UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the Quarterly Period Ended September 30, 2017
OR
For the Transition Period from to
001-34809
Commission File Number
GLOBAL INDEMNITY LIMITED
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
27 HOSPITAL ROAD
GEORGE TOWN, GRAND CAYMAN
KY1-9008
CAYMAN ISLANDS
(Address of principal executive office including zip code)
Registrant’s telephone number, including area code: (345) 949-0100
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that registrant was required to submit and post such files.). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.:
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of October 31, 2017, the registrant had outstanding 13,462,999 A Ordinary Shares and 4,133,366 B Ordinary Shares.
TABLE OF CONTENTS
Item 1.
Financial Statements:
Consolidated Balance SheetsAs of September 30, 2017 (Unaudited) and December 31, 2016
Consolidated Statements of OperationsQuarters and Nine Months Ended September 30, 2017 (Unaudited) and September 30, 2016 (Unaudited)
Consolidated Statements of Comprehensive IncomeQuarters and Nine Months Ended September 30, 2017 (Unaudited) and September 30, 2016 (Unaudited)
Consolidated Statements of Changes in Shareholders’ EquityNine Months Ended September 30, 2017 (Unaudited) and Year Ended December 31, 2016
Consolidated Statements of Cash FlowsNine Months Ended September 30, 2017 (Unaudited) and September 30, 2016 (Unaudited)
Notes to Consolidated Financial Statements (Unaudited)
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Item 4.
Controls and Procedures
Item 1A.
Item 5.
Item 6.
Signature
1
PART I – FINANCIAL INFORMATION
Consolidated Balance Sheets
(In thousands, except share amounts)
Fixed maturities:
Available for sale, at fair value (amortized cost: $1,355,690 and $1,241,339)
Equity securities:
Available for sale, at fair value (cost: $124,064 and $119,515)
Other invested assets
Total investments
Cash and cash equivalents
Premiums receivable, net
Reinsurance receivables, net
Funds held by ceding insurers
Receivable for securities sold
Deferred federal income taxes
Deferred acquisition costs
Intangible assets
Goodwill
Prepaid reinsurance premiums
Other assets
Total assets
Liabilities:
Unpaid losses and loss adjustment expenses
Unearned premiums
Federal income taxes payable
Ceded balances payable
Payable for securities purchased
Contingent commissions
Debt
Other liabilities
Total liabilities
Commitments and contingencies (Note 10)
Shareholders’ equity:
Ordinary shares, $0.0001 par value, 900,000,000 ordinary shares authorized; A ordinary shares issued: 13,458,465 and 13,436,548 respectively; A ordinary shares outstanding: 13,428,914 and 13,436,548, respectively; B ordinary shares issued and outstanding: 4,133,366 and 4,133,366, respectively
Additional paid-in capital
Accumulated other comprehensive income, net of taxes
Retained earnings
A ordinary shares in treasury, at cost: 29,551 and 0 shares, respectively
Total shareholders’ equity
Total liabilities and shareholders’ equity
See accompanying notes to consolidated financial statements.
2
Consolidated Statements of Operations
(In thousands, except shares and per share data)
Revenues:
Gross premiums written
Net premiums written
Net premiums earned
Net investment income
Net realized investment gains (losses):
Other than temporary impairment losses on investments
Other net realized investment gains (losses)
Total net realized investment gains (losses)
Other income
Total revenues
Losses and Expenses:
Net losses and loss adjustment expenses
Acquisition costs and other underwriting expenses
Corporate and other operating expenses
Interest expense
Income (loss) before income taxes
Income tax expense (benefit)
Net income (loss)
Per share data:
Net income (loss) (1)
Basic
Diluted
Weighted-average number of shares outstanding
3
Consolidated Statements of Comprehensive Income
(In thousands)
Other comprehensive income, net of tax:
Unrealized holding gains
Portion of other-than-temporary impairment losses recognized in other comprehensive income
Reclassification adjustment for (gains) losses included in net income (loss)
Unrealized foreign currency translation gains (losses)
Other comprehensive income, net of tax
Comprehensive income (loss), net of tax
4
Consolidated Statements of Changes in Shareholders’ Equity
Number of A ordinary shares issued:
Number at beginning of period
Ordinary shares issued under share incentive plans
Ordinary shares issued to directors
Reduction in treasury shares due to redomestication
Number at end of period
Number of B ordinary shares issued:
Number at beginning and end of period
Par value of A ordinary shares:
Balance at beginning of period
Balance at end of period
Par value of B ordinary shares:
Balance at beginning and end of period
Additional paid-in capital:
Share compensation plans
Tax benefit on share-based compensation expense
Accumulated other comprehensive income, net of deferred income tax:
Other comprehensive income (loss):
Change in unrealized holding gains (losses)
Change in other than temporary impairment losses recognized in other comprehensive income
Unrealized foreign currency translation gains
Other comprehensive income (loss)
Retained earnings:
Net income
Number of treasury shares:
A ordinary shares purchased
Treasury shares, at cost:
A ordinary shares purchased, at cost
5
Consolidated Statements of Cash Flows
Cash flows from operating activities:
Adjustments to reconcile net income to net cash used for operating activities:
Amortization and depreciation
Amortization of debt issuance costs
Restricted stock and stock option expense
Amortization of bond premium and discount, net
Net realized investment gains
Gain on disposition of subsidiary
Equity in the earnings of equity method limited liability investments
Changes in:
Other assets and liabilities, net
Federal income tax receivable/payable
Deferred acquisition costs, net
Net cash used for operating activities
Cash flows from investing activities:
Proceeds from sale of fixed maturities
Proceeds from sale of equity securities
Proceeds from maturity of fixed maturities
Proceeds from limited partnerships
Proceeds from disposition of subsidiary, net of cash and cash equivalents disposed of $1,269
Amounts paid in connection with derivatives
Purchases of fixed maturities
Purchases of equity securities
Purchases of other invested assets
Net cash provided by (used for) investing activities
Cash flows from financing activities:
Net borrowings under margin borrowing facility
Proceeds from issuance of subordinated notes
Debt issuance cost
Purchase of A ordinary shares
Net cash provided by financing activities
Net change in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
6
Global Indemnity Limited (“Global Indemnity” or “the Company”), incorporated on February 9, 2016, is domiciled in the Cayman Islands. On November 7, 2016, Global Indemnity replaced Global Indemnity plc as the ultimate parent company as a result of a redomestication transaction. The Company’s A ordinary shares are publicly traded on the NASDAQ Global Select Market under the ticker symbol GBLI. Please see Note 2 of the notes to the consolidated financial statements in Item 8 Part II of the Company’s 2016 Annual Report on Form 10-K for more information on the Company’s redomestication.
The Company manages its business through three business segments: Commercial Lines, Personal Lines, and Reinsurance Operations. The Company’s Commercial Lines offers specialty property and casualty insurance products in the excess and surplus lines marketplace. The Company manages its Commercial Lines by differentiating them into four product classifications: Penn-America, which markets property and general liability products to small commercial businesses through a select network of wholesale general agents with specific binding authority; United National, which markets insurance products for targeted insured segments, including specialty products, such as property, general liability, and professional lines through program administrators with specific binding authority; Diamond State, which markets property, casualty, and professional lines products, which are developed by the Company’s underwriting department by individuals with expertise in those lines of business, through wholesale brokers and also markets through program administrators having specific binding authority; and Vacant Express, which insures dwellings which are currently vacant, undergoing renovation, or are under construction and is distributed through aggregators, brokers, and retail agents. These product classifications comprise the Company’s Commercial Lines business segment and are not considered individual business segments because each product has similar economic characteristics, distribution, and coverage. The Company’s Personal Lines segment offers specialty personal lines and agricultural coverage through general and specialty agents with specific binding authority on an admitted basis. Collectively, the Company’s U.S. insurance subsidiaries are licensed in all 50 states and the District of Columbia. The Commercial Lines and Personal Lines segments comprise the Company’s U.S. Insurance Operations (‘Insurance Operations”). The Company’s Reinsurance Operations consist solely of the operations of its Bermuda-based wholly-owned subsidiary, Global Indemnity Reinsurance Company, Ltd. (“Global Indemnity Reinsurance”). Global Indemnity Reinsurance is a treaty reinsurer of specialty property and casualty insurance and reinsurance companies. The Company’s Reinsurance Operations segment provides reinsurance solutions through brokers and primary writers including insurance and reinsurance companies.
During the 1st quarter of 2017, the Company re-evaluated its Commercial Lines and Personal Lines segments and determined that certain portions of business will be managed, operated and reported by including them in the other segment. As a result, the composition of the Company’s reportable segments changed slightly. Premium that is written through a wholly owned agency that mainly sells to individuals, which was previously included as part of the Commercial Lines segment, is now included within the Personal Lines segment. In addition, one of the small commercial programs written by American Reliable Insurance Company (“American Reliable”), which was previously included within the Personal Lines segment, is now aggregated within the Commercial Lines segment. Accordingly, the segment results for the quarter and nine months ended September 30, 2016 have been revised to reflect these changes. See Note 13 for additional information regarding segments.
The interim consolidated financial statements are unaudited, but have been prepared in conformity with United States of America generally accepted accounting principles (“GAAP”), which differs in certain respects from those principles followed in reports to insurance regulatory authorities. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The unaudited consolidated financial statements include all adjustments that are, in the opinion of management, of a normal recurring nature and are necessary for a fair statement of results for the interim periods. Results of operations for the quarters and nine months ended September 30, 2017 and 2016 are not necessarily indicative of the results of a full year. The accompanying notes to the unaudited consolidated financial statements should be read in conjunction with the notes to the consolidated financial statements contained in the Company’s 2016 Annual Report on Form 10-K.
The consolidated financial statements include the accounts of Global Indemnity and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
7
The amortized cost and estimated fair value of investments were as follows as of September 30, 2017 and December 31, 2016:
As of September 30, 2017
U.S. treasury and agency obligations
Obligations of states and political subdivisions
Mortgage-backed securities
Asset-backed securities
Commercial mortgage-backed securities
Corporate bonds
Foreign corporate bonds
Total fixed maturities
Common stock
Total
As of December 31, 2016
Excluding U.S. treasuries and agency bonds, the Company did not hold any debt or equity investments in a single issuer that was in excess of 4% and 5% of shareholders’ equity at September 30, 2017 and December 31, 2016, respectively.
8
The amortized cost and estimated fair value of the Company’s fixed maturities portfolio classified as available for sale at September 30, 2017, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Due in one year or less
Due in one year through five years
Due in five years through ten years
Due in ten years through fifteen years
Due after fifteen years
The following table contains an analysis of the Company’s securities with gross unrealized losses, categorized by the period that the securities were in a continuous loss position as of September 30, 2017:
9
The following table contains an analysis of the Company’s securities with gross unrealized losses, categorized by the period that the securities were in a continuous loss position as of December 31, 2016:
The Company regularly performs various analytical valuation procedures with respect to its investments, including reviewing each fixed maturity security in an unrealized loss position to assess whether the security has a credit loss. Specifically, the Company considers credit rating, market price, and issuer specific financial information, among other factors, to assess the likelihood of collection of all principal and interest as contractually due. Securities for which the Company determines that a credit loss is likely are subjected to further analysis through discounted cash flow testing to estimate the credit loss to be recognized in earnings, if any. The specific methodologies and significant assumptions used by asset class are discussed below. Upon identification of such securities and periodically thereafter, a detailed review is performed to determine whether the decline is considered other than temporary. This review includes an analysis of several factors, including but not limited to, the credit ratings and cash flows of the securities and the magnitude and length of time that the fair value of such securities is below cost.
