating income

 

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because these amounts are heavily influenced by and fluctuate in part according to the availability of market opportunities and other factors. We have excluded from our operating income the aggregate $101.7 million ($93.7 million after-tax) termination fee we received from Transatlantic in 2011 as this is a non-recurring item. In addition to presenting net income determined in accordance with U.S. GAAP, we believe that showing operating income enables investors, analysts, rating agencies and other users of our financial information to more easily analyze our results of operations and our underlying business performance. Operating income should not be viewed as a substitute for U.S. GAAP net income. The following is a reconciliation of operating income to its most closely related U.S. GAAP measure, net income.

 

     Year Ended December 31,  
         2013         2012     2011  
     ($ in millions, except per share data)  

Net income

   $ 417.9      $ 493.0      $ 274.5   

Add after tax effect of:

      

Net realized investment gains

     (61.9     (291.1     (0.2

Other income — termination fee

                   (93.7

Foreign exchange loss

     8.0        0.8        3.1   
  

 

 

   

 

 

   

 

 

 

Operating income

   $ 364.0      $ 202.7      $ 183.7   
  

 

 

   

 

 

   

 

 

 

Basic per share data:

      

Net income

   $ 12.23      $ 13.67      $ 7.21   

Add after tax effect of:

      

Net realized investment gains

     (1.81     (8.07     (0.01

Other income — termination fee

                   (2.46

Foreign exchange loss

     0.23        0.02        0.08   
  

 

 

   

 

 

   

 

 

 

Operating income

   $ 10.65      $ 5.62      $ 4.82   
  

 

 

   

 

 

   

 

 

 

Diluted per share data:

      

Net income

   $ 11.95      $ 13.30      $ 6.92   

Add after tax effect of:

      

Net realized investment gains

     (1.77     (7.85     (0.01

Other income — termination fee

                   (2.36

Foreign exchange loss

     0.23        0.02        0.08   
  

 

 

   

 

 

   

 

 

 

Operating income

   $ 10.41      $ 5.47      $ 4.63   
  

 

 

   

 

 

   

 

 

 

 

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Diluted book value per share

We have included diluted book value per share because it takes into account the effect of dilutive securities; therefore, we believe it is an important measure of calculating shareholder returns.

 

     As of December 31,  
     2013     2012     2011  
     ($ in millions, except share and per share data)  

Price per share at period end

   $ 112.81      $ 78.80      $ 62.93   

Total shareholders’ equity

   $ 3,519.8      $ 3,326.3      $ 3,149.0   

Basic common shares outstanding

     33,417,882        34,797,781        37,742,131   

Add:

      

Unvested restricted share units

     47,899        135,123        249,251   

Performance based equity awards

     268,173        485,973        889,939   

Employee share purchase plan

     18,532        10,750        11,053   

Dilutive options/warrants outstanding

     976,104        1,224,607        1,525,853   

Weighted average exercise price per share

   $ 48.22      $ 47.02      $ 45.72   

Deduct:

      

Options bought back via treasury method

     (417,229     (730,652     (1,108,615
  

 

 

   

 

 

   

 

 

 

Common shares and common share equivalents outstanding

     34,311,361        35,923,582        39,309,612   

Basic book value per common share

   $ 105.33      $ 95.59      $ 83.44   

Diluted book value per common share

   $ 102.58      $ 92.59      $ 80.11   

Annualized return on average equity

Annualized return on average shareholders’ equity (“ROAE”) is calculated using average shareholders’ equity, excluding the average after tax unrealized gains or losses on investments. We present ROAE as a measure that is commonly recognized as a standard of performance by investors, analysts, rating agencies and other users of our financial information.

Annualized operating return on average shareholders’ equity is calculated using operating income and average shareholders’ equity, excluding the average after tax unrealized gains or losses on investments.

