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EVEREST GROUP, LTD. - Quarter Report: 2018 June (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

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

 
FOR THE QUARTERLY PERIOD ENDED:
June 30, 2018
 
 
Commission file number:
1-15731

EVEREST RE GROUP, LTD.
(Exact name of registrant as specified in its charter)
Bermuda
 
98-0365432
(State or other jurisdiction of
incorporation or organization)
 
 
(I.R.S. Employer
Identification No.)
Seon Place – 4th Floor
141 Front Street
PO Box HM 845
Hamilton HM 19, Bermuda
441-295-0006

(Address, including zip code, and telephone number, including area code,
of registrant's principal executive office)

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES
X
 
NO
 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES
X
 
NO
 

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

Large accelerated filer
X
 
Accelerated filer
 
Non-accelerated filer
Smaller reporting company
(Do not check if smaller reporting company)
Emerging  growth company
 


Indicate by check mark if the registrant is an emerging growth company and 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.

YES
   
NO
X

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES
   
NO
X

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

   
Number of Shares Outstanding
Class
 
At August 1, 2018
Common Shares, $0.01 par value
 
40,855,442


EVEREST RE GROUP, LTD

Table of Contents
Form 10-Q


Page
PART I

FINANCIAL INFORMATION

Item 1.
Financial Statements
 
     
 
Consolidated Balance Sheets June 30, 2018 (unaudited)
 
 
and December 31, 2017
1
     
 
Consolidated Statements of Operations and Comprehensive Income (Loss) for the
 
 
three  and six months ended June 30, 2018  and 2017 (unaudited)
2
     
 
Consolidated Statements of Changes in Shareholders' Equity for the three and
 
 
six months ended June 30, 2018  and 2017 (unaudited)
3
     
 
Consolidated Statements of Cash Flows for the six months ended
 
 
June 30, 2018  and 2017 (unaudited)
4
     
 
Notes to Consolidated Interim Financial Statements (unaudited)
5
     
Item 2.
Management's Discussion and Analysis of Financial Condition and
 
 
Results of Operation
32
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
59
     
Item 4.
Controls and Procedures
59
     

PART II

OTHER INFORMATION

Item 1.
Legal Proceedings
59
     
Item 1A.
Risk Factors
59
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
60
     
Item 3.
Defaults Upon Senior Securities
60
     
Item 4.
Mine Safety Disclosures
60
     
Item 5.
Other Information
60
     
Item 6.
Exhibits
61
     

EVEREST RE GROUP, LTD.
CONSOLIDATED BALANCE SHEETS



   
June 30,
   
December 31,
 
(Dollars and share amounts in thousands, except par value per share)
 
2018
   
2017
 
   
(unaudited)
       
ASSETS:
           
Fixed maturities - available for sale, at market value
 
$
14,242,890
   
$
14,756,834
 
(amortized cost: 2018, $14,435,792; 2017, $14,689,598)
               
Fixed maturities - available for sale, at fair value
   
3,192
     
-
 
Equity securities - available for sale, at market value (cost: 2018, $0; 2017, $130,287)
   
-
     
129,530
 
Equity securities - available for sale, at fair value
   
1,220,770
     
963,572
 
Short-term investments
   
293,191
     
509,682
 
Other invested assets (cost: 2018, $1,826,148; 2017, $1,628,753)
   
1,826,148
     
1,631,850
 
Cash
   
619,493
     
635,067
 
Total investments and cash
   
18,205,684
     
18,626,535
 
Accrued investment income
   
98,585
     
97,704
 
Premiums receivable
   
1,961,388
     
1,844,881
 
Reinsurance receivables
   
1,779,581
     
1,348,226
 
Funds held by reinsureds
   
368,680
     
292,927
 
Deferred acquisition costs
   
418,167
     
411,587
 
Prepaid reinsurance premiums
   
368,665
     
288,211
 
Income taxes
   
280,696
     
299,438
 
Other assets
   
404,439
     
382,283
 
TOTAL ASSETS
 
$
23,885,885
   
$
23,591,792
 
                 
LIABILITIES:
               
Reserve for losses and loss adjustment expenses
 
$
12,043,334
   
$
11,884,321
 
Future policy benefit reserve
   
48,845
     
51,014
 
Unearned premium reserve
   
2,141,399
     
2,000,556
 
Funds held under reinsurance treaties
   
17,087
     
18,030
 
Other net payable to reinsurers
   
312,474
     
218,017
 
4.868% Senior notes due 6/1/2044
   
396,894
     
396,834
 
6.6% Long term notes due 5/1/2067
   
236,610
     
236,561
 
Accrued interest on debt and borrowings
   
3,010
     
2,727
 
Equity index put option liability
   
9,218
     
12,477
 
Unsettled securities payable
   
54,563
     
38,743
 
Other liabilities
   
381,102
     
363,280
 
Total liabilities
   
15,644,536
     
15,222,560
 
                 
Commitments and contingencies (Note 8)
               
                 
SHAREHOLDERS' EQUITY:
               
Preferred shares, par value: $0.01; 50,000 shares authorized;
               
no shares issued and outstanding
   
-
     
-
 
Common shares, par value: $0.01; 200,000 shares authorized; (2018) 69,181
               
and (2017) 69,044 outstanding before treasury shares
   
692
     
691
 
Additional paid-in capital
   
2,172,701
     
2,165,768
 
Accumulated other comprehensive income (loss), net of deferred income tax expense
               
(benefit) of ($15,938) at 2018 and $9,356 at 2017
   
(445,338
)
   
(160,891
)
Treasury shares, at cost; 28,321 shares (2018) and 28,208 shares (2017)
   
(3,347,548
)
   
(3,322,244
)
Retained earnings
   
9,860,842
     
9,685,908
 
Total shareholders' equity
   
8,241,349
     
8,369,232
 
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
 
$
23,885,885
   
$
23,591,792
 
                 
The accompanying notes are an integral part of the consolidated financial statements.
               

1

EVEREST RE GROUP, LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)



   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Dollars in thousands, except per share amounts)
 
2018
   
2017
   
2018
   
2017
 
   
(unaudited)
   
(unaudited)
 
REVENUES:
                       
Premiums earned
 
$
1,729,818
   
$
1,369,681
   
$
3,349,245
   
$
2,681,778
 
Net investment income
   
141,322
     
134,508
     
279,616
     
256,797
 
Net realized capital gains (losses):
                               
Other-than-temporary impairments on fixed maturity securities
   
(888
)
   
(2,475
)
   
(958
)
   
(3,703
)
Other-than-temporary impairments on fixed maturity securities
                               
transferred to other comprehensive income (loss)
   
-
     
-
     
-
     
-
 
Other net realized capital gains (losses)
   
16,664
     
27,743
     
(8,167
)
   
81,699
 
Total net realized capital gains (losses)
   
15,776
     
25,268
     
(9,125
)
   
77,996
 
Net derivative gain (loss)
   
2,987
     
766
     
3,260
     
3,396
 
Other income (expense)
   
3,036
     
388
     
15,100
     
(4,578
)
Total revenues
   
1,892,939
     
1,530,611
     
3,638,096
     
3,015,389
 
                                 
CLAIMS AND EXPENSES:
                               
Incurred losses and loss adjustment expenses
   
1,341,314
     
861,275
     
2,398,491
     
1,632,063
 
Commission, brokerage, taxes and fees
   
383,402
     
299,956
     
741,041
     
582,225
 
Other underwriting expenses
   
93,099
     
78,869
     
189,383
     
154,756
 
Corporate expenses
   
6,633
     
6,919
     
15,629
     
15,376
 
Interest, fees and bond issue cost amortization expense
   
7,728
     
8,059
     
15,146
     
17,023
 
Total claims and expenses
   
1,832,176
     
1,255,078
     
3,359,690
     
2,401,443
 
                                 
INCOME (LOSS) BEFORE TAXES
   
60,763
     
275,533
     
278,406
     
613,946
 
Income tax expense (benefit)
   
(9,132
)
   
29,859
     
(1,807
)
   
76,629
 
                                 
NET INCOME (LOSS)
 
$
69,895
   
$
245,674
   
$
280,213
   
$
537,317
 
                                 
Other comprehensive income (loss), net of tax:
                               
Unrealized appreciation (depreciation) ("URA(D)") on securities arising during the period
   
(41,776
)
   
4,868
     
(232,400
)
   
24,416
 
Reclassification adjustment for realized losses (gains) included in net income (loss)
   
249
     
(8,993
)
   
(8,523
)
   
(11,192
)
Total URA(D) on securities arising during the period
   
(41,527
)
   
(4,125
)
   
(240,923
)
   
13,224
 
                                 
Foreign currency translation adjustments
   
(63,652
)
   
35,667
     
(45,953
)
   
47,560
 
                                 
Reclassification adjustment for amortization of net (gain) loss included in net income (loss)
   
1,815
     
2,004
     
3,630
     
4,008
 
Total benefit plan net gain (loss) for the period
   
1,815
     
2,004
     
3,630
     
4,008
 
Total other comprehensive income (loss), net of tax
   
(103,364
)
   
33,546
     
(283,246
)
   
64,792
 
                                 
COMPREHENSIVE INCOME (LOSS)
 
$
(33,469
)
 
$
279,220
   
$
(3,033
)
 
$
602,109
 
                                 
EARNINGS PER COMMON SHARE:
                               
Basic
 
$
1.71
   
$
5.98
   
$
6.85
   
$
13.10
 
Diluted
   
1.70
     
5.95
     
6.81
     
13.02
 
Dividends declared
   
1.30
     
1.25
     
2.60
     
2.50
 
                                 
The accompanying notes are an integral part of the consolidated financial statements.
                               

2

EVEREST RE GROUP, LTD.
CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS' EQUITY



   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Dollars in thousands, except share and dividends per share amounts)
 
2018
   
2017
   
2018
   
2017
 
   
(unaudited)
   
(unaudited)
 
COMMON SHARES (shares outstanding):
                       
Balance, beginning of period
   
40,978,634
     
41,057,991
     
40,835,272
     
40,898,864
 
Issued during the period, net
   
(5,718
)
   
7,221
     
137,644
     
166,348
 
Treasury shares acquired
   
(112,747
)
   
-
     
(112,747
)
   
-
 
Balance, end of period
   
40,860,169
     
41,065,212
     
40,860,169
     
41,065,212
 
                                 
COMMON SHARES (par value):
                               
Balance, beginning of period
 
$
692
   
$
691
   
$
691
   
$
689
 
Issued during the period, net
   
-
     
-
     
1
     
2
 
Balance, end of period
   
692
     
691
     
692
     
691
 
                                 
ADDITIONAL PAID-IN CAPITAL:
                               
Balance, beginning of period
   
2,163,519
     
2,141,653
     
2,165,768
     
2,140,783
 
Share-based compensation plans
   
9,182
     
9,006
     
6,933
     
9,876
 
Balance, end of period
   
2,172,701
     
2,150,659
     
2,172,701
     
2,150,659
 
                                 
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS),
                               
NET OF DEFERRED INCOME TAXES:
                               
Balance, beginning of period
   
(341,974
)
   
(185,518
)
   
(160,891
)
   
(216,764
)
Net increase (decrease) during the period
   
(103,364
)
   
33,546
     
(283,246
)
   
64,792
 
Cumulative change due to adoption of Accounting Standards Update 2016-01
   
-
     
-
     
(1,201
)
   
-
 
Balance, end of period
   
(445,338
)
   
(151,972
)
   
(445,338
)
   
(151,972
)
                                 
RETAINED EARNINGS:
                               
Balance, beginning of period
   
9,844,187
     
9,663,294
     
9,685,908
     
9,422,932
 
Net income (loss)
   
69,895
     
245,674
     
280,213
     
537,317
 
Dividends declared ($1.30 per share in second quarter 2018 $2.60 year-to-date
                         
per share in 2018 and $1.25 per share in second quarter 2017 and $2.50
                               
year-to-date per share in 2017)
   
(53,240
)
   
(51,304
)
   
(106,480
)
   
(102,585
)
Cumulative change due to adoption of Accounting Standards Update 2016-01
   
-
     
-
     
1,201
     
-
 
Balance, end of period
   
9,860,842
     
9,857,664
     
9,860,842
     
9,857,664
 
                                 
TREASURY SHARES AT COST:
                               
Balance, beginning of period
   
(3,322,244
)
   
(3,272,244
)
   
(3,322,244
)
   
(3,272,244
)
Purchase of treasury shares
   
(25,304
)
   
-
     
(25,304
)
   
-
 
Balance, end of period
   
(3,347,548
)
   
(3,272,244
)
   
(3,347,548
)
   
(3,272,244
)
                                 
TOTAL SHAREHOLDERS' EQUITY, END OF PERIOD
 
$
8,241,349
   
$
8,584,798
   
$
8,241,349
   
$
8,584,798
 
                                 
The accompanying notes are an integral part of the consolidated financial statements.
                               


3

EVEREST RE GROUP, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS



   
Six Months Ended
 
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
 
   
(unaudited)
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income (loss)
 
$
280,213
   
$
537,317
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Decrease (increase) in premiums receivable
   
(126,355
)
   
(337,069
)
Decrease (increase) in funds held by reinsureds, net
   
(77,794
)
   
(7,980
)
Decrease (increase) in reinsurance receivables
   
(467,011
)
   
8,270
 
Decrease (increase) in income taxes
   
43,516
     
18,362
 
Decrease (increase) in prepaid reinsurance premiums
   
(86,044
)
   
(87,091
)
Increase (decrease) in reserve for losses and loss adjustment expenses
   
223,202
     
97,493
 
Increase (decrease) in future policy benefit reserve
   
(2,169
)
   
(836
)
Increase (decrease) in unearned premiums
   
151,528
     
161,009
 
Increase (decrease) in other net payable to reinsurers
   
101,970
     
65,929
 
Increase (decrease) in losses in course of payment
   
162,073
     
288,557
 
Change in equity adjustments in limited partnerships
   
(45,898
)
   
(31,032
)
Distribution of limited partnership income
   
42,269
     
22,992
 
Change in other assets and liabilities, net
   
(111,220
)
   
(61,763
)
Non-cash compensation expense
   
17,566
     
15,725
 
Amortization of bond premium (accrual of bond discount)
   
17,677
     
22,475
 
Net realized capital (gains) losses
   
9,125
     
(77,996
)
Net cash provided by (used in) operating activities
   
132,648
     
634,362
 
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Proceeds from fixed maturities matured/called - available for sale, at market value
   
1,099,762
     
1,145,162
 
Proceeds from fixed maturities sold - available for sale, at market value
   
1,225,373
     
991,209
 
Proceeds from fixed maturities sold - available for sale, at fair value
   
1,065
     
-
 
Proceeds from equity securities sold - available for sale, at market value
   
-
     
18,802
 
Proceeds from equity securities sold - available for sale, at fair value
   
576,382
     
258,226
 
Distributions from other invested assets
   
2,978,865
     
2,476,399
 
Cost of fixed maturities acquired - available for sale, at market value
   
(2,163,331
)
   
(2,880,188
)
Cost of fixed maturities acquired - available for sale, at fair value
   
(4,381
)
   
-
 
Cost of equity securities acquired - available for sale, at market value
   
-
     
(2,610
)
Cost of equity securities acquired - available for sale, at fair value
   
(722,797
)
   
(258,543
)
Cost of other invested assets acquired
   
(3,168,655
)
   
(2,431,281
)
Net change in short-term investments
   
213,242
     
105,566
 
Net change in unsettled securities transactions
   
(33,351
)
   
47,800
 
Net cash provided by (used in) investing activities
   
2,174
     
(529,458
)
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Common shares issued during the period for share-based compensation, net of expense
   
(9,431
)
   
(5,847
)
Purchase of treasury shares
   
(25,304
)
   
-
 
Dividends paid to shareholders
   
(106,480
)
   
(102,585
)
Cost of shares withheld for taxes on settlements of share-based compensation awards
   
(14,859
)
   
(12,407
)
Net cash provided by (used in) financing activities
   
(156,074
)
   
(120,839
)
                 
EFFECT OF EXCHANGE RATE CHANGES ON CASH
   
5,678
     
3,218
 
                 
Net increase (decrease) in cash
   
(15,574
)
   
(12,717
)
Cash, beginning of period
   
635,067
     
481,922
 
Cash, end of period
 
$
619,493
   
$
469,205
 
                 
SUPPLEMENTAL CASH FLOW INFORMATION:
               
Income taxes paid (recovered)
 
$
(44,151
)
 
$
57,772
 
Interest paid
   
14,754
     
17,818
 
                 
The accompanying notes are an integral part of the consolidated financial statements.
               

4

NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)

For the Three and Six Months Ended June 30, 2018 and 2017

1.   GENERAL

Everest Re Group, Ltd. ("Group"), a Bermuda company, through its subsidiaries, principally provides reinsurance and insurance in the U.S., Bermuda and international markets.  As used in this document, "Company" means Group and its subsidiaries.

During the fourth quarter of 2017, the Company established a new Irish insurance subsidiary, Everest Insurance Ireland, designated activity company ("Ireland Insurance"), which will write insurance business mainly in the European markets.