For fixed maturities, the factors considered in reaching the conclusion that a decline below cost is other than temporary include, among others, whether:
10
According to accounting guidance for debt securities in an unrealized loss position, the Company is required to assess whether it has the intent to sell the debt security or more likely than not will be required to sell the debt security before the anticipated recovery. If either of these conditions is met the Company must recognize an other than temporary impairment with the entire unrealized loss being recorded through earnings. For debt securities in an unrealized loss position not meeting these conditions, the Company assesses whether the impairment of a security is other than temporary. If the impairment is deemed to be other than temporary, the Company must separate the other than temporary impairment into two components: the amount representing the credit loss and the amount related to all other factors, such as changes in interest rates. The credit loss represents the portion of the amortized book value in excess of the net present value of the projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. The credit loss component of the other than temporary impairment is recorded through earnings, whereas the amount relating to factors other than credit losses is recorded in other comprehensive income, net of taxes.
For equity securities, management carefully reviews all securities with unrealized losses to determine if a security should be impaired and further focuses on securities that have either:
The amount of any write-down, including those that are deemed to be other than temporary, is included in earnings as a realized loss in the period in which the impairment arose.
The following is a description, by asset type, of the methodology and significant inputs that the Company used to measure the amount of credit loss recognized in earnings, if any:
U.S. treasury and agency obligations – As of September 30, 2017, gross unrealized losses related to U.S. treasury and agency obligations were $0.495 million. Of this amount, $0.006 million have been in an unrealized loss position for 12 months or greater and are rated AA+. Macroeconomic and market analysis is conducted in evaluating these securities. Consideration is given to the interest rate environment, duration and yield curve management of the portfolio, sector allocation and security selection.
Obligations of states and political subdivisions – As of September 30, 2017, gross unrealized losses related to obligations of states and political subdivisions were $0.256 million. Of this amount, $0.057 million have been in an unrealized loss position for twelve months or greater and are rated investment grade. All factors that influence performance of the municipal bond market are considered in evaluating these securities. The aforementioned factors include investor expectations, supply and demand patterns, and current versus historical yield and spread relationships. The analysis relies on the output of fixed income credit analysts, as well as dedicated municipal bond analysts who perform extensive in-house fundamental analysis on each issuer, regardless of their rating by the major agencies.
11
Mortgage-backed securities (“MBS”) – As of September 30, 2017, gross unrealized losses related to mortgage-backed securities were $0.562 million. Of this amount, $0.008 million have been in an unrealized loss position for twelve months or greater. 75.9% of the unrealized losses for twelve months or greater are related to securities rated AA+. Mortgage-backed securities are modeled to project principal losses under downside, base, and upside scenarios for the economy and home prices. The primary assumption that drives the security and loan level modeling is the Home Price Index (“HPI”) projection. These forecasts incorporate not just national macro-economic trends, but also regional impacts to arrive at the most granular and accurate projections. These assumptions are incorporated into the model as a basis to generate delinquency probabilities, default curves, loss severity curves, and voluntary prepayment curves at the loan level within each deal. The model utilizes HPI-adjusted current LTV, payment history, loan terms, loan modification history, and borrower characteristics as inputs to generate expected cash flows and principal loss for each bond under various scenarios.
Asset-backed securities (“ABS”) - As of September 30, 2017, gross unrealized losses related to asset backed securities were $0.142 million. All unrealized losses have been in an unrealized loss position for less than 12 months. The weighted average credit enhancement for the Company’s asset backed portfolio is 22.5. This represents the percentage of pool losses that can occur before an asset backed security will incur its first dollar of principal losses. Every ABS transaction is analyzed on a stand-alone basis. This analysis involves a thorough review of the collateral, prepayment, and structural risk in each transaction. Additionally, the analysis includes an in-depth credit analysis of the originator and servicer of the collateral. The analysis projects an expected loss for a deal given a set of assumptions specific to the asset type. These assumptions are used to calculate at what level of losses the deal will incur its first dollar of principal loss. The major assumptions used to calculate this ratio are loss severities, recovery lags, and no advances on principal and interest.
Commercial mortgage-backed securities (“CMBS”) - As of September 30, 2017, gross unrealized losses related to the CMBS portfolio were $0.741 million. Of this amount, $0.102 million have been in an unrealized loss position for twelve months or greater and are rated AA+ or better. The weighted average credit enhancement for the Company’s CMBS portfolio is 25.6. This represents the percentage of pool losses that can occur before a mortgage-backed security will incur its first dollar of principal loss. For the Company’s CMBS portfolio, a loan level analysis is utilized where every underlying CMBS loan is re-underwritten based on a set of assumptions reflecting expectations for the future path of the economy. Each loan is analyzed over time using a series of tests to determine if a credit event will occur during the life of the loan. Inherent in this process are several economic scenarios and their corresponding rent/vacancy and capital market states. The five primary credit events that frame the analysis include loan modifications, term default, balloon default, extension, and ability to pay off at balloon. The resulting output is the expected loss adjusted cash flows for each bond under the base case and distressed scenarios.
Corporate bonds - As of September 30, 2017, gross unrealized losses related to corporate bonds were $0.838 million. Of this amount, $0.238 million have been in an unrealized loss position for twelve months or greater and are rated A- or better. The analysis for this asset class includes maintaining detailed financial models that include a projection of each issuer’s future financial performance, including prospective debt servicing capabilities, capital structure composition, and the value of the collateral. The analysis incorporates the macroeconomic environment, industry conditions in which the issuer operates, the issuer’s current competitive position, its vulnerability to changes in the competitive and regulatory environment, issuer liquidity, issuer commitment to bondholders, issuer creditworthiness, and asset protection. Part of the process also includes running downside scenarios to evaluate the expected likelihood of default as well as potential losses in the event of default.
Foreign bonds – As of September 30, 2017, gross unrealized losses related to foreign bonds were $0.188 million. Of this amount, $0.101 million have been in an unrealized loss position for twelve months or greater and are rated investment grade. For this asset class, detailed financial models are maintained that include a projection of each issuer’s future financial performance, including prospective debt servicing capabilities, capital structure composition, and the value of the collateral. The analysis incorporates the macroeconomic environment, industry conditions in which the issuer operates, the issuer’s current competitive position, its vulnerability to changes in the competitive and regulatory environment, issuer liquidity, issuer commitment to bondholders, issuer creditworthiness, and asset protection. Part of the process also includes running downside scenarios to evaluate the expected likelihood of default as well as potential losses in the event of default.
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Common stock – As of September 30, 2017, gross unrealized losses related to common stock were $3.750 million. All unrealized losses have been in an unrealized loss position for less than twelve months. To determine if an other-than-temporary impairment of an equity security has occurred, the Company considers, among other things, the severity and duration of the decline in fair value of the equity security. The Company also examines other factors to determine if the equity security could recover its value in a reasonable period of time.
The Company recorded the following other than temporary impairments (“OTTI”) on its investment portfolio for the quarters and nine months ended September 30, 2017 and 2016:
OTTI losses, gross
Portion of loss recognized in other comprehensive income(pre-tax)
Net impairment losses on fixed maturities recognized in earnings
Equity securities
The following table is an analysis of the credit losses recognized in earnings on fixed maturities held by the Company for the quarters and nine months ended September 30, 2017 and 2016 for which a portion of the OTTI loss was recognized in other comprehensive income.
Additions where no OTTI was previously recorded
Additions where an OTTI was previously recorded
Reductions for securities for which the company intends to sell or more likely than not will be required to sell before recovery
Reductions reflecting increases in expected cash flows to be collected
Reductions for securities sold during the period
Accumulated Other Comprehensive Income, Net of Tax
Accumulated other comprehensive income, net of tax, as of September 30, 2017 and December 31, 2016 was as follows:
Net unrealized gains (losses)from:
Fixed maturities
Foreign currency fluctuations
Deferred taxes
Accumulated other comprehensive income, net of tax
13
The following tables present the changes in accumulated other comprehensive income, net of tax, by component for the quarters and nine months ended September 30, 2017 and 2016:
Quarter Ended September 30, 2017
(Dollars in thousands)
Beginning balance
Other comprehensive income (loss) before reclassification
Amounts reclassified from accumulated other comprehensive income (loss)
Ending balance
Quarter Ended September 30, 2016
Amounts reclassified from accumulated other Comprehensive loss
Nine Months Ended September 30, 2017
14
Nine Months Ended September 30, 2016
Amounts reclassified from accumulated other comprehensive loss
The reclassifications out of accumulated other comprehensive income for the quarters and nine months ended September 30, 2017 and 2016 were as follows:
Details about Accumulated OtherComprehensive Income Components
Affected Line Item in theConsolidated Statements of
Operations
Unrealized gains and losses on available for sale securities
Foreign currency items
Total reclassifications
15
Net Realized Investment Gains (Losses)
The components of net realized investment gains (losses) for the quarters and nine months ended September 30, 2017 and 2016 were as follows:
Gross realized gains
Gross realized losses
Net realized gains
Common stock:
Derivatives:
Net realized gains (losses) (1)
16
The proceeds from sales and redemptions ofavailable-for-sale securities resulting in net realized investment gains for the nine months ended September 30, 2017 and 2016 were as follows:
Net Investment Income
The sources of net investment income for the quarters and nine months ended September 30, 2017 and 2016 were as follows:
Total investment income
Investment expense (1)
The Company’s total investment return on apre-tax basis for the quarters and nine months ended September 30, 2017 and 2016 were as follows:
Net realized investment gains (losses)
Change in unrealized holding gains and losses
Net realized and unrealized investment returns
Total investment return
Total investment return % (1)
Average investment portfolio
Insurance Enhanced Asset Backed and Credit Securities
As of September 30, 2017, the Company held insurance enhanced asset-backed, commercial mortgage-backed, and credit securities with a market value of approximately $37.9 million. Approximately $4.2 million of these securities were tax free municipal bonds, which represented approximately 0.3% of the Company’s total cash and invested assets, net of payable/receivable for securities purchased and sold. These securities had an average rating of “AA-.” Approximately $1.5 million of these bonds are pre-refunded with U.S. treasury securities. None of the remaining $2.7 million of tax free insurance enhanced municipal bonds, would have carried a lower credit rating had they not been insured.
17
A summary of the Company’s insurance enhanced municipal bonds that are backed by financial guarantors, including the pre-refunded bonds that are escrowed in U.S. government obligations, as of September 30, 2017, is as follows:
Financial Guarantor
Ambac Financial Group
Municipal Bond Insurance Association
Gov’t National Housing Association
Total backed by financial guarantors
Other credit enhanced municipal bonds
In addition to the tax-free municipal bonds, the Company held $33.7 million of insurance enhanced bonds, which represented approximately 2.1% of the Company’s total invested assets, net of receivable/payable for securities purchased and sold. The insurance enhanced bonds are comprised of $23.2 million of taxable municipal bonds, $10.4 million of commercial mortgage-backed securities, and $0.1 million of asset-backed securities. The financial guarantors of the Company’s $33.7 million of insurance enhanced asset-backed, commercial-mortgage-backed, and taxable municipal securities include Municipal Bond Insurance Association ($7.0 million), Assured Guaranty Corporation ($16.3 million), and Federal Home Loan Mortgage Corporation ($10.4 million).
The Company had no direct investments in the entities that have provided financial guarantees or other credit support to any security held by the Company at September 30, 2017.
Bonds Held on Deposit
Certain cash balances, cash equivalents, equity securities and bonds available for sale were deposited with various governmental authorities in accordance with statutory requirements, were held as collateral pursuant to borrowing arrangements, or were held in trust pursuant to intercompany reinsurance agreements. The fair values were as follows as of September 30, 2017 and December 31, 2016:
On deposit with governmental authorities
Intercompany trusts held for the benefit of U.S. policyholders
Held in trust pursuant to third party requirements
Letter of credit held for third party requirements
Securities held as collateral for borrowing arrangements (1)
Variable Interest Entities
A Variable Interest Entity (VIE) refers to an investment in which an investor holds a controlling interest that is not based on the majority of voting rights. Under the VIE model, the party that has the power to exercise significant management influence and maintain a controlling financial interest in the entity’s economics is said to be the primary beneficiary, and is required to consolidate the entity within their results. Other entities that participate in a VIE, for which their financial interests fluctuate with changes in the fair value of the investment entity’s net assets but do not have significant management influence and the ability to direct the VIE’s significant economic activities are said to have a variable interest in the VIE but do not consolidate the VIE in their financial results.