 

     Year Ended December 31,  
     2013     2012     2011  
     ($ in millions)  

Opening shareholders’ equity

   $ 3,326.3      $ 3,149.0      $ 3,075.8   

Deduct: accumulated other comprehensive income

            (14.5     (57.1
  

 

 

   

 

 

   

 

 

 

Adjusted opening shareholders’ equity

   $ 3,326.3      $ 3,134.5      $ 3,018.7   

Closing shareholders’ equity

   $ 3,519.8      $ 3,326.3      $ 3,149.0   

Deduct: accumulated other comprehensive income

                   (14.5
  

 

 

   

 

 

   

 

 

 

Adjusted closing shareholders’ equity

   $ 3,519.8      $ 3,326.3      $ 3,134.5   

Average shareholders’ equity

   $ 3,423.1      $ 3,230.4      $ 3,076.6   

Net income available to shareholders

   $ 417.9      $ 493.0      $ 274.5   

Annualized return on average shareholders’ equity — net income available to shareholders

     12.2     15.3     8.9
  

 

 

   

 

 

   

 

 

 

Operating income available to shareholders

   $ 364.0      $ 202.7      $ 183.7   

Annualized return on average shareholders’ equity — operating income available to shareholders

     10.6     6.3     6.0
  

 

 

   

 

 

   

 

 

 

 

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Relevant Factors

Revenues

We derive our revenues primarily from premiums on our insurance policies and reinsurance contracts, net of any reinsurance or retrocessional coverage purchased. Insurance and reinsurance premiums are a function of the amounts and types of policies and contracts we write, as well as prevailing market prices. Our prices are determined before our ultimate costs, which may extend far into the future, are known. In addition, our revenues include income generated from our investment portfolio, consisting of net investment income and net realized investment gains or losses. Investment income is principally derived from interest and dividends earned on investments, partially offset by investment management and custodial expenses and fees paid to our custodian bank. Net realized investment gains or losses include gains or losses from the sale of investments, as well as the change in the fair value of investments that we mark-to-market through net income.

Expenses

Our expenses consist largely of net losses and loss expenses, acquisition costs and general and administrative expenses. Net losses and loss expenses incurred are comprised of three main components:

 

   

losses paid, which are actual cash payments to insureds and reinsureds, net of recoveries from reinsurers;

 

   

outstanding loss or case reserves, which represent management’s best estimate of the likely settlement amount for known claims, less the portion that can be recovered from reinsurers; and

 

   

reserves for losses incurred but not reported, or “IBNR”, which are reserves (in addition to case reserves) established by us that we believe are needed for the future settlement of claims. The portion recoverable from reinsurers is deducted from the gross estimated loss.

Acquisition costs are comprised of commissions, brokerage fees, insurance taxes and other acquisition–related costs such as profit commissions and are reduced for ceding commission income received on our ceded reinsurance. Commissions and brokerage fees are usually calculated as a percentage of premiums and depend on the market and line of business. Acquisition costs are reported after (1) deducting commissions earned on ceded reinsurance, (2) deducting the part of deferred acquisition costs relating to the successful acquisition of new and renewal insurance and reinsurance contracts and (3) including the amortization of previously deferred acquisition costs.

General and administrative expenses include personnel expenses including stock-based compensation expense, rent expense, professional fees, information technology costs and other general operating expenses.

Ratios

Management measures results for each segment on the basis of the “loss and loss expense ratio,” “acquisition cost ratio,” “general and administrative expense ratio,” “expense ratio” and the “combined ratio.” Because we do not manage our assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments. General and administrative expenses are allocated to segments based on various factors, including staff count and each segment’s proportional share of gross premiums written.

Critical Accounting Policies

It is important to understand our accounting policies in order to understand our financial position and results of operations. Our consolidated financial statements reflect determinations that are inherently subjective in nature and require management to make assumptions and best estimates to determine the reported values. If events or other factors cause actual results to differ materially from management’s underlying assumptions or estimates, there could be a material adverse effect on our financial condition or results of operations. The following are the accounting estimates that, in management’s judgment, are critical due to the judgments, assumptions and uncertainties underlying the application of those estimates and the potential for results to differ from management’s assumptions.

 

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Reserve for Losses and Loss Expenses

Reserves for losses and loss expenses by segment as of December 31, 2013 and 2012 were comprised of the following:

 

     U.S. Insurance     International
Insurance
    Reinsurance     Total  
     December 31,     December 31,     December 31,     December 31,  
     2013     2012     2013     2012     2013     2012     2013     2012  
     ($ in millions)  

Case reserves

   $ 609.8      $ 508.8      $ 441.0      $ 550.5      $ 470.1      $ 479.8      $ 1,520.9      $ 1,539.1   

IBNR

     1,509.2        1,389.5        1,710.4        1,716.1        1,026.0        1,000.8        4,245.6        4,106.4   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reserve for losses and loss expenses