During the third quarter of 2016, the Company established domestic subsidiaries, Everest Premier Insurance Company ("Everest Premier") and Everest Denali Insurance Company ("Everest Denali"), which will be used in the continued expansion of the Insurance operations.

Effective July 1, 2016, the Company established a new Irish holding company, Everest Dublin Insurance Holdings Limited (Ireland) ("Everest Dublin Holdings").

2.   BASIS OF PRESENTATION

The unaudited consolidated financial statements of the Company for the three and six months ended June 30, 2018 and 2017 include all adjustments, consisting of normal recurring accruals, which, in the opinion of management, are necessary for a fair statement of the results on an interim basis.  Certain financial information, which is normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"), has been omitted since it is not required for interim reporting purposes.  The December 31, 2017 consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.  The results for the three and six months ended June 30, 2018 and 2017 are not necessarily indicative of the results for a full year.  These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the years ended December 31, 2017, 2016 and 2015 included in the Company's most recent Form 10-K filing.

The Company consolidates the results of operations and financial position of all voting interest entities ("VOE") in which the Company has a controlling financial interest and all variable interest entities ("VIE") in which the Company is considered to be the primary beneficiary. The consolidation assessment, including the determination as to whether an entity qualifies as a VIE or VOE, depends on the facts and circumstances surrounding each entity.

The preparation of 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 financial statements and the reported amounts of revenues and expenses during the reporting period.  Ultimate actual results could differ, possibly materially, from those estimates.

All significant intercompany accounts and transactions have been eliminated.

Certain reclassifications and format changes have been made to prior year's amounts to conform to the 2018 presentation.

5


Application of Recently Issued Accounting Standard Changes.

Accounting for Deferred Taxes in Accumulated Other Comprehensive Income (AOCI).  In February 2018, FASB issued ASU 2018-02 which outlines guidance on the treatment of trapped deferred taxes contained within AOCI on the consolidated balance sheets.  The new guidance allows the amount of trapped deferred taxes in AOCI, resulting from the change in the U.S. tax rate from 35% to 21% upon enactment of the Tax Cuts and Jobs Act ("TCJA"), to be reclassed as part of retained earnings in the consolidated balance sheets.  The guidance is effective for annual and interim reporting periods beginning after December 15, 2018, but early adoption is allowed.  The Company decided to early adopt the guidance as of December 31, 2017.  The adoption resulted in a reclass of $1,250 thousand between AOCI and retained earnings during the fourth quarter of 2017.

Accounting for Impact on Income Taxes due to Tax Reform.  In December 2017, the SEC issued Staff Accounting Bulletin ("SAB") 118 which provides guidance on the application of FASB Accounting Standards Codification ("ASC") Topic 740, Income Taxes, due to the enactment of TCJA.  SAB 118 became effective upon release.  The Company has adopted the provisions of SAB 118 with respect to measuring the tax effects for the modifications to the determination of tax basis loss reserves. Because of uncertainty in how the Internal Revenue Service ("IRS") intends to implement the modifications and the necessary transition calculation, the Company has determined that a reasonable estimate cannot be determined and has followed the provisions of the tax laws that were in effect prior to the modifications.  In 2018, the Company expects to record adjustments to the amount of tax expense it recorded in 2017 with respect to the TCJA as estimated amounts are finalized.  Further adjustments are not expected to have a material impact on the Company's financial statements.

Amortization of Bond Premium.  In March 2017, FASB issued ASU 2017-08 which outlines guidance on the amortization period for premium on callable debt securities.  The new guidance requires that the premium on callable debt securities be amortized through the earliest call date rather than through the maturity date of the callable security.  The guidance is effective for annual and interim reporting periods beginning after December 15, 2019.  The Company does not expect the adoption of ASU 2017-08 to have a material impact on its financial statements.

Presentation and Disclosure of Net Periodic Benefit Costs.  In March 2017, FASB issued ASU 2017-07 which outlines guidance on the presentation of net periodic costs of benefit plans.  The new guidance requires that the service cost component of net periodic benefit costs be reported within the same line item of the statements of operations as other compensation costs are reported.  Other components of net periodic benefit costs should be reported separately.  Footnote disclosure is required to state within which line items of the statements of operations the components are reported.  The guidance is effective for annual and interim reporting periods beginning after December 15, 2017.  The Company adopted the guidance effective January 1, 2018.  The adoption of ASU 2017-07 did not have a material impact on the Company's financial statements.

Disclosure of Restricted Cash.  In November 2016, FASB issued ASU 2016-18 and in August 2016, FASB issued ASU 2016-15 which outline guidance on the presentation in the statements of cash flows of changes in restricted cash.  The new guidance requires that the statements of cash flows should reflect all changes in cash, cash equivalents and restricted cash in total and not segregated individually.  The guidance is effective for annual and interim reporting periods beginning after December 15, 2017.  The Company adopted the guidance effective January 1, 2018.  The adoption of ASU 2016-18 and ASU 2016-15 did not have a material impact on the Company's financial statements.

Intra-Entity Asset Transfers.  In October 2016, FASB issued ASU 2016-16 which outlines guidance on the tax accounting for intra-entity asset sales and transfers, other than inventory.  The new guidance requires that reporting entities recognize tax expense from the intra-entity transfer of an asset in the seller's tax jurisdiction at the time of transfer and recognize any deferred tax asset in the buyer's tax jurisdiction at the time of transfer.  The guidance is effective for annual and interim reporting periods beginning after December 15, 2017.  The Company adopted the guidance effective January 1, 2018.  The adoption of ASU 2016-16 did not have a material impact on the Company's financial statements.
6


Valuation of Financial Instruments.  In June 2016, FASB issued ASU 2016-13 which outlines guidance on the valuation of and accounting for assets measured at amortized cost and available for sale debt securities.  The carrying value of assets measured at amortized cost will now be presented as the amount expected to be collected on the financial asset (amortized cost less an allowance for credit losses valuation account).  Available for sale debt securities will now record credit losses through an allowance for credit losses, which will be limited to the amount by which fair value is below amortized cost.  The guidance is effective for annual and interim reporting periods beginning after December 15, 2019.  The Company is currently evaluating the impact of the adoption of ASU 2016-13 on its financial statements.

Accounting for Share-Based Compensation. In March 2016, the FASB issued ASU 2016-09, authoritative guidance regarding the accounting for share-based compensation.  This guidance requires that the income tax effects resulting from the change in the value of share-based compensation awards between grant and settlement will be recorded as part of the consolidated statements of operations and comprehensive income/(loss).  Previously, excess tax benefits have been recorded as part of the additional paid in capital within the consolidated balance sheets.  The guidance is effective for annual reporting periods beginning after December 15, 2016 and interim periods within that annual reporting period.  The Company has implemented this guidance prospectively as of January 1, 2017.  The guidance also requires that the cost of employee taxes paid via shares withheld upon settlement of share-based compensation awards must be shown as a financing activity within the Statements of Cash Flows.  The Company has implemented this guidance retrospectively as of January 1, 2017.

Leases.  In February 2016, FASB issued ASU 2016-02 which outlines new guidance on the accounting for leases.  The new guidance requires the recognition of lease assets and lease liabilities on the balance sheets for most leases that were previously deemed operating leases and required only lease expense presentation in the statements of operations.  The guidance is effective for annual and interim reporting periods beginning after December 15, 2018.  The Company is currently evaluating the impact of the adoption of ASU 2016-02 on its financial statements.

Recognition and Measurement of Financial Instruments.  In January 2016, the FASB issued ASU 2016-01 which outlines revised guidance on the accounting for equity investments.  The new guidance states that all equity investments in unconsolidated entities will be measured at fair value, with the change in value being recorded through the income statement rather than being recorded within other comprehensive income.  The updated guidance is effective for annual and interim reporting periods beginning after December 15, 2017.  The Company adopted the guidance effective January 1, 2018.  The adoption of ASU 2016-01 resulted in a cumulative change adjustment of $1,201 thousand between AOCI and retained earnings, which is disclosed separately within the consolidated statement of changes in shareholders' equity.

Disclosures about Short-Duration Contracts. In May 2015, the FASB issued ASU 2015-09, authoritative guidance regarding required disclosures associated with short duration insurance contracts.  The new disclosure requirements focus on information about initial claim estimates and subsequent claim estimate adjustment, methodologies in estimating claims and the timing, frequency and severity of claims related to short duration insurance contracts.  This guidance is effective for annual reporting periods beginning after December 15, 2015 and interim reporting periods beginning after December 15, 2016.  The Company implemented this guidance effective in the fourth quarter of 2016.

Revenue Recognition.  In May 2014, the FASB issued ASU 2014-09 and in August 2015, FASB issued ASU 2015-14 which outline revised guidance on the recognition of revenue arising from contracts with customers.  The new guidance states that reporting entities should apply certain steps to determine when revenue should be recognized, based upon fulfillment of performance obligations to complete contracts.  The updated guidance is effective for annual and interim reporting periods beginning after December 15, 2017.  The Company adopted the guidance effective January 1, 2018.  The adoption of ASU 2014-09 and ASU 2015-14 did not have a material impact on the Company's financial statements.

Any issued guidance and pronouncements, other than those directly referenced above, are deemed by the Company to be either not applicable or immaterial to its financial statements.

7


3.     INVESTMENTS

The amortized cost, market value and gross unrealized appreciation and depreciation of available for sale, fixed maturity, equity security investments, carried at market value and other-than-temporary impairments ("OTTI") in accumulated other comprehensive income ("AOCI") are as follows for the periods indicated:


   
At June 30, 2018
 
   
Amortized
   
Unrealized
   
Unrealized
   
Market
   
OTTI in AOCI
 
(Dollars in thousands)
 
Cost
   
Appreciation
   
Depreciation
   
Value
   
(a)
 
Fixed maturity securities
                             
U.S. Treasury securities and obligations of
                             
U.S. government agencies and corporations
 
$
1,158,844
   
$
10,522
   
$
(24,870
)
 
$
1,144,496
   
$
-
 
Obligations of U.S. states and political subdivisions
   
525,087
     
14,731
     
(1,934
)
   
537,884
     
420
 
Corporate securities
   
5,783,255
     
50,084
     
(122,678
)
   
5,710,661
     
2,740
 
Asset-backed securities
   
491,885
     
127
     
(6,056
)
   
485,956
     
-
 
Mortgage-backed securities
                                       
Commercial
   
229,450
     
-
     
(6,475
)
   
222,975
     
-
 
Agency residential
   
2,144,163
     
7,389
     
(66,926
)
   
2,084,626
     
-
 
Non-agency residential
   
22
     
38
     
-
     
60
     
-
 
Foreign government securities
   
1,256,344
     
33,478
     
(52,825
)
   
1,236,997
     
136
 
Foreign corporate securities
   
2,846,742
     
59,779
     
(87,286
)
   
2,819,235
     
588
 
Total fixed maturity securities
 
$
14,435,792
   
$
176,148
   
$
(369,050
)
 
$
14,242,890
   
$
3,884
 
Equity securities
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 



   
At December 31, 2017
 
   
Amortized
   
Unrealized
   
Unrealized
   
Market
   
OTTI in AOCI
 
(Dollars in thousands)
 
Cost
   
Appreciation
   
Depreciation
   
Value
   
(a)
 
Fixed maturity securities
                             
U.S. Treasury securities and obligations of
                             
U.S. government agencies and corporations
 
$
1,540,952
   
$
9,816
   
$
(14,076
)
 
$
1,536,692
   
$
-
 
Obligations of U.S. states and political subdivisions
   
563,790
     
22,123
     
(444
)
   
585,469
     
-
 
Corporate securities
   
5,658,456
     
81,724
     
(41,175
)
   
5,699,005
     
2,488
 
Asset-backed securities
   
532,473
     
869
     
(1,982
)
   
531,360
     
-
 
Mortgage-backed securities
                                       
Commercial
   
235,794
     
616
     
(2,369
)
   
234,041
     
-
 
Agency residential
   
2,236,361
     
10,379
     
(35,838
)
   
2,210,902
     
-
 
Non-agency residential
   
497
     
41
     
(44
)
   
494
     
-
 
Foreign government securities
   
1,305,070
     
43,804
     
(34,847
)
   
1,314,027
     
178
 
Foreign corporate securities
   
2,616,205
     
77,045
     
(48,406
)
   
2,644,844
     
950
 
Total fixed maturity securities
 
$
14,689,598
   
$
246,417
   
$
(179,181
)
 
$
14,756,834
   
$
3,616
 
Equity securities
 
$
130,287
   
$
2,615
   
$
(3,372
)
 
$
129,530
   
$
-
 


(a)  Represents the amount of OTTI recognized in AOCI.  Amount includes unrealized gains and losses on impaired securities relating to changes in the value of such securities subsequent to the impairment measurement date.

Effective January 1, 2018, the Company adopted ASU 2016-01, which requires equity investments in unconsolidated entities to be measured at fair value, with any change in value being recorded within net realized capital gains/(losses) as part of the consolidated statements of operations and comprehensive income (loss).  Previously, changes in the market value had been recorded within AOCI as part of the consolidated balance sheets.  Therefore, effective January 1, 2018, equity security investments no longer have an impact upon the AOCI balance.

8


The amortized cost and market value of fixed maturity securities are shown in the following table by contractual maturity.  Mortgage-backed securities are generally more likely to be prepaid than other fixed maturity securities.  As the stated maturity of such securities may not be indicative of actual maturities, the totals for mortgage-backed and asset-backed securities are shown separately.


   
At June 30, 2018
   
At December 31, 2017
 
   
Amortized
   
Market
   
Amortized
   
Market
 
(Dollars in thousands)
 
Cost
   
Value
   
Cost
   
Value
 
Fixed maturity securities – available for sale:
                       
    Due in one year or less
 
$
1,157,956
   
$
1,158,176
   
$
1,041,885
   
$
1,050,094
 
    Due after one year through five years
   
7,151,383
     
7,045,835
     
7,545,731
     
7,554,248
 
    Due after five years through ten years
   
2,435,785
     
2,395,193
     
2,214,473
     
2,231,456
 
    Due after ten years
   
825,148
     
850,069
     
882,384
     
944,239
 
Asset-backed securities
   
491,885
     
485,956
     
532,473
     
531,360
 
Mortgage-backed securities:
                               
Commercial
   
229,450
     
222,975
     
235,794
     
234,041
 
Agency residential
   
2,144,163
     
2,084,626
     
2,236,361
     
2,210,902
 
Non-agency residential
   
22
     
60
     
497
     
494
 
Total fixed maturity securities
 
$
14,435,792
   
$
14,242,890
   
$
14,689,598
   
$
14,756,834
 


The changes in net unrealized appreciation (depreciation) for the Company's investments are derived from the following sources for the periods indicated:


   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
Increase (decrease) during the period between the market value and cost
                       
of investments carried at market value, and deferred taxes thereon:
                       
Fixed maturity securities
 
$
(40,921
)
 
$
(22,246
)
 
$
(260,406
)
 
$
(4,191
)
Fixed maturity securities, other-than-temporary impairment
   
456
     
(994
)
   
267
     
(5,495
)
Equity securities
   
-
     
1,193
     
-
     
7,192
 
Other invested assets
   
-
     
821
     
-
     
1,265
 
Change in unrealized appreciation (depreciation), pre-tax
   
(40,465
)
   
(21,226
)
   
(260,139
)
   
(1,229
)
Deferred tax benefit (expense)
   
(1,007
)
   
16,990
     
19,292
     
13,117
 
Deferred tax benefit (expense), other-than-temporary impairment
   
(55
)
   
111
     
(76
)
   
1,336
 
Change in unrealized appreciation (depreciation),
                               
net of deferred taxes, included in shareholders' equity
 
$
(41,527
)
 
$
(4,125
)
 
$
(240,923
)
 
$
13,224
 


The Company frequently reviews all of its fixed maturity, available for sale securities for declines in market value and focuses its attention on securities whose fair value has fallen below 80% of their amortized cost at the time of review.  The Company then assesses whether the decline in value is temporary or other-than-temporary.  In making its assessment, the Company evaluates the current market and interest rate environment as well as specific issuer information.  Generally, a change in a security's value caused by a change in the market, interest rate or foreign exchange environment does not constitute an other-than-temporary impairment, but rather a temporary decline in market value.  Temporary declines in market value are recorded as unrealized losses in accumulated other comprehensive income (loss).  If the Company determines that the decline is other-than-temporary and the Company does not have the intent to sell the security; and it is more likely than not that the Company will not have to sell the security before recovery of its cost basis, the carrying value of the investment is written down to fair value.  The fair value adjustment that is credit or foreign exchange related is recorded in net realized capital gains (losses) in the Company's consolidated statements of operations and comprehensive income (loss).  The fair value adjustment that is non-credit related is recorded as a component of other comprehensive income (loss), net of tax, and is included in accumulated other comprehensive income (loss) in the Company's consolidated balance sheets.