The Company has variable interests in three VIE’s for which it is not the primary beneficiary. These investments are accounted for under the equity method of accounting as their ownership interest exceeds 3% of their respective investments. The fair value of one of the Company’s VIE’s, which invests in distressed securities and assets, was $29.8 million and $32.9 million as of September 30, 2017
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and December 31, 2016, respectively. The Company’s maximum exposure to loss from this VIE, which factors in future funding commitments, was $44.0 million at September 30, 2017 and $48.6 million at December 31, 2016. The fair value of a second VIE that provides financing for middle market companies, was $26.8 million at September 30, 2017 and $33.2 million at December 31, 2016. The Company’s maximum exposure to loss from this VIE, which factors in future funding commitments, was $38.6 million at September 30, 2017 and $42.3 million at December 31, 2016. During the 2nd quarter of 2017, the Company invested in a new limited partnership that also invests in distressed securities and assets and is considered a VIE. The Company’s investment in this partnership has a fair value of $16.9 million as of September 30, 2017. The Company’s maximum exposure to loss from this VIE, which factors in future funding commitments, was $50.4 million at September 30, 2017. The Company’s investment in VIEs is included in other invested assets on the consolidated balance sheet with changes in fair value recorded in the consolidated statements of operations.
Interest rate swaps are used by the Company primarily to reduce risks from changes in interest rates. Under the terms of the interest rate swaps, the Company agrees with another party to exchange, at specified intervals, the difference between fixed rate and floating rate interest amounts as calculated by reference to an agreed notional amount.
The Company accounts for the interest rate swaps as non-hedge instruments and recognizes the fair value of the interest rate swaps in other assets or other liabilities on the consolidated balance sheets with the changes in fair value recognized as net realized investment gains (losses) in the consolidated statements of operations. The Company is ultimately responsible for the valuation of the interest rate swaps. To aid in determining the estimated fair value of the interest rate swaps, the Company relies on the forward interest rate curve and information obtained from a third party financial institution.
The following table summarizes information on the location and the gross amount of the derivatives’ fair value on the consolidated balance sheets as of September 30, 2017 and December 31, 2016:
Derivatives Not Designated as HedgingInstruments under ASC 815
Balance Sheet
Location
Interest rate swap agreements
The following table summarizes the net gain (loss) included in the consolidated statements of operations for changes in the fair value of the derivatives and the periodic net interest settlements under the derivatives for the quarters and nine months ended September 30, 2017 and 2016:
Consolidated Statement of
Operations Line
As of September 30, 2017 and December 31, 2016, the Company is due $3.3 million and $5.3 million, respectively, for funds it needed to post to execute the swap transaction and $14.2 million and $12.6 million, respectively, for margin calls made in connection with the interest rate swaps. These amounts are included in other assets on the consolidated balance sheets.
The accounting standards related to fair value measurements define fair value, establish a framework for measuring fair value, outline a fair value hierarchy based on inputs used to measure fair value, and enhance disclosure requirements for fair value measurements. These standards do not change existing guidance as to whether or not an instrument is carried at fair value. The Company has determined that its fair value measurements are in accordance with the requirements of these accounting standards.
The Company’s invested assets and derivative instruments are carried at their fair value and are categorized based upon a fair value hierarchy:
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In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset.
The following table presents information about the Company’s invested assets and derivative instruments measured at fair value on a recurring basis as of September 30, 2017 and December 31, 2016, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.
Assets:
Total assets measured at fair value (1)
Derivative instruments
Total liabilities measured at fair value
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The securities classified as Level 1 in the above table consist of U.S. Treasuries and equity securities actively traded on an exchange.
The securities classified as Level 2 in the above table consist primarily of fixed maturity securities and derivative instruments. Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, security prices are derived through recent reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information. If there are no recent reported trades, matrix or model processes are used to develop a security price where future cash flow expectations are developed based upon collateral performance and discounted at an estimated market rate. Included in the pricing of asset-backed securities, collateralized mortgage obligations, and mortgage-backed securities are estimates of the rate of future prepayments of principal over the remaining life of the securities. Such estimates are derived based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral. The estimated fair value of the derivative instruments, consisting of interest rate swaps, is obtained from a third party financial institution that utilizes observable inputs such as the forward interest rate curve.
For the Company’s material debt arrangements, the current fair value of the Company’s debt at September 30, 2017 and December 31, 2016 was as follows:
Margin Borrowing Facility
7.75% Subordinated Notes due 2045 (1)
7.875% Subordinated Notes due 2047 (2)
The fair value of the margin borrowing facility approximates its carrying value due to the facility being due on demand. The subordinated notes due 2045 and 2047 are publicly traded instruments and are classified as Level 1 in the fair value hierarchy.
There were no transfers between Level 1 and Level 2 during the quarters ended September 30, 2017 and 2016.
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Fair Value of Alternative Investments
Other invested assets consist of limited liability partnerships whose fair value is based on net asset value per share as a practical expedient. The following table provides the fair value and future funding commitments related to these investments at September 30, 2017 and December 31, 2016.
Real Estate Fund, LP (1)
European Non-Performing Loan Fund, LP (2)
Private Middle Market Loan Fund, LP (3)
Distressed Debt Fund, LP (4)
Limited Liability Companies and Limited Partnerships with ownership interest exceeding 3%
The Company uses the equity method to account for investments in limited liability companies and limited partnerships where its ownership interest exceeds 3%. The equity method of accounting for an investment in a limited liability company and limited partnership requires that its cost basis be updated to account for the income or loss earned on the investment. The investment income or loss associated with these limited liability companies or limited partnerships, which is reflected in the consolidated statements of operations, was $0.7 million and $0.9 million during the quarters end September 30, 2017 and 2016, respectively, and $2.4 million and $3.7 million during the nine months ended September 30, 2017 and 2016, respectively.
Pricing
The Company’s pricing vendors provide prices for all investment categories except for investments in limited partnerships whose fair value is based on net asset values as a practical expedient. Two primary vendors are utilized to provide prices for equity and fixed maturity securities.
The following is a description of the valuation methodologies used by the Company’s pricing vendors for investment securities carried at fair value:
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The Company performs certain procedures to validate whether the pricing information received from the pricing vendors is reasonable, to ensure that the fair value determination is consistent with accounting guidance, and to ensure that its assets are properly classified in the fair value hierarchy. The Company’s procedures include, but are not limited to:
During the quarters and nine months ended September 30, 2017 and 2016, the Company has not adjusted quotes or prices obtained from the pricing vendors.
The statutory income tax rates of the countries where the Company conducts or conducted business are 35% in the United States, 0% in Bermuda, 0% in the Cayman Islands, 0% in Gibraltar, 27.08% in the Duchy of Luxembourg, 0.25% to 2.5% in Barbados, and 25% on non-trading income, 33% on capital gains and 12.5% on trading income in the Republic of Ireland. The statutory income tax rate of each country is applied against the expected annual taxable income of the Company in each country to estimate the annual income tax expense. Generally, during interim periods, the Company will divide total estimated annual income tax expense by total estimated annual pre-tax income to determine the expected annual income tax rate used to compute the income tax provision. The expected annual income tax rate is then applied against interim pre-tax income, excluding net realized gains and losses and limited partnership distributions, and that amount is then added to the actual income taxes on net realized gains and losses, discrete items and limited partnership distributions. However, when there is significant volatility in the expected effective tax rate, the Company records its actual income tax provision in lieu of the estimated effective income tax rate.
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The Company’s income before income taxes from its non-U.S.subsidiaries and U.S. subsidiaries, including the results of the quota share agreements between Global Indemnity Reinsurance and the Insurance Operations, for the quarters and nine months ended September 30, 2017 and 2016 were as follows:
Quarter Ended September 30, 2017:
Net realized investment losses
Quarter Ended September 30, 2016:
Other income (loss)
Income before income taxes
Nine Months Ended September 30, 2017:
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Nine Months Ended September 30, 2016:
The following table summarizes the components of income tax benefit:
Current income tax expense:
Foreign
U.S. Federal
Total current income tax expense
Deferred income tax expense (benefit):
Total deferred income tax expense (benefit)
Total income tax expense (benefit)
The weighted average expected tax provision has been calculated using income before income taxes in each jurisdiction multiplied by that jurisdiction’s applicable statutory tax rate.
The following table summarizes the differences between the tax provision for financial statement purposes and the expected tax provision at the weighted average tax rate:
Expected tax provision at weighted average rate
Adjustments:
Tax exempt interest
Dividend exclusion
Other
Actual tax on continuing operations
The effective income tax benefit rate for the quarter ended September 30, 2017 was 46.8%, compared with an effective income tax rate of 10.0% for the quarter ended September 30, 2016. The increase in the income tax benefit rate is primarily due to losses incurred in the Company’s U.S. operations for the quarter ended September 30, 2017 as compared to a gain in 2016. Taxes were computed using a discrete period computation because a reliable estimate of an effective tax rate could not be made.
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The effective income tax benefit rate for the nine months ended September 30, 2017 was 5,194.1%, compared with an effective income tax benefit rate of 961.4% for the nine months ended September 30, 2016. The increase in the income tax benefit rate is primarily due to higher losses incurred in the Company’s U.S. operations for the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016. Taxes were computed using a discrete period computation because a reliable estimate of an effective tax rate could not be made.
The Company has an alternative minimum tax (“AMT”) credit carryforward of $11.0 million as of September 30, 2017 and December 31, 2016, which can be carried forward indefinitely. The Company has a net operating loss (“NOL”) carryforward of $21.8 million as of September 30, 2017, which begins to expire in 2035 based on when the original NOL was generated, and a NOL carryforward of $3.2 million as of December 31, 2016. The Company has a Section 163(j) (“163(j)”) carryforward of $6.0 million and $8.1 million as of September 30, 2017 and December 31, 2016, respectively, which can be carried forward indefinitely. The 163(j) carryforward is for disqualified interest paid or accrued to a related entity that is not subject to U.S. tax.
Activity in the liability for unpaid losses and loss adjustment expenses is summarized as follows:
Less: Ceded reinsurance receivables
Net balance at beginning of period
Purchased reserves, gross
Purchased reserves ceded
Purchased reserves, net of third party reinsurance
Incurred losses and loss adjustment expenses related to:
Current year
Prior years
Total incurred losses and loss adjustment expenses
Paid losses and loss adjustment expenses related to:
Total paid losses and loss adjustment expenses
Net balance at end of period
Plus: Ceded reinsurance receivables
When analyzing loss reserves and prior year development, the Company considers many factors, including the frequency and severity of claims, loss trends, case reserve settlements that may have resulted in significant development, and any other additional or pertinent factors that may impact reserve estimates.
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In the third quarter of 2017, the Company reduced its prior accident year loss reserves by $9.4 million, which consisted of a $7.3 million decrease related to Commercial Lines, a $1.3 million decrease related to Personal Lines, and a $0.8 million decrease related to Reinsurance Operations.
The $7.3 million reduction of prior accident year loss reserves related to Commercial Lines primarily consisted of the following:
The $1.3 million reduction of prior accident year loss reserves related to Personal Lines reflects $1.3 million in subrogation recoveries involving the 2015 wildfire.