     2,119.0        1,898.3        2,151.4        2,266.6        1,496.1        1,480.6        5,766.5        5,645.5   

Reinsurance recoverables

     (558.7     (517.3     (669.6     (620.6     (6.2     (3.2     (1,234.5     (1,141.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net reserve for losses and loss expenses

   $ 1,560.3      $ 1,381.0      $ 1,481.8      $ 1,646.0      $ 1,489.9      $ 1,477.4      $ 4,532.0      $ 4,504.4   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The reserve for losses and loss expenses is comprised of two main elements: outstanding loss reserves, also known as case reserves, and reserves for IBNR. Outstanding loss reserves relate to known claims and represent management’s best estimate of the likely loss settlement. IBNR reserves relate primarily to unreported events that, based on industry information, management’s experience and actuarial evaluation, can reasonably be expected to have occurred and are reasonably likely to result in a loss to our company. IBNR reserves also relate to estimated development of reported events that based on industry information, management’s experience and actuarial evaluation, can reasonably be expected to reach our attachment point and are reasonably likely to result in a loss to our company. We also include IBNR changes in the values of claims that have been reported to us but are not yet settled. Each claim is settled individually based upon its merits and it is not unusual for a claim to take years after being reported to settle, especially if legal action is involved. As a result, reserves for losses and loss expenses include significant estimates for IBNR reserves.

The reserve for IBNR is estimated by management for each line of business based on various factors, including underwriters’ expectations about loss experience, actuarial analysis, comparisons with the results of industry benchmarks and loss experience to date. The reserve for IBNR is calculated as the ultimate amount of losses and loss expenses less cumulative paid losses and loss expenses and case reserves. Our actuaries employ generally accepted actuarial methodologies to determine estimated ultimate loss reserves.

While management believes that our case reserves and IBNR are sufficient to cover losses assumed by us, there can be no assurance that losses will not deviate from our reserves, possibly by material amounts. The methodology of estimating loss reserves is periodically reviewed to ensure that the assumptions made continue to be appropriate. To the extent actual reported losses exceed estimated losses, the carried estimate of the ultimate losses will be increased (i.e., unfavorable reserve development), and to the extent actual reported losses are less than estimated losses, the carried estimate of ultimate losses will be reduced (i.e., favorable reserve development). We record any changes in our loss reserve estimates and the related reinsurance recoverables in the periods in which they are determined. Determining whether our estimated losses are sufficient to cover all reported and non-reported claims involves a high degree of judgment. It is our practice to address unfavorable loss emergence early in our long-tail lines of business while we tend to recognize favorable loss emergence more slowly in our long-tail lines once actual loss emergence and data provides greater confidence around the adequacy of ultimate estimates.

In certain lines of business, claims are generally reported and paid within a relatively short period of time (“short-tail lines”) during and following the policy coverage period. This generally enables us to determine with greater certainty our estimate of ultimate losses and loss expenses. The estimate of reserves for our short-tail lines of business and products, including property, crop, aviation, marine, personal accident and workers compensation catastrophe relies primarily on traditional loss reserving methodologies, utilizing selected paid and reported loss development factors.

Our casualty insurance and casualty reinsurance lines of business include general liability risks, healthcare and professional liability risks. Claims may be reported or settled several years after the coverage period has

 

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terminated for these lines of business (“long-tail lines”), which increases uncertainties of our reserve estimates in such lines. In addition, our attachment points for these long-tail lines are often relatively high, making reserving for these lines of business more difficult than short-tail lines due to having to estimate whether the severity of the estimated losses will exceed our attachment point. We establish a case reserve when sufficient information is gathered to make a reasonable estimate of the liability, which often requires a significant amount of information and time. Due to the lengthy reporting pattern of these casualty lines, reliance is placed on industry benchmarks supplemented by our own experience. For expected loss ratio selections, we are giving increasing consideration to our existing experience supplemented with analysis of loss trends, rate changes and experience of peer companies.

Our reinsurance treaties are reviewed individually, based upon individual characteristics and loss experience emergence. Loss reserves on assumed reinsurance have unique features that make them more difficult to estimate than direct insurance. We establish loss reserves upon receipt of advice from a cedent that a reserve is merited. Our claims staff may establish additional loss reserves where, in their judgment, the amount reported by a cedent is potentially inadequate. The following are the most significant features that make estimating loss reserves on assumed reinsurance difficult:

 

   

Reinsurers have to rely upon the cedents and reinsurance intermediaries to report losses in a timely fashion.