The Company's assessments are based on the issuers' current and expected future financial position, timeliness with respect to interest and/or principal payments, speed of repayments and any applicable credit enhancements or breakeven constant default rates on mortgage-backed and asset-backed securities, as well as relevant information provided by rating agencies, investment advisors and analysts.
9


Upon the adoption of ASU 2016-01 as of January 1, 2018, all equity investments in unconsolidated entities are recorded at fair value.  Prior to the adoption of ASU 2016-01, the Company classified certain equity securities as available for sale at market value.  The majority of the Company's equity securities classified as available for sale at market value prior to January 1, 2018 were primarily comprised of mutual fund investments whose underlying securities consisted of fixed maturity securities.  When a fund's value reflected an unrealized loss, the Company assessed whether the decline in value was temporary or other-than-temporary.  In making its assessment, the Company considered the composition of its portfolios and their related markets, reports received from the portfolio managers and discussions with portfolio managers.  If the Company determined that the declines were temporary and it had the ability and intent to continue to hold the investments, then the declines were recorded as unrealized losses in accumulated other comprehensive income (loss).  If declines were deemed to be other-than-temporary, then the carrying value of the investment was written down to fair value and recorded in net realized capital gains (losses) in the Company's consolidated statements of operations and comprehensive income (loss).

Retrospective adjustments are employed to recalculate the values of asset-backed securities.  All of the Company's asset-backed and mortgage-backed securities have a pass-through structure.  Each acquisition lot is reviewed to recalculate the effective yield.  The recalculated effective yield is used to derive a book value as if the new yield were applied at the time of acquisition.  Outstanding principal factors from the time of acquisition to the adjustment date are used to calculate the prepayment history for all applicable securities.  Conditional prepayment rates, computed with life to date factor histories and weighted average maturities, are used in the calculation of projected prepayments for pass-through security types.

The tables below display the aggregate market value and gross unrealized depreciation of fixed maturity and equity securities, by security type and contractual maturity, in each case subdivided according to length of time that individual securities had been in a continuous unrealized loss position for the periods indicated:


   
Duration of Unrealized Loss at June 30, 2018 By Security Type
 
   
Less than 12 months
   
Greater than 12 months
   
Total
 
         
Gross
         
Gross
         
Gross
 
         
Unrealized
         
Unrealized
         
Unrealized
 
(Dollars in thousands)
 
Market Value
   
Depreciation
   
Market Value
   
Depreciation
   
Market Value
   
Depreciation
 
Fixed maturity securities - available for sale
                                   
U.S. Treasury securities and obligations of
                                   
U.S. government agencies and corporations
 
$
740,474
   
$
(14,053
)
 
$
265,737
   
$
(10,817
)
 
$
1,006,211
   
$
(24,870
)
Obligations of U.S. states and political subdivisions
   
45,254
     
(651
)
   
36,939
     
(1,283
)
   
82,193
     
(1,934
)
Corporate securities
   
3,629,848
     
(78,597
)
   
807,050
     
(44,081
)
   
4,436,898
     
(122,678
)
Asset-backed securities
   
315,541
     
(4,760
)
   
92,906
     
(1,296
)
   
408,447
     
(6,056
)
Mortgage-backed securities
                                               
Commercial
   
156,895
     
(3,104
)
   
66,079
     
(3,371
)
   
222,974
     
(6,475
)
Agency residential
   
582,748
     
(11,118
)
   
1,321,462
     
(55,808
)
   
1,904,210
     
(66,926
)
Non-agency residential
   
-
     
-
     
-
     
-
     
-
     
-
 
Foreign government securities
   
302,046
     
(8,212
)
   
412,970
     
(44,613
)
   
715,016
     
(52,825
)
Foreign corporate securities
   
1,332,956
     
(35,840
)
   
584,790
     
(51,446
)
   
1,917,746
     
(87,286
)
Total fixed maturity securities
 
$
7,105,762
   
$
(156,335
)
 
$
3,587,933
   
$
(212,715
)
 
$
10,693,695
   
$
(369,050
)
Equity securities
   
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
7,105,762
   
$
(156,335
)
 
$
3,587,933
   
$
(212,715
)
 
$
10,693,695
   
$
(369,050
)



   
Duration of Unrealized Loss at June 30, 2018 By Maturity
 
   
Less than 12 months
   
Greater than 12 months
   
Total
 
         
Gross
         
Gross
         
Gross
 
         
Unrealized
         
Unrealized
         
Unrealized
 
(Dollars in thousands)
 
Market Value
   
Depreciation
   
Market Value
   
Depreciation
   
Market Value
   
Depreciation
 
Fixed maturity securities
                                   
Due in one year or less
 
$
628,144
   
$
(2,598
)
 
$
149,820
   
$
(13,881
)
 
$
777,964
   
$
(16,479
)
Due in one year through five years
   
3,911,655
     
(78,589
)
   
1,547,737
     
(106,257
)
   
5,459,392
     
(184,846
)
Due in five years through ten years
   
1,270,453
     
(42,618
)
   
367,885
     
(29,885
)
   
1,638,338
     
(72,503
)
Due after ten years
   
240,326
     
(13,548
)
   
42,044
     
(2,217
)
   
282,370
     
(15,765
)
Asset-backed securities
   
315,541
     
(4,760
)
   
92,906
     
(1,296
)
   
408,447
     
(6,056
)
Mortgage-backed securities
   
739,643
     
(14,222
)
   
1,387,541
     
(59,179
)
   
2,127,184
     
(73,401
)
Total fixed maturity securities
 
$
7,105,762
   
$
(156,335
)
 
$
3,587,933
   
$
(212,715
)
 
$
10,693,695
   
$
(369,050
)

10


The aggregate market value and gross unrealized losses related to investments in an unrealized loss position at June 30, 2018 were $10,693,695 thousand and $369,050 thousand, respectively.  The market value of securities for the single issuer (the United States government) whose securities comprised the largest unrealized loss position at June 30, 2018, did not exceed 7.1% of the overall market value of the Company's fixed maturity securities.  The market value of the securities for the issuer with the second largest unrealized loss comprised less than 1.1% of the Company's fixed maturity securities.  In addition, as indicated on the above table, there was no significant concentration of unrealized losses in any one market sector.  The $156,335 thousand of unrealized losses related to fixed maturity securities that have been in an unrealized loss position for less than one year were generally comprised of domestic and foreign corporate securities, U.S. government agencies and corporations, agency residential mortgage-backed securities and foreign government securities.  Of these unrealized losses, $135,754 thousand were related to securities that were rated investment grade by at least one nationally recognized statistical rating agency.  The $212,715 thousand of unrealized losses related to fixed maturity securities in an unrealized loss position for more than one year related primarily to agency residential mortgage-backed securities, foreign corporate securities, foreign government securities, domestic corporate securities and U.S. government agencies and corporations.  Of these unrealized losses, $207,796 thousand were related to securities that were rated investment grade by at least one nationally recognized statistical rating agency.  There was no gross unrealized depreciation for mortgage-backed securities related to sub-prime and alt-A loans.  In all instances, there were no projected cash flow shortfalls to recover the full book value of the investments and the related interest obligations.  The mortgage-backed securities still have excess credit coverage and are current on interest and principal payments.

The Company, given the size of its investment portfolio and capital position, does not have the intent to sell these securities; and it is more likely than not that the Company will not have to sell the security before recovery of its cost basis.  In addition, all securities currently in an unrealized loss position are current with respect to principal and interest payments.

The tables below display the aggregate market value and gross unrealized depreciation of fixed maturity and equity securities, by security type and contractual maturity, in each case subdivided according to length of time that individual securities had been in a continuous unrealized loss position for the periods indicated:


   
Duration of Unrealized Loss at December 31, 2017 By Security Type
 
   
Less than 12 months
   
Greater than 12 months
   
Total
 
         
Gross
         
Gross
         
Gross
 
         
Unrealized
         
Unrealized
         
Unrealized
 
(Dollars in thousands)
 
Market Value
   
Depreciation
   
Market Value
   
Depreciation
   
Market Value
   
Depreciation
 
Fixed maturity securities - available for sale
                                   
U.S. Treasury securities and obligations of
                                   
U.S. government agencies and corporations
 
$
1,077,051
   
$
(8,380
)
 
$
224,189
   
$
(5,696
)
 
$
1,301,240
   
$
(14,076
)
Obligations of U.S. states and political subdivisions
   
4,400
     
(27
)
   
37,886
     
(417
)
   
42,286
     
(444
)
Corporate securities
   
1,779,292
     
(24,942
)
   
700,098
     
(16,233
)
   
2,479,390
     
(41,175
)
Asset-backed securities
   
301,316
     
(1,467
)
   
72,780
     
(515
)
   
374,096
     
(1,982
)
Mortgage-backed securities
                                               
Commercial
   
101,821
     
(572
)
   
64,272
     
(1,797
)
   
166,093
     
(2,369
)
Agency residential
   
610,941
     
(4,836
)
   
1,343,547
     
(31,002
)
   
1,954,488
     
(35,838
)
Non-agency residential
   
-
     
-
     
69
     
(44
)
   
69
     
(44
)
Foreign government securities
   
327,790
     
(12,811
)
   
331,432
     
(22,036
)
   
659,222
     
(34,847
)
Foreign corporate securities
   
691,865
     
(19,381
)
   
450,860
     
(29,025
)
   
1,142,725
     
(48,406
)
Total fixed maturity securities
 
$
4,894,476
   
$
(72,416
)
 
$
3,225,133
   
$
(106,765
)
 
$
8,119,609
   
$
(179,181
)
Equity securities
   
-
     
-
     
113,506
     
(3,372
)
   
113,506
     
(3,372
)
Total
 
$
4,894,476
   
$
(72,416
)
 
$
3,338,639
   
$
(110,137
)
 
$
8,233,115
   
$
(182,553
)


11



   
Duration of Unrealized Loss at December 31, 2017 By Maturity
 
   
Less than 12 months
   
Greater than 12 months
   
Total
 
         
Gross
         
Gross
         
Gross
 
         
Unrealized
         
Unrealized
         
Unrealized
 
(Dollars in thousands)
 
Market Value
   
Depreciation
   
Market Value
   
Depreciation
   
Market Value
   
Depreciation
 
Fixed maturity securities
                                   
Due in one year or less
 
$
247,927
   
$
(962
)
 
$
206,113
   
$
(7,643
)
 
$
454,040
   
$
(8,605
)
Due in one year through five years
   
2,930,977
     
(42,480
)
   
1,200,414
     
(52,143
)
   
4,131,391
     
(94,623
)
Due in five years through ten years
   
612,702
     
(20,154
)
   
292,245
     
(12,680
)
   
904,947
     
(32,834
)
Due after ten years
   
88,792
     
(1,945
)
   
45,693
     
(941
)
   
134,485
     
(2,886
)
Asset-backed securities
   
301,316
     
(1,467
)
   
72,780
     
(515
)
   
374,096
     
(1,982
)
Mortgage-backed securities
   
712,762
     
(5,408
)
   
1,407,888
     
(32,843
)
   
2,120,650
     
(38,251
)
Total fixed maturity securities
 
$
4,894,476
   
$
(72,416
)
 
$
3,225,133
   
$
(106,765
)
 
$
8,119,609
   
$
(179,181
)


The aggregate market value and gross unrealized losses related to investments in an unrealized loss position at December 31, 2017 were $8,233,115 thousand and $182,553 thousand, respectively.  The market value of securities for the single issuer (the United States government) whose securities comprised the largest unrealized loss position at December 31, 2017, did not exceed 8.9% of the overall market value of the Company's fixed maturity securities.  The market value of the securities for the issuer with the second largest unrealized loss comprised less than 1.1% of the Company's fixed maturity securities.  In addition, as indicated on the above table, there was no significant concentration of unrealized losses in any one market sector.  The $72,416 thousand of unrealized losses related to fixed maturity securities that have been in an unrealized loss position for less than one year were generally comprised of domestic and foreign corporate securities, foreign government securities, U.S. government agencies and corporations and agency residential mortgage-backed securities.  Of these unrealized losses, $68,107 thousand were related to securities that were rated investment grade by at least one nationally recognized statistical rating agency.  The $106,765 thousand of unrealized losses related to fixed maturity securities in an unrealized loss position for more than one year related primarily to agency residential mortgage-backed securities, foreign corporate securities, foreign government securities, domestic corporate securities and U.S. government agencies and corporations.  Of these unrealized losses, $103,739 thousand were related to securities that were rated investment grade by at least one nationally recognized statistical rating agency.  There was no gross unrealized depreciation for mortgage-backed securities related to sub-prime and alt-A loans.  In all instances, there were no projected cash flow shortfalls to recover the full book value of the investments and the related interest obligations.  The mortgage-backed securities still have excess credit coverage and are current on interest and principal payments.

The components of net investment income are presented in the table below for the periods indicated:


   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
Fixed maturities
 
$
114,824
   
$
108,122
   
$
223,506
   
$
211,367
 
Equity securities
   
6,672
     
8,366
     
13,499
     
17,111
 
Short-term investments and cash
   
2,092
     
835
     
3,824
     
1,465
 
Other invested assets
                               
Limited partnerships
   
21,996
     
20,060
     
45,377
     
31,058
 
Other
   
2,659
     
2,285
     
6,984
     
4,557
 
Gross investment income before adjustments
   
148,243
     
139,668
     
293,190
     
265,558
 
Funds held interest income (expense)
   
1,939
     
1,724
     
5,569
     
4,872
 
Future policy benefit reserve income (expense)
   
(359
)
   
(416
)
   
(568
)
   
(735
)
Gross investment income
   
149,823
     
140,976
     
298,191
     
269,695
 
Investment expenses
   
(8,501
)
   
(6,468
)
   
(18,575
)
   
(12,898
)
Net investment income
 
$
141,322
   
$
134,508
   
$
279,616
   
$
256,797
 


12


The Company records results from limited partnership investments on the equity method of accounting with changes in value reported through net investment income.  Due to the timing of receiving financial information from these partnerships, the results are generally reported on a one month or quarter lag.  If the Company determines there has been a significant decline in value of a limited partnership during this lag period, a loss will be recorded in the period in which the Company identifies the decline.

The Company had contractual commitments to invest up to an additional $689,337 thousand in limited partnerships at June 30, 2018.  These commitments will be funded when called in accordance with the partnership agreements, which have investment periods that expire, unless extended, through 2023.

The Company's other invested assets at June 30, 2018 and December 31, 2017 included $387,160 thousand and $447,915 thousand, respectively, related to a private placement liquidity sweep facility.  The primary purpose of the facility is to enhance the Company's return on its short-term investments and cash positions.  The facility invests in high quality, short-duration securities and permits daily liquidity.

The components of net realized capital gains (losses) are presented in the table below for the periods indicated:


   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
Fixed maturity securities, market value:
                       
Other-than-temporary impairments
 
$
(888
)
 
$
(2,475
)
 
$
(958
)
 
$
(3,703
)
Gains (losses) from sales
   
(43
)
   
13,543
     
10,349
     
24,915
 
Fixed maturity securities, fair value:
                               
Gains (losses) from sales
   
(1,068
)
   
-
     
(1,082
)
   
-
 
Gains (losses) from fair value adjustments
   
958
     
-
     
958
     
-
 
Equity securities, market value:
                               
Gains (losses) from sales
   
-
     
-
     
-
     
(3,436
)
Equity securities, fair value:
                               
Gains (losses) from sales
   
(1,563
)
   
805
     
(1,523
)
   
5,321
 
Gains (losses) from fair value adjustments
   
17,800
     
13,397
     
(17,453
)
   
54,904
 
Other invested assets
   
581
     
(2
)
   
584
     
(1
)
Short-term investments gain (loss)
   
(1
)
   
-
     
-
     
(4
)
Total net realized capital gains (losses)
 
$
15,776
   
$
25,268
   
$
(9,125
)
 
$
77,996
 


The Company recorded as net realized capital gains (losses) in the consolidated statements of operations and comprehensive income (loss) both fair value re-measurements and write-downs in the value of securities deemed to be impaired on an other-than-temporary basis as displayed in the table above.  The Company had no other-than-temporary impaired securities where the impairment had both a credit and non-credit component.