The $0.8 million reduction related to Reinsurance Operations was from the property lines. Ultimate losses were lowered primarily in the 2015 accident year and partially offset by an increase in the 2016 accident year based on a review of the experience reported from cedants.
In the third quarter of 2016, the Company reduced its prior accident year loss reserves by $9.4 million, which consisted of a $6.5 million decrease related to Commercial Lines and a $2.9 million decrease related to Reinsurance Operations.
The $6.5 million reduction of prior accident year loss reserves related to Commercial Lines primarily consisted of the following:
The $2.9 million reduction related to Reinsurance Operations was from the property lines. Ultimate losses were lowered in the 2014 and 2015 accident years based on a review of the experience reported from cedants.
During the first nine months of 2017, the Company reduced its prior accident year loss reserves by $34.8 million, which consisted of a $26.2 million decrease related to Commercial Lines, a $4.5 million decrease related to Personal Lines, and a $4.1 million decrease related to Reinsurance Operations.
The $26.2 million reduction of prior accident year loss reserves related to Commercial Lines primarily consisted of the following:
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The $4.5 million reduction of prior accident year loss reserves related to Personal Lines primarily consisted of the following:
The $4.1 million reduction of prior accident year loss reserve related to Reinsurance Operations was from the property lines. Ultimate losses were lowered in the 2013 through 2015 accident years and partially offset by an increase in the 2016 accident year based on a review of the experience reported from cedants.
In the first nine months of 2016, the Company decreased its prior accident year loss reserves by $24.9 million, which consisted of an $18.8 million decrease related to Commercial Lines and a $6.1 million decrease related to Reinsurance Operations.
The $18.8 million decrease related to Commercial Lines primarily consisted of the following:
The $6.1 million reduction related to Reinsurance Operations was from the property lines. Ultimate losses were lowered for the 2013 through 2015 accident years due to lower than expected emergence of catastrophe losses.
7.875% Subordinated Notes due 2047
On March 23, 2017, the Company issued Subordinated Notes due in 2047 in the aggregate principal amount of $120.0 million through an underwritten public offering (the “2047 Notes”). Pursuant to the underwriting agreement, the Company granted the underwriters a 30 day option to purchase up to an additional $18 million aggregate principal amount of the 2047 Notes solely to cover over-allotments, if any. On March 30, 2017, the underwriters exercised their over-allotment option in the amount of $10 million principal amount of the 2047 Notes. As a result, the aggregate principal amount of the 2047 Notes increased to $130.0 million. The sale of the 2047 Notes pursuant to the over-allotment option closed on March 30, 2017.
The 2047 Notes bear interest at an annual rate equal to 7.875%, payable quarterly in arrears on January 15, April 15, July 15, and October 15 of each year, commencing July 15, 2017. The 2047 Notes mature on April 15, 2047. The Company has the right to redeem the 2047 Notes in $25 increments, in whole or in part, on and after April 15, 2022, or on any interest payment
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date thereafter, at a redemption price equal to 100% of the principal amount of the 2047 Notes being redeemed plus accrued and unpaid interest to, but not including, the date of redemption. If the Company redeems only a portion of the 2047 Notes on any date of redemption, the Company may subsequently redeem additional 2047 Notes.
The 2047 Notes are subordinated unsecured obligations and rank (i) senior to the Company’s existing and future capital stock, (ii) senior in right of payment to future junior subordinated debt, (iii) equally in right of payment with any existing unsecured, subordinated debt that the Company has issued or may issue in the future that ranks equally with the 2047 Notes, including the Company’s 7.75% subordinated notes for $100.0 million due 2045 and (iv) subordinate in right of payment to any of the Company’s future senior debt. In addition, the 2047 Notes are structurally subordinated to all existing and future indebtedness, liabilities and other obligations of the Company’s subsidiaries including the Company’s margin borrowing facilities.
The 2047 Notes do not require the maintenance of any financial ratios or specified levels of net worth or liquidity, and do not contain provisions that would afford holders of the 2047 Notes protection in the event of a sudden and dramatic decline in the Company’s credit quality resulting from any highly leveraged transaction, reorganization, restructuring, merger or similar transaction involving the Company that may adversely affect holders. The 2047 Notes do not restrict the Company in any way, now or in the future, from incurring additional indebtedness, including senior indebtedness that would rank senior in right of payment to the 2047 Notes. There is no right of acceleration of maturity of the 2047 Notes in the case of default in the payment of principal, premium, if any, or interest on, the 2047 Notes or in the performance of any other obligation of the Company under the notes or if the Company defaults on any other debt securities. Holders may accelerate payment of indebtedness on the 2047 Notes only upon the Company’s bankruptcy, insolvency or reorganization.
The Company incurred $4.2 million in deferred issuance costs associated with the 2047 Notes, which is being amortized over the term of the 2047 Notes. Interest expense, including amortization of deferred issuance costs, recognized on the 2047 Notes was $2.6 million and $5.4 million for the quarters and nine months ended September 30, 2017, respectively.
Please see Note 12 of the notes to the consolidated financial statements in Item 8 Part II of the Company’s 2016 Annual Report on Form 10-K for information on the Company’s Margin Borrowing Facilities and the 7.75% Subordinated Notes due 2045.
No A ordinary shares were repurchased during the quarters ended September 30, 2017 or 2016. During the nine months ended September 30, 2017 and 2016, the Company repurchased 29,551 shares and 28,099 shares, respectively, with an average price paid of $39.24 per share and $ 28.64 per share, respectively. The Company repurchased these shares from employees as payment for the tax liability incurred upon the vesting of the employee’s restricted stock in accordance with the Company’s Share Incentive Plan.
There were no B ordinary shares that were repurchased during the quarters ended September 30, 2017 or 2016.
Please see Note 13 of the notes to the consolidated financial statements in Item 8 Part II of the Company’s 2016 Annual Report on Form 10-K for more information on the Company’s repurchase program.
Fox Paine & Company (“Fox Paine”)
As of September 30, 2017, Fox Paine beneficially owned shares having approximately 84% of the Company’s total outstanding voting power. Fox Paine has the right to appoint a number of the Company’s Directors equal in aggregate to the pro rata percentage of the voting shares of the Company beneficially held by Fox Paine for so long as Fox Paine holds an aggregate of 25% or more of the voting power in the Company. Fox Paine controls the election of all of the Company’s Directors due to its controlling share ownership. The Company’s Chairman is a member of Fox Paine.
The Company relies on Fox Paine to provide management services and other services related to the operations of the Company, and Fox Paine may propose and negotiate transaction fees with the Company, subject to the provisions of the Company’s related party transaction policies including approval of the Company’s Audit Committee of the Board of Directors, for those services from time to time. The Company incurred management fees of $0.6 million and $0.5 million during the quarters ended September 30,
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2017 and 2016, respectively, and $1.6 million and $1.5 million during the nine months ended September 30, 2017 and 2016, respectively, as part of the annual management fee paid to Fox Paine. As of September 30, 2017 and December 31, 2016, unpaid management fees, which were included in other liabilities on the consolidated balance sheets, were $6.3 million and $4.6 million, respectively.
On September 17, 2017, the Company and Fox Paine entered into a confidentiality agreement whereby Fox Paine agrees to keep confidential proprietary information, as defined in the confidentiality agreement, it receives regarding the Company from time to time, including proprietary information it may receive from director or director nominees appointed by Fox Paine.
Crystal & Company
The Company incurred $0.1 million and $0.2 million in brokerage fees to Crystal & Company, an insurance broker, during the quarter and nine months ended September 30, 2016, respectively. James W. Crystal, the chairman and chief executive officer of Crystal & Company, was a member of the Company’s Board of Directors until he resigned on July 24, 2016.
Legal Proceedings
The Company is, from time to time, involved in various legal proceedings in the ordinary course of business. The Company maintains insurance and reinsurance coverage for such risks in amounts that it considers adequate. However, there can be no assurance that the insurance and reinsurance coverage that the Company maintains is sufficient or will be available in adequate amounts or at a reasonable cost. The Company does not believe that the resolution of any currently pending legal proceedings, either individually or taken as a whole, will have a material adverse effect on its business, results of operations, cash flows, or financial condition.
There is a greater potential for disputes with reinsurers who are in runoff. Some of the Company’s reinsurers’ have operations that are in runoff, and therefore, the Company closely monitors those relationships. The Company anticipates that, similar to the rest of the insurance and reinsurance industry, it will continue to be subject to litigation and arbitration proceedings in the ordinary course of business.
Commitments
In 2014, the Company entered into a $50 million commitment to purchase an alternative investment vehicle which is comprised of European non-performing loans. As of September 30, 2017, the Company has funded $35.8 million of this commitment leaving $14.2 million as unfunded.
In 2016, the Company entered into a $40 million commitment with an investment manager that provides financing for middle market companies. As of September 30, 2017, the Company has funded $28.2 million of this commitment leaving $11.8 million as unfunded.
In 2017, the Company entered into a $50 million commitment to purchase an alternative investment vehicle comprised of stressed and distressed debt instruments. As of September 30, 2017, the Company has funded $16.5 million of this commitment leaving $33.5 million as unfunded.
Effective January 1, 2017, the Company adopted new accounting guidance which changed several aspects of the accounting for share-based payment transactions. Under the new guidance, all excess tax benefits and tax deficiencies associated with share-based payment awards are required to be recognized as an income tax benefit or expense in net income with the corresponding cash flows recognized as an operating activity in the Consolidated Statement of Cash Flow as opposed to being reported separately as a financing activity. Excess tax benefits and deficiencies are no longer recognized in additional paid-in-capital. The new guidance removes the requirement to delay recognition of any excess tax benefit when there is no current taxes payable to which the benefit would be applied. The new guidance also allows an employer to repurchase more of an employee’s shares for tax withholding purposes without triggering liability accounting and to make a policy election to account for forfeitures as they occur, rather than estimating forfeitures upon issuance of the award.
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Upon adoption of this new accounting guidance, the Company elected to retain its policy of accruing the compensation cost based on the number of awards that are expected to vest. The adoption of this accounting guidance did not result in any cumulative adjustment or restatement. The provisions of this new guidance were adopted on a prospective basis and did not have a material impact on the Company’s financial position, results of operations or cash flows.
Options
No stock options were awarded during the quarters ended September 30, 2017 or 2016. No unvested stock options were forfeited during the quarters ended September 30, 2017 and 2016.
The Company did not award any stock options during the nine months ended September 30, 2017 or 2016. No unvested stock options were forfeited during the nine months ended September 30, 2017. 200,000 unvested stock options were forfeited during the nine months ended September 30, 2016.
Restricted Shares
No restricted shares were issued to employees during the quarters ended September 30, 2017 and 2016.
During the nine months ended September 30, 2017, the Company granted 22,503 A ordinary shares, with a weighted average grant date value of $38.21 per share, to key employees under the Plan. These shares will vest as follows:
During the nine months ended September 30, 2016, the Company granted 121,346 A ordinary shares, with a weighted average grant date value of $28.97 per share, to key employees under the Plan. Of the shares granted during the nine months ended September 30, 2016, 11,199 were granted to the Company’s Chief Executive Officer and vest 33 1/3 on each subsequent anniversary date of the grant for a period of three years subject to a true-up of bonus year underwriting results as of the third anniversary of the grant. 5,309 were granted to another key employee and were due to vest 100% on February 7, 2019. These shares were forfeited during the nine months ended September 30, 2017 as the key employee is no longer employed by the company. 8,253 were issued to other key employees and vest 33% on the first and second anniversary of the grant and vest 34% on the third anniversary of the grant contingent on meeting certain performance objectives and subject to Board approval. The remaining 96,585 shares were granted to key employees and will vest as follows:
During the quarters ended September 30, 2017 and 2016, the Company granted 6,245 and 8,802 A ordinary shares, respectively, at a weighted average grant date value of $42.40 and $29.70 per share, respectively, to non-employee directors of the Company under the Plan. During the nine months ended September 30, 2017 and 2016, the Company granted 19,713 and 28,416 A ordinary shares, respectively, at a weighted average grant date value of $39.82 and $29.40 per share, respectively, to non-employee directors of the Company under the Plan. All of the shares granted to non-employee directors of the Company in 2017 and 2016 were fully vested but are subject to certain restrictions.