 

   

Reinsurers must rely upon cedents to price the underlying business appropriately.

 

   

Reinsurers have less predictable loss emergence patterns than direct insurers, particularly when writing excess-of-loss reinsurance.

For excess-of-loss reinsurance, cedents generally are required to report losses that either exceed 50% of the retention, have a reasonable probability of exceeding the retention or meet serious injury reporting criteria. All reinsurance claims that are reserved are reviewed at least every six months. For quota share reinsurance treaties, cedents are required to give a periodic statement of account, generally monthly or quarterly. These periodic statements typically include information regarding written premiums, earned premiums, unearned premiums, ceding commissions, brokerage amounts, applicable taxes, paid losses and outstanding losses. They can be submitted 60 to 90 days after the close of the reporting period. Some quota share reinsurance treaties have specific language regarding earlier notice of serious claims.

Reinsurance generally has a greater time lag than direct insurance in the reporting of claims. The time lag is caused by the claim first being reported to the cedent, then the intermediary (such as a broker) and finally the reinsurer. This lag can be up to six months or longer in certain cases. There is also a time lag because the insurer may not be required to report claims to the reinsurer until certain reporting criteria are met. In some instances this could be several years while a claim is being litigated. We use reporting factors based on data from the Reinsurance Association of America to adjust for time lags. We also use historical treaty-specific reporting factors when applicable. Loss and premium information are entered into our reinsurance system by our claims department and our accounting department on a timely basis.

We record the individual case reserves sent to us by the cedents through the reinsurance intermediaries. Individual claims are reviewed by our reinsurance claims department and adjusted as deemed appropriate. The loss data received from the intermediaries is checked for reasonableness and for known events. Details of the loss listings are reviewed during routine claim audits.

The expected loss ratios that we assign to each treaty are based upon analysis and modeling performed by a team of actuaries. The historical data reviewed by the team of pricing actuaries is considered in setting the reserves for each cedent. The historical data in the submissions is matched against our carried reserves for our historical treaty years.

Loss reserves do not represent an exact calculation of liability. Rather, loss reserves are estimates of what we expect the ultimate resolution and administration of claims will cost. These estimates are based on actuarial and statistical projections and on our assessment of currently available data, as well as estimates of future trends in claims severity and frequency, judicial theories of liability and other factors. Loss reserve estimates are refined

 

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as experience develops and as claims are reported and resolved. In addition, the relatively long periods between when a loss occurs and when it may be reported to our claims department for our casualty insurance and casualty reinsurance lines of business increase the uncertainties of our reserve estimates in such lines.

We utilize a variety of standard actuarial methods in our analysis. The selections from these various methods are based on the loss development characteristics of the specific line of business. For lines of business with long reporting periods such as casualty reinsurance, we may rely more on an expected loss ratio method (as described below) until losses begin to develop. For lines of business with short reporting periods such as property insurance, we may rely more on a paid loss development method (as described below) as losses are reported relatively quickly. The actuarial methods we utilize include:

Paid Loss Development Method.    We estimate ultimate losses by calculating past paid loss development factors and applying them to exposure periods with further expected paid loss development. The paid loss development method assumes that losses are paid at a consistent rate. The paid loss development method provides an objective test of reported loss projections because paid losses contain no reserve estimates. In some circumstances, paid losses for recent periods may be too varied for accurate predictions. For many coverages, especially casualty coverages, claim payments are made slowly and it may take years for claims to be fully reported and settled. These payments may be unreliable for determining future loss projections because of shifts in settlement patterns or because of large settlements in the early stages of development. Choosing an appropriate “tail factor” to determine the amount of payments from the latest development period to the ultimate development period may also require considerable judgment, especially for coverages that have long payment patterns. As we have limited payment history, we have had to supplement our paid loss development patterns with appropriate benchmarks.