13


The proceeds and split between gross gains and losses, from sales of fixed maturity and equity securities, are presented in the table below for the periods indicated:


   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
Proceeds from sales of fixed maturity securities
 
$
862,150
   
$
562,718
   
$
1,226,438
   
$
991,209
 
Gross gains from sales
   
6,824
     
17,105
     
19,826
     
32,578
 
Gross losses from sales
   
(7,935
)
   
(3,563
)
   
(10,559
)
   
(7,663
)
                                 
Proceeds from sales of equity securities
 
$
376,507
   
$
117,911
   
$
576,382
   
$
277,028
 
Gross gains from sales
   
7,359
     
3,885
     
14,046
     
12,093
 
Gross losses from sales
   
(8,922
)
   
(3,080
)
   
(15,569
)
   
(10,208
)


4.      RESERVE FOR LOSSES, LAE AND FUTURE POLICY BENEFIT RESERVE

Activity in the reserve for losses and LAE is summarized for the periods indicated:


   
Six Months Ended
   
Twelve Months Ended
 
   
June 30,
   
December 31,
 
(Dollars in thousands)
 
2018
   
2017
 
Gross reserves at beginning of period
 
$
11,884,321
   
$
10,312,313
 
      Less reinsurance recoverables
   
(1,212,649
)
   
(990,862
)
           Net reserves at beginning of period
   
10,671,672
     
9,321,451
 
                 
Incurred related to:
               
      Current year
   
1,963,766
     
4,815,967
 
      Prior years
   
434,725
     
(293,386
)
           Total incurred losses and LAE
   
2,398,491
     
4,522,581
 
                 
Paid related to:
               
      Current year
   
490,884
     
1,280,605
 
      Prior years
   
2,089,606
     
2,062,634
 
           Total paid losses and LAE
   
2,580,490
     
3,343,239
 
                 
Foreign exchange/translation adjustment
   
(67,978
)
   
170,879
 
                 
Net reserves at end of period
   
10,421,695
     
10,671,672
 
      Plus reinsurance recoverables
   
1,621,639
     
1,212,649
 
           Gross reserves at end of period
 
$
12,043,334
   
$
11,884,321
 


Incurred prior years' reserves increased by $434,725 thousand for the six months ended June 30, 2018 and decreased by $293,386 thousand for the twelve months ended December 31, 2017.  The increase for the six months ended June 30, 2018, was due to $532,155 thousand of adverse development on prior years catastrophe losses, primarily related to Hurricane Harvey, Irma and Maria as well as the California wildfires.  The increase in loss estimates for Hurricanes Harvey, Irma and Maria was mostly driven by re-opened claims reported in the second quarter of 2018 and loss inflation from higher than expected loss adjustment expenses and in particular, their impact on aggregate covers.  This reserve increase was partially offset by $97,430 thousand of favorable development on prior years attritional losses which mainly related to U.S. and international property and casualty reinsurance business.  The favorable development was primarily identified through reserve studies completed in the second quarter of 2018.  The decrease for 2017 was attributable to favorable development in the reinsurance segments of $238,378 thousand, related primarily to property and short-tail business in the U.S. and Bermuda as well as favorable development on prior year catastrophe losses, partially offset by $37,137 thousand of adverse development on A&E reserves.  The insurance segment also experienced favorable development on prior year reserves of $55,007 thousand mainly on its workers compensation business, which is largely written in California.

14


The $408,990 thousand increase in reinsurance recoverables from December 31, 2017 to June 30, 2018 is primarily related to the additional catastrophe losses incurred in the second quarter of 2018 as well as a retroactive reinsurance transaction with a Mt. Logan Re segregated account effective in the second quarter of 2018.

5.     DERIVATIVES

The Company sold seven equity index put option contracts, based on two indices, in 2001 and 2005.  The Company sold these equity index put options as insurance products with the intent of achieving a profit.  These equity index put option contracts meet the definition of a derivative under FASB guidance and the Company's position in these equity index put option contracts is unhedged.  Accordingly, these equity index put option contracts are carried at fair value in the consolidated balance sheets with changes in fair value recorded in the consolidated statements of operations and comprehensive income (loss).  One of these contracts expired on June 9, 2017, with no liability due under the terms of the contract.

The Company has five remaining equity index put option contracts, based on the Standard & Poor's 500 ("S&P 500") index.  Based on historical index volatilities and trends and the June 30, 2018 S&P 500 index value, the Company estimates the probability that each equity index put option contract of the S&P 500 index falling below the strike price on the exercise date to be less than 2%.  The theoretical maximum payouts under these five equity index put option contracts would occur if on each of the exercise dates the S&P 500 index value were zero.  At June 30, 2018, the present value of these theoretical maximum payouts using a 3% discount factor was $406,448 thousand.  Conversely, if the contracts had all expired on June 30, 2018, with the S&P index at $2,718.37, there would have been no settlement amount.

The Company has one equity index put option contract based on the FTSE 100 index.  Based on historical index volatilities and trends and the June 30, 2018 FTSE 100 index value, the Company estimates the probability that the equity index put option contract of the FTSE 100 index will fall below the strike price on the exercise date to be less than 10%.  The theoretical maximum payout under the equity index put option contract would occur if on the exercise date the FTSE 100 index value was zero.  At June 30, 2018, the present value of the theoretical maximum payout using a 3% discount factor and current exchange rate was $41,076 thousand.  Conversely, if the contract had expired on June 30, 2018, with the FTSE index at ₤7,636.93, there would have been no settlement amount.

At June 30, 2018 and December 31, 2017, the fair value for these equity put options was $9,218 thousand and $12,477 thousand, respectively.

The fair value of the equity index put options can be found in the Company's consolidated balance sheets as follows:


(Dollars in thousands)
               
Derivatives not designated as
 
Location of fair value
 
At
   
At
 
hedging instruments
 
in balance sheets
 
June 30, 2018
   
December 31, 2017
 
                 
Equity index put option contracts
 
Equity index put option liability
 
$
9,218
   
$
12,477
 
Total
     
$
9,218
   
$
12,477
 


The change in fair value of the equity index put option contracts can be found in the Company's statement of operations and comprehensive income (loss) as follows:


(Dollars in thousands)
     
For the Three Months Ended
   
For the Six Months Ended
 
Derivatives not designated as
 
Location of gain (loss) in statements of
 
June 30,
   
June 30,
 
hedging instruments
 
operations and comprehensive income (loss)
 
2018
   
2017
   
2018
   
2017
 
                             
Equity index put option contracts
 
Net derivative gain (loss)
 
$
2,987
   
$
766
   
$
3,260
   
$
3,396
 
Total
     
$
2,987
   
$
766
   
$
3,260
   
$
3,396
 


15


6.     FAIR VALUE

GAAP guidance regarding fair value measurements address how companies should measure fair value when they are required to use fair value measures for recognition or disclosure purposes under GAAP and provides a common definition of fair value to be used throughout GAAP.  It defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly fashion between market participants at the measurement date.  In addition, it establishes a three-level valuation hierarchy for the disclosure of fair value measurements.  The valuation hierarchy is based on the transparency of inputs to the valuation of an asset or liability.  The level in the hierarchy within which a given fair value measurement falls is determined based on the lowest level input that is significant to the measurement, with Level 1 being the highest priority and Level 3 being the lowest priority.

The levels in the hierarchy are defined as follows:

Level 1:
Inputs to the valuation methodology are observable inputs that reflect unadjusted quoted prices for identical assets or liabilities in an active market;

Level 2:
Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument;

Level 3:
Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

The Company's fixed maturity and equity securities are primarily managed by third party investment asset managers.  The investment asset managers obtain prices from nationally recognized pricing services.   These services seek to utilize market data and observations in their evaluation process.  They use pricing applications that vary by asset class and incorporate available market information and when fixed maturity securities do not trade on a daily basis the services will apply available information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing.  In addition, they use model processes, such as the Option Adjusted Spread model to develop prepayment and interest rate scenarios for securities that have prepayment features.

In limited instances where prices are not provided by pricing services or in rare instances when a manager may not agree with the pricing service, price quotes on a non-binding basis are obtained from investment brokers.  The investment asset managers do not make any changes to prices received from either the pricing services or the investment brokers.  In addition, the investment asset managers have procedures in place to review the reasonableness of the prices from the service providers and may request verification of the prices.  In addition, the Company continually performs analytical reviews of price changes and tests the prices on a random basis to an independent pricing source.  No material variances were noted during these price validation procedures.  In limited situations, where financial markets are inactive or illiquid, the Company may use its own assumptions about future cash flows and risk-adjusted discount rates to determine fair value.  Due to the unavailability of prices for ninety-one private placement securities at June 30, 2018, an investment manager's valuation committee valued eighty-five of these private placement securities at $247,863 thousand.  A majority of the fair values determined by the valuation committee are substantiated by valuations from independent third parties.  Four of the private placement securities totaling $95,444 thousand are valued by the investment manager at amortized cost.  In addition, the Company valued two private placement securities at $53,715 thousand, representing par value.  Due to the unavailability of prices for sixty-six private placement securities at December 31, 2017, an investment manager's valuation committee valued sixty-five of these private placement securities at $165,173 thousand.  In addition, the Company valued one private placement security at $51,965 thousand, representing par value.

The Company internally manages a public equity portfolio which had a fair value at June 30, 2018 and December 31, 2017 of $490,863 thousand and $386,241 thousand, respectively, and all prices were obtained from publicly published sources.

16


Equity securities denominated in U.S. currency with quoted prices in active markets for identical assets are categorized as level 1 since the quoted prices are directly observable.  Equity securities traded on foreign exchanges are categorized as level 2 due to the added input of a foreign exchange conversion rate to determine fair or market value.  The Company uses foreign currency exchange rates published by nationally recognized sources.

All categories of fixed maturity securities listed in the tables below are generally categorized as level 2, since a particular security may not have traded but the pricing services are able to use valuation models with observable market inputs such as interest rate yield curves and prices for similar fixed maturity securities in terms of issuer, maturity and seniority.  For foreign government securities and foreign corporate securities, the fair values provided by the third party pricing services in local currencies, and where applicable, are converted to U.S. dollars using currency exchange rates from nationally recognized sources.

The fixed maturities with fair values categorized as level 3 result when prices are not available from the nationally recognized pricing services.  The asset managers will then obtain non-binding price quotes for the securities from brokers.  The single broker quotes are provided by market makers or broker-dealers who are recognized as market participants in the markets in which they are providing the quotes.  The prices received from brokers are reviewed for reasonableness by the third party asset managers and the Company.  If the broker quotes are for foreign denominated securities, the quotes are converted to U.S. dollars using currency exchange rates from nationally recognized sources.  In limited circumstances when broker prices are not available for private placements, the Company will value the securities using comparable market information or receive fair values from investment managers.

The composition and valuation inputs for the presented fixed maturities categories are as follows:

·
U.S. Treasury securities and obligations of U.S. government agencies and corporations are primarily comprised of U.S. Treasury bonds and the fair value is based on observable market inputs such as quoted prices, reported trades, quoted prices for similar issuances or benchmark yields;

·
Obligations of U.S. states and political subdivisions are comprised of state and municipal bond issuances and the fair values are based on observable market inputs such as quoted market prices, quoted prices for similar securities, benchmark yields and credit spreads;

·
Corporate securities are primarily comprised of U.S. corporate and public utility bond issuances and the fair values are based on observable market inputs such as quoted market prices, quoted prices for similar securities, benchmark yields and credit spreads;

·
Asset-backed and mortgage-backed securities fair values are based on observable inputs such as quoted prices, reported trades, quoted prices for similar issuances or benchmark yields and cash flow models using observable inputs such as prepayment speeds, collateral performance and default spreads;

·
Foreign government securities are comprised of global non-U.S. sovereign bond issuances and the fair values are based on observable market inputs such as quoted market prices, quoted prices for similar securities and models with observable inputs such as benchmark yields and credit spreads and then, where applicable, converted to U.S. dollars using an exchange rate from a nationally recognized source;

·
Foreign corporate securities are comprised of global non-U.S. corporate bond issuances and the fair values are based on observable market inputs such as quoted market prices, quoted prices for similar securities and models with observable inputs such as benchmark yields and credit spreads and then, where applicable, converted to U.S. dollars using an exchange rate from a nationally recognized source.

The Company sold seven equity index put option contracts, based on two indices, in 2001 and 2005.  The Company sold these equity index put options as insurance products with the intent of achieving a profit.  These equity index put option contracts meet the definition of a derivative under FASB guidance and the Company's position in these equity index put option contracts is unhedged.  Accordingly, these equity index put option contracts are carried at fair value in the consolidated balance sheets with changes in fair value
17


recorded in the consolidated statements of operations and comprehensive income (loss).  One of these contracts expired on June 9, 2017, with no liability due under the terms of the contract.

The Company's liability for equity index put options is categorized as level 3 since there is no active market for these equity put options.  The fair values for these options are calculated by the Company using an industry accepted pricing model, Black-Scholes.  The model inputs and assumptions are: risk free interest rates, equity market indexes values, volatilities and dividend yields and duration.  The model results are then adjusted for the Company's credit default swap rate.  All of these inputs and assumptions are updated quarterly.  One of the option contacts is in British Pound Sterling so the fair value for this contract is converted to U.S. dollars using an exchange rate from a nationally recognized source.

The following table presents the fair value measurement levels for all assets and liabilities, which the Company has recorded at fair value (fair and market value) as of the periods indicated:


         
Fair Value Measurement Using:
 
         
Quoted Prices
             
         
in Active
   
Significant
       
         
Markets for
   
Other
   
Significant
 
         
Identical
   
Observable
   
Unobservable
 
         
Assets
   
Inputs
   
Inputs
 
(Dollars in thousands)
 
June 30, 2018
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Assets:
                       
Fixed maturities, market value
                       
U.S. Treasury securities and obligations of
                       
U.S. government agencies and corporations
 
$
1,144,496
   
$
-
   
$
1,144,496
   
$
-
 
Obligations of U.S. States and political subdivisions
   
537,884
     
-
     
537,884
     
-
 
Corporate securities
   
5,710,661
     
-
     
5,329,446
     
381,215
 
Asset-backed securities
   
485,956
     
-
     
485,956
     
-
 
Mortgage-backed securities
                               
Commercial
   
222,975
     
-
     
222,975
     
-
 
Agency residential
   
2,084,626
     
-
     
2,084,626
     
-
 
Non-agency residential
   
60
     
-
     
60
     
-
 
Foreign government securities
   
1,236,997
     
-
     
1,236,997
     
-
 
Foreign corporate securities
   
2,819,235
     
-
     
2,806,620
     
12,615
 
Total fixed maturities, market value
   
14,242,890
     
-
     
13,849,060
     
393,830
 
                                 
Fixed maturities, fair value
   
3,192
     
-
     
-
     
3,192
 
Equity securities, fair value
   
1,220,770
     
1,180,851
     
39,919
     
-
 
                                 
Liabilities:
                               
Equity index put option contracts
 
$
9,218
   
$
-
   
$
-
   
$
9,218
 


There were no transfers between Level 1 and Level 2 for the six months ended June 30, 2018.

18


The following table presents the fair value measurement levels for all assets and liabilities, which the Company has recorded at fair value (fair and market value) as of the periods indicated:


         
Fair Value Measurement Using:
 
         
Quoted Prices
             
         
in Active
   
Significant
       
         
Markets for
   
Other
   
Significant
 
         
Identical
   
Observable
   
Unobservable
 
         
Assets
   
Inputs
   
Inputs
 
(Dollars in thousands)
 
December 31, 2017
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Assets:
                       
Fixed maturities, market value
                       
U.S. Treasury securities and obligations of
                       
U.S. government agencies and corporations
 
$
1,536,692
   
$
-
   
$
1,536,692
   
$
-
 
Obligations of U.S. States and political subdivisions
   
585,469
     
-
     
585,469
     
-
 
Corporate securities
   
5,699,005
     
-
     
5,488,819
     
210,186
 
Asset-backed securities
   
531,360
     
-
     
531,360
     
-
 
Mortgage-backed securities
                               
Commercial
   
234,041
     
-
     
234,041
     
-
 
Agency residential
   
2,210,902
     
-
     
2,210,902
     
-
 
Non-agency residential
   
494
     
-
     
494
     
-
 
Foreign government securities
   
1,314,027
     
-
     
1,314,027
     
-
 
Foreign corporate securities
   
2,644,844
     
-
     
2,637,892
     
6,952
 
Total fixed maturities, market value
   
14,756,834
     
-
     
14,539,696
     
217,138
 
                                 
Equity securities, market value
   
129,530
     
113,506
     
16,024
     
-
 
Equity securities, fair value
   
963,572
     
941,739
     
21,833
     
-
 
                                 
Liabilities:
                               
Equity index put option contracts
 
$
12,477
   
$
-
   
$
-
   
$
12,477
 


In addition, $96,162 thousand and $79,505 thousand of investments within other invested assets on the consolidated balance sheets as of June 30, 2018 and December 31, 2017, respectively, are not included within the fair value hierarchy tables as the assets are measured at NAV as a practical expedient to determine fair value.