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Earnings per share have been computed using the weighted average number of ordinary shares and ordinary share equivalents outstanding during the period.
The following table sets forth the computation of basic and diluted earnings per share:
Basic earnings per share:
Weighted average shares outstanding – basic
Net income (loss) per share
Diluted earnings per share:
Weighted average shares outstanding – diluted (1)
A reconciliation of weighted average shares for basic earnings per share to weighted average shares for diluted earnings per share is as follows:
Weighted average shares for basic earnings per share
Non-vested restricted stock
Weighted average shares for diluted earnings per share
If the Company had not incurred a loss in the quarter ended September 30, 2017, 17,721,954 weighted average shares would have been used to compute the diluted loss per share calculation which would have included 164,693 shares of non-vested restricted stock and 213,969 share equivalents for options.
The weighted average shares outstanding used to determine dilutive earnings per share for the quarter and nine months ended September 30, 2016 do not include 300,000 shares which were deemed to be anti-dilutive. There were no anti-dilutive shares for the quarter or nine months ended September 30, 2017.
The Company manages its business through three business segments. Commercial Lines offers specialty property and casualty products designed for product lines such as Small Business Binding Authority, Property Brokerage, and Programs. Personal Lines offers specialty personal lines and agricultural coverage. Reinsurance Operations provides reinsurance solutions through brokers and primary writers including insurance and reinsurance companies.
During the 1st quarter of 2017, the Company re-evaluated its Commercial Lines and Personal Lines segments and determined that certain portions of business will be managed, operated and reported by including them in the other segment. As a result, the composition of the Company’s reportable segments changed slightly. Premium that is written through a wholly owned agency that mainly sells to individuals, which was previously included as part of the Commercial Lines segment, is now included within the Personal Lines segment. In addition, one of the small commercial programs written by American Reliable Insurance Company, which was previously included within the Personal Lines segment, is now aggregated within the Commercial Lines segment. Accordingly, the segment results for the quarter and nine months ended September 30, 2016 have been revised to reflect these changes.
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The following are tabulations of business segment information for the quarters and nine months ended September 30, 2017 and 2016.
Income (loss) from segments
Unallocated Items:
Net realized investment loss
Loss before income taxes
Income tax benefit
Net loss
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Income tax expense
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In May, 2017, the Financial Accounting Standards Board (“FASB”) issued updated accounting guidance which clarifies whether changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. This guidance is effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted. Although the Company is still evaluating the impact of this new guidance, the Company does not anticipate it will have a material impact on its financial condition, results of operations, or cash flows.
In March, 2017, the FASB issued new accounting guidance which amends the amortization period for certain purchased callable debt securities held at a premium. Under current generally accepted accounting principles, entities generally amortize the premium as an adjustment of yield over the contractual life of the instruments. Under the new guidance, the amortizations period would be shortened to the earliest call date. This guidance is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The Company is still evaluating the impact of this guidance on its financial condition, results of operations, and cash flows.
In January, 2017, the FASB issued updated guidance that simplifies how an entity is required to test goodwill for impairment by eliminating the requirement to calculate the implied fair value of goodwill (i.e. Step 2 of the current goodwill impairment test). Under
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the new amendments, an entity may still first assess qualitative factors to determine whether it is necessary to perform a quantitative goodwill impairment test. If determined to be necessary, the quantitative impairment test shall be used to identify goodwill impairment and measure the amount of a goodwill impairment loss to be recognized, if any. A goodwill impairment loss is recognized for the amount that the carrying amount of a reporting unit, including goodwill, exceeds its fair value, limited to the total amount of goodwill allocated to that reporting unit. This guidance is effective for public business entities’ annual or interim goodwill impairment testing in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. Although the Company is still evaluating the impact of this new guidance, the Company does not anticipate it will have a material impact on its financial condition, results of operations, or cash flows.
In January, 2017, the FASB amended The Accounting Standards Codification to incorporate SEC Staff Announcements at the September 22, 2016 and November 17, 2016 Emerging Issues Task Force (EITF) Meetings. The announcement from September 22, 2016 specifically addresses Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606); ASU No. 2016-02, Leases (Topic 842); and ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, and provides the SEC staff view that a registrant should evaluate ASUs that have not yet been adopted to determine the appropriate financial statement disclosures about the potential material effects of those ASUs on the financial statements when adopted. If a registrant does not know or cannot reasonably estimate the impact that adoption of the ASUs referenced in this announcement is expected to have on the financial statements, then in addition to making a statement to that effect, that registrant should consider additional qualitative financial statement disclosures to assist the reader in assessing the significance of the impact that the standard will have on the financial statements of the registrant when adopted. In this regard, the SEC staff expects the additional qualitative disclosures to include a description of the effect of the accounting policies that the registrant expects to apply, if determined, and a comparison to the registrant’s current accounting policies. Also, a registrant should describe the status of its process to implement the new standards and the significant implementation matters yet to be addressed. This guidance, which is effective immediately, has been adopted by the Company.
In February, 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The new guidance increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This guidance is effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. Upon adoption, the Company expects to report higher assets and liabilities as a result of recognizing right-of-use assets and corresponding lease liabilities on the Consolidated Balance Sheets. The Company expects the new guidance to have minimal impact on the Consolidated Statement of Operations or Consolidated Statement of Cash Flows.
In June, 2016, the FASB issued ASU 2016-13,Financial Instruments – Credit Losses (Topic 326). The new accounting guidance addresses the measurement of credit losses on financial instruments. For assets held at amortized cost basis, the new guidance replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of information for credit loss estimates. For available for sale debt securities, credit losses should be measured similar to current GAAP; however, the new guidance requires that credit losses be presented as an allowance rather than as a write-down and allows for the reversal of credit losses in the current period net income. This guidance is effective for public business entities for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early application of this new guidance is permitted as of the fiscal years beginning after December 15, 2018 including interim periods within those fiscal years. This guidance will be applied using a modified-retrospective approach through a cumulative effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The Company is still evaluating the impact of this guidance on its financial condition, results of operations, and cash flows.
In May, 2014, the FASB issued (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Long and short duration insurance contracts, which comprise the majority of the Company’s revenues, are excluded from this accounting guidance. While insurance contracts are not within the scope of this guidance, the Company is currently still evaluating whether its revenue recognition policy for fee income will be impacted by this updated guidance. Fee income related to policies written by the Company was $0.6 million for the nine months ended September 30, 2017. This guidance is effective for public business entities for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Although the Company is still evaluating the impact of this new guidance, the Company does not anticipate it will have a material impact on its financial condition, results of operations, or cash flows.
Please see Note 22 of the notes to the consolidated financial statements in Item 8 Part II of the Company’s 2016 Annual Report on Form 10-K for more information on accounting pronouncements issued in 2016 which have not been implemented in 2017.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the consolidated financial statements and accompanying notes of Global Indemnity included elsewhere in this report. Some of the information contained in this discussion and analysis or set forth elsewhere in this report, including information with respect to the Company’s plans and strategy, constitutes forward-looking statements that involve risks and uncertainties. Please see “Cautionary Note Regarding Forward-Looking Statements” at the end of this Item 2 for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained herein. For more information regarding the Company’s business and operations, please see the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.
Recent Developments
On March 23, 2017, the Company issued Subordinated Notes due in 2047 in the aggregate principal amount of $120.0 million through an underwritten public offering. Pursuant to the underwriting agreement, the Company granted the underwriters a 30 day option to purchase up to an additional $18 million aggregate principal amount of the 2047 Notes solely to cover over-allotments, if any. On March 30, 2017, the underwriters exercised their over-allotment option in the amount of $10 million principal amount of the 2047 Notes. As a result, the aggregate principal amount of the 2047 Notes increased to $130.0 million. The sale of the 2047 Notes pursuant to the over-allotment option closed on March 30, 2017. See Note 7 of the notes to the consolidated financial statements in Item 1of Part I of this report for additional information on this debt issuance.
In April, 2017, the Company entered into a $50 million commitment to purchase an alternative investment vehicle comprised of stressed and distressed debt instruments. As of September 30, 2017, the Company has funded $16.5 million of this commitment leaving $33.5 million as unfunded.
Hurricanes Harvey, Irma, and Maria made landfall during the third quarter of 2017. The Company’s current estimate of net loss is approximately $30.6 million from Hurricanes Harvey, Irma, and Maria. Hurricanes Harvey, Irma and Maria impacted U.S. Insurance Operations by $12.9 million and Reinsurance Operations by $17.7 million. Actual losses from these events may vary materially from the Company’s current estimate due to the inherent uncertainties resulting from several factors, including the preliminary nature of the loss data available and potential inaccuracies and inadequacies of the data provided.
Effective September 16, 2017, David J.W. Bruce, Jason B. Hurwitz, and Arik Rashkes were appointed to the Company’s Board of Directors.
Overview
The Company’s Commercial Lines segment distribute property and casualty insurance products through a group of approximately 120 professional general agencies that have limited quoting and binding authority, as well as a number of wholesale insurance brokers who in turn sell the Company’s insurance products to insureds through retail insurance brokers. Commercial Lines operates predominantly in the excess and surplus lines marketplace. The Company manages its Commercial Lines segment via product classifications. These product classifications are: 1) Penn-America, which includes property and general liability products for small commercial businesses distributed through a select network of wholesale general agents with specific binding authority; 2) United National, which includes property, general liability, and professional lines products distributed through program administrators with specific binding authority; 3) Diamond State, which includes property, casualty, and professional lines products distributed through wholesale brokers and program administrators with specific binding authority; and 4) Vacant Express, which insures dwellings which are currently vacant, undergoing renovation, or are under construction and is distributed through aggregators, brokers, and retail agents.
The Company’s Personal Lines segment, via American Reliable, offers specialty personal lines and agricultural coverage through a group of approximately 270 agents, primarily comprised of wholesale general agents, with specific binding authority in the admitted marketplace.
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The Company’s Reinsurance Operations consisting solely of the operations of Global Indemnity Reinsurance, provides reinsurance solutions through brokers and on a direct basis. Global Indemnity Reinsurance is a Bermuda based treaty reinsurer for specialty property and casualty insurance and reinsurance companies. Global Indemnity Reinsurance conducts business in Bermuda and is focused on using its capital capacity to write catastrophe-oriented placements and other niche or specialty-focused treaties meeting the Company’s risk tolerance and return thresholds.
The Company derives its revenues primarily from premiums paid on insurance policies that it writes and from income generated by its investment portfolio, net of fees paid for investment management services. The amount of insurance premiums that the Company receives is a function of the amount and type of policies it writes, as well as prevailing market prices.
The Company’s expenses include losses and loss adjustment expenses, acquisition costs and other underwriting expenses, corporate and other operating expenses, interest, investment expenses, and income taxes. Losses and loss adjustment expenses are estimated by management and reflect the Company’s best estimate of ultimate losses and costs arising during the reporting period and revisions of prior period estimates. The Company records its best estimate of losses and loss adjustment expenses considering both internal and external actuarial analyses of the estimated losses the Company expects to incur on the insurance policies it writes. The ultimate losses and loss adjustment expenses will depend on the actual costs to resolve claims. Acquisition costs consist principally of commissions and premium taxes that are typically a percentage of the premiums on the insurance policies the Company writes, net of ceding commissions earned from reinsurers. Other underwriting expenses consist primarily of personnel expenses and general operating expenses related to underwriting activities. Corporate and other operating expenses are comprised primarily of outside legal fees, other professional and accounting fees, directors’ fees, management fees and salaries and benefits for company personnel whose services relate to the support of corporate activities. Interest expense is primarily comprised of amounts due on outstanding debt.