Reported Loss Development Method.    We estimate ultimate losses by calculating past reported loss development factors and applying them to exposure periods with further expected reported loss development. Since reported losses include payments and case reserves, changes in both of these amounts are incorporated in this method. This approach provides a larger volume of data to estimate ultimate losses than the paid loss development method. Thus, reported loss patterns may be less varied than paid loss patterns, especially for coverages that have historically been paid out over a long period of time but for which claims are reported relatively early and have case loss reserve estimates established. This method assumes that reserves have been established using consistent practices over the historical period that is reviewed. Changes in claims handling procedures, large claims or significant numbers of claims of an unusual nature may cause results to be too varied for accurate forecasting. Also, choosing an appropriate “tail factor” to determine the change in reported loss from the latest development period to the ultimate development period may require considerable judgment. As we have limited reported history, we have had to supplement our reported loss development patterns with appropriate benchmarks.

Expected Loss Ratio Method.    To estimate ultimate losses under the expected loss ratio method, we multiply earned premiums by an expected loss ratio. The expected loss ratio is selected utilizing industry data, historical company data and professional judgment. This method is particularly useful for new lines of business where there are no historical losses or where past loss experience is not credible.

Bornhuetter-Ferguson Paid Loss Method.    The Bornhuetter-Ferguson paid loss method is a combination of the paid loss development method and the expected loss ratio method. The amount of losses yet to be paid is based upon the expected loss ratios and the expected percentage of losses unpaid. These expected loss ratios are modified to the extent paid losses to date differ from what would have been expected to have been paid based upon the selected paid loss development pattern. This method avoids some of the distortions that could result from a large development factor being applied to a small base of paid losses to calculate ultimate losses. This method will react slowly if actual loss ratios develop differently because of major changes in rate levels, retentions or deductibles, the forms and conditions of reinsurance coverage, the types of risks covered or a variety of other changes.

Bornhuetter-Ferguson Reported Loss Method.    The Bornhuetter-Ferguson reported loss method is similar to the Bornhuetter-Ferguson paid loss method with the exception that it uses reported losses and reported loss development factors.

 

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During 2013, 2012 and 2011, we adjusted our reliance on actuarial methods utilized for certain casualty lines of business and loss years within each of our operating segments shifting from the expected loss ratio method to the Bornhuetter-Ferguson reported loss method to varying degrees depending on the class of business, for example excess casualty versus primary casualty, and how old the loss year is. Placing greater reliance on more responsive actuarial methods for certain casualty lines of business and loss years within each of our operating segments is a natural progression as we mature as a company and gain sufficient historical experience of our own that allows us to further refine our estimate of the reserve for losses and loss expenses. We believe utilizing only the Bornhuetter-Ferguson reported loss method for certain older loss years will more accurately reflect the reported loss activity we have had thus far in our ultimate loss ratio selections, and will better reflect how the ultimate losses will develop over time. We will continue to utilize the expected loss ratio method for the most recent loss years until we have sufficient experience to utilize other acceptable actuarial methodologies.

We expect that the trend of placing greater reliance on more responsive actuarial methods, for example from the expected loss ratio method to the Bornhuetter-Ferguson reported loss method, to continue as both (1) our loss years mature and become more statistically reliable and (2) as we build databases of our internal loss development patterns. The expected loss ratio remains a key assumption as the Bornhuetter-Ferguson methods rely upon an expected loss ratio selection and a loss development pattern selection.

The key assumptions used to arrive at our best estimate of loss reserves are the expected loss ratios, rate of loss cost inflation, selection of benchmarks and reported and paid loss emergence patterns. Our reporting factors and expected loss ratios are based on a blend of our own experience and industry benchmarks for long-tailed business and primarily our own experience for short-tail business. The benchmarks selected were those that we believe are most similar to our underwriting business.

Our expected loss ratios for short-tail lines change from year to year. As our losses from short-tail lines of business are reported relatively quickly, we select our expected loss ratios for the most recent years based upon our actual loss ratios for our older years adjusted for rate changes, inflation, cost of reinsurance and average storm activity. For the short-tail lines, we initially used benchmarks for reported and paid loss emergence patterns. As we mature as a company, we have begun supplementing those benchmark patterns with our actual patterns as appropriate. For the long-tail lines, we continue to use benchmark patterns, although we update the benchmark patterns as additional information is published regarding the benchmark data.

For short-tail lines, the primary assumption that changed during both 2013 as compared to 2012 and 2012 as compared to 2011 as it relates to prior year losses was actual paid and reported loss emergence patterns were generally less severe than estimated for each year due to lower frequency and severity of reported losses. As a result of this change, we recognized net favorable prior year reserve development in both 2013 and 2012.