The following tables present the activity under Level 3, fair value measurements using significant unobservable inputs by asset type, for the periods indicated:


   
Total Fixed Maturities, Market Value
 
   
Three Months Ended June 30, 2018
   
Six Months Ended June 30, 2018
 
   
Corporate
   
Foreign
         
Corporate
   
Foreign
       
(Dollars in thousands)
 
Securities
   
Corporate
   
Total
   
Securities
   
Corporate
   
Total
 
Beginning balance fixed maturities at market value
 
$
220,555
   
$
11,368
   
$
231,923
   
$
210,186
   
$
6,952
   
$
217,138
 
Total gains or (losses) (realized/unrealized)
                                               
Included in earnings
   
624
     
(504
)
   
120
     
1,346
     
(410
)
   
936
 
Included in other comprehensive income (loss)
   
190
     
-
     
190
     
425
     
-
     
425
 
Purchases, issuances and settlements
   
159,846
     
1
     
159,847
     
169,258
     
4,323
     
173,581
 
Transfers in and/or (out) of Level 3
   
-
     
1,750
     
1,750
     
-
     
1,750
     
1,750
 
Ending balance
 
$
381,215
   
$
12,615
   
$
393,830
   
$
381,215
   
$
12,615
   
$
393,830
 
                                                 
The amount of total gains or losses for the period
                                               
included in earnings (or changes in net assets)
                                               
attributable to the change in unrealized gains
                                               
or losses relating to assets still held
                                               
 at the reporting date
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
                                                 
(Some amounts may not reconcile due to rounding.)
                                               

19



   
Total Fixed Maturities, Market Value
 
   
Three Months Ended June 30, 2017
   
Six Months Ended June 30, 2017
 
   
Corporate
   
Foreign
         
Corporate
   
Foreign
       
(Dollars in thousands)
 
Securities
   
Corporate
   
Total
   
Securities
   
Corporate
   
Total
 
Beginning balance fixed maturities at market value
 
$
84,322
   
$
2,802
   
$
87,124
   
$
65,197
   
$
2,538
   
$
67,735
 
Total gains or (losses) (realized/unrealized)
                                               
Included in earnings
   
711
     
128
     
839
     
925
     
104
     
1,029
 
Included in other comprehensive income (loss)
   
172
     
-
     
172
     
143
     
-
     
143
 
Purchases, issuances and settlements
   
52,900
     
221
     
53,121
     
71,840
     
509
     
72,349
 
Transfers in and/or (out) of Level 3
   
-
     
-
     
-
     
-
     
-
     
-
 
Ending balance
 
$
138,105
   
$
3,151
   
$
141,256
   
$
138,105
   
$
3,151
   
$
141,256
 
                                                 
The amount of total gains or losses for the period
                                               
included in earnings (or changes in net assets)
                                               
attributable to the change in unrealized gains
                                               
or losses relating to assets still held
                                               
 at the reporting date
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
                                                 
(Some amounts may not reconcile due to rounding.)
                                               



   
Total Fixed Maturities, Fair Value
 
   
Three Months Ended June 30, 2018
   
Six Months Ended June 30, 2018
 
   
Foreign
         
Foreign
       
(Dollars in thousands)
 
Corporate
   
Total
   
Corporate
   
Total
 
Beginning balance fixed maturities at fair value
 
$
1,821
   
$
1,821
   
$
-
   
$
-
 
Total gains or (losses) (realized/unrealized)
                               
Included in earnings
   
(142
)
   
(142
)
   
(156
)
   
(156
)
Included in other comprehensive income (loss)
   
32
     
32
     
32
     
32
 
Purchases, issuances and settlements
   
1,481
     
1,481
     
3,316
     
3,316
 
Transfers in and/or (out) of Level 3
   
-
     
-
     
-
     
-
 
Ending balance
 
$
3,192
   
$
3,192
   
$
3,192
   
$
3,192
 
                                 
The amount of total gains or losses for the period
                               
included in earnings (or changes in net assets)
                               
attributable to the change in unrealized gains
                               
or losses relating to assets still held
                               
 at the reporting date
 
$
-
   
$
-
   
$
-
   
$
-
 
                                 
(Some amounts may not reconcile due to rounding.)
                               

 
   
Total Fixed Maturities, Fair Value
 
   
Three Months Ended June 30, 2017
   
Six Months Ended June 30, 2017
 
   
Foreign
         
Foreign
       
(Dollars in thousands)
 
Corporate
   
Total
   
Corporate
   
Total
 
Beginning balance fixed maturities at fair value
 
$
-
   
$
-
   
$
-
   
$
-
 
Total gains or (losses) (realized/unrealized)
                               
Included in earnings
   
-
 
   
-
 
   
-
 
   
-
 
Included in other comprehensive income (loss)
   
-
     
-
     
-
     
-
 
Purchases, issuances and settlements
   
-
     
-
     
-
     
-
 
Transfers in and/or (out) of Level 3
   
-
     
-
     
-
     
-
 
Ending balance
 
$
-
   
$
-
   
$
-
   
$
-
 
                                 
The amount of total gains or losses for the period
                               
included in earnings (or changes in net assets)
                               
attributable to the change in unrealized gains
                               
or losses relating to assets still held
                               
 at the reporting date
 
$
-
   
$
-
   
$
-
   
$
-
 
                                 
(Some amounts may not reconcile due to rounding.)
                               


The net transfers to/(from) level 3, fair value measurements using significant unobservable inputs were $1,750 thousand for both the three and six months ended June 30, 2018 for fixed maturities, market value.  The transfers related to securities that were priced using a recognized pricing service as of December 31, 2017.  The securities were subsequently priced using single non-binding broker quotes as of June 30, 2018.
 
20

The following table presents the activity under Level 3, fair value measurements using significant unobservable inputs for equity index put option contracts, for the periods indicated:


   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
Liabilities:
                       
Balance, beginning of period
 
$
12,205
   
$
19,429
   
$
12,477
   
$
22,059
 
Total (gains) or losses (realized/unrealized)
                               
Included in earnings
   
(2,987
)
   
(766
)
   
(3,260
)
   
(3,396
)
Included in other comprehensive income (loss)
   
-
     
-
     
-
     
-
 
Purchases, issuances and settlements
   
-
     
-
     
-
     
-
 
Transfers in and/or (out) of Level 3
   
-
     
-
     
-
     
-
 
Balance, end of period
 
$
9,218
   
$
18,662
   
$
9,218
   
$
18,662
 
                                 
The amount of total gains or losses for the period included in earnings
                               
(or changes in net assets) attributable to the change in unrealized
                               
gains or losses relating to liabilities still held at the reporting date
 
$
-
   
$
-
   
$
-
   
$
-
 
                                 
(Some amounts may not reconcile due to rounding.)
                               
 
7.     EARNINGS PER COMMON SHARE

Basic earnings per share are calculated by dividing net income by the weighted average number of common shares outstanding.  Diluted earnings per share reflect the potential dilution that would occur if options granted under various share-based compensation plans were exercised resulting in the issuance of common shares that would participate in the earnings of the entity.

Net income (loss) per common share has been computed as per below, based upon weighted average common basic and dilutive shares outstanding.


      
Three Months Ended
   
Six Months Ended
 
     
June 30,
   
June 30,
 
(Dollars in thousands, except per share amounts)
 
2018
   
2017
   
2018
   
2017
 
Net income (loss) per share:
                       
Numerator
                       
Net income (loss)
 
$
69,895
   
$
245,674
   
$
280,213
   
$
537,317
 
Less:  dividends declared-common shares and nonvested common shares
   
(53,240
)
   
(51,304
)
   
(106,480
)
   
(102,585
)
Undistributed earnings
   
16,655
     
194,370
     
173,733
     
434,731
 
Percentage allocated to common shareholders (1)
   
98.9
%
   
98.9
%
   
98.9
%
   
98.9
%
       
16,477
     
192,279
     
171,881
     
430,035
 
Add:  dividends declared-common shareholders
   
52,705
     
50,790
     
105,403
     
101,543
 
Numerator for basic and diluted earnings per common share
 
$
69,183
   
$
243,068
   
$
277,284
   
$
531,577
 
                                   
Denominator
                               
Denominator for basic earnings per weighted-average common shares
   
40,504
     
40,624
     
40,487
     
40,577
 
Effect of dilutive securities:
                               
Options
   
206
     
250
     
213
     
259
 
Denominator for diluted earnings per adjusted weighted-average common shares
   
40,710
     
40,874
     
40,699
     
40,836
 
                                   
Per common share net income (loss)
                               
Basic
 
$
1.71
   
$
5.98
   
$
6.85
   
$
13.10
 
Diluted
 
$
1.70
   
$
5.95
   
$
6.81
   
$
13.02
 
                                   
(1)       
Basic weighted-average common shares outstanding    
40,504
     
40,624
     
40,487
     
40,577
 
 
Basic weighted-average common shares outstanding and nonvested common shares expected to vest    
40,943
     
41,066
     
40,923
     
41,020
 
 
Percentage allocated to common shareholders    
98.9
%
   
98.9
%
   
98.9
%
   
98.9
%
                                   
(Some amounts may not reconcile due to rounding.)
                               


There were no anti-diluted options outstanding for the three and six months ended June 30, 2018 and 2017.

All outstanding options expire on or between February 18, 2019 and September 19, 2022.


21


8.     COMMITMENTS AND CONTINGENCIES

In the ordinary course of business, the Company is involved in lawsuits, arbitrations and other formal and informal dispute resolution procedures, the outcomes of which will determine the Company's rights and obligations under insurance and reinsurance agreements.  In some disputes, the Company seeks to enforce its rights under an agreement or to collect funds owing to it.  In other matters, the Company is resisting attempts by others to collect funds or enforce alleged rights.  These disputes arise from time to time and are ultimately resolved through both informal and formal means, including negotiated resolution, arbitration and litigation.  In all such matters, the Company believes that its positions are legally and commercially reasonable.  The Company considers the statuses of these proceedings when determining its reserves for unpaid loss and loss adjustment expenses.
 
Aside from litigation and arbitrations related to these insurance and reinsurance agreements, the Company is not a party to any other material litigation or arbitration.

The Company has entered into separate annuity agreements with The Prudential Insurance Company of America ("The Prudential") and an additional unaffiliated life insurance company in which the Company has either purchased annuity contracts or become the assignee of annuity proceeds that are meant to settle claim payment obligations in the future.  In both instances, the Company would become contingently liable if either The Prudential or the unaffiliated life insurance company were unable to make payments related to the respective annuity contract.

The table below presents the estimated cost to replace all such annuities for which the Company was contingently liable for the periods indicated:


   
At June 30,
   
At December 31,
 
(Dollars in thousands)
 
2018
   
2017
 
The Prudential
 
$
144,353
   
$
144,618
 
Unaffiliated life insurance company
   
33,372
     
34,444
 


9.    OTHER COMPREHENSIVE INCOME (LOSS)

The following tables present the components of comprehensive income (loss) in the consolidated statements of operations for the periods indicated:


   
Three Months Ended June 30, 2018
   
Six Months Ended June 30, 2018
 
(Dollars in thousands)
 
Before Tax
   
Tax Effect
   
Net of Tax
   
Before Tax
   
Tax Effect
   
Net of Tax
 
Unrealized appreciation (depreciation) ("URA(D)") on securities - temporary
 
$
(41,271
)
 
$
(906
)
 
$
(42,177
)
 
$
(250,431
)
 
$
17,840
   
$
(232,591
)
URA(D) on securities - OTTI
   
456
     
(55
)
   
401
     
267
     
(76
)
   
191
 
Reclassification of net realized losses (gains) included in net income (loss)
   
350
     
(101
)
   
249
     
(9,975
)
   
1,452
     
(8,523
)
Foreign currency translation adjustments
   
(69,202
)
   
5,550
     
(63,652
)
   
(51,857
)
   
5,904
     
(45,953
)
Reclassification of benefit plan liability amortization included in net income (loss)
   
2,297
     
(482
)
   
1,815
     
4,595
     
(965
)
   
3,630
 
Total other comprehensive income (loss)
 
$
(107,370
)
 
$
4,006
   
$
(103,364
)
 
$
(307,401
)
 
$
24,155
   
$
(283,246
)



   
Three Months Ended June 30, 2017
   
Six Months Ended June 30, 2017
 
(Dollars in thousands)
 
Before Tax
   
Tax Effect
   
Net of Tax
   
Before Tax
   
Tax Effect
   
Net of Tax
 
Unrealized appreciation (depreciation) ("URA(D)") on securities - temporary
 
$
(9,165
)
 
$
14,916
   
$
5,751
   
$
22,041
   
$
6,534
   
$
28,575
 
URA(D) on securities - OTTI
   
(994
)
   
111
     
(883
)
   
(5,495
)
   
1,336
     
(4,159
)
Reclassification of net realized losses (gains) included in net income (loss)
   
(11,067
)
   
2,074
     
(8,993
)
   
(17,775
)
   
6,583
     
(11,192
)
Foreign currency translation adjustments
   
38,560
     
(2,893
)
   
35,667
     
52,373
     
(4,813
)
   
47,560
 
Reclassification of benefit plan liability amortization included in net income (loss)
   
3,083
     
(1,079
)
   
2,004
     
6,166
     
(2,158
)
   
4,008
 
Total other comprehensive income (loss)
 
$
20,417
   
$
13,129
   
$
33,546
   
$
57,310
   
$
7,482
   
$
64,792
 
 

22


The following table presents details of the amounts reclassified from AOCI for the periods indicated:


   
Three Months Ended
   
Six Months Ended
     
   
June 30,
   
June 30,
   
Affected line item within the statements of
AOCI component
 
2018
   
2017
   
2018
   
2017
   
operations and comprehensive income (loss)
(Dollars in thousands)
                               
URA(D) on securities
 
$
350
   
$
(11,067
)
 
$
(9,975
)
 
$
(17,775
)
 
Other net realized capital gains (losses)
     
(101
)
   
2,074
     
1,452
     
6,583
   
Income tax expense (benefit)
   
$
249
   
$
(8,993
)
 
$
(8,523
)
 
$
(11,192
)
 
Net income (loss)
                                          
Benefit plan net gain (loss)
 
$
2,297
   
$
3,083
   
$
4,595
   
$
6,166
   
Other underwriting expenses
     
(482
)
   
(1,079
)
   
(965
)
   
(2,158
)
 
Income tax expense (benefit)
   
$
1,815
   
$
2,004
   
$
3,630
   
$
4,008
   
Net income (loss)

The following table presents the components of accumulated other comprehensive income (loss), net of tax, in the consolidated balance sheets for the periods indicated:


   
Six Months Ended
   
Twelve Months Ended
 
   
June 30,
   
December 31,
 
(Dollars in thousands)
 
2018
   
2017
 
Beginning balance of URA (D) on securities
 
$
49,969
   
$
115,558
 
Current period change in URA (D) of investments - temporary
   
(241,114
)
   
(67,268
)
Current period change in URA (D) of investments - non-credit OTTI
   
191
     
(4,030
)
Reclass due to early adoption of ASU 2018-02
   
-
     
5,709
 
Cumulative change due to ASU 2016-01
   
(1,201
)
   
-
 
Ending balance of URA (D) on securities
   
(192,155
)
   
49,969
 
                 
Beginning balance of foreign currency translation adjustments
   
(138,931
)
   
(266,818
)
Current period change in foreign currency translation adjustments
   
(45,953
)
   
121,917
 
Reclass due to early adoption of ASU 2018-02
   
-
     
5,970
 
Ending balance of foreign currency translation adjustments
   
(184,884
)
   
(138,931
)
                 
Beginning balance of benefit plan net gain (loss)
   
(71,929
)
   
(65,504
)
Current period change in benefit plan net gain (loss)
   
3,630
     
6,504
 
Reclass due to early adoption of ASU 2018-02
   
-
     
(12,929
)
Ending balance of benefit plan net gain (loss)
   
(68,299
)
   
(71,929
)
                 
Ending balance of accumulated other comprehensive income (loss)
 
$
(445,338
)
 
$
(160,891
)
                 
(Some amounts may not reconcile due to rounding.)
               


10.  CREDIT FACILITIES

The Company has two active credit facilities for a total commitment of up to $1,050,000 thousand and an additional credit facility for a total commitment of up to £145,000 thousand, providing for the issuance of letters of credit and/or unsecured revolving credit lines.  The following table presents the interest and fees incurred in connection with the two credit facilities for the periods indicated:


   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
Credit facility interest and fees incurred
 
$
105
   
$
106
   
$
210
   
$
210
 
 
23


The terms and outstanding amounts for each facility are discussed below:

Group Credit Facility

Effective May 26, 2016, Group, Everest Reinsurance (Bermuda), Ltd. ("Bermuda Re") and Everest International Reinsurance, Ltd. ("Everest International"), both direct subsidiaries of Group, entered into a five year, $800,000 thousand senior credit facility with a syndicate of lenders, which amended and restated in its entirety the June 22, 2012, four year, $800,000 thousand senior credit facility.  Both the May 26, 2016 and June 22, 2012 senior credit facilities, which have similar terms, are referred to as the "Group Credit Facility".  Wells Fargo Corporation ("Wells Fargo Bank") is the administrative agent for the Group Credit Facility, which consists of two tranches.  Tranche one provides up to $200,000 thousand of unsecured revolving credit for liquidity and general corporate purposes, and for the issuance of unsecured standby letters of credit.  The interest on the revolving loans shall, at the Company's option, be either (1) the Base Rate (as defined below) or (2) an adjusted London Interbank Offered Rate ("LIBOR") plus a margin.  The Base Rate is the higher of (a) the prime commercial lending rate established by Wells Fargo Bank, (b) the Federal Funds Rate plus 0.5% per annum or (c) the one month LIBOR Rate plus 1.0% per annum.  The amount of margin and the fees payable for the Group Credit Facility depends on Group's senior unsecured debt rating.  Tranche two exclusively provides up to $600,000 thousand for the issuance of standby letters of credit on a collateralized basis.
 
The Group Credit Facility requires Group to maintain a debt to capital ratio of not greater than 0.35 to 1 and to maintain a minimum net worth.  Minimum net worth is an amount equal to the sum of $5,370,979 thousand plus 25% of consolidated net income for each of Group's fiscal quarters, for which statements are available ending on or after March 31, 2016 and for which consolidated net income is positive, plus 25% of any increase in consolidated net worth during such period attributable to the issuance of ordinary and preferred shares, which at June 30, 2018, was $5,939,502 thousand.  As of June 30, 2018, the Company was in compliance with all Group Credit Facility covenants.