Critical Accounting Estimates and Policies
The Company’s consolidated financial statements are prepared in conformity with GAAP, which require it to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates and assumptions.
The most critical accounting policies involve significant estimates and include those used in determining the liability for unpaid losses and loss adjustment expenses, recoverability of reinsurance receivables, investments, fair value measurements, goodwill and intangible assets, deferred acquisition costs, and taxation. For a detailed discussion on each of these policies, please see the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. There have been no significant changes to any of these policies or underlying methodologies during the current year.
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Results of Operations
The following table summarizes the Company’s results for the quarters and nine months ended September 30, 2017 and 2016:
Losses and expenses:
Underwriting income (loss)
Income tax (expense) benefit
Underwriting Ratios:
Loss ratio (1):
Expense ratio (2)
Combined ratio (3)
NM – not meaningful
During the 1st quarter of 2017, the Company re-evaluated its Commercial Lines and Personal Lines segments and determined that certain portions of business will be managed, operated and reported by including them in the other segment. As a result, the composition of the Company’s reportable segments changed slightly. Accordingly, the segment results, presented below, for the quarter and nine months ended September 30, 2016 have been revised to reflect these changes. See Note 13 for additional information regarding segments.
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Premiums
The following table summarizes the change in premium volume by business segment:
Gross premiums written (1)
Personal Lines (3) (4)
Commercial Lines (4)
Reinsurance (5)
Total gross premiums written
Ceded premiums written
Personal Lines (4)
Total ceded premiums written
Net premiums written (2)
Total net premiums written
Total net premiums earned
Gross premiums written decreased by 5.6% and 8.3% for the quarter and nine months ended September 30, 2017, respectively, as compared to same periods in 2016. Gross premiums written include business written by American Reliable that is ceded to insurance entities owned by Assurant under a 100% quota share reinsurance agreement in the amount of ($1.4) million and $7.3 million for the quarters ended September 30, 2017 and 2016, respectively, and ($0.2) million and $30.9 million for the nine months ended September 30, 2017 and 2016, respectively. Excluding the business that is ceded 100% to insurance entities owned by Assurant, gross premiums written increased by 1.0% for the quarter ended September 30, 2017 as compared to same period in 2016. The growth in gross premiums written is mainly due to increased production within one of the Company’s Commercial Lines programs as a result of providing additional commission incentives for increased business, the introduction of a new program within the Company’s Commercial Lines, and increased gross premiums written within the Company’s Reinsurance Operations due to a new mortgage insurance treaty written in the fourth quarter of 2016. This increase was partially offset by declines in gross written premiums due to the discontinuance of one unprofitable program within the Company’s Commercial Lines, a targeted reduction of catastrophe exposed business within the Company’s Personal Lines, and underwriting actions taken within the Company’s Personal Lines to improve profitability.
Excluding the business that is ceded 100% to insurance entities owned by Assurant, gross premiums written decreased by 1.1% for the nine months ended September 30, 2017 as compared to the same period in 2016. The decline is mainly due to the discontinuance of one unprofitable program within the Company’s Commercial Lines, a targeted reduction of catastrophe exposed business within the Company’s Personal Lines, and underwriting actions taken within the Company’s Personal Lines to improve profitability. This decline was partially offset by an increase in gross premiums written within the Company’s
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Reinsurance Operations due to a new mortgage insurance treaty written in the fourth quarter of 2016, the introduction of a new program within the Company’s Commercial Lines, and increased production within two of the Company’s Commercial Lines programs as a result of providing additional commission incentives for increased business.
Net Retention
The ratio of net premiums written to gross premiums written is referred to as the Company’s net premium retention. The Company’s net premium retention is summarized by segments as follows:
Personal Lines (1)
Commercial Lines
Reinsurance
Total (1)
The net premium retention for the quarter and nine months ended September 30, 2017 decreased by 8.8 points and 3.6 points, respectively, for Personal Lines and decreased by 3.6 points and 2.1 points, respectively, for Commercial Lines as compared to the same period in 2016 primarily due to the Property Catastrophe Quota Share Treaty that became effective on April 15, 2017. Please see the Liquidity and Capital Resource section in Item 2 of Part I of this report for additional information on the Property Catastrophe Quota Share.
Net Premiums Earned
Net premiums earned within the Personal Lines segment decreased by 14.6% and 11.1% for the quarter and nine months ended September 30, 2017, respectively, as compared to the same period in 2016 primarily due to a decline in gross premiums written as well as the ceding of additional premiums under the property catastrophe treaties. Property net premiums earned were $44.3 million and $52.3 million for the quarters ended September 30, 2017 and 2016, respectively, and $139.5 million and $158.9 million for the nine months ended September 30, 2017 and 2016, respectively. Casualty net premiums earned were $8.0 million and $8.9 million for the quarters ended September 30, 2017 and 2016, respectively, and $24.6 million and $25.7 million for the nine months ended September 30, 2017 and 2016, respectively.
Net premiums earned within the Commercial Lines segment decreased by 6.3% and 6.6% for the quarter and nine months ended September 30, 2017, respectively, as compared to the same period in 2016. The decline in net premiums earned was primarily due to the Company discontinuing one of its programs within the Commercial Lines as well as the Company ceding additional premiums under the new Property Catastrophe Quota Share Treaty which was effective April 15, 2017. In addition, the net premiums earned during the nine months ended September 30, 2017 were also impacted by a slight decline in gross premiums written within the Commercial Lines’ small business program experienced in 2016. Property net premiums earned were $22.0 million and $25.7 million for the quarters ended September 30, 2017 and 2016, respectively, and $67.6 million and $77.8 million for the nine months ended September 30, 2017 and 2016, respectively. Casualty net premiums earned were $22.8 million and $22.1 million for the quarters ended September 30, 2017 and 2016, respectively, and $65.7 million and $64.9 million for the nine months ended September 30, 2017 and 2016, respectively.
Net premiums earned within the Reinsurance Operations segment increased by 9.6% for the quarter ended September 30, 2017 as compared to the same period in 2016. This increase was primarily due to a new mortgage treaty written in the fourth quarter of 2016 which is expected to earn out over an eight year period. This new mortgage insurance treaty will not be renewed. Net premiums earned within the Reinsurance Operations segment decreased by 0.7% for the nine months ended September 30, 2017 as compared to the same period in 2016 primarily due to reduced levels of property writings due to a competitive marketplace partially offset by the new mortgage treaty. Property net premiums earned were $10.4 million and $9.5 million for the quarters ended September 30, 2017 and 2016, respectively, and $27.8 million and $28.9 million for the nine months ended September 30, 2017 and 2016, respectively. Casualty net premiums earned were $1.2 million and $1.0 million for the quarters ended September 30, 2017 and 2016, respectively, and $3.6 million and $2.8 million for the nine months ended September 30, 2017 and 2016, respectively.
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Reserves
Management’s best estimate at September 30, 2017 was recorded as the loss reserve. Management’s best estimate is as of a particular point in time and is based upon known facts, the Company’s actuarial analyses, current law, and the Company’s judgment. This resulted in carried gross and net reserves of $649.7 million and $532.7 million, respectively, as of September 30, 2017. A breakout of the Company’s gross and net reserves, excluding the effects of the Company’s intercompany pooling arrangements and intercompany stop loss and quota share reinsurance agreements, as of September 30, 2017 is as follows:
Personal Lines
Reinsurance Operations
Each reserve category has an implicit frequency and severity for each accident year as a result of the various assumptions made. If the actual levels of loss frequency and severity are higher or lower than expected, the ultimate losses will be different than management’s best estimate. For most of its reserve categories, the Company believes that frequency can be predicted with greater accuracy than severity. Therefore, the Company believes management’s best estimate is more likely influenced by changes in severity than frequency. The following table, which the Company believes reflects a reasonable range of variability around its best estimate based on historical loss experience and management’s judgment, reflects the impact of changes (which could be favorable or unfavorable) in frequency and severity on the Company’s current accident year net loss estimate of $237.5 million for claims occurring during the nine months ended September 30, 2017:
Frequency Change
The Company’s net reserves for losses and loss adjustment expenses of $532.7 million as of September 30, 2017 relate to multiple accident years. Therefore, the impact of changes in frequency and severity for more than one accident year could be higher or lower than the amounts reflected above.
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Underwriting Results
The following table compares the Company’s combined ratios by segment:
The components of income and loss from the Company’s Personal Lines segment and corresponding underwriting ratios are as follows:
Acquisition costs and other underwriting expenses (2)
Loss ratio:
Current accident year
Prior accident year
Calendar year loss ratio
Expense ratio
Combined ratio
See “Result of Operations” above for a discussion on premiums.
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Other Income
Other income was $2.3 million and $1.0 million for the quarters ended September 30, 2017 and 2016, respectively, and $5.2 million and $2.7 million for the nine months ended September 30, 2017 and 2016, respectively. Other income is primarily comprised of fee income on installments, commission income and accrued interest on the anticipated indemnification of unpaid loss and loss adjustment expense reserves. In accordance with a dispute resolution agreement between Global Indemnity Group, Inc. and American Bankers Group, Inc., former parent of American Reliable, any variance paid related to the loss indemnification will be subject to interest of 5% compounded semi-annually. The increase in other income is primarily the result of the Company increasing its estimate of unpaid losses and loss adjustment expenses that would be indemnified by $9.2 million and $18.7 million during the quarter and nine months ended September 30, 2017, respectively.
Loss Ratio
The current accident year losses and loss ratio is summarized as follows:
Property losses
Catastrophe
Non-catastrophe
Casualty losses
Total accident year losses
Current accident year loss ratio:
Property
Property loss ratio
Casualty loss ratio
Total accident year loss ratio
The current accident year catastrophe loss ratio increased by 8.0 points and 7.1 points during the quarter and nine months ended September 30, 2017, respectively, as compared to the same period in 2016 driven by higher losses in the mobile home reserve category from hurricanes Harvey and Irma in the 3rd quarter of 2017 and higher losses in the agriculture reserve category from convective storms in the first six months of 2017.
The current accident year non-catastrophe property loss ratio increased by 9.0 points and 5.2 points during the quarter and nine months ended September 30, 2017, respectively, as compared to the same period in 2016. The increase in the loss ratio is driven by higher claims frequency and severity compared to last year.
The current accident year casualty loss ratio improved by 4.5 points and 5.6 points during the quarter and nine months ended September 30, 2017 as compared to the same period in 2016. The improvement in the loss ratio reflects lower reported claims frequency in each of the accident quarters of 2017 compared to the same accident quarters last year.
The calendar year loss ratio for the quarter and nine months ended September 30, 2017 includes a decrease of $1.3 million, or 2.5 percentage points, and a decrease of $4.5 million, or 2.7 percentage points, respectively, related to reserve development on prior accident years. There were no changes to net prior accident year losses during the quarter and nine months ended September 30, 2016. Please see Note 6 of the notes to the consolidated financial statements in Item 1 of Part I of this report for further discussion on prior accident year development.
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Reconciliation of non-GAAP financial measures and ratios
The table below reconciles the non-GAAP measures or ratios to its most directly comparable GAAP measure or ratio. The Company believes the non-GAAP measures or ratios are useful to investors when evaluating the Company’s underwriting performance as trends in the Company’s Personal Lines may be obscured by prior accident year adjustments. These non-GAAP measures or ratios should not be considered as a substitute for its most directly comparable GAAP measure or ratio and does not reflect the overall underwriting profitability of the Company.