During the years ended December 31, 2013, 2012 and 2011, we incurred $13.5 million, $179.6 million and $292.2 million of catastrophe-related losses. In addition, during the year ended December 31, 2012 we recognized $36.0 million related to drought losses on the U.S. Crop reinsurance book. We classify catastrophe losses as those losses that result from a major singular event or series of similar events (such as tornadoes) which are assigned a catastrophe loss number by industry data services, where our consolidated losses are expected to be at least $10 million per loss event or series of similar events and where we believe it is important to our investors’ understanding of our operations. We had a number of large losses incurred during the year ended December 31, 2013 that did not met our criteria to classify as a catastrophe loss.

We will continue to evaluate and monitor the development of these losses and the impact it has on our current and future assumptions. We believe recognition of the reserve changes in the period they were recorded was appropriate since a pattern of reported losses had not emerged and the loss years were previously too immature to deviate from the expected loss ratio method in prior periods.

The selection of the expected loss ratios for the long-tail lines is our most significant assumption. Due to the lengthy reporting pattern of long-tail lines, we supplement our own experience with industry benchmarks of expected loss ratios and reporting patterns in addition to our own experience. For our older loss years that are long-tail lines, the primary assumption that changed during both 2013 as compared to 2012 and 2012 as compared to 2011 as it relates to prior year losses was using the Bornhuetter-Ferguson loss development method

 

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for certain casualty lines of business and loss years as discussed previously. This method calculated a lower projected loss ratio based on loss emergence patterns to date. As a result of the change in the expected loss ratio, we recognized net favorable prior year reserve development in 2013, 2012 and 2011. For the year ended December 31, 2013, we recorded a decrease in losses and loss expenses of $110.5 million as a result of shifting from the expected loss ratio method to the Bornhuetter-Ferguson method for older loss years. Also during 2013, actual paid and reported loss emergence was more severe than estimated in our U.S. insurance segment for the 2011 and 2012 loss years. The additions to the 2011 and 2012 loss years are consistent with our practice of addressing unfavorable loss emergence early in our long-tail lines of business. We believe that recognition of the reserve changes in the period they were recorded was appropriate since a pattern of reported losses had not emerged and the loss years were previously too immature to deviate from the expected loss ratio method in prior periods.

Our overall change in the loss reserve estimates related to prior years decreased as a percentage of total carried reserves during 2013. During 2013 we had a net decrease of $180.3 million, or 4.0%, on an opening carried reserve base of $4,504.4 million, net of reinsurance recoverables. During 2012 we had a net decrease of $170.3 million, or 4.0%, on an opening carried reserve base of $4,222.2 million, net of reinsurance recoverables. We believe that these changes are reasonable given the long-tail nature of our business.

There is potential for significant variation in the development of loss reserves, particularly for the casualty lines of business due to their long-tail nature and high attachment points. The maturing of our casualty insurance and reinsurance loss reserves have caused us to reduce what we believe is the reasonably possible variance in the expected loss ratios for older loss years. As of December 31, 2013 and 2012, we believe the reasonably possible variances in our expected loss ratio in percentage points for our loss years are as follows:

 

     As of December 31,  

Loss Year

   2013     2012  

2005

         2.0

2006

     2.0     4.0

2007

     4.0     6.0

2008

     6.0     8.0

2009

     8.0     10.0

2010

     10.0     10.0

2011

         10.0         10.0

2012

     10.0     10.0

2013

     10.0     N/A   

The change in the reasonably possible variance for the 2005 through 2009 loss years in 2013 compared to 2012 is due to giving greater weight to the Bornhuetter-Ferguson loss development method for additional lines of business during 2013 and additional development of losses. As we gain more information and experience about our losses we are able to refine our estimate of the ultimate loss and as a result the reasonably possible variance in our losses is reduced. We believe the reasonably possible change in our loss reserves for the recent years is appropriate as we are relying on less information and experience about how the losses will ultimately develop compared to the older loss years. This was the case as it relates to the unfavorable loss reserve development we recognized in 2013 for the recent loss years in our U.S. insurance segment. The total reasonably possible variance of our expected loss ratio for all loss years for our casualty insurance and casualty reinsurance lines of business was six percentage points as of December 31, 2013. Because we expect a small volume of large claims, it is more difficult to estimate the ultimate loss ratios, so we believe the variance of our loss ratio selection could be relatively wide.