(Dollars in thousands)
 
At June 30, 2018
 
At December 31, 2017
Bank
 
Commitment
   
In Use
 
Date of Expiry
 
Commitment
   
In Use
 
Date of Expiry
Wells Fargo Bank Group Credit Facility
Tranche One
 
$
200,000
   
$
-
     
$
200,000
   
$
-
   
Tranche Two 
   
600,000
     
571,792
 
12/31/2018
   
600,000
     
538,214
 
12/31/2018
Total Wells Fargo Bank Group Credit Facility
 
$
800,000
   
$
571,792
     
$
800,000
   
$
538,214
   


Bermuda Re Letter of Credit Facility

Effective December 29, 2017, Bermuda Re renewed its letter of credit issuance facility with Citibank N.A. referred to as the "Bermuda Re Letter of Credit Facility", which commitment is reconfirmed annually with updated fees.  The current renewal of the Bermuda Re Letter of Credit Facility provides for the issuance of up to $250,000 thousand of secured letters of credit to collateralize reinsurance obligations as a non-admitted reinsurer.  The interest on drawn letters of credit shall be (A) 0.35% per annum of the principal amount of issued standard letters of credit (expiry of 15 months or less) and (B) 0.45% per annum of the principal amount of issued extended tenor letters of credit (expiry maximum of up to 60 months).  The commitment fee on undrawn credit shall be 0.15% per annum.

The following table summarizes the outstanding letters of credit for the periods indicated:


(Dollars in thousands)
 
At June 30, 2018
 
At December 31, 2017
Bank
 
Commitment
   
In Use
 
Date of Expiry
 
Commitment
   
In Use
 
Date of Expiry
Citibank Bilateral Letter of Credit Agreement
 
$
250,000
   
$
3,672
 
11/24/2018
 
$
250,000
   
$
3,297
 
2/28/2018
             
64,126
 
12/31/2018
           
3,672
 
11/24/2018
             
2,412
 
2/28/2019
           
73,626
 
12/31/2018
             
328
 
8/30/2019
           
344
 
8/30/2019
             
2,416
 
12/31/2019
           
93,855
 
12/30/2021
             
91,905
 
6/30/2022
           
-
   
Total Citibank Bilateral Agreement
 
$
250,000
   
$
164,859
     
$
250,000
   
$
174,794
   

 
24

 
Everest International Credit Facility

Effective November 9, 2016, Everest International renewed its credit facility with Lloyds Bank plc ("Everest International Credit Facility").  The current renewal of the Everest International Credit Facility, along with a May 17, 2017 amendment, has a four year term and provides up to £145,000 thousand for the issuance of standby letters of credit on a collateralized basis.  The Company pays a commitment fee of 0.1% per annum on the average daily amount of the remainder of (1) the aggregate amount available under the facility and (2) the aggregate amount of drawings outstanding under the facility.  The Company pays a credit commission fee of 0.35% per annum on drawings outstanding under the facility.

The Everest International Credit Facility requires Group to maintain a debt to capital ratio of not greater than 0.35 to 1 and to maintain a minimum net worth.  Minimum net worth is an amount equal to the sum of $5,326,009 thousand (70% of consolidated net worth as of December 31, 2015), plus 25% of consolidated net income for each of Group's fiscal quarters, for which statements are available ending on or after January 1, 2015 and for which net income is positive, plus 25% of any increase in consolidated net worth of Group during such period attributable to the issuance of ordinary and preferred shares, which at June 30, 2018, was $5,939,502 thousand.  As of June 30, 2018, the Company was in compliance with all Everest International Credit Facility requirements.

The following table summarizes the outstanding letters of credit for the periods indicated:


(Dollars in thousands)
 
At June 30, 2018
 
At December 31, 2017
Bank
 
Commitment
   
In Use
 
Date of Expiry
 
Commitment
   
In Use
 
Date of Expiry
Lloyd's Bank plc
 
£
145,000
   
£
-
     
£
145,000
   
£
-
   
     
-
     
-
       
-
     
-
   
Total Lloyd's Bank Credit Facility
 
£
145,000
   
£
-
     
£
145,000
   
£
-
   


11.  COLLATERALIZED REINSURANCE AND TRUST AGREEMENTS

Certain subsidiaries of Group have established trust agreements, which effectively use the Company's investments as collateral, as security for assumed losses payable to certain non-affiliated ceding companies.  At June 30, 2018, the total amount on deposit in trust accounts was $897,645 thousand.

The Company reinsures some of its catastrophe exposures with the segregated accounts of Mt. Logan Re.  Mt. Logan Re is a Class 3 insurer registered in Bermuda effective February 27, 2013 under The Segregated Accounts Companies Act 2000 and 100% of the voting common shares are owned by Group.  Separate segregated accounts for Mt. Logan Re began being established effective July 1, 2013 and non-voting, redeemable preferred shares have been issued to capitalize the segregated accounts.  Each segregated account invests predominately in a diversified set of catastrophe exposures, diversified by risk/peril and across different geographic regions globally.

The following table summarizes the premiums and losses that are ceded by the Company to Mt. Logan Re segregated accounts and assumed by the Company from Mt. Logan Re segregated accounts.


   
Three Months Ended
 
Six Months Ended
   
June 30,
 
June 30,
Mt. Logan Re Segregated Accounts
 
2018
 
2017
 
2018
 
2017
(Dollars in thousands)
               
Ceded written premiums
 
 45,887
 
 42,728
 
 126,923
 
 96,946
Ceded earned premiums
 
 65,067
 
 57,886
 
 126,476
 
 98,483
Ceded losses and LAE
 
 133,762
 
 24,812
 
 154,831
 
 44,397
                 
Assumed written premiums
 
 1,604
 
 3,763
 
 4,647
 
 6,495
Assumed earned premiums
 
 1,604
 
 3,763
 
 4,647
 
 6,495
Assumed losses and LAE
 
 -
 
 -
 
 -
 
 -


25


Each segregated account is permitted to assume net risk exposures equal to the amount of its available posted collateral, which in the aggregate was $1,151,595 thousand and $837,202 thousand at June 30, 2018 and December 31, 2017, respectively.  Of this amount, Group had investments valued at $46,095 thousand and $50,373 thousand at June 30, 2018 and December 31, 2017, respectively, in the segregated accounts.

Effective April 1, 2018, the Company entered into a retroactive reinsurance transaction with one of the Mt. Logan Re segregated accounts to retrocede $269,198 thousand of casualty reserves held by Bermuda Re related to accident years 2002 through 2015.  As consideration for entering the agreement, the Company transferred cash of $252,000 thousand to the Mt. Logan Re segregated account.  The maximum liability to be retroceded under the agreement will be $319,000 thousand.  The Company will retain liability for any amounts exceeding the maximum liability.

On April 24, 2014, the Company entered into two collateralized reinsurance agreements with Kilimanjaro Re Limited ("Kilimanjaro"), a Bermuda based special purpose reinsurer, to provide the Company with catastrophe reinsurance coverage.  These agreements are multi-year reinsurance contracts which cover specified named storm and earthquake events.  The first agreement provides up to $250,000 thousand of reinsurance coverage from named storms in specified states of the Southeastern United States.  The second agreement provides up to $200,000 thousand of reinsurance coverage from named storms in specified states of the Southeast, Mid-Atlantic and Northeast regions of the United States and Puerto Rico as well as reinsurance coverage from earthquakes in specified states of the Southeast, Mid-Atlantic, Northeast and West regions of the United States, Puerto Rico and British Columbia.  These reinsurance agreements expired in April, 2018.

On November 18, 2014, the Company entered into a collateralized reinsurance agreement with Kilimanjaro to provide the Company with catastrophe reinsurance coverage.  This agreement is a multi-year reinsurance contract which covers specified earthquake events.  The agreement provides up to $500,000 thousand of reinsurance coverage from earthquakes in the United States, Puerto Rico and Canada.

On December 1, 2015 the Company entered into two collateralized reinsurance agreements with Kilimanjaro to provide the Company with catastrophe reinsurance coverage.  These agreements are multi-year reinsurance contracts which cover named storm and earthquake events.  The first agreement provides up to $300,000 thousand of reinsurance coverage from named storms and earthquakes in the United States, Puerto Rico and Canada.  The second agreement provides up to $325,000 thousand of reinsurance coverage from named storms and earthquakes in the United States, Puerto Rico and Canada.

On April 13, 2017 the Company entered into six collateralized reinsurance agreements with Kilimanjaro to provide the Company with annual aggregate catastrophe reinsurance coverage.  The initial three agreements are four year reinsurance contracts which cover named storm and earthquake events.  These agreements provide up to $225,000 thousand, $400,000 thousand and $325,000 thousand, respectively, of annual aggregate reinsurance coverage from named storms and earthquakes in the United States, Puerto Rico and Canada.  The subsequent three agreements are five year reinsurance contracts which cover named storm and earthquake events.  These agreements provide up to $50,000 thousand, $75,000 thousand and $175,000 thousand, respectively, of annual aggregate reinsurance coverage from named storms and earthquakes in the United States, Puerto Rico and Canada.

On April 30, 2018 the Company entered into four collateralized reinsurance agreements with Kilimanjaro Re to provide the Company with catastrophe reinsurance coverage.  These agreements are multi-year reinsurance contracts which cover named storm and earthquake events.  The first two agreements are four year reinsurance contracts which provide up to $62,500 thousand and $200,000 thousand, respectively, of annual aggregate reinsurance coverage from named storms and earthquakes in the United States, Puerto Rico, the U.S. Virgin Islands and Canada.  The remaining two agreements are five year reinsurance contracts which provide up to $62,500 thousand and $200,000 thousand, respectively, of annual aggregate reinsurance coverage from named storms and earthquakes in the United States, Puerto Rico, the U.S. Virgin Islands and Canada.

26


Recoveries under these collateralized reinsurance agreements with Kilimanjaro are primarily dependent on estimated industry level insured losses from covered events, as well as, the geographic location of the events.  The estimated industry level of insured losses is obtained from published estimates by an independent recognized authority on insured property losses.  As of December 31, 2017, none of the published insured loss estimates for the 2017 catastrophe events have exceeded the single event retentions under the terms of the agreements that would result in a recovery.  In addition, the aggregation of the to-date published insured loss estimates for the 2017 covered events have not exceeded the aggregated retentions for recovery.  However, if the published estimates for insured losses for the covered 2017 events increase, the aggregate losses may exceed the aggregate event retentions under the agreements resulting in a recovery.

Kilimanjaro has financed the various property catastrophe reinsurance coverages by issuing catastrophe bonds to unrelated, external investors.  On April 24, 2014, Kilimanjaro issued $450,000 thousand of notes ("Series 2014-1 Notes").  The $450,000 thousand of Series 2014-1 Notes were fully redeemed on April 30, 2018 and are no longer outstanding.  On November 18, 2014, Kilimanjaro issued $500,000 thousand of notes ("Series 2014-2 Notes").  On December 1, 2015, Kilimanjaro issued $625,000 thousand of notes ("Series 2015-1 Notes).  On April 13, 2017, Kilimanjaro issued $950,000 thousand of notes ("Series 2017-1 Notes) and $300,000 thousand of notes ("Series 2017-2 Notes).  On April 30, 2018, Kilimanjaro issued $262,500 thousand of notes ("Series 2018-1 Notes") and $262,500 thousand of notes ("Series 2018-2 Notes").  The proceeds from the issuance of the Notes listed above are held in reinsurance trust throughout the duration of the applicable reinsurance agreements and invested solely in US government money market funds with a rating of at least "AAAm" by Standard & Poor's.
 
12.  SENIOR NOTES

The table below displays Holdings' outstanding senior notes.  Market value is based on quoted market prices, but due to limited trading activity, these senior notes are considered Level 2 in the fair value hierarchy.


                 
June 30, 2018
   
December 31, 2017
 
                 
Consolidated Balance
         
Consolidated Balance
       
(Dollars in thousands)
 
Date Issued
 
Date Due
 
Principal Amounts
   
Sheet Amount
   
Market Value
   
Sheet Amount
   
Market Value
 
4.868% Senior notes
 
06/05/2014
 
06/01/2044
   
400,000
   
$
396,894
   
$
396,728
   
$
396,834
   
$
420,340
 


On June 5, 2014, Holdings issued $400,000 thousand of 30 year senior notes at 4.868%, which will mature on June 1, 2044.  Interest will be paid semi-annually on June 1 and December 1 of each year.

Interest expense incurred in connection with these senior notes is as follows for the periods indicated:


   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
Interest expense incurred
 
$
4,868
   
$
4,868
   
$
9,736
   
$
9,736
 


13.  LONG TERM SUBORDINATED NOTES

The table below displays Holdings' outstanding fixed to floating rate long term subordinated notes.  Market value is based on quoted market prices, but due to limited trading activity, these subordinated notes are considered Level 2 in the fair value hierarchy.


           
Maturity Date
 
June 30, 2018
   
December 31, 2017
 
      
Original
            
Consolidated Balance
         
Consolidated Balance
       
(Dollars in thousands)
Date Issued
 
Principal Amount
   
Scheduled
 
Final
 
Sheet Amount
   
Market Value
   
Sheet Amount
   
Market Value
 
6.6% Long term subordinated notes
04/26/2007
 
$
400,000
   
05/15/2037
 
05/01/2067
 
$
236,610
   
$
236,651
   
$
236,561
   
$
233,072
 
 

27

 
During the fixed rate interest period from May 3, 2007 through May 14, 2017, interest was at the annual rate of 6.6%, payable semi-annually in arrears on November 15 and May 15 of each year, commencing on November 15, 2007.  During the floating rate interest period from May 15, 2017 through maturity, interest will be based on the 3 month LIBOR plus 238.5 basis points, reset quarterly, payable quarterly in arrears on February 15, May 15, August 15 and November 15 of each year, subject to Holdings' right to defer interest on one or more occasions for up to ten consecutive years.  Deferred interest will accumulate interest at the applicable rate compounded quarterly for periods from and including May 15, 2017.  The reset quarterly interest rate for May 15, 2018 to August 14, 2018 is 4.73%.

Holdings may redeem the long term subordinated notes on or after May 15, 2017, in whole or in part at 100% of the principal amount plus accrued and unpaid interest; however, redemption on or after the scheduled maturity date and prior to May 1, 2047 is subject to a replacement capital covenant.  This covenant is for the benefit of certain senior note holders and it mandates that Holdings receive proceeds from the sale of another subordinated debt issue, of at least similar size, before it may redeem the subordinated notes.  Effective upon the maturity of the Company's 5.40% senior notes on October 15, 2014, the Company's 4.868% senior notes, due on June 1, 2044, have become the Company's long term indebtedness that ranks senior to the long term subordinated notes.

On March 19, 2009, Group announced the commencement of a cash tender offer for any and all of the 6.60% fixed to floating rate long term subordinated notes.  Upon expiration of the tender offer, the Company had reduced its outstanding debt by $161,441 thousand.

Interest expense incurred in connection with these long term subordinated notes is as follows for the periods indicated:


   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
Interest expense incurred
 
$
2,702
   
$
3,033
   
$
5,093
   
$
6,970
 


14.   SEGMENT REPORTING

The U.S. Reinsurance operation writes property and casualty reinsurance and specialty lines of business, including Marine, Aviation, Surety and Accident and Health ("A&H") business, on both a treaty and facultative basis, through reinsurance brokers, as well as directly with ceding companies primarily within the U.S.  The International operation writes non-U.S. property and casualty reinsurance through Everest Re's branches in Canada and Singapore and through offices in Brazil, Miami and New Jersey.  The Bermuda operation provides reinsurance and insurance to worldwide property and casualty markets through brokers and directly with ceding companies from its Bermuda office and reinsurance to the United Kingdom and European markets through its UK branch and Ireland Re.  The Insurance operation writes property and casualty insurance directly and through brokers, surplus lines brokers and general agents within the U.S., Canada and Europe.

These segments are managed independently, but conform with corporate guidelines with respect to pricing, risk management, control of aggregate catastrophe exposures, capital, investments and support operations.  Management generally monitors and evaluates the financial performance of these operating segments based upon their underwriting results.

Underwriting results include earned premium less losses and loss adjustment expenses ("LAE") incurred, commission and brokerage expenses and other underwriting expenses.  We measure our underwriting results using ratios, in particular loss, commission and brokerage and other underwriting expense ratios, which, respectively, divide incurred losses, commissions and brokerage and other underwriting expenses by premiums earned.

For inter-affiliate reinsurance and business written through the Lloyd's Syndicate, business is generally reported within the segment in which the business was first produced, consistent with how the business is managed.


28


The Company does not maintain separate balance sheet data for its operating segments.  Accordingly, the Company does not review and evaluate the financial results of its operating segments based upon balance sheet data.
 