Non catastrophe property losses and ratio excluding the effect of prior accident year (1)
Effect of prior accident year
Non catastrophe property losses and ratio (2)
Catastrophe losses and ratio excluding the effect of prior accident year (1)
Catastrophe losses and ratio (2)
Total property losses and ratio excluding the effect of prior accident year (1)
Total property losses and ratio (2)
Casualty
Total Casualty losses and ratio excluding the effect of prior accident year (1)
Total Casualty losses and ratio (2)
Total net losses and loss adjustment expense and total loss ratio excluding the effect of prior accident year (1)
Total net losses and loss adjustment expense and total loss ratio (2)
Expense Ratios
The expense ratio increased by 3.5 points from 39.9% for the quarter ended September 30, 2016 to 43.4% for the quarter ended September 30, 2017 primarily due to a decline in net premiums earned. The expense ratio increased 0.8 points from 41.4% for the nine months ended September 30, 2016 to 42.2% for the nine months ended September 30, 2017.
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The components of income from the Company’s Commercial Lines segment and corresponding underwriting ratios are as follows:
Acquisition costs and other underwriting expenses (1)
Commercial Lines did not have any other income for the quarter ended September 30, 2017. Other income was $6.9 million for the quarter ended September 30, 2016, and $0.1 million and $6.9 million for the nine months ended September 30, 2017 and 2016, respectively. For the quarter and nine months ended September 30, 2016, other income of $6.9 million is comprised of the net gain on the asset sale of the Company’s wholly owned subsidiary, United National Specialty Insurance Company.
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The current accident year catastrophe loss ratio increased by 8.1 points during the quarter ended September 30, 2017 as compared to the same period in 2016 primarily due to the impacts from hurricanes Harvey and Irma in the third quarter of 2017. The current accident year catastrophe loss ratio improved by 3.3 points during the nine months ended September 30, 2017 as compared to the same period in 2016 primarily due to lower claims severity in 2017.
The current accident yearnon-catastrophe property loss ratio improved by 8.8 points and 10.6 points during the quarter and nine months ended September 30, 2017, respectively, as compared to the same period in 2016. The improvement in the loss ratio reflects lower reported claims frequency in each of the accident quarters of 2017 compared to the same accident quarters last year.
The current accident year casualty loss ratio improved by 9.9 points and 2.3 points during the quarter and nine months ended September 30, 2017, respectively, as compared to the same period in 2016. The improvement in the loss ratio is driven primarily by lower reported claims frequency as compared to the same period last year.
The calendar year loss ratio for the quarter and nine months ended September 30, 2017 includes a decrease of $7.3 million, or 16.2 percentage points, and a decrease of $26.2 million, or 19.6 percentage points, respectively, related to reserve development on prior accident years. The calendar year loss ratio for the quarter and nine months ended September 30, 2016 includes a decrease of $6.5 million, or 13.7 percentage points and a decrease of $18.9 million, or 13.2 percentage points, respectively, related to reserve development on prior accident years. Please see Note 6 of the notes to the consolidated financial statements in Item 1 of Part I of this report for further discussion on prior accident year development.
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The table below reconciles the non-GAAP measures or ratios to its most directly comparable GAAP measure or ratio. The Company believes the non-GAAP measures or ratios are useful to investors when evaluating the Company’s underwriting performance as trends in the Company’s Commercial Lines may be obscured by prior accident year adjustments. These non-GAAP measures or ratios should not be considered as a substitute for its most directly comparable GAAP measure or ratio and does not reflect the overall underwriting profitability of the Company.
The expense ratio improved by 1.3 points from 42.0% for the quarter ended September 30, 2016 to 40.7% for the quarter ended September 30, 2017. The expense ratio improved 1.0 points from 42.6% for the nine months ended September 30, 2016 to 41.6% for the nine months ended September 30, 2017. The improvement in the expense ratio is primarily due to lower compensation expense.
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The components of income from the Company’s Reinsurance Operations segment and corresponding underwriting ratios are as follows:
Current accident year (2)
Calendar year loss ratio (3)
Reconciliation of non-GAAPfinancial ratios
The table above includes a reconciliation of the current accident year loss ratio, which is anon-GAAP ratio, to its calendar year loss ratio, which is its most directly comparable GAAP ratio. The Company believes this non-GAAP ratio is useful to investors when evaluating the Company’s underwriting performance as trends in the Company’s Reinsurance Operations may be obscured by prior accident year adjustments. This non-GAAP ratio should not be considered as a substitute for its most directly comparable GAAP ratio and does not reflect the overall underwriting profitability of the Company.
Reinsurance Operations recognized income of $0.04 million and a loss of $0.01 million for the quarters ended September 30, 2017 and 2016, respectively and income of $0.2 million and $0.02 million for the nine months ended September 30, 2017 and 2016, respectively. Other income is comprised of foreign exchange gains and losses.
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The current accident year loss ratio increased by 107.9 points during the quarter ended September 30, 2017 as compared to the same period in 2016. The increase in the loss ratio was driven by the high frequency of catastrophe events in the 3rd quarter including hurricanes Harvey, Irma and Maria.
The current accident year loss ratio increased by 41.5 points during the nine months ended September 30, 2017 as compared to the same period in 2016. The increase in the loss ratio was mainly attributable to the higher impact from catastrophes through nine months of development as compared to the same period last year.
The calendar year loss ratio for the quarter and nine months ended September 30, 2017 includes a decrease of $0.8 million, or 6.8 percentage points, and a decrease of $4.1 million or 13.1 percentage points, respectively, related to reserve development on prior accident years. The calendar year loss ratio for the quarter and nine months ended September 30, 2016 includes a decrease of $2.9 million, or 27.4 percentage points and a decrease of $6.1 million, or 19.2 percentage points, respectively, related to reserve development on prior accident years. Please see Note 6 of the notes to the consolidated financial statements in Item 1 of Part I of this report for further discussion on prior accident year development.
Expense Ratio
The expense ratio increased by 0.4 points from 34.8% for the quarter ended September 30, 2016 to 35.2% for the quarter ended September 30, 2017. The expense ratio improved by 3.8 points from 36.7% for the nine months ended September 30, 2016 to 32.9% for the nine months ended September 30, 2017. The improvement in the expense ratio is primarily due to receiving a federal excise tax refund related to prior years.
Unallocated Corporate Items
The Company’s investments are managed distinctly according to assets supporting future insurance obligations and assets in excess of those supporting future insurance obligations. Assets supporting insurance obligations are referred to as the Insurance Obligations Portfolio. The Insurance Obligations Portfolio consists of cash and high-quality fixed income investments. Assets in excess of insurance obligations are referred to as the Surplus Portfolio. The Surplus Portfolio targets higher returns and is comprised of cash, fixed income, common stocks, and alternative investments.
The Insurance Obligations Portfolio has a market value of $845.7 million and the fixed income securities within have a credit quality of AA- and duration of 3.1 years. The Surplus Reserve Portfolio has a market value of $782.3 million and the fixed income securities within have a credit quality of A-and duration of 3.5 years.
Since the Company began managing its investments as two portfolios during the 2nd quarter of 2017, year to date performance metrics are an approximation. The Insurance Obligations Portfolio returned 2.7% for the nine months ended September 30, 2017 with net investment income of $13.4 million and realized gains of $0.5 million. The Surplus Portfolio returned 4.5% for the nine months ended September 30, 2017 with net investment income of $14.2 million and realized gains of $0.7 million.
Gross investment income (1)
Investment expenses
Gross investment income increased by 10.5% for the quarter ended September 30, 2017 and increased 1.8% for the nine months ended September 30, 2017, as compared with the same periods in 2016. The increase for the quarter ended was
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primarily due to an increase in yield within the fixed maturities portfolio. The increase for the nine months ended was due to an increase in yield and a larger investment portfolio, offset by a decrease in income related to the Company’s limited partnership investments.
Investment expenses decreased by 31.8% and 47.5% for the quarter and nine months ended September 30, 2017, respectively, as compared with the same periods in 2016. The decrease is mainly attributable to $1.5 million in upfront fees paid in 2016 to enter into a new investment in middle market corporate debt and equity investments in limited liability companies.
At September 30, 2017, the Company held agency mortgage-backed securities with a market value of $95.9 million. Excluding the agency mortgage-backed securities, the average duration of the Company’s fixed maturities portfolio was 3.2 years as of September 30, 2017, compared with 2.0 years as of September 30, 2016. Including cash and short-term investments, the average duration of the Company’s fixed maturities portfolio, excluding agency mortgage-backed securities, was 3.1 years as of September 30, 2017, compared with 1.9 years as of September 30, 2016. Changes in interest rates can cause principal payments on certain investments to extend or shorten which can impact duration. At September 30, 2017, the Company’s embedded book yield on its fixed maturities, not including cash, was 2.7% compared with 2.2% at September 30, 2016. The embedded book yield on the $117.2 million of municipal bonds in the Company’s portfolio, which includes $103.6 million of taxable municipal bonds, was 3.1% at September 30, 2017, compared to an embedded book yield of 2.8% on the Company’s municipal bond portfolio of $170.7 million at September 30, 2016.
Interest rate swap
Other than temporary impairment losses
See Note 2 of the notes to the consolidated financial statements in Item 1 of Part I of this report for an analysis of total investment return on a pre-tax basis for the quarters and nine months ended September 30, 2017 and 2016.
Corporate and Other Operating Expenses
Corporate and other operating expenses consist primarily of outside legal fees, other professional fees, directors’ fees, management fees, salaries and benefits for holding company personnel, development costs for new products, and taxes incurred which are not directly related to operations. Corporate and other operating expenses were $4.6 million and $5.0 million during the quarters ended September 30, 2017 and 2016, respectively and $11.0 million and $13.1 million during the nine months ended September 30, 2017 and 2016, respectively. This decrease is primarily due to incurring cost in connection with the re-domestication in 2016 which the Company did not incur in 2017.
Interest Expense
Interest expense increased 116.6% and 80.7% during the quarter and nine months ended September 30, 2017 as compared to the same period in 2016. This increase is primarily due to the Company’s $130 million debt offering in March, 2017. See Note 7 of the notes to the consolidated financial statements in Item 1 of Part I of this report for details on the Company’s debt.
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Income Tax Benefit
The income tax benefit was $7.9 million for the quarter ended September 30, 2017 compared with income tax expense of $1.1 million for the quarter ended September 30, 2016. The increase in the income tax benefit is primarily due to losses incurred in the Company’s U.S. operations for the quarter ended September 30, 2017 as compared to a gain in 2016.
The income tax benefit was $13.2 million for the nine months ended September 30, 2017 compared with income tax benefit of $10.4 million for the nine months ended September 30, 2016. The increase in the income tax benefit rate is primarily due to higher losses incurred in the Company’s US operations for the nine months ended September 30, 2017 compared to the same period in 2016.
See Note 5 of the notes to the consolidated financial statements in Item 1 of Part I of this report for a comparison of income tax between periods.
Net Income (Loss)
The factors described above resulted in a net loss of $8.9 million and net income of $9.5 million for the quarters ended September 30, 2017 and 2016, respectively, and net income of $13.4 million and $11.5 million for the nine months ended September 30, 2017 and 2016, respectively.
Liquidity and Capital Resources
Sources and Uses of Funds
Global Indemnity is a holding company. Its principal asset is its ownership of the shares of its direct and indirect subsidiaries, including those of its U.S. insurance companies: United National Insurance Company, Diamond State Insurance Company, Penn-America Insurance Company, Penn-Star Insurance Company, Penn-Patriot Insurance Company, and American Reliable Insurance Company; and its Reinsurance Operations: Global Indemnity Reinsurance.