If our final casualty insurance and reinsurance loss ratios vary by six percentage points from the expected loss ratios in aggregate, our required net reserves after reinsurance recoverable would increase or decrease by approximately $643.2 million. Excluding the impact of income taxes, this would result in either an increase or decrease to net income and total shareholders’ equity of approximately $643.2 million. As of December 31, 2013, this represented approximately 18% of total shareholders’ equity.

 

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In terms of liquidity, our contractual obligations for reserves for losses and loss expenses would also increase or decrease by approximately $643.2 million after reinsurance recoverable. If our obligations were to increase, we believe we currently have sufficient cash and investments to meet those obligations.

The following tables provide our ranges of loss and loss expense reserve estimates by business segment as of December 31, 2013:

 

     Reserve for Losses and Loss Expenses
Gross of Reinsurance Recoverable
 
     Carried
Reserves
     Low
Estimate
     High
Estimate
 
     ($ in millions)  

U.S. insurance

   $ 2,119.0       $ 1,670.0       $ 2,446.9   

International insurance

     2,151.4         1,643.7         2,368.4   

Reinsurance

     1,496.1         1,238.9         1,689.2   

Consolidated(1)

     5,766.5         4,652.0         6,405.1   
     Reserve for Losses and Loss Expenses
Net of Reinsurance Recoverable
 
     Carried
Reserves
     Low
Estimate
     High
Estimate
 
     ($ in millions)  

U.S. insurance

   $ 1,560.3       $ 1,209.1       $ 1,820.7   

International insurance

     1,481.8         1,120.0         1,643.4   

Reinsurance

     1,489.9         1,232.0         1,680.7   

Consolidated(1)

     4,532.0         3,649.0         5,056.9   

 

(1) For statistical reasons, it is not appropriate to add together the ranges of each business segment in an effort to determine the low and high range around the consolidated loss reserves.

Our range for each business segment was determined by utilizing multiple actuarial loss reserving methods along with various assumptions of reporting patterns and expected loss ratios by loss year. The various outcomes of these techniques were combined to determine a reasonable range of required loss and loss expense reserves. While we believe our approach to determine the range of loss and loss expense is reasonable, there are no assurances that actual loss experience will be within the ranges of loss and loss expense noted above.

Our selection of the actual carried reserves has typically been above the midpoint of the range. As of December 31, 2013, we were 4.1% above the midpoint of the consolidated net loss reserve range. We believe that we should be prudent in our reserving practices due to the lengthy reporting patterns and relatively large limits of net liability for any one risk of our direct excess casualty business and of our casualty reinsurance business. Thus, due to this uncertainty regarding estimates for reserve for losses and loss expenses, we have carried our consolidated reserve for losses and loss expenses, net of reinsurance recoverable, above the midpoint of the low and high estimates for the consolidated net losses and loss expenses. We believe that relying on the more prudent actuarial indications is appropriate for these lines of business.

Ceded Reinsurance

We cede insurance to external reinsurers in order to limit our maximum loss, to protect against concentration of risk within our portfolio and to manage our exposure to catastrophic events. Because the ceding of insurance does not discharge us from our primary obligation to the insureds, we remain liable to the extent that our reinsurers do not meet their obligations under the reinsurance agreements. Therefore, we regularly evaluate the financial condition of our reinsurers and monitor concentration of credit risk. No material provision has been made for unrecoverable reinsurance as of December 31, 2013 and 2012 as we believe that all reinsurance balances will be recovered.

 

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When we reinsure a portion of our exposures, we pay reinsurers a portion of premiums received on the reinsured policies. The following table illustrates our gross premiums written, ceded premiums written and net premiums written:

 

     Year Ended December 31,  
     2013     2012     2011  
     ($ in millions)  

Gross premiums written

   $ 2,738.7      $ 2,329.3      $ 1,939.5   

Premiums ceded

     (618.2     (491.5     (405.7
  

 

 

   

 

 

   

 

 

 

Net premiums written

   $ 2,120.5      $ 1,837.8      $ 1,533.8   
  

 

 

   

 

 

   

 

 

 

Ceded as a percentage of gross

     22.6     21.1     20.9