The following tables present the underwriting results for the operating segments for the periods indicated:


   
Three Months Ended
   
Six Months Ended
 
U.S. Reinsurance
 
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
Gross written premiums
 
$
652,109
   
$
474,993
   
$
1,296,331
   
$
1,053,951
 
Net written premiums
   
566,303
     
385,267
     
1,112,134
     
902,636
 
                                 
Premiums earned
 
$
603,884
   
$
478,494
   
$
1,167,269
   
$
960,018
 
Incurred losses and LAE
   
509,653
     
267,621
     
1,054,846
     
529,687
 
Commission and brokerage
   
148,712
     
112,423
     
276,032
     
214,781
 
Other underwriting expenses
   
15,472
     
14,278
     
32,358
     
28,529
 
Underwriting gain (loss)
 
$
(69,953
)
 
$
84,172
   
$
(195,967
)
 
$
187,021
 



   
Three Months Ended
   
Six Months Ended
 
International
 
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
Gross written premiums
 
$
399,024
   
$
319,786
   
$
765,748
   
$
586,203
 
Net written premiums
   
355,309
     
272,369
     
700,464
     
518,031
 
                                 
Premiums earned
 
$
363,795
   
$
263,816
   
$
707,399
   
$
535,397
 
Incurred losses and LAE
   
301,406
     
172,488
     
428,430
     
331,989
 
Commission and brokerage
   
92,088
     
64,847
     
174,265
     
130,997
 
Other underwriting expenses
   
10,349
     
9,814
     
20,925
     
19,294
 
Underwriting gain (loss)
 
$
(40,048
)
 
$
16,667
   
$
83,779
   
$
53,117
 



   
Three Months Ended
   
Six Months Ended
 
Bermuda
 
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
Gross written premiums
 
$
369,440
   
$
237,570
   
$
785,126
   
$
558,692
 
Net written premiums
   
355,236
     
217,814
     
750,204
     
522,846
 
                                 
Premiums earned
 
$
353,698
   
$
263,457
   
$
672,832
   
$
498,563
 
Incurred losses and LAE
   
250,097
     
165,305
     
379,610
     
293,737
 
Commission and brokerage
   
80,318
     
63,486
     
161,805
     
121,909
 
Other underwriting expenses
   
10,762
     
9,022
     
20,895
     
18,502
 
Underwriting gain (loss)
 
$
12,521
   
$
25,644
   
$
110,522
   
$
64,415
 



   
Three Months Ended
   
Six Months Ended
 
Insurance
 
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
Gross written premiums
 
$
645,948
   
$
569,300
   
$
1,150,923
   
$
1,003,747
 
Net written premiums
   
469,530
     
463,683
     
855,782
     
809,434
 
                                 
Premiums earned
 
$
408,441
   
$
363,914
   
$
801,745
   
$
687,800
 
Incurred losses and LAE
   
280,158
     
255,861
     
535,605
     
476,650
 
Commission and brokerage
   
62,284
     
59,200
     
128,939
     
114,538
 
Other underwriting expenses
   
56,516
     
45,755
     
115,205
     
88,431
 
Underwriting gain (loss)
 
$
9,483
   
$
3,098
   
$
21,996
   
$
8,181
 


29


The following table reconciles the underwriting results for the operating segments to income before taxes as reported in the consolidated statements of operations and comprehensive income (loss) for the periods indicated:


   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
Underwriting gain (loss)
 
$
(87,997
)
 
$
129,581
   
$
20,330
   
$
312,734
 
Net investment income
   
141,322
     
134,508
     
279,616
     
256,797
 
Net realized capital gains (losses)
   
15,776
     
25,268
     
(9,125
)
   
77,996
 
Net derivative gain (loss)
   
2,987
     
766
     
3,260
     
3,396
 
Corporate expenses
   
(6,633
)
   
(6,919
)
   
(15,629
)
   
(15,376
)
Interest, fee and bond issue cost amortization expense
   
(7,728
)
   
(8,059
)
   
(15,146
)
   
(17,023
)
Other income (expense)
   
3,036
     
388
     
15,100
     
(4,578
)
Income (loss) before taxes
 
$
60,763
   
$
275,533
   
$
278,406
   
$
613,946
 


The Company produces business in the U.S., Bermuda and internationally.  The net income deriving from and assets residing in the individual foreign countries in which the Company writes business are not identifiable in the Company's financial records.  Based on gross written premium, the table below presents the largest country, other than the U.S., in which the Company writes business, for the periods indicated:


   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
United Kingdom gross written premium
 
$
177,072
   
$
204,965
   
$
435,331
   
$
375,785
 


No other country represented more than 5% of the Company's revenues.

15.  SHARE-BASED COMPENSATION PLANS

For the three months ended June 30, 2018, share-based compensation awards granted were 375 restricted shares, granted on May 15, 2018, with a fair value of $226.950 per share.

16.  RETIREMENT BENEFITS

The Company maintains both qualified and non-qualified defined benefit pension plans and a retiree health plan for its U.S. employees employed prior to April 1, 2010.

Net periodic benefit cost for U.S. employees included the following components for the periods indicated:


Pension Benefits
 
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
Service cost
 
$
2,977
   
$
3,299
   
$
5,954
   
$
6,598
 
Interest cost
   
2,585
     
2,276
     
5,170
     
4,552
 
Expected return on plan assets
   
(3,670
)
   
(3,154
)
   
(7,341
)
   
(6,309
)
Amortization of net (income) loss
   
2,237
     
3,041
     
4,473
     
6,081
 
Net periodic benefit cost
 
$
4,129
   
$
5,461
   
$
8,256
   
$
10,921
 



Other Benefits
 
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Dollars in thousands)
 
2018
   
2017
   
2018
   
2017
 
Service cost
 
$
446
   
$
441
   
$
893
   
$
881
 
Interest cost
   
307
     
249
     
614
     
498
 
Amortization of prior service cost
   
(33
)
   
(33
)
   
(66
)
   
(66
)
Amortization of net (income) loss
   
94
     
75
     
188
     
151
 
Net periodic benefit cost
 
$
814
   
$
732
   
$
1,629
   
$
1,464
 
                                 
(Some amounts may not reconcile due to rounding.)
                               
 
30


The service cost component of net periodic benefit costs is included within other underwriting expenses on the consolidated statement of operations and comprehensive income (loss).  In accordance with ASU 2017-07, other staff compensation costs are also primarily recorded within this line item.

The Company did not make any contributions to the qualified pension benefit plan for the three and six months ended June 30, 2018 and 2017.

17.  INCOME TAXES

The Company is domiciled in Bermuda and has significant subsidiaries and/or branches in Canada, Ireland, Singapore, the United Kingdom, and the United States.  The Company's Bermuda domiciled subsidiaries are exempt from income taxation under Bermuda law until 2035.  The Company's non-Bermudian subsidiaries and branches are subject to income taxation at varying rates in their respective domiciles.

The Company generally applies the estimated annual effective tax rate approach for calculating its tax provision for interim periods as prescribed by ASC 740-270, Interim Reporting.  Under the estimated annual effective tax rate approach, the estimated annual effective tax rate is applied to the interim year-to-date pre-tax income/loss to determine the income tax expense or benefit for the year-to-date period.  If the annual effective tax rate approach produces a year-to-date tax benefit which exceeds the amount which is estimated to be recoverable for the full year, then the tax benefit for the interim reporting period will be limited as prescribed under ASC 740-270 to the estimated recoverable based on the year-to-date result.  The tax expense or benefit for the quarter represents the difference between the year-to-date tax expense or benefit for the current year-to-date period less such amount for the immediately preceding year-to-date period.  Management considers the impact of all known events in its estimation of the Company's annual pre-tax income/loss and effective tax rate.

18.  SUBSEQUENT EVENTS

The Company has evaluated known recognized and non-recognized subsequent events.  The Company does not have any subsequent events to report.
 

 
31

 
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

Industry Conditions.
The worldwide reinsurance and insurance businesses are highly competitive, as well as cyclical by product and market.  As such, financial results tend to fluctuate with periods of constrained availability, higher rates and stronger profits followed by periods of abundant capacity, lower rates and constrained profitability.  Competition in the types of reinsurance and insurance business that we underwrite is based on many factors, including the perceived overall financial strength of the reinsurer or insurer, ratings of the reinsurer or insurer by A.M. Best and/or Standard & Poor's, underwriting expertise, the jurisdictions where the reinsurer or insurer is licensed or otherwise authorized, capacity and coverages offered, premiums charged, other terms and conditions of the reinsurance and insurance business offered, services offered, speed of claims payment and reputation and experience in lines written.  Furthermore, the market impact from these competitive factors related to reinsurance and insurance is generally not consistent across lines of business, domestic and international geographical areas and distribution channels.

We compete in the U.S., Bermuda and international reinsurance and insurance markets with numerous global competitors. Our competitors include independent reinsurance and insurance companies, subsidiaries or affiliates of established worldwide insurance companies, reinsurance departments of certain insurance companies, domestic and international underwriting operations, including underwriting syndicates at Lloyd's of London and certain government sponsored risk transfer vehicles.  Some of these competitors have greater financial resources than we do and have established long term and continuing business relationships, which can be a significant competitive advantage.  In addition, the lack of strong barriers to entry into the reinsurance business and recently, the securitization of reinsurance and insurance risks through capital markets provide additional sources of potential reinsurance and insurance capacity and competition.

Worldwide insurance and reinsurance market conditions continued to be very competitive, particularly in the property catastrophe and casualty reinsurance lines of business.  Generally, there was ample insurance and reinsurance capacity relative to demand, as well as, additional capital from the capital markets through insurance linked financial instruments.  These financial instruments such as side cars, catastrophe bonds and collateralized reinsurance funds, provide capital markets with access to insurance and reinsurance risk exposure.  The capital markets demand for these products is being primarily driven by the current low interest environment and the desire to achieve greater risk diversification and potentially higher returns on their investments.  This increased competition is generally having a negative impact on rates, terms and conditions; however, the impact varies widely by market and coverage.

Rates tend to fluctuate by specific region and products, particularly areas recently impacted by large catastrophic events.  There was an unprecedented series of catastrophes in the third quarter of 2017 with Hurricanes Harvey, Irma and Maria, as well as a significant earthquake in Mexico City.  Additional catastrophe events occurred in the fourth quarter of 2017 with the wild fires in California and Hurricanes Nate and Ophelia.  The total industry losses for all of these worldwide events have been estimated to exceed $140 billion.  This was the second consecutive year with higher than average catastrophe losses.  During 2016, catastrophe losses included the Fort McMurray Canadian wildfire, Hurricane Matthew which affected a large area of the Caribbean and southeastern United States, storms and an earthquake in Ecuador.  There are industry reports that the catastrophe losses for 2016 reached their highest level in four years and the United States experienced the most loss events since 1980 and the highest total losses since 2012.  While the future impact on market conditions from these catastrophes cannot be determined at this time, there was some firming in the markets impacted by the 2016 catastrophes and as catastrophe losses increased in 2017, there is a growing industry consensus that there will be some firming of (re)insurance rates for the areas impacted by the catastrophes.

Commencing in 2015, we initiated a strategic build out of our insurance platform through the investment in key leadership hires which in turn has brought significant underwriting talent and stronger direction in achieving our insurance program strategic goals of increased premium volume and improved underwriting results.  Recent growth is coming from highly diversified areas including newly launched lines of business, as well as, product and geographic expansion in existing lines of business.  We are building a world-class
32


insurance platform capable of offering products across lines and geographies, complementing our leading global reinsurance franchise.  As part of this initiative, we launched a new syndicate through Lloyd's of London and formed Ireland Insurance, providing us access to additional international business and new product opportunities to further diversify and broaden our insurance portfolio.

Overall, we believe that given our size, strong ratings, distribution system, reputation, expertise and capital market vehicle activity the current marketplace conditions provide profit opportunities.  We continue to employ our strategy of targeting business that offers the greatest profit potential, while maintaining balance and diversification in our overall portfolio.

Financial Summary.
We monitor and evaluate our overall performance based upon financial results.  The following table displays a summary of the consolidated net income (loss), ratios and shareholders' equity for the periods indicated.


   
Three Months Ended
   
Percentage
   
Six Months Ended
   
Percentage
 
   
June 30,
   
Increase/
   
June 30,
   
Increase/
 
(Dollars in millions)
 
2018
   
2017
   
(Decrease)
   
2018
   
2017
   
(Decrease)
 
Gross written premiums
 
$
2,066.5
   
$
1,601.6
     
29.0
%
 
$
3,998.1
   
$
3,202.6
     
24.8
%
Net written premiums
   
1,746.4
     
1,339.1
     
30.4
%
   
3,418.6
     
2,752.9
     
24.2
%
                                                 
REVENUES:
                                               
Premiums earned
 
$
1,729.8
   
$
1,369.7
     
26.3
%
 
$
3,349.2
   
$
2,681.8
     
24.9
%
Net investment income
   
141.3
     
134.5
     
5.1
%
   
279.6
     
256.8
     
8.9
%
Net realized capital gains (losses)
   
15.8
     
25.3
     
-37.6
%
   
(9.1
)
   
78.0
     
-111.7
%
Net derivative gain (loss)
   
3.0
     
0.8
   
NM
     
3.3
     
3.4
     
-4.0
%
Other income (expense)
   
3.0
     
0.4
   
NM
     
15.1
     
(4.6
)
 
NM
 
Total revenues
   
1,892.9
     
1,530.6
     
23.7
%
   
3,638.1
     
3,015.4
     
20.7
%
                                                 
CLAIMS AND EXPENSES:
                                               
Incurred losses and loss adjustment expenses
   
1,341.3
     
861.3
     
55.7
%
   
2,398.5
     
1,632.1
     
47.0
%
Commission, brokerage, taxes and fees
   
383.4
     
300.0
     
27.8
%
   
741.0
     
582.2
     
27.3
%
Other underwriting expenses
   
93.1
     
78.9
     
18.0
%
   
189.4
     
154.8
     
22.4
%
Corporate expenses
   
6.6
     
6.9
     
-4.1
%
   
15.6
     
15.4
     
1.6
%
Interest, fees and bond issue cost amortization expense
   
7.7
     
8.1
     
-4.1
%
   
15.1
     
17.0
     
-11.0
%
Total claims and expenses
   
1,832.2
     
1,255.1
     
46.0
%
   
3,359.7
     
2,401.4
     
39.9
%
                                                 
INCOME (LOSS) BEFORE TAXES
   
60.8
     
275.5
     
-77.9
%
   
278.4
     
613.9
     
-54.7
%
Income tax expense (benefit)
   
(9.1
)
   
29.9
     
-130.6
%
   
(1.8
)
   
76.6
     
-102.4
%
NET INCOME (LOSS)
 
$
69.9
   
$
245.7
     
-71.5
%
 
$
280.2
   
$
537.3
     
-47.8
%
                                                 
RATIOS:
                 
Point Change
                   
Point Change
 
Loss ratio
   
77.5
%
   
62.9
%
   
14.6
     
71.6
%
   
60.8
%
   
10.8
 
Commission and brokerage ratio
   
22.2
%
   
21.9
%
   
0.3
     
22.1
%
   
21.7
%
   
0.4
 
Other underwriting expense ratio
   
5.4
%
   
5.7
%
   
(0.3
)
   
5.7
%
   
5.8
%
   
(0.1
)
Combined ratio
   
105.1
%
   
90.5
%
   
14.6
     
99.4
%
   
88.3
%
   
11.1
 
                                                 
                           
At
   
At
   
Percentage
 
                           
June 30,
   
December 31,
   
Increase/
 
(Dollars in millions, except per share amounts)
                           
2018
     
2017
   
(Decrease)
 
Balance sheet data:
                                               
Total investments and cash
                         
$
18,205.7
   
$
18,626.5
     
-2.3
%
Total assets
                           
23,885.9
     
23,591.8
     
1.2
%
Loss and loss adjustment expense reserves
                           
12,043.3
     
11,884.3
     
1.3
%
Total debt
                           
633.5
     
633.4
     
0.0
%
Total liabilities
                           
15,644.5
     
15,222.6
     
2.8
%
Shareholders' equity
                           
8,241.3
     
8,369.2
     
-1.5
%
Book value per share
                           
201.70
     
204.95
     
-1.6
%
                                                 
(NM, not meaningful)
                                               
(Some amounts may not reconcile due to rounding.)
                                               

33


Revenues.
Premiums.  Gross written premiums increased by 29.0% to $2,066.5 million for the three months ended June 30, 2018, compared to $1,601.6 million for the three months ended June 30, 2017, reflecting a $388.2 million, or 37.6%, increase in our reinsurance business and a $76.6 million, or 13.5%, increase in our insurance business.  The increase in reinsurance premiums was mainly due to increases in treaty property business, treaty casualty business, Latin American business and business written through our U.K. branch and Ireland office.  The rise in insurance premiums was primarily due to increases in many lines of business, including casualty, accident and health and business written through the Lloyd's Syndicate.  Gross written premiums increased by 24.8% to $3,998.1 million for the six months ended June 30, 2018, compared to $3,202.6 million for the six months ended June 30, 2017, reflecting a $648.4 million, or 29.5%, increase in our reinsurance business and a $147.2 million, or 14.7%, increase in our insurance business.  The increase in reinsurance premiums was mainly due to increases in treaty property business, treaty casualty business, Latin American business and business written through our U.K. branch and Ireland office, as well as a positive impact of $25.0 million from the movement of foreign exchange rates.  The rise in insurance premiums was primarily due to increases in many lines of business, including casualty, accident and health and business written through the Lloyd's Syndicate.