The principal sources of cash that Global Indemnity requires to meet its short term and long term liquidity needs, including the payment of corporate expenses, debt service payments, and share repurchases includes dividends, other permitted disbursements from its direct and indirect subsidiaries, reimbursement for equity awards granted to employees and intercompany borrowings. The principal sources of funds at these direct and indirect subsidiaries include underwriting operations, investment income, and proceeds from sales and redemptions of investments. Funds are used principally by these operating subsidiaries to pay claims and operating expenses, to make debt payments, fund margin requirements on interest rate swap agreements, to purchase investments, and to make dividend payments. In addition, the Company periodically reviews opportunities related to business acquisitions and as a result, liquidity may be needed in the future.
On October 29, 2015, Global Indemnity acquired rights, expiring December 31, 2019, to redeem an additional 3,397,031 ordinary shares for $78.1 million, which is subject to an annual 3% increase in price. As of September 30, 2017, the Company also had future funding commitments of $59.5 million related to investments. The timing of commitments related to investments is uncertain.
The future liquidity of Global Indemnity is dependent on the ability of its subsidiaries to pay dividends. Global Indemnity’s U.S. insurance companies are restricted by statute as to the amount of dividends that they may pay without the prior approval of regulatory authorities. The dividend limitations imposed by state laws are based on the statutory financial results of each insurance company within the Insurance Operations that are determined by using statutory accounting practices that differ in various respects from accounting principles used in financial statements prepared in conformity with GAAP. See “Regulation—Statutory Accounting Principles” in Item 1 of Part I of the Company’s 2016 Annual Report on Form10-K. Key differences relate to, among other items, deferred acquisition costs, limitations on deferred income taxes, reserve calculation assumptions and surplus notes. See Note 19 of the notes to the consolidated financial statements in Item 8 of Part II of the Company’s 2016 Annual Report on Form 10-K for further information on dividend limitations related to the U.S. Insurance Companies. The U.S. Insurance Companies did not declare any dividends during the quarter ended September 30, 2017. During the nine months ended September 30, 2017, the United National Insurance Company, the Penn-America Insurance Company, and American Reliable declared dividends of $17.8 million,
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$7.9 million, and $3.3 million, respectively, which were paid in September, 2017. In addition, United National Insurance Company paid a $35.0 million dividend, which was previously declared in 2015, to its parent company, American Insurance Services, Inc. during the nine months ended September 30, 2017.
For 2017, the Company believes that Global Indemnity Reinsurance, including distributions it could receive from its subsidiaries, should have sufficient liquidity and solvency to pay dividends. Global Indemnity Reinsurance is prohibited, without the approval of the Bermuda Monetary Authority (“BMA”), from reducing by 15% or more its total statutory capital as set out in its previous year’s statutory financial statements, and any application for such approval must include such information as the BMA may require. See “Regulation—Bermuda Insurance Regulation” in Item 1 of Part I of the Company’s 2016 Annual Report on Form 10-K. Global Indemnity Reinsurance did not declare or pay any dividends during the quarter or nine months ended September 30, 2017.
Cash Flows
Sources of operating funds consist primarily of net premiums written and investment income. Funds are used primarily to pay claims and operating expenses and to purchase investments.
The Company’s reconciliation of net income to cash used for operations is generally influenced by the following:
Net cash used for operating activities was $13.6 million for the nine months ended September 30, 2017 and net cash used by operating activities was $9.3 million for the nine months ended September 30, 2016. The decrease in operating cash flows of approximately $4.3 million from the prior year was primarily a net result of the following items:
Net premiums collected
Net losses paid
Underwriting and corporate expenses
Net federal income taxes paid
Interest paid
See the consolidated statement of cash flows in the consolidated financial statements in Item 1 of Part I of this report for details concerning the Company’s investing and financing activities.
Liquidity
Property Catastrophe Quota Share
Effective April 15, 2017, the Company entered into an agreement to cede 50% of its property catastrophe losses for all single occurrences over $3 million up to a loss of $40 million. This treaty has an aggregate limit of $60 million and will expire on June 1, 2018.
As a result of entering into this treaty, the Company did not renew the $20 million in excess of $20 million layer of its property catastrophe treaty on June 1, 2017.
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Public Debt Offering
On March 23, 2017, the Company issued the 7.875% Subordinated Notes due 2047 in the aggregate principal amount of
$120.0 million through an underwritten public offering. Pursuant to the underwriting agreement, the Company granted the underwriters a 30 day option to purchase up to an additional $18 million aggregate principal amount of the 2047 Notes solely to cover over-allotments, if any. On March 30, 2017, the underwriters exercised their over-allotment option in the amount of $10 million principal amount of the 2047 Notes. As a result, the aggregate principal amount of the 2047 Notes increased to $130.0 million. The sale of the 2047 Notes pursuant to the over-allotment option closed on March 30, 2017.
Other than the items discussed in the preceding paragraphs, there have been no material changes to the Company’s liquidity during the nine months ended September 30, 2017. Please see Item 7 of Part II in the Company’s 2016 Annual Report on Form 10-K for information regarding the Company’s liquidity.
Capital Resources
During the first quarter of 2017, Global Indemnity made a capital contribution in the amount of $96.0 million to its subsidiary, Global Indemnity (Gibraltar) Limited. Through a series of additional capital contributions and repayment of certain intercompany balances, U.A.I. (Luxembourg) IV S.à.r.l. was the ultimate recipient of this capital contribution in the amount of $93.5 million.
Global Indemnity Group, Inc. issued a promissory note in the amount of $120.0 million to U.A.I. (Luxembourg) Investment S.à.r.l. during the first quarter of 2017. This note bears interest at a rate of 8.15% and matures in 2047.
Other than the items discussed in the preceding paragraphs, there have been no material changes to the Company’s capital resources during the nine months ended September 30, 2017. Please see Item 7 of Part II in the Company’s 2016 Annual Report on Form 10-K for information regarding the Company’s capital resources.
Contractual Obligations
The Company has commitments in the form of operating leases, commitments to fund limited liability investments, subordinated notes, and unpaid losses and loss expense obligations. As of September 30, 2017, contractual obligations related to Global Indemnity’s commitments, including any principal and interest payments, were as follows:
Operating leases (1)
Commitments to fund limited partnership investments (2)
Subordinated notes due 2045 (3)
Subordinated notes due 2047 (4)
Unpaid losses and loss adjustment expenses obligations (5)
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Off Balance Sheet Arrangements
The Company has no off balance sheet arrangements.
Cautionary Note Regarding Forward-Looking Statements
Some of the statements under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report may include forward-looking statements within the meaning of Section 21E of the Security Exchange Act of 1934, as amended, that reflect the Company’s current views with respect to future events and financial performance. Forward-looking statements are statements that are not historical facts. These statements can be identified by the use of forward-looking terminology such as “believe,” “expect,” “may,” “will,” “should,” “project,” “plan,” “seek,” “intend,” or “anticipate” or the negative thereof or comparable terminology, and include discussions of strategy, financial projections and estimates and their underlying assumptions, statements regarding plans, objectives, expectations or consequences of identified transactions or natural disasters, and statements about the future performance, operations, products and services of the companies.
The Company’s business and operations are and will be subject to a variety of risks, uncertainties and other factors. Consequently, actual results and experience may materially differ from those contained in any forward-looking statements. See “Risk Factors” in Item 1A of Part I in the Company’s 2016 Annual Report on Form 10-K for risks, uncertainties and other factors that could cause actual results and experience to differ from those projected. The Company’s forward-looking statements speak only as of the date of this report or as of the date they were made. The Company undertakes no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.
For the quarter ending September 30, 2017, global equities rallied for the sixth consecutive quarter. A broad-based expansion of economic growth, supportive monetary policy, and benign inflation helped drive equity markets higher during the third quarter. Eurozone confidence reached a decade-high in September on the back of solid employment and manufacturing data and a reacceleration in the services sector. The US economy continued on an upward trajectory, and signs of firming inflation increased investors’ expectation of further monetary policy tightening at the end of the year. As the global economy continued to gain momentum, central banks began to normalize their long-standing loose monetary policies. Angela Merkel was reelected for a fourth term as German Chancellor. US equities rose for the eighth straight quarter. Despite continued White House turmoil and heightened U.S. tensions with Russia and North Korea, strong employment data and corporate earnings helped propel the S&P 500 Index to a series of new highs. Within the S&P 500 Index, 10 of the 11 sectors posted positive results for the quarter. Consumer staples was the only sector to post a negative return, with much of the weakness attributed to the poor performance of the tobacco and food products groups.
Global fixed income markets generated positive returns in the third quarter. Escalating geopolitical tensions between the US and North Korea and serial disappointments in inflation data helped to contain the increase in sovereign yields prompted by central bank policy normalization. Generally strong economic data, a rally in commodity prices, and continued demand for yield-producing assets supported credit markets and spreads tightened further. Most developed market currencies strengthened versus the US dollar as political uncertainty and continued skepticism about the US Federal Reserve’s (Fed’s) projected rate-hiking path weighed on the greenback.
The Company’s investment grade fixed income portfolio continues to maintain high quality with an A+ average rating and duration of 3.1 years. The Insurance Obligations Portfolio has a credit quality of AA- and duration of 3.0 years. The portion of the Surplus Portfolio comprised of cash and fixed income securities has a credit quality of A- and duration of 3.4 years.
Portfolio purchases were focused within agency mortgage backed securities, U.S. corporate bonds and asset backed securities. These purchases were funded primarily through sales of U.S. credit, commercial mortgage backed securities, andtax-exempt municipals, as well as maturities and paydowns. During the third quarter, the portfolio’s allocation to agency mortgaged backed securities increased and the allocation to tax-exempt municipals decreased.
There have been no other material changes to the Company’s market risk since December 31, 2016. Please see Item 7A of Part II in the Company’s 2016 Annual Report on Form 10-K for information regarding the Company’s market risk.
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Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in the Company’s reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of September 30, 2017. Based upon that evaluation, and subject to the foregoing, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2017, the design and operation of the Company’s disclosure controls and procedures were effective to accomplish their objectives at the reasonable assurance level.
Changes in Internal Control over Financial Reporting
There have been no changes in the Company’s internal controls over financial reporting that occurred during the quarter ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.
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PART II-OTHER INFORMATION
The Company is, from time to time, involved in various legal proceedings in the ordinary course of business. The Company maintains insurance and reinsurance coverage for risks in amounts that it considers adequate. However, there can be no assurance that the insurance and reinsurance coverage that the Company maintains is sufficient or will be available in adequate amounts or at a reasonable cost. The Company does not believe that the resolution of any currently pending legal proceedings, either individually or taken as a whole, will have a material adverse effect on its business, results of operations, cash flows, or financial condition.
The Company’s results of operations and financial condition are subject to numerous risks and uncertainties described in Item 1A of Part I in the Company’s 2016 Annual Report on Form 10-K, filed with the SEC on March 10, 2017 and the Company’s Quarterly Report on Form 10-Q, filed with the SEC on May 10, 2017. The risk factors identified therein have not materially changed.
The Company’s Share Incentive Plan allows employees to surrender the Company’s A ordinary shares as payment for the tax liability incurred upon the vesting of restricted stock. There were no shares surrendered by the Company’s employees during the quarter ended September 30, 2017. All A ordinary shares surrendered by the employees by the Company are held as treasury stock and recorded at cost until formally retired.
None.
On August 8, 2017, the Company’s subsidiary, Global Indemnity Group, Inc. and William J. Devlin, Jr. amended Mr. Devlin’s executive employment agreement to allow for the vesting of any unvested A ordinary shares held by Mr. Devlin upon a change in control of the Company, as defined in the amendment.
On August 8, 2017, the Company and Stephen Green amended Mr. Green’s executive employment term sheet to allow for the vesting of any unvested A ordinary shares held by Mr. Green upon a change in control of the Company, as defined in the amendment.
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+ Filed or furnished herewith, as applicable.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Registrant
November 9, 2017
/s/ Thomas M. McGeehan
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