Net written premiums increased by 30.4% to $1,746.4 million for the three months ended June 30, 2018, compared to $1,339.1 million for the three months ended June 30, 2017.  Net written premiums increased by 24.2% to $3,418.6 million for the six months ended June 30, 2018, compared to $2,752.9 million for the six months ended June 30, 2017.  These changes are consistent with the changes in gross written premiums.  Premiums earned increased by 26.3% to $1,729.8 million for the three months ended June 30, 2018, compared to $1,369.7 million for the three months ended June 30, 2017.  Premiums earned increased by 24.9% to $3,349.2 million for the six months ended June 30, 2018, compared to $2,681.8 million for the six months ended June 30, 2017.  The change in premiums earned relative to net written premiums is the result of timing; premiums are earned ratably over the coverage period whereas written premiums are recorded at the initiation of the coverage period.

Net Investment Income.  Net investment income increased by 5.1% to $141.3 million for the three months ended June 30, 2018, compared with investment income of $134.5 million for the three months ended June 30, 2017.  Net investment income increased by 8.9% to $279.6 million for the six months ended June 30, 2018, compared with investment income of $256.8 million for the six months ended June 30, 2017.  Net pre-tax investment income, as a percentage of average invested assets, was 3.1% for the three months ended June 30, 2018 compared to 3.0% for the three months ended June 30, 2017.  Net pre-tax investment income, as a percentage of average invested assets, was 3.1% for the six months ended June 30, 2018 compared to 2.9% for the six months ended June 30, 2017.  The increases in both income and yield were primarily the result of higher income from our limited partnerships and higher income from our fixed income portfolio, partially offset by lower dividend income from our equity portfolio.

Net Realized Capital Gains (Losses).  Net realized capital gains were $15.8 million and $25.3 million for the three months ended June 30, 2018 and 2017, respectively.  The net realized capital gains of $15.8 million for the three months ended June 30, 2018 were comprised of $18.8 million of net gains from fair value re-measurements, partially offset by $2.1 million of net realized capital losses from sales of investments and $0.9 million of other-than-temporary impairments.  The net realized capital gains of $25.3 million for the three months ended June 30, 2017 were comprised of $14.4 million of net realized capital gains from sales of investments and $13.4 million of net gains from fair value re-measurements, partially offset by $2.5 million of other-than-temporary impairments.
34


Net realized capital losses were $9.1 million and net realized capital gains were $78.0 million for the six months ended June 30, 2018 and 2017, respectively.  The net realized capital losses of $9.1 million for the six months ended June 30, 2018 were comprised of $16.5 million of net losses from fair value re-measurements and $1.0 million of other-than-temporary impairments, partially offset by $8.4 million of net realized capital gains from sales of investments.  The net realized capital gains of $78.0 million for the six months ended June 30, 2017 were comprised of $54.9 million of net gains from fair value re-measurements and $26.8 million of net realized capital gains from sales of investments, partially offset by $3.7 million of other-than-temporary impairments.

Net Derivative Gain (Loss).  In 2005 and prior, we sold seven equity index put option contracts, six of which remain outstanding.  These contracts meet the definition of a derivative in accordance with FASB guidance and as such, are fair valued each quarter with the change recorded as net derivative gain or loss in the consolidated statements of operations and comprehensive income (loss).  As a result of these adjustments in value, we recognized net derivative gains of $3.0 million and $0.8 million for the three months ended June 30, 2018 and 2017, respectively, and net derivative gains of $3.3 million and $3.4 million for the six months ended June 30, 2018 and 2017, respectively. The change in the fair value of these equity index put option contracts is generally indicative of the change in the equity markets and interest rates over the same periods.

Other Income (Expense).  We recorded other income of $3.0 million and $0.4 million for the three months ended June 30, 2018 and 2017, respectively.  We recorded other income of $15.1 million and other expense of $4.6 million for the six months ended June 30, 2018 and 2017, respectively. The changes were primarily the result of fluctuations in foreign currency exchange rates, income related to Mt. Logan Re and changes in deferred gains related to any retroactive reinsurance transactions.  We recognized foreign currency exchange income of $19.1 million and foreign currency exchange expense of $1.1 million for the three months ended June 30, 2018 and 2017, respectively.  We recognized foreign currency exchange income of $29.0 million and foreign currency exchange expense of $5.0 million for the six months ended June 30, 2018 and 2017, respectively.
35


Claims and Expenses.
Incurred Losses and Loss Adjustment Expenses.  The following tables present our incurred losses and loss adjustment expenses ("LAE") for the periods indicated.


   
Three Months Ended June 30,
   
Current
   
Ratio %/
 
Prior
   
Ratio %/
 
Total
   
Ratio %/
(Dollars in millions)
 
Year
   
Pt Change
 
Years
   
Pt Change
 
Incurred
   
Pt Change
2018
                                                 
Attritional
 
$
941.6
     
54.3
%
   
$
(97.4
)
   
-5.6
%
   
$
844.2
     
48.7
%
 
Catastrophes
   
65.0
     
3.8
%
 
   
432.2
     
25.0
%
 
   
497.2
     
28.8
%
 
Total
 
$
1,006.6
     
58.1
%
 
 
$
334.8
     
19.4
%
 
 
$
1,341.3
     
77.5
%
 
                                                                
2017
                                                             
Attritional
 
$
808.3
     
59.0
%
   
$
(0.6
)
   
0.0
%
   
$
807.8
     
59.0
%
 
Catastrophes
   
53.5
     
3.9
%
 
   
-
     
0.0
%
 
   
53.5
     
3.9
%
 
Total
 
$
861.8
     
62.9
%
 
 
$
(0.6
)
   
0.0
%
 
 
$
861.3
     
62.9
%
 
                                                                
Variance 2018/2017
                                                             
Attritional
 
$
133.3
     
(4.7
)
pts
 
$
(96.8
)
   
(5.6
)
pts
 
$
36.4
     
(10.3
)
pts
Catastrophes
   
11.5
     
(0.1
)
pts
   
432.2
     
25.0
 
pts
   
443.6
     
24.9
 
pts
Total
 
$
144.8
     
(4.8
)
pts
 
$
335.2
     
19.4
 
pts
 
$
480.0
     
14.6
 
pts



   
Six Months Ended June 30,
   
Current
   
Ratio %/
 
Prior
   
Ratio %/
 
Total
   
Ratio %/
(Dollars in millions)
 
Year
   
Pt Change
 
Years
   
Pt Change
 
Incurred
   
Pt Change
2018
                                                 
Attritional
 
$
1,898.8
     
56.7
%
   
$
(97.4
)
   
-2.9
%
   
$
1,801.3
     
53.8
%
 
Catastrophes
   
65.0
     
1.9
%
 
   
532.2
     
15.9
%
 
   
597.2
     
17.8
%
 
Total
 
$
1,963.8
     
58.6
%
 
 
$
434.7
     
13.0
%
 
 
$
2,398.5
     
71.6
%
 
                                                                
2017
                                                             
Attritional
 
$
1,559.0
     
58.1
%
   
$
(0.4
)
   
0.0
%
   
$
1,558.6
     
58.1
%
 
Catastrophes
   
73.5
     
2.7
%
 
   
-
     
0.0
%
 
   
73.5
     
2.7
%
 
Total
 
$
1,632.5
     
60.8
%
 
 
$
(0.4
)
   
0.0
%
 
 
$
1,632.1
     
60.8
%
 
                                                                
Variance 2018/2017
                                                             
Attritional
 
$
339.8
     
(1.4
)
pts
 
$
(97.0
)
   
(2.9
)
pts
 
$
242.7
     
(4.3
)
pts
Catastrophes
   
(8.5
)
   
(0.8
)
pts
   
532.2
     
15.9
 
pts
   
523.7
     
15.1
 
pts
Total
 
$
331.3
     
(2.2
)
pts
 
$
435.1
     
13.0
 
pts
 
$
766.4
     
10.8
 
pts
                                                                
(Some amounts may not reconcile due to rounding.)
                                                             


Incurred losses and LAE increased by 55.7% to $1,341.3 million for the three months ended June 30, 2018, compared to $861.3 million for the three months ended June 30, 2017, primarily due to unfavorable development of $432.2 million on prior years catastrophe losses, mainly related to Hurricanes Harvey, Irma and Maria, and an increase in current year attritional losses of $133.3 million, mainly due to the impact of the increase in premiums earned and changes in the mix of business.  The increase in loss estimates for Hurricanes Harvey, Irma and Maria was mostly driven by re-opened claims reported in the second quarter of 2018 and loss inflation from higher than expected loss adjustment expenses and in particular, their impact on aggregate covers.  These increases in losses were partially offset by favorable development on prior years attritional losses of $97.4 million in 2018.  The current year catastrophe losses of $65.0 million for the three months ended June 30, 2018 related to Cyclone Mekunu ($50.0 million) and the U.S. winter storms ($15.0 million).  The current year catastrophe losses of $53.5 million for the three months ended June 30, 2017 related to the South Africa Knysna fires ($25.0 million), the 2017 U.S. Midwest storms ($15.0 million) and the Peru storms ($13.5 million).
36


Incurred losses and LAE increased by 47.0% to $2,398.5 million for the six months ended June 30, 2018, compared to $1,632.1 million for the six months ended June 30, 2017, primarily due to unfavorable development of $532.2 million on prior years catastrophe losses, mainly related to Hurricanes Harvey, Irma and Maria and the 2017 California wildfires, and an increase in current year attritional losses of $339.8 million, mainly due to the impact of the increase in premiums earned and changes in the mix of business.  The increase in loss estimates for Hurricanes Harvey, Irma and Maria was mostly driven by re-opened claims reported in the second quarter of 2018 and loss inflation from higher than expected loss adjustment expenses and in particular, their impact on aggregate covers.  The increase in losses was partially offset by favorable development on prior years attritional losses of $97.4 million in 2018.  The current year catastrophe losses of $65.0 million for the six months ended June 30, 2018 related to Cyclone Mekunu ($50.0 million) and the U.S. winter storms ($15.0 million).  The current year catastrophe losses of $73.5 million for the six months ended June 30, 2017 related to the South Africa Knysna fires ($25.0 million), Cyclone Debbie in Australia ($20.0 million), the 2017 U.S. Midwest storms ($15.0 million) and the Peru storms ($13.5 million).

Commission, Brokerage, Taxes and Fees.  Commission, brokerage, taxes and fees increased by 27.8% to $383.4 million for the three months ended June 30, 2018 compared to $300.0 million for the three months ended June 30, 2017.  Commission, brokerage, taxes and fees increased by 27.3% to $741.0 million for the six months ended June 30, 2018 compared to $582.2 million for the six months ended June 30, 2017.  The changes were primarily due to the impact of the increases in premiums earned and changes in the mix of business towards additional pro rata business.

Other Underwriting Expenses.  Other underwriting expenses were $93.1 million and $78.9 million for the three months ended June 30, 2018 and 2017, respectively.  Other underwriting expenses were $189.4 million and $154.8 million for the six months ended June 30, 2018 and 2017, respectively.  The increases in other underwriting expenses were mainly due to the impact of the increases in premiums earned and costs incurred to support the continued expansion of the insurance business.

Corporate Expenses.  Corporate expenses, which are general operating expenses that are not allocated to segments, remained consistent at $6.6 million and $6.9 million for the three months ended June 30, 2018 and 2017, respectively, and $15.6 million and $15.4 million for the six months ended June 30, 2018 and 2017, respectively.

Interest, Fees and Bond Issue Cost Amortization Expense.  Interest, fees and other bond amortization expense was $7.7 million and $8.1 million for the three months ended June 30, 2018 and 2017, respectively.  Interest, fees and other bond amortization expense was $15.1 million and $17.0 million for the six months ended June 30, 2018 and 2017, respectively.  The decreases in expense for both the three and six month periods were primarily due to the conversion of the long term subordinated notes from a fixed rate of 6.6% to a floating rate, which is reset quarterly per the note agreement.  The floating rate was 4.7% as of June 30, 2018.

Income Tax Expense (Benefit).  We had an income tax benefit of $9.1 million and an income tax expense of $29.9 million for the three months ended June 30, 2018 and 2017, respectively, and income tax benefit of $1.8 million and an income tax expense of $76.6 million for the six months ended June 30, 2018 and 2017, respectively.  Income tax expense is primarily a function of the geographic location of the Company's pre-tax income and the statutory tax rates in those jurisdictions, as affected by tax-exempt investment income and foreign tax credits and as calculated under the annualized effective tax rate ("AETR") method.  Variations in the AETR generally result from changes in the relative levels of pre-tax income, including the impact of catastrophe losses and net capital gains (losses), among jurisdictions with different tax rates.  The change in income tax expense (benefit) for the three and six months ended June 30, 2018 compared to the three and six months ended June 30, 2017 was primarily due to the additional unfavorable catastrophe loss development in 2018.  In addition, the tax rate was lowered from 35% in 2017 to 21% in 2018 under the Tax Cuts and Jobs Act ("TCJA") which was enacted on December 22, 2017.
 
37


Net Income (Loss).
Our net income was $69.9 million and $245.7 million for the three months ended June 30, 2018 and 2017, respectively.  Our net income was $280.2 million and $537.3 million for the six months ended June 30, 2018 and 2017, respectively.  The changes were primarily driven by the financial component fluctuations explained above.

Ratios.
Our combined ratio increased by 14.6 points to 105.1% for the three months ended June 30, 2018, compared to 90.5% for the three months ended June 30, 2017, and increased by 11.1 points to 99.4% for the six months ended June 30, 2018, compared to 88.3% for the six months ended June 30, 2017.  The loss ratio component increased 14.6 points and 10.8 points for the three and six months ended June 30, 2018, respectively, over the same periods last year mainly due to higher prior year catastrophe losses primarily related to Hurricanes Harvey, Irma and Maria and the 2017 California wildfires.  The commission and brokerage ratio components increased slightly to 22.2% for the three months ended June 30, 2018 compared to 21.9% for the three months ended June 30, 2017, and increased slightly to 22.1% for the six months ended June 30, 2018 compared to 21.7% for the six months ended June 30, 2017, reflecting changes in the mix of business.  The other underwriting expense ratios were comparable at 5.4% and 5.7% for the three months ended June 30, 2018 and 2017, respectively, and 5.7% and 5.8% for the six months ended June 30, 2018 and 2017, respectively.

Shareholders' Equity.
Shareholders' equity decreased by $127.9 million to $8,241.3 million at June 30, 2018 from $8,369.2 million at December 31, 2017, principally as a result of $240.9 million of unrealized depreciation on investments net of tax, $106.5 million of shareholder dividends, $46.0 million of net foreign currency translation adjustments and repurchase of 0.1 million common shares for $25.3 million, partially offset by $280.2 million of net income, $6.9 million of share-based compensation transactions and $3.6 million of net benefit plan obligation adjustments, net of tax.

Consolidated Investment Results

Net Investment Income.
Net investment income increased by 5.1% to $141.3 million for the three months ended June 30, 2018, compared with investment income of $134.5 million for the three months ended June 30, 2017.  Net investment income increased by 8.9% to $279.6 million for the six months ended June 30, 2018, compared with investment income of $256.8 million for the six months ended June 30, 2017.  The increases were primarily due to an increase in limited partnership income and higher income from our fixed income portfolio, partially offset by lower dividend income from our equity portfolio.

The following table shows the components of net investment income for the periods indicated.


   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Dollars in millions)
 
2018
   
2017
   
2018
   
2017
 
Fixed maturities
 
$
114.8
   
$
108.1
   
$
223.5
   
$
211.4
 
Equity securities
   
6.7
     
8.4
     
13.5
     
17.1
 
Short-term investments and cash
   
2.1
     
0.9
     
3.8
     
1.5
 
Other invested assets
                               
Limited partnerships
   
22.0
     
20.1
     
45.4
     
31.1
 
Other
   
2.7
     
2.3
     
7.0
     
4.6
 
Gross investment income before adjustments
   
148.2
     
139.7
     
293.2
     
265.6
 
Funds held interest income (expense)
   
1.9
     
1.7
     
5.6
     
4.9
 
Future policy benefit reserve income (expense)
   
(0.4
)
   
(0.4
)
   
(0.6
)
   
(0.7
)
Gross investment income
   
149.8
     
141.0
     
298.2
     
269.7
 
Investment expenses
   
(8.5
)
   
(6.5
)
   
(18.6
)
   
(12.9
)
Net investment income
 
$
141.3
   
$
134.5
   
$
279.6
   
$
256.8
 
                                 
(Some amounts may not reconcile due to rounding.)
                               

38


The following tables show a comparison of various investment yields for the periods indicated.


 
At
 
At
 
June 30,
 
December 31,
 
2018
 
2017
Imbedded pre-tax yield of cash and invested assets
3.3%
 
3.0%
Imbedded after-tax yield of cash and invested assets
2.9%
 
2.8%



 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2018
 
2017
 
2018
 
2017
Annualized pre-tax yield on average cash and invested assets
3.1%
 
3.0%
 
3.1%
 
2.9%
Annualized after-tax yield on average cash and invested assets
2.7%
 
2.5%
 
2.7%
 
2.5%


Net Realized Capital Gains (Losses).
The following table presents the composition of our net realized capital gains (losses) for the periods indicated.


   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
(Dollars in millions)
 
2018
   
2017
   
Var